U.S. Chamber of Commerce

March 28, 2011 By wpengine

In Dodd-Frank’s Shadow: The Declining Competitiveness of U.S. Public Equity Markets

David Daniels*

As we enter into 2011, things are looking up. The Dow Jones has recently broken through 12,000 and is climbing to pre-recession heights. The economy has emerged from the greatest downturn since the Great Depression and continues to show modest growth.[1] Unemployment is slowly decreasing.[2] But all is not well. A potentially worrying trend that gained traction at the beginning of the millennia continues to unfold: the decline of the competitiveness of U.S. public equity markets.

For example, consider the U.S. primary equity markets. In 2000, these markets attracted 54% of all global initial public offerings (IPOs)—IPOs by foreign companies issued on at least one public exchange outside the company’s domestic market.[3] Similarly, foreign companies raised about 82% of the dollar value of all global IPOs on U.S. public exchanges.[4] The numbers were 26% and 10%, respectively, in 2010.[5] Foreign companies, it seems, have been increasingly likely to forego our public equity markets and list elsewhere. These figures, however, do not tell the whole story. So-called Rule 144A IPOs—issuances done on U.S. private equity markets—by foreign companies have risen markedly in proportion. Over the past ten years, the number of these issuances as a percentage of total global IPOs in the U.S. has increased from 62% to 81%.[6] The percentage value of these IPOs has grown even faster—from 60% to 95%.[7]

The proportionate rise in private equity issuances is especially important. Although technology has improved access to foreign markets for retail investors, the private equity market continues to be accessible only to institutional entities and the very wealthy.[8] More tellingly, foreign companies cross-listed on U.S. exchanges incur, on average, a 2.47% lower cost of capital than in Rule 144A markets (11.54% vs. 14.01%, respectively).[9] Since companies accessing these private equity markets are free from most U.S. securities regulation, including registration and liability under the Securities Act of 1933 and the Sarbanes-Oxley Act,[10] the rising regulatory and litigation burden imposed by such legislation may be an important factor in accounting for the proportionate increase in Rule 144A market issues and foreign companies’ shift to overseas exchanges.

Indeed, global financial services executives have confirmed that the litigious nature of U.S. capital markets is a central factor in undermining the competitiveness of those markets.[11] The perceived unfairness and unpredictability of the U.S. legal system have driven companies away from our public exchanges; 46% of executives surveyed believed the U.K. had more predictable legal outcomes compared with 16% for the U.S.[12] Likewise, 43% of executives thought the U.K. had a fairer legal process versus 14% for the U.S.[13] Furthermore, a majority of executives felt companies listed in the U.K. were less likely to be sued than those listed on our public exchanges.[14] However, while there are benefits of a stricter legal system, they may not outweigh the liability costs imposed on companies trading publicly in U.S. equity markets.

There is no doubt that tough enforcement mechanisms serve key deterrence and compensatory goals. Wronged shareholders should be compensated for their losses and corporate wrongdoers must be deterred from managerial shirking and self-dealing. Yet the U.S. legal system may not be accomplishing either of these goals in the securities litigation context. Deterrence of wrongdoing is undermined by corporations and their insurers typically bearing the full cost of any settlement against individual defendants.[15] Federal securities class actions, a feature unique to the American legal system,[16] fail to adequately compensate victims for their losses. Because the vast majority of federal security class actions are either settled or dismissed,[17] shareholder compensation often falls short. The median ratio of class action settlement to investor losses, which has steadily declined over the past fifteen years, is now at only 2.4%.[18] While average settlements, adjusting for outliers, are at an all-time high,[19] so are plaintiff’s attorney fees that further reduce the value of what injured shareholders ultimately receive.[20] Section 308 of the Sarbanes-Oxley Act was intended to streamline the regulatory process by adding civil penalties obtained from defendants to a fund used to compensate plaintiffs,[21] but the number of federal securities class action filings has not significantly declined over the last decade.[22]

Several other factors have led to the decline in the competitiveness of U.S. public equity markets. Increasing liquidity in foreign and private markets and better regulation of foreign public markets have each eroded the competitive advantage that our public exchanges once had.[23] Improvements in technology have made it easier for U.S. investors to invest in foreign markets.[24] Not only is there little that can be done to reverse the impact of these factors; such advancements are actually beneficial for us. U.S. companies can safely tap into a wider range of markets for funding, and U.S. investors can better diversify their holdings by investing overseas with a smaller increase in risk or inconvenience. Instead, policy makers should focus on a fourth factor: the regulatory costs imposed on companies choosing to list on our public equity markets versus the foreign and private alternatives. Such costs have been cited by financial services CEOs as the most important issue in determining the international competitiveness of our public equity markets.[25]

Policy makers should be mindful, however, of reducing regulatory costs too much. A “race to the bottom” would not improve our markets’ competitive position and would only harm their integrity. Instead, regulatory costs should be balanced against increasing transparency and accountability so that risk and agency costs are reduced. In turn, corporate borrowing costs would decrease and share prices should increase.

