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Guerrillas in the Boardroom

Shareholder activists are getting smarter—and could soon claim their biggest scalp

Mario Tama/Getty Images News

It didn’t garner much attention, but earlier this month, the chairman of a Fortune 500 company was kicked out of his job, and it wasn’t by management. Shareholders voted out Ray Irani, the chairman and former CEO of Occidental Petroleum, at the company’s annual meeting, with 76 percent of investors denying Irani the post. Irani had planned to retire in 2014, but criticism of his outsized compensation package—he averaged over $80 million in annual salary over the past decade—and questions about his using the board to attempt to replace his successor, CEO Stephen Chazen, led to an early demise.

The Irani ouster was the latest in a flood of shareholder activism, hitting annual meetings of the largest publicly traded companies in America over the past several years. Over 600 shareholder proposals have been filed this year, including a vote by JPMorgan Chase shareholders on May 21 on whether to split the positions of CEO and chairman, which would ensure that Jamie Dimon does not hold both.

If this sounds like democracy in action, with shareholders expressing their preferences for the companies they own, and making their voices heard, that’s because it is. But it’s a very peculiar, American-style democracy, complete with unequal representation, lobbying, attempts to rig or delay voting and a byzantine set of rules. For that reason, it has often been often ineffective; but recently, activists have deciphered how to navigate this process and are increasingly changing corporate behavior. Across all types of proposals, activists have been very successful this year. As of April, activists won 66 percent of all proposal votes, compared to 51 percent in 2012.

Shareholder activism, which includes everything from union pension funds and socially responsible investors to hedge funds staging hostile takeovers of corporate boards, dates back to the 1940s, and the SEC’s adoption of Rule 14a-8. Under the rules, anyone with $2,000 worth of shares can file what is known as a proposal, which can get a vote at the annual shareholder’s meeting. “It provides a valuable opportunity for shareholders to convey concerns to management,” said Brandon Rees, the acting director of the AFL-CIO’s Office of Investment.

Most early proposals had to do with corporate governance, but the 1970s brought the first proposals on social issues, such as divestment from South Africa or environmental responsibility. Over time, however, socially responsible investors began focusing on corporate governance: the best way to get a CEO’s attention on an issue was by threatening to replace him. “I was head of corporate affairs for the Teamsters, blasting out proposals,” said Bartlett Naylor, now with Public Citizen. “I realized that you can’t get anywhere with ‘Be nice to your employees.’ But when we filed a proposal about splitting the chair and the CEO, it was amazing how the corporate secretary would want to come down to the Teamster offices and see what our concerns were.”

This shift, from making proposals designed primarily to generate headlines (“Activists Protest Annual Meeting”) to seeking real changes in the way corporations manage their affairs appealed to a broader spectrum of shareholders. “When you ask shareholders to vote, you’re not asking all Americans,” Naylor explained. “These people are making money on that company. So you have to use the tools available to you to get management to do what you want.” While the Sisters of Mercy and a Wall Street institutional investor like TIAA-Cref may define shareholder value differently, all have a common interest in protecting their long-term investments and increasing returns. While tighter controls on management and independent boards may not automatically lead to better working conditions or a more sustainable planet, socially responsible investors did find value in using their power as shareholders, particularly amid a wave of predatory corporate behavior throughout the last decade which had dire impacts on the economy. So while the social proposals continued, an unspoken alliance on corporate governance was struck.

The road to a shareholder vote, however, is fraught with obstacles.  Companies have recently implemented confusing notice periods to try and artificially limit proposals. They often challenge the validity of proposals with the SEC, arguing that they violate the technical rules governing the process. Companies argue that the activist stands to gain a personal benefit from the proposal, or that the proposal deals with a matter “relating to the company’s ordinary business operations.” One celebrated case from 2012 went even further: Chevron subpoenaed Trillium Asset Management, a sustainable investment group that sponsored several proposals in the past, for documents relating to their work. In another example, the U.S. Chamber of Commerce recently put out a study arguing that union-backed shareholder activism doesn’t increase shareholder value, in a clear attempt to stop the surge in proposals. Said Brandon Rees, “A lot of these companies have a view that any vote against management is a wrong vote.”

More often, companies try to pre-empt shareholder proposals by meeting with shareholders and reaching an agreement acceptable to both sides that gets the proposal withdrawn. “About one-third of these cases come to agreements,” said Tim Smith, a longtime activist shareholder with Walden Asset Management who files about twenty-five proposals a year. “We don’t always get everything we want, but we often at least move the needle.”

