Friday, January 10, 2014

SEC Encourages "Sustainable" Shareholder Activism

Shareholder activism has been an emerging trend for some time now. ESG, which stands for Environment, Social, and Governance, is meant to capture the three Ps of sustainability in the corporate context. It has been commonly accepted in academia and its popularity has now been surging in the main stream for some years. Socially responsible investment funds are also trending like hashtags.


The landmark case in the 70s made this popular. A group of activist investors then were able to convince the court that SEC was wrong to allow Dow Chemical to omit the shareholder resolution that limited the sale of napalm for use in the Vietnam War. After the court’s decision, there were close to 600 socially oriented shareholder resolutions filed between 1973 and 1978. See Proffitt & Spicer, 2006.

Nowadays, NGOs and socially orientated groups have begun to use a combination of street protests and shareholder activism as their tactics to promote their cause. ESG, in this sense, has real teeth to take a bite at getting publicly held corporations to be more responsible.

But is shareholder resolution really a good method to force the corporate hand?

First, most publicly held companies have so many institutional and entrenched shareholders that it is almost impossible to get the majority to take any kind of meaningful action. Although the regulatory barrier of entry is low (SEC only requires $2000 in shares and commitment of holding the shares until after the annual meeting), the cost of coordination and filing the resolution may be high. Usually activist shareholders are required to have third party brokerage firms confirm their holdings. The activist shareholders are also required to have the resolution drafted which means time and research. Poorly drafted resolution may be worse than no action at all, so activist shareholders must do their due diligence. All of these translate into cost that activist shareholders may not have.

In addition, there is also a little well know SEC Rule called 14a-8. Under this Rule, SEC staff often will side with corporations and permit the omission of activist shareholder resolutions from the corporate proxy statement because the resolution is either a matter related to the company’s ordinary business operations and therefore excludable from the proxy statement at the discretion of the board of directors; or the resolution relates to less than 5% of the company’s assets, sales and revenue, and therefore excludable.

These shareholders are also seldom passed. Even if passed, these resolutions are often non-binding. So aside from harm to good-will, corporations often face little pressure to do anything about the activist shareholders.

The SEC recently issued guidance that companies are encouraged to allow sustainability oriented shareholder resolutions make its way onto the proxy statement. SEC Staff will also no longer consider Rule 14a-8 a default win for companies with respect to activist shareholder resolutions dealing with sustainable developments. Whether this new SEC direction will make an impact is hard to say. Even if more and more shareholder resolutions are passed, companies will still have to comply and the public and potential investors will still have to do their due diligence and keep sustainability on their radar.