Shareholder Proposal Reform Rebutted

Shareholder Proposal Reform or Fat-Cat Entrenchment?

The U.S. Chamber of Commerce Center for Capital Markets Competitiveness (CCMC) released a paper on shareholder proposal reform, which contains a “set of recommendations for the SEC on fixing the broken Rule 14a-8 system in order to protect investors and make the public company model more attractive.” See also the Chamber’s press release, U.S. Chamber Offers Recommendations to SEC on Shareholder Proposal Reform.

Rule 14-8 is not broken, many of the Chamber’s attestations are alternative facts and its recommendations are more likely to hurt our economy than help it. The paper is very similar to their previously released Responsible Shareholder Engagement And Long-Term Value Creation: Modernizing the Shareholder Proposal Process. As I wrote in my rebuttal last year (Business Roundtable to SEC: Muzzle Shareholders),

‘modernization’ for the Business Roundtable means moving the SEC further and further from its primary mandate of ‘investor protection’ by creating a democracy-free zone for entrenched managers.

Chamber’s Shareholder Proposal Reform Grounded in Alternative Facts and False Premises

The paper reminds readers that Rule 14a-8 provides 13 exemptions allowing companies to exclude shareholder proposals.  It then takes a leap into alternative facts with “the SEC has never allowed unfettered access to a company’s proxy statement” (with regard to shareholder proposals). From that alternative fact, the paper then argues,

The true facts have seen the erosion of shareholder rights, with regard to the inclusion of proposals in corporate proxies. After it’s founding, the SEC was largely a champion of shareholder rights, requiring companies to include proposals on any ‘proper subject’ in the proxy. The idea was to “approximate the conditions of the old-fashioned meeting.” SEC v. Transamerica Corp. (3d Cir. 1947) was the first and only case in which the SEC brought suit to compel an issuer to include a shareholder proposal. As Jill E. Fisch notes in The Transamerica Case.

The Transamerica decision represented the high point in SEC protection of shareholder voting. Rule X-14A-7 afforded shareholders the broadest power with respect to the introduction of shareholder proposals; it imposed no qualification requirements, limits on the number of proposals allowed or subject matter limits. (my emphasis)

The court concluded issuer-specific limitations interfered with the intent of Congress that shareholder voting rights operate as a check on the abuse of power by corporate management and that Rule X-14A-7 was consistent with that intention. 

From that high-point, the SEC began chipping away at shareholder rights with regard to the proxy. The rules were amended so that shareholder proposals could only target issues directly related to the corporation. When grey areas arose, such as a 1951 proposal to consider the advisability of abolishing Greyhound’s segregated seating system in the South, the SEC insulated management from proposals motivated by a ‘general’ cause, even if the proposal concerned issues directly related to the corporation, by granting no-action letters.

Then came the ‘ordinary business rule,’ allowing exclusion of proposals concerned with day-to-day business decisions, followed by other exclusions. The proxy was transformed from the equivalent of a face-to-face meeting where any issue could be raised to a right limiting proposals to profit-oriented general strategies. President Reagan’s SEC excluded shareholder proposals that concerned “operations which account for less than five percent of the issuer’s gross assets” and by disqualifying proposals from shareholders unless they owned at least $1,000 of common stock for at least a year. Proposals must stem from economic motives; that became the clear philosophy that was adopted within fairly recent history.

However, the post-Cracker Barrel SEC accepted the untenability of enforcing a bright line between the market and society. The bright line was removed in 1998 when the SEC announced it would return to a case-by-case approach regarding when social policy issues fall within the scope of the ‘ordinary business’ exclusion.

Yes, “guardrails” have been put in place over the years but not to protect investors, as the Chamber claims in the Shareholder Proposal Reform paper. Instead, those barriers have created a maze with so many false passageways to inclusion in the proxy that it takes an expert to navigate the process, especially when companies hire outside counsel to prepare legal briefs arguing, not the merits of the proposal but the many technical traps that can result in a proposals exclusion. 

