While the decision of the Second Circuit Court of Appeals binds many
public companies of that specific jurisdiction, the SEC must now decide
whether to propose a clarifying change to Rule 14a-8(i)(8) ("the
Rule"), binding all companies subject to Federal Securities
Law and alleviating courts of difficult interpretation. A letter from
shareholders to the Honorable Christopher Cox, requesting a return to
the pre-1990 interpretation of the Rule, stressed an important
distinction: ". . . between using a shareholder resolution as a
back-door device to contest a specific election and using a shareholder
resolution in order to change the rules for election so as to further
the long-term interests of shareholders." It is this distinction
which also divides the opinions of Stephen Bainbridge, Margaret Blair
and Lynn Stout on one side from those of Lucian Bebchuk. Bainbridge,
Blair and Stout espouse theories such as "director primacy" and hold
views opposing the shareholder primacy norm. Their views appear to
coincide with a decision against shareholder resolutions as a means to
undermine a board’s power through elections. Their views appear to
greatly differ from those of Bebchuk’s, who proposes allowing
shareholders to alter "rules-of-the-game" decisions or else elect a new
team of directors who will. This report will use Bainbridge, Blair
and Stout’s theories in support of an amendment seeking to expand the
rule’s exclusions regarding shareholder proposals to limit
shareholders’ input dealing with elections in general, while Bebchuk’s
theories will be relied upon to amend the Rule in order to empower
shareholders. This assumption arises primarily from a grand
simplification of both groups’ views: "director primacy" v.
"shareholder primacy norm," respectively and this report will utilize
their theories to weigh the arguments in favor and in opposition to an
A revision to the Rule proposed by the SEC, if taking into account
American International Group’s (“AIG”) arguments, would ultimately seek
to reduce shareholders’ rights in initiating “permitted” changes to the
bylaws. The American Federation of State, County & Municipal
Employees (“AFSCME”) submitted for inclusion in the 2005 proxy
statement, a shareholder proposal requiring publication of
shareholder-nominated candidates for director positions. Rather than
suggesting nominees for the purpose of opposing the nominating
committee’s selection of candidates, the shareholder proposal was an
attempt to alter procedures for elections in general, instead of
causing a “contested contest” in a particular election. Additionally,
if the proposal was included in the proxy statement, the board would
have had an opportunity to state its reasons for opposition. The
shareholder proposal appears not to be a unique one. The shareholder
proposal appears quite similar to the one in AOL Time Warner Inc.,
in which case the SEC initially denied the company’s request for
no-action relief in December of 2002, but then subsequently issued a
No-Action letter, stating that there “appeared to be some basis” that a
contested election could result. The initial letter is one of many
which are demonstrative of the SEC implementing its pre-1990
interpretation of the Rule, which the Commission now concedes as a
III. Rationale behind Increasing Shareholder Power
When analyzing Professor Bebchuk’s articles, it becomes apparent
that he is in favor of reducing “substantial impediments facing
shareholders when they seek to replace incumbent directors.” Instead
of relying on intervention by legislators and regulators, he is in
favor of enabling shareholders themselves. According to Bebchuk,
allowing shareholders the ability to initiate special interest
proposals would not give shareholders “blackmail power,” since
proposals that were purely designed to advance special interests would
not pass by a majority vote. In other words, even if no revision
was made to the Rule, nominated candidates who attempted to further
their own interests would not garner favor, let alone election to the
board. Bainbridge persisted in the fact that such shareholders would
still maintain power over the board, due to the board’s uncertainty
regarding which proposals would fail and thus, would be inclined to
make concessions. Using Bebchuk’s analysis, such concessions would
be unnecessary as special interest resolutions (and nominees advancing
them) have received little support in the past. Bainbridge also
offers the Panglossian argument, which would not promote an amendment
in expanding the Rule to exclude any proposal touching upon any facet
of elections. Instead, such a theory would actually counter any
sort of reform to the Rule, relying instead on the marketplace to
produce its own optimal governance terms. Such a standard
contractarian approach, however does not explain why federal
intervention has altered state laws with rules geared towards
protecting investors. Bebchuk explains that without the federal
intervention of the last seven decades, shareholders would not have
even been as empowered as they are currently. Such a viewpoint does
not further a need to amend the Rule to limit shareholders from
nominating worthy candidates, but does provide justification in
amending the Rule to specify allowing general election procedure
information and excluding information regarding specific nominees for
the purpose of causing contested elections.
