In September 2020, the Securities and Exchange Commission amended Rule 14a-8 of the Securities Exchange Act to increase the eligibility requirements for a shareholder to submit proposals.[1] Rule 14a-8, also called the shareholder proposal rule, governs when a company must include a shareholder proposal in its proxy statement.[2] Passed by a 3-2 vote, the amendments have led to contentious debates about their potential impact on corporate governance.

Recent Amendments

Among other things,[3] the September 2020 amendments make the following significant changes to the shareholder proposal process:

First, the SEC increases the ownership threshold for initial inclusion of a proposal in the proxy statement. Previously, the rule required at least $2,000 or 1% of a company’s securities for at least one year.[4] The amendments shifted this requirement to a tiered system that requires shareholder proponents to demonstrate continuous ownership of at least $2,000, $15,000, and $25,000 of the company’s securities for a period of 3 years, 2 years, and 1 year, respectively.[5]

Second, the amendments prohibit the aggregation of holdings for the purposes of satisfying the amended ownership thresholds.[6]

Third, the amendments impose heightened levels of shareholder support required for a proposal to be eligible for resubmission at the same company’s future shareholder meetings. Previously, the resubmission thresholds were set at 3%, 6%, and 10% of shareholder support for matters previously voted on once, twice or three or more times in the last five years, respectively.[7] The amendments increased these thresholds to 5%, 15%, and 25%, respectively.[8]

Supporters of the amendments argue that the increased ownership threshold is a necessary modernization to adjust for present-day stock price values,[9] to ensure that “a shareholder-proponent has a meaningful ownership interest in the company that will receive the proposal.”[10] Proponents of increased resubmission thresholds, including Business Roundtable, assert that previous low barriers to resubmission allowed a fraction of small-stakes shareholders to “override the expressed will of a majority of shareholders indefinitely,” creating a “tyranny of the minority.”[11]

Shareholder Proposals and Rule 14a-8

The shareholder proposal process represents one channel for management-owner communication and engagement. This process poses little to no costs for eligible shareholders to present proposals to the management and other shareholders and solicit proxies for those proposals.[12] However, the shareholder proposal process involves corporate costs and resources. Corporations must prepare responses to the proposals and seek no-action relief from the SEC for any proposals they believe should be excluded, which consumes time and resources.[13]

Driven by this cost concern, some restrictions to refine eligible shareholders and proposals become necessary. Rule 14a-8 imposes two types of grounds on which corporations may rely to exclude shareholder proposals—procedural and substantive. The SEC’s September 2020 amendments focus on the procedural restrictions on eligibility, although corporations can also exclude proposals that they have already substantially implemented[14] and proposals that deal with a matter relating to the company’s ordinary business operations.[15] The cost to companies in the shareholder proposal process is one of the stated motivations for the recent amendments. The SEC claims that the recent amendments will save around $70 million per year across companies in the Russell 3000 index.[16] However, a recent study showed that most public companies do not receive any shareholder proposals and that the average Russell 3000 company receives a proposal once every 7.7 years.[17] Because large-cap companies have traditionally received the vast majority of shareholder proposals,[18] they bear most of the cost concerns in the shareholder proposal process.

Heightened Eligibility Thresholds Would Hinder ESG Shareholder Advocacy

The shareholder proposal process has been an important platform for environmental, social, and governance (ESG) issues.[19] Shareholder proposal campaigns have been critical in making practices such as annual director elections, majority vote rules for director elections, shareholder approval for poison pills, and proxy access bylaws common corporate governance practices.[20] Because Rule 14a-8 provides substantive grounds of exclusion to corporations, ESG issues comprise the main subject matter of shareholder proposals.[21] In the 2020 proxy season, despite decreased overall shareholder proposals, the percentage voted and number of passing proposals increased among environmental, social and political (ESP) proposals.[22]

Although institutional investors have been increasingly conscious of ESG issues in their strategies,[23] their efforts cannot adequately replace the ESG proposals that less well-capitalized retail investors could submit. Because institutional investors are more principled in that they must first “analyze an issue, develop practical guidelines, and [wait] for a consensus to emerge,”[24] it often takes time before issues that began with smaller shareholders gain traction within the broader investment community.[25] Taking away retail investors’ options to make proposals that may inspire and lead to wider acceptance of proposals is like “cutting off that incubation period that is so vital for a consensus to emerge.”[26] Furthermore, large institutional investors such as the “Big Three” – Blackrock, State Street, Vanguard—have chosen to merely vote on proposals submitted by others, instead of putting forward proposals advocating for governance changes they favor in their voting guidelines.[27] Bebchuk and Hirst posit that factors like fear of public and political backlash and business ties with corporate managers incentivize index fund managers to show deference to corporate managers, even when nondeference in the form of actively submitting proposals may be more value-maximizing.[28]

