In no-action context, SEC asks Delaware Supreme Court to address state law question

By Cydney Posner

The SEC has posted a new no-action letter under Rule 14a-8 regarding an AFSCME proposal that would amend CA, Inc.'s bylaws to require the company to reimburse the reasonable expenses (printing, mailing, legal, solicitation, travel, advertising and public relations expenses), incurred by a stockholder or group of stockholders in running a short slate (under 50%) of director nominees in a contested election, provided that at least one nominee on the short slate was elected to the board.

While Corp Fin denied CA's request to omit the proposal from its proxy on a number of other grounds (including that the proposal related to a procedure for the election of directors--see my posting on 12/06/07), with respect to CA's argument that the proposal could be excluded as improper under state law (rule 14a-8(i)(1)), or as a violation of law (rule 14a-8(i)(2)), the SEC has certified the state law questions raised to the Delaware Supreme Court. Under Section 11(8) of Article IV of the Delaware Constitution, the Delaware Supreme Court may hear and determine questions of law certified to it by the SEC. Corporate Counsel points out that this is the first use of this new process, which was created last summer, through an amendment of the Delaware Constitution, to permit greater cooperation between the SEC and Delaware Supreme Court on issues related to Delaware law. The SEC's certification points out that, faced with two conflicting opinions on Delaware law from Delaware law firms, Corp Fin does not resolve disputed questions of Delaware law. The specific questions certified are (1) whether the proposal is a proper subject for action by stockholders as a matter of Delaware law, and (2) whether the proposal, if adopted, would cause CA to violate any Delaware law to which it is subject.

CA argued that, because the proposed bylaw would be binding, it would require that reimbursement be provided in all future contests meeting the proposed criteria, without the possibility of the exercise of any discretion by the board of directors. As a result, the bylaw would deprive the CA board of its statutory authority to manage the use of the company's funds with regard to contested elections, in violation of state law. The bylaw would also eliminate the ability of the board to distinguish between the use of corporate funds to pay proxy solicitation expenses of stockholders when the contest involves clear disagreements between competing slates of directors over concrete policy issues, which, CA argued, Delaware courts have approved, and contests involving personal disagreements or disputes that are not shared by the stockholders generally, for which reimbursement has not been sanctioned.

AFSCME argued that a "meaningful threat of director replacement" is an important safety valve in ensuring that corporations are managed in stockholders' interests. However, short slate election contests are relatively rare, and AFSCME contends that the unavailability of reimbursement contributes to the scarcity of these contests. (Because the board approves payment of expenses, expenses are, as a practical matter, reimbursed only when the contest results in the election of a majority of directors and a change of control.) Among other things, AFSCME argues that Delaware law confers broad authority on stockholders to adopt bylaws, provided they do not violate the certificate of incorporation or Delaware law, including bylaws constraining the board's ability to act with respect to the expenditure of corporate funds.

The SEC's certification states that, without a resolution form the Delaware court under this new process, Corp Fin intends to inform CA that it has not satisfied its burden of demonstrating that it may exclude the AFSCME Proposal under Rule 14a-8(i)(1) or Rule 14a-8(i)(2) (i.e., require CA to include the proposal).