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SEC Commissioner Lee on the Amendments to Rule 14a-8

The final rules represent the capstone in a series of policies that will dial back shareholder oversight of management at the companies they own. Last year, the Commission adopted guidance on proxy advisors and proxy solicitation that made it more difficult and costly for investment advisers to vote shares on behalf of their clients in reliance on independent proxy voting advice.[1] Then, earlier this year, the Commission adopted new rules and additional guidance related to proxy advisors that injected further cost and complexity into the voting process and mandated greater issuer involvement in proxy voting decisions.[2] Having made it more difficult for shareholders to exercise their voting rights, the Commission now adopts amendments that will narrow access to another important mechanism for shareholder oversight: the shareholder proposal process. These actions collectively put a thumb on the scale for management in the balance of power between companies and their owners.[3]

Today’s amendments, however, do not acknowledge this clear policy choice, purporting instead to be looking after the interests of shareholders by yet again adopting policies they strongly oppose. We received thousands of letters objecting to the proposed rules, explaining why these changes are not in the interests of shareholders or in the long-term interests of the companies they own.[4] Individual investors, asset managers, pension funds and labor unions representing the interests of teachers, firefighters, and service employees, state and local governments, universities, religious institutions, numerous investor organizations representing trillions of dollars in assets under management, US Senators, academics, a Commissioner at the Federal Election Commission, state securities regulators, our own Investor Advisory Committee—shareholders of every ilk and many others wrote in overwhelming numbers to urge us not to adopt these amendments.[5]

Letters in opposition to these changes vastly outnumber those in support and evidence a stark division of views between shareholders and management. Today’s rules do not take a balanced approach to this division of interests, but rather almost universally reject the comments and data submitted by shareholders, failing in the process to reckon with very real costs of reducing shareholder oversight.

Today’s amendments do not serve shareholders or the capital markets more broadly. They will have pronounced effects in two important respects. First, in connection with environmental, social, and governance (ESG) issues at a time when such issues—climate change, worker safety, racial injustice—have never been more important to long-term value. Second, in connection with smaller shareholders, Main Street investors, who will be dramatically disadvantaged by the changes we adopt today.

Undermining ESG Initiatives

These changes will be most keenly felt in connection with ESG issues, which comprise the main subject matter of shareholder proposals, at a time when such proposals are garnering increasing levels of support. The Commission has long declined to erect higher barriers for shareholders in submitting proxy proposals. For example, in 1997 the Commission proposed an increase in the resubmission thresholds like the ones adopted today, but wisely decided against the changes due to concerns expressed by shareholders.[6]

Why now then, despite an even greater outcry from shareholders? Ostensibly because of costs associated with shareholder proposals. In fact, the Commission’s own analysis shows that the number of overall shareholder proposals has been trending down in recent years and, as of the 2018 proxy season, was at roughly the same level as in 1997.[7] It is exceedingly rare for most companies to receive a shareholder proposal at all. An analysis of Russell 3000 companies reveals that, on average, only 13 percent of companies received a shareholder proposal in a particular year between 2004 and 2017.[8] That translates to approximately one proposal every 7.7 years for the average company.[9]

Notably, however, while the overall number of shareholder proposals has gone down in recent years, support for certain types of shareholder proposals has been on the rise. Climate change, workforce diversity, independent board leadership, and corporate political spending, as well as other ESG-related issues, are increasingly important to investors—and increasingly present on proxy ballots.[10] Governance-related proposals have long-dominated shareholder proposals and helped improve corporate governance in significant ways, including the normalization of annual director elections and majority vote rules for director elections.[11] But environmental and social proposals have been ascendant in recent years, making up more than half of all proposals filed in recent seasons.[12] And there has been a marked increase in support for such proposals in the last decade, with average support reaching 24 percent in 2018 up from single digits just after the financial crisis.[13] Thus we move to restrain these efforts just as they are gaining real traction.    

This is consistent with efforts at the Department of Labor that would restrict ESG investment by retirement plans, and make it harder for such plans to vote on ESG-related proposals.[14] Notable among such proposals are those related to climate change. An advisory committee to the CFTC recently released a comprehensive report finding that climate change poses major risks not just to individual businesses, but “to the stability of the U.S. financial system and to its ability to sustain the American economy.”[15] Shareholder proposals related to climate change continued to increase in number and in support last season, garnering an average of 31 percent support, with four such proposals passing.[16] Shareholders are beginning to accomplish on climate change what they have accomplished on numerous other significant issues crucial to good governance and long-term value[17]—focus management attention and drive valuable and needed change. The Commission should be encouraging this kind of engagement, not stifling it.

