Thank you, Chairman Schapiro.
Corporate governance is about the allocation of control and the mechanisms by which those with control are held accountable. A fundamental governance challenge is to strike the appropriate balance between allowing directors and officers room to exercise their business judgment in fulfilling their fiduciary responsibilities while ensuring that there is a proper check on the managerial discretion of corporate decision makers.
A second dimension of balance is central to the shareholder access proposal before the Commission today — namely, the relationship between state corporate law and the federal securities laws. Mandatory disclosure is at the core of the federal securities laws. Through mandatory disclosure, for example, the federal securities laws facilitate market discipline as a means of holding boards and management accountable. As an initial matter, however, state corporate law determines the powers, rights, and duties of corporate actors and constituencies. The federalism balance has been struck with state corporate law governing internal corporate affairs.
In regulating the internal affairs of corporations, states — as clearly exemplified by Delaware — have adhered to a so-called “enabling” approach as opposed to a “mandatory” approach. Mandatory corporate law forces a single governance scheme on all firms without leaving a firm flexibility for variation and adaptation based on its distinct circumstances. The enabling approach allows for the type of efficient private ordering that the mandatory approach denies. Recognizing that one-size-fits-all mandates are inappropriate for many enterprises, the predominant enabling approach allows the internal affairs of each corporation to be tailored to its own attributes and qualities, including its personnel, culture, maturity as a business, and governance practices.
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Private ordering has been at work in recent years in the very area before us today: the election of directors. Market discipline has resulted in shareholder empowerment and enhanced accountability. The past few years have witnessed a notable trend away from plurality voting toward majority voting for directors, even in the absence of legislative or regulatory mandates. Over 50 percent of the S&P 500 companies now have some form of majority voting. On a percentage basis, fewer smaller companies have seen fit to switch to majority voting, although many have. States have been responsive, accommodating the trend by amending their corporations codes to facilitate majority voting.1
Some may claim that the majority voting trend does not go far enough to empower shareholders because many corporations still employ a plurality standard. Let me make two points. First, given that the present move toward majority voting has been underway for a short time, the swift progress is impressive. Indeed, majority voting is not the only director election development to take hold; boards also have been de-staggering. Second, the virtue of private ordering is that companies are not forced into the same box. That companies have not uniformly adopted majority voting is not an indictment of enabling corporate law, but rather it reflects the value of allowing a company to tailor its governance structure and practices. In yielding to the unique circumstances of different companies, enabling corporate law expects firms to follow different paths to achieving the best result for the enterprise.
New section 112 of the Delaware General Corporation Law is even more to the point for purposes of the proposal before us. In April of 2009, the Delaware legislature adopted section 112, which explicitly authorizes, but does not require, bylaws granting shareholders access to the corporation’s proxy materials to nominate directors.
In addition, Delaware adopted new section 113. Section 113, which also is enabling, permits a bylaw providing for the corporate reimbursement of shareholders soliciting proxies for the election of directors. Even without access to the company’s proxy materials, a shareholder can nominate directors on its own independent proxy. Section 113 is directly responsive to the argument that shareholders are discouraged from waging a proxy contest because of the cost.
Sections 112 and 113 — as well as the active consideration of similar amendments to the Model Business Corporation Act, which 30 states have adopted, at least in part — illustrate how state corporate law has proven itself to be adaptive in facilitating shareholder director nominations, consistent with private ordering.2 These code provisions ensure shareholders the opportunity to offer and adopt bylaw amendments that they believe are best for the company. In some instances, shareholders may decide that no such bylaws at all are appropriate.
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This takes me to the following: Unfortunately, I am not able to support the proposal before the Commission. There are a number of shortcomings with the proposal, but for now I will stick to stressing my fundamental concern: The proposal, especially proposed Rule 14a-11 dictating a direct right of access to the company’s proxy materials, encroaches far too much on internal corporate affairs, the traditional domain of state corporate law.
