by Paul B.W. Miller and Paul R. Bahnson
In this new day of challenging everything about corporate governance that used to be meekly accepted by a complacent investing public, it should come as no surprise that the selection process for corporate directors is under scrutiny in the press and at the Securities and Exchange Commission.
Specifically, the Division of Corporation Finance sought public input earlier this year on the need for new proxy rules that would reform long-established procedures for nominating and electing corporate directors. According to the SEC, many respondents to that solicitation “urged the commission to adopt rules that would provide security holders with greater access to the nomination process and the ability to exercise their rights and responsibilities as owners of their companies.” All this makes sense in the new era of greater investor involvement and increased communication.
As a result, the commission released for comment a proposed rule addressing these concerns earlier this fall. In introducing the proposal, Chairman William Donaldson said, “Board unresponsiveness, sometimes tied to corporate governance weaknesses, demonstrates the need for shareholders to have a more meaningful voice in the proxy process.”
This particular proposal, if enacted in SEC regulations, will be yet another in an ongoing series of reforms undertaken to put an end to the flood of accounting and other scandals, including the demise of Andersen. The goal of all these proposals, of course, is to greatly strengthen the capital markets’ foundation, which was rocked by the revelations of outrageous misdeeds.
Unquestionably, the most visible response is Sarbanes-Oxley, which created the Public Company Accounting Oversight Board to replace the American Institute of CPAs as the chief public accounting regulator.
Notably, that act also shoved a lever under the previously secure platform occupied by top executives, shaking their comfortable, everything-is-under-control world by compelling them to take responsibility for financial reporting and the integrity of their financial statements. In conjunction with new and revised exchange listing requirements, SOX is responsible for a host of governance reforms, mostly aimed at producing more independent and more empowered boards of directors.
With this larger picture in mind, the SEC’s current proposal makes a lot of sense: If directors are to be more than mere buddy boards selected by CEOs for their dependability, then shareholders must be able not merely to reject management’s nominees, but also to put forward the names of candidates whom they trust to represent their needs. Toward this goal, the commission has proposed two triggers, both of which would enable qualifying shareholders to have their nominees included in company proxy materials. Under existing rules, shareholders face a formidable and costly campaign to solicit proxies on their own.
One trigger would be activated whenever more than 35 percent of the shares voting by proxy withhold approval for any management-nominated candidates. The rationale is that the presence of a large chunk of withheld votes shows that the shareholders don’t trust management or the nominees.
The other trigger would be activated whenever more than 50 percent support is given in an annual meeting to a shareholder-initiated proposal that would allow qualifying owners to place nominees on the proxy ballot. To ensure that this trigger isn’t pulled indiscriminately, the proposal must be
advanced by one or more shareholders who together have controlled at least 1 percent of the stock for a year or more.
The pulling of either trigger will cause proxy materials in subsequent years to include nominees submitted by one or more shareholders who have controlled more than 5 percent of the company’s stock for at least two years.
Despite the complexity of these triggers and the difficulty of getting them pulled, the proposed reforms evoked a knee-jerk response from the Business Roundtable, which calls itself simply an “association of CEOs of leading corporations with a combined workforce of more than 10 million employees in the U.S. and $3.7 trillion in annual revenues.”
In fact, the BRT sees itself as the Tyrannosaurus Rex of the business world, entitled to devour whomever it wishes. Evidence of this Jurassic attitude shows up in an October 1 comment letter signed by Henry McKinnell, Pfizer’s chairman and chief executive and chair of the BRT committee that keeps a wary eye on the SEC.
McKinnell’s first paragraph invoked the hackneyed plea for more research before any action. How can he possibly think that the SEC won’t realize that the goal is postponement and eventual cancellation?
He then whined that the various percentage thresholds must be set higher, much higher, by claiming that “the triggering events will result in the application of shareholder access rules to most, if not all, companies rather than only companies where there has not been an effective proxy process.”
If the proposed rule brings changes, who beside McKinnell and his colleagues at the BRT will think it’s a bad thing? The managers of any company with effective proxy processes will have little to fear from increased shareholder involvement flowing from the SEC’s initiative. On the other hand, increased access will be a nightmare for managers who have hidden behind superficial or illusory proxy processes.
We were astounded when McKinnell arrogantly argued for much higher thresholds “because of some of the voting practices of institutional investors.” On behalf of his previously immune colleagues, he claims that institutional investors should be disenfranchised because they routinely withhold votes after applying rigid criteria to director candidates, such as those who reject candidates whom “are inside directors or affiliated outside directors and sit on the audit, compensation or nominating committee [or] are audit committee members and the non-audit fees paid to the auditors are excessive [or they] attended less than 75 percent of the board and committee meetings without a valid reason for the absences.”
Amazingly, he complained that the existence of this trigger would lead to “more frequent withhold votes for directors,” as if it is a bad thing when institutional investors exercise their rights.
What the tyrannosaurs are missing is that the criteria are designed to identify folks who are on the board to raise their right hands while extending their left hands for their pay checks. In all likelihood, Mr. McKinnell is a smart man but his letter suggests that he and his cronies may be clueless about the real issue.
He then dug a deeper hole, fruitlessly invoking overwrought fears of doom and gloom by alleging that much higher trigger points are necessary to avoid “substantial disruption and significant cost to a company, which will be borne by all the company’s shareholders.” While costs will be incurred, they will happen only if management resists shareholders instead of voluntarily addressing their needs.
He also missed the point that all shareholders bear huge costs when managers have unfettered freedom to run companies for their own benefit. For example, if Tyco and WorldCom had incurred the cost of getting responsible boards in place, tremendous amounts of money would have been saved later. These dinosaurs still haven’t realized that an asteroid has struck their world.
To make a bigger point, we live in a democratic society that values free and open campaigns and elections in our nation’s governance. It is not cheap, but who in our society is going to argue that these costs aren’t worth it? (After all, would anyone praise Saddam Hussein’s low-cost approach to conducting elections?)
This attitude is now being carried over to the corporate sector. Improving the proxy process will be more costly, but the benefits will be there, especially in eliminating the BRT’s buddy boards.
Events of the last few years have shone a bright light in many dark places, including some mahogany-paneled smoke (screen)-filled board rooms. We don’t expect BRT executives to like the changes. In fact, we would probably oppose the changes if they did. But it doesn’t matter what we or the BRT think: The real test is what the shareholders think.
We hope that the proposal becomes a rule so that shareholders can use their voices and votes to put an end to the too-common tendencies of executives to protect their well-feathered nests with transparent and bombastic comment letters.
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