The GMI Blog

BRT and Chamber of Commerce Prevail on Proxy Access

By Paul Hodgson – Chief Communications Officer

The U.S. Court of Appeals has agreed with the Business Roundtable and the Chamber of Commerce and has struck down the SEC’s proxy access rule. This is a major setback for good governance.

U.S. Circuit Judge Douglas Ginsburg wrote for the three-judge panel: “The commission inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters.” Whether this is true or not, it means that the SEC must re-frame the rule, attempting to make it less complex, and put together a more detailed and more accurate cost/benefit analysis. If Congress would properly fund the SEC, this effort would be eased considerably. But organizations like the BRT and the Chamber of Commerce appear to want it both ways, to cut the budget of the SEC and to give it more work.

GMI is and always has been a strong supporter of proxy access. Even though the number of companies that this rule is likely to affect is tiny, the rule is no less important to increase shareholder democracy in those few cases. The fact that so few companies will be affected also calls into question the somewhat extreme reaction of the business community to this rule. It was even more like a red rag to a bull than the CEO/worker pay ratio, and that was bad enough. It is difficult to understand why anyone who supports a successful capitalist economy, based on shareholders investing in good management and electing effective representatives to the board, should object to those shareholders occasionally electing a representative directly, and getting rid of directors who clearly do not have their best interests at heart.

Predictably, "Private Ordering" Does Not Give Shareholders Proxy Access

The excellent Race to the Bottom blog has a post by J. Robert Brown Jr. proving that, as predicted, "private ordering" does not give shareholders a meaningful opportunity to get companies to adopt proxy access. Private ordering is a term that means letting the market decide instead of imposing a regulatory standard.

Remember when Delaware adopted sections 112 (access bylaws) and 113 (proxy reimbursement)?  It was supposed to usher in an era of private ordering.  Management and shareholders would come to agreement on access bylaws and reimbursement for proxy contests.  Eschewing one size fits all, each company could devise the most efficient set of terms given their own particular situation.

Now, a couple of years later, there has been no private ordering.  With respect to access bylaws, there are none that have been adopted under Section 112. (emphasis added)

Only one company, HealthSouth, has adopted a provision granting reimbursement for a proxy contest, and even that one has a great big loophole. Like Brown, I support private ordering in many cases, to prevent a "one-size-fits all" standard that stifles innovation, limits competition, and too often has adverse unanticipated consequences.

But shareholders are at a decided disadvantage in the private ordering realm, particularly for those provisions that go into the articles of incorporation.  Often provisions that are designed to promote private ordering simply result in a categorical rule that favors management.

Nell Minow - Editor

The Proxy Access Premium

Congress promises, the SEC delivers, and the courts take it away.  The Chamber of Commerce and Business Roundtable promised to challenge the proxy access rule in court as soon as it was issued, and they came through, and the SEC has halted the application of the rules until the litigation is resolved. 

As the court examines the challenge to the Commission's justification and economic and legal analyss of the rule, a new study from Harvard's Bo Becker, Daniel Bergstresser, and Guhan Subramanian should provide some important support.  They took the opportunity of the rule's suspension to measure its value with an elegantly  designed event study that factors in institutional ownership of issuers who are prospects for shareholder nominations.

This unexpected development [of the rule's suspension] provides the basis for a natural experiment. If shareholder access increases shareholder value, then companies that would have been most exposed to the new rule should decline in value, relative to companies that would have been more insulated from the rule. If shareholder access decreases shareholder value, then companies that would have been most exposed to the rule should increase in value, relative to those what would have been more insulated. This natural experiment allows a rough quantification of the value of
shareholder proxy access. In addition, the experiment allows testing of hypotheses about board influence. If there is heterogeneity across firms in the value of shareholder influence through the board of directors, or across different types of shareholders in their ability to improve the value of target firms, our natural experiment provides an opportunity to quantify those differences.

