This proxy season, companies saw more shareholder proposals than in the past, a change that has been widely attributed to actions by the SEC and its Division of Corporation Finance that had the effect of making exclusion of shareholder proposals—particularly proposals related to environmental and social issues—more of a challenge for companies. As discussed in this article in the WSJ, investors are taking the opportunity to press for more changes at companies. Nevertheless, the prescriptive nature of many of the proposals, especially climate-related proposals, has prompted many shareholders, including major asset managers, to vote against these proposals. Will next season reflect lessons learned by shareholder proponents from this proxy season?
Under Rule 14a-8, a shareholder proposal must be included in a company's proxy materials "unless the proposal fails to satisfy any of several specified substantive requirements or the proposal or shareholder-proponent does not satisfy certain eligibility or procedural requirements." The Rule sets forth a number of exceptions on which companies may rely to exclude shareholder proposals from their proxy materials, including Rule 14a-8(i)(5), the economic relevance exception, and Rule 14a-8(i)(7), which permits a company to omit a proposal that "deals with a matter relating to the company's ordinary business operations." In November last year, Corp Fin issued Staff Legal Bulletin 14L, which outlined Corp Fin's most recent interpretations of these exceptions, presenting its approach as a return to the perspective that historically prevailed in 1998. The 1998 release described the policy underlying the ordinary business exclusion as resting "on two central considerations. The first relates to the subject matter of the proposal. [P]roposals relating to [ordinary business] matters but focusing on sufficiently significant social policy issues . . . generally would not be considered to be excludable, because the proposals would transcend the day-to-day business matters and raise policy issues so significant that it would be appropriate for a shareholder vote. . . . The second consideration relates to the degree to which the proposal seeks to 'micro-manage' the company by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment." The SEC "clarified that specific methods, time-frames, or detail do not necessarily amount to micromanagement and are not dispositive of excludability."
Beginning in 2017, during the tenure of SEC Chair Jay Clayton, Corp Fin issued three SLBs interpreting "significant social policy," "micromanagement" and "economic relevance"—three SLBs that were generally viewed as facilitating the exclusion by companies of shareholder proposals. In 2021, SLB 14L rescinded the three SLBs, reversing some of the Clayton-era interpretations. As a result, SLB 14L generally had the effect of expanding the availability of the social policy exception and limiting the concept of micromanagement, in effect making it more problematic for companies to exclude shareholder proposals under those exclusions. (See this PubCo post.)
And in a proposing release issued just last month, a release that did not propose to amend Rule 14a-8(i)(7) (but instead proposed to narrow three other substantive exclusions), the SEC nevertheless took the occasion to expressly reaffirm the SEC's 1998 standards for determining whether a proposal relates to ordinary business for purposes of Rule 14a-8(i)(7). (See this PubCo post.)
According to the WSJ, as of July 29, shareholders submitted 650 proposals to S&P 500 companies, representing an increase from 613 proposals in 2021 and 556 proposals in 2020, according to Esgauge, a data analytics firm. The article reports that, in 2022, except for 12 proposals submitted, all proposals were related to environmental, social and governance issues. If adopted, the SEC's new proposal to narrow three substantive exclusions under Rule 14a-8 may further exacerbate the difficulty for companies to exclude shareholder proposals.
In July, the SEC proposed new amendments to Rule 14a-8 to modify three of the substantive exclusions on which companies rely to omit shareholder proposals from their proxy materials: Rule 14a-8(i)(10), the "substantial implementation" exclusion, would be amended to specify that a proposal may be excluded as substantially implemented if "the company has already implemented the essential elements of the proposal." Rule 14a-8(i)(11), the "substantial duplication" exclusion, would be amended to provide that a shareholder proposal substantially duplicates another proposal previously submitted by another proponent for a vote at the same meeting if it "addresses the same subject matter and seeks the same objective by the same means." Rule 14a-8(i)(12), the resubmission exclusion, would be amended to provide that a shareholder proposal would constitute a "resubmission"—and therefore could be excluded if, among other things, the proposal did not reach specified minimum vote thresholds—if it "substantially duplicates" a prior proposal by "address[ing] the same subject matter and seek[ing] the same objective by the same means." The SEC indicated that almost half of the no-action requests the staff received under Rule 14a-8 in 2021 were based on these three exclusions. The release indicated that the proposal is intended to provide clearer standards and greater certainty; the proposal would also have the effect of narrowing these three exclusions, once again increasing the challenge for companies of excluding shareholder proposals. (See this PubCo post.)
