Securities Mosaic® Blogwatch
March 27, 2015
The Unintended Consequences of Proxy Access Elections
by David A. Katz

Editor's Note: David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz specializing in the areas of mergers and acquisitions and complex securities transactions. The following post is based on an article by Mr. Katz and Laura A. McIntosh that first appeared in the New York Law Journal; the full article, including footnotes, is available here.

It's official: Proxy access is the darling of the 2015 season. Shareholder-sponsored proxy access proposals are on the ballots of more than 100 U.S. public companies this spring. These precatory proposals seek a shareholder vote on a binding bylaw that would enable shareholders who meet certain ownership requirements to nominate board candidates and have them included in the company's own proxy materials. Powerful institutional investors have given the proxy access movement enormous momentum this spring, and blue chip firms such as GE, Bank of America, and Prudential have voluntarily adopted versions of proxy access in advance of their annual meetings. Companies such as Citigroup have agreed to support proxy access shareholder proposals in their definitive proxy materials. In the absence of regulatory guidance, proxy advisors such as ISS have stepped into the breach to define the terms and conditions of proxy access. As proxy access proposals proliferate - after years of controversy - the primary debate now seems to be whether a 3 percent or 5 percent ownership threshold is more appropriate.

All this is not to say that proxy access is a fait accompli, and its current popularity among shareholders certainly does not mean that it is the right choice for American corporations. It is very much an open question whether proxy access will become an established part of U.S. corporate governance. Interestingly, despite all the ballot-box excitement, there has been little discussion of what shareholders could expect if proxy access were to become widely adopted and - as is the stated goal - directors proposed by a shareholder were then elected. In fact, it is likely that "proxy access directors" would find themselves in an unenviable position, facing conflicts and conundrums that many proponents of proxy access do not appear to have fully considered.

Proxy access directors, by analogy to "constituency" or "blockholder" directors, would, on the one hand, be required to fulfill their legal duties and fiduciary obligations to all shareholders. On the other hand, they would be seen as owing allegiance to one or more shareholders in particular - shareholders whose agendas were compelling enough, and different enough from the company's current strategy and direction, for them to seek their own board seats using the company's own proxy statement. As major shareholders frequently collaborate in private (as permitted by an exemption to the proxy solicitation requirements), the identities and goals of a proxy access director's supporters would not necessarily be publicly known. Because of this lack of transparency, the role of a proxy access director would be even less well understood than that of the typical constituency director. We believe that this situation would be rife with potential pitfalls for the director, for the board, and for the company and its shareholders.

Constituency Directors

"Constituency directors" are those whose election to the board is due to a special relationship between the company and a particular entity or group. Common examples of constituency directors on public company boards include parent company executives or directors, representatives of unions or creditors, designees of classes of preferred shares, winners of short-slate proxy contests run by hedge funds or other activists, or private-investment-in-public-equity (PIPE) transaction appointees. In some cases, private companies that become public may continue to have directors who represent ongoing private equity or venture capital investments, or original founding family members representing significant ownership of the company. The term "blockholder directors" is generally used to indicate the subset of constituency directors whose board membership is due to a particular class of stock or to an insurgent group of shareholders.

A constituency director is intended to represent the interests of a particular group or entity on the board. The director may be expected to, among other things, advocate for certain positions advantageous to the sponsor (in which case the director's relationship with the sponsor should be fully disclosed to the board and shareholders), relay information to the sponsor (in which case the board should ensure that the sponsor is required to keep the information confidential), or focus on aspects of oversight that are of particular interest to the sponsor. Regardless of a constituency director's arrangement with his or her sponsor, Delaware law is very clear: Every director owes fiduciary duties to all the shareholders of a company. A constituency director has neither the right nor the obligation to favor a sponsor over the other shareholders. Articulating a (fully disclosed) sponsor's viewpoint in a board meeting is on one side of the line; voting against the interests of shareholders other than the sponsor is on the other. Indeed, blockholder directors run significant risks regarding losing the protections of the business judgment rule if they act for the benefit of their sponsors and to the detriment of the other shareholders.

