Analysis and Recommendations on Shareholder Proposal Decision-Making under the SEC No-Action Process

Sanford Lewis is Director at the Shareholder Rights Group. This post is based on a Shareholder Rights Group memorandum by Mr. Lewis, with editorial assistance from Andrew Toritto.

The shareholder proposal process, administered by the Securities and Exchange Commission (SEC) under Rule 14a-8, is a pillar of modern corporate governance.

The Shareholder Rights Group is a coalition of investors protecting shareholders’ rights to engage with public companies through shareholder proposals. Our analysis submitted to the SEC on July 2, 2018 concludes that certain changes in SEC practices during the 2018 proxy season raised serious threats to this well-established right. We include recommendations for corrective SEC guidance.

The Shareholder Proposal Process

Rule 14a-8 administered by the Securities and Exchange Commission authorizes investors who have held more than $2000 in shares for more than a year to file proposals to be considered by fellow investors through public companies’ annual corporate proxy statements. [1] The process provides a necessary forum for investors to engage with company leadership at both the board and executive levels, as well as to share and debate major issues with fellow shareholders—to monitor and assess risks, reform corporate governance and provide feedback to companies on critical issues.

Shareholder proposals are typically non-binding. They offer a flexible mechanism for investors with diverse goals and objectives to request enhanced disclosures and increased accountability of corporate boards and managers regarding emerging, neglected, or systemic long-term risks and opportunities. Many current corporate practices, such as the issuance of sustainability reports, and effective attention to long-term environmental and social risks such as climate change, have been substantially initiated and shaped by shareholder proposals.

Securities and Exchange Commission Rule 14a-8 sets forth the process for determining whether or not a shareholder proposal may appear on a corporation’s annual proxy statement. Decision-making under the rule is overseen by SEC Staff through an informal process of correspondence between companies, Staff and proponents. If a company’s management believe that a proposal does not meet the criteria articulated in the rule for acceptable proposals, it can write to the Staff and request that the Staff confirm that it will “take no action” if the Company omits the proposal from the proxy statement. This no-action letter process is determinative of the fate of many proposals each year.

Recently, SEC and external actions have had—or propose to have—a significant impact on this process. Portions of the corporate community have long resisted the proposal process. In 2017, the US House of Representatives passed the Financial Choice Act. Section 844 of the bill would have eviscerated the shareholder proposal process by confining the filing of shareholder proposals to only the largest institutional investors, and by making it more difficult to resubmit proposals at a company. While the prospects are dim for that bill becoming law, the pressure on the SEC from the corporate community to limit shareholder proposals has persisted, and helped to prompt changes in policy during the 2018 proxy season.

Staff Bulletin 14I

On November 1, 2017, the Staff issued guidance regarding the process on (Staff Legal Bulletin 14I, or “SLB 14I”), for the first time inviting boards of directors to weigh in on whether proposals received are “relevant” or address “significant issues for the company” pursuant to Rule 14a-8(i)(7) (ordinary business) and Rule 14a-8(i)(5) (relevance). [2] Despite concerns that this would lead to reflexive exclusions when boards weighed in, instead the board findings submitted on significance of proposals led to a cogent outcome: most boards of directors proved unable to demonstrate to the SEC Staff that topics of shareholder proposals were insignificant to their companies. Instead, the new process had the counterproductive effect of increasing legal costs for both investors and companies.

Micromanagement

While SLB 14I did not increase the exclusion of proposals, other changes in SEC practice did. Changes to interpretation of micromanagement interfered with the long-standing work of investors and fiduciaries to encourage improve performance on companies’ climate change responses. At a time in which shareholder proposals are receiving unprecedented levels of voting support due to recognition of risks to investments, the micromanagement rulings threaten to undermine market-wide investment objectives on an array of issues implicating corporate risk management and financial and ESG performance.

The Staff excluded proposals as micromanagement which asked companies to set goals and targets for reducing greenhouse gases. Of greatest concern to many in the proponent community is the Staff decision in EOG Resources, Inc. (February 26, 2018), which allowed micromanagement exclusion of a proposal asking the company to set company-wide, quantitative, time-bound targets for reducing greenhouse gas (GHG) emissions and issue a report discussing its plans and progress towards achieving these targets. This decision runs contrary to long-standing precedent; the Staff had long found identical proposals, including at oil and gas companies, to not constitute micromanagement [3]. The same proposal has been deliberated upon by shareholders at dozens of companies, many of which have set science-based targets (SBTs) to reduce their GHG emissions after receiving shareholder proposals—and either having the proposals go to a vote, or proponents withdrawing the proposals in exchange for company commitments. Undermining the right to file such proposals threatens to interrupt this productive interchange between shareholders and their companies.

