Is the SEC ‘no action’ process the next battleground in the ESG backlash?

The US Securities and Exchange Commission is not free from political influence. The appointment of new commissioners, including chairs, are the prerogative of the sitting president – albeit with the caveat that no more than three out of the five can represent the same party.

With the passing of power between Democrat and Republican leaders comes a parallel swing of the pendulum at the financial watchdog, despite its independence. Such oscillations have, however, arguably intensified in recent years, particularly when it comes to the oversight of shareholder proposals.

Consecutive record-breaking years in terms of the sheer volume of ESG-focused resolutions being filed and put to vote at US listed firms is increasingly drawing the ire of right-wing critics, opening yet another front in the war on ESG.

But the recent abundance is in stark contrast to the lean years during President Trump’s administration, which saw the SEC increasingly allow companies to exclude shareholder proposals on ESG issues – particularly emissions reduction targets – via its “no action” process.

Through this decades-old mechanism companies can ask for reassurance that the SEC will not act if they omit a shareholder proposal from its proxy statement by appealing to rules that govern the process. Rules around ordinary business, micromanagement and substantial implementation carried particular force during the Trump years, defeating many ESG-orientated proposals.

Following the election of President Biden in 2020 and the appointment of SEC chair Gary Gensler in 2021 came new guidance and proposed rule changes to the “no-action” process, substantially tipping the balance of power away from companies and their interpretations of the rules that govern it in favour of shareholders – much to the chagrin of some in the corporate world and their supporters.

It is perhaps unsurprising then that the mechanism is now firmly in the crosshairs of Republican critics, including those within the SEC itself. But rather than trying to tip the balance back in their favour, the aim now seems to be the dismantling of the “no action” process itself.

In June, Republican SEC commissioner Mark Uyeda suggested that US companies could completely bypass the regulator when determining whether a shareholder proposal should go to the vote by setting their own standards, governed at state level.

Speaking at the Society for Corporate Governance he said the financial watchdog’s Rule 14a-8 provides only a “procedural bases for exclusion”, which should be viewed as “default standards that apply only if companies decline to establish their own standards in their governing documents”.

Just a few days later, the Republican’s ESG Working Group raised its own concerns on the “no action” mechanism in a memorandum to the Republican members of the House Committee on Financial Service, outlining its key priorities and concerns.

Noting the “burdening” of companies by the “influx of ESG-related proposals”, the group stated that there “must be sensible reforms to the SEC’s no-action letter process and granting companies greater autonomy in developing their own shareholder proposal procedures.”

One of the four anti-ESG bills advanced by the House Committee on Financial Service last week, titled The Businesses Over Activists Act, seeks to clarify that the SEC does not have the power to regulate shareholder proposals and would prevent it from forcing companies to table them.

History repeating itself  

Sanford Lewis, an attorney at US-based legal adviser Strategic Counsel and a veteran observer of shareholder proposal battles, tells Responsible Investor that commissioner Uyeda is “echoing Exxon and the right-wing think tank the Manhattan Institute which have also recently resurfaced the same idea”. But he adds that the notion has previously been considered and rejected by the SEC in 1982 during the administration of President Reagan.

At that time there was even “opposition from the corporate community”, adds Con Hitchcock, a US lawyer specialising in corporate and securities law, who says there was an opinion that it was better to stick with the “devil you know than one you don’t”.

The only change that emerged from that review was that shareholders must hold $1,000 of stock for at least a year before filing – previously there was no restriction.

Hitchcock describes Uyeda’s suggestion as “one of those bottom desk drawer ideas that crops up every time someone talks about making a change”. But adds that it is being floated with “some degree of serious consideration”.

This view was echoed by Lewis, who pointed to the number of footnotes in Uyeda’s speech. “This is a significant investment in research toward these ideas, whether it is with an eye toward rulemaking, legislation or litigation.”

