Editor's Note: University of Wisconsin Law School professor Gordon Smith spoke recently with the Chicago Tribune on the issue of shareholders nominating candidates for positions on corporate boards. The article below is reprinted with permission.
Deadline in SEC's review of governance
Most heat centers on nominations by shareholders
By Andrew Countryman
Chicago Tribune staff reporter
July 6, 2003
Federal regulators are approaching a potential turning point on the rights of stockholders, with shareholder activists lobbying hard for rules to allow many more contested elections for corporate boards.
The Securities and Exchange Commission staff faces a July 15 deadline for a review of director nomination rules and other issues on shareholder access to corporate proxy statements.
Corporate America is speaking out strongly against allowing shareholders to nominate director candidates more easily--or, at the very least, urging the SEC to go slow.
At stake is a potentially fundamental shift in corporate governance, one that could either bring democracy or chaos to the boardroom, depending on where you sit.
The SEC has received more than 500 comments about its review, many from activists and individual investors who say they want a greater voice over U.S. companies. Perhaps it is not surprising that few of them would write in to defend the status quo, but the sheer volume is unusual for such SEC debates.
Sarah Teslik, the executive director of the influential Council of Institutional Investors, urged giving long-term investors "reasonable access" to company proxies, calling greater influence over directors "the single most important reform."
Investor JoAnne Svendsgaard of Oakland wrote"As long as board members feel executives can remove them, board members will not protect shareholders as they should.
"Unless shareholders have a say in director selections, we cannot expect a meaningful drop in the frauds, restatements, bankruptcies, excessive compensation packages and other troubles that plague our large companies."
Others were more blunt. Ed Carroll wrote two sentences
"Enough is too much already. Stop the thieves, please."
Just how to do that--and whether shareholder nominations are the best method--is a matter of considerable debate. Though the SEC has maintained that the rules are merely under review, experts said some change is likely in the offing.
"I expect to see some rulemaking coming out of this," University of Wisconsin law professor Gordon Smith, who has studied shareholder activism and director selection, said in an interview.
"I think the SEC is interested in encouraging shareholder participation. I think it's natural" in the wake of recent corporate scandals, though he noted serious reservations could prompt the SEC to be cautious.
Many companies, in contrast, say shareholders already participate through board nominating committees. Allowing shareholder nomination and contested elections, they say, could invite people with dubious motivations.
"Whereas certain shareholders may nominate directors for self-serving reasons, such as personal gain or to further a political agenda, the board is required to act in the best interests of the company and all its shareholders," wrote Henry McKinnell, chief executive of Pfizer Inc. and a leader of the influential Business Roundtable.
"An access proposal, if adopted, is likely to create a disincentive for able candidates to seek, and for current members to continue with, board service," wrote David Silk, chairman of a proxy changes task force of the Association of the Bar of the City of New York, warning of potential contentiousness and "balkanization" of boards.
Firms favor slow approach
Many business leaders are urging the SEC to take its time, saying it should wait until the existing slew of corporate governance changes have had a chance to take hold.
"We recommend that the commission defer deciding ... until the numerous improvements to the corporate governance structure of public companies have been implemented and their consequences made clear to the commission, shareholders, issuers and the marketplace," wrote Craig Tyle, general counsel of the Investment Company Institute, a mutual fund trade group.
Many on both sides are recommending various forms of compromise, short of unlimited nominations by any shareholder.
Some have suggested allowing shareholders to simply vote no on company candidates, rather than the current yes or withholding a vote, which noted Yale University finance professor Ivo Welch said "is reminiscent of voting in communist regimes--and naturally has similarly effective outcomes."
No-vote advocates typically would require firms to nominate replacements for those receiving a majority vote against.
But Smith has reservations, saying such a system could be used to advance hostile takeovers, and that it's more efficient to settle the issue at the annual meeting, rather than holding multiple elections.
"It's not cheap, with a big public company, to send ballots out to everybody," he said.
Several are urging restrictions on who can nominate candidates--often those representing at least 3 percent or 5 percent of shares outstanding, with minimum holding periods.
Many also suggest limiting the number of shareholder candidates, often one nominee per major shareholder.
But others have noted the difficulty in electing even one candidate, plus potential impediments to one individual's influence over the board.
Longtime shareholder activist Robert A.G. Monks, citing his unsuccessful efforts to win election to the Sears, Roebuck and Co. board more than a decade ago, hints at the potential problems for shareholder candidates.
"It seems very doubtful that there is any way for an independent candidate to be elected to the board of a company that contests his election competently," he wrote to the SEC, suggesting that companies should have at least three directors nominated by shareholders.
Impact unknown
But some experts, including Cynthia Richson, director of corporate governance for the State of Wisconsin Investment Board, say it would be risky for boards to simply dismiss such director battles.
The mere existence of these fights, she suggested, could cause underperforming boards to shape up.
If the shareholders win a spot, others wonder if lone directors would be able to bring about real change, and given institutional investors' accompanying push for annual election of directors, if they would have only brief tenures.
Richson said that's why shareholders need to be able to nominate enough candidates to replace an entire board.
"You've got to have that ability, or otherwise they have the ability to ostracize and marginalize that one representative," she said in an interview.
Smith notes that not just anyone can join a board and make it more effective, saying directors need to exercise judgment in shareholders' best interests, not simply reflect popular will.
"One thing we haven't focused on ... is that it's really not a plug-and-play system," he said.
Nonetheless, Smith said a shareholder-nominated director could have positive effects.
"My sense is if they get someone in there, and there's a real discussion ... and there's a pushback from some of the other directors, then maybe they come to some sort of reasonable accommodation that's best for the company."
Copyright (c) 2003. Chicago Tribune Company. All rights reserved. Used with permission.
Submitted by on July 22, 2003
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