Dodd-Frank and Shareholder Rights

The SEC is rapidly going about formulating regulations around the Dodd-Frank bill, which is the first significant regulatory reform affecting share ownership in decades. This process will generate much too much commentary, but I had a few thoughts from where I've stood over the years, as the officer of an issuer, an investment analyst, and as an institutional shareholder.

Congress and the SEC are hoping that institutional shareholders will act like "sheriff's deputies" in the Old West, watching out for bad corporate behavior, taking action, and reporting the behavior to the badge. Unfortunately, having read many hundreds of proxy voting records for my institutional clients over the years, I can say that if I've seen a dozen instances of specific votes against a management proposal, that is an overestimate. Granted, this was before the advent of the proxy voting firms, which I consider overpriced , rife with conflicts, and of little value in their current incarnations. Nothing I've seen recently changes the lack of active voting by institutional money managers or mutual fund managers.

Institutional proxy voting has routinely been handled by legal departments. 'nuff said. They are checking boxes. The typical, diversified mutual fund will have about 2% or less of assets in a full equity position. So, that's fifty positions that the portfolio manager has to care about from the corporate governance side. In order to thrive in the business and generate good investor inflows, portfolio managers focus on short-term, absolute and relative performance, marketing, fund governance, staff supervision, and portfolio inflows and outflows. Finally, the senior managers of traditional funds are really afraid of getting too entangled with their companies. They fear learning of developments that might make them insiders and inhibit trading. Their analysts are focused on working their models to the third decimal point and know very little about corporate governance.

So, though it's romantic to think of fund managers as sheriff's deputies, they are more like the ranchers, who support the marshal, but care deeply about their personal issues like land, water and keeping their own cattle.

The first draft of the regulations hands primacy to shareholders with positions of 3% or above. An interesting, and completely arbitrary number. Ironically, it is very possible to get a 3% position in a diversified mutual fund, and very easy to get it in a concentrated, non-diversified fund. However, it seems as if the Act will hand over primacy to hedge funds which will routinely have large, concentrated positions, assuming they can be measured properly. The last thing American corporations need is to cede their mediocre corporate governance to hedge funds, which can be counted on only to generate benefits for themselves and not for the long-term benefit of the enterprise and its stakeholders.

If you are in a position to comment on the regs, please do: they need a lot of work.