SEC Trampled Rights. September 23 was a bad day for shareholders, society, and the environment. It was an action typical of the Trump Administration, where political appointees work counter to the missions of regulatory bodies. The only significant “support” for the amendments from shareholders came from a few fake letters, which Chairman Clayton read into the record when introducing the rules. Although few companies expressed support for the changes, their trade associations worked to ensure investors would have fewer tools available to hold boards accountable.
I would join other concerned shareholders suing the SEC for failing to comply with the legal requirements in promulgating these rules. However, given that implementation of several provisions is delayed, I will join with others to ask the SEC to overturn the rules once President Biden appoints a new Chairman.
SEC Trampled Economic Returns
The SEC’s own Chief Economist found the rules would exclude 75% of shareholders from the process. His report was not submitted until the comment period was over. Coincidence? See Memorandum from S.P. Kothari, Chief Economist, to File No. S7-23-19, Analysis of Data Provided by Broadridge Financial Solutions, Inc. (Aug. 14, 2020).
Chairman Clayton asserted that 5 shareholders file most of the proposals and they go unsupported. Mine averaged over 50% support for at least the last two years. The other “gadfly” filers also have good track records, often better than institutional investors.
For a less biased view of the role of gadflies, read The Giant Shadow of Corporate Gadflies. Nili and Kastiel conclude the SEC’s focus on gadflies is misplaced. Gadflies have a role as “governance facilitators” because large institutional investors fail to utilize the shareholder proposal mechanism themselves. Instead of cutting gadflies out of the process, they ask how can we bring larger investors into the process?
My petition to the SEC would be much more effective in getting institutional investors to monitor corporate governance. SEC rules currently facilitate the ability of fund customers to compare costs and historical earnings but do nothing to help compare voting records. See Mutual Fund Wars Over Fees AND Proxy Votes.
The biggest mistake of the rulemaking was only considering the cost of shareholder proposals, not the benefits. As noted in the SEC press release:
The Commission’s amendments are intended to help ensure that the ability to have a proposal included alongside management’s in a company’s proxy materials… is appropriately calibrated and takes into consideration the interests of not only the shareholder who submits a proposal but also the company and other shareholders who bear the costs associated with the inclusion of such proposals in the company’s proxy statement.
Yes, proposals do cost something for companies to process. However, The High Cost of Governance Deficits: A Case for Modern Governance by Diligent Institute found companies that had adopted the type of proposals I file (e.g. annual election of directors and simple majority vote standards) had higher equity returns. The top 20% of the S&P 500, as measured by strong corporate governance, outperformed the bottom 20% by 17% over the period measured.
According to Siblis Research, the market cap of S&P 500 companies (leaving out thousands of other companies) rose $1.8 trillion during the two years measured by Diligent. The lost opportunity costs of increased gains provoked by shareholders demanding better corporate governance amounts to billions of dollars each year. That amount far exceeds the SEC’s small estimated costs to companies for including or trying to exclude shareholder proposals.
SEC Trampled Shareholder Rights: Legal Analysis
Rather than synopsize the rules, readers are directed to legal briefs from the following:
The amended rules will make it difficult for organizations like the Interfaith Center on Corporate Responsibility and As You Sow to represent the interests of shareholders, including many small institutional shareholders, who hold modest stakes at many companies. Raised resubmission thresholds will kill a great many environmental and social proposals. If these rules had been in place during apartheid in South Africa, its fall would have been delayed by years.
SEC Trampled Shareholder Rights: Other Views
Interfaith Center on Corporate Responsibility
Josh Zinner, CEO of the Interfaith Center on Corporate Responsibility, included the following in their press release:
The new rule guts the existing shareholder proposal process, which has long served as a cost-effective way for shareholders to communicate their priorities and concerns to management, with little economic analysis supporting the needs for these substantial changes.
The new rules appear to be based on a wholly unsupported assumption that shareholder proposals are simply a burden to companies with no benefits for companies or non-proponent investors when there is 50 years of evidence to the contrary.
