Long hot summer? Fall will be no cooler. Washington’s workload is high. As implementation of Dodd-Frank grinds along—159 down, 241 to go as of Year One, reckons a Davis Polk memo— two issues inspire talk: political action committees (PACs), and proxy access struck down, but not dead. In addition, some arcane aspects of Dodd-Frank are in focus—e.g., security-based swaps and the Volcker Rule. Proxy plumbing is getting attention, and the enforcement staff of the Securities and Exchange Commission is exerting new subpoena power. Meanwhile, debt rules.
Associated Press
Political Spending Under Scrutiny
The American humorist Will Rogers once famously complained, “Politics has become so expensive that it takes a lot of money even to be defeated.” After the Summer of Scandals, we might add that it takes a lot of money to resign as well. The fact is that politicians need money to run campaigns, whether they win, lose or go down in flames.
More than ever, corporations want to help any politician likely to do a good job for business. There’s a catch, though. Under federal election laws, corporations may contribute directly to local campaigns, but they must form political action committees to donate to federal elections (for president, vice president or Senate). The Supreme Court case Citizens United v. Federal Election Commission in January 2010 affirmed the company’s right to form such committees. Boosted by this decision, PAC expenditures rose last year to a record $305 million—more than four times the levels seen for the midterm elections in 2006, based on Federal Election Commission records compiled by the Center for Responsive Politics.
Of this amount, about one-third was donated by liberal groups and two-thirds by conservative groups. Numbers for 2011 were uncertain as of mid-year. Some 92 of the 439 sitting members and delegates in the House failed to meet the May 15 deadline for filing annual financial disclosure forms, and 20 of 50 Senators were late as well. Given the approach of the 2012 elections, numbers are likely to rise compared to 2010.
As corporations spend more to influence Washington, shareholders are doing more to influence corporate spending. President Obama is reportedly working on an order to require federal contractors to disclose the past two years’ worth of political contributions. A Reuters report quoted White House spokesman Eric Schultz as saying, “The draft executive order is still in draft form and undergoing review. But broadly speaking, the President is committed to improving our federal contracting system, making it more transparent and more accountable.”
Shareholders are busy on the PAC issue too. During the spring 2011 proxy season, shareholders at more than 80 companies voted on resolutions to make companies disclose political spending. Of the Fortune 100, more than one in three received political spending proposals this year—up from one in five the previous three years, according to Proxymonitor.org. The resolutions—from pension funds, unions and socially oriented investment funds—met with mixed success, yet some prevailed. Like last year, overall support was around 30 percent, but this year, a political spending resolution at Sprint-Nextel filed by the AFLCIO got a 53 percent vote—a sign of the times as the 2012 elections approach.
Proxy Access: The Sequel
One of the best-known provisions in Dodd-Frank was one granting the SEC authority to issue rules on proxy access. The Business Roundtable and the U.S. Chamber of Commerce successfully challenged this authority in court, but supporters, including Ann Yerger of the Council of Institutional Investors, have vowed to keep fighting for it. A special task force of the American Bar Association has been tackling the topic of “Impact of Federal Government Initiatives.” The group, co-chaired by former SEC Corporate Finance Division head Alan Beller and Allen C. Goolsby III of Hunton & Williams, includes many of the country’s most experienced and brightest legal minds, including Leo J. Strine Jr., recently named Chancellor of the Delaware Chancery Court, and Holly Gregory, partner of Weil Gotshal.
The task force is drafting a revision to the Model Business Corporation Act (MBCA) to deal with director qualifications; it may also produce a white paper. In the minutes to its most recent meeting, participants noted that companies could prepare for any future proxy access rules by setting limitations on director qualifications, as long as the qualifications were not discriminatory or unreasonable.
Currently, the MBCA has no real guidance on the appropriate limits of director qualifications. The same applies to corporation statutes and case law. Most of the mandatory director qualification provisions deal with residency and/or shareholder status. The Delaware case Stroud v. Milliken says that director qualifications have to be “reasonable,” but this is not defined. Some companies have addressed these topics in their governance policies but very few have addressed director qualifications in their bylaws or charters.
Swap Owners Revealed
Effective July 16, a new Dodd-Frank-inspired rule on Beneficial Ownership Reporting Requirements and Security- Based Swaps (one of seven swap-related rules proposed so far in 2011) clarifies that an investor holding a swap should still be considered a beneficial owner for the purpose of reporting ownership, and should refrain from short-swing trading. While swap holders, as investors, might want to avoid these requirements, companies need to have them in place so that they can know their owners and their owners can’t arbitrage.
