In remarks this week before the Chamber of Commerce, new SEC Chair Jay Clayton indicated that the SEC will be taking a hard look at the shareholder proposal rules. As reported in thedeal.com, Clayton advised that it is “very important to ask ourselves how much of a cost there is….how much costs should the quiet shareholder, the ordinary shareholder, bear for idiosyncratic interests of other [investors].” Clayton was certainly speaking to a receptive audience—the Chamber has also recently voiced criticism of the shareholder proposal process (see this PubCo post) and, on the same day as Clayton’s remarks, issued its own report proposing changes to staunch the flow of proposals (discussed below). As you may recall, in the Financial CHOICE Act of 2017, the House also proposed to raise the eligibility and resubmission thresholds for shareholder proposals to levels that would have effectively curtailed the process altogether for all but the very largest holders. Although that Act is currently foundering in the Senate, at the same Chamber presentation, Commissioner Michael Piwowar commented to reporters that the SEC could certainly act on its own without any impetus from Congress, observing that the “chairman sets the agenda, but I’m going to be meeting with folks at public companies to talk about their experiences with proxy season.” With both the House and the Chamber having weighed in, if the SEC now takes up the cause on its own, the question is: just how far will it push?
Currently, to be eligible to submit a shareholder proposal, the shareholder must have continuously held, for at least one year, company shares with a market value of at least $2,000 or 1% of the voting securities. With regard to resubmission, shareholder proposals that deal with substantially the same subject matter as proposals that have been included in the company’s proxy materials within the past five years may be excluded from proxy materials for an upcoming meeting (within three years of the last submission to a vote of the shareholders) if they did not achieve certain voting thresholds, which vary depending on the number of times previously submitted: if proposed once in the last five years, the proposal may be excluded if the vote in favor was less than 3%; if proposed twice and the vote in favor on the last submission was less than 6%; and if proposed three times or more and the vote in favor on the last submission was less than 10%.
You might recall that the CHOICE Act would mandate a substantially higher eligibility threshold for submission of shareholder proposals, which could run to billions of dollars for some larger companies, and would preclude many currently prolific proponents, such as some pension funds and environmental, social and governance (ESG) activists, from submitting proposals at all. More specifically, the Act would require the SEC to revise the eligibility requirements for shareholder proposals to eliminate the dollar threshold entirely and provide eligibility only where the shareholder holds 1% of company’s voting shares (or a higher threshold if the SEC so determined). It also would increase the required eligibility holding period for shares from one year to three years. In addition, it would require the SEC to raise the resubmission thresholds as follows: if proposed once in the last five years, the proposal could be excluded if the vote in favor was less than 6%; if proposed twice and the vote in favor on the last submission was less than 15%; and if proposed three times or more and the vote in favor on the last submission was less than 30%. And, in a provision that seems expressly tailored to limit (or at least restructure) the activity of that most frequent submitter of shareholder proposals, John Chevedden, the Act would prohibit an issuer “from including in its proxy materials a shareholder proposal submitted by a person in such person’s capacity as a proxy, representative, agent, or person otherwise acting on behalf of a shareholder.’’ (Chevedden often handles shareholder proposals on behalf of his associates and interacts with Corp Fin as their representative.) (See this PubCo post and this PubCo post.)
Timed to coincide with Clayton’s remarks, the report from the Chamber’s Center for Capital Markets Competitiveness characterized the current shareholder proposal process under Rule 14a-8 as essentially “broken” and “yet another burden on companies and their shareholders that only serves to make the public company model less attractive”:
“For decades, the fundamental purpose of the shareholder proposal system was to allow certain investors to put forth constructive ideas on how to improve a company’s governance and performance. The SEC often took the position that proposals dealing with personal grievances, or those of a social or political nature, were not proper subjects for shareholders to vote on under Rule 14a-8, largely because such proposals sought to advance goals other than running the business more efficiently and profitably. This balanced approach helped prevent abuse of the system, while still affording shareholders a voice in the management of the companies they invested in. The long-standing guardrails that were put in place to protect investors have steadily weakened, and the shareholder proposal system today has unnecessarily devolved into a mechanism that a minority of interests use to advance idiosyncratic agendas that come at the expense of other shareholders. As a result, proposals dealing with social or political issues and topics that the federal securities laws have long treated as not material are ending up in proxy statements with increasing frequency, even when the proposal’s subject matter is wholly unrelated to a company’s long-term performance. In fact, half of all proposals submitted to Fortune 250 companies during the 2016 proxy season dealt with some type of social or policy-related matter.”
