Rogue Missives Friday, May 23, 1997

Every shareholder in a publicly-owned corporation is familiar with the proxy statements that accompany annual reports -- "familiar" in the sense that one is familiar with the junk mail one cursorily glances at before tossing it in the trash. If Americans are notably apathetic voters in political campaigns, they seem more apathetic about their voting privileges as shareholders. The consequences, of course, are the same: a republican system in which elected representatives grow more distant from those they are representing, and a system in which activists controlling a small number of votes are able to wield disproportionate influence.

What's curious about this with regard to American business is that the American system of joint-stock companies is one of the only in the world that clears a real space for shareholder control. Unlike the German or Japanese models, where companies tend to be situated in interlocking relationships and where banks often have controlling interests in corporations, the American model offers the potential for more diffuse ownership and, through the mechanisms of public elections and proxy resolutions, the opportunity for individual shareholders to help guide the direction of the companies they own.

In practice, of course, mutual funds, pension funds, and other large institutional shareholders end up playing roles that are not dissimilar to those played by banks or other corporations in Japan and Germany. And for all the talk of revolutions in shareholding patterns, the American system has still done a relatively poor job of diffusing stock ownership, with something like 90% of all individually-owned shares held by just 10% of the population. If this is democracy, it is one that rests on a relatively narrow base.

Nonetheless, what remains most striking about the way the American system functions in practice is not the power of institutional shareholders or the sheer number of people who play no part at all in shaping corporate behavior. Rather, what is most striking is the degree to which elections of boards of directors and votes on shareholder resolutions are fundamentally shadow plays, the results of which are predeternined and unchangeable. Elections are held that everyone knows are already won (or lost). In this world, having ten percent of the votes cast against you is evidence of serious opposition.

To be sure, much of this rubber-stamping, particularly today, stems from the fact that it would be hard to quarrel with the performance of many American corporations. Even in the interests of democracy, for instance, it would be foolish for Intel's shareholders to challenge the plans of Andrew Grove. At the same time, it's also true that the last decade has seen more real electoral contests for power between management and dissident shareholders than the previous three decades combined. But there's still an enormously long way to go before the relationship between shareholders and the companies they own can be termed genuinely democratic.

All of which makes the recent struggle over the control of SALLIE MAE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLM)") else Response.Write("(NYSE: SLM)") end if %> an intriguing and, in some respects, heartening story. Sallie Mae, also known as the Student Loan Marketing Association, is the federally-chartered and government-sponsored enterprise that currently buys guaranteed loans from lenders in order to allow them to make more loans. Sallie Mae benefits from its affiliation with the government because it's able to buy loans at below-market interest rates because its risk of default is so low.

Soon after taking office, though, President Clinton attacked Sallie Mae as an unnecessary middle man helping banks perform services -- most obviously student loans -- the government could do better on its own. As a result, Congress passed a plan revoking Sallie Mae's federal charter and requiring the company, which has $47 billion in assets, either to privatize itself or be liquidated by the year 2013. The plan also provided for the government to begin to lend directly to students.

As a result, Sallie Mae is facing a March 1998 deadline, by which time it has to produce a privatization plan or face liquidation. In the face of that deadline, the corporation has been riven by a battle between two groups of shareholders, one backing management and the other backing a group of dissident shareholders which calls itself the Committee to Restore Value at Sallie Mae (CRV).

Both management and CRV favor privatization, as by all indications do the vast majority of Sallie Mae shareholders. The two sides disagree sharply, though, about the direction the company should pursue as an independent corporation. Unlike many shareholder groups, CRV is interested in more than democratizing the process by which directors are elected or eliminating sweetheart deals for friends of management. Instead, CRV is actively seeking to alter the shape of Sallie Mae's future, and to dictate the nature of its business operations.

Sallie Mae's management wants the corporation to retain its current focus, buying guaranteed loans from banks, while expanding its business in other areas, including the servicing of consumer loans, consulting, and software services. Management sees its business as secure and almost guaranteed to be profitable and wants to build on its already established network of relationships with commercial lenders.