The position of a constituency director can be precarious from a practical as well as a legal standpoint. It is not uncommon for constituency directors to be board outsiders, distrusted and isolated to varying degrees. The board frequently views a constituency director as an adversary, or at least as the eyes and ears of the sponsor, and thus other directors may be unwilling to engage in open discourse on strategic or other sensitive matters in his or her presence. In extreme cases, official board meetings can become pro forma affairs, while the real business of the board is conducted either off the record or in special committees formed for the purpose of excluding the constituency director. The legality of these tactics may fall into a fact-dependent gray area, but in practical terms, effective isolation is very difficult for an excluded director to overcome. By the same token, it is often a mistake for a board to isolate a constituency director who is actually truly independent of the constituency that promoted their election.

A recent article by Vice Chancellor Travis Laster of Delaware and Delaware lawyer John Mark Zeberkiewicz discusses the rights and duties of blockholder directors under Delaware law and concludes that care must be taken on both sides: Boards must recognize the rights of blockholder directors to participate fully in board decision-making, absent a conflict of interest with respect to a specific situation, while at the same time blockholder directors must be diligent in fulfilling their duties to all shareholders equally and should recognize that the position of representing particular constituencies may make them vulnerable to claims of breach of their duty of loyalty.

One such claim arose in the 2013 case In re Trados, in which Vice Chancellor Laster found that directors representing venture capitalist holders of the company's preferred stock had a conflict of interest in a sale transaction and therefore applied the entire fairness standard of review. While in Trados the court concluded that the transaction was substantively (though not procedurally) fair to all shareholders and thus found that the blockholder directors had not breached their fiduciary duties, this conclusion was based on a highly fact-specific analysis. Well-advised public company boards do their best to minimize the risk of having transactions reviewed under the elevated standard of entire fairness, and Trados is a reminder to boards with blockholder directors (as well as to individual blockholder directors) to be alert to potential conflicts.

Boards with constituency or blockholder directors also must contend with the different investment horizons that may be represented by these directors. Venture capital investors, hedge fund activists and others are generally known for seeking short-term profits, often at the expense of a company's long-term prospects. While directors in Delaware are expected to use their business judgment to determine the appropriate time horizons for their decision-making, Vice Chancellor Laster has indicated that a director representing a short-term investor may have an inherent conflict: "A blockholder director who also serves in a fiduciary capacity for [a short-term] investor can face a conflict of interest: The blockholder director's duties to the corporation require that the director manage for the long term, while the blockholder director's duties to the investor require that the director manage for an exit." It is this conflict that, they say, "poses serious risk because it creates exposure to a claim for a loyalty breach." The argument that some blockholder directors necessarily face an inherent conflict may not be the predominant view at the moment, but nonetheless it is a point that boards with blockholder directors should not dismiss lightly.

The issues created by having blockholder directors on a board are numerous and difficult. Having such directors elected to the board through proxy access adds another layer of complexity to what often is already a delicate situation.

Proxy Access Directors

Proponents of proxy access frequently speak in terms of "shareholder representation" and "democracy." These buzzwords are intended to appeal to the American understanding of political fairness. However, this metaphor fundamentally misunderstands the nature of a corporate board. In the United States, a public company board is not designed to be a representative democracy in which different directors speak for particular interest groups. Widespread utilization of proxy access could produce a system in which various factions nominate their candidates and the result could be an unpredictable array of representatives all owing allegiance to their individual sponsors. Such a situation could easily produce a dysfunctional board riven by divisive deadlocks and incapable of making decisions or providing effective oversight. American business owes much of its success to the current fiduciary model, in which the full board is required to use its collective business judgment to benefit the corporation and its shareholders on an ongoing basis. This structure enables boards to maximize the value of the corporation over the long term.

Significant shareholders or shareholder groups that nominate a director through proxy access would expect the director to promote their interests at the board level. If they did not see a particular benefit to nominating their own candidate, after all, it would hardly be worth the effort. However, if proxy access directors do not act for the benefit of all shareholders, they will breach their fiduciary duties - thus potentially giving rise to legal challenges from other shareholders (or even directors), subjecting transactions to elevated review, and even, potentially, forfeiting the protection of the business judgment rule - and likely will find themselves isolated from board deliberations and discussions by the other directors. In such circumstances, proxy access directors may be unable to further the goals of their nominating shareholders; moreover, their presence could be detrimental to the company and all of its shareholders.

