Risk & Governance Weekly

Cox: Access Uncertainty Could Hurt Shareholders

By L. Reed Walton

Investors could be hurt by lack of disclosure and even possible fraud in absence of a clear rule on proxy access for 2008, Securities and Exchange Commission Chairman Christopher Cox told a Senate panel this week.

Cox said he plans to hold a vote on an interim rule this year--possibly barring shareholder access altogether--while the agency prepares an expanded proxy access rule next year. He defended his plan before lawmakers at a Nov. 14 hearing of the Senate Committee on Banking, Housing, and Urban Affairs.

Senate Democrats have urged Cox to allow shareholders to continue filing proxy access proposals based on a 2006 federal court ruling that the SEC improperly allowed American International Group (AIG) to exclude a proxy access resolution submitted by the American Federation of State, County, and Municipal Employees (AFSCME). The agency expressed “no view” on the issue during the 2007 proxy season, and proxy access proposals went to a vote at three U.S. companies this year. The best showing was a 53.4 percent vote at Cryo-Cell International in July.

Letting the court decision stand without a rule, Cox told lawmakers, would create a “law of the jungle” for shareholder proposals. “Anti-fraud and disclosure rules are out the window,” Cox said.

In July, the SEC issued two competing rules on proxy access, or the right of investors to nominate directors to appear on corporate proxy statements. One rule would essentially bar access altogether by allowing companies to once again exclude those proposals.  The other rule would erect new hurdles for investors wishing to submit proxy access bylaw proposals, including a 5 percent ownership stake as well as comprehensive disclosure requirements.

“There are 42 million-plus shareholders in the U.S.; not all are large, responsible shareholders,” Cox said.  Without a firm rule, he said, investors angling for a seat on a corporate board “wouldn’t even necessarily be bound to tell the truth.”

Dissident shareholders launching proxy contests are now required to disclose their dealings with the company whose board they challenge. AFSCME and other institutional investors argued that similar disclosure requirements should not be applied to investors who simply want to file an access bylaw proposal, but don’t intend to seek control of the company.

Senator Robert Menendez, a Democrat from New Jersey, questioned the validity of additional disclosure requirements, as he said shareholders usually vote on the merits of a proxy contest itself, rather than on the background of the dissidents.

Cox, however, warned lawmakers of “hidden agendas” in proxy solicitation by large, short-term shareowners such as hedge funds. He told lawmakers he would prefer to “freeze the status quo” of barring investor access to the proxy, which has been commission policy since the 1970s.

This option closely resembles the commission’s proposal that would allow companies to continue excluding access resolutions, though Cox would not say whether the commission plans to adopt either proposed rule. He hinted during testimony at the possibility that the agency may opt for a third alternative.

“[T]here is a widespread assumption that having published the two proposals, the commission has only a binary choice--that we must adopt one of them, or do nothing,” Cox said, "but in fact, we may also adopt a rule that is different than either of those proposed.”

“The only requirement is that the proposed rule, and the questions the agency has asked, provide fair notice to the public of what the commission is contemplating," he said.

Senator Jack Reed, a Rhode Island Democrat who chaired the hearing, argued that blocking access was no longer the status quo after the court’s decision in AFSCME v. AIG.

That decision, by the U.S. Court of Appeals for the Second Circuit, which covers New York, Vermont, and Connecticut, does not amount to a rule on proxy access for the entire country, Cox said. If no rule is passed, there will be a state of “legal uncertainty,” he said, with the possibility of federal courts issuing conflicting rulings on whether access proposals should appear on proxy statements.

In January, Reliant Energy sued in federal court in Texas to block a proxy access proposal filed by hedge fund Seneca Capital. Seneca withdrew the proposal in February before the court reached a final decision on Reliant’s lawsuit. Appeals from federal courts in Texas go to the U.S. Court of Appeals for the Fifth Circuit, which might have ruled differently on the issue than the Second Circuit did, a possibility Cox cautioned lawmakers about.

Cox also cited a recent U.S. Supreme Court decision, Long Island Care at Home v. Coke, which ruled in part that an agency’s power to administer a program created by Congress includes the ability to create rules that fill legislative “gaps.” The case was a labor dispute, and had nothing to do with securities law, but Cox claimed the case could be seen in the future as legal precedent to strike down the Second Circuit’s AFSCME decision.

Reed asked Cox if he believed that this decision overruled AFSCME v. AIG. Cox conceded it hadn’t, but said that the decision made it easier for other courts to rule similarly in the future.

“You’re putting a lot of weight on a case that doesn’t involve laws you’re responsible for,” Reed countered.

Throughout the hearing, Cox appeared unwavering in his decision to have a rule in place that would most likely bar access for the 2008 season, despite the fact that the one of the SEC’s two Democratic commissioners has resigned and the other is poised to leave. Both commissioners supported the draft rule that would allow investors to file access bylaw proposals. Senate Democrats have proposed two candidates for those seats. For more details, see this week’s “SEC Spotlight.”

“The agency throughout its history has continued to function sometimes short-handed,” Cox said in a statement after the hearing. “There have been over 80 cases where the agency has made rules with less than a full complement [of commissioners].”

Proxy access was not on the agenda at the SEC’s Nov. 15 open meeting. SEC observers expect the commission may seek to address the issue when it meets the week after Thanksgiving.

Investor advocates, meanwhile, expressed disappointment with Cox’s testimony.  “It would rock the market if Cox were to declare that the Second Circuit were not the circuit that opined on securities litigation issues,” said Richard Ferlauto, director of pension and benefit policy for AFSCME.

Ferlauto said that the labor union is prepared to go to court again to defend shareholder access to the proxy. “We want to see proxy access exist in this market, and we will do what it takes” either with litigation or pushing for a proxy access law in Congress, he said.

“The SEC failed to act on the proxy access issue for years when it had a full commission," Dennis Johnson, senior portfolio manager for the California Public Employees’ Retirement System, told lawmakers at the hearing. “Why the rush to judgment now? ...[T]he right time to take action on such a critical issue is after the thoughtful deliberation of a full, five-member bipartisan commission,” Johnson said.