SEC adopts amendments to the shareholder proposal rules

At an open meeting this morning, the SEC voted (once again, three to two) to adopt two highly controversial proposals: amendments modifying the criteria for eligibility and resubmission of shareholder proposals in Rule 14a-8, and amendments to the SEC rules implementing the whistleblower program.  The shareholder proposal press release indicates that the change to the submission threshold, which has not been amended since 1998, “appropriately takes into consideration the interests of not only the shareholder who submits a proposal, but also the other shareholders who bear the costs associated with reviewing, considering and voting on such proposals in the company’s proxy statement.” Similarly, the changes to the resubmission threshold, which has not been amended since 1954, “relieve companies and their shareholders of the obligation to consider, and spend resources on, matters that had previously been voted on and rejected by a substantial majority of shareholders without sufficient indication that a proposal could gain traction among the broader shareholder base in the near future.” The changes to the whistleblower program, according to the whistleblower press release, “are designed to provide greater clarity to whistleblowers and increase the program’s efficiency and transparency.”  In both cases, the rulemakings generated an energetic—some might say heated—discussion among the Commissioners in the course of the long meeting, as well as substantial pushback through the public comment process. 

This post addresses only the rulemaking on shareholder proposals.  I plan to publish a post regarding the whistleblower rule changes and an update to this post with more detail about the final rules at a later time, so stay tuned.

The amendments to the shareholder proposal rules will become effective 60 days after publication in the Federal Register and will apply to any proposal submitted for an annual or special meeting to be held on or after January 1, 2022.  The final rules also “provide for a transition period with respect to the ownership thresholds that will allow shareholders meeting specified conditions to rely on the $2,000/one-year ownership threshold for proposals submitted for an annual or special meeting to be held prior to January 1, 2023.”

The amendments to the shareholder proposal rules modify the eligibility criteria for submission (applying three different thresholds, based on level and duration of stock ownership) as well as the resubmission thresholds, permitting exclusion of proposals that received votes lower than 5%/15%/25% if voted on one, two or three or more times, respectively. (See this PubCo post.)  The final amendments also provide that a person may submit only one proposal per meeting, whether as a shareholder or acting as a representative; prohibit aggregation of holdings for purposes of satisfying the ownership thresholds; facilitate engagement with the proponent; and update other procedural requirements.

According to the press release, the amendments are based on staff experience with shareholder proposals, including the 250 no-action requests relating to shareholder proposals that Corp Fin received in 2018:

“as part of their efforts to appropriately calibrate the resubmission thresholds, the staff conducted a review of shareholder proposals that ultimately received a majority of the votes cast on a second or subsequent submission 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.” 

When the SEC proposed, in 2019, to “modernize” the shareholder proposal rules by increasing the eligibility and resubmission thresholds, SEC Chair Jay Clayton observed 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,” and then-Commissioner Robert Jackson characterized the proposal as swatting “a gadfly with a sledgehammer.” As was clear at this open meeting to consider adoption of the proposal, those firm viewpoints have persisted.  (See this PubCo post.)  

The proposal has been similarly contentious from the get-go in the public sphere, drawing a proliferation of comments that continued through at least September 15. (For a sampling, see this PubCo post.) One reason is that shareholder proposals have recently assumed an increasingly significant role as investors have begun to intensify their focus on environmental issues, such as climate change, and social issues, such as racial injustice and inequity. The pandemic has also highlighted workforce health and safety issues. Shareholder proposals are viewed by their proponents and others as instrumental in driving companies to address many of these issues and their potential impact on sustainability and long-term shareholder value. Accordingly, the proposals met with stiff resistance from several 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.” Reuters reported that investors continued to press the SEC in letters and meetings with SEC staff until almost the last minute, hoping to put the kibosh on the proposed amendments altogether, and perhaps contributing to the postponement of the meeting from last week.

On the other hand, various corporate groups have long pushed the SEC to raise the bar on shareholder proposals. In 2014, the Chamber of Commerce, along with other corporate groups, submitted a rulemaking petition requesting the SEC to increase the resubmission thresholds, citing a “growing crescendo of respected voices…attesting to the unacceptable negative consequences for investors of the overwhelmingly verbose and often senseless assault on the ability of shareholders and portfolio managers to focus on how to manage their securities investments wisely, as well as the diversion of serious management focus away from the best interests of shareholders.” Arguing similarly in support of rule changes, the National Association of Manufacturers maintained that the current low submission and resubmission thresholds allow shareholder voices to be “too-easily be drowned out by third parties with little-to-no stake in a company.”

At the open meeting

It should come as no surprise that the Commissioners’ views on this rulemaking were staunchly held. To those voting in support, in light of significant changes in communications and the mode of retail investing over time, the proposal reflected an appropriate and necessary rebalancing of the costs and interests of shareholder proponents as against the subject companies and the other shareholders (who must share in the costs). To the opponents, the changes restrict yet another mechanism for shareholder oversight of management, particularly affecting smaller holders and proposals related to ESG issues just as they are increasing in favor, with little cost savings for most companies.