They found that

share prices of companies that would have been most exposed to shareholder access declined significantly compared to share prices of companies that would have been most insulated from the rule.  Specifically, we find 61 basis point spread between firms with high institutional ownership and firms with low institutional ownership for that day’s returns....This value loss is particularly striking because the event under examination creates only some probability (less than 1) of losing shareholder proxy access. To the extent that the market anticipated that the Business Roundtable challenge will not be successful, our results only measure the value loss from delaying shareholder proxy access by one year. That is, the overall value of shareholder proxy access is likely to be larger than what is captured.

Their working paper has an excellent summary of the history and significance of proxy access as an initiative and has important implications for rebutting the challenge that the rule is not sufficiently supported by the evidence.

Nell Minow - Editor

A Real Conservative on Proxy Access

Thank goodness for Marty Robins who finally says what all political conservatives and other free market types should have been saying all along.  In an excellent op-ed in the Huffington Post, Robins calls on his fellow conservatives to "do the right thing on proxy access."  He says that the challenge to proxy access filed by the Business Roundtable and the Chamber of Commerce is shameful in its claim that the rule is arbitrary and capricious because it will permit undue influence by unions.  He makes the key point about why this scare tactic is disingenuous: "Far from authorizing candidacies by fringe groups with trivial stock positions, the rules require a 3% holding for three years, which in many cases such as Apple, GE and other companies of the same size, will require over a billion dollars of stock. They also do not guarantee anyone a board seat, but only a spot on a ballot." (emphasis in the original) 

Anyone with a given stock position in a company should have the same rights, irrespective of their nature or affiliation. I feel that the labor laws are too heavily weighted toward labor, especially public employees, and that mandating card check to replace secret ballot in organizing drives would be a disaster for the economy. But saying that something is bad only because it bolster the voice of unions undermines the conservative movement.

Invoking the specter of union domination suggests that far from principled opposition to a public policy, the supposedly mainstream Roundtable and Chamber may not care much about investors as a whole but care more about their "class" avoiding challenges to their authority. I sincerely hope that this is not the case and that other business organizations and conservatives will disavow these anachronistic sentiments and recognize that many business practices need to change in order to facilitate recovery and avoid future disasters.

To facilitate the election of genuine conservatives, it is essential to demonstrate that this would serve the interest of the country as a whole and is not a movement limited to the privileged. For example, if we don't want a Consumer Financial Protection Bureau taking steps which will reduce consumer lending and borrowing at a time when this would be disastrous for the economy, we need lenders to demonstrate that they have learned from recent debacles and will behave responsibly on their own. In order to avoid and roll back the burdensome, counterproductive policies of the present administration, conservatives need to demonstrate that they are serious about individual responsibility, And that starts in the boardroom.

Thanks to Mr. Robins for pointing when executives and directors forget that responsibility, capitalism means that the people who provide the capital should get to replace them. 

Take a look at this excellent piece from Bruce Watson at Daily Finance on proxy access.  

The central critique of the new SEC ruling is that shareholders are not smart enough -- and, ironically, not invested enough -- to choose the best policies for their companies. However, over the past two years, scandals have rocked BP, Target, Hewlett Packard (HPQ), Merrill Lynch, Lehman Brothers, AIG (AIG), Halliburton, and dozens of other companies. In context, it is unclear if the professional decision-makers that stockholders pay to manage their companies are acting in the best interests of their employers.

Nell Minow - Editor

Roundtable and Chamber Sore Losers

Somewhat predictably, as if swimming against the tide were second nature, the Business Roundtable and the US Chamber of Commerce have combined to launch a law suit to both block the SEC’s proposed rulemaking on proxy access and, as if that weren’t arrogant enough, to prevent any further attempts to introduce it in the future.

Better still, some of the quotations in the accompanying press release are hilarious. Take this one from David Hirschmann, president and CEO of the U.S. Chamber’s Center for Capital Markets Competitiveness:

“The SEC’s proxy access rule empowers unions and other special interests at the expense of the vast majority of retail shareholders….”

