SEC Chair Jay Clayton announced earlier this week that the SEC will be holding a roundtable to discuss the proxy process, date TBD. Potential topics include the voting process, retail shareholder participation, shareholder proposals, proxy advisory firms and technology and innovation. In 2010, the SEC issued a concept release soliciting public comment on whether the SEC should propose revisions to its proxy rules to address the infrastructure supporting the proxy system, so-called “proxy plumbing.” Back then, the SEC had decided that it was time to do some maintenance on the creaky old plumbing system. However, as then Commissioner Elisse Walter, quoting Kurt Vonnegut, commented at the 2010 open meeting to vote on the concept release: “It’s a flaw in the human character that everyone wants to build, but nobody wants to do maintenance.” That statement was more prophetic than she probably anticipated when she made it: nothing came of the concept release. Whether more results from this current effort remains to be seen.
The 2010 concept release sought public comment on whether there were improvements necessary to promote greater efficiency and transparency in the U.S. proxy system and to enhance the accuracy and integrity of shareholder votes. Depending on the public reaction, the SEC expected at the time to propose new rules tackling those issues.
The concept release was divided into three categories: (i) transparency and accuracy of the process; (ii) shareholder participation and communications; and (iii) relationship between voting power and economic interest. In the first category, the release addressed issues such as overvoting and undervoting, which can occur when there is a mismatch between the share amounts shown on the books of the voting intermediary and amounts credited for the account of the intermediary on the company’s books; the need for vote confirmation through contact among the vote tabulators, solicitors and others; proxy voting by institutional shareholders, which may loan shares but may not be able to recall the shares in time to vote them; and the reasonableness of and method for calculating fees for distribution of proxy materials. In the second category, the release addressed the ability of companies to communicate with their shareholders, including topics such as shares held in street name and NOBO and OBO lists; ways to encourage retail participation through investor education or improvement of internet platforms; and data tagging of the proxy statement. In the third category, the release looked at proxy advisory firms, including whether they were subject to conflicts of interest, failed to conduct proper research or published incorrect information and whether they should be subject to enhanced oversight, including a requirement for SEC filings by these firms; whether the proxy rules should be revised to accommodate dual record dates (as permitted in some cases in Delaware) and to address issues related to the ability of a former shareholder to continue to vote shares after they have been sold; and empty voting, which can occur when voting rights associated with shares are decoupled from the shares’ economic interest, for example, when a shareholder buys a put option on shares the holder retains the right to vote. (See this Cooley News Brief.)
In his statement, Clayton observed that the proxy process is a fundamental component of shareholder engagement, which is, itself, a “hallmark of our public capital markets.” Since the 2010 concept release, the level of reported shareholder engagement has increased from 6% of the S&P 500 to 72% in 2017. In addition, he maintained, the “SEC’s rules governing the proxy process are at the center of investor participation in, and influence over, corporate governance at U.S. public companies.” In light of the many changes to the “markets, technology and how companies operate,” the time had come for the SEC to “review whether our existing rules are achieving their objectives effectively.”
While no agenda has yet been set, Clayton asked the staff to consider the following topics, some of which may make you think this is Groundhog Day:
Voting Process: Does addressing problems associated with over-voting and under-voting sound familiar? How about “empty voting” (when the voting rights are held separately from the economic interest)? Other issues on the list to be considered are problems in confirming whether shares are voted in accordance with instructions (especially given the number of participants in the process), and costs and challenges associated with distributing proxy materials and communicating with shareholders, particularly street name holders, whether NOBOs or OBOs.
Retail Shareholder Participation: What accounts for the huge spread between the participation rate of retail voters compared with institutional voters? For the 2017 proxy season, retail shareholders voted approximately 29% of their shares, while institutional investors voted approximately 91% of their shares. To what extent is the low level of retail participation a problem that should be addressed? Are there rules that inappropriately inhibit retail participation? Would better communication and coordination among proxy participants, increased use of technology, rule changes or investor education increase participation? How should individuals who invest through mutual funds or pension funds be able to participate in the governance of their public company investments?
Shareholder Proposals: In his statement, Clayton emphasized the need for balance in the shareholder proposal process: while shareholders “may benefit from the engagement and potential for enhanced performance brought about by consideration of a shareholder proposal,” the shareholders are also the ones that ultimately bear the costs associated with inclusion of a shareholder proposal in the company’s proxy statement. Clayton notes in particular that only a small group of shareholders submits a “significant percentage” of the proposals submitted.
