Thank you, Chairman Schapiro.
I join my colleagues in thanking the staff — particularly those from the Division of Corporation Finance — for your hard work throughout this rulemaking. I appreciate your professionalism and commitment.
Today, the Commission is adopting rule changes to provide shareholders with “proxy access.” New Exchange Act Rule 14a-11 creates for shareholders a minimum federal right of access to a company’s proxy materials to nominate directors. As amended, Exchange Act Rule 14a-8 will allow shareholders to include in a company’s proxy materials a proposal to amend the company’s bylaws to provide for proxy access, subject to a major exception. That is, shareholders are unable to opt out of the Rule 14a-11 access regime, even if they want to. The proxy access right the Commission is establishing under Rule 14a-11 is mandatory.
The Rule 14a-8 amendment facilitates shareholders in crafting what the shareholders believe to be an appropriate access regime for a particular company. I welcome the Rule 14a-8 amendment as a sensible step that empowers shareholders, respects the traditional role of states in regulating internal corporate affairs, and allows for efficient private ordering.
Unfortunately, the Commission has chosen to do more than amend Rule 14a-8. The Commission also is adopting Rule 14a-11, the mandates of which displace private ordering and state law and negate the import and effect of shareholder choice when it comes to determining the contours of proxy access. Neither theory nor data adequately substantiate the Commission’s imposition of the mandatory Rule 14a-11 proxy access right. Accordingly, I am not able to support the final rule before us and respectfully dissent.1
Although there are other shortcomings with the rulemaking, the balance of my remarks focuses on my fundamental concerns. An extended version of my remarks will be available on the Commission’s website.
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The tradition of state corporate law has been not to regulate by mandate. To the contrary, in regulating the internal affairs of corporations, states have adhered to a so-called “enabling” approach as opposed to a “mandatory” approach.
Mandatory corporate law forces a universal governance scheme on all firms without permitting an enterprise to adapt its approach to governance and corporate accountability to its distinct circumstances, as mandatory corporate law forces each firm into the same governance box without regard to what may be best for the enterprise and its shareholders. Recognizing that one-size-fits-all mandates are inappropriate for many businesses, the enabling approach defers to private ordering to determine how each firm should be organized to advance its particular needs and interests most effectively. Enabling corporate law allows the internal affairs of each corporation to be tailored to the firm’s unique attributes and qualities.
The countless characteristics that differentiate thousands of public companies from each other underscore why a mandatory approach to corporate governance is ill-advised. The risk that uniform dictates will be counterproductive is heightened when the dictates are imposed, without variation and without room for innovation, across an expanse of diverse and evolving enterprises and constituencies. Instead of being subject to the constraints of mandates, companies should be permitted to follow different paths in achieving the best results for the enterprise. Stated more directly, Rule 14a-11’s principal flaw is that it imposes a minimum right of proxy access, even when shareholders may prefer a more limited right of access or no proxy access at all.2
The adopting release expresses the rulemaking’s animating rationale succinctly: “After careful consideration of the comments received on the Proposal, we are adopting amendments to the proxy rules to facilitate the effective exercise of shareholders’ traditional state law rights to nominate and elect directors to company boards of directors.” I see the rule’s impact differently. To me, Rule 14a-11’s immutability conflicts with state law. Rule 14a-11 is not limited to facilitating the ability of shareholders to exercise their state law rights, but instead confers upon shareholders a new substantive federal right that in many respects runs counter to what state corporate law otherwise provides. Modifying the phrase “state law rights” with the word “traditional,” as the adopting release does, does not change the reality that Rule 14a-11 is at odds with state law.
First, as already noted, the mandatory approach of Rule 14a-11 conflicts with the traditional enabling approach of states to corporate law. In adopting Rule 14a-11, the Commission is displacing the longstanding judgment of states and their duly-elected legislatures that private ordering generally is preferable to one-size-fits-all governance mandates.
Second, and more specifically, Rule 14a-11 frustrates the operation of new section 112 of the Delaware General Corporation Law. Section 112 expressly authorizes, but does not require, bylaws granting shareholders access to a corporation’s proxy materials to nominate directors.3 Section 112 authorizes an “opt in” to access and expressly states that access rights, if afforded, may be subject to any limitations that are lawful.
Rule 14a-11, however, denies shareholders the very flexibility section 112 allows them in fashioning proxy access rights. The Commission’s rule forces a company and its shareholders into the Rule 14a-11 access regime, even if the shareholders prefer to opt out of Rule 14a-11, such as by adopting a bylaw permissible under Delaware law that imposes more restrictions before a shareholder is afforded access. Given this, I struggle to see how it can be claimed that Rule 14a-11 “facilitate[s] the effective exercise of shareholders’ traditional state law rights,” at least when it comes to Delaware — the principal jurisdiction of incorporation in the U.S. for public companies.
