Gadfly importance to democratic corporate governance is often underrated. We are currently under attack by the Business Roundtable (BRT) and others seeking to substantially raise the ownership threshold for submitting and resubmitting proposals. BRT, for example, contends proposals from small shareholder divert “significant time and resources to issues that, at best, have an attenuated connection to the long-term interests of investors.”
Securities and Exchange Commission (SEC) Chair Clayton indicates the SEC will review shareholder proposal rules. It is “very important to ask ourselves how much of a cost there is… how much costs should the quiet shareholder, the ordinary shareholder, bear for idiosyncratic interests of other [investors].” Contrary to Clayton’s assertion, our proposals receive wide-spread support.
Three families submitting 31% of the proposals in 2019 is not historically unusual. Proposals submitted by gadflies have been proportionately decreasing over the last 85 years. Others have stepped up only gradually. Too many investors believe corporations must be democratic-free zones. The bifurcation of human values and economics now threatens not only our political democracy but our salubrious planet as a life-support system. The solution to these problems lies in generating market competition around the values expressed through proxy voting by funds, not in shuttering the proxy proposal system.
Gadfly Importance Dominates: 1934 – 1982
The Securities and Exchange Act of 1934 was passed “in the belief that shareholders could not vote effectively until they had adequate information and the right to communicate with each other.”
In 1942, the SEC rule providing for shareholder proposals was 215 words long (including the title). Any “qualified security holder” could submit proposals. There were no minimum ownership requirements, no holding periods, no limits on the number of proposals. Management could exclude proposals only when not a “proper subject for action” by shareholders. That standard was not dependent on the interpretations of SEC staff but on state laws where a company was incorporated. Almost immediately, companies began lobbying the Commission for more restrictions. (The Evolving Role of Rule 14a-8 in the Corporate Governance Process) They have been at it ever since.
A 1947 hearing on proxy rules before a House Committee charged shareholder proposal rules would provide a “field day for crackpots.” [165 Com. & Fin. Chron. 273 (May 22, 1947)]
“Gadfly” investor Lewis Gilbert soon recognized rules are not self-enforcing but depend on shareholder vigilance. Thankfully, gadfly importance was recognized when the SEC sided with the “crackpots’ in enforcing its rules. After many challenges, the SEC’s powers were finally sustained in the 1947 case, SEC v Transamerica, when judge John J. Biggs Jr. ruled, “a corporation is run for the benefit of its stockholders and not for that of its managers.” (see The SEC Proxy Proposal Rule: The Corporate Gadfly)
Wilma Soss
The recent bells of alarm rung by corporate managers seeking to restrict the rights of shareholders, especially small shareholders, is nothing new. For the first five decades, so-called “gadfly” individual investors like the Gilbert brothers, Wilma Soss (Federation of Women Shareholders), and others were virtually the only ones filing shareholder proposals. A study of 286 shareholder proposals submitted between 1944 and 1951 found that 137, or 48% were submitted by the Gilbert brothers, the so-called ‘crackpots’ of their day.
Only two shareholder proposals not supported by management received more than 50% support during the period 1942 to 1982; none by the prolific Gilberts. Still, gadflies had an impact. With prompting by advocates like the Gilberts and Soss, the SEC soon required proxies to include disclosure of top salaries, bonus and profit-sharing plans, pension and retirement plans, as well as income received through the sale of stock and options.
Without early gadflies like the Gilbert brothers and Wilma Soss we would not have the right to file proposals or vote on auditors… and there would be even fewer women on boards.
Lewis Gilbert, who embodied early gadfly importance, recognized “we cannot have good political government unless we have good corporate governments,” since “our political leaders reflect the thinking of the corporate world.” (Lewis Gilbert’s Dividends and Democracy Still Timely) Banning small shareholders from the proxy proposal process would be like banning discussions in public elections to millionaire business leaders. Oligarchies are not democracies.
