The Dodd-Frank Wall Street Reform and Consumer Protection Act directed the Securities and Exchange Commission to adopt new rules that will allow shareholders to have their director nominees included in company proxy materials. The new rules passed by a 3-2 vote of the commissioners at an SEC open meeting in August and are now scheduled to go into effect in November (60 days from September 16, when the rules were published in the Federal Register). For the first time, proxy access will allow a shareholder or group of shareholders who holds at least three percent of the total voting power of a company’s securities and who has held the shares continuously for at least three years, to use management’s proxy materials for the nomination of up to 25 percent of the company’s board of directors, provided the shareholder is not seeking a change of control of the company or to gain more board seats than the maximum number provided for under the new rules.
Regardless of your personal viewpoint, proxy access is being hailed as a game changer that significantly enhances shareholder rights and, in particular, is widely believed to give institutional investors unprecedented power in board director elections. Until now, shareholders who wanted to elect their own directors have had to bear the expense of the election costs. The new rules give shareholders access to the company’s proxy statement, putting them on the same level as company-nominated directors. The majority of the director community is still uncertain about the true impact of the new rules, according to the results of a survey conducted by NACD Directorship as part of the first Board Confidence Index (see story page 38).
Said one public company director, “Everyone should take note of the fact that there is going to be more scrutiny of the representation on boards. There is a broad misconception that boards are not representing shareholders well when in fact, I believe, that is not the case. Be that as it may, boards should probably be looking at this issue offensively. Boards that are well governed should rest comfortably, but self assessment is always important and this now provides an extra incentive.”
Editor’s Note: Since this article was published, the SEC stayed the effectiveness of its proxy access rules due to a legal challenge by the U.S. Chamber of Commerce and the Business Roundtable.
The changes in the winds for the boardroom are twofold: the prospect that directors will have to either campaign for election in a popularity contest that could pit boards against management, or fight dissident nominees to maintain their seats. Most of the tens of thousands of public-company directors now serving on America’s public-company boards (estimates vary, but our research suggests the number could be as high as 75,000) have been nominated to boards by an independent nominating and governance committee. Based on disclosures to the SEC mandated since 2003, sources for these nominees vary. In rough order of prevalence, they include recommendations to the nominating committee from non-management directors, senior managers, executive recruiting firms, and shareholders submitting names to the nominating committee. (Half of the 701 respondents to the 2010 Public Company Governance Survey said their boards use an executive recruiting firm for directors). Some governance experts see proxy access as a deal breaker for many director candidates who may not want to face the prospect of having to fight for a board seat and risk harm to their reputations by failing to succeed in a director election.
The concern that proxy access will politicize the director election process—by driving shareholders dissatisfied with company performance to propose their own director candidates—has been fueled in part by the U.S. Chamber of Commerce and the Business Roundtable. Both organizations have criticized proxy access for the potential handicaps it places on the more than 10,000 publicly traded companies whose 2011 proxies have already been made accessible to some shareholders. The rule is seen as federalizing what was originally left up to the discretion of individual company boards.
William Gruver, who serves on the board of TheStreet.com, says he is of mixed mind on the rule. “In an ideal world, having a popular wide-open process where anyone can nominate as many candidates as they’d like is the democratic ideal,” he says, “but we’re not ancient Athens. We live in a much more complex world and what gets lost in that ideal is some of the subtleties that might influence a vote and can be understood by directors who are responsible for nominations and might not be as well understood by the shareholder base.”
Gruver knows something about running for office. After retiring from a 20-year career at Goldman Sachs, he moved full time to his home in the tiny resort town of Eagles Mere, Penn., where he became a three-term mayor. He ultimately decided not to seek re-election because of the rigors of the political campaign process. When asked if he would agree to run on a dissident slate at a company, he said it would depend on the circumstances—a sentiment expressed by other directors.
Tom Wajnert, lead director of RJR, has been opposed in a director election in which he prevailed, and would be willing to run again. He advises boardroom brethren “not to get worked up about” the rule changes. When shareholders nominate directors, it’s important for them to make their perspective and point of view known to the company and its sitting directors. “I don’t see this as personal campaigning. The people who are nominated are usually very qualified and if they’re not, the proxy advisors won’t recommend them,” Wajnert says.
Given his prodigious board experience, Edward A. Kangas, who is non-executive chairman of Tenet Healthcare and serves on boards including United Technologies and Intuit, is among the highly regarded statesmen of corporate governance. He says he is okay with making the director election process “more democratic.” He believes that if a board is doing a good job and CEO compensation is truly aligned with the interests of shareholders there is little to worry about, even with the new rule. On the other hand, if a company is doing a poor job and is being unresponsive to shareholders, and proxy advisors such as Institutional Shareholder Services (ISS) start to recommend withhold votes, there will be some shareholders who will say, “We’re not happy with that” and they’ll want to make a change. “I’m okay with that, too,” Kangas says, “and think sometimes it will improve governance.”
