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This is a guest blog written by Holly Testa, Director of Shareowner Engagement, First Affirmative Financial Network

holly testa first affirmative

The 600+ page Financial CHOICE Act passed the House of Representatives on June 9th. This bill, largely a rebuttal to Dodd-Frank, carries the subtitle Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs. We at First Affirmative, an investment management firm specializing in Sustainable, Responsible, Impact investing, do not believe this accurately reflects the bill’s provisions—specifically with respect to Section 844.

Section 844 seeks to curtail our clients’ rights as investors and our ability to meet our fiduciary responsibilities to clients.

Short, Sweet and Drastic

In a scant page and a half, 844 would amend the current shareholder proposal (shareholder resolution) process under rule 14 a-8 which was first established in 1942 by the Securities and Exchange Commission (SEC).

Provisions of Section 844:

  • Proposal submission threshold requires 1% ownership over three years. (Previously $2000 over one year.)
  • Resubmission threshold (the ability to refile the same resolution in subsequent years) 6% in year 1 (up from 3%); 15% in year 2 (up from 6%); 30% in year 3 (up from 10%);
  • Prohibits shareholder proposals by proxy, preventing investors from delegating right of ownership to professional advisors.

Under the existing rule, investors who own at least $2,000 or 1% in common stock for one year, and meet other eligibility and procedural requirements, have the right to file shareholder proposals that may be presented to all other shareholders for a vote at the annual general meeting (AGM).

This process has long served as a cost-effective way for corporate management and boards to better understand shareholder priorities and concerns. While the outcome of shareholder proposal votes are non-binding, corporate and board practices now considered best or even standard practice, such as the requirement for boards to have a majority of independent directors and hold annual director elections, were first introduced via this process.

Doing the Math on the 1%

Some supporters of Section 844 believe that the current threshold for eligibility to file a resolution is too low. Even if this viewpoint was more widely held, Section 844 effectively employs a nuclear device when a flyswatter might do.

Most shareholder proposals are filed at large cap companies (companies with a minimum value of $10 billion). Under 14a-8, a broad spectrum of investors have the right to file a proposal. Under Section 844 only investors that have owned at least $100 million (of a $10 billion firm) for three years could file.

In the case of Apple, which has a market capitalization of around $800 billion, an investor would need to hold around $8 billion for three years. Subsequently, only about ten of the very largest of money managers would be eligible to file. These investors generally do not file shareholder resolutions, as their size gives them ready access to corporate board rooms. But many of them do vote proxies and, as we note later in this piece, some are voting for proposals submitted by smaller shareholders.

The asset management firms that would meet the 1% threshold do so only because they manage a large enough pool of assets on behalf of many smaller investors. These firms would, in effect, be granted special ownership rights by managing a significant pool of client assets, while other investors are denied these rights. What is being advertised as a “modernization” of the shareholder proposal process is an evisceration given the 1% threshold would eliminate virtually all shareholder proposals.

Here’s New York State Comptroller Thomas P. DiNapoli, who is in charge of the $186 billion New York State Common Retirement Fund:

“The Common Retirement Fund’s positions in individual companies are in the tens or hundreds of millions, with some over $1 billion, which makes it outrageous and inequitable that we would not be able to make requests of corporate boards through shareholder resolutions.” He believes that “This misguided legislation would greatly diminish shareholders’ ability to protect and enhance their investments and drastically reduce corporate accountability.”

Further compounding the proposed 1% threshold provision, the resubmission thresholds are a barrier to educating companies and shareholders on emerging or little understood issues. Change takes time within large and complex corporations, such that emerging issues may take years of consideration before they are fully understood and accepted. The average support level of shareholder proposals filed asking for annual board of director elections was less than 10% in 1987 but increased to 81% by 2012. Annual board elections are now accepted as good corporate governance.

Prohibiting proposals by proxy denies investors access to professional assistance in the exercise of this key right of ownership. Our clients, for example, would continue to authorize us to make buy and sell decisions and vote their proxies, but then need to act on their own behalf when filing shareholder proposals. Conversely, companies can continue to access professional assistance by retaining attorneys and other experts to act on their behalf.

All fiduciaries have a duty to monitor investment risk, and many, including First Affirmative, consider filing proposals to uncover potential risks and preserve long-term value to be inherent to this duty. This provision reduces our ability to undertake risk management and protect the long-term value of our clients’ investments.

Understanding the Opposition to the Current Process

Two common objections to the shareholder proposal process relate to concerns about materiality and cost.

Materiality

The Business Roundtable states that “Most social, environmental and political proposals, such as those related to corporate political spending, climate change and human rights, have only an attenuated connection to shareholder value and are generally not issues material to a company’s business.”

The Business Roundtable’s inability to see the connection of environmental, social, and governance (ESG) issues to shareholder value, puts them behind the curve. Many shareholder proposals are aimed at transparency around these types of data to ensure corporations have accurately assessed important risks. Per Michael Bloomberg:

“Increasing transparency makes markets more efficient and economies more stable and resilient.”

A significant number of companies seem to agree, including some of the largest investors. In 2016, 17 large U.S. mutual fund companies voted for more than 50 percent of climate change-related resolutions. In 2017, BlackRock, Inc., the world’s largest asset manager, joined this trend and voted in favor of shareholder proposals at Occidental Petroleum and ExxonMobil requesting enhanced disclosures on the management of climate-related risk. Both proposals received strong majority support.

BlackRock’s decision demonstrates the Company’s commitment to implementing an enhanced proxy voting policy developed earlier this year in response to a shareholder proposal filed by First Affirmative and Walden Asset Management. The proposal requested an explanation for the disconnect between BlackRock’s integration of ESG into their investment analysis and publications addressing climate change and their proxy voting policies which led them to vote against climate-related proposals.

Cost

A report by the U.S. Chamber of Commerce postulated $87,000 as the average cost of responding to a shareholder resolution to a company. However, arriving at this estimate requires some creativity. The figure is based on an ambiguously worded 1998 company survey conducted by the SEC in 1998 that produced a perplexing range of estimated costs ranging from just $10 up to $1.2 million.

Moreover, the $87,000 estimate is disclosed as the “implied cost … per proposal based on the assumption that corporations seek to exclude all proposals.” Corporations in fact seek to exclude relatively few proposals each year by utilizing the SEC “no action process” that allows for exclusions based on specific criteria, with only 27% of resolutions submitted being challenged in 2016.  Given that legal expenses dramatically increase the cost of any given resolution, the $87,000 estimate is highly questionable.

Companies can exert some control over costs and our engagement with BlackRock serves as a model. When companies choose to battle with their shareholders the cost can be substantial.  Conversely, when companies choose conversation the outcome can be a withdrawal and productive engagement that is arguably an investment and not a cost.

Bottom line: Companies that focus on the benefits rather than the inconveniences can develop effective communications strategies that leverage the shareholder resolution process for the benefit of all stakeholders. In part two of this series, we will explore how the existing shareholder process has been instrumental in enhancing corporate transparency on critical ESG issues and potential consequences to corporations and investors should provision 844 be implemented.

To learn more about ongoing investor efforts to prevent the implementation of this provision, see this link.

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