According to the WSJ, companies have had "to spend more time and money to engage with investors as they submit more proposals." In addition, proposals have become more prescriptive, "resulting in a lower percentage of proposals gaining majority support. It dropped to 10.6% this year from 16.2% last year, according to Esgauge."
In this paper, BlackRock Investment Stewardship—BlackRock is reportedly the largest asset manager worldwide—provided its perspective on climate-related shareholder proposals that were coming up for votes during the 2022 proxy season. In 2021, BIS "supported 47% of environmental and social shareholder proposals," but, BIS predicted, the results in 2022 were expected to fall well short of that level. Why is that? According to BIS, climate-related shareholder proposals submitted in 2021 focused on "material business risks" or requested reports providing information that would be useful to investors to help them assess a company's "ability to generate durable long-term value." BIS considered these proposals "to be consistent with long-term value creation" and not undue constraints on management's strategic efforts to create shareholder value.
In the view of BIS, however, "many of the climate-related shareholder proposals coming to a vote in 2022 are more prescriptive or constraining on companies and may not promote long-term shareholder value." BIS attributed the change to SLB 14L (discussed above), which BIS maintained "broadened the scope of permissible proposals that address 'significant social policy issues,' [resulting] in a marked increase in environmental and social shareholder proposals of varying quality coming to a vote." In addition, some of BIS's vote determinations might be affected by the current geo-political context—particularly the impact on climate-related proposals of the Russian invasion of Ukraine —as well as "energy market pressures and the implications of both for inflation."
And, according to this recent BIS voting spotlight, BIS's predictions were largely on the mark. Although more proposals were submitted this year, the SEC permitted fewer exclusions, resulting in more proposals coming to a vote. In 2021, of 368 U.S. E&S proposals, 80 were omitted (presumably with staff taking a no-action position), 183 withdrawn and 105 voted on. By comparison, in 2022, of 460 U.S. E&S proposals, only 31 were omitted, 184 withdrawn and 245 voted on. BIS indicated that, in the U.S., it "saw a 133% increase in the number of environmental and social (E&S) shareholder proposals, many of them more prescriptive than in prior years, enabled by changing [SEC] guidance." In voting on behalf of its clients, BIS said that it "supported 24% of E&S shareholder proposals in the U.S. this year, down from 43% last year, reflecting how these factors made these proposals less supportable in the 2021-22 proxy year." That was apparently consistent with the pattern of votes overall; E&S shareholder proposals voted at U.S. companies attracted 27% shareholder support on average—down from 36% last year—which suggests that most investors took a measured, materiality-based approach in their analysis and voting on this year's proposals."
The Spotlight maintains that, as compared to proposals submitted last year, many of the proposals this proxy season "were unduly constraining on management or were overly prescriptive as to information sought or timeframes. Others failed to recognize the progress made such that companies had largely met the ask of the proposal." BIS explained that it had "been more supportive of management this year, as companies make progress on setting climate action strategies and managing material related risks and opportunities that affect their ability to generate long-term financial returns." In addition, BIS noted that "many climate-related shareholder proposals sought to dictate the pace of companies' energy transition plans despite continued consumer demand, with little regard to company financial performance."
In the 2022 proxy season, BIS identified a number of specific concepts that ultimately led to a reduction of its support for some shareholder proposals. These included proposals that "sought decommissioning fossil fuel assets, elimination of financing and insurance underwriting for fossil fuel projects, and cessation of fossil fuel exploration and development. Many of these more prescriptive proposals attracted lower levels of investor support more broadly." Others identified by BIS included: "[r]equiring alignment of bank and energy company business models solely to a specific 1.5?C scenario; [c]hanging articles of association or corporate charters to mandate climate risk reporting or voting; [s]etting absolute scope 3 GHG emissions reduction targets; [d]irecting climate lobbying activities, policy positions or political spending, among others."
Among social proposals, "diversity equity and inclusion audits in the U.S. achieved notable support, with eight proposals passing and six others receiving more than 40% support; [BIS] supported 54% of these proposals this season." BIS "supported 21% of all environmental, social, and governance (ESG) shareholder proposals put to a vote in the 2021- 22 proxy year."
The article observes that, although almost all shareholder proposals are nonbinding, if they reach majority support or even a substantial level of support—the WSJ suggests that level is 25% to 30% of votes, although some might use a higher threshold—investors expect companies to take some action. A number of instances are cited in the article where companies indicated that they would take or carefully consider the action requested in the proposal after the proposal received more-than-majority support. According to a commentator from an asset manager cited in the article, they believe that "when a proposal has received a solid level of support from investors, that should generally be a signal to the board that this is a material issue to investors and something that they should look into."
