Shareholder proposals under Rule 14a-8 have played a major role in transforming corporate America, bringing to the fore everything from non-staggered boards and majority voting for directors to disclosure concerning diversity and lobbying expenditures. Most shareholder proposals are “precatory”—advisory rather than binding. The SEC has encouraged this through its understanding that precatory proposals are generally “a proper subject for action by shareholders under the laws of the jurisdiction of the company’s organization.” But this understanding has now come under extreme pressure. Based on an interpretation of Delaware corporate law recently advocated by a partner at a prominent Delaware law firm, SEC Chair Paul Atkins, has suggested that the agency should re-interpret the rule to allow companies to exclude precatory proposals as not a proper subject for shareholder action.
In a recent paper, I make a legal and a policy argument against this proposed re-interpretation. The legal argument is that given Rule 14a-8’s current language and a proper understanding of state law (at least in Delaware), the SEC’s traditional approach is correct, and the agency cannot reverse itself through a mere re-interpretation. The policy argument is that precatory proposals play a useful role in public company governance. Although it may be worth exploring ways to introduce more private ordering, shareholders must have a central role in shaping that private ordering.
Consider first the legal argument. What is the status of precatory shareholder proposals under Delaware corporate law? There’s not much in that law about such proposals, and the paper on which Atkins relies concludes that shareholders do not have a guaranteed right to make such proposals. I agree, but it is also true (and that paper does not disagree) that Delaware law does not prohibit the proposals either. Precatory proposals are permissible under Delaware law.
If precatory proposals are permissible, then they are “a proper subject for action by shareholders” under Delaware law, and hence not excludable under Rule 14a-8. Things would get a bit trickier were a company to attempt to disallow precatory proposals under its bylaws or certificate of incorporation, but even then the proposals would remain a proper subject for action by shareholders under Delaware law, which is the key terminology in the rule. The SEC of course has the power to re-write the rule either to allow companies to limit precatory proposals for their shareholders or to limit such proposals in all companies. But that would require amending the rule under formal notice-and-comment rulemaking. Atkins contemplates re-interpreting the rule through no-action letters. That is inconsistent with Rule 14a-8’s language. Hence the title of my paper: “Rule 14a-8 Permits Precatory Proposals, and the SEC Can’t Just Say It Ain’t So.”
Since I first wrote the paper, we have entered into the current proxy season of annual shareholder meetings. The SEC drastically cut back on its usual no-action letter process for considering whether companies may exclude proposals under the rule. The SEC is not currently opining on whether most bases for excluding proposals are valid, creating considerable confusion for companies and shareholders. But the SEC did indicate willingness to provide no-action guidance on the proper subject for shareholder action exclusion, leaving open the interpretive strategy Atkins outlined.
Soon after announcing that procedure however, a presidential executive order directed the SEC to consider amending Rule 14a-8. It then became quite unclear whether companies would take the bait and argue that precatory proposals are excludable or instead wait out this proxy season and see what the agency does about amending the rule. It looks as if companies have chosen the latter option—as of this writing, it appears the SEC has not received any no-action requests on the proper subject for shareholder actions.
It may well be that the SEC will wind up following my advice (but surely not taking my advice) and not attempt to drastically change practice under Rule 14a-8 through a no-action letter. Instead, it will formally amend Rule 14a-8. That is procedurally the right way to move forward, but not necessarily the right thing to do.
Which brings us to the policy argument in favor of precatory proposals. The success of proposals in reforming corporate governance over the past decade and in focusing attention on important social issues affecting businesses points to significant value. Empirical studies yield mixed results, the norm in scholarship on corporate governance, but studies using a gold-standard methodology tend to suggest proposals add value. These studies focus on cases where the vote is very close to 50-50. Among those cases, companies where the proposal just barely passed saw a noticeable increase in shareholder value relative to companies where the proposal barely failed. Of course, many proposals, especially environmental and social ones, get little support, but those do not seem to cause any great harm. Shareholders seem to be doing a decent job at sorting the wheat from the chaff.
The strongest argument for reforming the 14a-8 process is that private ordering through state competition and choice for individual companies may lead to valuable experimentation and useful variation among companies with differing circumstances. But, state law and private ordering also lead to some bias favoring managerial entrenchment over shareholder interests. The federal government has a significant role to play in policing the governance process to guard against too strong an anti-shareholder turn. That is the point of federal proxy regulation.
I am thus skeptical whether the current system really needs major change. But, if the SEC does decide to allow more private ordering, it will be important to give shareholders a significant role in determining the rules of the game. If we allow company bylaws to restrict or possibly eliminate precatory proposals, then SEC rules need to protect the ability of shareholders to enact bylaws that regulate the shareholder proposal process. That ability is rooted in state law already, but federal regulation may be needed to ensure that shareholders can effectively exercise that power granted by state law.
Going forward in the face of potential SEC rulemaking, the policy analysis will need to be expanded and applied to a wider range of alternatives that the SEC might consider. A broad world of potential alternatives opens up. But in the meantime, please Chair Atkins: Don’t shortcut the hard work of legal reform by using a few speeches and no action letters to throw away decades of practice in an interpretation that distorts current law.
Brett McDonnell is Dorsey & Whitney Chair and professor at the University of Minnesota Law School. This post is based on his recent article, “Rule 14a-8 Permits Precatory Proposals, and the SEC Can’t Just Say It Ain’t So,” available here.