Yesterday, the DC Circuit heard the appeal in the litigation by the U.S. Chamber of Commerce and the Business Roundtable against the SEC related to proxy access. The Wall Street Journal reports that the judges appeared "to buy into two business groups' argument that the SEC hadn't properly considered its economic impact." The article reports that two members of a three-judge panel "questioned the assumptions underpinning the SEC's analysis of the rule's costs, including its estimate of the number of contested director elections, or proxy contests, that would result under the rule." Apparently, for purposes of calculating costs, the SEC predicted that the number of proxy contest would decline from the number that occurred in 2009:
Judge Douglas Ginsburg also questioned the SEC's number. "Why wouldn't the number go up? Why would it go down?" he asked.
Quinn said one reason the SEC believes proxy contests could decline is that boards might back off a proxy fight because they would have to weigh whether fighting was a good use of shareholder money. Quinn said the SEC believes it is "reasonable" to expect boards in some cases to acquiesce to investors' wishes.
[Judge] Sentelle and Ginsburg seemed skeptical, noting the SEC didn't cite any examples of such reversals by boards in the past. "It seems like it is taking out of thin air the proposition that this would occur," Sentelle said.
Plaintiff's counsel, Eugene Scalia, contended that the SEC used inconsistent data, relying on a study that found that 15% of companies would have their board nominees contested in 2011 under the new regime to show that the rule would facilitate shareholder rights, but then using a lower estimate of the increase in the frequency of proxy fights to calculate the rule's costs. " ‘When it suited its interests, the SEC said the contests would be frequent,' Scalia said. ‘When it came to costs, it did an about-face.' "
The business groups argue that the rule would impose unnecessary costs and favor institutional investors like labor unions and pension funds at the expense of ordinary shareholders. They say the SEC failed to properly assess the rule's effects on "efficiency, competition and capital formation," in violation of the Administrative Procedure Act.
The agency does not know what it has wrought," Scalia told judges David Sentelle, Douglas Ginsburg and Janice Rogers Brown, calling the rule "extremely costly."
He said the commission failed to adequately consider alternatives to new regulation in light of a 2009 amendment to Delaware corporation law related to proxy access. "It would have been more reasonable for the commission to stand back and look at the shifting legal landscape," he said.
It may have been more reasonable, but that doesn't necessarily make it arbitrary and capricious," said Ginsburg.
The panel peppered SEC assistant general counsel Randall Quinn with questions about the agency's estimates for how often proxy challenges would occur and how much they would cost.
The SEC estimated there would be 51 proxy contests a year under the new rule, known as 14a-11.
But the judges noted that there were 57 contested board elections in 2009 under the old proxy contest system (which will also continue to be available).
"How do you come up with a lower number when you're expanding the universe?" Sentelle asked.
Quinn said the estimate only included how often the new system would be used, and that two-thirds of companies do not have shareholders that would meet the 3% stock requirement.
In fact, he said, at most companies, if the five largest institutional investors were combined, they still wouldn't meet the 3% threshold.
"So apparently [the rule] will have no effect because hardly anyone will be qualified to use it," Ginsburg said.
"If you have a large company with a serious problem with board performance, shareholders could form groups and use the rule," Quinn responded.
The SEC estimated that proxy contests would cost large companies $14 million, but Quinn argued that it could be less. "Not every board will decide to wage a contested fight against the shareholder nominee," he said.
The panel asked whether this had ever happened before, and Quinn said he did not know.
You're taking it out of thin air, the proposition that this would occur," said Sentelle.
Quinn called it a "reasonable, possible outcome."
"I'll take possible, I'm not sure about reasonable," countered Sentelle.
The WSJ indicates that a ruling may come down in June.