Joris M. Hogan and Alicia M. Gimenez
Special to Law.com
January 26, 2007

The 2nd U.S. Circuit Court of Appeals recently upheld the right of shareholders to include in a company's proxy statement proposals concerning procedures for electing directors generally.

Following this court decision, and after years of inconsistent decision making on the issue, the SEC's Division of Corporation Finance promised to take up the matter of shareholder access at the end of January 2007.

On Monday, corporate boards lost more leverage in the battle to retain control of director elections when the SEC announced that it would not back Hewlett-Packard Co.'s attempt to block a shareholder resolution relating to the election of directors.

This development and the recent 2nd Circuit decision are significant because together they signal a possible sea change in this area of the law.

Section 14a-8 of the Securities Exchange Act specifies when a company must include a shareholder's proposal in its proxy statement and identify the proposal in its form of proxy when the company holds an annual or special meeting of shareholders. A proposal is made on behalf of one or more shareholders, addressed to the company, recommending or requiring that the company and/or its board of directors take certain action.

Shareholders must be eligible and follow certain procedures to have their proposals included in a company's proxy statement. For example, a shareholder must have continuously held for at least one year before the date on which the shareholder submits the proposal at least $2,000 in market value or 1 percent of the company's securities entitled to be voted on the proposal at the meeting. If a shareholder fails to follow one of the eligibility or procedural requirements, the company may exclude the proposal, but only after it notifies the shareholder of the problem and the shareholder fails to adequately correct it.

Under a few specific circumstances, a company is permitted to exclude proposals, even though the shareholder met the proposal eligibility and procedural requirements. A company must first submit to the SEC its reasons for excluding a given proposal, based upon one or more of 13 grounds listed in the regulation.

Relevant to this discussion, one of the grounds provides that a corporation may exclude a shareholder proposal if it relates to an election for membership on the company's board of directors or analogous governing body.

On Sept. 5, 2006, the 2nd U.S. Circuit Court of Appeals reversed the 2005 decision of the District Court for the Southern District of New York, which permitted American International Group, Inc.'s board to exclude a shareholder proposal from the company's proxy statement.

The shareholder proposal, submitted by the American Federation of State, County & Municipal Employees, one of the country's largest public service employee unions, related to the amendment of AIG's bylaws. The amendment, if adopted by a majority of AIG's shareholders at the company's 2005 annual meeting, would have required AIG, under certain circumstances, to publish the names of shareholder-nominated candidates for director positions, together with any candidates nominated by the company's board. In its decision, the District Court relied on the SEC's post-1990 interpretation of Rule 14a-8 and determined that the shareholder proposal could be excluded on the basis that the rule permitted exclusion of stockholder proposals that "relate to an election" of the directors and/or would result in contested elections.

Siding with the shareholders, the 2nd Circuit reversed and held that Rule 14a-8 permits exclusion of stockholder proposals that relate to a specific election but not proposals, such as AFSCME's, that relate to procedures for elections of directors generally. More meaningful than the ruling itself was the 2nd Circuit's acknowledgement of the conflict between the pre- and post-1990 interpretations of Rule 14a-8 and the court's statement that the SEC's current interpretation of its rule advanced in its amicus brief in support of AIG's position "does not merit the usual deference we would reserve for an agency's interpretation of its own regulations."

The 2nd Circuit's decision reopened the door to proxy access on a company-by-company basis.

In late September 2006, four pension plans, which own about $700 million worth of Hewlett-Packard securities, submitted a resolution that sought to allow shareholder-nominated candidates to run for seats on HP's board of directors. This was the first proxy access proposal filed after the AIG ruling. Led by the New York State Common Retirement Fund, the pensions included Connecticut Retirement Plans and Trust Funds, the North Carolina Retirement Systems and AFSCME.

HP's board responded by filing a no-action letter with the SEC to reject the shareholder resolution submitted for its March annual meeting of the shareholders.

On Monday, the SEC declined to back HP's attempt to block the proposal. Corporations had hoped that the SEC would have adopted a rule by now, which would have made it difficult for shareholders to amend the bylaws of a corporation to allow for shareholder-nominated candidates on the slate of director election ballots. The SEC, which had planned to discuss proxy access on Dec. 13, 2006, postponed consideration of the issue until later this month.

The 2nd Circuit ruling, coupled with the recent SEC announcement, is potentially of great import for shareholders, especially hedge funds and shareholder activists, who have been pushing for greater access to corporate proxy statements.

In a statement by Richard Ferlauto, director of AFSCME's pensions and benefits policy who was active in the AIG case, said that the pension plan is "committed to litigation" if HP does not include the resolution in its proxy for the March annual meeting. Furthermore, he stated that the recent developments give "a green light to shareholders to file other proposals and for those that have been filed to move forward."

Joris M. Hogan is a partner specializing in mergers and acquisitions as well as securities law, and Alicia M. Gimenez is an associate in the corporate group of Torys LLP.

FN1 Furthermore, the proposal and any accompanying statement may not exceed 500 words and must be received by the company's "principal executive officers" not less than 120 calendar days before the date of the company's proxy statement released to shareholders in connection with the previous year's annual meeting or, in other circumstances, within a reasonable time before the company begins to print and mail its proxy materials.