SEC Commissioner Daniel Gallagher delivered a speech at the Stanford Law School’s Annual Directors’ College. He talked about shareholder activism and the role of the SEC in corporate governance. He also discussed different types of activism, and considered the reappraisal of each by asking the question, “Is [such activism] aimed at creating long-term shareholder wealth, and does it actually do so?”
Commissioner Gallagher’s remarks were both extensive and extensively footnoted. The big-picture questions that he raised were (i) whether the regulatory process encouraged private actions that helped to create long-term economic wealth and (ii) whether those who bore fiduciary responsibilities to shareholders (e.g., the directors of corporations and institutional asset managers) were fulfilling their obligation to shareholders to create long-term economic wealth.
Effectively, the Commissioner distinguished between three types of activism: (i) political or cause activism, in which a shareholder seeks to influence a company’s actions for reasons that often are adverse to the interests of other shareholders; (ii) short-term economic activism, in which a shareholder urges an issuer to take an action that could create a short-term pop in the issuer’s stock, but also could diminish the issuer’s long-term prospects; and (iii) long-term activism, in which a shareholder exhorts an issuer to conduct itself in a manner that could lead to the best long-term outcome. The Commissioner criticized the first type of activism and discussed some of the difficulties in distinguishing between the second and third types.
Regarding its role as an overseer of issuer conduct, Commissioner Gallagher argued that the SEC should return to its previous role as a regulator of disclosure, but qualified that advice with the observation that the SEC was not well suited to regulate corporate governance. Matters of governance, the Commissioner said, would be better left to the oversight of individual states. The Commissioner also discussed the process by which the SEC should respond to requests from issuers relating to proxy matters, and cited a number of possible fixes that he had proposed previously. He added that, in addition to the earlier fixes he proposed, the SEC also should consider converting the shareholder proposal no-action process to an SEC advisory opinion process.
On the subject of activist hedge funds, the Commissioner said that the key question to ask is whether (i) activist hedge funds drive long-term value creation or (ii) short-term gains to activism come at the expense of long-term corporate growth. He “admitted” that he remained skeptical of the idea that the answer could be found in econometrics alone, and turned instead to the SEC’s role in regulating activist hedge funds, focusing on Section 13 reporting obligations and how the investor-focused purpose of the rule might be better served.
Commissioner Gallagher also expressed concern that advisers to institutional investors are paying insufficient attention to their fiduciary obligations when they decide whether or not to support a particular activist’s activity, and stated that “even if advisers to these funds are not SEC-registered, they are fiduciaries, they are in the markets we oversee, dealing with SEC registrants, and they should be held accountable for their activities.” The Commissioner was sharply critical of big proxy advisory firms and of advisers that effectively delegate their fiduciary obligations to such firms. He said that the SEC and state regulators are not policing this area sufficiently.
Regarding the creation of a corporate culture that favors long-term wealth creation over short-term stock pops, Commissioner Gallagher offered a number of “radical” ideas, including the following:
- the assignment of greater voting rights to shares that are held for long-term appreciation,
- dual share classes and
- specifying that directors’ duties to shareholders should be tailored to shareholders with long-term investment horizons.
Ultimately, Commissioner Gallagher said, the best results would be obtained if the SEC hosted a roundtable where representatives from interested groups could debate different solutions, with the SEC acting as a neutral intermediator.
Lofchie Comment: The most surprising part of the Commissioner’s speech was the distinction he made between investors who have a short-term economic attachment to an issuer and those who take the long view. Assuming that such a distinction can be practical and not merely theoretical, the question is whether the government (state or federal) is able to play a role in making that distinction without itself becoming the arbiter of defining issuers’ long-term interests.
That said, it is also notable that Commissioner Gallagher’s views on “short-termism” were on the same page with those of Commissioner Stein in the related news story linked below. Although one might doubt that Commissioner Stein would share Commissioner Gallagher’s negative views of politically motivated activism, or his general skepticism about the role of the federal government, the fact that two Commissioners were able to agree on so much could be evidence of an emerging consensus at the SEC.