Shareholder Proposal Reform: Materiality

According to the Chamber’s Shareholder Proposal Reform paper, “half of all proposals submitted to Fortune 250 companies during the 2016 proxy season dealt with some type of social or policy-related matter,” which it infers are immaterial. Shareholders are not just economic robots, demanding the highest profits possible without regard to harm to society or the environment. Additionally, determining what is material is a problematic task. As I noted in my letter opposing the Financial Choice Act,

Aside from serving to increase accountability, proposals often serve as an “early warning” system. Had companies listened, we might have avoided the 2008 financial collapse, since proposals concerning predatory subprime lending and the securitization of such subprime loans were introduced in 2000. Proposals beginning in 2003 asked securitizers to police their loan pools. See letter to the SEC from Paul M. Neuhauser dated 10/2/2007.

Seeking to buttress their argument that social and policy proposals have little relevance, the Chamber’s paper notes that between 2006 and 2016, “Fortune 250 companies received 445 proposals dealing with corporate political disclosures — a perennial favorite topic of activists. Only 1 of these proposals during that time frame received majority backing.” However, that does not mean such proposals are having no impact. As a result of the efforts of the Center for Political Accountability (CPA) its and its partners, 153 leading public companies, including 53 in the S&P 100, have adopted political disclosure and oversight.

Justice Anthony Kennedy’s majority opinion in the 2010 Supreme Court case of Citizens United v FEC, which limited the government’s ability to constrain corporate expenditures for political purposes, included the following ideal of internal democracy within corporate governance as a partial justification for the Court’s opinion:

With the advent of the Internet, prompt disclosure of expenditures can provide shareholders and citizens with the information needed to hold corporations and elected officials accountable for their positions and supporters. Shareholders can determine whether their corporation’s political speech advances the corporation’s interest in making profits, and citizens can see whether elected officials are ‘in the pocket’ of so-called moneyed interests.

I strongly disagree with the decision but Justice Kennedy’s opinion does reinforce my own long-standing belief that real democracy depends on more than just a democratic government. It depends on democratic structures and mindsets throughout society, especially in the operation of corporations, which have so much influence on other social institutions, including governments at all levels.

Yet, corporations are not required to make the disclosures Justice Kennedy referenced. Certainly, it is not in the interest of some CEOs and entrenched boards to make such disclosures, since doing so would make it more difficult for them to have politicians in their “pockets.”

Shareholder Proposal Reform Paper Blames Shareholder Proposals for a Litany of Unrelated Problems

The Chamber’s Shareholder Proposal Reform goes on to argue

a very small subset of investors have come to dominate the shareholder proposal system, while the vast majority of investors— including those that routinely vote against social and political proposals—bear the costs. Fully one-third of all shareholder proposals in 2016 at Fortune 250 companies were sponsored by six individual investors, while 38% of proposals were sponsored by institutions with an explicit social, religious, or policy purpose. Including a proposal on a proxy or seeking “no-action” relief from the SEC staff creates significant costs for all shareholders.

My wife and I are among the “six individual investors” mentioned, so I take personal offense at the implication that our proposals create a burden on “the vast majority of investors.” The paper implies our proposals have little or no merit or support. During the last five years, 132 of our proposals have been voted on. Most received substantial support in the 30-50% range. Well over 20% received a majority vote. See Exhibit 1 (Download in Excel Exhibit1, included in my letter to Congress on the Financial CHOICE Act). My figures do not count the many proposals we file and withdraw because of negotiated agreements or the equivalent. See WD-40 Win Win – Majority Vote Standard  and Broadridge Amends Proxy Access: Allows 50 for two cases in July of this year alone.

