SEC Proposes Rules to Restrict Shareholder Proposals

Do the new rules facilitate constructive engagement, or transfer power to CEOs?

The Securities and Exchange Commission (SEC), during its public meeting on November 5, 2019, voted 3-2 to consider amendments that would change the rule that governs the process for shareholder proposals to be included in a company’s proxy statement. This rule, Exchange Act Rule 14a-8, requires most publicly traded companies to include shareholder proposals, subject to certain ownership restrictions, in their proxy statements.

These shareholder proposals have been used in a wide variety of ways over the decades since the SEC was first formed, but most recently to propose actions to mitigate climate change, change corporate governance standards, nominate candidates for corporate boards, and to restrict CEO pay. Most shareholder proposals never get to a proxy ballot. Corporate representatives spend time with those proposing these measures and see if they can negotiate changes that are satisfactory. Some are deemed irrelevant or dismissed because they interfere with a company’s ordinary business. 

SEC Chair Jay Clayton says the proposed amendments “would facilitate constructive engagement by long-term shareholders in a manner that would benefit all shareholders and our public capital markets.” Lisa Woll, CEO of US SIF: The Forum for Sustainable and Responsible Investment, disagrees, saying that the proposal, “transfers power to CEOs and company management at the expense of their shareholders. Investors have not sought these changes; corporate trade associations have.” US SIF’s mission is to shift investment practices towards sustainability, focusing on long-term investment and the generation of positive social and environmental impacts.

How Much Stock Do You Need to Get a Proposal on the Ballot

As the rule currently stands, the minimum stock ownership necessary to file a resolution at a corporation’s annual meeting is $2,000, which must be held for at least one year. This ownership level was last amended in 1999. The SEC is proposing instead that shareholders would have to own $25,000 of the target company’s stock for at least one year, a multiple of 12.5 compared to the current figure, or $15,000 for at least two years. Smaller shareholders who own at least $2,000 but less than $15,000 worth of the company’s stock would have to wait three years to file a resolution. From a practical point of view, the shareholder must own enough to prevent the value of the holding to drop below the threshold during the previous year in order to file a proposal. If the value falls below the cutoff, the waiting period starts again.

The rule also has provisions for the level of support a shareholder proposal that does not garner a majority must win in order to be considered on a future ballot. The proposal changes these thresholds from 3 percent in the first year, 6 percent in the second year and 10 percent in subsequent years to 5 percent, 15 percent and 25 percent. The proposal also allows a company to exclude a proposal in future years if one that wins 25-50 percent if the support drops by 10 percent from the previous year’s level.     

How Big of a Problem are Shareholder Proposals?

Based on the major changes proposed to this rule by the SEC, one would think that shareholder suggestions have been a huge problem for corporations. US SIF’s Woll, however, says that on average, only 13 percent of Russell 3000 companies received a shareholder proposal in any one year between 2004 and 2017. In other words, the average Russell 3000 company receives a proposal once about every 8 years. Data collected by US SIF shows that between 2016 and 2018, the largest number of shareholder proposals were related to proxy access, which includes nominations for the board of directors.  

ESG Issues 2016-2018
Source: Sustainable Investments Institute.

According to the Shareholder Rights Group, an association of investors formed in 2016 to defend shareowners rights to engage with public companies on issues related to governance and long-term value creation comprised of a number of faith-based investing and environmental action groups, “Most shareholder proposals seek to warn a company and its investors about emerging issues relevant to the firm’s long-term sustainability, and/or to improve governance, disclosure, risk management or performance.” 

Business Roundtable Supports the Change

The Business Roundtable, a group formerly chaired by JP Morgan & Chase CEO Jamie Dimon, has been a key supporter of changing these rules. The group initially submitted a proposal to change the shareholder proposal rule in 2014. In a letter to the SEC by John A. Hayes, Chair of the Corporate Governance Committee at Business Roundtable, the current resubmission rules, “do little to protect shareholders and companies from needless expense and effort. Moreover, changes over the past decade in the proxy voting process have exacerbated the ineffectiveness of the Resubmission Rule, increasing the likelihood that companies will be required to repeatedly provide, and shareholders repeatedly review and vote on, proposals that are of no interest to a significant majority of shareholders.”

In essence, the Business Roundtable believes that the ability of shareholders to submit initiatives that may require a vote causes companies to spend time and money that could be better used elsewhere.

SEC Commissioner Robert Jackson's Dissent

SEC Commissioner Robert Jackson's Dissent

"Whatever problems plague corporate America today, too much accountability is not one of them."

SEC Commissioner Robert Jackson, who was one of the dissenting votes, said in a statement and in a conference call following the vote that though the existing rules could use some updating, the proposal as currently written is not the right path. Jackson’s staff studied the types of investor initiatives that would be removed from proxy ballots if the new rule is approved, and noted that the evidence shows that the proposed changes remove key CEO accountability measures from the ballot. “Whatever problems plague corporate America today, too much accountability is not one of them,” Jackson said. 

Amberjae Freeman, chief operating officer of Etho Capital, which creates public equity index strategies that deliver financial performance driven by climate efficiency, innovation, diversification, and superior environmental, social and governance (ESG) sustainability, says that the rule as originally written was designed to protect investors and to make it possible for more voices to be heard. She believes that shareholder activism is a way to balance the short-term profit focus of most publicly traded corporations with long-term value. Freeman says, “Shareholders should be able to bring up issues that could detract from long-term shareholder value.” Freeman quotes Adam Smith, who back in 1776 said in An Inquiry into the Nature and Causes of the Wealth of Nations:

“...The interest of the dealers, however, in any particular branch of trade or manufactures, is always in some respects different from, and even opposite to, that of the publick....The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention.”

Though many credit Adam Smith with defining capitalism, Freeman sees the book as a warning to keep an eye on corporate behavior in order to avoid causing damage.

Changes Already Enacted Under the Radar Using Legal Bulletins

Bryan McGannon, Director of Policy and Programs for US SIF, notes that the SEC has made a number of changes under the radar using staff legal bulletins. Bulletin 14k, issued on October 16, 2019, discusses which shareholder initiatives can be dismissed because they fall under the “ordinary business” exception. The examples listed in the bulletin involved climate change proposals made by shareholders, saying that one that specified specific greenhouse gas targets was considered micromanagement, but one that made a general statement about reducing carbon footprint was acceptable. “These proposals had been allowed in past years, but are now being excluded based on these recent bulletins,” McGannon says. It appears that the general climate towards shareholder involvement is getting less friendly.

McGannon says that most shareholder initiatives are relatively short, and non-binding for the most part. He says that the proposal creates a tiered system of ownership, which is new, and restricts proposals to individual investors. Under the current rule, several investors could band together to attain the required ownership level. “As soon as you take away that aggregating, you’re taking away proposal filing power from religious groups and investing clubs,” McGannon says. Since the SEC’s guidance is that an investor should have diversification, an individual would need a substantial portfolio to hold $25,000 in a single position, including the buffer one would need to keep that holding from dropping below the threshold value during the year. 

What's Next?

What’s next for this rule proposal? The entire proposal comprises over 300 pages, and once it’s published in the Federal Register, the 60-day public comment period commences. McGannon says that US SIF is pushing to extend the comment period since the document contains more than 100 questions that anyone interested can comment upon. We will update this article once the rule has been published and include a link to the comments.

Once the comment period is closed, the SEC’s staff must consider all of the submissions, then write a final version of the rule. The edited rule goes back to the SEC for a vote before being enacted.  

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