Introduction to the SDX Protocol

James Woolery is Deputy Chairman of Cadwalader, Wickersham & Taft LLP, Co-Chair of its Corporate Department and head of its Business Development Group. This post is based on an excerpt from the Shareholder Director Exchange (SDX) Protocol, a framework to guide engagement between directors, which is sponsored by Cadwalader, Wickersham & Taft LLP, Teneo Holdings, LLC, Tapestry Networks, Inc. and the participating directors and investor representatives of the SDX™. The complete publication is available here.

The Shareholder-Director Exchange (SDX™) [1] is a working group of leading independent directors and representatives from some of the largest and most influential long-term institutional investors. [2] SDX participants came together to discuss shareholder-director engagement and to use their collective experience to develop the SDX Protocol, a set of guidelines to provide a framework for shareholder-director engagements. While the decision to engage directly with investors should be made in consultation with or at the request of management, the 10-point SDX Protocol offers guidance to US public company boards and shareholders on when such engagement is appropriate and how to make these engagements valuable and effective.

Changes to the corporate governance landscape, including an increasing focus on better and more effective governance practices, the frequency and scale of activist campaigns, the increased use of proxy advisory services, and an increased understanding of the potential benefits of direct engagement, have led institutional investors and public company boards to review their current approaches to shareholder-director engagement. More institutional investors are seeking meetings with the public company directors they elect, and more directors are accepting these requests. Some boards are proactively requesting meetings with significant shareholders.

In December 2013, Securities and Exchange Commission Chair Mary Jo White emphasized the importance of direct engagement by stating “the board of directors is—or ought to be—a central player in shareholder engagement.” [3]

This post synthesizes the perspectives of participating directors, institutional investor representatives, and other thought leaders concerning four key reasons why the time is right for the SDX Protocol:

  • Shareholders are increasing their involvement with public companies and are often focused on corporate governance matters
  • Directors are responding by engaging more frequently with the company’s owners
  • Both investors and directors are realizing significant value from direct engagement
  • Perceived barriers to engagement can be avoided or addressed

Shareholders are increasing their involvement with public companies and are often focused on corporate governance matters

One of the most significant developments in corporate affairs in recent years is the shift in the balance of power between shareholders and the management and boards of the companies in which they commit their capital. Passive shareholders whose portfolios are largely indexed have long seen engagement as an important tool; now, active shareholders are no longer content with exiting their investments when operating performance, investment returns, or corporate governance are unsatisfactory. With increasing frequency, more investors are attempting to influence the corporate governance and operations of companies through the proxy process or other forms of activism, and long-term investors are increasingly willing to consider and support these efforts. It is shortsighted for corporate boards to avoid engaging with their long-term investors when activists frequently meet with those same institutions to pursue corporate change.

Some directors involved with the SDX Protocol noted that companies on whose boards they sit have received engagement requests because performance, policies, or practices have triggered shareholder interest. This is more than just anecdotal, as traditional activism is clearly on the rise:

  • Activist shareholder interventions (e.g., seeking board representation, share buybacks, CEO removal) increased 88% between January 1, 2010 and September 20, 2013, with the majority of that growth in Europe and the United States. [4]
  • Activist shareholders worldwide have stepped up their actions at companies with market capitalizations exceeding $2 billion by 129% since January 2010. [5] The average market value of companies targeted by activists increased to $8.2 billion in 2012, up from $3.9 billion in 2011. [6]
  • The number of shareholders globally with a stated activist strategy has more than doubled over the last decade. [7]
  • Activist funds are estimated to have over $100 billion in assets under management—three times the amount invested in 2008. [8]

An important change from the past is that activists no longer need to take large stakes in their targets to gain leverage over companies, even those that were previously viewed as unapproachable because of their large size. Today, relatively small positions can provide a platform for disproportionate influence, as in the case of ValueAct’s 0.8% position in Microsoft and Pershing Square’s 1% position in Procter & Gamble. [9]

In addition, some institutional investors are pushing companies to change policies and practices, adopting tactics traditionally associated with activists. For example, the California State Teachers’ Retirement System recently co-sponsored a proposal with activist fund Relational Investors in an effort to break up Timken Co. The two organizations objected to the Timken family holding three of 11 board seats while holding only 10% of the stock. [10]

The Shareholder Rights Project at Harvard Law School has targeted staggered boards of directors with remarkable success. In 2012 and 2013, 58 of the 61 declassification proposals submitted by the Shareholder Rights Project and the investors it represents that went to a vote were passed by shareholders, with an average of 81% of votes cast in support; many other companies declassified by settlement. [11]

To prepare for potential activities like those described above, companies must be mindful of a growing list of red flags that can draw the attention of activists and corporate governance experts and have led to engagement requests or activist campaigns: [12]

