CII Comment Letter on Proposed Amendments to Rule 14a-8

Kenneth A. Bertsch is Executive Director and Jeffrey P. Mahoney is General Counsel at the Council of Institutional Investors. This post is based on a CII letter to the SEC in response to request for comments on the proposed rule regarding the submission and resubmission of shareholder proposals (discussed in posts here and here).

The Council of Institutional Investors (CII), appreciates the opportunity to provide comments to the United States (U.S.) Securities and Exchange Commission (SEC or Commission) in response to proposed amendments to Rule 14a-8 (the “Rule”) in Release No. 34–87458, Procedural Requirements and Resubmission Thresholds Under Exchange Act Rule 14a–8 (the “Release”).

CII is a nonprofit, nonpartisan association of U.S. public, corporate and union employee benefit funds, other employee benefit plans, state and local entities charged with investing public assets, and foundations and endowments with combined assets under management of approximately $4 trillion. Our member funds include major long-term shareowners with a duty to protect the retirement savings of millions of workers and their families, including public pension funds with more than 15 million participants—true “Main Street” investors through their pension funds. Our associate members include non-U.S. asset owners with about $4 trillion in assets, and a range of asset managers with more than $35 trillion in assets under management.

CII opposes the Release, which seeks to reduce shareowner rights. Shareowner proposals, which almost always are nonbinding, are an essential tool for expressing the collective voice of a company’s shareowners on particular matters, and have made important contributions to corporate governance over the last 50 years.

We believe the current Rule works well and believe the SEC has not made the case for the changes proposed in the Release. The number of shareholder proposals filed annually has been in decline since 2015, and on average, a company receives only one proposal every seven years.

Average voting support for proposals has increased. That reflects well on the Rule and indicates that shareholder proposals are not a growing burden on public companies.

The SEC’s proposal appears to have the potential to have a significant impact in reducing the number of shareholder proposals. The SEC estimates that revision of ownership requirements will reduce the number of proposals by 0% to 56%, in addition to a more than 9% reduction of proposals due to other elements of the proposal. While we believe the SEC’s analysis is deeply flawed, the potential for a reduction of shareholder proposals by up to about two-thirds suggests the proposal could have far-reaching effects.

The SEC’s proposed increase in votes required for shareowners to raise the same subject in the future puts the cart before the horse; the SEC should fix proxy plumbing that delivers unreliable vote counts before experimenting with new, higher vote requirements.

We also view the SEC’s various proposals to intervene in the shareholder/management engagement process as unnecessary, unfair micromanagement. These include limits on the use of representatives by shareholders, and burdens on shareholder proponents to provide their calendars to company managements, with no requirement that management engage with proponents.

This letter presents general comments on the Release (page 3), analysis of specific elements of the SEC proposed amendments (page 10), review of the SEC’s analysis of costs and benefits of the proposed amendments (page 24) and responses to the specific questions the SEC poses in the Release (page 31). The latter frequently refer back to the earlier discussion, and we request the SEC to incorporate our full response in consideration of question responses.

We sought to provide as much response to the SEC’s questions as we could within the limited time provided for comments on the Release and the SEC’s proposal to regulate proxy advisory firms and require them to provide subject company management with the right to pre-review reports, analysis and recommendations. (Both proposals were announced the same day and have the same limited comment period.) We believe the two proposals together (1) are the most significant SEC attempt to limit shareholder rights since the Commission was created; (2) are fundamentally flawed and should be withdrawn so that the SEC can re-think key elements of the proposals and also spend time on credible cost-benefit analysis, should the Commission decide to re-propose changes; and (3) introduce substantial new complexity and micromanagement to proxy voting, while not addressing the major problems in the system. The SEC poses a total of 345 questions in the two releases. We and 90 investors and investor organizations requested longer comment periods, but never received any response to these requests from the SEC. Therefore, we submit these comments now in anticipation of the February 3 comment deadline. We would note that SEC staff has told us they would welcome comments after February 3 but were equivocal about when might be too late; we may offer further comment at a later date.

General Comments

CII members believe that effective corporate governance and disclosure serve the best long-term interests of companies, shareowners and other stakeholders. Effective corporate governance helps companies achieve strategic goals and manage risks by ensuring that shareowners can hold directors to account as their representatives, and in turn, directors can hold management to account, with each of these constituents contributing to balancing the interests of the company’s varied stakeholders.

Council members use a variety of stewardship tools to improve corporate governance and disclosure at the companies they own. These tools include casting well-informed proxy votes; engaging in dialogue with portfolio companies (including with board members, as appropriate), external managers and policymakers; filing shareowner resolutions; nominating board candidates; litigating meritorious claims; and retaining or dismissing third parties charged with assisting in carrying out these activities.

Before responding to the specific elements of the proposed amendments, the Council would like to make several overarching points. Most generally for this proposal, which in every section seeks to curb shareholder rights, we would agree with this comment from Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware:

If you try to attempt to limit [shareholder resolutions], in one way or another, inadvertently you may remove from consideration a resolution that has greater core significance to the company. A rule that is less restrictive is probably the better rule.