Targeting Retail Investors

The types of shareholders who will be most affected by these amendments are individual shareholders with smaller holdings who will be shut out of the shareholder proposal process to a startling degree by today’s amendments. Indeed, the final rules severely restrict smaller shareholders from accessing the process, even prohibiting them from banding together to protect their interests—a reversal of nearly 40 years of Commission policy.[18] As an initial matter, the rules include a huge, unprecedented hike in the eligibility thresholds—an increase of 12-and-a-half times in the required investment amount for a one-year holding period. Thus if shareholders wish to exercise their right to submit a shareholder proposal, they must either invest what is likely a substantial portion of their portfolio[19] into a single company, or be forced to hold an investment for two additional years, giving up the right of active and prudent management of their own assets. Wealthier investors, meanwhile, suffer no such restrictions.

The release actually asserts that these choices—a forced additional two-year holding period or a further investment of $23,000 that investors may not be able to afford—hardly represent a cost at all to these shareholders.[20] Imagine dictating portfolio management in this manner to Wall Street investors, while claiming that it actually does not constitute a cost to them at all. We would almost certainly have to defend that position in court, but smaller investors, of course, may lack the resources to ensure that same accountability.

Further, the release now prohibits investors from aggregating their holdings to meet the eligibility thresholds. This is particularly problematic in light of the newly heightened thresholds and the lack of a rationale for this prohibition. There is no fundamental difference between a single concerned shareholder with a sufficient economic stake in a company and multiple shareholders with a shared concern who together have a sufficient stake.[21] In fact, this kind of collective effort requires coordination and expense above and beyond individual effort, and thus potentially reflects a greater commitment. What’s more, the shareholders who would have to aggregate to reach the thresholds are among the least likely to be able otherwise to get management’s attention in the way that wealthier shareholders can.

We’re blocking smaller shareholders at every turn and we’re doing so without including analysis of available data regarding retail accounts—data we have, data we have analyzed and recently put into the comment file, but have omitted from this release. To be clear, we do discuss the data in the adopting release but only to defend the decision to omit it from the proposal and from this release, not to reckon with the cost the data illustrates: that retail investors will be greatly disenfranchised by these changes.[22]

The Commission has in the past stated that an important goal of the 14a-8 process is to provide an avenue of communication for smaller shareholders.[23] In a sharp departure from that traditional view, today’s release not only makes it harder for small shareholders to access this avenue of communication, but goes so far as to dismiss this disenfranchisement as irrelevant, not even meriting analysis in the release.[24] Here’s the reasoning behind this troubling conclusion: the release weighs the value of shareholder proposals in terms of whether they will be put to a vote and eventually gain majority support; therefore, dramatically reducing the number of shareholders eligible to submit proposals is not a relevant cost because, the argument goes, any truly valuable proposal that a smaller shareholder might have submitted can still be submitted by a larger shareholder who meets the heightened thresholds.[25]

First, this ignores evidence that many institutional investors may be less likely to submit proposals, relying instead on smaller shareholders to get important issues on the ballot.[26] Second, and more importantly, this reasoning rejects the idea that there is value to individual shareholders in having the option to submit proposals. That option, unlike most any other in the securities markets, is valued at zero. Thus, we not only roll back the rights of the smallest investors, but we fail to assign any value whatsoever to those rights.

In the end, these amendments will restrict shareholders’ ability to oversee and engage with management of the companies they own. They do not properly value shareholder proposals or shareholder rights. And they will restrain shareholder efforts on issues that are of pressing importance to them and to our broader economy. I must respectfully dissent.[27]

ENDNOTES

[1] See Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers, Rel. No. IA-5325 (Aug. 21, 2019); Commission Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice, Rel. No. 34-86721 (Aug. 21, 2019).

[2] See Exemptions from the Proxy Rules for Proxy Voting Advice, Rel. No. 34-89372 (July 22, 2020); Supplement to Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers, Release No. IA-5547 (July 22, 2020).

[3] See Matt Levine, “Money Stuff: Companies Push Back on Proxy Advisers,” Bloomberg (Oct. 29, 2019) (“Here, too, a fight over proxy advisers, with the Business Roundtable (CEOs) on one side and the Council of Institutional Investors (big shareholders) on the other, is pretty clearly about the allocation of power between corporate CEOs and shareholders. And the SEC’s view is apparently that CEOs should have a bit more power and shareholders a bit less.”).

[4] See Comments on Proposed Rule: Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8, https://www.sec.gov/comments/s7-23-19/s72319.htm.