Jon Hale of Morningstar points to Chairman Clayton’s claim that he is “protecting Main Street investors.” (Sustainability Matters: New SEC Rule Weakens Influence of Main Street Investors)
What Clayton really means is that he wants to protect corporations from small investors proposing too many bothersome resolutions. Why? The stated claim is to “modernize” the rules in order to make it more costly for Main Street investors to offer resolutions because responding to their resolutions costs corporations money…
However, Hale argues:
Shareholder resolutions send important signals to corporate management about investor concerns and often lead to notable changes. Shareholder concerns surfaced in the resolution process have led to new practices being widely adopted across markets, including, for example, electing directors by majority vote and giving shareholders the opportunity to vote on executive compensation practices.
With regard to climate change and sustainability, Hale writes:
The shareholder-resolution process has sent a crucial signal to companies that they need more information about these risks and how companies plan on managing them.
Average support for shareholder resolutions on environmental and social issues has been steadily increasing, with average support doubling between 2004 and 2018.
Like me, Hale argues:
Shareholder resolutions and the proxy process make financial markets better for ordinary investors. While the process will persevere under its new limits, there was no good reason for this rule, other than a Trump administration regulator taking action on behalf of certain D.C.-based business trade organizations that want to stifle the voice of investors who have indeed been more concerned in recent years about how public companies address ESG risks, especially those related to climate change.
As Hale points out, “the number of resolutions voted on each year has remained fairly constant over the past two decades.” The real change is growing support. My conclusion is that entrenched managers and boards don’t like being told what to do, even though proposals are advisory. Shareholder proposals are like unsolicited consulting. The cost averages out to $23,000 per firm. How much would McKinsey & Company charge for such services?
Jackie Cook of Morningstar gets further into the weeds. Worker safety and human rights at meatpacking plants will soon be under the radar. (SEC Proxy Voting Rule Changes Could Weaken Minority Shareholder Influence)
The effect of these rule changes would be to exclude two of the three 2020 resolutions that directly addressed the plight of poultry workers as well as several other shareholder ballot initiatives filed at meatpacking companies by minority shareholders.
Shareholder resolutions are often uncannily prescient in raising material ESG concerns. That’s because the filers–state-, municipal- and union-run pension funds, foundations, faith-based investors, and responsible investment asset managers–typically spend years tracking risks specific to industries and to whole supply chains.
The SEC’s rule demonstrates a failure to comprehend that ESG issues, including climate change, increasingly have material impacts on company value. The commission’s rule will actively impair the right of retail shareholders to communicate publicly with their companies on these critical issues…
The SEC has intervened to disrupt a system that has worked with fairness and integrity for over 50 years. Companies have gained deep insight into potential material risks to their businesses courtesy of their shareholder engagements. Investors have had a forum to raise their concerns, assisting companies to outperform. This is an ecosystem-based on mutual respect and a common goal; helping companies be as good as they can be. The new SEC rules will force shareholders to escalate to litigation and other means. (Andrew Behar)
With this rule, the SEC has voted to actively muzzle retail shareholders’ ability to communicate, using non-binding proposals, in the public forum of company proxies. Far from a proposal to protect Main Street investors, this rule change makes it more difficult for shareholders to have a meaningful voice with their companies. This vote comes at a time when shareholders are appropriately acknowledging — and asking their companies to address — a wide range of social and environmental issues that have the potential to harm our environment, economy, and companies’ value. The market is moving inexorably into a new era of sustainable business practices; the SEC’s new rule demonstrates a failure to understand and support this necessary transition. (Danielle Fugere)
Lisa Woll, CEO of US SIF: The Forum for Sustainable and Responsible Investment, made the following statement:
The SEC has made these changes even though they are entrusted with protecting investors. This would seem to warrant allowing the filing of shareholder proposals without unnecessary roadblocks.
“The new ownership and resubmission thresholds are intended to restrict shareholders from holding companies accountable on issues like climate, diversity and worker rights which impact long-term share value. The changes to Rule 14a-8 will disenfranchise investors and shift power to company CEOs and management.
Compounding the 1,150 percent increase in the ownership thresholds are significant increases in resubmission thresholds and scrapping the ability of shareholders to aggregate their shares. This will largely erase a retail investor’s ability to file proposals.
