Proxy advisers Proxy advisers are companies—the big ones are Institutional Shareholder Services and Glass Lewis—that give recommendations to institutional investors about how to vote their shares on corporate matters. There are thousands of public companies and essentially all of them ask their shareholders to vote on a bunch of things every year. Mostly this is routine stuff like election of directors, approval of executive pay, non-binding shareholder proposals asking the managers to prepare environmental reports, etc., but sometimes it is high-stakes stuff like hostile takeover proposals or proxy fights for control of the board of directors. That's a lot to keep track of, and a lot of institutional investors don't have time to think deeply about all of it. So they outsource much of this thinking to the proxy advisory firms: The proxy advisory firms employ people who think about it, develop policies about how they plan to vote on recurring questions, write recommendations on how to vote on each particular question for each particular company, and send those recommendations to their clients, the big institutional investors who subscribe to their research. And then the institutions vote however they want, which often means pretty reflexively voting however ISS and Glass Lewis recommend. Corporate managers really dislike this. (Oversimplifying: Institutional investors used to just vote however management recommended, and now they vote however the proxy advisers recommend, which is sometimes against management.) Their objection often takes the form "who put ISS and Glass Lewis in charge, anyway?" There is actually a really straightforward answer to this question, which is: The investors did. Institutional investors subscribe to their recommendations and pay their fees because they find them useful. ISS and Glass Lewis have no special regulatory power; they have the ability to influence the votes of big institutional investors only because those big institutional investors generally find their recommendations useful. From first principles you'd expect the proxy advisers to be responsive to big institutional investors' desires. If, for instance, every big institutional investor thought that it was a waste of time to ask public companies to prepare reports on their environmental stewardship, you would expect ISS and Glass Lewis to recommend voting no on shareholder proposals for those reports. If every big institutional investor decided to get really into environmental stewardship, you would expect ISS and Glass Lewis to recommend voting yes. On a lot of general policy matters—broad structural things like "should companies care about the environment" or "should the chairman and CEO be different people"—you would expect the proxy advisers to mostly do the work of aggregating the preferences of big investors and making it administratively easier for those investors to vote their preferences. You know you want certain sorts of environmental stewardship, you know all the other big investors want the same sorts of environmental stewardship, you know that ISS knows that and has policies favoring those sorts of environmental stewardship, a thousand companies have a thousand proposals with the word "environment" in them, ISS recommends voting for 300 and against 700, you just vote like ISS tells you because that's what you're paying them for. That is oversimplified, though; lots of corporate votes are not easily decided by universal rules. Proxy fights are particularly difficult: A company's board of directors and managers have one strategic vision, an activist shareholder has another strategic vision, they both make lots of arguments and prepare lots of research and call each other lots of names, and general rules like "always vote with management" or "always vote with the activist" seem likely to lead to trouble. In those circumstances you would expect ISS and Glass Lewis to have some general policies—"always vote for the side whose plans will add the most value," that sort of thing—and to put a lot of work into understanding which side is better. But you also might expect many big investors to have more developed views of their own. Big institutional investors don't pay attention to every one of the thousands of routine proxy proposals, but at least some of them will have strong views on a big proxy fight at a company they care about. You might expect ISS and Glass Lewis to want to know those views. If ISS recommends voting for the activist in a proxy fight, and all of its big investor clients vote for management instead, then that is a little embarrassing just from a responsiveness-to-customers perspective. ISS and Glass Lewis should be helping investors vote the way they want, and if it recommends that they vote the way that they don't want, that's a failure. You might also expect the customers to want ISS and Glass Lewis to know their views before making their recommendations. This is a little subtler: If you're a big investor, and you pay attention to a proxy fight, and you think that the activist is right, and ISS recommends voting with management, that doesn't