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By Matthew S. Sarna, University of Maryland Francis King Carey School of Law

Overview

The 2016 Proxy Season results are in and point to a continued surge in shareholder activism. The past two years have seen an exponential rise in shareholder proposals among large-cap, S&P 500 companies, culminating in several pronounced industry standards. Accordingly, corporate governance attorneys and in-house counsel alike must continue to be cognizant of this shifting paradigm to best serve their clients.
This QuickCounsel aims to provide a broad-stroke perspective on the 2016 Proxy Season and its underlying trends by providing a brief overview of the history and regulation of shareholder activism; illustrating the growing prominence in proxy access proposals; and analyzing corporate strategies for responding proactively to shareholder proposals.

Shareholder Activism and the Rise in Proxy Access

Few forces have influenced strategic and financial decisions as has the rise in shareholder activism. Although boards may view this phenomenon as an obstructive hurdle, an optimistic perspective would point to the clash between boards and activists as an essential function in constructing market standards and precedent.

A. Rules Governing Shareholder Engagement

Almost a century ago in 1919, Henry Ford decided to divert Ford Motor Company's earnings and profits into advancing social objectives, as opposed to distributing it to shareholders through special dividends. The Court in Dodge v. Ford Motor Co.1, ruled in favor of the shareholder dissidents, however, shifting the landscape of shareholder activism. The present day regulatory scheme is primarily grounded in Rule 14a-8,2 which governs shareholder proposals. In short, the Rule addresses when a company must include a shareholder proposal in its proxy statement, and proscribes what qualifies as a shareholder proposal, which shareholders have eligibility, and which specifics relate to the content and submission of proposals.
Shareholder proposals come in many shapes in forms. However, the majority revolve around social and political, compensation-related, and governance issues. The primary targets of these proposals tend to be large-cap, S&P 500 companies3. Accordingly, having historically received the majority of shareholder proposals,4 large-cap companies maintain the ability to set industry standards for mid-cap companies to follow. This dynamic can be explained as the trickle-down effect in standard-setting.
Breaking down the different types of proposals, successful social and political shareholder proposals have been trending upwards over the past three years. Specifically, five proposals regarding political, environmental, and anti-discrimination issues were passed during 2016 proxy season as compared to zero passing in 20155. Because 2016 was a contentious election year, look for a heavy uptick in politically-related shareholder proposals during the 2017 Proxy Season6.
Compensation-related proposals can generally be broken down into proposals on limiting golden parachutes, stock retention, and clawbacks. As compared to social and political proposals, however, the number of these proposals among large-cap companies significantly shrank in 2016 and zero proposals passed. Nine proposals in total had passed through 2014 and 2015; this decrease can partially be attributed to several proposed SEC rules regulating these types of proposals7. Additional SEC regulations, including the recent SEC final rule on CEO pay-ratio disclosure requirements, may continue to depress these figures in 2017.
Proxy access proposals have recently come to the forefront of shareholder activism as the most popular form of governance proposals. "‘Proxy Access' is shorthand for the crucial mechanism that gives shareholders a meaningful voice in corporate board elections. It refers to the right of shareholders to place their nominees for director on a company's proxy card."8 The 2015 Proxy Season saw an exponential spike in proxy access proposals. This growth, in large part, can be attributed to Scott M. Stringer, the New York City Comptroller's, office, which submitted proxy access proposals to 75 companies in 2015 and continued the effort by submitting 72 proposals in 2016. This effort was named the Board Accountability Project. Stringer's proposals this year essentially focused on the same factors as in 2015. These key factors were the 3% stock ownership threshold, three-year holding requirement, and limitation on nominees to 25% of the board.
Several activist groups, including Arjuna Capital, Trillium Asset Management, and Pax World Management, have already set their sights on several major U.S. banks for the 2017 season. The demand will be for companies to disclose their compensation data for male and female employees and also to publish statistics on the race and gender of their employees9. Other issues in the loading tray for 2017 include golden parachute packages and the influence of stock repurchases on executive compensation.10

