Are shareholder 'social issue' demands really 'in the public interest'?

[Editor's note: This story originally was published by Real Clear Wire.]

By Bernard Sharfman
Real Clear Wire

Shareholder activists on both sides of the political spectrum have increasingly been using shareholder proposals to debate the most pressing and divisive social issues of our times.  Issues such as abortion, gun rights, and climate change.  This increased usage has been facilitated by the SEC taking the position that it has broad authority to compel public companies to include shareholder proposals on social issues in their proxy statements. While these issues need to be addressed, their resolution is to be found in the political arena.  That is how our democracy works.  They should not be and will not be resolved by a vote of shareholders.

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Responding to these proposals cost corporations tens of millions of dollars each year, not to mention the loss in efficiency caused by distracting management from their focus on company business.  Most importantly, they pressure management to take stands on divisive issues.  For a public company to thrive, it must provide a big tent that covers millions of customers and employees who reside on every possible point of the political spectrum.  Antagonizing a significant number of these stakeholders by forcing management to take sides on social issues is not how a public company is going to maximize profits.

This is why the National Association of Manufacturers (“NAM”) recently petitioned a federal appeals court to intervene in a lawsuit involving a shareholder proposal submitted to Kroger Co. (National Center for Public Policy Research v. SEC, 5th Cir., No. 23-60230):

[NAM] moves to intervene to raise a fundamental threshold issue addressed by neither party but affecting every publicly traded company in the United States: Whether the First Amendment and federal securities laws allow the SEC, through its Rule 14a-8, to compel a corporation to use its proxy statement to speak about abortion, climate change, diversity, gun control, immigration, or other contentious issues unrelated to its core business or the creation of shareholder value.

NAM’s petition was granted.  As NAM points out in its petition, nothing in Section 14 of the Exchange Act of 1934 (“34 Act”) the statutory authority governing the SEC’s regulation of the proxy process, grants the SEC with such power:

It shall be unlawful for any person, by the use of the mails or by any means or instrumentality of interstate commerce or of any facility of a national securities exchange or otherwise, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors, to solicit or to permit the use of his name to solicit any proxy or consent or authorization in respect.

So, why does the SEC think it has the authority to compel the insertion of shareholder proposals on social issues, not only when they are not significant to a company’s business, but also when there is not even a “nexus” between the social issue and the company? The only explanation is that the Commission is interpreting the statutory terms, “in the public interest” and “for the protection of investors” (investor protection), to mean that it has almost unlimited discretionary authority to compel shareholder proposals.

If so, the SEC has totally misunderstood the term “in the public interest.”  This term does not give it broad authority to act as it wants.  As stated by the U.S. Supreme Court in NAACP v. FPC: “This Court’s cases have consistently held that the use of the words ‘public interest’ in a regulatory statute is not a broad license to promote the general public welfare.  Rather, the words take meaning from the purposes of the regulatory legislation.” In essence, the term is an empty shell, with no real meaning, until it is filled up with the identifiable policy objectives and constraints that Congress writes into a statute.

What fills up “in the public interest” in the 34 Act is investor protection, promoting “efficiency, competition, and capital formation,” and the constraint of “materiality.” Investor protection is the primary mission of the 34 Act.  Like the Securities Act of 1933, its focus has always been on protecting “investors from fraud, an unlevel informational playing field, the extraction of private benefits from the firm by firm insiders, and investors’ propensity to make unwise investment decisions.” Thus, being informed of the risks of buying, selling, and the holding securities in their investment portfolios is how investor protection is defined under our securities laws.  There is no connection between this definition of investor protection and shareholder proposals on social issues.

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Compelling such shareholder proposals does not promote “efficiency, competition, and capital formation.” These proposals can do nothing but cause financial harm to a company and result in a reduced ability to compete with private and foreign companies who do not have to deal with these proposals. In regard to materiality, a shareholder proposal on a social issue which is not significant to informing shareholders of a company’s investment risk is not a matter “to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to buy or sell the securities registered.” 

The interpretation of the two statutory terms presented here does not support the argument that the SEC has broad authority to compel companies to insert shareholder proposals on social issues into their proxy statements. On the contrary, it demonstrates the unreasonableness of trying to interpret the terms as if they do.  In sum, it is simply not “in the public interest” for the SEC to have such authority.

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