Gadflies in the Boardroom are an Inversion of Shareholder Democracy

Updated on

America’s corporate proxy season is officially underway, and for another consecutive year activists are calling the shots. So far in 2021 a record number of social and environmental-focused proposal are on the ballot—continuing a shift in this annual forum from the concerns of normal investors to a small but vocal minority.

Get The Full Series in PDF

Get the entire 10-part series on Charlie Munger in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.

Q1 2021 hedge fund letters, conferences and more

Putting Proposals On The Corporate Ballot

Federal securities laws provide shareholders with an opportunity to put proposals on the corporate ballot, that then go up for a vote at the company’s annual meeting.  This process is funded by the corporation, and therefore by the company’s other shareholders.  In effect, the greater group of shareholders are taxed to subsidize the activity of those filing resolutions.

Many of the proposals come from a small handful of activists who have made the shareholder proposal process into their own personal hobby.  Far from being a dialogue with shareholders about issues important to the value of their investment, the process has been hijacked.  One activist brags on twitter about filing 90 proposals per year.

Indeed, in 2019, three activists were responsible for 39% of proposals submitted, with one activist alone accounting for 25% of the total. Noted proposer John Chevedden has made the same proposal at Ford Motor Company 15 years in a row, despite owning only $5,000 worth of shares.

Significantly, most shareholder proposals push initiatives favored by political progressives.  Approximately two-thirds of proposals during the 2020 season were submitted by individuals or non-profit groups. The sponsorship of proposals by other investors outside of socially oriented investment vehicles, progressive religious institutions and labor groups still remains exceedingly rare; 3% according to the Manhattan Institute.

SEC Reforms

The SEC took steps last year to undertake modest reforms of this process and ensure it works in the interests of the majority of shareholders.  For example, it now requires that in order to remain on the ballot after a failed vote, the minimum support threshold to remain on the ballot in the next year was increased from 3% to 5%.

To be clear, shareholders remain free to fund their own proxy campaign, they are not being silenced.  They simply have to demonstrate a little more support before they have access to the company-funded ballot.

Leading up the SEC’s update of the proxy rules, the average support for shareholder proposals was steadily in decline. In 2019, only 6% of shareholder proposals received majority votes—down from 11% in 2017 and 10% in 2018. The overwhelming majority of shareholder proposals fail.

It is important to note that this is not a costless process.  During its rulemaking, the Commission cited commenters who estimated that the average cost of responding to a proposal for inclusion in the company’s proxy statement can cost anywhere from $87,000 to $150,000 per proposal.

A Complete Inversion Of Shareholder Democracy

Consider what this means.  Shareholders pay for the expenses of a proposal, they overwhelmingly vote against the proposal in the form of 97% of the votes case against the proposal (a voting failure rate that would make any politician hide in shame), and then shareholders are forced to fund the proposal again next year! In short, the system is a complete inversion of shareholder democracy.

Rather than abolishing resubmission, the prior SEC Chairman adopted rules to modestly increase the threshold of support for resubmission from 3% to 5%.  Senate Democrats have responded disproportionately and called for the new rules to be abolished.

The case for reversal is weak, but some change of course is likely under the new administration.  Elections have consequences. If the SEC wants to modify the rule, a particular focus on gadfly proposers would be appropriate.

Approach To The Gadfly Problem

Former Commissioner Jackson opposed the new restrictions at the time they were adopted and suggested that the Commission might instead pursue a compromise rule more narrowly tailored to the “gadfly” problem.  He suggested one approach would be to limit the total number of proposals any one proposer could put onto company ballots in a given year and called for further deliberation on the issue.

Commissioner Lee, while serving as Acting SEC Chair, recently urged reconsideration of the shareholder proposal process and noted “The goal is to bring greater clarity to the no-action relief process, increase the number of proposals on the ballot that are well-designed for shareholder deliberation and votes, and reduce the number that are not.”[1]

It is in everyone’s interest, from companies to proposing shareholders and the Commissioners as well, to find bi-partisan compromise in the SEC’s review of its recently updated rules, lest the unpredictable back and forth staff interpretations over the years now evolve to a new normal of back-and-forth swings in formal rules from one Chairman to the next.

Former Commissioner Jackson’s proposed compromise, with a focus on the small group of activists who abuse the process, is a good start.

Article by J.W. Verret, Associate Professor, George Mason University Antonin Scalia Law School