B. Proactivity, Worth the Effort?

Corporations facing the possibility of shareholder activism, specifically proxy access proposals, have several deployable options. The first set of options comports with the saying, "The best defense is a good offense." Proactivity, through SEC No-Action Letters (NALs), has proven successful recently specifically for large-cap, S&P 500 companies11. In 2016, the SEC issued NALs to 38 issuers to exclude proxy access proposals on the basis that the proposal had already been substantially implemented under Rule 14a-8(i)(10). Prior to 2015, NALs focused on the potential for ambiguous results and shareholder confusion12. Under the SEC's more recent approach however, a proposal can be excluded if "there is a direct conflict between management and shareholder proposals."13
The substantial implementation exclusionary rule had seldom been utilized in prior proxy seasons, given that proxy access has only recently come into fruition. Based on an analysis of the 2016 Proxy Season data, it appears that the SEC is most concerned with the stock ownership threshold as one of the most important elements of the "essential objective" of the proposals, as compared to the holding requirement, group size, and limitation on percentage of the board14. Accordingly, in the vein of proactivity, companies looking to preempt a comprehensive shareholder proposal should focus first on retooling their ownership threshold bylaws.
Based on this past year, the 3% ownership threshold appears to be the current industry safe harbor. However, excluding a shareholder proposal under 14a-8(i)(10) in 2016 still may result in a proposal in 2017 to amend the new bylaw to include the provisions initially left out. On the other hand, companies may just as rightfully take a reactive approach to proposals and engage in a contested vote for proxy access with its shareholder proponents.
Additionally, in accordance with proactivity, corporate governance attorneys and in-house counsel should take the time to familiarize themselves with the Institutional Shareholder Service's (ISS) newly launched QualityScore System. Both ISS and Glass Lewis are the preeminent governance services, and should be consulted for both shareholder proposal and proxy access standards.
There are both advantages and disadvantages to proactivity. Adopting a proxy access bylaw with the newly-set market standards in advance of a proposal may avoid prolonged negotiations with potential proponents and avoid the expense and publicity of both the NAL process or a contested vote. However, while the trend certainly points to a continued surge in proxy access proposals for 2017, there is no guarantee that a specific company will actually receive a proposal, giving little merit to a proactive approach. This concept is even more applicable to mid-cap companies that lag behind on adopting market standards15. Additionally, to-date there appears to be little disadvantage to companies that wait until they receive a proposal to act. Although this could change, companies taking a reactive approach have been able to respond to a proposal by, among other things, adopting a bylaw and negotiating its withdrawal, utilizing Rule 14a-8(i)(10), or defeating the proposal at a meeting. Regardless of the company's strategy, however, each company must be cognizant in its responsiveness16 to proposals. Poor responsiveness could result in a negative board recommendation from ISS.

Conclusion

The rise in proxy access proposals has shaken up the world of corporate governance. The 2016 Proxy Season continued 2015's pronounced surge. Accordingly, corporate attorneys and boards must adapt with this changing landscape and stay up to date on recent SEC rulings, ISS and Glass Lewis guidance, and reporting data or find themselves left in the dust. Companies can either adopt a proactive or reactive approach. However, there is no one-size-fits-all solution and each company must gauge itself in accordance with its surroundings.

Additional Resources

• https://www.jpmorgan.com/jpmpdf/1320693986586.pdf _________________________________

1204 Mich. 459, 170 N.W. 668 (1919). 217 CFR 240.14a-8. 3For a more skeptical perspective, arguing that poorly managed companies are the main targets of shareholder proposals as opposed to general large-cap companies, see Bryan Armstrong, The New Crisis: Shareholder Activism, Ashton Partners, at 2 (last accessed Nov. 15, 2016) 4See Office of the New York City Comptroller, Boardroom Accountability Project (2014) 5For a detailed quantitative analysis of the 2016 Proxy Season as compared to 2015, see Sullivan & Cromwell LLP, 2016 Proxy Season Review (July 11, 2016) 6See Chelsea Naso, US Election Will Shake Up Activism, Okapi CEO Says, Law360 (Oct. 17, 2016). 7See, e.g., SEC Proposes Rules Requiring Companies to Adopt Clawback Policies on Executive Compensation, SEC 2015-36 (July 1, 2015). 8Proxy Access, Council of Institutional Investors (last accessed November 15, 2016) 9Laura Colby, Goldman, Citigroup Targeted by Diversity Activists in 2017, Bloomberg (Dec. 26, 2016) 10Christopher P. Skroupa, 2017 Proxy Season Rollout -- What's Next for Shareholder Engagement?, Forbes (Oct. 11, 2016) 11The SEC maintains an extensive database of its issued No-Action Letters. 12Yafit Cohn, Simpson Thacher & Bartlett LLP, The 2016 Proxy Season: Proxy Access Proposals, Harvard Law School Forum on Corporate Governance and Financial Regulation (August 26, 2016) 13Id. at 3. 14See supra note 5, at 8. 15See supra Section A. regarding the "trickle-down effect." 16See U.S. Proxy Voting Policies and Procedures, Institutional Shareholder Services, at 17–18 (Dec. 18, 2015)

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