According to SEC Chair Jay Clayton, although it has long been recognized that shareholder proposals, using the company’s proxy statement, can have benefits for all shareholders. Nevertheless, the economic reality is that shareholder proposals impose costs on companies and on non-proponent shareholders, while the costs to the shareholder-proponent are low, both in absolute terms and relative to other metrics (such as the cost they might otherwise incur to access other shareholders).  In addition, there is a risk that shareholder-proponents could misuse the proposal process to the detriment of the company and the other shareholders. The SEC’s framework for “reconciling these overlapping and, in some cases competing, interests to best serve our markets and our shareholders generally” requires that, to submit a proposal, the shareholder must have a “meaningful ‘economic stake or investment interest’ in a company.”

The rulemaking recalibrates the two thresholds to “better ensure that the interests of those who submit, and re-submit, shareholder proposals are appropriately aligned with the interests of their fellow shareholders who must take the time to review, consider and vote on those proposals.” He noted in particular, a new transition provision that will allow any “investor who today is eligible to submit a proposal— by having held at least $2,000 worth of company securities for one year—[to] continue to be able to submit a proposal without increasing the dollar amount of their holdings.” He viewed these recalibrated thresholds as appropriate in light of the SEC’s experience—for example, that “out of approximately 65 million direct and indirect investors in companies subject to the proxy rules in 2018, only 170 shareholder-proponents submitted proposals that appeared in proxy statements.  That is roughly equal to three shareholder-proponents per million investors.”

With regard to the resubmission thresholds, he contended that, while they may have been appropriate during the era of snail mail in 1954, they are not reasonable today:

“A shareholder-proponent should not be able to command the time and attention of the company and other shareholders to review, consider and vote on a proposal if nine out of ten votes cast by their fellow shareholders have been against the proposal after it’s been submitted for a vote three or more times in five years.  This is worth reiterating: Yes, 90 percent or more of fellow shareholders could oppose a proposal year in and year out and yet still be required to consider it again, year in and year out.” 

Clayton also stressed that the amendments “are agnostic as to the subject matter of any particular shareholder proposal” and are not intended to address the merits of any particular proposals.  

Commissioner Elad Roisman, who led the process for this rulemaking, also highlighted, as a key rationale for these amendments, the changes in the nature of communications and shareholder ownership since the rules were last modified.  According to Roisman, the “thresholds in Rule 14a-8 were always intended to strike a balance.  On the one hand the rule offers a powerful tool for a shareholder to bring attention to his or her particular proposal.  But, on the other hand, each proposal comes at a cost, since other shareholders bear the expense associated with including a proposal in a company’s proxy statement and they must devote time and attention to considering each proposal.”

Although, he argued, “we all have a right to get on our soapboxes, we have no right to force others to pay for them.” But, without these changes designed to strike a better balance,

“that is what the rule has come to enable.  Between 2003 and 2014, only five people accounted for the vast majority of all the proposals submitted by individual shareholders.  Many have recycled the same proposals across different companies, regardless of the particular company whose shareholders were funding the ballot. An analogy demonstrates how low the bar is currently set for someone to submit a proposal.  For our largest companies, $2,000 represents less than .0000002 percent—or two billionths—of their stock value.  If we apply that same percentage to the U.S. population, it amounts to less than one person.  Imagine if one person could demand the attention of the President and both houses of Congress for a pet issue, and then require their proposal be printed up and voted on in a nationwide referendum, funded by every taxpayer.”

Moreover,  he argued, these proposals are most often rejected, yet the current rules allow the proposal to be resubmitted over again even if 90% to 97% of the shareholders vote against it.

The ability of shareholders “to require a company to include his or her own proposal in the company’s proxy statement is not a fundamental right,” he argued. When the rule was originally adopted, the concept was viewed as fairly radical and, according to a former Commissioner, it was widely “predicted that the proxy solicitation would be converted into a forum for crackpots, and hare-brained reformers.” The reason that prediction was not realized, Roisman maintained, was because the SEC “placed limits on shareholders’ ability to wield company resources.”  It is now the SEC’s “responsibility to reassess Rule 14a-8 to ensure that shareholder-proponents demonstrate a sufficient economic stake or investment interest in a company before they are able to submit proposals.  We owe that to the 99.9997 percent of shareholders in our public companies who do not submit shareholder proposals but who bear the costs of voting on them.”

Commissioner Hester Peirce largely agreed with the two statements above, but, if she had her druthers, she would take it further—a lot further. She questions why we have Rule 14a-8 at all? The concerns expressed by some observers that the SEC is going too far lead her

“to ask, by contrast, whether our amendments go far enough. Would we all be better off without Rule 14a-8 because it draws the SEC and its staff into places we do not belong? Why should the Commission be in the business of adjudicating which shareholder proposals are allowed in proxies? As noted by one commenter, there are legitimate questions as to whether Rule 14a-8 exceeds the statutory authority provided by Congress under Section 14 of the Exchange Act and improperly interjects the Commission into matters of state corporate law. As I have emphasized elsewhere, the securities laws are focused on getting investors the information they need to understand the long-term financial value of companies, not on determining how corporations and their shareholders interact with one another.”

