United States: SEC Commissioner Peirce "Airs Her Grievances" With CII

Last Updated: May 14 2019
Article by Cydney Posner

Happy International Women's Day! To celebrate, let's hear from Hester Peirce, the only woman SEC Commissioner. (Irony intended.)

In a speech delivered a few days ago to the Council of Institutional Investors, after expressing her gratitude for those contributions by CII to the public debate that Peirce views favorably (regarding proxy voting, stock buybacks and disclosure reform), she takes the opportunity to "air her grievances," citing as a model Seinfeld's 1997 Festivus episode. ("I got a lot of problems with you people, and now you're gonna hear about it.") What's her complaint? It's the focus of CII and other investors on what she views to be "non-investment matters at the expense of concentration on a sound allocation of resources to their highest and best use. Real dollars are being poured into adhering to an amorphous and shifting set of virtue markers." And the pressure on the SEC "to get on the bandwagon and drag others with us is pretty intense. We are being asked more and more to shift securities disclosure to focus more on matters that do not go to an assessment of how effectively companies are putting investor money to work."

In this regard, Peirce has more than one bone to pick. She begins with CII's position expressed in a letter to the SEC disapproving of mandatory shareholder arbitration provisions in governing documents, triggered by the recent shareholder proposal to Johnson & Johnson. In that instance, the company received a shareholder proposal requesting adoption of mandatory shareholder arbitration bylaws. The company requested, and Corp Fin granted, no-action relief if the company relied on Rule 14a-8(i)(2) (violation of law) to exclude the proposal. In its response, the staff deferred to an opinion from the Attorney General of the State of New Jersey that the provision would be illegal under state law. (See this PubCo post.) Peirce first questioned whether, with regard to federal law, a court might find that state law was preempted by the Federal Arbitration Act. With regard to the policy of mandatory arbitration, CII had argued that "shareowner arbitration clauses in public company governing documents represent a potential threat to principles of sound corporate governance that balance the rights of shareowners against the responsibility of corporate managers to run the business." That threat results in part from the "non-public nature of arbitration and thus the absence of a 'deterrent effect.'"Another concern raised by other commentators is that mandatory arbitration can preclude class actions. But from Peirce's perspective, that consequence would be a favorable one:

"The problem is that these class actions are rarely decided on the merits. Instead, the cost of litigating is so great that companies often settle to be free of the cost and hassle of the lawsuit. Settlements are rarely public and certainly involve no publication of broadly applicable legal findings. Additionally, such suits can depress shareholder value since they often result in costly payouts to make the suit go away that do not inure to the benefit of shareholders. Indeed, the cost of defending and settling these suits is a substantial cost of being a public company. The result is that the company's shareholders are ultimately harmed by the very option intended to protect them: first by the company's diversion of resources to defend often meritless litigation, and second by the resulting decline in the value of their shares. Case law remains untouched, and the shareholders not involved in the process have no idea what happened. A big chunk of shareholder money typically goes to nice payouts for the lawyers involved."

While she would not "insist on mandatory arbitration provisions for all companies," she clearly disagreed with CCI on the merits of these provisions.

Next, she questions CII's opposition to modifying the shareholder proposal rules. For example, CII has maintained that the shareholder proposal process provides an essential tool that has, over time, resulted in important changes in corporate governance that are now well-accepted: "shareowner proposals provide a means for shareowners to communicate not just with management and the board, but also with other shareowners, also to gauge whether other investors share concerns and approaches on a particular issue." Moreover, "many improvements in U.S. corporate governance practices would not have occurred without a robust shareowner proposal process in place." But Peirce believes reform is necessary. In her view, the "current thresholds permit, indeed encourage, a handful of shareholders to put forward proposals that incur considerable costs borne by all shareholders. Shareholders are able to submit losing proposals over and over again. In recent years, many of these proposals are not even related to core corporate governance issues, but instead promote a tiny group of shareholders' personal political and social preferences. Ultimately, many companies faced with a proposal, even one that reflects the idiosyncratic preferences of a small number of shareholders, may resort to negotiating backroom deals with the proponents. These deals may not be in the best interest of the company and thus of the other shareholders who have not been part of the process." Not to mention the "opportunity cost" for the SEC staff when they are called upon to deal with the plethora of no-action requests, even when the proposals "have no chance of succeeding were they put to a vote. The time staff spend on such activities must necessarily detract from time they could otherwise spend on more useful endeavors, such as rulemaking and reviewing disclosures, both of which provide more benefit to a greater number of investors. Moreover, the 14a-8 process foists staff into an inappropriate policymaking role. For these reasons, I believe fundamental reform in this area is important."

