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Back in 2014, a few companies, facing shareholder proposals from the prolific shareholder-proposal activist, John Chevedden, and his associates, adopted a “direct-to-court” strategy, bypassing the standard SEC no-action process for exclusion of shareholder proposals.  In each of these cases, the court handed a victory of sorts to Mr. Chevedden, refusing to issue declaratory judgments that the companies could exclude his proposals. (At the end of the day, one proposal was defeated, one succeeded and one was ultimately permitted to be excluded by the SEC. See this PubCo post, and these News Briefs of 3/18/14, 3/13/14 and 3/3/14.) Now, ten years later, ExxonMobil has picked up the baton, having just filed a complaint against Arjuna Capital, LLC and Follow This, the two proponents of a climate-related shareholder proposal, seeking a declaratory judgment that it may exclude their proposal from its 2024 annual meeting proxy statement. In summary, the proposal asks Exxon to accelerate the reduction of GHG emissions in the medium term and to disclose new plans, targets and timetables for these reductions.  Will Exxon meet the same fate as the companies in 2014? Perhaps more significantly, Exxon took this action in part because it viewed the SEC’s shareholder proposal process as a “flawed” system “that does not serve investors’ interests and has become ripe for abuse by activists with minimal shares and no interest in growing long-term shareholder value.” If Exxon is successful in its litigation, will more companies, likewise faced with environmental or social proposals and perhaps perceiving themselves beset by the same flawed process, follow suit (so to speak) and sidestep the SEC?

SideBar

Of course, the cases against John Chevedden might not be particularly prophetic.  In all three cases, the courts held that the companies had no standing:  Mr. Chevedden had “irrevocably” agreed not to sue the companies if the proposals were excluded.  As a result, the agreement not to sue removed the possibility of impending injury to the company, and the possibility of litigation by the SEC or other shareholders appeared remote.  In some instances, he had also essentially mooted the case by providing “written promises not to present the proposal at the annual meeting if it is not included in the proxy materials…”

The Proposal

The proposal was submitted by Arjuna, a registered investment adviser, and Follow This, a Dutch company, in mid-December. The precatory proposal asks that Exxon “go beyond current plans, further accelerating the pace of emission reductions in the medium-term for its greenhouse gas (GHG) emissions across Scope 1, 2, and 3, and to summarize new plans, targets, and timetables.” Exxon contends that proposals addressing substantially the same subject matter were submitted in 2022 and 2023, in the first instance solely by Follow This, and, in the second case, by both Arjuna and Follow This.  According to Exxon, both proposals were “overwhelming rejected” by the shareholders.

In the complaint, Exxon charges that the proposal “does not seek to improve ExxonMobil’s economic performance or create shareholder value. Like the previous proposals, it is designed instead to serve Arjuna’s and Follow This’s agenda to ‘shrink’ the very company in which they are investing by constraining and micromanaging ExxonMobil’s ordinary business operations….This sweeping intrusion into ExxonMobil’s ordinary business operations is designed to substitute Defendants’ preferences for the judgment of ExxonMobil’s management and board in determining how best to operate the company in an efficient and environmentally conscious way.” 

The proponents

While Exxon views shareholder engagement as “critical for improving its business,” Exxon alleges that Arjuna and Follow This are “not like most ExxonMobil investors. Driven by an extreme agenda, they pursue what Follow This calls a ‘Goldilocks Trojan Horse’ strategy: They (or their clients) become shareholders solely to campaign for change through shareholder proposals that are calculated to diminish the company’s existing business.” In particular, Exxon contends, they don’t want to improve Exxon’s “business performance or increase shareholder value. To the contrary, Defendants share a different goal—disrupting ExxonMobil’s investments and development of fossil fuel assets and causing ExxonMobil to change its business model, regardless of the benefits, costs, or the world’s needs.”

Arjuna, Exxon alleges, is an “activist investment firm that pursues its own agenda, at the expense of shareholder value.”  In a prior case,  one of Arjuna’s managing partners “admitted that Arjuna does not hold and does not recommend that anyone purchase ExxonMobil stock. She further testified that the only reason Arjuna’s Chief Investment Officer owned ExxonMobil stock was to allow Arjuna to submit shareholder proposals.” Similarly, Follow This, Exxon alleges, “seeks to radically change the business model of energy companies and impose its agenda on them.” 

In both cases, Exxon alleges, these activists have submitted multiple shareholder proposals over the years to “interfere with ExxonMobil’s business and to promote their own interests over those of ExxonMobil’s shareholders.” To be sure, Exxon alleges, all of their shareholder “proposals that were voted on by shareholders were overwhelmingly rejected.” But, Exxon contends, “Congress did not intend for the proxy rules to be used in this way.”  Dealing with shareholder proposals can be expensive—up to $150,000 to process a single proposal, per SEC estimates—and many of the proposals “deal with matters relating to the company’s ordinary business operations in service of special interests that are not shared with other shareholders.”

