New SEC Staff Legal Bulletin Raises Questions and Uncertainties for Investors and Companies

Sanford Lewis

Shareholder Rights Group

In a guidance issued November 1, the SEC Staff has taken an innovative “outside the box” approach to the shareholder proposal process.  The new Staff Legal Bulletin 14I has raised numerous questions and uncertainties among investors and companies.

The House of Representatives earlier this year passed a radical revision to the shareholder proposal process in a section of the Financial Choice Act, which would dramatically constrain the ability of shareholders to file proposals, including requirements that would limit the filing of proposals to only the few wealthiest shareowners. That bill is not expected to pass the Senate and become law. However, this approach was recently echoed in a Treasury Department report that recommended an upward revision of proposal filing and resubmission thresholds.

These reform efforts do not appear grounded in evidence of an actual problem with the shareholder proposal process. For instance, there has been no increase in the number of proposals filed or appearing on corporate proxies in recent years. Instead, shareholder proposals are winning larger supporting votes from shareholders, demonstrating that the process is functioning well and fulfilling its intended purpose: to act as an investor protection vehicle. In addition, cost estimates offered by companies have been highly exaggerated. There is really no evidence that the shareholder proposal process is posing new or difficult burdens on companies.     

However, the SEC Staff has now taken action that might be understood to be an attempt to respond to corporate critics.  In its new Bulletin 14I, the SEC Staff requests that boards of directors weigh in on issues of whether a proposal is relevant to a company or addresses a significant policy issue that transcends ordinary business.   A board’s negative determinations on significance or relevance will apparently be given substantial consideration in Staff decisions as to whether a shareholder proposal must appear on the proxy: 

Accordingly, going forward, we would expect a company’s no-action request to include a discussion that reflects the board’s analysis of the particular policy issue raised and its significance. That explanation would be most helpful if it detailed the specific processes employed by the board to ensure that its conclusions are well-informed and well-reasoned. We believe that a well-developed discussion of the board’s analysis of these matters will greatly assist the staff with its review of no-action requests under Rule 14a-8(i)(7). [Emphasis added]

In light of the SEC’s investor protection mission, the SEC Staff might find a board statement useful, but legally speaking, it cannot be the final word.  The shareholder proposal process is typically utilized by investors to address issues that are being neglected by corporate boards  —  blind spots that may lead to crushing liabilities or reputational damage.

As important, the proposal process has long allowed investors to provide guidance to companies on issues where the board and company policies are posing harm to society or the environment. (Examples recognized by the courts or the Commission include dangers of nuclear power, the production of napalm by Dow Chemical used in the Vietnam War, discrimination and concerns over animal cruelty in the production of foie gras.) The courts and the SEC have long held that board and management do not hold a monopoly on expertise on these issues of societal impact beyond those of shareholders, and that shareholders have a right through the proposal process to weigh in.

Moreover, we have seen an increasing interest by share owners of all sizes in proposals for addressing systemic risk, such as risk to the entire economy or to the natural resource base on which the economy depends.

The history of board reactions to shareholder proposals is telling. In thousands of instances, boards reflexively recommend a “No ” vote on resolutions whether they are addressing a  governance matter or a social or environmental issue like climate change.  Even where a resolution topic has merit, boards and corporate secretaries have long tried to keep corporate proxies free from resolutions that provoke debate among investors.  Investors perceive the goal of the corporate secretary at many issuers as using legal tools to contest resolutions, even if they are matters of legitimate policy debate, rather than engage in balanced consideration of the pros and cons of the issue.

No wonder that many investors are skeptical about the approach of the Bulletin. Will boards effectively deliberate on relevance and significance, or use this invitation as an opportunity to continue and further advance their reflexive opposition to proposals? Does the board’s potential fiduciary liability for neglecting important issues provide a check on abuse of the new bulletin? It seems a stretch to assume that in every instance a board finding of irrelevance or insignificance is “considered” and “unbiased.”  

So while the board might share useful insights on how they think about an issue, these insights are surely not the exclusive evidence of whether a proposal addresses a significant policy concern for investors or is relevant to the company. If the SEC is to continue protecting investor rights and interests, the Staff surely needs to give substantial weight to investors’ evidence as well.

It is in the realm of possible outcomes that this Bulletin could prove a positive benefit to investors, by encouraging boards to consider the significance and relevance of a proposal. At least theoretically, this could encourage more in depth board consideration of a proposal, and increased communication with investors instead of merely issuing routine statements in opposition to proposals.

The outcome is uncertain. To say the least, we can expect an interesting proxy season ahead.