Speech by SEC Commissioner:
American Enterprise Institute Issues Surrounding The SEC's Shareholder Access Proposal
Commissioner Cynthia A. Glassman
U.S. Securities and Exchange Commission
March 8, 2004
Good afternoon, and thank you for inviting me to participate in this program. In light of the very thorny decisions we face on the proxy access proposal, programs such as this one help illuminate the issues, and ultimately make for a more informed rulemaking process. I have not reached any definitive conclusions regarding the proposal, and unfortunately I do not think we will be able to resolve all of the issues today. But this debate will continue at the Commission at the public roundtable on March 10, and after the roundtable the Commission will accept comments until March 31 to allow people to submit additional information.
Before beginning, I note that the views I express today are my own, and not necessarily those of the Commission or its staff.
The Commission's proxy access proposal presents what I have referred to in other contexts as the Goldilocks dilemma of rulemaking. That is, some people think a proposal goes too far, others think it does not go far enough, and our challenge is to get it "just right." In this case, where there are varied and often irreconcilable views, getting it right is a daunting task. As I noted when we voted to put this proposal out for comment, a compromise position may end up pleasing nobody.
In discussing the proposal, I think it is important to start with some context. The issue the Commission is trying to address with the proxy access proposal is a very real and serious one. A closed nomination process dominated by powerful CEOs, and entrenched directors, led to an unhealthy coziness in some instances between ostensibly independent directors and the executives whose performance they were supposed to oversee. When the Board acts as a rubber-stamp for management, it does not necessarily act in the best interest of shareholders. The access proposal is a natural response to the perception among some shareholders that the nomination process is not serving their interests. Given that perception, it is easy to understand why they would want to do the job themselves.
The choice facing the Commission is not between doing something or doing nothing in this area. We have already approved significant rule changes by the New York Stock Exchange and Nasdaq market that will affect the way nominating committees operate. For one thing, the new rules will require that all nomination decisions be made by independent members of the Board. Removing the CEO from the formal process, and putting it in the hands of non-management directors, is more likely to result in a process where the Board acts as the owners' surrogate. If the independent directors are truly independent and take their responsibility seriously, then that is a significant step that should improve the effectiveness of the nomination process and quality of nominees.
The Commission also recently adopted new rules that would require companies to disclose how they go about selecting directors, and provide information about if and how shareholders can participate in the process. These rules are too new to know how they will impact the nomination process, but the hope certainly is that they will lead to improved communication with shareholders and increased Board responsiveness to shareholder concerns.
In terms of the topic of this program, when looking at whether the Commission's proposal serves a useful purpose, one obvious question is: Do shareholders need access to the proxy? If shareholders feel that a company is poorly governed and unresponsive, the most readily available and commonly used remedy is to vote with their feet and put their hard-earned capital where it will earn a better return. If enough shareholders vote no-confidence by selling their shares, the cost of the firm's capital will increase to the point where it will either reform or it will go out of business. However, for several reasons - including indexing, tax consequences and the size of large institutional investors and their resulting need to "own the market" - selling is not an attractive option for all shareholders. It appears that those shareholders most need a road to reform from within. I would be interested in hearing the panel's views on whether that is the case.
One issue raised by critics of the proposal is that it could have unintended consequences, or be subject to abuse. Under our proposal, the theory is that a small percentage of large, long-term shareholders will act in an objective manner to further the corporation's interests by determining whether to pursue increased access to the proxy, and ultimately by nominating a Board candidate who is better than management's nominee. However, opponents say that empowering a small minority of shareholders could wind up advancing an agenda that may be inconsistent with the interests of all shareholders in maximizing shareholder value. While electing a nominee would require a majority of the votes cast at a shareholder meeting, under the proposal a minority of the votes cast could trigger the new rules, which itself could impose substantial costs on the company that would be borne by all shareholders. In addition, it has been suggested that the potential of a triggering event could itself allow shareholders to exert pressure on management to strike backroom deals.
Some have also raised concerns about whether institutional money managers can serve as disinterested surrogates for the shareholder base. Some money managers compete for their jobs based solely (or at least primarily) on the performance of the funds they manage. If their funds do not perform, they will lose investors, their compensation will decrease, and ultimately they may lose their jobs. Other money managers, however, are chosen through a political selection or election process. According to some commentators, that political dynamic raises the prospect that some large institutions could have parochial interests that diverge from the interests of other shareholders. In other words, some institutions are not perfect surrogates because they may have goals that include something other than maximizing shareholder return. These managers also may not be subject to the same market discipline because the investors on whose behalf they act may not be able to take their capital elsewhere. Pension fund beneficiaries, for example, do not have unfettered freedom to pick up and leave if the fund manager is not acting consistent with their wishes. I look forward to hearing the panelists' views on whether political or social pressures might affect the process.