Later in the season Staff found other proposals micromanaged by “seeking to impose specific methods for implementing complex policies.” [4] Our research indicates that this specific phrase, drawn from the 1998 Release, [5] has never been expressly applied or quoted as a rationale of prior Staff decisions. In the absence of articulated limits on this new “specific methods for limiting complex policies” doctrine, many other long-standing shareholder proposals will also become subject to challenge. For instance, many board and employee diversity proposals either request specific methods for addressing company policies, or request that companies set targets to improve their performance. [6]

Conflicting Proposals

Further, other decisions under Rule 14a-8(i)(9) excluded shareholder proposals as a result of management introducing “conflicting” proposals that merely ratified the status quo. This had the effect of allowing corporate gamesmanship to override shareholder rights.

The “conflicting proposal” rule does not exist to provide an avenue for management to develop after-the-fact “counterproposals” solely for the purpose of excluding properly submitted shareholder proposals. [7] During the 2018 season, Staff seemingly surrendered to this form of company gamesmanship by excluding shareholder proposals. Although two early decisions in the season [8] simply allowed companies to exclude the proposals, six later decisions added a requirement that the company include information in the proxy. [9]

This new approach [10] of allowing company ratifications of existing policy to displace properly submitted shareholder proposals has directly undermined the established ownership right of shareholders to file proposals for inclusion in the proxy. Ratification of the status quo in lieu of a shareholder’s proposal, besides being unnecessary, means that shareholders only ever hear management’s side of an issue, and undermines the ability of shareholders to request specific reforms. With no articulated limits other than finding a “logical” conflict between proposals, this new approach seems to invite and allow companies to exclude proposals at will.

Evolving SEC Policy: Errors of Omission are Far More Harmful to Investors and Companies Than Errors of Over-Inclusion

The SEC Staff has evolved its doctrines for the shareholder proposal process from time to time. Experience shows that policy changes that increase omissions of proposals can be quite detrimental to the SEC’s investor protection mission. Recent examples of proposals excluded only to later prove to have been early warnings of highly material risks:

  • In 2000, Shareholders of Household International, which was one of the largest subprime lenders in the United States, filed a resolution requesting a committee of outside directors to develop and enforce policies to ensure “that accounting methods and financial statements adequately reflect the risks of subprime lending and … employees do not engage in predatory lending practices” and issue a report to shareholders. In Household International, (March 13, 2000) the Staff deemed this proposal excludable as ordinary business. By 2002 Household International settled a groundbreaking case with 20 state attorneys generals over predatory lending (Iowa DOJ News Release, October 11, 2002). A significant anticipatory opportunity was barred by the SEC decision. Several other related proposals were excluded as well. [11] Even as the market was in early signs of collapse, these proposals were considered by the SEC to be excludable, regardless of the clear systematic risk posed by subprime lending.
  • An excluded proposal at Wells Fargo inquired about whether the employee compensation system was exposing the bank or economy to excess risk. Wells Fargo (February 14, 2014). To date, Wells Fargo has paid at least over a $1 billion in fines and penalties for its reckless risk management and employee incentives, including penalties for opening 3.5 million accounts for customers without consent, abusive auto loan practices, and in related suits by customers and investors.

It is in this historic context that recent decisions expanding the prospects for exclusion of proposals must be evaluated. Not only do the new doctrines undermine shareholder rights, the new conflicting proposals and micromanagement doctrines threaten to lead to exclusion of many proposals with material investor protection implications—undermining the leverage of shareholders to engage with their companies on important issues of risk, governance and performance.

We respectfully recommend that the Staff issue additional guidance which could better serve the interests of investors as well as companies by providing greater predictability, reduce need for test cases to clarify the Staff’s positions, and restoration of shareholder rights:

  1. Confirm that proposals requesting that a company set targets or improve its performance on significant policy issues are not considered micromanagement unless they attempt to direct minutiae of operations. Delineate clear limits on the new micromanagement doctrine of excluding proposals that seek specific methods for addressing complex policies. Continue to recognize that investors have a practical ability to request both disclosure and action on long term business strategy on ESG matters, including goal setting and increasing the scale, pace and rigor of responses to significant policy issues.
  2. Prevent the abuse of the conflicting proposals rule, Rule 14a-8(i)(9). Establish a rebuttable presumption against a “conflict” with a shareholder proposal when a management seeks ratification of an existing policy. Although the Staff requirement for the proxy statement to mention the excluded proposal may help inform investors, the approach still undermines the rights and logic of shareholders being able to request specific reforms. Advisory proposals as a general proposition, cannot legally conflict with management proposals.
  3. Provide additional detail in no-action decisions, applying the decision-making rule to the facts and language of the proposal to clarify the dispositive issues.
  4. Identify categories of proposals where Board “findings” tend to be less relevant to determination of significance. We would recommend that these include instances where the board is in no better position than proponents or the Staff to assess significance to shareholders, such as where a proponent documents that the company’s (1) externalities can impose portfolio-wide impacts; (2) activities may pose systemic risks; or (3) reporting has material gaps in its ESG disclosure.
  5. Identify categories of proposals that the Staff views as “governance” proposals exempt from relevance and significance challenges.
  6. Clarify the need for the board section of a no-action request to include analysis of the substance and significance of the proposal, as well as documentation regarding the content of the board process. The Staff should encourage boards to include appropriate specifics relative to their “findings,” including backup data, minutes and records of board discussion, identifying any personnel or experts consulted by the board on the issue, or references to material reviewed or evaluated to reach their conclusion.

