Earlier this month, the SEC’s Investor Advisory Committee devoted part of its agenda to the topic of proxy access and the much debated Rule 14a-8(i)(9), which permits companies to exclude shareholder proposals from their proxy statements if they directly conflict with management proposals for the same meeting. Among the speakers were Zach Oleksiuk, a representative of BlackRock, Darla Stuckey, president of the Society of Corporate Secretaries, and Mike Garland, from the NYC Comptroller’s office (which, you may recall, has sponsored 75 proxy access proposals this proxy season), as well as Corp Fin’s Chief Counsel, David Fredrickson. The discussion centered on three key topics: appropriate terms of and restrictions on proxy access, the purpose of proxy access and the proper interpretation of Rule 14a-8(i)(9).
Terms of and restrictions on proxy access. The speakers representing investors began by endorsing the concept of proxy access, observing that the right to nominate directors is one of the fundamental rights attached to share ownership. Because it is so fundamental, Oleksiuk noted, his starting position was to be supportive of proxy access proposals that provide a reasonable opportunity to nominate without excessive restrictions. That translated into support for proposals that are consistent with the SEC’s now vacated rules: 3% ownership thresholds, continuously held for at least three years, with the ability to nominate up to 25% of the board. He generally opposed higher thresholds as creating a “meaningless right” (although he might make exception for some smaller companies, where 5% thresholds may be acceptable). He also rejected burdensome restrictions and unreasonable limits on aggregation (no reason to shut out smaller holders). In addition, he indicated that BlackRock may vote against governance committee members and board leaders who reject the opportunity to provide proxy access by excluding shareholder proposals and substituting a conflicting management proposal with high thresholds.
Of course, Oleksiuk maintained, even better than “private ordering” through shareholder proposals would be a federal proxy access rule adopted by the SEC that would apply to all public companies. Garland echoed that view. Conducting an independent solicitation is far too expensive for almost all shareholders, making that alternative effectively unavailable. But absent a rule, his office supported the “de facto market standard” of 3%/3 years for 25% of the board. In the last few years, Garland indicated, his office had submitted seven proxy access proposals using that standard, six of which received majority support. What’s more, he believes that support for proxy access with those thresholds to be a “settled question among the investor community.”
[Sidebar: The recently announced positions of CalSTRS and CalPERS on proxy access certainly support that view, as reported in thecorporatecounsel.net blog, CalSTRS has just announced updates to its corporate governance principles favoring the 3%/3-year model and advised that it “will also urge fellow shareholders to withhold their votes from company directors who either exclude a three-and-three shareholder proposal from the proxy statement, or who deliberately preempt such a shareholder proposal with one of their own that establishes more excessive thresholds.” CalPERS announced that, in connection with its push to address climate change, it “is targeting 33 companies in the energy sector this proxy season calling for shareowners to have the right to nominate directors to corporate boards. Changing corporate directors is one of the best ways to change corporate practices.” However, the claim that there is a consensus on the 3%/3-year model among the investor community might be something of a stretch. As reported by Gretchen Morgenson in her Sunday NYT column, the Vanguard Group, a $3 trillion mutual fund company, has never supported a proxy access proposal with a 3% threshold. Rather, according to Morgenson, it supports proxy access proposals with a steeper 5% ownership threshold. Challenged by Morgenson about its rationale for supporting the higher hurdle, Vanguard’s controller responded that Vanguard believes that “’accessing the proxy is a significant, potentially disruptive step (even if justified) that should only be undertaken by some critical mass of shareholders, and we feel that 5 percent is that appropriate level….’”]
Notably, one Committee member, former SEC Commissioner Steven Wallman, later questioned the apparently consensus view that proxy access should be available only to long-term and larger holders. He advocated a “radical” rethinking of proxy access that would open up the field. (The topic of hedge fund “activists” that are interested primarily in short-term rewards was unfortunately not raised in that context.)
In his presentation, Garland also rejected various restrictive provisions that inhibit use of proxy access, such as group size limits, limits on director compensation from third parties, no allowance for share lending, limitations on resubmission of candidates and onerous reps and warranties, some of which he viewed as problematic for externally managed funds. (He was aghast at range of limitations that would be imposed by Whole Foods, requiring a 3000-word proposal.) The sorts of restrictions that Garland saw as untenable, Stuckey viewed as reasonable issues to be discussed: Shouldn’t there be a limit on the number of shareholders allowed to aggregate? Should “ownership” be defined as “net long” beneficial ownership? Should proxy access be unavailable if there is also an ongoing proxy contest? Should the nominee be required to satisfy qualifications, such as independence, absence of Clayton Act issues and other bylaw qualifications?
