Last week, the SEC voted to issue a new rule proposal intended to "modernize" the shareholder proposal rules, with Commissioners Robert Jackson and Allison Lee dissenting. Generally, the proposal would modify the criteria for eligibility and resubmission of shareholder proposals; provide that a person may submit only one proposal per meeting, whether as a shareholder or acting as a representative; and facilitate engagement with the proponent. As anticipated, at the meeting, the commissioners expressed strong views on these issues, with Chair Jay Clayton observing that a "system in which five individuals accounted for 78% of all the proposals submitted by individual shareholders" needs some work, and Commissioner Jackson characterizing the proposal as swatting "a gadfly with a sledgehammer." The proposal is subject to a 60-day comment period.
The SEC considers Rule 14a-8, which was first adopted in 1942, to be an accommodation that enables proponents to present their proposals and to have proxies solicited for those proposals at the cost of the company—and ultimately all the shareholders—with little or no cost to themselves. But to prevent the inappropriate or excessive use of company resources and waste of shareholders' time and attention, the SEC imposed a number of limitations on use of the rule, such as share ownership requirements necessary for eligibility, the number of proposals that a shareholder may submit for any one meeting, and limitations on length and submission deadlines. The SEC is proposing to amend some of those limitations.
In support of the proposal, particularly the effort to raise the resubmission thresholds, the SEC cites a 2014 rulemaking petition from, among others, the Chamber of Commerce, the American Petroleum Institute and the NACD, as well as calls for reform from the Business Roundtable, Nasdaq and others. However, the proposals have met with stiff resistance from some shareholder groups. For example, as reported in MarketWatch, the executive director of CII characterized the proposal as "an unnecessary interference in the free market [that] would impede investors' voice on critical matters at U.S. public companies." And the president of As You Sow, a frequent proponent on ESG issues, said in the same article that "[t]he SEC has been unable to point to any demonstrable problem with the current shareholder system or make a case for how its proposal to limit shareholder rights will improve company value....To the contrary, this proposed rulemaking has the potential to increase shareholder and company risk, particularly regarding growing climate concerns. We don't believe that it will withstand public or legal scrutiny."
At the SEC's 2018 Proxy Roundtable, some of the controversy centered around the propriety of the initial eligibility and resubmission threshold levels. Some panelists viewed the shareholder proposal process as an essential tool that has, over time, resulted in important changes in corporate governance that are now well-accepted. For example, the CalSTRS representative noted that the process is especially useful if holders won't engage. James McRitchie observed that many of the proposals submitted decades ago by the Gilbert Brothers (see this article), such as the right to ratify the selection of auditors, are now standard fare at annual meetings. Similarly, a representative of the NYC pension fund described a long history of voting for proposals that, over time, gained substantial public acceptance, thus making the case for retaining low resubmission thresholds. In addition, with the prevalence of dual-class voting, one panelist suggested, even a low percentage of the total vote could actually represent a significant percentage of the outside vote. These participants advocated retention of the current thresholds. The AFL-CIO representative contended that thresholds were intentionally low to allow small investors the opportunity to participate; big institutional investors can pick up the phone and engage directly with the company on their issues and don't need the shareholder proposal process, he maintained. Another panelist suggested that the current rule is a cost-effective way to facilitate private ordering.
On the other side, some panelists, such as the representative of the Business Roundtable, argued that shareholder proposals allow a few holders to attempt to impose on companies their personal policy priorities, but involve costs that are borne by all shareholders. Moreover, the low resubmission thresholds allow a small subset to override majority will. In addition, the representative of the Chamber of Commerce argued that the shareholder proposal process was one of the factors driving companies away from IPOs. (In response, the AFL-CIO representative noted that the average public company receives a shareholder proposal only once every 7.7 years, and so it was preposterous to suggest that shareholder proposals were a reason companies avoided going public.) These panelists advocated raising the initial and resubmission ownership thresholds, longer holding periods, disclosure of the proponents' holdings in the company, filing fees and strengthening of the "misleading statements" and "relevancy" exclusions. (See this PubCo post.)
