(CN) – The Securities and Exchange Commission split across party lines last week on an issue widely considered to be the most contentious the SEC has ever faced, voting 3-2 to propose new rules that would empower shareholders to nominate directors to corporate boards.
“This is the most contentious issue that has ever faced the SEC,” said Professor J.W. Verret, Mercatus Center Senior Scholar at George Mason University.
The three Democratic commissioners on the SEC approved the rule they say will enhance director accountability and give shareholders a more direct voice to management.
SEC Chairman Mary Schapiro has indicated that proxy access would be among the commission’s top priorities this year.
“The nation and the markets have recently experienced, and remain in the midst of one of the most serious economic crises of the past century,” Schapiro said in a statement. “This crisis has led many to raise serious questions and concerns about the accountability and responsiveness of some companies and boards of directors, to the interests of shareholders.”
Under the current process, board members nominate a slate of candidates and send the information to shareholders through proxy materials, giving them information to help vote their shares.
If shareholders want to nominate other candidates they’re forced to launch expensive proxy fights.
Verret at the Mercatus Center said the process of running an alternative candidate can cost $10 million to $20 million, paid for by the candidate, while the corporation pays for incumbents’ expenses. The proposed rule will permit shareholders to put candidates on the ballots with the corporation paying the expenses.
Verret added that there are two methods to permit shareholders to gain access to corporate ballots. The first would involve the SEC writing a rule directly into securities law that would mandate the circumstances in which shareholders can nominate directors. The second is a more flexible method that would permit shareholders to adopt a bylaw to allow companies to craft their own method to nominate directors.
Delaware, where many companies incorporate, recently passed proxy access laws that allow companies to amend their bylaws to include shareholder-nominated directors to ballots.
Despite indicating that she would put forth a proposal for both methods, Shapiro decided to propose only the first, more restrictive method, Verret said.
The proposal would require different minimum levels of stock ownership depending on the size of the company. A shareholder of a large company with a global market value of $700 million would have to own 1 percent of the company’s share; this would be increased to 3 percent to 5 percent for small and medium size companies. Shareholders must have held shares for at least one year.
The issue has come to vote three times in the past 70 years. Similar proposals were rejected by the SEC in 2003 and 2007, with then-majority Republicans’ blocking shareholders’ efforts.
Many believe a legal battle is inevitable if the rules are adopted.
Verret cites an influential 1990 case in which Business Roundtable, an association of chief executive officers of leading U.S. companies, successfully sued the SEC and struck down a similar rule in the D.C. Circuit because it impeded on state corporate governance.
“Federal securities laws were not intended to pre-empt state law and the relationship between shareholders and boards of directors – specifically their right to vote,” Verret said. “There’s a significant risk that this rule will be struck down by the Business Roundtable v. SEC decision.”
A bill introduced last week by Senator Charles Schumer (D-NY) might give shareholders a way around that federal ruling. Verret said the “Shareholder Bill of Rights” would give the SEC express authority to adopt proxy access rules “so it couldn’t be challenged in the courts.”
Schumer’s bill also requires corporate directors to be subject to annual shareholder votes and to receive a majority of the votes in order to remain on the board.
The U.S. Chamber of commerce was quick to speak out against the decision, issuing a statement condemning the rule before it was even unveiled.
The SEC will hold a 60-day public comment period on the proposed amendments.
“This proposal represents nearly seven years of debate about whether the federal proxy rules should support – or stand in the way of – shareholders exercising their fundamental right to nominate directors,” said Schapiro. “Today marks the first step toward finally concluding that debate.”