January 4, 2019
As the U.S. Securities and Exchange Commission (SEC) works on developing a proposal to improve the proxy process following the roundtable last November, the Council on Institutional Investors (CII) released a report highlighting their analysis of shareholder proposals. The analysis included 3,600 shareholder proposals that went for a vote between 2011 and 2018 and found that most proposals would not be impacted if the SEC raised the resubmission threshold for such proposals:
“…the current resubmission thresholds exclude so few proposals that overall, moderate and even substantial increases to the thresholds still render most shareholder proposals eligible for resubmission.”
If a shareholder proposal fails to get majority support from shareholders the first time it is presented, in order to remain on the ballot the following year, the proposal must receive 3 percent support. The following year it must receive 6 percent support to appear on the ballot again, and 10 percent support on the third attempt to be resubmitted within five years of the proposal being submitted. Proposals receiving more than 10 percent support may be resubmitted indefinitely, even when 90 percent of shareholders believe the proposal is not in the company’s best interest. These thresholds have not been updated since 1954, despite the significant market changes that have occurred since that time.
In 1998, the SEC considered raising the resubmission threshold to 6 percent on the first attempt, 15 percent on the second attempt, and 30 percent in the third attempt, but ultimately decided against the proposed thresholds due to “serious concerns” from the shareholder community. In 2017, the U.S. House of Representatives passed H.R. 10 the “Financial CHOICE Act of 2017” which directs the SEC to raise the resubmission thresholds to the same level considered by the SEC in 1998, but the legislation was unfortunately never considered in the U.S. Senate.
CII’s findings directly contradict the claims of activist investors who say that raising the resubmission thresholds would shut out the voices of small shareholders and not allow for adequate participation on their behalf. CII examined over 3,600 proposals and found that only 38 of the proposals that eventually won substantially higher support after being resubmitted would be excluded over a seven-year period under the thresholds set in the CHOICE Act, the most restrictive thresholds analyzed. The findings also discredit the claim that many proposals that start with little support ultimately gain majority support for shareholders.
In 1954, when the SEC imposed the current thresholds, substantially more proposals were excluded as a result:
“When the SEC first adopted the thresholds, between one-half and three-quarters of proposals failed to win sufficient support for resubmissions. But as the resubmission thresholds remained fixed over time and institutional investors more actively participated in shareholder voting, the proportion of proposals ineligible for resubmission dropped substantially to 5% after the first attempt.”
It is clear the SEC intended to put reasonable limits on the resubmission of shareholder proposals, not to shut out small shareholders or shareholders with minority views, but to ensure the views of the vast majority of shareholders are respected and reduce the burden of redundant proposals on companies.
One of the market changes that has occurred since the initial thresholds were put in place is the dominance of two proxy advisory firms over corporate governance of public companies. In a comment to the SEC, Tom Quaadman of the U.S. Chamber of Commerce pointed out how Institutional Shareholder Services (ISS), one of the two dominant proxy advisory firms, often serves as the gatekeeper for whether a proposal obtains enough support to be resubmitted:
“In 2018, ISS supported 95% of the perennially defeated by resubmitted proposals, or ‘zombie’ proposals, examined. ISS has recommended voting ‘for’ 79% of certain zombie proposals at least one of the times they have appeared on the ballot since 2001. This creates a system where resubmissions of shareholder proposals are not determined by a majority of shareholders but rather the recommendations of ISS.”
Quaadman goes on to explain the cost to companies of “zombie proposals”:
“These zombie proposals pose an enormous cost in terms of corporate resources spent to deal with proposals every year. Company costs including expenses determining whether the proposal meets SEC requirements, challenging the proposal, drafting language for the proxy statement, printing and mailing costs, and proxy solicitation costs. Continually resubmitted shareholder proposals can create distractions for management and boards, which have a fiduciary duty to focus on the long-term interests of the company.”
Given the increase in environmental and social shareholder proposals and the significant market changes that have centralized decision-making regarding corporate governance in recent years, the SEC should enact higher resubmission thresholds to restore balance to the system. Resubmission thresholds must be a part of the conversation as the SEC considers reform of the proxy process. Raising the thresholds will benefit Main Street investors and increase the attractiveness of public markets. Ultimately, companies that are able to focus on shareholder proposals with greater support that bring positive changes, instead of wasting resources on proposals that never pass, will be able to create more value for their shareholders.