Beat the CRA Clock
At the end of March, Senator Sherrod Brown (D-OH), Chairman of the Senate Banking Committee, and Congressman Michael San Nicolas (D-Guam), Vice-Chair of the House Financial Services Committee, introduced (S.J. Res. 16; H.J. Res. 36) under the Congressional Review Act (CRA) to overturn recently adopted changes to the SEC’s shareholder proposal rule. The changes to Rule 14a-8 mark the culmination of a years-long corporate campaign to raise the bar for shareholders submitting and resubmitting proposals for a vote at annual meetings. The investor community overwhelmingly opposed the changes. More than 200 organizations have written to Congress in support of the CRA resolution. If successful, Congress will nullify the rule, turning the regulatory clock back to the pre-rule landscape, and will preclude the SEC from adopting a substantially similar rule without congressional reauthorization. The window to act is short. Shareholders need to whip 51 votes by early May when the CRA clock runs out.
SIDEBAR: Inside the Washington bubble, discussing the ins and outs of the CRA tool is a favorite pastime. Is it a blunt instrument? An effective mechanism to curb the growth of the administrative state? What does “substantially similar” mean? A once-obscure oversight tool, the CRA resolution of disapproval was rarely used until 2017 when Republicans used it fourteen times to reverse Obama-era regulation. This year, Democrats have introduced six CRA resolutions (this week, the Senate successfully reversed the rollback of the methane emissions rule). See U.S. Congressional Research Service, The Congressional Review Act (CRA): Frequently Asked Questions.
Below, we take a closer look at the SEC rule changes and provide the CFA Institute perspective. For a more technical summary of the rule amendments, please scroll to the bottom of the blog post.
Beat the CRA Clock: Summary
On September 23, 2020, the SEC voted 3:2 to finalize changes. Requirements were raised for shareholder engagement and representation, as well as eligibility for submitting and resubmitting proposals for a vote at annual corporate meetings.
The Commission majority at the time (former Chair Jay Clayton, Commissioners Elad Roisman and Hester Peirce) explained the regulatory changes were necessary to:
- “modernize” the current shareholder proposal regime, which was partially reviewed and updated more than 20 years ago;
- ensure the interests of shareholder proponents are better “aligned” with all shareholders, ostensibly by diminishing the number of so-called corporate gadflies submitting the “vast majority” of shareholder proposals; and
- reduce the costs imposed on companies and non-proponent shareholders.
Dissenting Commissioners Allison Lee and Caroline Crenshaw stated that the final rule:
- is not cost-benefit justified;
- disenfranchises and targets retail investors;
- undermines ESG initiatives; and
- amounts to a policy choice in clear opposition to investor protection.
Commissioner Lee summarized, changes in rules “represent the capstone in a series of policies that will dial back shareholder oversight of management at the companies they own.” Commissioner Crenshaw added that the cumulative effect of the reforms “will effectively curtail shareholders’ rights to express their views.”
SIDEBAR: This is not the first time the SEC and Congress have expressed interest in amending Rule 14a-8. In the late 1990s, the SEC proposed raising the resubmission thresholds but ultimately did not adopt any changes. In the 115th Congress, legislation raising the thresholds passed in the House of Representatives as part of the Financial CHOICE Act (see Section 844). During the Trump Administration, the Treasury Department recommended that resubmission thresholds be “substantially revised” in its Capital Markets report.
In its latest annual report, the SEC Office of the Investor Advocate listed numerous objections to the rulemaking. They concluded it was “adopted in contravention of the Commission’s internal policies for full and objective economic analysis…and, at the very least, the spirit of the Administrative Procedure Act.” The Office of the Investor Advocate recommended Congress overturn the rule, adding that investors “should not have to bear the expense of litigation to overturn such a flawed rulemaking.” In advance of the rulemaking, the SEC’s Investor Advisory Committee issued recommendations concerning the shareholder proposal rule, stating that the SEC guidance and rule proposals on proxy advisors and shareholder proposals “may collectively shift the balance in a manner that does not serve investor interests.”
During his Senate confirmation hearing, in response to a question posed by Senate Banking Committee Ranking Member Pat Toomey (R-PA) about whether as chair he would “revisit” this rulemaking and the proxy advisor rule, now SEC Chair Gary Gensler left the door open. Gensler stated he would “work with the [Commission] staff and economists, and fellow commissioners to understand those rules better.”
The changes adopted under the final rule are sweeping; the increase in hurdles to shareholders significant; while the cost-savings to public companies, by the SEC’s own admission, “minimal.”
