Tucked into the Financial Choice Act (FCA), the recent endeavor in the House of Representatives to overturn significant segments of the Dodd-Frank Act, was an entirely unrelated provision. Section 844 of the FCA proposed a number of changes to Rule 14a-8,[1] including tougher eligibility standards. To submit a proposal, shareholders would have to own at least 1 percent of a company’s outstanding voting shares continuously for three years.[2] Instead of holding around 15 shares of Apple for 12 months, the proposed standards would require something closer to 5 million shares for 36 months. Instead of acquiring $2000 worth of securities, as the rule now allows,[3] they’d need to invest more than $7 billion in Apple. Few shareholders would meet these requirements. Nor did the FCA stand alone. Others have called for similar restrictions.^[4]

The impetus for these restrictions was not a significant increase in the use of the rule. During the 2016 proxy season, shareholders submitted 916 proposals to public companies. The number was neither a record nor, in historical context, unusual.[5] Moreover, total submissions had little or no relationship to the number of proposals actually presented to shareholders for a vote. By one estimate, 40 percent of the 474 public interest proposals in 2015 were withdrawn.

Nor did cost appear to be the impetus. The actual expense of adding a proposal to the proxy statement is likely nominal. With companies already having to draft and circulate the proxy materials to shareholders, an additional proposal adds at most a modest amount of volume.[6] Moreover, these expenses have probably been reduced through the advent of electronic dissemination of proxy materials. To the extent costs include the expenses associated with seeking exclusion of a proposal, such amounts are a consequence of management, not shareholder, behavior. Companies can control them by including the proposal in the proxy statement. Indeed, with the number of no-action requests down from earlier decades, companies seem increasingly comfortable with this approach. [7]

What has changed, however, has been the growing level of support for shareholder proposals. Proposals are almost always precatory. As a result, they advise rather than command. Implementation is left to the discretion of the board. Proposals are, therefore, a cost effective mechanism for assessing the collective views of shareholders. Moreover, to the extent considered in subsequent years, proposals provide insight into the evolving positions of the owners of the company.

Offered the ability to provide their views on particular issues, shareholders have increasingly been willing to do so. Governance matters routinely attract substantial, if not majority, support. Similarly, environmental, social and governance proposals (“ESG”) have grown in popularity, receiving around 20 percent of the votes in 2016.[8] That compares with under 3 percent in the 1970s and under 10 percent in the late 1990s.

The collective views of shareholders have become increasingly important in the engagement process between owners and managers. Proponents negotiating over possible reforms can speak on behalf of a broader base of owners while directors can consider the level of support in fashioning an appropriate response. Moreover, the ability to speak collectively has generated results. Staggered board provisions, at least among larger companies, have all but disappeared. Majority vote provisions have become ubiquitous, and proxy access bylaws have been rapidly implemented. In the ESG area, most of the largest companies have issued corporate responsibility or sustainability reports. Much of what is known about political contributions has emerged as a result of the shareholder proposal process.[9]

Nor do proposals need to receive a majority of the votes cast to signal the importance of an issue to management. A shareholder proposal at Exxon-Mobil called for the appointment of a climate change expert to the board of directors. Although the initiative received only about 20 percent of the vote in 2015 and 2016, Exxon this year appointed such an expert to the board.

Imposition of substantial restrictions on the use of the rule will reduce the availability of this type of information and impair the engagement process between owners and managers. The Securities and Exchange Commission’s role as informal arbiter will be reduced.[10] At the same time, concern over the relevant issues will not go away. Shareholders will continue to seek changes in governance practices, environmental policies, and sustainability matters. Without Rule 14a-8, however, they will be forced to find alternative mechanisms of influence, whether public campaigns addressing corporate behavior, litigation over the level of disclosure, or exercise of their right to inspect documents relating to board oversight. The shift in approach will add cost and uncertainty to the engagement process.

The restrictions will also result in increased pressure for more systemic reforms. Without awareness of the collective views of shareholders, company-by-company negotiations will likely become less effective. The decline in private ordering will provide a greater incentive to seek regulatory and legislative reform. Sarbanes-Oxley and Dodd-Frank show that this can occur when the time is right.

