Trends in Securities Law and Shareholder Activism

Q&A with Keir Gumbs, Covington & Burling LLP

As Special Counsel in the SEC’s Division of Corporation Finance, what were some of your major responsibilities?

I was a special counsel in the Office of Chief Counsel within the Division of Corporation Finance. That office is like the general counsel‘s office for the division. We provided interpretive guidance internally to the lawyers who were reviewing registration statements, proxies, and other filings. When they had interpretive questions, they would come to our office. Similarly, folks from the outside would come to us if they had questions about an SEC rule or a noaction letter or things of that nature. It was a very good training ground for what I do now in private practice.

I had a number of areas where I was expected to develop expertise, like most special counsels in that office. One of those was shareholder proposals, which is why proxies and shareholder proposals have become such a big part of my practice. The other things that I worked on included Rule 144, general questions about the application of the Securities Act, and some of the forms of the Securities Act.

Tell us about your role at the SEC when you worked as counsel to Commissioner Roel Campos.

Substantively it was generally the same areas of law, but it was actually quite different from what I did in the Division of Corporation Finance. Working for a commissioner is an interesting experience for a couple of reasons. People who aren’t familiar with the SEC assume that the commissioners know every single thing being done at the commission, every line that’s been written in a no-action letter or comment letter, and every enforcement case backwards and forwards. In reality, a lot of what commissioners do is enforcement. Probably 60–70% of what I did was enforcement-related. The rest of it was rulemaking-related, with a little bit of policy discussion sprinkled in between. In the enforcement context, the way that enforcement cases are brought by the SEC, generally a staff attorney in the Division of Enforcement will prepare a recommendation to the commissioners, then the commissioners get to vote on it before they move forward with whatever the action is. As counsel to the commissioner, my job would be to act as the representative of my boss, Commissioner Campos, in discussions with the Division of Enforcement. So if he really cared about affinity-based fraud and there was a case that involved affinity-based fraud, he would want to make sure that I would express his views to the staff in how that case was being investigated, some of the theories being pursued, and things of that nature. Once they had the case and they were bringing it back before the commission, my job was to prep him so he could ask good, educated questions about the action and make sure that what the staff was doing was in line with his views as a commissioner.

On the rulemaking front, it’s very similar. If a division is coming up with a rulemaking, there are many drafts—sometimes as many as 20 to 30 drafts will circulate before that draft is proposed. That drafting process is fascinating because the staff has its views that are reflected in the approach it is taking in the rulemaking, but also my boss would have his own views that he would want to make sure were reflected in the rulemaking, whether it was questions asked in the request for comments or actually relating to the structure of the rule itself. It was a great way to really get to know the rules, not just for the Division of Corporation Finance, but also for investment management, trading and markets, and some of the other offices at the SEC.

On the policy side, you would often have meetings where folks from the outside would come in to talk to the SEC about rulemaking and an experience that their company or firm was going through that might impact or influence the way the SEC thinks about a particular issue or rule. That was great preparation for being in private practice because a lot of my time was spent reading through some of the materials being circulated, helping prepare the commissioner for the meetings he was going to have, and thinking through the challenges, the issues he would care about, and the potential traps related to the subject of the meeting. This was very similar to what I do in private practice when we have clients come in and we are preparing to go before a judge or someone at the SEC or some other third party.

Were there any rulemakings that you worked on at the SEC that you now address regularly in practice? How has the application of those rules and regulations played out in your practice?

The two that stand out for me are securities offering reform and the notice and access rules that allow companies to deliver proxies over the Internet.

With respect to the securities offering reform, the Securities Act of 1933 and securities laws were enacted seven to eight decades ago. They were written at a time with a particular framework in mind. It was a time where securities were held in certificated form. There weren’t that many individuals participating in the securities markets, and there was a lot of confusion. There were not as many different ways for people to participate in securities offerings because you did not have the Internet, and you did not have all of the other electronic methods of communication. All of those differences really influenced the way the Securities Act was drafted. The SEC didn’t reevaluate those rules based on the Securities Act in a holistic way for decades. In 2004–2005, the SEC proposed and adopted rules relating to changes in the way that securities offerings are conducted, taking advantage of the Internet, recognizing differences among companies, between the largest and smallest companies, and things of that nature. It was a really great experience because I had an opportunity to influence the direction of how securities law was going to move for decades to come. It’s fascinating thinking about how companies can best take advantage of the Internet, telephones, and fax machines, and what information is actually delivered to someone at the time of sale. When you are making wholesale changes to an area of law like that as a regulator, I think you are very concerned about whether you have gone too far, how it is going to impact the markets and impact investors. You do not want to do anything that will make it harder to raise capital, but you also do not want to do anything that is going to eliminate protections for investors. It has been quite pleasant to see how those rules have been implemented in practice because I don’t think there has been a drop-off in capital raising. In fact, there has been a significant increase in the number of capital-raising transactions that have taken place and those rules made it easier. At the same time, it is fairly clear that we were able to maintain investor protections, which was very reassuring.