A commonly cited provision that goes too far in increasing costs without a commensurate increase in benefits is Section 404 of the Sarbanes-Oxley Act.[26] Envisioned as a way of bolstering the credibility of public companies’ internal control systems, Section 404’s costs of verification and disclosure have ended up being many times greater than expected.[27] First-year implementation costs of internal control systems for large companies were eighty times greater than originally planned and recurring costs vastly exceed initial estimates.[28] Worse yet, smaller companies were disproportionately burdened.[29] Although Section 404 addressed serious internal control issues that led to the corporate scandals of the dot-com era and likely increased intra-firm transparency, critics argue its benefits are difficult to measure, thus making its costs all the harder to justify. [30]

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) was signed into law. One of the things it did was to ease the burden Section 404 had on small companies and introduce several corporate governance mandates that aim to increase transparency and accountability of companies listed on U.S. public equity markets.[31] Unfortunately, neither of these goals is likely to be met in the short term.

One of Dodd-Frank’s most ambitious corporate governance provisions, Section 971, aimed to open up the director nomination process to shareholders via proxy and instill more accountability upon corporate directors.[32] Critics, however, argue that improved shareholder proxy access would lead to harmful investor activism[33] and an unnecessary focus on political issues diverting attention away from creating shareholder wealth.[34] Due to a legal challenge by the U.S. Chamber of Commerce, the SEC has stayed implementation of the provision until the 2012 proxy season.[35]

Another promising provision, Section 951, was designed to give shareholders a non-binding advisory vote on executive and director compensation,[36] but its efficacy in improving managerial accountability has also been called into question. Specifically, opponents contend it will shift power to proxy advisory firms and not to individual shareholders who are seldom involved in the voting process.[37]

Ultimately, the Dodd-Frank Act does not go far enough toward improving the competitiveness of our public equity markets. Much more needs to be done. Securities litigation reform is one possibility, but such change is unlikely. Instead, policy makers should focus on better balancing the costs of regulation against increased corporate transparency and accountability. If nothing is done, our leadership in providing the best public equity markets will continue to erode.

* J.D. Candidate, 2013, Harvard Law School.

[1] National Income and Product Accounts Gross Domestic Product, 4th Quarter and Annual 2010 (Second Estimate), Bureau of Economic Analysis (March 21, 2011), http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm.

[2] Unemployment Rate – Updated Monthly, http://employeeissues.com/blog/unemployment-rate/ (Mar. 21, 2011).

[3] Committee on Capital Markets Regulation, Share of Global IPOs (Narrowly Defined) Captured by U.S. Exchanges (December, 2010), http://www.capmktsreg.org/competitiveness/2010Q3update/(2A)Share_of_Global_IPOs_Captured_by_US_Exchanges(narrow).pdf .

[4] Id.

[5] Id.

[6] Committee on Capital Markets Regulation, Rule 144A IPOs by Foreign Companies as a Percentage of Total Global IPOs in the U.S. (December, 2010), http://www.capmktsreg.org/competitiveness/2010Q3update/(4)Rule_144A_IPOs_by_Foreign_Companies_as_a_Percentage_of_Total_Global_IPOs_in_the_US.pdf.

[7] Id.

[8] Committee on Capital Markets Regulation, Committee Interim Report, 34 (November 30, 2006), http://www.capmktsreg.org/pdfs/11.30Committee_Interim_ReportREV2.pdf.

[9] Luzi,Hail & Christian Leuz, Cost of Capital Effects and Changes in Growth Expectations around U.S. Cross-Listings, 52 (European Corp. Goverance Inst., Paper No. 46, 2006), http://www.law.yale.edu/documents/pdf/cbl/HL_ECGI_Fin461.pdf .

[10] Committee on Capital Markets Regulation, supra note 6, at 45.

