In his recent speech, SEC Commissioner Daniel Gallagher also commented on the state of SEC Rule 14a-8--the so-called shareholder proposal rule.
First, he identified the problem:
The Commission’s rules have for decades permitted qualifying shareholders to require the company to publish certain proposals in the company’s proxy statement, which are then voted upon at the annual meeting.
Unfortunately, the Commission has never adequately assessed the costs and benefits of this process. Currently, a proponent can bring a shareholder proposal if he or she has owned $2,000 or 1% of the company’s stock for one year, so long as the proposal complies with a handful of substantive—but in some cases discretionary—requirements. Activist investors and corporate gadflies have used these loose rules to hijack the shareholder proposal system.
The data and statistics are striking. In 2013, the number of shareholder proposals rose ... [but] only 7% of shareholder proposals received majority support in 2013.
These proposals are not coming from ordinary shareholders concerned with promoting shareholder value for all investors. Rather, they are predominantly from organized labor, including union pension funds, which brought approximately 34% of last year’s shareholder proposals, as well as social or policy investors and religious institutions, which accounted for about 25% of 2013’s proposals. Approximately 40% were brought by an array of corporate gadflies, with a staggering 24% of those proposals brought by just two individuals.
He then turned to possible solutions:
First, the holding requirement to submit proxies should be updated. $2,000 is absurdly low, and was not subject to meaningful economic analysis when adopted. The threshold should be substantially more, by orders of magnitude: perhaps $200,000 or even better, $2 million. But I don’t believe that this is actually the right fix: a flat number is inherently over- or under-inclusive, depending on the company’s size. A percentage threshold by contrast is scalable, varies less over time, better aligns with the way that many companies manage their shareholder relations, and is more consistent with the Commission’s existing requirements. Therefore, I believe the flat dollar test should be dropped, leaving only a percentage test. ...
I also think we need to take another look at the length of the holding requirement. A one-year holding period is hardly a serious impediment to some activists, who can easily buy into a company solely for the purpose of bringing a proposal. All that’s needed is a bit of patience, and perhaps a hedge. A longer investment period could help curtail some of this gamesmanship. ...
He also recommends giving companies greater power to exclude shareholder proposals affecting ordinary business matters and capping the number of times a proposal can be repeated.
Much of the Commissioner's analysis is consistent with arguments I made recently in Preserving Director Primacy by Managing Shareholder Interventions. As the abstract explains:
Even though the primacy of the board of director primacy is deeply embedded in state corporate law, shareholder activism nevertheless has become an increasingly important feature of corporate governance in the United States. The financial crisis of 2008 and the ascendancy of the Democratic Party in Washington created an environment in which activists were able to considerably advance their agenda via the political process. At the same time, changes in managerial compensation, shareholder concentration, and board composition, outlook, and ideology, have also empowered activist shareholders.
There are strong normative arguments for disempowering shareholders and, accordingly, for rolling back the gains shareholder activists have made. Whether that will prove possible in the long run or not, however, in the near term attention must be paid to the problem of managing shareholder interventions.
This problem arises because not all shareholder interventions are created equally. Some are legitimately designed to improve corporate efficiency and performance, especially by holding poorly performing boards of directors and top management teams to account. But others are motivated by an activist’s belief that he or she has better ideas about how to run the company than the incumbents, which may be true sometimes but often seems dubious. Worse yet, some interventions are intended to advance an activist’s agenda that is not shared by other investors.
This [essay] proposes managing shareholder interventions through changes to the federal proxy rules designed to make it more difficult for activists to effect operational changes, while encouraging shareholder efforts to hold directors and managers accountable.
In particular, I argued that:
An appropriate starting point would be the shareholder proposal rule, which figures in about a third of shareholder interventions. Under current law, companies may not opt out of Rule 14a-8. If the law were changed to permit companies to adopt provisions in their articles of incorporation–either in the initial pre-IPO articles or by charter amendment thereafter–that would provide both a check on shareholder interventions and, if widely adopted, it would also provide evidence that investors prefer such provisions.
A less sweeping opt out provision would allow corporations to opt out of the current exemption in Rule 14a-8(i)(1) for proposals that are not proper as a matter of state corporate law. Under present law, a corporation must include in its proxy statement a shareholder proposal that is not a proper subject of a shareholder action under the law of the state of incorporation provided that the proposal is framed as a recommendation. Allowing companies to exclude such proposals even if phrased in precatory terms would provide a rough first cut at effecting the proposed substance/procedure distinction.
In order to effect that distinction, the exemption under Rule 14a-8(i)(7) for proposals relating to ordinary business expenses needs to expanded and revitalized. Under current law, the ordinary business exclusion is essentially toothless. The SEC requires companies to include proposals relating to stock option repricing, sale of genetically modified foods and tobacco products by their manufacturers, disclosure of political activities and support to political entities and candidates, executive compensation, and environmental issues. Obviously, however, these sort of ordinary business decisions are core board prerogatives. Because deference to board authority remains the default presumption, this exemption therefore needs to be expanded and revitalized.
Activist shareholders who make use of Rule 14a-8 should be required to provide greater disclosures with respect to their motivations, goals, economic interests, and holdings of the issuer’s securities (including derivative positions), so that their fellow shareholders can assess whether the activist’s goals are consistent with the interests of all shareholders. Towards the same end, the eligibility threshold for using Rule 14a-8 should be increased to require that the proponent have held a net long position of 1 percent of the issuer’s voting stock for at least two years. In addition to decreasing the risk that the activist would be pursuing private rent seeking, by discouraging proposals from activists using an empty voting strategy, such a change will ensure that activists are long-term investors rather than short-term speculators.
The proxy rules also should be amended to prevent hedge funds from compensating those members of an issuer’s board of directors that were nominated by the fund. The recent trend toward such payments raises serious conflicts of interest, as the hedge fund’s nominees likely will be loyal to the fund rather than the issuer. In particular, such directors have financial incentives to acquiesce in—or even assist—private rent seeking by their fund sponsor.