Saturday, February 8, 2020
As most readers of this blog are likely aware, the SEC recently proposed some rather dramatic changes to the rules governing shareholder proposals under Rule 14a-8. Among other things, the revisions would raise ownership and holding period requirements, raise the thresholds for resubmission, and bar representatives from submitting proposals on behalf of more than one shareholder per meeting.
The changes have at least the potential to fundamentally reshape the corporate governance ecosystem, and part of the reason for that is highlighted in a new paper by Yaron Nili and Kobi Kastiel, The Giant Shadow of Corporate Gadflies. As they document, forty percent of all shareholder proposals are submitted by just five individuals, who have made the practice something of a combined life’s mission and personal hobby. The proposals submitted by these individuals tend to focus on corporate governance, and they also tend follow the stated governance preferences of large institutional investors. As a result, these proposals frequently win substantial, if not majority, support, and have a real impact on target companies – which means, over time, they dramatically alter the norms of what is considered good corporate governance.
Now, there’s no legal reason why we have to depend on a handful of quirky individuals to reshape corporate governance – institutional investors have far greater holdings and could submit proposals far more widely – but, for whatever reason, institutions mainly prefer instead to wait for someone else to propose something and then vote in favor of it. Some pension funds may be active in submitting proposals, but large mutual funds never submit any, even though they have far greater resources to do so. As a result, if the revisions to 14a-8 take effect, they could dramatically inhibit the activity of these “gadflies” and thus shareholder proposal activity across the board (of course, some of these gadflies have been at it for decades – Evelyn Davis, one prominent gadfly, died in 2018 – so the reality is, the passage of time might limit their activity anyway).
Nili and Kastiel offer a few policy proposals to relieve the system’s reliance on gadflies. They suggest we create a nonprofit organization whose job it is to submit proposals, or create a rotating system whereby popular governance reforms are automatically included on corporate ballots.
All of that, of course, assumes that institutional investors want these reforms. That may not be an unreasonable conclusion – they vote for them, after all – but that just begs the question why the largest institutions aren’t submitting proposals in the first place.
Nili and Kastiel have a couple of theories. One possibility is that large mutual funds believe that taking the lead on a proposal would anger managers at their portfolio companies. Funds may depend on these companies for other business, or simply depend on cordial relationships with managers in order to engage with them about various governance-related issues. Being the face of a proposal – rather than quietly voting in favor of one – could create frictions in these relationships. Alternatively, the big mutual fund companies may feel that obtrusive activism will make them political targets. There are already rumblings about the need for greater fund regulation, which is why BlackRock is now busy trying to pretend that it doesn’t have the influence it obviously has. Open agitation for governance changes might spur a more aggressive regulatory response.
But if that’s right, we might expect large asset managers to at least oppose any changes to Rule 14a-8, because the managers rely on their retail shareholder-avatars to advance the mutual funds’ own agendas. Yet that’s not what seems to be happening.
There are some asset managers – especially, though not exclusively, ones who focus on corporate social responsibility issues – who have objected to the SEC’s proposed revisions. But the largest have not. BlackRock submitted a letter that says – well, honestly, nothing at all; it takes no position. Meanwhile, Reuters reports that Vanguard submitted a letter that supports restricting the use of 14a-8, though the details are not clear, and nothing’s up at the SEC website as of this posting.*
So, what gives?
Well, an alternative explanation – championed by some commenters, including Sean Griffith and Dorothy Lund – is that large asset managers do not want to be stewards, and do not like voting on governance changes; they do it because the regulatory system requires or at least encourages them to do so. If that’s the case, these asset managers would be delighted by the prospect of fewer 14a-8 proposals for them to worry about.
But there’s another possibility. As it turns out, BlackRock may not have taken a position, but the Investment Company Institute, which is a trade association of mutual fund companies, did. In its letter, the ICI generally supports the 14a-8 changes, and even recommends further limits on proposals that are submitted by investors in mutual funds.
And that, it seems, may part of the issue here. Mutual fund companies are, well, companies. Even if they do appreciate the power that Rule 14a-8 gives them over their portfolio investments, they don’t like receiving 14a-8 proposals themselves, either from shareholders in their mutual funds, or at the corporate level. (BlackRock, for example, often receives proposals submitted under Rule 14a-8.)
*It’s hard to draw any conclusions without seeing Vanguard’s letter, but I do note that Wellington Management’s sustainability arm signed on to a letter submitted by Principles for Responsible Investment, which generally urged the SEC to keep the current framework and avoid changes that would disrupt the proposal process. This is significant because Wellington is one of the managers Vanguard uses for its external/active funds, though Vanguard recently gave its external managers freedom to vote separately from Vanguard’s indexed funds. So, that’s an interesting dynamic.