Gadfly’s Joined and Empowered: 1983 – 2004
Lewis Gilbert
Until 1987 Lewis Gilbert was 0-for-2000 on 50 years of his shareholder proposals. Then he won a majority vote at the Chock Full O’Nuts Corporation on 1/30/87 to allow shareholders to ratify the auditor. Why did he win? Gadfly importance was supported by conscientious institutional investors who began filing their own proposals.
With the formation of the Council of Institutional Investors in 1985, institutional investors became much more involved in corporate governance, and companies began to pay more attention to shareholder voice as expressed both directly and through proxy proposals. From 1987 to 1994, public pension funds sponsored 463 proxy proposals seeking changes in corporations’ governance. In 1992 the SEC passed new rules allowing shareholders to directly communicate with each other, reducing barriers to shareholder coalitions.
A study examining 2,042 proposals submitted between 1987 and 1994 found 23% (463) submitted by institutional investors, primarily pension funds. Gadfly importance remained. The Gilbert brothers submitted 22% (449), Evelyn Davis 15% (314), while 10% (213) came through the United Shareholders Association, a group of individual investors. Interestingly, the study found:
Proposals sponsored by the so-called gadflys (active individual investors) garner fewer votes and are associated with a slight positive impact on stock prices. In contrast, proposals sponsored by institutional investors (i.e., public pension funds) or coordinated groups of investors receive signicantly more votes and appear to have some small but measurable negative impact on stock prices. (my emphasis)
In 1996 individuals (including gadflies) filed 65% of all proposals. In 1998 the SEC passed a significant rule designed to increase shareholder participation (particularly individual shareholder participation) in corporate governance by rewriting Rule 14a-8 in “plain English” and putting the text of the rule in a question and-answer format. Institutional investors, especially labor unions, religious groups and pension funds started filing even more proposals.
In 2003 there was a 56% jump in corporate governance proposals over 2002 in response to corporate scandals (Enron, WorldCom, etc.). Those numbers subsequently fell because many issues of concern were addressed by Sarbanes-Oxley. According to a study by Thomas and Cotter for the period 2002-2004 involving 1,454 proposals:
- 534 proposals, or 36.7% filed by individuals
- 364 proposals, or 25.0% filed by labor unions
- 156, or 10.7% filed by religious groups
- 154, or 10.6% filed by public institutions
- 137, or 9.4% filed by social activists
- 110, or 7.6% were filed by private institutions
The study found “proposals sponsored by individuals and private institutions received the highest votes, at 36.02% and 35.44%, respectively.”
Gadfly Importance Remains Today
According to a review by attorneys from Gibson, Dunn & Crutcher LLP:
For 2017 shareholder meetings, shareholders have submitted approximately 827 proposals, which is significantly less than the 916 proposals submitted for 2016 shareholder meetings and the 943 proposals submitted for 2015 shareholder meetings.
As is typically the case, John Chevedden and shareholders associated with him (including James McRitchie, Kenneth and William Steiner, and Myra Young) submitted by far the highest number of shareholder proposals for 2017 shareholder meetings—approximately 203, which is 24.5% of all shareholder proposals submitted to date in 2017.
A review by a partner at Sullivan & Cromwell LLP of the 2019 proxy season found support for environmental, social, and political (“ESP”) proposals reached 28% this year, continuing the upward trend from less than 10% ten years ago to 26% in 2018.
Governance-related proposals were more likely to reach a vote (64.4% in 2019; vs 69.9% in 2018) and continued to represent the vast majority of proposals that actually passed. The percentage of proposals that passed in 2019 (21% of voted proposals) increased from 13% of those voted in 2018. Gadfly importance remains, particularly in the area of corporate governance.
