Money Stuff: The SEC Opposes Shareholder Proposals

When I was starting out as a young corporate lawyer, I worked on several 14a-8 shareholder proposals. I did this because I was very junior and nobody else wanted them. Here is how 14a-8 proposals work:

1. US public companies have annual meetings where shareholders can vote on various things, mainly electing the board of directors and approving executive pay. The companies send out proxy statements to the shareholders, explaining the stuff that they are voting on; the shareholders vote by tearing out the proxy card at the back of the proxy statement, checking the box for “Yes” or “No” on each question, and mailing it back to the company. [1]
2. Historically, shareholders can participate in this process not only by voting on the company’s proposals, but also by submitting proposals of their own. A shareholder might say “hey I think the company should do ______,” submit a proposal to the company (“Resolved, the shareholders think the company should do ______”), submit a little supporting statement, and if all goes well the company will include her proposal in the proxy statement for shareholders to vote on. The company can include its own statement along with the proposal, often of the form “Here’s why you should vote against her proposal,” but the shareholders get to vote on it. The US Securities and Exchange Commission rule regulating these proposals is Rule 14a-8.
3. (Note that this is different from a “proxy fight.” In a proxy fight, an activist sends out its own proxy materials to shareholders, at significant expense, trying to get them to, for instance, vote for a competing slate of board candidates. In Rule 14a-8 proposals, the activist gets to put her proposal in the company’s own proxy statement. Generally speaking big activist hedge funds wage proxy fights; small social activist shareholders do 14a-8 proposals.)
4. These proposals can’t do much. In particular, they are not binding: They are just recommendations to the board of directors, and the board is free to ignore them even if the shareholders all vote for them. [2]
5. Rule 14a-8 also has other limits on what a proposal can say, and the company does not have to include a proposal in its proxy if the proposal violates those rules. The proposal and supporting statement can’t contain any false information. It can’t be about a shareholder’s “personal claim or grievance.” It can’t be too trivial: If it “relates to operations which account for less than 5 percent of the company's total assets … and for less than 5 percent of its net earnings and gross sales,” the company can leave it out of the proxy. But it can’t be too business-y either: If it “deals with a matter relating to the company’s ordinary business operations,” the company can leave it out. And the company can leave it out if “the company has already substantially implemented the proposal,” or if it “substantially duplicates” another shareholder proposal in the same proxy, or if it “addresses substantially the same subject matter as a proposal” from a previous proxy that didn’t get much shareholder support.
6. In practice, this means that a lot of shareholder 14a-8 proposals tend to relate to environmental, social or governance topics. “The company should write a report about reducing its fossil fuel use,” or “about separating the jobs of chief executive officer and board chair,” or “increasing diversity on its board of directors,” or something like that.
7. Companies generally don’t like these proposals. If a shareholder submits a proposal saying “the company should write a report on its fossil fuel use,” and the board replies “no we shouldn’t,” and a majority — or even a substantial minority — of shareholders votes for the proposal, that is embarrassing; it suggests that the company is not in tune with its shareholders. Even just replying to the proposal — writing a paragraph in the proxy saying “actually we don’t need to write this report” — is a little embarrassing. The company would prefer to just ignore the proposal, to not print it in the proxy statement.
8. And so in practice companies will often try to omit the proposals from their proxy statements, claiming that they violate some part of Rule 14a-8.
9. But the rule is a little vague, and it is often not clear if a proposal violates it. So companies commonly ask the SEC if they can exclude a proposal. The way this works is that the company writes a letter to the SEC explaining why it thinks the proposal violates Rule 14a-8, and the SEC sends back a letter either agreeing (so the company can omit the proposal) or disagreeing (so the company has to include the proposal). For boring legalistic reasons the SEC never actually agrees to anything: If it agrees with the company, instead of saying “we agree that you can omit this proposal,” it says “we will not recommend taking any enforcement action against you if you omit this proposal.” Thus the SEC’s response is called a “no-action letter.” The no-action letters are public; you can read them here. A sample — the first alphabetically — is this letter from the SEC telling AbbVie Inc. to go ahead and omit a shareholder proposal from its proxy statement asking it to “issue a report … assessing how the Company’s advertisement and promotion of puberty blockers impacts AbbVie’s legal and reputational risks.” That sort of thing.
10. Some sad law firm associate has to write these letters to the SEC explaining why the shareholder proposal is bad.

