We join with the Council of Institutional Investors in strongly opposing the falsely named “CHOICE” Act, which would eliminate critical shareholder rights and market responses that ensure the integrity of our financial markets. The proposal would sharply reduce the number of shareholder proposals and shareholder oversight on ceo pay, restrict the ability of independent proxy advisory firms to provide essential information and guidance on matters of corporate governance, and entrench underperforming and overpaid executives. It has been less than a decade since the financial meltdown and Congress, fueled by corporate political contributions, is trying to get rid of some of the reforms that restored the credibility of our financial markets.
CII supports sensible, effective rules that safeguard investors and strengthen markets.
Three Principles to Protect Investors and Strengthen Capital Markets
As Congress and the administration consider revamping key aspects of America’s financial regulatory system, CII urges policymakers to uphold and enhance critical protections for investors.
Painful reminders of the massive failures of oversight—by regulators and corporate boards—that contributed to the financial crisis of 2008 are with us still. The market meltdown cost millions of Americans their jobs and homes, and devastated their retirement savings. Robust reforms have helped to restore investor confidence in the integrity of the marketplace. That trust must not be undermined.
That’s why CII believes that any future financial reforms should uphold three principles that foster fair, stable and vibrant markets:
- Protect fundamental shareholder rights
- Promote effective disclosure and reliable financial reporting
- Safeguard the independence of the Securities and Exchange Commission (SEC)
The House Financial Choice Act, however, would weaken critical shareholder rights that investors need to hold management and boards of public companies accountable, and that foster trust in the integrity of the U.S. capital markets. CII has outlined its concerns in detail in recent comment letters here and here, in a Member Toolkit and below on this page.
CII Member Toolkit for Responding to the CHOICE Act
1. Protect fundamental shareholder rights
Robust shareholder rights ensure that investors are treated fairly and equitably, that management and boards are accountable to owners and that market participants have confidence in the integrity of capital markets.
Strong public company boards of directors are the first line of defense for shareholders. The board has a fiduciary duty to see that senior managers run the company in the long-term interest of its owners. But holding directors accountable to shareholders is inherently challenging in today’s public companies, where equity ownership is dispersed among thousands of owners. Balanced rules ensure that shareholders have fundamental safeguards, including a level playing field in director elections, a meaningful vote and effective tools to engage management and the board.
Support fair rules for shareholder proposals.
- Shareholder proposals are essential tools for investors, individually and collectively, to express their views to management and boards on major governance and other issues. The vast majority of these votes are strictly advisory; even if they pass, boards can choose whether to act on them.
However, the major U.S. House bill to roll back financial regulation would sharply increase the regulatory hurdle for shareholder proposals. The legislation reportedly would require any shareholder wishing to put a proposal on a public company ballot to own at least 1 percent of the company’s stock for a minimum of three years. That would raise the stock ownership threshold for filing a proposal at Apple, the largest market cap company, to $7 billion. This radical change could effectively shut out shareholder proposals. Congress should not micro-manage the shareholder proposal process, which the SEC has overseen well for decades, and especially not through draconian restrictions on filers. Read more…
Support fair rules for electing directors.
- The House bill would prohibit the SEC from finalizing a proposed rule to allow shareowners to freely vote for the board candidates they favor in a contested election for board seats. The SEC’s proposal for universal proxies would give shareholders voting by proxy (the vast majority of investors) the same voting options as shareholders who vote in person: freedom of choice to vote for the specific combination of director nominees they believe best serves their interests. Congress should not block SEC action on this critical mechanism for holding directors accountable to the shareholders they are elected to represent. And the SEC should adopt its proposed rule as soon as possible. Read more…
- Shareholders should have the power to remove directors in uncontested elections, too, if they think the directors are doing a poor job. That is why CII supports a strong majority vote standard in director elections, rather than a plurality standard that permits boards to ignore the owners’ wishes when the majority of owners oppose directors standing for re-election. At the very least, there should be clarity about the vote standard the company uses. Too often, shareholders are in the dark about how votes for director are counted. The SEC should finalize its proposal to require companies to provide clear disclosure in proxy statements of the voting standard used in uncontested director elections. Read more…
Support fair shareholder votes on executive compensation.