There is precedent in Delaware for challenging the loyalty of disinterested, outside directors. In a 2011 case, the Court of Chancery refused to dismiss a claim of breach of loyalty in a going-private transaction because it concluded that the outside directors - though they themselves had no financial conflicts, and despite the fact that all shareholders were treated equally in the transaction - possibly had been intimidated and harassed by the former chief executive to approve a transaction for his benefit and not in the best interests of the shareholders generally. This case is a powerful signal to directors - particularly those who owe their position to a constituency of some kind - that they must not be (or even appear to be) unduly influenced by any particular interest group to the detriment of the company as a whole. Proxy access directors may be particularly vulnerable to claims of influence, lack of independence, and disloyalty because of their relationships with their shareholder sponsors and the web of potentially divergent interests they may be expected to "represent."

Further complicating the position of proxy access directors is the fact that, unlike typical constituency directors, their shareholder sponsors may not be clearly defined or even publicly known. It is understood in the current environment that significant shareholders can and do communicate and collaborate with each other to influence corporate management and policy (a reality that, regrettably, often eludes the reporting requirements under Section 13(d)). Borrowing from so-called "wolf pack" tactics familiar from proxy fights in recent years, shareholder activists could - with or without formal agreements - nominate each other for board seats, increase their positions in target company stock, agree to vote in support of each other's nominees in different companies' elections, and engage in other stratagems to increase and pool their influence and voting power. A proxy access director nominated pursuant to such tactics would owe his or her position to a group unknown to the board and undisclosed to the other shareholders. If elected, the director's allegiances likewise would be unclear and potentially manifold.

Without an identified constituency, a proxy access director could be subject to influences that may be powerful but poorly understood by the other directors. It could be very difficult for the board to ensure that the proxy access director did not participate in discussions or votes in which the director had a conflict of interest of some kind, though failure to do so could make the board vulnerable to possible breach of fiduciary duty claims and a heightened standard of review of its decisions. It also would be quite difficult for the board to ensure that the company had confidentiality agreements in place with all of the potential recipients of information passed along by the proxy access director, who could face liability if he or she improperly disclosed board deliberations and information to third parties. Moreover, the board may have little incentive to work with the proxy access director, on the theory that if the director did not perform to the expectations of the sponsoring shareholders, he or she may well be replaced the following year by a different nominee. These factors could lead the board to conclude that isolating the director as much as possible from sensitive board deliberations may be the best way to protect the board's decision-making process and the company as a whole from the vulnerability introduced by the proxy access director's presence on the board.

Unintended Consequences

The detrimental consequences of proxy access fall into three general categories. First, there are those that occur before and during the proxy solicitation period. These include waste of corporate resources, negative publicity, the impairment of a company's ability to attract qualified candidates to stand for election as a director, and the undermining of the company's nominating committee and board leadership. Proxy access could cause tension among shareholders, particularly large shareholders, who disagree in public or private over whether to nominate candidates for inclusion in the proxy, and if so, which ones. It also could cause internal controversy for large shareholders; institutional investors or pension funds, for example, may find themselves pressured by certain constituencies (such as unions) to participate in proxy access for political reasons, while other constituencies support the current board's direction on substantive grounds. The instability caused by proxy access - like that created by proxy fights - could create significant disruption in a business, as executives, managers, and employees struggle with fear and uncertainty about the future. Damaging effects on hiring, long-range planning, and employee retention can cause lasting harm to a corporation regardless of the election results.

Second, there are those consequences that relate to the composition of the board. Were proxy access to become widespread and effective, a board could become unable to ensure that it would have the necessary expertise (such as the audit committee financial expert mandated by the Sarbanes-Oxley Act or industry specialists) or make progress toward a desired diversity of skills, genders, and backgrounds. Moreover, it could create the potential for distrust and a lack of collegiality that would reduce the board's effectiveness and distract the company's management, and it would increase the likelihood of politicization and balkanization of directors into factions with different goals.

