One of the peculiar things about the SEC’s proposed rule on shareholder voting is its focus entirely on process--a desire to improve the proxy voting "process," where companies have not been "responsive" to shareholder "interests"--without any consideration of why this would be a useful change in the way public companies organize themselves or relate to their shareholders.
Indeed, in the introductory material to the proposed rule, the SEC specifically abjures an intention to achieve any purpose other than simply to improve the proxy process: "We recognize," the statement says, "that the proposed procedure could include other nomination procedure triggering events, such as economic performance . . . being delisted by a market, being sanctioned by the Commission, being indicted on criminal charges, having to restate earnings, or having to restate earnings more than once in a specific period. Because, however, today’s proposals relate to the proxy process in connection with the nomination of directors, we are of the view that that the nomination procedure triggering events should be tied closely to evidence of ineffectiveness or security holder dissatisfaction with a company’s proxy process."
This strikes me as highly unusual--maybe unprecedented. Here is a regulatory agency proposing to make substantial and possibly significant changes in the rules relating to how directors of corporations are chosen, and the only reason it can advance is that in some companies the process may be "ineffective" or the shareholders may be "dissatisfied." What do these words mean? In what way is the process "ineffective?" What would the process accomplish if it were "effective?" About what are the shareholders "dissatisfied," and what would the process have to accomplish in order for the shareholders to be "satisfied?"
To these questions, the SEC provides no answer. It seems to assume that the proxy rules are an end in themselves, and not merely a means to an end. The failure of the SEC to identify anything as a legitimate goal that it is seeking to help shareholders achieve makes it impossible to judge whether the proposed rules are well-designed or not.
For example, if we suppose that shareholder interests extend to assuring that environmental concerns are taken into account by the corporation when it sites its manufacturing facilities, then the SEC’s proposed rules seem relatively well-designed to achieve this end. They make it possible for shareholders who are dissatisfied with a corporation’s environmental policies to place one or two directors on the board, and by calling attention to this issue at board meetings these directors might be able to increase the priority that the corporation’s management accords to these environmental concerns.
However, by leaving the triggering events open-ended--focusing on something as non-specific as the "dissatisfaction" of shareholders--the SEC has opened the director nomination and election process to all possible causes of shareholder dissatisfaction--extending beyond environmental concerns to such things as services outsourcing, investment in certain countries, and production of certain products. All of these become possible sources of dispute if a generalized shareholder dissatisfaction is framed as the issue.
On the other hand, if we suppose that the interest of shareholders is in maximizing shareholder value, the SEC’s proposal is not well designed. In that case, placing one or two directors on a board will not achieve very much. It would be very hard to demonstrate that one or two directors would be able to make a dysfunctional management into an aggressive and successful one. In this case--to be effective--the proxy rules should make it easier for shareholders to replace the entire board, or at least a majority. A triggering event in this case might be the failure of the company to meet certain profitability goals or to maintain rough parity with the profitability of its industry peers.
Fundamentally, it is a dispute over what are the legitimate interests of shareholders that has made these proposed rules so controversial, and it is not possible to debate the efficacy of this proposal without first coming to a conclusion about this question.
In framing this proposed rule, the SEC appears to have assumed something that--as the lawyers say--is not in evidence: that shareholders have a generalized right under corporate law to express dissatisfaction through the election of directors about matters that extend beyond the failure to operate the corporation profitably as a business. Or at least that this right is so well developed and recognized that the SEC should employ its rule-making authority to assure that it is implemented.
In corporate law, this is far from clear, and as you will see in the conference that follows, this is the underlying issue. There is no point debating whether the SEC’s proposed rules are sensible until this fundamental question is resolved.
