The U.S. House of Representatives’ Financial Services Committee approved the Financial CHOICE Act of 2017 last Thursday, clearing it for a vote before the entire House.1 The bill contemplates sweeping changes affecting a range of matters, but tucked away among its nearly 600 pages is a brief section that would raise the bar for shareholders seeking to put proposals on public companies’ annual meeting ballots.2
Bill would impose more stringent requirements for shareholders seeking to put proposals on companies’ annual meeting ballots:
Raises ownership threshold to 1% of a company’s outstanding shares (from the current lesser of $2,000 or 1%) and raises holding period threshold to three years (from the current 1 year)
Raises percentage of shareholder vote a proposal must win to be eligible for resubmission
Eliminates proposals by a non-shareholder acting on behalf of a shareholder
Changes likely to reduce the frequency of shareholder proposals for companies, particularly those with larger market capitalizations
- Larger, more sophisticated shareholders may fill the void
The Proposed Changes and Potential Benefits
Under current SEC regulations, a shareholder who has held either 1% or $2,000 worth of a public company’s outstanding shares for at least a year is eligible to submit a proposal for inclusion in the company’s proxy statement for its annual meeting.3 Even if a shareholder proposal fails to garner majority support initially, the proponent may resubmit it as long as it obtained at least 3% of the vote when last presented. This percentage increases to 6% with the next resubmission and to 10% for any subsequent resubmission. The SEC also generally permits shareholder proposals by a non-shareholder on behalf of a shareholder,4 a practice which has produced a cottage industry of professional, non-shareholding advocates for proposals.
For years many in the corporate community have complained that the SEC’s shareholder proposal process is broken, principally because the eligibility rules permit special interest proposals by shareholders with very small economic stakes at risk. The Manhattan Institute5 recently published startling statistics for Fortune 250 companies which demonstrate how askew the landscape has become:
In 2016, companies faced 1.26 shareholder proposals on average
In 2017, over one third of the shareholder proposals were submitted by just three shareholders: John Chevedden, Kenneth Steiner and James McRitchie
Since 2006, only 1% of institutional shareholders—unaffiliated with labor unions, public employee pension plans or religious/social/public policy oriented shareholders—have sponsored proposals
In 2016, only 7% of shareholder proposals received majority shareholder support (even less excluding proxy access proposals)
The Financial CHOICE Act of 2017 takes aims at the key shareholder proposal eligibility provisions. Section 844 of the bill would require the SEC to eliminate the alternative $2,000 ownership threshold and “require the shareholder to hold” at least 1% of the subject company’s shares. Accordingly, it does not appear to permit aggregation of shares by multiple shareholders to reach this threshold. The bill would also require the SEC to increase the holding period requirement from 1 year to 3 years and to increase the minimum shareholder support threshold for resubmissions within a five-year window from the current 3% (for the first resubmission), 6% (for the next resubmission) and 10% (for any subsequent resubmissions) to 6%, 15% and 30%, respectively. Lastly, the bill would abolish proposals from non-shareholders completely.
This trilogy of proposed changes would have the effect of making it harder for shareholders to submit proposals. For many large-cap companies, the new ownership threshold would require millions if not billions of dollars in minimum stock ownership.6 Indeed, almost all shareholder proposals today would be ineligible under the 1% rule, including not just those sponsored by gadflies but even the proposals of many of the major public pension funds.7
Many companies will applaud these changes because they often view shareholder-submitted proposals as, at best, annoyances or distractions. The Business Roundtable estimates that each shareholder proposal costs the company combatting it, on average, $87,000,8 and many public companies receive multiple proposals every year.9
Potential Unintended Consequences
There is little doubt the Financial CHOICE Act’s more stringent criteria for making a proposal should lead to fewer Rule 14a-8 shareholder proposals, saving companies time and money. More subtly though, it may remove the company’s opportunity to make its case about prevailing shareholder topics against relatively weaker opponents, and then to use those victories to dissuade subsequent challenges from stiffer opponents.
Indeed, the Financial CHOICE Act may serve as a clarion call to the sophisticated investors who can afford to make shareholder proposals under the new regime.10 Under the current rules, many of these shareholders have a free-riding incentive to let gadflies and ESG-oriented groups bear the cost of the shareholder proposal process. With those traditional shareholder proponents knocked out of the box, larger shareholders may fill the void. This new class of proponents can be expected to make proposals which are more targeted and nuanced, with some proponents waging ad campaigns to bolster their causes against companies most vulnerable to criticism. They may beef up their internal resources to accommodate the shareholder proposal mission as part of their ongoing corporate outreach function.
The recent stunning success of the New York City Pension Funds’ proxy access initiative is an object lesson.11 A well-resourced shareholder proponent selected specific corporate targets for the proposal. The success of the initiative compelled other companies to seek to preempt a similar fate. The result: within a two year period, proxy access is a market standard for large companies.12 And like other popular shareholder proposals such as de-staggering of boards, majority voting and poison pill redemptions, proxy access provisions will likely ripple their way down the corporate food chain to the mid-caps and smaller companies.
What’s more, the bill could eliminate one of the oft-ignored benefits of the shareholder proposal process: the ability to submit proposals gives the public a mechanism to air their grievances with company management, yet in most cases poses very little risk of actually requiring immediate change—after all, the majority of all non management proposals are soundly rejected. If that outlet for complaints is removed, aggrieved shareholders may have no choice but to resort to more direct, blunt action,13 such as binding bylaw proposals,14 withhold vote for director campaigns, or even the ouster of company directors via proxy access or in a conventional contest.15
The proposed legislation only increases procedural hurdles for bringing proposals, not substantive ones. For example, it does not alter the current (and relatively shareholder-friendly) SEC rules regarding when management can omit proposals related to “ordinary business.”16 The current trend in favor of socially- and environmentally-minded proposals17 from certain large institutional investors is likely to continue unabated absent SEC rule or staff interpretative modifications.
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The Financial CHOICE Act of 2017 has a long way to go before it becomes law. Like the other elements of the bill, the shareholder proposal reform provisions may look very different if and when implemented. In current form, the bill would make it harder for shareholders to submit Rule 14a-8 proposals. This could provide companies with relief from the burden they face from a number of relatively minor skirmishes. On the other hand, the vacuum created by the tightened eligibility standards may create unintended consequences for companies which need to be examined in greater detail.