Third, Rule 14a-11 denies a state the ability to opt out of the federal right of access by adopting a more restrictive right than the federal rule creates.4 For example, assume a state legislature prefers only to confer proxy access upon shareholders with a five percent ownership stake while keeping the same holding period as Rule 14a-11 and adopts a statutory provision to this effect. Notwithstanding the state legislature’s considered policy judgment concerning corporate governance, shareholders still could avail themselves of Rule 14a-11’s easier right of access. Shareholders of a company incorporated in the state would have a federal right of access at a substantially lower ownership threshold than the state legislature determined was appropriate.
If the Commission were in fact to facilitate the ability of shareholders to exercise their state law rights, the final rule would not override shareholder choice by substantively negating shareholder-approved bylaws that are lawful under state law. Nor would Rule 14a-11 effectively displace state law as it does by overriding corporation codes that afford shareholders a less generous right of access, if any. As I see it, the rationale behind the rulemaking argues in favor of Rule 14a-8’s private ordering approach and against Rule 14a-11’s mandate.
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Although the rule does not permit shareholders to opt out of Rule 14a-11, shareholders are permitted to adopt a more generous access right than Rule 14a-11 affords. I have two thoughts to offer on the one-way flexibility shareholders are allowed in determining the contours of proxy access.
First, one cannot readily extrapolate from the logic of mandatory disclosure — whereby companies can disclose more than what the federal securities laws mandate but shareholders cannot opt out of required disclosures — to justify a Commission mandate, such as Rule 14a-11, that dictates the substance of internal corporate affairs. The essence of the disclosure philosophy of securities regulation is that, when armed with information, shareholders are well-positioned to evaluate companies and, as each shareholder sees fit, can agitate for change or reallocate its investments. By ensuring that shareholders have the information they need to make informed decisions, mandatory disclosure leverages market discipline as a means of corporate accountability and promotes private ordering. As a regulatory technique, disclosure thus contemplates that the government will not engage in more direct substantive regulation of corporate affairs but instead will defer to shareholders to evaluate the substance of how companies are organized and run.5
Rule 14a-11 stands in sharp contrast. Rule 14a-11 denies shareholders room to engage in the kind of private ordering that mandatory disclosure is intended to facilitate and therefore frustrates the kind of shareholder choice that disclosure seeks to empower. Unlike the widespread support shareholders voice for mandatory disclosure, there are good reasons to believe that shareholders often will prefer a more limited access right than Rule 14a-11 grants or no proxy access at all,6 and yet Rule 14a-11 will not allow shareholders this choice.
Second, the one-way flexibility shareholders have to deviate from Rule 14a-11 reveals an inconsistent view of shareholder judgment. The Commission accepts that shareholders should be able to exercise their collective judgment to provide for easier access to the proxy, but the Commission does not permit the same shareholders to limit the right of access or opt out of Rule 14a-11 entirely.
More to the point, Rule 14a-11 is in tension with the premise of the Rule 14a-8 amendment the Commission is adopting today. Insofar as Rule 14a-11 is binding as a minimum federal right of access, Rule 14a-11, as a practical matter, confines the extent to which shareholders can avail themselves of Rule 14a-8 to fashion the shareholders’ preferred proxy access regime. Thus, the rulemaking again battles with itself. Even as the rulemaking recognizes the virtue of private ordering in amending Rule 14a-8, the Commission rejects private ordering when it comes to Rule 14a-11.
In short, the Commission’s asymmetric treatment of shareholder choice is not well-founded.
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Before concluding, let me briefly address the economic studies that have informed this rulemaking.
The mixed empirical results do not support the Commission’s decision to impose a one-size-fits-all minimum right of access. Some studies have shown that certain means of enhancing corporate accountability, such as de-staggering boards, may increase firm value, but these studies do not test the impact of proxy access specifically. Accordingly, what the Commission properly can infer from these data is limited and, in any event, other studies show competing results. Recent economic work examining proxy access specifically is of particular interest in that the findings suggest that the costs of proxy access may outweigh the potential benefits, although the results are not uniform. The net effect of proxy access — be it for better or for worse — would seem to vary based on a company’s particular characteristics and circumstances.
To my mind, the adopting release’s treatment of the economic studies is not evenhanded. The release goes to some length in questioning studies that call the benefits of proxy access into doubt — critiquing the authors’ methodologies, noting that the studies’ results are open to interpretation, and cautioning against drawing “sharp inferences” from the data. By way of contrast, the release too readily embraces and extrapolates from the studies it characterizes as supporting the rulemaking, as if these studies were on point and above critique when in fact they are not.