The Shareholder Rights Group respectfully submits that these six recommendations are prudent and fully aligned with the Commission’s mandate to protect and serve investors and the capital markets. We welcome the opportunity to further discuss these findings and recommendations with policymakers, including SEC Commissioners and Staff, as well as fellow investors, corporate counsel, and boards.

Endnotes

117 CFR 240.14a-8, https://www.gpo.gov/fdsys/pkg/CFR-2013-title17-vol3/pdf/CFR-2013-title17-vol3-sec240-14a-8.pdf(go back)

2https://www.sec.gov/interps/legal/cfslb14i.htm(go back)

3For instance, in ONEOK, Inc. (February 25, 2008) the same proposal was found not to raise ordinary business or micromanagement concerns.(go back)

4JPMorgan Chase (March 30, 2018) (two decisions).(go back)

5The 1998 Release involved the recasting of the shareholder proposal rule into the current Q&A format, and also considered and rejected amendment to the resubmission threshold.(go back)

6Another example of specific methods for complex policies are shareholder proposals that address issues of executive pay have sought clawbacks—the recovery of executive pay as an effective means to hold executives accountable for misconduct. Valeant Pharmaceuticals International shareholders submitted a proposal requesting that the company claw back some of its executive pay incentives. Valeant agreed to their demands. http://www.iccr.org/sites/default/files/resources_attachments/2017iccrimpacts04.20.17.pdf Similarly shareholders successfully withdrew a proposal as Wells Fargo and Co. agreed to expand its clawback policy. https://www.nytimes.com/2017/06/16/business/wells-fargo-clawback-fair-choice-act-shareholders.html(go back)

7Cypress Semiconductor Corp. (March 11, 1998) denying exclusion under 14a-8(c)(9): “[S]taff notes that it appears that the Company prepared its proposal on the same subject matter in or significant part in response to the Mercy Health Services proposal.” Genzyme Corporation (March 20, 2007) denying exclusion under 14a-8(i)(9). “[W]e note your representation that you decided to submit the company proposal on the same subject matter to shareholders, in part, in response to your receipt of the AFL-CIO Reserve Fund proposal.”(go back)

8AES Corporation (December 19, 2017), CF Industries Holdings, Inc. (January 30, 2018).(go back)

9

The later rulings noted:

Accordingly, we will not recommend enforcement action to the Commission if the Company omits the Proposal from its proxy materials in reliance on rule 14a-8(i)(9), provided that the Company’s proxy statement discloses, consistent with rule 14a-9:

  • that the Company has omitted a shareholder proposal to lower the ownership threshold for calling a special meeting,
  • that the Company believes a vote in favor of ratification is tantamount to a vote against a proposal lowering the threshold,
  • the impact on the special meeting threshold, if any, if ratification is not received, and the Company’s expected course of action, if ratification is not received. eBay Inc. (February 26, 2018), Capital One Financial Corporation (February 21, 2018), ITT Inc. (February 22, 2018), Skyworks Solutions, Inc. (March 23, 2018), JPMorgan Chase & Co. (February 26, 2018), NetApp, Inc. (June 26, 2018).(go back)

10Examples of prior Staff decisions declining to apply the rule to exclude a proposal based on a company’s attempt to game the system include Cypress Semiconductor Corp. (March 11, 1998) denying exclusion under 14a-8(c)(9): “[S]taff notes that it appears that the Company prepared its proposal on the same subject matter in or significant part in response to the Mercy Health Services proposal.” Genzyme Corporation (March 20, 2007) denying exclusion under 14a-8(i)(9). “[W]e note your representation that you decided to submit the company proposal on the same subject matter to shareholders, in part, in response to your receipt of the AFL-CIO Reserve Fund proposal.”(go back)

11Washington Mutual (February 5, 2008), Merrill Lynch (February 19, 2008; February 20, 2008), KB Home (January 11, 2008), and Lehman Brothers (February 5, 2008).(go back)

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