That’s just laughable.  In case you needed a reminder, the SEC’s rules require a corporation to include in its proxy materials director nominees put forward by a shareholder (or group of shareholders) who have owned three percent or more of company stock for at least three years. If Mr. Hirschmann thinks that any union or indeed any “special interest group” could own three percent of a Fortune 500 company, then he has a fairly inflated opinion of the value of union pension funds.

And then there’s this one from Larry Burton, executive director of Business Roundtable:

“This unprecedented intrusion into areas historically reserved for the states would handcuff directors and boards, shut out the vast majority of retail shareholders and exacerbate the short-term focus that is now seen as one of the root causes of the financial crisis.”

Short-term focus? Didn’t the SEC’s rules just say three years the shares had to be owned? Have these people even read the rules? And actually, the broker non-vote rule was far more successful in shutting out the vast majority of retail shareholders…. And don’t even get me started on the insidious subtext that it was the SEC that was at the root cause of the financial crisis.

Wait a minute. Swimming against the tide IS second nature at the BRT, the “climate change is a conspiracy theory” experts.

Paul Hodgson - Senior Research Associate

Why Proxy Access Matters

Thanks to business, law, economics, and society blog, "The Conglomerate" for publishing my thoughts on the SEC's new proxy access rule:

The SEC's new proxy access rule is a modest and most welcome step forward. The post Enron reforms addressed many of the concerns that led to the avalanche of business failures almost ten years ago but did little to improve the ability of boards of directors to manage risk. And that led to the even bigger avalanche of business failures a few years later.

One problem was the post-Enron reliance on board "independence," despite the fact that dozens of academic studies have failed to show any reduced risk or increased return correlating to the number of independent directors. That is not because independence is unimportant. It is because there is no such thing as independence as long as management controls who is -- and is not -- put on the ballot for election.

The very term "election" is absurd in this context. Edward J. Epstein has said that shareholder elections “are procedurally much more akin to the elections held by the Communist party of North Korea than those held in Western democracies.” Under the current system, management picks the slate of candidates, no one runs against them, and management counts the votes. Managers even know how shareholders vote. As soon as the votes come in, they can call and try to persuade (or pressure) those who vote against them. And, of course, management has access to the corporate treasury to finance its search for candidates and solicit support for their election, while anyone running against them must put up their own money. (Successful dissident slates often get reimbursed, however, once they are in office.) Management has access to the shareholder list; a dissident shareholder still faces significant obstacles, including millions of dollars for lawyers, ads, mailings, and more. 

As a result, CEO compensation has gone from being absurd to being offensive, to threatening the economy through perverse incentives. And shareholders have no way to respond. Panglossian free market acolytes will argue that objecting investors can sell the stock but that ignores the transaction costs and the fundamental contradiction that doing so is to sell at a low rather than a high. More important, it ignores the all-but universal adoption of shareholder-unfriendly management compensation due in large part to management control of the board. Market forces will operate far more efficiently if board members are subjected to even the very small market test of a very limited ability for shareholders to put alternate candidates to a vote.

The complaints of those who see specters of "special interests" are hypocritical and disingenuous.  No one will be elected to the board without the support of more than 50 percent of the shareholders.  That means they will need to persuade not just "activist" funds but also staid institutions like foundations and mutual finds that their candidates are better than executives'.  If the shareholders get more than 50 percent of the vote, it is their opponents who are "special interests."  It is appalling that the very people who rhapsodize about the purity of the markets when it comes to their products (unless they can persuade the government to impose barriers to entry or limits to liability) get weak in the knees when it comes to their board members.  Lehman Brothers had a board that included an actress, a theatrical producer, and a retired admiral -- and no one who understood the complex securities that lead to their implosion.  The Wall Street Journal found more than 80 directors currently serving even though a majority of the votes cast by shareholders were against them.  We have found some who serve despite only a third of the votes cast.  Proxy access is important but majority vote requirements for service on a board are crucial.

The providers of capital should play a role in deciding who has the all-important fiduciary duty to minimize the inevitable agency costs of a capitalist system. The proxy access rule will establish the credibility of our markets and economy and encourage investment. As Thomas Paine might have said, if this be capitalism, make the most of it.

