Consider this scenario: A Republican President and Congress repeal the Patient Protection and Affordable Care Act, thus vitiating any statutory justification for the HHS contraceptive mandate. As a result, employers remain free to cover as much or as little contraception as they would like. And 10% of companies decide not to cover contraceptives at all. Realizing this fact—and maintaining his very strong commitment to “reproductive rights”—multibillionaire financier Warren Buffett decides that he is going to start taking equity stakes in those 10% of companies that are publicly traded. His highly paid consultants have shown that “contraceptive equity” can play well with stockholders when presented in the right context. Thus Buffett starts to buy stock in companies without contraceptive coverage while his lawyers prepare “proxy resolutions” for the annual shareholder meetings pursuant to Securities and Exchange Commission (SEC) Rule 14a–8. These resolutions call on directors to adopt “contraceptive equity” in their provision of healthcare and thus force directors and management either to (a) accede to Buffett’s socially liberal demands, or (b) face a costly and drawn-out fight for the opinion of shareholders against a sophisticated opponent with infinite resources.
Thankfully, current SEC rules will not allow this to happen. Rule 14a–8(i)(7), in particular, would probably allow a corporation to exclude these hypothetical Buffett proposals from the slate of issues presented to shareholders as relating to “ordinary business” (i.e., here, the particulars of employee compensation). Thus any corporation that wishes to exclude contraceptive coverage for any reason would be able to do so without external interference from wealthy social crusaders.
And yet, some social conservatives have recently denounced this same rule for preventing a shareholder proxy resolution from going forward against PepsiCo. At issue is whether or not PepsiCo should continue to contract the taste-testing of new products such as Pepsi Next to Senomyx, a corporation that performs the testing using proteins cultured with the use of HEK–293, a kidney-cell line derived from a baby killed by induced abortion in 1972.
Concerned pro-life shareholders tried to include the following resolution in Pepsi’s annual proxy statement: “Shareholders request that the Board of Directors adopt a corporate policy that recognizes human rights and employs ethical standards which do not involve using the remains of aborted human beings in both private and collaborative research and development agreements.” PepsiCo’s attorneys informed the SEC that they would exclude this language pursuant to the “ordinary business” exception and attorneys for the SEC, in turn, informed PepsiCo that they would not recommend an enforcement action if PepsiCo did exclude the resolution.
This was a correct decision by PepsiCo and the SEC. Corporate law can (and should) provide very few avenues for social activism—even when the cause is noble, as here—in order to prevent administrative inefficiency, large transaction costs, and substantively flawed outcomes (as in the Buffett hypothetical). Pro-life consumers are right to boycott PepsiCo until they desist from their unethical product research, and pro-life investors would be right in selling any PepsiCo equity in protest. “Shareholder activism,” however, is not the answer.
PepsiCo and HEK–293
In the summer of 2011 the pro-life watchdog group, Children of God for Life (CGFL), discovered that PepsiCo had contracted out some of its product research to Senomyx, a company that uses the abortion-derived kidney cell HEK–293 in its research. CGFL had previously alerted the public that Campbell Soup was using Senomyx for abortion-derived research. Senomyx uses the HEK cells to culture a kind of protein (G proteins) used by the body for taste-sensation at the molecular level; this lets them construct objective and scientific approaches to new flavors in a lab. The public outcry it engendered (or at least the potential outcry) caused Campbell to sever ties with Senomyx.
These (and other) forms of consumer activism by CGFL are to be praised. HEK–293 is a problematic agent of biomedical research. As Dr. Alvin Wong has noted, “Grave injustice is involved in reaping profits from such direct by-products of a willful abortion. One can argue that by accepting such a product from the developer of the cell line in order to market it, there is already ratification of the developer’s act, which is one of grave complicity with respect to the abortions.” Likewise on the demand-side Dr. Wong argues, “The use of HEK 293 may give the impression of legitimizing abortion as a source of products used in well-intentioned medical treatments, and of collaborating with the abortion industry.” This is particularly salient in the case of HEK–293 in its potential to legitimate abortion as a tool of medical research for numerous and sundry ends.
As in the case with abortion-derived vaccines for children, right reason can allow non-complicit use in the right circumstances—with HEK–293, I suspect this is the case as regards its use in potential treatments of cystic fibrosis. Yet that is not the case with Senomyx testing, which is for the entirely petty use of flavor optimization. As someone once remarked to me, “At least ‘Soylent Green’ fed the starving; this is just perverted.”
These petty unethical uses provide their own unique difficulty in that their seeming smallness can—if not checked—make it impossible to function ethically in a modern consumer society. As Dr. Gerard Nadal notes, “The more that HEK 293 is used (and it is used rather ubiquitously now), how many products are we morally obliged to refrain from using? How many medical treatments, with no ethically sound alternative, must we forgo? HEK 293 is used to manufacture proteins in thousands of labs, and is omnipresent. What do we do with a field already saturated by the use of aborted cell lines?” Those are not easy questions.
So if the use of these abortion-derived lines is unethical on the supply side and unethical on the demand-side, why not use principles of corporate law to stop the producer?
The Trouble with Shareholder Activism
Shareholder activism has a long and varied history as it relates to “social” (that is, non-share-value maximizing) issues.
