The biggest threat to free-market capitalism today may not be coming from the Democratic majority in Congress, but from the Republican majority at the Securities and Exchange Commission. At issue is shareholder access to company proxy statements, a seemingly esoteric subject, but one that has profound implications for economic freedom in the United States.
The SEC purportedly is considering a rule that would allow shareholders with as little as a 3 percent stake in a company to nominate directors to that company, with the requirement that those directors be include on the company’s proxy statement. The result would be special interests — primarily labor unions through their pension funds — gaining seats on corporate boards, or using the threat of director nomination to leverage their anti-market agendas.
In September, a circuit court ruled in favor of the American Federation of State, County, and Municipal Employees pension plan in its case against AIG, the large insurance company. AFSCME wanted to place a shareholder proposal in the company’s proxy materials that would have changed the bylaws in order to facilitate shareholder nomination of directors. Essentially, the union was trying to make an end-run around the SEC rule that allows companies to exclude shareholder proposals related to an election. The court, finding ambiguity in the SEC rules, required the SEC to clarify.
The simple and well-advised SEC fix would be to make clear that such bylaw amendments can be excluded. Unfortunately, pressure from so-called “shareholder activists” makes it possible that the SEC will allow such proposals. Indeed, there are now some indications that the SEC may go further, adopting a rule similar to the one then-chairman William Donaldson proposed in 2003 that would require companies to include shareholder-nominated director candidates on their own proxy statements. Shareholders with stakes as small as a 3 percent could be given this power.
Existing rules do not preclude shareholder activism. Dissident shareholders can and do mount proxy fights to challenge company-nominated slates of directors, but they do so by distributing their own proxy materials at their own expense. Moreover, the listing standards for both the Nasdaq and NYSE require that boards be composed of a majority of independent directors, who themselves comprise the search committees for new directors. It is exceedingly unlikely that shareholder groups can do a better job of hiring directors than search committees and the professional executive search firms on which they rely.
To understand what this is really about you need only look to the plaintiffs in the case that triggered this situation. By way of their pension funds, unions have big stakes in virtually every significant corporation today. A shareholder-access rule would allow them to achieve through the backdoor what they have been unable to accomplish through honest collective bargaining. Card-check agreements would be just the beginning since the unions will insist not only on leveraging the companies they have stakes in to unionize, but will place the same demands on corporate partners and suppliers. The unions could undermine free trade by requiring companies to shift away from foreign suppliers, or by pushing an anti-market dream list of measures — ranging from Kyoto-like carbon restrictions to interference in foreign policy through the manipulation of defense contractors. Empowering unions and other pressure groups to influence corporate-governance decisions on this basis will substitute coerced political judgment for business judgment.
That’s called socialism.
The direct and indirect costs of granting shareholder access to proxy materials are considerable, and would represent another reason for companies to avoid or exit U.S. public capital markets. (Note that the U.S. already has declined to third place in new public offerings, behind London and Hong Kong, under the regulatory strains of Sarbanes-Oxley.)
The Securities and Exchange Commission may feel that some form of shareholder access is inevitable, and that it can use rulemaking to provide some certainty. SEC chair Christopher Cox, a staunch supporter of economic freedom, should resist the inevitability argument, fight the good fight, and avoid what could amount to a pre-emptive surrender. The SEC should not adopt a rule that in large part would surrender corporate governance to anti-corporate interests.