Third, there are those consequences that relate to the board's ability to fulfill its legal duties and obligations. Proxy access directors would owe a duty of loyalty to all shareholders under Delaware law - as all directors do - yet they might feel themselves to be - or be expected or viewed by others to be - beholden to the particular shareholder group that nominated them and pushed for their election. In conjunction with the paramount issue of loyalty, questions of confidentiality, transparency, board committee structure, and board dynamics could arise. Complications familiar from the constituency/blockholder director context likely would be exacerbated if sponsored directors were to reach the board through proxy access. Boards would be addressing these issues in a context of significant uncertainty, both as to the legal questions of fiduciary duty and as to the factual questions of a proxy access director's allegiance.

If proxy access directors are elected in any meaningful number, boards will be contending with an array of complications that have the potential to impair board functioning in ways that the current debate has not addressed. As the popularity of proxy access reaches a high-water mark this season, shareholders should consider carefully whether they really want what proxy access proponents are asking for. If not, now is the time for them to say so.

March 27, 2015
This Week In Securities Litigation (Week ending March 27, 2015)
by Tom Gorman

The Supreme Court handed down the Omnicare decision on Securities Act Section 11 liability for opinion statements this week. In a judgment joined by all nine Justices the Court reversed the Sixth Circuit, concluding that opinion statements in a registration statement are actionable if the opinion is not believed or contrary to facts known at the time. The Section also imposes liability for the omission of material facts which a reasonable, objective investor would have expected to be disclosed.

Statistics published by Cornerstone Research show that while the number of securities class action settlements last year is about the same as in the prior year, the dollar amount of the settlements declined significantly. Nevertheless, the number of settling actions alleging GAAP violations increased significantly while the number of securities class actions paralleled by an SEC enforcement action declined.

Finally, the SEC filed two administrative proceedings last week, centered on violations of Exchange Act Section 15(a). One named 21 individuals and entities in a scheme involving one broker-dealer which used the others to acquire securities for it in offerings and in the secondary markets for a cut of the profits on resale. The other is a related action.


Rules: The Commission adopted Rules under the JOBS act regarding Reg. A+ (here).

Proposed rules: The Commission proposed rules which would require broker-dealers trading in off-exchange venues to become members of a national securities association (here).

Testimony: Chair Mary Jo White testified before the House Committee on Financial Services (March 24, 2015). Her testimony focused on the SEC's agenda and FY 2016 budget request (here).

Remarks: Commissioner Kara M. Stein delivered remarks titled International Cooperation in a New Data-Driven World at the Brooklyn Law School International Business Law Breakfast Roundtable (March 26, 2015). Her remarks focused on systemic risk, effective swaps regulation and better accounting standards (here).

Remarks: Commissioner Luis A. Aguilar delivered remarks titled Preparing for the Regulatory Challenges of the 21st Century at the Georgia Law Review Annual Symposium (March 20, 2015). His remarks focused on efforts of the SEC to enhance its data gathering and analytics, the globalization of securities regulation and creating an environment for combating fraud (here).

Supreme Court

Omnicare, Inc. v. Laborers District Council Construction Pension Fund, No. 13-435 (S. Ct. March 24, 2015). The case centers on a registration statement filed by Omnicare in connection with a public offering of common stock. The firm is the largest pharmacy provider for nursing home residents in the U.S. In part it analyzed the impact of various federal and state laws on the business of the firm which included statements of belief regarding the firm's compliance. Later the Government filed enforcement actions against the firm and plaintiffs brought suit alleging the statements of "belief" regarding compliance were false. The District Court granted Omnicare's motion to dismiss, concluding statements of opinion were not actionable. The Sixth Circuit reversed, holding that if the statements were "objectively false" the statements were actionable.

