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Today’s Shareholder Access Post: What About That Third Trigger?

As proposed, the SEC’s shareholder access rule incorporates two triggers:

1. A shareholder puts forward a proposal to authorize shareholder nominations, which is then approved by the holders of a majority of the outstanding shares; or
2. Shareholders representing at least 35% of the votes withhold authority on their proxy cards for their shares to be voted in favor of any director nominated by the incumbent board of directors.

In addition, the SEC’s proposing release solicited comments on a possible third triggering event, which would have three criteria:

[A] A security holder proposal submitted pursuant to Exchange Act Rule 14a-8, other than a direct access security holder proposal, was submitted for a vote of security holders at an annual meeting by a security holder or group of security holders that held more than 1% of the company's securities entitled to vote on the proposal for one year and provided evidence of such holdings to the company; [B] The security holder proposal received more than 50% of the votes cast on that proposal; and [C] The board of directors of the company failed to implement the proposal by the 120th day prior to the date that the company mailed its proxy materials for the annual meeting.

As the SEC acknowledged, this proposal just invites time-consuming disputes on such minutiae as whether the board failed to implement the proposal.

There is a more fundamental flaw with this third trigger, however. State corporate law provides that the key player in the statutory decisionmaking structure is the corporation’s board directors. As the Delaware code puts it in section 141, the corporation’s business and affairs “shall be managed by or under the direction of a board of directors.” The vast majority of corporate decisions accordingly are made by the board of directors alone (or by managers acting under delegated authority). Shareholders essentially have no power to initiate corporate action and, moreover, are entitled to approve or disapprove only a very few board actions. The statutory decisionmaking model thus is one in which the board acts and shareholders, at most, react.

The proposed trigger shifts that balance of power in favor of the shareholders. At present, the vast majority of shareholder proposals under SEC Rule 14a-8 must be phrased as recommendations rather than as directives to the board. If a precatory proposal passes but the board of directors decides after due deliberation not to accept the shareholders’ recommendation, the board’s decision currently is protected by the business judgment rule. Hence, the board’s power of direction is insulated from being trumped by the shareholders.

To be sure, the proposed trigger would not mandate that boards implement precatory proposals. It would, however, ratchet up the pressure on boards to accede to shareholder proposals even when the board in the exercise of its business judgment believes the proposal to be unwise. As we shall see, if adopted, Rule 14a-11 would impose significant direct and indirect costs on the corporation. In order to avoid a shareholder nomination contest, the board therefore might implement a proposal it deems unsound.