Similarly, with notice and access, whenever you wanted to deliver a proxy statement before 2007, the presumption was that you delivered it physically, like an actual physical proxy being put in the mail. There was guidance that allowed you to deliver it electronically with the consent of the shareholder, but that was still relatively limited. With the notice and access rules, the commission wanted to liberalize the way that companies deliver proxy materials over the Internet by allowing companies to send a notice of Internet availability that told shareholders that the proxy materials were available online and how they could access them. We were not sure how that rulemaking was going to turn out; we were not sure if a lot of companies were going to take advantage of changes or if it was going to impede the ability of shareholders to obtain proxy materials. In practice, there have been very mixed results with respect to that rulemaking. On one hand, you do see more companies using the Internet more frequently to deliver proxy materials, but on the other hand, there has been a decrease in shareholder participation with respect to companies that have relied on notice and access. This was something the SEC was told about but did not necessarily change in the rulemaking. So that rulemaking is one that has not been quite as good or consistently positive as was the case with securities offering reform, but it was still an advancement in how companies and investors could better utilize the Internet.

In your current practice with Covington & Burling, please tell us about the types of matters you regularly advise upon.

My practice roughly falls into three buckets. One bucket is related to general disclosure and compliance. In that bucket I help companies and investors comply with periodic reporting, disclosure requirements, proxy disclosure requirements, insider trading, Section 16, beneficial ownership, and a variety of securities regulations.

The second bucket of my practice is transactional in nature. I do some crowdfunding in that space, and I help companies with securities offerings and occasionally M&A or tender offer transactions.

The third bucket is corporate governance. That includes helping companies and investors understand, interact, and engage with each other with respect to corporate governance issues like shareholder proposals, proxy access, majority voting, and things of that nature.

I enjoy all three parts of my practice. I think the governance piece is where things have changed the most. It is a very dynamic practice area and one that I have really enjoyed.

Much of your practice focuses on advising boards and investors with respect to corporate governance issues including shareholder activism and proxy access:

• How have the objectives of shareholder activists changed in recent years?

Investor activists have become more sophisticated and professional. That is by far the biggest change. You see that especially with shareholder proposals. When I first started practice back in the late nineties, shareholder proposals were in my view a kind of untamed wild frontier. In the types of proposals that were submitted there was a very wide variety, from supersophisticated proposals by large sophisticated institutional investors, to very unsophisticated proposals from individuals, and sometimes other institutional investors, on a variety of topics. Simpler ones included things like: “We want you to change the wrapper on the Tootsie Roll,” or “We want you to give all shareholders the same discounts on cars as you give employees.” But there were also serious topics, such as board independence, employment discrimination, and committee auditor independence, so it was a mishmash.

It was very interesting as a young lawyer to try to apply the very loose framework that had been created in the proxy rules for evaluating shareholder proposals to see whether a particular proposal could be excluded, should be excluded, or should not be excluded. Now things have changed. Those same retail investors who were submitting “We want you to sell a different brand of soda in your stores,” are now submitting proposals such as: “We want a board report on risk and how your board oversees risk”; “We want you to tell us everything that you are doing about sustainability”; and “We want you to tell us how your political spending activities, or your lobbying activities, or your charitable giving, is consistent with the culture and values that the company purports to promote.” So it has become much more sophisticated, much more professional. There are fewer shareholders involved in the process than had been the case, but the few that are involved have an outsized influence.

