Shareholder Proposals and the Freedom to Invest

Investors’ right to file shareholder proposals has contributed to the success of the US capital markets.

Large, publicly traded companies play a dominant role in the U.S. economy: pharmaceutical companies influence the medicines available in our pharmacies and their cost, health insurers influence which treatments will be affordable to patients, and tech companies influence the degree to which consumers are subject to surveillance or privacy in their use of email and social media.

The free market, and the relationship between investors and issuers, is grounded in investors’ rights as company owners to elect directors as well as file shareholder proposals. The job of boards is to oversee the executives who are day-to-day managing the company. The rights to vote upon directors, as well as to present focused issues through shareholder proposals, are part of the bundle of rights investors possess and value as company owners. The unfettered exercise of these rights reinforces the relationship of trust needed for capitalism to thrive.

Shareholder proposals address issues relevant to companies that are neither trivial nor “picayune.” Risks of potential lawsuits against the company, operational disruptions from droughts, floods and fires, and of ethical scandals that shake consumer or investor confidence— these are typical issues in shareholder proposals and raise material concerns for investors. This private ordering process can allow good ideas to proliferate in the market, advancing best practices and reducing the pressure for government regulation or for more confrontational or costly approaches by shareholders, such as voting against the board, or litigation.

Without the right to make proposals, corporate management can more easily ignore the voice of small shareholders, pension funds, and other investors.

The shareholder’s right to place proposals on the proxy, and the freedom to express a collective voice by voting on such proposals, are part of the social and legal compact between investors and companies that maintains the trust needed for capitalism to thrive. This trust has resulted in the US becoming the largest and most envied capital market in the world.

Shareholder proposals are largely non-binding. Non-binding proposals give companies the flexibility to address shareholder concerns without displacing the traditional role of the board of directors to oversee the operations of the company.

What is a Shareholder Proposal?

Shareholders—as owners of a company—have a legal right to offer proposals to appear on the corporate proxy statement to be voted upon at a company’s annual shareholders meeting. Corporations are required to hold these annual meetings in order for shareholders to vote
on matters related to the corporation such as auditor ratification, election of directors, and executive compensation. The Securities and Exchange Commission (SEC) requires public companies to file an announcement ahead of the annual meeting including its items of business called the proxy statement.4 SEC Rule 14a-8 allows shareholders to submit statements of up to 500 words (“shareholder proposals”) to be included in the company’s proxy statement.

The proxy statement is therefore the vehicle by which investors are informed of proposals by other investors. SEC Rule 14a-8 defines a shareholder proposal as a specific request from the shareholder - a “recommendation or requirement that the company and/or its board of directors take action, which you intend to present at a meeting of the company’s shareholders.” The SEC states that the proposal “should state as clearly as possible the course of action” that the shareholder believes the company should follow.

“Shareholder proposals are a crucial tool for investors to engage with their companies. Engagement covers a host of strategies investors use to obtain additional information and influence the policies and practices of their portfolio companies on governance and sustainable value creation.”

Some shareholder proposals seek changes in governance infrastructure, for example, requesting that the CEO and the board chair be separate people to increase the independence of the board and its ability to oversee the company on behalf of shareholders. Or they might request a change in voting standards to allow proposals to be passed by a vote of a simple majority rather than a larger voting threshold of supermajority, thus creating a better balance of power between the company and its investors. Other proposals may address environmental or social challenges facing the company—issues that may also be the subject of a wider social or political debate, but which nonetheless have a potential financial impact on the company or the larger economy on which returns depend.

For example, a proposal may request the disclosure of the company’s assessment of its operations, policies and practices designed to mitigate environmental, regulatory or liability risks associated with its mining operations. In another instance, a proposal may request
that a company report as to its timeline and plan for how it expects to transition to meet its stated objective of net zero greenhouse gas emissions. Some of these proposals might be described as “social or political proposals,” but they must nonetheless be relevant to the company’s business according to SEC rules and comply with more than a dozen strict SEC rules for acceptable proposals and filings.

Most shareholder proposals are non-binding. Non-binding proposals give companies the flexibility to address shareholder concerns without displacing the traditional role of the board of directors to oversee the operations of the company.

