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Financial Choice Act Passes the House, With Major Changes in Proxy Proposal Rules:

ISSUERS; BEWARE OF GETTING WHAT YOU WISH FOR, WE WARN…

The oddly and inaptly named “Financial Choice Act” which, among other things, makes a feeble first attempt to repeal and replace Dodd-Frank, has passed the House, with not a single Democratic Party vote, as expected. It has three proposals regarding shareholder proposals that should provoke a vigorous debate when the bill is taken up by the Senate:

• Shareholder proponents would have to have 1% of the outstanding shares, held continuously over a three year period.

• The resubmission thresholds (consistent with the SEC’s old 1997 proposal that was never adopted) would rise to 6% on first submission, 15% on the second submission, and 30% on the third submission)

• Shareholder proposals would have to be proposed by shareholders themselves, and not by any designated “proxies” - which a few proponents have tried to sneak in to avoid the current one-proposal-per-proponent rule.

Here’s our take on this, as 50+ year observers of shareholder meetings and the rise and fall - and sometime successes - of shareholder proposals:

Right now there is a pretty good chance that the bill as a whole will not make it through the Senate. Surely there are much bigger legislative challenges that need more attention, and more urgently, than these offhanded and highhanded swipes at very longstanding individual investor rights, which, as our recent article on the Gilbert brothers noted, date back to the 1940s. But there is at least one set of decent proposals in the bill - to loosen regulation and capital requirements at smaller financial institutions - that might well drive the overall deal along.

The use of “proxies” to evade the current rules can be handled directly by the SEC…which indeed, they should attend to, we say.

The revised resubmission thresholds - which the SEC could also institute on its own, after a written release and comment period - are not terribly draconian, although 5%, 10% and 20% hurdles have better “optics” that may make them a lot more palatable. They might reduce the number of proposals put forth each year, as the Business Roundtable desires…but not necessarily so, since serial proponents can simply move on to other companies, while maybe submitting different proposals at companies where they failed to make the mark…as proponents have been doing forever.

The real deal-killer, if dealings are begun, is likely to be - and should be - the 1% of the outstanding share threshold that’s being proposed: As activist investors were quick to point out, this provision would rule out the participation of ordinary individual investors altogether…And guess what, most institutional investors would be squeezed out too at most large-cap companies, even if many of them band together: An investor in Apple - with its $745 billion market cap - would have to have seven billion dollars-worth of shares to put a proposal forward.

Our own big concerns however, revolve around the likely consequences to issuers of “getting what they wish for” - which, we believe, would likely be very negative ones.

First, we’d note, rather cynically - but based on our many years of attending meetings and tabulating votes - that having a few seemingly offbeat or even frivolous proposals on the ballot is often a good thing for corporate citizens, in that they create a nice aura of “shareholder democracy in action” - but often serve to distract voters from the truly important issues on the agenda or in the air. (Why, for example, did so many corporate chieftains send cars for - and in a few cases give cars to Evelyn Y. Davis - surely the peskiest and most audience-annoying gadfly ever?)

But to put small-shareholder proposals in a more positive light, as they should be put and as we have written over many years, shareholder proposals serve as a sort of “pressure gauge” that often provides an early warning to companies that there is some level of shareholder discontent. And they often provide a useful way for shareholders to “blow off a bit of steam” rather than to have issues suddenly “explode” at the meeting itself.

We especially need to note that virtually every one of the corporate governance practices we now take for granted - like nominating women to the board, having majority voting rules, and even ‘proxy access’ were first proposed by smaller shareholders - and typically received negligibly low votes for many years before ultimately catching on with investors. The campaign to “end the stagger system,” which was begun in the 1940s by individual investors Lewis and John Gilbert – which typically received less than 20% of the votes cast through the 1990s - became nearly universal in just a few short years. The annual election of directors is now considered a “best practice” by stock exchanges and by U.S. companies.

An April whitepaper drafted by Ceres, ICCR and US IF (the US Sustainable Investment Forum) made perhaps the most important and under-remarked-upon point of all; that the shareholder proposal tradition “helps investors to protect their ownership rights and interests” [and to assert them, we’d add] “and helps to hold corporate boards accountable to the owners of the corporation.”

Last, but far from least, it is downright dumb to think that the Cheveddens and Steiners and McRitchies of the world would simply slink away. Nor would we expect many of the largest and most active institutional investors to quietly

accede to the idea that this bill provides issuers - or investors - with some sort of meaningful “financial choice.”

Here’s what Anne Simpson, Investment Director, Sustainability at Calpers, the biggest U.S. public pension fund had to say: “This raises the bar for entry to ordinary investors and would make shareholder proposals a billionaire investor’s privilege, when it should be a right for all investors….If this channel is closed off, investors will have to exercise their votes in other ways...That would be unfortunate.” 

We’d bet the ranch that activist investors of many stripes would band together to create more agitation – and more and better-crafted shareholder proposals than ever before, “on principal.” But also, as Simpson suggests if one reads between the lines, companies that stiff-arm reasonable investor requests will find their Nominating Committee directors, and others - being targeted by Vote No campaigns, and sometimes losing.

Lastly, as we have noted many times before, corporate governance has become a huge and profitable business for literally thousands of mostly intelligent and pretty crafty players…So issuers, do, please, be alert to the potentially dire consequences of getting what you wish for before jumping on the Business Roundtable’s bandwagon.