On November 5th, 2019, the Securities and Exchange Commission (SEC) announced two proposed rules that will have an impact on how investors will be able to vote their proxies, engage with companies and hold management accountable. Together, these proposals shift power from investors to corporate management.
The first proposal makes changes to Rule 14a-8 of the Securities and Exchange Act of 1934 (1934 Act), which sets the parameters for the shareholder proposal process. The second proposal aims to further regulate proxy advisory firms and their ability to provide independent research, data and voting services to their clients under the 1934 Act.
The shareholder proposal rule (Rule 14a-8) is a vitally important, market-based mechanism for shareholders to communicate with boards, management and other shareholders on important corporate governance risks as well as social and environmental issues that are not being properly addressed.
For decades, the shareholder proposal process has been one of the most visible and verifiable ways in which investors can practice responsible ownership. It provides shareholders’ the ability to file resolutions at companies’ annual meetings.
Rule 14a-8 was designed to protect investors, including those with limited stock holdings. The threshold to file shareholder proposals (currently $2,000 of shares held for one year) was intentionally set at a level to allow both individual and institutional shareholders to engage corporate boards and senior management.
In addition, the current rule allows resubmission thresholds that provide an opportunity for proposals to gain support over time. Proposals that required resubmission/multiple resubmissions to gain support have contributed to significant and tangible benefits at countless companies. For example, recent proxy access proposals (granting investors the right to nominate board directors to appear on the proxy) at Netflix, Citigroup and Cisco started in the single-digits but in subsequent years earned majority votes. Shareholder proposals also have contributed to such advances as independent boards of directors, say-on-pay vote requirements and adoption of global human rights principles. The proposed rule will make it significantly more difficult for investors to get critical issues on the meeting agendas of publicly traded companies.
Proxy advisory firms help investors meet their fiduciary responsibilities by providing efficient and cost-effective research services to help inform their proxy voting decisions. This proposed rule would require proxy advisory firms to give issuers the opportunity to review and comment on the proxy advice before it is issued. It would also allow issuers to include a link to the issuers' views when proxy advice is sent to recipients. These changes would increase costs to investors and delay the timely delivery of the reports to investors. It also potentially threatens the integrity of the proxy advice because it compromises the independence of the research.
What’s in the Proposed Rules?
Rule 14a-8 - Shareholder Proposals
The proposal does away with the simple requirement that shareholders must hold at least $2,000 worth of company shares for one year to be eligible to file a shareholder proposal at its annual meeting. Instead, the proposed rule creates a new tiered system based on the length of time the shares are held. For shares held one year, the SEC proposes a massive 1200 percent increase in the stock ownership required—to $25,000. If held for two years, the amount is $15,000 and for three years, the level is $2,000.
No Aggregation of Shares
Historically, investors have been able to combine their holdings to meet the ownership threshold in order to file a resolution. The SEC proposal bars share aggregation while also imposing a huge increase in the ownership threshold for shares held less than two or three years.
The support that shareholder proposals must receive—based on the percentage of the shares voted—to be eligible for resubmission historically has been set at modest levels to allow emerging issues to build broader support over time. The current thresholds necessary in order to resubmit are 3 percent of the shares voted the first year, 6 percent the second year and 10 percent the third year and beyond. The proposal raises these to 5 percent, 15 percent and 25 percent respectively.
The SEC also proposes an entirely new “momentum” provision that seems to seek to ensure that some of the proposals that successfully get more than 25 percent of the vote may not be able to be resubmitted. This provision allows a proposal to be omitted from the proxy if it reaches the 25-50 percent range after three years, but the proposal’s support decreases by 10 percent from the previous year’s vote. This sets up a possible illogical scenario where a proposal that loses support from 49 percent to 44 percent in the fourth year (a 10 percent decline from 49 percent) can be omitted, but a proposal that remains steady at 27 percent on the fourth year’s vote can be resubmitted. The imposition of this rule would declare that a vote of 44 percent is a weaker outcome than a vote of 27 percent.
The proposed rule would not allow an investor or a representative to offer more than one shareholder proposal per meeting. A shareholder-proponent would not be permitted to submit one proposal in his or her name and simultaneously serve as a representative to submit a different proposal on another shareholder's behalf for consideration at the same meeting. An investment advisor with several clients with different concerns about the same company would be forced to make a difficult choice on which proposal to put forward.
The proposed rule would also mandate that the proponents make themselves available to the company for dialogue in person or by phone. For asset owner proponents who have hired asset managers or other representatives for their professional guidance and advocacy services, this represents an interference with the client/manager relationship. This portion of the proposed rule is a radical departure.
Proxy Advisor Rule
Issuer Pre-review of Proxy Advice
This rule mandates that proxy advisory firms give issuers (companies) an opportunity to review and provide feedback on proxy voting advice before proxy advisory firm clients get to see it. It also requires proxy advisory firms to include a link to an issuer’s position paper if the issuer disagrees with the proxy advisory firm’s conclusions. This is unprecedented interference with the ability to provide independent
research that investors rely on. It is also in direct contrast to the regulation of stock analyst reports. Those rules prohibit stock analysts from sharing draft research reports with target companies, other than to correct factual errors after approval from the firm’s legal or compliance department.
Therefore, if the SEC adopts its proxy advisor regulation, a stock analyst and a proxy advisor could write a report on the same company and the stock analyst would violate securities laws by showing it to the company in advance, while the proxy adviser would violate the law if it did not show it to the company in advance.
Currently, the two predominant proxy advisory firms, ISS and Glass-Lewis, have an informal process to allow issuers to correct any factual inaccuracies in their reports.
Disclosure of Conflicts
The proposed rule includes a largely non-controversial provision that mandates that proxy advisors disclose material conflicts of interest in their voting advice.