As the record voting support in the 2021 annual meeting season demonstrates, shareholder proposals are understood by investors of all kinds as a critical tool to drive improvements in disclosure and performance on environmental, social and governance (ESG) matters.1 In seeming contradiction of this reality, the Securities and Exchange Commission over the last few years adopted new measures designed to constrain rather than encourage proposals.
The impediments included 2020 amendments to the shareholder proposal rule that will make it more difficult for shareholders to file proposals or submit them to a subsequent vote, by steeply increasing the filing and resubmission thresholds. Proponents have filed a lawsuit seeking to invalidate these rule amendments, based on the failure of the underlying cost-benefit analysis to consider the enormous economic benefits of shareholder proposals.
Regardless of whether the lawsuit is successful in overturning the rule amendments, there are other major impediments erected to shareholder proposals in recent years. From 2016 to 2020, the Division of Corporation Finance adopted numerous informal changes to the shareholder proposal program, through staff legal bulletins and no action decisions, that overlay multiple complexities and principles for exclusion, often contradicting the basics of the rule. These new principles adopted by staff multiplied the number of grounds on which a company could object to a given shareholder proposal. They also increased the opportunities for SEC staff to base exclusions on highly subjective assessments, rather than basing staff no action decisions on objective criteria.
As an example, when it comes to assessing whether the company receiving a proposal is taking actions that effectively negate the need for the proposal, the recent staff interpretations added a whole new option for exclusion. Now, in addition to seeking to exclude a proposal by arguing that it was substantially implemented by the company’s actions, Staff Legal Bulletin 14 J implies that even if the proposal is not substantially implemented, a company and its board can seek exclusion by arguing that implementing the actions requested by the proposal would not pose a significant difference or “delta” beyond what the company is already doing. This new highly subjective rule for allowing exclusion based on company actions is inconsistent with the analysis required by the substantial implementation rule.
Similarly, evaluation of whether a proposal is relevant to a company went from the simple tests prescribed by Rule 14a-8(i)(5) to a complex new set of subjective evaluation criteria under Rule 14a-8(i)(7).2
We make the following recommendations to reduce subjectivity, bring the proposal process back into alignment with the rules promulgated by the Commission, and better reflect the market’s new emphasis on ESG metrics and performance:
• Advisory proposals on a significant policy issue like climate change requesting a company to set targets or improve its performance at the scale, pace, and rigor required by external public policy goals and timeframes should not be considered to be micromanagement unless they attempt to direct the minutiae of operations.
• The Staff Legal Bulletin provisions that delineated micromanagement as a vast subjective analytical process of the Staff should be repealed, eliminating the new subjective analysis added by a staff bulletin of considering whether the proposal addresses “outcomes” or “strategies.” Those criteria were inconsistent with the rule, which actually instructs shareholders that “Your proposal should state as clearly as possible the course of action that you believe the company should follow.” Rule 14a-8(a).
• An issue should be viewed as a significant policy issue that transcends ordinary business when it either involves an issue of “widespread controversy” or is focused on an environmental, social, or governance issue involving potential for a significant impact on the environment, society or stakeholders, and on investors or the company.
• Extraneous interpretive rules and guidelines such as the application of 'delta' from company actions in rule 14a-8(i)(7) are inconsistent with the language and intent of the rule and should be revoked. The added assessments increased subjectivity, including encouraging boards of directors to weigh in on subjective issues.
• Relevance and significance to a company should be evaluated under Rule 14a-8(i)(5) not Rule 14a-8(i)(7), and if the proposal shows that the company's operations or activities targeted by the proposal have potential for significant social or environmental impacts, such impacts suffice to make a proposal “otherwise significantly related to the company’s business” to the company for purposes of Rule 14a-8(i)(5).
• In assessing substantial implementation, the Staff should look to the essential purpose of the proponent, including the proposal’s background statement as well as its guidelines. Moreover, the Staff should encourage proponents to include in the proposal or cover letter criteria for an objective assessment as to whether the essential purpose it would be considered fulfilled and therefore the proposal deemed substantially implemented.
The current SEC leadership, with its focus on ESG and good government, has the capacity to eliminate the Staff’s deviations from the rule as the Commission articulated it, reduce subjectivity of staff decision-making and halt the growing length and complexity of no action challenges. The Commission’s leadership can follow these recommendations to “reset” the no action process in line with the rule and the market’s hunger for ESG-responsive disclosures by issuers.
1 See Sustainable Investments Institute news release at https://siinstitute.org/press/2021/Proxy_Preview_20201_Press_Release_pdf and additional news releases at https://www.iccr.org/about-iccr/latest-updates.
2 See for example Staff Legal Bulletin 14 J regarding board analysis.