Proxy Access Revisited: Regulatory Function of the Rule 14a-11 Formula

Proxy access grants shareholders the right to place their director nominees on corporate proxy materials. The Securities and Exchange Commission (the “SEC”) has been trying to regulate proxy access for almost 70 years since 1942. The most recent SEC regulations are Rule 14a-11 and Rule 14a-8. On August 25, 2010, the SEC adopted Rule 14a-11, mandating proxy access at all public companies. Any shareholder or shareholder group that held more than 3% of a public company’s shares for more than 3 years would be eligible to nominate candidates for up to 25% of the company’s board seats (the “Rule 14a-11 Formula”). Rule 14a-11 was vacated by the U.S. Court of Appeals for the D.C. Circuit on July 22, 2011 because the court decided that Rule 14a-11 was “arbitrary and capricious” in Bus. Roundtable and Chamber of Com. v. S.E.C. The SEC did not appeal the case, but adopted an amendment to Rule 14a-8 on September 14, 2011 to prohibit companies from excluding shareholder proposals that seek board nominations from proxy materials. Amended Rule 14a-8 allows eligible shareholders to propose proxy access standards on a company-by-company basis, rather than the universal, mandatory approach under Rule 14a-11. Since the vacation of Rule 14a-11, there have been heated debates surrounding the Rule 14a-11 Formula. Some scholars asserted that the Rule 14a-11 Formula was too rigid and had no practical significance.

I argue that the Rule 14a-11 Formula has not only been accepted as a standard proxy access formula, but also has practical significance in implementing Rule 14a-8 and pushing forward proxy access acceptance among major public companies. To obtain shareholders and corporate management’s proxy access proposals and their voting results, I examined 75 companies that received proxy access proposals in 2012, 2013 and 2014 and their SEC Form DEF 14A filings in the data from the SEC EDGAR database. The research results in the following data regarding the voting results of proxy access proposals:

 

Table 1. Voting Results of Proxy Access Proposals in 2012, 2013 and 2014

2012 2013 2014 (till August 31)
Proxy Access Proposals 24 23 28
3% for 3 years 48% 57% 54%
Other Variations 18% 10% 16%
Management Proposals

3% for 3 Years

N/A 79% 96%
Majority Votes 2 4 [6]

 

In the three years since the SEC first permitted Rule 14a-8 shareholder proposals on proxy access, proxy access proposals following the Rule 14a-11 Formula have prevailed in ballot voting more frequently than other variations. Proposals based on the Rule 14a-11 Formula have received a majority of votes cast at 12 public companies, including Nabors Industries Ltd. (2012), Chesapeake Energy Corp. (2012), Verizon Communications (2013), CenturyLink (2013), Darden Restaurants (2013), Abercrombie & Fitch (2014) and Boston Properties (2014). However, similar proposals failed to receive such a majority vote at 6 companies, including The Walt Disney Company (2013), Walgreen’s (2014), Comstock Resources (2014) and Oracle (2014). Proxy access proposals submitted by shareholders that were based on the Rule 14a-11 Formula, on average, have been approved by 51% of shareholders during the period from 2012 to 2014.[1] All of the proxy access proposals from corporate management followed the Rule 14a-11 Formula and were approved, on average, by over 95% of the voting shareholders. Variations that are not based on the Rule 14a-11 Formula fared substantially worse, receiving an average 13% of shareholder votes. In 2014, proxy access proposals following the Rule 14a-11 Formula received 54% average shareholder support, with 6 out of 10 proposals receiving over 54% of the vote. But shareholder proposals seeking to provide proxy access of other variations failed, such as (1) holders with at least 1% but less than 5% ownership for two years or (2) 25 holders of $2,000 each with at least 1% but less than 5% for one year. These proposals received average shareholder support of only 16%.

I believe that the above data and analyses support that the Rule 14a-11 Formula has been accepted and followed by both shareholders and corporate management as a proxy access standard. Rule 14a-8 allows shareholders relative freedom to choose their own proxy access formula, but shareholders voluntarily prefer the Rule 14a-11 Formula over other variations. It seems that a private agreement has been reached among shareholders and corporate management to follow the Rule 14a-11 Formula, which is reflected in the prevailing majority approval voting results on proxy access proposals with the Rule 14a-11 Formula by corporate management and shareholders. Some scholars argue that the majority support for the Rule 14a-11 Formula is principally due to large institutional shareholders, who tend to disfavor low ownership thresholds and have not supported other variations. Proxy advisory firms, such as Institutional Shareholder Services Inc. and Glass-Lewis have expressed concern over low ownership thresholds such as 1% and the potential for replacement of nearly half the board in just a single election. This may contribute to shareholders’ preference and agreement on the Rule 14a-11 Formula, but I think the major reason is that the Rule 14a-11 Formula provides a practical solution to both shareholders and corporate management.

Firstly, the Rule 14a-11 Formula fills up an information gap in proxy access, which could not have been achieved by shareholders and corporate management individually. It is difficult for individual shareholders and corporate management to obtain information on the consequences of various proxy access formulas due to a lack of funds and collective action problems, let alone reach agreements on a specific formula that balances interests of various players. Through its empirical research since 1942 and 5 major regulation proposals, the SEC provides shareholders and corporate management with information on how to balance shareholders’ director nomination and election rights and the importance of a stable and unitary board of directors. The Rule 14a-11 Formula achieves a balance between facilitating shareholder’s proxy access rights and minimizing disruption of corporate management and company’s costs. Even after its vacation, the formula continues to fill up the information vacuum. Secondly, the Rule 14a-11 Formula minimizes shareholders and corporate management costs in reaching a consensus on proxy access formula and fully participate in corporate governance. Proxy access proposals seek to provide shareholders with a mechanism for placing their director nominees in a company’s proxy statement and on its proxy card, thereby avoiding the cost to a shareholder of sending out its own proxy statement. Proxy access provides shareholders with a cost-effective means of running their own candidates, providing all shareholders with greater ability to shape the composition of the board. Establishing criteria for proxy access enables shareholders to more fully participate in corporate governance, serving as stricter monitors. Shareholders’ investments are usually diversified so that they can minimize investment risk, which mitigates specific risk in a company. But the downside of this strategy is that if shareholders’ investment in a company is minimal, it is impractical for the shareholders to coordinate and take informed collective actions to monitor the management of the company. Proxy access eases the way for shareholders to participate in and affect company management. By establishing the Rule 14a-11 Formula, the SEC not only minimizes shareholders and corporate management costs but also enables shareholders to fully participate in corporate governance.

ENDNOTES

[1] I average the results of proxy access proposal votes across companies to summarize the results, acknowledging that companies differ by such things as market cap, shareholder dispersion and character, and the thresholds that the proposals had to achieve to be approved.

The preceding post comes to us from Shifeng Ni, student at Columbia Law School.