By: Christopher P. Skroupa, Contributor
Corporate Governance and Institutional Investment
Published in Forbes.com on 9/26/2011
Is Proxy Access Dead? Ask Boards, CEOs and Shareholders
The summer of 2007 marked the initial implosion of mortgage
securitization, igniting the 2008 market meltdown and its ensuing
financial and economic crisis. As global markets and the economy moved
through the storm, the governance of public companies took center stage,javascript:void(0);
opening a discussion on how to address the relative roles of boards,
CEOs and shareholders.
Following the 2008 election these three groups, their constituents,
the newly elected Obama Administration and Congress negotiated reforms
intended to restore confidence in the global markets along with
provisions to enhance transparency and accountability of public
companies.
The enactment of The Dodd-Frank Financial Reform Act (“The Act”)
represents a beginning as opposed to the resolution of the debate on
corporate governance reforms. Amongst a host of newly shaped corporate
governance provisions is proxy access. The term itself—proxy access—is
uninspired. One has to be a practitioner to define it and to understand
its significance in the realm of how public companies relate to
shareholders—the realpolitik surrounding legislative change and the allocation of policy benefits.
By definition corporate governance is the practice through which
public companies and stakeholders participate in the creation of
policies and actions designed to drive long-term value. Stakeholders
are defined to include boards of directors, CEOs and shareholders. Some
experts apply an expanded definition of stakeholder to include
employees, unions, customers, markets and operational or service
communities.
In the U.S. governance principles favor the interests of
shareholders versus in Europe where they favor the interests of
companies. This is a significant distinction affecting shareholder
engagements.
Making and Breaking Proxy Access
Despite its less-than-saucy hook, corporate governance is important
for stakeholders seeking input into key decisions influencing a company
and its share price. So the rules of the road for this process matter
greatly because they lead boards, CEOs and shareholders through a
minefield of competitive terrain, vested interests and contrasting
visions.
The new proxy access provision was considered a big shift in that it
opened up the board nomination process to institutional investor
shareholders through a streamlined process—often advocating for greater
participation in policy-setting. According to Francis Byrd, Editor of BYRDwatch
and Senior Vice President of Laurel Hill Advisory Group, “The
establishment of proxy access was for the primary benefit of the public
and union pension funds, groups characterized as governance advocates
and intermediate or long-term investors.”
The new provision gave these and other institutional investor
shareholders the ability to nominate board candidates and run short
slates—a strategy often used by hedge funds and governance advocates
seeking to place a limited number of directors on a board without
seeking to replace the full board and take control of a company.
Yet not all have agreed with the wisdom of the new provision.
Opponents argue that special interest groups could misuse proxy access
for non-investment objectives. For instance, “Labor unions could elect
directors who favor union jobs or who could prevent a company from
expanding into a right-to-work state even if hiring non-union workers or
expanding into a right-to-work state would be in the best interest of
the company’s stockholders as a whole,” says Robert T. Clarkson, Partner
of Jones Day Silicon Valley.
The United Brotherhood of Carpenters’ Director of Corporate Affairs,
Edward Durkin, agrees that, “Direct engagement in short-slate campaigns
by pension funds makes little sense—getting pension funds directly
engaged in potentially expensive short-slate campaigns at one of
hundreds or thousands of portfolio companies makes little sense, even
with proxy access rights.” Durkin further adds, “The big public pension
funds have money invested in relational investing or governance funds
that are engaging in this activity already so the funds have their hands
in board challenges, albeit one step removed from direct engagement.”
However having a different take, Paul Hodgson, researcher for
independent governance firm GMI states that, “It is certainly
conceivable that institutional shareholders such as pension funds might
try to elect a director for activist reasons. But how could this be
possible given SEC constraints and requirements in implementing the
ruling–especially for large high-profile companies?” Hodgson is
referring to the requirement of a 3% ownership stake held for 3 years—a
significant hurdle for public and union pension funds to jump over
successfully.
These and other arguments taken, proxy access is one example of the
gap between CEOs and board members and other stakeholders on positions
regarding roles and accountabilities in value creation. “Public
companies have been historically concerned about the goals of governance
advocates, sometimes for good reasons, yet often based on stereotypes
of unions, since they usually are not seeking broad changes in strategy
or special dividends or payouts,” argues Byrd. Boiling it all down,
hidden agendas and leverage-ability dominate what are otherwise material
agenda topics.
Proxy Access and National Politics
Taken one step up, place proxy access and its polarizing net effect
into the bigger picture. Proxy access and other policy and practice
changes of The Act were voted in by a Democratic Congress holding a
majority in both the House and the Senate. It was signed into law by a
Democratic President. Following the 2010 mid-term elections, the
Republicans gained a majority in the House, the discussion on financial
reform—including proxy access—shifted away from implementation to repeal
or revision.
This is expected to remain status quo until 2012 when the results of
the upcoming Presidential and Congressional elections will determine the
future of The Dodd-Frank Act.
In the interim, immediately following SEC issuance of the new proxy
access rule, opponents challenged it in federal court. Scoring a
victory, the Business Roundtable and U.S Chamber of Commerce
successfully vacated the new provision, removing the ability for public
or union pension funds to challenge or reshape boards of directors.
