Are issuers precluded from raising concerns about proxy advisory firm recommendations, particularly errors and incomplete or outdated information that form the basis of a recommendation? Are firm conflicts of interest insufficiently transparent? Are proxy advisory firms an effective “market-based solution” helping large numbers of institutional investors with time and resource constraints make better voting decisions? Are proxy advisory firms “faux regulators,” wielding too much influence—with too little accountability—in corporate elections and other corporate matters? Maybe all of the above? At an open meeting this morning, the SEC voted, with two dissents, to propose amendments to add new disclosure and engagement requirements for proxy advisory firms and to “modernize” the shareholder proposal rules by increasing the eligibility and resubmission thresholds. These actions represent the third phase of the SEC’s efforts to address the proxy voting system, the first phase being the proxy process roundtable (see this PubCo post) and the second phase being the SEC’s recently issued interpretation and guidance (see this PubCo post). As anticipated, at the meeting, the commissioners expressed strong views on these topics, 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 Robert Jackson characterizing the proposal as swatting “a gadfly with a sledgehammer.” Both proposals are subject to 60-day comment periods. Next up, according to Clayton, proxy plumbing and universal proxy.
Proxy advisory firms
The new proposal would amend the definition of “solicitation” in Rule 14a-1(l) to essentially codify the SEC’s earlier interpretation and clarify when proxy advisor recommendations are “solicitations”; amend the exemptions to the proxy solicitation rules in Rule 14a-2(b) by providing for disclosure by proxy advisory firms of material conflicts of interest and providing a standard opportunity for all registrants to review the advice (provided that they file definitive proxies at least 25 days prior to the meeting); and amend Rule 14a-9 to provide illustrations of potentially problematic misstatements by proxy advisory firms. Here is the SEC rule proposal—more to come on that later. (For a summary, see this PubCo post.)
More specifically, according to the press release regarding proxy advisory firms, the proposal would amend
- Rule 14a-1(l), to modify the definition of “the terms ‘solicit’ and ‘solicitation,’ to specify the circumstances when a person who furnishes proxy voting advice will be deemed to be engaged in a solicitation subject to the proxy rules. The proposed amendment would also codify the Commission’s view that voting advice provided in response to an unprompted request would not constitute a solicitation.”
- Rules 14a-2(b)(1) and 14a-2(b)(3), for proxy voting advice businesses, to condition these exemptions from the information and filing requirements of the proxy rules on the following:
- “They must include disclosure of material conflicts of interest in their proxy voting advice;
- “Registrants and certain other soliciting persons must be given an opportunity to review and provide feedback on proxy voting advice before it is issued (with the length of the review period dependent on the number of days between the filing of the definitive proxy statement and the date of the shareholder meeting); and
- “Registrants and certain other soliciting persons may request that proxy voting advice businesses include in their voting advice a hyperlink or analogous electronic medium directing the recipient of the advice to a written statement that sets forth the registrant’s or soliciting person’s views on the proxy voting advice.
In addition, the proposed amendments would “permit proxy voting advice businesses to require registrants and other soliciting persons to enter into confidentiality agreements for materials exchanged during the review and feedback period and would allow proxy voting advice businesses to rely on the exemptions where failure to comply with the new conditions was immaterial or unintentional.”
- Rule 14a-9 to “include examples of when the failure to disclose certain information in the proxy voting advice could, depending upon the particular facts and circumstances, be considered misleading within the meaning of the rule.”
This 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; facilitate engagement with the proponent; and update procedural requirements. Here is the new rule proposal—more on that later. (For a summary, see this PubCo post.)
More specifically, according to the press release regarding shareholder proposals, the proposal would amend Rule 14a-8(b) to
- modify the current eligibility requirement ($2,000 or 1% of a company’s securities held for at least one year)
- to eliminate the 1% percent threshold, and
- apply any of the following three alternative thresholds:
- “continuous ownership of at least $2,000 of the company’s securities for at least three years;
- continuous ownership of at least $15,000 of the company’s securities for at least two years; or
- continuous ownership of at least $25,000 of the company’s securities for at least one year.”
- require shareholder proponents that rely on representatives to submit their shareholder proposals provide authorizing documentation that indicates “the shareholder-proponent’s identity, role and interest in a proposal that is submitted for inclusion in a company’s proxy statement”; and
- require shareholder proponents to state their availability to “meet with the company, either in person or via teleconference, no less than 10 calendar days, nor more than 30 calendar days, after submission of the shareholder proposal, and provide contact information as well as business days and specific times that the shareholder-proponent is available to discuss the proposal with the company.”