[11] See Michael R. Bloomberg & Charles E. Schumer, Sustaining New York’s and the U.S.’ Global Financial Services Leadership, 73 (2007).

[12] Id. at 76.

[13] Id. at 76.

[14] See id. at 76.

[15] Committee on Capital Markets Regulation, supra note 6, at 78.

[16] Id. at 71.

[17] National Economic Research Associates, Trends 2010 Year-End Update, 13 (December 2010).

[18] Id. at 25.

[19] Id. at 18.

[20] Id. at 23.

[21] Committee on Capital Markets Regulation, supra note 6, at 82.

[22] See National Economic Research Associates, supra note 14, at 2.

[23] Committee on Capital Markets Regulation, supra note 6, at 4.

[24] Id. at 4.

[25] Bloomberg, supra note 9, at 79.

[26] Stephen M. Bainbridge, Corporate Governance and U.S. Capital Market Competitiveness, 16 (UCLA School of Law, Paper No. 10-13, 2010), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1696303.

[27] Id. at 23.

[28] Id. at 23–24.

[29] Id. at 24.

[30] Id. at 29.

[31] Stephen M. Bainbridge, The Corporate Governance Provisions of Dodd-Frank, 2 (UCLA School of Law, Paper No. 10-14, 2010), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1698898##.

[32] Id. at 2.

[33] Id. at 11.

[34] Paul Atkins, The SEC’s Sop to Unions, Wall St. J., Aug. 27, 2010, at A15.

[35] Bainbridge, supra note 29, at 11.

[36] Id. at 2.

[37] See Stephen M. Bainbridge, Will the Unaccountable Power of RiskMetrics Put Teeth in the Dodd Bill’s Say on Pay Provision?, ProfessorBainbridge.com (Apr. 22, 2010), http://www.professorbainbridge.com/professorbainbridgecom/2010/04/will-the-unaccountable-power-of-risk-metrics-put-teeth-in-the-dodd-bills-say-on-pay-provision.html.

Preferred citation: David Daniels, In Dodd-Frank’s Shadow: The Declining Competitiveness of U.S. Public Equity Markets, 1 Harv. Bus. L. Rev. Online 56 (2011), https://www.hblr.org//?p=1072.

March 10, 2011 By wpengine

Injury or Deterrence: The End of Class-Action Litigation and Its Benefit to Consumers

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Jason Sherman*

On November 8, The Wall Street Journal asked, “Is D-Day Approaching For Class-Actions Lawsuits?” The next day, the Supreme Court heard oral arguments for AT&T Mobility v. Concepcion. The lower courts held AT&T Mobility’s (“ATTM”) adhesion contract’s arbitration clause unconscionable because it prevented class actions through either litigation or arbitration. However, the Federal Arbitration Act, as argued by ATTM, may preempt the finding by the lower courts, ultimately allowing corporations to use “no class action” clauses to shield themselves from class action litigation or arbitration. The media has mostly predicted that the case will be resolved in favor of ATTM, and as Professor Brian Fitzpatrick said, “it could end class-action litigation in American as we know it.” Many believe this lack of access to class action will “have harmful public policy consequences”[1] that “would cut off the only meaningful method to redress widespread discrimination, fraud, or other violations of the law.”[2]

But Justice Alito asks the hinging question, “Why are these people better off with class rights than not?” Class-action rights are an important tool for deterring corporate exploitation, but a ruling for ATTM effectively destroys arbitration—an important tool for consumers to efficiently recover for their injuries without costly litigation expenses.

ATTM argued that without the class action waiver in contracts, companies would likely stop using arbitration altogether. The Chamber of Commerce similarly argues that businesses will stop opting for arbitration without the class action waiver because class arbitration doesn’t share the advantages of individual arbitration. Instead, a single class arbitrator deals with sometimes thousands of disputes leading to time-consuming, procedurally complex, and expensive suits—even more so than the traditional class litigation due to the lack of access to appellate review and complex class arbitration rules.

Despite the focus on the advantages of class actions, consumers individually benefit more from the one-on-one non-aggregated arbitration. While a simplification of the class arbitration rules by Congress is ultimately advantageous, that is arguably a slow process. In the meantime, preserving the bilateral arbitration as alternative means of dispute resolution provides consumers access to a neater, cleaner, cheaper, and faster way of solving disputes.[3] Studies have also shown that consumers prevail against businesses more often in arbitration[4] and the average duration of the claim is only 8.6 months compared to 2.5 years in litigation.[5] Arbitration allows consumers to bring claims for significantly smaller damage amounts into court because of the decreased costs of resolution. Additionally, 82% of people would choose arbitration over litigation to sue a corporation,[6] and many individual-to-individual contracts including property and second-hand car sales almost always require arbitration. Thus, consumers not only benefit from arbitration, but prefer it to resolve their legal disputes.