Proxy advisory firm ISS characterizes this issue as one of "responsiveness," indicating that it will vote on a case-by-case basis on individual directors, committee members or the entire board of directors as appropriate if the "board failed to act on a shareholder proposal that received the support of a majority of the shares cast in the previous year.... " ISS will also consider the following factors:
- "Disclosed outreach efforts by the board to shareholders in the wake of the vote;
- Rationale provided in the proxy statement for the level of implementation;
- The subject matter of the proposal;
- The level of support for and opposition to the resolution in past meetings;
- Actions taken by the board in response to the majority vote and its engagement with shareholders;
- The continuation of the underlying issue as a voting item on the ballot (as either shareholder or management proposals); and
- Other factors as appropriate."
Also to be taken into account is the impact of shareholder engagement and negotiation. In one case cited in the article, engagement with the proponents led the company to ultimately support the proposal, resulting in 98% support for the proposal. The WSJ also cites prolific shareholder proponent, James McRitchie, who advised that he "submitted around 80 shareholder proposals this year. Roughly 30 of those were resolved by agreements with the companies before the annual meetings were held. Companies were able to exclude another 12 from their proxies, he said. The rest were either voted on or will be voted on at coming meetings. Shareholder proposals have naturally become more prescriptive in recent years, Mr. McRitchie said. If a company says it will reduce emissions by 2050, the next step for an investor might be to ask a company for a report on how it will get there, he said."
What to expect for next year? One commentator anticipated an increase in the number of proposals. Moreover, many proponents were likely to learn the lessons of the 2022 proxy season and tweak their proposals accordingly.
In this article from Sustainable Governance Partners, an ESG consulting firm (hat tip to thecorporatecounsel.net blog), the authors conclude that, in light of the conflict of short-term pressures—the energy crisis arising out of the war in Ukraine, high inflation and a global economic slowdown—against long-term systemic risks reflected in the 2021 surge in approval of ESG-driven shareholder proposals, it's no surprise that the 2022 proxy season voting results "created mixed messages and left room for interpretation." The authors suggested three important takeaways:
- "Investors are increasingly open to 'khaki' solutions." The authors highlight the need to recognize that nuance and pragmatism are necessary elements of sustainability strategies. The article refers to Blackrock CEO Larry Fink's annual letter, which acknowledged that the "transition to net zero" will "not happen overnight. We need to pass through shades of brown to shades of green. For example, to ensure continuity of affordable energy supplies during the transition, traditional fossil fuels like natural gas will play an important role both for power generation and heating in certain regions, as well as for the production of hydrogen." (See this PubCo post.) The authors suggest that this recognition of "'khaki finance' provides companies with opportunities to gather shareholder support for sustainability strategies that are both ambitious and pragmatic."
- "ESG is not dead." The rumors of ESG's untimely death are not true, the authors contend. In a key element of their analysis, the authors observe that, "[i]n reality, investors are not moving away from ESG, and are deepening the breadth and depth of their analysis. We expect that investor ESG analysis will evolve toward more nuance and rigor and that simplistic, bright line approaches to ESG will be the only mortalities coming out of this period of enhanced scrutiny. Indeed, shareholders drove record-high support for a range of environmental and social (E&S) proposals, even as they became more discerning on others."
- "Investor 'off-season' engagement remains essential." In the midst of a busy proxy season, it may be tricky to get the attention of shareholders for purposes of engagement; the authors advocate prior discussions with large investors during the off-season to better position the company to explain its "nuanced ESG dilemmas, including the real-world implications of a prescriptive shareholder proposal, the company-specific merits of their pay design, or the behind-the-scenes strengths of individual directors. There is no substitute for real shareholder dialogue, and 2022 hammered home that point."
Consistent with the assessment of BlackRock above, the authors counted a "flood of E&S-related proposals," a significant increase from 2021 to almost 600. And, the authors observe, the SEC was "increasingly unwilling to allow companies to exclude proposals from the ballot. However, average support and passage rates for environmental and social (E&S) shareholder proposals declined significantly." The authors then did some significant unpacking of those conclusions:
- Companies negotiated "dozens of withdrawals" of proposals, especially proposals of the type that voters strongly supported in 2021, "rather than risk adverse votes."
- Just as BlackRock was disinclined to support prescriptive proposals, so the authors here found that the proliferation of prescriptive proposals—those seeking "specific strategic action, rather than just additional disclosure"—especially those related to climate, dissuaded many voters from voting in favor.
- However, the authors found that "proposals seeking additional disclosure and oversight of social justice matters—most notably racial equity audits—received higher support," a trend the authors "expect to continue in the future."
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