The proposal would also amend Rule 14a-8(c) to “apply the one-proposal rule to ‘each person’ rather than ‘each shareholder’ who submits a proposal,” eliminating 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.
In addition, the proposal would amend Rule 14a-8(i)(12) to replace the current resubmission thresholds (3%, 6% and 10% for matters voted on once, twice or three or more times in the last five years), to allow exclusion if a proposal 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.
In addition, 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.”
The press release indicates that the staff gathered data to “appropriately calibrate the resubmission thresholds,” reviewing shareholder proposals that were submitted between 2011 and 2018: “Of those proposals that ultimately went on to receive majority support, 98 percent of the proposals started with support of over 5 percent of the votes cast in their first submission. Of the proposals that obtained majority support on their third or subsequent submissions, approximately 95 percent received support of over 15 percent on their second submission, and 100 percent received support of over 25 percent on their third or subsequent submission.”
Notably, as discussed below, Jackson took issue with the nature and extent of the evidence collected by the SEC and had his staff collect other data. I could be wrong, but it sure seemed that Commissioner Elad Roisman was a little miffed and chastised Jackson for not having shared his data in advance so that it could be taken into account in formulating the proposal.
At the meeting…
For advocates of the proposal, the changes reflected efforts to merely modernize rules that had not been updated for decades. To Chair Jay Clayton, the proposals are “rooted in two essential aspects of effective regulation—modernization and retrospective review.” The business of proxy advice “was virtually non-existent” 20 years ago, but some of these businesses are now “large and multi-faceted,” providing services comparable to rating agencies and research analysts. “These market developments,” he asserted, “require our attention.” Similarly, the shareholder proposal resubmission thresholds had not been amended since 1954. Since then, the “retail / institutional shareholder split has flipped from 90% retail / 10% institutional in 1950, to 20% retail / 80% institutional in 2017.” Moreover, with regard to the shareholder proposal proposal (take that, spellcheck), Clayton observes, “it is clear to me that a system in which five individuals accounted for 78% of all the proposals submitted by individual shareholders would benefit from greater alignment of interest between the proposing shareholders and the other shareholders—who hold more than 99% of the shares. Yes, you heard that right, five individuals accounted for 78% of all the proposals submitted by individual shareholders.”
However, the aspect of Clayton’s statement that provides the most insight into his perspective was this: following the proxy roundtable, the SEC received hundreds of comment letters, the most striking of which (to Clayton) were from long-term Main Street investors,
“all of whom expressed concerns about the current proxy process. A common theme in their letters was the concern that their financial investments—including their retirement funds—were being steered by third parties to promote individual agendas, rather than to further their primary goals of being able to have enough money to lessen the fear of ‘running out’ in retirement or to leave money to their children and grandchildren.
These letters are a helpful reminder that the issues the Commission grapples with in this area are not a matter of (1) shareholders versus companies or (2) businesses that provide proxy voting advice versus companies. These are false dichotomies. We must recognize that there is a myriad of investor interests and preferences. Many of these interests overlap substantially, such as the thirst for information material to an investment decision. But there are many others that do not and may be in direct conflict, such as a desire for a company to sell or buy a particular business or undertake a particular study or course of action. Understanding and responding to these interests, including both common and conflicting interests, in a fair and efficient manner is an import function of corporate governance and our proxy rules are intended to facilitate that function. Accordingly, our proxy process, in its components and as a whole, necessarily reflect the need for a rich exchange of information and the need to balance the interests of proponents of shareholder proposals with the interests of their fellow shareholders….
The Commission staff—and many others—have been considering today’s issues since at least 2010. It is time to move from debate in the abstract to constructive engagement on actionable proposals. We make that transition today.”
Commissioner Roisman, who steered this project through the rulemaking process, attempted to “draw the contours of a policy solution that is meant to work for everyone.” Summarizing the pros and cons, he observed that those
“favoring regulatory action argue that the prevalent use of professional voting advice in our marketplace raises serious concerns, including that proxy voting advice businesses have their own conflicts of interests that could bias their advice to clients, undermining their position as independent experts. Additionally, their use of one-size-fits-all methodologies carries implicit bias, favoring certain companies’ business models over others, and possibly exacerbating short-termism in our markets. Many have worried that their publication of voting advice containing errors has the ability to go unchecked, and the widespread use of their voting advice by asset managers has made the governance principles they propound de-facto standards, despite no regulatory oversight or public notice and comment process.
Others have opposed any regulatory action, offering several counter-arguments: 1) proxy voting advice businesses are creations of an efficient market, formalizing voting principles demanded by their sophisticated client base; 2) they are independent experts, so prevalent use of their advice operates as an appropriate check on the management of public companies; and 3) alternatively, asset managers who subscribe to proxy voting advice businesses’ advice do not always follow their recommendations, so fears of their outsized influence are overstated. We have also heard vehement warnings that new regulation of proxy voting advice businesses could disrupt a highly streamlined and choreographed proxy season for asset managers, and introduce new costs that would be passed on to investors.”
