‘Killing the canary’: SEC hands more power to boards in shareholder rights overhaul

Having submitted a proposal in late August to hand greater power to US states to have the final say on shareholder resolutions, the SEC has now doubled down by proposing to eliminate the Notice of Exempt Solicitation entirely.

Announcing the rules on Wednesday, SEC chairman Paul Atkins said: “The proposals reflect two of my highest regulatory priorities. First, ensuring that the Commission does not improperly intrude into state corporate law when applying the federal securities laws. Second, updating the Commission’s rules to reflect developments in market practice and technology, and other innovations, since the rules’ adoption or last amendment.”

The new proposals are effectively increasing the threshold for investors to propose, access and vote on shareholder resolutions whilst strengthening the power of boards to ignore them.

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'Regulatory patchwork'

Going forward, shareholders who find that their resolution has not been included in proxy materials will have to turn to states, rather than the SEC to appeal the move. Critics warn that this risks creating a regulatory patchwork and race to the bottom with companies being incentivised to settle in a state with weaker levels of shareholder protection.

“For a diversified investor, a single national standard would be replaced by up to fifty separate frameworks, most of which do not yet exist, adjudicated in fifty separate court systems at the investor’s expense. It is fragmentation with a built-in incentive for companies to relocate toward whichever regime offers to silence shareholders” warned Danielle Fugere, president and chief counsel of As You Sow.

But Atkins presented the changes as an opportunity for states: "As we experience an exciting period of increased competition among states for corporate domicile, there is no better time for the Commission to recognise the limits of its authority, relative to state law, for regulating shareholder proposals. Competition has always been the engine for innovation and progress in America. As part of states’ efforts to attract companies, the proposed rescission of Rule 14a-8 should, if adopted, provide states with both the legal clarity and the motivation to implement their own ideas for a sensible shareholder proposal framework."

Sarah Wilson, CEO of independent proxy voting agency Minerva Analytics countered: "The SEC's reasoning doesn't stand up to scrutiny. States have always been free to set their own governance standards, and on the Commission's own account only one has used that freedom in eighty years: Texas, which made proposals harder to bring and said nothing at all about what shareholders are entitled to vote on. Handing this to the states isn't neutral. It's a decision about the outcome.

"The issue was never competition between states. It is communication between companies and their shareholders, which is precisely what the federal proxy rules are for. Taken together, the proposals would leave an unbalanced relationship between companies and the providers of their capital" she added. 

Notice of Excempt Solicitation scrapped

The SEC has also scrapped the requirement to publish a Notice of Exempt Solicitation. Consequently, investors wishing to campaign for a resolution will lose the ability to file their supporting materials on the SEC’s EDGAR platform, leaving the onus to publicise and coordinate their message entirely on the shareholders themselves. In contrast, in Europe and the UK, companies are generally required to include qualifying shareholder resolutions in the official notice of meeting distributed to all shareholders.

Shareholder rights group As You Sow warned that this risks creating information asymmetry. “The company’s proxy statement remains mandatory and publicly filed, while shareholder analysis of that statement has no official home” the group said.

Responding to plans to limit access to the EDGAR platform, Wilson said that the stated incentive was to remove 'clutter.' "The proposed remedy then removes the channel for everybody, including the large holders for whom it was designed and who are the only ones the rule ever required to use it.

She highlights that the SEC itself had previously suggested alternatives that would enable large investors to still access EDGAR but now risks excluding everyone.  "Company communication channel control is already asymmetric, how does price discovery and risk management work if you only get one side of a story? For an administration that believes in free speech and free markets this approach seems to sit quite uncomfortably with that thesis" she said. 

In proposals to amend Rule 14a-4, the SEC would grant companies discretionary authority to vote proxies on matters raised at a shareholder meeting but excluded from the proxy card, making it easier for boards to quash shareholder dissent during a meeting.

Fierce criticsm 

The changes have sparked fierce opposition from asset owners and shareholder rights groups. Responding to the news, Thomas Di Napoli, trustee of the $295.4bn New York State Common Retirement Fund said the SEC was abandoning its core mission to protect American Investors.

“For more than 80 years, the shareholder proposal process has been a cornerstone of American corporate governance that has strengthened board oversight, improved risk management, and fostered productive dialogue between investors and companies. With this attempt to rescind Rule 14a-8, the SEC has chosen to allow corporate management to shield themselves from accountability rather than protect the investors it was created to serve” he said, calling on companies to continue accepting shareholder proposals.

Lindsey Stewart, director of Institutional Insight at Morningstar warned that the changes brought new challenges for major investors. “Institutional investors are likely to lament the further fragmentation and complexity in shareholder engagement with companies that is implied by the SEC’s latest announcements on Rule 14a. Although there’s much disagreement among investors on the issues addressed by shareholder resolutions, they are near-unanimous on the value of being able to submit non-binding proposals to US companies through a process overseen by a federal regulator. And at a time when US states are already competing to attract companies to their jurisdictions by implementing less shareholder-friendly business regulations, many institutional investors will be worried about an accelerating ‘race to the bottom’ on shareholder rights.”

“This is not a loss for any one organization; it is a loss for the free market,” said Andrew Behar, CEO of As You Sow. “Shareholder proposals are the most efficient and inexpensive form of risk intelligence a board will ever receive. They arrive early, in writing, from the people whose capital is at stake, and they cost a company almost nothing to read and engage. Killing the canary does not make the mine any safer.”