The engagement provision mandates that proponents make themselves available to companies for dialogue within a specific time frame– the onus is entirely on the investor. The Rule does not impose any obligation whatsoever on the company to engage, even if proponents provide the requisite information. The SEC should not be managing these engagements.
We are also troubled by the Final Rule’s limitation on the ability of representatives to act on behalf of investor clients who have designated them to do so. The SEC has not articulated what problem this is intended to solve, particularly if the representative has a fiduciary relationship with the investor, such as a registered investment adviser or an attorney.
Additionally, there were serious process questions in the way this rule came about. SEC data about the impact of these new thresholds on investors revealed that 75% of retail investors would not qualify to file a shareholder proposal. However, while the original proposal was released on November 5, 2019, and comments were due on February 5, 2020, the SEC’s Division of Economic and Risk Analysis (DERA) made this information public on August 14, 2020.
Shareholder proposals play an invaluable role by providing a low-cost method for shareholders to talk to management and to each other about the future of their company and important policy issues affecting the company. The votes on shareholder proposals provide more precise information about shareholders’ views of the given topic. In our view, the Commission should not be in the business of reducing these lines of communication. Such reductions will likely be unavoidable now.
Timothy Smith, Director of ESG Shareowner Engagement, released the following statement:
I have had the privilege of being involved in company engagements and the filing of shareholder resolutions on environmental and social issues since they started almost fifty years ago. And our firm Boston Trust Walden filed the first shareholder resolution ever filed by a mutual fund in 1986.
While the SEC has updated the shareholder resolution rules over the past decades, it has never led to such a wholesale disenfranchisement of shareholders as we witnessed today. The result of these new rules is a severe limiting of the ability of shareowners to address ESG issues with companies—issues that often have a significant impact on the bottom line and shareholder value.
Astoundingly, this is happening when addressing diversity, climate change, and human rights have never been more urgent. Even more concerning is that the SEC is taking these backward-looking steps at the same time the Department of Labor (DOL) is working to restrict investor proxy voting, seemingly rushing towards a decision before the election.
Said Amy Borrus, CII’s executive director:
The amendments weaken the voice of investors and jeopardize faith in the fairness of U.S. public capital markets by making the filing process more complicated, constricting and costly. The result will be fewer shareholder proposals—and that is precisely the goal of the business lobby that pressed the SEC to make these changes. Simply put, CEOs and corporate directors do not like being second-guessed by shareholders on environmental, social and governance matters.
What’s more, she added, raising thresholds to file and refile shareholder proposals is an unnecessary interference in the free market. For decades, the shareholder proposal process has been a well-functioning pillar of corporate governance in U.S. capital markets. It is a cost-effective way for shareholders to communicate with each other and with management through votes on proposals. Some of the benefits of this process include:
- Shareholder proposals permit investors to express their voice collectively on issues of concern to them, without the cost and disruption of waging proxy fights.
- Electing directors by majority vote is now the norm at 90% of large-cap U.S. companies.
- Independent directors constituting a majority of the board,
- Independent board leadership,
- Board diversity,
- Sustainability reporting,
- Non-discrimination policies,
- Annual elections for all directorsShareholder proposals have encouraged many companies to adopt governance policies that were initially resisted but today are viewed widely as best practice. All of the following came about driven by shareholder proposals.
- Most public companies do not receive shareholder resolutions. So, they will not receive any portion of the savings the Commission estimates, which may explain why most companies did not submit comments advocating for the change. From 2014-2017, only 13% of Russell 3000 companies received a shareholder proposal, on average. In other words, the average Russell 3000 company can expect to receive a proposal once every 7.7 years. For companies that receive a proposal, the median number of proposals is one per year.
- Shareholder proposals are almost always non-binding. The board generally does not have to act in response to a proposal.
The SEC breached its own stated procedures for using economic analysis in rulemaking and failed to grapple with the damaging impacts investors cited or to justify the changes. (See joint investor letter here.)
