The Background: The U.S. Securities and Exchange Commission ("the SEC") has announced that it may no longer review no-action letter requests relating to shareholder proposals submitted to companies under Rule 14a-8. The SEC has repeatedly fine-tuned its rules and interpretations governing the Rule 14a-8 process over the decades since enactment of the Rule. If adopted, this reform would be a major—and welcome—change from established SEC practice.
The Issue: If the SEC revamps the Rule 14a-8 shareholder proposal process in this way, it would remove itself as an unqualified "referee" in the shareholder proposal process. The process would then align with the process for other no-action requests before the SEC, with guidance given only on novel or difficult issues.
Looking Ahead: As the volume of shareholder proposals has increased, so has the focus on potential reforms. The need for substantive, market-beneficial changes in this area has never been greater. The SEC should consider not only whether the shareholder proposal process should largely be guided by state law, but also whether the market—not SEC personnel—should determine the proper avenue for shareholder democracy.
Last December, the federal government shut down for more than a month during a protracted budget dispute. For public companies, the shutdown occurred at a critical time of the proxy season—the period when many companies seek the SEC's permission to exclude shareholder proposals from proxy statements for their spring annual meetings. Overall, the longest government shutdown in U.S. history and the furlough of most SEC personnel did not seriously impede the shareholder proposal process, although some companies decided to include proposals in their proxy statements rather than exclude them without SEC guidance.
Over the summer, after looking back at the impact of the furlough, the SEC floated the possibility of reforms to the Rule 14a-8 shareholder process. Essentially, the SEC is once again considering whether to align its procedures for addressing Rule 14a-8 no-action requests more closely with its approach to other no-action requests, such as those for Rule 144A private placements. In the usual case, the SEC only responds to no-action requests that pose novel or difficult issues, whereas for shareholder proposals, the SEC is the arbiter on every request.
We applaud the SEC's openness to a more light-handed and restrained approach to the current shareholder proposal structure. However, the SEC should go beyond merely limiting its issuance of guidance under existing Rule 14a-8. While it is true that many companies and shareholder proponents have come to rely on the SEC's guidance as to whether proposals may be properly excluded, the shareholder proposal rule was originally designed to facilitate engagement between companies and their shareholders. Removing the SEC from its current role as "referee" in the process would further encourage this direct interaction, in line with the rule's original intention. Further, it is our view that the SEC is an unnecessary arbiter of shareholder proposals—and the more appropriate perspective is not that the SEC should largely remove itself from the shareholder proposal process, but that it must.
As the SEC continues to consider reforms in this area, we hope that it gives thoughtful consideration to the issues outlined below.
State Law Defines the Substance—Why Shouldn't It Guide the Process?
First, the SEC should consider the gating issue of whether the shareholder proposal process, which ultimately relates to shareholder voting, is properly guided by state law. Congress enacted federal legislation regarding the shareholder proposal process and designated the SEC as the agency with responsibility for ensuring that proxy solicitations are conducted in the public interest. Although this designation effectively preempted conflicting state regulation, a number of commentators and the SEC itself have acknowledged that the shareholder proposal rule was intended to implement shareholders' rights to access the corporate ballot under state law, and that the proper subjects of shareholder proposals are those defined as appropriate under state law. Accordingly, the SEC's current participation as a referee in the shareholder proposal process is not only unnecessary, it interferes with rights properly left to a company's internal governing documents, themselves governed by state law.
Why Allow Free Riders in the Shareholder Proposal Process?
Of the close to 800 shareholder proposals originally submitted in 2018, only 39 ultimately came to a vote and passed. Under the current 14a-8 structure, hundreds of proposals are submitted each year on topics that are not material—or even relevant—to a majority of a company's shareholders. Correspondingly, companies submit a high number of requests for Rule 14a-8 no-action relief to the SEC each year. For example, during the 2018 proxy season, companies submitted 256 no-action requests for the staff's consideration. This heavy workload not only burdens companies needlessly but also taxes SEC resources, with the agency dedicating a number of personnel each winter to deal exclusively with Rule 14a-8 no-action requests.
Importantly, the costs of shareholder proposals are not borne solely by the proposing shareholders, but instead by the receiving companies and their shareholders at large. This is true whether a proposal is relevant to all shareholders and a valid subject for shareholder action, or whether it appeals only to the special interests of a select few. The Center for Capital Markets Competitiveness has indicated that the average shareholder proposal costs a company $87,000. Moreover, as Professor Susan Liebeler noted in her seminal and ageless critique of the proxy proposal process, A Proposal to Rescind the Shareholder Proposal Rule, the indirect costs of shareholder proposals can be considerable as boards and management teams address marginal proposals instead of focusing on creating value for all of their shareholders.
