The Corporate Contract and the Private Ordering of Shareholder Proposals

Should Coca-Cola do more to protect abortion rights?[1] Should Mastercard track gun purchases?[2] Should Disney’s workplace DEI trainings be more sensitive to conservative perspectives?[3] More importantly, should an activist holding only a nominal stake in any of these companies be able to force a shareholder vote on such divisive questions? Under Rule 14a-8 (the “Rule”), the answer is yes.

Promulgated under Section 14(a) of the Exchange Act of 1934, the Rule requires a public corporation to include any qualifying shareholder proposal on the corporation’s proxy statement. The Rule thus enables a single shareholder to force a corporate referendum on whatever hot-button issue that they wish to spotlight.

The Problem

Today, shareholder-activists pepper corporations with proposals in record numbers. Under the ESG banner, As You Sow and other like outfits annually target corporations with proposals concerning progressive priorities ranging from climate change, labor relations, and political lobbying to reproductive rights, gun safety, and diversity, equity, and inclusion. Meanwhile, conservative organizations like the National Center for Public Policy Research have begun submitting competing proposals, seeking to undermine ESG initiatives and urging a return of corporate focus to profits.

Caught in the crossfire are America’s largest businesses. Corporate leaders complain that these divisive proposals are costly distractions, consuming valuable board time, driving up legal fees, and drawing unwanted media attention. Average investors have shown little enthusiasm for backing them, yet the SEC has exacerbated the situation. Before 2022, companies could exclude any proposal concerning an environmental, social, or political issue if it lacked a “sufficient nexus” to a company’s business. But under the Biden administration, the SEC abandoned this longstanding interpretation of the Rule. The result has been an ever-growing number of proposals being put before shareholders each year.

A Solution

In a forthcoming article, I offer a path out of this morass. Under Delaware law, which governs most public companies, a corporation’s charter and bylaws represent a binding “contract” between the corporation and its shareholders. Moreover, Delaware law affords broad freedom in the corporate contract to regulate shareholders’ governance rights, including the right to make or vote upon a proposal at a shareholder meeting. And because a shareholder’s access to the Rule is itself dependent on these state-law rights, a provision in the corporate contract restricting shareholder proposals is not preempted by the Rule or the Exchange Act.

While skeptics have long questioned the SEC’s authority under the Exchange Act to impose the Rule, both skeptics and proponents alike have largely failed to recognize that shareholder proposals are subject to private ordering. Instead, relying exclusively on the dicta of a 77-year-old lower-court precedent, SEC v. Transamerica Corp., most have assumed that the Rule imposes an unbending federal mandate on all public companies to hold a shareholder referendum on any qualifying proposal. The Transamerica dicta, however, is both non-binding and out-of-step with subsequent U.S. Supreme Court decisions interpreting the federal securities statutes. Indeed, even the SEC has recognized that shareholder proposal rights may be altered pursuant to state law and that the Rule permits such private ordering.

Implications

Beyond pragmatic implications, the private ordering of shareholder proposals has immediate constitutional and policy ramifications. The ability of corporations to limit or eliminate proposals made under the Rule complicates the arguments recently made by skeptics in pending litigation that the Rule violates the First Amendment guarantee against compelled speech. Corporations do, in fact, have a choice. Because each company may, through the terms of its governing documents, choose what kinds of proposals to include in its proxy statement, no company is forced to carry a proposal due solely to government mandate. Access to private ordering may also quiet the recent clamor among congressional Republicans eager to reform the Rule. If left-leaning activists have hijacked the Rule for partisan ends, as conservatives claim, then public companies already possess the tools necessary to push back.

Importantly, simply because public companies may, through private ordering, regulate shareholder proposals does not mean that every company will choose to do so. The risk of political backlash, resistance among investors, and other practical considerations may lead some, perhaps most, public companies to leave shareholder proposal rights untouched. At the same time, the opportunity to escape the SEC’s unpredictable no-action process and adjudicate shareholder-proposal disputes before the sophisticated and more politically-insulated courts of Delaware could prove tempting. Different companies will weigh these considerations differently – just as economic efficiency would require. Through private ordering, each company may tailor shareholder proposal rights to best meet its needs, and securities markets may efficiently price those rights for the benefit of investors.

ENDNOTES

[1] See Shareholder Proposal on page 114 of Coca-Cola’s 2023 Proxy Statement.

[2] See Shareholder Proposal on page 126 of Mastercard’s 2022 Proxy Statement.

[3] See Shareholder Proposal on page 83 of Disney’s 2022 Proxy Statement.

This post comes to us from Mohsen Manesh, the L.L. Stewart Professor of Business Law at the University of Oregon School of Law. It is based on his recent article, “The Corporate Contract and the Private Ordering of Shareholder Proposals,” available here.

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