Admittedly, truly small claims are still expensive to resolve through basic arbitration, but a private competitive marketplace forces most corporations to make adjustments to contracts that make arbitration more attractive to consumers with smaller monetary claims. ATTM’s contract, for instance, includes many consumer friendly features to encourage consumer arbitration of even small amounts including a $7,500 minimum recovery if the arbitral award is greater than ATTM’s last settlement offer and double attorney fees and expenses which ATTM states it similarly will not seek for itself.[7] These provisions allow consumers, such as the Concepcion’s, to use arbitration for almost any monetary claim. The district court (which held against ATTM) even agreed that these provisions “sufficiently incentivize consumers” to pursue “small dollar” claims and “prompts” ATTM to make favorable offers “even for claims of questionable merit.” Also, Professor Robert Mnookin of Harvard Law School states, “The question to ask is why an individual AT&T customer would not be better, should she have a dispute . . . with the waiver and the provision with the $7,500 kicker.”[8] In a competitive market, such as mobile phone coverage, companies will respond to the consumer pressure to litigate small claims through the inclusion of consumer friendly contractual provisions.

In summation, if the primary goal of dispute resolution is injury recovery for consumers and not private deterrence, arbitration clauses with provisional incentives for small monetary claims benefit the individual even with the class-action waiver. Without discussing the merits of class-action lawsuits, legal theorists mostly agree that the monetary receivers of class action litigation are normally the plaintiffs’ attorneys and rarely do consumers receive any of the injury compensation. While this private deterrence mechanism may be seen as important, the individual seeking recovery for injuries inflicted on them will benefit from a ruling for ATTM by the Supreme Court in the spring.

* J.D. Candidate, 2013, Harvard Law School.

[1] Brief of Civil Procedure and Complex Litigation Processors as Amici Curiae in Support of Respondents at 3, AT&T Mobility LLC v. Vincent and Liza Concepcion, 584 F.3d 849 (2010) (No. 09-893).

[2] Public Citizen’s Consumer Justice Project, AT&T Mobility LLC v. Vincent and Liza Concepcion Enforceability of Class-Action Bans in Arbitration Agreements, Consumer L. & Pol’y Blog (Feb. 11, 2011, 1:49 PM), http://pubcit.typepad.com/clpblog/concepcion/.

[3] U.S. Chamber Institute for Legal Reform, Arbitration: Simpler, Cheaper, and Faster Than Litigation (survey conducted by Harris Interactive, Inc. Apr. 2005), http://www.adrforum.com/rcontrol/documents/ResearchStudiesAndStatistics/2005HarrisPoll.pdf.

[4] Ernst & Young LLP, Outcomes of Arbitration (2004), http://www.adrforum.com/rcontrol/documents/ResearchStudiesAndStatistics/2005ErnstAndYoung.pdf; see also Arbitration Better than Court for Consumer Debtors, Study Shows. U.S. Chamber Institute for Legal Reform (Feb. 11, 2011, 4:02 PM), http://www.instituteforlegalreform.com/component/ilr_media/30/pressrelease/2008/422.html.

[5] Mark Fellows, The Same Result As in Court, More Efficiently: Comparing Arbitration and Court Litigation Outcomes, Metro. Corp. Counsel, July 2006, at 32, available at http://www.adrforum.com/rcontrol/documents/ArticlesByFORUMStaff/200607FellowsMCC.pdf.

[6] U.S. Institute for Legal Reform, Key Findings From a National Survey of Likely Voters (Apr. 2008), http://www.instituteforlegalreform.com/issues/docload.cfm?docId=1092.

[7] Philip J. Loree Jr., AT&T Mobility LLC v. Concepcion: What is the Scope of Federal Preemption in Class Waiver Cases?, Loree Reinsurance & Arb. L.F. (Feb. 11, 2011, 4:15 PM), http://loreelawfirm.com/blog/att-mobility-llc-v-concepcion-what-is-the-scope-of-federal-preemption-in-class-waiver-cases.