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In a statement in response to the lawsuit, the Interfaith Center on Corporate Responsibility said that

“Exxon is asking the court to silence the voices of its shareholders, even though it is their capital that is at stake. This is especially dangerous for diversified shareholders like pension funds and retirement savers, who suffer lasting economic harm when companies like Exxon prioritize their own short-term cash flows over the health of the critical systems upon which our economy relies. Securities laws are designed to protect the voices of shareholders. In attacking the shareholder proponents rather than addressing the substance of the issues, Exxon’s suit seeks to silence the voices of investors who are dependent on healthy systems for long-term returns on their investments….  

“Typically, the question of whether a company can omit a shareholder proposal is determined by the SEC, which has an investor protection mandate.  In appealing directly to a ‘friendly’ Texas court, Exxon is seeking to establish a new precedent which has rarely been used. If successful it could usher in a new era where companies sue investors to prevent shareholder debate on important issues of disagreement. Should companies move in this direction, we would expect to see investors increasingly invoke strategies such as votes against directors and litigation in the form of shareholder derivative lawsuits to resolve disputes with boards and management—a slippery and very costly slope for all parties. Rather than address the substantive issues, the suit attacks the proponent’s motives, when in fact the vast majority of climate-related proposals filed at the company have sought to raise awareness about the imperative for Exxon to evolve its business model and move toward the low carbon energy future investors know is inevitable. A number of these proposals have received substantial support from ExxonMobil shareholders.”

The SEC’s process

In its complaint, Exxon contends that “the number of proposals that shareholders submit each year is rising.” Citing data in remarks by SEC Commissioner Mark Uyeda (see this PubCo post), Exxon points out that “the number of proposals submitted in 2023 was 18 percent higher than in 2021. And the number of proposals that were voted on at annual shareholder meetings rose by 40 percent during that period. Proposals focused on environmental and social issues increased at an especially high rate, with the number of submissions growing by 52 percent and the number voted on by 125 percent between 2021 and 2023.” In addition, Exxon alleges, the level of coordination on proposals among activist investors has increased. Why has the number of proposals increased?  According to Exxon, the number “each year is rising because of how the SEC staff is applying the shareholder proposal rules,” as activist organizations rely on current guidance by SEC staff to submit their proposals. The increases in the number of proposals, Exxon contends, “have occurred despite no change in the language of the statute or the applicable SEC rules. They can be traced only to changes in SEC staff positions on the application of the shareholder proposal rules.”

SideBar

What are these changes in staff positions? You might recall that, beginning in 2017, Corp Fin issued several new SLBs (I, J and K) addressing, among other things, the exclusions under rules 14a-8 (i)(5), economic relevance, and (i)(7), ordinary business, an exclusion on which companies frequently rely to seek to omit environmental and social proposals.   SLB 14I provided that, under 14a-8(i)(5), when a proposal related to operations that accounted for less than 5% of total assets, net earnings and gross sales, but raised issues of “social or ethical significance,” the test allowed exclusion when the matter was not “otherwise significantly related to the company,” and the staff viewed “the analysis as dependent upon the particular circumstances of the company to which the proposal is submitted.” (See this PubCo post.) Under Rule 14a-8(i)(7), proposals could be excluded if they raised matters that were “so fundamental to management’s ability to run a company on a day-to-day basis that they could not, as a practical matter, be subject to direct shareholder oversight”—unless, that is, the “significant policy exception” applied. That exception would preclude exclusion of the proposal if the proposal “would transcend the day-to-day business matters and raise policy issues so significant that it would be appropriate for a shareholder vote.” In SLB 14K, the staff advised that the issue of policy significance should be company-specific—“whether the proposal raises a policy issue that transcends the particular company’s ordinary business operations”—rather than whether the particular issue is of general significance. That is, under SLB 14K, the staff took “a company-specific approach in evaluating significance, rather than recognizing particular issues or categories of issues as universally ‘significant.’” (See this PubCo post.)

Then, in October 2020, the SEC adopted amendments to Rule 14a-8 to modify the eligibility criteria for submission of shareholder proposals, as well as the resubmission thresholds; 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. Proponents thought the amendments 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). Opponents of the amendments viewed the changes as a restriction on a mechanism for shareholder oversight of management, particularly affecting smaller holders and proposals related to ESG issues. The rulemaking generated an animated discussion among the commissioners in the course of the long meeting, as well as substantial pushback through the public comment process, discussed in more detail in this PubCo post and this PubCo post. Then-SEC Chair Jay Clayton observed that a “system in which five individuals accounted for 78% of all the proposals submitted by individual shareholders” needed some work, and former Commissioner Jackson characterized the proposal as swatting “a gadfly with a sledgehammer.” (See this PubCo post.)

