Should shareholder proposals be early warnings for emerging issues and retail challenges? SEC Staff says no.
The socially responsible investment community views the shareholder resolution process as a vehicle for allowing investors to raise and debate issues that may eventually impinge on the corporate bottom line. However, a recent meeting with the staff of the Securities and Exchange Commission indicated that such a view is not necessarily shared by the SEC staff.
First, some legal background. Shareholders that hold over $2000 of shares in a company for over a year are entitled under SEC rules to submit proposals for the company to publish on the proxy statement it issues before its annual meeting. However, the SEC staff also oversees a process of assessing whether particular proposals can be excluded from the proxy based on various SEC rules allowing certain proposals to be excluded. One of the exclusion rules most commonly asserted by companies is that a resolution impinges on the company’s “ordinary business” — addressing issues so mundane that they are not considered appropriate for shareholder deliberations. There are several wrinkles in the staff definition of ordinary business that can determine whether an issue will be kept off the proxy.
Risk evaluation. Prior to 2009, resolutions asking for a company to disclose the financial risks associated with their activities were deemed by the SEC to be excludable as “risk evaluation”. On this basis, in 2008 proposals at Washington Mutual, Bear Stearns, and Lehman Brothers asking for a report on subprime lending practices and risks were kept off the proxy by the SEC. Needless to say, keeping this information out of the proxy did not work out well for investors in these companies. In 2009, after the subprime lending crisis hit, the SEC issued Staff Legal Bulletin 14 E. which changed its policy on risk evaluation. The new policy is to allow shareholders to submit proposals on risk evaluation, but only if the core issue of the proposal addresses what the staff considers to be a “significant policy issue.”
But other staff decisions relating to “significant policy issue” were controversial. For example, this year the staff found proposed issues not “significant” included:
• Net neutrality (a free and open internet) filed at internet providers, even though President Obama had himself publicly declared it an important issue.
• Bottled water quality and labeling, even though this issue is garnering high visibility media and decisions of numerous state and local governments to avoid buying bottled water.
Members of the SEC staff noted in a meeting with stakeholders (including investors and companies) on July 12, 2010 that they view their job as determining whether an issue may have the staying power or whether it could be just a fad. In their view, only firmly engrained issues are appropriate to go to the proxy. The Director of the Division of Corporation Finance, Meredith Cross, stated that the staff decision-making process may lag behind some shareholders’ expectations. She stated that the staff should not, for instance, treat as “significant” this year an issue that they think might yet become significant next year.
Significant policy issue. The SEC staff deliberates on a case-by-case basis as to whether a proposal addresses a “significant policy issue” such that it will not be considered ordinary business. This year, the staff concluded that even though it might seem “ordinary business” for a poultry farm to decide what kind of additives to put in chicken feed, a proposal seeking a phaseout of certain antibiotics in chicken feed presented a significant social policy issue that could appear on the Tyson Foods proxy. What apparently made the issue significant to the staff was that the practice is being banned in Europe. Similarly, even though environmental management of facilities generally could be ordinary business, environmental impacts and financial risks associated with the natural gas extraction process known as hydraulic fracturing were deemed a “significant policy issue” due to the level of environmental concern facing these practices.
Retail product selection. While allowing proposals filed at manufacturing companies addressing the products that they sell, the SEC staff routinely excludes proposals that ask retailers to take some responsibility on their end for potential impacts of products that they sell. For instance, the staff has allowed exclusion of numerous proposals asking retailers to avoid selling toxic cosmetics, toys or nanomaterials. Similarly, in the past year, the staff blocked proposals at two banks that proposed altering bank lending practices to ban loans to companies engaged in coal mining through mountaintop removal.
Opportunities for Shareholder Response
1. The current process places proposals on emerging issues at the mercy of the SEC staff to assess whether they are “significant enough” this year to appear on the proxy, even though many issues and risks of great concern to investors evolve quickly. Witness the staff decision, in the midst of the subprime lending crisis, to rethink prior exclusions of “risk disclosure” proposals. The SEC policies for disallowing proposals on emerging issues and retail products are not mandated by court decisions or regulatory language, but rather are products of SEC staff deliberation. As such, these policies could be overturned by the Commissioners.
2. Comments of Corporation Finance Director Cross implied that the staff may declare some new issues to be “significant” prior to each proxy season. Therefore, it may be appropriate for shareholders to notify the Division of Corporation Finance prior to the coming proxy season (no later than September) of any specific issues that they believe to be “significant social policy issues,” and to seek a staff declaration that those issues are appropriate for resolutions in the upcoming season.