Saturday, November 11, 2017
SEC Commissioner Jay Clayton recently gave a speech where he remarked:
I have become increasingly concerned that the voices of long-term retail investors may be underrepresented or selectively represented in corporate governance. For instance, the SEC staff estimates that over 66% of the Russell 1000 companies are owned by Main Street investors, either directly or indirectly through mutual funds, pension or other employer-sponsored funds, or accounts with investment advisers… And, if foreign ownership is excluded, that percentage approaches approximately 79%.
… A question I have is: are voting decisions maximizing the funds’ value for those shareholders?
In situations where the voting power is held by or passed through to Main Street investors, it is noteworthy that non-participation rates in the proxy process are high. … This may be a signal that our proxy process is too cumbersome for retail investors and needs updating.
What’s interesting is that there are two different ideas here. One concerns the voting power of mutual funds and pension funds; the other concerns the votes of retail shareholders themselves.
As for retail votes, Jill Fisch has an article on this very subject forthcoming in the Minnesota Law Review. She recommends that retail shareholders be given access to electronic platforms, similar to those available to institutions, that allow them to set advance voting instructions without requiring them to make a company by company decision.
The broader question, though, is whether we do in fact want to encourage greater retail participation, and what the effects are likely to be. There’s long been an argument that retail investors should not invest directly, and the rules governing securities markets have, to a greater and greater extent, become less hospitable to them. (Stephen Choi, for example, has argued that investors should only be allowed to participate in capital markets if they demonstrate a certain degree of sophistication.) If that’s right, it makes little sense to encourage their participation in corporate governance.
At the same time, though, public companies love retail investors, because they are less likely to coordinate with pesky activists, and are assumed to be more supportive of management. I’ve often wondered if that was the motivating force behind Loyal3 (which recently folded shop), providing a free online brokerage for retail investors that wanted stock in their favorite brands.
Given what appears to be the general Republican preference, I rather suspect that they believe shareholder involvement in corporate governance is a net negative, and I wonder if Clayton’s newfound push for retail investor involvement is actually a stealth attempt to provide management with a bulwark against activist challenges.
Certainly, that appears to be the theme of Clayton’s actions: the rest of his speech expresses concern about shareholder proposals, and a recent SEC staff opinion suggests a shift to more deference to corporate boards when deciding excludability. In that context, his conflation of retail investor voting with mutual fund voting seems like something of a shot across the bow targeting mutual fund voting power. I can imagine, for example, a push to transition to pass-through voting for mutual funds, combined with a few measures that encourage retail investor participation.
But if that’s the kind of thing Clayton is hinting at – and to be sure, no one has suggested it so far, but it would make sense as an endgame – I do wonder how much it (and other efforts to involve retail shareholders) will backfire. I imagine retail investors, if seriously encouraged to participate, might be more – not less – likely to vote for social proposals and other less-than-wealth-maximizing actions that, these days, mutual funds tend to avoid unless pressed. And as Jill Fisch points out, retail investors might adopt advance voting instructions that set automatic triggers to challenge management when certain underperformance benchmarks are met. If the default assumption is that retail investors are less informed and less attentive, encouraging their greater participation may be something of a double-edged sword, from management’s perspective.
Moreover, if we have greater retail involvement in the voting process, Delaware might have to revisit decisions like Corwin v. KKR, 125 A.3d 304 (2015), which rest - at least implicitly - on the assumption of a sophisticated (institutional) shareholder base. And that’s something I'm pretty sure management would not want.