In AFSCME v. AIG, the Court of Appeals for the Second Circuit today provided a powerful impetus to the efforts of institutional shareholders to expand proxy access. The court’s decision does not directly grant shareholders the right to present their own slates of director nominees in the company’s proxy statement. However, it does challenge the long-standing interpretation of Rule 14a-8(i)(8) as permitting a company to exclude a shareholder proposal granting shareholders increased proxy access. If the SEC fails to respond to the court’s decision by clarifying or amending Rule 14a-8(i)(8), shareholder activists predict a surge in shareholder proposals to establish liberal proxy access procedures on a company-by-company basis.

Rule 14a-8(i)(8) permits a company to exclude a shareholder proposal that “relates to an election for membership on the company’s board of directors.” AFSCME submitted a proposal for inclusion in AIG’s 2005 proxy statement. The proposal, if adopted, would have amended AIG’s bylaws to require the company to include in its proxy material director candidates nominated by a shareholder together with the candidates nominated by AIG’s board. AIG sought the approval of the SEC’s staff to omit the proposal pursuant to Rule 14a-8(i)(8). The staff issued a no-action letter to the effect that it would not recommend to the SEC an enforcement action against AIG if AIG excluded the proposal from its proxy statement. AFSCME sued in federal district court to compel AIG to include the proposal in its next proxy statement. Although the District Court ruled in favor of AIG, the Court of Appeals reversed.

The Court of Appeals first noted that the reference in Rule 14a-8(i)(8) to proposals that “relate to an election” could equally apply to proposals that address a “particular election and not elections generally” and to proposals that relate to “a particular election or elections generally.” The court then observed that from 1976 (when the SEC last revised the election exclusion) to 1990 the staff interpreted the rule as excluding shareholder proposals if they would lead to an immediate election contest which would be governed by other proxy rules (in particular, those relating to proxy solicitations). The court also observed that “[i]t was not until 1990 that the [staff] first signaled a change of course by deeming excludable proposals that might result in contested elections, even if the proposal purports to alter general procedures for nominating and electing directors.” In light of the ambiguity of Rule 14a?8(i)(8) itself, and the inconsistency in the staff’s interpretation, the court decided that “an agency’s interpretation of an ambiguous regulation made at the time the regulation was implemented should control unless the agency has offered sufficient reasons for its changed interpretation.” Accordingly, the court held that “a shareholder proposal that seeks to amend corporate bylaws to establish a procedure by which shareholder-nominated candidates may be included in the corporate ballot does not relate to an election within the meaning of the Rule and therefore cannot be excluded from the corporate proxy materials under that regulation.”

The opinion ignores the fact that no-action letters seldom provide the rationale for the staff’s position, not only because each letter turns on the specific facts presented, but also because providing such a rationale would severely constrain the staff’s resources.

In passing, the court noted that “we take no side in the policy debate regarding shareholder access to the corporate ballot. There might be perfectly good reasons for permitting companies to exclude proposals like AFSCME’s, just as there may well be valid policy reasons for rendering them non-excludable. However, Congress has determined that such issues are appropriately the province of the SEC, not the judiciary.” The court then invited the SEC to reconsider Rule 14a-8(i)(8), saying that the SEC could “certainly change its [original] interpretation of the election exclusion, provided that it explains its reasons for doing so.”

AIG may seek a review of this decision by a panel of the Second Circuit or appeal the decision to the Supreme Court. In addition, the SEC may seek to respond to the court’s complaint that the staff’s no-action letters failed to explain its reasons for changing its interpretation of the election exclusion.

For further information, please contact Peter M. Menard at (213) 617-5483.