Tag Archives | proxy access

What if a Proxy Access Candidate Isn't Qualified?

Keith Bishop begins to address at least one of the issues raised by J.W. Verret (Defending Against Shareholder Proxy Access: Delaware’s Future Reviewing Company Defenses in the Era of Dodd-Frank) but in a much more positive manner.

What happens when a shareholder nominates someone who doesn’t meet the qualification requirements of the bylaws?… One approach is for the chairperson to rule on whether a nominee’s name can be properly brought before the meeting for a vote.  This approach is entirely consistent with the idea that a person who does not meet the qualifications for service as a director is not entitled to be elected.  This approach appears to be in accord with case law.  Waterbury v. Temescal Water Co., 11 Cal. App. 632 (1909) (applying former law).

If the corporation allows a vote on the unqualified candidate and the candidate receives a sufficient number of votes to win a seat on the board, then there is likely to be even more confusion because the General Corporation Law does not specify any mechanism for “seating” board members.

California does provide an expedited judicial process for determining the outcome of elections in Corporations Code Section 709.  However, that process must be initiated by a shareholder “or any person who claims to have been denied the right to vote”.  By its terms, therefore, the procedure is not available directly to either the corporation or a nominee who is not also a shareholder. (Proxy Access & Director Qualification Requirements)

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No Need for Hysteria Over New Proxy Access Rules

In the wake of the SEC’s approval of management proxy access for three percent shareholders, it’s quite surprising to note the vehemence of the remaining opposition to such action. For example, the Wall Street Journal in its lead editorial on August 30, 2010 entitled Alinsky Wins at the SEC, which in itself makes clear the extent of its opposition, states that the new rule will only “help activists and unions, not shareholders.” Similarly, an unnamed official of the U.S. Chamber of Commerce speaking on Yahoo Finance on August 25, 2010 states that it will fight this action “using every method available” because it is “a giant step backwards for average investors” and David Hirschmann, the Chamber’s President/CEO of its Center for Capital Markets Competitiveness, in the same place, characterized the new rules as ones that allow “the proxy process to be [used] to give labor-union pension funds and others greater leverage to try to ram through their agenda” which “makes no sense.”

Institutional investors and other proponents of improved governance should be prepared to respond in the media and elsewhere to such arguments.

Perhaps the most simple and compelling response is that the new rules permit nothing which was not already permitted – i.e. a change in board composition through shareholder vote. That is, any investor has been and remains able to wage a proxy fight for board representation to seek to “ram through” (or pursue) their agenda. While the new rules are intended to and will obviously lead to more minority representation by reducing the cost of its pursuit, it was already contemplated by all pertinent law. Investors have also had and retain the right under 1934 Act Rule 14a-8 to include on proxy cards many proposals for action not involving director elections.

Indeed, allowing proxy access to investors hardly guarantees them a board seat. They still must convince the holders of the requisite number of shares in the pertinent jurisdiction – none of which is being changed – to vote for their candidates. If simply allowing proxy access to minority holders of itself will greatly expedite their candidacies, what does this say about the level of shareholder satisfaction with management and its slates?

Even if a board seat is obtained by an investor, it is just that; a seat, and not a majority capable of imposing its own agenda. Given that proxy access for large firms with market caps exceeding $33 billion will require ownership of more than $1 billion of stock for more than three years, one wonders why there is so much concern. We are not talking about miniscule, “gadfly” shareholders with no real economic interest, only pursuing a social agenda. What is more a part of capitalism than allowing a meaningful voice to large investors in a company?

Apart from these somewhat mechanically-oriented, but still significant, arguments, lurks the ultimate consideration, namely the need for better governance, which can only be accomplished with real accountability for boards. When Jim McRitchie brought all of this to the fore 8-10 years ago through his writings and suggestions to the SEC, reasonable, knowledgeable people could argue about whether there was a general governance problem. In light of the numerous debacles over the last decade starting with Enron, few would want to take the negative side of this argument today. Many, including the author of this post, would argue about how to improve governance, but the “whether” part of the debate is a different story.

