Keynote Address at the John L. Weinberg Center for Corporate Governance’s 25th Anniversary Gala

Good evening, ladies and gentlemen. Thank you, Larry [Cunningham], for your generous introduction and your kind invitation for me to be here today. It is an honor and pleasure for me to participate in the Weinberg Center's twenty-fifth anniversary. Larry, I should also like to congratulate you on your recent appointment as director of the Center. I know that you are deeply devoted to the Center's mission, and I am confident that you will contribute to its work in extraordinary ways, consistent with the excellence that has defined your career.

Tonight marks my third time attending this forum, but my first as SEC Chairman. So, I am sure that you appreciate that the views I express here are in my capacity as Chairman and do not necessarily reflect those of the SEC as an institution or of my fellow Commissioners. With that disclaimer out of the way, it is a pleasure to return to the Weinberg Center-and a special privilege to do so tonight. For a quarter century, the Center has distinguished itself as one of the premier and longest-standing corporate governance institutions in academia. Its insights command the attention of practitioners in boardrooms and courtrooms alike. And tonight, we convene not only to honor the Center's legacy, but also to build on it.

As a leading venue for informed dialogue, the Weinberg Center commits itself to shaping and influencing corporate governance. In that spirit, I am delighted to discuss one of my top priorities as Chairman, which is to make being a public company an attractive proposition for more firms. Let's face it: in many quarters and for many reasons, taking a company public is no longer so "cool" as it once was. There are approximately 4,700 exchange-listed companies today, compared to a high point of approximately 7,800 in 2007.[1] My goal is to reverse this trend-to "Make IPOs Great Again" -and it involves three pillars. First, we must simplify and scale the SEC's disclosure requirements to reduce the costs of preparing SEC filings and, at the same time, make them more comprehensible. Second, we must de-politicize shareholder meetings and return their focus to voting on director elections and significant corporate matters. Finally, we must reform the litigation landscape for securities lawsuits to eliminate frivolous complaints, while maintaining an avenue for shareholders to continue to bring meritorious claims. My remarks this evening will focus on the latter two pillars, each of which also implicates state corporate law.

***

In the past few proxy seasons, perhaps nothing has epitomized the politicization of shareholder meetings more than shareholder proposals focused on environmental and social issues.[2] These proposals, which reflect views from both sides of the political aisle, generally call for actions that are not binding on the company-referred to as "precatory proposals"-and frequently involve issues not material to the company's business. When voted on at meetings, they almost always receive even lower support than shareholder proposals do generally.[3] Nonetheless, these proposals consume a significant amount of management's time and impose costs on the company.[4] However, is a company actually required to include these precatory shareholder proposals in its proxy materials? The answer to this question lies at the intersection of the Commission's Rule 14a-8 and state corporate law.

While Rule 14a-8 provides a mechanism for a shareholder to include its proposal in the company's proxy statement,[5] the rule can only be used for proposals that can properly be brought before a shareholder meeting under state law.[6] If a proposal is not permissible under state law-that is, if it is not a "proper subject" for action by shareholders-Rule 14a-8 permits a company to exclude the proposal from its proxy statement.[7] The original 1942 version of Rule 14a-8 embodied this concept,[8] and it lives today in paragraph (i)(1) of the rule.[9]

State law governs whether a proposal is a "proper subject."[10] So, are precatory proposals a "proper subject" for action by shareholders under Delaware law? The expertise and domain of the Commission and its staff is in the federal securities laws. Accordingly, it is appropriate for the agency to defer to those who practice Delaware law, including many of you in the room this evening, to answer this question. But at least one Delaware practitioner has recently concluded that precatory proposals are not a "proper subject" because Delaware law does not confer to stockholders an inherent right to vote on precatory proposals.[11]

The view that Delaware law does not provide shareholders the right to have their precatory proposals addressed by companies is not a new one.[12] Speaking at an SEC roundtable on proxy rules and state corporate law in 2007, Leo Strine, who was Vice Chancellor [of the Delaware Court of Chancery] at the time and who I understand delivered the keynote address at the Symposium earlier today, said the following about precatory proposals under Delaware law: "In Delaware, [we] vote on real things…We do not have imaginary voting. We do not have therapy for whoever…We do not have what I call 'pizza on the wall.' That is precatory proposals."[13]

But if precatory proposals are not a "proper subject" for shareholder action under Delaware law-and more than two-thirds of S&P 500 companies are incorporated in the state[14]-why have companies not sought to exclude precatory shareholder proposals pursuant to paragraph (i)(1)? At the same 2007 roundtable, the late Marty Dunn, a much-admired lawyer in the SEC's Division of Corporation Finance, posited exactly this question.[15] In response, then-Chancellor Strine said, "[the SEC] made…up [precatory proposals and Delaware is] fine with it."[16]

