Corporate Accountability: the SEC and the Rights of Shareholders

On Your Behalf—March 2010

The United Methodist Church is concerned that corporations operate responsibly and that shareholders are able to exercise their rights as owners. Paragraph 163I of the Social Principles is dedicated to corporate responsibility: “Corporations are responsible not only to their stockholders, but also to other stakeholders: their workers, suppliers, vendors, customers, the communities in which they do business, and for the earth, which supports them.” In addition, Resolution 4071, Investment Ethics, supports “petitioning the US Securities and Exchange Commission or Congress for changes in proxy rules” in order “to persuade corporations to integrate responsible business practices on environmental, social and governance issues into their operations …”

Proxy Materials and Proxy Voting

As part owners of companies, shareholders have the right to vote at the companies’ annual meetings. Since most shareholders do not attend annual meetings, where directors are elected and other important governance decisions are made, they typically cast their votes by way of a proxy ballot (not unlike an absentee ballot), which they submit either by mail or electronically. In the absence of more direct involvement, the proxy ballot represents the shareholder’s most important tool to direct or influence a company’s governance and business practices.

The Securities and Exchange Commission (SEC) recently has provided shareholders welcome support in exercising their proxy voting rights. In a series of rule changes and interpretive decisions, the SEC has significantly expanded the type of information that companies must include in the materials that accompany proxy ballots. The new information required by the SEC should help shareholders make better-informed decisions when voting their proxies.

Greater Disclosure on Proxy Materials

In December 2009, the SEC issued new rules that require companies to provide greater disclosure on risk, compensation and corporate governance issues. As a result, beginning February 28, 2010, proxy statements must include information on:

• compensation policies and their relationship to risk management (for example, whether compensation policies are encouraging excessive risk-taking by employees);
• the background and qualifications of director nominees;
• any legal actions involving company executives, directors and director nominees;
• the role diversity plays in the consideration of director nominees;
• board leadership structure (including whether the chairperson of the board and the chief executive officer are two separate individuals, and if not, why not);
• stock awards to company executives (the value of options must be reported as of the date they are awarded); and
• any conflicts of interest involving compensation consultants.

In addition, the SEC now requires companies to report vote results within four business days of the annual meeting.

In announcing these changes, SEC Chairman Mary L. Schapiro explained that good corporate governance is possible only when “those who manage a company—that is, officers and directors—are effectively held accountable for their decisions and performance. But accountability is impossible without transparency. By adopting these rules, we will improve the disclosure around risk, compensation, and corporate governance, thereby increasing accountability and directly benefiting investors.”

The General Board of Pension and Health Benefits (General Board) sent a letter of support last year when the SEC began considering these changes.

More information is available at www.sec.gov/rules/final/2009/33-9089.pdf.

Recognition of the Role of Climate Change

The General Board, along with many other faith-based investors, has filed numerous shareholder resolutions encouraging companies to consider the risk that climate change poses to business operations. Recognizing that climate change may pose operational risks to companies, the SEC voted in January to provide public companies enhanced interpretive guidance on existing disclosure requirements that may be triggered by climate change issues.

The interpretive guidelines direct companies to consider disclosing the impact climate change may have on their business operations due to:

• existing laws and regulations relating to climate change (costs may be incurred if there is a federally mandated “cap and trade” scheme);
• international accords on climate change (e.g., Kyoto Protocol);
• changing business trends caused by climate change (e.g., decreased demand for products that contribute significantly to greenhouse gas emissions); and
• potential material impacts of climate change (e.g., business interruptions due to severe weather).

These interpretive guidelines, the first such guidelines focusing specifically on climate change issues, are not intended to take sides on the climate change debate, but rather to provide clarity and consistency in existing SEC disclosure rules. The complete text is available at www.sec.gov/rules/interp/2010/33-9106.pdf.

More ESG Shareholder Resolutions

Investors have had the right for many years to submit resolutions for consideration by all shareholders at companies’ annual meetings. These resolutions most often call upon the company to issue a report on various environmental, social or governance (ESG) issues or take a particular action.

Resolutions must comply with SEC guidelines and are occasionally challenged by the companies to whom they are addressed. If a company feels a resolution is not consistent with SEC guidelines, it will inform the SEC that it intends to exclude the resolution from the company proxy statement. The company’s hope is that the SEC will take “no-action” against it for excluding the resolution.

The SEC generally has upheld company efforts to exclude shareholder resolutions when the subject matter of such resolutions is considered to be “ordinary business” and within the purview of corporate management’s day-to-day business responsibility. Typically, the SEC has considered resolutions requesting that companies evaluate the risk associated with its policies and business practices as “ordinary business.” Accordingly, since 2002, the SEC has routinely approved “no-action” requests for shareholder resolutions calling for a report on financial risk information relating to ESG issues.

In a recent Staff Legal Bulletin issued on October 27, 2009, however, the SEC conceded that its approach “may have resulted in the unwarranted exclusion of proposals that relate to the evaluation of risk but that focus on significant policy issues.” The SEC will now “consider whether the underlying subject matter of the risk evaluation involves a matter of ordinary business to the company. In those cases in which a proposal’s underlying subject matter transcends the day-to-day business matter of the company and raises policy issues so significant that it would be appropriate for a shareholder vote, the proposal generally will not be excludable …”

This ruling may mean that more ESG shareholder resolutions will appear on proxy ballots beginning in the 2010 proxy season. The complete text of SEC Staff Legal Bulletin 14E (CF) is available at http://www.sec.gov/interps/legal/cfslb14e.htm.

Thanks to these recent SEC decisions, investors now will have valuable information on director qualifications, compensation arrangements and risk disclosure that was once unavailable. It is not surprising that the General Board was one of many voices encouraging the SEC to adopt these recent actions (see our letters addressed to the SEC at www.gbophb.org/sri_funds/SECletters.asp). In fact, many of our concerns were addressed directly in the SEC decisions. The new rules and guidelines should help all investors make better decisions and all shareholders become more responsible owners.