Friday, September 23, 2016

Governance pros testify on shareholder proposals, disclosure

By Anne Sherry, J.D.

A House Financial Services subcommittee hearing with the broad title of “Corporate Governance: Fostering a System that Promotes Capital Formation and Maximizes Shareholder Value” ended up focusing somewhat narrowly on a few discrete topics. Leaders at CalPERS, the Business Roundtable, the Society of Corporate Governance Professionals, and the Manhattan Institute gave their views on shareholder proposal thresholds, proxy advisors, and the SEC disclosure regime. Several subcommittee members also used the opportunity to posit whether clawbacks may have prevented the cross-selling fraud at Wells Fargo.

Shareholder proposals. The SEC’s shareholder proposal process under Rule 14a-8 dominated the hearing before the Subcommittee on Capital Markets and Government Sponsored Enterprises. The ownership and resubmission thresholds in particular garnered the most discussion. The ownership threshold requires a shareholder to hold $2,000 in stock or 1 percent, whichever is less, for a year before submitting a proposal. Several of the witnesses believed the $2,000 threshold to be far too low, often amounting to a tiny fraction of a percentage point of a company’s market cap.

The resubmission threshold permits a company to exclude a resubmitted proposal if it received less than 3, 6, and 10 percent of the vote, respectively, if proposed once, twice, or thrice in the preceding 5 years. Darla C. Stuckey, President and CEO of the Society of Corporate Governance Professionals, likened the resubmission threshold to a sieve. The “tyranny of the 10 percent” allows many proposals to be resubmitted indefinitely. Stuckey cited the example of a Consolidated Edison shareholder proposal that went to a vote for 16 years in a row. The proposal received between 10 and 17 percent of votes cast ever year, but never qualified for exclusion under the resubmission thresholds. Today, she said, 96 percent of proposals pass the 3-percent threshold in the first year.

Proxy advisory firms. James R. Copland, Senior Fellow and Director of Legal Policy at the think tank Manhattan Institute, connected the resubmission issue to proxy advisory firms like Institutional Shareholder Services. A large percentage of institutional shareholders vote based on proxy advisory firms’ advice, he said, making ISS a gatekeeper: “If ISS supports a proposal, it can remain indefinitely on the ballot.” In the last 10 years, 31 percent of shareholder proposals were resubmissions, Copland said. As for the ownership threshold, Copland agreed that the dollar amount was low but seemed to argue that the one-year holding requirement could be lower. He cited the example of a hedge fund that buys a big stake in a company it wants to try to turn around. Requiring the hedge fund to wait a year to submit a shareholder proposal doesn’t make sense, he said.

French Hill (R-Ark) asked the witnesses about conflicts of interest at proxy advisory firms. John Engler, the former Michigan governor who now serves as president of Business Roundtable, said that firms sit on both sides of a transaction when they make recommendations about good governance while offering to sell companies strategies to solve the problems the firms identify. Copland also said conflicts are a significant consideration, but highlighted the disconnect between what proxy advisory firms do and what the median shareholder wants. Mutual funds, he said, excepting the largest companies like Vanguard, have to do everything they can to reduce their administrative costs. That means relying on the advice of ISS or Glass Lewis. Because of this, retail investors who own mutual funds are effectively voting along proxy advisory firms’ recommendations, even though ISS is eight times more likely to support a shareholder proposal than the median investor.

Anne Simpson, who is Investment Director, Sustainability at CalPERS, said that the institutional investor ultimately is aligned with management: both want companies to do well. But she said, a small investor has a daunting task of looking at complicated corporate disclosure, comparing the differences over time, comparing the company with other companies, and relating executive compensation to financial performance. Simpson said that CalPERS strongly supports the SEC’s Dodd-Frank rulemaking efforts on executive compensation, including the pay ratio disclosure, say-on-pay, and clawbacks.

Clawbacks. After Stuckey observed that companies spend $90 million every year on the direct costs of responding to shareholder proposals, Brad Sherman (D-Cal) related this figure to the recent Wells Fargo scandal. If the SEC had promptly entered a clawback rule, he posited, Wells Fargo executives may not have had the incentive to push for cross-selling. Sherman suggested that “crony capitalism” costs shareholders more than $90 million per year. On that remark, Simpson said that CalPERS has $1 billion invested in Wells Fargo and lost more than $90 million “just on that one company, just from that series of decisions not in the public interest.” Governor Engler pushed back against the “aspersions that there are boards running amok breaching their fiduciary duties.” He pointed out that CalPERS earned a 0.6 percent return last year, well below the assumed rate of 7.5 percent. “Maybe it’s crony capitalism, maybe it’s bad investment,” he said.

Diverse boards. Ranking Member Carolyn Maloney (D-NY) asked about board diversity. Her bill requiring companies to report directors’ gender is based on two studies cited in a GAO report finding that greater gender diversity increased profits by about 5 percent. CalPERS has done extensive research and found that diversity is important in two key ways, Simpson said. First, it promotes good risk management by challenging groupthink. Second, diversity relates to talent recruitment. If you confine yourself to a small pool of candidates like former Fortune 500 CEOs, “you are fishing in a very small pool,” she said.