Three of the five most prolific proponents were the individual investors who have been prominent for a number of years: John Chevedden, Kenneth Steiner, and James McRitchie/Myra Young. Collectively, these individuals and their family members were responsible for the submission of 233 proposals… Overall, they represented 31% of all proposals submitted (up from about 27% in 2018) and the clear majority of governance-related proposals (62%, up from about 58% in 2018). (my emphasis)
Gadfly Importance Cannot be Measured in a Single or Even Several Seasons
The Never-Ending Quest for Shareholder Rights: Special Meetings and Written Consent by Emiliano Catan and Marcel Kahan found:
Out of the 114 firms in our sample that granted that power over 2005-2017, 80% had received a precatory proposal. Relatedly, 84% of the unique firms that received at least one shareholder proposal asking for the right to call special meetings had granted their shareholders that right by the end of 2017…
The proposals were almost exclusively filed by individuals (as opposed to pension funds or other institutional investors). Remarkably, close to 90% of the proposals were filed by members of four families (the Chevedden family, the Steiner family, the Young-McRitchie family, and the Rossi family).
The actions of four gadfly families not only improved the long-term value of our companies, they also helped move the entire market by driving what is considered best practice. Sixty-five percent of S&P 500 companies now allow shareholders to call special meetings. Driving beta (the whole market) is much more impactful and sustainable even on individual portfolios than seeking a slight short-term firm-specific alpha edge. That has been my philosophy and I think it is a perspective shared by other gadflies through history. The value of a diversified portfolio is much more dependent on market trends than the performance of any one holding.
More investors should focus on beta and good environmental, social and governance (ESG) practices in order to increase long-term returns, argue Jim Hawley and Jon Lukomnik in The Long and Short of It: Are We Asking the Right Questions – Modern Portfolio Theory and Time Horizons (download). See also More Beta: The Long and Short of It.
Attack on Gadflies Depends on Obscuring Their Traditional Focus on Corporate Governance
The fact that three families submitted 31% of the proposals in 2019 is not historically unusual. As we have discussed, gadflies submitted almost 100% of shareholder proposals for the first 50 years. By 1996 the proportion filed by individuals fell to 65%. By 2002-2004 it dropped to 36.7%. Yet, even with this dramatic downward trend, there is a vocal call to raise the submission thresholds from $2,000 held for one year to as much as 1% of a company’s outstanding shares held for three years. Filing a proposal at Apple, for example, would require $10 billion of stock held for three years. (see Financial CHOICE Act: Take Action)
As discussed by J. Robert Brown, Jr., a member of the Public Company Accounting Oversight Board:
The impetus for these restrictions was not a significant increase in the use of the rule. During the 2016 proxy season, shareholders submitted 916 proposals to public companies. The number was neither a record nor, in historical context, unusual. Moreover, total submissions had little or no relationship to the number of proposals actually presented to shareholders for a vote. By one estimate, 40 percent of the 474 public interest proposals in 2015 were withdrawn. Nor did cost appear to be the impetus. The actual expense of adding a proposal to the proxy statement is likely nominal.
With the number of no-action requests down, seeking permission from the SEC to exclude proposals, Brown speculates that companies seem increasingly comfortable with simply arguing against shareholder proposal in their proxy statements.
What has changed, however, has been the growing level of support for shareholder proposals. Environmental, social and governance proposals (“ESG”) have grown in popularity, receiving around 20 percent of the votes in 2016. That compares with under 3 percent in the 1970s and under 10 percent in the late 1990s.
A typical editorial entitled Shareholders are costing their companies — and calling it democracy, rails against gadfly importance.
It’s becoming an all-too-frequent occurrence at publicly traded companies: An investor holding just a few shares of stock puts forward a shareholder proposal that’s only tangentially related to the company’s operations or strategy. And if it secures even just a few votes, it can be reintroduced year after year.
However, as Brown notes,
The emphasis on the “few shares of stock” and “tangentially related” obscures the actual role of retail investors in the engagement process. They mostly submit governance proposals, and their proposals mostly receive substantial support.
During the 2019 proxy season my proposals averaged 52.3% support. Chair Clayton indicated the SEC would review shareholder proposal rules, noting it is “very important to ask ourselves how much of a cost there is… how much costs should the quiet shareholder, the ordinary shareholder, bear for idiosyncratic interests of other [investors].” If corporate governance gadfly submissions were really “idiosyncratic,” why do they win the vote of so many shares?