While Bebchuk appears to be in favor of shareholder nominated
candidates, he proposes procedural requirements in assuring that
holding and owning requirements are met and limits resubmission of
defeated proposals. In demonstrating options to the board, he
explains that “when confronted by a challenger running on a platform of
adopting value-enhancing change … management would likely be able to
win by … pledging to initiate the promised change.” Not only would
this discourage challengers from initiating a proxy contest in the
first place, but provides little justification for amending the Rule.
The SEC’s concern in proposing an amendment to the Rule is to make sure
the board retains its control and so as not to allow shareholders’
nominees to cause contested elections; however, this is hardly a
concern considering electoral challenges to the board’s candidates are
IV. Rationale behind Limiting Shareholder Power
Utilizing Bainbridge’s rationale, limiting shareholder proposals
like AFSCME’s through an amendment would seem inevitable, as he
considers this the “majoritarian default.” Such a default rule
assumes shareholders to be “rationally apathetic” and lacking incentive
to actively participate in decision-making. Bainbridge’ reasoning
does not take into account those shareholders, such as AFSCME’s who
desire to initiate change to the bylaws. Instead, Bainbridge assumes
most shareholders will passively acquiesce to candidates proposed by
the board. While it is true that activist institutional investors
were not previously the norm, due to the length and complexity of
disclosure documents, it is apparent that informed shareholders are now
trying to get more involved, and it is necessary to clarify what their
particular rights are in terms of elections. However, Bainbridge notes
that active investor involvement in corporations would disturb the very
essence of practicality: “centralization of essentially non-reviewable
decision-making authority in the board.” In his opinion when
managers do put their own interests before shareholders it is simply
for fear of being voted off the board and such a situation permits
resistance to proxy contest reform. This justification, however, is
difficult to reconcile since shareholders may still vote on the removal
of directors, without attempting to reform the proxy contest.
Bainbridge’s view regarding shareholders is best depicted through one
rather controversial statement: “Shareholder voting is properly
understood not as a primary component of the corporate decision-making
structure, but rather as an accountability device of last resort, to be
used sparingly, at most.”
Turning now to Blair and Stout’s article, it is clearly in favor of
management with somewhat more complex theories than Bainbridge’s.
Instead of focusing on the usual struggle between the board and
shareholders, Blair and Stout study a team production model comprised
of shareholders, management, employees and even creditors. It is
this team which the board, as a “mediating hierarchy,” is designed to
protect, and not the shareholders interests alone. Such a theory
dispels the board as agents of shareholders and defines the board as
the “trustees” of the team. Such a theory supports allowing an
amendment to the Rule in favor of the board, if the amendment would
also benefit other members of the team; however, this would be a
drastic change from current thought, which focuses on the shareholder
primacy norm. This “trustee” rationale appears somewhat similar to the
business judgment rule in that it would argue the board was acting in
good faith when serving the team and such an argument cannot normally
be successfully contested. As boards are often thought to know more
about what ails their respective corporations than courts, an amendment
to the Rule in favor of the board would most likely not be countered by
shareholders, since the board could use the business judgment rule as
its defense. While it has often been suggested that “shareholder
delegation of decision-making authority to the board is in the
shareholders’ best interests” in regards to efficiency and sound
judgment, boards must consider the rise of informed and outspoken
shareholders. And even if by chance these intelligent shareholders
nominate a sub-par nominee to the board, according to Bebchuk, such a
nominee would never even gain majority vote and could be kept from
re-appearing in the next year’s proposal by failing the “two meeting
rule.” However, when the board acts as a “trustee” towards
shareholders, as well as other employees on the “team,” it does not
treat shareholders any different from those who are mere staff
employees. If this were the case in practice, both employees of
corporations as well as creditors, would be allowed voting rights. One
potential issue with such a scheme would be mass confusion regarding
the differentiation between debt and equity and the fact that
bondholders are given priority through fixed payments, whereas
shareholders are traditionally given voting rights as owners of the
corporation. In such a scheme, creditors would be given the best of
both worlds (voting/ ownership rights and fixed payments), leaving
shareholders owning perhaps ten percent of the company, without much to
show. Such chaos may cause shareholders to remove themselves from the
“team” and seek higher opportunity costs elsewhere.