The Supreme Court, in a unanimous decision, vacated the lower court rulings and remanded with instructions. Justice Kagan, writing for seven members of the Court, began by stating that the Sixth Circuit and the Funds "wrongly conflates facts and opinions." While Section 11 by its plain terms applies to statements about facts it nevertheless still applies to opinions. First, an opinion implies that the speaker "actually holds the stated belief." Thus if the speaker knew the statement was incorrect the expression of an opinion to the contrary would become an untrue statement of fact. Likewise, if the opinion contained an imbedded statement of fact which is incorrect again there would be an untrue statement of fact. Here the Funds claim that Omnicare turned out to be wrong is not sufficient to support Section 11 liability.

Second, the omissions provision of Section 11 must be considered. In part the Section states that there can be liability if Omnicare "omitted to state facts necessary" to make its opinion regarding legal compliance "not misleading." Under this part of the statute the question turns on "the perspective of a reasonable investor: The inquiry (like the one into materiality) is objective." Under this provision the investor can reasonably expect "not just that the issuer believes the opinion (however irrationally), but that it fairly aligns with the information in the issuer's possession at the time. Thus, if the registration statement omits material facts about the issuer's inquiry into or knowledge concerning a statement of opinion, and if those facts conflict with what a reasonable investor would take from the statement itself, then §11's omissions clause creates liability." The test here is an objective one of what a reasonable persons would understand from the statement.

Finally, to plead a Section 11 claim the securities law plaintiff cannot simply claim that the opinion was wrong. Rather, the complaint must call into question the basis of the claim or specify the facts which should have been disclosed. The decision was vacated and the case remanded since the omission theory was not considered by the lower courts. Justice Scalia concurred in part and in the judgment. Justice Thomas concurred in the judgment.

Securities Class Actions

Last year the number of securities class action cases settled remained largely constant compared to the prior year, according to a report by Cornerstone Research (here). At the same time the number of cases alleging GAAP violations increased, although only a small percentage involved restatements. Curiously, the number of securities class actions paralleled by an SEC enforcement action, which tend to be the larger, more complex cases, declined despite a claimed emphasis on financial fraud actions by the Commission.

In 2014 there were 63 court approved settlements, about the same as the prior year. Yet when compared to the five year period of 2010 through 2014, the number of settled cases declined about 35%. In 2014 67% of the settled cases alleged GAAP violations, a significant increase over the 61% average for such claims since the passage of the Reform Act. Interestingly, only 29% of those cases involved a restatement. 21% of the cases which alleged GAAP violations also named the auditor as a defendant. However, only 16% of the settled cases involved a parallel SEC enforcement action. That is significantly less than the 18% in 2013 and 21% in 2012. The median settlement for all post-Reform Act cases with a parallel SEC action of $12.9 million is more than twice that of cases without a corresponding Commission action, reflecting perhaps in part the fact that those actions tend to be more complex. In 2014 the median settlement for cases with a parallel SEC action was $9.4 million compared to $5.5 million for others.

SEC Enforcement - Filed and Settled Actions

Statistics: During this period the SEC filed 0 civil injunctive action and 2 administrative proceeding, excluding 12j and tag-along-actions.

Unregistered broker-dealer: In the Matter of Global Fixed Income, LLC, Adm. Proc. File No. 3-16460 (March 26, 2015) is a proceeding which names as Respondents Global, a registered broker dealer that primarily buys and sells fixed income securities for its own account, its owner Charles Kempf, and 19 other entities and individuals. For a period of three years beginning in June 2009 Global directed the other Respondents to purchase about $2.5 billion in New Issues for it and another $2.3 billion in securities in the secondary market. Before each New Issue Global transferred money to the Respondents' account to be held on behalf of Global. After the purchase the allocations were transferred to Global which sold them on the secondary market, typically at a small profit. The profits from all of the transactions were divided. The Order alleges violations of Exchange Act Section 15(a). To resolve the action Global and each other respondent consented to the entry of a cease and desist order based on Exchange Act Section 15(a). Charles Kempf, the owner and CEO of Global, agreed to the entry of an order suspending him from the securities business for a period of one year. In addition, Global and Mr. Kempf will, on a joint and several, basis pay disgorgement of $2,435,989.61 along with prejudgment interest. Each of the other Respondents agreed to pay disgorgement. In addition, Global will pay a penalty of $500,000 while each other entity Respondent agreed to pay a penalty of $50,000 and each individual Respondent (other than Mr. Kempf) will pay a $5,000 penalty. See also In the Matter of David Boyle, Adm. Proc. File No. 3-16459 (March 26, 2015)(similar proceeding naming as a Respondent the 1/3 owner of Etck, a firm which is a Respondent in Global; settled with a cease and desist order based on Section 15(a) and the payment of disgorgement and a $5,000 penalty).

