Proxy ruling a caution signal for SEC

The recent appellate court decision rejecting an SEC rule on proxy access for shareholders was a signal to the commission to slow down its rulemaking and take more care in measuring the costs versus the benefits of any new rule.

The rule was designed to make it easier for shareholders to nominate outsiders to boards. It would have required companies to include in their proxy materials information about shareholder-nominated candidates for election as directors.

The regulation, which has long been sought by institutional-investor groups, would have allowed groups that had owned at least 3% of the voting power of a company’s stock for at least three years to nominate board candidates, and have them included in the company’s proxy materials, which are mailed to shareholders at the company’s expense.

Previously, groups attempting to elect candidates to boards had to shoulder the costs of mailing proxy materials related to the candidates and waging the proxy campaign.

However, business groups opposed the regulation, saying that it would make it easier for special-interest groups such as hedge funds, corporate raiders and union-connected pension funds to elect directors who would do their bidding.

The Securities and Exchange Commission approved the regulation last year by a 3-2 vote. It was scheduled to become effective last November, but the SEC stayed that, pending the outcome of the court challenge.

A three-judge panel of the U.S. Court of Appeals for the District of Columbia Circuit unanimously rebuked the SEC for its failure to satisfy the provisions of the Administrative Procedure Act, which require cost-benefit studies to justify a new government regulation.

The court ruled July 22 that the SEC “acted arbitrarily and capriciously” in failing to adequately consider the rule’s effect on “efficiency, competition and capital formation.”

“Here the commission inconsistently and opportunistically framed the costs and benefits of the rule, failed adequately to quantify the certain costs or to explain why those costs could not be quantified, neglected to support its predictive judgments, contradicted itself and failed to respond to substantial problems raised by commenters,” the court said in the decision written by Judge Douglas H. Ginsburg.

MORE PERSUASIVE

In effect, the court agreed with the business groups that there was a possibility of special-interest Trojan horses’ being elected to corporate boards to do the bidding of those interests, which might not maximize the long-term return of other investors in the company.

Apparently, the court found the arguments of the U.S. Chamber of Commerce and the Business Roundtable about the dangers and likely costs of special-interest-group infiltration of corporate boards more persuasive then the SEC’s arguments that the costs and dangers would be minimal.

There is evidence that unions might be tempted to use their voting clout to further union interests.

In 2004 the California Public Employees’ Retirement System, whose head at the time was a union official, used its shareholding in Safeway Inc. to try to get rid of Steven Burd, who had produced stellar results as chief executive, and then leaned on the company to settle a strike on union-favorable terms. CalPERS failed on both counts, but its attempts provided a warning about the possible divided loyalties of union-connected shareholders.

The SEC could appeal, but given that the decision was unanimous, it would be better advised to go back to square one and reconsider the proxy-access rules. It should try to improve shareholder input on board selection while minimizing the costs and the opportunity for special-interest disruption.

In the meantime, the ruling should encourage the SEC to be more thorough in its cost-benefit analyses of the more than 100 new rules that it is required to write under the Dodd-Frank financial reform law, because the courts will be watching and won’t approve shoddy work. That would be good for all investors, as it should lead to lower costs and fewer unintended consequences.