SEC Proposed Rule Could Have a Detrimental Impact on Activist Investors

On November 5, 2019, the Securities and Exchange Commission (“SEC”) proposed amendments to Rule 14a-8 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which governs the shareholder proposal process. The proposed amendments, which the SEC has said are meant to modernize the rules that have not been significantly updated since 1954 (SEC Press Release, SEC Proposes Amendments to Modernize Shareholder Proposal Rule), have the potential to limit activism by smaller shareholders. 

Rule 14a-8 regulates those circumstances when a publicly traded company must include a shareholder proposal in its proxy materials for a vote at the annual shareholder meeting. In particular, this Rule includes the requirements for a shareholder to submit a proposal, as well as the ways in which a company may exclude a shareholder proposal from its proxy materials. Under the current rule, in order to submit a proposal, the shareholder must meet certain requirements, including submitting only one proposal per meeting, owning at least $2,000 worth or 1% of the shares entitled to vote on the proposal at the meeting continuously for twelve months, and meeting various other the submission requirements. (17 CFR § 240.14a-8). Companies may exclude a shareholder proposal under one of the thirteen enumerated exclusions, such as when the proposal (i) is not a “proper subject for action by shareholders under the laws” of the company’s state of organization (ii) sets forth a request that “relates to the redress of a personal claim or grievance against the company,” (iii) sets forth a request that “the company would lack the power or authority to implement,” (iv) sets forth a request “relating to the company’s ordinary business operations,” or (v) sets forth a matter that “the company has already substantially implemented…”. (17 CFR § 240.14a-8(i)(1)-(13)).

The proposed amendments would alter the requirements for submitting a shareholder proposal. Under the new rules, a shareholder could only submit a proposal under one of the following three scenarios: (i) continuous ownership of at least $2,000 worth of the company’s securities for at least three years; (ii) continuous ownership of at least $15,000 worth of the company’s securities for at least two years, or (iii) continuous ownership of at least $25,000 worth of the company’s securities for at least one year. (SEC Release No. 34-87458, Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8). In addition, the proposed rules would change the shareholder proposal resubmission thresholds. Under the current rules, a company can exclude a resubmitted shareholder proposal if it deals with substantially the same subject matter as a previously included proposal if the most recent vote within the prior three years was (i) less than 3% if voted on once, (ii) less than 6% if voted on twice, and (iii) less than 10% if voted on three or more times (17 CFR § 240.14a-8(i)(12)). The proposed rule would increase the required voting thresholds to 5%, 15%, and 25%, respectively and add in an additional exclusion relating to proposals that have been voted on three or more times in the most recent five years. (SEC Release No. 34-87458, Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8). Lastly, the proposals would curtail the one proposal rule by indicating that “each person” versus “each shareholder” can submit only one proposal per shareholder meeting. This change would prevent a shareholder representative from submitting a proposal in their name as an owner of shares and also submitting different proposals on behalf of other shareholders at the same meeting. (SEC Release No. 34-87458, Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8).

The proposed amendments are based on the SEC and its staffs’ experiences with shareholder proposals, as well as the general changes in the marketplace that provide shareholders with other methods to raise concerns and effect change, such as through social media or direct communication with the company. (SEC Release No. 34-87458, Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8; SEC Press Release, SEC Proposes Amendments to Modernize Shareholder Proposal Rule). During 2018, 788 shareholder proposals were submitted and the SEC received more than 250 no-action letter requests relating to shareholder proposals. (Gibson, Dunn & Crutcher LLP, Shareholder Proposal Developments During the 2018 Proxy Season). Jay Clayton, Chairman of the SEC, stated that “the proposed amendments would facilitate constructive engagement by long-term shareholders in a manner that would benefit all shareholders and our public capital markets.” (SEC Press Release, SEC Proposes Amendments to Modernize Shareholder Proposal Rule). 

The SEC has said the proposed changes will modernize the shareholder proposal process and allow for continued engagement between companies and shareholders and that the changes are “content neutral” with the goal of providing greater transparency and efficiency to the proxy process (SEC Press Release, SEC Proposes Amendments to Modernize Shareholder Proposal Rule; Chasan & Kishan, Bloomberg: Corporate New, Silencing the Nun: SEC Aims to curb Small Investors’ Activism), but others do not necessarily view the proposed changes in a favorable light. Sister Nora Nash, the director of corporate social responsibility for the Sisters of St. Francis of Philadelphia, believes the changes will mostly affect small shareholders and their ability to engage with companies (and their executives and boards) and hold companies accountable for their actions. (Chasan & Kishan, Bloomberg: Corporate New, Silencing the Nun: SEC Aims to curb Small Investors’ Activism). Fiona Reynolds of UN-backed Principles for Responsible Investment thinks the proposed rules are a direct attack on shareholders and their right to have a voice when they own shares of a company and Holly Testa of First Affirmative Financial Network believes the changes will have a “chilling effect” on small shareholders and limit their ability to garner meetings with companies. (Chasan & Kishan, Bloomberg: Corporate New, Silencing the Nun: SEC Aims to curb Small Investors’ Activism).

The 60-day comment period on the proposed rule changes is open. While it seems highly likely that these rules will be implemented at the end of the period, what is unknown is how the proposed rules, if implemented, will impact smaller shareholders who do not have the same access and voice as large investors, many of which are institutions.