As support for, and the importance of, proposals has grown, efforts to justify restrictions have increasingly focused not on the matter submitted to shareholders but on the nature of the proponent and the level of ownership. Restrictions have therefore been justified by the need to eliminate small investors from using the rule. According to one editorial:

It’s becoming an all-too-frequent occurrence at publicly traded companies: An investor holding just a few shares of stock puts forward a shareholder proposal that’s only tangentially related to the company’s operations or strategy. And if it secures even just a few votes, it can be reintroduced year after year.[11]

The emphasis on the “few shares of stock” and “tangentially related” obscures the actual role of retail investors in the engagement process. They mostly submit governance proposals, and their proposals mostly receive substantial support.[12] In short, they play a material role in keeping management informed on matters deemed important to shareholders.

Preventing retail investors from using the rule will deprive them of a significant role in the governance debate and deny all shareholders the right to speak on important initiatives. Moreover, the proposed solution – a dramatic increase in the ownership thresholds – will have indiscriminate effect.[13] Even large institutions will sometimes have difficulty meeting the requirements.

Rule 14a-8 could use some modernization. The rule does not adequately reflect the current relationship between owners and managers.[14] Proposed restrictions, however, are not designed to modernize but to reduce the role of shareholders in the governance process. They are reminiscent of efforts at disclosure reform that initially focused on “overload” and reductions in available information rather than on effectiveness and the overall quality of the disclosure.[15] Given the evolving nature of the relationship between directors and shareholders, changes to Rule 14a-8 should have as the underlying purpose not the reduction in the number of proposals but the improvement in the communications process between companies and their owners.

ENDNOTES

[1] Rule 14a-8, 17 CFR 240.14a-8.

[2] See Section 844(b)(2), Shareholder Proposals, The Financial CHOICE Act of 2017, HR 10, 115^th Cong., 1^st Sess. (2017), https://www.congress.gov/115/bills/hr10/BILLS-115hr10ih.pdf (proposal would “require the shareholder to hold 1 percent of the issuer’s securities entitled to be voted on the proposal, or such greater percentage as determined by the Commission”). The Financial Choice Act was approved by the Financial Services Committee of the House of Representatives on May 4, 2017.

[3] Rule 14a-8 currently defines the eligibility thresholds as “at least $2,000 in market value, or 1%, of the company’s securities entitled to be voted on the proposal at the meeting for at least one year” from the date of submission of the proposal.  17 CFR 240.14a-8(b).

[4] Modernizing the Shareholder Proposal Process, Business Roundtable, Oct. 31, 2016, http://businessroundtable.org/resources/responsible-shareholder-engagement-long-term-value-creation (“For proposals related to topics other than director elections, a truly reasonable standard could be to use a sliding scale based on the market capitalization of the company, with a required ownership percentage of 0.15 percent for proposals submitted to the largest companies and up to 1 percent for proposals submitted to smaller companies. Additionally, if a proposal were submitted by a group or by a proponent acting by proxy, the ownership percentage sliding scale could be increased to up to 3 percent.”).

[5] The numbers are consistent with earlier periods. See Exchange Act Release No. 39093 (Sept. 18, 1997) (“Between 300 and 400 companies typically receive a total of about 900 shareholder proposals each year.”). In 1982, shareholders submitted 972 proposals. See Commissioner James C. Treadway, Jr., Shareholder Proposal Rule, Remarks to Edison Electric Institute Seminar on Current SEC Developments, Washington, D.C., June 23, 1983, at 1, https://www.sec.gov/news/speech/1983/062383treadway.pdf.

[6] Proposals and supporting statements are limited to 500 words. See Rule 14a-8(d), 17 CFR 240.14a-8(d). Statements of opposition in contrast are not subject to a space limitation and can be significantly longer than the shareholder proposal.

[7] In 1983, companies filed 495 requests for no action relief. See Memorandum to John Huber and Linda Quinn from Bill Morley, Re: Shareholder Proposals, Nov. 16, 1983, at 2 (“noting 414 contested proposals in 1983, with 328 letters issued by the Division and 495 contested proposals in 1982, with 315 letters issued by the Division), http://3197d6d14b5f19f2f440-5e13d29c4c016cf96cbbfd197c579b45.r81.cf1.rackcdn.com/collection/papers/1980/1983_1116_StatisticalShareholder.pdf.

