[Editor's note: This story originally was published by Real Clear Wire.]
By Timothy M. Doyle & Robert G. Eccles
Real Clear Wire
The U.S. Securities and Exchange Commission (SEC) has several roles and one of them is to regulate certain aspects of the shareholder proposal process. This process occurs when shareholders of a company submit proposals to be included in a company’s proxy materials to be voted on at a company’s shareholder or annual meeting.
A recent dispute between ExxonMobil (Exxon) and Arjuna Capital, a small impact investor, has received national attention. What started out as a simple dispute has morphed into a legal battle after Exxon decided to continue a lawsuit even after the activist investors withdrew their controversial proposal from consideration. This is a risky move for the company in terms of its already challenged reputation. It’s also risky in terms of the implications of the court’s decision on shareholder rights. This extremely aggressive legal strategy was countered by an equally aggressive move by the California Public Employees Retirement System (CalPERS) and others. CalPERS claims that the lawsuit threatens all shareholders and was behind an effort to remove Exxon’s entire board.
Exxon’s annual meeting was held today. The preliminary voting results are in and range in support from 87% to 98% with an average of 95%. The 87% number is relatively low in a director vote and likely reflects negative investor sentiment. However, the 95% number shows broad support remains for Exxon’s board. In short, the vote simply illustrates the importance of the court’s ruling.
The court’s ruling from this suit may well change the way shareholders proposals are handled at publicly traded companies throughout the U.S. The real issue here is who determines what type of shareholder proposals end up being voted on.
Historically, the SEC had an internal policy under Rule 14a-8 to handle this type of dispute. Unfortunately, and part of the problem, is that this policy has been reinterpreted with each successive administration and subsequent SEC Chair. This is but one example of tradition and precedent being disregarded because of increasing partisanship. We have written about how the Department of Labor’s ever changing amendments under ERISA are another example of this. Unfortunately, the current SEC is attempting to further the policy agenda of the current administration with a broad reading of its Congressional mandate. Add that to a divided Congress and it’s no wonder that a lawsuit was filed, and a retaliation occurred.
Under SEC Rule 14a-8 companies must include shareholder proposals unless they fall under one of thirteen exceptions. Historically, if a company reasonably believed that a submitted shareholder proposal could be excluded under one of the exceptions it must notify the SEC. Further, to avoid a potential enforcement action and lawsuit, a company typically also petitions the SEC for what is referred to as a “no action” letter or an agreement not to proceed with an enforcement action. Practically speaking, obtaining this letter is the difference between a proposal being included for a vote or not.
Traditionally, one of those exceptions, the “ordinary business exception,” allowed a company to withhold a proposal if it related to the company’s “operations” unless the proposal involved a “transcendent or significant policy” issue but could nonetheless not “micromanage” a company’s day-to-day operations. This ultimately became a case-by-case analysis and while it may not have been a perfect option and is currently the subject of potential Congressional reform and judicial review, at least there was a reasonable opportunity to make the case that an exception applied.
Unfortunately, and applicable to this case, the SEC decided to substantially restrict the ability of companies to make their case under the ordinary business exception. (There are other issues in the Exxon case, but we focused on this particular one given the impact). Back in 2021, in “Staff Legal Bulletin No. 14L (CF)” the SEC decided not to intervene in the shareholder proposal process if the proposal involved an issue that had a “broad societal impact” regardless if there was a “nexus between a policy issue and the company” or it “micromanaged” the day-to-day operations of the company. This eventually led to an historical number of shareholder proposals including the one filed with Exxon. We do not agree with the SEC’s decision to broaden the scope of Rule 14a-8. A pivotal role of the SEC is to protect investors, not to facilitate those who want to use the shareholder proposal process to pursue policy objectives—even those we agree with like the need to address the challenge of climate change. Furthermore, proposals about broad social impact that are beyond the scope of a company’s business put real costs on the company that are ultimately borne by all of its shareholders.
In July 2023, Congress attempted to reform how the SEC handled these issues. Several 14a-8 reform bills were voted out of Committee. Unfortunately, they were all on party line votes, so no serious bipartisan debate or compromise occurred. These bills are unlikely to make it to the floor for debate in the current 118th Congress. Given the SEC’s novel approach to the ordinary business exception analysis and reform bills seemingly stuck in Congress, it’s not surprising that a company who receives a disproportionate number of shareholder proposals, many of which are about broad social impact rather than shareholder value creation, would seek a judicial remedy.
While a legal decision would give some finality to the specific issue being litigated, there is real concern that an opinion may have unintended consequences by placing a chilling effect on the important relationship between shareholders and companies. Each plays an important role in ensuring that our robust capital markets remain the envy of the world. While outside the scope of this piece, some of these issues go to the fundamental role of a company in today’s society and the proper role of government oversight.
As for the specific issue at hand, is there a practical solution? The short answer is “Yes” and it’s a two-step one. Given the proclivities of Congress to act slowly, especially in a hyper-partisan political environment, the most prudent first step would be for the SEC to reevaluate how it interprets its role in the shareholder proposal process and clarify the rules used to exclude irrelevant shareholder proposals. This would give companies a reasonable opportunity to explain why they think a given proposal should be excluded, while protecting the rights of shareholders to engage with boards and management, as well as submit proposals when appropriate.
The second step is for Congress to act and at the very least clarify the SEC’s role and add some common-sense sustainable guardrails to ensure certainty in the shareholder proposal process. This would go a long way in preventing this issue from reoccurring every four years. The majority of shareholders and companies yearn for a return to normalcy where issues are resolved outside of lawsuits and vote against an entire boards of directors. These dynamics threaten both shareholder value creation and effectively addressing issues that have broad social impact.
Robert G. Eccles is at the Saïd Business School, University of Oxford.
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