Is financial reform putting too much emphasis on shareholders who aren’t there for the long haul?
By Heidi N. Moore, contributor
One potential irony of financial reform: Would instituting new rules to limit short-term decision-making in the boardroom lead us to favor those who make short-term decisions in the markets?
The financial reform bill, it turns out, comes down squarely on the side of shareholders as the ultimate power. Since the 1930s, corporate governance has been in the hands of boards of directors. Now, warns Jones Day partner Bob Profusek, Congress is shifting that to putting a lot of power in the hands of shareholders, a trend first carved out by the Sarbanes-Oxley Act.
Profusek, who is a board member himself, says the financial reform act empowers shareholders through three provisions:
1. Proxy access: Allowing shareholders to have more influence in nominating their own candidates for boards of directors. The Senate wanted to set rules for what kinds of shareholders would qualify — say, those who own 5% of a stock and hold it for more than two years — but that didn’t make it into the bill. Dodd-Frank currently throws the issue back to the SEC, which has been plumping for it since 2003.
2. Say-on-pay: Shareholders get to vote (although their votes are non-binding) on executive compensation, and to get a comparison of executive pay compared to metrics of financial performance like dividends and shareholder returns. All the members of a firm’s compensation committee on the board would also have to be “independent directors” with no “conflicts of interest” with current management.
3. Elimination of brokers’ ability to cast votes for shareholders: Usually, when retail investors buy shares, they sign over to their broker the right to cast votes for them. This arrangement — called voting in “street name” — would be dismantled by new regulations, requiring retail shareholders to cast their own votes.
More of these corporate governance issues are described by David Huntington over at the Harvard Law School Corporate Governance Forum.
Profusek, who is a board member himself, is displeased with these developments, mostly because they extend the remedies for financial firms to all firms. He doesn’t believe that moving more power to shareholders will fix anything. Bear Stearns was brought down in part by a shareholder run, for instance, and Merrill Lynch’s Stan O’Neal was cheered by shareholders even as the bank took on more and more risk — as long as it was getting close to similar profits as Goldman Sachs
Mostly, Profusek believes the shareholder debate is an old one, a relic of Sarbanes-Oxley, which has no place in the financial reform bill. “One of the things that bothers me is what does any of it have to do with finreg?” he asks. “Did Lehman implode because they didn’t have proxy access? Did Bear Stearns go down because they didn’t have any of this junk? No. If a Martian landed on Washington, he’d say ‘why are you guys talking about this stuff?'”
Legally, Profusek believes that the move toward more shareholder power is destructive because the courts won’t back up shareholder decisions. “What shareholders think is not necessarily what directors have to do,” he says. “Courts don’t let shareholder rules get in way of fiduciary good faith.”
He also objects that most shareholders now are not long-term owners, but what he calls “renters,” or institutions and people looking for short-term profits and returns. He points out that the average shareholder held a NYSE stock for 8 years back in 1960; by 2009, shareholders held on to NYSE stocks for an average of just seven months. He suggests an inherent irony in the new shareholder privilege: “Well, wait a minute. We just decided a minute ago that the main issue with banks is risk and short-term thinking. In fact, the majority of institutional ownership is not investing, it’s speculating.”
There are opinions just as strong on the other side of the argument. Lucian Bebchuk, a Harvard Law professor and outspoken proponent of corporate governance reform, recently made the case that the deck is stacked against shareholders financially if they object to management but believe in a company:
“Any reform of corporate elections should include ending incumbents’ monopoly over the corporate ballot — the proxy card sent by the company at its expense to all shareholders. Only board-nominated candidates get to appear on this ballot; challengers must bear the costs of sending (and getting back) their own proxy card to shareholders. Providing shareholders with proxy access — the right to place candidates on the ballot — would contribute to leveling the playing field … The primary purpose of a proxy-access reform is to facilitate increased involvement by long-term institutional investors that have ‘skin in the game’ but not a big block of shares. Consider, for example, the asset manager TIAA-CREF, a long-term investor holding on the order of half a percent of the shares of many large public companies.”
There is also no question that the Dodd-Frank bill is not alone in extending the ideas of Sarbanes-Oxley. The G-20, for instance, is looking to reform how accounting is reported.
Notice that even in the midst of the shareholder-versus-executive war, some shareholders are more equal than others. Bebchuk makes no argument in favor of retail investors or “activist” hedge fund managers, including Carl Icahn, who gather shares to displace management or change companies they’re invested in. Instead, Bebchuk mostly favors greater influence by large institutional investors, who can be considered sophisticated, in the same way that Profusek favors the native intelligence and self-determination of large public companies.
So far, this is not a war being waged for the little guy.
–Heidi Moore is Sweeping the Street while Colin Barr is on vacation.