When a company and activists cannot come to agreement, the proposal goes before shareholders at the annual meeting. The company can place arguments opposing the proposal into the proxy statement that goes to shareholders. Activists have their own letters they send off. And the campaign to influence big shareholders who control lots of votes begins. Some of that process involves a relatively obscure pair of organizations, Institutional Shareholder Services (ISS) and Glass, Lewis & Co. These are known as shareholder advisory firms, and they wield significant influence over the outcome of the more controversial proposals.

Investors argue that the advisory firms serve as a good way to get a quick sense of a proposal, almost like a Cliff’s Notes for asset managers. Some funds not only take advice from shareholder advisors, but vow in their bylaws that they will follow any recommendations the advisors give. Even if clients of advisory firms do their own independent analysis, studies have shown that ISS and Glass, Lewis can sway as much as 10 percent of the vote on a shareholder proposal; others put it at 25 percent. So activists will meet or share information with the shareholder advisory firms, in the hopes that the firms will recommend their proposals. ISS and Glass-Lewis often do so (73 percent of the time this year), which is why corporate lobbyists have petitioned policymakers to regulate them, to reduce their impact.

So far, corporations haven’t succeeded in shutting down shareholder activism; in fact, the victories have only accelerated. “In the 1980s, a proposal for annual director elections would get something like 10-15 percent of the vote,” said Rees. “Today they get 80-90 percent support.” Less than a third of boards of S&P 500 companies are not selected through shareholder elections, down 50 percent from 20 years ago.

Even votes that fail can lead to changes. “It opens the door for greater communication between management and shareholders,” says Walden’s Tim Smith. Activists also use proposals to try and influence regulators to codify rules across the system—numerous proposals this year demanding disclosure of corporate spending, on political campaigns and lobbying, send a clear signal to the SEC. This has worked in the past: Laws like auditor independence and independent compensation committees started as shareholder proposals.

The Dodd-Frank financial reform law put in place a mandatory non-binding vote called “say on pay,” giving shareholders the chance to weigh in on executive compensation packages. Though say on pay has no force of law, in two high-profile cases in 2012 where shareholders rejected compensation plans, at Citigroup and Chesapeake Energy, not only did they both reform their compensation packages, but both companies’ CEOs were subsequently dumped. The AFL-CIO consciously looks at companies who lose their say on pay votes, subsequently filing more specific executive compensation proposals that would force changes.

The biggest test case for shareholder activism this year is at JPMorgan Chase. The company has resisted splitting their chairman and CEO position, a proposal filed by investors holding $320 billion in assets. Building on the general lack of confidence in corporate boards to properly oversee management, especially since the accounting scandals of Enron and WorldCom in the early 2000s and the financial crisis of 2008, activists believe that CEOs cannot credibly oversee themselves. And studies point to higher shareholder returns at companies that split the two roles. This is particularly acute at JPMorgan Chase, where a wave of scandals and regulatory violations raise serious questions about the company’s internal controls, and the company’s stock price trades below its asset value. The real-world consequences to this lack of oversight are obvious from the Great Recession.

Lisa Lindsley, Director of Capital Strategies at AFSCME and a co-sponsor of the proposal, explained that JPMorgan Chase barely reacted at all to their initial filing. “We held one phone call with their corporate secretary, who didn’t seem to take it seriously at all,” Lindsley said. “Perhaps they think they’re beyond reproach. It speaks to the insular nature of the board.”

Glass, Lewis and ISS have recommended splitting the positions, siding with activists. Other large investors, like Warren Buffett, have sided with Dimon, and the board of directors endorsed him as well. In an attempt to lobby the last holdouts through threats, Dimon has warned that he would quit JPMorgan if his roles were split. With the three largest shareholders of the company—institutional firms BlackRock, Vanguard and Fidelity—still undecided, the outcome remains in doubt.

Success in this proposal won’t mean that JPMorgan will suddenly become a model of sound corporate governance overnight. But an independent chairman would at least have a chance to exhibit some oversight at a dysfunctional company. And it could cause yet more ripple effects through corporate America, which now must deal with the biggest threat to their status quo in decades: their own shareholders.

David Dayen is a freelance writer based in Los Angeles.