The Proposed SEC Rule Change Could Have Major Impact on Investors – What You Need to Know
By Mark Tulay, Skytop Contributor, May 1, 2020
What the Upcoming SEC Ruling Portends for Wall Street and Main Street
In John Lennon’s last album in 1980 he released the song “Beautiful Boy”. The song’s lyrics included the famous quote “Life is what happens when you are busy making other plans.” As we struggle to bring into focus the long-term impacts of a post-COVID-19 world, Lennon’s quote is a poignant reminder of the uncertainties that lie ahead.
The same unknowns face proponents of the shareholder resolution process in the US as the SEC is poised to “modernize the rules that govern the process for shareholder proposals to be included in a company’s annual proxy statement”. Here’s what astute investors need to know about the ensuing changes in the new normal of shareholder proposals – and why these changes will matter to Wall Street and Main Street.
Shareholder Resolutions Coming of Age
In 2018, roughly 5,700 proxy materials were filed with the Securities and Exchange Commission (SEC) and this year promises to eclipse this. If you’re not familiar with the peculiarities of proxy season, a shareholder resolution is a non-binding recommendation by shareholders to the board of directors of publicly traded companies. Regulated by the SEC, resolutions are voted on at the company’s annual meeting. While the shareholder issues often change from year to year, the mechanics of filing shareholder resolutions – and the requirement to pass SEC scrutiny – has remained largely unchanged since 1954. This will end, however, when the SEC enacts changes to Rule 14a-8.
Roughly 4,300 resolutions were filed between 2010 and 2019 that focus on a company’s environmental, social, and sustainability performance and cover such issues as climate change, board diversity, sustainability governance, political activities and human rights. The average annual support for resolutions on these non-traditional financial issues over the last ten years is 20%, according to the Sustainable Investment Institute (Si2), as depicted below.
Source: Sustainable Investments Institute (Si2)
Proposed SEC Rule Changes
The proposed SEC rule changes would:
- Raise proposal resubmission thresholds from 3%, 6% and 10% for proposals voted on once, twice or three or more times respectively to 5%, 15%, and 25%;
- Exclude proposals that have been voted on three or more times in the last five years;
- Eliminate pooling of shares to meet minimal filing thresholds;
- Raise the bar on the proposal submission eligibility requirements favoring large and long-term investors;
- Create additional requirements for proposal submission;
- Require that each shareholder-proponent commit to meeting with the company after the proposal submission within a specified time.
Impact on Investors if the SEC Rule is Enacted
Proponents argue that these shareholder resolutions are a critically important tool for small investors to influence business practices and vehemently oppose the proposed changes. Ceres – a global network comprised of over 175 institutional investors representing $30 trillion in assets under management – warns that the proposed rule changes would “restrict an important avenue that investors use to manage risk and respond to emerging trends.” Moreover, back-testing by Si2 contends that under the new rules 30% of the 614 proposals that went to vote between 2010 and 2019 would not have been eligible for resubmission.
Market Reactions to SEC Rule Changes
Shareholder access proponents are asking why the SEC would try and fix a process that they believe isn’t broken. “Shareholder proposals provide an early warning signal on risks and opportunities for management and boards. It allows them to test the waters with their broader investor base on key issues identified by active investors, and to get a more complete picture of shareholder views and concerns. Why would the SEC advocate for less information on these complex, financially material issues? How would less information benefit investors? The SEC hasn’t provided an answer for that,” said Heidi Welsh, Si2’s Executive Director.
However, the Business Roundtable and other powerful groups see things differently and are seeking to “modernize” the shareholder voting rules. The US Chamber of Commerce and the Business Roundtable contend that the shareholder resolution process has been overly politicized by organizations that do not have shareholder’s best interests in mind. “I am proud to support proposing these amendments,” said SEC Commissioner Roisman, “I believe that these proposed changes will facilitate and encourage meaningful company-shareholder engagement, and make changes that can help prevent the misuse of the process.”
What the friction comes down to is the future of investor access to CEO and board member mindshare. The market is split between investment firms like BlackRock and Vanguard that manage trillions and can easily reach a CEO and those investment firms that represent millions and even billions in assets under management which do not garner the same level of access. As a result, increasingly mid-sized and smaller investment managers have come to rely on the shareholder resolutions process as a way to democratize the process, amplify their voice, and share their concerns directly and pointedly with the CEO, Board of Directors and other like-minded investors.
The Resulting New Normal
The rule changes will likely go into effect before the November election and will reshape the future of shareholder-management discourse for years to come. The rule changes will:
- Dramatically curb investor voice for most investment managers in delivering good corporate governance practices;
- Build a bigger mote for CEOs to disregard constructive counsel from actively engaged shareholders;
- Remove early warning signals to CEOs concerning financially materials stakeholder concerns;
- Owing to the pandemic, shareholder meetings are likely to shift from in-person to virtual meetings which will provide more comfort and distance between CEOs and Boards and shareholders;
- Large investors will have an outsized voice in shareholder resolution process, and smaller investors’ voice will be diminished;
- CEOs will have to look elsewhere for stakeholder feedback, perhaps turning to sustainability ratings for guidance;
- As a result of the resulting gap in shareholder activism communications, corporate sustainability reporting will become increasingly important;
- Early insights into changing customer behaviors will have to come from customers and stakeholders directly, versus shareholder activists.
Josh Zinner, CEO of ICCR echoed the sentiment of the opposition to the revisions: “For over 75 years, the shareholder proposal process has served as a cost-effective way for corporate management and boards to gain a better understanding of shareholder priorities and concerns. We see this unjustified action by the SEC as part of a broader move across this Administration to realign the regulatory landscape in favor of corporate interests at the expense of the public interest.”