Cam C. Hoang, a Partner at Dorsey & Whitney LLP, warns that Staff denial of H&R Block Inc.’s request to exclude my proxy access proposal “discourages thoughtful, comprehensive discussions at the outset, since proponents may revisit the issues in subsequent years.” (SEC Denial of H&R Block’s Request to Exclude Proxy Access Proposal, The Harvard Law School Forum on Corporate Governance and Financial Regulation)
In the interest of “thoughtful discussions” on proxy access, I offer some additional points on Ms. Hoang’s post that I hope will be helpful to companies and shareholders alike. I’ll try to address them in the order Hoang raised them. Yes, I’ll be repeating her name frequently below, mostly so I can easily go back and find this post in the future, since I have so many posts on the basic subject of proxy access.
Hoang: Mainstream Proxy Access
It remains to be seen whether the broader investor base will support these proposals at companies that have already adopted “mainstream” proxy access. Among other data points, we will watch for ISS’s recommendation on the shareholder proposal at H&R Block, as well as voting results at the company’s annual meeting on September 8, 2016.
What is “mainstream” proxy access? Hoang, and many in the corporate governance industrial complex, seem to think proxy access rights limited to groups of twenty is mainstream. I think it is like “clean” coal, largely a fantasy. The SEC rejected such limitations when they adopted Rule 14a-11. Clean coal isn’t clean and proxy access with the current limitations being offered by companies isn’t really access.
Hoang: Multi-stage Approach
It is important to note that he adopted a multi-stage approach towards implementing his version of proxy access, a tactic that has been used in the past and now may be applied more frequently to other governance policies, practices and procedures.
What Hoang calls a “multi-stage approach,” I call democracy. Even the Constitution is subject to amendments. First land-owning white men from Europe had that right to vote. Later, the vote was extended to others. I know, many think corporations are a democracy-free zone. They are not. My ideal “version of proxy access” is far from what was arrived at by the SEC in Rule 14a-11. See ISS Should Reconsider Their Analysis of H&R Block Proxy Access Proposal. However, I moved on to accept that consensus model because it was the result of years of thoughtful discussion. Many companies are still trying to game the system, providing the appearance of proxy access without the substance.
Hoang: Essential Elements
He then submitted the current proposal for amendments, contending that since the company’s proxy access bylaw did not include certain provisions which he considered “essential elements” of his proxy access template, there had not been substantial implementation of the current proposal.
When submitting a proxy proposal, shareholders have 500 words to explain it, whereas Rule 14a-11 took closer to 500 pages. Companies can take as many words as they want to rebut. Yes Ms. Hoang, it may take many many years of amendments just to get back to square one.
It would be a lot easier and clearer if proponents could just reference the SEC’s vacated Rule 14a-11. In California, all regulations must meet the “clarity” standards of the Procedure Act and be reviewed by the Office of Administrative Law for compliance to those standards. According to SEC Staff, federal regulations are too vague and too little understood to be cited in proposals as standards, even regulations that have not been vacated. (Dell, March 30, 2012)
Hoang: Negotiated and Withdrawn
Substantial implementation of shareholder proposals should be considered in the context of the company’s recent actions on the same policies, practices and procedures, with particular attention to issues that have already been negotiated and withdrawn by shareholders. This is especially appropriate for lengthy and procedurally specific bylaws such as proxy access that could otherwise become the subject of a series of shareholder proposals for ancillary changes, year after year.
Ms. Hoang seems to think that when a proxy proponent withdraws a proposal they have reached full agreement with the company. While that can be the case, most of the time it is not. Many social and environmental proposals are withdrawn every year for many reasons. Unlike largely binary provisions, like seeking a declassified board, proxy access has many details. When negotiating on proxy access, I have almost always informed company representatives that unless they include the provisions of Rule 14a-11, I will be back with amendments. I have also provided this caution when speaking to groups, like the Society for Corporate Governance.
Hoang: Substantial Implementation
In February and March of 2016, the Staff had granted no-action relief on the basis of substantial implementation to more than 30 companies that had adopted proxy access bylaws and received alternate proxy access proposals.
In the February 12th no-action letters, SEC Staff essentially substituted their judgement for that of shareholders. They apparently think they know the proponent’s objective better than the proponent does. It is similar to a court substituting its own business judgment for that of a board of directors. Staff found three percent held for three years are essential elements for substantial implementation but not capping the number of members in a group is not. The company has the burden of proof under Rule 14a-8(g) but neither most companies nor Staff providing any evidence regarding the unimportance of the group limitation to substantial implementation.
