Lawrence A. Hamermesh
Ruby R. Vale Professor of Corporate and Business Law
Widener University School of Law, Wilmington, Delaware
On July 22, while I was vacationing and enjoying relatively cool temperatures in northern Maine, the District of Columbia Court of Appeals, suffering in Washington’s heat and humidity, issued an opinion invalidating Rule 14a-11, which the Securities and Exchange Commission had adopted about a year earlier.
Now that I’m back in the office and have had a chance to reflect on the Court of Appeals’ opinion, I can only begin to describe how mixed my feelings are on this whole subject. On one hand, I was involved with the preparation of the rule while employed with the Commission last year, and I feel particularly badly for those staff members who worked so hard and so long on such a contentious issue, attempting in good faith with great intellect and practicality to respond to the policy judgments of a sharply divided Commission. As I explain below – and anything I say surely is not necessarily a reflection of the views of the Commission or any of those staff members – I don’t believe that the court did justice to their efforts.
On the other hand, I have never been a fan of proxy access, at least in the form of a mandatory rule. And even more important, I believe (with Marcel Kahan and Ed Rock) that the tempest about the effects – good or bad – of Rule 14a-11 has been vastly overblown. Unfortunately, and for reasons I review below, I’m not at all convinced that the proxy access question has disappeared, and I’m not at all convinced that the members of the Chamber of Commerce and the Business Roundtable will necessarily be pleased with the aftermath of the court decision that those organizations ostensibly won.
At this point we don’t know what will happen next – whether the Commission will re-propose Rule 14a-11 with new economic analysis, go forward only with the amendments to Rule 14a-8 that weren’t challenged in the litigation, or do nothing at all (see Stan Keller’s analysis, of the options). Certainly if the private ordering scheme advocated by opponents of Rule 14a-11 is allowed to go forward (with leave under Rule 14a-8 for shareholders to propose and adopt proxy access bylaws under statutes like Section 112 of the Delaware General Corporation Law), there is every reason to think that proxy access proposals will become as ubiquitous as majority voting initiatives, that the fights over the content of such proposals will be much more heated and vexatious, and that the terms of the proxy access that will result from those fights will be less appealing to incumbent directors than the relatively mild rule that the court struck down.
All of that remains to be seen, but, as I said earlier, the sum and substance of proxy access will likely amount to no more than an expensive distraction. The July 22 court opinion, however, has potential impact that extends far beyond proxy access. At the risk of being overdramatic, it is entirely possible that the Commission’s basic authority to promulgate regulations under the Exchange Act has been fundamentally impaired. Here’s the thinking behind my concern:
The court determined that the Commission’s prediction that “directors might choose not to oppose shareholder nominees had no basis beyond mere speculation.” In so stating, the court overlooked what is well known to any corporate practitioner: that many proxy contests are settled, with directors acceding to the election of one or more candidates put forward by proxy contestants. (See a recent report from DealLawyers.com). Obviously, and as the Commission recognized, some boards will scorch the earth in opposing a dissident faction, and will spend a lot of corporate money through the bitter end. But no sophisticated observer can possibly deny what the court found so incredible, namely, that not all boards of directors choose to fight all battles at all costs. Certainly nothing in the directors’ fiduciary duties under state law compels such circumscribed discretion and limited range of business judgment.
In concluding that the Commission failed in its duty to evaluate the economic consequences of Rule 14a-11, the court further engaged in a remarkable display of judicial activism. The court referred to one study indicating that Rule 14a-11 would have deleterious economic consequences, and acknowledged that the Commission considered that study but found it unpersuasive in light of subsequent studies criticizing it. The court even acknowledged that the Commission relied on two studies suggesting that proxy access would promote positive economic returns. Somehow, however, the court determined that these two studies were “relatively unpersuasive.” That determination, critical to the entire ruling, was truly remarkable. Those studies may well be erroneous in one or more ways. But are courts now in the business of rendering unexplained and unreviewable evaluations of empirical studies? If the court made some analysis to determine that the two studies relied on by the Commission were “relatively unpersuasive,” it certainly did not share that analysis with the public, nor did it articulate any institutional comparative advantage that gave its economic judgments priority over those of the Commission. And it most certainly did not even cite the leading Supreme Court opinion (Chevron) on the question of the deference owed by courts to administrative agencies acting within the sphere of their delegated authority.
In any event, based on what any fair observer would acknowledge is mixed economic evidence, the court concluded that the Commission had not sufficiently supported its conclusions. The court also faulted the Commission for not obtaining the “crucial datum” of the extent to which contests under Rule 14a-11 would displace traditional proxy contests – as if that “datum” were actually a datum rather than an inherently speculative proposition.
It is evident what is alarming about the court’s analysis. As noted earlier, it’s not a concern (to me at least) that proxy access has suffered a setback. Proxy access will be back, for better or worse – it’s only a matter of time. The court’s legal analysis is problematic, rather, when one ponders the Commission’s overall regulatory authority and ability to implement the statutory directives of an elected Congress. When are economic analyses ever conclusive or anything other than “mixed?” Controlled experiments may be available to test the efficacy of new drugs or environmental controls, but they are simply not a luxury that is generally realistically available to test the policies that the Commission is charged with evaluating. If “mixed” economic studies mean that the Commission can’t act without giving the Chamber of Commerce or the Council of Institutional Investors the option to set a regulation aside, the Commission is essentially hamstrung. This result may well appeal to ideological opponents of regulation, but not to those who believe that reasonable regulation of securities markets is essential to an economically efficient system of capital formation. One can only hope, as Stan Keller has suggested, that the DC Circuit itself – or the Supreme Court – will limit the future use of the sort of non-deferential judicial review reflected in last month’s proxy access opinion.