Clayton has previously indicated that the SEC would 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].” (See this PubCo post.)
Questions for consideration include whether the current minimum shareholder ownership thresholds for submission as well as the thresholds for resubmission are appropriate? Are there tests, other than the amount and duration of share ownership, that would be appropriate? Do the proposal and engagement processes properly take into account the “voices of long-term retail investors”?
The shareholder proposal process remains a current hot topic. As discussed in this PubCo post, two new groups have recently been formed to take aim at the shareholder proposal process—its use by proponents and its implementation by Corp Fin—from both the right and the left ends of the political spectrum. On one side is a new group, the Main Street Investors Coalition, formed to wage a multi-million dollar campaign aimed at countering the influence exercised by a number of large institutional investors and asset managers in the shareholder proposal process, particularly in connection with issues the Coalition views as inherently social or political. For example, last year, proposals to enhance disclosures regarding climate change won majority votes at three major companies, in large part as a result of support from mammoth asset managers such as BlackRock and Vanguard, and two climate change proposals won majority support this year. It’s also been reported that nine ESG proposals were successful in winning majority votes this year. (See, e.g., this PubCo post.) According to the Coalition, as the “size and influence of these massive institutional holders has grown, so too has their power, influence and share of voice—drowning out the voices and interests of Main Street investors who, despite controlling the single largest pool of equity capital in the world, have almost no ability today to influence the decisions these funds make on their behalf, with their money. The Main Street Investors Coalition was created to help change that.” The Coalition proposed four solutions to reform a system that it views as “badly broken, costly and inherently unfair.”
On the other end of the political spectrum is another coalition formed by a group of investors, the Shareholder Rights Group, which is focused on defending shareholders’ “rights to engage with public companies on governance and long-term value creation,” especially through the shareholder proposal process. The Group, which consists of 14 institutional investors that manage approximately $25 billion in assets, as reported by Bloomberg BNA, as well as a prolific proponent of shareholder proposals, John Chevedden. Members of the Group have submitted numerous shareholder proposals on a variety of ESG topics, such as climate change and corporate governance. In particular, the Group levels criticism at Corp Fin for a perceived recent shift in approach to shareholder proposals, especially its implementation of SLB 14I (2017) and its recent decisions under Rule 14a-8(i)(9), the exclusion for conflicting proposals. That SLB was viewed as expanding the application of the Rule 14a-8(i)(7) “ordinary business” exclusion and the Rule 14a-8(i)(5) “economic relevance” exclusion. With regard to Rule 14a-8(i)(9), the Group is critical of Corp Fin decisions to allow companies to “game the process” by introducing their own conflicting management proposals after receipt of the shareholder proposals. To address these issues, the Group presented Corp Fin with a series of recommendations.
Proxy Advisory Firms: Do investment advisers and others rely excessively on proxy advisory firms for information aggregation and voting recommendations? Are issuers allowed a fair shot at raising concerns about recommendations, especially about errors and incomplete or outdated information on which a recommendation is based? Are proxy advisory firm’s voting policies and procedures sufficiently transparent? Would comparisons of recommendations across similarly situated companies have value? Are any conflicts of interest (e.g., consulting services) adequately disclosed and mitigated? Should proxy advisory firms be regulated? Should prior staff guidance about investment advisers’ responsibilities in voting client proxies and retaining proxy advisory firms be modified?