[8] Email from Robert H. Mnookin, Samuel Williston Professor of Law, Harvard Law School, to Jason Sherman, J.D. Candidate, 2013, Harvard Law School (Nov. 22, 2011, 19:10 EST) (on file with author)

Preferred citation: Jason Sherman, Injury or Deterrence: The End of Class-Action Litigation and Its Benefit to Consumers, 1 Harv. Bus. L. Rev. Online 50 (2011), https://www.hblr.org//?p=978.

November 29, 2010 By wpengine

Distilling the Debate on Proxy Access

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David Page^*

In August 2010, the SEC issued its final rule on proxy access, which gives shareholders the right to place director nominees directly on the company’s proxy card, thereby sparing shareholders a large part of the expense of waging a traditional proxy contest.^{^[1]} This rulemaking, and the SEC’s subsequent decision in October to delay implementing the rule pending a challenge from the Business Roundtable, has fueled a vigorous debate on the merits of proxy access and the details of its implementation.^{^[2]} Some of the arguments made by commentators and academics are particularly interesting and useful in framing the contours of the debate.

The central arguments that support proxy access are founded in enhanced board accountability and responsiveness. Supporters contend that proxy access will make board elections more competitive and less of a rubber stamp for the board’s nominees.^{^[3]} In turn, this should make boards more responsive to shareholders and increasingly vigilant in performing their oversight duties to avoid potential election defeats.^{^[4]} Supporters also argue that since board oversight lapses played a significant role in the recent financial crisis, the time is ripe for governance reforms that increase board accountability.

A second and related line of arguments used by supporters is that shareholders need proxy access to adequately exercise their state law right to elect and remove board members.^{^[5]} Without proxy access, supporters claim that shareholders cannot effectively exercise this right given the prohibitively high expenses of a traditional proxy contest. The numbers support this assertion: Marcel Kahan and Edward Rock report that over 99% of elections are uncontested,^{^[6]} which does not comport with the notion of shareholders effectively exercising their role in board elections.

Proxy access opponents have a number of compelling rebuttal arguments. A primary contention is that proxy access will lead to the nomination of “special interest directors,” such as individuals representing unions or those with social or environmental agendas.^{^[7]} Even if these individuals do not win election, dissenters contend that their presence on the ballot will force companies to become overly focused on politically charged issues at the expense of creating long-term shareholder value, thereby harming the firm’s competitiveness.^{^[8]} Dissenters envision that these candidates, for example, might attempt to extract concessions from boards in exchange for removing their name from the ballot – a form of “proxy access greenmail.”^{^[9]} A recent study by Bo Becker, Daniel Bergstresser, and Guhan Subramanian that examines stock price effects surrounding the SEC’s proxy access rule announcements, however, finds that firms most likely to be affected by proxy access have experienced abnormal positive gains as a result of the announcement, suggesting value in proxy access.^{^[10]}

Other opposition arguments include the contention that proxy access is not required in order to promote board responsiveness in light of the recent shift by many companies to majority voting rules,^{^[11]} as well as the claim that high-quality directors might be discouraged from serving on boards if they are more likely to face electoral competition from shareholder nominees.^{^[12]} Finally, some dissenters take issue with the requirement that shareholders (or a group of investors) must own 3% of the company’s shares for a minimum of three years before gaining proxy access to nominate directors, claiming that these requirements improperly discriminate between shareholders holding the same class of stock.^{^[13]}

In contrast to the interesting points made by the supporters and dissenters, perhaps the most intriguing argument comes from Kahan and Rock: that the proxy access rules will have little to no impact on the status quo, particularly for large, widely held firms.^{^[14]} They bolster this contention in several ways. First, they argue that the 3%, three-year requirement is a tough obstacle that will limit proxy access.^{^[15]} Given that the twenty largest public retirement funds combined own only 2.8% ofGoldman Sachs and the ten largest pension funds hold less than 2.5% of Bank of America, this claim seems plausible, especially with respect to large corporations.^{^[16]} Kahan and Rock also contend that not many shareholder concerns under the current status quo go unaddressed—in 2009, only eleven firms in the Russell 3000 index received a majority withhold vote and failed to make a satisfactory response^{^[17]}—suggesting a limited number of situations in which proxy access will be useful. Finally, Kahan and Rock argue that shareholders who want to take an activist position already have a sizeable array of tactics available to them, such as sponsoring shareholder resolutions, campaigning for withhold votes, running a traditional proxy contest, or asking a company to place a certain person on the board.^{^[18]} They argue that the availability of proxy access, though a new option for activism, is not enough to induce activism by investors, such as mutual funds, that have not been active in the past or have only been active in very limited high-stakes situations.^{^[19]}

Essentially, the proxy access debate will generate heightened shareholder awareness of corporate governance issues, but it is not clear that the rule will produce real governance changes. If Kahan and Rock are right, proxy access may be more of a symbolic corporate governance reform than one of practical consequence.

