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Director-Investor Communication Is Coming. Here’s How to Do It

Stephen Davis and Jon Lukomnik | July 7, 2015

for DeAnnIf the surprise-packed 2015 proxy season carried any lesson, it was that the era of shareholder-director communication has arrived—especially as an antidote to (or a prophylactic against) the challenge of activist investors.

But just when you think a practice is settled, new uncertainties pop up. Some bear special attention, as they carry potentially profound consequences.

First, it’s true that many companies and advisers now accept that at least some directors should have the task of communicating with investors in their job descriptions. But directors are only just beginning to address whether they have engineered the right channels to get accurate information on what their shareholders think about them. Many firms rely on the investor relations officer to report regularly to boards on what their investors are saying and doing. But listen to what T. Rowe Price governance chief Donna Anderson said in June at the International Corporate Governance Network 20th anniversary conference in London: “When IR gets involved,” she noted in a panel on ownership, “it ups the hot air quotient.”

She wasn’t criticizing IR professionals, just noting that they are often best at relating to portfolio managers about quarter-to-quarter business issues. Governance executives at funds have a longer-term and more structural focus. When Anderson and her counterparts want to tackle a governance issue, the first stop is usually the governance officer or corporate secretary, who often is in the general counsel’s office.

So boards should get an intelligence briefing on investors from both the IR staff and the governance chief. That way they hear “in stereo,” so to speak, not just how the stock is trading, but also how funds may vote their shares. Some corporate directors at the ICGN conference went further, advising that boards hear directly from funds.

That approach may be taking hold. At a Harvard Law School roundtable in June, two big mutual funds reported that they had recently made presentations to full corporate boards on how they view governance issues both specifically at the company, and more generally. That’s a new phenomenon, which the governance managers say had a two-way payoff: The investors learned as much from the board as directors learned from the investors.

Now, we may not see a lawsuit anytime this year alleging director breach of fiduciary duty if a board fails to hold meetings with investors. But a dose of direct information may be the ounce of prevention that smart boards use to avoid a pound of cure in the form of derivative lawsuits, messy proxy fights, and activist battles.

It’s also the latest indication that high-level communication is proliferating, even while short of such full-court summits as the two mutual funds disclosed. One huge fund at the Harvard event reported that 20 percent of 1,400 engagements this year involved corporate directors. Last year, the fund said, meetings with directors amounted to just half that number.

One Wall Street adviser to corporations agreed, noting that most client firms had never reached out to index funds—but were doing so now, through directors. In fact, a few companies have launched governance road shows alongside conventional road shows. Such exercises put board members into direct touch with governance professionals at funds.

But here’s the new wrinkle, brought to the surface in a panel discussion hosted in May by Lazard. “Knowing what major shareholders are thinking has become a de facto part of the duty of care,” Lazard’s Corporate Preparedness Group wrote in a summary of the discussion. “It is not sufficient to rely on management.” In other words, the Lazard panel opined, it has become critical for directors, as a feature of fiduciary duty, to hear directly from their shareowners rather than having investor messages mediated by corporate executives.

Some corporate directors at the Harvard roundtable agreed. Said one: “Boards must have a process to guarantee that they get direct information from the investors—because executives may harbor a tendency to shoot the messenger.” Funds at the Harvard roundtable also backed that approach; they contended that, whether they meet with directors or executives, the full board should be informed with as little filtering as possible.

That makes sense; involved directors have often sought information sources other than corporate management in many areas, from reading sell-side research reports to monitoring social media opinions in order to gauge customer satisfaction so as to exercise their fiduciary duties. With governance issues increasing in importance, it was only a matter of time until directors applied the same thinking to them.

Now, we may not see a lawsuit anytime this year alleging director breach of fiduciary duty if a board fails to hold meetings with investors. But a dose of direct information may be the ounce of prevention that smart boards use to avoid a pound of cure in the form of derivative lawsuits, messy proxy fights, and activist battles.

Talking the Talk

A related uncertainty is also arising this year. It has long been commonplace that lawyers warn boards against engaging with investors for fear of exposing directors to the legal peril of breaching Regulation Fair Disclosure. Either leave the job to management, they urge, or if directors have to meet with investors, say nothing substantive.

We have often disagreed—as has U.S. Securities and Exchange Commission staff guidance. We contend that Reg FD is no barrier to communication on governance issues. But this year it became increasingly clear that halfway measures such as one-way engagement are not what shareholders want. “We prepare extensively for meetings, and we want to hear what directors think; so it isn’t helpful if they are just in listening mode,” said one governance chief at a large fund complex.

On the other hand, not all directors are skilled at two-way dialogue with investors. As T. Rowe Price’s Anderson added at the ICGN, “Most directors aren’t good at engagement … when they do it, it sometimes doesn’t go well for the company.”

So should boards only field “camera ready” directors in such outreach? Investors are split on that, judging from a recent EY roundtable on corporate governance in New York. Some preferred to devote time only to directors skilled at engaging. Others said they sometimes get more from directors who may be, ahem, less than smooth, so long as they know the company.

Either way, investors agreed that any director engaging with them must have dossiers on who the investors are, their interests, and their concerns. “We are a long-term investor,” one fund representative said, “so don’t send us a director who just wants to talk about a bad ISS recommendation at an upcoming meeting.”

As proxy season 2015 gives way to summer, now may be the time to incorporate such engagement lessons.