The Commission Has Put the Cart Before the Horse

At the November 2018 roundtable on the proxy process, there was a striking unanimity among participants that the most pressing reforms that are needed lie in the area of “proxy plumbing,” that is, the nuts and bolts about the ways that proxies are solicited and votes are counted. The issue has been on the table since even before the Commission issued its Concept Release on the topic in 2010, yet we have seen little progress since then.

CII has repeatedly requested the Commission to give priority to addressing proxy plumbing. In September 2019 the Commission’s Investor Advisory Committee (IAC) published a report that made a series of recommendations about how the proxy solicitation process can be more accurate and transparent. Although there may be disagreements over some details, the need for action on this front is greater than it was 10 years ago.

This is not just a question of misplaced priorities and lack of focus on investor protection. Proxy plumbing specifically should be fixed before raising shareholder proposal “resubmission” levels, a key element of the SEC Release proposal. Prominent Delaware attorney Gil Sparks famously said that in a contest closer than 55% to 45% “there is no verifiable answer to the question ‘who won?’” We believe the margin of error in vote counts today (more than 10 years later) may be less than this when approval of a proposal is at stake, usually at 50% plus one vote, because of special efforts made by intermediaries to fix various anomalies that arise in the proxy voting process. We understand, however, that intermediaries generally do not make special efforts just because eligibility to resubmit shareholder proposals hang in the balance. However, as these thresholds currently are relatively low, the harm is limited. In proposing to raise the resubmission thresholds to 15% the second year a subject matter is considered, and 25% the third year, the issue becomes more serious. More proposals are likely to run up against the higher resubmission thresholds, and with future proposals on the same subject blocked from consideration, in some cases due to erroneous vote counts.

The “Momentum Requirement” proposed in the Release makes it even worse. Under that proposed rule, which we discuss in more detail below, a 10% decline in voting support from a proposal on a particular subject (for example, from 40% to 36%) under some circumstances would be grounds to exclude a proposal on the same subject matter the next time it is proposed. The SEC should discuss whether voting intermediaries will make special efforts to deliver an accurate vote count at, say, a 36.0% threshold.

As part of the SEC’s decision on whether to move forward with increased “resubmission” thresholds and the Momentum Requirement, we request the Commission to (1) evaluate the potential interaction of deficiencies in the accuracy of the U.S. proxy voting system with raising the thresholds; (2) research and explain whether companies have sufficient basis to determine that vote counts they are required to report in Form 8-Ks are accurate; and (3) explain whether, and if so how, the Commission will use its authority to require accurate vote counts. As part of this explanation, we request the SEC to describe what specific steps the Commission is taking and will take going forward to require companies to deliver accurate vote counts, specifically including at “resubmission” thresholds and at the critical percentage thresholds for particular proposals under the Momentum Requirement.

Shareholder Proposals Provide an Effective Mechanism for Shareholder Communication

How does a company’s board and management learn what its shareholders think about a given issue? To be sure, a company may have an Investor Relations department that stays in close touch with a company’s largest shareholders and that may field questions or comments from shareholders. In addition, and apart from earnings calls and similar outreach, individual directors from some companies now engage with shareholders on specific topics of concern, and a recent Conference Board report indicates that some companies are experimenting with surveys to get a better sense of the views of retail shareholders. It is also possible to get an impression of what shareholders think from the news media, and perhaps as well as from social media.

But none of these methods allows a company to accurately learn the views of its shareholders as a whole. Shareholder proposals provide a useful solution and a relief valve far short of a proxy fight. We understand that management of some companies expend resources in an attempt to keep the proxy statement under exclusive control of the board, and oppose including any and all shareholder proposals. It important to understand that part of the resistance by management may stem from the fact that many governance practices that proposals challenge serve to protect or entrench insiders, who have no incentive to make a change. Why, for example, would a company voluntarily end its poison pill unless there is strong support for such a measure, as reflected in shareholder votes? Or declassify its board of directors?

Because a shareholder proposal must address a specific topic, it can provide more information and nuance about what shareholders think than, say, a vote on whether a director should be re-elected or a say-on-pay vote. For example, in an annual meeting, the shareholders may vote to approve a performance-based equity plan, while at the same time supporting a shareholder proposal against accelerated vesting of unearned options. Such a result sends a message that shareholders may be generally satisfied with the company’s executive compensation plan, but favor a specific revision. Such information cannot be gleaned from a vote to re-elect the chairman of the board’s compensation committee or the say-on-pay vote (and the collective view certainly cannot be learned with any degree of accuracy from social media postings).

The value of shareholder proposals as a means of communication is not limited to shareholders talking to management. Proposals allow shareholders to speak to, inform and test the waters on an issue with their fellow shareholders. A company’s proxy materials tell shareholders what the company wants them to know; a shareholder proposal alerts shareholders to an issue that their fellow shareholders think is important—and invites their input on the topic. It may be in the self-perceived interest of some managers or board members to totally control the flow of information to a company’s shareholders, but such a result is not in the interest of shareholders as a whole. Keeping the lines of communication open is important in a marketplace that has substantial restrictions on communications between shareholders.