* J.D./M.B.A. Candidate, 2012, Harvard Law School & Harvard Business School.

[1] 17 C.F.R. pts. 200, 232, 240, and 249 (2010).

[2] Bus. Roundtable & Chamber of Comm. of U.S., Securities Act Release No. 9149, Exchange Act Release No. 63,031, Investment Company Act Release No. 29,456 (Oct. 4, 2010).

[3] Proxy Access, Council of Institutional Investors, http://www.cii.org/resourcesKeyGovernanceIssuesProxyAccess (last visited Nov. 20, 2010).

[4] Id.

[5] See, e.g., Paul Atkins, The SEC’s Sop to Unions, Wall St. J., Aug. 27, 2010, at A15.

[6] Marcel Kahan & Edward B. Rock, The Insignificance of Proxy Access 18–19 (U. Pa., Inst. for Law & Econ. Research Paper No. 10-26; N.Y.U. Law and Econ. Research Paper No. 10-51), available at http://ssrn.com/abstract=1695682.

[7] See Atkins, supra note 5.

[8] Id.

[9] See Kahan & Rock, supra note 6, at 84.

[10] Bo Becker, Daniel Bergstresser & Guhan Subramanian, Does Shareholder Proxy Access Improve Firm Value? Evidence from the Business Roundtable Challenge 14 (Harvard Bus. Sch. Fin., Working Paper No. 11-052), available at http://ssrn.com/abstract=1695666.

[11] 17 C.F.R. pts. 200, 232, 240, and 249 (2010).

[12] See Becker, Bergstresser & Subramanian, supra note 5, at 2, 14.

[13] See Atkins, supra note 5.

[14] See generally Kahan & Rock, supra note 6.

[15] Id. at 2.

[16]Alain Sherter, SEC “Proxy-Access” Rule Won’t Really Help Shareholders Manage Big Companies, BNET (Aug. 26, 2010, 10:29 AM), http://www.bnet.com/blog/financial-business/sec-8220proxy-access-8221-rule-won-8217t-really-help-shareholders-manage-big-companies/7233.

[17] Kahan & Rock, supra note 6, at 86.

[18] Id. at 87–88.

[19] Id. at 88.

Preferred citation: David Page, Distilling the Debate on Proxy Access, 1 Harv. Bus. L. Rev. Online 15 (2010), https://www.hblr.org//?p=585.

November 29, 2010 By wpengine

The Rise and Fall of the Proxy Access Idea: A Narrative

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Laurenz Vuchetich*

Every person involved in the creation or exercise of any discipline tends to strive toward absolutes. Is the idea of proxy access a step closer to immaculate corporate governance? According to the most recent actions of its introducers, it is not—or at least not yet.

In mentioning some of the events and ruminations on proxy access that have been present in the previous seventy years, I should not and cannot argue about the potential and profound impact proxy access might be having on corporate America, especially with regard to its current activist-unfriendly form introduced by the SEC. However, as it is a matter of political economy, my concern is related to a sudden decision announced by the SEC on October 4, 2010.[1] It undermined the efforts and gradual development of an idea that, at first sight, appears to have insignificant real drawbacks for its opponents and at least a few positive contingent disciplinary effects on the directors of a public company. The announced stay on implementation of Rule 14a-11 could either be interpreted as vivid insecurity and doubt casted about its own “baby” by the SEC, or maybe as something else.

