SEC-Mandated Proxy Access: Don't Change A System That Works

Tuesday, September 1, 2009 - 01:00

The Editor interviews Thomas Quaadman, Executive Director, Financial Reporting Policy and Investor Opportunity, U.S. Chamber of Commerce's Center for Capital Market Competitiveness.

Editor: Please tell our readers about your background and professional experience.

Quaadman: After I graduated from New York Law School in 1991, I serveda judicial clerkship in Connecticut and engaged in private practice for a few years. Following that I became chief of staff to Rep. Fossella (Rep. New York) for over eleven and a half years. During his tenure, he served on the House Financial Services Committee and later chaired a subcommittee of the Republican Policy Committee on Economic Competitiveness. I did a lot of work on issues which were of concern to both committees. I joined the Chamber about a year ago.

Editor: What major issues do you see on the corporate governance front?

Quaadman: This fall we face a very unique juncture in the experience of public corporations in the United States. The SEC will be reviewing comments to its proxy access rules and Congress will be considering Senator Charles Schumer's Shareholder Bill of Rights and Representative Gary Peters's Shareholder Empowerment Act. These measures can radically change the way U.S. corporations are governed.

If these proposals come to fruition, we will see a federalization of corporate law. It also represents an unprecedented takeover of our markets by the government. For the last 150 years, ourcorporate structures have been governed by state corporate law. This has provided a very diverse system of governance that has led to the most productive economy in world history.

While some are using the excuse of a financial crisis to make radical changes in the governance of U.S. corporations, the reality is that over 97 percent of our companies have had nothing to do with the financial crisis.

Some large activist investors (particularly union pension funds) see SEC-mandated proxy access as an important tool to get more leverage in the boardroom to push a political agenda. From our vantage point we believe that these misguided proposals will harm the American economy and constrain the ability of the business community to create jobs.

Editor: Describe the SEC's proxy access proposal.

Quaadman: The SEC proxy access proposal opens the door for an activist investor to put its nominee on the board if it held its stock for at least one year and the number of shares it held exceeded three thresholds: one, three and five percent of the outstanding stock depending on company size. We believe, as we stated in letters to the SEC, that this represents a fundamental re-altering of corporate governance in the United States. These changes will harm the American economy by creating strong incentives for public corporations to avoid the reach of the SEC by encouraging them to seek domiciles outside the United States and to avoid use of U.S. securities markets. This will make the United States less competitive in a global economy.

Editor: What actions has the U.S. Chamber taken?

Quaadman: Knowing that the SEC had proxy access as one of its top agenda items, we sent a letter to Chairwoman Shapiro in late April in which we made three points. One was that the process by which directors are elected is a matter of state corporate law and that states like Delaware have addressed this issue by authorizing corporations to adopt bylaws that provide for shareholder access to management's proxy statement. Secondly, the SEC does not have the legal authority to engage in such rule making. And finally, some issues where theSEC does have the authority to act, such as increaseddisclosure and proxy voting participation, are of such great importance that the SECshouldfocus its attention on those issues rather than on issues relating to the internal governance of corporations, which have traditionally been the domain of the states.

Editor: You mentioned the stock ownership thresholds for nominating stockholders. Has the U.S. Chamber taken a position on that?

Quaadman: We have not taken a position on thresholds. It is our position that this is a matter of state corporate law. We think that one of the advantages of the Delaware law amendmentsis that they provide flexibility by permitting companies to select the approach that works best for them. Thus, a company can decide that shareholder access is, or is not, the way to go. It leaves the decision with respect to proxy access up to the company.It permits the decision to emerge from a dialogue among investors, directors and management. If, as a result of that dialogue, a company decides that it is best not to engage in shareholder access, then it does not have to adopt it. But if it does decide that shareholder access is something that should be pursued, then it can structure shareholder access in a way that works best for that company.

Our comment letter to the SEC with respect to its proxy access proposal calls into question the SEC's authority to engage in that rule-making and makes the point that proxy access should be governed by state law.

Editor: Would the passage of Senator Schumer' s Shareholder Bill of Rights Act and Representative Peters's Shareholder Empowerment Act remove any question as to the right of the SEC to adopt its proxy access proposal?

Quaadman: Yes. We are opposed to both bills. Among other things, we feel, as I mentioned, that the SEC should not have the authority to intrude in matters reserved for state corporate law. In addition to confirming the authority of the SEC with respect to proxy access, the Schumer bill contains provisions for annual "say on pay" votes, majority voting, ending staggered boards and separating the CEO and chairman's role (the Peters bill is similar).