[5] Take, for example, commenters on the proposal to raise the eligibility thresholds. The comment file reveals scant support for this measure, approximately 16 comment letters almost exclusively from issuers and their representative organizations. On the other side—even setting aside the letter writing campaigns that produced thousands of investor letters opposing the proposal and looking only at individualized submissions—there are over 15 times as many letters specifically opposing the heightened eligibility thresholds. These letters in opposition are from individual investors, from institutional investors, from organizations representing the interests of investors, and from numerous others. The comment letters on other elements of the proposal reveal a similar imbalance and a similar division in interests.

[6] See Amendments to Rules on Shareholder Proposals, Rel. No. 34-40018 (May 21, 1998) [1998 Adopting Release] (“We had proposed to raise the percentage thresholds respectively to 6%, 15%, and 30%. Many commenters from the shareholder community expressed serious concerns about this proposal. We have decided not to adopt the proposal, and to leave the thresholds at their current levels.”).

[7] See Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8, Rel. No. 34-8745, at Figure 1 (Nov. 5, 2019); see also Sullivan & Cromwell, 2020 Proxy Season Review: Part 1, Rule 14a-8 Shareholder Proposals (July 15, 2020), https://www.sullcrom.com/sc-publication-2020-proxy-season-review-part-1-rule-14a-8  (“Overall, the total number of shareholder proposals declined, continuing a downward trend that began in 2015.”).

[8] See Comment Letter from Council of Institutional Investors (Jan 30, 2020).

[9] The release further reasons that too many proposals that are unlikely to become successful are permitted to remain on the ballot under the current rule. It defines success, however, as proposals that are likely to gain broad or majority support in the near term. This ignores the long history of shareholder proposals that have gained traction only after decades of shareholder advocacy and further ignores the value of proposals that may never gain majority support. In fact, even proposals that never go to a vote can have a significant effect on corporate governance, as proposals are often withdrawn by proponents in exchange for voluntary changes by companies.

[10] See Sullivan & Cromwell, 2019 Proxy Season Review: Part 1, Rule 14a-8 Shareholder Proposals (July 12, 2019), https://www.sullcrom.com/2019-proxy-season-review-part-1-rule-14a-8-shareholder-proposals (“This year nearly half of submitted ESP [environmental, social, and political] proposals went to a vote, while in 2018 only about a third reached the shareholder vote stage.”).

[11] See Kosmas Papadopoulos, The Long View: The Role of Shareholder Proposals in Shaping U.S. Corporate Governance (2000-2018) (Feb. 6, 2020), https://corpgov.law.harvard.edu/2019/02/06/the-long-view-the-role-of-shareholder-proposals-in-shaping-u-s-corporate-governance-2000-2018/ (“Annual director elections, majority vote rules for director elections, shareholder approval for poison pills, and proxy access bylaws are some of the critical governance practices that have become common practice thanks to investor support for shareholder proposal campaigns led by a wide variety of investors—some large; others small.”).

[12] See Maximilian Horster and Kosmas Papadopoulos, Climate Change and Proxy Voting in the U.S. and Europe (Jan. 7, 2019), https://corpgov.law.harvard.edu/2019/01/07/climate-change-and-proxy-voting-in-the-u-s-and-europe/  (“In 2017 and 2018, shareholder resolutions focusing on environmental and social issues made up the majority of all filed shareholder proposals, showing a notable increase relative to resolutions focusing on governance topics compared to prior years.”); Peter Reali, Christina Gunnell, and Jennifer Grzech, 2020 Proxy Season Preview (Apr. 27, 2020), https://corpgov.law.harvard.edu/2020/04/27/2020-proxy-season-preview/ (“The number of E&S proposals and support for them hit an all-time high in 2019, a trend that has continued for three consecutive years. E&S proposals accounted for more than half of all proposal filings in 2019 (55%) and garnered 26.8% support. We expect the 2020 proxy season to see a similar uptick in support for these proposals.”).

[13] See Kosmas Papadopoulos, The Long View: US Proxy Voting Trends on E&S Issues from 2000 to 2018 (Jan. 31, 2019), https://corpgov.law.harvard.edu/2019/01/31/the-long-view-us-proxy-voting-trends-on-es-issues-from-2000-to-2018/.

[14] See Department of Labor, Notice of Proposed Rulemaking on Financial Factors in Selecting Plan Investments Amending “Investment duties” Regulation at 29 CFR 2550.404a-1 (June 23, 2020); Department of Labor, Notice of Proposed Rulemaking on Fiduciary Duties Regarding Proxy Voting and Shareholder Rights (Aug. 31, 2020).

[15] See Managing Climate Risk in the U.S. Financial System, Report of the Climate-Related Market Risk Subcommittee, Market Risk Advisory Committee of the U.S. Commodity Futures Trading Commission (Sept. 9, 2020), https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf.

