At the 26th Annual Corporate Law Institute at Tulane University, SEC Commissioner Daniel Gallagher spoke about the “federalization of corporate governance” and argued that the SEC should take a lesser role in shareholder proposals.
According to Commissioner Gallagher, the trend toward increased federalization of corporate governance law seems well entrenched, since Dodd-Frank has mandated an array of federal regulations relating to matters traditionally left to state corporate governance law.
One area where Commissioner Gallagher believes the SEC’s incursions have had a particularly negative effect is shareholder proposals. According to Commissioner Gallagher, while the conduct of the annual shareholder meeting is generally governed by state law, the process of communicating with shareholders to solicit proxies for voting at that meeting is regulated by the SEC.
However, the Commissioner stated that the SEC has never adequately addressed the costs and benefits of this process, noting that a proponent can currently bring in a shareholder proposal if he or she has owned $2,000 or 1% of the company’s stock for one year, so long as the proposal complies with a handful of requirements. Commissioner Gallagher stated that “activist investors and corporate gadflies have used these loose rules to hijack the shareholder proposal system,” and that the majority of shareholder proposals “are brought by individuals or institutions with idiosyncratic and often political agendas that are often unrelated to, or in conflict with, the interests of other shareholders.” According to Commissioner Gallagher, only 1% of proposals are brought about by ordinary institutional investors.
Commissioner Gallagher said that, while he isn’t sure whether shareholder proposals are needed at all, the SEC’s rules should be remedied nonetheless to prevent activist investors from crowding out institutional investors. His suggestions included:
- updating the holding requirement to submit proxies from the flat dollar test of $2,000 to a percentage test, which he believes is scalable and varies less over time (the Commissioner stated that rigorous analysis must be applied to determine what percentage is an appropriate default);
- reassessing the length of the holding requirement, since a longer investment period could help prevent some activists from buying into a company solely for the purpose of bringing a proposal;
- setting the requirements as to the substance of proposals in order to avoid proposals with dubious “significant policy issues”;
- reassessing the rule that permits the exclusion of proposals that are contrary to the SEC’s proxy rules, including proposals that are materially false and misleading or that are overly vague, since the “burden to ensure that a submission is clear and accurate should be placed on the proponent, not the company”; and
- strengthening the resubmission thresholds and possibly adopting a policy that excludes for the following five years a proposal which fails in its third year to garner majority support.
Lofchie Comment: Dodd-Frank contains a number of ill-considered requirements for how firms must structure their internal operations, including that the Chief Compliance Office responsible for compliance with the U.S. Commodity Exchange Act must report directly to the Board of Directors of the relevant institution. Consider the case of a major non-U.S. bank, which may operate in 20 or more countries and must comply with dozens or hundreds of laws in each of those countries. That the compliance officer responsible for one U.S. statute must report directly to the Board when, in the ordinary course of events, that compliance officer would be several levels below the Board in the corporate hierarchy, is ultimately a waste of time and a drain on corporate resources, as firms must figure out how to comply with a completely arbitrary governance requirement. Shouldn’t it be sufficient that swap dealers are obligated to comply with the law? Why is it also necessary to dictate which individuals must report directly to a firm’s Board?