On July 15, 2011 the U.S. Court of Appeals for the District of
Columbia decided against the proxy access rule with the net effect of
pushing back on governance advocates. In the decision Justice Ginsberg
cites SEC failure as a prime reason to vacate. According to the
decision, the SEC failed to conduct a proper and complete cost-benefit
analysis on how pension funds were to use it. Hodgson reflects that,
“it is perfectly believable that the SEC did not present a proper and
complete cost-benefit analysis, especially given the constraints on
their staff and budget.”
In the decision, “Justice Ginsberg cites the SEC for insufficient
consideration given to the prospect that labor would use proxy access as
a bargaining tool or that a public fund would seek specific benefits”,
states Byrd. He adds, “Looking a majority of instances, public and
union pension funds are not focused on labor organizing activity or
political goals but on a philosophy of seeking “good” corporate
governance as a mechanism for improving the oversight of portfolio
companies—aka long-term holdings.” Ed Durkin agrees, “As to the court
decision, good cost-benefit analysis is always a good thing in
promulgating new regulations, but the Roundtable and the Chamber’s
protests about Labor’s non-investment objectives is the same old BS.”
In spite of urging from The Council on Institutional Investors, an
advocate of governance reforms, the SEC did not to address the court’s
concerns, choosing instead to drop proxy access all together for other
regulatory issues.
Is Proxy Access Dead?
Proponents and opponents alike believe proxy access has a future.
Kenneth Bertsch, President and CEO of the Society of Corporate
Secretaries & Governance Professionals, argues that, “the court
ruling did not kill proxy access. Proxy fights will run on a
company-by-company basis, and the proposed access regimes may be more
shareholder-friendly.”
Lawyer Michael R. Littenberg, head of the public companies practice
at Schulte Roth & Zabel believes that, “The adverse effect of the
court decision on governance activists has probably been overstated. In
any given year, it’s unlikely that universal proxy access would have
affected more than a handful of companies, considering the time and
effort required to put forward highly qualified access nominees. Absent
significant performance concerns by a large percentage of shareholders
the chances of getting an access nominee on the board was low,
especially if that candidate was perceived as representing a special
interest.”
Supporting the notion that the defeat of proxy access is expected to
have little impact on hedge funds, Hodgson details that, “Proxy fights
will be limited to director elections run by hedge funds with a
significant position in a company, or potentially as the result of
winning a class action lawsuit.” Back to business as usual, pension
funds and other long-term investors—many hedge fund activists—will run
tactical campaigns in pursuit of immediate returns. Littenberg says, “It
would have been hard to satisfy the 3yr/3% ownership requirement of the
new provision. In addition, activists generally have not found the
current state law framework an impediment to running a short slate.”
The Rise of Private Ordering
So if you are a board member, CEO or shareholder private ordering
appears to be the fallback mechanism for allowing access to board
nominations. It’s in our collective future—at least for the next year or
two.
With the SEC voluntarily staying the court’s ruling, the rise of
private ordering provides a readily available mechanism for investors to
continue to seek access for board nominations. Private ordering would
provide changes to proxy access on a company-by-company basis through
the interaction between shareholders and portfolio companies—avoiding
the courts, Congress or the SEC.
However, don’t expect a flood of proposals. According to Byrd, “The
governance advocate institutional investors will tread carefully and be
quite selective in their targets, focusing on mega and large cap
companies with poor performance or visible governance scandals, while
hedge funds, if they use this tactic at all, are more likely to target
small-cap issuers.”
According to Ken Bersch, “I suspect that shareholder proposals for
bylaws more liberal than the SEC mandated minimal ruling would have been
the major battleground on this subject even if the court had upheld the
SEC proxy access proposal given the challenge involved in nominating
directors under the new rule.” A benefit for shareholders, a public
company “could face the possibility of a private ordering submission
that could likely lower the threshold 3 year/3% requirement perhaps down
from three, two or one percent,” projects Byrd. However, should the
proposals face defeat, “companies could argue that there is no or little
support for proxy access and push for SEC resubmissions to revert to
the 3% rule.”
Much will remain unchanged for active investors including pension and
labor funds—the courts did not take away historical tools and powers of
persuasion. “Over the last several years, activist investors have
successfully encouraged change at many companies, moving the pendulum
further in their direction. The SEC decision to shelve—for at least the
time being—will not change this dynamic,” argues Hodgson. “Hedge funds
will continue to work with other shareholders. A strong on-going
shareholder engagement program is a necessary defense for
companies–failure to engage could have devastating results if a company
has a period of poor performance,” adds Byrd.
Forward Agenda
Regarding outlook, Durkin states, “Going forward, the way pension
funds could directly influence board composition is to first articulate a
perspective on how to assess a board’s performance in delivering
long-term value, then use majority-voting rights-to-vote against
directors that fail to deliver. Then approach those boards with high
negative votes about some new blood being added to the board.”
The bulk of the proxy access proposals for the 2012 annual meeting
season will likely be submitted between November 2011 and January 2012.
“I expect the activist agenda to include a multitude of board
organization and management topics—other topics will include the
separation of the Chairman and CEO roles and executive compensation.
Emerging topics such as political contributions also are on the
horizon,” says Littenberg.
Success remains to be defined, and will be so by market participants.