Quiet, Pesky Shareholders!

Republicans aren’t just trying to gut Dodd-Frank. They’re also trying to make corporations less accountable to their small investors.

Dodd Frank
House Financial Services Committee Chairman Jeb Hensarling, left, speaks to the media while flanked by House Speaker Paul Ryan on Capitol Hill on Wednesday in Washington.

Mark Wilson/Getty Images

Just one day before President Trump announced to the world his intention to withdraw the United States from the Paris climate agreement, a stunning revolt occurred at Exxon Mobil’s annual shareholder meeting. A large majority of shareholder votes—62.3 percent—were cast in favor of a proposal asking the oil and gas behemoth to produce a yearly evaluation of the long-term business impacts posed by global initiatives designed to reduce climate change.

An investor group, led by the New York State Common Retirement Fund and supported by asset management giant BlackRock, submitted the proposal. It came at an especially delicate time for Exxon: New York state’s attorney general is currently investigating whether the company “has been making false and misleading statements” to investors “about specific safeguards it purports to have put in place to protect the company from risks posed by future climate change-related regulations.” The attorney general of Massachusetts is conducting a similar investigation.

Exxon, which recommended that its shareholders vote against the proposal, is not the only firm to face the climate change–related concerns of investors. About three weeks before the Exxon vote, shareholders of Occidental Petroleum also defied the board’s wishes, passing a similar proposal with 67 percent support. Both companies appeared to recognize the significance of the votes, with Exxon’s CEO acknowledging the need “to step back and reflect on the vote and the messages that we’re getting” and Occidental’s board chairman forecasting ongoing “shareholder engagement on the topic and … additional disclosure about the company’s assessment and management of climate-related risks.” On the crucial subject of climate change, shareholder voice is resonating.

And yet the very ability of shareholders to launch such initiatives is now in peril. Last Thursday the House of Representatives, by a vote of 233–186, passed the Financial CHOICE Act, a wide-ranging bill aimed at lifting many of the financial regulations enacted in the 2010 Dodd-Frank Act. Much of the public discussion on the Financial CHOICE Act has focused on the proposed overhaul of the financial regulatory framework, but another vital part of the act has largely slid under the radar. The House bill would silence the voices of small shareholders of American companies.

Currently, shareholders that have held either $2,000 worth of stock or 1 percent of a company’s voting shares for one year can submit a proposal to a company. These proposals, such as the ones submitted to Exxon and Occidental, allow shareholders to raise issues of concern with management and typically involve a range of environmental, social, and corporate governance issues. The law requires management to include proposals and any supporting statements in the proxy statement sent to all shareholders before an annual meeting, where shareholders then vote.

Under the CHOICE Act, the $2,000 eligibility threshold would be replaced with a requirement that investors own 1 percent of the company’s voting shares for a period of three years—or an even a higher percentage if the Securities and Exchange Commission so decides.

An innocuous change? Quite the opposite. The effect of this revision, if promulgated, would be that only the largest, most powerful shareholders will be able to use the proposal mechanism. Are you an investor who is concerned about potential legal and reputational risks or the moral implications that may be associated with child labor and dangerous working conditions in Apple’s supply chain? Or perhaps your concerns relate to the lack of diversity in Apple’s senior leadership? Your ability to engage the company on these issues could become prohibitively expensive—unless, that is, you’re the rare investor who can meet the new threshold, which would amount to $7.5 billion in stock.

Even some of the nation’s largest investors would be unable to avail themselves of the proposal tool.  The New York State Common Retirement Fund, which holds approximately $186 billion in assets in trust and is the country’s third biggest pension fund, has decried the effect that such a change would have on its ability to engage with corporate America: “The … 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.”

What is the rationale for this proposed change? In the House Financial Services Committee’s comprehensive summary of the bill, the committee argues that “the shareholder proposal process has become one of the favorite vehicles for special interest activists to advance their social, environmental, or political agendas” and that “gadfly” equity-holders increasingly “advance idiosyncratic agendas.”

This cynical narrative should be repudiated. First, there is little reason to believe that the proposal process is now being inordinately relied upon for what opponents would view as fringe causes. In 2016, investors filed 916 proposals with American firms. In 1982, the number was 973. Of the 916 proposals submitted last year, less than half involved environmental and social questions.

Second, the committee argues that broad shareholder support for proposals is lacking. Relying on an analysis by conservative think tank the Manhattan Institute, it notes that “not a single environmental-related shareholder proposal has received the majority support of shareholders over board opposition.”  Of course, this analysis was published before the decisive votes at Exxon and Occidental noted above. But that underscores the point. Until fairly recently, issues such as global warming and human rights were peripheral in corporate decision-making, their risk potential underexplored. But that is no longer the case: Our understanding of how these issues affect business activity has become increasingly sophisticated.

The proposal process plays a key educational function. Corporate management, understandably, may not be aware of the range of effects associated with its operations. Proposals allow investors to put emerging and otherwise underappreciated issues on the company’s radar, facilitating institutional learning and responsiveness. This is done in a way that preserves the board’s central role of presiding over corporate affairs. In other words, because most shareholder proposals are nonbinding, they play an advisory role. It may be difficult for management to simply ignore a proposal that receives a significant percentage of the shareholder vote. But in these situations we should expect management to meaningfully engage with the subject at issue.

Third, under existing law, safeguards already exist to protect companies against inappropriate proposals. Firms, for example, are legally permitted to exclude proposals that relate to personal claims, grievances, or interests; that are not significantly tied to the firm’s business; that are outside of the firm’s power to implement; or that deal with the firm’s ordinary business operations.

And finally, the view that social and political issues are improper subjects for shareholder action ignores important historical instances of shareholders holding corporations accountable for bad behavior.

In the 1950s, the law specifically allowed management to refuse to circulate proposals that were submitted “primarily for the purpose of promoting general economic, political, racial, religious, social or similar causes.” In the case Medical Committee for Human Rights v. SEC, decided during the Vietnam War era, the U.S. Court of Appeals for the District of Columbia Circuit grappled with an SEC decision allowing Dow Chemical to exclude a proposal asking the corporation to cease manufacturing and selling napalm. Notwithstanding the law’s exclusions, the court felt that shareholders should be able to put before fellow investors ‘‘the question of whether they wish to have their assets used in a manner which they believe to be more socially responsible but possibly less profitable.” Soon after the case, the SEC amended its rules to mitigate the effect of the social cause exclusion, paving the way for proposals related to a range of social policy concerns, including divestment from apartheid-era South Africa.

As the Financial CHOICE Act makes its way to the Senate, Democrats should move to save the shareholder proposal process. If enacted, the amendments would have a chilling effect on efforts to promote a more humane, sustainable form of American capitalism.