August 27, 2018
Over the past several years, there has been an evolution in shareholder activism. In 2017, we experienced a broadening of scope, with the number of activists’ investments spanning multiple countries becoming increasingly more common. But while international activism is continuing to grow, the latest proxy season saw shifting trends domestically, as changes in guidance from the SEC, shifting attitudes on traditional governance matters, several new societal developments and technological advancements are all shaping the efforts of activist investors.
In turn, these new trends identified in the 2018 proxy season indicate that board directors and executives will need to start planning now for a new era of investor relations. Despite the changing interests of shareholders, new regulatory guidance and an increase in virtual shareholder meetings, boards and executives will need to double down on shareholder engagement relations efforts to ensure favorable outcomes on proxy ballots in the years to come.
In November 2017, the SEC issued Staff Legal Bulletin No. 14I, which provided guidance on Rule 14a-8, a rule relating to the exclusion of a shareholder proposal. Specifically, SLB 14I expanded on the “ordinary business” exemption, which allows for exclusion when a proposal “deals with a matter relating to the company’s ordinary business operations;” and the “economic relevance” exemption, which allows for exclusion when a proposal “deals with a matter not significantly related to the issuer’s business.”
However, this guidance did not gain much traction this season. Only one company, Dunkin Brands Group, successfully used it to have a proposal excluded. Dunkin argued that a proposal requesting a report on the environmental impact of a specific packaging be excluded, since the packaging related to less than 5 percent of the Company’s total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year.
This unique situation, is unlikely to set a precedent going forward. But successful exclusions making use of this new guidance in the coming years could still become the norm. More importantly, the mere publication of SLB 14I could be an indication of future changes in guidance relating to Rule 14a-8.
Compared to 2017, proxy access proposals saw a decline in both the volume of submissions and voting support in 2018. This is notable, as proxy access was the most popular governance resolution last year. Additionally, its adoption has been common, with the provision now in place at roughly two-thirds of S&P 500 firms.
Another notable trend in governance proposals was an almost three-fold uptick in proposal volume for special meeting and written consent rights. But while the volume increased, support for these proposals declined on average from 2017. Interestingly too, about one-third of these proposal recipients were also targeted in 2017 by proxy access resolutions.
Say on Pay proposals – those in which shareholders provide an advisory vote on executive remuneration – were approved overwhelmingly this year, with shareholders approving more than 91 percent of companies’ executive compensations this proxy season. However, this season saw a 1 percent decline in Say on Pay approvals as compared to 2017, with a substantial increase in failures at S&P 500 firms.
Environmental and social proposals (E&S) and governance proposals experienced a decline in submissions this year compared to 2017, but E&S proposals saw some uptick in support. Roughly 41 percent of E&S proposals reached at least 30 percent support this year – up from 29 percent last year. Additionally, while 94 percent of E&S proposals received under 50 percent support, that is still an improvement on the 97 percent of proposals that failed to receive a majority in 2017.
Social issues were at the forefront of E&S proposals put forth this year. For example, Investors for Opioid Accountability submitted a proposal to multiple companies requesting a report on how the board is addressing opioid-related business risks at four drug manufacturing and distribution companies. The proposal passed at Depomed Inc. (62.3%), with support from both ISS and Glass Lewis. Proposals were withdrawn from McKesson and Cardinal Health, with the latter agreeing to disclose financial risks posed and the measures taken by the board.
In addition to the increase in proposals relating to the growing opioid crisis, other social issues have entered the spotlight, as votes were clearly influenced by the changing social climate. This has been typified by the “Me Too” movement. Average votes against all-male boards this season were well above the typical 3 to 4 percent. Votes against nominating/governance chairs at S&P 500 boards that still lack gender diversity also rose above historic levels. Looking more broadly, opposition votes at all-male S&P 1500 boards more than doubled since 2015, with those board chairs receiving an average opposition of 15.2 percent this year. In contrast, only 3.5 percent of votes were cast in opposition for nominees to the same role at boards that have a female representation of at least 20 percent.
The social momentum behind the “Me Too” movement also influenced other facets of the proxy process. For example, this year saw an increase in proxy disclosures emphasizing culture, board refreshment, and diversity. Additionally, with high-profile controversies at some S&P 500 companies over the past year, shareholders are taking precautions by seeking to adjust policies in place at many corporations. CalPERS, for instance, is considering revisions to its governance principles to include specific reference to corporate culture and sexual harassment in board responsibilities and human capital management.
But not all trends were borne out of social shifts. As technology has improved, virtual-only meetings saw an increase this proxy season. In the first six months of 2018, corporate solutions provider Broadridge Financial Solutions hosted 212 virtual shareholder meetings – a nearly 18 percent increase from the first half of 2017. While virtual meetings have their advantages, such as wider participation and lower costs, they are currently only legal in 30 states, with some, like California, placing restrictions on their use.
