Risk & Compliance

SEC Proposal Protects Executives, Hamstrings Investors

Proposed rule changes would pressure proxy advisory firms to take a more management-friendly stance in their reports and vote recommendations.
David McCannNovember 6, 2019
SEC Proposal Protects Executives, Hamstrings Investors

Delivering what could be considered a body blow to investor rights, the Securities and Exchange Commission on Tuesday proposed rule changes that would limit the ability of public-company investors to hold corporate insiders accountable.

Under the proposed rules (see here and here), companies would get two chances to review proxy materials before proxy advisory firms send them to their client shareholders (in advance of shareholder votes on issues like executive compensation and significant transactions).

The SEC called it “a period of review and feedback through which companies would be able to identify errors in proxy voting advice.” The goal is helping to ensure that investors “make voting determinations on the basis of materially complete and accurate information,” the SEC said in its proposal.

If they recommend that investors vote against company executives’ wishes, proxy advisers would have to provide their analysis to management and include executives’ objections in their final report.

The SEC additionally aims to make it harder for shareholders to require companies to include a shareholder proposal in proxy statements. While the commission maintained the longstanding $2,000 stock ownership threshold for submitting a proposal, shareholders would be required to have held the stock for at least three years.

Further, the thresholds for resubmitting a failed shareholder proposal would increase. Currently, companies can exclude a proposal from a proxy statement if the matter was voted on at least once in the last three years and did not receive at least 3%, 6%, or 10% of the vote, depending on whether the matter has been voted on once, twice, or three or more times, respectively.

Those thresholds have been in place since 1954. Now, the SEC is proposing that they be raised to 6%, 15%, and 30%.

The proposal also would require proxy firms to disclose “material conflicts of interest.” According to the SEC, various conflicts of interest could affect the objectivity or reliability of proxy firms’ advice. For example:

  • A proxy firm providing voting advice to clients on a registrant while also earning fees from the registrant for providing advice on corporate governance and compensation policies
  • A proxy firm providing voting advice on a matter in which affiliates or clients have a material interest, such as a business transaction or a shareholder proposal put forward by a client
  • A proxy firm providing to institutional investors ratings or registrants’ corporate governance practices while at the consulting for those registrants

“Today’s proposals are rooted in key principles of our federal securities laws — disclosure of material conflicts of interest and constructive shareholder-issuer engagement,” SEC chairman Jay Clayton said in a statement.

The Other Side

In a dissenting opinion, commissioner Robert Jackson noted that while the SEC hadn’t examined its proxy rules for years, “these issues have been thoughtfully debated for decades.”

However, he charged, “rather than engage carefully with the evidence produced by those debates, today’s proposal simply shields CEOs from accountability to investors…. Today’s proposal imposes a tax on [proxy] firms who recommend that shareholders vote in a way that executives don’t like.”

Why? Consider, Jackson said, a proxy adviser deciding how to advise shareholders in a proxy fight driven by poor corporate performance.

“Recommending that investors support management comes with few additional costs under today’s proposal,” he said. “But firms recommending a vote against executives must now give their analysis to management, include executives’ objections in their final report, and risk federal securities litigation over their methodology.”

He continued, “The SEC is interfering in decades-long relationships between investors and their advisers in a way that will significantly skew voting recommendations toward executives. That will be especially true in cases, such as investor proposals to strengthen the link between CEO pay and performance, where proxy advisers have historically engaged in the careful, firm-specific analysis that such proposals require.”

Jackson even suggested that the amended rules could knock some proxy advisory firms out of business. That would be regrettable, he noted, give the already-scant competition in the space.

While Glass Lewis and Institutional Shareholder Services dominate the market, their domination would increase yet further should second-tier players (including Egan-Jones Proxy Services, InGovern Research Services, Institutional Investor Advisory Services India, and Stakeholders Empowerment Services) be compromised.

Also slamming the proposed rules was the Council of Institutional Investors. Like Jackson, CII was particularly incensed by the prospect of proxy advisers being pressured to take a more management-friendly approach in their reports and vote recommendations.

It’s “the opposite of what is required by regulation of stock analyst reports,” CII noted. Current rules prohibit analysts from sharing draft research reports with target companies, other than to check facts after approval from a company’s legal or compliance department.

The raised stock ownership and resubmission thresholds for shareholders “will restrict the ability of retail investors to submit shareholder proposals and impede future new social an environmental proposals, since those generally take time to gain traction,” CII argued.

Ken Bertsch, CII’s executive director, summed up the organizations viewpoint this way: “CEOs do not like public challenges to how and how much they are paid, or to be second-guessed by shareholders on a range of environmental, social, and governance matters.

“That,” he continued, “is what is driving the concerted effort by lobbyists for CEOs to prod the SEC to shackle proxy advisory firms and limit shareholder proposals. The rules are an unnecessary interference in the free market, and would impede investors’ voice on critical matters at U.S. public companies.”

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