By Jonathan Stempel
NEW YORK (Reuters) - U.S. investor advocates have
hailed a new rule making it easier to oust corporate directors,
but it could be susceptible to legal challenges by opponents
who argue it curbs shareholders' say in how companies are run.
The specter of a court fight was raised by Kathleen Casey,
a U.S. Securities and Exchange commissioner who dissented in
the agency's 3-2 vote last week adopting the rule.
Critics say "proxy access," as the rule is known, could
propel fringe candidates onto boards who do not have a
company's best interests at heart.
"Lawsuits are virtually certain," said Joseph Grundfest, a
Stanford Law School professor and former SEC commissioner. "The
list of plaintiffs include many trade associations and
corporations that would be affected by the rules or have to
Grundfest said the rule could also run afoul of the
Administrative Procedure Act, a federal law explaining how
federal agencies set up regulations, because the rule may not
rationally relate to its intended purpose.
The new rule gives shareholders who own 3 percent of a
company's stock for at least three years a right to list their
nominees for board seats on the company ballot.
Previously, shareholders would have to lobby for board
seats through the mail, a costly and time-consuming process
long used by investors like Carl Icahn, and now being used by
the billionaire Ron Burkle against Barnes & Noble Inc.
Small companies are exempt from the new rule for three years.
The SEC was expected to craft a proxy access rule in 2009,
but took more time amid concern a court could strike it down.
Yet even the new rule might infringe state limits on power
to elect and empower shareholder nominees, according to J.W.
Verret, a George Mason University law professor who said he has
helped some Fortune 50 companies fight insurgent slates.
"States have a number of methods whereby boards can defend
against proxy access," he said.
Among them, he said, are to let boards set minimum
qualifications for directors, deny insurance coverage to
insurgents that board members ordinarily insist on, and even
block insurgents from sitting on key subcommittees.
Not everyone believes such a conflict is insurmountable.
"The SEC has regulated proxy voting for some time, though
the substantive shareholder rights are based on state law,"
said Bruce Aronson, a professor at Creighton University School
of Law in Omaha, Nebraska.
"I expect courts would respect that. Down the road, if U.S.
companies adopt measures to thwart the proxy access rule, there
could be substantial litigation."
The SEC won power to adopt the rule under the financial
regulation overhaul known as Dodd-Frank, which President Barack
Obama signed into law in July.
Supporters included pension funds, unions and governance
specialists who believe it can help push underperforming
companies to adopt changes. CalPERS, which invests $200 billion
and is the largest U.S. public pension fund, called it a
"thoughtful, fair rule."
Opponents included business groups such as the Business
Roundtable and U.S. Chamber of Commerce. They fear the rule
might give too much power to dissident hedge funds and activist
shareholders that might put their short-term interests first.
SEC Chairman Mary Schapiro supported the rule, calling it
"a matter of fairness and accountability." But Casey, who
dissented along with the agency's other Republican
commissioner, said "the rule is so fundamentally and fatally
flawed that it will have great difficulty surviving judicial
Brett McDonnell, a University of Minnesota Law School
professor, said it may appear incongruous for the SEC in its
451-page review of the changes to proclaim wider proxy access
for "individual shareholders" and then limit it to large ones.
George Mason University's Verret said boards could try to
thwart dissident slates through what he called a "whitemail"
defense, named for the white proxy cards that insurgent
"It is perfectly OK for boards to pay insurgents to go
away," he said, explaining the defense, "and not to nominate
themselves for election via the proxy process."
McDonnell said courts might urge the SEC to make the proxy
access rule more flexible.
"As it stands, the law appears internally contradictory,"
he said. "You could perhaps fix the problem by allowing
shareholders to opt out of the rule in any direction they
choose. Much of the law would still be valid."
(Reporting by Jonathan Stempel in New York; Editing by Martha
Graybow and Derek Caney)