Chairman Christopher Cox of the Securities and Exchange Commission told lawmakers this week that the agency plans to issue proposed proxy rule changes by late July, in an effort to have final rules in place before the 2008 U.S. proxy season.
Cox said the proposed rules would address non-binding shareholder resolutions and proxy access (i.e., the ability of long-term investors to nominate directors to appear on management proxy statements). As part of this process, the commission also is reviewing a proposed New York Stock Exchange rule to bar brokers from casting uninstructed shares in board elections.
While Cox signaled that the SEC would not revive a draft 2003 proxy access rule that would apply to all companies, his comments suggested that the commissioners are still trying to reach an agreement on the issue. "We're still actively engaged in discussions," he said.
Cox made his comments during a rare appearance by all five SEC commissioners before the House Committee on Financial Services. For almost four hours on June 26, lawmakers quizzed the SEC officials on various topics, including the competitiveness of U.S. capital markets, the ability of shareholders to sue bankers and others who help companies defraud investors, whether small companies should be subject to internal control reporting requirements, and a pilot program that requires advance commission approval of corporate fines.
While Cox said earlier that the SEC would issue a rule this summer, he was more definitive at the House hearing about the expected timetable. However, he declined to shed much light on the new rules during generally respectful questioning from lawmakers. Cox, a former Republican congressman from California, previously served on the financial services committee.
Rep. Barney Frank, the Massachusetts Democrat who chairs the House panel, said the committee would hold a "full hearing" after the new proxy rules are proposed. "There is a lot of interest on the issue," he noted.
The commission has struggled for years to reach a consensus on proxy access. The SEC, which abandoned the draft rule in 2005 amid corporate opposition, was forced to revisit the issue after a New York-based federal appeals court ruled in September 2006 that the agency improperly allowed American International Group (AIG) to exclude a proxy access proposal.
Shareholder advocates, who say that proxy access is needed to ensure board accountability, have urged the SEC to clarify that investors may continue to file access resolutions at specific companies. Access proposals received 45 percent support at UnitedHealth and 43 percent at Hewlett-Packard this year. An access proposal filed by a dissident investor will be on the ballot July 16 at Cryo-Cell International, a small-cap firm in Florida.
Corporate interests have argued that proxy access is not necessary, given the various reforms already adopted by many companies, such as majority voting in board elections.
During the hearing, several Democratic lawmakers spoke in favor of proxy access. "This is an issue of great significance," Rep. Frank noted, according to the Associated Press. Another lawmaker said he would be concerned if the SEC adopts a high economic threshold that would bar most shareholders from participating. Rep. Brad Sherman from California observed that "the world has not caved in" after the SEC stopped granting corporate "no action" requests to omit access proposals following the AIG ruling.
Noting that the AIG decision applies only to one section of the country, Cox said, "we need to make sure that there's one rule for the whole country, that everyone understands it, and that we have it in time for the next proxy season," he said.
Annette Nazareth, one of two Democratic commissioners on the SEC, noted her support for the commissioners to address the issue. "I would want action on proxy access as soon as we can," she said.
It appears that Cox is leaning toward allowing shareholders to pursue access proposals at specific companies, instead of proposing a universal rule that applies to all issuers. "I share your concerns about imposing a federal set of detailed rules on what is a matter of state law," Cox told lawmakers. "A national bylaw is not an approach I would favor."
When asked by Rep. David Scott of Georgia about the utility of non-binding (or precatory) shareholder proposals, Cox recalled the arguments made by proponents and critics at three agency roundtables in May.
While some companies view these proposals as a "nuisance" and a distraction, Cox acknowledged: "they're non-binding, and therefore there is a limit to the distraction that [they] can provide."
While Cox didn't reveal his views on whether stricter filing requirements are needed, he did say that the SEC is studying the feasibility of electronic shareholder forums. "We want to make sure we have healthy communication at all times with companies," he said.
"The more communication, the better," Cox told lawmakers. "We're looking for a cost-effective means that doesn't interfere with the running of the company."
The commission has acted three times since 1970 to revise Rule 14a-8, which governs shareholder proposals. In 1998, the SEC backed away from stricter limits on resubmitted proposals after companies objected to another provision that would have allowed investors who own more than a 3 percent stake to override no-action decisions by agency staff.
Democratic Rep. Melvin Watt of North Carolina asked Cox about the proposed NYSE rule and voiced concern that broker votes enabled a CVS/Caremark director to win election in May. Watt noted that investor advocates and North Carolina Treasurer Richard Moore have asked the company to provide more information on how broker votes were cast, but they were "stiff-armed."