CRV, on the other hand, believes Sallie Mae should adopt a more aggressive approach in its new incarnation. The group, which is led by founder Albert Lord, wants the corporation to abandon plans to expand into sideline businesses. Instead, it wants Sallie Mae to become a lender in its own right, competing with banks to make loans directly to students and schools. Obviously, such a strategy runs the risk of alienating Sallie Mae's long-time customers, and it would also put SLM directly in competition with the federal government. But CRV argues that the risks of the plan are more than outweighed by the potential for enormous gains that could be reaped by a company with Sallie Mae's name recognition and $47 billion in assets.

CRV actually has eight members on SLM's board of directors, which is a majority of shareholder-elected directors. There are, though, eight political appointees, which has kept CRV from being able to implement its plan.

What's remarkable about this dispute is both the magnitude of the decision, which is to say that it really is the company's future that is at stake here, and the fact that it has been shareholders who have been given the power to make it. Both CRV and Sallie Mae management have held shareholder elections designed to garner majority support for their plans. Since Sallie Mae has 52.8 million shares outstanding, both sides needed 26.4 million votes (plus one) in order to claim victory.

Neither side has been able to do that.

CRV held a dissident shareholders meeting on Friday, May 9, at which the group had expected to be able to announce that its plan was victorious. Instead, the dissidents said that by their count they had received 23 million votes, and Lord could only say, "We're feeling like a winner at this point." Unsurprisingly, Lord called on Sallie Mae Chairman William Arcenaux to adopt CRV's plan and to install a new group of directors. He also extended the voting until May 29 in a quest to get the three million votes CRV needed. According to the group's tally, which had 15 million votes in favor of SLM's management, there were 13 million votes still uncast.

The following Thursday, though, Sallie Mae held a special shareholders meeting at which it announced the results of its election, which showed 21 million votes cast in favor of management and 21 million cast in favor of CRV. Although 20% of the votes remained uncast, and although Sallie Mae extended the voting until June 5, the shareholders' verdict seemed clear: a pox on both your houses. And Sallie Mae's CEO, Lawrence Hough, was honest enough about that.

"The writing is on the wall," Hough said after the meeting. "There is something about these plans that [shareholders] do not like."

Lord, of course, pounced on the vote as evidence of shareholders' lack of confidence in management, and argued that these issues needed to be resolved sooner rather than later. He blamed management for seeking to delay a final decision. Hough was somewhat more sanguine about the results of the vote, and more open to possible compromise.

"It's clear that the vast majority of our shareholders want privatization," he told Reuter, "but many of them have concerns about board control and board representation."

After the meeting, Sallie Mae management and CRV began negotiations about their respective proposals. In particular, it seems likely that a shareholder meeting may be called at which shareholders will have the chance to approve a privatization plan that contains no reference to future business plans. What's less likely, but still a possibility, is that shareholders may have a chance to vote on competing slates of directors.

While the merits of the two plans are not irrelevant -- analysts in the industry tend to favor CRV's more aggressive approach, while certain institutional shareholders have expressed support for management -- what's most important, and most interesting, about the Sallie Mae case is that shareholders have made the crucial decision about the company's future, even if that decision has been "We want a better alternative." In a sense, the fact that neither side was able to claim a majority is the strongest testimony possible to the reality of the democratic process in this case. We are, in other words, as far from rubber-stamping as possible.

In more substantive terms, it also seems true that the ambivalence of shareholders has prompted a newfound attention to their interests from management. And it's equally true that this entire struggle has forced both sides to consider its own plans more carefully, and to begin to think about how compromise might be possible. The Sallie Mae situation is clearly a unique one, in some respects closer to the experiences of Eastern European companies privatizing than to most American corporations. Still, we should look to it as a model for the future democratization of meaningful business strategy, and as an example of what happens when those proxy statements don't end up in the garbage.

-- Jim Surowiecki (Surowiecki)

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