exactly harm you, as an ISS subscriber. You can still vote however you want; you can just ignore this particular recommendation because you have your own independent view. On the other hand, it does harm you as a shareholder: Some investors will vote the way ISS says, since not everyone will be paying as much attention as you are. ISS's recommendation matters, and if you think that the activist is right and better for the company, you will want ISS to recommend voting for the activist. So you might call ISS up and say "hey we think the activist is right here." And if all of the big institutional investors call ISS up to say that, ISS might say, well, as a matter of customer service, we should tell our clients to vote the way they want to vote anyway. The U.S. Securities and Exchange Commission is in the process of cracking down on proxy advisers by, basically, making it harder for them to recommend voting against corporate management. (They will have to run their recommendations by managers first, and if the managers don't like them they can sue.) This crackdown is extremely controversial; we have talked about it a couple of times, and it has brought out objections from all sorts of investors. Carl Icahn hates it. I suppose I am more or less in the camp of the objectors. (Here's a comment letter that is "largely critical" of the SEC's proposed rules; it quotes something I wrote and refers to me as "one widely read Wall Street wag," which is probably the nicest thing anyone has ever said about me.) SEC Commissioner Elad Roisman, who seems to be leading the charge for the proposed rules, gave a speech a couple of weeks ago dismissing a lot of these objections as "myths." Here's one myth he talks about: Before I conclude, I will tell you about a particular concern I have about the independence of proxy voting advice businesses, which I can only hope is a myth. I have been told that some asset manager clients of these businesses use them as a "fig leaf." As it was explained to me, everything in proxy voting advice business reports is in there because certain asset managers get together and decide, for instance, that they do not like a particular member of a company's board of directors. They then instruct the proxy voting advice business to recommend a vote against the director. The term I heard for this practice is "social arbitrage," a way for an asset manager to vote against a company, while maintaining its relationship with management so that it can sell products to that company such as providing 401(k) services. A coordinated effort along the lines I just described is deeply troubling to me. This is exactly the type of conflict of interest I worry about—that a proxy voting advice business might base its general proxy voting advice to all its clients on the preferences of a select group of its own clients, whether they are asset managers or shareholders themselves. I believe that this type of conflict should be disclosed to all consumers of proxy voting advice businesses' reports. Also, I think this type of behavior could represent a potential Section 13D violation. The "conflict of interest" here is that a proxy advisory firm might recommend that its clients vote the way the clients say they want to vote! I dunno, it does not seem like much of a conflict. Imagine saying it about another business. "I have heard that car manufacturers make SUVs because a lot of their customers keep telling them that they want SUVs; I believe that this type of conflict should be disclosed to all car buyers," come on. Still he has a point. I mean, I wrote a version of this "social arbitrage" story when we talked about the proxy adviser rules a few months ago. And I explained it not only as a matter of good customer service (tell your clients to vote the way they want to vote because that's what they're paying you for), and not only as a matter of social arbitrage (tell your clients to vote the way they want to vote because that gives them cover with the corporate managers they're voting against), but also as a matter of regulatory arbitrage. The point, I wrote, is that the proxy advisers provide a way for the institutional investors to coordinate with each other, without, you know, coordinating with each other: It is generally awkward for institutional investors to get together and discuss their investments. We have talked many times about worries that it might be an antitrust problem for the big institutional investors who own all the companies to get together to talk about how to run those companies. Securities regulation of "groups" can also make it difficult for investors to coordinate their voting with each other. Also, just, big institutional investors do compete with each other and have proprietary views and methods and preferences, and they might not want to sit down with each other and compare notes. What I called "securities regulation of 'groups'" is what Roisman calls "a potential Section 13D violation": If multiple big shareholders of a public company are getting together to agree on how the company should be run and how to vote their shares, then they generally have