Cox explained that some smaller companies would be unable to meet quorum requirements without broker votes. He said this concern will be "in the mix" as the commissioners consider broker votes and other proxy issues, and he noted that the SEC may conduct a separate rulemaking to address the NYSE rule.
Broker votes do account for a significant percentage of the shares in U.S. companies. About 85 percent of exchange-traded securities are held by brokers and banks on behalf of their clients, according to the SEC. Traditionally, brokers have cast those shares in favor of management nominees, prompting the Council of Institutional Investors and other shareholder advocates to describe the practice as "ballot-box stuffing."
Rep. Paul Kanjorski, a Pennsylvania Democrat, asked Cox about complaints by business groups that the Sarbanes-Oxley Act is discouraging foreign companies from entering American capital markets.
"I don't think the sky is falling," Cox said. "All around us, there's more competition." At the same time, he noted that U.S. markets are still attracting foreign companies. "We're on pace to have the most foreign listings in the U.S. since 1997."
Commissioner Paul Atkins offered a different view. "There is no doubt that regulatory costs do discourage issuers from coming to the U.S.," he said. While he agreed that some companies are attracted by U.S. legal protections, Atkins said, "others can be repelled if regulations are not in balance."
The lawmakers expressed widely divergent opinions on securities class-action lawsuits. Several Democrats praised the SEC's recommendation that the U.S. government submit a brief in support of investors in an upcoming Supreme Court case on "scheme liability" (i.e., whether shareholders should be able to sue bankers, vendors, and other "secondary actors" who help companies engage in fraud.) The outcome of that case may affect the efforts of Enron investors to recover billions of dollars from three of the company's former underwriters.
The case, known as Stoneridge Investment Partners v. Scientific-Atlanta, produced a rare SEC split under Cox. He joined with the agency's two Democratic commissioners to vote for filing a brief to support investors. The Office of the Solicitor General, which represents federal agencies, decided not to back investors after hearing opposition from the Treasury Department, the Federal Reserve, and White House officials, according to news reports.
Noting that the Solicitor General represents the government, not just the SEC, Cox said it's not uncommon for other agencies to have different views on a Supreme Court case. He said the SEC was within its rights to make its recommendation, "given our charter and our responsibilities" to protect investors. Cox defended his vote by noting, "I thought it was important to be consistent" with the 2004 position that the agency took in the Homestore litigation, where investors claimed that AOL Time Warner helped the company inflate its revenues.
Rep. Frank praised the SEC's position in Stoneridge and distinguished that case from other securities law disputes, such as the recent Tellabs decision, where the Supreme Court tightened pleading standards. Frank said he supports efforts to require more evidence of fraud, but he opposes the elimination of a whole class of scheme liability claims.
Atkins and Commissioner Kathleen Casey, who voted against the Stoneridge recommendation, said the liability standards detailed in the agency's brief were too vague. "It's important to have a test that draws a clear line," Atkins noted.
Meanwhile, several Republicans denounced the SEC's recommendation. Rep. Richard Baker of Louisiana said the agency's position is a "clear and present danger" to U.S. capital markets. Rep. Tom Price of Georgia warned of "settlement extortion" by plaintiffs' lawyers, noting that there have been $43 billion in securities settlements in the past decade.
Rep. Ed Royce of California cited the concerns about frivolous litigation raised in a report by U.S. Senator Charles Schumer and New York Mayor Michael Bloomberg. Royce and 15 other Republican lawmakers have asked the SEC to prepare a report on the costs and benefits of securities lawsuits.
In a June 22 letter, the lawmakers asked the agency to examine settlements and detail the transaction costs--including attorneys' fees--that decrease the value of shareholders' investments. The letter also asked the SEC to address if there are sufficient legal protections to deter "professional plaintiffs," and whether there is a need for a "pay-for-play" ban on political contributions by plaintiffs' lawyers to government officials who oversee public pension funds. Finally, the SEC was asked to recommend whether private settlements should be coordinated with Fair Fund distributions by the agency.
Royce asked the SEC to complete that report by the end of the year. Cox said the agency would produce the report, and he appeared receptive to the suggested pay-for-play ban.
Cox was asked by several Democrats about whether the SEC was considering a proposal to allow companies to mandate the arbitration of investors' claims. In response, Cox said, "we have no pending proposal" to do so, repeating comments that he made to a Senate panel in May.
*This article originally ran in the June 28 edition of Governance Weekly.