Shareholder Proposal Reform then goes on with an apparent effort to blame proxy proposals for the reduction in the number of public companies during the last two decades, our failing struggle to achieve even 2% GDP growth and the “ability of American households to build wealth.” This is all because of the “substantial ‘tax’ on companies” imposed by the cost of shareholder proposals. None of these claims have any basis in fact nor is any substantive evidence provided. I addressed the GDP issue last week toward the end of Proxy Access Battlefront Shifts: HRB No-Action Rejected. I argued that companies and employees in other developed countries do not have to worry about healthcare and other modern essentials, which are considered rights elsewhere. That contributes more to our slow growth than the small costs companies must bear for shareholder proposals.

Regarding the cost of shareholder proposals, which appears to be at the heart of the paper’s argument for shareholder proposal reform, I agree that companies are often spending too much, although it is a much smaller amount than the Chamber presumes. Instead of filing expensive slap suits or even requesting no-action letters, why not pick up the phone and talk with the proponent? When companies have contacted me, we have usually been able to reach an agreement. However, the cost of including proposals in the proxy or even of requesting a no-action letter from the SEC is minimal. For fact-based analyses, see The Dangerous “Promise of Market Reform”: No Shareholder Proposals and The Value of the Shareholder Proposal Process.

Shareholder Proposal Reform #1: Raise Thresholds

US Chamber of Horrors

The Chamber recommends resubmission requirements be raised from support of 3% to 6%; 6% to 15%; and from 10% to 30%.

How many years did it take to end legalized slavery, segregation, the ban on gay marriage? Although now widely recognized by corporations as an important risk issue, climate change was widely dismissed for years. Good ideas usually take time to be recognized.

Even ideas like the majority vote standard to elect directors took many years to achieve a 30% support level after first being proposed. Because that standard has been adopted by more than 90% of the S&P 500, many at the Chamber probably believe the standard is nearly universal. It is not. Most companies still use a plurality standard for uncontested elections. The vote of one share gets directors in such companies elected. It can still take years to get such resolutions adopted at small-cap companies, although support grows gradually almost every year.

Shareholder Proposal Reform #2: Withdraw Staff Legal Bulletin 14H (CF)

The Chamber argues the former interpretation of (i)(9) was “relied on for years.” However, the exemption started out as the equivaltent of a rabbit path and ended up more like a freeway.

At the time of adoption, proposals could be excluded under subsection (i)(9) only in very narrow circumstances and only where adoption of competing proposals could be harmful to shareholders. As General Electric (Jan. 28, 1997) and Northern States ((July 25, 1995) demonstrated, proposals could be excluded where adoption resulted in confusion or uncertainty in actual implementation or where, as a result of incompatibility, implementation of both proposals was impossible.

By the time I appealed the no-action letter granted to Whole Foods Market, a competing proposal merely needed to address the same subject. It was a rule change over time without going through the rulemaking process. See Appeal of No-Action on Proxy Access at Whole Foods Markets (WFM).

Staff Legal Bulletin No. 14H (CF) does not adhere completely to original intent, which staff determined was “to prevent shareholders from using Rule 14a-8 to circumvent the proxy rules governing solicitations.” However, it gets us where we need to be in defining the meaning of “directly conflicts” with regard to Rule 14a-8 exclusions.

The guidance still provides some wiggle room for companies to game the system by proposing the opposite. For example, if a shareholder proposes proxy access a company could invoke (i)(9) by countering with a proposal to deny any form of proxy access. However, in most cases that tactic will backfire. Whole Foods became something of a pariah when they put up a counter proxy access proposal to mine with thresholds that could never be met. Taking a “do the opposite” stand might be funny in comedy but not when carrying out the fiduciary duties of a board.

Yes, as the Shareholder Proposal Reform paper notes, staff relied on another interpretation for years, but they did so illegally, just as they had previously denied the right of shareholders to proxy access until AFSCME v AIG (2006). That case involved a 2004 bylaw proposal submitted by AFSCME to the American International Group (AIG) requiring that specified nominees be included in the proxy.  AIG excluded the proposal after receiving a no action letter from the SEC and AFSCME filed suit.

