Reform Comes to the Boardroom
Early last month a federal appeals court issued a ruling on a shareholder proxy access case that has the potential to dramatically transform the way corporate boards operate. The case involved an attempt by the American Federation of State, County and Municipal Employees (AFSCME) , one of the nation's largest unions, to have shareholder-nominated candidates for corporate boards be included in the proxy statement that management sends to shareholders.
The Second Circuit Court of Appeals in New York concluded that publicly traded companies cannot exclude shareholder proposals designed to allow shareholders to place shareholder-nominated directors on management's proxy statements. Within thirty-six hours of the court's decision, Securities and Exchange Commission chair Christopher Cox announced that the SEC would conduct an open meeting on the matter on October 18. According to Stuart Grant, managing partner of Grant and Eisenhofer, legal counsel to AFSCME, "Chairman Cox did not call this meeting to say, 'Good job Circuit Court, we are with you.'" Shareholder activists fear that the SEC will attempt to rescind the advancement of shareholder rights.
There are more than 80 million Americans who currently hold shares in American corporations. The vast majority of them pay little attention to the arcane rules that govern elections to the boards of directors of the companies that they ostensibly own. Most stock owners either ignore the proxy statement they receive in the mail or dutifully vote management's slate. But the outcome of this case has tremendous significance for the corporate governance movement.
Under existing rules, it is extremely difficult for shareholders to run their own candidates for boards of directors of large companies. Currently, company management is allowed to send out proxy statements-- the means by which shareholders vote--that include only their hand- picked candidates. It is prohibitively expensive for a shareholder, or a group of shareholders, to put forward a candidate for director. Candidates not included on management's proxy list have to spend their own money for mailings to shareholders and legal filings with the SEC. Effectively reaching tens of thousands of shareholders can cost hundreds of thousands of dollars if a candidate is not included on management's list. Real corporate democracy is rarely practiced.
Management control of board elections has been a closely guarded prerogative for several reasons. There is fear that with easier access to corporate boards, small groups with narrow interests could skew companies away from increasing shareholder value toward tangential "social" issues. And some financial experts argue that in the long term, hedge fund managers--investors who purchase large amounts of stocks often with the intention of taking over the board--are a market- driven way to discipline inefficient and under-performing companies. But as economist John Maynard Keynes quipped, "In the long run, we are all dead." By the time corporate raiders and hedge fund entrepreneurs get around to transforming dysfunctional companies, tremendous shareholder value has been lost.
Corporate America needs the discipline of democracy to help rid it of some very bad habits. More than 100 major companies are being investigated for the backdating of stock options, executive compensation is out of control and directors who focus on the long-term value of the company rather than short-term stock price are rare. Shareholder candidates (a 3 percent stock ownership would be required for gaining access to the proxy statement) with a clear platform would provide company shareholders real choice on the future direction of the business.
The history of shareholder activism has gone through many stages. After the stock market crash of 1929, activists and politicians helped push through the Securities Act of 1933 and the Securities and Exchange Act of 1934, both designed to regulate stock market abuses by providing greater transparency and oversight. In the late 1940s, James Peck, a member of the Congress for Racial Equality, bought stock in Greyhound so he could attend the annual company meeting to challenge the bus company's treatment of blacks in the South. In the 1970s and '80s, various group campaigns were initiated that challenged corporate behavior in South Africa, Northern Ireland and other areas of conflict. The so-called "Sullivan Principles," for instance, were shareholder proposals designed to put pressure on companies doing business in South Africa during the apartheid era.
With the rise of institutional investors in recent years, shareholder activism has taken center stage as the most effective way to use large share holdings to change corporate behavior. Rather than simply selling shares in companies that engage in "bad" behavior, shareholder groups are using active engagement to push for change. At a recent meeting of the Council of Institutional Investors, a leader in corporate-governance advocacy, the upcoming SEC meeting was a major topic of discussion among pension fund trustees. Council chair Jack Ehnes stated, "Resolutions on proxy access would make boards more responsive to shareowners, more thoughtful about whom they nominate to serve as directors and more vigilant about their oversight responsibilities."
There is a great deal at stake in the upcoming hearings, and there are a number of directions the SEC can go. The ostensible reason for the hearing is to "clarify" the proxy voting procedures and establish nationwide standards to avoid confusion. Corporate leaders who desire the status quo will push Cox to undue the court's decision. But if the SEC undermines the court's ruling--a fear that many believe is the real reason for the open meeting--shareholders will have suffered a significant setback. It would be the first time since the 1934 origin of the act that the commission has diminished shareholder rights.
Large activist pension investors, like the California Public Employees Retirement System and California State Teachers Retirement System, are watching closely and encouraging Cox and the SEC to respond positively to the court decision before the 2007 proxy season commences. Sean Harrigan, president of the Los Angeles Police and Fire Pension Board, views the proxy fight as fundamental. "In light of the corporate fraud, deception and abuse that has become so pervasive among corporate boards in recent years, access to the proxy is the most effective vehicle which would align the interest of the corporate board with that of corporate owners, rather than that of corporate CEOs," Harrigan recently commented. If the SEC is truly interested in restoring investor confidence in American corporations, it will enthusiastically embrace this opportunity for progressive corporate reform.