Offering fraud: SEC v. BioChemics, Inc., Civil Action No. 12-12324 (D. Mass.) is a previously filed action against the company and its founder and two promoters. The complaint alleged that beginning in 2009, and continuing through mid-2012, the firm and the individual defendants raised at least $9 million from 70 investors based on a series of misrepresentation about the firm. Previously the company agreed to a partial settlement which was recently entered by the Court. Under the terms of that partial settlement the company was enjoined from violating Securities Act Section 17(a) and Exchange Act Section 10(b). This week the Court entered a supplemented judgment, based on a motion by the Commission, ordering the company to pay disgorgement of $15,105,325, prejudgment interest and a penalty of $750,000. The litigation continues as to the individuals. See Lit. Rel. No. 23220 (March 25, 2015).

Criminal cases

Investment fund fraud: U.S. v. Zemlyansky, Case No. 1:12-cr-00171 (S.D.N.Y.). Mikhail Zemlyansky was charged with securities fraud tied to defrauding investors out of about $18 million with his claimed investment funds. To implement the scheme, Mr. Zemlyanski used two entities, Lyons Ward & Associates and the Rockford Group. Investors were told the firms were settlement claims funding companies that invested in law suits in return for a portion of future settlements. Documents and account statements were created for use by cold-callers to solicit investors with boiler room tactics. In reality there were no investment funds and investor money was misappropriated. A racketeering claim was based on a scheme that ran over a five year period beginning in 2007 tied to the New York State no-fault auto insurance law. That law requires prompt payment for medical treatment from auto accidents but permitted patients to assign the right to reimbursement from an insurance company to others including clinics. Over the years of the scheme Mr. Zemlyansky's organization defrauded auto insurance companies out of over $100 million by creating and operating medical clinics that provided unnecessary and excessive medical treatment to take advantage of the no-fault law. The organization owned and controlled over a dozen medical professional firms, paying licensed medical professionals to use their licenses to form the entities. The proceeds from this activity were laundered through check-cashing entities and shell companies. Finally, Mr. Zemlyansky's organization operated high-stakes illegal poker games in Brooklyn. Tens of thousands of dollars per game in profits were generated. A jury convicted Mr. Zemlyansky of racketeering conspiracy, securities fraud, mail fraud and wire fraud after a four week trial. The date for sentencing has not been set.


Investment fund fraud: The Serious Frauds Office announced that David Dixon pleaded guilty to five fraud related offenses tied to investment schemes he ran involving Arboretum Sports (USA) and Arboretum Sports (UK) Limited. Three schemes were conducted. In the first investors put up funds in what they were told was a riskless gambling venture. In the second investors were induced to purchase shares in a firm supposedly linked to famous casinos. The third was an advanced fee scheme. Mr. Dixon will be sentenced in April 2015.

March 27, 2015
Proxy Statements: Pru Includes Lead Director Video
by Broc Romanek

Last year, I blogged about how to file video on EDGAR - and predicted that the use of video in SEC filings would explode over the next decade as a disclosure tool. More recently, I blogged that I thought we would see more video during this proxy season. Two days ago, Prudential filed its proxy statement (here's the interactive version) - and lo and behold, it includes this 5-minute video from the company's lead director! As required, the video's script was filed as additional soliciting material with the SEC.

