Earlier this year, two proposals were floated to enhance shareholder engagement with directors, one from a working group called the Shareholder-Director Exchange and the other from The Conference Board. While it may now be almost de rigueur for management to engage with shareholders, engagement between shareholders and boards is a bit more of a rare bird. (See these February and March news briefs.) SDX reports that, during the 2014 proxy season, less than a quarter of the S&P 500 reported engagement efforts or policies in their proxy statements. At the same, institutional shareholders have increasingly been throwing in their lot with activist investors. (See, e.g., this news brief from last year.) Both of these engagement proposals were framed as efforts to thwart “activist” investors that sometimes form unholy alliances with traditionally passive institutional holders to pressure management into making changes desired by the activist hedge fund. The theory behind these efforts is that, by enhancing the process and regularizing communications between directors and institutional shareholders, shareholders and directors will develop a healthier relationship that can be helpful in overriding any unhealthy influence of hedge fund activists.
Sidebar: Activists? Really? Isn’t an activist a person or entity that is disruptive – in the benign sense of the word — for the greater good, the public interest. Martin Luther King was an activist. Does coercing companies to take action to increase the value of their own hedge fund’s portfolio really merit the honorable designation of “activist”? (See, for example, this article from Reuters discussing pressure from activist hedge funds on Walgreen’s to engage in a tax inversion transaction, pressure that was ultimately resisted.) After all, isn’t terminology half the battle? There’s a reason that opponents of the estate tax call it the “death tax.”
Now, as discussed in this article in Law360, as well as in this DealBook column, one of these proposals, the Shareholder-Director Exchange, is being trumpeted by a group of institutional shareholders, including BlackRock and Vanguard. (Interestingly, as reflected in this news brief, Reuters earlier reported that Vanguard has displayed increased activism of late as evidenced in its increased support for the opposition in various high-profile proxy contests.) These institutions, which together manage over $10 trillion in assets, have sent letters to the 1,000 largest U.S. public companies urging them to adopt the SDX protocol for direct engagement between directors and shareholders. (The shareholder engagement recommendations developed by the Conference Board, together with a diverse group of advisers, are intended to address, not only activists’ influence, but also a broader problem The Conference Board believes to be undermining the relationship between companies and their shareholders: shareholders’ lack of trust in large corporations resulting from the scandals and crises of the past decade. The Conference Board advocates that the interests of all stakeholders must be taken into account to achieve “sustainable shareholder value.” In addition, in contrast to the SDX protocol, while the Conference Board believes that engagement can enhance trust and confidence, it contends that, depending on the company, “[o]verengagement can lead to systemic overload and inefficient use of limited resources.” Instead, the Conference Board argues that engagement should not be routine, but should instead be used only in “special circumstances.”)
As discussed in this February DealBook column, SDX includes representatives from large institutional investors and board members from large companies, but no activists. The protocol provides “a voluntary set of standards that companies and investors can adopt, [under which] boards will be encouraged to meet with longtime shareholders to discuss issues of corporate governance, management performance and deal activity, as needed. The purpose is not for board members and shareholders to discuss operations, financial results or return-of-capital plans — topics that are more appropriate for management, ” and more likely to cause discussions to run afoul of Reg FD. According to one director, “’[w]hen shareholders want to talk to directors, it’s because they hate the pay program, they don’t like the C.E.O. or they want to know how directors are thinking about other governance issues, such as destaggering the board’…..The protocol states that when either a company or an investor wants to engage with the other, they will approach designated contacts, like a corporate secretary, and request a meeting. The other party will acknowledge the request as soon as possible, and agree to meet within 20 business days. When the sides do meet, the goal is to create an environment where frank discussions can occur. The protocol calls for the independent nonexecutive chairman or other lead directors to attend, and for senior members of the institutional investment group to participate. Management, lawyers and bankers are discouraged from attending the meetings. The protocol suggests that meetings be between a company and one investor, but it allows for flexibility, so that several investors could approach directors about similar concerns. It also suggests that shareholders might attend board committee meetings or strategy retreats, or special investor days. Once both parties air their grievances, the boards and investors are encouraged to commit to next steps resulting from the meeting, and to share the information about the engagement with other board members, management and other investor colleagues.”
The steps of the SDX protocol, which may seem a bit like spending months discussing the shape of the table as a prelude to peace negotiations, include the following:
- The scope is focused “on real-time, two-way interactions between non-executive directors of public company issuers and representatives from long-term institutional investors, such as asset managers and public pension funds, and is intended to supplement management’s investment relations efforts.
- Each company and institutional investor is to develop a clear policy describing how it will approach shareholder-director engagement, with decisions regarding acceptance or rejection of engagement overtures to be determined on a case-by-case basis.
- Entities develop lists of appropriate topics for engagement, focused on governance-related topics that are the responsibility of the board, including board composition and leadership, board oversight of capital allocation, executive succession, takeover defenses and management performance. The decision to engage should be made in consultation with management, including the purpose of the engagement, topics for discussion and preparation.
- Companies and investors will each establish a primary contact for receiving engagement requests, such as the corporate secretary for companies.
- Depending on the topics to be discussed, each institution will select at least two persons to represent them who will continue through subsequent engagements on those topics.
- Typically, meetings will involve one company and one investor (but could involve larger groups) and may be in person or virtual, or might even involve attendance by investors at board committee meetings. Meeting preparation will involve review of relevant materials, including corporate governance guidelines, proxy voting policy and training on relevant legal issues. The parties will agree in advance on the topics for discussion, the format and venue, participants, expectations for confidentiality and desired outcomes. One result of the engagement should be an agreement on next steps (although changes in policy are not necessarily the only positive outcome that might result from the discussion), as well as communication of information about the engagement to board, management or investor colleagues who were not present.
- While success does not necessarily depend on changes in policy, active listening and willingness to either take action in response to valid concerns or explain why action is not being taken are critical.
- All parties should review and update the engagement process annually, and the SDX working group plans to review and update the protocol annually.
- The SDX protocol should be customized as appropriate.
It will certainly be interesting to see if the acceptance by companies and institutions of this type of framework really makes a difference in furthering the engagement process.