Social issues will undoubtedly continue to play a driving role in the proxy process, as shown by this season’s greater emphasis on gender diversity and issues such as the opioid crisis. Looking deeper, however, several less obvious factors have the potential to dictate proxy activity in the coming years.
In examining those shareholder proposals focused on issues “outside” of the year’s main themes, it’s evident that shareholder support has reached a plateau or, in some instances, started to decline. As noted earlier, the recent popularity of proxy access proposals has made their adoption common place, with about two-thirds of S&P 500 currently having provisions in place. And yet, this year saw a decrease in not only submissions, but also voting support.
The decline in support this year could be a reaction to the extensive focus on proxy access seen last year. An equally likely explanation is that those companies where proxy access provisions haven’t been adopted have a majority shareholder base simply opposed to adopting this proposal. Often times proposals can be put forward year after year – even after receiving well below majority support.
The SEC’s recent changes to Rule 14a-8 makes situations concerning recurring proposals all the more interesting, especially if the recent SBL 14I is an indication of more guidance to come. Currently, under Rule 14a-8, proposals that deal with “substantially the same subject matter as another proposal” can be excluded if it receives less than 3 percent of the vote once within 5 years; less than 6 percent on its most recent vote if voted on twice in 5 years; or less than 10 percent on its previous vote if it has been voted on three times in the previous 5 years.
Known as the 3%/6%/10% rule, this threshold allows for a surprising number of proposals to be submitted year after year. If this 3%/6%/10% rule were to change, there could be tremendous implications for the number of proposals being resubmitted. The results of such a move could be significant, greatly reducing the resubmission of many failed proposals.
An analysis from FTI Consulting, which examined 2,449 shareholder proposals submitted between 2001 and 2018 using data from ISS, found that only about 27 percent of these perpetually rejected proposals would be eligible for a fourth year on the ballot if the SEC were to increase its thresholds to a 6%/15%/30% rule.
Further, of the 2,449 proposals examined, 723 – or, about 30 percent – were resubmitted three or more times without reaching majority. Under the current threshold, these resubmitted proposals constituted about 32 percent of all failed proposals over this period. Notably, only 5 percent of these 2,449 shareholder proposals examined actually passed.
Interestingly, despite failing to reach majority support over multiple years (some of the proposals examined were resubmitted up to twelve times over this period), the majority of these proposals received the backing of proxy advisory firms. For example, ISS recommended voting “for” 79 percent of these resubmitted proposals at least one of the times they appeared on the ballot. More recently during the 2018 proxy season, ISS support jumped to 95 percent for repeat proposals.
Looking beyond the continued influence of societal movements on proxy efforts, the recent guidance on Rule 14a-8 could potentially have the most consequential, longest lasting impacts on corporate governance and shareholder votes. If the declines in submission volume and support for previously championed efforts such as proxy access are any indication, the most recent changes to Rule 14a-8 might not have been enough to satisfy the SEC. Other actions, such as raising the threshold for proposal resubmission, could be on the horizon. Doing so would reduce perennial proposals that fail to garner support but challenge current components of shareholder rights. The SEC will find it difficult to strike a proper balance.
Regardless of whether the SEC ultimately gives corporate managers greater latitude to exclude repeated shareholder proposals, social and environmental issues will still dominate the proxy ballot for the short-term. While societal phenomena such as the “Me Too” movement may drive short-term across the broader spectrum of environmental and social topics, overall interest from shareholders in these areas is unlikely to fade. Instead, shareholder proposals concerning environmental and social issues will all but certainly be tailored to better reflect the material risks to an individual issuer and evolving guidance from regulators. Additionally, proposals will be more readily discussed and debated at companies that host their annual general meetings and shareholder votes in virtual forums, leading to increased voter participation. Companies that choose to host virtual meetings should ensure that both board directors and executives are well versed in these issues, which are often of interest to retail shareholders who are less likely to attend non-virtual meetings.
Proxy access and say-on-pay votes will also be impacted by the expansion of virtual meetings. Despite the downward trends in support for these types of resolutions, the ease of voting in virtual meetings will make high-profile proxy battles even more harshly contested. Disney’s battle over executive remuneration this year was marked by weeks of speculation and media reporting. The widespread attention raised the profile of that particular proxy contest, drawing greater attention to the vote and likely spurring greater participation. Companies seeking to assuage shareholder concerns would be wise to do so outside the limelight to the extent possible. Personal comments on social media by executives about topics of interest to investors are particularly inadvisable, given the volatile experiences of companies having outspoken CEO’s thus far in 2018.
Working through established, regulated channels to correspond with a company’s investor base is the best possible path for issuers to engage with shareholders about corporate governance concerns. Even with evolving guidance from regulatory bodies expected, working through official channels offers issuers the best opportunity to provide valuable proxy information. While investor attention may be turning away from traditional matters of corporate governance to issues driven by societal trends, that does not mean traditional means of shareholder engagement are obsolete. In fact, strong investor relations efforts are perhaps now more critical than ever.