The U.S. Securities and Exchange Commission’s proposed revisions to the shareholder voting process, including new regulations on proxy advisory firms and stiffer rules on corporate ballot proposals, are facing pushback from investor groups ahead of a potential showdown in 2020.
Both rule proposals, though separate, have in common an attempt by the SEC to reform key elements of the shareholder voting system that haven’t changed for decades. Whether the proposed changes are for better or worse is a question that divides market participants. Several shareholders groups worry the SEC’s efforts favor corporations at the expense of investors.
“We think both rule proposals undercut important shareholder rights and appear to be aimed at muffling the voice of investors at U.S. public companies,” said Amy Borrus, deputy director of the Council of Institutional Investors, which represents pension funds and other large investors.
By contrast, the SEC’s actions have received support from business interests who have argued that proxy firms have grown to become influential arbiters of corporate governance without regulatory oversight and that the shareholder proposal process is prone to abuse by small groups who don’t have a meaningful long-term commitment to a company.
The U.S. Chamber of Commerce and the National Association of Manufacturers have vocally supported both ideas, which a divided SEC proposed on Nov. 5 and may decide next year. NAM has lobbied the SEC to take action for years, saying it wants to “make the proxy process more responsible to Main Street investors and more reflective of business realities.”
“We intend to keep working with the SEC to ensure that both proposals are finalized and implemented appropriately in the weeks and months ahead,” Charles Crain, director of tax and domestic economic policy at NAM, said in a recent statement.
The push for action follows more than a decade of back and forth between regulators and market participants. The SEC in 2010 issued a concept release seeking comment on whether it should intervene to improve the proxy system, though it took no subsequent action.
SEC Chairman Jay Clayton revived interest in these topics. The agency hosted a roundtable on proxy issues last November and followed in August by publishing guidance stating its views on proxy-related matters, just months before releasing its latest rules proposals.
Both matters could be voted on in early 2020, sometime after the deadline for public comments.
But several market participants, including CII, New York City Comptroller Scott Stringer and other shareholder advocates, are concerned that regulators may be rushing. They are urging the SEC to double the time allowed for comments from the expected 60-day period to 120 days given the scope of both proposals, which total 320 pages and invite readers to respond to many questions.
“The two proposals are, in effect, a two-pronged attack on rights — proxy voting and shareowner proposals — that form the heart of the New York City Retirement Systems’ corporate governance program,” Stringer said in a Nov. 20 letter.
The SEC plans to allow 60 days of comments once the proposals are published in the Federal Register. Asked if it would consider extending that time frame, the agency declined to comment. As of Wednesday, the proposals had not been published in the Federal Register.
First, the SEC is proposing to increase scrutiny on proxy firms, which sell voting advice to institutional investors on matters like corporate elections, mergers, and executive pay. Proxy firms also provide voting advice on climate-change policies and other hot-button social issues.
The proxy advisory business has grown more influential given the outsize role that institutional investors — which own between 70 and 80 percent of the market value of U.S. public companies by some estimates — play in modern capital markets. As such, asset managers that own shares in hundreds or more public companies often rely on dominant proxy firms like Institutional Shareholder Services Inc. and Glass Lewis & Co. for advice on voting matters.
But business interests have argued that ISS and Glass-Lewis provide advice that is conflicted and error prone — criticism that the proxy firms and clients who rely on their advice dispute.
Among the SEC’s proposed revisions, proxy advisers will be required to increase disclosure about conflicts of interest if they wish to remain exempt from securities filing requirements.
Proxy advisory firms will also be required to give corporate management an opportunity to review and respond to the firms’ voting recommendations — provided that issuers file their proxy materials 25 days before a shareholder meeting. The proxy firms won’t be obligated to change their recommendations in accord with a corporation’s response.
Issuers will also be able to request that proxy firms include a hyperlink or some similar tool on their materials that directs readers to management’s response to its recommendations.
“From the issuer’s perspective, this is all reasonable,” said Simpson Thacher & Bartlett LLP partner Karen Hsu Kelley, who heads the firm’s public company advisory practice. “How can you argue with including disclosure of material conflicts of interest? And doesn’t it seem reasonable that companies should be given the opportunity to review and provide feedback, especially with respect to errors?”
CII says that its own analysis shows weak evidence for issuer’s concerns that proxy firms publish advice rife with errors, arguing that most claims of errors are actually methodological differences. CII also worries that allowing corporate managers to become more involved in the furnishing of proxy reports could hurt the ability of those firms to issue objective advice. Borrus called the SEC proposal an “unprecedented interference with the private market.”