The whole of the proposal is about far more than the driving goal of the ’34 Act to empower investors by putting information in their hands. The proposal reaches too far past the point of being about disclosure or even about the voting process. Rather, the fundamental essence of the proposal is to realign corporate control at the federal level.
It is important to recognize how the proposal, particularly Rule 14a-11, would operate in practice. Even if a majority of a company’s shareholders determine that Rule 14a-11 is not in the firm’s best interests, the proposal would nonetheless force the company’s shareholders into the Rule 14a-11 access regime, as shareholders cannot opt out of Rule 14a-11 by prohibiting access or by adopting eligibility requirements more restrictive than those of Rule 14a-11. Nor can the board, even when in compliance with its fiduciary duties, choose for the company not to be subject to Rule 14a-11.
By way of illustration, assume that the shareholders of Delaware Corp., a large accelerated filer, adopt a proxy access bylaw pursuant to section 112 of the Delaware code, and that the bylaw requires that a nominating shareholder or group has beneficially owned at least three percent of Delaware Corp.’s shares for at least two years. The interplay between state law and Rule 14a-11 would result in the substantive negation of the shareholder-approved bylaw, as the lower one-percent/one-year Rule 14a-11 eligibility requirements would, in effect, override the shareholder-approved three-percent/two-year requirements. Put simply, the mandates of Rule 14a-11 not only work to displace private ordering and state law, but risk negating the import of a shareholder vote.
In addition to the concerns I have already raised, there are numerous questions concerning the practical implementation of the rules; the disclosures that may be appropriate; the proper triggering events and shareholder eligibility requirements; and the possible untoward influence of so-called “special interest” directors.
On this last point, we need to be mindful that proxy access might privilege certain shareholders at the expense of others. More generally, some shareholders presumably do not welcome access, and some that presently do may reconsider once access begins to play out in practice. Shareholders are not monolithic, and at least some shareholders will undoubtedly be skeptical of how other shareholders take advantage of the access they are afforded.
None of this is to say that nothing should be done when it comes to refining the regime governing shareholder voting. In fact, I suggest a counterproposal to what is before us. I recommend considering the following: amending Rule 14a-8(i)(8) to permit shareholders to include in the company’s proxy materials a bylaw proposal that would allow shareholders proxy access for nominating directors so long as the company’s jurisdiction of incorporation has adopted a provision explicitly authorizing a proxy access bylaw. Such an amendment to Rule 14a-8(i)(8) would accommodate state corporate law developments and rest on firmer legal ground than today’s proposal.
Not only does this counterproposal respect private ordering, but it benefits from not requiring the Commission to assert itself into corporate governance by drawing a number of lines in the way the Commission does to establish eligibility requirements under proposed Rule 14a-11. The Commission is not well-positioned to decide “who is in” and “who is out.” Yet under the proposal the Commission will vote on today, shareholders, regardless of their preferences, have no choice but to accept as a federal mandate the lines the Commission draws.
Other refinements to the proxy machinery may be warranted in the future. Areas meriting attention include, among others, e-proxy; the distinction between “objecting” and “non-objecting” beneficial owners; and so-called “empty voting.” Particularly in light of today’s proposal, the role and influence of proxy advisory firms, including their potential conflicts of interest, also should be scrutinized.
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In closing, I join my colleagues in recognizing the diligent efforts of those from the staff, particularly in the Division of Corporation Finance, who contributed to this rulemaking.
Undoubtedly, the comments on the proposal will be extensive and, as always, I look forward to considering them.
1 See, e.g., Delaware General Corporation Law §§ 141(b), 216.
2 See Press Release, American Bar Association Section of Business Law, “Corporate Laws Committee to Address Current Corporate Governance Issues” (Apr. 29, 2009). Before Delaware’s recent legislative enactments, North Dakota, presumably in an effort to compete with Delaware for corporate charters, had adopted a new corporations code affording shareholders a broad range of substantive rights.