The first whispers of the proxy access idea can be traced back to the early forties of the past century, when staff members of the SEC proposed shareholder access to companies’ proxy materials.[2] Then, a similar suggestion occurred in the late seventies.[3] Another attempt to introduce proxy access was launched in 2003, in light of, and as a consequence of the Enron-WorldCom corporate failure: this proposal had envisaged thresholds that were considerably higher than the most recently adopted rule.[4] However, similarly to the last month’s events, two traditionally influential interest groups (the aforementioned opponents of proxy access), the Business Roundtable and the U.S. Chamber of Commerce, strongly lobbied against this rule. After the AFSCME case,[5] in which the Delaware Supreme Court clearly denounced the passivity of the SEC in relation to proxy access, the Commission amended the rule by permitting corporations to exclude any proposal that “relates to an election for membership on the company’s board of directors or analogous governing body.”[6] However, shortly after the election of President Obama, the SEC once again tackled the proxy access idea by providing a more structured alternative for those provisions.[7] Finally, after introducing the Dodd- Frank bill, it became clear that the SEC had not only obtained the formal authority to issue shareholder proxy access rules, but it also had been given an unambiguous sign by Congress to make this rule.[8] The Rule was adopted on August 25, 2010 and was planned to be effective from November 15, 2010.[9] It seemed that nothing would stop the proxy access rule from becoming the reality of corporate America until the Business Roundtable and the U.S. Chamber of Commerce filed a complaint in the D.C. Circuit Court of Appeals, triggering a sudden, unprecedented act by the SEC.[10] This event would not have attracted much attention if it had not triggered the SEC to announce a stay on implementation of the proxy access rule on October 4, 2010. A relevant practical implication of this event was that proxy access would not be effective for the 2011 proxy season.

Along with the described events, academic papers have been published in abundance on the proxy access issue. For example, Marcel Kahan and Edward Rock argue in their most recent working paper that proxy access, especially in its most recent form (3% ownership and three years holding threshold) is of little importance and practical use in comparison to other available instruments in corporate governance.[11] Therefore, its impact (which is under the current proposal largely constrained) cannot serve as an excuse to exercise the stay remedy that has never been used before.

The behavior of the Business Roundtable and Chamber of Commerce in the October 2010 event was in accordance with its inherent duty of protecting the interest of management; however, the stay imposed by the SEC is entirely unexpected. So, what else is there to consider that might go beyond academic debates in the proxy access story?

Taking into account the recent U.S. Senate elections and Wall Street’s criticism of President Obama and the Democrats, a viable reason for this sudden and unexpected decision of the SEC may be evident at last: in order to appease Wall Street and therefore gain political points and support, placing a stay on proxy access seemed to be an opportune political concession at that point.

By just broadly looking at the events surrounding proxy access from its beginnings until today, it seems that history repeats itself. In a corporate world that already has certain instruments aimed at fixing flaws in corporate governance, proxy access is given a minor role and has been subject to political trade, rather than corporate governance enhancement.

To test whether the minor impact argument is true or not, we will have to wait for another proxy season, unless the SEC (or the D.C. Circuit Court of Appeals – which is fairly unlikely) decides, once again, to regard proxy access as insignificant and thus, yet again, not allow the testing of this idea in the U.S. corporate environment.

* LL.M. Candidate, 2011, Harvard Law School.

[1] Bus. Roundtable & Chamber of Comm. of U.S., Securities Act Release No. 9149, Exchange Act Release No. 63,031, Investment Company Act Release No. 29,456 (Oct. 4, 2010).

[2] 17 C.F.R. pt. 239 (1942).

[3] 42 Fed. Reg. 44,860 (Sept. 7, 1977); 42 Fed. Reg. 23,901 (May 11, 1977).

[4] 17 C.F.R. pts. 240, 249, and 274 (2003).

[5] CA, Inc. v. AFSCME Emps. Pens. Plan, 953 A.2d 227 (Del. 2008).

[6] 17 C.F.R. pt. 240 (2007).

[7] See 17 C.F.R. pts. 200, 232, 240, 249, and 274 (2009).

[8] See Pub. L. No. 111-203, § 971, 124 Stat. 1376, 1915 (2010) (to be codified at 15 U.S.C. § 78o-7).

[9] 17 C.F.R. pts. 200, 232, 240, and 249 (2010).

[10] Bus. Roundtable v. SEC, No. 10-1305 (D.C. Cir., filed Sept. 29, 2010).

[11] Marcel Kahan & Edward B. Rock, The Insignificance of Proxy Access (U. Pa., Inst. for Law & Econ. Research Paper No. 10-26; N.Y.U. Law and Econ. Research Paper No. 10-51), available at http://ssrn.com/abstract=1695682.

Preferred citation: Laurenz Vuchetich, The Rise and Fall of the Proxy Access Idea: A Narrative, 1 Harv. Bus. L. Rev. Online 18 (2010), https://www.hblr.org//?p=594.

U.S. Chamber of Commerce

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