Remarks at the 26th Annual Corporate Law Institute, Tulane University Law School
Commissioner Daniel M. Gallagher
http://www.sec.gov/News/Speech/Detail/Speech/1370541315952#_edn10
New Orleans, LA, March 27, 2014
II. Shareholder Proposals
One area where the SEC’s incursions into corporate governance have had a particularly negative effect is shareholder proposals.
1. The Problem
While the conduct of the annual shareholder meeting is generally governed by state law, the process of communicating with shareholders to solicit proxies for voting at that meeting is regulated by the Commission. 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,[v]with an amazing 41% of those proposals addressing social and environmental issues.[vi] And while proposals calling for disclosure of political contributions or lobbying activities continued to predominate,[vii] these proposals received particularly poor support from shareholders.[viii] Overall, only 7% of shareholder proposals received majority support in 2013.[ix]
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.[x]
In other words, the vast majority of proposals are brought by individuals or institutions with idiosyncratic and often political agendas that are often unrelated to, or in conflict with, the interests of other shareholders. I find it particularly notable that corporations that donated more funds to Republicans than to Democrats were more than twice as likely to be targeted with political spending disclosure proposals sponsored by labor-affiliated funds.[xi]
Astonishingly, only 1% of proposals are brought by ordinary institutional investors—including hedge funds. As you all know, hedge funds are not shy about elbowing their way into the boardroom when they believe a shake-up is overdue. The low level of hedge fund activism here implies that their concerns with corporate management are being addressed using avenues other than shareholder proposals—as most legitimate concerns can be.[xii]
Given all of this, it’s time we asked whether the shareholder proposal system as currently designed is a net negative for the average investor.[xiii]
2. Needed Reforms
a. Who should be able to bring a proposal?
All of this isn’t to condemn shareholder activism per se. I’ll leave that debate to Marty Lipton and Lucian Bebchuk. But existing shareholders who are unhappy with management have a range of well-accepted responses other than proposals. Given the depth and liquidity of today’s markets, passive investors can simply sell their position—taking the s0-called “Wall Street Walk.” Activist investors can threaten to take this Walk as a means of influencing management. Investors can also vote against directors who are not sufficiently overseeing management—this strategy doesn’t have a clever name, but perhaps “vote the bums out” will do.
And, of course, where management is breaching its fiduciary duties, investors can have recourse to the courts. This “see you in court” strategy is particularly viable given the outstanding job the Delaware courts do, day in and day out, in refereeing disputes between shareholders and management. Given these and other strategies, I’m not sure we need shareholder proposals at all.
But if we must have shareholder proposals, the SEC’s rules can and should do a better job ensuring that activist investors don’t crowd out everyday and long-term investors—and that their causes aren’t inconsistent with the promotion of shareholder value.
One thing is clear: we can’t continue to take the approach of our current regulatory program, especially the all too liberal program of the last five years, and simply err on the side of over-inclusion. It is enormously expensive for companies to manage shareholder proposals. They must negotiate with proponents, seek SEC no-action to exclude improper ones, form and articulate views in support or opposition in the proxy, include the proposal and the statement in the proxy itself, then take the vote on it at the annual meeting. Conversely, companies can simply fold and acquiesce to the activists’ demands. Both approaches are costly, and these costs are borne by all shareholders. Taking money out of the pocket of someone investing for retirement or their child’s education and using it instead to subsidize activist agendas is simply inexcusable. It is incumbent on the Commission to create a regulatory environment that promotes shareholder value over special interest agendas. I have a few suggestions.
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.[xiv] 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.
Of course, we’d have to make sure we get the percentage holding requirement right. Requiring a sufficient economic stake in the company could lead to proposals that focus on promoting shareholder value rather than those championed by gadflies with only a nominal stake in the company. We would need to apply rigorous economic analysis to determine what percentage would be an appropriate default, as well as what factors should be taken into account when deviating from that default. This could be an opportunity to address the practice of “proposal by proxy,” where the proponent of a resolution—typically one of the corporate gadflies—has no skin in the game, but rather receives permission to act “on behalf” of a shareholder that meets the threshold. While I would support banning proposal by proxy, we could also consider alternatives such as requiring a proponent acting on behalf of one or more shareholders to meet a higher percentage threshold of outstanding shares than would be the case for a proponent who owns the shares directly.