At one point in the late 1990s– early 2000s, one of the biggest proponents of shareholder proposals was organized labor, because labor pension funds were huge participants in the process. But that has changed dramatically. Now you don’t see nearly as many labor funds involved in submitting shareholder proposals as before. On the retail side you used to see a ton of retail investors, such as Evelyn Davis or individuals like John Chevedden and others. What has happened is that there is now a much smaller number of individuals who are submitting shareholder proposals, but they have an outsized influence. Someone like John Chevedden—himself or with his affiliates—submits on average 10% to 20% of the shareholder proposals in a given year. This is pretty significant for one guy or a handful of people, and that is a big change from where things were previously.

There are two types of activists. You have what I consider to be the more governance-oriented activists, and those are the people who tend to do shareholder proposals. Then you also have what I would consider to be the more value-based activists, such as hedge funds—people who come in and say that they want you to increase the dividend, or want you to increase the share repurchase program. They sometimes use shareholder proposals. In both cases the activists have become a lot more active in the last couple of years.

• Please discuss the influence of proxy advisory firms on shareholder activism.

Proxy advisory firms are in some ways the fuel that makes shareholder activism work, because many firms and institutional investors subscribe to the services of proxy advisory firms. As a result, the recommendations and views of proxy advisory firms have a significant influence on corporate governance. If a proxy advisory firm says our policy is that we will always vote against boards if they do X, Y, and Z, then guess what—going forward, fewer boards are going to do X, Y, and Z because they do not want to have investors vote against their say-on-pay or against their directors. So proxy advisory firms have a very significant influence.

In some circles there is a view that it is an outsized influence, because you have one or two organizations, in the form of ISS and Glass Lewis, who together are arguably the most significant forces in corporate governance. When they come out with their policy updates every year, they dramatically influence what companies do in terms of what kind of governance features they incorporate, adopt, or amend, or how they structure their compensation program. Each of them has guidance around how they evaluate executive compensation, and that guidance really influences how companies make decisions. That has been a source of frustration for some companies who think that it may not be appropriate for one or two actors to have the level of influence held by ISS or Glass Lewis.

Some of these things are subjective, such as why it is worse for a director to sit on six boards rather than just three. But notwithstanding those objections, they provide a very important function for the proxy ecosystem, which is that you have lots of institutional investors that hold literally millions of shares in their portfolio and who even in the best of circumstances would not have very much time to dedicate to any one company’s proxy. So they have to rely on someone to help them execute their voting responsibilities. That is the role of ISS and Glass Lewis. So from that perspective it is good, because otherwise those shares might not get voted, or they might be less informed in the process. That is the counterpoint for companies or for people who criticize the proxy advisory firms. But it is certainly the case that they are very influential. There was a GAO study several years ago that said on average they have anywhere from 15% to 30% of the vote at a given company. That is a pretty significant influence when you don’t have full participation in proxy solicitations, because that ISS recommendation can be the difference between something passing or not passing.

• Do you find that public companies are more willing to engage with shareholder activists these days?

Yes, I think say-on-pay is probably one of the most significant developments with unintended consequences in corporate governance. Because of the say-onpay vote, which was part of Dodd- Frank, companies annually have to put the compensation of their executive officers, as disclosed in the proxy, up for a vote. That process usually results in companies going out and engaging with their investors—to figure out what investors think about their compensation packages so that they are more likely to get the votes that they need. In order to do so, many companies use engagement as a method to figure out what is and is not important to their investors and what their investors think about the companies in general.

In general, proxy advisory firms have had an increased influence since say-on-pay, and that is not a bad thing. I do think that has resulted in companies doing a lot more engagement with shareholders than would have been the case before.

You are considered an expert in Sarbanes-Oxley and Dodd- Frank. What are some of the main requirements of the Acts that you work with on a regular basis in practice?

For Sarbanes-Oxley, the main requirements for most people like me who work on it regularly and do disclosure work are the internal controls and disclosure controls. Every time a company files a periodic report, they have to get certification from their CEO and CFO as to the effectiveness of their internal controls and disclosure controls. There’s also an assessment of internal controls that is done by the auditor.

For Dodd Frank, it probably has to be the say-on-pay. It is not that we are spending a ton of time on say-on-pay every single day, but when looking at engagement, it really has influenced the way that companies think about engagement. That part of it impacts my work and I imagine the work of most people who practice in this area. There is a lot left to be done. Proxy access is actually another example. The SEC got authority to adopt proxy access. They did so, but the rule was invalidated. Now we are in a world where companies can submit proxy access bylaws. And even though they are not directly a result of the Dodd-Frank Act, there is a clear nexus, because when the SEC adopted its proxy access rule, it also amended the proxy rules to allow the inclusion of proxy access shareholder proposals. This was by far the number one topic last year and it looks like it may be the number one topic this year as well.