The Commission, through the note to paragraph 14a-8(i)(1), contemplates whether precatory proposals are a "proper subject."[17] The note reflects a codification of the Commission staff's views that there is a presumption that precatory proposals are a "proper subject" under state law.[18] However, the notion that Rule 14a-8 gives shareholders the right to present precatory proposals- when state law does not-is supported neither by the text of the note nor its history. In fact, the note expressly states that a company can overcome the presumption.[19] Furthermore, when the Commission amended the note in 1983,[20] the purpose was to "make it clear that whether the nature of the proposal, mandatory or precatory, affects its includability is solely a matter of state law, and to dispel any mistaken impression that the Commission's application of paragraph [(i)](1) is based on the form of the proposal."[21]

Pulling all of this together, if there is no fundamental right under Delaware law for a company's shareholders to vote on precatory proposals-and the company has not created that right through its governing documents-then one could make an argument that a precatory shareholder proposal submitted to a Delaware company is excludable under paragraph (i)(1) of Rule 14a-8. If a company makes this argument and seeks the SEC staff's views,[22] and the company obtains an opinion of counsel[23] that the proposal is not a "proper subject" for shareholder action under Delaware law, this argument should prevail, at least for that company. I have high confidence that the SEC staff will honor this position.

In 2007, Delaware amended its constitution to give the SEC the ability to certify questions to its highest court for declaratory judgements.[24] So far, the Commission has taken advantage of this tremendous opportunity only once-in June of 2008,[25] shortly before I left the SEC as a Commissioner in my prior tour of duty. Interestingly, that certification also involved whether a shareholder proposal was a "proper subject" for shareholder action.[26] The court issued its decision just 20 days after the Commission's certification.[27] As I stated at the time, I salute the court for its speed in deciding the issue.[28] If the need for the Commission to certify a question to the court arises in the future, I hope that both the agency and the court will continue to benefit from this unique partnership to expeditiously resolve matters of Delaware law that arise in the context of the federal securities laws.

***

While we are on the topic of the role of states in shareholder proposals, I also want to discuss recent developments in Texas. Last month, the state's shareholder proposal law went into effect and added a new section to the Texas Business Organizations Code ("TBOC").[29] If a company opts into this section, then a shareholder must own at least $1 million in market value or three percent of the company's voting shares, among other requirements, to submit a shareholder proposal.[30] These thresholds are obviously significantly higher than those in Rule 14a-8.[31] Some commenters have raised the issue of whether submission thresholds established by a state are preempted by Rule 14a-8.[32]

Two years ago, Commissioner Mark Uyeda addressed the concept of private ordering for shareholder proposals.[33] I agree with his view that "[R]ule 14a-8's procedural bases for exclusion…should be viewed as default standards that apply only if companies decline to establish their own standards in their governing documents."[34] While Commissioner Uyeda's remarks were focused on standards contained in a company's governing documents, I see no difference if the standards are contained within a state's corporate law.

Shortly after the Commission adopted the original version of Rule 14a-8, then-SEC Chairman Ganson Purcell explained that "[t]he right that [the rule is] endeavoring to assure to the stockholders are those rights that he has traditionally had under State law."[35] If a shareholder does not have a right to submit a proposal under state law-because it fails to satisfy requirements imposed by either state law or the company's governing documents-then what right is Rule 14a-8 assuring?

So, if a company has opted into the Texas law, or has otherwise properly established conditions in its governing documents, and receives a shareholder proposal from a proponent that does not satisfy the requirements in the Texas law or the governing documents, then the proposal should be excludable under paragraph (i)(1) of Rule 14a-8.

***

While the interplay between paragraph (i)(1) and state corporate law are is interesting, I believe a fundamental reassessment of Rule 14a-8 is in order. To that end, Shareholder Proposal Modernization is on the Commission's policy agenda,[36] and as part of this modernization effort, I have asked the staff to evaluate whether the Commission's original rationale for adopting Rule 14a-8 in 1942 still applies today, especially in light of developments in the proxy solicitation process and shareholder communications generally over the last 80 plus years.[37]

Mindful that Section 14 of the Securities Exchange Act of 1934 (the "Exchange Act"), under which Rule 14a-8 is promulgated, is centrally concerned with disclosure,[38] the Commission should re-evaluate the rule's fundamental premise that shareholders should be able to force companies to solicit for their proposals-to the extent that a shareholder proposal is a proper subject for shareholder action under state law-at little or no expense to the shareholder. In fact, Chairman Purcell faced questions on this fundamental premise in a Congressional hearing over 80 years ago.[39] Thus, it is only prudent for the Commission to review and reassess the original intent behind the rule and the role that it serves our capital markets today. Of course, the Commission must first propose changes, then gather and consider public feedback before adopting any changes. This process does not happen overnight. Until any changes are finalized, I encourage companies, shareholder proponents, and their advisors to consider the points that I have raised this evening.[40]

***

Turning to my other topic for tonight's remarks-securities litigation reform and Delaware's role in it-while class action securities litigation can serve an important path for vindication of rights as well as a deterrence function,[41] meritless, vexaciousvexatious, or frivolous litigation also has the marginal effect of driving capital away from the U.S. public markets.[42] Press reports, conferences, and academic papers are replete with much commentary on this issue. It is incumbent on legislatures and regulators to ensure that their laws and rules are not being "gamed" or abused to support someone's business model. Reform may be needed to ensure that the "cost" of being a public company does not involve frivolous lawsuits and exorbitant plaintiffs attorneys' fees masked as recoveries for shareholders.[43] All companies pay for these costs-even ones that are not subject to lawsuits-through increased D&O insurance premiums. Absent federal legislative changes, states can have significant influence in shaping reform in securities litigation. Reform should not be equated with the elimination of lawsuits, but rather, it can mean providing companies with optionality for how best to resolve disputes with their shareholders.