What is that last question about? By way of background, as fiduciaries, investment advisers owe their clients duties of care and loyalty with respect to services provided, including proxy voting. Accordingly, in voting client securities, an investment adviser must adopt and implement policies and procedures reasonably designed to ensure that the adviser votes proxies in the best interest of its clients. Prior SEC staff no-action guidance (Egan-Jones Proxy Services, avail. 5/27/04, and Institutional Shareholder Services Inc., avail. 9/15/04) indicated that one way advisers may demonstrate that proxies are voted in their clients’ best interest is to vote client securities based on the recommendations of an independent third party—including a proxy advisory firm—which serves to “cleanse” the vote of any conflict on the part of the investment adviser. Historically, investment advisers have frequently looked to proxy advisory firms to fill this role. As a result, the staff’s prior guidance was often criticized for having “institutionalized” the role of—and, arguably, the over-reliance of investment advisers on—proxy advisory firms, in effect transforming them into faux regulators. As discussed in this Cooley Alert, in response to frequently voiced criticisms that proxy advisory firms wielded too much influence—with too little accountability—in corporate elections and other corporate matters, in 2014, the SEC’s Divisions of Investment Management and Corp Fin issued Staff Legal Bulletin No. 20, “Proxy Voting Responsibilities of Investment Advisers and Availability of Exemptions from the Proxy Rules for Proxy Advisory Firms,” which sought to reinforce the responsibilities of investment advisers as voters by reinvigorating their due diligence and oversight obligations with respect to any proxy advisory firms on which they rely. In that guidance, the staff indicated additional steps that an investment adviser could take to demonstrate that proxy votes were cast in accordance with clients’ best interests. In addition, investment advisers were advised to “adopt and implement policies and procedures that are reasonably designed to provide sufficient ongoing oversight of the third party in order to ensure that the investment adviser, acting through the third party, continues to vote proxies in the best interests of its clients,” including measures to identify and address the proxy advisory firm’s conflicts on an ongoing basis. For example, the investment adviser was advised to ascertain, among other things, “whether the proxy advisory firm has the capacity and competency to adequately analyze proxy issues.” (See also this PubCo post.)
In addition, in response to criticism that proxy advisory firms were often subject to undisclosed conflicts of interest that could affect their vote recommendations, the SLB strengthened the disclosure obligations of proxy advisory firms in connection with conflicts of interest. However, these obligations were highly decaffeinated in comparison to the potential requirements that were floated in connection with the SEC’s 2010 proxy plumbing concept release or the 2010 report from the NYSE Commission on Corporate Governance. The proxy plumbing concept release suggested requiring more disclosure regarding potential conflicts of interest, requiring proxy advisory firm registration, requiring proxy advisory firms to describe their review processes in filed reports and requiring proxy advisor recommendations to be filed with the SEC. In 2010, the NYSE Commission on Corporate Governance had commended the SEC for issuance of the proxy plumbing concept release, including provisions regarding proxy advisors. The NYSE Commission advocated that proxy advisors be held to appropriate standards of transparency and accountability, including adherence to strict codes of conduct and requirements to disclose the policies and methodologies that they use to formulate specific voting recommendations, all material conflicts of interest and the company’s response to the firms’ analyses and conclusions. The Financial Choice Act of 2017, which passed the House but died in the Senate, would have also required registration of proxy advisory firms. (See this PubCo post.)
Technology and Innovation: Are there ways that technology, such as blockchain, can be used to make the proxy process more efficient and effective for participants or to streamline or create more accountability in the process?
Other Commission Action: Under this caption, the idea of universal proxy cards has once again reared its head. A universal proxy is a proxy card that, when used in a contested election, includes a complete list of board candidates, thus allowing shareholders to vote for their preferred combination of dissident and management nominees using a single proxy card. Clayton observed that, under the existing rules, nominees must consent to including their names on a proxy card, with the result that, in an election contest, a dissident may not include the other party’s nominees unless it receives consent, which, he noted, rarely occurs. You might recall that, in 2016, the SEC proposed amendments to the proxy rules mandating the use of universal proxy cards in contested elections, but no action was ever taken. Clayton seems to be suggesting that universal proxy cards be a topic of discussion at the roundtable. (See this PubCo post.)
Currently, in contested director elections, shareholders can choose from both slates of nominees only if they attend the meeting in person. Otherwise, they are required to choose an entire slate from one side or the other. (Dissidents’ “short slates” allow shareholders to select company nominees to round out the short slates, but again, shareholders are then forced to choose between the two complete slates.) Because a later-dated proxy revokes an earlier-dated one under state law, it’s not easy to split votes between slates. Strongly held opinions have been voiced about universal proxies, both pro and con. Activists—hedge fund and otherwise—tend to favor universal proxies, while companies are more often opposed to them.
The SEC apparently considered requiring universal proxies back in 1992. Then, in 2014, the Council of Institutional Investors filed a rulemaking petition asking the SEC to reform the proxy rules to facilitate the use of universal proxies in proxy contests. (See this News Brief.) Interestingly, although the 2016 proposal was still on the SEC’s Spring 2018 agenda for long-term actions, and reportedly, SEC officials had indicated publicly that the topic remained a priority, Reuters recently reported that, according to “several people familiar with the matter,” Clayton “has in fact shelved the proposal.” Apparently, not so much. (See this PubCo post.