“ESG month” may not be exactly what you think. It’s the moniker, according to Politico, ascribed to the plan of the House Financial Services Committee, reflected in this interim report from its ESG Working Group, “to spend the next few weeks holding hearings and voting on bills designed to send a clear signal: Corporations, in particular big investment managers, should think twice about integrating climate and social goals into their business plans.” But this is not just another generic offensive in the culture wars; according to Politico, this effort is more targeted—aimed not at major brands of beer or amusement parks, but rather at the processes that some argue activists use to pressure companies to address ESG concerns, as well as the “firms that play big roles in ESG investing.” At the first of six hearings on July 12, Committee Chair Patrick McHenry maintained that the series of hearings and related proposed legislation was not about “delivering a message,” but was rather about protecting investors and keeping the markets robust and competitive. First item up? Reforms to the proxy process to prevent activists from diverting attention from core issues; while he supported shareholder democracy, he believed that democracy should reflect the say of the shareholders, not external parties that, in his view, exploit the existing process to impose their beliefs. The Working Group appears to have identified the shareholder proposal process as instrumental in promoting ESG concerns. Will this spotlight have any impact?
What is the ESG Working Group? The report tells us right upfront: “The Environmental, Social, and Governance (ESG) Working Group was created at the beginning of this Congress for the specific purpose of developing a policy agenda designed to protect the financial interest of everyday investors from progressive activists who are using our institutions to force far-left ideology on Americans.” The report identifies a number of priorities, including reforming the proxy system, ensuring the accountability of the proxy advisory firms, enhancing the alignment of voting decisions with retail investors’ best interests (also involves proxy advisors), increasing transparency and oversight of large asset managers “to ensure their practices reflect the pecuniary interest of retail investors,” improving ESG rating agency accountability and transparency, and protecting U.S. companies from burdensome EU regulations. In addition, in light of the “politicization of the SEC”—as the Working Group sees it—another priority is to “strengthen oversight and conduct thorough investigations into federal regulatory efforts that would contort our financial system into a vehicle to implement climate policy,” and to “demand transparency, responsibility, and adherence to statutory limits from financial and consumer regulatory agencies.” I counted at least 18 bills that the Committee is proposing to address these issues.
At least six of those bills related to the shareholder proposal process, including one to authorize the exclusion of shareholder proposals from proxy materials if the subject matter is environmental, social or political; one to clarify that an issuer may exclude a shareholder proposal under Rule 14a-8(i) without regard to whether it relates to a significant social policy issue; and one to amend the Exchange Act to prohibit the SEC from compelling the inclusion of shareholder proposals or any discussion related to a shareholder proposal in proxy materials altogether. (Of course, it’s unlikely that any of these bills would be viable in the Senate or signed by the President.)
That one-third of the bills proposed were related to the shareholder proposal process seems to be no accident—the Working Group appears to view the shareholder proposal process as a critical mechanism used by activists to impose their agendas on companies, as evidenced by the volume of ESG-related shareholder proposals submitted this proxy season. The “recent surge in ESG-related proposals,” the Working Group contended, “adds unnecessary pressure on corporate boards, wastes corporate resources, and hinders informed decision-making by retail investors, who must spend valuable time reading and evaluating these proposals.” In the Working Group’s view, the “no-action letter process has become a mechanism for SEC staff to project its views about the ‘significance’ of non-securities issues, rather than a process for ensuring shareholder proponents’ interests are aligned with those of their fellow shareholders.”
According to the report, the increase in shareholder proposals resulted from changes in rule interpretations by the SEC “that made it easier for politically motivated proposals to be included in annual proxy statements. This resulted in a 51 percent rise in environmental proposals and a 20 percent increase in social proposals. Chair Gensler’s use of the SEC as a political tool is deeply concerning, as it puts the investments of hard-working Americans at risk and sets a dangerous precedent of weaponizing the agency for progressive purposes.” The report is referring to Corp Fin’s SLB 14L, the effect of which was to relax some of the interpretations of “significant social policy,” “micromanagement” and “economic relevance” imposed under three Clayton-era SLBs, which were rescinded, making exclusion of shareholder proposals—particularly proposals related to environmental and social issues—more of a challenge for companies. SLB 14L presented its approach as a return to the perspective that historically prevailed prior to the issuance of the three rescinded SLBs. (See this PubCo post.)
The Working Group also took issue with the current ownership thresholds for submission of shareholder proposals, under which relatively small shareholders can submit proposals. In the Working Group’s view, these thresholds allow the process to be “overwhelmingly exploited by activists driven by social or political agendas, leading to an increasing number of ESG-related shareholder proposals. Moreover, given the significant influence of proxy advisors, companies are unable to exclude repeat ESG-related proposals, regardless of whether shareholders have previously rejected them. As a favorable recommendation from a proxy advisor firm can easily garner 25 investor percent support, shareholder proposals backed by proxy advisors can be resubmitted indefinitely, even if they don’t necessarily serve the long-term interests of companies and retail investors.” The report advocated that the SEC raise the thresholds for submission and and resubmission of shareholder proposals.
The SEC’s proposed amendments to Rule 14a-8 were another concern raised by the Working Group, particularly the proposed amendment to Rule 14a-8(i)(12), the resubmission exclusion, which would 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 Working Group contends that these “proposed changes will result in significant abuse and circumvention of the rule, allowing activists to resubmit previously rejected proposals by making minor modifications to the text of the proposals,” and “will only serve to encourage more activism, placing additional strain on companies’ and investors’ time and resources.”
The report concluded by advocating “sensible reforms to the SEC’s no-action letter process” as well as greater autonomy for companies “in developing their own shareholder proposal procedures. By recognizing that corporate governance is primarily the responsibility of the company and its shareholders, decision-making should remain in the hands of those directly impacted.”