The Internet Poised To Play An Even Larger Role In Shareholder Activism

The Internet is about to become an even more powerful tool for shareholder activism, thanks to Chairman Schapiro at the Securities and Exchange Commission.  (That's her, announcing the proposed rule on May 20th)

The Chairman announced that the SEC is going to put out for comment a rule that would allow any investor, or group of investors, holding a minimum amount of securities in a company to nominate up to 25% of the directors for a board election.  The company would be forced to put these nominations on the proxy ballot.

There are restrictions on this to keep people from buying securities before the election and then dumping them afterwards, as well as minimum holdings for the nominees or group supporting the nominees, but the Chairman knows this is a big deal.

By allowing a single shareholder to pool groups of other investors to aggregate the minimum amount needed, it seriously weakens the ability of companies to fight off non-political activist shareholders.

The CEO's nightmare scenario
What's the scenario that most CEOs are probably worried about?

1. An activist shareholder decides to run a slate of board seats.  (25% = 2 seats possible on an 8 director board)
2. S/he files a nomination with the SEC and puts up a website with the forms for others to join the campaign.
3. Using guerilla marketing techniques and the voracious nature of the financial press for a serious proxy battle, the campaign gets a lot of free media attention, driving people to go to the website and use their shares to "second" the nomination by submitting the paperwork to the SEC.
4. Potential members of the nominating group include people who directly own the stock, as well as people who own it indirectly through mutual funds.

It's this last category that will be stunning in its effect.  Let's say I went crazy and bought Vanguard's S&P 500 Index (VFINX) for my IRA.  Because it's a retirement account, I almost certainly bought it and held it, and probably forgot it.  I, along with every other person holding that, is a target for the activist director campaign because I have held it for more than a year.  With the addition of a few professional investors with a sizable holding and a little money to bankroll an online campaign, I could be sitting on the board within a year.

The reason this is so groundbreaking is because non-politically motivated activist shareholders are a "perfect storm" of financial public relations.  They bring together all the factors that make for a great media story and a headache for upper management:

1. A company in trouble (the media loves to kick people when they're down);
2. A David v. Goliath story (financial press loves to run stories about "the little guy" keeping the big guys honest);
3. A conflict/showdown between two parties (this is true in non financial journalism as well.  When two people are arguing, the story is writing itself and people want to watch/read)

When a company is in trouble is when an agitating shareholder emerges, and that's when the rest of the shareholder base is ripe for an activist nomination slate.  It's a steamroller that gets worse and worse.

Who wins and loses

Currently "regal" boards lose
Corporations that don't already have some shareholder nominated board seats are about to lose their power over 25% of their board.  When agitators emerge, if they aren't handled well and feel like they have to run for director seats, they will pose a very real threat.  A good lesson in how to handle them badly can be taken from the case study I wrote about Eric Jackson's campaign against Yahoo!'s management. [PDF]

Non political activist shareholders (small/med/large) win
All that web traffic generated from stories about your disagreements with the current management over their running of the company?  That just became a marketing campaign for the board seats you so desperately want in order to effect a management change of direction.  You could, in theory, accomplish it without paying for a single piece of direct mail.  You could even do it through a Facebook group.

Political activist shareholders - no effect
Political activist campaigns continue to struggle because they simply do not speak to the needs of shareholders.  Shareholders want to make money, and political activist shareholder campaigns usually fail to address that need, focusing entirely on non-revenue issues. 

While they may see a little bump in effectiveness,  I don't think this is a game changer for them.  Folks like the unions, who run activist shareholder campaigns from time to time, will be happy but won't be sitting on a lot of boards a year from now.

What's the Timeline?
Chairman Schapiro made her announcement (text version) on May 20th, and once the proposed rule is posted on the website there will be 60 days for comment. 

Given the Chairman's language, there seems little chance of this proposed rule not becoming policy.  Over and over again, the Chairman has tied issues of "questionable and illegal corporate practices" to shareholder participation on corporate boards.  This steamroller appears to have momentum.