The American Civil War began on April 12, 1861 or 150 years ago today. Texas companies now appear to believe they are again outside the United States with respect to federal laws regarding proxies, based on the flawed decisions of Judge Lee H. Rosenthal. As reported at theCorporateCounsel.net on April 5th:
KBR filed a lawsuit in the Federal District Court for the Southern District of Texas seeking a declaratory judgment that would allow the company to exclude a shareholder proposal submitted by John Chevedden due to his alleged lack of eligibility. Yesterday, the court ruled in KBR’s favor, upholding the Apache decision from last year (which had been filed in the exact same court). We have posted the court’s memorandum and order in our “Shareholder Proposals” Practice Area.
Like Apache, KBR filed a lawsuit rather than attempt to exclude the proposal through the normal SEC channels (and thus challenging the Hain Celestial position of the Staff regarding the use of introductory letters from brokers as evidence of ownership under Rule 14a-8(b)).
Ted Allen, reporting for RiskMetrics (ISS), went into more detail, which I abbreviate here (Federal Judge Allows KBR to Omit a Shareholder Proposal, 4/5/2011):
Following the litigation strategy used by oil company Apache in 2010, KBR bypassed the SEC’s no-action process that is used by hundreds of companies each proxy season and filed a lawsuit in federal court in Houston, where the engineering company is based.
While the court’s ruling is not legally binding outside Texas, this case may inspire other companies to bypass the no-action process and file their own lawsuits. Chevedden has been a magnet for omission requests in recent years, in part because he and his network of retail investors typically file more than a hundred proposals each season on popular governance topics like declassification and the repeal of supermajority voting rules. This year, more than a dozen companies have raised a variety of eligibility challenges against Chevedden network proposals, but few have obained no-action relief from the SEC.
In its lawsuit, KBR argued that Chevedden’s ownership letter from Ram Trust Services (RTS), a Maine-chartered non-depositary trust company, failed to satisfy the requirements of SEC Rule 14a-8(b)(2), which requires investors to provide a statement from a “record” holder, which can be an “introducing broker” or a bank, according to the SEC staff. KBR argued that RTS is not a record holder, because it is an investment adviser and is not a participant in the Depository Trust Co. (DTC), a nationwide clearing agency that holds most of the shares that are owned by U.S. retail investors.
The KBR lawsuit was heard by U.S. District Judge Lee H. Rosenthal, the same judge who ruled for Apache in a relatively narrow decision in March 2010. In the Apache case, Rosenthal said a similar RTS letter was not sufficient to comply with Rule 14a-8(b)(2), but the judge did not address a second ownership letter from Northern Trust because it was submitted too late.
Since the Apache decision, the staff of SEC’s Corporation Finance Division has rejected similar arguments raised by Devon Energy, Prudential Financial, and Union Pacific to omit proposals filed by Chevedden and affiliated investors.
Notwithstanding those staff decisions, Judge Rosenthal concluded that the Apache decision was still good law, in part because of the eligibility requirements the SEC adopted in August for its proxy access rule, Rule 14a-11. In that rule, the SEC said an investor whose broker is not a DTC participant must “obtain and submit a separate written statement from the clearing agency participant through which the securities of the nominating shareholder . . . are held, that (i) identifies the broker or bank for whom the clearing agency participant holds the securities, and (ii) states that the account of such broker or bank has held, as of the date of the written statement . . .”
I contacted Jay Robert Brown, Professor, University of Denver Sturm College of Law, who blogs at theRacetotheBottom. Here’s his quick response. (I hope he takes up the subject further.):
The reigning principles of administrative law is that courts are obligated to defer to agency interprestations of their own rules. In this case, the staff of the SEC has made its position clear and the court should have followed it. Had it been litigated with someone having the necessary resources, the outcome likely would have been different. Some of the analysis also is wrong. The analysis that the SEC simply defers to courts in this area is not supported by the citations in the case. All of this means that its an unfortunate result for John Chevedden but not likely to be followed by other courts.
It may not be followed by other courts but there are a lot of companies in Rosenthal’s jurisdiction. Apache, for example, issued its definitive proxy on April 7 without including a proposal from Chevedden. Although they had warned the SEC earlier this year of their intention, the SEC did not issue a no-action letter and Apache did not go to court. They simply waited for the KBR decision as a go-ahead.
Now I learn that Kinetic Concepts, also based in Texas, informed the SEC on April 5 that despite the SEC’s March 21 denial of their no-action request, Kinetic will also move forward without a proposal from Chevedden, based on the KBR decision.
However, even a quick glance at page 6 of her decision (2011-04-04 KBR Chevedden Docket 24 – Memorandum and Order) reveals the judge didn’t base it on what is required in order to show evidence of ownership for a 14a-8 proposal. Instead, she bases her decision on evidence of ownership requirements adopted in 14a-11, which are provisions for placing shareowner director nominees on the proxy. Aside from being on a completely different subject, these rules are not even in effect, since the SEC put a stay on the rules pending a court decision!
Now Apache and Kinetic Concepts no longer feel compelled to even go to court. They are simply citing the flawed decision, which goes against several SEC failed no-action requests, assuming that no one will bother to enforce the law.
Chevedden files a lot of resolutions on core corporate governance issues and they are frequently supported by a majority of shareowners. It is no wonder that those who oppose more democratic corporate governance are so ready to attack. However, this latest court decision stretches the bounds of credulity. With last week’s budget agreement behind us, maybe the SEC will finally wake up to this usurpation of power and will enforce the law.
When the SEC issues a no-action letter, it is merely stating that it will not bring an enforcement action against the company. Since the SEC has not issued no-action letters to either Apache or Kenetic the SEC is free to bring an enforcement action against them but such action would, of course, be a matter of administrative discretion.
I recommend readers help raise the profile of this failure to act by sending e-mails to the Office of Chief Counsel at email@example.com and the Chairman at firstname.lastname@example.org. Also, fill out the form at https://tts.sec.gov/oiea/QuestionsAndComments.html since this will go to the Division of Enforcement, which would be the office actually taking action, if anyone does at the SEC.
It could be something as simple as the following:
I understand Apache and Kinetic Concepts informed the SEC they would exclude shareowner proposals from John Chevedden and further they will do so without the SEC issuing letters indicating it would take no action on such an omission. In fact, the SEC rejected such a request from Kinetic Concepts on March 21. These companies have not met the burden of 14a-8(g). They have not demonstrated they are entitled to exclude these proposals. In fact, the SEC said as much in letters issued to Hain Celestial, Union Pacific, Devon Energy, Prudential, News Corp. and Kinetic Concepts.
I believe taking action against Apache and Kinetic Concepts should be a high priority for the SEC. Otherwise, a growing number of companies will simply believe they can ignore shareowner resolutions, which form an important cornerstone of corporate governance.
Lewis Gilbert was instrumental in winning a formal SEC rule in 1943 that shareowner proposals be included in the proxy. After many challenges, the SEC’s powers were finally sustained in the 1947 case, SEC vTransamerica, when judge John J. Biggs Jr. ruled, “a corporation is run for the benefit of its stockholders and not for that of its managers.”
It took until 1988 for a shareowner proposal by Richard Foley to finally get a majority vote. Rights, which have taken many decades to win could be gone very quickly if we simply do nothing to defend them. The SEC’s rules are not self-enforcing but depend on shareowner vigilance. “All that is necessary for evil to triumph is for good men to do nothing.” While we aren’t sure who said it first, Edmund Burke or Leo Tolstoy, we all know it to be true.