Nell Minow - Editor

Proxy access rools!

Well, they did it. In a 3-2 vote yesterday the SEC set on track proxy access for the 2011 proxy season. All shareholders need is a 3% stake for 3 years. How elegant.

Republican SEC commissioners think it will give fringe groups too much power….

How many fringe groups do you know that could own 3% of a company for 3 years?

And apparently the corporate community is having a hissy fit (an American term of which I am inordinately fond).

And the Business Roundtable has vowed to fight this until the last man is standing.

“Hey, I thought blogs were supposed to be news….”

OK. OK. Sorry.

And there is a three-year moratorium on companies with less than $75 million in market capitalization.

All in all, it’s almost as if rational people made this decision and are ready to implement it.

Oh, yes, this was the SEC, not Congress.

Now about that triennial Say on Pay vote….

Paul Hodgson - Senior Research Associate

Another Misguided Piece from Professor Bainbridge

Stephen M. Bainbridge, who has been consistently wrong about just about everything since his defense of excessive CEO compensation more than 20 years ago, continues his losing streak with a blog, to make ad hominem attacks on those who want to hold the managers of public corporations accountable, meet their obligations as fiduciaries, or legitimize the concept of capitalism by protecting their investments

In a current post, Bainbridge is reduced to trying to characterize shareholders as "thin-skinned" for having the temerity to challenge his attacks.  I suppose this is consistent with his overall approach that corporate managers should be unfettered by any constraints from those whose capital is at risk as well.  

I've spent the better part of my career crossing swords with these folks and I find them a remarkably thin skinned bunch. Call them "self-appointed" or "gad flies" or "water carriers for left liberal organizations like unions" and they get all offended.

Presumably, this is his attempt at humor.  If people are offended, I suspect it is for being mischaracterized.  Once again, he is wrong on the facts and wrong on the law.

The first rule of credible disagreement is being able to state your opponent's point in a manner that meets their approval.  The second is a willingness to assume the same intentions on the part of both sides.  If there are water carriers for the left, you had better identify and criticize the water carriers for the right. 

I actually agree with Bainbridge's point that good lawyers advise their clients on the best way to meet the requirements of the law to pursue their interests, though I would not use the word "circumventing" to describe the duties of an officer of the court in upholding the law.  The legal system benefits from vigorous and rigorous application of the law by all parties, and I assume that he grants that right to shareholders as well.He quotes J.W Verret, who is writing an article about 16 "defenses" for companies to use to prevent shareholders from availing themselves of their rights under the forthcoming proxy access regulations, and who got all excited about Jim McRitchie's actually paying attention to what he was writing.  "I haven’t seen such acerbic rhetoric since I testified next to Nell Minnow [sic] of the Corporate Library when the House Financial Services Committee was first considering proxy access in 2009.  Rhetoric and invective, however, are a poor substitute for reason."  Yes, he might want to take that last point under advisement; it better describes his testimony, with unsupported and shrill claims about the irresponsibility and bad motives of shareholders (with loving disregard of any potential parallel concerns about corporate managers -- and how's that working out on Wall Street?).  I'd love to see a citation for the "acerbic rhetoric" he attributes to me.  My only recollection is asking him to support his outlandish assertions -- and his silence in response.  And any documentation for his claims that fiduciary institutional investors have any motive other than sustainable value creation over the long term?  Still crickets.  Instead all we get is his suggestion that boards defer all of their decisions to an executive committee made up of only their own appointed directors to avoid being sullied by someone who might disagree.

Let's do the math, shall we?  Proxy access will not put anyone on the board unless a majority of the shareholders vote in favor of the candidate.  No director will be elected without the support of a wide and very heterogeneous range of institutional and individual shareholders.  That is what capitalism means.  Proxy access and majority vote provisions are the best way (I am sure Professors Verret and Bainbridge will agree that it is far better than government intervention) to mitigate agency costs and align the interests of managers, directors, and investors and prevent the kinds of abuses that led to the atrocities of the subprime and derivatives era, and the Enron, Worldcom, Adelphia, Global Crossing, era before that. 

