The SEC vs. shareholders

Larry Ribstein —  30 August 2010

One of the great myths about the SEC’s new proxy access rule is that it is pro-shareholder, or at least gives new clout to shareholders. This is simply wrong, since the SEC evidently did not intend to help shareholders, or at least anything like a significant fraction of the universe of shareholders, and almost certainly has not succeeded in doing so.

Let’s start out with the heroic assumption that more shareholder proxy access might be a good thing to offset excessive managerial power under state law. I don’t believe that, but I’m assuming it for the sake of getting to the nub of the problem. Based on this assumption, the SEC’s amendment to Rule 14a-8 clarifying that shareholders may use the rule to propose proxy access makes sense.

I will go further and assume for the sake of argument that it was constructive for the SEC to provide in Rule 14a-11 for its own version of proxy access for 3%-3-year shareholders. I am very sympathetic with the argument of former SEC Commissioner Paul Atkins and in a WSJ editorial that this rule was designed to, and does, favor unions, who are uniquely able to maintain such substantial holdings for this period, and to disfavor hedge funds, which cannot. Indeed, I would go further and say that there may be many reasons why this rule perversely unbalances corporate governance. But I suppose that one might make similar arguments against any version of SEC-imposed proxy access, and I’m going to be as charitable as possible.

The real problem is that the SEC has barred any possibility for the shareholders or state law to provide for less proxy access than under the new rule. How can a rule that bars shareholders from making certain types of governance rules, either directly or by choosing the state of incorporation, increase shareholder participation in governance?

Perhaps the answer is that shareholders shouldn’t participate in governance because they are too easily manipulated and misled and simply don’t know what’s good for them. Rather, the SEC knows best.

But as dissenting Commissioner Paredes points out, this is inconsistent with the whole point of proxy access and with the SEC’s stated intent to “facilitate the effective exercise of shareholders’ traditional state law rights.” Dissenting Commissioner Casey also said:

[T]he adopting release goes through a jiu-jitsu exercise of purporting to give deference to state law and to increase shareholder choices under state law, when in fact the rules do exactly the opposite. As a result, the logic does violence to our historical understanding of the roles of federal securities law, state law, shareholder suffrage and private ordering, with potentially far-reaching implications. * * *

Consider the most obvious anomalies: If the shareholders can’t be trusted to decrease proxy access, why should they be trusted to increase it? If we fear that managers, even with the new proxy rule, can still manipulate shareholders, then why trust the shareholders to do anything? And if the shareholders can’t be trusted, why should the securities laws force firms, at great cost, to inform shareholders so they can participate in the proxy process? In other words, the rule is fundamentally inconsistent with the whole point of the securities laws to provide the disclosure necessary to enable the shareholder to be effective governors of their firms.

Finally we have Eric Talley’s argument that

[i]n at least some regulatory areas, the stock of empirical data for or against a proposed intervention is so impoverished or underdeveloped that it would be difficult to reject virtually any empirical hypothesis about outcomes; and here the burden of proof becomes insurmountable. Proxy access may well be one of those areas. * * * * * * [I]f we’re genuinely interested in maximizing “long term shareholder value” (a topic that may be ripe for another debate, another time), the benefit of modest regulatory experimentation deserves a seat at the prescriptive table.

One can sympathize with Eric as he relishes the prospect of turning his considerable empirical skills to analyzing the effects of this rule, as he and so many others did with SOX. But from a public policy standpoint, if we really want experimentation, then how about giving state law a chance, and specifically Delaware’s new proxy access rules? Or how about a sunset provision in the SEC rule, instead of the massive hubris that it can settle this issue once and for all?

In short, the best argument for the SEC rule is that shareholders generally are a hindrance to good corporate governance. The SEC therefore exists not to help the shareholders exercise their power, but to decide which shareholders should control corporations. Even if by some stretch of the imagination this is right, it’s not what the securities laws provide. If we accept these notions we should get rid of the securities laws and the SEC as presently constituted and reconstitute our corporate governance framework from scratch.

Larry Ribstein


Professor of Law, University of Illinois College of Law

2 responses to The SEC vs. shareholders


    Thanks for the characteristically thoughtful and provocative post, Larry. But your excerpt does omit from my prior post on a couple of dimensions. First, I noted specifically that the empirical knowledge-producing value of regulatory experimentation predominates in areas that appear to be “close cases” on the empirical merits. Conversely, in situations where our empirical knowledge is well developed, the value of experimentation diminishes. I personally believe that our current empirical knowledge about proxy access is pretty darned indeterminate. (You may or may not agree with this proposition — it is unclear from your post). Moreover, even if the SEC were thinking rationally about its deliberations (and here I think we agree politics probably trumped all else), the SEC might still be too dynamically biased against experimentation — a type of regulatory short-termism, if you will. Thus, if the SEC ultimately made a justifiable decision to experiment here, they likely came to that conclusion only through a Forrest-Gumpian stroke of good fortune — but that’s true of a lot of things in life and law, I guess. Second, assuming one is convinced that this case is close enough for some form of regulatory experimentation, it’s probably important to pay attention to the ingredients of a probative experiment. Perhaps the most important element is control. [For background, see my piece with Colin Camerer in the Handbook of Law and Econ]. Random assignment is the cleanest form of control — but has obvious problems (constitutional and otherwise) in this sort of setting and is a non-starter. In some cases, I guess, endogenous self selection by firms (as the Delaware statute prescribed) can be informative descriptively, but it has severe problems in identification and causation. Viewed in this light, perhaps the mandatory nature of 14a-11 probably has a couple of things going for it: it does not create the type of assignment bias problems that make the DE statute difficult to study empirically (and under 14a-11 there are still viable control groups — e.g. foreign listed firms); and it doesn’t raise a “who goes first” externality issue, where risk- and ambiguity-averse competitive corporations may be chary about becoming the first canary to go into the proxy access cave for others to observe. As to your point on sunset provisions, I agree. But implicitly nothing prevents the SEC from revisiting this issue as more empirical information comes in (see the uptick rule).

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  1. - August 30, 2010

    Ribstein on Access…

    Larry decides to be as charitable as possible and still comes out against new Rule 14a-11: Let’s start out with the heroic assumption that more shareholder proxy access might be a good thing to offset excessive managerial power under state law. I don’t…