I haven't had a chance to put together my own vid of Pru's cool things like last year as I'm flying out to Taiwan this morn for spring break, but here's a list of some cool things in Pru's proxy this year:

– Two letters to shareholders; a short one from the CEO/chair & a longer one from the lead director (which links to the lead director's video)

– Graphic on board diversity

– Graphic on board nominee tenure

– Graphic on board evaluation that is done with the help of an independent third party

– Box on board engagement that highlights the adoption of a clawback and proxy access through engagement efforts

– Boxes on environmental & sustainability as well as corporate community initiatives

– Boxes on good governance practices and also one called "Paper or bytes? Using resources responsibly"

– Box on the factors used for determining to reappoint independent auditor

– Box on formulaic framework for incentive programs and how Pru significantly removed discretion from its programs

– Box on why they use AOI versus GAAP

– Boxes that show the formulas for all of their plans

– Box on what is impacting the CEO's pension accrual

– Back front cover highlights the work & employment programs they are involved with the Veteran community

– Back cover graphically shows Pru's shareholder engagement cycle

– Once again offering a tree or bag if registered holders vote (planted over 550k trees so far under this program)

– Highlights a $5 Starbucks card incentive to registered shareholders if they combine their registered account & brokerage account. You can get a sustainable bag, plant a tree & get a cup of coffee if you vote & consolidate!

OECD's "Trust and Business Project"

The OECD has numerous principles that promote responsible business conduct, such as the Principles on Corporate Governance and the Anti-Bribery Convention. The OECD is undertaking a large "Trust and Business Project" - and as part of its work has launched an online survey on Business Integrity and Corporate Governance. Please fill out the survey.

Senate Committee Mulls Changes in Nonqualified Deferred Compensation Rules

Here's news from this Towers Watson blog; here's the intro:

As part of a series of hearings on tax reform, the Senate Finance Committee recently held a hearing on the issue of fairness in the tax code. In connection with the hearing, the committee's ranking Democrat, Sen. Ron Wyden (D-OR), released a report on tax avoidance strategies that outlines possible recommendations for reforming nonqualified deferred compensation (NQDC) as part of an expected tax reform proposal. In his opening statement, Sen. Wyden noted that the report is intended to "shed some light on some of the most egregious tax loopholes around."

– Broc Romanek

March 27, 2015
Omitted Shareholder Proposals and the Anti-Fraud Provisions
by J Robert Brown Jr.

Michican apparently has a unique provision with respect to shareholder proposals.  The Corporate Code in the state required companies to provide notice of meetings to shareholders (not the unusual part) and to include notice of any shareholder proposal that is a proper subject for shareholder action (the unusual part).  As the provision provides: 

  • Unless the corporation has securities registered under section 12 of title I of the securities exchange act of 1934, chapter 404, 48 Stat. 892, 15 U.S.C. 78l, notice of the purposes of a meeting shall include notice of shareholder proposals that are proper subjects for shareholder action and are intended to be presented by shareholders who have notified the corporation in writing of their intention to present the proposals at the meeting. The bylaws may establish reasonable procedures for the submission of proposals to the corporation in advance of the meeting. 

In GWYN R. HARTMAN REVOCABLE LIVING TRUST v. SOUTHERN MICHIGAN BANCORP, INC., the Sixth Circuit allowed a suit to go forward that notified shareholders only that a "shareholder planned to propose a resolution urging the board to amend the company's bylaws."  There was no actual description of the proposal.  

The shareholder challenged the sufficiency of the notice and the Sixth Circuit agreed that a claim had been stated.   

  • We are hard-pressed to understand how mere acknowledgement of the existence of a proposal - without describing even its subject matter - amounts to "notice" under the statute. By Bancorp's lights, "notice of a shareholder proposal" requires only a statement that there will be a shareholder proposal. By our lights, that is not "notice."

The case turned entirely on Michigan law.  But this brings up an interesting aside with respect to Rule 14a-8 and shareholder proposals under the federal system.

The holding may turn on state law but implicates concepts under the federal proxy rules.  Rule 14a-8 no doubt at first blush looks like an example of administrative support for shareholders, allowing them to include in some cases their proposal in the company's proxy statement.  The actual exegesis of the provision, however, was quite different.  The rule was largely designed to eliminate a problem confronted by issuers with respect to disclosure under the antifraud provisions.   