These difficult issues will have to be addressed by proponents and critics of the proposal, and ultimately weighed by the Commission. For purposes of today's discussion, the starting point for the debate is a comment submitted to the Commission by Randy Kroszner. Randy suggests a common sense, two-step approach that I have used in analyzing this issue and other rulemakings at the Commission. Namely, the first thing we have to do is to make sure we have accurately defined the goal of the rulemaking. Once we define the goal, we must then try to tailor a rule that achieves the stated objectives with the lowest cost. That second step is complicated in the proxy access context because the SEC must stay within the confines of the authority set out in our enabling legislation. The implicit assumption of this process is that, if we determine that we cannot achieve the intended objectives through rulemaking - whether because of limitations on our authority or because the costs are too high - then the Commission's first obligation is to do no harm.
The first step - defining the objective - has proven more elusive than one would have hoped. One thing we should all be able to agree upon is that providing shareholders more meaningful access to the nomination process for its own sake is not the ultimate objective, but rather a means to meet the ultimate objective. So what is the ultimate objective? What problem are we trying to solve? Several possibilities come to mind, including: (i) improving performance and therefore shareholder value, as Randy suggests; (ii) improving Board responsiveness to shareholders; or (iii) electing a more diligent Board. In my view, the ideal impact of the rule would be to enable shareholders to ferret out the complacent Boards, allow a majority of shareholders to put on those Boards someone who will be constructive, but not divisive - and leave the effective Boards alone. The challenge is how we accomplish that.
The Commission's objective, as stated in our proposing release, is to grant increased access "where criteria suggest that the company has been unresponsive to security holder concerns as they relate to the proxy process." So, I am very interested in hearing the panel's view on the significant issues raised in Randy's comment letter:
- Is there harm in maintaining the status quo? Is a rule change warranted?
- If so, is the objective that we have articulated in our proposing release the right one?
- Would the proposed triggers accomplish the objectives?
- Are there other triggers that would be more appropriately aligned with the objective - for example, financial performance or regulatory sanctions?
- More fundamentally, is proxy access even an appropriate means for the Commission to use to achieve the intended objective?
Randy suggests some sensible answers to these questions. However, reasonable minds can ask whether his proposal to reduce legal barriers to shareholder participation in corporate governance outside the nomination process would address concerns raised by proponents of shareholder access. The two proposals are not mutually exclusive, and I look forward to hearing from the panelists whether Randy's proposal should be pursued as an alternative, rather than a supplement, to the Commission's proposal.
Before we go down the path that Randy suggests, we also need to know why we should believe that reducing barriers to institutional lobbying of management would increase shareholder value. Would enabling institutional investors to be more active mean that they would embrace that role, and if so would it have the desired effect? Although there are some regulatory barriers, that does not completely explain why more institutional investors haven't already adopted the CalPERS model of shareholder activism. Even under current rules, institutions can have a significant impact on corporate governance if they have the will to do so.
Furthermore, the apparent intent of Randy's proposal is to give institutions greater sway over management. However, if opponents of the Commission's proposal are right, and some institutions can be poor surrogates for shareholder interests, then why should we look for alternative means to increase institutional influence over corporate decision-making?
In addition to those issues raised by Randy's proposal, I have been wrestling with a number of fundamental questions raised by the proposal and the comments. To list just a few:
- Does the proposal increase access for all investors, or does it discriminate against individual investors? If so, is this a serious defect or not?
- How real are the risks that triggering events would occur at so-called "good" companies? What evidence is there one way or the other on this question? How should the Commission react to what undoubtedly will be uncertainty in this area?
- What evidence is there that directors nominated by shareholders that meet the proposed standards would be "special interest" or "single issue" candidates, or otherwise disruptive to board processes? Alternatively, what evidence is there that adding such directors will benefit board dynamics or operations?
- Many commentators cite the fact that shareholders currently must bear the cost of waging a proxy contest as an unreasonable barrier to the nomination process. However, imposing those costs on dissident shareholders forces them to weigh the cost of the process against the potential benefits. It also forces them to consider the likelihood of success before shouldering that cost, and also imposing reactive costs on the company and the shareholders as a group. Is it possible to increase access by reducing the cost of a proxy contest, but keep some of the economic incentives in place - for example, by having the company reimburse the shareholder proponent if the contest achieves some threshold level of success?
Given the difficulty of these issues, I understand why several incarnations of the SEC have explored proxy access over the last 60 years, and have ultimately decided not to take direct action. We are facing the Goldilocks dilemma. As Randy points out, if we worry about special interests and make the triggers too high, then the rule will not have the intended effect. If we set the triggers too low, then they are more susceptible to misuse. The problem for me is that we are not sure what triggers, let alone the appropriate levels, are "just right," and we will have to deal with uncertainty about how the rule actually will be used in practice. I am still trying to assess the costs and benefits to determine what in my mind will be the right outcome. That is why my remarks today have focused on questions, not answers.
Thank you. I would be happy to take any questions.