In 2020, the SEC, chaired by Jay Clayton, proposed a set of amendments aimed to add transparency and fairness to the proxy advisory process. Unfortunately, under the leadership of current SEC Chair Gary Gensler, the rules were never enforced and were eventually overturned. However, new litigation and research shows that the problems that the 2020 rule were designed to address still remain.
A bit of context: Shareholders are part owners of their companies and have the right to vote on many resolutions that affect the operations and future of the company. However, there are concerns that have been raised with the shareholder voting process.
First, many corporations question the motives behind the actions of activist investors. As Chairman Clayton noted in an ACCF webinar on December 4th, a shareholder only needs to spend at most $10,000 to own sufficient shares to bring a resolution to a vote. But if the million shareholders of the company spend an hour to consider it, and if their time is worth (very conservatively) $25/hour, then a resolution “that costs $10,000 to raise on the one hand, costs $25 million [to consider] on the other.”
The low cost to raise proposals has emboldened activist shareholders to bully companies with proposals that seemingly undermine the primary businesses of the corporation. In fact, the activists’ goal often appears to be aimed at driving companies out of business. And as Chairman Clayton noted, it is reasonably cheap to harass companies with proposals in an effort to do so. Publicly held companies must be able to protect their interests and safeguard valid business decisions from disruptive proposals that do not align with the company’s long-term goals and which deviate from the company’s strategic focus.
In fact, one company recently has brought suit against two activist investor groups that have brought forth a shareholder proposal that would “change its day-to-day business by altering the mix of – or even eliminating – certain of the products it sells.” A court win for the corporation could significantly limit the number of frivolous shareholder proposals allowed by the SEC, a major win for American business – and common sense.
The second issue is the rise of the business of proxy advisors. Since most shareholders and money managers do not have the time or resources to properly evaluate these resolutions, proxy advisory firms often are hired to do the research for investors and provide them with voting advice. In fact, clients have become so reliant on proxy advisors that they often “robo-vote,” that is, they automatically vote with a proxy firm’s recommendation without any additional review.
Given shareholders’ lack of resources, there is clearly a need for proxy advisors; they provide a valuable service that benefits the investor. However, a number of concerns have been raised regarding these firms. For example, many have noted that the proxy advisory market is a duopoly. Just two companies (ISS and Glass Lewis) control 97% of the market. Further, there is a lack of transparency regarding methodologies used to develop advice. As a result, at times neither their clients nor corporate management know how a conclusion was reached, and the firms being researched have no ability to dispute the conclusions of proxy advisors, especially given the common practice of robo-voting.
There is also a very significant concern about potential conflict of interest. Specifically, proxy firms also provide consulting services to companies on issues like ESG (environment, social and governance). So if a proxy firm is providing a recommendation on an ESG-related shareholder resolution, and the advisor would also provide consulting services on that same issue if the resolution passes, there is a clear conflict of interest.
Importantly, a new study by my colleagues and I at the American Council for Capital Formation (ACCF) has found that proxy advisors’ recommendations are often disputed by the companies themselves. In fact, in 2023 there were 64 supplemental filings that disputed proxy recommendations. The 64 filings can be described as alleged factual errors, analytical errors or serious disputes. This is just the latest in a series of similar studies that has shown numerous disputes between companies and the proxy advisors who provide advice to shareholders on proposed resolutions every year. And the disputes are not lessening over time. It’s just the opposite. The 64 supplemental filings are the most since ACCF began tracking this information in 2016.
The 2020 rule that was overturned by Gensler contained – in Clayton’s words – “very modest changes” that attempted to address some of the concerns raised by requiring proxy advisors to share their recommendations with companies at the same time as they were shared with clients, and then establish a mechanism for companies to share their thoughts on the proxy firm’s advice prior to the shareholder vote on the issue. Essentially, the rule would have added significant transparency to the proxy advice process and given companies a voice in the shareholder recommendation process.
As US Chamber of Commerce President and CEO Suzanne Clark said “[t]he 2020 Proxy Advisor Rule was put in place to protect investors.” Chairman Gensler should heed those words and change course to provide transparency to the proxy advisor process.
Kyle Isakower is Senior Vice President for Energy and Regulatory Policy at the American Council for Capital Formation
Author’s addendum (February 5, 2024): Two days after this opinion piece was posted, the two activist groups (Follow This and Arjuna Capital) that proposed the shareholder resolution in an effort to change the company’s (ExxonMobil) policy and strategic focus agreed to pull their proposed resolution under the threat of the company’s lawsuit. Nevertheless, the company has not dropped their lawsuit, in an apparent effort to establish a precedent for appropriate shareholder actions during proxy season. ExxonMobil CFO Kathy Mikells stated that ”the process to get proxy proposals excluded is just flawed, with activists that are masquerading as investors who make the same proposals year after year that are garnering only minimal support along the way.”
Continue to watch this space for further updates as the lawsuit progresses and for any further developments that unfold.