The court ruled the prohibition on shareowner elections contained in Rule 14a-8 applied only to proposals “used to oppose solicitations dealing with an identified board seat in an upcoming election” (also known as contested elections). SEC Staff had reinterpreted the rule without providing an opportunity for public comment, as required by the Administrative Procedure Act. The SEC subsequently adopted a formal rule banning proposals aimed at prospective elections and later adopted a more restrictive proxy access rule.

The Chamber complains a 500 word proposal costs companies a substantial amount of money to include in the proxy. Now they want what appears to be an even longer explanation of the proponents motives and particulars, as well as from anyone acting on behalf of the proponent. Proponents are already required to submit evidence of the required ownership from a broker or bank. Proponents already state the need for the proposal in their 500 word statements.

For years, many companies have complained that shareholders should not be able to seek expert advice when submitting proposals or responding to company inquiries. Yet, those same companies employee legal counsel, both internally and outside, to craft their arguments as to why proposals should be kept of the proxy. Under Shareholder Proposal Reform, will companies be required to make the same disclosures the Chamber requests be added for proponents and their agents?

I have been submitting proposals for almost twenty years and have never hired counsel to assist me in crafting or defending a proposal before SEC staff or the courts. However, I routinely get help from others in the submission process, to ensure all the details are correct, and at other stages if needed. Many people hire financial advisors to help them invest, why should barriers be erected to discourage them from getting assistance in filing shareholder proposals? The Chamber’s recommendation is especially disconcerting, given that researchers have found that proposals are excluded “mainly due to sponsors’ lack of experience and knowledge.” (An Analysis of Omitted Shareholder Proposals)

It also seems odd to have the Chamber advocating for mandatory inclusion of the proponent’s name and other particulars, given past history.Exchange Act Release No. 4950 (Oct. 9, 1953) included the following (The Evolving Role of Rule 14a-8 in the Corporate Governance Process):

In order to discourage the use of this rule by persons who are motivated by a desire for publicity rather than the interests of the company and its security holders, it is proposed to provide that the managements’ proxy material need not contain the name and address of the security holder if it contains, in lieu thereof, a statement that the name and address of the security holder will be furnished upon request.

It there is one good recommendation in Shareholder Proposal Reform, perhaps it is the change to require publishing the proponent’s name in the proxy. That might save me time in voting my proxy, since I can see if the name is a trusted one and move with an expedited review from there.

Shareholder Proposal Reform #4: The 5% Solution

In 1982, the Commission amended Rule 14a-8 to include a provision that a matter failing the 5% test would still have to be included in the company’s proxy materials if it was “otherwise signicantly related to the issuer’s business.” The Chamber argues the Commission should reassert the original intent of the 14a-8(i)(5) exclusion by allowing proposals to be excluded that do not meet the 5% asset and net earnings threshold, regardless of the underlying subject matter.

Apparently, the Chamber wants to return to the good old days of Peck v. Greyhound Corp., 97 F. Supp. 679 (S.D. NY 1951) when a civil rights activist submitted a proposal recommending that “management consider the advisability of abolishing the segregated seating system in the South” to the Greyhound Corporation. The SEC also approved the exclusion of shareholder proposals that an investment firm divest from liquor stocks, and that another company extend to women the same pension benefits as it offered to men. (Protecting Markets from Society: Non-Pecuniary Claims in American Corporate Democracy)

More recently, we might have avoided the 2008 financial collapse if banks had heeded the warnings of shareholder proposals also failing the 5% threshold concerning predatory subprime lending and the securitization of such subprime loans. Proposals beginning in 2003 asked securitizers to police their loan pools. See letter to the SEC from Paul M. Neuhauser dated 10/2/2007.

Had the board of Wells Fargo’s not opposed such a proposal, they could have escaped both losses due to subprime loan practices but also their more recent scandal involving opening unwanted accounts.

