Shareholder advocates argue that the U.S. Securities and Exchange Commission's proposed changes to the rules on shareholder resolutions and proxy advisers would tip the scales of the process in favor of corporate management and ultimately hurt capital markets. Business groups contend that the changes are sorely needed.
Companies are coming under increased pressure from investors to disclose how environmental, social and governance risks could impact their bottom line and to outline how they are addressing those risks and opportunities. Shareholders say that a key way to raise those concerns with companies is by making proposals that other shareholders can vote on at companies' annual meetings. But as the number of ESG-focused resolutions increased, business groups lobbied to reform the shareholder resolution process that they said allowed certain special interest groups to push their political agendas.
The U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness in recent comments suggested the reforms are "long overdue."
"Over time, the commission’s prudential guardrails have steadily weakened, and the shareholder proposal system today has unnecessarily devolved into a free-for-all that a small minority of interests use to advance idiosyncratic agendas at the expense of main street investors," the chamber wrote. The SEC's proposal is an "important step toward rebalancing the scales for the benefit of main street investors."
But sustainability group Ceres, in comments co-signed by 37 investor organizations, argued the changes would unduly shield corporate managers from being accountable to shareholders to "the detriment of investors, capital markets, and the economy."
The changes "would reduce long-term shareholder value by excluding proposals that result in greater returns or significant cost savings" to companies, Ceres and the investors wrote. "Shareholder proposals, particularly ones that address ESG issues, help corporations manage risk, especially long-term and systemic risk. Such proposals are also critical to combat instances in which corporate managers rely on inaccurate information."
What the SEC would change
The SEC in November 2019 proposed to increase the amount of support a shareholder resolution would need to be reconsidered in the years following an initial vote under the proxy process regulation. Rather than resolutions needing at least 3% support the first year, 6% the second year, and 10% the third and subsequent years after an initial vote to be reconsidered, the SEC would raise those thresholds to 5%, 15% and 25%, respectively.
The Sustainable Investments Institute found that if the rule had been applied from the beginning of 2010 through Nov. 18, 2019, about 30% of ESG resolutions would not have been eligible for resubmission under the SEC's proposed changes. That total is almost three times the number of resolutions that could have failed existing threshold requirements over that time, according to Market Intelligence's analysis of the data.
In the same rulemaking, the SEC also proposed to change the broader eligibility requirements to submit a resolution. Currently, a shareholder must have continuously held at least $2,000 or 1% of a company's stock for at least one year. The SEC would drop the 1% requirement but a shareholder would need to hold at least $25,000 in securities in the applicable company for at least one year, or $15,000 for two years, or $2,000 for three years to submit a resolution. The proposed shareholder resolution process rule includes additional transparency requirements on the part of the shareholder, particularly when they are being represented by an organization.
In another rulemaking, the SEC proposed to subject proxy advisory firms to new disclosure requirements for potential conflicts of interest, giving companies an opportunity to review proxy voting advice for errors and codifying the SEC's position that proxy voting advice constitutes a solicitation.
The combined impact of the rules
When the agency proposed the rulemakings, Commissioner Robert Jackson suggested the rules would significantly tip the scales in favor of corporate management over shareholders. Jackson argued that "raising the thresholds at the same time we are imposing a tax on anti-management advice gives us no opportunity to observe the effects of that tax on the levels of support proposals should be expected to receive."
A number of shareholder advocates echoed Jackson's concerns about the two rules. The changes to the proxy rules will make it more challenging for proxy advisers to recommend shareholders vote against management, which will, in turn, decrease how much support those resolutions get from investors at annual meetings even as the SEC is increasing the resubmissions thresholds, the advocates said.
Ceres, for example, argued that the changes are arbitrary because the SEC has not estimated the impact of the proposed proxy rule on shareholder voter participation. The group also said the SEC's cost-benefit analysis of the rule is incomplete because it fails to account for the benefits that shareholder resolutions have brought to companies by raising issues that could result in significant losses in such areas as predatory lending and climate change.
The Interfaith Center on Corporate Responsibility and the Principles for Responsible Investment, known as PRI, also worried that the proposed changes would significantly hamper shareholders' ability to engage with companies on key issues and questioned whether the SEC had properly calculated costs and benefits.
The changes would "gut the existing shareholder proposal process, which has long served as a cost-effective way for shareholders to communicate their priorities and concerns, in exchange for minuscule and poorly supported benefits for companies," said the interfaith center, a coalition of more than 300 institutional investors representing more than $500 billion in invested capital.
Business groups back proposal
A number of business groups and companies generally voiced support for the proposed changes to both the proxy rules and the shareholder resolution process and urged the commission to go even further in some areas.
For example, Nasdaq Inc. argued that the SEC should prohibit the use of representatives in submitting a shareholder proposal. A proponent could still use a law firm or other adviser to consult on the proposal, but the proponent would have to submit the proposal and engage with the company on that resolution directly. Doing so would ensure the proponent "has a genuine and meaningful interest in the relevant proposal," Nasdaq wrote.
Southwestern Energy Co. also commented on the use of representatives to submit resolutions. The SEC should require the proponent to sign the resolution page and date it or embed the text of the resolution in the letter authorizing a group to represent that shareholder, Southwestern wrote. "This requirement would help assure that the substance of the proposal was in fact before the proponent when the authorization was signed rather than simply attaching a previously signed form letter, as frequently occurs," Southwestern said.
Nasdaq and the Business Roundtable, an association of company CEOs, each suggested the resubmission thresholds for the first and third years should be higher at 6% and 30%, respectively. And the roundtable urged the agency to adjust the stock ownership requirements every three years on a going-forward basis to account for inflation.
The SEC had requested comment on whether it should require shareholders that co-file a resolution to identify a lead filer in their request, which the chamber and the Business Roundtable said they support. Not knowing who the lead is can cause logistical problems for a company trying to negotiate and communicate with that group of shareholders, especially if they are not all aligned on their objectives, the chamber said.