The heightened thresholds also hinder adoption of ESG governance practices by discounting and taking away the inherent value in the option to submit proposals regardless of whether a shareholder actually exercises that option.[29] For example, the expectation that a shareholder can submit a proposal that will be on the proxy statement is itself a bargaining power and can facilitate shareholder-company engagement. In the 2020 proxy season, the number of governance-related proposals fell further because companies continued to proactively adopt market standard practices such as proxy access and engage with shareholder-proponents on issues such as diversity and composition.[30]

Lastly, despite the framework of the agency problem between shareholders and the management, these two groups of constituents are not in a zero-sum game. When retail investors lose their option to submit proposals that may not garner significant support, the corporation stands to lose the signaling value that these unsuccessful proposals can still provide. Regardless of their outcomes, shareholder proposals keep corporations informed of what matters to different types of investors. A proposal that does not have majority support can still be eventually adopted by a company, sometimes with the directors acquiescing to practices that they previously vehemently opposed. Proposals that garner minority support can build to signal a momentum of governance changes. For example, many corporations acquiesced to adopting governance practices such as board declassification, majority voting, and proxy access due to pressure from a wider momentum of shareholder proposals.[31] Restriction in unsuccessful proposals that retail investors may bring will limit the corporation’s channel of information and will delay the process where corporations may voluntarily adopt shareholder proposals.

ENDNOTES

[1] SEC Adopts Amendments to Modernize Shareholder Proposal Rule, Sec. Exch. Comm’n (Sept. 23, 2020).

[2] 17 C.F.R § 240.14a-8.

[3] See Eleazer Klein et al., SEC Increases Rule 14a-8 Thresholds, Harv. L. Sch. F. on Corp. Governance (Oct. 12, 2020).

[4] Supra note 1.

[5] Id.

[6] See Commissioner Caroline A. Crenshaw, Statement on Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8, Sec. Exch. Comm’n (Sept. 23, 2020) (remarking that the amendments represent “a decision to eliminate the nearly 40 year practice of allowing shareholders to take collective action to express a shared position”).

[7] Supra note 1.

[8] Id.

[9] The requirements for initial inclusion in the proxy statement have not been substantially amended since 1988. Supra note 1.

[10] Procedural Requirements and Resubmission Thresholds under Exchange Act, Rel. No. 34-89964, 10 (Sept. 23, 2020).

[11] Responsible Shareholder Engagement and Long-term Value Creation, Business Roundtable (Oct. 2016).

[12] Supra note 10, at 10.

[13] Lisa M. Fairfax, Social Activism through Shareholder Activism, 76 Wash. & Lee L. Rev. 1129, 1158 (2019).

[14] 17 C.F.R § 240.14a-8(i)(10).

[15] 17 C.F.R § 240.14a-8(i)(7).

[16] Supra note 10, at 22-23.

[17] Jonas Kron & Brandon Rees, Frequently Asked Questions about Shareholder Proposals 1.

[18] Sullivan & Cromwell, 2020 Proxy Season Review: Part 1, Rule 14a-8 Shareholder Proposals, at 6 (July 15, 2020). Sullivan & Cromwell’s proxy season review defines “large-cap” companies to mean U.S. S&P 500 companies.

[19] Lisa M. Fairfax, Social Activism through Shareholder Activism, 76 Wash. & Lee L. Rev. 1129, 1161 (2019) (citing James D. Cox & Thomas L. Hazen, Cox & Hazen on Corporations 781 (2d ed. 2003)).

[20] Kosmas Papadopoulos, The Long View: The Role of Shareholder Proposals in Shaping U.S. Corporate Governance, Harv. L. Sch. F. on Corp. Governance (Feb. 6, 2019).

[21] Commissioner Allison Herren Lee, Statement on the Amendments to Rule 14a-8, Sec. Exch. Comm’n (Sept. 23, 2020).

[22] Supra note 18, at 1. Sullivan & Cromwell’s proxy season review divides shareholder proposals into three categories: environmental, social and political (ESP), governance-related proposals, and compensation-related proposals.

[23] See Andrew R. Sorkin, BlackRock’s Message: Contribute to Society, or Risk Losing Our Support, N.Y. Times (Jan. 15, 2018).

[24] Brian Croce, Reform Request on Shareholder Resolutions Drawing a Line in the Sand for Public Companies, Activists, Pensions & Invs. (Mar. 18, 2019, 1:00 AM).

[25] Supra note 19, at 1161.

[26] Supra note 24.

[27] Lucian Bebchuk & Scott Hirst, Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy, 119 Colum. L. Rev. 2029, 2102 (2019).

[28] Id. at 2061.

[29] Commissioner Allison Herren Lee, supra note 21 (noting that there is value to individual shareholders in having the option to submit proposals and that the option is valued at zero).

[30] Sullivan & Cromwell, 2020 Proxy Season Review: Part 1, Rule 14a-8 Shareholder Proposals, at 3 (July 15, 2020).

[31] Lisa M. Fairfax, Just Say Yes? The Fiduciary Duty Implications of Directorial Acquiescence, 106 Iowa L. Rev. 1315, 1325-28 (2021).

This post comes to us from Xinyi Mao, a second year student at Columbia Law School and a staff member of the Columbia Business Law Review.