“We think the rule proposals would bias proxy adviser reports and recommendations toward management,” Borrus said.
ISS is battling the SEC on its own front. The firm sued the agency in October, alleging that SEC guidance on proxy matters that was published in August just before the new rules proposals was “arbitrary and capricious” and could impede its ability to deliver independent research.
“It speaks volumes that the institutional investors which hire proxy advisers are not the ones calling for new, more onerous rules such as those now being contemplated,” ISS CEO Gary Retelny said in an emailed statement to Law360.
ISS insists that it manages conflicts of interest. The company has a subsidiary, ISS Corporate Solutions, which advises companies on how to improve their corporate governance and executive compensation policies. ISS maintains that its subsidiary’s business remains separate from the voting recommendations the parent company provides to shareholders.
Glass-Lewis, which is mostly owned by the Ontario Teachers Pension Plan, did not respond to requests for comment. The firm has said it manages and disclose conflicts and corrects errors when they happen.
The SEC has also codified in its proposal the agency’s prior interpretation that voting advice provided by proxy firms is considered a solicitation under federal proxy rules, meaning that such firms could be held liable if their advice is found to be false or misleading.
Separate from the SEC’s bid to regulate proxy firms is a proposal that would raise the bar on investors who want to submit items for vote at shareholder meetings. Among other things, the new proposal would toughen resubmission rules for ballot items that have failed by large majorities in prior votes.
Current rules require a proposal to gain at least 3% support to be resubmitted if voted on once, at least 6% support if voted on twice, and at least 10% support if voted on three times. The new proposal would respectively raise those resubmission requirements to 5%, 10% and 25%.
Business interests for years have argued that those thresholds should be raised on the premise that “zombie proposals” — meaning proposals that are continually rejected by large majorities of shareholders — are too easy to resubmit, costing companies and investors time and money.
The resubmission rules haven’t been updated since 1954, an era when most shareholders were retail investors. Clayton, who voted for both proposals, cited the market’s shift toward institutional investors as reasons for why be believes changes are needed.
“A lot of people see the resubmission threshold as ripe for updating,” said Covington & Burling LLP senior counsel David Martin, a former director of the SEC’s Division of Corporate Finance.
The SEC also wants to raise the minimum requirements for an initial shareholder proposal.
Shareholders are currently required to own at least $2,000 in company stock for one year before submitting a proposal for vote. Under the revision, shareholders who own $2,000 in company stock would have to wait three years before they could submit a proposal.
If a shareholder only owns company stock for two years, they would be required to own $15,000 worth of shares in order to submit a proposal, or $25,000 if they only owned stock for one year. The SEC said it wants to raise the initial criteria, which has not changed since 1998, to ensure proponents own a meaningful stake in a company or demonstrate a long-term commitment.
The SEC’s proposal also contains a “momentum” requirement that would let a company exclude a shareholder proposal even if it surpassed 25% support under certain conditions if the proposal’s support declined by 10% compared with the last time it was voted on.
The SEC’s two Democratic appointees, Robert Jackson and Allison Herren Lee, voted against both proposals regarding proxy firms and shareholder submissions, describing them as an affront to investor rights. Lee has called the new shareholder proposal requirements “stifling,” noting that many successful reforms to corporate governance take years to gain traction.
“While Chairman Clayton claims to be out to protect the Main Street investors, the proposed rules further disenfranchise us,” shareholder advocate James McRitchie said in a comment letter to the SEC.
Mayer & Brown LLP counsel Laura Richman, who advises public companies, described the SEC’s approach is balanced. She noted that submitting a proposal is an inexpensive way for shareholder proponents to publicize their issues while the company assumes the cost.
“Nobody is being silenced,” Richman said. “They [the SEC] are trying to update the threshold to modernize it.”
Clayton has said the proposal is meant to provide greater alignment between the proposing shareholders’ interests and the remaining shareholders, pointing to a 2018 study that said five individuals were responsible for 78% of all shareholder proposals between 2003 and 2014.
Clayton’s broader aim since taking the helm at the SEC has been to make capital markets more hospitable to public companies, which have dwindled in recent decades. Next year could represent the last opportunity for Clayton to shape the SEC’s agenda given the looming presidential election and potential for change in leadership in 2021.
However the proxy firm and shareholder proposals pan out, lawyers expect action next year.
“It’s clearly going to be on the SEC’s plate for 2020, both of these,” Richman said.