Does this stuff matter? I tend to believe that shareholder voting is largely symbolic and less important than people think, and that view is probably informed by my experience of writing dull 14a-8 no-action letter requests. This stuff doesn’t matter much. But it has some symbolic importance. The standard theory is:

• Shareholder proposals, and the level of support they command from big asset managers, tell you something about the ESG interests of investors. If lots of companies get proposals saying “write a report on fossil fuels,” and those proposals all get 60% shareholder support, then that tells you that investors care a lot about fossil fuels. Companies will try to minimize their fossil fuel use, regulators will pay attention, etc., even if the actual nonbinding votes to issue reports don’t specifically accomplish much.
• When a company loses a vote — it says “no we shouldn’t write a report” and shareholders vote for it anyway — that tells you something broader about shareholder dissatisfaction. If 60% of shareholders are voting against management’s recommendation, that’s probably not just because they want to read a report about fossil fuels; it suggests that they have lost confidence in management more generally. That is a sign to activist hedge funds that perhaps they should mount a proxy fight and try to take over the board, or to potential buyers that perhaps they should mount a hostile takeover bid. If management has lost the confidence of shareholders, it might be time for new management.

So companies don’t like them, not so much for their substance, but for the risk of creating or highlighting disagreements with shareholders. We talked last year about a lawsuit that Exxon Mobil brought against two shareholders who submitted nonbinding environmental proposals under Rule 14a-8. That was an unusual and drastic response: Normally, a company would just submit a no-action request to the SEC if it wanted to omit the proposals. But Exxon didn’t trust the SEC. I wrote:

Basically Exxon’s complaint here is that activist shareholders submit a lot of environmental proposals that other shareholders don’t support, Exxon considers them to be a nuisance, but the SEC disagrees. But the SEC’s views are not the law. So Exxon has gone to court to find a friendly judge to rule that it can omit these proposals, because a court ruling is the law: If a court rules that Exxon can omit environmental proposals, then it (and other companies) can keep doing that forever, without asking the SEC for permission. 

This worked out fine for Exxon. But also, that was the previous SEC. The current SEC has the opposite view: It also considers shareholder proposals to be a nuisance. And so yesterday it might have ended them, putting out this statement:

The Division of Corporation Finance … has determined to not respond to no-action requests for, and express no views on, companies’ intended reliance on any basis for exclusion of shareholder proposals under Rule 14a-8. ...

Pursuant to Rule 14a-8(j), companies that intend to exclude shareholder proposals from their proxy materials must still notify the Commission and proponents no later than 80 calendar days before filing a definitive proxy statement. We remind companies and proponents, however, that this requirement is informational only, there is no requirement that companies seek the staff’s views regarding their intended exclusion of a proposal, and no response from the staff is required.

Essentially, the process is the same as before — a shareholder submits a proposal, the company grumbles, it hires a lawyer, and the lawyer sends a letter to the SEC saying “we think we can omit this proposal” — except that now the response is automatic: The SEC will, in every case, “respond with a letter indicating that, based solely on the company’s or counsel’s representation, the Division will not object if the company omits the proposal from its proxy materials.” The SEC is no longer in the business of objecting when companies omit shareholder proposals.

That doesn’t mean the company is right: The company still has to follow Rule 14a-8, and if it omits a proposal that it shouldn’t, then … the shareholders can sue? In practice, though, it hardly seems worth hiring lawyers to sue companies for excluding your proposal to write a report about fossil fuels or puberty blockers. It’s not clear what the equilibrium us. Michael Levin writes:

[SEC Chair Paul] Atkins clearly seeks to assure companies they can exclude proposals with little fear of what the SEC will do to them. Yet his statement will probably lead to less certainty, not more, among companies and activists. Sure, a number of smaller proponents or those with less popular ideas will decline to even submit their proposals, which undoubtedly is part of the goal here.

More experienced proponents with greater resources might consider tactics like [suing or waging their own proxy fights], leading to greater attention and cost. Those proponents might escalate even further, to binding bylaw amendments, withhold campaigns, and proxy contests.