Blair and Stout hold an interesting view on derivative suits in that
they do not give rights to shareholders per se, but to the corporation
itself. In other words, shareholders are not given rights to sue for
themselves, but for the corporation or “team” to whom case law finds
fiduciary duties to be owed. The explanation offered by the two
professors that the business judgment rule negates the shareholder
primacy norm, thus negating the board’s status as an agent, seems to be
a reason for empowering shareholders. Since according to such a theory,
the board does not owe any fiduciary duties, such as the duty of
loyalty to the shareholders, they must resort to amending bylaws and
nominating candidates who will look out for their interests. Such
theories if proposed to the shareholders themselves, would cause great
concern and would force the shareholders into taking on an
“everyone-for-himself” sort of approach to survive. I think the
appropriate question that arises in anyone’s mind at this point is,
“why give shareholders any rights regarding the election process at
all?” To which Blair and Stout have prepared an answer: to act as a
mere safety net in extreme misconduct situations. What these
scholars appear to be conclusively stating is that shareholders’ voting
rights are of such little value that they are unlikely to influence
outcomes; but, if this is true, then why not allow shareholders the
satisfaction in thinking they are nominating candidates to the board,
while in actuality no real threat of overthrow could arise?
My primary recommendation to the SEC would be to amend the Rule by
in favor of expanding shareholders’ rights in regards to elections. I
believe an amendment would be a more efficient alternative than to
force controversial proposals to be resolved in lengthy lawsuits. Cases
such as Bebchuk v. CA, Inc. and Gen. Datacomm Indus., Inc. v. State of Wis. Inves. Bd.
have already demonstrated courts’ unwillingness to review unripe
situations and this provides an even greater incentive to corporations
to rely on internal problem-solving. This way, boards would be
bound by the new clearly-stated Rule and would most likely be deterred
from attempting to circumvent the law by soliciting a No-Action letter
from the SEC. It would be inefficient for a board to attempt to deny
the plainly-written text of the Rule in hopes that the SEC would revert
to the pre-1990 interpretation. I strongly concur with the views of the
Second Circuit Court Judge, Wesley, in AFSCME v. AIG. The
court opined that “an agency’s interpretation of an ambiguous
regulation made at the time the regulation was implemented or revised
should control unless that agency has offered sufficient reasons for
its changed interpretation.” The Rule’s last revision in 1976 was
pretty clear in stating the all election-related proposals would not be
excluded. This is seen through the exceptions the SEC clearly stated it
was not excluding: cumulative voting rights, general qualification for
directors and political contributions to the issuer. All of these
seem to “relate to an election,” but were permitted in the 1976
interpretation. While the SEC stated that based on the 1976
interpretation, shareholder proposals could be excluded under the
election exclusion if they resulted in an “immediate election contest,”
a shareholder proposal establishing a process to wage a future election
contest would be far from immediate. Rather, it is unknown whether a
contested election would even result in the future. However, the SEC
seems to have altered the interpretation without any reasoning in 1990
and even then appeared uncertain of the new interpretation, as
evidenced by its wavering application through 1998. While it is true
that the SEC applied the original interpretation for approximately
sixteen years, it can be easily changed so long as some reason is
stated beyond mere “mistake.”
We must look at the general purpose of the Rule which appears to
have been to allow certain election-related proposals, while excluding
those that might result in a contest. Under such a proposed purpose, it
seems counterintuitive to refuse proposals such as AFSCME’s, without
also excluding the exceptions stated above. These exceptions are very
important in that they demonstrate the Commission’s original intent
when promulgating the Rule and are indicative of a drastic change in
policy from the one in place for sixteen years.
My recommendation would seek to allow general proposals such as
AFSCME’s even if ultimately resulting in a contest and exclude
proposals intentionally waged to trump the board. While it is important
to extend rights to the shareholders of a corporation, such rights must
not be limitless. Allowing shareholder proposals on any
election-related factor would be far too broad, while excluding the
right to contribute to the election process entirely would be too
limiting. This would ultimately be a fact-intensive inquiry. Investors
need a mechanism with which to replace incumbent directors and such a
mechanism will force the directors to make decisions with the
shareholders in mind. I am opposed to an amendment to the Rule which
would prohibit all information dealing with an election. While the SEC
might appear to be satisfied with such an amendment, their real concern
seems to be with shareholders’ ability to wage election contests
without undertaking a full-blown proxy solicitation. Even though
the SEC is justified in thinking that shareholders may be able to
bypass full disclosure regarding their nominees by placing such
information in a proposal, there is no solid basis for the SEC to
believe so. There is no reason to believe that simply because
shareholders would have the option of nominating candidates that they
would no longer use a proxy to vote for the board’s candidates, or to
believe that the shareholder proposal would become a way to “beat the
system” so to speak. It would be safe to assume that those eligible of
nominating candidates (3% shareholders of a year) would be
sophisticated business persons capable of following the same disclosure
rules which would apply to the board.
