The Destructive Ambiguity of Federal Proxy Access

ABSTRACTAfter almost seventy years of debate, on August 25, 2010, the U.S. Securities and Exchange Commission adopted a federal proxy access rule. The D.C. Circuit promptly invalidated the new rule before it ever went into effect. This Article examines the ill-fated rule and concludes that, although the D.C. Circuit did not identify its flaws, the rule was ambiguous in its application and unlikely to increase shareholder input into the composition of corporate boards. More troubling was the SEC's ambiguous justification for its rule, which was neither grounded in state law nor premised on a normative vision of the appropriate role of shareholder nominations in corporate governance.Although the federal proxy access rule in its current form is now dead, had it gone into effect, its practical significance would have been minimal. The SEC's ambiguous approach to proxy access, an approach that significantly predates its adoption of Rule 14a-11, is particularly problematic because its rules continue to burden issuer-specific innovations in nominating procedures. The SEC has acknowledged this criticism but has refused to remove existing regulatory burdens.The core of the problem, as illustrated by the SEC's experience with proxy access, is that federal regulation is poorly suited for regulating corporate governance. Private ordering offers a more flexible mechanism for maintaining equilibrium in the allocation of power between shareholders and managers. Absent federal regulatory interference, existing state law permits issuer-specific innovation regarding the shareholder role in nominating director candidates. This Article concludes by outlining the federal regulatory changes necessary to enable effective private ordering.INTRODUCTIONUnder U.S. corporate law, the shareholders elect the board of directors.1 In most cases, however, those shareholders do not nominate director candidates. Instead, the nominating committee of the board chooses a slate of candidates, and those candidates are submitted to the shareholders for approval.2 Absent the infrequent phenomenon of an election contest,3 shareholders do not participate in the nomination process.4The Securities and Exchange Commission (SEC) has struggled for years to regulate the shareholders' role in nominating directors.5 As early as 1942, the SEC proposed a rule that would have required issuers to include shareholdernominated candidates in their proxy statements.6 Ultimately, the SEC abandoned the proposal. In the ensuing almost-seventy years, the SEC revisited the issue at least five times but failed to adopt a rule allowing proxy access.7Adoption of a shareholder nomination rule faced several obstacles. First, from the outset, the rule faced strong opposition from business interests. Indeed, measured by the number of comment letters, proxy access is, by far, the SEC's most controversial rule-making initiative.8 Second, as the SEC refined the federal proxy rules in response to ongoing marketplace developments, the details of a proxy access rule became both increasingly important and impossible to perfect. Fundamentally, the SEC was unable to drafta proxy access rule that would satisfy everyone. Third, the D.C. Circuit declared in its 1990 decision in Business Roundtable v. SEC that the SEC lacked the authority to regulate corporate governance through the proxy rules.9 A shareholder nomination rule was likely to raise a potential conflict with this holding and to trigger litigation seeking to invalidate the rule.10When Congress authorized the SEC to adopt a federal proxy access rule as part of the Dodd-Frank financial regulatory reforms,11 it removed the last of these hurdles, clearing the way for the SEC both to adopt proxy access and, more importantly, to consider explicitly the corporate governance implications of increasing shareholder access to the proxy. Yet Rule 14a-11,12 the SEC's proxy access rule, adopted on August 25, 2010, when the ink on Dodd-Frank was barely dry,13 was limited in scope and ambiguous in both its application and its justification. …