In a decision that could affect the ability of shareholders to control company actions, the U.S. Court of Appeals in Washington on Tuesday struck down a rule that barred public companies from restricting shareholder voting rights.
"This is a dark day in corporate governance," said Howard Sherman, manager of proxy advisory services at the Institutional Shareholder Services Assn. in Washington.
Without deciding on the merits of the so-called one-share, one-vote rule, the appeals court said the Securities and Exchange Commission had exceeded its authority when it required all companies listed on U.S. exchanges to give shareholders equal voting powers.
The complex issue is of primary importance to anyone who owns a share of company stock, according to stockholder rights groups. It strikes at the heart of corporate governance by determining who can make company policy: the company's owners or its managers.
The impetus for Tuesday's ruling goes back to a 1988 decision by the Securities and Exchange Commission that sought to stop firms from limiting the power of some shareholders by passing two-tiered stock plans. The plans generally gave one group of shareholders most of the voting rights and the other higher dividend payments.
Two-tiered plans gained popularity in the mid-1980s as an anti-takeover device. However, some shareholders contend that they allow managers to ignore interests of the majority while consolidating power for themselves.
Until the SEC barred the plans, they had become so popular that one in every nine companies listed on the American Stock Exchange had passed them, said Bob Shabazian, an exchange spokesman. Other exchanges contacted Tuesday said similar statistics were not readily available.
Last year, the Business Round-table, an association of 200 major corporations, challenged the SEC rule, saying it restricted the ability of companies and their shareholders to govern themselves. The plans cannot be enacted without shareholder approval, and shareholders should have the right to decide for themselves, said Robert D. Rosenbaum, partner at the Washington law firm Arnold & Porter, which represents the Business Roundtable.
The appeals court sided with the business group, saying the SEC was overstepping its bounds by making rules that should be made by states. Corporate governance issues are generally decided by state legislatures. The SEC has the right only to interpret and enforce rules passed by states and ensure that corporate disclosure is adequate to protect public shareholders, the court said.
The SEC said it was disappointed with the ruling and would review it to determine its next step. The securities regulator could ask the Supreme Court to review the ruling or could press for Congress--which originally empowered the SEC--to give it more authority.
"Congress acted on the premise that shareholder voting could work, so long as investors secured enough information and, perhaps, the benefit of other procedural protections," the court said in its unanimous opinion. "It did not seek to regulate the stockholders' choices. If the Commission believes that premise misguided, it must turn to Congress."
Big shareholders were incensed about the ruling.
"If a company wants to be publicly traded, they have obligations to shareholders not to perpetuate management through this type of technique," said Eric Wollman, administrative manager of New York City's Office of the Comptroller.
Moreover, some held that the plans were passed only because holders often were given little choice of whether to approve them.
"A lot of dual-class voting systems were approved through a coercive process," Sherman said. Some company managers who sponsored the plans included them in corporate restructurings that they said were necessary--which more or less assured their approval. Once approved, shareholders were given only a choice between dividends or votes.
"The SEC's original ruling was correct, and it put to rest a very hostile, anti-shareholder practice," Sherman said. "If the SEC does not have jurisdiction in an area with such dire implications to corporate governance, there is something fundamentally wrong with the system."
The United Shareholders Assn., a shareholder rights group founded by corporate raider T. Boone Pickens Jr., called the ruling "a major blow to America's 47 million shareholders and the entire free enterprise system."
Meanwhile, the New York, Pacific and American stock exchanges said they were reviewing the ruling but could not predict what actions they would take.