Finding Common Ground on Shareholder Proposals

Keith F. Higgins is Chair of the Securities and Governance Practice at Ropes & Gray LLP. This post is based on a Ropes & Gray publication authored by Mr. Higgins.

The process by which shareholders are permitted to include their proposals in company proxy statements is under attack. The Business Roundtable and the Chamber of Commerce have each published reform proposals that would sharply limit these proposals. The Financial CHOICE Act, which passed the House of Representatives on a strictly partisan vote, includes provisions that are similarly, if not more, restrictive. Not surprisingly, the Council of Institutional Investors is vigorously opposing these efforts. It is an area in which agreement between the two sides has been elusive. At the risk of wading into the corporate governance equivalent of the Middle East peace talks, here are some proposals that, while they do not completely overhaul the process, might make it better without undermining the fundamental rights the shareholder proposal rule provides.

Resubmission Thresholds. Many proposals that receive limited support are proposed year after year. Currently, if over a five-year period a proposal fails to receive 3% support once, 6% twice or 10% three times, a company may exclude it. That means if 90% of the shareholders oppose the same proposal three years in a row, the company must nevertheless include it in the proxy statement if submitted in the following year. That is too low. The business community has suggested an increase to 6%/15%/30%, which the Securities & Exchange Commission proposed in 1997 but never acted upon. Maybe those are not exactly the right numbers, but they are likely pretty close. Resubmission thresholds should be increased.

Initial Eligibility. A shareholder owning a very small number of company shares can cause the company to include its proposal in the proxy materials. The current eligibility threshold is ownership of at least $2,000 in market value of the company’s outstanding securities for one year. The CHOICE Act would set a flat 1 percent, which the BRT proposal would apply to smaller companies with a smaller percentage for larger ones. What threshold of ownership should entitle a shareholder to shift the cost of distributing a proxy proposal from itself to the company (and therefore to all shareholders)? Trying to answer that question is a fool’s errand—any number is likely to be arbitrary. Any effort will likely be seen as results-oriented. We should recognize that small shareholders can have good ideas and focus instead on setting the resubmission thresholds appropriately. Increasing the length of ownership requirement to three years, however, should be considered.

Proposals by Proxy. The CHOICE Act would expressly prohibit proposals by a person acting on behalf of a shareholder. This prohibition is directed at a small number of individuals who are thought to account for almost one-third of the proposals submitted at all companies each year. The difficulty with prohibiting proposals by proxy is that there isn’t anything inherently wrong with someone who is duly authorized doing something for you that you could do on your own. There have been concerns expressed whether authorizations obtained by some proponents are in fact blank-dated, blanket authorizations to which proposals can be attached after they are signed. Perhaps as a modest first step, the SEC could require someone acting on a beneficial owner’s behalf to submit a recently dated, specific authorization naming the company, describing the exact proposal and identifying the year of the annual meeting at which the proposal will be made. Such a step would ensure that those authorizing someone to act on their behalf know precisely what it is they are authorizing.

False or Misleading Statements. Few things are more galling to a company than a shareholder proposal that has a supporting statement with factual errors. A company can exclude a proposal if it violates the proxy rules, including by containing materially false or misleading statements. The SEC staff has taken the view, many would say appropriately, that a false or misleading statement must be material to the proposal and supporting statement taken as a whole, which is a high standard. The offending statement must also be a fact, not simply an opinion with which the company disagrees. As a result, companies frequently find themselves in the situation of being unable to exclude proposals that contain inaccuracies.

Shareholders do not benefit when there are factual inaccuracies in a proxy statement. The SEC should consider changing the rule so that if a company brings a factual inaccuracy to the proponent’s attention, and the proponent declines to change it, the company can exclude the portion that contains the inaccuracy. The company would still be required to include the proposal and supporting statement, as redacted, in the proxy statement with disclosure that tells shareholders a portion that was false or misleading was omitted. Because proponents might worry about the objectivity of the company’s determination, the SEC could require the company to state whether a committee of independent directors approved the redaction. The SEC staff should not act as a referee.

Relevance. Currently, companies may exclude a proposal that relates to operations that account for less than 5 percent of their total assets, net earnings and gross sales, and that “is not otherwise significantly related to the company’s business.” A court decision and SEC guidance have resulted in the “otherwise” provision swallowing the rule. The SEC should consider making the 5 percent threshold a true bright line, as well as whether the 5 percent level might be too low.

The suggestions above would not be enough for those opposing the shareholder proposal process and they would likely go too far for many of its defenders. As such, maybe they are just the right medicine as a first step in making the proposal process work better for all shareholders.

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One Comment

  1. Ed Durkin
    Posted Tuesday, October 10, 2017 at 2:20 pm | Permalink

    I believe that Keith Higgin’s suggested proposals for addressing key aspects of the Securities and Exchange Commission’s shareholder proposal rule (Rule 14a-8) do begin to set a reasonable middle ground for what shapes up as a very contentious debate. Over the decades, the Carpenter pension funds have exercised their proposal submission rights more than any other investor, submitting 1,114 Rule 14a-8 proposals since the 2000 proxy season ( ). We believe that reforms advanced by these proposals and supported by shareholder majorities, including stock option expensing, pay-for-performance compensation standards, auditor independence standards, and majority voting in director elections have enhanced corporate governance for all parties. At the same time, we believe an updating of Rule 14a-8 is in order. Unfortunately, the proposals from the Chamber of Commerce, the BRT, and that in the CHOICE Act seem more designed to eliminate an important shareholder right than improve its functioning. Resistance to all changes to modernize the Rule is similarly counter-productive. Modest increases in eligibility and re-submission thresholds are due, as are reforms to address concerns regarding the “proposal by proxy” issue, and clarify certain substantive bases for no-action letter relief. In that regard, the reform options suggested by the former Director of the SEC’s Division of Corporation Finance do indeed represent a commonsense step forward on Rule 14a-8 reform.