Proxy Access and Shareholder Activism: Navigating the United States Activist Landscape after Dodd-Frank

Introduction

With the toppling of corporate giants that occurred during the subprime mortgage crisis and subsequent recession, investors became increasingly wary of corporate leadership and how it might affect the value of their shares. As a result, shareholders are increasingly proactive in the affairs of their investment companies through shareholder activism. In particular, 2016 indicated a trending version of shareholder activism—proxy access—where shareholders and corporations alike came to agreements allowing shareholders voting powers in electing board leadership.

Defining Shareholder Activism and Proxy Access

The phrase "shareholder activism" refers to a range of activities by one or more shareholders of a publicly traded corporation intended to result in some change in the corporation. This spectrum ranges from more aggressive forms like hedge fund activism, where investors seek significant changes in the company's strategy, to one-on-one engagements between shareholders and companies via "say on pay" advisory votes.

Proxy access falls on the middle part of the spectrum, under the general category of shareholder proposals. Shareholder proposals are those that look to affect changes in the company's operations or strategy. Proxy access specifically refers to the right for qualifying shareowners to elect director nominees during board elections via a company proxy card. While this is understood as standard practice in various countries internationally, in the United States, the movement to allow such access has met its own set of trials and tribulations even after Congress introduced the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010.

Dodd-Frank Meets Resistance

Section 971 of Dodd-Frank amended Section 14(a) of the Securities Exchange Act of 1934 to include a provision explicitly granting the SEC the power to require company proxy (or consent, or authorization) solicitations to include nominees by shareholders to serve on the board of directors. In August 2010, the SEC attempted to exercise this power by approving a proxy access rule to make such a nomination easier for share owners. However, the victory for share owners was short lived as the SEC was met by stiff corporate and political resistance. A subsequent lawsuit (Business Roundtable v. U.S. Sec. & Exch. Comm'n, 647 F.3d 1144 (D.C. Cir., 2011)) challenging the rule succeeded and the SEC vacated its proxy access rule even before it took effect.

Why Companies Are Concerned with Proxy Access

Proxy access provides certain shareholders the right to nominate directors to a company's board without having to go through a typical proxy contest. Even though the SEC proxy access rule was overturned in 2011 in Business Roundtable, the unofficial standard has remained at 3%/3-year ownership thresholds for shareholders who can participate in proxy access. A new term also appeared in agreements, limiting the vote to 10-25% of the eligible director seats.

Resistors to the proxy access movement raised legitimate concerns. Those who argue against proxy access proposals bring up issues ranging from the nomination of special interest directors with minority shareholder agendas, short-termism, impairment of company ability to attract and retain quality directors, politicization of the boardroom and subsequent weakening of the board's effectiveness in management, and mixed effect on corporate performance and long-term shareholder value. With the right resources and terms, alliances—"wolf packs" as suggested in Garcia's article—could be formed to take over entire boards. According to Garcia, FactSet tracked 46 campaigns dating back to 2003, wherein in 34 of those campaigns, a dissident group sought and won at least one board seat in 14 of those campaigns. Out of those 14, six campaigns resulted in the dissident group winning all of the sought board seats.

PWC says that some of these types of activists have engaged in such activity for decades. Characterized as "corporate raiders," these activists can take over control of the board to affect the changes they seek, which can often lead to the breakup of the company, obviously to the detriment of other shareholders. Indeed, shareholder proposals with the right leverage can change these proposals into hedge fund activism, the most extreme end of the shareholder activism spectrum. Such activism via "wolf pack" campaigns have affected board changes in companies from Darden to Petsmart. In the case of Petsmart, Jana Partners LLC and Longview Asset Management, by becoming controlling shareholders, pressured Petsmart to a private equity buyout.

In 2015, at least 18 companies submitted no-action letters to block shareholder proposals for proxy access. In that same year, the Division of Corporate Finance of the SEC publicly declared that it would no longer express any views related to the proxy access issue.