Lewis tells RI that the “new assault on the shareholder proposal process is placing engaged investors on alert”. Although a lot of the talk is “recycling old wine in new bottles”, he says, if the balance among the commissioners at the SEC shifts toward Republican “you never know in this environment how extreme their reforms might be”.

Conceivable, but unadvisable  

It is “conceivable” that a company could already amend its bylaws to state that shareholders do not have the right to present proposals at its annual meeting, Hitchcock says, “and if there’s no right to present the proposal, there’s no right to vote on it, then there’s no right to ask to put something in the proxy”.

But there is a key distinction between what a company can do under state law and what it can do under federal securities law, he adds.

“Shareholder proposals can be a useful way, if nothing else, to blow off steam, to send management and the board a message that we don’t like X”
Con Hitchcock, lawyer   

Delaware general corporate law, which most large US listed firms fall under, states that company bylaws must be consistent with applicable federal law. This means that a company cannot change, for example, filing thresholds – such as those on the number of shares or length of ownership needed for a shareholder to file – as these are set out by the SEC.

A company could potentially deny the right to submit shareholder proposals for a vote at the annual meeting, but if it does allow them, then the procedures around them must be consistent with SEC federal law.

But if a company opted to prevent shareholders from raising issues like climate change at its annual meeting, Hitchcock says that the pushback would likely extend beyond those just concerned about that issue, and would become a broader governance concern.

“I could see individual investors and [big proxy advisers] Glass Lewis and ISS saying that if a board of directors removes the right of shareholders to offer proposals on issue X, we will recommend voting against those directors.”

Removing a pressure valve  

The removal of a shareholder’s right to file a non-binding, advisory proposal also removes a low stake avenue for protest, leaving investors with votes against the board as the remaining avenue for protest on an issue.

“Shareholder proposals can be a useful way, if nothing else, to blow off steam, to send management and the board a message that we don’t like X,” Hitchcock says.

Amy Borrus, executive director of the Council of Institutional Investors, the nonpartisan association of US pension funds, believes that few large-cap companies would try to block the filing of shareholder proposals.

“Doing so could trigger a shareholder backlash, potential litigation and reputational risk,” she tells RI.

Borrus describes the shareholder proposal process as a “well-functioning pillar of corporate governance in US capital markets for many decades”, one which “provides a cost-effective mechanism for proponents to communicate with fellow shareholders and for shareholders as a group to communicate with management through votes on proposals”.

But if a company did attempt to deny shareholders the right to file proposals, one option would be for an investor to take the company to state court. Something like this happened in 2020 when a Californian trial lawyer unsuccessfully took NorthWestern Corp to court in Montana in a bid to get his proposal on the ballot of the US energy firm.

Hitchcock says such an approach is not advisable in most instances. “I don’t think the Delaware courts would be terribly sympathetic to a lawsuit challenging the ability of the company to restrict substantive rights.”

Genuine conversation

Dave Wallack, executive director at For the Long Term, the US non-profit working with state investors on long-term sustainable growth, thinks that the proposal put forward by Uyeda and others is “nonsensical” and would essentially throw the baby out with the bath water.

“The ability of shareholders to create some accountability for boards and for managers, is something that’s worthy of defending and fighting for,” he says.

Wallack acknowledges that the SEC under Gensler has “opened the doors a little bit” when it comes to the number of ESG-focused proposals making it through to the vote and adds that it is a “great conversation to have” as to how the process could evolve.

But the response that the system should be dismantled and devolved to each state he says, “is not a genuine focus on how do we evolve this situation”.

“It’s an optimal balance between the rights of shareholders to be a part of this process and also making sure that businesses are able to create value and operate in a way that’s not overwhelmed by this process,” he adds.

Everyone would benefit from a “genuine conversation between the right and the left about how we can manage ESG risk disclosure in a way that works, how we could manage shareholder rights in a way that works”, Wallack tells RI, “but that’s not the conversation we’re having right now, and that’s a little disappointing”.