Nell Minow - Editor

Bebchuck Tells It on Proxy Access

Cheers to Harvard Professor Lucien Bebchuck for his stirring op-ed on proxy access.  He makes the key points that this last-minute effort to gut the provision by imposing and insurmountable threshold (a) inserts (presumably corporate-authored) language to replace provisions where there was no conflict between the House and Senate versions so it was acceptable as it was and (b) makes proxy access into a tool that can only be used by raiders who are just as likely to exploit shareholders as corporations are.

Any reform of corporate elections should include ending incumbents’ monopoly over the corporate ballot — the proxy card sent by the company at its expense to all shareholders. Only board-nominated candidates get to appear on this ballot; challengers must bear the costs of sending (and getting back) their own proxy card to shareholders. Providing shareholders with proxy access — the right to place candidates on the ballot — would contribute to leveling the playing field.

Managements have long opposed proxy-access reform and have thus far succeeded in blocking it. In the wake of the financial crisis, however, the Securities and Exchange Commissionproposed a proxy-access rule and seemed determined to adopt it this year. Because business groups threatened to challenge in court the S.E.C.’s authority to adopt such a rule, the Senate and the House bills sought to support the agency’s reform by affirming this authority. Under the senators’ amendment, however, the financial regulation legislation would not merely affirm the S.E.C.’s authority but rather severely limit it.

The proposed amendment cannot be viewed as an attempt to reconcile the Senate and House bills. These bills were largely identical in affirming the S.E.C.’s authority and leaving the design of a proxy-access rule to S.E.C. rule-making. Rather than reconciling different arrangements found in the Senate and House bills, the amendment would replace an identical arrangement appearing in both bills with a different arrangement appearing in none.

If adopted, this new arrangement would largely eliminate the benefits that proxy-access reform could provide. A 5 percent ownership threshold would make the proxy provisions largely useless for the main set of investors whose involvement the proxy-access reform is intended to facilitate. (Emphasis added)

The New York Times also has a pointed editorial about the blatant links between campaign contributions and support for business-oriented revisions to the legislation. 

Congress has vowed to get tough with financial companies. But not so tough that members won’t eagerly solicit and accept their campaign contributions. While the House and Senate have been wrestling over financial reform legislation, members of the relevant committees have found time to conduct more than 800 fund-raising events.

The tawdry symbiosis is so routine that some members are crying foul about a preliminary investigation by the House’s new independent ethics watchdog.

Shareholders should make sure that Congress and the White House know how important proxy access and majority vote are to them.  And then they need to let corporations know that boards who think that it is an appropriate use of shareholder funds to promote policies that are not in our interests will not be permitted to continue to serve.

Nell Minow - Editor

Letter to Valerie Jarrett

Dear Ms. Jarrett,

I was shocked today to hear that there are rumors that the White House is trying either to block proxy access or to raise the threshold necessary to initiate access to a level which even the largest funds cannot hope to reach.

Given the administration’s explicit support of proxy access – one of the most important precepts of strong corporate governance – such a change of direction, if it were true, would be a serious betrayal of trust.

If we cannot get significant corporate reform through after the kind of economic crisis we have just been through then there is no possibility that the U.S. will catch up to the levels of good corporate governance that are practiced by the rest of the Western world. To put it bluntly, if the level of value destruction, the level of lying, guilt, greed, and cupidity that has just been evidenced by many in the corporate community is not sufficient to warrant a basic tenet of shareholder protection, then it is hard to know what kind of behavior will be.

Corporations are owned by shareholders, not by The Business Roundtable, whose continued denial of global climate change has lost it any of the shreds of credibility that still clung to it.

Please ensure that the House and the Senate retain the proxy access language in the final bill that was in each of the original bills.

Yours sincerely,

Paul Hodgson - Senior Research Associate