Wednesday, February 05, 2020

Main Street, gadflies, and corporate democracy: a first look at comments on the SEC’s proxy proposal

By Mark S. Nelson, J.D.

The deadline for submitting public comments on the SEC’s recently issued twin proxy system proposals expired February 3, 2020. Thus far, the many comments received on the proposals have overwhelmingly come from individuals, academics, and religious and eleemosynary groups. The largest number of comments, however, appear to be submitted in two form letters. Comments from securities industry groups are noticeably absent, at least in name, from the proposal on shareholder proposals, while some industry groups did weigh in on the proxy advisers proposal.

The proxy proposals in brief. The SEC in November 2019 proposed to reform the proxy system by raising the thresholds for submitting shareholder proposals and to regulate aspects of the proxy advisory business (Amendments to Exemptions From the Proxy Rules for Proxy Voting Advice, Release No. 34–87457, November 5, 2019; Procedural Requirements and Resubmission Thresholds Under Exchange Act Rule 14a–8, Release No. 34–87458, November 5, 2019).

The SEC’s twin proxy proposals take aim at two related issues. First, one of the proposals would increase the eligibility requirements for making shareholder proposals by instituting a tiered threshold such that larger investors could make proposals sooner than smaller investors, who would not have to hold as much stock but who would have to abide by a longer holding period. That proposal also would increase the resubmission thresholds that govern the amount of support required and the time frame for keeping a shareholder proposal alive. The proposed resubmission thresholds are close to the thresholds proposed in the defunct Republican-led Financial CHOICE Act (Section 844) in the 115th Congress and in a defunct SEC proposal from the 1990s (related concurrence).

A second proxy proposal would bring proxy advisory firms more firmly within the SEC’s grasp. Currently, only a few proxy advisers register with the Commission and they typically do so as pension consultants under the Adviser Act’s rules. The proposal would, among other things, subject proxy advisers to requirements on conflicts of interest and transparency that would allow companies reviewed by these firms to raise objections to proxy recommendations. The SEC already had partially co-opted prior Congressional proposals to regulate proxy advisers by withdrawing two no-action letters dealing with the use of proxy advisory recommendations. Commenters on this second SEC proposal can judge whether it aligns more nearly with the highly restrictive House bill or the more modest Senate bill (See H.R. 4015—reintroduced in the 116th Congress as H.R. 5116—and S. 3614). The main point here is that, as of the last Congress, there was bipartisan agreement on at least the need for proxy adviser regulation, but not necessarily on the scope of such regulation.

Many companies believe that the proxy system is badly broken and that proxy advisers, in particular, exert disproportionate influence over proxy voting. SEC Commissioner Elad Roisman, the SEC’s point person for proxy system reforms, recently gave a speech in which he sought to counter "myths" about the SEC’s proxy proposals. Specifically, he said the proposals are not the product of corporate lobbying and they do not enshrine a supposed SEC goal of marginalizing smaller shareholders.

As an example, Roisman explained the proposal to increase the eligibility thresholds for making shareholder proposals thus: "for those who hold $2,000 worth of shares in a company, our proposal would not raise the monetary threshold at all. Instead, it would require that such an investor hold this amount of stock for longer than is currently required—three years, instead of one year—before submitting a proposal" (emphasis in original).

A preliminary comment by Scott Stringer, New York City Comptroller, had attempted to preempt arguments like those made later by Commissioner Roisman, by asserting instead that the SEC’s proxy proposals were driven by corporate interests that seek to "radically tilt" the proxy system in favor of corporate managers.

Targeting the gadflies? James McRitchie, publisher of Corporate Governance ( and a frequent submitter of shareholder proposals, seems to think so. McRitchie’s was one of the first to comment on the proposals and his somewhat later comment submitted January 27, 2020 opens by reciting SEC Chairman Jay Clayton’s statement at the open meeting where the proxy proposals were approved in which Clayton suggested that the proposals could aid Main Street Investors by curbing the influence of a small number of corporate shareholders who account for a large percentage of shareholder proposals.

According to Clayton: "it is clear to me that a system in which five individuals accounted for 78 percent of all the proposals submitted by individual shareholders would benefit from greater alignment of interest between the proposing shareholders and the other shareholders—who hold more than 99 percent of the shares."

In reply, McRitchie said the shareholder proposals that he (and others) have submitted to companies often generate wide support. "It is time to set the record straight that my proposals, like the proposals of Chevedden and Steiner, are often widely supported," said McRitchie. "The argument from those who want to reduce democratic corporate governance seems to be that low thresholds for submitting and resubmitting shareholder proposals allow a few shareholders to impose their personal policy priorities on companies, with costs borne by all shareholders, most of whom do not support those proposals."

