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Mar 07, 2019

SEC’s Peirce tackles CII on arb and shareholder proposals

Commissioner backs companies being able to avoid courts to resolve disputes

SEC member Hester Peirce has questioned the Council of Institutional Investors’ (CII) stance on the key corporate governance issues of mandatory arbitration and filing shareholder proposals.

Speaking at the CII’s spring conference on Tuesday, Peirce expressed a general concern that ‘many investors these days seem focused on 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. I do not want the SEC to become an enabler of this shift in focus.’

As an example, she raised concerns about CII’s position regarding a recent Johnson & Johnson shareholder proposal that, if approved, would ‘request the board of directors to take all practicable steps to adopt a mandatory arbitration bylaw’ for disputes between a shareholder and the company and/or its directors, officers or controlling persons.

CII submitted a letter to the agency on January 31 supporting Johnson & Johnson’s successful effort to gain the SEC staff’s permission to exclude the proposal from its proxy. In the letter, the institute noted its policy that ‘companies [should not] attempt to bar shareowners from the courts through the introduction of forced arbitration clauses.’

This policy is based on the view 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,’ CII general counsel Jeffrey Mahoney wrote.

Investors fear that forcing disputes to go to arbitration rather than the court system generally means they do not become part of the public record and, therefore, may lose their deterrent effect, he noted. Other critics of mandatory arbitration argue that it deprives shareholders – or other complainants – of options that would otherwise be available to them in court, including that such clauses may prevent them from joining together in a class action.

SEC member Robert Jackson last year responded to a report that the securities industry was looking to include mandatory arbitration clauses in an IPO by stating: ‘The idea is that our division of corporation finance will be forced to approve the IPO, stripping shareholders of their right to their day in court – and radically altering the balance between shareholders and corporate insiders.

‘I’ve expressed a great deal of skepticism about proposals like these in the past; as I told the Senate in October, I do not have the sense that what we have in corporate America today is too much accountability.’

Peirce takes a different stance. ‘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,’ she said this week. ‘Settlements are rarely public and certainly involve no publication of broadly applicable legal findings. Additionally, such suits can depress shareholder value as they often result in costly payouts to make the suit go away that do not inure to the benefit of shareholders.’

The cost of defending and settling these suits is ‘a substantial cost of being a public company,’ she argued. Shareholders are ultimately harmed by the company diverting resources to defend ‘often meritless’ litigation, and by the resulting decline in the value of their shares, she added. ‘All that is not to say that I would insist on mandatory arbitration provisions for all companies. That would not be an appropriate exercise of our investor protection mandate. If shareholders value the ability to bring class actions, they can divert their investments to companies that offer such options.’

Speaking to Corporate Secretary later, CII executive director Ken Bertsch emphasized the institute’s view that it is important to have a court process available to shareholders that leaves a public record. He noted that proposals such as the one submitted to Johnson & Johnson are relatively rare.

Peirce also voiced her differences with CII over the thresholds for being able to submit shareholder proposals. Under SEC Rule 14a-8, a shareholder is eligible to submit a proposal only if, among other things, it has continuously held at least $2,000 in market value, or 1 percent, of the company’s voting stock for at least one year.

Peirce said this week that she sees ‘a clear need for reform in this area.’ The existing thresholds permit, or even encourage, a handful of shareholders to put forward proposals that incur considerable costs borne by all shareholders, she argued. Shareholders are also able to submit losing proposals multiple times. ‘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,’ she added.

Companies faced with such proposals 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 [that] have not been part of the process,’ Peirce said. Alternatively, companies may seek SEC approval to exclude proposals, a review process that imposes an enormous opportunity cost on the staff, she added.

By contrast, CII in a December 5, 2018 letter to the Senate Banking Committee said it generally believed the Rule 14a-8 requirements are appropriate. It argued that the existing shareholder proposal process has led to several improvements in US corporate governance, such as proxy access and annual director elections – even if such policies were initially unpopular.

‘The cost to public companies of the existing shareowner proposal process is generally low and the process often results in benefits to companies,’ CII said, adding that among companies that receive a proposal, the median number is one per year.

‘We think it’s a good rule and working effectively,’ Bertsch told Corporate Secretary.