The Narrowing Channels of Shareholder Communication

Directors owe fiduciary duties — the duty of loyalty and the duty of care. In most jurisdictions (including Delaware), the directors owe these duties to stockholders. Even where the duties are formulated differently, the stockholders are a most important constituency — one that has much to lose if the directors botch the job. Yet, despite this fundamental obligation, the channels of communication between boards and shareholders are narrowing, potentially leaving directors with less information about what shareholders actually want. The result is a corporate governance system increasingly divorced from shareholder input, even as ownership becomes more concentrated.

The landscape of share ownership has transformed dramatically. Passively managed index funds now own a majority of the equity in publicly traded companies, with the largest institutional investors holding the lion’s share. These firms may technically own much of the stock market, but they hold these shares not for themselves, but on behalf of millions of individual investors in pension and index funds. And, while in recent years, many of these institutional investors became significantly more vocal on operational, governance, ESG, DEI and other issues that they wanted their invested companies to pursue, recent events are quieting their voices. Earlier this year, the SEC issued guidance that increased the risk that institutional investors holding more than 5% of voting securities in a public company would be unable to file required SEC reports on Schedule 13G and would instead need to use the more onerous Schedule 13D disclosure. (Many funds and money managers are extremely reluctant to file under Schedule 13D.)

This new guidance suggests that an investor that discusses with the company only how its views on a particular topic may inform its own voting decisions would not be disqualified from using Schedule 13G, but going beyond that and exerting pressure on management around specific topics could trigger the requirement to file Schedule 13D. For many funds, especially passive funds that hold positions across the entire market, this fine distinction creates difficult practical problems. Investors for whom Schedule 13G eligibility is a priority may abandon their historical engagement tactics in favor of silence or publishing general policies instead of direct dialogue, in order to avoid an unwelcome Schedule 13D form. Investors who continue to engage are often taking a more cautious approach to shareholder engagement and, as a result, boards are feeling less pressure from these institutional investors to implement changes in response to shareholder feedback. The candid conversations that once helped boards understand shareholder priorities will become rarer and less substantive.

Just as institutional engagement faces new constraints, the right to submit nonbinding or “precatory” shareholder proposals is also being questioned. These proposals have for many years been submitted under SEC Rule 14a-8 and ask the corporation or the board to take certain actions that, even if the proposal were adopted, would not be required to be adopted, such as those requesting reports on environmental or social topics or many governance changes. Such proposals are frequently dismissed as a waste of time and have been subject to increased criticism in recent months. For example, in a recent speech, SEC chairman Paul Atkins suggested the SEC may be open to allowing corporations to foreclose the ability of shareholders to submit such precatory proposals. If a corporation were able to provide a legal opinion that such a proposal was “not a proper subject” for shareholder action under Delaware law, Atkins had “high confidence” the SEC staff would honor this position and not object if the corporation excluded the proposal from the company’s proxy statement and did not introduce it at the annual meeting. Effectively, he is inviting this challenge to be made. This approach would allow Delaware companies — and following similar logic, companies incorporated in other states — to exclude nearly all nonbinding shareholder proposals, even if the SEC did not formally amend the rules, which apparently also is being considered.  

Atkins also suggested companies might be able to adopt bylaws that impose new and more stringent procedural requirements for any Rule 14a-8 shareholder proposal, such as increased ownership or holding period thresholds, that could allow exclusion of proposals that do not meet these enhanced standards. Even before Atkins’ speech, some jurisdictions had erected similar hurdles. For example, Texas now permits nationally listed corporations to require shareholders seeking to submit proposals hold at least $1 million in market value or 3% of voting shares for six months before the meeting and throughout its duration. Proponents must also solicit holders representing at least 67% of voting power entitled to vote on the proposal.

In another context, the SEC also recently approved a procedure where individual shareholders are not being encouraged to vote at shareholder meetings, but instead to give the company a proxy, so their shares can be voted by management. Individual, or “retail”, investors often fail to return proxy cards or otherwise vote at meetings and, in some companies, this can make it difficult to obtain a quorum for the meeting or to pass measures. Recent SEC action allows companies to adopt a program under which they can vote shares held by investors who opt into the arrangement. While administratively convenient, this solution effectively discourages shareholders from participation and potentially represents another reduction in authentic shareholder voice.

For directors, these converging trends highlight complex issues. In most instances, the directors’ duties do not require they actually canvas shareholder opinion, but instead they should use their best judgement as fiduciaries to act on the shareholders’ behalf. But the above (and other) trends in corporate governance mean the views of the corporation’s actual owners are becoming less available to boards. As directors consult mostly with each other, management and their own advisors, they may find themselves increasingly in an echo chamber where their biases and decisions are applauded rather than challenged. If this begins to happen, the board should consider whether receiving this more limited feedback really benefits their ability to act in the best interest of their shareholders.