In separate comments to the SEC, some commenters "expressed concern about the costs associated with management's consideration of a proposal and/or its inclusion in the proxy statement. Two commenters cited an estimate indicating an average cost to companies of $87,000 per shareholder proposal, another commenter estimated its cost at more than $100,000 per proposal, and another commenter cited a cost of approximately $150,000 per proposal. Other commenters suggested the costs to companies are low and noted that most companies receive few, if any, shareholder proposals." In addition, some commenters "expressed concern that a large number of proposals are submitted by a small number of individuals who own nominal stakes in the companies to which they submit proposals. One commenter disagreed with this concern because proposals submitted by these individuals between 2004 and 2017 received an average level of support of 40 percent and, in the commenter's opinion, this level of support 'indicates these filers provide a valuable service to fellow shareholders by promoting good corporate governance.' "
Below is a summary of the proposal:
Rule 14a-8(b)—Eligibility Requirements
Under the existing rule, the current version of which dates to 1998, to be eligible to submit a shareholder proposal, a proponent must have continuously held at least $2,000 in market value or 1% of the company's voting securities for at least one year by the date the proposal is submitted. In addition to inflation and increases in share prices, there have been many developments since 1998, including a rise in engagement and alternative ways to communicate preferences to companies.
In crafting the new proposal, the SEC indicates that the modifications were informed by public input from the proxy roundtable, discussed above. In devising the ownership thresholds and holding periods in Rule 14a-8(b), the SEC aimed "to strike an appropriate balance such that a shareholder has some meaningful 'economic stake or investment interest' in a company before the shareholder may draw upon company resources to require the inclusion of a proposal in the company's proxy statement, and before the shareholder may use the company's proxy statement to command the attention of other shareholders to consider and vote upon the proposal."
The proposing release indicates that the SEC considers the balance to currently be out of whack: "the $2,000 threshold, adjusted for inflation, would be equal to $3,152 in 2019 dollars. Moreover, using the cumulative growth of the Russell 3000 Index as a proxy for the average increase in companies' values, a $2,000 investment in a company in 1998 would be worth approximately $8,379 today." For smaller holders, however, the SEC believes that the length of time owning the company's securities may be an indicator of a sufficient interest, as it suggests that the shareholder may continue to hold the shares after the vote on the proposal.
Under the proposal, a shareholder would be eligible to submit a proposal under Rule 14a-8 if the shareholder satisfied one of three tests:
The shareholder must have continuously held at least
- "$2,000 of the company's securities entitled to vote on the proposal for at least three years;
- $15,000 of the company's securities entitled to vote on the proposal for at least two years; or
- $25,000 of the company's securities entitled to vote on the proposal for at least one year."
The SEC considers this tiered approach to be preferable because it "takes into account the varying situations of shareholders and would be preferable to a one-size-fits-all approach." To determine the value, the shareholder would look at whether, at "any date within the 60 calendar days before the date the shareholder submits the proposal, the shareholder's investment is valued at the relevant threshold or greater, based on the average of the bid and ask prices." The SEC is also proposing to eliminate the current 1% ownership threshold, which few shareholders are eligible to use and "historically has not been utilized." The proposal would not permit shareholders to aggregate their shares with other holders to meet the minimum thresholds (even though they were allowed to do so back in 1983). However, shareholders could co-sponsor proposals so long as each shareholder met the eligibility requirement. In that context, although not required, the SEC believes that proponents should, as a best practice, "clearly state in their initial submittal letter to the company that they are co-filing the proposal with other proponents and identify the lead filer, specifying whether such lead filer is authorized to negotiate with the company and withdraw the proposal on the co-filer's behalf."
Proposals Submitted on Behalf of Shareholders
Proposals are often submitted by representatives on behalf of shareholders—think, e.g., John Chevedden and his group. However, some have raised a question as to whether it is really the shareholder who has a genuine and meaningful interest in the proposal, or whether the proposal is more of interest to the representative, while the shareholder simply acquiesces. Rule 14a-8 does not address a shareholder's ability to submit a proposal for inclusion in a company's proxy materials through a representative, and Corp Fin has, so far, issued only (non-binding) guidance on the question, indicating that shareholders need to document and submit their delegations of authority.
The proposal would amend the Rule 14a-8 eligibility rule to require that a shareholder using a representative to submit a proposal must provide the SEC with documentation that:
- "Identifies the company to which the proposal is directed;
- Identifies the annual or special meeting for which the proposal is submitted;
- Identifies the shareholder-proponent and the designated representative;
- Includes the shareholder's statement authorizing the designated representative to submit the proposal and/or otherwise act on the shareholder's behalf;
- Identifies the specific proposal to be submitted;
- Includes the shareholder's statement supporting the proposal; and
- Is signed and dated by the shareholder."