In 2004, Northstar Asset Management raised issues related to Wells’ loan sales and asked the bank’s board to “conduct a special executive compensation review” because, according to banking regulators at the time, Wells Fargo had “not adjusted compensation policies to discourage abusive sales practices” and did not have adequate audit procedures in place. The board dismissed the request, saying that Wells Fargo’s “compensation and commission policies are designed to encourage appropriate sales practices” and that the bank had “comprehensive monitoring and audit procedures.” (Here’s How Wells Fargo’s Board Of Directors Just Failed Customers, by Eleanor Bloxham, Fortune, 4/14/2017.

Proposala addressing social issues that do not appear to meet the 5% economic threshold can easily spiral to much higher impacts, depending on social reputation and black swan risks. Companies seeking a no-action letter under 14a-8(i)(5) usually try to do so under the ordinary business exclusion as well [Rule 14a-8(i)(7)] Since the ordinary business exclusion applies irrespective of the actual impact on earnings or assets, companies using it can forgo the need to assess the economic significance of the proposal to the company. The SEC should eliminate the 5% rule as essentially redundant.

Shareholder Proposal Reform #5: Prohibit Images, Photos or Graphic in Proposals

In anticipation of a problem that does not yet exist, the Chamber recommends

So far, this is a solution in search of a problem, since few proposals have been submitted making use of images. Rushing to ban graphics before we have more than a handful of cases is like banning proxy access proposals before a consensus began to form around what those would look like. We could have saved many years in three separate rulemaking processes by allowing a few years of experimentation. I recommending waiting a few years and assessing the issue based on real submissions.

Shareholder Proposal Reform #6: Clarify Prohibition of Personal Grievance Proposals

The Chamber provides no evidence or examples of abuse. We have seen a few cases related to proposals filed by former employees, who may use the proposal process as a platform to state their case for a grievance. If there is any abuse, it is probably denying shareholders the right to file a proposal that any other shareholder could file but is granted no-action just because of a past dispute with the company. Shareholders should not lose their rights simply because they once had a dispute with the company.

Shareholder Proposal Reform #7: Crack Down on Misleading Statements

The report contends, “the SEC staff has eroded the viability of this exemption by placing the burden on issuers to prove that a statement made by a proponent is materially false or misleading” Rule 14a-9 clearly prohibits the use of false or misleading statements with regard to any material fact. To my knowledge, this is being enforced.

The Chamber’s real objection appears to the following provision in Rule 14a-8(g):

Who has the burden of persuading the Commission or its staff that my proposal can be excluded? Except as otherwise noted, the burden is on the company to demonstrate that it is entitled to exclude a proposal.

Rule 14a-8(g) applies to the entire filing, not just Rule 14a-9 standards regarding misleading statements. It certainly would not make sense to put the burden of proof on shareholders for Rule 14a-9 but keep the burden of proof on the company with regard to all other provisions.

The burden of proof assumption has been in place since the outset when the only exclusion allowed was the right to delete proposals not deemed to be “a proper subject for action” by shareholders. The exclusion mostly turned on state law. It was up to management to provide affirmative evidence. See Exchange Act Release No. 4979, 1954 WL 5772 (Jan. 6, 1954) quoted in The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors:

The rule places the burden of proof upon the management to show that a particular security holder’s proposal is not a proper one for inclusion in management’s proxy material. Where management contends that a proposal may be omitted because it is not proper under state law, it will be incumbent upon management to refer to the applicable statute or case law and furnish a supporting opinion of counsel.

Conclusion

I do not mean to imply the proxy proposal process is perfect. I would love to see it go back to empowering shareholders as it did in 1947. However, I think the likelihood of repealing all those regulations and guidance documents are slim.

Many things are broken in America – healthcare, educational systems, infrastructure, our tax system, the criminal justice system (especially as it pertains to white collar corporate crime), even our election system is subject to foreign interference – Rule 14a-8 is not broken. The Chamber would do well to focus its attention elsewhere. What and I missing? Comments welcome.