Chapter 1 Overview of the Shareholder Proposal Rule
For well over half a century, the Securities and Exchange Commission (SEC) has had a rule, now Rule 14a-8, that has provided shareholders with the right to include proposals in a company’s proxy materials. The shareholder proposal rule provides shareholders with a vehicle for expressing their views to management and other shareholders on matters that are important to them. This process is a relatively inexpensive alternative for shareholders when compared to the means available to raise shareholder concerns, such as tender offers and proxy contests.
1.02. Purpose Of The Shareholder Proposal Rule
Promulgated under Section 14 of the Securities Exchange Act of 1934, the rule was first adopted in 1942 to allow shareholders to have a voice in the major policy decisions of the companies in which they have made an equity investment. The rule has stood — and continues to stand — at the center of a long-standing debate over the appropriate roles of shareholders, managers and directors. The rule has been revised on numerous occasions since 1942 as the Commission has attempted to balance the views of various constituencies. Most recently, in 1998, the SEC attempted a broad reform but received a record number of comments that reflected a lack of consensus over what the results should be. Despite the number of reform efforts that have caused the rule to undergo numerous significant changes over the years, the purposes of Rule 14a-8 have remained a constant. Since its early releases in the 1940s, the SEC has made clear that the rule is designed to prevent management from using discretionary voting authority to effectively shut out shareholders from being able to propose alternative courses of corporate action. In addition, the shareholder proposal rule has served as a vehicle for shareholders to inform management of their concerns and as a means for shareholders to communicate with each other. In some cases, shareholder proposals have had an impact on companies’ decisions to make changes.
1.03. The Shareholder Proposal Rule Process
Specifically, Rule 14a-8 governs the process whereby a shareholder may include a proposal along with management’s proposals in a company’s proxy materials. In a plain English “Q&A;” format, the rule sets forth procedural and substantive requirements that a shareholder must meet. Shareholders who submit shareholder proposals are known as “proponents.”
Companies that receive shareholder proposals can seek to prevent them from being included in their proxy materials if they believe that the proponents did not meet these requirements. Companies intending to omit a proposal pursuant to this provision must notify the SEC of their intention to do so, and send a copy of that correspondence to the proponent. The process requires the filing of a “no-action” request with the Office of the Chief Counsel of the Division of Corporation Finance.
The staff then considers the request — along with any rebuttal provided by the proponents — and issues a response indicating its views with respect to the company’s intention to omit the proposal. Thousands of no-action letters regarding shareholder proposals have been issued over the past 60 years. This process is unique because the staff is placed in the role of arbiter between a company’s management and its shareholders more than in any other context.
As could be expected, this role places the staff in a tenuous position because shareholders and companies frequently disagree over whether a proposal is excludable on the substantive or procedural grounds in the rule. While some issues have been resolved through the no-action process over time, the complexity of the remaining issues has only grown. In addition, due to a number of factors, such as ease of communication on the Internet, the number of proposals has steadily increased each year. These trends place additional pressure on the staff’s resources.
1.04. How the Shareholder Proposal Rule is Used
During the first few decades of its existence, the rule was primarily used by individual shareholders to submit proposals, which then rarely received significant support at the balloting box. For the most part, these early proponents used shareholder proposals to challenge corporate governance practices. These pioneers, such as the Gilbert brothers, paved the way for future proponents as their activities led to courtroom challenges that upheld the SEC’s adoption and interpretation of the rule.
Another trend grew as the Vietnam war came to an end, when shareholders shifted their focus to social responsibility and political issues. These proposals, which dissected the role and responsibilities of companies, included challenges by Ralph Nader’s legendary “Campaign GM” and by church groups concerned over South Africa’s apartheid policy. These new types of proposals led to more complex issues for the SEC staff to resolve and the heightened conflicts led to more litigation, eventually producing reform efforts by the SEC in 1976 and 1982.
During the takeover boom in the 1980s, shareholders began to submit proposals to express dismay over the willingness of companies to install new anti-takeover devices. This development marked the first time that institutional investors became more willing to submit proposals on a number of corporate governance matters. Ultimately, the interest by institutional investors in being able to more freely communicate led to a 1992 overhaul by the SEC of the rules governing the proxy solicitation process. While this overhaul did not have a direct impact on the shareholder proposal rule, it led to greater communication among shareholders that, in turn, made them more willing to submit proposals.
The 1990s saw dramatic increases in the number and types of proposals. In addition to companies, institutional and individual shareholders became quite sophisticated in the nuances of the rule. The number of proposals submitted each year has increased since that time and negotiation and settlement have become part of the process at many companies.
1.05. Future of the Shareholder Proposal Rule
As reflected by the lack of consensus that stifled major revision in the recent reform effort in 1998, all parties continue to be disgruntled by the rule as well as its application. The continued controversy will inevitably lead to another reform effort at some point in the future. In fact, the current rulemaking project regarding shareholder nominations may lead to revisions to Rule14a-8.
The SEC staff has no vested interest in remaining the arbiter, but continues in that role without any viable alternative. The companies’ goal, of course, is to reduce the number of proposals, perhaps by raising the bar for shareholder eligibility to submit proposals. On the other hand, shareholders believe that companies should not be able to exclude proposals based on “technicalities” and that companies should not be able to ignore proposals that receive support by a majority of the votes cast. As rapid advancements in technology make it much easier for shareholders to inform themselves about proposals, the balance of power may continue to shift towards more latitude for shareholders.