We expect only a few companies to get aggressive with these exclusions. … We guess many companies will grudgingly accept the certainty of a vote on a couple of ESG proposals that will almost certainly fail, based on recent proposal votes, to avoid the threat of worse.

So it is not clear whether the SEC has actually gotten rid of shareholder proposals with this new approach; it’s possible that shareholders will keep submitting them and companies will be afraid to exclude them. But it does seem clear that the SEC wants to get rid of shareholder proposals: Companies think they are a nuisance, and now the SEC thinks so too.

Right now, the US government controls Fannie Mae and Freddie Mac: The two “government-sponsored enterprises” that dominate the US mortgage market are in conservatorship and run by the government, and the government also effectively owns them. The ownership, though, is a bit tricky. The US Treasury owns two bits of the GSEs’ capital structures:

1. It effectively owns 79.9% of their common stock (in the form of warrants). The other 20.1% trades in the market and is owned by various public shareholders, including notably Bill Ackman’s Pershing Square funds.
2. It owns an unusual instrument called “senior preferred stock.” The senior preferred stock (SPS) is senior to the common stock — it is effectively like debt — and it keeps growing. The government loaned the GSEs a total of about $191 billion ($119.7 billion to Fannie Mae, $71.6 billion to Freddie) when it bailed them out after the 2008 financial crisis, in exchange for SPS which carried a 10% interest rate. But over the years, the terms of the SPS were amended, so that now effectively 100% of any increase in the GSEs’ net worth goes to increase the amount they owe the government. Fannie and Freddie have by now paid the Treasury back considerably more than the $119.7 billion and $71.6 billion that they borrowed, [3]  but their debt has increased; they now owe $227 billion and $140.2 billion, respectively, and those numbers increase each quarter. [4]  That is: Fannie and Freddie owe the government $367 billion, which is considerably more than their net worth, and 100% of their profits of Fannie and Freddie go to increasing the amount they owe the government. So the common stock has essentially no interest in their future profits and should be worth zero.

The common stock is not worth zero (Fannie Mae closed at $9.35 yesterday, Freddie Mac at $8.33), because nobody believes Point 2 above. That is what the terms of the Fannie and Freddie senior preferred stock say, but many people dislike it. In particular, the terms of the SPS were amended by the Obama administration in a way that was very bad for shareholders and that seems to be quite unpopular in the Trump administration. There has been somewhat vague talk, for many years, about undoing it. 

That talk has, however, been wrapped up in more complicated and even vaguer talk about what to do with Fannie and Freddie generally. There is a widespread assumption that something has to be done. Fannie and Freddie have been in conservatorship for 17 years now. Eventually, people assume, that must end. Some stuff has to happen. The stuff that has to happen is, approximately:

1. The conservatorship has to end. Fannie and Freddie have to go back to being somewhat regular companies, run by boards of directors answerable to their owners, though they will be heavily regulated to make sure they are well capitalized and serving their social purpose (making mortgages cheap).
2. The capital structure has to get cleaned up. If Fannie and Freddie become normal companies, they can’t have this ever-increasing debt to the government. Something has to be done to give them a more normal capital structure; the residual claimants will have to be shareholders.
3. There will probably have to be some sort of public offering. Right now, depending how you count, Fannie and Freddie are probably undercapitalized: They back trillions of dollars of mortgages with relatively little equity. So they would have to raise more money to get out from government conservatorship. And the US Treasury owns most of the value of these companies, and might want to sell shares in any offering. There has been talk of a $30 billion public offering as soon as this year.

We have talked about all of this a few times this year. (In particular I went through the structures and history in detail in January, and I am being rather brisk here) A general point that I have made is that all of the details are very much up for debate: The conservatorship will end, the capital structure will get more normal, and some stock will be sold, but how? 

