Corporate & Securities Law

My Testimony Re: Citizens United & Corporate Governance

Earlier this year the Supreme Court affirmed the free speech rights of corporations by way of the Citizens United case.  President Obama then chided the Court in a rare face-to-face attack during his state of the Union, the blogosphere rightly noted the poor form and ungentlemanly conduct of that move, and former Chief Justice Marshall incidentally shuddered in his grave in response.  Much has been said previously on this case of greater interest, including by Bainbridge, Ribstein, and Somin.

I confess I have very little understanding of campaign finance law, or the first amendment for that matter.  I am therefore surprised, as I imagine our TOTM readers will be, that I should be drawn into this fracas with an invitation to testify in Congress before the House Financial Services Committee about his particularly tense issue.  Just when I was looking forward, I might add, to a welcome spring break devoted to scholarship.  (Did I really just say that?)  (Also, spoiler alert- why would financial services have anything to do with this issue?)

Then again, I am a C-Span junkie, and my grandma loves seeing me on tv, so I went up to the Hill once again.  It was a great panel that included, with links to their opening statements:

• Professor John C. Coffee, Jr., Adolf A. Berle Professor of Law, Columbia Law School
• Mr. Karl J. Sandstrom, Of Counsel, Perkins Coie
• Ms. Ann Yerger, Executive Director, Council of Institutional Investors
• Professor J.W. Verret, Assistant Professor of Law, George Mason University School of Law
• Ms. Nell Minow, Editor and Co-Founder, The Corporate Library
• Professor Michael Klausner, Nancy and Charles Munger Professor of Business and Professor of Law, Stanford Law School
• Mr. Jan Baran, Partner, Wiley Rein LLP

The hearing was focused on a bill introduced by Congressman Capuano (D-MA) which would, among other things, require a shareholder referendum on political expenditures by publicly traded corporations through amendment to the Securities Exchange Act of 1934.  Wait a moment, I asked myself, wasn’t the 34 Act dedicated to two purposes: investor protection and capital formation?  Yes, as I looked them up, I noticed that those are the two guiding principles listed in the Act.  There is nothing about campaign finance or labor policy mentioned in the legislative history of the securities laws whatsoever.

In short, this bill sought to hijack the securities laws to regulate campaign finance.  Even worse, it sought to give Union and State Pension Funds a veto over corporate political spending.  As such, my thesis today was simple: trying to achieve labor and campaign policy goals through the securities laws leaves ordinary investors, who hold shares through their 401(k)s, holding the tab for this politically motivated activity.  I will update with the C-span link when it becomes available, but until then the text of my testimony is below.

“Chairman Kanjorski, Ranking Member Garrett, and distinguished members of the Committee, it is a privilege to testify in this forum today. My name is J.W. Verret.  I am an Assistant Professor of Law at George Mason Law School, a Senior Scholar at the Mercatus Center at George Mason University and a member of the Mercatus Center Financial Markets Working Group.  I also direct the Corporate Federalism Initiative, a network of scholars dedicated to studying the intersection of state and federal authority in corporate governance.

There are two types of shareholders in American publicly traded companies.  The first are retail investors, or ordinary Americans holding shares through retirement funds and 401(k)s.  Half of all American households own stocks in this way.  The other type of investor is the institutional investor, including union pension funds as well as state pension funds run by elected officials. The ?Shareholder Protection Act of 2010? seeks to give those institutional investors leverage over companies for political purposes at the expense of retail investors.

Today?s legislation attempts to hijack the securities laws to regulate campaign finance.  It would limit the ability of companies to communicate with legislators by giving Union shareholders power to stop those communications.  This bill does not, however, limit Union political spending in any way.  Further, it has nothing to do with the investor protection goals of the Securities Exchange Act.

Shareholders have two available remedies if they become dissatisfied with the performance of their companies. Shareholders can sell their shares, or they can vote for an alternative nominee in the next annual election of the Board.  And they do both with some frequency.  In the rare event that political advocacy actually results in corruption, there is a third line of defense in place.  If the Audit Committee of the Board of Directors, which is independent of company management, determines that any political donations are inappropriate they are required under the Foreign Corrupt Practices Act to stop them immediately.

The structure of American corporate law rests the authority to manage the day-to-day affairs of the company, including decisions of how to invest the company?s funds, with the Board of Directors.  Putting corporate expenditures to a shareholder vote, as today?s legislation requires, is the first step toward turning shareholder votes into town hall meetings.  Some shareholders may want the company to locate a new factory in their town or give away free health benefits for employees without regard to whether the expenses risk bankrupting the company.

Shareholders choose the board of directors and delegate authority to make these decisions to the board to avoid that very problem.  California?s voter referendums have made its Constitution one of the longest in the world and helped precipitate its budget crisis. Today?s legislation is a first step down a similar path for American companies.

Political risk poses a danger to the 401(k)s of ordinary Americans more now that every before.  Political leaders responsible for policies that subsidized dangerous mortgage practices through Fannie Mae and Freddie Mac now seek to expand financial regulations to generate the appearance of responsive action.

The Supreme Court recently affirmed that corporations have a constitutional right to advocate on behalf of their shareholders.  Corporations do so particularly to protect the property rights of those shareholders from expenses associated with regulations whose benefits may exceed their cost.  Many reputable companies spend money for this purpose.  Berkshire Hathaway, one of the most highly regarded companies in America, spent $3 million dollars last year advocating for the interests of the company and its shareholders.

This bill purports to re-define state corporate law to make un-voted expenditures a violation of the corporation?s fiduciary duty to its shareholders.  This represents a serious misunderstanding of how corporate law is structured.  As Justice Powell wrote: ?No principle of corporation law and practice is more firmly established than a State’s authority to regulate domestic corporations, including the authority to define the voting rights of shareholders.?

The bills under consideration would also add disclosure requirements for political spending, but political expenditures rarely approach the materiality requirements of the securities laws sufficient to require disclosure.  In 2008, for example, Exxon Mobile reported political expenditures of roughly $450,000.   In that same time period it earned $45 billion dollars.  Its political expenditures amounted to .001% of annual earnings.  If shareholders had the time and expertise to review corporate expenditures at that minute level, they would be running companies rather than investing in them.

Today?s bill has absolutely nothing to do with reforming financial regulation in response to the financial crisis, and is indeed a distraction from that vital work.  It is a power grab by union pensions funds and state elected treasurers in an attempt to enhance their leverage over the retirement savings of ordinary Americans.  To call today?s bill a ?Shareholder Protection Act? is fundamentally misleading.”

Full post as published by Truth on the Market on March 12, 2010 (boomark / email).