Securities Regulation Daily Senate committee weighs proxy reforms
Thursday, December 6, 2018

Senate committee weighs proxy reforms

By Amanda Maine, J.D.

With the U.S. proxy system under increased scrutiny, the Senate Banking Committee held a hearing on how to improve the way the proxy voting system operates, including if and how proxy advisory firms should be regulated and whether the current procedure for submitting shareholder proposals should be changed. The hearing follows a round table hosted by the SEC last month on how to reform the proxy system, which addressed voting mechanicsshareholder proposals, and the role of proxy advisory firms, and legislation introduced in Congress that would subject proxy advisory firms to SEC oversight.

Chairman and Ranking Member statements. In his opening remarks, Banking Committee Chairman Mike Crapo (R-Idaho) took aim at the shareholder proposal process by expressing concern that it has been taken over by those pursuing an environmental, social, or political agendas, which, according to Crapo, have little or nothing to do with a company’s financial performance or shareholder value. Crapo also echoed concerns by SEC Chairman Jay Clayton that the concerns of long-term investors, including retail investors, are not served by the current proxy rules given the influence of large institutional investors.

Ranking Member Sherrod Brown (D-Ohio) used his opening remarks to assail corporations that put short-term profits over long-term investment, specifically calling out General Motors, which recently announced layoffs and plant closings. Corporations like GM have spent billions on stock buy backs, and, according to Sen. Brown, GM will have spent double on these buy backs than that they will save on closing their plants. He also expressed his opposition to lowering the thresholds for shareholders to submit proposals for a vote, stating that it would undermine shareholder oversight of the companies that they own.

Witness statements. Witnesses testifying for the committee included former SEC Commissioner Daniel Gallagher, who said that the Commission is operating under an antiquated statutory framework when it comes to proxy issues. While he acknowledged that the SEC is very capable and possesses the expertise to tackle many issues, such as using technology in the proxy system, the time is right for meaningful congressional action.

Thomas Quaadman of the Chamber of Commerce’s Center for Capital Markets Competitiveness, echoed concerns he expressed at the SEC’s recent round table on the U.S. proxy system, including "zombie proposals," or shareholder proposals that are voted on for several years while never getting close to a majority vote. These "zombie proposals" create a waste of company assets and are a distraction from other corporate matters, he said.

Michael Garland, New York City’s assistant comptroller for corporate governance and responsible management, decried what he said were unfounded suggestions by critics of proxy advisory firms that these firms’ clients are like lemmings, blindly following their recommendations off a cliff. The comptroller oversees the fourth largest public pension system in the U.S., and it has a long-term investment horizon, Garland said. He stressed that regardless of what recommendation a proxy advisory firm makes, the comptroller casts its proxies according to its own guidelines. This requires the timely receipt of the proxy advisory firm’s report, he stated.

ESG proposals. One issue of contention involved shareholder proposals regarding environmental, social, and governance (ESG) issues, which some senators and witnesses referred to as "political" proposals. Quaadman said several times that such proposals make over 50 percent of shareholder proposals, while hardly any of those proposals pass. Most of these proposals are not linked to the economic well-being of the company or shareholder returns, he said. While he supports the shareholder proposal process, he does not want to see it "perverted" for political or social gains.

Quaadman’s remarks led to a bit of a sparring match with Sen. Brian Schatz (D-Hawaii) who wondered what makes something a political issue. As an example, he asked if a proposal regarding climate change, which may affect power plants in coastal regions, would be "political." Quaadman responded that if these types of proposals keep coming up and never pass, at some point, it makes sense to give them a "time out" by reforming the thresholds for resubmissions of certain shareholder proposals. Schatz seemed unconvinced, countering that just because a company keeps denying that it have resources that are in peril, it should not mean shareholders cannot continue to subject it to a vote.

Garland expressed his support for ESG or "political" proposals, citing in particular a statement by the Financial Accounting Standards Bureau that climate change is a systemic risk to the global financial system. As for social proposals, he noted that his organization had submitted several proposals about discrimination based on sex or sexual identity that did not pass, but ultimately made an impact on the corporations that were targeted.

Proxy advisory firms. Crapo quizzed Garland on his statement that his organization uses the reports of proxy advisory firms to inform them on their own recommendations. Garland stated that his organization’s obligation is to implement the guidelines put in place by its board of trustees, which may be different from the recommendation made by the proxy advisory firm. He expressed his opposition at legislation that would insert issuers between the proxy advisory firms and investors, such as allowing issuers access to the proxy advisory firms’ research reports to identify possible errors before the clients can see them.

Senator John Kennedy (R-La) inquired about possible conflicts regarding proxy advisory firms. Gallagher stated that there are two types of conflicts of interest. The first involves proxy advisory firms providing consulting services to the issuers they study and report on, which he does not find that problematic since these kinds of conflicts are disclosed. More insidious, however, involve instances where the proxy advisory firm is providing advice to an institutional investor that is providing more in fees than another institutional investor, giving it greater influence that could result in more pressure on the proxy advisory firm, Gallagher explained.

Senator Catherine Cortez Masto (D-Nevada) asked if proxy advisory firms should be subject to more regulation by the SEC. Gallagher responded that he is not a "real regulatory type by nature" and supports the free market, but it is about time that the SEC play a role in this space. "Whenever you have a fiduciary duty flowing…and you put in the middle a party that may not have that duty," the SEC should regulate it, and he pointed to the congressional legislation for the regulation of credit rating agencies as something legislators should examine.

Garland said that he would oppose any regulations that would slow access to information or impose costs. Quaadman stated that there are flaws in the system that need to be addressed and that he supports a heightened level of oversight.

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