HFSC ESG Hearings: Q&A on the SEC Shareholder Proposal Process

In July 2023, Republican members of the House Financial Services Committee initiated a series of hearings regarding ESG investing.  Several  witnesses on July 12 and 13 asserted that the shareholder proposal process is forcing companies and shareholders to consider "activist" proposals that are irrelevant to  the company. This  interpretation and other statements made during the hearing were inconsistent with the facts and SEC rules.  The following Q&A is intended to help set the record straight.

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Question: Are shareholder proposals allowed to be filed on issues that have no “nexus” or "relevance" to a company?

Answer: These critiques demonstrate a misunderstanding of the SEC shareholder proposal process.  SEC rules already allow companies to exclude a proposal that is not relevant to the company’s business.  Specifically, Rule 14a-8(i)(5) states that a proposal can be excluded "If the proposal relates to operations which account for less than 5 percent of the company's total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company's business."  

Question: Why has the portion of shareholder proposals addressing environmental and social issues  increased?

Answer: The increase reflects the growing understanding among investors of the importance of these issues to a company’s current and future prospects, as well as how a company’s externalized costs (e.g. pollution) may harm the entire portfolio of diversified investors. Shareholder proposals on environmental, social, and governance issues have long served as a cost effective “early-warning system” for companies to identify emerging risks before they become financial liabilities. 

Question: Is it true that the filers of shareholder proposals are merely a small group of activist investors who “abuse” the resolution process ?

Answer: No matter who the proponent may be-- asset owners, asset managers, individual investors, or advisors acting on behalf of their investor clients—genuine success depends upon persuading fellow shareholders of the business case of the request.

The repeated, simplistic and inaccurate characterization of proponents is not based on facts. Filers include investment firms, state and city pension funds, unions, foundations and faith-based institutions. The largest portion of filers are investment firms and foundations.

As an example, the members of the Interfaith Center on Corporate Responsibility (ICCR) led by religious investors, have been involved in filing shareholder resolutions for over 50 years. These investors are not pushing a “leftist agenda”, but are raising important and material issues to the attention of the board and management–and have been doing so for decades. ICCR members together hold $ 4 Trillion in assets under management.  

The proposal process is non-partisan, open to any shareholder, no matter their political leanings, to make a request of the company they own to consider action to address relevant business risk and/or opportunity. It is then the purview of their fellow shareholders to exercise their right to evaluate the proposal and vote based on their understanding of the value proposition.

The proponent itself--whether a large institution or an individual--does not matter as long as the investor has sufficient ownership in the company. As an example, two individual investors submitted 18 governance-related resolutions in 2023 that received a majority vote and a further 33 resolutions with votes receiving 40 to 50% shareholder support. 

Question: Under the leadership of Chair Gensler, has the SEC made it too easy to file shareholder proposals?

Answer: The current administration of the SEC has effectively responded to company and investor feedback, ensuring the process is now efficient and predictable for all. By issuing Staff Legal Bulletin 14L which eliminated guidance established under the Trump administration that compelled SEC staff to make highly subjective decisions on cases of ordinary business, the current administration has restored clear and objective rules. This has resulted in fewer legal challenges, while still effectively ensuring proposals are relevant and barring proposals that, for example, relate solely to the day-to-day operations of the company or attempt to micromanage.

Question: Are corporate proxies overrun with shareholder proposals?

Answer: Shareholder proposals constitute only a tiny fraction of the matters upon which proxies are voted during a proxy season. In 2022, investors cast over 28,000 votes at shareholder meetings at companies in the Russell 3000 index. These include votes on the election of directors, executive compensation, auditor ratification, and various other management-sponsored proposals. Shareholder proposals constituted just 2 percent of all matters on which proxy votes were cast.

Question: Are shareholder proposals a costly expense for companies?

Answer: The high cost figures being discussed by some are not grounded in any measurement but represent speculative and exaggerated “upper bound” cost estimates. The only cost that companies must incur under the rule is the de minimus cost of printing a 500-word statement of the shareholder in the proxy. 

Question: Are shareholder proposals becoming an inappropriate distraction to companies?

Answer:  Shareholder proposals are filed to elevate board and management consideration of issues relevant to a company’s future. Ultimately, the company’s investors assess and vote on whether there is a strong business case for the board to increase attention to an issue and implement the recommendations of the proposal. This is a “marketplace of ideas” that is fully functional. In short, shareholder democracy is working and is a keystone of American capitalism and corporate governance.

Question: Has the shareholder proposal process been taken over by “professional” activists?

Answer:  Many asset managers and asset owners file proposals requesting information vital to their decision-making to address risk management issues at companies. The shareholder proposal rule is a complex set of procedural and substantive requirements. Given this complexity, the average institutional or retail investor may require help to navigate the process. Professional advisors fill this market demand, assisting shareholders seeking active engagement to draft and file shareholder proposals, and in some instances, to represent the shareholder in direct engagement with companies. This is no different from any other arena - medicine, real estate, business transactions - where experts are hired to assist in fulfilling complex tasks.