By Joann S. Lublin (WSJ)
In a major breakthrough for investor clout in the boardroom, HealthSouth Corp. is moving to become the first big U.S. business to reimburse activist shareholders for the expense of unseating management-backed directors.
The move may spur other companies to follow suit, corporate-governance specialists said. It comes as the Securities and Exchange Commission considers “proxy access” rules that would give investors greater leeway to nominate directors.
HealthSouth is attacking a knotty governance issue: Many boards remain insulated, but it can cost hundreds of thousands of dollars or more for an outside contender to run against a director. A campaign can involve repeated mailings to every investor. Directors endorsed by management, meanwhile, use company coffers to finance their candidacies.
On Monday, HealthSouth plans to announce that its directors authorized a corporate bylaw requiring reimbursement of “reasonable” expenses for a successful dissident board candidate. The bylaw also will partly cover the tab for those gaining at least 40% of the votes cast. Final board approval is likely by midweek, company officials said.
The new reimbursement rule takes advantage of a recent Delaware law allowing such bylaws. More than half of U.S. public companies are incorporated in Delaware.
Due to the cost of proxy fights, few dissidents bother to make board challenges. Just 75 shareholder contests for board seats have occurred so far in 2009, according to RiskMetrics Group Inc., a proxy-advisory firm. Challengers won at least one seat through votes or settlements in 58 of those fights.
Reimbursement could change the “balance of power in director elections” by tackling the expense of the contests, said Charles Elson, who promoted the HealthSouth bylaw as chairman of its board’s nominating and corporate-governance committee. Mr. Elson runs the Weinberg Center for Corporate Governance at the University of Delaware’s business school.
HealthSouth overhauled its management and board after a six-year, $2.6 billion accounting scandal was uncovered in 2003. Five former chief financial officers pleaded guilty to various crimes. This past June, former Chief Executive Richard Scrushy was ordered to pay $2.88 billion in a suit brought by shareholders of the Birmingham, Ala., rehabilitation concern.
The reimbursement bylaw will let “the voice of all shareholders—not just well-funded ones— be heard,” said Jay Grinney, HealthSouth’s president and chief executive.
HealthSouth’s action may encourage other companies, especially those under pressure from activist investors, to follow suit, said Patrick McGurn, special counsel for RiskMetrics.
The American Federation of State, County and Municipal Employees submitted proposals this year to change bylaws at Office Depot Inc. and Dell Inc. to reimburse successful board challengers for “reasonable” outlays. The proposals received 39.1% and 35.2% of the votes cast respectively, strong showings for such a measure. Spokesmen for Office Depot and Dell declined to comment.
AFSCME plans to propose at least six similar bylaws in 2010, including at some prior targets, said Richard Ferlauto, the union’s director of corporate governance and pension investment.
Without proxy access, mandatory reimbursement represents “a good substitute for holding boards more accountable,” he said.
The SEC this month said the agency will wait until next year to vote on whether to adopt proxy access. Its proposal would let owners of at least 1% of a company with a global market value of at least $700 million include information about their board nominees incorporate proxy materials. Shareholders of midsize companies would need a 3% stake and investors at smaller concerns would need to own a 5% stake.
Business groups oppose the idea, saying it would give activist investors too much power.
If other companies start reimbursing board challengers, “that reduces pressure on the SEC to do something about proxy access,” suggested Robert J. Giuffra Jr., a partner at Sullivan & Cromwell LLP. He represented CA Inc. during a closely watched reimbursement case brought by AFSCME’s pension fund. Last year, the Delaware Supreme Court sided with the software company.
Delaware lawmakers later revamped the state’s corporate law to permit reimbursement bylaws. The legislation took effect Aug. 1.