to disclose that publicly and are subject to a lot of rules and restrictions. So they don't do that. Big shareholders don't just meet in back rooms and come to agreements about what to do. But the proxy advisers are sort of an indirect way to do that, a way for big investors to reach a kind of consensus without talking to each other directly. Perhaps by calling the advisers and telling them how they want to vote, but that is not a requirement. If all of the big investors hire the same advisers, if they all have the same general approach to big questions and pick advisers who share that approach, that's a way to coordinate too. The proxy advisers give the big investors more power collectively than they'd have on their own—and thus reduce the power of corporate managers—because they provide a focal point for investor coordination. Obviously if you are a corporate manager you don't like this; you want more power for yourself. (Roisman's first "myth" is that "the SEC's proxy modernization agenda is driven by the lobbying efforts of corporate interests," which gives you a sense of the objections to the proposed rules.) If you're a big institutional investor you do like this, because it concentrates your power. But be careful. Ten years ago it was uncontroversial to say that big institutional investors should have more power over corporate affairs; that was just called "good governance," responsiveness to shareholder interests. Now it is a bit more controversial. The big institutional investors are so big and so powerful now. People are worrying that it is an antitrust problem to have all the companies owned by the same big investors; they worry about the "Problem of Twelve" in which a dozen people control the majority of the votes in every public company. Tools that concentrate investor power, that allow big institutional investors to work together, now raise suspicions. Everything is securities fraud To me the weirdest case of securities fraud might always be "Blackfish." SeaWorld Entertainment Inc. operates parks that have orcas. A documentary film called "Blackfish" claimed that SeaWorld mistreated the orcas. After "Blackfish" came out, some people stopped going to SeaWorld parks, because of the mistreatment of the orcas. SeaWorld's investors asked management about this, and management said, no, "Blackfish" was having no effect on attendance. The company didn't exactly lie about the attendance—it honestly reported its financial results each quarter—but it apparently did lie about the cause of the lower attendance. The cause was "Blackfish," management apparently knew it was "Blackfish," and management told investors it wasn't "Blackfish." For this, the SEC sued SeaWorld and settled for about $5 million in 2018. Investors also sued, though, and they didn't settle until yesterday: SeaWorld Entertainment Inc. said it would pay $65 million to settle claims that it violated securities laws by not being upfront with investors about the effect a critical documentary had on its business. A documentary called "Blackfish" chronicled SeaWorld's practices related to its treatment of captive orcas, also known as killer whales, that drew criticism from lawmakers and animal-rights activists. Released in July 2013, "Blackfish" claimed that orcas suffer while in captivity. A class-action lawsuit in 2014 alleged that the theme-park operator, its board and executives knew or were reckless in not knowing about the documentary's effect on attendance. Everything bad that a public company does, I often say, is securities fraud, and whenever I then go on to list all the weird unintuitive bad things that are also securities fraud, "abusing orcas" is on the list. Because, yes, now, canonically, being cruel to orcas is securities fraud. Insider trading gift taxes This is a little old (last May) but delightful, who cares, here is an absurd hypothetical. You're the chairman of the board of a public company. You're rich and old, so you're making plans to pass on your wealth to your heirs, and you'd like to minimize gift and estate taxes. There are lots of complicated ways to do that, but one simple way is to give them property that (1) is worth a lot of money but (2) you can say is not worth a lot of money. The public company of which you are the chairman gets an acquisition proposal and begins negotiating a merger in which it would be acquired at a large premium. The negotiations are not public, but of course you know about them because you are chairman of the board. You own a million shares of the company. The shares trade at $50. The merger price is $80. You think about it and say: "If I give these shares to my heirs today, I will pay gift taxes on $50 million worth of stock, the current market value. Then next week we'll announce the merger and the shares will be worth $80 million. I'll pass along $80 million of assets and pay taxes on only $50 million of it, good deal." So you hurry to hand your shares over to your heirs, then you sign and announce the merger. The questions—to which the answers are of course not legal advice!—are: - Is this insider trading?
- Does it work? For taxes?