With a new SEC majority in place, in November 2021, Corp Fin issued new SLB 14L, which outlined Corp Fin’s most recent interpretations of the ordinary business and the economic relevance exclusions under Rule 14a-8, and rescinded the three earlier SLBs—SLBs 14I, 14J and 14K. Generally, new 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.) Under SLB 14L, with regard to (i)(7), SLB 14L provided that the staff will “focus on the social policy significance of the issue that is the subject of the shareholder proposal. In making this determination, the staff will consider whether the proposal raises issues with a broad societal impact, such that they transcend the ordinary business of the company.” In addition, Corp Fin said that it would take a “measured approach to evaluating companies’ micromanagement arguments—recognizing that proposals seeking detail or seeking to promote timeframes or methods do not per se constitute micromanagement. Instead, we will focus on the level of granularity sought in the proposal and whether and to what extent it inappropriately limits discretion of the board or management.” “Going forward,” the staff indicated, it would not necessarily exclude a proposal that suggested “targets or timelines so long as the proposals afford discretion to management as to how to achieve such goals.” The effect of SLB 14L was to make exclusion of shareholder proposals—particularly proposals related to environmental and social issues—more of a challenge for companies, smoothing the glide path for inclusion of proposals submitted by climate and other activists, both pro- and anti-ESG.

In this context, it’s worth noting that the National Association of Manufacturers is now challenging the SEC’s use of Rule 14a-8 altogether, claiming that neither the First Amendment nor the federal securities laws allow the SEC to use Rule 14a-8 to compel a company to speak about contentious political or social issues, such as abortion, climate change, diversity or gun control, that are “unrelated to its core business or the creation of shareholder value.” (See this PubCo post.) 

Exxon contends that it is eligible to exclude the proposal on two bases. First, it argues that the proposal is excludable under Rule 14a-8(i)(7) because it “deals with a matter relating to the company’s ordinary business operations.” According to Exxon, “[t]argets and plans for reducing GHG emissions are prime examples of ordinary business operations for an energy company like ExxonMobil. They require a detailed and balanced understanding of ExxonMobil’s business, global supply and demand, technical intricacies of emissions reductions, the selection of products and services the company offers, and other matters understood by management and the board.” In addition, Exxon contends that the proposal is excludable under Rule 14a-8(i)(12) because it “addresses substantially the same subject matter as the 2023 Proposal and the 2022 Proposal, and the resubmission criteria of Rule 14a-8(i)(12) are not met.” The resubmission criteria permit exclusion of a proposal if “the most recent vote [on the duplicative proposal or proposals] occurred within the preceding three calendar years and the most recent vote was: (i) Less than 5 percent of the votes cast if previously voted on once; (ii) Less than 15 percent of the votes cast if previously voted on twice; or (iii) Less than 25 percent of the votes cast if previously voted on three or more times.”

But if Exxon believes that it’s excludable on these two bases, you may ask, why skirt the SEC? Presumably, that’s because of how Exxon perceives the SEC staff to be “applying the shareholder proposal rules.” According to Exxon, the “plain language of Rule 14a-8 supports excluding the 2024 Proposal, but current guidance by SEC staff about how to apply the rule can be at odds with the rule itself.” As a result, it appears, Exxon elected not to go through the typical process of requesting the SEC staff to take a no-action position on its intended exclusion and instead to seek “declaratory relief from this Court to stop this misuse of the current system.” More specifically, Exxon seeks a declaration that it may exclude the proposal from its 2024 proxy statement and not present it for a shareholder vote.  Time will tell whether Exxon will succeed—and others emulate.

SideBar

In his 2023 remarks, Commission Uyeda observed that,  in his view, the recent interpretative changes in SLB 14L have led to a surfeit of proposals, the aggregate effect of which is “value-eroding.”  In the “year before SLB 14L, the staff concurred with a company’s argument to exclude a proposal pursuant to paragraph (i)(7) 40% of the time and did not concur 25% of the time. These outcomes nearly reversed in the year after SLB 14L, when the staff concurred 23% of the time and did not concur 54% of the time.” (Interestingly, from October 1, 2022 to March 31, 2023, Uyeda noted that the staff concurred with exclusion under (i)(7) 45% of the time. However, he attributed this “higher success rate” during this period to “companies becoming more judicious with their no-action requests based on paragraph (i)(7), after better understanding the staff’s position in SLB 14L. Companies made only 73 requests to exclude a proposal pursuant to paragraph (i)(7) during this six-month period from 2022 to 2023, as compared to 100 requests and 92 requests during the same period from 2021 to 2022 and 2020 to 2021, respectively.”) However, Uyeda noted, during the same period from 2021 to 2023, the percentage of favorable votes declined from 36% in 2021 to 24% in 2023, and the percentage of majority of votes cast declined from 19% to 5%. The decline for E&S proposals was even more dramatic, from 37% favorable votes in 2021 to 20% in 2023, with only 3% actual majority votes. At that time, several asset managers characterized many shareholder proposals as too prescriptive or unconnected to material risks or long-term value, or generally of decreased overall quality. (See this PubCo post and this PubCo post.)

Posted by Cydney Posner

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