SEC Makes Ousting of Directors Easier

By Jessica Holz and Dennis Berman (WSJ)

Shareholders won greater clout to place directors on corporate boards Wednesday, marking the latest victory for the “shareholder rights” movement that has gradually chipped away power from top executives running U.S. corporations.

But a party-line split vote at the Securities and Exchange Commission, and a denunciation of the new rule by a Republican commissioner who suggested it is illegal, points to new skirmishes ahead. Public companies, including some of the country’s largest, also hope to strike down the rule, which they say will be used to distract management and advance special-interest agendas.

For now, shareholders will have greater sway over who is eligible for election to a corporate board. Those powers mean that investors, including hedge funds, pension funds and unions, could eventually have greater influence over the strategic and financial choices of U.S. companies.

In a decision years in the making, the SEC voted 3-2 in favor of the “proxy access” rule, which requires companies to 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% of a company’s stock and have held the shares for a minimum of three years.

Currently, shareholders who want to oust board members must foot the bill for mailing separate ballots, as well as wage a separate campaign to woo shareholder support. Both are too costly and time-consuming for most.

Now, the targeted companies will essentially be footing the bill for the dissidents, including them in the official proxy materials. The new rule will be in place in time for the 2011 annual meeting season next spring.

SEC Chairman Mary Schapiro, who won on an issue that had dogged two of her predecessors, said the rule is a victory for shareholders seeking more control over how their companies are run. It will “enhance investor confidence in the integrity of our system of corporate governance,” she said.

Hedge funds, pension funds and labor unions have pushed for the rule for years, contending that corporate boards have little incentive to be responsive to shareholder concerns because they rarely face contested elections. After all, they argue, shareholders own the company, and should have sway over its direction. Management—even the chief executive—are hired help.

For the SEC’s two Republican commissioners, the rule violates what they view as a delicate, but effective, understanding between shareholders and company management. For critics of Ms. Schapiro, the rule will create an unruly clash of competing interests that could bog down corporate decision making.

The two SEC opponents were Republican commissioners Kathleen Casey and Troy Paredes. Ms. Casey, a lawyer and former Capitol Hill staffer who has served at the SEC since 2006, sought to lay the groundwork for a legal challenge, calling the rule “fundamentally and fatally flawed.”

Ms. Casey argued the SEC fell short in its due diligence to show the benefits of proxy access outweigh the costs. “The policy objectives underlying the rule are unsupported by serious analytical rigor,” she said, warning of “significant harm to our economy.”

Ms. Schapiro rejected the notion that the SEC acted hastily without making the case that the public needs the new rule. She cited the hundreds of comments reviewed by the SEC—among the most it has received for a proposed rule—and the “long and careful consideration” by the agency.

Alaska’s Ben Creasy, who works at the state’s insurance department, wrote a letter in support of proxy access to the SEC. “Who watches the watchman,” Mr. Creasy wrote July 1. “[I]n a society like ours, the watcher of the watchers is the people at large, and if the people are crippled in their power, the management will take advantage of the freedom.”

The new rules are part of a broader, years-long reconsideration of who holds power in a public company. Prior to the corporate raiders of the 1980s, chief executives largely ruled without fear of rebuke. More recently, hedge funds, calling themselves “shareholder activists,” have upped the ante, repeatedly attacking management pay, perks and strategic direction.

Slowly, both custom and law have moved in the activists’ favor. Worried about shareholder dissent, boards have gotten more aggressive about the performance of top executives. And they have been less willing to overlook indiscretions, as recently happened when Hewlett-Packard Co. ousted CEO Mark Hurd. Both executives and boards have also relented more easily to takeover offers, at the urging of shareholders.

Congress’s financial-regulation law, passed in July, gives the SEC clear authority to make rules on proxy access, likely blocking one line of attack. But opponents could argue that the SEC didn’t follow the right procedure in making its rules.

Ms. Casey’s comments “will certainly energize the business community to take a look at mounting a legal challenge,” said John Olson, a lawyer at Gibson, Dunn & Crutcher LLP, who advises several corporate boards.

The final rule addressed some business concerns. Smaller companies will be exempt from complying with it for three years. Investors won’t be able to borrow stock to meet the 3% threshold, and they won’t be able to use the new power to seek a change of control at a company. And they can nominate directors for no more than a quarter of a company’s board.

The rule nonetheless sets up a divide between large and small companies, with the smaller ones more vulnerable to proxy-access attacks, given the economics at play. It would take an investment of $2.4 billion to pass the 3% threshold for a company the size of Verizon Communications Inc., a sum few hedge funds can produce. But for a smaller company, say the size of Leap Wireless International Inc., the sum required would be only around $28 million.

Some veteran corporate leaders think boards with poor governance practices will be the initial targets of proxy-access contests next year. The new rule “provides a bigger club for activists to deal with those companies,” said James M. Kilts, former CEO of Gillette Inc. and a founding partner of Centerview Partners, a private equity firm. “The only thing you can do is try to resolve the issues so disgruntled shareholders are happy,” he said.

Robert S. “Steve” Miller, chairman of American International Group Inc., fears “people with narrow-interest agendas will seek board seats” despite the laudable objectives of proxy access. As a result, public-company boards may become more cautious and bureaucratic, he said, “eroding their competitiveness with privately held companies and with foreign-domiciled companies.”

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