CII views the filing and voting of shareholder proposals to be an important way to promote effective corporate governance. Indeed, over the past three decades in particular, shareholder proposals have been the most important vehicle by which shareholders raised—and helped change—corporate policies on a wide range of core governance issues, including majority voting for and annual election of directors, independent board leadership, appropriate forms of compensation of outside directors, proxy access, board diversity, clawbacks of unearned executive compensation, appropriate accounting for stock options, fair employment practices and meaningful sustainability reporting, to name a few.

The Current Process is Working Well; The Release Is a Solution in Search of a Problem

Rule 14a-8 is working well. Some Washington lobbyists for management interests have vastly exaggerated the extent to which shareholder proposals are used. As institutional investors who actually vote proxies know, shareholder proposals make up less than 2% of voting items, and the vast majority of their time is spent on management proposals. Some commentators also seem to miss that nearly all proposals are non-binding—they are simply requests from shareholders for the board to consider some policy, practice or idea. The effort by Washington corporate lobbyists to restrict the rule likely relates to the fact that shareholder proposals get much more support now than in decades past. We believe that rising support levels indicate the shareholder proposal rule is working.

Most public companies do not receive any shareholder proposals. On average, 13% of Russell 3000 companies received a shareholder proposal in a particular year between 2004 and 2017. 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.

In our view this is not evidence of a “problem” that needs to be solved and certainly not on a market-wide basis. In addition, the “problem” is hardly getting worse—quite the opposite, in fact. A 2019 report by Sullivan & Cromwell concluded:

Overall, the total number of shareholder proposals significantly declined, continuing a downward trend from 2015. A total of 678 shareholder proposals have been submitted to-date in 2019, relative to 751 at this time last year, 788 for 2018 as a whole and 836 for 2017. The decline relative to this time last year is led by a 12.5% drop in environmental, social, and political (“ESP”) proposals, closely followed by compensation-related proposals (11.9% drop), with governance-related proposals declining by a smaller proportion (6.2% drop). The overall decline would have been steeper but for the increase in proposals against investing or managing on the basis of ESP factors (so-called anti-ESP proposals).

Moreover, the level of support for shareholder proposals remains strong. The Sullivan & Cromwell report breaks down the 2018 and 2019 level of support as follows:

Summary of 2018-2019 Shareholder Proposals

Shareholder Proposals Submitted Shareholder Proposals Voted On Average % of Votes Cast in Favor Shareholder Proposals Passed
Proposal Type YTD 2019 2018 YTD 2019 2018 YTD 2019 2018 YTD 2019 2018
Environmental, social and political 323 387 146 139 28% 26% 9 8
Governance-related 303 335 195 234 37% 37% 41 31
Compensation-related 52 66 30 42 24% 23% 2 0
Total 678 788 471 415

If the “problem” perceived by the Release—too many proposals from too many small shareholders—is, at most, isolated to only a handful of very large companies with resources to handle various issues raised by complex operations, why should the Commission change the Rule to affect the thousands of publicly traded companies that rarely, if ever, receive a shareholder proposal? The Release has no answer.

Lobbyists for corporate executives have suggested there is a particular problem with shareholder proposals that raise issues related to environmental and social impacts on company performance, and that this problem justifies limiting shareholder proposal rights in general (including corporate governance proposals). For example, the Business Roundtable—which advocates mainly for large company CEOs and arguably was the key lobbying group spurring the current efforts (now joined by the majority of the SEC) to reduce shareholder proposal rights—says the shareholder proposal process needs “modernization” because the thresholds for resubmission of proposals are too low and because “excluding proposals relating to general social issues is difficult for companies.” It is true that all social policy proposals could be excluded before 1970, based on SEC precedents that permitted Greyhound Corp. to exclude shareholder proposals in the late 1940s and early 1950s urging the company to desegregate buses. Those proposals to desegregate buses may have been viewed at the time as “idiosyncratic,” with “no rational relationship to the creation of long-term shareholder value” and in “conflict with what a typical investor views as material to making an investment or voting decision,” to use the Business Roundtable’s words on recent social policy matters implicated in shareholder proposals. However, in our view, those proposals were prescient, dealt with a socially important issue with long-term implications both for society and for shareholder value, and were material to how Greyhound operated.

If anything, these data suggest that companies are increasingly engaging in dialogue with proponents and are recognizing the value of folding ESG considerations into their daily operations. Some have referred to a shift in corporate attitudes as a “new paradigm.” This would not appear to be the time to turn off the spigot, as the Release would inevitably do—and is intended to do—for a number of proposals.

For these reasons, the Council views the proposals in the Release as bad policy that cannot be defended on the ostensible ground of cost savings. In the sections that follow, we address the specific elements of the Release and explain our reservations about them. We also provide answers to each of the 69 sets of questions that the Commission posed in the Release.

The complete letter, including footnotes, is available here.

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