Recognizing, however, that repeal of the rule is unlikely, she suggests that one reason it persists is that it provides the parties involved with “an efficient and cheap arbitration mechanism” at the expense of the SEC and its staff. But those parties complain every year “to the SEC staff about a lack of consistency and transparency in their decision making.” 

Her second problem with Rule 14a-8 is that many of the issues addressed are more about stakeholders than shareholders: “Why should we—or more precisely our staff—be in the business of sorting through these weighty issues?” The Rule itself is not very clear about the nature of the SEC’s “involvement in the consideration of the exclusion of a proposal. So essentially the rule drops a whole host of very divisive issues on the desks of Commission staffers to sort through. Our staff have better ways to spend their days and evenings, and, frankly, we do too. Stockholder-corporate relations are outside of our jurisdiction, but stakeholder-corporate relations are even farther outside our purview.” (In the end, she advocates fresh SEC guidance on the interpretation of “significant social policy issue” under the Rule’s exclusions.)

Commissioner Allison Lee, who dissented, viewed the rulemaking as the “capstone in a series of policies that will dial back shareholder oversight of management at the companies they own,” putting “a thumb on the scale for management in the balance of power between companies and their owners.” Although the changes purport to be looking after the interests of shareholders, the weight of comment letters on the proposals make clear that shareholders “strongly oppose” these changes. In her view, the rules are not balanced, “but rather almost universally reject the comments and data submitted by shareholders, failing in the process to reckon with very real costs of reducing shareholder oversight.”  She highlighted, in particular, the expected negative impact on ESG proposals and small shareholders. 

First, she contended that the “changes will be most keenly felt in connection with ESG issues, which comprise the main subject matter of shareholder proposals, at a time when such proposals are garnering increasing levels of support.”  Although the rationale given for the changes is the cost, in her view, that seemed at odds with the fact that the number of shareholder proposals is trending down: an “analysis of Russell 3000 companies reveals that, on average, only 13 percent of companies received a shareholder proposal in a particular year between 2004 and 2017. That translates to approximately one proposal every 7.7 years for the average company.” However, the number of social and environmental proposals—including climate change, workforce diversity and corporate political spending—has been rising, as has the level of support for these proposals, “with average support reaching 24 percent in 2018 up from single digits just after the financial crisis….Shareholder proposals related to climate change continued to increase in number and in support last season, garnering an average of 31 percent support, with four such proposals passing.”

Second, Lee argued that the amendments would have the most impact on “individual shareholders with smaller holdings who will be shut out of the shareholder proposal process to a startling degree by today’s amendments.” The change to the eligibility threshold—”an increase of 12-and-a-half times in the required investment amount for a one-year holding period”—would require many smaller shareholders to invest a large portion of their investment portfolios or force a much longer holding period.  In addition, shareholders may no longer aggregate to meet the submission threshold, thus further disadvantaging small holders, who “are among the least likely to be able otherwise to get management’s attention in the way that wealthier shareholders can.” The adopting release dismisses the disenfranchisement of these shareholders as irrelevant and even rejects “the idea that there is value to individual shareholders in having the option to submit proposals.”

Commissioner Caroline Crenshaw, who likewise dissented, was also critical of the impact of the final amendments on small shareholders. “For the wealthy,” she said, “$25,000 may not be a significant stake in a single equity. But a recent survey revealed that the mean value of stock ownership for 90% of Americans is less than $150,000. For the average American’s retirement account, $25,000 is an outsized concentration at odds with modern portfolio theory.” Of course, under the new rules, the shareholder could hold the shares for three years, but it “is  unreasonable to expect an investor who identifies an existing problem, but cannot afford to invest $25,000, to wait three years to suggest a solution.”

In addition, she contended the benefit to companies was minimal:

“The release claims that the changes will save nearly $70 million per year across the companies in the Russell 3000 index. That is, on average, about $23,000 per company—less than the individual has to invest. But the data shows that in most years, companies do not receive even one proposal. We are raising the bar for retail shareholder proposals to save corporate costs that the Commission’s own analysis acknowledges are minimal….Who benefits from this misalignment of incentives? Per the staff’s analysis, a limited number of S&P 500 companies will receive some marginal cost savings. But this comes at a significant cost to investors. The staff’s analysis suggests that after today’s rule, roughly three quarters of retail accounts for most S&P 500 companies could not file a proposal.”

Instead of restricting so many retail investors, she advocated that the SEC take a different approach: “improving accuracy and transparency in the proxy voting system,” along with modifying other policies “that may be disincentivizing shareholder participation in the proxy process.

Changes to shareholder proposal rules

According to the press release, the final amendments will, among other things:

Note that the proposed “momentum” requirement has been eliminated, as reported by Reuters.  That provision would have permitted 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.” (See this PubCo post.)