Stockholder Proposals—Law and Policy Considerations

An article forthcoming in the Michigan Business & Entrepreneurial Law Review, claims that stockholders lack the inherent power to submit precatory proposals under Delaware law. In a recent speech, Paul Atkins, the Chairman of the Securities and Exchange Commission, cited the unpublished draft and its claim approvingly. On November 17, the SEC issued a statement announcing that it will no longer respond to most no-action requests, and an issuer that seeks to exclude a proposal from its proxy ballot must simply notify the Commission of its decision. The only exception noted in the statement is a request relating to Rule 14a-8(i)(1); presumably the SEC intends that exception to reflect its newfound interpretation that precatory proposals are improper under Delaware law.

As longtime scholars of Delaware corporate law, we are skeptical of the strength of this claim–indeed, we argue that the article’s characterization of Delaware law has it backwards. Because DGCL § 141(a) vests legal authority over the corporation in the board of directors, stockholders may not introduce a resolution that requires the directors or officers to act, except on matters the DGCL formally commits to stockholder authority, such as amending the bylaws. As a result, most stockholder proposals are merely advisory. Indeed, when Congress mandated a stockholder Say-on-Pay vote in the Dodd Frank Act, it described it as “advisory.”

The SEC has long legitimized its proxy rules as creating a procedural vehicle for preserving the substantive rights that exist under corporate state law. Yet, by regulating proxy access, the SEC determines what matters are proper or improper for stockholder voting, often restricting stockholder rights beyond the contours of state law. For example, Rule 14a-8 imposes minimum ownership requirements, holding periods, and limits on successive proposals. No Delaware statute or judicial opinion imposes such restrictions. The latest attempt to restrict precatory stockholder proposals goes much further, threatening a significant disruption to the balance of power between directors and stockholders.

The Scope of Stockholders’ Authority

Any resolution the stockholders approve in a vote is an “act of the stockholders” and a formal expression of the stockholders’ will. This is true regardless of whether a resolution would, if approved, require management to act. The result of a stockholder vote must be recorded in the official minutes and, for some companies, publicly reported. Even “advisory” proposals, then, are “binding” on the corporation in this sense.

Stockholders have the statutory power to elect and remove the directors, as well as powers that are “incidental” to these, such as the power to communicate among themselves in advance of a meeting, to nominate board candidates, and to present and vote on advisory resolutions. Stockholders’ incidental powers are expressly reserved in § 121 of the DGCL. When properly read together, §§ 121, 141(a), 141(k), 211, and 212 of the DGCL grant powers to the corporation within an authority structure that preserves stockholders’ power to advise the board as “necessary or convenient to the conduct, promotion or attainment of the business or purposes.” DGCL § 121

Moreover, stockholders’ exercise of their incidental powers is a necessary component of corporate governance. For example, although the statute does not formally authorize stockholders to nominate director candidates, the absence of that power would frustrate stockholders’ power to elect directors, and so, Delaware courts have made clear that stockholders may nominate director candidates. See, e.g., Moran v. Household Int’l., Inc., 500 A.2d 1346, 1355 (Del. 1985). Similarly, because the ability of a stockholder to run an effective proxy contest requires stockholders to communicate amongst themselves, directors cannot take action that would unduly inhibit stockholder communications, even though the DGCL does not contain any reference to inter-stockholder communication rights. See The Williams Companies Stockholder Litigation, 2021 WL 754593, *38 (Del. Ch. Feb. 26, 2021).

In previous eras, stockholders freely exercised the power to submit advisory resolutions, as well as resolutions to commit the stockholders, as an independent body, to action. Though the practice has lapsed, it was once common for stockholders to submit and vote on a resolution to form a “stockholders investigative committee,” tasked with examining a matter of stockholder concern independently from the board. When Willard Saulsbury, Jr., a stockholder of the Delaware Railroad Company (and the son of the former Chancellor of Delaware), presented such a proposal to the company’s stockholders in 1902, no one suggested that stockholders lacked the power to bind themselves to such an investigation. Saulsbury Causes Stir, Wilmington Morning News, Jan. 10, 1902, at 1.

There are good reasons to recognize that stockholders’ incidental powers encompass requests (as opposed to demands) for board action. For example, because only the board can initiate an amendment to the charter, if stockholders want to amend the charter, they must ask the board to initiate the amendment. The stockholders can only make such a request, as a body, by approving an advisory proposal.

The claim that stockholders may only take actions that formally compel corporate action presents a diminished view of stockholders’ role in corporate governance and limits the ability of stockholders to communicate both with each other and the board.

The Longstanding Judicial View

Consistent with the view that stockholders possess such incidental powers, federal and state courts, including Delaware courts, have long validated advisory stockholder resolutions. Courts tend to ground the stockholder’s power to submit an advisory proposal in other express powers guaranteed to stockholders by statutory law, as well as the congressional intent, reflected in section 14(a) of the Securities Exchange Act “to require fair opportunity for the operation of corporate suffrage.” SEC v. Transamerica Corp., 163 F.2d 511, 571 (3d Cir. 1947).

Professor Louis Loss, the former associate General Counsel of the SEC, is credited for first conceptualizing the precatory proposal and explaining that proposals that fell outside of specific statutory rights were consistent with Delaware law when framed as requests rather than binding mandates. In 1976, the SEC formalized precatory proposals in guidance and explained that “recommendations or requests” were proper under Rule 14(a)-(8). Specifically, the SEC stated:

[P]roposals by security holders that dictate or direct the board to take certain action may constitute an unlawful intrusion on the board’s discretionary authority under the typical statute. On the other hand, however, proposals that merely recommend or request that the board take certain action would not appear to be contrary to the typical state statute, since such proposals are merely advisory in nature and would not be binding on the board even if adopted by a majority of the security holders. Exchange Act Release No. 34-12999 (Nov. 22, 1976).

