The Securities and Exchange Commission Amends the Shareholder Proposal Rule

The SEC today announced adoption of a final rule making important—and, in my opinion—long overdue changes to Rule 14a-8 (the shareholder proposal rule).

Before today's amendments, under Rule 14a–8(b)(1), a shareholder-proponent must have owned at least 1% or $2,000 (whichever is less) of the issuer’s voting securities for at least one year prior to the date on which the proposal is submitted. Per Rule 14a–8(c), the proponent may only submit one proposal per corporation per year. The proponent may continue to submit the same proposal to the same firm year after year in the hopes that it will eventually be adopted by the shareholders, provided the proposal annually receives a specified level of support. Under Rule 14a–8(d), a proposal and any accompanying supporting statement may not exceed 500 words in length.

There are a number of substantive grounds on which a proposal may be excluded from the company's proxy statement, which I detail in my book Corporate Law (Concepts and Insights).

Absent Rule 14–8, there would be no vehicle for shareholders to put proposals on the firm’s proxy statement. Shareholders’ only practicable alternative would be to conduct a proxy contest in favor of whatever proposal they wished to put forward. The chief advantage of the shareholder proposal rule, from the perspective of the proponent, thus is that it is cheap. The proponent need not pay any of the printing and mailing costs, all of which must be paid by the corporation, or otherwise comply with the expensive panoply of regulatory requirements.

As I explained in my article, Revitalizing SEC Rule 14a-8’s Ordinary Business Exclusion: Preventing Shareholder Micromanagement by Proposal, 85 Fordham L. Rev. 705 (2016):

The shareholder proposal rule long was a tool mainly of gadflies and social activists. Shareholder proposals were rare and almost uniformly defeated by wide margins. The process thus “amounted to little more than a nuisance for corporate management.” Much of the law governing shareholder proposals developed during this period in which the stakes were low.

In contrast, today the stakes are quite high. The volume of shareholder proposals has increased dramatically over the last two decades. Proponents are no longer just gadflies and social justice warriors, but rather now include major institutional investors such as hedge funds and union and government pension funds. Although most proposals still fail to receive majority shareholder support, a growing number do. This is true not only for laggard firms, but increasingly even for successful ones. As a result, all corporate directors and managers now must take shareholder proposals quite seriously.

Simultaneously with the rising volume of proposals came a dramatic shift in their subject matter. Historically, most shareholder proposals focused on issues of corporate social responsibility. Over the last two decades, however, a growing number of proposals focused on corporate governance questions. Today, many proposals address issues traditionally regarded as board or management prerogatives, as a substantial number effectively seek to manage or even micromanage corporate decisions. This shift has become especially prominent in the growing use of shareholder proposals by hedge funds seeking to effect changes in management personnel or corporate strategy of targeted companies.

Rule 14a-8 was never intended to permit shareholders to micromanage a corporation.

But that is, increasingly, what activist shareholders are trying to use it to do.

The SEC's Adopting Release is best described as prolix. One hundred and ninety five pages to adopt amendments that total four and a half pages. As those who labor in this vineyard know, however, the SEC was reprimanded by courts repeatedly in the years 2005-2012 for adopting rules without a sufficient evidentiary basis and/or a sufficiently detailed cost-benefit analysis:

The United States Court of Appeals in the District of Columbia, the country’s most important administrative law court, has told the S.E.C. that it has a “statutory obligation to determine as best it can the economic implications of the rule.” Between 2005 and 2012, the court consistently reversed the agency for not conducting an adequate cost-benefit analysis of the rules it proposed.

The court said, for example, that the S.E.C. had “inconsistently and opportunistically framed the costs and benefits” of its 2010 proxy access rule, a major agency initiative, and had “failed adequately to quantify the certain costs or to explain why those costs could not be quantified.” For a 2005 mutual fund governance regulation, the agency had failed to adequately apprise itself of “the economic consequences of a proposed regulation before it decided whether to adopt the measure.”

Of late, the SEC has been trying to avoid that problem by explaining its actions at interminable length.

In any event, the amendments make several key changes—almost all procedural, rather than substantive—that limit who can make proposals but do not change the subject matters to which proposals can be addressed:

• Amend the criteria that a shareholder must satisfy to be eligible to have a proposal included in a company’s proxy statement. A shareholder now must demonstrate continuous ownership of at least:
  
  • $2,000 of the company’s securities entitled to vote on the proposal for at least three years;
  • $15,000 of the company’s securities entitled to vote on the proposal for at least two years; or
  • $25,000 of the company’s securities entitled to vote on the proposal for at least one year.
  • Aggregation of holdings for purposes of meeting the ownership requirements will no longer be permitted.
• Modify the rule limiting the number of proposals that may be submitted for a particular company’s shareholders’ meeting (the “one-proposal rule”) to establish that a single person may not submit multiple proposals at the same shareholders’ meeting, whether the person submits a proposal as a shareholder or as a representative of a shareholder.
  • Under the existing rule, some activists tried to get around the one proposal per company limit by advancing a proposal in their own name while advancing a second proposal purportedly while acting as a representative of another shareholder. The change shuts down that loophole.
• The proponent must state in writing that it is available to meet with company management (at the latter's option) at specified times not less than 10 days or more than 30 days after the proposal is submitted.
  • This is purported to increase the likelihood of shareholder-management engagement.
• Revise the levels of shareholder support a proposal must receive to be eligible resubmit the same proposal at the same company’s future shareholders’ meetings.
  • A shareholder proposal will be excludable from a company’s proxy materials if it addresses substantially the same subject matter as a proposal, or proposals, previously included in the company’s proxy materials within the preceding five calendar years if the most recent vote occurred within the preceding three calendar years and the most recent vote was:
    • Less than 5 percent of the votes cast if previously voted on once;
    • Less than 15 percent of the votes cast if previously voted on twice; or
    • Less than 25 percent of the votes cast if previously voted on three or more times.

Predictably, these rather modest changes have produced ferocious complaints from activist shareholders and their allies in both the academy and politics.

Consider, for example, the complaints from SEC Commissioner Allison Herren Lee (Democrat):

Letters in opposition to these changes vastly outnumber those in support and evidence a stark division of views between shareholders and management.

It is true that the activist community put together a massive astroturf campaign to oppose the changes, but so what? The SEC doesn't take polls to decide public policy.

... in connection with smaller shareholders, Main Street investors, who will be dramatically disadvantaged by the changes we adopt today.

Nonsense. First, the previous $2,000 limit was adopted in 1998 and has never been adjusted for inflation:

Under the new rule, as long as the shareholder is a long-term investor, you actually need a smaller investment—in real dollars—than you did in 1998.

In addition, the thresholds are set so low that owners of minuscule percentage of a company's stock get to force a vote on their pet proposal:

While Commissioner Lee purportedly is concerned for the poor investor who must cobble together a few thousand dollars to make a proposal (at the company's expense), she knows full well that many—if not most—meaningful and substantive proposals these days come from certain subsets of institutional investors—"socially responsible" investment funds, religious investment funds, union pension funds, and the like— who typically hold many times the required amount of stock.

I must assume that Commissioner Lee also knows, although she doesn't admit it, that the retail investors who do use the shareholder proposal are three longstanding gadflies who have abused the system for years (charts from Proxy Monitor):

In fact, when you break it down, basically what Ms. Lee is doing here is protecting one person:

John Chevedden is an interesting fellow. In any case, however, add in his less vigorous compatriots, Ken Steiner and James McRitchie, and the three of them "sponsored 38% of all shareholder proposals."

Why is Commissioner Lee so bound and determined to ensure that these three hobbyists get to keep being gadflies with no skin in the game?