Festivus, Fortnite, and the SEC’s relationship with institutional investors

They all managed to be touchpoints in a Tuesday speech SEC Commissioner Hester Peirce delivered at the Council of Institutional Investors spring conference.

“Institutional investors are the market’s repeat, long-term, and bulk players. Costs that are not important to the occasional investor add up to amounts that matter greatly to investors that trade frequently or in large size,” Peirce said. “It is helpful for me to know, for example, the types of information you find to be material in making decisions about where to trade. More generally, your voices are very important in discussions about whether and how to change market structure in both the equity and the fixed income markets. In particular, you have emphasized the importance of market transparency in our thinking about effective market structure.”

Peirce noted her particular appreciation for CII’s suggestions regarding the use of blockchain technology to track proxy voting and address other concerns in that process. “In addition to advocating systemic changes, you have made some suggestions for ‘near term improvements,’ including recommending changes to assure vote confirmation. I especially welcome your thoughts when they are different from my own. While I remain skeptical of the value of the mandatory use of a universal proxy card, I realize that you, among others, disagree with me, and I find your thoughtful advocacy in favor of universal proxy cards to be helpful as I seek to fully think through the issue.”

After praising, but not necessarily agreeing with, CII’s opinions on disclosure reform and the use of dual-class shares by issuers, Peirce, saying that “speeches are not very interesting if they only focus on points of agreement and appreciation,” segued into the famous “Festivus” episode of Seinfeld. She repurposed dialogue from George Costanza’s father on the fake holiday’s Airing of Grievances: “I got a lot of problems with you people, and now you’re gonna hear about it.”

“What then do I have to complain about?” Peirce asked, turning to yet another pop culture phenomenon to make her point. She recalled a recent conversation with a boy who obsessed with the video game Fortnite.

“He described to me how much he enjoyed long stretches of playing the game, which I found surprising given that he is a great athlete and generally one of the most active boys I have ever met. Indeed, if I had just a tenth of his energy, I would be champing at the bit to reverse every last delegation of authority to the SEC staff just so I would have enough to do,” Peirce said. “How is it, then, that a boy who has so much energy can sit still in the virtual world of Fortnite? How is it that this simulated environment can drown out the real distractions around him?”

She “sees a parallel” in today’s investment world. 

“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. The pressure, however, to get on the bandwagon and drag others with us is pretty intense,” Peirce said.

“We are being asked more and more to shift securities disclosure to focus more on matters that do not go to an assessment of how effectively companies are putting investor money to work,” she added. “Indeed, in some instances, we are being asked to make it harder for companies to use their resources effectively. I will talk about several examples, but my list is only illustrative of a broader trend that concerns me because I do not think it is consistent with investor protection.”

To cite a specific example, Peirce raised concerns about CII’s position with respect to a recent Johnson & Johnson shareholder proposal.

A Johnson & Johnson shareholder submitted a proposal that, if approved, would have started the process to shift shareholder disputes with the company to mandatory arbitration. Johnson & Johnson sought the SEC staff’s concurrence under Rule 14a-8 with the company’s decision not to include the proposal in its proxy. While that request was pending, the New Jersey Attorney General submitted a letter stating that adoption of the proposal would violate New Jersey state law. CII also submitted a letter stating that “shareholder arbitration clauses in public company governing documents reflect a potential threat to principles of sound governance.” Deferring to the Attorney General’s interpretation of his own state’s law, the SEC staff granted the company permission to reject the proposal. 

“Without engaging on the issue of any particular state’s law, I will say that the New Jersey A.G.’s letter does not help us to confront how federal law would interact with a bylaw provision like the one proposed,” Peirce said. 

CII argues 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.” Among its worries is the non-public nature of arbitration and thus the absence of a “deterrent effect,” Peirce explained. “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.” 

“Additionally, such suits can depress shareholder value since they often result in costly payouts to make the suit go away that do not inure to the benefit of shareholders. Indeed, the cost of defending and settling these suits is a substantial cost of being a public company. The result is that the company’s shareholders are ultimately harmed by the very option intended to protect them—first by the company’s diversion of resources to defend often meritless litigation, and second by the resulting decline in the value of their shares,” she added.

On the broader question of shareholder proposals, CII has recently argued against changing the SEC’s current Rule 14a-8. “The current thresholds permit, indeed encourage, a handful of shareholders to put forward proposals that incur considerable costs borne by all shareholders,” Peirce said. “Shareholders are able to submit losing proposals over and over again. 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.”

“Ultimately, many companies faced with a proposal, even one that reflects the idiosyncratic preferences of a small number of shareholders, 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 who have not been part of the process,” she added.

Another area where Peirce and CII may not see eye to eye: the push for new types of disclosure. 

CII, for example, has supported efforts to require companies to disclose information about board members’ personal characteristics. SEC staff did just that a couple weeks ago when the Division of Corporation Finance issued new compliance and disclosure guidance related to disclosures of board qualifications

“Despite the emphasis on self-identification, I worry that this staff ‘expectation’ will work with other pressures to force reticent board members and nominees to divulge personal details they would prefer to keep private. I hope that I am wrong,” Peirce said. “A person who does not want to share his sexual orientation, religion, or ethnic background with the world may face pressure to do just that in order to allow the company to get ‘credit’ for having a diverse board. What happens when a person decides to convert to a different religion or discovers that she has a different ethnic or cultural heritage than she previously understood? Would these changes require her to notify the board for potential reconsideration of her board membership? Will decisions that are, for some people, of an intensely personal nature suddenly become the stuff of 8-Ks?”

Institutional investors also have been a strong voice in favor of regulation that supports the incorporation of environmental, social, and governance in investing. The International Organization of Securities Commissions issued a statement, in January, directing issuers to consider whether ESG factors should be included in their disclosures. It endorsed the use of private disclosure frameworks purportedly designed to get at these factors and suggested that some disclosures now being made voluntarily under these frameworks should be incorporated into these disclosures. The SEC did not vote on the statement and did not sign on.

“I found the statement to be an objectionable attempt to focus issuers’ on a favored subset of matters, as defined by private creators of ESG metrics, rather than more generally on material matters,” Peirce said. “Explicit consideration of ESG factors must therefore require something more than what is already contemplated by our laws and by our longstanding definition of ‘materiality.’ Issuers already spend considerable amounts of money complying with existing disclosure requirements. Requiring disclosures aimed at items identified by organizations that are not accountable to investors unproductively distracts issuers.” 

“I do not believe that investors are best served when our staff is distracted by matters unrelated to our core mission,” she added.