As this suggests, the SEC assumed, consistent with judicial opinions, that stockholder proposals couched as requests to the board were uncontroversially lawful. Delaware experts agreed, with such noted figures as Frank Balotti stating at an SEC Roundtable, “I think precatory resolutions are authorized by [DGCL §] 211, which says that a stockholder can bring before a meeting that is proper for a stockholder to act on.”

Courts reached the same conclusion. In Medical Committee for Human Rights v. SEC, the U.S. Court of Appeals for the D.C. Circuit considered the exclusion of an advisory stockholder proposal by a Delaware corporation. Observing that the “overriding purpose” of Section 14(a) of the 1934 Act “is to assure to corporate shareholders the ability to exercise their right—some would say their duty—to control the important decisions which affect them in their capacity as stockholders and owners of the corporation,” the court affirmed the stockholder’s power to present the proposal, characterizing it as consistent with congressional intent not to “isolate such managerial decisions from shareholder control.” 432 F.2d 659, 681 (D.C. Cir., 1970), vacated as moot, 404 U.S. 403 (1972).

In Conservative Caucus Research, Analysis & Educ. Foundation, Inc. v. Chevron Corp., the Delaware Court of Chancery considered a demand for access to the stockholders’ list. One of the stockholder’s purposes was to communicate with the other stockholders about a proposal couched as a precatory request for board action. Chevron argued that the stockholder lacked a “proper purpose” to obtain the stockholders’ list because the resolution was nonbinding, and thus of limited effect. The Chancery Court disagreed, reasoning that “[j]ust because the resolution only requests the board to take certain action … does not make it improper nor change its purpose: to influence the board to [take a particular action].” 525 A.2d 569, 572-73 (Del. Ch. 1987)(emphasis added).

In Auer v. Dressler, a corporation’s president refused to call a special stockholders’ meeting, as the bylaws required him to do, in part because the stockholders sought a vote on an advisory resolution. While expressly acknowledging that stockholder approval of the resolution would not have required management to do anything, the New York Court of Appeals nonetheless concluded that the resolution was proper, noting its validity for the stockholders to “express[] themselves” and put “on notice the directors who will stand for election at the annual meeting.” 306 N.Y. 427, 118 N.E.2d 590 (1954).

In 2015, the Sixth Circuit interpreted Michigan law, which mandates that stockholders receive notice of stockholder proposals, to require notice of a resolution that merely requested the board to act. Though the company vigorously opposed the resolution, neither the company nor the court suggested that the resolution was invalid because it was nonbinding. Gwyn R. Hartman Revocable Living Trust UAD 111693 v. Southern Michigan Bancorp, Inc., 780 F.3d 724, 727 (6th Cir. 2015).

In sum, courts in Delaware and beyond have consistently refused to treat a shareholder resolution differently simply because it was advisory or precatory.

The Value of Stockholders’ Advisory Proposals

The elimination of precatory proposals would impair the effectiveness of corporate governance. They enable the company’s own investors to generate ideas and solutions for the corporation’s business. That proposals add value is evidenced by the frequency with which boards settle, or voluntary agree to do some or all of what a proposal requests rather than submitting the proposal to a vote. The frequency of these settlements suggests that boards view many advisory proposals promoting objectives that are  in the corporation’s best interest.

Advisory proposals not only show respect for the board’s managerial authority, they are also practical: a stockholder might present a good idea but lack the operational sophistication to draft the optimal bylaw provision to make it happen. Similarly, the board may be better positioned than a stockholder to navigate potential conflicts between the proposed bylaw and other aspects of the corporation’s governing documents. The advisory nature of such proposals, then, encourages collaboration between the stockholders and the board.

If advisory proposals were eliminated, certain stockholders, perhaps those with large share holdings or personal relationships with board members, would still have access to the board, but through informal and opaque channels that exclude other stockholders. Informal channels not only fail to convey the will of the stockholders as a body, thus potentially distorting the board’s understanding of stockholders’ views, but can generate agency costs and present fiduciary duty challenges that lead to litigation.

Moreover, opponents of mandatory disclosure have often pointed to precatory shareholder proposals as facilitating private ordering, which can serve as a more efficient alternative than mandatory one-size-fits-all regulation. For example, during the protracted debate over the SEC’s climate risk disclosure rule, opponents of the rule argued that “The shareholder proposals process is a recognized method through which shareholders register their voice,” that “the evidence suggests that shareholders and managers are working hard together to determine which companies ought to disclose what additional information” and that “the [shareholder proposal] system is handling the intervention of political activism tolerably well”.  Cunningham, L.A. (2022). Comment letter on SEC climate proposal by 22 law and finance professors. Precatory proposals facilitate private ordering, and eliminating stockholders and managers’ ability to collaborate on firm-specific disclosure regimes could strengthen the need for mandatory disclosure.

Ultimately, boards should not expect their stockholders to go quietly into the night if their power to vote on advisory proposals is lost. Stockholders may respond by amending the bylaws to permit precatory proposals. They may seek greater constraints by proposing mandatory and potentially ill-conceived bylaw amendments. Prevented from expressing nuanced disagreement with the board’s position on a particular policy issue, stockholders may be forced to implement more aggressive tools such as withdrawing voting support from director candidates; waging proxy contests; removing directors; and opposing executive compensation. We may see the revival of old-fashioned procedures, such as stockholder investigative committees. In short, the elimination of precatory proposals seems short-sighted if its objective is to improve stockholder-board relations or reduce pressures on directors.