Shareholders Query SEC on No Action Letter Process: Why disempower share owners from seeking information on financial and environmental risks?

The process by which the Securities and Exchange Commission decides whether it will allow companies to exclude a shareholder’s proposal from the annual meeting proxy is coming under increasing scrutiny of the investing community. Many share owners believe the SEC’s process is disempowering investors from seeking information on risks at the very time when empowerment is most needed.

In a meeting with the staff of the SEC Division of Corporation Finance on September 22, an array of shareholder representatives from institutional, pension and socially responsible funds(1) expressed dissatisfaction with aspects of the current SEC process. The meeting was chaired by Meredith Cross, the newly instated Director of the Division of Corporation Finance.

In preparation for the meeting, the author collaborated with several investor organizations including the Social Investment Forum, the Interfaith Center on Corporate Responsibility and Shareowners.org to conduct an internet survey of 40 shareholders, most of whom identified themselves as frequent filers of shareholder resolutions. 80% of respondents said they found the no action letter process to be frustrating or extremely frustrating. Strikingly, 85% of the respondents disagreed with the statement "the staff no action letter process is transparent and accountable" and 81% of the respondents disagreed with the statement "the staff provides sufficient information and justifications for individual decisions."

Principal among the shareowner objections to the current process is a legal bulletin issued by the SEC staff during the Bush Administration declaring that the SEC would allow companies to exclude shareholder resolutions that ask companies to disclose financial risks associated with environmental issues. The same so-called risk evaluation exclusion has since then also been applied to human rights, public health, climate, and even subprime lending issues.

Most of the 15 or so investor representatives who participated in the September 22 meeting with SEC staff criticized this so-called risk evaluation exclusion. We referred to a letter from 60 investors sent December 11, 2008 to then President-elect Obama, hoping for change in this area. That letter noted:

The adoption of this new bar on resolutions requesting “risk evaluation” represented a significant departure -- disregarding the reasonable and principled approach that had governed at the SEC for decades, and replacing it with a radical interpretation of the rules. The result has been to limit shareholder resolutions to questions about the impact that companies are having on society in general, excluding vital questions about the impact that any of these issues may have on the company’s future finances. Institutional investors, especially those that hold long-term stakes in the marketplace, have expressed interest in being able to monitor the financial impacts that various issues pose on their portfolio holdings.

Notably, 90% of the respondents to the shareowner survey stated that they had been forced by staff rulings to write resolutions to avoid asking for disclosure of particular financial risks that they were concerned about. This is a vexing matter of censorship of investor inquiry for an agency that has been accused of botching its handling of Bernie Madoff and other recent disasters.

The new Division Director, Meredith Cross, noted that it “sounds pointy-headed to say that risk is not a big issue or one that shareholders should not be concerned about.” Since coming to the SEC as an Obama appointee in June 2009, Cross has been asking her staff to clarify why this risk evaluation exclusion makes sense. This observer had the sense that she has not yet gotten satisfactory responses to her questions so far; no rationale for the exclusion was offered in the meeting. It remains to be seen whether and how Cross will reverse this misguided policy.

In the meeting it also became apparent that the staff of the SEC works very hard on its review of each resolution challenged by a company. However, some of the review criteria utilized by the staff, and described in the meeting, raised many an eyebrow. For example, it appears that in determining whether a resolution addresses a “social policy issue” that would render the resolution permissible, staff ponders whether the issue is "big" enough in terms of the level of public, legislative and media attention that it is getting to merit “significance.” It seems that a wide array of resolutions – including the issue of consumer privacy and freedom of expression on the internet, disclosure of water sources by bottling companies, and asking a company to develop a policy for reinvestment in the communities it does business, have been excluded because the SEC staff did not view those policy issues as “big.”

Many lawyers in the meeting, representing corporations as well as investors, seemed surprised at these staff determinations of what is a sufficiently “big” issue. What special expertise and political mandate does the staff have to pick and choose among the many corporate social responsibility issues?

The staff also is making some interesting calls about whether an issue is sufficiently relevant to a company receiving a resolution. As an example, the staff has allowed various large retailers, including Wal-Mart, to exclude resolutions asking what they were doing to reduce the toxicity of products they sell. The staff apparently allowed these resolutions to be excluded as “ordinary business” because of their opinion that these issues of toxicity were inadequately related to the retailers’ businesses.

Although no immediate changes were proffered by Cross or her staff on these contentious issues, the staff does seem to be poised to make some modest modifications of the no action letter process in the coming season. This includes providing an additional sentence or two in no action letters to clarify why a resolution was found to be excludable as "ordinary business." The staff may also modify the standard, but confusing, language in their response letters stating that a company had provided “some basis” for finding an exclusion to be applicable; they may replace that language with a clearer statement that the company had met its burden of proof.

These changes may alleviate a bit of the investors’ frustration regarding transparency of the process. However, there was no indication from the SEC staff, or from Meredith Cross, that the risk evaluation exclusion or the other issues of concern in the decisionmaking framework would be addressed before the coming season.

The mood among the investors attending the meeting was restless, to say the least. The coming shareholder resolution season should be an interesting one, as investors continue to assert their rights to place key issues on the proxy and before annual meetings.

- Sanford Lewis

(1) Among those attending the meeting were Paul Neuhauser, Tim Smith of Walden Asset Management, Adam Kanzer of Domini Social Investments, Jonas Kron of Trillium Asset Management, Sanford Lewis (the author of this post), representing the Investor Environmental Health Network and other investor clients, Damon Silvers of the AFL-CIO, Richard Simons of New York City Public Employees Retirement funds, Richard Metcalf of LIUNA, Ann Yerger of the Council of Institutional Investors, Rich Ferlauto of AFSCME, and several others. Also present were some of the leading attorneys representing companies in the no action letter process.