SEC staff says shareholder proposals process should lag behind emerging issues

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.

In the Aftermath of the Deepwater Horizon Oil Disaster: Can we install Precaution in the Corporate Operating System?

In the Aftermath of the Deepwater Horizon Oil Disaster: Can we install Precaution in the Corporate Operating System?

Should BP and other corporations follow the “precautionary principle”?

By Sanford Lewis

We don’t yet know the full toll on regional and global ecosystems and economies from the unprecedented BP Deepwater Horizon oil catastrophe in the Gulf Coast. But it is not too soon to draw one lesson — the need for a dramatically different decision-making principle to operate whenever a corporation threatens what is most valued by humanity. Now is a good moment to ask whether there is more we can do to install such a principle in the corporate “operating system.”

 

For over a decade, there has been a mostly quiet and scholarly discussion about the Precautionary Principle. This is essentially a common sense notion that when an activity may pose the potential for severe or irreversible damage to the things we hold dear, businesses and governments must take all reasonable precautionary measures to avoid the damage. The principle demands action even in the face of uncertainties, such as how likely it might be for such severe damage to occur, or whether the acting entity may be held legally accountable for the resulting damage.

Despite its common sense, the Principle does not drive relevant decisions in most corporations today. In the case of the Gulf Coast disaster, BP reportedly saved $500,000 by omitting a remote acoustical emergency valve. The company had fought regulations in the US, similar to those already effect in Norway and Brazil, which require such a valve. And while other companies voluntarily install the valves even where not legally required, BP and its contractors did not do so. We will probably never know whether the valve would have stopped the current disaster. But the uncommon sense of the Precautionary Principle would dictate that the valve should have been in place.

This raises the question of whether it is possible to install this principle in corporate “operating systems” in a way that would lead companies to make more precautionary decisions.

Here are a few ideas for reader input.  Do these ideas strike you as worth pursuing as part of corporate social responsibility and socially responsible investment initiatives?

Integrate the Precautionary Principle to Enterprise Risk Management?

Enterprise Risk Management (ERM) is a widely used process by which a company reviews and manages its “risk profile.” See Enterprise Risk Management Framework of the Committee of Sponsoring Organizations of the Treadway Commission (COSO) (2004).  Financial and reputational risks are typical drivers of decisions under ERM. In contrast, integrating the Precautionary Principle to ERM would mean requiring action when  the environment or other core social values such as human rights are seriously threatened, regardless of projections of whether  the related costs will be internalized to the corporate bottom line.  Some forward-looking companies such as Dell, Samsung and Bristol-Myers Squibb  have  already adopted the Precautionary Principle.  One wonders whether and how those companies are already integrating the Principle to ERM.  Where else are there opportunities to advance Precaution as a decision-making principle within ERM?

The  Precautionary Principle and human rights? The Deepwater Horizon disaster is not just an environmental catastrophe. Because it threatens the right to livelihood of  many coastal people who rely on the ocean for fishing, and the right to a  healthy environment,  it also is a human rights disaster. The Precautionary Principle is relevant to protection of human rights as well as to the environment.  Shouldn’t society require that businesses operationalize the idea that if their actions may trample fundamental human rights, even if there is some uncertainty, they must consider and apply measures  to avoid such harms?   The opportunity to instill such a principle may exist now.  Professor John Ruggie, the Special Representative of the UN Secretary-General on Business and Human Rights, has proposed a framework that would, among other things, encourage corporations to “respect” human rights by exercising “due diligence.”  (The framework is due to be refined and finalized by June 2011.)  At a recent gathering to discuss the framework, lawyers asserted that getting their corporate clients to engage in “due diligence” is difficult because “human rights” are  so amorphous.  How can they know with certainty when such rights are about to be violated?  Could integrating the Precautionary Principle, or something like it, into the UN framework help to ensure that corporations respect human rights even in the face of uncertainty?  

Integrate the precautionary principle to  corporate charters, perhaps beginning with emerging “green” and “sustainable”  corporate models?

The deepest place to install the Precautionary Principle would be in the “DNA” of the corporation, the corporate charter.  At least theoretically, efforts could be undertaken to amend corporate charters to require the application of the Precautionary Principle. But an easier place to begin may be through the new efforts to provide mechanisms to incorporate  and  certify companies as “green” or “sustainable.” For instance, on April 14, 2010, the state of Maryland established a new law allowing companies to incorporate as “Benefit Corporations,” integrating societal benefit goals to their charters and missions, and backing this up with review and certification by respected third-party certifiers (much like Underwriters’ Laboratory reviews safety).  Other states are also considering such laws. The incorporation and certification programs that are emerging are an attempt to overcome widespread greenwash, as a result of companies like BP attempting to self-certify or brand themselves as green.  Could a litmus test be whether the new “green” corporations have adopted and operationalized the Precautionary Principle?

There are many other potential opportunities and strategies for integrating the Precautionary Principle to corporate decision-making, such as shareholder resolutions, legislation, and directors’ fiduciary duties.  In the aftermath of Deepwater Horizon, the time is ripe to begin the work of integrating the common sense of precaution to corporate decision-making systems. Which of these opportunities do you find most promising, and why?