In particular, as a legal matter, the Treasury can drive as hard a bargain as it wants. The key piece here really is cleaning up the capital structure by getting rid of Treasury’s ever-growing senior preferred stock. Here are some ways that might happen:

• Treasury might say “okay you owe us $367 billion under the current terms of the SPS, so pay us $367 billion and we’ll call it even. [5]  And then you can go public with a normal capital structure (and we’ll own 79.9% of the stock when you do).” And then Fannie and Freddie would have to raise $367 billion from investors just to pay back Treasury, which would dilute their current common stock down to roughly nothing.
• Treasury might say “okay you borrowed $191 billion and have repaid that with interest, the $367 billion stuff was just an Obama-era mistake, we’re going to call it even right now. You don’t have to pay us any more; you can go public with a normal capital structure right now, and we’ll own 79.9% of the stock when you do.” And then Fannie and Freddie’s current common stock would be quite valuable.
• Any number between $0 and $367 billion. “Why don’t you pay us back another $50 billion and we’ll call it even,” or whatever.

It is not quite true that this choice is zero-sum, but there is an obvious tradeoff here. Every dollar that the Treasury extracts for itself comes from the current Fannie and Freddie shareholders; every dollar that the shareholders get in a sense comes out of Treasury’s claim. (Not entirely, though, because treating the shareholders well arguably maximizes the market value of the companies and thus of Treasury’s 79.9% stake.) 

Crudely speaking everyone assumes that, if the Trump administration takes Fannie and Freddie public, it will land somewhere closer to the “we’re calling it even right now” side of things, and the existing public shareholders — many of whom bought their stock back when it seemed worthless — will do extremely well. But of course things were different in different administrations, and there’s no guarantee that Trump will actually get around to it. People have been talking about Fannie and Freddie exiting conservatorship for more than a decade; what’s the rush? 

Today Bill Ackman gave a clever presentation on what the government should do with Fannie and Freddie. Bloomberg’s Katherine Burton reports:

Billionaire Bill Ackman said now isn’t the right time for the Treasury to sell its shares of the government-sponsored mortgage giants known as Fannie Mae and Freddie Mac.

The Pershing Square Capital Management founder held a presentation on X Tuesday that said it “will take significant time” for the government to “deliberately execute” an initial public offering of its shares of Federal National Mortgage Association and Federal Home Loan Mortgage Corp. He also laid out a series of moves — including re-listing on the New York Stock Exchange — that could help Trump take some action sooner.

Here is the presentation. The essential thesis is: Look, sure, whatever, there are lots of details to figure out about how they can exit from conservatorship, how to recapitalize them and how to structure and execute a public stock offering. But right now, the government could do something much quicker and simpler and easier. It could just go ahead and declare that the senior preferred stock has already been paid back, and make $367 billion of liabilities disappear from Fannie’s and Freddie’s books. (“Account for the Repayment of the SPS,” says the presentation.) That would, uh, be good for Bill Ackman? Like:

1. If Fannie’s and Freddie’s profits go back to accruing to its common shareholders, instead of to the government, that will be good for their common shareholders. Right now the shares trade based on the assumption that the profits might eventually go back to the shareholders, but there is a lot of uncertainty. Just eliminating the SPS will resolve that uncertainty and increase the expected cash flows to the common stock, some of which Pershing Square owns.
2. Then eventually Fannie and Freddie could do stock offerings and exit conservatorship. But that could take years, and might happen in a less friendly administration. Getting rid of the government’s senior preferred stock now removes a lot of risk from the common stock: Presumably a future less friendly administration couldn’t get it back.

I mean, the argument is not “this would be good for Bill Ackman.” The argument, which I think is plausible, is that zeroing the government’s preferred stock is also a necessary first step to eventually returning Fannie and Freddie to investors. “Investors would either assign a very low valuation multiple to a company whose prior shareholders were wiped out by the government without just compensation,” says the presentation (slide 23), “or more likely choose not to invest. We believe an SPS conversion would severely impair the value of Treasury’s stakes in Fannie and Freddie.” Because the government did not zero Fannie and Freddie’s shareholders in 2008, when it took them over, it can’t zero them now. The simplest thing for the government to do with the GSEs, and also the most useful for Bill Ackman, is to write off the $367 billion that Fannie and Freddie owe to the Treasury. Everything else can wait. 

We talked last week about South Korean retail investors logging on at midnight to speculate on US meme stocks. I wrote: “It is strange to think that frictionless global markets would cause stock prices to be set by the least rational investors but I suppose that is the working theory here.” I guess I was sort of kidding. Like, my intuitive model was that if every investor has frictionless electronic access to every financial asset, then if prices became irrational, smart well-capitalized arbitrageurs could quickly step in to correct them.