  • Underperformance, whether operating performance or relative shareholder return
  • Unplanned CEO or C-suite transition
  • Significant litigation or government investigative activity
  • Reputational event with negative mainstream or social-media attention
  • Series of operational mishaps suggesting lack of board oversight
  • Financial restatements, late filing, lack of clean audit opinion, or unplanned change of audit firm
  • Board composition (e.g., quality, diversity, tenure, “overboarding”)
  • Below-average support for management proposals (e.g., say on pay, director nominees)
  • Above-average support for shareholder proposals (e.g., CEO-chair separation, political contribution disclosure)
  • Failure to implement election outcome or resolution supported by shareholder majority
  • Disfavored compensation practices or elements
  • Significant activist stake in company
  • Plurality voting policy
  • Classified board
  • Dual-class stock
  • Disempowered nonexecutive chair, lead director, or presiding director
  • Controversial transaction activity, including related-party transactions
  • Takeover defense plans
  • Poor disclosures and shareholder communications
  • Environmental, social, and other governance considerations (e.g., labor issues, environmental legislation, sustainability practices, or reporting)
Deciding when to engageThe presence of a red flag may not be sufficient reason to engage. Deciding when to make or accept an engagement request is a case-by-case determination based on the company’s or investor’s general philosophy of shareholder-director engagement and other important contextual factors. For more, see the second point of the SDX Protocol, “Adopting a clear policy for engagement.”

Directors are responding by engaging more frequently with the company’s owners

Forward-thinking directors have moved to mitigate the impact of the shifting balance of power toward shareholders by engaging with longer-term shareholders. SDX participants reported that this type of engagement has become increasingly common.

Activists and corporate governance campaigners can use the presence of the red flags noted above as a lever to gain shareholder support for their initiatives, and failure to engage with shareholders can only bolster their efforts. James Woolery, chairman-elect of Cadwalader, Wickersham & Taft LLP, recently made this point: “Unable to effectively communicate with their boards, shareholders are routinely turning to aggressive activism … Boards that don’t engage with their investors on a continuing basis risk making themselves vulnerable to activists eager to exploit the lack of communication.” [13]

Objective self-analysis by companies can identify points of vulnerability that could lead to engagement requests or more disruptive forms of shareholder activism. Having a clear view of a company’s vulnerabilities may lead the board to undertake an engagement process with shareholders designed to listen to concerns and explain the board’s approach to strategy, business challenges, and compensation, for example. A company’s corporate secretary can help the board and its nomination and governance committee by surfacing current governance issues, as well as any specific items cited by the company’s largest shareholders.

Management’s roleA company’s primary investor relations function is vested in its management—specifically in the company’s senior officers and investor relations professionals. Company management will continue to lead engagement with shareholders with respect to operating performance, financial matters, strategic execution, and other operational and performance matters for which management is directly responsible.

The SDX Protocol respects that relationship and is not intended to subordinate management’s primary role in shareholder interaction, but rather to supplement investor relations activities by clarifying when and how the independent board directors ought to engage with the shareholders who elected them.

However, it is important that management and boards are unified and consistent in their communications with shareholders. In order for shareholder-director engagement to be an effective component of a company’s overall communications effort, boards should coordinate engagements with management, including discussing the purpose of the engagement, topics for discussion, and preparation. Except in rare cases where confidentiality from management has been requested, the board should review with management the matters discussed during the engagement.

Both investors and directors are realizing significant value from direct engagement

While shareholder activism is often the trigger for board-shareholder engagement, interaction between shareholders and directors is increasing simply because it is seen as beneficial to both parties. Engagement improves transparency, mutual understanding, and the overall quality of governance in the market. Engagement can also reduce friction and transaction costs.

SDX participants noted that engagement benefits companies by enabling them to do the following:

  • Demonstrate quality of board oversight. Direct engagement gives boards the opportunity to present their processes, philosophy, and rationales with respect to specific corporate governance issues important to shareholders. In doing so, boards can improve the perception of, or enhance the awareness of, the company’s unique business context and the quality and thoughtfulness of board efforts. Explaining a board’s processes also builds a valuable sense of the board’s accountability.
  • Create direct and open channels for substantive and productive communication. Proactive engagement in the normal course of business, on clearly defined engagement topics, creates channels of communication between the board and representatives of its shareholders and can help the company provide context for the business environment and explain key strategic or governance decisions. The development of professional relationships arising from this process—and the experience directors gain through engagement—can improve targeting of communication and greatly enhance outcomes when directors solicit shareholder support in times of corporate crisis (e.g., activist attack, proxy battle, etc.).
  • Better understand investor perspective of business and governance issues. Investors have an informed view of the company and its competitive landscape, both on an absolute basis and relative to its peers. Boards can gain valuable insight on how company management and strategy is perceived by the market. Investors can also be a source of insight on the attributes and skills desirable in board members or, in some cases, a source of candidates to consider for board membership.
  • Influence proxy-voting decisions. Companies can move the percentage of votes for or against a proposal, either when engagement is requested or by requesting engagement. For example, companies can seek engagement to provide context for the board’s thinking and enable investors to cast fully informed votes. This may convince investors to take an exception from their proxy-voting guidelines.