Future Progress May Depend on Millions of “Gadflies”
This post has reviewed gadfly importance. I have shown that investors do not have to be large to affect best ESG practices. Funds with super portfolios like BlackRock, State Street, Vanguard and Fidelity have never initiated changes through the use of proxy proposals. Research on US passive managers, which are responsible for one quarter of all votes at S&P 500 companies, concludes:
Specifically, we find that relative to active funds, index funds are significantly more likely to side with firm management on contentious corporate governance votes. Low-fee index funds are even more likely to vote with firm management, which indicates that the low-cost structure of index funds directly affects their capacity to monitor. Index funds are also less likely to use exit to enforce governance, and we find no evidence that index funds engage with firm management either publicly or privately.
The largest funds have a built-in bias in favor of management because a major portion of their business depends on winning contracts from corporate executives to administer company 401(k) and other retirement plans. These funds have never filed a proxy proposal. They are not leaders; they are followers. However, they do respond to public opinion. Shareholder rights are currently under attack for the simple reason that support for governance, as well as environmental and social proposals has increased dramatically over time. Public opinion is the main driver.
[P]ublic opinion on corporate governance issues, as reflected in media coverage and surveys, is strongly associated with investor voting, particularly mutual fund voting. In addition, even proxy advisor’s recommendations are associated with public opinion… media coverage captures the attention of proxy advisors, institutional investors and individual investors, and is thus reflected in recommendations and votes.
Main Street investors want to earn returns but they also want companies to reduce externalities, foisting off the environmental and social costs of production onto workers and taxpayers. Investment in funds using ESG strategies has soared and now represents 25% of all investments. “Greenwishing” Main Street and 401(k) investors are often surprised to learn “ESG funds” offered by the largest mutual fund families vote against most ESG proposals. That is because fund families like BlackRock and Vanguard typically vote their ESG designated funds just like they vote their other funds… with management.
Funds are required to notify the SEC of how they voted but these records are filed a year later and are practically encrypted. Thousands of filings cannot be sorted without the aid of sophisticated programming. Main Street investors, Mr. and Ms. 401(k), increasingly invest in ESG funds because many want to do well, while doing good.
I have petitioned the SEC to make proxy voting information available in real-time and in machine readable format. That would spark competition among funds around their proxy voting records, much like the current market competition around low fees and performance history. Armed with proxy voting information, millions of “gadflies” could demand funds live up to the ESG principles they appear to espouse.
These small investors would not need to learn the intricacies of filing shareholder proposals under SEC Rule 14a-8. They would simply need to compare the voting records of funds on offer through their retirement plans, selecting those reflecting their own values. If no such funds are available through their current employer, they could request better options, aligned with their values, and probably the values espoused by their employer. Few companies make it a public goal to cheat employees and contractors, despoil the environment or do evil. All investors, including the mega-funds need to do a better job of monitoring their investments to ensure companies are well governed. Since a combination of BlackRock, Vanguard, and State Street constitute the largest shareholder at 40% of U.S. public companies and nearly 90% at S&P500 firms, their votes matter.
My petition can be found under Petitions for Rulemaking Submitted to the SEC as File 4-748, Jul. 9, 2019 Request to amendment of Title 17, §270.30b1-4, Report of proxy voting record Submitted by: James McRitchie, Corporate Governance.
Submit comments on File 4–748 by including that file number in the subject line and emailing them to rule-comments@sec.gov. You can write something as simple as the following:
I want to know how the funds I invest in vote their proxies. I support the suggested reporting amendments, which would spark competition between funds around proxy voting records, similar to current market competition around low fees and performance history.
See also, Proxy Voting Alignment Will Drive Index Fund Competition – Corporate Governance and Petition for Real-Time Disclosure of Proxy Votes – Corporate Governance.
I learned much from this – an outstanding history, analysis and summary of issues!