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Reforming the Proxy Process to Safeguard Investor Interests

House Committee on Financial Services

Subcommittee on Capital Markets

Reforming the Proxy Process to Safeguard Investor Interests

Thursday, July 13, 2023

Topline

  • Republicans criticized the politicization of capital allocation, the outsized influence of proxy advisors, and the effects of activist proposals relating to social policy.
  • Democrats highlighted the benefits of shareholder proposals and argued that ESG disclosures are material information for investors.

Witnesses

  • Christopher Netram, Managing Vice President, Policy, National Association of Manufacturers
  • Dr. Joshua White, Assistant Professor of Finance and the Brownlee O. Currey Jr. Dean’s Faculty Fellow at Vanderbilt University’s Owen Graduate School of Management
  • Tim Doyle, Senior Policy Advisor, Bipartisan Policy Center
  • Jonathan Berry, Managing Partner, Boyden Gray PLLC
  • Nell Minow, Vice Chair, ValueEdge Advisors

Opening Statements

Subcommittee Chairwoman Ann Wagner (R-Mo.)

In her opening statement, Wagner expressed her concerns surrounding the Biden Administration’s efforts to force non-material environmental, social, and political issues on companies and investors. She explained that these issues increase the cost of participating in American markets and burden retail investors. Wagner noted the primary purpose of our public market is economic growth and emphasized that it is crucial to reform the proxy process.

 

Subcommittee Ranking Member Brad Sherman (D-Calif.)

In his opening statement, Sherman explained that if a material portion of the investment community holds that specific information is material, it is the responsibility of Congress to ensure they receive that information. He said investors that care about the environmental impact of their investments will turn to investing in European companies who provide that information if American companies don’t adapt. Sherman concluded the hearing is not about cost and explained that the hearing was being held by members who don’t want to give shareholders a chance.

 

Representative Bill Huizenga (R-Mich.)

In his opening statement, Huizenga discussed how proxy advisory firms have seized power to shift policy, explaining that the proxy process no longer promotes long-term shareholder value and operates without transparency or accountability. He concluded that Republicans would promote policies that protect retail investors, maximize returns, and increase financial security.

 

Full Committee Ranking Member Maxine Waters (D-Calif.)

In her opening statement, Waters accused Republicans of working to muzzle the ability of shareholders to bring forth proposals that can influence the direction of the companies they own.

 

Testimony

Christopher Netram, Managing Vice President, Policy, National Association of Manufacturers

In his testimony, Netram explained how third parties have hijacked the proxy process to distract companies from their fiduciary duties, using the proxy ballot to advance their political and social agendas. He added that the SEC is empowering these groups by proposing ESG disclosure mandates. Netram called on Congress to prevent the SEC from empowering activists. He noted that proxy firms operate with minimal regulatory oversight, causing their lack of transparency, conflict of interest, and errors to go largely unchecked. Netram concluded that the SEC’s proposed, far-reaching mandates won’t inform investors but will harm manufacturers.

 

Dr. Joshua White, Assistant Professor of Finance and the Brownlee O. Currey Jr. Dean’s Faculty Fellow at Vanderbilt University’s Owen Graduate School of Management

In his testimony, White discussed 2022’s 100% surge in environmental and social proposals, noting that investor support for these proposals has plummeted. He said that asset managers who rely less on proxy advisors yield higher returns on their investments. White explained how the largest proxy adviser often skews its environmental and social recommendations due to pressure from the proponents of ESG proposals. He concluded that this places additional pressure on public companies, which discourages companies from going public, limiting investment opportunities for retail investors.

 

Tim Doyle, Senior Policy Advisor, Bipartisan Policy Center

In his testimony, Doyle called on the Financial Services Committee to work with non-profits, thinktanks, academics, and investors to find common language when using the term ESG, explaining that this would improve capital markets, protect retail investors, and encourage more companies to go public. He noted that proxy advisors are for-profit, which presents a conflict of interest between their recommendations and their clients. Doyle called for more transparency and oversight, citing errors in proxy adviser reports.

 

Jonathan Berry, Managing Partner, Boyden Gray PLLC

In his testimony, Berry explained that politically motivated shareholder proposals are a main entry point by ESG-focused activists, money managers, and advisers to influence public companies to adopt their agendas. He added that environmental and social proposals now represent most of the proposals in Russell 3000 companies. Berry said the SEC blocked anti-ESG proposals from consideration on company proxy statements, concluding that the SEC has demonstrated a pattern of disfavoring conservative proposals.