The Role of the Shareholder Proposal Process in Shareholder Engagement
The SEC observes that the process for shareholder proposals often involves engagement with the company, a process the SEC "encourage[s] both before and after the submission of a shareholder proposal." Recently, the level of shareholder engagement has increased, often leading to agreement and withdrawal of proposals, a trend that the SEC views as "beneficial both to companies and to shareholders." Accordingly, to facilitate dialogue, the proposal would add an engagement component to the eligibility requirements. Specifically, under the proposal, each proponent would be required to include a statement "that he or she is able to meet with the company in person or via teleconference no less than 10 calendar days, nor more than 30 calendar days, after submission of the shareholder proposal," including contact information for the shareholder (not the representative, although the representative could join the conversation) and days and times of availability.
One Proposal Limit
The Rule 14a-8 limitation to a single proposal by any shareholder per shareholders' meeting has been in place since 1976, and the SEC believes that allowing representatives to submit multiple proposals for the same meeting would undermine the purpose of the limit. To that end, the proposal would amend Rule 14a-8(c) to apply the one proposal rule to "each person" rather than "each shareholder," stating that "[e]ach person may submit no more than one proposal, directly or indirectly, to a company for a particular shareholders' meeting. A person may not rely on the securities holdings of another person for the purpose of meeting the eligibility requirements and submitting multiple proposals for a particular shareholders' meeting." The proposal would eliminate the possibility that a shareholder proponent could submit one proposal as a shareholder and another as a representative at the same meeting or that a representative could submit more than one proposal on behalf of different shareholders. A representative or other adviser could still provide more than one shareholder with assistance in navigating the process or other advice—a representative just could not submit more than one proposal per meeting. The SEC is, however, seeking comment on whether to do away with the concept of submission by representatives altogether.
The idea that a shareholder proposal need not be submitted to shareholders if substantially the same proposal was previously submitted and received less than a specified percentage of the vote has been part of the rule since 1948 (in that case, 3%). The purpose of the resubmission provision was "to relieve the management of the necessity of including proposals which have been previously submitted to security holders without evoking any substantial security holder interest therein." That threshold was subsequently changed to the current resubmission thresholds (3%, 6% and 10% for matters voted on once, twice or three or more times in the last five years) in 1954, although there have since been several unsuccessful attempts to raise the thresholds. In the proposing release, the SEC expressed its concern
"that the current resubmission thresholds may allow proposals that have not received widespread support from a company's shareholders to be resubmitted—in some cases, year after year—with little or no indication that support for the proposal will meaningfully increase or that the proposal ultimately will obtain majority support. Companies and their shareholders bear the burdens associated with management's and shareholders' repeated consideration of these proposals and/or their recurrent inclusion in the proxy statement. While we recognize that some proposals may necessitate resubmission to obtain majority support, we do not believe shareholders whose proposals are unlikely ever to obtain or at least without a significant change in circumstances obtain such support—and thus to reflect the interests of a majority of shareholders—should be permitted to require companies and other shareholders to bear the costs associated with their proposals. If a proposal fails to generate meaningful support on its first submission, and is unable to generate significantly increased support upon resubmission, it is doubtful that the proposal will earn the support of a majority of shareholders in the near term or without a significant change in circumstances."
In support of its argument, the SEC points to its review of shareholder proposals that received a majority of the votes cast between 2011 and 2018, which showed that approximately 90% of those winning proposals received majority support on the first submission; of the remaining 10%, 60% received 40% or more of the votes cast on the initial submission and nearly all of the remaining proposals garnered support of at least 5% on the first submission. In addition, of the 864 unique proposals that were resubmitted during that period, only 54 (6.5%) ultimately received majority support.
The SEC acknowledges, however, under the proposed new resubmission thresholds, one of these proposals would have been excludable and that there have been a few instances where proposals that received less than 5% the votes cast have "gone on to garner significantly greater shareholder support." The SEC also estimates that approximately 85% of the proposals resubmitted between 2011 and 2018 would have been eligible for resubmission under the proposed resubmission thresholds. In addition, the SEC suggests that the current resubmission thresholds may have a different impact today than when originally adopted, as the proportion of proposals that remain eligible for resubmission is greater today than was initially the case.
According to the proposing release, the proposal would increase the resubmission thresholds "to allow companies to exclude resubmitted proposals that have not received broad support and appear less likely to be on a sustainable path toward achieving majority shareholder support." The proposal would amend Rule 14a-8(i)(12) to allow a company to exclude a proposal that deals with substantially the same subject matter as a proposal previously included in the company's proxy materials within the last five years if the most recent vote occurred within the preceding three years and the most recent vote was:
- Less than 5% if previously voted on once;
- Less than 15% if previously voted on twice; or
- Less than 25% if previously voted on three or more times.
