Shareholder engagements impacted by New SEC Guidelines

A shift in the shareholder meeting arena has occurred, and it has taken most corporations by surprise.  If your company has recently experienced a short-notice cancellation of a meeting with a top-tier index investor, do not take it personally, as you are not alone.  Last week, Alliance Advisors noted that across its diverse client base, a trend emerged whereby BlackRock called off scheduled engagement meetings.  The move was cited as a reaction to the Securities and Exchange Commission’s walking back guidance that had allowed big index-fund investors to push influence on ESG-related topics with corporates.

In the past, BlackRock shared how they intended to use their sizeable positions in nearly every company to start discussing ESG concerns so as to minimize risk within their ever-growing portfolio. In an investor letter back in 2020, BlackRock stated that as a fiduciary to its clients, BlackRock believed it has an obligation to consider the impact of ESG issues in its investing. It went on to state, “Our investment conviction is that sustainability- and climate-integrated portfolios can provide better risk-adjusted returns to investors. And with the impact of sustainability on investment returns increasing, we believe that sustainable investing is the strongest foundation for client portfolios going forward.” Around this time, BlackRock made a commitment to use voting power to compel companies to enhance their ESG reporting.  This might all now change.

This change by the SEC is primarily impacting the top-tier index investors.  Over the years, as index investing grew in popularity, so too did their coffers.  According to Investor’s Business Daily, Vanguard became the #1 owner of 330 stocks in the S&P 500 back in 2022. Further research indicated BlackRock was a remote second-top owner, ranking as the No. 1 investor in just 38 S&P 500 companies. ^1. Now, even if these indexers are not the #1 holder in other portfolio companies, they tend to hold over 5% regardless.  As such, the likes of Vanguard, BlackRock, and State Street are among the most frequent filers of 13G filings with the SEC.  This category of filing lies at the heart of this new guidance.

Since these passive investors were so heavily exposed to such a large swath of the S&P 500 and had little to no investment discretion over those holdings, a decision was made that leveraging their immense voting power provided a lever they had not possessed in the past – the influence of corporate strategy.  This is now called into question. As a refresher, when beneficial ownership of more than five percent of a voting class of a company’s equity securities registered under the Securities Exchange Act is accumulated, the person/entity is required to file a Schedule 13D with the SEC. Depending upon the facts and circumstances, the person/entity may be eligible to file the more abbreviated Schedule 13G in lieu of Schedule 13D. Schedule 13G is a shorter version of Schedule 13D with fewer reporting requirements.  The latest move by the SEC focuses on the 13G requirement of the investor as having no intention of influencing control of the issuer.

At the heart of the matter, here is what seems to be causing this pause of investor engagement…

Question 103.12

Question: Under what circumstances would a shareholder’s engagement with an issuer’s management on a particular topic cause the shareholder to hold the subject securities with a disqualifying “purpose or effect of changing or influencing control of the issuer” and, pursuant to Rule 13d-1(e), lose its eligibility to report on Schedule 13G?

Answer: The determination of whether a shareholder acquired or is holding the subject securities with the purpose or effect of “changing or influencing” control of the issuer is based on all the relevant facts and circumstances and will be informed by the meaning of “control” as defined in Exchange Act Rule 12b-2.

The subject matter of the shareholder’s engagement with the issuer’s management may be dispositive in making this determination. For example, Schedule 13G would be unavailable if a shareholder engages with the issuer’s management to specifically call for the sale of the issuer or a significant amount of the issuer’s assets, the restructuring of the issuer, or the election of director nominees other than the issuer’s nominees.

In addition to the subject matter of the engagement, the context in which the engagement occurs is also highly relevant in determining whether the shareholder is holding the subject securities with a disqualifying purpose or effect of “influencing” control of the issuer. Generally, a shareholder who discusses with management its views on a particular topic and how its views may inform its voting decisions, without more, would not be disqualified from reporting on a Schedule 13G. A shareholder who goes beyond such a discussion, however, and exerts pressure on management to implement specific measures or changes to a policy may be “influencing” control over the issuer. For example, Schedule 13G may be unavailable to a shareholder who:

• recommends that the issuer remove its staggered board, switch to a majority voting standard in uncontested director elections, eliminate its poison pill plan, change its executive compensation practices, or undertake specific actions on a social, environmental, or political policy and, as a means of pressuring the issuer to adopt the recommendation, explicitly or implicitly conditions its support of one or more of the issuer’s director nominees at the next director election on the issuer’s adoption of its recommendation; or
• discusses with management its voting policy on a particular topic and how the issuer fails to meet the shareholder’s expectations on such topic, and, to apply pressure on management, states or implies during any such discussions that it will not support one or more of the issuer’s director nominees at the next director election unless management makes changes to align with the shareholder’s expectations.²

So what does this mean for corporates?  Well, a couple of things come to mind.  Firstly, I have heard while attending past Vanguard & BlackRock conference presentations that these indexers tend to request meetings with only those corporates with whom they either have issues respective to their ESG strategies or were keen to gather more insights into potentially concerning areas.  These indexers liked to say that if a corporation did not hear from them, consider it lucky, as that means these indexers had no issues with the corporate strategy.  So, if one of these index investors has requested a meeting with our company but uncharacteristically asked to postpone/cancel that meeting, then you might just have more time to consider what was at issue with these investors, facing less pressure to address it on terms other than your management’s. Secondly, should these investors wish to continue engaging corporates in hopes of affecting changes to their ESG-related strategies, their 13G status would look to change, requiring them to file 13D, which is a more onerous filing requirement.

At Alliance Advisors help companies stay engaged with their shareholders year-round, not just ahead of annual meetings, or even just after quarterly results.  Alliance Advisors is uniquely positioned to help companies across all market capitalizations, industries, and sectors to understand shareholder activity (buying/selling) as well as keep investors attuned to the critical messaging about your company’s corporate strategy.

¹ – https://www.investors.com/etfs-and-funds/sectors/sp500-one-investor-is-the-largest-owner-of-two-thirds-of-u-s-companies/

² – https://www.sec.gov/rules-regulations/staff-guidance/compliance-disclosure-interpretations/exchange-act-sections-13d-13g-regulation-13d-g-beneficial-ownership-reporting