CII research found that the SEC’s new thresholds for resubmitting shareowner resolutions would have more than doubled the number of excluded governance proposals in 2011-2019. In particular, the new thresholds would have reduced the number of proposals for independent chairs and to improve disclosure on political contributions and lobbying. This is a conservative estimate based on retroactive application of the changes. Companies have substantial opportunity to influence votes at the margins of a threshold. Under increased resubmission thresholds companies will probably take steps to depress votes marginally more than 15% in the second year or 25% in the subsequent year.
Many important 2020 governance proposals that would have been eligible for resubmission in 2021 will be blocked by the new resubmission thresholds:
- Require independent board chairs (Facebook, Southwest Airlines, Tenet Healthcare)
- Report on incentive-based compensation and risks of material losses (Wells Fargo)
- Consider employee pay in setting CEO pay (3M, Mondelez International)
- Institute a majority vote standard for the election of directors (Sinclair Broadcast Group)
- Provide shareholders the right to act by written consent (Cognizant Technology Solutions Group, Kohl’s, Norfolk Southern, Pfizer)
- Reduce the threshold for shareholders to call a special meeting (Howmet Aerospace, Lincoln National)
- Take steps to consolidate share classes to have one vote per share (Coca-Cola Consolidated, Tyson Foods)
Proposals related to environmental and social matters will be sharply curtailed. This, at a time when significant threats to shareholder value stemming from such issues have emerged. Such risks include those related to the Covid-19 pandemic, diversity and inclusion, human capital management, and climate change. Shareholder proposals play a critical role in focusing corporate boards’ attention on the need to develop new expertise, new oversight models, and new strategies to protect and drive shareholder value.
Bruce Freed, president of the Center for Political Accountability, issued the following statement on the Securities Exchange Commission’s 3-2 vote to restrict shareholder activity. Founded in 2003, CPA leads efforts to bring transparency and accountability to corporate political spending:
Three Securities and Exchange Commission members have acted to severely curb shareholders’ ability to file and refile resolutions at U.S. public companies. This not only gags shareholders, the companies’ actual owners, but it seriously endangers companies themselves.
Proxy resolutions have been crucial for prompting companies to address such critical issues as executive compensation, diversity, climate change and political spending. Without the shareholder resolution, political disclosure and accountability would not be a mainstream practice for companies today, nor would they be dealing with the serious risk that secret and ill-considered spending poses for companies legally, for their reputations and for their bottom lines. (See CPA’s comment letter to the SEC on the proposed rule change.)
When the Center launched its efforts 17 years ago, few if any companies disclosed or had board oversight of their political spending with corporate funds. Today, these practices are the norm. As the soon-to-be released 2020 CPA-Zicklin Index will show, 247 S&P 500 companies disclose some or all of their political spending with corporate funds, and 263 S&P 500 companies have some level of board oversight of their political spending. The Index, issued annually by CPA and The Wharton School’s Zicklin Center for Business Ethics Research, is a benchmarking of the political disclosure and accountability policies of the S&P 500. Those companies are among dominant political spenders.
Shareholder engagement has brought success at many companies. But more work remains to be done, and shareholders and companies will pay a steep price if the new rule remains intact.
Looking ahead, the new rule is unsupportable by the record and will be challenged in court.
Beyond the legal challenge, shareholders will continue to press companies, and companies will need to act responsibly and adopt strong sunlight and accountability policies. Those that fail to do so will be putting themselves at risk. Most recently that risk was spotlighted by the litigation FirstEnergy, the Akron, Ohio utility, is facing as a result of multi-million dollar contributions it made to a nonprofit ‘dark money’ organization ensnared in an alleged corruption scandal.
Sanford Lewis, Director, Shareholder Rights Group, said:
The provisions of the new rule, separately and together, are a mix of the ill-advised and unlawful, involve impractical micromanagement of relationships between clients, advisors, shareholders and companies, and in undermining shareholder rights will have significant unintended consequences on investor protection, the public interest, efficiency and competition.
Laura Campos, Director of Corporate & Political Accountability at the Nathan Cummings Foundation noted:
Rather than protecting investors, these new rules serve only to remove an important check on the myopic pursuit of short-term profits at the behest of corporate executives and their trade associations. As support for shareholder proposals on investment-relevant issues like climate change and racial equity has grown, so too have efforts to shut down shareholders’ ability to file proposals.
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