The common way that corporations today exclude these resolutions, as noted above and at issue with PepsiCo, is by characterizing them as “ordinary business matters” under SEC Rule 14a–8(i)(7). As PepsiCo’s attorneys pointed out in their SEC filing, “the term ‘ordinary business’ refers to matters that are not necessarily ‘ordinary’ in the common meaning of the word, but instead the term ‘is rooted in the corporate law concept of providing management with flexibility in directing certain core matters involving the company's business and operations.’ ” Professor Bainbridge explains that in 1992 the SEC “adopted a bright-line position that for the first time effectively excluded an entire category of social issue proposals.” Six years later, however, the SEC reversed its position to apply a “case-by-case approach” which excludes as ordinary business proposals that seek to “micro-manage” a corporation, while retaining “proposals broadly relating to such matters but focusing on significant social policy issues, such as affirmative action and other employment discrimination matters.” Bainbridge describes this as “the frustratingly ambiguous task of deciding whether a particular proposal is ‘significant.’ ”
Typically these social-activism resolutions come from the left. Common causes that find their way into statements are animal “rights” and Palestinian “liberation.” Also common is the SEC’s case-by-case analysis allowing the exclusion of proposals that would seek to end animal cruelty (e.g., the selling of raccoon-dog fur by Dillard’s) or a fund’s divestment from firms that “profit” from the “Israeli occupation” of the West Bank and East Jerusalem.
As a general rule, excluding these statements makes sense and should be encouraged. Yet the standard applied by the SEC is ambiguous: what proposals are “significant” is far from clear. There are similarly unclear guidelines about categories of proposals that are and aren’t “significant social policy issues” such as employment discrimination, but these only serve to further confuse issues. So (these are real cases), while Home Depot could exclude a socially conservative proposal requiring it to disclose its large contributions to charities in order to see how much money it gives to LGBT organizations, Disney could not exclude a socially conservative proposal calling on the company to extend anti-discrimination protections to “ex-gays.” Likewise while Dillard’s could exclude a proposal to ban fur, GE could not exclude a proposal demanding a catalogue of its animal testing. What one sees isn’t a right-left inconsistency within the SEC, but a general intra-“worldview” inconsistency generated by arbitrary distinctions between what is and isn’t a “significant” social policy issue. Why should this surprise us? It is far from obvious that attorney-advisers from an independent federal agency have any particular capacity to draw either sophisticated or publicly responsive distinctions between social-policy positions.
Apart from agency incapacity in drawing reasonable policy lines, these resolutions can be problematic on their own. The transaction costs they generate simply in their exclusion are considerable. If and when they succeed, those costs bubble. Management has to expend resources in the proxy contest if it intends to oppose. If the resolution succeeds there can be high compliance costs depending on the circumstances of the resolution. Invariably, the losing side of the resolution (as these are contentious social issues) will mount its own proxy contest at the next year’s shareholders’ meeting. The entanglement of directors and management in contentious social issues—in particular in their implementation through firm policy—will increase board and management scrutiny, thus inviting related and unrelated derivative suits (i.e., suits brought by shareholders on behalf of the corporation against management), the legitimate and frivolous of which are just as expensive to litigate and settle. In the end, more social and ethical proxy resolutions mean more expensive regulatory compliance and costly litigation. It is a bleeding of wealth from diverse shareholders (families, retirees, pension funds, endowments, optioned employees, etc.) to plaintiff’s lawyers and major corporate firms.
Lastly, as a political matter, social neutrality is the prudent course. While perhaps PepsiCo can be forced into abandoning its HEK–293 research, that same principle of broad shareholder activism would open the door to substantively bad outcomes like corporate commitment to “reproductive rights” or Israeli “divestment.” Giving a freer hand to a Warren Buffett or a George Soros or a Cecile Richards to influence corporate policy through small-stake shareholder activism is a tremendous risk to take in order to stop abortion-derived soda research now or any other conservative policy goal in the future.
Given the administrative, practical, and political problems in shareholder activism, pro-life activists should not undertake proxy resolutions. While perhaps the 1992 SEC categorical exclusion was too broad, it would be good for our system to approach one in which social or ethical considerations were generally not dealt with in the space of corporate law or securities regulation. Regardless, until such a time pro-lifers should avoid contributing to regulatory waste by filing such resolutions.
What pro-life consumers can do—and thankfully are doing—is boycott companies such as PepsiCo who refuse to end or repudiate their illicit product testing. Like Campbell, perhaps PepsiCo can be shown the error of its ways through concerted signals within the market. Likewise, pro-life investors can comply with the so-called “Wall Street Rule” and sell their shares in PepsiCo, the idea being that if you disagree with firm policies, you divest yourself of your shares rather than try to change the policies. Investors here thus avoid remote complicity in PepsiCo’s unethical gains while also signaling to others in the market that such unethical conduct is not endorsed by investors.
While the benefits of these forms of direct-action might be remote and speculative, they allow individual actors to fulfill moral obligations while avoiding both the tremendous economic inefficiencies of activist interference in corporate governance and the likely hijacking of these methods by the radical left.
If you don’t like how Pepsi Next was developed, buy a Coke Zero; don’t hire a lawyer.
Michael A. Fragoso is a student at Notre Dame Law School.