The answer to the first one seems like a clear no—you never trade, no one is deceived, etc.—though it is maybe a little … insider-trading-adjacent? Like, you are using your inside knowledge of a pending merger, which you got in your fiduciary capacity as the chairman of the company, to minimize your own taxes. It doesn't cost your shareholders anything, but still it feels just a tiny bit sordid. The answer to the second question is also no, which we know because the Internal Revenue Service actually issued a ruling on it.[1] "Under the fair market value standard," says the IRS, "the hypothetical willing buyer and seller of a publicly-traded company would consider a pending merger when valuing stock for gift tax purposes." So the "fair market value" of the stock, when it is transferred, is $80, and you have to pay gift taxes on an $80 million gift. Even though the actual market value of the stock is $50, and even though only a few insiders—including you—know that it's really worth $80. It's weird, right? Here's a summary from Bessemer Trust, which notes: The [IRS] fails to even mention one critical fact. The donor was the Chairman of the Board of the publicly traded corporation, and federal securities laws may have prohibited the donor from disclosing confidential information regarding the merger to a purchaser. … A hypothetical purchaser who was dealing with a hypothetical seller who knew about the information but could not disclose it would not be able to find out about the information even if the buyer made diligent and persistent inquiries. And in fact there were actual willing buyers and sellers of the stock, at the time of this gift, who thought it was worth $50, and who traded it at $50. But its fair market value, the price that a hypothetical willing buyer would pay a hypothetical willing seller, was, says the IRS, $80. The hypothetical market is more efficient than the real one. Even weirder, what if someone else gifted the stock on the same day? Not the chairman of the board of the company, but just some random public shareholder who knew nothing about the merger talks? Would the fair market value of that gift also be $80 per share, even though the stock was trading at $50 and the giver didn't know anything different? Does the chairman have to pay taxes at an $80 valuation because, you know, come on, his timing was an obvious tax dodge, or does the $80 valuation apply to everyone, even people who weren't dodging taxes and had no idea that the stock was "really" worth $80? Elsewhere in unusual estate tax planning, we talked last year about a theory that Jeanne Calment, the oldest person who ever lived (she died at 122), was, in my words, "actually a synthetic hybrid construct assembled to defer taxes." I wrote: Specifically the hypothesis is "that Jeanne's daughter Yvonne acquired her mother's identity after her death in order to avoid paying inheritance tax and that Jeanne Calment's death was reported by her family as Yvonne's death in 1934." I do not know if this is true, but it is beautiful. Here we have a story of someone reaching the absolute outer limits of human potential, coming as close as any human being ever has to living forever, and—it's a tax arbitrage. It just seems right, you know? Why shouldn't the greatest peaks of human achievement be the results of tax structuring? Well, at the New Yorker, Lauren Collins looked into the case, and it seems like the switcheroo theory is probably wrong. Also, though, even if Calment—who "quit smoking at a hundred and seventeen, but never gave up having a nightly glass of port"—was a synthetic hybrid, she probably wasn't a synthetic tax hybrid: In 1934, inheritance taxes for the family would likely have amounted to six per cent of Jeanne's assets, which totalled around two hundred and fifty thousand francs. This was a rate that they surely could have managed, particularly given—et voilà !—the group's discovery that Jeanne had inherited a minor fortune from her father, in 1926. Oh well, it seems that the secret of human longevity is not in fact tax structuring, it is just an old-fashioned regimen of clean living, cigarettes and alcohol. Things happen Don't buy your cryptography from a company owned by the CIA. U.S. Officials Say Huawei Can Covertly Access Telecom Networks. SoftBank Takes Another Multibillion-Dollar Hit From Bad Bets. Big Tech's Smallest Deals Get New Antitrust Scrutiny. Tech Startups Are Flooding Kenya With Apps Offering High-Interest Loans. BlackRock Climate Vow Pays Off With ETF's $600 Million Debut. Deutsche Bank Sells Dollar AT1 in Credit-Market Breakthrough. Charles Scharf Puts Stamp on Wells Fargo With Overhaul of Reporting Lines. Nissan Sues Ghosn in Japan, Seeks $91 Million in Damages. SEC Charges Orchestrator of Cryptocurrency Scheme Ensnaring Physicians. Argentina seeks support from IMF and congress for debt plan. How Shareholder Rights Affect Firms' Financing Decisions. Flyers mascot Gritty cleared of assault allegations, then taunts a nun. Congrats Siba! If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] By "ruling" I mean a "Chief Counsel Advice," a memo from the IRS Chief Counsel about the IRS's view on the matter, which is not officially binding but which people do tend to rely on. Also the facts in the CCA are more complicated than my stylized facts, because in real life the stock was given not directly to the heirs but to a grantor retained annuity trust designed to minimize gift and estate taxes. Also I should note that James Creech on Twitter pointed this case out to me (to ask if it was insider trading). | 
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