What is the purpose of proxy access? One of the more interesting discussions surrounded a question posed by Stuckey: “what is the problem that proxy access is designed to address?” Interestingly, Oleksiuk maintained that he did not view proxy access as a mechanism to be used routinely. In that regard, Garland observed that, based on standard terms, proxy access would rarely be used in practice, the implication being that concerns regarding massive board disruption were largely misplaced. Citing a recent CFA Institute report (and ignoring the aggregation concept), Garland noted that even CalPERS, the largest public pension system, rarely owns more than 0.5% of the outstanding shares of any company.
[Sidebar: That observation would appear to be supported by data cited by Morgenson in her column: again referring to the CFA Institute report, she noted that investors in countries allowing director nominations with 3% thresholds “rarely wound up putting director candidates forward. Over the previous three years, the report said, those investors used proxy access to nominate board members fewer than 10 times a year, on average. Similar outcomes occur in Europe, with its 1 percent threshold.”]
Oleksiuk did not even view proxy access as a means to reinforce “shareholder democracy.” Indeed, he viewed nominating committees to be in the best position to nominate directors as a general matter. Rather, he viewed proxy access as a mechanism to ensure that boards focus on long-term issues and to address governance failures, such as the persistence of “zombie directors” – directors who remain on the board (as a result, e.g., of plurality voting or refusal by boards to accept their resignations) even though they fail to win majority votes.
But Stuckey wondered, if the problem is “zombie directors,” is proxy access really the right remedy? First, she observed that there were only 52 zombie directors, and most of those were properly elected under plurality voting, even if they failed to achieve majority support. Given the limited scope of the problem, doesn’t proxy access sweep too broadly? Shouldn’t the cure be more narrowly tailored, she argued, limited instead to a requirement for majority voting? Only if the majority vote is ignored would proxy access make sense and then only on a case-by-case basis. Garland contended that zombie directors are only the most visible manifestation of underlying problems. Agreeing with BlackRock, he maintained that just the existence of proxy access as a tool would have a beneficial impact on corporate governance and board accountability. Just as important as independence and accountability is the need to ensure that directors have the right skill set. It is easier to have discussion, he argued, if a proxy access right is available. One Committee member echoed that concept, maintaining that, even if proxy access is rarely used, it leads to accountability by virtue of the cultural impact of the threat of holding directors to account.
The Whole Foods fracas and Rule 14a-8(i)(9). When Corp Fin Chief Counsel David Fredrickson began his presentation, the topic shifted to the recent Whole Foods fracas and the Corp Fin decision to reassess Rule 14a-8(i)(9), the conflicting proposals exclusion. (For more background, see this post.) Fredrickson essentially reiterated comments previously made by Corp Fin Director Keith Higgins, as discussed in this post. He indicated that Corp Fin’s initial Whole Foods’ decision allowing exclusion of a proxy access proposal under Rule 14a-8(i)(9) was framed by prior no-action positions related to the right of shareholders to call special meetings. There, the staff had viewed shareholder proposals as “preempted” by management proposals on the same subject matter, even if the terms were quite different. Now, the staff was reassessing that position, and part of the reassessment involved a determination as to whether any potential changes were only interpretive (and therefore could be resolved by the staff) or whether action by the SEC Commissioners was necessary. When pressed by a Committee member, however, Fredrickson refused to concede that the shareholder proposal system was structurally flawed (although he acknowledged that he was willing to entertain the idea).
Garland advocated that, if companies want to submit their own proposals to a vote, both proposals should be on the ballot. Moreover, he rejected companies’ gaming the system using Rule 14a-8(i)(9). That was a theme raised again by several Committee members, who questioned the “tactical” use of the 14a-8(i)(9) exclusion. One Committee member questioned why Corp Fin had strayed from its earlier precedents that defined “conflict” more narrowly and rejected the tactical use of conflicting management proposals. Another Committee member questioned whether it was the proper role of the SEC to screen out conflicting information for the board, suggesting instead that it was the duty of the board to decide what approach to take, based on the board’s assessment of various data points that would be gleaned from allowing votes on both conflicting proposals. Based on indications from members of her organization, Stuckey observed that, in her view, few companies would exclude shareholder proposals as conflicting and few were willing to litigate the issue. Some companies, she believed, would include both shareholder and management proposals, regardless of conflict.