Utilizing the approach that many still take, (despite the theory
espoused by Lynn & Stout) shareholders and the board are involved
in a principal-agent relationship. It may be argued that the board has
actual authority to engage in only those actions which would benefit
the shareholders and the implied authority to make secondary decisions
leading to the success of the shareholder primacy norm principle. It is
already well known that the board holds control regarding the state of
incorporation or reincorporation and amendments to the charter.
Shareholders also understand that their initiated bylaw amendments may
not set solid rules, nor force the board to do anything. However,
shareholders must be afforded the opportunity to at least have their
proposals included in the proxy statement, along with those of the
board. Shareholders derive their primary power from their right to
vote. Currently it is one of a reactive nature, allowing shareholders
to react to the nominees presented by the board instead of bringing
forth their own. Cases like Stahl v. Apple Bancorp, Inc.
provide a key example of a board simply working around shareholders’
desires, by postponing a key meeting in which a proxy contest regarding
election procedures was to be discussed. It is such tactical strategies
taken by boards which necessitate allocating initiative rights to
shareholders. Currently, shareholders live and work by the board’s
schedule, but hopefully by an amendment to the Rule, shareholders can
prove their ability to contribute to the corporation. In applying
Bebchuk’s words, we see that “a reform that provides shareholders with
the power to make rules-of-the-game decisions would lessen the need for
other corporate law reforms.” Without such a reform to give
shareholders incentive to participate in the corporations they “own,”
there will constantly be need for outside intervention, leading to a
self-fulfilling prophecy that shareholders are merely passive
 Letter from Peter Montagnon,
Director of Investment Affairs, Association of British Insurers, to
Christopher Cox, Chairman, Securities and Exchange Commission (Oct. 16,
2006) (on file with the SEC).
 Margaret Blair & Lynn Stout, A Team Production Theory of Corporate Law, 85 Va. L. Rev. 247 (1999); Stephen Bainbridge, Director Primacy and Shareholder Disempowerment, 119 Harv. L. Rev. 1735 (2006).
 Lucian Bebchuk, Case for Increasing Shareholder Power, 118 Harv. L. Rev. 833 (2005); Letting Shareholders Set the Rules, 119 Harv. L. Rev. 1784 (2006).
 SEC Rule 14a-8(i)(8) (2006).
 Del. Code Ann. tit. 8, § 109(a).
 AFSCME v. AIG, Inc., 2006 WL 2667941 (2d Cir. 2006).
 No-Action Letter from the SEC, AOL Time Warner Inc., 2003 WL 942784 (2003).
 Bebchuk, Set the Rules, supra note 3, at 1785.
 Bebchuk, Increasing Power, supra note 3, at 1799.
 Bebchuk, Set the Rules, supra note 3, at 1800.
 Id. at 1805.
 Bebchuk, Increasing Power, supra note 3, at 871-72.
 Id. at 871.
 Id. at 856.
 Bainbridge, supra note 2, at 1742.
 Id. at 1751.
 Id. at 1749.
 Id. at 1740.
 Del. Code Ann. tit. 8, § 141(k).
 Bainbridge, supra note 2, at 1750.
 Blair & Stout, supra note 2, at 253.
 Smith v. Van Gorkom, 488 A.2d 858 (Del. Sup. Ct. 1985)
(providing an exception to the general belief that the business
judgment rule is air-tight).
 Bebchuk, Increasing Power, supra note 3, at 1871.
 Blair & Stout, supra note 2, at 293.
 Id. at 312.
 Bebchuk v. CA, Inc., 902 A.2d 737 (Del. Ch. 2006); Gen.
Datacomm Indus., Inc. v. State of Wis. Inv. Bd., 731 A.2d 818 (Del. Ch.
 See AFSCME, supra note 6.
 Adoption of Amendments Relating to Proposals by Security
Holders, Exchange Act Release No. 34-129999, 41 Fed. Reg. 52,994,
52,998 (Nov. 22, 1976).
 See AFSCME, supra note 6.
 Stahl v. Apple Bancorp., 579 A.2d 1115 (Del. Ch. 1990).
 Bebchuk, Increasing Power, supra note 3, at 844.