Even with the adopting release’s unbalanced presentation of the economic data, the most the Commission can justifiably claim is that proxy access may improve a company’s performance. This empirical basis is too infirm to support the Commission’s decision to adopt Rule 14a-11. Rather, the varied economic findings are consistent with the view that different governance arrangements are optimal for different companies. Given this, the Commission should amend Rule 14a-8 to facilitate private ordering but should not adopt Rule 14a-11’s mandates.
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Notwithstanding my objections to Rule 14a-11, once the Dodd-Frank Act passed and it was certain that the Commission would adopt a mandatory right of access, I was prepared to support a compromise that, in my view, would have improved the outcome of this rulemaking substantially. Unfortunately, we have ended up with a final rule that I cannot support.
I would like to conclude how I began — by thanking the staff for your dedicated efforts. Your work is not done, however; Rule 14a-11 now must be administered. I know you will do a professional job, but I am concerned that the opportunity cost of your time and effort in administering the rule will be considerable, only adding to the rule’s cost.
1 In shoring up the Commission’s authority to adopt a proxy access rule, section 971 of the Dodd-Frank Wall Street Reform and Consumer Protection Act expressly permits the Commission to “exempt an issuer or class of issuers” from any proxy access requirement. The section directs the Commission, in evaluating whether to grant an exemption, to consider whether any proxy access right the Commission adopts “disproportionately burdens small issuers.”
The Commission has determined that smaller companies will not be subject to Rule 14a-11 until three years after the rule becomes effective. The Commission should have taken a more neutral stance, exempting small issuers outright from Rule 14a-11 while the Commission studies the rule’s impact. As it stands, any future exemption will require the Commission to scale back Rule 14a-11’s reach, and the status quo — namely, that smaller companies will be subject to Rule 14a-11 in a few years — may prove to be sticky because the Commission’s current judgment is that smaller entities should be subject to the rule.
I strongly encourage the Commission to use the three-year period to evaluate whether Rule 14a-11 should be modified as it applies to smaller companies. The Commission must be willing to amend Rule 14a-11, if appropriate.
Another potential exemption also merits attention. To mitigate the risk that proxy access will dissuade companies from going public and listing on U.S. exchanges, the Commission should consider exempting a company from Rule 14a-11 for three years after the company’s initial public offering.
2 For several reasons, shareholders may not prefer a regime of ready access to nominate directors. For example, some shareholders may be skeptical of how other shareholders may take advantage of the access they are afforded. One particular concern is the potential untoward influence of so-called “special interest” directors. The concern has been expressed that special interest directors may have goals that compete with maximizing firm value, putting such directors at odds with the best interests of shareholders as a whole.
Second, some have reasoned that a shareholder may leverage Rule 14a-11 to extract private benefits that the shareholder enjoys at the firm’s expense. In this view, a shareholder may threaten to nominate a director unless the company capitulates to the shareholder’s idiosyncratic demands — demands that other shareholders may not support.
Third, disagreement at the highest levels of a firm can be important to ensuring that issues are fully aired and deliberation is robust. However, too much conflict can generate distrust and disharmony that undercut the ability of the board and management to run the business productively. The enterprise and its stakeholders may be disserved by the additional dissension, disruption, and distraction that result if certain shareholder nominees run.
Fourth, given a company’s particular governance practices, shareholders may decide that the risks of proxy access do not justify the potential marginal benefit of allowing shareholders to nominate directors more easily. Indeed, a number of corporate governance changes have occurred in recent years — including a significant rise in majority voting, a steady de-staggering of boards, and a meaningful increase in board independence — that may convince shareholders that access is not justified.
Requiring shareholders to accept what they see as a suboptimal and inefficient governance regime is unlikely to instill investor confidence or promote capital formation.
3 When adopting section 112, the Delaware legislature also adopted section 113 permitting a bylaw for the corporate reimbursement of shareholders soliciting proxies for the election of directors. Without access to the company’s proxy materials, a shareholder still can nominate directors using its own independent proxy. Section 113 directly responds to the argument that shareholders are discouraged from waging a proxy contest because of the cost.
The Model Business Corporation Act was amended in 2009 along the lines of sections 112 and 113 of the Delaware code.
4 The adopting release states it clearly: “Consistent with the Proposal, Rule 14a-11 will apply regardless of whether state or foreign law or a company’s governing documents prohibit inclusion of shareholder director nominees in company proxy materials or set share ownership or other terms that are more restrictive than Rule 14a-11 under which shareholder director nominees will be included in company proxy materials.”
5 This perspective can be seen at work in the Commission’s 2009 rulemaking enhancing corporate governance and compensation proxy disclosures. See Release No. 33-9089, available at http://www.sec.gov/rules/final/2009/33-9089.pdf (proxy disclosure enhancements).
6 See supra note 2.