  • One of the earliest disclosure problems [under the proxy rules] concerned the failure by management to disclose shareholder proposals that it knew would be made at an upcoming meeting. The problem of nondisclosure was particularly acute when management sought discretionary voting authority in order to oppose the proposal. The Commission responded by amending the proxy rules. Management was required to disclose any proposal that it knew would be made at the meeting and to provide shareholders with an opportunity to vote on the matter... While mostly solving the concern under the antifraud provisions, the requirement left management in the uncomfortable position of having to craft a description of a proposal that it was not making.  Amendments proposed two years later sought to lift the obligation from management. Shareholders would be allowed to include their proposal in the company's proxy statement and, whenever opposed by management, could insert a one hundred word statement of support.

The SEC, Corporate Governance, and Shareholder Access to the Board Room  The effect of the changes? "[T]hey solved a serious problem, providing ground rules for the disclosure of shareholder proposals but shifting the burden from management back to the proposing shareholders."

Rule 14a-8 fixed things for proposals included in the proxy statement.  What about those omitted?  A proxy proposal omitted under Rule 14a-8 may still, in some cases, be presented at the shareholder meeting.  Rule 14a-4 allows a company to seek discretionary voting authority for "[a]ny proposal omitted from the proxy statement and form of proxy pursuant to § 240.14a-8".  Nonetheless, it would presumably be material to shareholders to know in deciding whether to grant the discretionary authority that the authority was going to be used to vote down specific proposals at the meeting.  A failure to disclose the possibility would at least in some cases vioate the antifraud provisions.  

The federal proxy rules have no express requirement like the one in Michigan but the antifraud provisions arguably have the same effect.  

March 26, 2015
The Latest Attempt To Slow The Revolving Door At The SEC
by David Zaring

I have argued in a paper that the revolving door seems much less problematic than conventional wisdom would have it. And Ed DeHaan, Simi Kedia, and their co-authors have found that SEC lawyers who go through the door usually try to show off when at the agency by bringing and winning bigger cases.

But Congressman Stephen Lynch isn't so sure about that door, and has introduced the SEC Revolving Door Restriction Act of 2015 to put some brakes on it. His press release:

H.R. 1463, the SEC Revolving Door Restriction Act of 2015, amends the Securities Exchange Act of 1934 to prevent former employees of the SEC from seeking employment with companies against which they participated in enforcement actions in the preceding 18 months. H.R. 1463 defines enforcement action as court actions, administrative proceedings, or Commission opinions. Former employees must seek an ethics opinion from the SEC if they are interested in seeking employment within a year of their termination at the SEC with a company that was subject to an SEC enforcement action in which they participated.

I'm actually not too sure what this adds to the typical revolving door restriction. Federal prosecutors can never work on matters on which they worked while in government service. And they are barred from representing clients for at least one year. This lengthens that limitation to 18 months, but at the White House, it's already 2 years for lobbying.

The agency isn't too excited about this, as they have observed over at Jim Hamilton's World of Securities Regulation:

Delaying staffers' employment in the private sector would affect a significant number of SEC employees, who have a long tradition of leaving government service to join the defense bar. At the 2015 SEC Speaks conference, when current and former agency staff members were asked by Chair Mary Jo White to stand, at least two thirds of the room took to their feet.

But it doesn't seem to add much to the regs already in place. Even POGO, the NGO that seems to be behind the introduction of the bill, acknowledges - indeed, it collects data on - previous ethics restrictions: "SEC regulations require former employees to file [ethics] statements if they intend to represent an employer or client before the agency within two years of their SEC employment." This even gives them the out of a waiver. But you can look over the text of the bill and let me know if you see anything more than a more specific ban of agency officials working on matters post-employment that they handled pre-termination.

View today's posts

3/27/2015 posts

HLS Forum on Corporate Governance and Financial Regulation: The Unintended Consequences of Proxy Access Elections
SEC Actions Blog: This Week In Securities Litigation (Week ending March 27, 2015) Blog: Proxy Statements: Pru Includes Lead Director Video
Race to the Bottom: Omitted Shareholder Proposals and the Anti-Fraud Provisions
Conglomerate: The Latest Attempt To Slow The Revolving Door At The SEC

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