Potential SEC Reforms to Restore Main Street Market Trust
With the rise of so-called Environmental, Social and Governance-focused investing (ESG), a select few activist institutional investors are increasingly pressuring companies on political issues that have little—or even a detrimental impact—on public companies’ profits.
This corporate politicking by some pension funds hurts average investors because it diverts companies to focus on hot button issues like climate change instead of increasing shareholder value.
The shareholder proposal system, where investors owning as little as $2,000 or a 1 percent stake in a company can submit shareholder proxy proposals on everything from climate change to gender issues, needs reform to ensure that shareholder engagement reflects the interests of actual shareholders—not special interests.
Moreover, the proxy advisory industry has been captured by a duopoly: two firms, Institutional Shareholder Services and Glass Lewis, control 97 percent of the market. Those companies have glaring conflicts of interest, as they often provide shareholder voting recommendations on publicly traded companies and consulting services to those same businesses.
Nasdaq, along with hundreds of publicly traded companies, sent a Feb. 4 letter to the Securities and Exchange Commission urging it to take strong regulatory action to regulate proxy advisory firms to address three serious problems: conflicts of interest, accuracy and transparency.
The SEC should adopt strong protections for companies and proxy advisory customers to ensure conflicts are eliminated, minimized and disclosed. The SEC should also require proxy advisory firms to engage with public companies on errors in reports as well as provide transparency in their voting recommendations.
“A lot has changed since [the proposal rules were adopted],” SEC chair Jay Clayton said at a December conference. “We need to be mindful of these changes, and make sure our approach to the very important issue of shareholder engagement reflects the realities of today’s markets and today’s investors.”
ESG proxy proposals backed by proxy advisory firms are on the rise. Shareholders proposed 464 such resolutions in 2018, up from 407 in 2010, according to the Sustainable Investments Institute. Institutional asset managers such as BlackRock, State Street and Vanguard—which combined represent 40 percent of public company shares—have recently altered their voting guidelines to be more open to ESG proposals that call for action on issues not connected to a company’s profitability.
In fact, according to the Manhattan Institute’s annual Proxy Monitor review, more than half of all shareholder proposals submitted during the 2017 proxy season involved social issues with no connection to a company’s financial performance.
Along with reforming the proxy advisory industry, the SEC could enact three simple reforms to reform the shareholder proposal system to work for average investors.
First, it should raise resubmission standards for proxy votes. Year after year, companies deal with similar “zombie” shareholder proposals pushed by politically conscious investors with little support. An SEC rule, established in 1954, requires repeat submissions to have received just 3 percent support after the first submission, 6 percent on the second and 10 percent on the third to be submitted the following year. In 1997 the SEC proposed raising the thresholds to 6, 15 and 30 percent, respectively, but the measure was not adopted. It’s time to raise the standards.
Simply analyzing a proposal to determine if it’s valid costs public companies at least $87,000, according to 2009 data from the U.S. Chamber of Commerce. More recent anecdotal data indicates companies spend roughly $150,000 analyzing each proposal. Large public companies routinely face more than 15 proposals per year—that adds up to more than $2 million in annual compliance costs.
That cost falls hardest on smaller companies, where fending off politically motivated shareholder proposals means that they have fewer resources to invest in employees, research and other vital functions critical to the enterprise.
Second, the SEC should raise the standard of ownership to submit a proposal. Shareholder proposals should come from funds and individuals who actually have a vested stake in the company. The SEC should consider raising the ownership threshold from $2,000 to $10,000.
The SEC should also consider raising the amount of time a shareholder seeking to put forth a proposal has invested in the company—from one year to two or three. This will ensure more resources are focused on proposals from shareholders with skin in the game compared to those seeking to push political points.
Third, the SEC should also weigh imposing a time-out phase for proposals. For example, if a proposal fails to garner a certain amount of support for three years in a row, the shareholder wouldn’t be allowed to submit the same proposal again without waiting a few years. This would cut down the compliance cost for companies dealing with “zombie” shareholder proposals that return year after year from the same activist shareholders without garnering even close to majority support.
A report last fall from the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness showed that 32 percent of all failed proposals between 2001 and 2018 were zombie proposals. Low thresholds for repeatedly failed proposals have allowed a small group of activists to hijack the process to advance political issues like climate change unrelated to creating long-term value for public company shareholders.
As they seek to reform the shareholder proxy process to best reflect the interests of Main Street investors, the SEC should also consider requiring those seeking to advance shareholder proposals to explain how the proposal would increase shareholder value, whom the shareholder is submitting the proposal on behalf of, and disclose the number of other companies where the same proposal has been introduced. Adding this level of transparency is crucial to help average investors understand the process.
The shareholder proposal system isn’t working as it should. The SEC could go a long way toward reforming the process and restoring the trust of Main Street investors by ensuring common sense measures orient the proxy system towards long-term value creation and constructive shareholder engagement.