Are there any differences or new trends in the types of matters clients seek your advice and help with now as opposed to when you began in private practice?

Clients have gotten very savvy in the way they use their outside lawyers. Clients will now create the first draft in a disclosure document, which reduces their reliance on outside counsel. That is generally good for them from a budget perspective. The biggest challenge is that it is much tougher to train junior associates. When I started, it wasn’t uncommon for a client to ask to have a junior associate draft a proxy. Now, following the financial crisis and economic downturn that we had in 2007– 2009, clients are less likely to ask to have a junior associate draft a proxy. More often they will draft it themselves, and then ask me to review it substantively and ask to have a junior associate do a form check. This is a significant change and makes it difficult for younger lawyers to get more detailed drafting and preparing disclosure document experience.

You also have worked on corporate political spending disclosures. Can you share any recent developments in this area?

Of all of the areas in my practice, this is the one that I am frequently surprised at the level of interest. First of all, I think that the influence of money in politics is horrible. I understand the level of fervor with which many of the activists in this space follow political spending. That fervor has resulted in some very positive developments in the context of disclosure. There is an index, the CPA-Zicklin Index, that is kind of like the Rosetta Stone if you want to understand how political spending is viewed from the eyes of investors. That index comes out every year, and this most recent version, which was published in the fall of 2015, was the first to include all S&P 500 companies, which is a most significant development. It now provides investors and companies with a relatively objective way to evaluate political spending disclosures, whether they are good or bad, whether they are sufficiently extensive or too extensive, and so forth.

There’s a rulemaking petition that is asking the SEC to adopt a rule that would require companies to disclose political spending. Setting aside whether that is a good or bad thing, that rule has gotten more than a million—closer to two million—comments. That is illustrative of the level of interest in the topic among investors and the public at large. This petition and the CPA-Zicklin Index are significant developments. There are many more companies that provide disclosure and think about their disclosure around political spending than was the case five or six years ago. The rulemaking petition and the CPA-Zicklin Index are big parts of that.

Do you have any helpful insights from current trends you are seeing related to governance policies and procedures?

The most significant insight relates to proxy access. It’s a trend. At the last count I saw, there were 200 companies that have adopted proxy access. I imagine that number is likely to double in the next year or two, and it is likely to become a very common practice, at least among larger public companies. The trend I am seeing with proxy access is that a lot of companies who have not received a shareholder proposal on the topic can read the writing on the wall, and they are taking the initiative to engage with their investors and among their board about the topic of proxy access, addressing issues such as: what kind of proxy access regime they would be willing to live with, what things they could not live with, and what kinds of issues their directors or investors have with proxy access. That by far is the trend that I am seeing the most in terms of governance policies and procedures.

What are some of your biggest career accomplishments?

I would say my biggest accomplishment is that I have developed a practice that I love. I have a great set of clients, and a wonderful team of colleagues, both partners and associates. I have been able to influence the development of the law with respect to securities while maintaining a good relationship with the SEC. There are a lot of people who don’t like what they do. I love what I do. What I do is interesting. I get up every day and look forward to the challenging questions and novel issues that clients may come up with. I look forward to engaging with the SEC, to understand where the staff is coming from on issues to help my clients navigate their guidance and so forth. It’s great to have found a niche for myself in this practice where I feel fulfilled, but I also feel that I am able to make a real contribution.

Keir Gumbs is a partner at Covington & Burling LLP, Washington, D.C., and vice chair of the Securities & Capital Markets Group. He advises public and private companies, nonprofit organizations, institutional investors and other clients in corporate, corporate governance, securities regulation, and transactional matters. He is widely recognized as a “go-to” expert for a variety of securities law matters, including the Dodd-Frank Act and related rulemakings. Prior to joining Covington & Burling, Keir was with the SEC, where he served as Counsel to SEC Commissioner Roel C. Campos. Before serving the commissioner, Keir was a staff attorney and later a Special Counsel in the Office of Chief Counsel in the SEC’s Division of Corporation Finance.