Paul Hodgson: Shareholder proposals: a victim of their own success (Part 2)

On Tuesday this week, CalSTRS’ CEO Jack Ehnes sent a letter to California Democrat Maxine Walters, the ranking member of the Financial Services Committee that discussed the Financial CHOICE Act on Wednesday.

“As ranking member, we hope that Ms. Waters was able to express our concerns about the bill at the hearing. Everything is shrouded in this idea of financial deregulation that sounds really good, but then they’ve included these aspects that really hurt shareholder rights. We talk about five main points in the letter,” said CalSTRS’ Corporate Governance Portfolio Manager Aeisha Mastagni.

The letter singles out for special concern five provisions of the discussion draft. First is the attack on the shareholder resolution process. The Act seeks to eliminate the $2,000 ownership threshold and require investors to own a minimum of one per cent of outstanding voting stock over three years. As the letter says: “While one percent may sound like a small amount, even a large investor like the $200 billion CalSTRS fund does not own one per cent of publicly traded companies.”
The letter also criticises the Act’s provisions that: prevent the SEC from enacting a universal proxy; allow many more companies to evade employing an external auditor; impose unnecessary regulatory burdens and restrictions on proxy advisers; allow private equity fund advisers to evade proper disclosure. But the most important objection to the bill remains the attempt to undo 50 years of progress through shareholder engagement.

“It’s creating a solution for a system that isn’t broken,” said Mastagni. “A 1 per cent threshold is just so over-the-top, if you were to raise it for inflation it would only go up to around $3,000. The issue that you need to remember,” she continued, “is that this is a mechanism that allows not just large shareholders like CalSTRS to communicate with companies but it is a process for small shareholders to communicate with them as well. If you eliminate the ability for shareholders small or large to use this process to bring up what we think are really important issues, how else are shareholders going to exercise their rights except through using their director votes? Is that really the route that you want to go down?”

The subject of director votes led to the recent Wells Fargo AGM, where several directors only just made re-election. I commented to Mastagni that it would be difficult, for example, to see how all the issues that were raised at the meeting could’ve been raised had they not been the subject of shareholder resolutions. Mastagni commented: “The issues at Wells Fargo have taken so long to come to light that shareholders decided to use their director votes to protest. There were a lot of directors there who squeaked by. I wouldn’t have wanted to be one of those directors sitting on that stage and barely more than half the shareholders supported me.”Meanwhile, on Wednesday, J. Robert Brown, Professor of Corporate Governance at the University of Denver, posted to the Social Science Research Network (SSRN) a paper entitled Corporate Governance, Shareholder Proposals, and Engagement Between Managers and Owners.

Brown puts together a set of cogent arguments for the retention of the shareholder resolution process.
For example: “Proposals developed into a signaling device for management. To the extent receiving significant support, management understood that the topic required serious attention and necessitated ‘outreach’.” In addition, repeat proposals offered boards an understanding of increased levels of support for some ideas.
He points to their many successes – abolition of poison pills, of staggered boards, implementation of majority vote provisions and proxy access bylaws.

“It’s creating a solution for a system that isn’t broken”

Mastagni added: “And these are legitimate issues. For example, here at CalSTRS we’ve got over 500 companies to adopt the majority vote [system for electing directors] in the Russell 2000, through engagement as well as shareholder resolutions.” Brown notes that successes are not simply limited to governance provisions: “In 2015, 81% of the largest companies issued corporate responsibility or sustainability reports. Much of what is known with respect to political contributions has been a result of the shareholder proposal process.”
The attempt to remove the ability of shareholders to submit proposals is not driven, says the paper, by any record numbers of proposals, nor by the cost of including them on the ballot. Mastagni made a similar point: “The costs of fighting these proposals that companies complain about so much is largely self-induced. They are the ones fighting these proposals and challenging them at the SEC. Just put it in the proxy,” she said.

Opposition to shareholder resolutions is driven, Brown contends, by their very success. When few received majority support, they could be ignored.
Now they are a driver of change, they can no longer be ignored. But Brown is not a blind supporter of the rule as it stands, and he summarises a range of reforms that would improve its functioning.
“Silence is seen as accepting the Bill,” summed up Mastagni. “It’s really important that shareholders raise their voices about this issue. Not everybody realizes exactly what’s included in the Act that is going to affect us as long-term shareholders, that will affect our ability to protect the retirement benefits of our members.”