Consistent with state laws governing the proper role of shareholders versus directors, shareholder proposals are typically advisory in nature (or "precatory") and not binding on a corporation. That fact does not, however, render the corporate proxy statement the appropriate venue for all shareholder input. Moreover, shareholders have other available methods to express their views to the companies in which they invest, including letters to boards of directors, public advertisements in The Wall Street Journal, or even the free, immediate and widespread dissemination of their views through social media. As currently constructed, the Rule 14a-8 process gives shareholders—even those without a meaningful investment in a company—free access to the corporate proxy statement, which is distributed to thousands if not millions of readers, at no cost to the proponent. Any efforts by the SEC to reform the Rule 14a-8 process should consider and address this imbalanced "free rider" problem.
Why Not Let Private Ordering Determine the Shareholder Proposal Process?
As noted earlier, state law should—and does—direct the proper subject of shareholder voting; however, it cannot address every possible permissible (or excludable) subject of shareholder action. Accordingly, companies should consider adopting bylaws that implement procedures and standards that will define the shareholder proposal process, much in the way that corporate bylaws define other forms of shareholder action, such as the nomination of directors and the calling of special meetings. Such bylaws would render the current Rule 14a-8 no-action process, along with its costs and burden on the SEC, unnecessary. Among other things, corporate bylaws can set forth the manner and extent to which a company's board of directors will participate in the shareholder proposal process. In particular, the analysis of whether a particular social proposal should be considered to be an "ordinary business" matter involves a high degree of judgment and is squarely within the authority and responsibility of the board of directors, acting as a steward for the company's shareholders. As the SEC itself stated in Staff Legal Bulletin 14I, a board acting in a fiduciary role and "with the knowledge of the company's business and the implications for a particular proposal on that company's business is well situated to analyze, determine and explain whether a particular issue is sufficiently significant because the matter transcends ordinary business and would be appropriate for a shareholder vote." Accordingly, the board's well-informed and well-reasoned judgment on the matter should be determinative, and the business rule would apply if a board's decision to exclude a shareholder proposal from a company's proxy statement were challenged. Further, in light of Rule 14a-8's goal of engagement between companies and shareholders, companies should consider the most appropriate way to share their board's analyses and conclusions relating to proposals with their shareholders.
The topic of proxy access is particularly instructive here. Although the SEC's final universal proxy access rules were ultimately invalidated, many large U.S. public companies have adopted bylaws through private ordering discussions with shareholders that define when and how shareholders may nominate director candidates in the corporate proxy statement. Why shouldn't the shareholder proposal process follow a similar approach? This method would allow the market to determine the appropriate procedure and subject matter for shareholder proposals, just as it did in the development of market standards for proxy access. Importantly, as shareholders are able to leverage their voting power in director elections, companies would be just as incentivized to engage and privately negotiate with their investors as they were in the development of proxy access bylaws, allowing shareholders a strong voice in developing reasonable bylaws governing shareholder proposals. Such engagement would also allow for shareholders invested in the long-term value of the company to work with the board and management on developing shareholder proposal standards that are tailored to best meet the individual facts and circumstances around a company and its ownership base.
Would the Shareholder Proposal Process Pass Muster Under an Appropriate Cost-Benefit Analysis If It Were Adopted Today?
In recent years, companies have increasingly contended with an influx of shareholder proposals on general societal issues, such as political contributions, environmental issues, and human rights. This development has persisted despite the SEC's earlier views that the privilege of including shareholder proposals in proxy statements should not be abused "by using the rule to achieve personal ends which are not necessarily in the common interest of the issuer's security holders generally." Companies have spent significant amounts of money and board and management time to exclude inappropriate and immaterial proposals, even as these proposals garner little support and rarely prevail. As an example, even with the headline-grabbing coverage of climate change issues, environmental and socially-focused proposals tend to garner low support—in 2018, they received around 24% of votes cast. Under the current system, corporate assets and time are being wasted to subsidize shareholder votes on proposals that nonetheless don't attract shareholder consensus. And as noted above, under the current system, the SEC also allocates significant resources to the shareholder proposal review process. Ultimately, these costs are distributed even more widely to U.S. taxpayers generally. In our view, the Rule 14a-8 process would not pass muster as an appropriate cost-benefit if issued today, and the SEC should focus on creating a structure that leads to a more sensible cost-benefit balance, especially as in the current environment, shareholders with special interest proposals may garner more corporate and shareholder attention than proposals concerning corporate long-term value.
It is past time for the SEC to step aside as "referee" and allow for companies and shareholders to engage directly on shareholder proposals. With the SEC limiting its voice to new or challenging issues, companies should be confident in navigating the shareholder proposal process by deploying a thoughtful and well-informed process for board determinations of whether a given proposal is appropriate for shareholder action. We urge boards of directors to stand ready to take action in the anticipated new era of SEC "no action."
Two Key Takeaways
- Although the SEC's rulemaking, interpretation, and substantive views have long governed the shareholder proposal process, these matters are more appropriately guided by state corporate laws and corporate bylaws.
- Companies and their boards of directors, engaging with their shareholders, are well-equipped to make determinations relating to the exclusion of shareholder proposals from the corporate proxy materials. We urge the SEC to permit them to do so.