Unfortunately, recent actions by the Delaware legislature suggest that the state is not only uninterested in reform, but instead, seems to embrace the litigation costs that abusive lawsuits impose on companies franchised in Delaware. As many of you in the room are aware, through Senate Bill 95 ("SB 95"), Delaware recently amended its General Corporation Law (the "Corporation Law") with respect to a couple of matters related to intra-corporate affairs claims, which include federal securities law claims.[44] First, in permitting forum selection in Delaware for federal securities law claims, SB 95 also prohibited mandatory arbitration with respect to these claims.[45] Second, SB 95 extended the Corporation Law's prohibition on fee shifting to federal securities law claims.[46]

I am disappointed by these two targets of SB 95. While mandatory arbitration and fee shifting are not without controversy,[47] they also have merits, including, with respect to mandatory arbitration, quicker payments to harmed shareholders and reduced litigation costs[48]-and, with respect to fee shifting, fewer frivolous lawsuits.[49] Companies should have the ability to determine, after weighing the pros and cons, whether one, both, or neither of these provisions is appropriate for their business and shareholder base.

When the Commission articulated its views last month that mandatory arbitration provisions are not inconsistent with the federal securities laws,[50] I explained that the company, and not the Commission, should decide the particular method of resolving disputes with the company's shareholders.[51] Unfortunately, for public companies that consider mandatory arbitration to be a vital aspect of their dispute resolution strategy, SB 95 has effectively eliminated Delaware as an option for incorporation.

Turning to fee shifting, many of you here this evening are well aware of the history of fee shifting in the Delaware courts and legislature. In 2014, the Delaware Supreme Court held that the fee-shifting bylaw of ATP Tour, a non-stock corporation, was valid.[52] Within a year, more than 50 public companies adopted such bylaws.[53] However, in mid-2015, the Delaware legislature, through Senate Bill 75 ("SB 75"),[54] declined to extend the ATP decision to stock corporations and instead, prohibited fee shifting for internal corporate claims.[55]

Following SB 75, some commentators predicted an exodus of companies reincorporating to another state and the potential demise of Delaware as the leading state for corporate charters.[56] I was one who said at the time that SB 75 could be the proverbial straw that breaks the camel's back of Delaware's primacy as the chosen state of franchise.[57] Those predictions have not necessarily materialized over the past decade,[58] but the pressure on and alternatives to Delaware are growing. Moreover, this possibility of a "DExit" sprang back to life earlier this year, with one prominent venture capital firm publicly announcing its reasons for reincorporating in Nevada.[59]

As part of an effort to halt "DExit,"[60] Delaware passed Senate Bill 21 ("SB 21") in March of this year to amend provisions of the Corporation Law related to controlling stockholder transactions and inspection of books and records.[61] If SB 21 were one step forward by Delaware to modernize its Corporation Law, the prohibition of mandatory arbitration and fee shifting for federal securities law claims in SB 95 were two giant steps backward.

However, I recognize that SB 95 was developed and became law at a time when the Commission had not made its views on mandatory arbitration clear to the public. With the benefit of clarity under the federal securities laws, I hope that the Delaware legislature will revisit the prohibition of both mandatory arbitration and fee shifting with respect to federal securities law claims. Doing so can help Delaware be a leader in the reform of securities litigation.

***

In closing, the declining number of public companies that I referenced at the outset of my remarks is not inevitable or irreversible. It is a signal that the costs of being a public company, coupled with the politicization of shareholder meetings, and ever-present specter of costly, frivolous litigation, have negatively impacted the vibrancy of our capital markets. Taken together, these forces have eroded American competitiveness; locked retail investors out of many of the most dynamic companies; and pushed entrepreneurs to seek capital elsewhere, either in the private markets or competing jurisdictions.

The chance to reverse these trends is well within your reach-and requires your renewed commitment to the principles that made the U.S. capital markets exceptional. For a quarter century, the Weinberg Center's scholarship and leadership have exemplified that commitment. The Center has left a profound imprint on corporate governance, and its legacy calls on everyone anew to reflect thoughtfully, but without delay, on how we can update rules and practices to better serve U.S. capital markets, investors, and business.

I commit that the SEC in the coming years will play its part, as well. We must do so to ensure that the American public capital markets remain the envy of the world through growth, vibrancy, innovation, and nimbleness.

The Weinberg Center has my sincere congratulations on attaining twenty-five years of achievement-and my gratitude, once again, for the privilege of celebrating them with you here tonight. It has been my pleasure speaking with you. You have been a very patient and indulgent audience, and I welcome your active involvement in the issues that I have raised for your consideration tonight.

Thank you.