Introduction to the Ordinary Business Rule

Ordinary business

A basic principle of SEC Rule 14a-8 is that a proposal should not supplant or attempt to control the day-to-day decision-making of the corporation, referred to as “ordinary business.” The company’s officers are hired to manage the company under the oversight of the board of directors. The board is accountable as an elected representative of the shareholders. As such, the management and board have important day to day discretion in running the company—who to hire, how much to pay them, what kind of products or services the corporation should offer and many other ordinary business matters that it takes to run a business.

While a focus on ordinary business is not appropriate for a shareholder proposal, the courts and the SEC have made a notable exception when shareholder proposals address important policy issues for a company on which it is appropriate for shareholders to weigh in, often referred to as the “social policy” exception. Such proposals are described as transcending ordinary business.

For instance, while the day-to-day lending practices of a bank are ordinary business, when there is evidence that the bank is engaging in predatory policies and practices, shareholders are able to file a proposal asking the company to disclose more about this issue and its current policies. Similarly, policies regarding the amount of compensation paid to employees are generally ordinary business, but proposals coming from shareholders that challenge excessive compensation of the CEO or of directors are appropriate. A pharmaceutical company’s prices for its products are ordinary business, but company policies exploiting a pandemic to exploit vulnerable consumers may be seen to transcend ordinary business. Day to day legal compliance on environmental regulations is ordinary business, but significant pollution incidents or catastrophes that a company may be liable for may be an appropriate topic for a shareholder proposal because it transcends ordinary business.

An important related limitation is for proposals not to micromanage. Even if the topic transcends ordinary business, proponents must not be so granular in their request to the company that they attempt to micromanage the business. The discretion of the board and management is protected in this process. That is why many proposals often ask the board or management to disclose more about their policies and practices, and proposals seeking action are typically advisory rather than a mandatory order.

The History of SEC rules and Shareholder Proposal Regulation

During the United States’ first century, corporations had small numbers of investors and were largely controlled by shareholders through deliberations and voting that took place at in-person shareholder meetings. As the US economy grew, and corporations had to bring in large amounts of capital from thousands of investors, shareholder meetings went from in-person affairs to being conducted by proxy, and management solicited blanket voting authority based on little or no information. Ownership and control were largely divorced, and corporate abuse of the proxy, which frustrated the free exercise of the voting rights of stockholders, was rampant. Section 14 of the Securities Exchange Act of 1934 addressed this concern by authorizing the SEC to regulate proxy solicitation.

The SEC adopted the predecessor to SEC Rule 14a-8 in 1942, recognizing that shareholders need notice of proposals to be made by fellow shareholders. One court explained that, “the rationale underlying this development was the Commission’s belief that the corporate practice of circulating proxy materials which failed to refer to the fact that a shareholder intended to present a proposal at the annual meeting rendered the solicitation inherently misleading.” SEC Staff reiterated this purpose, explaining that “[t]he Senate Banking and Currency Committee recognized the need to provide not only for disclosure of matters management planned to present, but also for shareholders to be given ‘reasonable opportunity to present their own proposals and views to fellow security holders.”

Thus, SEC Rule 14a-8 advances the overall Securities Exchange Act’s goal of shareholder democracy—a central purpose of the 1934 Act in reaction to weakening shareholder control and increasingly concentrated corporate power in professional managers. Shareholder democracy stands for the principle that, in return for access to the securities exchanges, the law provides that corporations would incur a corresponding duty to give the shareholders fair suffrage. Referring to 14a-8, one recent judicial decision noted that “[t]he Commission enshrined this edict in its regulations, believing that “fair corporate suffrage” required that all shareholders receive notice of such matters when their proxies are solicited.”

Governance Proposals

Governance proposals and the role of individual investors

Governance engagements seek to ensure that a well-functioning board can effectively oversee the interests of shareholders. For example, proposals to increase the independence of the audit or risk committee have the potential to reduce accounting fraud risk. Likewise, engagements to increase the holding period of equity-based pay reduce management incentives to manipulate short-term earnings.

Governance shareholder proposals can also increase investors’ ability to engage with companies. It has been shown that it is more costly for investors to engage with companies with entrenched managers.14 The entrenchment of management is principally measured and affected by the corporate governance infrastructure including whether the company has characteristics such as:

• Staggered boards ƒ  

• Limits to shareholder by-law amendments

• Supermajority requirements for mergers ƒ  

• Supermajority requirements for charter amendments ƒ  

• Poison pills ƒ  

• Golden parachutes

Shareholder proposals that improve corporate governance structures on these aspects are frequently part of an overall strategy by investors to provide a better balance of power between investors and a company’s management and board.