What is not okay, Kangas says, is the director nominee who is not independent because of his or her allegiance to a specific cause or issue. “I believe that directors represent all shareholders. If I were on a board and there was a director or two who were basically representing the interests of one investment fund and were simply worried about that one shareholder, that would be outrageous. Independent directors need to represent all shareholders, not a distinct subset.”
The SEC may have closed the door on easy access by approving a three-percent three-year holding requirement. Robert A.G. Monks, the shareholder activist who co-founded ISS and The Corporate Library, an independent research firm of which he is a principal and member of its board, thinks these caveats establish a high enough threshold to be “dissuasive.”
To that point, some funds are not allowed to hold as much as one percent of any equity in their portfolio, so shareholders would have to get together to amass shares to qualify for access. “It’s not going to be easy, but it’s not going to be completely impossible either. To nominate a director will require a high degree of collaboration and coordination,” says Francis Byrd, senior vice president and risk practice leader in corporate governance at the Laurel Hill Advisory Group.
These kinds of collaborations have been happening long before proxy access. In fact, they have been occurring since the proxy reforms of 1992. Veterans in the field will remember the proxy reforms advocated by United Shareholders Association (USA) founded by T. Boone Pickens and Ralph Whitworth (who reportedly worked for $1 a year to advance the cause of shareholders). When those reforms resulted in easier communications among shareholders, the USA actually closed its doors, announcing that its mission had been accomplished.
More recently, Whitworth’s firm, Relational Investors, teamed up with the California State Teachers’ Retirement System (CalSTRS) to try to resolve a number of governance concerns both shareholders had with Occidental Petroleum. After a year of discussions with various company officials and no results, the investors threatened to nominate as many as four new directors in a classic proxy fight for control that ultimately, forced the retirement of Ray R. Irani as CEO. Shareholders may not use the new proxy-access mechanism for such initiatives, but the point is clear: the most effective way to prevent shareholders from nominating their own slates is to understand and address their concerns before they file for access. Certainly this has been the case when shareholders filed proxy resolutions about governance matters other than access. During the 2010 proxy season, after successfully engaging companies to make corporate governance changes, CalSTRS withdrew 21 of the 28 shareholder proposals it had filed on various governance matters.
“It’s important that the board not over- or under-react…it’s also important for the board to understand what investors are looking for. Take a step back: Investors are interested in maximizing their returns; it would be foolish of them to suggest something that would not be in the best interest of the company,” said one major public company director. “The framework is now in place for more scrutiny on the selection of board members, but the levers can be adjusted if that becomes necessary,” said this director.
Shareowners have a 30-day window—no later than 120 days prior to the proxy filing, no greater than 150 days—to notify the company and the SEC of director nominees. The company, however, has until 14 days after the close of this window to respond to the nominating shareowner or groups. This allows the board to collectively evaluate the candidates and make a decision regarding the slate to be presented. A public company has the ability to exclude a shareowner nominee if:
- The nominating or shareholder group has not met compliance requirements.
- The nominating shareowner or group or nominee does not meet the eligibility requirements.
- Including the nominee(s) would result in the company exceeding the maximum number of nominees.
If a board chooses to exclude a nominee, it must notify the nominators within 14 days following the window for nomination submissions. In return, the nominating shareowner or group has 14 days upon receipt of the board’s notification to respond. This is the nominator’s opportunity to fix any defects in the nomination.
Investor groups (including labor unions and pension funds) have largely applauded the new proxy-access measure, which has been described as a “silver bullet” for shareholders. The California Public Employees’ Retirement System (CalPERS), the country’s largest public-pension fund with assets of more than $206 billion, achieved its top governance goal with the new rule and plans to use it with a careful aim.
In advance of passage of proxy access, CalPERS and CalSTRS began building a database of independent directors. The Diverse Director Database, nicknamed “3D,” is a pool of qualified candidates who can be nominated for seats on poorly performing corporate boards in which they hold shares. Anne Sheehan, head of corporate goveranance at CalSTRS, explained to one corporate governance writer the reasons the pension fund wants to expand the director pool. [NACD has a similar database, Directors Registry.]
“We are working on establishing a database of independent director candidates and we are doing that for a few important reasons,” Sheehan said. “One reason is that there is now demonstrated economic value from having a diverse board of directors and we believe that makes the composition of boAards a shareholder value issue. Another reason is the necessity to expand the pool of qualified candidates.”
