Investors Defend Non-Binding Proposals
Submitted by: Ted Allen, Director of Publications
Investor advocates defended non-binding shareholder proposals as a useful tool of engagement with companies and urged the Securities and Exchange Commission not to scale back the ability of investors to file those resolutions.
"Non-binding proposals have an important purpose in our market," said Ted White, a former California pension fund official, who now is a strategic advisor with Knight Vinke Asset Management. "Some of the topics raised in non-binding proposals a decade ago now are accepted as best practices."
Investors also urged the SEC to ensure that investors can bring proxy access resolutions at companies. "No issue is more important to our members than the power to nominate directors," said Ann Yerger, executive director of the Council of Institutional Investors (CII).
White and Yerger made their comments at a May 7 roundtable, where a Delaware judge, corporate lawyers, and several law professors questioned the value of non-binding shareholder proposals and urged the SEC to limit annual meetings to bylaw amendments and director elections. While investor advocates hope the SEC will allow shareholders to file proxy access proposals, most of the discussion focused on non-binding resolutions and alternative ways to raise concerns with companies, including a proposal to establish secure online forums for investors.
During the all-day roundtable in Washington, the five SEC commissioners heard testimony from 20 panelists on a wide range of issues, including the shifting balance of power from boards to investors, technological advancements to facilitate shareholder communication, and the problems of "empty" voting and "over-voting."
The agency plans to release a draft rule this summer, but the commissioners and senior Corporation Finance Division staff members did not shed much light on the potential details. The SEC appears to be considering new limits on non-binding (also known as "precatory") proposals under Rule 14a-8 as the agency explores whether to give investors a limited right to nominate board nominees or file proxy access proposals at individual firms. Until a court ruling last year, the SEC allowed companies to exclude access proposals.
Additional SEC roundtables are scheduled for May 24 and 25. The next forum is to focus on voting and procedural issues, while the final roundtable will likely feature comments from investors and corporate advocates.
During the May 7 forum, several panelists noted that non-binding proposals have no legal standing under the corporate laws of Delaware and other states. As the panelists explained, these proposals arose under the federal laws that govern proxy disclosures.
Delaware Chancery Judge Leo Strine Jr. compared non-binding proposals to "prisoner litigation for stockholders" and described them as "imaginary" votes. “In Delaware, shareholders vote on 'rea'’ things, such as the election of directors and major transactions," the judge noted.
Likewise, the SEC, in a briefing paper for the forum, said "it is questionable whether the proxy system is the most efficient means of shareholder communication with management on purely advisory matters."
Stanley Keller, a securities lawyer with Edwards Angell Palmer & Dodge in Boston, stressed the need for an alternative mechanism to handle non-binding proposals. "I think it would be moving backward to simply eliminate them, but there should be a way to take them out of the annual meeting process and focus the meeting on just binding proposals," he said.
At the same time, several panelists noted that companies can face real consequences if they ignore precatory proposals that receive majority support. Amy L. Goodman, a partner at the law firm of Gibson, Dunn & Crutcher, which represents directors and companies, warned that directors at firms with new majority vote requirements may face difficulty getting elected if they fail to respond to those proposals.
Likewise, Cary Klafter, a vice president and corporate secretary at Intel, noted: "We’re entering an era where every vote is a potential proxy contest."
(Under its benchmark policy, ISS advises investors to withhold support from directors who fail to act on a shareholder proposal that won support from a majority of the shares outstanding the previous year, or that won a majority of votes cast the two previous two years.)
Binding or Non-Binding?
Investor advocates and some panelists defended non-binding proposals as a useful way to open a dialogue with companies. Ninety-seven percent of the proposals filed by shareholders each year are precatory, Yerger of CII noted.
"Without the ability to ask other shareholders to give their views on these matters, companies would be less willing to talk," said Paul Neuhauser, a law professor of the University of Iowa.
Yerger said most investors prefer to file non-binding proposals, because binding resolutions are perceived as "a stick" and too "prescriptive." She also noted that it is challenging to draft a well-crafted bylaw and supporting statement without exceeding the 500-word limit under SEC rules. Finally, many companies still have supermajority (e.g., 75 percent) requirements, which make it very difficult to pass a bylaw that’s opposed by management. "Our members would be concerned if we were to move to a binding-proposal-only regime," she said.
John Wilcox, senior vice president at TIAA-CREF, recounted how the teachers’ pension fund filed non-binding proposals seeking majority voting in board elections at 10 firms this season. All 10 proposals were withdrawn after the companies agreed to adopt bylaw changes.
"We prefer non-binding proposals because it’s important to us not to micromanage the decision-making of the company," Wilcox told the SEC.
Commissioner Paul Atkins questioned Wilcox on the transparency of these negotiations with companies and likened the process to "arm twisting." Atkins said majority vote proponents are using negotiations to achieve an election change that has been rejected by shareholders at some firms. "To me, it's a tyranny of the minority," the commissioner said.
Change to the No-Action Process?
