Over 60 years ago, a group of SEC commissioners met around a table at the Pennsylvania Athletics Club – where the commission had temporarily relocated because of World War II – to discuss a controversial proposal. The proposition, aimed at giving shareholders the right to have their director candidates on the proxy, didn’t pass and the issue slipped somewhat under the radar until last summer.
Then a different set of SEC commissioners met behind closed doors to consider a similar proposal. This time the commissioners proposed a rule that, if passed, will give shareholders the right to open up the proxy ballot to their director candidates. If that candidate were to receive enough votes, shareholders would then have a representative on the board. For obvious reasons, this possibility is ruffling a few feathers.
Some predict annual meetings will turn into town hall meetings with different shareholder representatives vying for votes. By applying the democratic process to the proxy process, companies will be forced to adhere to shareholder concerns and lose track of long-term goals, suggests Robert Profusek, a partner at law firm Jones Day.
Others think this proposal is long overdue and represents the first step in corporate board democratization. What’s key for IROs is that those adamantly in favor of this rule are public pension funds managing billions of dollars. Their support is symptomatic of institutional dissatisfaction with corporate boards. Some pension funds are so unhappy with board behavior that they’re preempting the SEC’s process and publicizing their intention to nominate director candidates themselves.
In December four heavyweight pension funds – AFSCME Employees Pension Plan, the New York State Common Retirement Fund, the California Public Employees’ Retirement System (Calpers) and the California State Teachers’ Retirement System (CalSTRS) – announced their plan to submit a shareholder proposal to open up Marsh & McLennan’s proxy to a shareholder nominee. The move is a direct response to the mutual fund scandal at Putnam [of which Marsh & McLennan is the parent], says John Chartier, a spokesperson for the New York State Common Retirement Fund.
If the SEC approves the shareholder access rule, this proposal could be the first of many, according to Craig Roeder, a partner with law firm Baker & McKenzie. ‘There is probably going to be a kind of cottage industry dealing with those proposals, either directly or indirectly, based on corporate governance issues,’ he predicts.
The jury’s still out
As this issue of IR magazine goes to press, Exchange Act Rule 14a-11, as it’s officially known, is still being considered by the SEC, with an official decision expected by March. It’s impossible to predict the SEC’s decision, but the cards seem to be in shareholders’ favor; two commissioners, Harvey Goldschmid and Roel Campos (the only two Democrats on the commission) are both openly endorsing the proposal.
According to Patrick McGurn, vice president of Institutional Shareholders Services, it’s not a question of ‘if it gets adopted, but what gets adopted and the date it goes into effect.’ If the rule is approved this spring, for example, shareholder nominees could be on the proxy as early as 2005.
Currently, the proposal outlines two triggers that must precede shareholder nominees’ presence on the proxy. First, shareholders have to vote to open a company’s proxy process. They can do this in one of two ways: shareholders owning at least 1 percent of voting power can submit a proposal to open up a company’s proxy ballot, which must be approved by 50 percent of shareholders. Alternatively, 35 percent of shareholders can withhold votes from one or more of the management’s nominees.
These qualifications could change in the final ruling, however, and SEC commissioner Cynthia Glassman has already expressed concern that these thresholds are too low.
Back in October 2003 when the rule was first announced, Glassman told the SEC she would prefer the limit to be upped to at least 50 percent of shareholders withholding votes. She feels the rules in their existing state might hurt good companies while failing to improve poorly governed ones.
But pension funds don’t believe these triggers are too low at all. Jack Ehnes, CEO of CalSTRS, argues that no matter how much one plays with the calibration of the triggers, shareholder nominees would still have to be voted in.
There’s a further hurdle, too. Once they’ve voted to open the proxy, shareholders must then qualify to nominate a director candidate. For this to happen, shareholders – or shareholder groups – are required to own 5 percent or more of the company’s voting shares for at least two years. They also have to express their intent to satisfy this minimum ownership threshold at least until the date of the company’s AGM. And security holder nominees have to satisfy the independence criteria for directors set out in the listing standards of the company’s exchange.
The politics of investing
Experts think this rule will force IR professionals to become more involved in governance issues. They will have to be tuned into shareholder voting intentions pre-proxy, for example, and be able to report their observations on those intentions to management. To do this, IROs should communicate more with corporate secretaries, says John Wilcox, vice chairman of Georgeson Shareholder.
‘IR has been focused primarily on institutional investors and their capacity as investment decision-makers, and it hasn’t really focused on institutional investors’ capacity as voters or policy-makers,’ comments Wilcox. ‘The IRO and corporate secretary need to work very closely together and share information to really enable the company to know who its shareholders are in their entirety.’
Richard Ferlauto, director of pension investment at AFSCME, recommends IROs not view this as a hostile rule but instead use it as a tool to open communications with major institutional holders. ‘Major pension funds have a very strong interest in corporate health and growth; the rule will be used [by them] appropriately’ he says.
McGurn agrees. He also thinks companies should be proactive in addressing shareholders’ proposals that received a majority vote in 2003 as this could be the best way to prevent them from withholding votes from management nominees in 2004.
‘We’re already seeing a substantial amount of fallout from this rule at this point,’ McGurn says. Around 30 companies have already followed through with shareholder resolutions that received a majority support as a precautionary measure.
Power to the people
While the shareholder access rule would likely create more work for IROs, it might help rebuild shareholder trust by offering investors the opportunity to have a representative present at board meetings. The rule is, after all, a direct response to what went on inside the boardrooms of Enron, WorldCom and Tyco, where shareholders’ interests were conspicuously absent.
Goldschmid goes one step further in suggesting the rule is ‘very much in the nation’s interest’ because contested elections are non-existent in the US. ‘[This rule] would give a dissatisfied majority of shareholders the ability to shake up a weak management and board combination,’ he concludes.
Mark Roe, Joseph Flom assistant professor at Harvard Law School, agrees with this. Having a shareholder director could well be preferable to having a proxy fight, he suggests. ‘Nowadays there is nothing that puts new blood in the boardroom, short of a full-scale takeover proxy fight,’ he notes. Roe also thinks this rule will help communications between a company and its shareholders as investors become more active in director elections.
Conversely, Wilcox thinks the proposal is likely to make companies and shareholders more combative rather than more communicative. In his response to the SEC’s proposal, he writes: ‘We have seen the most progress in the past ten years in new procedures that allow companies and shareholders to talk and find more peaceful ways of solving their problems – and this [rule] does not encourage those procedures.’
But Ehnes maintains that a healthy tension between shareholders and boards is both positive and necessary. ‘Part of the benefit of this [rule] is just getting the board’s attention to good governance – and this does that,’ he says. He also feels board members will be more sensitive to shareholder concerns under the threat of competing against director nominees.
Fiery annual meetings
Regardless of what happens with this particular SEC regulation, there’s no doubt shareholder activism is on the rise around the world, and companies should be conscious of investors’ dissatisfaction with board decisions.
Last year, shareholders submitted more than 1,100 proposals and, if this rule passes, that number is bound to increase significantly, according to McGurn. In 2004, he predicts, ‘You’ll see some investors soliciting no-vote campaigns against individual directors over issues ranging from independence to poor stewardship of executive pay.’ As he says, ‘It’s going to be a fascinating year to watch some of the tallies as they come in for director elections.’
Roeder is also expecting a significant number of companies to receive shareholder proposals requesting access to the ballot this year. If institutional investors are as dissatisfied as Marsh & McLennan’s holders, he could be right on the money.