In addition, the report contends, these proposals are, for the most, losing propositions. According to the report, “[p]roposals dealing with social or other political matters have…, in general, received very low support when put to a vote….Moreover, a very small subset of investors have come to dominate the shareholder proposal system, while the vast majority of investors—including those that routinely vote against social and political proposals—bear the costs. Fully one-third of all shareholder proposals in 2016 at Fortune 250 companies were sponsored by six individual investors, while 38% of proposals were sponsored by institutions with an explicit social, religious, or policy purpose.”
While historically, the tally in favor of shareholder proposals to enhance disclosure regarding climate change has been a dismal one, this proxy season, climate change proposals were successful at three major companies. (See this PubCo post.) In addition, as discussed in this PubCo post, a recent survey by EY showed that investors actually are concerned about ESG issues, and take information about ESG into account in making investment decisions. Notably, many of the ESG-related shareholder proposals request that companies provide additional information. EY surveyed over 320 institutional investors, one-third of which had over $10 billion in assets under management, about the importance of nonfinancial reporting, in particular, the role ESG analysis plays in their investment decision-making. Looking at data over several years, EY found that there was a global trend toward increased interest in nonfinancial information on the part of investment professionals as well as an enhanced focus on ESG factors, albeit an informal one, in the investor decision-making process. Analyzing information over a three-year period, EY concludes that ESG factors are now playing an increasingly influential role in investment decision-making. Interestingly, EY contended that ESG analysis has shifted over time from a primary focus on corporate governance issues to a now equal interest in environmental issues, particularly climate change.
The report then goes on to characterize the problem of shareholder proposals as one of the factors contributing to the recent decline in the number of IPOs and public companies: “We believe that reform of the shareholder proposal process is an incremental but important step toward tilting the scales back in favor of the majority of public company investors. No company wants to go public only to find itself subject to endless politically driven campaigns intended to embarrass an enterprise that was built from scratch by its founders. And no small subset of activists should be able to commandeer long-standing SEC rules for their own parochial purposes. Rule 14a-8 reform is long overdue, and we look forward to working with policymakers to help make reform a reality.”
As discussed in this PubCo post, some commentators take a different view, attributing the decline in the number of public companies and IPOs primarily to a variety of other factors—the fear of loss of decision-making control, the easing of the rules related to private capital-raising, regulatory changes that have permitted companies to remain private longer, the availability of enhanced liquidity for privately held shares—while the burdens associated with regulatory compliance tend to figure less prominently on the list of deterrents.
The reforms of the shareholder proposal process advocated by the Chamber are more extensive than those contained in the CHOICE Act, and consistent with regard to amendment of the resubmission thresholds, but do not otherwise address the eligibility threshold. The Chamber’s proposed reforms include the following:
The SEC’s resubmission rule should be amended to raise the thresholds for levels of support that proposals must receive in order to be eligible for resubmission. The amounts recommended are based on a 1997 SEC rulemaking proposal that did not succeed:
- “Less than 6% support on the previous submission if voted on once within the previous five calendar years.
- Less than 15% support on the previous submission if voted on twice within the previous five calendar years.
- Less than 30% support on the previous submission if voted on three or more times within the previous five calendar years.”
The SEC should withdraw Staff Legal Bulletin 14H (CF), issued in October 2015, to restore certainty under the Rule 14a-8(i)(9) exemption. Rule 14a-8(i)(9) allows the exclusion of a proposal if it directly conflicts with one of the company’s own proposals. The recommendation refers to the reversal of the Whole Foods no-action decision regarding conflicting proposals and related Staff Legal Bulletin, which, the report advises, “was never considered or approved by the full Commission and has added a great deal of uncertainty to the no-action process.”