Almost 3,000 of the sitting directors on companies in the Russell 3000 are over age 70, she noted, while many companies have retirement policies that typically go into effect at age 72. This means that many boards will be retiring directors in the next two years, leaving seats open for nomination and election. “Couple that with the adoption of majority voting standards by companies and this looks like a significant long-term shareholder value concern,” Sheehan said. “Add to that the last three decades of market collapses, beginning with the 1987 crash, and we as long-term investors have to take the director pool seriously.”
As to qualifications, the SEC’s recent disclosure rules are “going to be very valuable for shareholders, because we should learn why the sitting directors are on the boards,” Sheehan notes. “Naturally, the qualifications are going to have to match the company’s needs. We will put quality people in the database, many of whom will not have prior public-company board service, and we will do some screening to be sure that the qualifications that people put forth are true, but the final decision will still be made by shareholders when they vote. The nominating committees on these boards are going to be critical to this effort as well. In the final analysis, we are dealing with a human problem and there are no guarantees. There aren’t any in the current environment and the existence of the CalSTRS/CalPERS database is not going to produce any magical guarantees either.”
Passing the Legal Test
Some investors are hugely concerned that proxy access will be stymied by litigation while momentum around the access issue wanes. Dissenters in the 3-2 vote along party lines were Republican Commissioners Kathleen L. Casey and Troy A. Paredes. “I believe the law is so fundamentally flawed that it will have a great difficulty surviving judicial scrutiny,” said Casey, after the SEC announced adoption of the rule.
David Hirschmann, president and CEO of the Chambers’ Center for Capital Markets Competitiveness Group, has said it “will carefully review the rule that was approved…and will continue to fight this flawed approach using every method available.” Opponents of the rule had 60 days from its date of passage on August 25 to file a legal challenge. (Outside counsel for the Chamber, which has successfully challenged other SEC rules, is Eugene Scalia, son of Supreme Court Justice Antonin Scalia.)
Monks said he is concerned legal challenges could slow down implementation but others, including Patrick McGurn, special counsel to ISS, think the SEC did a thorough job “putting its ducks in a row,” noting that the SEC’s initial draft was 250 pages but the final version at 451 pages addressed issues such as the costs and benefits of the rule and its potential impact on competition and capital formation that would likely be the basis for a court challenge.
The bottom line on proxy access? ISS McGurn warns, “If you’re dead wood in the boardroom, you’re in trouble.”
Hi, I read with interest all that has been put accross for us to make comments.
I find a problem with the proxy director and the question is: does it a proxy director represent the interests of the shareholder more or better than other director?
Next is the shareholder participation in decision making seen with the apointing of the proxy director?It is however in the best interest of the shareholder that come with fears of the repeat of the Enron case and of recent the Lehman brothers-2008. To me, I find it convincing that corporate governance still has not found its proper definition that can legally impact on the tasks,roles and performance of the directors,the CEOs and the independence of the firm. Do financial statements imply any positive performance indicator for the corporate governance?
What is wrong with state owned enterprises, why dont we talk about these state or public sector enterprises and their management boards? Should they operate and tasked for the boards to perform like their counterparts in private sector? So what is the correct definition of corporate governance that should be central to all business in private and public sectors. Why dont we have one universal body for corporate governance and a establish a respected chartered institute for corporate governance since it has become a global debabe for this century. I believe this must be debated within governments and the regonal bodies must take this challenge real. the United Nations must take the lead for public sector to say the least:United Nations Corporate Governance. It must be defined separate from a political, the type of governance which should be business like. I can help contribute to this philosophy to represent the Growing economies agenda, to establish best corporate governance for the independence of state owned enterprises.
I stand to be educated on this important area of study.
Richard Gudoi Gid’Agui
True, board members should contest for the psots like it is done in cooporative business. The challenges is to get the right people who should serve the interests of the investor. The issue is democratic but suits only some entities. However, the issue is: if directors in the boardroom dont know their tasks and roles, they take wrong decisions. What underlies this is lack of skills in the boardroom. Board committees should have skills in all their perfroamcne. A board member must be liable in total for the failure of an enterprise and be committed to courts of law. Ethics must be paramount. skills is a must, directors liablity is a major concern much as it is for the independent committees and CEO as a technical skill and incentives must be clearwith their relationships with the investors and the board. who has powers to supervise the CEO and investments. what about the decisions from the minority shareholders and communities, bankers and custmers-what is their role and how are they protected?
Richard Gudoi Gid’Agui