The Proxy Rules and Restrictions on Shareholder Voting Rights
40 Pages Posted: 8 Nov 2016
Date Written: October 27, 2016
Shareholders in public companies vote not by attending the meeting but by exercising their rights under the federal proxy rules. Recognizing this, the Securities and Exchange Commission has at times described the proxy rules as neutral in effect, designed only to provide shareholders with the same rights accorded under state law. In fact, this has often not been the case. Over their eighty-year development, the rules have often reduced rather than complemented the rights otherwise available to shareholders at these meetings.
This can be seen with particular clarity in connection with the erosion of shareholder voting rights. Under the proxy rules, Rule 14a-8 permits shareholders to submit a proposal for inclusion in the proxy statement. The rule contains procedural conditions and substantive restrictions that allow for the exclusion of some proposals. Shareholders seeking to avoid these limitations may either distribute their own proxy statement, an often prohibitively expensive step, or, under state law, wait for the meeting and make the proposal there.
To the extent that shareholders opt for the latter approach, the proxy rules all but guarantee that the effort will fail. Upon execution of a proxy card, Rule 14a-4 allows for the involuntary transfer to management of discretionary authority to vote against any proposal that arises from the floor of the meeting and does not otherwise appear in a proxy statement. The transfer even applies where adequate notice of an impending proposal is provided and management has sufficient time and opportunity to obtain voting instructions from shareholders. Shareholders can only avoid the transfer of discretionary authority by circulating their own proxy statement or refusing to return the proxy card. Such a refusal forces the shareholder either to forego the right to vote or to attend the meeting and cast a ballot in person. Neither represents a satisfactory solution.
The policy reflected in Rule 14a-4 has been justified as beneficial to shareholders. The approach is convenient. The proxy process is rendered more efficiently. Imposing the restrictions avoids shareholder “confusion.” In fact, the discretionary authority provided under Rule 14a-4 is better understood as the byproduct of an uneven evolution in the development of the proxy rules. For much of the history of these provisions, shareholders were less organized and showed only modest interest in their impact on corporate governance. The rules, therefore, mostly reflected the interests of issuers. Rather than duplicating rights available at the meeting, they were used to restrict or reduce those rights.
The approach to discretionary voting contained in Rule 14a-4 raises serious governance concerns. The system effectively forces shareholders to submit proposals under Rule 14a-8 for inclusion in the proxy statement. Only in these circumstances must management provide shareholders with the explicit right to vote for or against the matter and forgo the use of discretionary authority. At the same time, however, reliance on Rule 14a-8 can have significant drawbacks. A complicated provision often interpreted in an arbitrary fashion, shareholders must incur the expense of crafting a proposal that avoids application of the many substantive and procedural hurdles contained in the rule. In addition, they often must undertake the costs of defense when management seeks omission of the proposal from the proxy statement.
More importantly, however, the rule is simply not available for some types of proposals. The Commission has categorically excluded entire topics from Rule 14a-8. Proposals are, for example, routinely excluded to the extent addressing the rotation, ratification or qualification of the outside auditor, despite the obvious importance of the topic to shareholders. A proposal in this area, therefore, can only be made through a separate proxy solicitation or from the floor of the meeting; reliance on Rule 14a-8 is entirely foreclosed. Yet when the proposal is made from the floor, management routinely obtains the discretionary voting authority to ensure defeat.
This Article traces the evolution of discretionary voting power under the proxy rules. The history is one of continuous expansion of the company’s right to such authority. The Article also discuss the imperfect, indeed ineffective, mechanisms that can be used to prevent the transfer of discretionary voting authority from shareholders to management. Finally, the Article examines possible changes in the regulatory regime that can address these concerns.
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