- The 2010 Dodd-Frank Act’s requirement that public companies offer shareholders a periodic advisory vote on executive compensation (“say on pay”) has been a winning game-changer for companies and their shareholders. Say-on-pay votes enable shareholders, individually and collectively, to express their views about CEO pay. They have sparked improved communication between boards and shareholders, and greater understanding among investors about corporate strategy and how pay incentives drive the strategy.
While say-on-pay votes are strictly advisory and most pass by wide margins, they have led many board compensation committees to improve pay-for-performance incentives in executive compensation. Shareholders overwhelmingly support annual say-on-pay votes.
The House bill would require companies to hold say-on-pay votes only when there is an ill-defined “material change” to executive compensation. Congress should preserve the requirement that companies hold regular say-on-pay votes and the option for this important vote to occur annually. Read more…
Support fair rules for “clawbacks” of unearned executive compensation.
- Dodd-Frank’s requirement that companies recover (claw back) incentive-based compensation from executives when a material error results in a financial restatement is simply fair pay for fair play. Executives who reap additional pay for “hitting the numbers” should not be rewarded when they fail to hit the numbers. Congress should preserve this important shareholder protection.
Support independent proxy research.
- Independent research helps investors cast informed proxy votes. But access to independent research is threatened by a proposed legislative provision that could drive up the cost of voting responsibly–and possibly drive proxy advisory firms out of business.
Proxy advisory firms play a vital and necessary role in assisting pension funds and other institutional investors in carrying out their fiduciary duty to vote proxies in the best interest of plan participants and clients. Many investors purchase research from proxy advisory firms but vote according to their own guidelines.
The House bill would give companies an incentive to try to delay publication of proxy advisor reports as long as possible, increasing costs to advisory firms and their investor clients. Congress should not interfere with the right of investors to purchase independent proxy research. Read more…
2. Promote effective disclosure and reliable financial reporting
Investors and other market participants depend on prompt, transparent disclosure of important corporate financial information. High-quality, timely disclosure gives investors a full picture of a company’s businesses and helps investors price risk. But some observers have proposed drastic cuts in corporate reporting requirements for public companies.
Support disclosure requirements that investors need to make informed investment and voting decisions.
- Investors are the primary users of financial reporting information, and they do not view “information overload” as a problem. A CFA survey of investors found that 80 percent of respondents did not think reducing the volume of financial statement disclosure was important. Investors are more concerned with obtaining meaningful information. While eliminating disclosure overlap makes sense, regulators should focus on protecting investors—the owners of public companies—when considering appeals for reduced disclosure. Congress and the SEC should balance corporate demands for less disclosure with investors’ need for effective disclosure.
- Hedging by executives undercuts pay incentives. Equity granted as a long-term incentive is supposed to be at risk; hedging insulates executives from risk. It also severs alignment with long-term shareholders. That’s why CII policies call on public companies to bar executives from hedging company stock. At a minimum, shareholders should be able to know if and how executives are hedging, because hedging weakens alignment of executive pay with long-term shareholder value.
Dodd-Frank’s requirement that companies disclose their policies on company-stock hedging by executives would give investors a better understanding of who is allowed to hedge and how. But Congress should let the SEC adopt its proposed hedging disclosure rule, not gut requirements for disclosure of hedging.
3. Safeguard the independence of the SEC
Sufficient, stable and independent SEC funding is critical to ensuring the integrity of the U.S. capital markets.
Support full funding for the SEC.
Support the SEC’s rulemaking authority.
- Flexible rulemaking authority helps keep the SEC nimble and responsive to changing market needs. But the House bill would heap additional, unnecessary reviews on the SEC that would hamstring its rulemaking capacity and undermine its ability to fulfill its mission. The SEC would do little else but evaluate its rules.
Shareholders are no fans of unneeded regulation. But the SEC already performs cost-benefit analyses on proposed rules, as numerous laws require (including the Administrative Procedure Act, the Paperwork Reduction Act of 1980, the Small Business Regulatory Enforcement Fairness Act of 1996 and the Regulatory Flexibility Act). While some costs of proposed rules can be estimated reliably, the benefits of regulation are often difficult to measure. Congress should not shackle the SEC with excessive cost-benefit analysis requirements.
Universal Proxy Cards
- The right of shareholders to elect directors to represent them is a fundamental right of share ownership. That right is especially critical when there is a contest for board seats. Contested elections are pivotal events for companies and for shareholders, since board seats, and in some cases, board control, are at stake.
