Shareholder Proposal Reform under the Financial CHOICE Act of 2017: A Welcome Development for Companies or a Trojan Horse?

The U.S. House of Representatives’ Financial Services Committee approved the Financial CHOICE Act of 2017 last Thursday, clearing it for a vote before the entire House.¹ The bill contemplates sweeping changes affecting a range of matters, but tucked away among its nearly 600 pages is a brief section that would raise the bar for shareholders seeking to put proposals on public companies’ annual meeting ballots.² 

Highlights 

• Bill would impose more stringent requirements for shareholders seeking to put proposals on companies’ annual meeting ballots: 
  • Raises ownership threshold to 1% of a company’s outstanding shares (from the current lesser of $2,000 or 1%) and raises holding period threshold to three years (from the current 1 year) 
  • Raises percentage of shareholder vote a proposal must win to be eligible for resubmission 
  • Eliminates proposals by a non-shareholder acting on behalf of a shareholder 
• Changes likely to reduce the frequency of shareholder proposals for companies, particularly those with larger market capitalizations 
• Larger, more sophisticated shareholders may fill the void 

The Proposed Changes and Potential Benefits 

Under current SEC regulations, a shareholder who has held either 1% or $2,000 worth of a public company’s outstanding shares for at least a year is eligible to submit a proposal for inclusion in the company’s proxy statement for its annual meeting.³ Even if a shareholder proposal fails to garner majority support initially, the proponent may resubmit it as long as it obtained at least 3% of the vote when last presented. This percentage increases to 6% with the next resubmission and to 10% for any subsequent resubmission. The SEC also generally permits shareholder proposals by a non-shareholder on behalf of a shareholder,⁴ a practice which has produced a cottage industry of professional, non-shareholding advocates for proposals. 

For years many in the corporate community have complained that the SEC’s shareholder proposal process is broken, principally because the eligibility rules permit special interest proposals by shareholders with very small economic stakes at risk. The Manhattan Institute⁵ recently published startling statistics for Fortune 250 companies which demonstrate how askew the landscape has become: 

• In 2016, companies faced 1.26 shareholder proposals on average 
• In 2017, over one third of the shareholder proposals were submitted by just three shareholders: John Chevedden, Kenneth Steiner and James McRitchie 
• Since 2006, only 1% of institutional shareholders—unaffiliated with labor unions, public employee pension plans or religious/social/public policy oriented shareholders—have sponsored proposals 
• In 2016, only 7% of shareholder proposals received majority shareholder support (even less excluding proxy access proposals) 

The Financial CHOICE Act of 2017 takes aim at the key shareholder proposal eligibility provisions. Section 844 of the bill would require the SEC to eliminate the alternative $2,000 ownership threshold and “require the shareholder to hold” at least 1% of the subject company’s shares. Accordingly, it does not appear to permit aggregation of shares by multiple shareholders to reach this threshold. The bill would also require the SEC to increase the holding period requirement from 1 year to 3 years and to increase the minimum shareholder support threshold for resubmissions within a five-year window from the current 3% (for the first resubmission), 6% (for the next resubmission) and 10% (for any subsequent resubmissions) to 6%, 15% and 30%, respectively. Lastly, the bill would abolish proposals from non-shareholders completely. 

This trilogy of proposed changes would have the effect of making it harder for shareholders to submit proposals. For many large-cap companies, the new ownership threshold would require millions if not billions of dollars in minimum stock ownership.⁶ 

Indeed, almost all shareholder proposals today would be ineligible under the 1% rule, including not just those sponsored by gadflies but even the proposals of many of the major public pension funds.⁷ 

Many companies will applaud these changes because they often view shareholder-submitted proposals as, at best, annoyances or distractions. The Business Roundtable estimates that each shareholder proposal costs the company combatting it, on average, $87,000,⁸ and many public companies receive multiple proposals every year.⁹ 

Potential Unintended Consequences 

There is little doubt the Financial CHOICE Act’s more stringent criteria for making a proposal should lead to fewer Rule 14a-8 shareholder proposals, saving companies time and money. More subtly though, it may remove the company’s opportunity to make its case about prevailing shareholder topics against relatively weaker opponents, and then to use those victories to dissuade subsequent challenges from stiffer opponents. Indeed, the Financial CHOICE Act may serve as a clarion call to the sophisticated investors who can afford to make shareholder proposals under the new regime.¹⁰ Under the current rules, many of these shareholders have a free-riding incentive to let gadflies and ESG-oriented groups bear the cost of the shareholder proposal process. With those traditional shareholder proponents knocked out of the box, larger shareholders may fill the void. This new class of proponents can be expected to make proposals which are more targeted and nuanced, with some proponents waging ad campaigns to bolster their causes against companies most vulnerable to criticism. They may beef up their internal resources to accommodate the shareholder proposal mission as part of their ongoing corporate outreach function. 

