Tuesday, July 22, 2014

Should Pension Funds Police Corporate Governance?

Author: David Schwartz J.D. CPA

It is often said that good corporate governance helps reduce a company’s investment risk, ensures the effective deployment of shareholder capital, and ultimately contributes to the long-term performance of public companies. . . On the other hand, the absence of a robust corporate governance infrastructure can lead to poor decisions resulting in bad outcomes for the company and its shareholders. 

SEC Commissioner Luis A. Aguilar has long been a champion of empowering shareholders to enforce sound corporate governance.  In a July 1, 2014 address before a meeting of the Latinos on Fast Track (LOFT) Investors Forum, Commissioner Aguilar once again addressed the role pension plans and other institutional investors play in ensuring that the companies they invest in make sound governance decisions.  Not only are pension funds obligated to vote their shares, according to Aguilar, but they should also work to make certain that shareholder voting rights are not restricted, and actively support measures that support shareholder rights and enhance their ability to communicate their views to management.

Usually, for pension fund trustees and asset managers, the way you normally communicate with your companies is by exercising the power to vote the shares you own. In fact, voting the shares is one of your fiduciary obligations. As the U.S. Department of Labor has stated, “the fiduciary act of managing [fund] assets [that] are shares of corporate stock … include[s] the voting of proxies [relating] to those shares of stock.” 

The importance of voting shares also brings with it the responsibility to monitor company policies to make sure that they are supportive of the voting rights of shareholders and do not seek to limit shareholder rights. For example, it has been suggested that company policies that seek to adjust or restrict share voting rights, such as the issuance of new classes of stock with unequal voting rights called “dual-class voting,” may at times be designed to limit shareholder rights by enhancing certain classes of shares over others. Likewise, proposals for supermajority voting requirements and poison pill plans have been said to be used, at times, to undermine the rights of one set of constituents over other constituents. 

It has long been understood that a pension fund trustee’s first interest is to proactively preserve its right as an owner of the company. To that end, pension fund trustees must be vigilant in preserving their ownership right by proactively monitoring and working against restrictions on shareholder rights—and by supporting measures that enhance shareholder rights and their ability to communicate their views.

It should not be news to pension funds that they are expected to vote the proxies for shares in their portfolio.  But the kind of shareholder engagement Commissioner Aguilar describes goes beyond merely voting shares.  Rather, he advocates a more active role for pension plans as champions of communication not only between shareholders and management, but between shareholders themselves.  

[B]ecause communications with other shareholders can also bring benefits, pension funds should encourage their portfolio companies to establish forums that allow shareholders to communicate with other shareholders. For example, there are a few progressive companies that have developed online shareholder forums where shareholders can pose questions to the company on a real-time basis, view other shareholders’ questions and the company’s responses, and engage in online discussions with other shareholders. The SEC has tried to encourage these forums, and in January 2008, the Commission adopted rules to facilitate the use of electronic shareholder forums by public companies and their shareholders. Unfortunately, these forums have not yet been widely adopted by U.S. domestic issuers. I believe that good corporate governance starts with communication and transparency, and I encourage you to explore these kinds of forums with your portfolio companies. I also ask that you let the Commission know of any needed improvements to the 2008 rule that could make these forums more common and more useful.

Commissioner Aguilar acknowledges that pension funds already have many challenges on their plates.  However, he sees exercising rights associated with share ownership, and assuring that portfolio companies have effective corporate governance to be integral parts of the investment process.  The more active the engagement, Aguilar says, the more effective the investment process.  

I want to acknowledge again the significant challenges faced by pension funds.  You are required to invest prudently, in a diversified manner, at low costs, in a way that ensures reasonable long-term investment returns. You are asked to do so in an environment with ever-increasing obligations, less contributions, volatile markets, and a ballooning retirement wave.  This is no doubt a very challenging environment.

Meeting these challenges requires that, among many other factors, you effectively exercise the important ownership rights you have as shareholders.  Exercising those rights, and assuring that a company has effective corporate governance, needs to be an integral part of the investment process.