Shengling Zhu

In modern corporations, shareholders and the board of directors maintain a delicate balance of power: substantive business decisions are made by directors and executives, while shareholders retain their right to amend the bylaw and make procedural modifications. However, the line between procedure and substance is less clear in practice than in principle. A centralized executive and a group of dispersed shareholders often fight over the substantive policies of the company through shareholder proposals. As institutional shareholders become more proactive, even proposals that are destined to fail could have a meaningful impact on corporate governance.

Zuckerberg Confronted by Minority Shareholders

Mark Zuckerberg, the CEO and Chairman of Facebook, has come under attack by some of the most important shareholders of Facebook. After a disappointing second-quarter followed by a continuous decline in stock value, in mid-October several institutional shareholders joined a shareholder proposal requesting the removal of Zuckerberg as Chairman of Facebook. The initial proposal was filed by Trillium Asset Management in June. It recommends the Board of Directors to “adopt [the independence of Chair from rest of the Board] as policy, and [accordingly] amend the bylaws as necessary.” The proposal also claims that the lack of independence contributed to controversies and risk exposure, including “Russian meddling in US election,” “proliferating fake news,” and racial profiling of ads, which eventually cost the shareholders. The new supporters of the proposal include several pension funds of New York City (NYC), as well as the state treasurers of Illinois, Rhode Island, Pennsylvania, and the comptroller of NYC.

These shareholders, however, do not seem to play a key role in Facebook’s corporate governance. The NYC comptroller oversees Facebook shares valued at around $745 million, while the other three states’ share value barely exceeds $30 million. Facebook’s assets, on the other hand, values at $460 billion. Together with Trillium Asset Management, the institutional shareholders still fall short of being significant shareholders. Moreover, Mark Zuckerberg’s voting rights vested in his shares are around 60%, giving him the final say on all shareholder proposals. The proposal will be voted upon by shareholders during the annual meeting of Facebook next year in May.

Effects and Limits of Shareholder Proposals

Given Zuckerberg’s dominant control over the shareholder proposal, it seems to have at best a symbolic effect. However, even a symbolic shareholder proposal can have real impact on the corporate governance of the company. Public opinion may motivate the company to adjust its policies. After joining the activist shareholders, the NYC comptroller, Scott Stringer, released a public statement on the social and financial responsibilities that Facebook should take. It openly presses Facebook to tackle the “real risks” and enhance investors’ trust in the company. A shareholder proposal could lead public discussions on presumably internal issues of the company and attract the market’s attention.

A shareholder proposal, although doomed to fail, can also serve as a bargain chip between the shareholder groups and the Board of Directors. If the corporation is reluctant to directly implement the suggested policy as part of its governing procedure to exclude the proposal (R.14a-8(i)(10)), it has to recommend shareholders to vote one way or another and explain the reasoning behind its recommendation. To keep reputational harm at bay, a company would imply that policies in place are adequate. It may have the incentive to address the issue at stake in a more proactive manner. In fact, Facebook has been conducting its business in an apparently risk-averse manner: the company has claimed that it will keep up its efforts against security threat in 2019. The 2019 budget in protecting users is expected to be 50% more than the total amount in this year, which, by the end of October, has already exceeded the entire 2017 spending in this area. Trillium Asset Management “welcomed Zuckerberg’s commitment to invest in security.”

However, a minority shareholder proposal subject to the approval of a controlling shareholder has its limit. Some proposals are systematically rejected by majority shareholders, such as climate-related ones, when the shareholders’ interests are not completely compatible with social values. Even if a minority shareholder proposal is backed by the Board of Directors, to implement it effectively is another issue, especially in a company that has been long controlled by an overwhelmingly dominant figure. In this respect, Tesla could be Facebook’s reference: although a shareholder proposal that requires a permanent separation of the chairman and CEO positions promptly followed Elon Musk’s stepping down, it would not achieve the intended goal if the new chairman did not “ha[ve] the chutzpah to stand up to Musk.”

Future “No-Action Letter” To Be Issued by SEC

The SEC seems to impose more limitations upon shareholder proposals, but in practice the bar proves to be high. Although the Staff Legal Bulletin No. 14I (SLB 14I) permits the Board to introduce their analysis of the shareholder proposal at stake in no-action requests, few have resulted in no-action relief. On the other hand, Financial CHOICE Act may have more impact on fundamental proposals of corporate governance such as the separation of the chairman position from the CEO. By raising the stock ownership threshold the activist shareholders must attain in order to keep the proposal on the ballot, it may be increasingly difficult for shareholders to change the initial power structure of large companies.