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SEC Reacts to Appeals Court Ruling on Shareholder's Proxy Access Proposal

A federal appeals court panel has ruled that a shareholder proposal seeking to amend a company's by-laws to establish a procedure by which shareholder-nominated candidates may be included on the corporate ballot does not relate to an election within the meaning of the SEC's proxy rules and cannot be excluded from corporate proxy materials. The proxy access by-law proposal would amend the by-laws to require the company to publish the names of shareholder-nominated candidates for director positions together with any candidates nominated by the board of directors (AFSCME v. American International Group, Inc., CA-2, September 5, 2006).

An SEC no-action letter and a federal district court ruling allowed the company to exclude the proposal based on rule 14a-8(i)(8), which allows the exclusion of a proposal relating to an election for membership on a company's board of directors. However, the appeals court ruled that a shareholder proposal does not relate to an election under the exclusion if it simply seeks to amend the corporate by-laws to establish a procedure by which certain shareholders are entitled to include in the corporate proxy materials their nominees for the board of directors.

While a proposal can be excluded under the election exclusion if it would result in an immediate election contest, the panel noted that a proposal may not be excluded under rule 14a-8(i)(8) if it would simply establish a process for shareholders to wage a future election contest. The court reasoned that a 1976 SEC interpretation reflected the view that the election exclusion is limited to shareholder proposals used to oppose solicitations dealing with an identified board seat in an upcoming election and rejects the somewhat broader interpretation that the election exclusion applies to shareholder proposals that would institute procedures making such election contests more likely.

With deference to the 1976 SEC interpretation, the appeals court interpreted the election exclusion as applying to shareholder proposals that relate to a particular election and not to proposals, as in this case, that would establish the procedural rules governing elections generally.

AIG suggested that the interpretation of the election exclusion adopted by the panel improperly conflicts with a proposed SEC rule that would require corporations in particular circumstances to include certain shareholder nominated director candidates in the corporate proxy statement.

The SEC's proposed rule 14a-11 would entitle a holder of at least 5% of the corporation's voting stock to place a nominee on the corporate ballot, but only if the proxy access rule had been activated by one of two triggering events, including the adoption by majority vote of a shareholder proposal submitted by a holder of more than 1% of the company's voting stock. The court said that proposed rule 14a-11 essentially establishes a process by which the shareholder proposal mechanism, subject to heightened eligibility requirements, may be employed to adopt a proxy access rule that is uniform across companies.

The court recognized that its holding facilitates a process for adopting non-uniform proxy access rules that are less restrictive than that created by proposed rule 14a-11. There may be no reason for a rule based on proposed rule 14a-11 to coexist with the procedure that the holding makes available to shareholders. If the Commission ultimately decides to adopt rule 14a-11, then such an action, although unnecessary, would likely be sufficient to modify the interpretation of rule 14a-8(i)(8) that the court adopted.

The SEC, reacting quickly to the court's ruling, announced that the Division of Corporation Finance will recommend an amendment to rule 14a-8 regarding director nominations by shareholders. The staff proposal, still to be developed, will address issues raised by the decision. The Commission has calendared the recommendation for consideration at an open meeting to be held on October 18, 2006.

SEC Chairman Christopher Cox said that important shareholder rights in the proxy process are best secured under a consistent national application of rule 14a-8 to shareholder proposals. Therefore, to provide certainty with regard to shareholder proposals in every judicial circuit, he has directed the staff to prepare recommendations for revisions to rule 14a-8 that will assure its consistent nationwide application. He said that a final proposal will be considered at an open meeting of the Commission that will be scheduled to allow a final rule to go into effect in time for the 2007 proxy season.