- In contested director elections, management and the dissident shareholder who is running competing candidates should provide shareholders with proxy cards that list all director nominees. Such “universal proxy” cards would guarantee that all shareholders are able to choose among all nominees to vote for the specific combination of nominees that they prefer, regardless of which slate they are on.
- But that is not what happens now in contested elections at U.S. companies. Shareholders can choose any combination of nominees only if they vote in person at the meeting. For many retail and institutional investors, however, attending shareholder meetings is prohibitively costly and time-consuming. The vast majority of shareholders vote by marking proxy cards. And shareholders voting by proxy when there is contest for board seats generally can only vote either management’s card or the dissident’s card. They cannot “split their ticket” and vote for some nominees from each side.
- Mandatory universal proxy cards for all contested elections would guarantee that shareholders are able to choose from among all board nominees, regardless of whether they vote in person or by proxy.
- Opponents of universal proxy cards contend their use would encourage more proxy contests or favor dissidents. But there is no compelling evidence for either assumption.
- The SEC’s universal proxy proposal does not eliminate the substantial cost and risk associated with waging a dissident campaign. Legal, administrative and solicitation expenses required for a dissident to wage a proxy contest can run to six or seven figures. Furthermore, the SEC proposal requires dissidents to solicit shareholders representing at least a majority of outstanding votes.
- A Harvard study found that universal proxy cards in general favor neither management nor dissidents. Perceptions vary about which side benefits more, and those perceptions depend on contest-specific circumstances. Companies and dissidents have been on both sides of this issue. Tessera Technologies sought universal cards in its 2013 contest with dissident Starboard Value, as did Shutterfly in its 2015 proxy fight with Marathon Partners, but the companies were rebuffed. When dissidents sought universal proxy cards at Target in 2009 (Pershing Square) and DuPont in 2015 (Trian Fund Management), the companies declined. Parties in contests rarely request universal proxy cards because they assume the other side will refuse. The only clear “winner” from universal proxy cards is the investor.
- Claims that universal proxy cards would empower special interests do not hold up, either. Ultimately, board seats would go to nominees who receive the most votes.
- Shareholder proposals are an essential tool for investors, individually and collectively, to express their views to management and boards on major governance and other issues.
- The vast majority of shareholder proposals are strictly advisory; even if they pass, companies can choose whether to act on them.
- Shareholder proposals have encouraged many companies to adopt enhanced governance policies that today are viewed widely as best practice. For example, electing directors by majority vote, a radical idea a decade ago when shareholders pressed for it in proposals, is now the norm at 90% of large-cap U.S. companies.
- The CHOICE Act would require a shareholder wishing to put a proposal on a company’s annual meeting ballot to own at least 1% of the stock for three years (the current threshold is $2,000 worth of stock for one year). That would raise the ownership threshold to file a shareholder proposal at Apple, for example, to $7.5 billion. At Wells Fargo, the threshold to file would be $2.6 billion. Even the largest pension funds would not be able to file shareholder proposals.
- Current SEC rules require a shareholder to refile a proposal only if it has received at least 3 percent of the vote on its first submission, 6 percent on the second and 10 percent on the third. The House bill would raise those thresholds to 6 percent, 15 percent and 30 percent, respectively.
- Those hurdles would also knock out many shareholder proposals. The percentage of proposals since 2000 that are estimated to fall below those thresholds are 13.32 percent, 31.5 percent, and 50.14 percent, respectively
- Critics contend that shareholder proposals are a growing burden on companies. But the number of shareholder proposals has not climbed significantly. In recent years, it has vacillated from a high of 1,126 in 2009 to a low of 691 in 2011.
- What has changed is that support for shareholder proposals has grown and represents a significant proportion of investors.
- In 2016, 61 percent of proposals that came to a vote received at least 25 percent support from shareholders, up from 31 percent in 2000 (source: ISS Voting Analytics).
- The proportion of proposals that win the support of a majority of shareholders has risen, too. In 2016, 21 percent of proposals received a majority of votes cast, up from 15 percent in 2000 (source: ISS Voting Analytics).
