SEC guidance opens the door for more ESG proxy proposals

More shareholder proposals with a focus on environmental and social issues are likely to make it onto company proxy statements in 2022, thanks to new Securities and Exchange Commission guidance, sources said.

In a legal bulletin published Nov. 3, the SEC's division of corporation finance rescinded its last three legal bulletins — promulgated under the Trump administration — related to Exchange Act Rule 14a-8, that concern shareholder proposals. The latest bulletin also outlined changes in the division's views on what constitutes "ordinary business" and "economic relevance" when it determines whether a shareholder proposal should be excluded from a company's proxy statement.

"It's pretty clear that the goal of this, whether it's stated or implicit, is to allow more E and S proposals to end up in company proxy," said Sean Donahue, Washington-based partner in Goodwin Procter LLP’s capital markets practice and chairman of the law firm’s public company advisory practice.

Shareholders can file proposals before a company’s annual meeting. If a company thinks a proposal is out of bounds or has already been addressed, it can file a no-action letter with the SEC, requesting permission not to include the proposal in its proxy statement.

Under the previous administration, the SEC issued bulletins that included language that made it more likely for the SEC to rule in favor of companies seeking no-action relief, sources said.

The SEC granted no-action relief to a record number of environmental and social proposals during the 2021 proxy season: 77 as of June 30, a 14% increase over the 2020 season and above the previous high of 74 in 2017, according to data from proxy advisory firm Institutional Shareholder Services Inc.’s governance and research unit, Rockville, Md.

The three bulletins the SEC rescinded Nov. 3 “were out of line” with historical SEC precedent and “muddied the waters on what’s going to be allowed and what’s going to be eligible to be thrown out through the no-action process,” said Bryan McGannon, Washington-based director of policy and programs at US SIF: The Forum for Sustainable and Responsible Investment.

Other stakeholders, including the U.S. Chamber of Commerce, took issue with the SEC’s action.

Tom Quaadman, Washington-based executive vice president of the Chamber’s Center for Capital Markets Competitiveness, said in a statement that the SEC sided with a small minority of activists over the vast majority of American investors.

“By repealing longstanding guidance about treatment of shareholders proposals, the SEC has stated its preference to turn boardrooms and shareholder meetings into political debate societies on issues the SEC admits have no nexus to the actual business of the company,” Mr. Quaadman said. “This will all come at the expense of companies’ ability to focus on long-term performance, including the welfare of their employees, customers and shareholders. The SEC’s action undermines the regulatory progress made in recent years to encourage companies to go, and stay, public, which will result in fewer opportunities for retail investors.”

The SEC’s two Republican commissioners, Hester M. Peirce and Elad L. Roisman, also criticized the bulletin in a statement and said it “furthers the recent trend of erasing previous commissions’ and staffs’ work and replacing it with the current commission’s flavor-of-the-day regulatory approach.”

In the Nov. 3 bulletin, SEC staff indicated that shareholder proposals “squarely raising human capital management issues with a broad societal impact” and proposals that request “companies adopt time frames or targets to address climate change” are no longer likely excludable.

Proposals that the staff previously viewed as excludable because “they did not appear to raise a policy issue of significance for the company may no longer be viewed as excludable,” the SEC noted, singling out human capital management issues.

In the past, SEC staff has excluded proposals that requested companies adopt time frames or targets to address climate change on micromanagement grounds. Going forward, the SEC said it “would not concur in the exclusion of similar proposals that suggest targets or time lines so long as the proposals afford discretion to management as to how to achieve such goals.”

On “economic relevance,” the shareholder proposals that raise issues of broad social or ethical concerns related to the company’s business may not be excluded, even if the relevant business falls below the economic thresholds. The “economic relevance” exception permits a company to exclude a proposal that “relates to operations which account for less than 5% of the company’s total assets at the end of its most recent fiscal year, and for less than 5% of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company’s business,” the SEC noted.

Danielle Fugere, president and chief counsel at Berkeley, Calif.-based shareholder group As You Sow, said shareholders care deeply about human capital and climate issues and want to see action from companies.

Proposals related to human capital management topped the list of E and S proposal topics filed in 2021, with 133 proposals, up from 77 the previous year, according to ISS data. Climate change-related proposals were the second-most prevalent proposal type with 89 proposals filed, up from 58 the previous year, and a record 11 climate-related proposals made it onto proxy statements and earned majority support in 2021, ISS found. Of the 133 human capital proposals, 35 made it on the ballot and eight were passed.

Of the 89 climate proposals, 25 made it to a ballot as of June 30.

“With those majority votes, shareholders are sending a strong signal that they expect action from companies on climate, they expect companies to be transitioning, along with the rest of the economy toward net-zero, and taking advantage of the opportunities that exist so companies that are not changing or not being responsive are less likely to be successful down the road,” Ms. Fugere said.

Now that companies are less likely to get no-action relief from the SEC on E and S issues, they will likely be more willing to engage shareholders that submit proposals, sources said.

“If the proponent knows you don’t have much of a leg to stand on in your no-action request given that there’s really not a lot of substantive bases, I think it does put the proponent in a strong negotiating standpoint with the company,” Goodwin Procter’s Mr. Donahue said. “I think proponents, perhaps, will be emboldened to say, ‘Either put the proposal on your proxy or do exactly what I’m going to ask you to do, but doing something short of that I don’t know if I’m willing to (withdraw) the proposal.’”

Ms. Fugere hopes there will be fewer no-action fights in the future. “I think it’s better to spend the time to resolve the concerns, then decide how to move forward in a way that is reasonable,” she said.