Activist Investors Are Putting Ideology Before Shareholder Value

Under the leadership of Gary Gensler, the Securities and Exchange Commission (SEC) is empowering activist investors to pursue their preferred politics and social causes at the expense of investors’ interests. According to a November 3, 2021 SEC staff memo

Staff will no longer focus on determining the nexus between a policy issue and the company, but will instead focus on the social policy significance of the issue that is the subject of the shareholder proposal. In making this determination, the staff will consider whether the proposal raises issues with a broad societal impact, such that they transcend the ordinary business of the company. (Emphasis added)

This admission is stunning. No longer hiding behind a false claim that ESG shareholder proposals improve profits, the SEC is greenlighting actions that could harm investors but achieve a politically correct social goal.

Not surprisingly, the number of campaigns initiated by activist shareholders — many motivated by political ideology rather than fiduciary duty — jumped 34% between the first half of 2021 and the first half of 2022, according to asset manager Lazard.

These trends bode ill for ordinary investors. When activist investors successfully pressure corporate management to embrace fashionable political ideas — rather than growing their companies for the long haul and stewarding shareholders’ capital — ordinary people pay the price, in the form of lower returns on their retirement savings.

The term “activist investor” may conjure up images of protestors waiving signs outside a company’s headquarters. But these kinds of activists are typically hedge funds and private equity firms.

They follow a well-established playbook. First, they buy a minority stake in a publicly traded company. Then, through a combination of public and behind-the-scenes pressure, push the company to pursue their political and social objective.

Frequently, this involves waging a proxy fight for seats on the company’s board of directors. The activists nominate their own candidates for the board and try to convince other shareholders to vote for them.

Consider Engine No. 1’s victory against ExxonMobilXOM
last year. The tiny San Francisco investment firm bought a tiny 0.02% of the energy giant’s shares in the hopes of convincing the company to reduce its greenhouse gas emissions. To achieve this goal, the firm pushed for three candidates to be nominated to the board, which looked like a long shot.

But then, Engine No. 1 convinced some of the company’s biggest institutional investors — including BlackRockBLK
and State Street that have been public about their desire for corporate America to reduce carbon emissions — to vote for the alternative nominees who are now on the board.

Activist investors success in the corporate boardroom does not necessarily translate into beneficial corporate actions, however. The recent spikes in global energy prices and global energy insecurity demonstrate the folly from imposing arbitrary and unrealistic reduction targets on the energy sector. And no amount of PR changes these current constraints.

In other examples, activist investor,

· Tulipshare began pressuring Tesla to link Elon Musk’s pay package to the company’s performance on non-financial metrics like social impact.

· Starboard launched a failed proxy battle against chemicals manufacturer Huntsman this year, citing management’s unwillingness to make certain climate disclosures as a partial justification for trying to shake up the board.

Instead of implementing rules that promote sound corporate management, the Biden administration once again made activists’ jobs even easier. In September 2022, the administration finalized a rule that requires companies to use “universal proxy cards.” Essentially, all proposed directors — those nominated by activists, as well as current directors nominated by management teams and large, long-term shareholders — will now appear on the same ballot, which spares small activist firms from the considerable expense of mailing their own proxy cards to shareholders.

And activists may soon notch another win, depending on the outcome of a court case in Delaware. The case involves medical device maker MasimoMASI
, which recently changed its bylaws to require activist firms that nominate directors to disclose their funders and any other possible conflicts of interest.

Politan Capital Management holds a roughly 8.8% stake in Masimo and sued the device manufacturer to block the bylaw changes and the ensuing disclosures. While this case involves a more traditional proxy fight over corporate strategy, it has important implications for whether corporate boards can implement bylaw changes that make proxy battles and pressure campaigns less attractive for political ideologues.

It is the broader implications from these activist investors that are so disconcerting. More than 50-years ago Milton Friedman famously noted that “there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits.”

The reason for this focus is simple: focusing on profits, while obeying all applicable rules and regulations, enables companies to serve their vital role of providing the goods and services we need to live longer, healthier, and happier lives. This focus also ensures the financial viability of the owners of these firms, which include the pension funds that hundreds of millions of families are relying on to ensure a secure retirement.

Increasingly, the activists who are initiating proxy fights disagree with these basic premises. If they get their way, the core social value of businesses will be undermined to the detriment of consumers and ordinary investors.