[16] See Sullivan & Cromwell, supra note 7.

[17] See Papadopoulos, supra note 11.

[18] See Procedural Requirements and Resubmission Thresholds under Exchange Act, Rel. No. 34-[], 34 (Sept. 23, 2020) [Adopting Release] (acknowledging that “the Commission allowed shareholders to aggregate their holdings when it first adopted ownership thresholds in 1983”).

[19] See Commissioner Allison Herren Lee, Statement on Shareholder Rights (Nov. 5, 2019) (noting a staff analysis of retail investor portfolios indicates a median portfolio value of approximately $27,700).

[20] See Adopting Release at 138-39 (“More generally, we do not believe that the additional investment in the company needed to hold the same $2,000 of stock for three years instead of one, or to meet the revised threshold for a one-year holding period (i.e., $25,000 – $2,000 = $23,000), on its own constitutes a cost to shareholder-proponents, as this amount represents the holding or purchase of assets that will earn an expected rate of return in the form of capital gains and/or dividends.”). To the extent the release acknowledges any costs, it characterizes them as “marginal.” See id. at 109.

[21] The release dismisses this obvious fact without providing any basis whatsoever, simply saying “we believe that allowing shareholders to aggregate their securities to meet the new thresholds would undermine the goal of ensuring that each shareholder who wishes to use a company’s proxy statement to advance a proposal has a sufficient economic stake or investment interest in the company.” See id. at 34.

[22] See Memorandum from S.P. Kothari, Chief Economist, regarding the analysis of data provided by Broadridge Financial Solutions, Inc. (Aug 14, 2020) [DERA Memo]. The preliminary analysis appended to the memorandum analyzed data from over 28 million retail investor accounts and, subject to various limitations, estimated that anywhere from approximately 50 percent to 77 percent of such account holders would be newly excluded from eligibility to submit shareholder proposals under heightened thresholds similar to those included in the final rule. The heightened thresholds assumed in the analysis differ from those included in the final rules. Specifically, the analysis assumes thresholds of $3,000 for five years, $15,000 for three years, and $25,000 for one year, while the final rules sets thresholds of $2,000 for three years, $15,000 for two years, and $25,000 for one year. The Commission has not included updated analysis of the data under the final rule’s thresholds in the Adopting Release. Nevertheless, the tiered structure and wealth requirements of the thresholds assumed in the analysis are similar to those included in the final rules and the most significant differences relate to the duration of holdings periods. The account data analyzed is only for a two-year period such that any holding period beyond that two-year period have to be assumed, whether it is for an additional year or an additional three years. Thus the analysis is suggestive as to the effects of the final rules.

[23] See 1998 Adopting Release (“Also as proposed, we are increasing the dollar value of a company‘s voting shares that a shareholder must own in order to be eligible to submit a shareholder proposal — from $1,000 to $2,000 — to adjust for the effects of inflation since the rule was last revised. There was little opposition to the proposed increase among commenters, although several do not believe the increase is great enough to be meaningful, especially in light of the overall increase in stock prices over the last few years. Nonetheless, we have decided to limit the increase to $2,000 for now, in light of rule 14a-8’s goal of providing an avenue of communication for small investors.”).

[24] See Adopting Release at 89 (“We concur with the conclusions of the Commission’s Chief Economist set forth in the August 14, 2020 memorandum accompanying the Preliminary Staff Analysis.”); DERA Memo (concluding that the analysis regarding the exclusion of retail investors from eligibility is “not relevant to the economic question central to the proposal.”).

[25] See DERA Memo (“I did not believe the analysis was relevant to what I viewed as the economic question central to the proposal:  whether amending the thresholds would result in fewer shareholder proposals being put to a vote.”); Adopting Release at 33 (“In those situations where a shareholder decides not to alter portfolio diversification, we note that an issue that is sufficiently important to the broader shareholder base may be brought to the company’s attention by other shareholders, including those that are eligible to submit a shareholder proposal.”).

[26] See Comment Letter from Lucian A. Bebchuk (Feb. 3, 2020) (“The Economic Analysis fails to give adequate weight to the evidence that significant institutional investors tend to avoid the submission of shareholder proposals though they regularly vote for certain types of shareholder proposals.”).

[27] I want to add that my opposition to these rules is not a criticism of the staff, who have consistently and for months done remarkable work under very difficult circumstances. I know many of you are juggling a number of pressing demands, including family, child care, education, and more. I have the deepest respect and gratitude for your work. My concern lies with the majority’s policy choice in finalizing these rules in a way that I believe will not serve markets well.

These remarks were delivered on September 23, 2020, by Allison Herren Lee, commissioner of the U.S. Securities and Exchange Commission.

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