Shareholder proxy proposals are a sure sign of spring, but the potential exists for Congress to dramatically curtail the ability of small investors to access management’s proxy materials. House Financial Services Committee Chairman Jeb Hensarling (R-Texas) intends to introduce a revised financial regulation bill that would roll back many Dodd-Frank Act measures by the end of the month, and make other substantive amendments to the securities laws. According to a committee memo, provisions of the legislation under consideration, known as the CHOICE Act 2.0, would put the shareholder proposal process out of the reach of all but the largest investors, and would fundamentally change the way the process currently works.
Currently, under Exchange Act Rule 14a-8, shareholders must have continuously held at least $2,000 in market value, or one percent, of the company's outstanding voting securities for a year or more. The eligibility thresholds date to 1998, when the SEC amended the proxy rules to increase the dollar amount from $1,000. The SEC recognized that many commenters, including organizations such as the American Bar Association and the American Society of Corporate Secretaries, criticized what they considered to be a de minimis ownership requirement.
For example, one commenter suggested increasing the minimal ownership threshold to $10,000 while maintaining the one year ownership requirement. According to the comment letter:
The current $1,000 or proposed $2,000 thresholds are in effect de minimis requirements that ordinarily have little practical import. This is particularly true because the Commission currently permits one or more stockholders to aggregate their holdings to reach the minimum threshold. Given the time and expense that inclusion of stockholder proposals cause companies and their stockholders, and the lengthening of already lengthy proxy statements, a $10,000 threshold maintained for one year is not unreasonable and would serve the needs of responsible, long-term investors.
The SEC rejected these arguments, however. As stated by the Commission in the adopting release, “we have decided to limit the increase to $2,000 for now, in light of rule 14a-8's goal of providing an avenue of communication for small investors.”
The CHOICE Act 2.0, as described in Chairman Hensarling’s memo, would eliminate the $2,000 ownership threshold, and would require investors to own a minimum of one percent of the issuer's voting securities over a three year period in order to submit a proposal. A quick glance at recent Rule 14a-8 no-action submissions demonstrates the magnitude of this change.
As an example, noted shareholder proponent John Chevedden recently proposed a bylaw to Celgene Corp. that would prohibit management from having access to the vote totals cast by proxy on certain executive pay matters prior to the annual meeting. Celgene is a large-cap company with a market capitalization in excess of $97 billion. Few inhabitants of the current shareholder proponent universe could aspire to a minimum holding level of nearly $1 billion in Celgene stock in order to be eligible to submit a proposal.
According to the memo circulated to the House Financial Services Committee, the CHOICE Act 2.0 would prohibit the common practice of shareholders authorizing other individuals to submit proposals on their behalf. As of the end of the first quarter of this year, issuers had submitted 226 no-action letter requests to the SEC to exclude shareholder proposals. Two individuals, John Chevedden and Kenneth Steiner, submitted more than a quarter of these first quarter proposals. The most active shareholder proponents often submit proposals in their own names, but in many cases, shareholders who meet the eligibility threshold will nominate a well-known shareholder activist to act on their behalf.
Issuers have often complained about the practice of proposals by proxies. Companies have unsuccessfully argued to the SEC that Rule 14a-8(h)(1) only allows shareholders to nominate representatives to attend the annual meeting on their behalf, and not to stand in for the shareholder at any earlier stage in the process. Companies have apparently had some success with this argument in the rare cases brought against shareholder representatives in federal district court, but the numbers of court challenges to proxy submissions by designated representatives are too small to threaten current practice.
The CHOICE Act 2.0 would end the debate by prohibiting shareholders from authorizing representatives to bring forth proposals in their names. This provision, coupled with a one percent/three-year ownership threshold, would effectively shut down the shareholder proposal process as it currently exists. A mechanism that now allows even relatively small holders access to the proxy materials, and therefore to their fellow shareholders, of the largest public companies, would be restricted to a few of the largest institutional investors.
There is no doubt that shareholder proposals are costly, and often receive limited investor support. However, the process is a valued component of shareholder democracy, and democracy, in any form, can be messy. While the proper ownership threshold, which was intended to be a low bar when it was adopted in 1998 and has remain untouched since, is a legitimate topic for debate, the effective elimination of the shareholder proposal process could further separate the corporate entity from its owners.
For more data and analysis on the 2017 proxy season, Bloomberg Law subscribers can access our Proxy Season Analytics page on the Corporate Practice Center.
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