McRitchie also suggested that Clayton offered no evidence that a small number of active shareholders distort the shareholder proposal process (he asked rhetorically if baseball players and fans would complain if only a few players accounted more most home runs).

McRitchie also claims that his shareholder proposals in the current proxy season have received 52.3 percent support. McRitchie, however, acknowledges that some proposals on newer issues (e.g., share buy backs and cybersecurity) received little support (McRitchie also suggested that new proposals take time to catch on because funds may not yet have a relevant voting policy). But McRitchie said many older proposals received much greater support (e.g., annual director elections, majority vote for directors, proxy access, eliminating supermajority voting, special meetings, and political spending).

More recently, McRitchie posted a supplemental comment on his website (the comment does not yet appear on that provides a more detailed analysis of the specifics of the proxy proposals. For example, McRitchie notes that the SEC could make an inflation adjustment to the shareholder proposal eligibility requirement that would raise the monetary threshold from $2,000 to $2,500.

For comparison, Neuberger Berman also voiced opposition to both proxy proposals. The firm said the costs to companies under the current proxy system are not that great when viewed in light of the benefits derived from shareholder proposals. "We strongly believe minority shareholders deserve a voice, and that it is not only appropriate but advisable that companies balance perspectives from across their shareholder base," said the firm.

Academics and lawmakers. Senator Tammy Duckworth (D-Ill) submitted a comment critical of both the proxy adviser and shareholder threshold proposals. With respect to proxy advisers, Sen. Duckworth said the requirement that proxy advisory firms be subjected to comments from the companies they review could undermine the independence of proxy advisory recommendations.

Senator Duckworth also cited data from outgoing SEC Commissioner Robert Jackson suggesting that proposals on shareholder director nominations and limits on executive stock sales would have failed the third and higher resubmission threshold described in one of the SEC’s proposals, something she said would create a proxy system based on short-term interests that would potentially deny worthy shareholder ideas of the time needed to gain support.

John C. Coates, the John F. Cogan Professor of Law and Economics at Harvard Law School, and Barbara Roper, director of investor protection at Consumer Federation of America, commented that the SEC should "revis[e] and re-propos[e] a more reasoned and defensible set of changes to improve the proxy system for all investors." Both Coates and Roper are also members of the SEC’s Investor Advisory Committee, whose Investor-as-Owner Subcommittee recently recommended that the SEC reconsider the twin proposals on proxy advisers and shareholder proposals.

According to Coates and Roper, the SEC’s emphasis on proxy advisers is misplaced because the small number of large fund complexes present an equal or bigger problem. Coates and Roper said that Investment Company Act rules applicable to large fund complexes are insufficient because they do not squarely address how these funds operate at the "complex" level. As compared to proxy advisers, Coates and Roper stated: "But the SEC’s focus is not justifiable from a policy or cost-benefit perspective, and is also politically risky for the agency, as it will leave the SEC embarrassingly behind the curve when the influence of large fund complexes becomes too politically and financially obvious to ignore."

Other writers on the subject have likewise noted the influence of the big four fund complexes. For example, retired Delaware Chief Justice Leo Strine recently wrote that the biggest fund complexes exercise outsized influence over corporate elections and shareholder proposals.

However, Paul Mahoney, David and Mary Harrison Distinguished Professor of Law University of Virginia School of Law, and J.W. Verret, associate law professor at the Antonin Scalia Law School, George Mason University and a senior scholar at the Mercatus Center, wrote in support of the SEC’s proposals. Both Mahoney and Verret are also members of the SEC's Investor Advisory Committee and they submitted a comment explaining their dissent from the IAC’s recommendation that the SEC reconsider its proxy proposals. They emphasized the outsized influence of the two dominant proxy advisers.

Similarly, Tom Quaadman, executive vice president of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, commented that proxy advisers present conflicts of interest, lack transparency, and are prone to errors. "Such disruptive behavior of an unregulated capital markets participant should not continue, and lack of regulatory action has allowed these issues to persist over time. The proxy advisory industry should not be permitted special exemptions to laws generally applicable to other business enterprises," said Quaadman.

Provenance of proxy comments. The SEC’s website noted that two form letters received by the agency account for many of the comments opposing the proposed changes to the eligibility requirements and resubmission thresholds for shareholder proposals. The SEC posted a note on the public comments webpage for the proposal indicating that the agency had been contacted by some of the owners of email addresses that sent one of the form letter types indicating that those persons had not submitted the comment letters. These letters total more than 13,000 in number and potentially present issues similar to those that arose when SEC Chairman Jay Clayton cited letters he said came from ordinary investors supporting the proposed changes. Subsequent investigations by news organizations found that those letters may have been submitted by dark money interest groups and that the letters’ signatories often did not authorize the letters.