The US Court of Appeals for the District of Columbia Circuit (the Court) has vacated Rule 14a-11 under the Securities Exchange Act of 1934, as amended (the Exchange Act), which was adopted by the Securities and Exchange Commission (the SEC) in August 2010. Rule 14a-11 was designed to facilitate access by shareholders to public companies' proxy statements in order to propose nominees for election to boards of directors.

On September 29, 2010, the Business Roundtable and the Chamber of Commerce of the United States of America filed a petition with the Court seeking review of Rule 14a-11. The petitioners also filed with the SEC a motion to stay the effectiveness of Rule 14a-11 pending review by the Court. The SEC granted the motion to stay the effectiveness of Rule 14a-11 and further stayed the effectiveness of the amendments to Rule 14a-8 under the Exchange Act adopted contemporaneously with Rule 14a-11. The rules were to take effect on November 15, 2010.

In the adopting release for Rule 14a-11, the SEC noted that it had adopted the rule based on its belief that it would lead to cost savings for shareholders seeking to nominate directors, in part due to reduced printing and postage costs and reduced expenditures for advertising compared to those associated with a traditional proxy contest.¹ In addition, the SEC stated that the rule "has the potential of creating the benefit of improved board performance and enhanced shareholder value." The SEC also noted that it had considered both the anticipated costs to be imposed upon public companies by the rule related to the preparation of required disclosure, and potential adverse effects on board performance resulting from the rule, and had concluded that the benefits of the rule would justify its costs.

In a unanimous opinion written by Judge Douglas Ginsburg on behalf of the three-judge panel, the Court found that the SEC "inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters." The Court, therefore, vacated Rule 14a-11 for being in violation of the federal Administrative Procedure Act. The Court did not address the petitioners' additional arguments that the SEC had arbitrarily rejected proposed alternatives to the proxy access rule or that the rule violates the First Amendment of the US Constitution.

In particular, the Court found that the SEC, among other things:

• Neglected both to quantify the costs that companies would incur in opposing shareholder nominees and to substantiate the rule's predicted benefits;
• Relied upon insufficient empirical data when it concluded that the rule would improve board performance and increase shareholder value;
• Failed to adequately consider that institutional investors with special interests, such as unions and state pension funds, may use the rule as leverage to gain concessions from companies unrelated to shareholder value;
• Arbitrarily ignored the effect of the rule upon the total number of election contests; and
• Failed to adequately address the benefit from proxy access for shareholders of investment companies and costs that the rule would impose upon investment companies by disrupting the structure of their governance.

In responding to this decision, the SEC could ask for a rehearing before the Court, appeal the Court's decision to the US Supreme Court, or refine its economic analysis as directed by the Court and re-propose a different proxy access rule. In each case, it is virtually certain that any new proxy access rule would not be effective in time for the 2012 proxy season.

Shareholder Proposals to Modify Company Nomination Procedures

The Court's ruling does not affect the validity of the amendments to Rule 14a-8 under the Exchange Act that were adopted by the SEC contemporaneously with Rule 14a-11. Those amendments provide that shareholders can require companies, under certain circumstances, to include proposals in their proxy materials that would require or request amendments to company charters and bylaws addressing nomination procedures for members of boards of directors. This would mean, for example, that shareholders could propose resolutions to require a company to amend its bylaws in order to specify particular procedures by which shareholders can propose director nominees. In order to submit a proposal under this amended rule, a shareholder proponent would be required to have continuously held at least $2,000 in market value (or 1%, whichever is less) of the company's securities entitled to be voted on the proposal at the meeting, for a period of one year prior to submitting the proposal.

The SEC has not yet announced whether and when it plans to lift its stay on the effectiveness of amendments to Rule 14a-8. If the stay is lifted, the amended rule may take effect prior to the 2012 proxy season.

Footnotes

1 "Facilitating Shareholder Director Nominations," Release Nos. 33-9136; 34-62764; IC-29384; File No. S7-10-09, August 25, 2010, available at http://www.sec.gov/rules/final/2010/33-9136.pdf.

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