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SEC Chairman Clayton on Modernizing the Shareholder Proposal Framework

Over the past three years, we have engaged in a number of retrospective reviews of the rules that implement our securities law framework.  These reviews often, but not always, have yielded the unassailable conclusion that modernization is necessary and appropriate.  This should come as no surprise given how much has changed in the past 20, 30, 40 or more years since key rules were last comprehensively reviewed.  At a macro level, I note that interaction among market participants, including trading, disclosures and other information-based interactions, is now largely electronic, adding tremendous efficiencies but also new challenges.  Virtually all trading in equities is electronic.  The days of disclosure reports and proxy materials being filed in paper form, but not electronic form, with the Commission are well behind us.  In addition, as I have noted at other recent open Commission meetings, our Main Street investors generally have shifted from investing directly in our public companies to investing through mutual funds and ETFs.[1]  For many small and medium-sized companies, our private capital markets are the only reasonable means for obtaining financing to grow their businesses.  As I often say, the core principles are the same as they were in the 1930s, but the landscape is far different.

As just a few examples of our modernization efforts, I note our recent amendments to the accredited investor definition, where for the first time we recognized that individuals who meet clear, established measures of financial sophistication should be allowed to participate in our private capital markets, rather than limiting participation to only those who meet blunt net worth or income tests.  We also recently updated the business, legal proceedings and risk factors disclosure requirements under Regulation S-K.  As part of those amendments, the Commission modernized our disclosure requirements to recognize that human capital accounts for — and drives — long-term business value at many companies in many different ways, much more so than it did 30 years ago.

As another example, last week’s amendments to Rule 15c2-11 recognized that technological advancements have made it possible for us to require that the information available to investors in the OTC markets be more timely.  These changes will enable investors to make better informed investment decisions and reduce the ability of bad actors to perpetuate fraud in the “penny stock” and “microcap” markets.  And, as a final example, this summer, the Commission modernized our rules and guidance governing proxy voting advice.  These actions will improve transparency, particularly by requiring the disclosure of material conflicts, and reaffirm core principles of the fiduciary duty investment advisers owe to their clients when they vote.  Among other changes in our markets, those amendments reflect the shift, which I noted a few moments ago, of Main Street investors to investing more through fund structures.

In the area of shareholder proposals, the review and modernization question is, at least to me, very straightforward, including because it is based on long-standing and clear Commission principles.  Our predecessors long recognized, in concert with prevailing state law, that proposals made by individual shareholders to all other shareholders, using the company’s proxy statement, can have benefits for all shareholders, including through improved transparency and corporate governance.  Accordingly, the Commission has adopted and administered rules that are designed to facilitate that engagement process in a reasonable, transparent and fair manner.

In that regard, the Commission also has long recognized a few key economic realities.  First, in addition to the potential benefits from engagement among shareholder-proponents, companies and non-proponent shareholders, shareholder proposals impose costs on companies and on non-proponent shareholders.  These costs are significant, even more so when viewed across today’s more diversified portfolios that are a hallmark of modern investing.

Second, the costs to the shareholder-proponent are low, both in absolute terms and relative to other metrics.  These metrics include, among others, (1) the costs to all the other non-proponent shareholders of reviewing and voting on the proposals that I just mentioned, (2) market capitalization — in other words, the amount other shareholders have invested in the company — and (3) the cost the shareholder-proponents would incur to access non-proponent shareholders, and demand their time and attention, through another means.

Third, in addition to a desire to improve long-term value to all shareholders, there is a risk, particularly in light of the low absolute and relative costs of submitting a proposal — in other words, the economic incentives — that shareholder-proponents would use the proposal process in a way that does not benefit the company or its other shareholders.[2]

Years ago, the Commission articulated a framework for reconciling these overlapping and, in some cases competing, interests to best serve our markets and our shareholders generally.  More specifically, the Commission determined that in order to submit a shareholder proposal for inclusion in the company’s proxy statement, a shareholder-proponent must have demonstrated a meaningful “economic stake or investment interest” in a company.[3]

Taking into account the many changes in our markets over the past 30 plus years, as well as our experience with the shareholder proposal process under Rule 14a-8, the Commission staff has recommended restructuring and recalibrating the current shareholder ownership threshold for initial submissions as well the shareholder support thresholds for resubmissions.  Their carefully tailored and modest refinements will better ensure that the interests of those who submit, and re-submit, shareholder proposals are appropriately aligned with the interests of their fellow shareholders who must take the time to review, consider and vote on those proposals.

Turning to the initial submission threshold, I will start by noting an important transition matter.  Any investor who today is eligible to submit a proposal — by having held at least $2,000 worth of company securities for one year — will continue to be able to submit a proposal without increasing the dollar amount of their holdings.  All that will be required is that they continue to hold those securities.  For all other shareholder-proponents, there will be three, tiered thresholds: the first retains the $2,000 dollar threshold for those who have maintained at least that level of holdings for at least three years.  We are also adding two additional ownership thresholds of at least $15,000, for holdings of at least two years, and at least $25,000 for holdings of at least one year.  This tiered approach, with its combination of ownership amounts and length of holding periods, will more effectively implement the Commission’s long-standing framework in today’s marketplace.

Here, I want to put this approach in perspective relative to the current threshold requirements which have not been amended since 1998.  First, as I noted, under the transition provision of the amended rule, all shareholders who qualify today to submit a proposal for inclusion in the company’s proxy statement will continue to qualify so long as they maintain at least their current holdings through the date of the submission (and, as under our current rules, through the date of the relevant shareholder meeting).  Going forward, shareholders will simply need to (1) hold the same small stake — set in 1998 — longer or (2) increase their stake in order to submit a proposal earlier.  I firmly believe these marginal requirements are both more in line with the Commission’s long-standing policy and, at their core, are of minimal additional cost to shareholder-proponents, particularly those who have already been — or now are — committed to the long-term health of a company.