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.
Making adjustments along these lines will go a long way towards ensuring that the proposals that make it onto the proxy are brought by shareholders concerned first and foremost about the company—and the value of their investments in that company—not their pet projects.
b. What issues should proponents be able to raise?
I also believe that we need to do a better job setting requirements as to the substance of proposals. While I don’t think a complete reevaluation of the existing categories for exclusion is necessary, we do need to re-think their application.
For example, the “ordinary business” criterion for exclusion in our rules has been perennially problematic.[xv] This provision permits exclusion of a proposal that deals with the company’s “ordinary business operations,” unless it raises “significant policy issues.” However, these terms are not defined and the Commission has given no guidance, leaving the Staff to fend for itself in determining whether to issue no-action relief pursuant to the provision.
As a result, we have seen a number of dubious “significant policy issue” proposals. For example, in 2013 the Staff denied no-action relief to PNC Bank with respect to a proposal requesting a report on greenhouse gas emissions resulting from its lending portfolio, on the grounds that climate change is a significant policy issue—arguably a reversal of a prior Staff position.[xvi] And, in 2012, Staff denials of no-action relief forced AT&T, Verizon, and Sprint to include a net neutrality proposal, even though proposals on that same topic were excludable in prior years as ordinary business. That year, 94% of AT&T shareholders voted “no” on the net neutrality proposal despite the best efforts of Michael Diamond, who some of you will know as Mike D. of the Beastie Boys—who, by helping to bring the proposal to a vote, at least succeeded in his fight for the right to proxy.[xvii]
It is a disservice to the Staff—and, more importantly to investors—when the Commission promulgates a discretion-based rule for the Staff to administer without providing guidance as to how to exercise that discretion. In addition to providing better guidance, the Commission needs to become more involved in the administration of this rule. In particular, I believe that the Commission should be the final arbiter on the types of proposals for which the Staff proposes to deny no-action relief on “significant policy issue” grounds. The Presidential appointees should vote on these often-thorny policy issues and not hide behind the Staff.
We also need to take another look at the rule which permits the exclusion of proposals that are contrary to the Commission’s proxy rules—including proposals that are materially false and misleading or that are overly vague.[xviii] In Staff Legal Bulletin 14B, issued in 2004,[xix] the Staff curtailed the use of this ground for exclusion in light of the extensive Staff resources that were being consumed in their line-by-line review of shareholder proposals, instead forcing issuers to use their statement in opposition to take issue with factual inaccuracies or vagueness.[xx] I believe issuers have raised some legitimate concerns with this approach. For example, while issuers are not legally responsible for the proposals or statements in support, they are still being forced to publish, in their proxy, statements they believe are false or misleading. Moreover, use of the statement in opposition is sometimes an incomplete remedy. Taking valuable space to correct misstatements distracts from a substantive discussion about the proposal itself, and proposals that are overly vague make it difficult to draft a sensible rebuttal.
In light of these competing concerns, I believe the pendulum has swung too far in the direction of non-intervention. And I’m not alone in this belief. Recently, a district court in Missouri granted summary judgment to Express Scripts, permitting it to exclude a proposal that contained four separate misstatements.[xxi] While I support companies exercising their right to take matters to the court system,[xxii] which can serve as a useful external check on the SEC’s no-action process, companies shouldn’t have to go through the time and expense of litigation to vindicate their substantive rights under our rules. The burden to ensure that a submission is clear and factually accurate should be placed on the proponent, not the company. I believe that the Staff should take a more aggressive posture toward proponents that fail to meet that burden. And I hope issuers would refrain from using our rule to quibble over minutiae. If this happy medium is not achievable, I believe the SEC needs to revisit our rules: we as a Commission either need to give the Staff the capacity to enforce the rule as it is currently written, or craft a rule that is enforceable.
c. How many times may a proposal be repeated?
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3. Conclusion
Implementing these kinds of reforms can, I believe, help provide some much-needed improvement to the shareholder proposal system. I hope the Commission can consider such common-sense issues in the near future. These are real and substantial issues, and the Commission has the authority to effectuate needed change. We should not dare Congress to intervene due to our inaction, as it had to with the JOBS Act.
