Political disclosures: reaching the tipping point

Activist shareholders have been clamoring for years for greater disclosure on corporate political spending, and the 2013 proxy season may have signaled a tipping point in gaining crucial support. For the first time, two shareholder proposals on political expenditure disclosure gained more than 50 percent shareholder support: aerospace contractor Alliant Techsystems received a 64.8 percent vote in favor of a disclosure proposal, and a proposal at fertilizer maker CF Industries received 66 percent shareholder support.

These two high votes are ‘very significant’, according to Heidi Welsh, executive director of the Sustainable Investments Institute (Si2), a non-profit shareholder watchdog that has pushed for greater corporate disclosure. According to Si2, there were at least 125 political spending proxy proposals in 2013, 84 of which went to a vote. ‘I think companies have come to realize they can get burned by spending money in politics and on campaigns,’ Welsh notes.

Alliant and CF Industries were not the only companies to see high votes. This year Trillium Asset Management also received nearly 50 percent support for its proposal asking energy company Hess to disclose its policies on political expenditures.

‘We are capitalists, and for us to do our job well we need a well-functioning political system and a well-functioning market,’ explains Jonas Kron, Trillium’s director of shareholder advocacy. ‘Right now, the money is interfering with the political system.’ Trillium may refile a similar proposal at Hess during next year’s proxy season, as well as proposals at other companies in the telecommunications and energy industries.

Litigation now a possibility

Such votes are still relatively low, however, averaging about 32.1 percent this year – the fourth year in a row votes have been in the low 30 percent range, according to the Center for Political Accountability (CPA). ‘We view 2013 as a successful proxy season because there has been continued corporate adoption of disclosure accountability,’ says CPA president Bruce Freed.

The ballot box is not the only place where shareholders are targeting companies – the courtroom may be the next venue for them to strike. Earlier this year the New York State Common Retirement Fund filed a book and records lawsuit against technology manufacturer Qualcomm after discussions about political contributions fell apart. The lawsuit, the first of its kind, ultimately settled out of court, but it marks a new line of attack in the battle over political disclosure.

It also offers a cautionary tale, some commentators say, as to why shareholder dialogue is a necessity when it comes to political expenditures. Qualcomm admitted when the lawsuit was filed that it had been developing a new policy on political expenditure disclosure, including information on payments to trade associations and 501(c)(4) organizations. The policy would have given the retirement fund all the information it sought, but sources close to the parties say miscommunication turned what could have been a simple discussion into a legal battle.

The fund declined to comment on what caused the litigation, and spokesperson Eric Sumberg would not rule out future lawsuits. ‘The precedent-setting transparency that was achieved through litigation against Qualcomm underscores the effectiveness of such a strategy,’ Sumberg says. Such lawsuits, he notes, are merely ‘one tool the fund can use to obtain information about corporate political expenditures’. Qualcomm did not return calls for comment.

‘It was an incredibly effective tool,’ Kron points out. ‘It was a warning shot off the bow: the risk of ignoring shareholder concern is great.’

Welsh agrees that similar lawsuits may be in the works for next year. ‘Qualcomm caved and gave over the information,’ she says. ‘Given the novel strategy and the great interest in it from the proponent’s perspective, I think we’re likely to see more of such litigation.’

Cost is an issue

But others think these lawsuits are too pricey to be commonplace, and may not stand a chance if they actually go to court. ‘I would not be surprised to see the New York Retirement Fund or other large groups pursuing lawsuits as an avenue of attack in the future,’ says Keir Gumbs, a corporate governance attorney with Covington & Burling. ‘But there are good arguments to be made that it’s not the right avenue. Delaware law can’t really be used for fishing expeditions – rather, it is used for investigating wrongdoing, and there was no readily apparent wrongdoing in the Qualcomm case.’

The Qualcomm lawsuit is a good example of how companies should engage with shareholders to avoid costly and very public fights. ‘It seemed like for a lot of companies the light bulb went on, partially because of Qualcomm,’ says Ken Gross, a partner at Skadden Arps Slate Meagher & Flom. ‘I’ve seen disputes arising that shouldn’t have because things simply weren’t tended to. Most of the things being sought can be responded to in a positive way.’

In fact, many companies are doing just that. According to Welsh, 29 of the 125 political spending disclosure proposals this year (which include lobbying disclosure proposals) were withdrawn after negotiations with companies. As of August, the CPA had reported 16 agreements this year between shareholders and companies, the largest number since 2008.

‘Companies are moving toward more disclosure than previously, but it may be that the easy deals have been done,’ Welsh says. ‘Companies seem to be willing to put in one place the knowable information, which is in the public arena anyway.’

