The Best Policy

The War on Shareholder Activists

A shocking D.C. court decision that stops shareholders from nominating independent, new corporate directors.

Mean judge.

Last week, a conservative panel of judges on the D.C. Circuit’s Court of Appeals—the second-most important court in the land—struck down an effort to inject a tiny bit of democracy into corporate governance.

The back story is a bit turgid, but bear with me. The SEC, in an effort to enhance shareholder rights, enacted a rule that permitted shareholders who have owned 3 percent of a corporation for at least three years to nominate a slate of directors in opposition to those proposed by the incumbent board of directors. Additionally, the company would be required to circulate the alternate slate’s names, and a brief statement, in conjunction with the board’s own nominated slate of directors. This rule was a small step toward turning the now perfunctory process of board elections into true democracy.

The D.C. circuit struck down the rule (PDF), saying that the SEC had acted in an arbitrary and capricious manner, not adequately considering the costs to corporations of burdens imposed by being required to include and circulate this information. Corporations, of course, spend untold millions promoting and compensating their entrenched incumbent board members. Yet even this one small effort to open the door to corporate democracy was slammed shut.

Why does this matter? There are really only three ways to change the behavior of a public corporation: regulate it, litigate against it, or use one’s ownership position to alter management behavior. We have lived through a period of failed corporate governance, and these failures contributed to the economic cataclysm of ‘08. Given how badly corporations failed us, we have an obligation to pursue all three methods of reform. Those who want to maintain the existing failed structures have pushed back vigorously against all of them.

The Dodd-Frank law was the effort to use regulation to change corporate behavior. And we know how Wall Street and the Chamber of Commerce have been pushing back against its mandates, working hard to repeal, defund, limit, or delay it.

Litigation to correct corporate behavior has a narrower range. It is available when behavior has been illegal, not when it merely reflects poor judgment. Even so, corporate America has fought back viciously when state attorneys general or the Department of Justice try to bring structural litigation to alter corporate behavior. Here I speak from experience. Back in 2003, our efforts in the New York state attorney general’s office to stem the tide of sub-prime debt was deemed an egregious violation of our role and successfully halted by the banks with the assistance of President George W. Bush’s federal regulators. Surely, the voices of the plutocracy proclaimed, the corporate titans knew what they were doing! The facts now speak for themselves.

So all that is left is trying to change corporate behavior from within. Those shareholders who try to influence the behavior of management ought to get a more welcome reception, right? After all, management is legally bound to act on behalf of shareholders and owes them a fiduciary duty, an obligation of loyalty. So how have the traditional voices of corporate leadership reacted when asked to provide a greater opportunity for their owners to participate? Just as they did when responding to regulators or litigators.

In unison, the voices of management said: Leave us alone. We know better than you. Even though you may own the company, we are better equipped to decide what to do than you.

CEOs and board members afraid that shareholders will actually be able to select a new slate of candidates are acting just as politicians do when they are supposed to represent the public but are really afraid of democracy. The D.C. Circuit’s opinion is the same as a decision made by old party bosses in a smoke-filled room. What gerrymandering is to politics, limiting board nominations is to corporate governance. Protecting incumbents is the goal, not serving the best interests of voters or the corporation.

Those who all along have rejected the notion that there are any flaws in our economic policies or corporate governance are now struggling to build retaining walls to resist even minimal efforts to allow ownership control over management. They have figured out how to push back against all three of the mechanisms available to bring reform – regulation, litigation, and shareholder control. In the end, their push back will lead only to the entrenchment of failed governance. And from that, we all suffer—owners and consumers alike.