If you look at what is actually happening in corporate governance over the last five to six years, a lot of reforms have been taking place, and these are being done without government mandates. So, some companies are deciding to go with majority voting, and others aren't. Some companies are deciding to split up CEO and chairman's roles, and others aren't. You have some that are ending staggered boards, and others aren't.

This is happening because many companies are engaged in a dialogue with their shareholders, management and directors to come up with the structure that works best for that company. For some companies, all of these things may work, for others none of them may work. Most of them are going to fall in between.

The proxy access rule is not needed becausecorporations do listen to their shareholders. This is clear from a study by Professor Joseph Grundfest of Stanford Law School and The Rock Center School of Corporate Governance at Stanford University. The study revealed that 31 percent of the companies that were targeted by "just vote no" campaigns experienced disciplinary CEO turnover, and that another 50 percent of targeted companies made other strategic changes. When there is a concentrated effort by investors to really engage in a dialogue, there is an 80 percent change rate.

The problem with the one-size-fits-all approach is that it mandates how the structures are to work, and it leads to a system that forces square pegs to be pounded into round holes - and we think this is wrong.

Just to take one example, separating the CEO's and chairman's roles may work for some companies. Nevertheless, some companies where those roles are combined have been the most successful in recent corporate history. Take Warren Buffett, Bill Gates and Sam Walton - all of whom simultaneously held both the CEO and chairman's roles for extended periods. Over the same period each of their companies generated untoldwealth for their shareholders and created thousands of jobs. Yet, for some reason some people think that is a practice that should be outlawed. Why should a successful practice be outlawed? There is no clear rationale for that.

Editor: What problems emerge if one or more directors are nominated through a process other than one based on an evaluation by the directors and management of their value to the corporation?

Quaadman: The SEC proposal has the potential of electing directors whose goals may not include increasing long-term stockholder value. Injecting directors with their own agendas into board deliberations can create an adversarial atmosphere that fractures the board and puts the company's future at risk.

One of the unintended consequences is that the SEC is going to be turned into a larger version of the federal elections commission. Because the SEC will be forced to spend time and other resources trying to administer corporate elections, it will be diverted from the many pressing issues growing out of the financial crisis.

Editor: Some have said the current proxy voting system is beset with problems that affect its ability to accurately reflect shareholders' views. What is the U.S. Chambers' position?

Quaadman: The Chamber opposed the repeal of Rule 452 of the New York Stock Exchange that gave brokers the ability to vote shares of beneficial owners unless otherwise instructed. This greatly reduced the voting power of retail shareholders. Surveys show that the actual retail voting pattern correlates very closely with the pattern followed by brokers when voting uninstructed shares. It seems clear that the SEC is providing preferential treatment to a small group of investors within a larger investor community.

What we have seen is a reduction in the participation of retail investors with this trend being exacerbated by amended Rule 452; the current OBO/NOBO rules; e-proxies; the role of proxy advisory firms; naked voting and overvoting; and failure of some institutional voters to take voting seriously. The complexity of the current voting system has the potential for causing the vote to be miscast, not voted or otherwise influenced. This means that corporation policies will cease to be shaped by those who in fact own a majority of their stock.

Editor: Would you care to comment on the fact that while AFL-CIO administered pension funds have shown great interest in how those proxies are voted, the vast majority of institutional investors have been passive, having turned the voting of their shares over to proxy advisory firms.

Quaadman: As you mentioned, institutional investors have for the most part become passive about the way in which their shares are voted, with the result that proxy advisory firms apply their own standards to determine how those shares are voted. This means that proxy advisory firms are playing a critical role in the proxy voting system. Because they lack an economic interest in the shares they are voting, it is hard to say that their votes necessarily reflect the views of the institutions they serve or the investors in those institutions.There are a couple of proxy advisory firms that are extremely influential. Yet, they and the other such firms are not regulated by the SEC or other financial watchdogs.

In contrast to the passivity of most institutional investors, certain large institutional investors have become extremely active. A couple of months ago, we released a study, conducted by Navigant Consulting, of 166 shareholder proposals submitted by AFL-CIO-administered pension plans. The study found that those proposals did not increase shareholder value over the short term. Over the long term the evidence indicated that they actually decreased shareholder value.

These results provide an indication of how nominees of those pension funds would perform if they were elected directors. They would, like the shareholder proposals sponsored by union pension funds, place more emphasis on grandstanding than improving corporate performance.

For all the reasons I have discussed, any approach to proxy access makes little sense until ways are found to level the playing field so that the views of the retail shareholder are given proper weight notwithstanding the current defects in the proxy voting system. This is a pressing issue requiring immediate attention by a blue ribbon committee appointed by an appropriate body.

Please email the interviewee at with questions about this interview.