 

Nell Minow, Vice Chair, ValueEdge Advisors

In her testimony, Minow emphasized that investors are the best positioned to decide what information is material. She noted that only a small percentage of companies receive any shareholder proposals, and that shareholder votes are not binding. Minow explained that capitalism depends on investors ability to decide what is political, versus what is material.

 

Question & Answer

Politicization & Activism

Wagner asked White to provide insight into the recent tranche of politically motivated proposals and how they have impacted the focus of corporate boards. White explained that the corporate boardroom has become politicized, which may force public companies to go private.

 

Wagner asked about the significance of the shift away from the SEC’s long-standing criteria, which relied on a proposal having a connection to the company’s ordinary business operations. Netram said the shift is incredibly significant, noting that companies are being forced to deal with issues that are well outside of their control, instead of focusing on things crucial to their business.

 

Rep. Dan Meuser (R-Pa.) asked how the politicization of capital allocation, influenced by proxy advisors, impacts market confidence and investor trust. White explained  that the trust investors place in their advisers may be eroded if they rely too heavily on proxy advice.

 

Rep. Erin Houchin (R-Ind.) asked if it’s fair for companies to be forced to continue to invest resources to fight activist proposals that do not benefit the company and its shareholders, especially if similar proposals have been rejected in previous years. Netram said no, explaining that when a broad majority of shareholders have rejected a proposal, they should not have to continually reassess and re-engage with activists on those ideas.

 

Houchin asked how the dominance of social and policy issues in corporate meetings conflicts with the objectives of increasing capital formation and promoting efficient markets. Netram said the SEC has encouraged activists to hijack the proxy ballot and divert time, resources, and attention away from the underlying business.

 

Rep. Stephen Lynch (D-Mass.) asked if activists are directing proxy votes, or if there’s causation between the views of the participants of funds and the way the proxies are voting. Minow said public pension funds are focused on ensuring their asset managers make decisions purely for the benefit of plan participants.

 

Rep. Mike Lawler (R-N.Y.) asked White about the persistence and prevalence of socially oriented shareholder activism and the influence of proxy advisory firms on boards making effective business decisions. White explained it takes boards a long time to respond to shareholder proposals.

 

Shareholder Proposals

Waters asked Minow about her views on Republican efforts to stifle free market capitalism by refusing to allow ordinary investors to have a voice in how their investments are managed. Minow noted that corporate boards have become more engaged due to shareholder proposals. She added that shareholder proposals are nonbinding, explaining that companies can ignore the results of a proposal.

 

Huizenga asked how important it is for shareholders to have an active role in the shareholder voting process. Netram said it’s very important, emphasizing that retail investors deserve a voice in the process.

 

Rep. David Scott (D-Ga.) asked Minow if she agreed with SEC Commissioner Uyeda that there has been an increase in shareholder proposals over the past two years. Minow said yes, adding that many of the proposals were withdrawn following successful negotiations.

 

Scott asked Minow if she would attribute the increase to the SEC’s November 2021 guidance about the application of Rule 14a-8, and whether to give no action relief to companies that seek to avoid voting on shareholders proposals. Minow explained that ruling was a return to earlier guidance, noting that many of those rules were tightened during the Trump Administration. She added that investors generally preferred the earlier guidance.

 

Scott asked if Minow was aware of any shareholder proposal that led to a negative change or the deterioration of a company. Minow explained that since even 100% votes can be ignored by a company, that has not happened.

 

Rep. French Hill (R-Ark.) asked how the proposal process changed when the SEC limited no action release under Rule 14a-8? Netram said the Rule gives activists a roadmap to micromanage a company. He said removing the guidance would allow companies to flourish.

 

Hill asked if the SEC’s guidance would increase litigation risk for companies, and if it would have any other potential impacts on corporate governance. White said the guidance would continue to tip the scales towards special interest groups, noting the SEC’s disagreement for no action release requests increased more than 50%. He predicted this increase would continue under the new rule proposals.

 

Rep. Frank Lucas (R-Okla.) asked how the SEC decided on their current treatment of shareholder proposals, and how their position has changed over the past decade. Berry explained that the SEC delved into the substance of corporate governance, opening the door to significant shareholder proposals in the environmental and social space.