[8] See Elizabeth Ising, Ronald O. Mueller, & Lori Zyskowski, Shareholder Proposal Developments During the 2016 Proxy Season, Gibson Dunn, June 28, 2016, at 12 (“Ninety-one of these [environmental and social] proposals have been withdrawn, and 125 of these proposals have been voted on, averaging support of 20.7% of votes cast.”), http://www.gibsondunn.com/publications/Documents/Shareholder-Proposal-Developments-2016-Proxy-Season.pdf

[9] Sarah C. Haan, Shareholder Proposal Settlements and the Private Ordering of Public Elections, 126 Yale L. J. 262, 265-66 (2016) (“The shareholder proposal settlement has become increasingly popular as a tool for negotiating private rules for corporations on matters that are, by long tradition, subjects of public regulation. . . .Today, much of what is publicly known about how large, publicly held companies spend money to influence federal, state, and local elections and ballot proposals comes from disclosures that conform to privately negotiated standards. More than one hundred such agreements exist, most with Standard and Poor’s (S&P) 500 companies, although the precise number is difficult to determine due to the secrecy that pervades settlement.”).

[10] Significant reduction in this informal role has, in the past, been opposed. See Exchange Act Release No. 40018 (May 21, 1998) (“Some of the proposals we are not adopting share a common theme: to reduce the Commission’s and its staff’s role in the process and to provide shareholders and companies with a greater opportunity to decide for themselves which proposals are sufficiently important and relevant to the company’s business to justify inclusion in its proxy materials. However, a number of commenters resisted the idea of significantly decreasing the role of the Commission and its staff as informal arbiters through the administration of the no-action letter process.”).

[11] Maria Ghazal, General Counsel, Business Roundtable, Shareholders are costing their companies — and calling it democracy, Washington Post, May 3, 2017, https://www.washingtonpost.com/opinions/shareholders-are-costing-their-companies–and-calling-it-democracy/2017/05/03/6cb42102-29db-11e7-be51-b3fc6ff7faee_story.html?utm_term=.dd9c22eefd78

[12] James McRitichie is one of the individuals who makes significant use of the rule. Ten of his shareholder access proposals went to a vote between Jan. 1, 2016 through June 30, 2016. They received the following percentages: Apple (32.7%); Kansas City Southern (26.8%); QUALCOMM Incorporated (46.9%); Bio-Rad Laboratories, Inc. (19.9%); CSP Inc. (7.5%); Genomic Health, Inc. (35.5%); Medivation, Inc. (63.5%); Proto Labs, Inc. (71%); SciClone Pharmaceuticals, Inc. (88.2%); and SolarCity Corporation (11.4%). See Annex A, 2016 Proxy Season, Sullivan & Cromwell, July 11, 2016. See also Dave Michaels, Republicans Declare War on Corporate Gadflies, Financial Regulation Newsletter, WSJ, May 5, 2017 (“Mr. Chevedden, for instance, has sponsored 91 proposals since 2007 that garnered more than 50% support, ISS data shows. The average rate of support for his proposals was 39%.”).

[13] Under the proposal put forth by the Business Roundtable, the ownership threshold at Apple would increase from $2000 to around $1 billion. The increase was described as “modest.” See Ghazal, supra note 11 (“Last year, the Business Roundtable . . . recommended specific, modest changes to modernize the rule to work better for shareholders and companies”).

[14] See J. Robert Brown, Jr., The Evolving Role of Rule 14a-8 in the Corporate Governance Process, 93 DU Law Review Online 151 (2016), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2767712

[15] See International Cooperation in a New Data-Driven World, Remarks by Kara M. Stein, Commissioner, Securities and Exchange Commission, Brooklyn Law School International Business Law Breakfast Roundtable, March 26, 2015, https://www.sec.gov/news/speech/2015-spch032615kms.html (“Currently, the SEC’s Division of Corporation Finance is spearheading a project to examine the effectiveness of corporate disclosures.   While the initiative was initially named ‘The Disclosure Overload Project,’ its mission has been broadened to also address whether we need to enhance, improve, and in some cases add disclosure.”).

This post comes to us from J. Robert Brown, Jr., the Lawrence W. Treece Professor of Corporate Governance and the director of the Corporate & Commercial Law Program at the University of Denver Sturm College of Law. Professor Brown is also a member of the Standing Advisory Group of the Public Company Accounting Oversight Board. The post is based on his recent article, “Corporate Governance, Shareholder Proposals, and Engagement Between Managers and Owners,” available here.