As discussed below, the last threshold would also be subject to a "momentum" requirement. A proposal deals with substantially the same subject matter if it shares the same "substantive concerns" as an earlier proposal, rather than having the "specific language or actions proposed to deal with those concerns." The SEC notes that only "votes for and against a proposal would be included in the calculation of the shareholder vote. Abstentions and broker non-votes would not be included in the calculation."
The SEC believes that the more significant increases to the second and third thresholds make sense because they are "intended to provide a better indicator of proposals that are more likely to ultimately obtain majority support than the current thresholds." According to the SEC, the "overwhelming majority" of resubmitted proposals that ultimately obtain majority support received more than 15% of the vote on the second submission and over 25% on their third submission. Based on its analysis, the SEC estimates that "under the proposed 15% / 25% thresholds, there would be 14% / 27% more proposals that would be excludable than under the current rules," but that few "would have been on a path toward more meaningful shareholder support."
The SEC believes that the proposed new thresholds strike an appropriate balance, saving costs for companies and providing incentives to "shareholders to submit proposals on matters that resonate with the broader shareholder base to avoid exclusion," while preserving companies' ability to engage through the shareholder approval process. Notably, the SEC points out, the rules are not a permanent bar, but instead mandate only a three-year cooling-off period after which the proposal could be resubmitted.
Although the SEC considered alternative vote-counting methodologies, such as excluding insiders, and whether to allow resubmission in the event of material developments, the SEC elected not to go those routes, but is requesting comment on those possibilities.
In addition to the higher resubmission thresholds, the proposal would "add a new provision that would allow for exclusion of a proposal that has been previously voted on three or more times in the last five years, notwithstanding having received at least 25 percent of the votes cast on its most recent submission, if the proposal (i) received less than 50 percent of the votes cast and (ii) experienced a decline in shareholder support of 10 percent or more compared to the immediately preceding vote." An example would be a proposal that received 30% of the vote on the second submission, but only 26% in favor on the third submission, reflecting decline of over 10% on the third vote; that proposal would now be excludable under the proposal even though the vote on the third submission exceeded the 25% threshold. The proposed new momentum requirement would not apply where the proposal received a majority vote in favor at the time of the most recent shareholder vote, even if the vote reflected a decline of 10% or more.
At the open meeting where the proposal was considered, data-driven Commissioner Jackson voted against the proposal, contending that the SEC had not conducted sufficient study of the evidence. To consider the effects of the proposal "on the balance of power between insiders and investors, we should examine the kinds of proposals that will be taken off the ballot—and their effect on firm value. Today's release does not even attempt to do that. Instead, the proposal simply assumes that high levels of support indicate a good proposal—and that lower levels of support suggest that a proposal is bad." But investor interest takes time to coalesce, he argues.
To understand the effect of the shareholder proposal process on ordinary shareholders, his staff looked at the data and found that "inclusion of shareholder proposals by an American public company tends to increase long-term value. But so-called gadfly proposals—those brought by the ten most frequent individual submitters each year—appear to have the opposite effect, destroying long-run value for ordinary investors....Unfortunately, today's release doesn't engage with those questions—instead adopting pro-management changes that swat a gadfly with a sledgehammer."
In Commissioner Lee's view, shareholder proposals, such as majority vote rules for the election of directors and increased adoption of proxy access bylaws, "often highlight the need for important corporate reforms that are later adopted." Yet, the proposal would adversely affect smaller shareholders, creating "structural advantages for wealthier investors.... An investor who holds only $2000 worth of stock must now wait three years to submit a proposal. For context, an analysis of retail investor portfolios indicates that the median portfolio value is approximately $27,700. Thus, Main Street investors would generally have to invest virtually their entire portfolio into one company (something we strongly discourage) to enjoy the same rights as Wall Street investors, or they would have to wait three years to catch up to them."
Likewise, the changes to the resubmission thresholds are also "stifling to shareholders." Significantly, the new "momentum" requirement would "block resubmissions when there is a 10% drop in support, even if these significantly higher thresholds are met. This is presumably because a 10% change in support is considered significant. But, under the proposal, that change is only significant when it shows a drop, not an increase, in support. Let's look at the numbers: For shareholders to get from the first to the second resubmission threshold, they must show a 200% increase in support. A 199% increase? Not enough to move forward. A 10% decrease? Sufficient to block resubmission." (For more discussion of the commissioners' views expressed at the open meeting, see this PubCo post.)
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