If I am building a house and specify in the contract that the furnace must meet an annual fuel-utilization-efficiency rating of 95% but the contractor installs one with an 80% rating, they have not met the essential terms of the contract. Based on the anomalous no-action letters beginning February 12th, if Staff were issuing an informal opinion on substantial implementation, they would apparently argue the quality of the furnace does not matter. It is as if Staff arbitrarily deems only a roof and walls to be essential elements of a house.
Under Rule 14a-8(i)(10). as properly applied, boards are free to adopt elements that do not conflict with those requested in a shareholder proposal. If a proposal specifies a range, boards can select a percentage at the high end. Unless specified, boards can round down to the nearest whole number instead of rounding up to arrive the appropriate number of shareholder nominees for a specified percentage of the board. However, boards should not be entitled under Rule 14a-8(i)(10) to round an infinite number of shareholders forming a group down to 20. That is not substantial implementation.
If Chair White were to suspend no-action opinions based on Rule 14a-8(i)(10) and call for a review of the history of that subdivision, Staff would find a very similar situation to what they found in investigating the evolution of how (i)(9) was reinterpreted. Starting out narrowly, Staff gradually widened the exemption far beyond its original intent. J. Robert Brown, a former member of the SEC’s Investor Advisory Committee, has already done much of this review in his Comment Letter on Rule 14a-8(I)(10), Securities & Exchange Commission, June 18, 2015 (June 18, 2015). See U Denver Legal Studies Research Paper No. 15-26.
Hoang: ISS and Large Investors
…if ISS and certain large institutional investors voice support for the amendments, companies may wish to make conforming changes consistent with the proposed amendments.
Hoang seems to be advising companies to fight meaningful proxy access, acquiescing only if ISS and “certain” large institutional investors voice support. I suppose that’s good advice if you are afraid proxy access will actually be used at your company… or if you want to keep spending money on legal counsel to file no-action requests every year.
Most shareholders have investments in many companies. Just as majority voting requirements for directors mostly spread from well-governed companies to poorly governed companies, the same will hold true for proxy access. (Does Majority Voting Improve Board Accountability?) Is your company still fighting majority vote requirements?
Does your company want to be a corporate governance leader or a laggard? Of course, if your company is largely controlled by a founder with a rubber-stamp board, fighting on may be the only way to remain in control. For example, I have frequently voiced my suspicions about certain companies. Companies like those may want to fight on, rather than face the risk that proxy access will be invoked and directors will actually hold regular executive sessions.
I would rather see companies in my portfolio spend money on something productive. Fighting Rule 14a-11 style proxy access is a waste of corporate assets.
Thanks for your spirited rebuttal of our piece as posted on the HLS Forum! From my perspective, there’s nothing undemocratic (and furthermore, something entirely reasonable) about looking at a set of amendments in the context of the original proposal, when analyzing substantial implementation. Also, consider evidence of the scope of the related negotiations, particularly when the original proposal is of a recent vintage. This approach does not necessarily foreclose shareholder proposals that raise substantive concerns and reflect evolving governance standards. What it does do is free companies and shareholders from the tyranny of a series of proposals for one-off amendments, which can be an undue drain on time and resources!
On the proxy access terms at issue, it’s an interesting debate as to what’s essential. I see conceptually how there’s a real difference between 20 vs an unlimited number of shareholders who may aggregate their shares to nominate a director candidate. I wonder practically what a campaign involving an unlimited number of shareholders would look like, and whether it’s feasible – potentially a shareholder representative acting by proxy for a large number of retail holders? It would be interesting to get your thoughts there.
With respect to “looking at a set of amendments in the context of the original proposal,” I hope the SRI community will weigh in on this one. Although proxy access is complex, it has only a short history of proxy filings in comparison to those on animal rights or environmental concerns. Taking a partial victory and coming back for more has a long history in corporate as well as civil rights. Think about the right to vote, the right to marry, even the right to reenter the country.
With regard to an unlimited number of shareholders, this provision is especially important at small- and micro-caps where institutional investors are scarce and where corporate governance is often at its worst. Even at companies with large institutional shareholders, I think we all recognize that many large funds have never even filed a proxy proposal, so they are highly unlikely to risk future sales of retirement investment products by organizing director nominations under proxy access.
Yes, coordination issues may be difficult but more so for shareholders than companies. Companies will be dealing with one representative, whereas that representative will be dealing with a potentially unlimited number of shareholders. There have been attempts to organize shareholders through the Gilbert brothers and the United Shareholders Association pre-Internet. Shareowners.org and MoxyVote.com showed the way but lacked funding. With growing concerns around Citizens United, I think the time is coming for more retail involvement in corporate governance.
The software to coordinate dozens, hundreds or even thousands of shareholders isn’t that costly and could be taken on by an organization like AsYouSow.org or others. All they would need is a grant from something like the Open Society Foundation and maybe a KickStarter campaign.