This represents an evolution of focus for SEC Chairman Mary Schapiro. One of her first actions upon becoming chairman was to tape a sign on her door that read, “How does it help investors?” Yet the SEC has a broader mission. As stated on its website, “The mission of the U.S. Securities and Exchange Commission is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.” Fortunately, the SEC has not ignored these additional two parts of its mission.
Volcker Rule Challenged
Another hot topic is the so-called Volcker provision within Section 619 of Dodd- Frank, which would bar proprietary trading by banks, stipulating that only trading for customers be allowed. The provision is part of a larger, unimplemented proposal by former Federal Reserve Bank Chairman Paul Volcker intended to help reduce the kinds of risks caused by seemingly unholy alliances among different kinds of financial institutions—the giant lending/brokerage/investment banking/ insurance combos in “diversified financial institutions” that arose in the last decade after Glass-Steagall was repealed. Some believe that financial “modernization” transferred undue wealth to the financial sector. As the 2008 crisis showed, this growth created a leverage that put our real economy (money made from products and services, not just interest and fees) at risk.
The Volcker Rule seems sensible, but for small businesses there may be an unintended consequence. The June 2011 report of the SEC Government-Business Forum on Small Business Capital Formation, which issued a report in June, included participants from the Biotechnology Industry Organization, National Association of Small Business Investment Companies and the National Venture Capital Association. All took issue with the Volcker Rule, along with several other provisions of Dodd-Frank.
The small-business funders object to saddling small private-equity funds with the same measures intended to curb mega-billion- dollar hedge funds: “Often confused with hedge funds, [which] in volatile situations can affect the nationwide economic outlook and pose a systemic risk, small-business private-equity funds investing in only a tiny fraction of the total U.S. economy and bank capital…do not pose a systemic risk.”
In implementing the Volcker Rule, the report stated, the government should make it clear that “systemic” risky practices do not apply to the small-business sector: “If these funds were forced to adhere to the same policies reserved for systemically risky entities, then the result would be extremely detrimental to the small-business owners that rely on this niche small-business investment industry as a primary source of patient capital.”
Proxy Plumbing Redux
Now, with Dodd-Frank implementation well underway, the SEC is returning to a more systemic issue—the U.S. proxy system. It’s now been more than a year since the SEC released its 40-page concept release on this topic, nicknamed proxy plumbing. Concerns include:
- Accuracy, transparency and efficiency of the voting process (including disclosure of share ownership)
- Communication and shareholder participation (including company communications with beneficial owners)
- Relationship between voting power and economic interest (including the role of proxy advisory firms)
This last issue is likely to be the main focus of the SEC, as some corporate leaders are concerned that there is not enough transparency about how recommendations are developed. In our comment letter last fall, NACD recommended more transparency and independence: “Companies should be able to understand the standards by which they are being judged, and advisors should be free from any conflicts of interest.”
Broader Subpoena Power
In June, the SEC amended its rules to give authority to the director of its Division of Enforcement to “issue witness immunity orders.” These orders, channeled through the Department of Justice, can force individuals to give testimony or provide other information under pain of prosecution.
Previously, the SEC’s enforcement director had to submit the requests to the full Commission first. Because the new rule was considered an internal matter of SEC operations, it did not have to go through a notice and comment period. The rule is intended to “increase the effectiveness and efficiency of the Division’s investigations.” The change could help the SEC cast a wider net more quickly when conducting investigations in response to complaints under the whistleblower bounty provisions of Dodd-Frank.
Corporate boards would be well advised to prepare now for such complaints. Directors need to ensure that companies have not only a strong compliance program but also a process for internal investigations if and when a complaint results in a federal investigation. While there is some chance that this Congress (or a future one) will overturn the whistleblower bounty rule; for now, it is the law of the land.
Debt Rules
Last, but not least, there’s a new entity in town, the Joint Select Committee on Deficit Reduction, established by the Budget Control Act of 2011, and chaired by Sen. Patty Murray (D-Wash.) The 12-member bipartisan group will propose ways to balance the government’s budget. In addition to slashing expenditures, it could eliminate some corporate tax breaks. Boards can ask management to explore and explain the potential impact (“where are we vulnerable?”) The Committee has until Nov. 23 to report its recommendations to Congress, which must then vote on them by Dec. 23.