 

Rep. Andrew Garbarino (R-N.Y.) asked if there should be a cooling-off period if a shareholder proposal is rejected multiple times by a majority of shareholders. Berry said yes.

 

Garbarino asked about the cost of shareholder proposals to companies. Netram said their cost stems from the time and attention executives are forced to divert from the operation of normal business. Garbarino asked if there is a cost to retail investors, to which Netram said yes.

 

Garbarino asked how the increased level of detail and specificity in shareholder proposals creates governance risks by distorting the board decision making process. Netram said it gives greater power to shareholder activists by allowing shareholders to keep making minor changes to proposals and force management to consider each alteration.

 

Garbarino asked if there was a way to change Rule 14a-8 to combat the submission and resubmission of non-germane shareholder proposals. Netram said we must ensure proposals germane to the underlying business are the focus. Garbarino asked White to discuss the SEC’s proposed amendments and their potential impact on the public market. White said the new rules would make it harder to remove shareholder proposals from the proxy.

 

Rep. Gregory Meeks (D-N.Y.) asked Minow to share examples of shareholder proposals that have contributed to positive changes within a company. Minow said proposals have led to boards being far more engaged, effective, and qualified. She added shareholder proposals have also led to more accountability in companies, and changes in CEO pay.

 

Proxy Advisory Firms

Wagner asked if companies can review proxy firm recommendations and provide feedback. Netram said no, explaining that there is no way for companies to ensure the data incorporated into the firm’s recommendations is accurate. Wagner asked why businesses should have the opportunity to review and offer feedback on draft proxy firm recommendations. Netram explained that people rely on the success of their companies for their wellbeing, causing inaccuracies to be harmful for both companies and investors.

 

Wagner asked if requiring proxy advisers to disclose their methodologies, calculations, and information sources would lead to a more transparent advisory process. Netram agreed that it would.

 

Huizenga asked how the influence of proxy advisors impacts the decision-making process of companies and their boards. Netram said companies try to contort themselves to match what the recommendations of advisory firms.

 

Rep. Bryan Steil (R-Wisc.) questioned the rationale behind Chair Gensler’s decision to strike down the proxy advisor rule.  Netram explained that Gensler’s decision was made in order to reverse changes made during the Clayton-era, which he believed had given excessive power to companies.

 

Steil asked about the impact of allowing the proxy firm duopoly to play out when misinformation is being produced. Berry said proxy advisors will give in to shareholder activists, leading to all sorts of potentially illegal behavior. Steil asked about a solution, and Netram emphasized that legislation is needed to bring transparency, legislation that would require the disclosure of conflicts of interest, methodologies, and sources of information and ensure anti-fraud standards apply to proxy firms.

 

Steil asked Berry about the existence of conflicts of interest at the largest proxy firms. Berry cited conflicts of interest between consulting and proxy advice.

 

Climate Disclosures

Rep. Sean Casten (D-Ill.) asked Netram if climate risks qualify as material information for investors. Netram said the answer depends on the company.

 

Casten asked if Netram knew the percentage of investors who commented that the current voluntary reporting was inadequate to meet the demand for climate-related information. When Netram demurred, Casten noted that it was 90% of investors, adding that 97% of investors also commented in support of including climate disclosure in public companies’ Form 10-K’s. Casten concluded that there is no debate over whether climate disclosure is material.

 

Huizenga asked if companies are already required to disclose climate change related impacts with a material impact on their business and operations. Berry said yes, if the impact is material. Huizenga asked if there was a good reason to deviate from the current standard. Berry said no, arguing the status quo is a time-tested standard.

 

Rep. Juan Vargas (D-Calif.) asked if shareholders want to know about the environmental impacts of the companies they invest in. Minow explained that while environmental issues impact every company in America, the fossil fuel industry is opposed to disclosing this information. She added that no one has presented an ESG proposal or vote that was detrimental to anybody.

 

Meeks asked if proxy firms actively push ESG related information out to investors, or if it’s customary for investors to ask for ESG related information about a company as part of their established proxy voting policies. Minow said clients have different relationships with ISS, noting there are clients in either category.

 

Rep. Emanuel Cleaver (D-Mo.) asked if proxy advisors always favorably recommend climate or social proposals. Minow said no, adding that clients often differ from advisors’ recommendations on controversial topics. White agreed with Minow, noting that some proxy advisors have conflicts of interest. White said he was concerned with the lack of oversight and control by just two firms in this area.

 

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