Activist Shareholders Gain Ground

In 2015, Apple adopted proxy access in its bylaws. Scott Stringer, the New York City Comptroller, lauded the move as a "tipping point" for more boards to start the shift of working with investors to provide greater accountability that will drive long-term value. Patrick McGurn of Institutional Shareholder Services (ISS) described Apple as a "bellwether" that would influence other companies to examine the issue.

2015 was a high-water mark for the proxy access movement. In that year, more than 20% of companies in the S&P 500 adopted proxy access, up from 2014 by 1%. Several of the 115 companies that embraced proxy access in 2015 included major companies like Apple, Inc., Citigroup, Inc., Coca-Cola Co., General Electric Co., JPMorgan Chase & Co, McDonald's Corp., Prudential Financial, Inc., and Verizon Communications. The average percentage of votes case in favor of proxy access proposals was 55% in 2015, up from 34% in 2014. A leader in the proxy access movement in 2015 was the New York City Comptroller in conjunction with the New York City pension funds, when they launched the Boardroom Accountability Project, including proxy access proposals to 75 select companies.

Does the Proxy Access Trend Affect Your Company?

A recent report by Sullivan & Cromwell LLP indicates that the numbers of governance-related shareholder proposals that have been voted on and that have passed have stalled, and even declined slightly for the year of 2016. This was on account of fewer proposals on board declassification and action by written consent and largely unsupported proposals for share buybacks. The focus of shareholder proposals has invariably been on large-cap companies, specifically those companies listed in S&P 500, as opposed to small- or mid-cap companies. This has resulted in a bifurcated corporate governance landscape with "shareholder-friendly" governance provisions being far more common in larger companies rather than smaller companies. The report indicates that rather than focus on pushing the same initiatives on smaller companies, that shareholders have generally moved on to "the next topic" affecting larger companies; nevertheless, the industry has predicted that shareholders will begin to focus on instituting similar changes in mid-cap companies.

This certainly does not mean that small- or mid-cap companies have nothing to worry about by way of proxy access. Shareholder activists remain active in their initiatives in all market-caps (see the pie chart on p. 23). The statistics may also be misleading in the case of small- to mid-cap companies, as the relatively small number of traditional governance proposals coming to a vote at these smaller companies understates the effect of these proposals. Companies might adopt proxy access initiatives before they come to a vote, for example. Smaller companies might also mimic best practices at large-cap companies, precluding the need for shareholders to vote on these issues.

Sullivan & Cromwell LLP says there is no one-size-fits-all approach to this question. Your company might consider adopting a proxy access bylaw in advance of receiving the proposal. In this way, the company starts with the terms most preferable to the board and may avoid having to dedicate the time, expense, and possible negative PR from waiting for a vote to occur. On the other hand, there is no way to predict whether the movement towards proxy access initiatives geared towards smaller companies will occur soon, if at all. Companies may wish to focus resources on more pressing activism issues.

PricewaterhouseCoopers LLP cautions that companies once targeted for activism may be targets once again for activism, depending on the company response, the significance of changes affected and the perception of the board's independence and open-mindedness. They suggest that companies conduct periodic self-assessments for risk factors and engage in tailored and focused shareholder engagement programs to strengthen long-term relations with investors and boost company resilience.

Conclusion

While historically larger-cap companies tend to be targets for proxy access proposals, small- and mid-sized companies should remember that activism occurs in all market-caps. As such, companies should continually conduct self-assessments, and remain vigilant in communicating with and developing strong relations with investors.

Additional Resources:

Gretchen Morgenson, Mutual Fund Giants Vote to Keep the Insiders In, N.Y. Times (May 29, 2015)

Beth Jinks, PetSmart Surges After Being Targeted by Activist Fund, Bloomberg.com (July 3, 2014) Schedule 13D, U.S. Securities and Exchange Commission (Dec. 5, 2012)