- The SEC oversees a robust appeals process that allows companies to exclude proposals from the proxy card that do not meet certain procedural and/or substantive hurdles. SEC staff has a well-earned reputation for deliberating fairly. In 2013-2015, companies challenged nearly one-third of shareholder proposals and about half were omitted from the proxy.
- Companies complain about the burden of costs “imposed” by shareholder proposals. But incurring those costs is largely their choice; it is the cost of trying to exclude the proposal from the proxy. The cost to put a proposal on the proxy ballot is de minimus.
Say on Pay
- A periodic advisory vote on executive compensation (“say on pay”) is an essential tool for investors, individually and collectively, to express their views on a matter that goes to the heart of corporate governance and performance. It is important for boards and their compensation committees to frame pay decisions around long-term shareholder interest, and not simply respond in a vacuum to pay demands of senior managers.
- The 2010 Dodd-Frank Act requires public companies to offer shareholders say-on-pay votes annually, every other year or every three years. Most companies hold say-on-pay votes annually, which CII and most institutional investors prefer.
- But lthe Financial CHOICE Act includes a provision that would require public companies to hold advisory votes on executive compensation only when there is a “material change” to executive compensation.
- A 12-year global study found significant benefits from say on pay. Following adoption of say-on-pay laws in various markets, the link between CEO pay and firm performance increased, especially at companies with poor pay practices and weak governance. Say on pay also coincided with reduced disparity between CEO compensation and the pay of other top executives, a factor associated with higher firm valuation.
- Say-on-pay votes have been a catalyst for discussion between U.S. boards and shareholders, leading to greater investor understanding of company strategy and how pay incentives drive the strategy. Growing comfort in engaging on pay is leading to more discussion between companies and investors on a range of other issues.
- Since 2011, when say-on-pay became mandatory at U.S. public companies, boards have been eliminating club memberships, tax gross-ups and other executive perks. They have also strengthened links between executive compensation and corporate performance.
- Say-on-pay votes usually are not controversial, and shareholders generally have been deferential to board compensation committees, except where shareholders clearly see a problem. Each year since 2011, more than 97 percent of say-on-pay proposals win majority support of shareholders.
- Eliminating say-on-pay votes would prompt more investors to vote against corporate directors at companies with troublesome pay practices, because they would have no other mechanism by which to signal their disapproval.
Investor access to independent proxy research
- Proposed legislation would require proxy advisory firms to give companies advance copies of their recommendations and elements of their research and to resolve corporate complaints about errors prior to voting. It would also force proxy advisory firms to hire an ombudsman to address issues companies raise.
- The new regulatory scheme would pressure proxy advisors to accede to management’s recommendations to minimize delays and added costs, reducing the value of the research to investors. Moreover, the scheme might inhibit proxy advisors from even issuing research and recommendations where the subject company invokes the process and does not confirm its agreement with the resolution of issues raised.
- It would also narrow the already-limited window for investors to cast thousands of votes during the spring proxy season.
- It would create new barriers to entry, including yet-to-be determined registration qualification standards to be set by the SEC, in what has been a low-margin industry with few competitors, and potentially drive some proxy advisory firms out of business
- Solutions already exist to address significant errors in proxy advisors’ reports:
- Companies can quickly offer corrections to proxy advisor reports and communicate them to the marketplace via a regulatory filing in addition to the error correction processes undertaken by the proxy advisors themselves.
- Proxy advisors do revise reports to correct material errors as well as to include any new information that is material. Critically, we understand that the leading providers communicate that information to clients immediately in the form of an alert to subscribers.
- Market discipline is the ultimate backstop: advisory firms that make too many errors risk reputational damage and the loss of investor clients.
- The proposed regulatory scheme is based on the false premise that proxy advisory firms dictate proxy voting results. There is no compelling empirical evidence to support that assumption; moreover, academic literature suggests otherwise
- Many pension funds and other institutional investors buy and review proxy advisors’ research and recommendations, often buying research and recommendations from multiple providers, but vote according to their own guidelines.
- For example, in 2016, Institutional Shareholder Services (ISS), the largest proxy advisory firm, recommended against say-on-pay proposals at 12 percent of Russell 3000 companies. Yet just 1.7 percent of those proposals received less than majority support from shareholders.
- Similarly, while ISS opposed the election of 6.5 percent of director-nominees in the 2016 proxy season, just 0.2 percent failed to garner majority support.