Likewise, SDX participants noted that engagement benefits investors by enabling them to do the following:

  • Evaluate board effectiveness. Investors gain real insight into boardroom composition, capabilities, function, and dynamics by meeting with a company’s directors.
  • Create direct and open channels for substantive and productive communication. Direct engagement creates channels for communication and can create a history of good-faith engagement with respect to corporate governance issues. Investors may receive better reaction to their own requests and perspectives when there is a track record of engagement.
  • Better understand director perspective of business and governance issues. Hearing a director explain the board’s approach offers a unique window into the company that enhances the investor’s understanding of the company’s situation and thinking.
  • Influence governance policies and practices. Direct engagement gives investors the opportunity to present unfiltered views and can persuade a company to reconsider and change corporate governance policies and practices. Investors can communicate their concerns directly to the board and potentially avoid the need to file a shareholder resolution or take a public position on a proxy item. Investors can use engagement to better inform their voting decisions and to supplement their overall investment thesis regarding a company.

Perceived barriers to engagement can be avoided or addressed

Some key objectives of the SDX Protocol are to address legacy practices and concerns that have historically kept directors from engaging with their shareholders and to provide solutions to issues that could be problematic. The table below outlines concerns and responses that SDX participants identified.

Concern Response
Resource constraints There is insufficient time for directors to meet with all shareholders or for most institutional investors to meet with directors from all portfolio companies. Both groups have many demands on their limited time. Despite time and resource constraints, company boards and investors make time for engagement when an issue is of sufficient importance. The SDX Protocol identifies factors that help directors and investors prioritize engagement opportunities. SDX participants also noted that the time required to prepare for and conduct engagements is relatively modest. Engagement conducted before an issue has a chance to become a significant problem can ultimately save time for participants. Avoiding perfunctory or non-issue driven engagements can serve to preserve resources and allow participants to focus their efforts on issues of critical importance.
Compliance concerns Engagement with shareholders creates a risk of violating Regulation FD (Fair Disclosure) and subjecting the company and/or director(s) to liability. With appropriate training, there is minimal risk that engagement will create a compliance event for issuers or institutional investors who wish to avoid becoming insiders. Additionally, corporate governance and other topics typically discussed during engagement are not the type of disclosures on which regulators are focused. For more, see Appendix 1: Regulation FD considerations.
Management or director reluctance Historically, senior management—particularly the CEO, CFO, and head of investor relations—handled most company-investor engagement. For varied reasons, both members of management and the board may be reluctant to deviate from this historical practice. Shareholder-director engagement does not subordinate management’s primary role in investor relations activities; the board’s role is to supplement management’s work in particular situations or on appropriate topics. The primary focus of shareholder-director engagement should be with institutional investors that share the board’s commitment to long-term value creation. For more, see the text box “Management’s role,” above. In addition, companies and investors benefit when their engagements demonstrate the quality of their representatives responsible for the matters discussed.
Lack of trust of underlying motivations Companies and institutional investors sometimes perceive engagement requests as coming in bad faith: issuers fear an intent to embarrass, and institutional investors fear an intent to do nothing beyond sit through the requested meeting. SDX participants reported that engagement requests are generally made and accepted in good faith and can generate substantial value for both parties.
Risk of mixed messages Companies are concerned that having multiple people speak for the company—the CEO and one director, or several directors—increases the risk that messaging will be inconsistent. Institutional investors may worry that their investment and corporate governance professionals may also provide inconsistent messaging. The risk of mixed messaging already exists: virtually all companies and institutional investors of scale delegate communications to multiple individuals. Appropriate coordination between boards and management can mitigate this risk effectively.The concern also assumes that the only purpose of engagement is to talk; however, listening is equally important.
Risk of harming relationship Some opportunities to engage are missed because of concern that engagement may harm the relationship between the company and investor. Meetings can go poorly if there is no clear objective or agenda, the wrong representative is selected, the parties are not sufficiently prepared, or for other reasons. Directors are elected by shareholders and no benefit arises from isolating each party. Failing to meet can be the more significant risk. SDX participants noted that engagements rarely backfire for either party, and that this risk can be minimized by following the SDX Protocol.
Adapting the SDX™ Protocol for engagement with other types of shareholdersThe SDX Protocol is focused primarily on public company board engagement with institutional investors in real-time, two-way dialogue. However, this focus is not meant to imply that there is no value to be gained from better engagement with or communication between other shareholders and directors. Indeed, recent data shows that one-third of US company shares, on average, are held outside of institutional accounts and that individual ”retail” shareholders can affect voting outcomes. [14] Therefore, most principles of the SDX Protocol can be adapted for engagement with other types of shareholders or other types of meetings.

