Close

Are you in compliance?

Don't miss out! Sign up today for our weekly newsletters and stay abreast of important GRC-related information and news.

Activism With Sharp Elbows in 2015

Stephen Davis and Jon Lukomnik | January 6, 2015

We think weather forecasters should have to appear alongside a score showing how their past predictions have squared with reality. That would help consumers weigh how much to trust them based on their track record.

Well, we don’t do weather, but we’re committed to showing how our annual prognostications in corporate governance pan out. So before we unveil our guesses for 2015, let’s review the accuracy of our 2014 predictions.

In the first of four forecasts we predicted that 2014 would be the “year of director engagement with investors.” We went so far as to say that director talks with investors will begin to be “if not commonplace, at least widely accepted.”

We’ll take an A on that one. Engagement became the buzzword of 2014, with everyone from law firm Wachtell Lipton to the Council of Institutional Investors spelling out channels and guidelines for dialogue. What turbo-charged interest was, of course, the rise of activist investors and their targeting of even America’s largest corporations, once seen as impregnable. Boardrooms sought to strengthen defenses by reaching out to their big, long-term holders. Exhibit A: when SDX, the Shareholder-Director Exchange, held a recent workshop on dialogue in New York, it was packed with top corporate and investor executives.

If we scored a bull’s eye on our first prediction, we were wildly off the mark on the second. We projected that 2014 would be the year of fiduciary duty, with groundbreaking guidance from Britain’s Law Commission and new regulation from the U.S. Securities and Exchange Commission and Labor Department setting fresh standards for how investor agents behave as owners.

As it turned out, the Law Commission’s report went wobbly: It did open the possibility that funds can take broader environmental, social, and governance risks into account, but left ample room for interpretation. It broke barriers only in subtle ways that could take years to unfold in courts and practice. And on our side of the Atlantic? Nope; the expected major guidance on fiduciary duty remains stuck in the bowels of the SEC and Labor Department. The wait continues for yet another year.

Our third forecast was that 2014 would prove the tipping point when more top U.S. companies split the chair and CEO roles than combined them. As Maxwell Smart might have said: “Missed it by that much.” Spencer Stuart’s latest Board Index shows that a record-high 47 percent of S&P 500 firms divided the jobs in 2014. That’s up from 45 percent in 2013 and 37 percent in 2009—and still just short of the majority we predicted. Assuming trends continue, if the historic crossover point doesn’t happen in 2015, it will almost certainly come in 2016.

We guess that Gallagher, together with the U.S. Chamber of Commerce and allies in the new Congress, will move to related policy targets in 2015. On their wish lists: curbing long-standing rules governing shareholder proposals and repealing investor-backed provisions of the Dodd-Frank Act.

Finally, we prophesied that the issue of economic inequality would gain traction thanks to U.S. congressional elections and Pope Francis’s pivot from issues of personal morality to social fairness. Boards, we cautioned, “may have to be proactive, watching this trend and reviewing their social profiles to avoid criticism.”

We get a C- on that one. While it didn’t happen across the market, individual firms stumbled. The private equity firm Westbrook, for example, got burned in December when it sought to evict renters from a newly purchased property in London that it planned to develop into a high-income complex. The rich-versus-poor story that erupted forced Westbrook to sell its investment in a hurry. And in other markets, the inequality argument continues to play out in unforeseen ways. Most recently we saw a 50,000-strong protest that shut down central Dublin over the question of whether residents should have to pay water utilities anything at all for turning on the tap.

With that mixed record to judge us by, let’s turn to 2015. We start with an overarching, and disheartening, projection: the toxic polarization that we have seen in politics is likely to spread to the capital markets, in parallel to progress encouraging civility and engagement between investors and boards. What do we mean?

For one, we forecast an unprecedented assault on proxy advisers, despite their position as generally trusted resources for institutional investors. As we noted in our November column, SEC Staff Legal Bulletin 20 (SLB 20), together with the European Securities and Market Authority (ESMA) proxy adviser code of best practice, introduced new complaint protocols that give companies their first-ever open channel to target vote-recommending firms. SEC Commissioner Daniel Gallagher is emerging here as a point man. He has prodded corporations to monitor ISS and Glass Lewis reports for inaccuracies and to use new protocols to bring complaints to the attention both of investors and his personal office. We expect a wave of grievances aimed at discrediting the proxy advisory industry.

Commissioner Gallagher is involved in another offensive that could herald a return to sharp partisanship in 2015. In a highly unusual move, Gallagher co-authored a year-end academic paper with Stanford University’s Joe Grundfest accusing Harvard University of breaching securities law. The duo cited Harvard Law School’s Shareholder Rights Project (SRP) clinic, which used what they allege is inaccurate and misleading information to support shareholder resolutions calling for an end to classified boards. Yale Law School professor Jon Macey demolished the argument in twin analyses, but critics saw Gallagher and Grundfest’s far-fetched attack as the opening salvo in a drive to get SEC staff to quash more shareowner resolutions.

We guess that Gallagher, together with the U.S. Chamber of Commerce and allies in the new Congress, will move to related policy targets in 2015. On their wish lists: curbing long-standing rules governing shareholder proposals and repealing investor-backed provisions of the Dodd-Frank Act. Proponents are likely to try to slip measures into legislation President Obama might otherwise be inclined to sign. That, in turn, could trigger a counter-reaction in the shareholder community and fuel a new round of strident, adversarial clashes. We expect the return of proxy access as a flashpoint in 2015, for example.

The irony is that a breakout in hostilities, after several years of quiet, would come at the same time as boards and big investors make landmark, but discreet, progress in engagement. We predict those advances will continue, first because the activist threat to boardrooms will remain powerful in 2015.

But a second, under-the-radar reason is a phenomenon we have dubbed “i2i”—that is, investor-to-investor engagement. Funds are reaching out to each other more frequently to share perspectives. Some mutual funds, for instance, have developed internal metrics to determine which activists they can trust and work with, and which ones they should shun.

Our forecast is that large, like-minded public and sovereign wealth funds both in the United States and abroad will be speaking together more frequently about joint approaches on market-wide governance issues such as proxy access and board tenure. Such i2i dialogue among responsible investors will amplify their influence, making it that much more logical for corporate boards to engage with, rather than ignore, them.

Finally, we expect 2015 to usher in markedly improved reporting by audit committees and auditors—particularly in Britain, where enhanced reporting rules are taking root, but in the United States too. Parties increasingly see the value in a more detailed letter from auditors rather than fact-free boilerplate.

Watch this space in January 2016 to see if we beat your local weather forecaster’s record.