She also takes issue with the current pressure from many institutional shareholders to "push for new types of disclosure," which she considers to be tantamount to "'hijack[ing]' our disclosure apparatus for unintended purposes, [which] can cause considerable mischief." In particular, she observes that CII "has supported efforts to require companies to disclose information about board members' personal characteristics," and observes that, in a recent CDI, the staff concurred with that view, supporting the disclosure of self-identified diversity characteristics of directors under certain circumstances. (See this PubCo post.) However, Peirce objects to the CDI:

"Despite the emphasis on self-identification, I worry that this staff 'expectation' will work with other pressures to force reticent board members and nominees to divulge personal details they would prefer to keep private. I hope that I am wrong. A person who does not want to share his sexual orientation, religion, or ethnic background with the world may face pressure to do just that in order to allow the company to get 'credit' for having a diverse board. What happens when a person decides to convert to a different religion or discovers that she has a different ethnic or cultural heritage than she previously understood? Would these changes require her to notify the board for potential reconsideration of her board membership? Will decisions that are, for some people, of an intensely personal nature suddenly become the stuff of 8-Ks?"

She emphasizes that corporations "benefit from being able to draw from a population that is rich in its diversity"; rather, her concern is with "unintended consequences, among them invasion of board members' privacy and an undue focus on personal features that may have little relation to talent as a director.

Another manifestation of the push by institutional investors for new types of disclosure is the current wave of support for environmental, social and governance disclosure regulation. She remarked that the SEC did not sign up to the recent statement on ESG investing issued in January by The International Organization of Securities Commissions, which "directed issuers to consider whether ESG factors—which are not defined—should be included in their disclosures, endorsed the use of private disclosure frameworks purportedly designed to get at these factors, and suggested that some disclosures now being made voluntarily under these frameworks should be incorporated into these disclosures." Peirce objected to the statement because she viewed it as "an objectionable attempt to focus issuers' on a favored subset of matters, as defined by private creators of ESG metrics, rather than more generally on material matters." U.S. securities laws focus on "materiality," and ESG disclosure requirements could well be outside the scope of that concept.

In Peirce's view, requiring "disclosures aimed at items identified by organizations that are not accountable to investors unproductively distracts issuers." She believes that the SEC should focus its efforts on its core mission of "protecting investors, facilitating capital formation, and fostering fair, orderly, and efficient markets"; to do otherwise is a distraction.

SideBar

A more extreme perspective on disclosure regarding social issues was offered by former Senator Phil Gramm at the SEC's most recent proxy roundtable. He contended that, when organized special interest groups are unable to convince the legislature or the agencies to adopt laws or rules promoting their views, they instead sometimes use "intimidation" to impose policies on corporate America that, in Gramm's view, are not in the interests of shareholders. In his view, the index funds, a growing category of investment fund, have advocated for certain high-profile social issues that have gained public favor strictly as a marketing tool to promote their funds. When investment advisors vote against social issues and are identified as part of the "flat-earth society," he said, they will see an adverse effect on the marketability of their products. As index funds grow, he predicted, this problem would increase, with the result that we would "undo the Enlightenment" and return to the Middle Ages, where these "leeches" bled business and stopped growth. It's one thing, he said, for a holder to vote its own shares on social issues, but when voting the shares of others, they should vote only to increase shareholder value. (See this PubCo post.)

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