The discussion topics and panelists for the first forum suggest that the SEC wants to liberate the Corporation Finance staff from its time-consuming role as arbiter of what proposals are allowed on corporate ballots each proxy season.
This year, the SEC received about 400 "no-action" requests by companies to exclude shareholder proposals. For each request, the staff assesses whether the proposal is excludable on 13 possible grounds. As the agency's briefing paper noted, this determination is often "subjective," forces the staff "to make difficult decisions about the suitability of particular proposals," and has "resulted in frequent criticism."
Of the 13 grounds, most of the controversy has arisen over provisions of Rule 14a-8 that allow exclusion of proposals that relate "to ordinary business operations" or if the company has "substantially implemented" the resolution. Companies historically have sought to omit social proposals under the "ordinary business" exclusion, but the commission ruled in 1998 that the proposals that "relate to sufficiently significant social policy issues" may not be excluded.
During the roundtable, John C. Coffee, a law professor at Columbia University, said the "ordinary business" exclusion has been interpreted by the SEC in a “haphazard” manner, depending on "political popularity."
Intel’s Klafter said the lack of consistent no-action rulings during the no-action process can be "frustrating," while Goodman said the process can "become very adversarial and puts everyone in a bad light."
Yerger had a different view. While observing that "14a-8 is the rule that everybody loves to hate," she said the process has mostly worked to date and most investors "are comfortable with the 13 exclusions" and still want the SEC to be involved.
Several panelists urged the SEC to consider imposing new barriers to filing proposals (such as charging proponents a fee).
Professor Roberta Romano of Yale University Law School observed that the costs of 14a-8 proposals are borne by all shareholders, rather than the individual filers. By contrast, investors who wage proxy fights do take on significant economic risk and often are successful in their efforts to increase shareholder value. "Investors need to have some 'skin in the game' if you want everyone to behave," she noted.
While the SEC has provided investors "not enough democracy" to nominate directors, Coffee said the agency has allowed "a little too much democracy" for the filing of non-binding proposals. "We are subject to the tyranny of the 100-share shareholder," he noted.
Coffee and other panelists suggested that the SEC increase the minimum economic stake (which is now $2,000) to file a proposal to a 1 percent stake or 1 million shares. Such a change, he said, would save companies money and "focus shareholders on important issues."
"Shareholder attention is a precious commodity," Coffee noted. "Minimizing the number of proposals will actually increase attention to the most important issues."
However, White of Knight Vinke expressed opposition to increasing the economic hurdles to filing. "One cannot assume that a million-share stockholder is smarter than a 100-share stockholder," he said. Similarly, Neuhauser argued that "small shareholders should be able to participate."
Professor Stephen Bainbridge of the UCLA School of Law and R. Franklin Balotti, a Delaware lawyer who represents companies, suggested that the SEC allow the exclusion of proposals that have no material impact on the company. Bainbridge compared the current system to the proliferation of ballot initiatives in California.
Other panelists, including Professor Larry Ribstein of the University of Illinois, questioned whether the SEC would be able to make materiality-based determinations on proposals. White said the SEC should not try to judge resolutions on this basis.
"The market does a good job of judging proposals," White noted. "Bad proposals do lose."
Online Forums for Investors
Several panelists raised concerns about the agency's proposal that companies set up secure Internet forums for investors as a supplement to non-binding proposals. The SEC has hired BroadRidge Financial Solutions to explore the feasibility of this approach.
As the SEC’s briefing paper explained, such an approach would allow investors to communicate with companies "24/7 throughout the year, rather than only at annual meetings." Such an electronic forum, the SEC said, could provide a "powerful means to advance non-binding proposals" by allowing shareholders to anonymously discuss issues with other investors and to conduct non-binding votes. The agency noted that the proxy rules would have to be amended so that forum participants would not be deemed as conducting a solicitation.
Neuhauser expressed skepticism that "serious" investors would use such a forum. "To the extent it looks like an Internet chat room, it would be entirely useless," the Iowa professor said, citing examples of irrelevant postings that appeared on the Yahoo! Finance chat room for General Electric.
"Will the company or the SEC regulate it? If it is controlled by the company, then some shareholders won't trust it," he said, adding that SEC oversight of investor forums would raise freedom-of-speech concerns.
Corporate advocates also didn’t embrace the concept. "I would caution you about creating a whole new process with a few participants," said Klafter of Intel.
Experimenting With Proxy Access
Several commentators urged the SEC to allow shareholders and companies to "experiment" with proxy access and not try to impose a broad access rule like the agency staff proposed in 2003. The SEC abandoned that rule in 2005 amid opposition from corporate interests, Bush administration officials, and two of the commissioners.
"Can't we all recognize that we're not that smart? We can't figure out the appropriate standard for all public companies," said Joseph Grundfest, a former SEC commissioner who now is a Stanford University law professor. "We should let shareholders and companies work out access on their own."
Likewise, Wilcox said proxy access will need a "tremendous amount of careful thought." As the TIAA-CREF official noted, "the shareholder proposal process is a useful way to test various approaches as to how it might work."
*This article originally appeared in the May 15 edition of Governance Weekly.
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