Negotiating a path to success

Negotiations helped make proxy season easier for pharmaceutical firm Merck. The tipping point for the company came about seven years ago, when shareholders and the firm’s then CEO were pushing for greater disclosure across the board. Merck had opposed shareholder attempts to open up its books, but the company then decided to sit down with the activists and the CPA. ‘We realized that the complexities of what was being asked for were far less daunting than we originally thought,’ says Charles Grezlak, vice president of state government affairs and policy at Merck. ‘The administrative burden wasn’t much of a problem.’

Merck decided to set up a committee, limiting most of its funds to state-level candidates, mostly incumbents, and forgoing federal campaigns or 501(c)(3) organizations. Merck lobbyists would make recommendations to the committee, headed by the general counsel, which would then evaluate whether the donations were in line with Merck’s business strategy. No litmus test on social issues, such as gay rights or the environment, was set in stone, but any campaign would be evaluated for reputational risk.

Since the new policy has been put in place – it’s been rejigged several times over the years, including nixing donations to state judicial campaigns two years ago – Merck has risen to the top of the CPA’s index, considered the best gauge of whether a firm has been transparent in its giving. ‘I don’t think we’ve had one question on political spending in five years,’ Grezlak says. 

That’s not to say that Merck hasn’t been targeted by shareholders for its political activities. Earlier this year, free-market association the National Center for Public Policy Research (NCPPR) filed a proxy proposal to have Merck disclose its lobbying goals and political expenditures regarding the company’s support of the Affordable Care Act. At the pharmaceutical company’s annual meeting in May, the proposal received less than 5 percent support and was opposed by the company.

According to the conservative NCPPR, Merck (and other members of the Pharmaceutical Research and Manufacturers of America association) had spent hundreds of millions of dollars to promote the healthcare law – much of which was likely shareholder money.

The NCPPR is unlikely to go forward with a similar proposal at Merck next proxy season, but it will continue to pressure other companies for greater disclosure when it comes to political and lobbying expenditures, according to Justin Danhof, general counsel at the organization. ‘The impetus for our work is when we see ‘crony capitalism’ that violates the free market,’ he says, noting that pharmaceutical, energy and soft drink companies are in the NCPPR’s crosshairs. ‘We want sunshine on these issues. Merck has disclosed a lot more in recent years, more than it ever has.’

Danhof notes that, while such proxy proposals are unlikely to pass, they are a call to action and may spur change among companies. ‘They will make companies think twice about corporate expenditures in the future,’ he predicts.

These proposals underscore the point many shareholders make regarding corporate political activity: that donations to politicians can lead very easily to serious controversy, and a subsequent drop in stock price. ‘In the long term, if Merck follows the path of unpopular laws – such as Obamacare – it will make the company weaker,’ Danhof says.

Citizens United

Much shareholder angst on the issue of political contributions stems from the 2010 Supreme Court decision in the Citizens United vs Federal Election Commission case, which allowed corporations to spend more in campaigns. ‘The Citizens United case really intensified the interest,’ Grezlak says. ‘Most panels I’ve been on have shown that major corporations haven’t given much more. For Merck, the Citizens United case made no difference at all in how we approach giving.’

In fact, the decision may have had the opposite effect, galvanizing shareholders and scaring off potential corporate donors. ‘Every time a case seems to allow more money into the system, it energizes those who want more disclosure in the first place – the activist groups looking for more traction on what corporations will disclose,’ Gross says.

The Citizens United case may have opened the floodgates for more corporate cash in elections, but it also affirmed the need for transparency in where that cash was spent. In the 8-1 majority opinion, Justice Anthony Kennedy wrote that while the government could not suppress political speech, it could (and likely should) mandate online disclosure.

And since the ruling, Justice Antonin Scalia has said that the more corporate free speech there is, the better – as long as it is fully disclosed. ‘For my part, I do not look forward to a society which, thanks to the Supreme Court, campaigns anonymously,’ Scalia said in a 2012 interview with CNN.

Trade association dues

One area where shareholders have faced an uphill battle is in getting corporations to disclose how their trade association dues are spent. At Merck, shareholders yielded some compromise on trade association reporting. ‘There are so many associations that we are a member of, most of which don’t even give political donations,’ Grezlak says. Instead, Merck and its shareholders agreed on a $25,000 threshold in dues for trade association reporting.

Many investors, including Amalgamated Bank, have pushed for companies to list their trade association dues and describe corporate political priorities in their filings, but a lot of companies have pushed back on providing that information. ‘The trade associations are supposed to tell corporations how much of their dues are used for political purposes but many companies aren’t reporting it,’ Freed says.

