Shareholders who feel that their views are not represented on the company’s board of directors have been given a new way into the boardroom by the Securities and Exchange Commission (SEC). As a part of the shareholder rights movement, on August 25, 2010, the SEC voted 3-2 in favor of the so-called proxy access rule.
The vote was along political party lines with the commissioners who were appointed by Democrats voting for the change and Republicans voting against it. In addition to changing the way public companies elect board of directors, this rule highlighted an unusual collection of allies – hedge funds, pension funds and labor unions.
The Wall Street Journal and other financial publications reported that approval of the proxy access rule requires that “companies include the names of all board nominees, even those not backed by the company, directly on the standard corporate ballots distributed before shareholder annual meetings. To win the right to nominate, an investor or group of investors must own at least 3 percent of a company’s stock and have held shares for a minimum of 3 years.”
To casual observers, this new rule may seem to be a minor annoyance to a company CEO and management who often can count on a rubber-stamp of their decisions from their board of directors. However, this rule chips away at executive power.
At the current time, shareholders who want to remove board members must pay for mailing separate ballots and conduct separate campaigns to obtain shareholder support. In the past, this process has been seen as too expensive and time-consuming. With this SEC ruling, companies that have dissident shareholders must pay the costs for including them in official proxy materials. This new rule will be in place and applicable for the 2011 annual shareholder meetings.
A Backlash over Board Diligence
This rule has been years in the making and comes on the heels of shareholder distrust of executive compensation and high-profile malfeasance such as Hewlett-Packard’s ouster of CEO Mark Hurd. The financial regulation law passed by Congress in July 2010 gives the SEC authority to enact rules on proxy access. However, the opponents to this new rule argued that the commission did not follow proper procedure in making this rule. After the vote, most observers of the SEC felt that a legal challenge of this rule is imminent.
This rule is a part of the shareholder backlash involving distrust of corporate boards of directors and their due diligence in shaping corporate governance. The SEC chair, Mary Schapiro, was quoted as saying that the rule was “a victory for shareholders seeking more control over how their companies are run. She noted in the Wall Street Journal, “It will enhance investor confidence in the integrity of our system of corporate governance.”
Not surprisingly, the two Republican appointed SEC commissioners vehemently disagreed with Shapiro. Kathleen Casey and Troy Paredes said that the current rules for access to the board of director are sufficient. Their primary objections seem to lie weighing the costs versus the benefit of this proxy access and they warned of “significant harm to our economy.”
Some opponents of the new rule such as former SEC commissioner Paul Atkins see more sinister forces at work. In an article published two days after the decision in the WSJ, Atkins noted these minority stock holders “would use it (the new rule) to advance their own labor, social and environmental agendas instead of the corporation’s goal of maximizing long-term shareholder wealth. The rule will give them pressure points with which to hold companies hostage until their pet issues are addressed.”
Strange Bedfellows
It is rare for labor unions to find themselves on the same political side as hedge funds and pension funds. However, the fight over proxy access rule has proven, once again, that politics do indeed make for strange bedfellows.
Even though their individual members have little in common, managers of pension funds, hedge funds and labor unions have been at the forefront of corporate governance reform for many years. These groups are typically minority shareholders in publicly-traded companies and they have made considerable noise about corporate boards having no incentive to be responsive to shareholder concerns because they seldom face opponents in their re-election to the board. This new rule will allow these groups to mount campaigns to replace board of directors that they feel are too cozy with company management.
What This Rule Means for Publicly Traded Companies
Assuming that this proxy access rule holds up to a court challenge, which is not guaranteed, the new rule will increase the clout of dissident shareholders. However, financial websites and bloggers noted that the new rule has some safeguards for the companies affected. For example, smaller companies will be exempt from complying with the rule for three years. In addition, investors will not be able to “borrow” stock to meet the 3 percent requirement and they can nominate directors for no more than one-quarter of the company’s board.
Because the costs for mounting a proxy access fight in large companies would still be prohibitive, smaller companies will be more likely to have to fend off proxy access attacks by dissident shareholders than large companies. This will mean that small and medium sized companies with (what are perceived) as poor governance policies can look forward to proxy access fights as soon as the rule passes legal muster.
Is This a Positive Step or Political Deal?
It is no coincidence that this new access to proxy rule is changing now after the biggest economic meltdown since the Great Depression. Many feel that the richly-compensated CEO’s and acquiescent boards that support them are to blame for much of the economic mess that has littered the global markets. As noted above, this change in access to proxy rule is a partial response to shareholders whose portfolios have been decimated.
The important question remains – is this good public policy or is it what former commissioner Atkins calls, a “Trojan horse?” Does it fix a flaw in the system or is it a way for political supporters of the current administration to gain leverage on corporations in which they are minority shareholders?
Whether this new way for shareholders to register displeasure with management’s compensation and policies will result in better corporate governance or it will cause boards of directors to become cautious and put them at a disadvantage with privately-held companies remains to be seen. However, given the many management scandals and outright ineptitude that were overlooked by boards of directors in the past few years, perhaps this proxy access rule will be a wake-up call to both shareholders and boards of directors.