As new chair takes over at SEC, shareholder proposals process under scrutiny

Clayton’s appointment highlights the different views on the SEC’s ‘Rule 14a-8’

Simmering conflict about the process of submitting shareholder proposals under US securities laws could be a feature of the new regime of incoming Securities and Exchange Commission (SEC) Chair Jay Clayton.

A recent report by Florida’s State Board of Administration (SBA) reflects these mixed views and rejects the latest recommendations of corporate lobby group the Business Roundtable, which has called for a “full-scale modernisation” of the regulations.

The rules governing this process, collectively known as Rule 14a-8, have since inception been resisted by corporations who regard them as too onerous and open to abuse from shareholders.

But from the shareholders’ perspective, it’s often argued that Rule 14a-8 provides corporates with too advantageous mechanisms to exclude their proposals from the proxy via the costly and time-consuming ‘no-action letters’ process at the SEC.

Clayton is a partner at Wall Street law firm Sullivan & Cromwell, one of the firms frequently used by corporates to try to block shareholder proposals in the ‘no action’ process.

As his appointment is pending Senate confirmation, uncertainty remains as to whether the SEC would reform the rule – and if so what the tone at the top of a Republican-dominated SEC would be.

Trump still has to appoint three Commissioners to join the current two appointed by President Obama.

On January 25 Senator Michael Crapo, Chairman of the Senate Committee on Banking, Housing and Urban Affairs, tweeted that he had a “positive discussion” with Clayton, whom he described as “an impressive nominee”.

Commenting on the recommendations suggested by the Business Roundtable, which convenes CEOs, Tracy Stewart, Senior Corporate Governance Analyst at Florida’s SBA, told RI that the administration change could mean there is potential for their suggestions to be seriously considered.

Michael McCauley, SBA’s Senior Officer, Investment Programs & Governance, noted that the Business Roundtable’s suggestions are part of a decades-long “whole debate and rationale that regulation has run amok and become too granular”.

The SBA’s report has challenged some of the Business Roundtable’s ideas to “modernise” Rule 14a-8, which CEOs say “it is often used to promote self-interest of a minority of shareholders, frequently at a significant cost to the company”.

Mainly the Business Roundtable took issue with the threshold for submitting proposals ($2,000 in market value or 1% of company’s outstanding stock held for at least one year).

“A number of shareholders take advantage of this holding threshold, described as “absurdly low” by former SEC Commissioner Daniel Gallagher, to submit proposals […] to further their personal agendas,” the report of the Business Roundtable says.Instead, the American CEOs proposed a qualifying threshold of up to 3% of the stock depending on the type of company, and an increased three-year holding period.

SBA’s Stewart suggested that this proposal would be irrelevant in practice. “They are trying to limit the proposal filers to being institutions. I don’t think it is fair to knock out every non-wealthy investor in the US and I don’t think it matters. The facts show those are not the investors making the proposals.”

McCauley added: “Other types of investors will fill the gap, whether it is the unions, public pension funds, or other investor organisations, they would come in and focus on the issue they feel strongly about.”

The SBA’s report stated that its staff examined data by proxy firm firm ISS on SEC filings of no-action requests for 2013-2015. Their findings showed that companies used Rule 14a-8 to challenge one-third of shareholder proposals (“often on very shaky standing,” SBA noted) and about half of them were omitted from the proxy.

In addition, the report stated that an average of just over 500 proposals went to a vote per year, which is an average of only one in six US companies receiving one shareholder proposal annually (taking into account the universe of the Russell 3000 index and that there could be a large variety of corporate governance issues that could be voted on).

The SBA’s report observed: “About 16% of these proposals receive a majority support [on] issues that investors feel are important. Even proposals with fairly low support in one year can quickly build momentum to becoming majority-supported proposals in the next.”

In response to the alleged costs for companies associated with challenging shareholders’ proposals, the SBA’s report highlighted that those proposals are legally non-binding and that there is no requirement to be challenged. “Any response costs to a shareowner proposal could be nearly zero (no more than a typical engagement call with investors, which is quite commonplace).”

Notably the Business Roundtable wrote: “Most social, environmental and political proposals, such as those related to corporate political spending, climate change and human rights, have only an attenuated connection to shareholder value and are generally not issues material to a company’s business.”

In a recent article, Bernard S. Sharfman, Adjunct Professor of Business Law at the George Mason University School of Business, welcomed the US House of Representatives’ legislative efforts to repeal section 971 of the Dodd-Frank Act, which vest the SEC with authority to issue rules on proxy access.

Sharfman wrote that once the SEC has a majority of Republicans, Commissioners would be being able to modify Rule 14a-8. Then the SEC should return to “its traditional position on proxy access, i.e., providing the board with discretion to omit shareholder proposals on proxy access from a company’s proxy materials.”

A spokesperson for the SEC told RI that there is no news regarding updates or amendments of Rule 14a-8.