The adopted changes:
- Amount to using a sledgehammer to swat a few so-called corporate “gadflies.” Preliminary analysis by the SEC’s own Division of Economic Research and Analysis (DERA) estimated 50-77% of retail investor accounts analyzed would be newly excluded from eligibility to submit shareholder proposals.
- Risk stymying the formation of consensus that tends to build on governance and material issues over time, allowing good governance reforms to die on the vine. The changes target environmental and social proposals, support for which has been on the rise, by raising the bar for resubmission of shareholder proposals. As Commissioner Lee summarized, these “changes will be most keenly felt in connection with ESG issues, which comprise the main subject matter of shareholder proposals, at a time when such proposals are garnering increasing levels of support.”
- Exclude a substantial segment of retail investors from participating in the shareholder proposal process. As Commissioner Caroline Crenshaw put it, the new $25,000 threshold is a “significant stake in a single equity” for the wealthy and an “outsized concentration at odds with modern portfolio theory” for the average American’s retirement account. It is ironic that the barriers to entry for retail investors are raised at a time when increased retail investor participation in the markets is championed as “market democratization.”
- Overstate the burden to issuers. On average, a company can expect to receive one proposal every 7.7 years. The majority of shareholder proposals are nonbinding. Additionally, a significant subset of public companies provide insiders with special voting rights. By the SEC’s own estimate, “only roughly 0.0003% of investors actually submitted shareholder proposals that appeared in 2018 proxy statements.” The effects of the rulemaking “likely will be minimal because most firms receive few proposals each year and the costs of responding to proposals likely are a small percentage of the costs associated with being a public company.” Critically, the rulemaking did not account for dual-class shares and votes by insiders in the rulemaking methodology.
CFA Institute View
CFA Institute submitted a comment letter to the SEC on its original proposal in which we agreed that measured changes to proposal thresholds are appropriate. For example, we supported indexing the submission threshold for inflation to $3,000. This is not the measured approach the Commission took, however, and CFA Institute has consistently maintained that substantial changes to what we see as a functioning shareholder proposal system are unnecessary and potentially counterproductive.
As we summarized in our comment letter, we believe the new overly onerous regime will ultimately harm the overall corporate governance of US listed companies. We are also concerned the new initial ownership threshold tiers will diminish the rights of retail investors when it comes to raising their corporate governance concerns. Retail investors should not be discouraged from sharing their input based on their ownership in a company.
Amendments to Rule 14a-8, the Shareholder Proposal Rule
The amendments to the SEC Rule 14a-8, governing shareholder proposals included in company proxy statements, adopted changes which include:
Raising the initial ownership threshold for submitting a proposal from the current standard of $2,000 stock ownership for at least one year to a new tiered structure:
- $25,000 of continuous stock ownership for one year;
- $15,000 for two years, and
- $2,000 for three years.
- $2,000 shareholdings purchased by November 2019 are grandfathered for filing purposes.
Prohibiting aggregation of shares to meet ownership thresholds – a reversal of the current standard.
Raising the resubmission thresholds for the same proposal at the same company from 3%, 6%, and 10% shareholder support for matters previously voted on once, twice, or three or more times in the last five years to 5%, 15% and 25%, respectively. A shareholder proposal that fails to meet these thresholds can then be excluded from a company’s proxy materials. Under current rules, a shareholder proposal is also excludable if it is substantially similar to a proposal included in proxy materials in the last 5 years and if the most recent vote on the comparable proposal took place in the last 3 years and failed to meet the relevant threshold.
Introducing engagement availability requirements. Shareholder proponents must provide in writing to issuers their meeting availability (availability window must be 10-30 calendar days after proposal submission).
Applying the one-proposal limit to each person, rather than each shareholder. Representatives will not be permitted to submit more than one proposal at the same meeting, even if that representative were to submit each proposal on behalf of different shareholders.
Significantly, the Commission did not adopt the “Momentum Requirement” considered under the original SEC proposal. This provision would have allowed companies to exclude any shareholder proposal previously voted on three or more times in the preceding five calendar years if:
- the proposal did not receive majority of the votes cast on its most recent submission, and
- support declined by 10% or more compared to the immediately preceding shareholder vote on the same subject matter.
The final rule will apply to shareholder proposals submitted for annual or special meetings starting January 1, 2022.
About the Author
credit @ Getty Images / Yuanyuan Yan. The original, Shareholder Proposal Rule: Will Proponents Have the Votes in Time to Beat the CRA Clock? was published on April 23, 2021.
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