The recalibrated thresholds we are considering today also are appropriate in light of the other aspects of our historical experience with shareholder submissions.  For example, as the release notes, out of approximately 65 million direct and indirect investors in companies subject to the proxy rules in 2018, only 170 shareholder-proponents submitted proposals that appeared in proxy statements.  That is roughly equal to three shareholder-proponents per million investors.

I also want to note that, consistent with the Commission’s long-standing approach to determining when shareholders are eligible to have their proposals included in a company’s proxy materials, the revised requirements are agnostic as to the subject matter of any particular shareholder proposal.  The rule has never been, and the final rule will not be, a way for the SEC to regulate or make judgments with respect to the merits of any particular shareholder proposal topic.

Turning now to the resubmission thresholds, or in other words, the voting support threshold for determining when a company can omit a resubmitted proposal because it did not garner sufficient shareholder support when previously voted on.  In the era of mail and limited avenues for shareholder communications with each other and with registrants, the current 3, 6 and 10 percent thresholds, adopted in 1954 — yes, over 65 years ago — may have been reasonable, but they are not reasonable today.  A shareholder-proponent should not be able to command the time and attention of the company and other shareholders to review, consider and vote on a proposal if nine out of ten votes cast by their fellow shareholders have been against the proposal after it’s been submitted for a vote three or more times in five years.  This is worth reiterating: Yes, 90 percent or more of fellow shareholders could oppose a proposal year in and year out and yet still be required to consider it again, year in and year out.

Under today’s amendments, generally speaking, a proponent submitting a proposal for the first time will only need to garner the support of 1 out of 20 of the votes cast by fellow shareholders in order to avoid taking a time out before submitting again.  If a proposal has been submitted three or more times, the amendments to the resubmission thresholds will do nothing to prevent the proposal from being submitted again as long as the most recent submission received the support of at least 1 out of every 4 votes cast.  If that doesn’t happen – that is, if 3 or more out of every 4 votes cast votes against the proposal, the proposal can still can be submitted again, but just after a brief  time out.  Considering the aggregate time and attention required of non-proponent shareholders to review, consider and vote on each proposal, these modest amendments to the resubmission thresholds make common sense.

As I stated initially, today’s amendments reflect a concerted, years-long effort by Commission staff, and I thank them for their dedication to modernizing our rules, and I commend their efforts.

In particular, I would like to acknowledge the following staff members for their contribution to this effort:

From the Division of Corporation Finance:  Bill Hinman, David Fredrickson, Tamara Brightwell, Matt McNair, Lisa Kohl and Luna Bloom.

From the Division of Economic and Risk Analysis:  S.P. Kothari, Hari Phatak, Marie-Louise Huth, Vlad Ivanov, Xanthi Gkougkousi, Olga Itenberg, Lauren Moore, Andrew Glickman, Wei Liu, Andy Kim and Morgan Williams.

From the Office of the General Counsel:  Bob Stebbins, Michael Conley, Bryant Morris, Dorothy McCuaig, Tracy Hardin and Daniel Matro.

From the Office of Investment Management:  David Bartels, Raymond Be, Judy Lee and David Orlic.

Following the staff’s presentation of the recommendations, in recognition of Commissioner Roisman’s efforts to modernize and improve our proxy voting framework, I will turn it over to him for his opening remarks.  Then, I will ask Commissioner Peirce, Commissioner Lee and Commissioner Crenshaw for any remarks.

So, without further ado, Bill [Hinman], I turn it over to you.

ENDNOTES

[1] Chairman Jay Clayton, Transparency for our Investors and at the Commission (Aug. 5, 2020), available at https://www.sec.gov/news/public-statement/clayton-open-meeting-iac-20200805; Chairman Jay Clayton, Proxy Voting—Reaffirming and Modernizing the Core Principles of Fiduciary Duty and Transparency to Provide for Better Alignment of Interest Between Main Street Investors and the Market Professionals Who Invest and Vote on Their Behalf, available at https://www.sec.gov/news/public-statement/clayton-open-meeting-2020-07-22.

[2] See Notice of Proposal to Amend Proxy Rules, Release No. 34-4114 (July 6, 1948) [13 FR 3973, 3974 (July 14, 1948)] (In 1948, the Commission adopted three new bases for exclusion, including the personal-grievance exclusion, to “relieve the management of harassment in cases where [shareholder] proposals are submitted for the purpose of achieving personal ends rather than for the common good of the issuer and its security holders.”); Notice of Proposed Amendments to Proxy Rules, Release No. 34-4950 (Oct. 9, 1953) [18 FR 6646, 6647 (Oct. 20, 1953)] (In 1953, the Commission amended the shareholder-proposal rule to allow companies to omit the name and address of the shareholder-proponent to “discourage the use of this rule by persons who are motivated by a desire for publicity rather than the interests of the company and its security holders.”); Proposed Amendments to Rule 14a-8, Release No. 34-19135 (Oct. 14, 1982) [47 FR 47420, 47427 (Oct. 26, 1982)] (In addressing the personal-grievance basis for exclusion in 1982, the Commission noted that “[t]here has been an increase in the number of proposals used to harass issuers into giving the proponent some particular benefit or to accomplish objectives particular to the proponent.”).

[3]  See Amendments to Rule 14a-8 Under the Securities Exchange Act of 1934 Relating to Proposals by Security Holders, Release No. 34-20091 (Aug. 16, 1983) [48 FR 38218 (Aug. 23, 1983)].

These remarks were delivered on September 23, 2020, by Jay Clayton, chairman of the U.S. Securities and Exchange Commission.

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