You might recall that the SLB regarding Rule 14a-8(i)(9), the exclusion for conflicting proposals, was issued in 2015, narrowing the application of the exclusion by redefining the meaning of “direct conflict.” Under the 2015 guidance, the question became “whether a reasonable shareholder could logically vote for both proposals” because both seek a similar objective. If so, the proposals are not in “direct conflict.” The staff’s new interpretation made it substantially more challenging for companies to rely on the exclusion. The guidance was largely in response to a surprising conflict over the application of that exclusion that arose originally in the context of a shareholder proposal for proxy access that had been submitted to Whole Foods. That proposal would have permitted shareholders holding at least 3% of the company’s voting securities to nominate up to 20% of the board and to include those nominees in the company’s proxy statement. In its no-action request to the SEC, Whole Foods advised that it was submitting a conflicting proxy access proposal at the same meeting that included different terms; for example, it would allow any single shareholder owning at least 9% of the company’s common to submit nominations to be included in the company’s proxy statement. Initially, the SEC staff granted the company’s no-action request to omit the proxy access shareholder proposal from its proxy statement. In view of its success, a significant number of companies then followed the Whole Foods model, although most opted for lower thresholds in their conflicting management proposals. The Whole Foods shareholder proponent then requested that the entire SEC reconsider and reverse the Whole Foods decision. The SEC did reconsider the issue and the SLB followed. (See these PubCo posts: 12/8/14, 1/5/15, 1/20/15, 2/11/15, 3/19/15 and 10/22/15.)
To close the information gap (compared to the level of company disclosure) and provide more transparency to investors, the SEC should require proponents to include sufficient disclosure regarding their economic interests and objectives. The laundry list of recommended disclosures by the proponent and beneficial owner (if different) includes name and address, number of shares owned or subject to rights to acquire, purpose of ownership, objectives regarding the company, arrangements providing benefits to the proponent in connection with submission of the proposal, and similar proposals submitted by the proponent to other companies. The recommendation also suggests that, to ensure that a proponent has an economic interest in the company, the SEC should define “ownership” in the context of eligibility for submitting a proposal.
The SEC should reassert the “relevance rule” under 14a-8(i)(5) by allowing excludability of a proposal if the subject matter does not meet a specified financial materiality threshold—less than 5% of a company’s total assets and 5% of net earnings. The report indicates that the exclusion was in effect prior to 1982, but then was amended to allow a proposal failing these tests to be included in the proxy statement if it was “otherwise significantly related to the issuer’s business,” a concept that, the report contends, has been significantly expanded over time.
To ensure that the proposal remains within the 500-word limit and avoids misleading images, the SEC should prohibit the use of images, photos or graphs in proposals. However, the report advocates that the SEC should allow proposals to include hyperlinks to websites that the proponent wishes to include (which could, of course, substantially expand the word count, although outside the four corners of the proxy statement).
The SEC should issue additional guidance regarding its policies under Rule 14a-8(i)(4), the exclusion for proposals that relate to a redress of a personal claim or grievance. Additional guidance would provide market participants with more certainty regarding the staff’s policing of Rule 14a-8(i)(4) and should facilitate the exclusion of personal claim or grievance proposals, so that proposals address only subject matters that affect investors as a whole.
The SEC should revitalize the exclusion for proposals that include materially false or misleading statements. Currently, proposals may be excluded under Rule 14a-8(i)(3) “if the proposal or supporting statement is contrary to any of the Commission’s proxy rules,” including rules that prohibit false or misleading statements in proxy soliciting materials. However, the report contends, in practice, “the SEC staff has eroded the viability of this exemption by placing the burden on issuers to prove that a statement made by a proponent is materially false or misleading,” often erring “on the side of proponents, even in cases where an issuer believes that it will result in false or misleading information being included in its proxy statement.”