“Scaling” engagement and communications with broader groups of shareholders may require the use of alternative approaches, including the use of technological resources and tools. Some current options include virtual annual meetings, electronic forums, and investor “days” that enable better communication or dialogue in between regularly scheduled events. Some newer technologies can validate the number of shares owned by participants in a forum or survey and provide secure communications in a company-controlled site. Other technologies can provide data on shareholder sentiment and voting patterns that enable a company to more effectively engage with its shareholders. Companies and investors are advised to keep informed of technology that may enable them to be more efficient or inclusive.

The SDX™ Protocol process

The work of the Shareholder-Director Exchange has been supported by Tapestry Networks, Cadwalader, Wickersham & Taft LLP, and Teneo Holdings, together with Broadridge Financial Solutions. Tapestry, Cadwalader, and Teneo conducted interviews with public company directors, institutional investor representatives, subject matter experts, and other thought leaders about shareholder-director engagement. For a list of working group participants and others interviewed in connection with the SDX, please see Appendix 2. The SDX Protocol reflects a majority perspective on detailed recommendations. [15]

Tapestry, Cadwalader, and Teneo can be contacted to discuss the SDX Protocol more generally or to provide further context and information with respect to shareholder-director engagement. Broadridge can be contacted to discuss the SDX Protocol and alternative methods in which engagement can be scaled to incorporate retail and other individual investor classes. For contact information for Tapestry, Cadwalader, Teneo, or Broadridge, please see Appendix 3.

The SDX™ Protocol

The Shareholder-Director Exchange Protocol (SDX Protocol) was created by a working group of leading independent directors and representatives from some of the largest and most influential long-term institutional investors. The group came together to provide guidance to other investors and directors about the growing trend towards shareholder-director engagement.

The working group has devised the SDX Protocol to assist public company boards and institutional investors who wish to consider engagement by providing a practical framework for effective, mutually beneficial engagement. Although the SDX Protocol can be utilized in the context of a corporate crisis, it is intended to be a broader template for addressing corporate issues in the normal course of business.


Companies and investors often miss valuable opportunities to engage. While the SDX Protocol does not offer a one-size-fits-all approach to engagement, it does provide meaningful guidance and concrete suggestions from seasoned engagement practitioners. It is offered in service to public company directors and investors to enable them to more effectively make and respond to engagement requests.

The SDX Protocol can accessed in its entirety here.


[1] SDX and the SDX logo are trademarks of Tapestry Networks, Inc., Cadwalader, Wickersham & Taft LLP, and Teneo Holdings, LLC.
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[2] Working group participants and others interviewed in connection with the development of the SDX Protocol are identified in Appendix 2.
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[3] Securities and Exchange Commission Chair Mary Jo White, “Remarks at the 10th Annual Transatlantic Corporate Governance Dialogue” (speech, December 3, 2013). Note that SDX participants do not wish to subordinate management’s primary role with respect to investor relations, but rather to provide an additional mechanism for engagement with a company’s owners. Management’s role is addressed more fully in the text box “Management’s role.”
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[4] Linklaters, “Activist Investors Turn Up the Heat in Global Boardrooms,” news release, November 11, 2013.
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[5] Ibid.
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[6] James C. Woolery, “Bridging the Chasm Between Boards and Shareholders,” Wall Street Journal, October 9, 2013.
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[7] Linklaters, “Activist Investors Turn Up the Heat in Global Boardrooms.”
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[8] Woolery, “Bridging the Chasm Between Boards and Shareholders.”
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[9] Company and investor filings.
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[10] Louis M. Thompson, “When Pension Funds Turn Activists,” Compliance Week, December 17, 2013.
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[11] Lucian Bebchuk, Scott Hirst, and June Rhee, “Towards Board Declassification in One-Hundred S&P 500 and Fortune 500 Companies,” Harvard Law School Forum on Corporate Governance and Financial Regulation (blog), October 30, 2013.
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[12] This list will likely evolve over time. Corporate secretaries can ensure their boards are kept up to date with the latest thinking in governance to avoid unwelcome surprises.
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[13] Woolery, “Bridging the Chasm Between Boards and Shareholders.”
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[14] Broadridge and PwC, “2013 Proxy Season Recap,” ProxyPulse, accessed January 11, 2014.
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[15] Participation was in an individual capacity and neither these individuals nor the institutions with which they are affiliated necessarily endorse all aspects of the SDX Protocol.
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One Comment

  1. Gregory A. Brake
    Posted Wednesday, February 5, 2014 at 9:53 pm | Permalink

    The SDX has the extraordinary potential of letting the steam out of distracting activists by creating responsible communication lines and a valuable lessons learned resource environment. This is innovative.