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Proxy Battle Pickle

Publication Date: 
November 01, 2010
CNBC - Squawk Box
Becky Quick

Discussing new proxy rules submitted to SEC for consideration, with Joseph Grundfest, former SEC commissioner, and Douglas Holtz-Eakin, Financial Crisis Inquiry Commission.


QUICK: Our next guest says that there is plenty of evidence calling for a change in corporate governance rules. Joining us right now from Palo Alto is Professor Joe Grundfest.

He is Stanford University Professor of Law. He's also a former SEC Commissioner.

And Joe, when we start talking about election day, we've been looking to what happens across the nation. But you've been looking at what happens on election day when it comes to shareholder rights.

And you've got some very interesting information you've come up with. Why don't you lay some of that out for us?

GRUNDFEST: Good morning, Becky. Thank you very much. Yes, this really is an election day story. We've been working with the Investor Research Responsibility Council looking at voting mechanisms in corporate America.

And one of the interesting things that we found is that there can really can be a disconnect between who gets to vote in a corporate election and the best interest to the people who are voting.

If we'd step back for a minute and just have a look at what happens, the kinds of elections we're having tomorrow, if you're going to be voting here in California, you're typically a citizen of California and you're going to live with the consequences of your decision.

You're going to raise taxes, lower taxes, improve services, decrease services. That's a decision that's going to affect you.

But in corporate America, it turns out that it's relatively easy to have shareholders vote in elections even though their economic incentives might not be aligned with those of the corporation in which they're voting.

QUICK: You know, you lay out a very interesting example in the notes. And maybe that will help people understand it, too. This has a lot to do with those who are trading short at this point and some of the interesting ways.

Why don't you give us an example of how somebody would be able to issue a lot of votes or cast a lot of votes in a shareholder election but maybe not have a big ownership position?

GRUNDFEST: Absolutely, Becky. Let me give you one of the simplest possible examples. Let's assume that I happen to own a million shares of just about any publicly traded corporation.

But at the same time that I hold those million shares and am legally able to vote a million shares on a corporate election, I've also gone short five million shares.

So what that means is that from the perspective of my portfolio, I'll actually make more money if the value of that company's stock declines.

Despite that fact, as long as I'm a shareholder of record for those million shares, I get to cast those millions of shares just like the other shareholders who are actually going to make money if the stock price increases.

QUICK: But that gets you into a really interesting perspective. We're not suggesting that those who go short would have their rights taken away for the long shares that they hold.

GRUNDFEST: Absolutely not. In fact, given the amount of information that we have, I think the fairest thing to say is we don't know whether this is a big problem, a small problem or is a practical matter, a non-problem.

The amount of information that we lack about this phenomenon and its implications far outweighs the amount of information that we have. And if there's going to be a call to action in this area, I think it's a relatively simple one.

It makes sense to find out because engaging in these sorts of decoupling transactions, whether it's in the equities market or in the debt market, is relatively easy. It's relatively cheap. And it's becoming cheaper and easier all the time.

QUICK: What made you start looking into this idea? Because it's not something that had occurred to me before.

Were there complaints that had come up from some companies who felt like perhaps their elections were being taken over by people who had alternative interests?

GRUNDFEST: Well, this is an idea that's been bouncing around in the academia for many years now. And we decided to do this to collect all the literature that we could, tried to do a relatively comprehensive literature survey and lay the questions out altogether in one place.

I think when we take all of the different articles that have been written, look at all the different concerns that have been expressed and compile them in one document, you'd begin to see a larger and bigger pattern.

And it makes the question of finding out what's going on in corporate America on the voting front all the more important especially as Congress and the SEC keeps placing more emphasis on the voting process.

QUICK: This paper's been sent to the SEC, correct?

GRUNDFEST: Absolutely. It's been filed as a comment with the Commission.

QUICK: And what is the takeaway? That we need to do more work?

GRUNDFEST: Absolutely. The takeaway is we may have a problem. The takeaway is not that there is any particular need for regulation. The takeaway is definitely not that we need any intervention at this point.

The takeaway instead is we may have a problem. It may go to the very core functions of corporate democracy. We know that Congress and the SEC are looking more and more to have shareholders decide these matters in elections.

And if we can't really trust the electoral process, what kind of confidence should we put in that mechanism?


GRUNDFEST: Well, great question, Doug. I think, as a practical matter, what you'd be most concerned about is evidence that shareholders who have these deep-coupled voting and economic interests actually have turned out to be pivotal in elections.

That would be the worst case, a situation where a shareholder who actually had an interest in a company's stock price going down or a debt holder who was hedged out through credit default swaps or other mechanisms, having an interest in a particular tranche of debt failing or losing value, actually participating in the legal process, in the electoral process in a way that tilts the outcome.

That would be the sort of red flag. And then you'd want to look for the number of times which that may actually have happened. Again, I think the important thing right now is let's roll up our sleeves.

Let's find out whether this is really a problem before we actually start taking any regulatory actions.

QUICK: All right, Professor Grundfest, we want to thank you very much for your time this morning.

GRUNDFEST: Thank you, Becky.

QUICK: Always good talking to you.

GRUNDFEST: Take care.

QUICK: You too.