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December 11, 2007

SEC Sacrifices Shareholder Rights to Achieve Temporary Certainty
    by Bill Baue

Instead of reaffirming shareholder rights to file resolutions to nominate directors, the SEC cites uncertainty as a rationale for stripping these rights. -- �Those who would give up essential rights to purchase a little temporary certainty, deserve neither rights nor certainty,� to paraphrase a saying attributed to Ben Franklin. On November 28, the Securities and Exchange Commission (SEC) sacrificed shareholder rights on the altar of temporary certainty. Shareholders now know, in no uncertain terms, that they do not have the right to file resolutions seeking access to the corporate proxy to nominate the directors who are supposed to serve their interests.

The uncertainty they were spared from remains unclear, however. It�s got something to do with disclosure of potential conflicts of interest for those doing the nominating, according to Republican SEC Chairman Chris Cox in his July speech proposing the rule. And also antifraud protections to keep nominators from lying, he added at a hearing before the Senate Committee on Banking, Housing, and Urban Affairs in mid-November. And then there�s this decision the Supreme Court made in June that�s really significant, though it escaped Cox�s notice until this November testimony and rulemaking speech--almost a half-year later (SEC spokesperson John Nester confirmed that Cox was not aware of the case at the July open meeting.)

�I do not believe that we are in a state of great uncertainty, let alone an escalating one,� said Commissioner Annette Nazareth, the lone Democrat and dissenter to this rule on the Commission, in a speech excoriating the rule implemented. �The discussion of uncertainty contained in the release appears to be a post-hoc rationalization of a path that was ill-conceived in the first place.�

Lynn Turner, Chief Accountant for the SEC from 1998 to 2001, likens the SEC line of reasoning on uncertainty (which CalPERS CEO Fred Buenrostro characterized as �illusory�) to �Chicken Little running around saying the sky is falling.�

�When nothing else works or makes sense, one is left dreaming up excuses, which appears to be the current mode of operation of this Commission,� Turner told me. �If there were legitimate concerns about disclosure and antifraud provisions, then a responsible Commission would have dealt with them head on, but instead the SEC just stripped investors of the right to nominate candidates who represent them, leaving only candidates chosen by those already in power.�

In a November 16 letter to the SEC, American Federation of State, County, and Municipal Employees (AFSCME) President Gerald McEntee points to resolutions filed by his union that call for the kinds of disclosure that would create certainty--so a model exists. AFSCME has played an instrumental role in promoting shareholder rights. In September 2006, AFSCME won its lawsuit on appeal against AIG, which had omitted (with SEC permission) a resolution seeking proxy access to nominate directors.

In its decision, the federal Second Circuit chided the SEC for contravening the rule the Commission established in 1976 and upheld for more than a dozen years allowing such resolutions. Starting in 1990, the court pointed out, the SEC changed course and started disallowing such resolutions--without explaining this change or seeking public input on it. The judges even admonished the SEC for refusing to admit in the Commission�s amicus brief supporting AIG that it changed interpretation of its 1976 rule.

As recently as the November Senate hearing, Cox continued to insist that �in the SEC�s view, that interpretation [endorsing the omission of proxy access resolutions] had been in effect since 1976.� This view of reality allows the SEC to contend that it is not curtailing shareholder rights.

�The Commission�s action for the upcoming proxy season preserves every right shareholders previously enjoyed, while guaranteeing the fundamental investor protections that the appeals court decision placed in doubt,� SEC spokesperson John Nestor told me.

The accuracy of this statement, which hinges on the term �previously,� depends on worldview. In the SEC world, the commission had been consistently limiting shareholder rights since 1976. In the Second Circuit world, the SEC had �previously� (1976 to at least 1990) allowed shareholders the right to file resolutions seeking access to the proxy--rights that shareholders haven�t enjoyed for almost two decades, with this deprivation continuing into next proxy season.

Cox contends that the June Supreme Court decision (Long Island Care v. Coke) regarding conflicting rule interpretations by a federal agency (in this case the Department of Labor) heightens uncertainty. Specifically, the Supreme Court approved the DOL�s present rule interpretation, while the Second Circuit disapproved the SEC�s current rule interpretation.

�[T]hat the DOL may have interpreted the two regulations differently at different times in their history is not a ground for disregarding the present interpretation, which the DOL reached after proposing a different interpretation through notice-and-comment rulemaking, making any unfair surprise unlikely,� stated Justice Beyer in the unanimous decision.

If the two cases supported an apples-to-apples comparison, the contradiction between them on the issue of implementing present interpretations would create potential uncertainty. However, the SEC changed its interpretation without any �notice-and-comment rulemaking,� making this an apples-to-oranges comparison.

�When Cox appeared before the Senate Banking Committee, I have to believe he intentionally misled members of the Committee and the public by implying that Long Island Care created greater uncertainty because it conflicted with the decision in AFSCME,� said Jim McRitchie, editor of a leading corporate governance website and co-filer of the 2002 rulemaking petition proposing proxy access for nominating directors.

�Anyone who had read the first few pages of Long Island Care would easily see the Court gave deference to the agency because the rules had gone through public notice and comment--not because they had changed their minds and decided to reinterpret their own rules without going through the required rulemaking process, as was the case in AFSCME,� McRitchie told me.

McRitchie applauds AFSCME for filing proxy access proposals for next year�s proxy season at companies with egregious lapses in board oversight--specifically Bear Stearns and JPMorgan Chase, both companies implicated in the subprime mortgage meltdown.

�Should we protect directors who brought us the subprime mess, or should shareowners be able to hold them accountable and nominate replacements?� McRitchie asks. �Proxy access is the most important of all reforms and gets to the heart of what is essentially an undemocratic election process that enables self-perpetuating entrenched boards and managers.�

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