A new U.S. Securities and Exchange Commission rule that makes it easier for public company shareholders to nominate corporate directors faced tough scrutiny today from a three-judge panel at the U.S. Court of Appeals for the D.C. Circuit.
Represented by Gibson, Dunn & Crutcher partner Eugene Scalia, the Business Roundtable and the U.S. Chamber of Commerce sued the SEC last fall to overturn the proxy access rule, which was voluntarily stayed by the agency pending the suit.
The rule allows a shareholder or group of shareholders who have owned 3% of a company’s voting stock for at least three years to have their own corporate director candidates added to the company’s proxy materials.
The business groups argue that the rule would impose unnecessary costs and favor institutional investors like labor unions and pension funds at the expense of ordinary shareholders. They say the SEC failed to properly assess the rule’s effects on “efficiency, competition and capital formation,” in violation of the Administrative Procedure Act.
“The agency does not know what it has wrought,” Scalia told judges David Sentelle, Douglas Ginsburg and Janice Rogers Brown, calling the rule “extremely costly.”
He said the commission failed to adequately consider alternatives to new regulation in light of a 2009 amendment to Delaware corporation law related to proxy access. “It would have been more reasonable for the commission to stand back and look at the shifting legal landscape,” he said.
“It may have been more reasonable, but that doesn’t necessarily make it arbitrary and capricious,” said Ginsburg.
The panel peppered SEC assistant general counsel Randall Quinn with questions about the agency’s estimates for how often proxy challenges would occur and how much they would cost.
The SEC estimated there would be 51 proxy contests a year under the new rule, known as 14a-11.
But the judges noted that there were 57 contested board elections in 2009 under the old proxy contest system (which will also continue to be available).
“How do you come up with a lower number when you’re expanding the universe?” Sentelle asked.
Quinn said the estimate only included how often the new system would be used, and that two-thirds of companies do not have shareholders that would meet the 3% stock requirement.
In fact, he said, at most companies, if the five largest institutional investors were combined, they still wouldn’t meet the 3% threshold.
“So apparently [the rule] will have no effect because hardly anyone will be qualified to use it,” Ginsburg said.
“If you have a large company with a serious problem with board performance, shareholders could form groups and use the rule,” Quinn responded.
The SEC estimated that proxy contests would cost large companies $14 million, but Quinn argued that it could be less. “Not every board will decide to wage a contested fight against the shareholder nominee,” he said.
The panel asked whether this had ever happened before, and Quinn said he did not know.
“You’re taking it out of thin air, the proposition that this would occur,” said Sentelle.
Quinn called it a “reasonable, possible outcome.”
“I’ll take possible, I’m not sure about reasonable,” countered Sentelle.
As for concerns that institutional investors like unions might have conflicting interests with other shareholders, Quinn said that the average market capitalization of Fortune 500 companies is $23 billion. That means a group of shareholders would need a $700 million stake in the company to use the new proxy access procedure. With so much invested, he said, “It’s unlikely that a shareholder or group of shareholders would seek concessions from the company that would damage its value.”