He points out that trade association and 501(c)(4) donations are now given the most attention during CPA-company meetings – and companies are starting to listen. ‘The number of companies disclosing at least some information about trade associations is increasing. We’ve seen a steady pattern,’ he observes. ‘We’ve also seen more pushback.’

Some commentators suggest the fracas over political expenditure disclosures completely revolves around trade association dues. ‘The truth is that this issue is mostly about trade associations and the misperception that companies are engaging with lobbying – via trade associations – which they wouldn’t be comfortable doing themselves,’ says Gumbs.

In 2012, according to a Deloitte report on board practices, nearly half of large-cap companies disclosed their membership in trade associations that make political expenditures. Among mid-cap and small-cap companies, disclosure was much lower (22 percent and 8 percent, respectively). Larger companies were also more likely to disclose their own political contributions: 65 percent of large caps compared with 36 percent of mid-caps and 17 percent of small caps.

SEC rulemaking delayed

Shareholders – and a number of corporate governance experts – are hoping the SEC will tackle the issue. The SEC had originally put the proposed rule on its docket for this year, but it has since backed away from committing resources to the problem.

SEC chairman Mary Jo White testified earlier this year that her agency is not yet working on rules, but the more than half a million comments to the regulator – the highest number received during a petition for rulemaking – in favor of SEC-mandated disclosure lead many to believe it’s only a matter of time. The comments were in response to a 2011 petition by 10 law professors. Democratic commissioner Luis Aguilar has also urged the agency to draft a rule.

Controversy may kill such a rule before it’s even proposed, though. Leading lawmakers on the House Financial Services Committee such as New Jersey’s Scott Garrett have warned against the SEC taking a stand on political contribution disclosure, saying the issue is too controversial. For now, it seems as if the SEC is focused on other things.

‘When you look at the momentum or interest in the rule, with more than 600,000 comments – a record at the SEC, by the way – and you look at the fact that it’s the number one environmental and social issue… yeah, it’s important,’ says John Keenan, corporate governance analyst at the American Federation of State, County and Municipal Employees.

Key questions to consider

Companies looking to pacify shareholders should first evaluate how many dollars are spent for political purposes and who is in charge of making those donations. ‘It’s important for companies to figure out precisely what they are doing and who is doing it,’ Gumbs says, noting that at some corporations only the regulatory affairs departments can approve political donations, while at others, several departments have discretion over political expenditures.

Another wrinkle is that certain states, such as New Jersey and Illinois, prohibit board members or executives from making political contributions. So-called pay-to-play laws were designed to create firewalls so government contracts could not be bought by wealthy corporations, which is another good reason for boards to have written policies on political expenditures at all levels. ‘It is nothing short of a minefield,’ Gross says.

Some companies, due to the pressures exerted by shareholders, have pledged not to get involved in elections, either at the state or federal level. And a few shareholders have become more brazen in their proxy proposals, asking to ban all political expenditures at Starbucks or requiring Johnson & Johnson to align its contributions with corporate values (those proposals gained only 4 percent and 6 percent support, respectively).

‘It’s a very hot topic and a very emotional one, unfortunately,’ says Ning Chiu, a corporate governance attorney with Davis Polk & Wardwell. ‘Once companies get emotional, they may make the wrong decision. Nothing on this issue makes people happy.’

If a company makes donations, it should have written policies specifying the dollar threshold over which it will disclose expenditures, says Chiu. ‘You can’t disclose for every dollar spent, especially at the state and local levels where donations are smaller,’ she explains. ‘You don’t see that level of disclosure for any other part of the company.’

Written policies are a must either way. ‘They can protect companies from risk,’ Freed explains. For instance, if a company has a policy on 501(c)(4) donations – either prohibiting such donations outright or specifying in which cases the company makes them – it can protect the company from shakedowns for political cash by certain groups.

Making public such policies allows shareholders to know you are watching your wallet. Welsh points to votes on similar disclosure proposals this proxy season at Aetna and Valero Energy as proof. Both firms have been embroiled in controversy: Aetna for its trade association dues allegedly being used to overturn the Affordable Care Act, and Valero for spending money to help overturn California’s climate change laws.

The disclosure proposal at Aetna got only 6.7 percent support, however, while Valero netted 42.9 percent. The reason, Welsh says, is that Aetna’s political donation policy is clearly stated and detailed, while Valero’s is not. ‘Even if you are involved in a lot of controversies, but you are up-front about it and disclose what you’re spending, investors are likely to give you a little more leeway,’ she concludes.