But what is “irrational,” really? If the value of its stock is its expected future cash flows then, fine, whatever, but if the value of a stock is the maximum amount that a retail investor will pay for it, then maybe the arbitrageurs should push prices up. In that vein, I got an email from Eric Schoenberg at Columbia:

I am working on just such a model where stock prices are set by the least rational individuals based on a theory called k-level reasoning.

The basic model was developed to explain behavior in the beauty contest game inspired by Keynes where a large number of players each guess a number between 0 and 100 with the goal of being closest to 2/3 the average of all guesses. If the most rational players determined the outcome of this game the winning number would be 0, the unique Nash Equilibrium, but in reality the winning guess is always much higher (20 or so is a pretty good guess). The descriptive theory offered to explain this is that some people are Level 0 players who guess randomly (average guess of 50), and some are Level 1 players who assume other players are Level 0 and guess 33 (2/3 of 50), while Level 2 players assume other players are Level 1 and guess 22. The point is that nobody in this model cares that the “correct number” is 0, they are simply responding to their beliefs about what people slightly less thoughtful than themselves will do. In other words, the least rational player is the driving force in this game, and I believe a similar argument can be made for financial markets.

I say from time to time that someone should write a textbook of meme finance. That’s kind of a joke, though: How do you make meme finance rigorous and mathematically tractable? Maybe like this.

On the other hand. One chapter of the meme finance textbook will be “what numbers to choose for stuff,” and it will be extremely nonrigorous and stupid. Like, if you are the chief executive officer of a public company, and you want to signal confidence in the company’s prospects by buying some stock, how much stock should you buy? Traditional finance does not offer a right answer, per se, but you could come up with various sensible-sounding amounts. (I don’t know, “10% of your net worth” or “1% of the stock” or “one day’s trading volume” or “$1 million” or whatever.)

But the meme finance textbook will tell you: The amount of shares that you buy has to have a “420” in it, or a “69,” or ideally both. Those are the meme finance numbers and they have magic powers. If you do stuff in units of 69 and 420 then your stock will go up. I do not make the rules; I merely document them. Last week CG Oncology Inc. — a biopharma company making a bladder cancer drug! — announced that its chairman and CEO will be buying 690,420 shares of stock. Sure he will! Why not! Verity Data published a note on the announcement, saying:

It is certainly possible that he arrived at that number of shares for some innocuous reason, but the use of “420” and “69” in the same number is something we have seen from the likes of Elon Musk and meme stocks and may suggest he is looking to attract the attention of eagle-eyed retail investors.

Yeah. Well. Eventually investment bankers are going to come in to meet with companies with ideas for how to get their stock prices up, and the investment bankers will heave a long sigh and say “you have to do something with 69 and 420,” and the executives will heave a long sigh and say “really,” and the investment bankers will say “yes,” and they’ll all stare at each other dead-eyed for a minute, and then the company will wearily announce a new $420.69 million bond deal and investors on Reddit will cheer and the stock will go up.

I wrote yesterday about a hedge fund that trades Hermès bags. A reader emailed: “Can I just say how giddy it makes me that we’re one step closer to trading designer goods via warehouse receipts?  And inevitably finding out one day that a bin supposedly full of luxury handbags is in fact full of handbag-painted rocks?” That is of course a joke about “abstract commodity space,” and about the time that JPMorgan owned some nickel that turned out to actually be rocks. 

I should say though that it is also more or less the theory of nonfungible tokens? Remember NFTs? Like, you traded receipts for exclusive singular luxury objects, but the objects were not actually tied to the receipts and in many cases were lit on fire; the receipts were what traded for millions of dollars. [6] By 2030 nobody will believe what crypto was like in 2021, but it was nuts.

I was recently a guest on two fun podcasts that I want to tell you about. One is Michael Lewis’s podcast revisiting The Big Short 15 years after it came out. You can listen to that here. The other is a Planet Money+ episode with Mary Childs and Kenny Malone in which we discuss my love for the movie Margin Call. You can listen to that here.

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