A federal judge in Texas ruled Monday that KBR may omit a board declassification proposal filed by California shareholder activist John Chevedden after concluding that he failed to provide sufficient proof of ownership
Following the litigation strategy used by oil company Apache in 2010, KBR bypassed the SEC’s no-action process that is used by hundreds of companies each proxy season and filed a lawsuit in federal court in Houston, where the engineering company is based.
While the court’s ruling is not legally binding outside Texas, this case may inspire other companies to bypass the no-action process and file their own lawsuits. Chevedden has been a magnet for omission requests in recent years, in part because he and his network of retail investors typically file more than a hundred proposals each season on popular governance topics like declassification and the repeal of supermajority voting rules. This year, more than a dozen companies have raised a variety of eligibility challenges against Chevedden network proposals, but few have obained no-action relief from the SEC.
In its lawsuit, KBR argued that Chevedden’s ownership letter from Ram Trust Services (RTS), a Maine-chartered non-depositary trust company, failed to satisfy the requirements of SEC Rule 14a-8(b)(2), which requires investors to provide a statement from a “record” holder, which can be an “introducing broker” or a bank, according to the SEC staff. KBR argued that RTS is not a record holder, because it is an investment adviser and is not a participant in the Depository Trust Co. (DTC), a nationwide clearing agency that holds most of the shares that are owned by U.S. retail investors.
The KBR lawsuit was heard by U.S. District Judge Lee H. Rosenthal, the same judge who ruled for Apache in a relatively narrow decision in March 2010. In the Apache case, Rosenthal said a similar RTS letter was not sufficient to comply with Rule 14a-8(b)(2), but the judge did not address a second ownership letter from Northern Trust because it was submitted too late.
Since the Apache decision, the staff of SEC’s Corporation Finance Division has rejected similar arguments raised by Devon Energy, Prudential Financial, and Union Pacific to omit proposals filed by Chevedden and affiliated investors.
Notwithstanding those staff decisions, Judge Rosenthal concluded that the Apache decision was still good law, in part because of the eligibility requirements the SEC adopted in August for its proxy access rule, Rule 14a-11. In that rule, the SEC said an investor whose broker is not a DTC participant must “obtain and submit a separate written statement from the clearing agency participant through which the securities of the nominating shareholder . . . are held, that (i) identifies the broker or bank for whom the clearing agency participant holds the securities, and (ii) states that the account of such broker or bank has held, as of the date of the written statement . . .”
“The SEC’s comments on Rule 14a-11 show that Apache’s reasoning is still persuasive and provides a basis to conclude that the SEC no-action letters do not undermine Apache,” the judge ruled.
Chevedden argued that KBR did not have legal standing to obtain a declaratory judgment because he had promised not to sue if the company omitted his proposal. However, the judge said his refusal to withdraw his proposal “shows a willingness to continue to litigate the dispute” and “creates an uncertainty that KBR is entitled to have clarified.”
Chevedden said he is considering an appeal.
The SEC staff had planned to address Rule 14a-8(b)(2) in a staff legal bulletin, but the staff was unable to obtain a consensus among senior commission officials on new standards before the 2011 proxy season, SEC observers have said. The KBR case is further evidence of the continued uncertainty faced by shareholder proponents and companies over proof of ownership until the SEC provides more guidance.