According to Roisman, the proposal was designed to apply consistently, require disclosure of material conflicts and improve on current market practices. For example, Roisman noted, the aspect of the proposal giving issuers an opportunity to engage with proxy advisory firms and respond to their final voting advice reflects an expansion of successful current market practices—the type of opportunity that ISS has made available to the largest companies and the more recent practice of Glass Lewis to obtain feedback from issuers on the data underlying their reports and the reports themselves. The proposal makes these types of opportunities available on a general basis, he said.
With regard to changes to the shareholder proposal rules, Roisman noted that updates were required in light of concerns expressed by “market participants that rules are not working as intended, or are being misused,” as well as developments in the market. “When the SEC first adopted its resubmission thresholds [in 1954], the vast majority (i.e., between one-half and three-quarters) of proposals failed to win sufficient support to be resubmitted,” he pointed out, “In contrast, today the 3, 6, and 10 percent resubmission thresholds preclude a much smaller proportion of shareholder proposals than in the past.”
Commissioner Hester Peirce (whose statement has, at this time, not yet been posted) voted in favor. Here, she contended that the main issue was at what point should a shareholder be able to compel other shareholders to pay for that shareholder’s particular enthusiasms. (The leitmotif of her remarks recently has been problems at her condo. Her analogy: Why should she have to pay for other people’s coffee at her condo building? Her speech at the Securities Regulation Institute also included a lengthy analogy about the broken windows in her condo. Is it time for a new condo?)
Commissioners Jackson and Allison Lee dissented, both essentially viewing the proposal as a series of limitations on shareholders’ ability to hold corporate insiders accountable. While the data-driven Jackson agreed that updating the rules made sense, he believed that the proposals did not reflect careful engagement with the evidence and went too far in shielding CEOs, imposing
“a tax on firms who recommend that shareholders vote in a way that executives don’t like. To see why, consider a proxy advisor deciding how to advise shareholders in a proxy fight driven by poor performance. Recommending that investors support management comes with few additional costs under today’s proposal. But firms recommending a vote against executives must now give their analysis to management, include executives’ objections in their final report, and risk federal securities litigation over their methodology. Taxing anti-management advice in this way makes it easier for insiders to run public companies in a way that favors their own private interests over those of ordinary investors.”
While the requirements apply across the board, “the real costs of today’s new regime lie in considering the issuer’s feedback, including the issuer’s response in the proxy advisor’s report, and facing litigation from an issuer angry about the methodology used to provide anti-management advice,” costs that are unlikely to arise in the context of a recommendation favorable to management. Before proposing these changes that tilt “corporate voting toward incumbent management in this way,” the SEC should have studied the potential consequences extensively.
Jackson also strikes the same theme with regard to the proposed changes regarding shareholder proposals—not enough 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.
A better approach, he suggests, “is to examine how these new rules would affect shareholder proposals that enhance value by making management more accountable to investors.” Accordingly, Jackson’s staff collected some data. He found that, for example, the proposal would remove 40% of proxy access proposals after three tries and more than half of proposals to limit CEOs from selling stock they receive as compensation. “Whatever one’s personal view of the merits of these particular investor initiatives,” he contended, “all should agree that we should have considered the costs and benefits of removing them from the ballot before proceeding. Yet the release offers no analysis of that question at all.”
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.”
Commissioner Lee also contended that both proposals “operate to suppress the exercise of shareholder rights.” The proposals would “make it more costly and more difficult for shareholders to cast their votes or even to get their issues onto corporate ballots.” Perhaps in contrast to Clayton, she sees “a stark divide between issuers and shareholders on the policies reflected here. The bottom line is that these policy choices, if adopted, would shift power away from shareholders and toward management.” But why make this policy choice when the data shows that management wins the vote about 90% of the time?
In her view, the proxy advisor proposal could impair shareholders’ ability to vote in reliance on independent recommendations. While accurate information is necessary, the data does not support the argument that the error rate is “sufficient to warrant a rulemaking.” In addition, greater issuer involvement, required by the proposal, would not improve proxy voting advice, but rather would reflect their stake in the outcome, potentially undermining the independence of the recommendations. And the mandatory delays could also wreak havoc on the timing of recommendations, perhaps giving companies more review time than proxy advisors have to craft the recommendation. Moreover, she said, the proposal does not give the same review opportunities to proponents of proposals.
In 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 second proposal will 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.”