The recent stunning success of the New York City Pension Funds’ proxy access initiative is an object lesson.¹¹ A well-resourced shareholder proponent selected specific corporate targets for the proposal. The success of the initiative compelled other companies to seek to preempt a similar fate. The result: within a two year period, proxy access is a market standard for large companies.¹² And like other popular shareholder proposals such as de-staggering of boards, majority voting and poison pill redemptions, proxy access provisions will likely ripple their way down the corporate food chain to the mid-caps and smaller companies. 

What’s more, the bill could eliminate one of the oft-ignored benefits of the shareholder proposal process: the ability to submit proposals gives the public a mechanism to air their grievances with company management, yet in most cases poses very little risk of actually requiring immediate change—after all, the majority of all non management proposals are soundly rejected. If that outlet for complaints is removed, aggrieved shareholders may have no choice but to resort to more direct, blunt action,¹³ such as binding bylaw proposals,¹⁴ withhold vote for director campaigns, or even the ouster of company directors via proxy access or in a conventional contest.¹⁵ 

The proposed legislation only increases procedural hurdles for bringing proposals, not substantive ones. For example, it does not alter the current (and relatively shareholder-friendly) SEC rules regarding when management can omit proposals related to “ordinary business.”¹⁶ The current trend in favor of socially- and environmentally-minded proposals¹⁷ from certain large institutional investors is likely to continue unabated absent SEC rule or staff interpretative modifications. 

The Financial CHOICE Act of 2017 has a long way to go before it becomes law. Like the other elements of the bill, the shareholder proposal reform provisions may look very different if and when implemented. In current form, the bill would make it harder for shareholders to submit Rule 14a-8 proposals. This could provide companies with relief from the burden they face from a number of relatively minor skirmishes. On the other hand, the vacuum created by the tightened eligibility standards may create unintended consequences for companies which need to be examined in greater detail. 

Footnotes 

_{1) Press Release, U.S. House of Representatives, Financial Services Committee, Committee Approves Financial CHOICE Act to End Bank Bailouts, Promote Economic Growth (May 4, 2017). A draft of the proposed text of the bill can be found here.
2) For an overview of the shareholder proposal process, see generally U.S. Securities & Exchange Commission, Division of Corporate Finance, Staff Legal Bulletin No. 14 (July 13, 2001).
3) 17 CFR § 240.14a-8(b).
4) SEC rules do not specifically provide for proposals in this fashion, but the staff has generally been permissive of them in responses to no-action letter requests. See, e.g., U.S. Securities & Exchange Commission, Division of Corporate Finance, Response of the Office of Chief Counsel to Incoming Letter dated December 7, 2012, from Ameriprise Financial, Inc. (December 21, 2012).
5) Proxy Season Preview: Shareholder Activism en Marche, Proxy Monitor Report (Spring 2017).
6) As of May 8, 2017, the top 50 U.S. public companies by market capitalization each had over $100 billion in market capitalization.
7) Ning Chiu, Financial CHOICE Act Imposes Sweeping Shareholder Proposal Reforms, Briefing: Governance (April 25, 2017). See also Sam Ro, Stock Market Investors Have Become Absurdly Impatient, Business Insider (August 7, 2012) (suggesting that the average holding period of stock is only five days).
8) See Stephen M. Bainbridge, A Comment on the SEC's Shareholder Access Proposal, Engage (November 14, 2003) (p. 20). However, this figure has been criticized as an overestimate. See The Business Case for the Current SEC Shareholder Proposal Process, Ceres (April 2017), pp. 11–12.
9) Supra note 5 (noting that Fortune 250 companies face an average of 1.26 shareholder proposals per year).
10) End of Shareholder Proposal Process as We Know It?, Rivel (April 21, 2017).
11) Press Release, New York City Comptroller, Comptroller Stringer, NYC Pension Funds Launch National Campaign To Give Shareowners A True Voice In How Corporate Boards Are Elected (November 6, 2014).
12) Shareholder Questions: Management's Considerations for 2017 Annual Meetings, PricewaterhouseCoopers (February 2017), p. 9.
13) Andrew Vittorio, Shareholder Advocacy Tool Shut Down in Republican Plan, Bloomberg BNA (April 20, 2017), p. 2 (quoting Professor David Webber).
14) Most shareholder proposals today are precatory, or non-binding. See Proxy Access and Advance Notice Bylaws in the Wake of Invalidation of the SEC’s Proxy Access Rule: An Approach to Private Ordering, Corporate Governance Commentary (November 2011), n. 1 (“The vast majority of shareholder proposals are of the … ‘precatory’ type because of the dual challenges of drafting an actual by-law and fitting it into the 500 hundred word limit [of] Rule 14a-8”).
15) Indeed, some fund managers have already touted their willingness to take such steps. E.g., Joann S. Lublin & Sarah Krouse, State Street to Start Voting Against Companies That Don’t Have Women Directors, Wall Street Journal (March 7, 2017); Ross Kerber, BlackRock Vows New Pressure on Climate, Board Diversity, Reuters (March 13, 2017).
16) 7 CFR § 240.14a-8(i)(7).
17) See generally Is Your Nonfinancial Performance Revealing the True Value of Your Business to Investors?, Ernst & Young (2017).}