The status quo has not worked. In far too many cases, directors have been asleep at the proverbial switch while managements brought down companies and imposed huge costs on societies. One way or the other, there needs to be additional accountability for boards, and this initiative is quite modest, in that it does not change in any way the substantive standards to which directors are held. That is, the only accountability for even catastrophic decisions is removal from office – not financial liability. Commentators have lamented the modesty of this effort.

When called upon to defend the new rules, all concerned should keep in mind and remind the public, what they do and don’t do relative to the status quo, as well as why this action has been taken now.

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Proxy Access Concerns

I received the following from Andrew Shapiro, President, Lawndale Capital Management, LLC yesterday afternoon.

This morning, the SEC released and approved final rules relating to Proxy Access. These rules were a bit changed from earlier comment releases and greatly limit practical use of the new rule. The full adoption release (451 pages) can be found at http://www.sec.gov/rules/final/2010/33-9136.pdf.

I haven’t come close to reading the full release yet but several opinions come to mind.

First and foremost, I am most pleased with and grateful that the SEC passed rules making it easier for shareholders of companies to submit 14a-8 shareholder proposals providing for proxy access rules that can be stronger and superior to the minimal and weak proxy access standard the SEC has passed this morning. Of course it is important that state laws support and provide for any stronger proxy access rule passed by shareholders to be mandatory and enforceable, not advisory.

Criticisms of the minimalist SEC Proxy Access rule itself.

Criticism 1) The idea of exempting small company boards from the increased accountability that proxy access might provide shareholders is frankly #ssbackwards. Shareholders of smaller companies, having already lost corporate governance protections from various other small company exemptions (e.g. certain Sarbanes Oxley provisions, etc) are most in need of proxy access to offset the more prevalent dysfunction found in small company board’s governance.

Criticism 2) There are substantial fixed costs to conduct a traditional proxy contest to force accountability upon a poorly governed company’s board, regardless of that company’s size. This is a huge barrier to shareholders and entrenchment protection for bad boards and management’s of smaller companies. The costs saved for shareholders of smaller companies via the implementation of proxy access serve a far greater proportional savings and reform role than they do in larger company contests.

Criticism 3) One particular aspect of proposed exemptions from proxy access for smaller issuers is the definition often proposed for “small company” which measures “public float” [generally of less than $75MM.] Use of “public float” to measure an issuers size rather than straight market capitalization exacerbates the basic problem.

The more shares held by those “affiliated” with the issuer, the higher the overall market cap of the issuer that would gain the exemption and the more issuers that will be exempted from proxy access. Yet it should be quite obvious that the more shares held by affiliated parties, the greater likelihood of an insular, dysfunctional and completely unresponsive board.

Here’s how why or how this point works:

  • Company A – $75MM market cap or lower (no matter what the “affiliated” ownership is – exempt from proxy access
  • Company B – $80MM market cap and NO “affiliated” ownership – subject to proxy access;
  • Company C – $110MM market cap company but with 35% “affiliated” ownership means market float of only $71.5MM (100-35%affiliated = 65% public times $110mm market cap)

Thus this larger small company is also EXEMPT. Yet with 35% insider ownership, the accountability mechanism of proxy access is most necessary.Note again – with such high insider ownership in Company C, above, passage of a shareholder 14a-8 proposal to establish an even stronger proxy access rule (where it would seem most needed) is almost impossible.

Criticism 4) The amount of director representation allowed under proxy access is limited to only 25% of a board rounded down. This means that, with boards of 7 or less directors, only ONE director can be nominated via proxy access. Note, with a director’s motion requiring a second to even get entered in a Board’s minutes, there is very limited influence a single director may bring to a board room, especially the most dysfunctional boards. The % membership cap should have been 33% or rounded up with a minimum of nominees always being TWO directors.

Criticism 5) This rule will not greatly alter the amount of disruption, economic and otherwise, that takes place with proxy contests nor meaningfully reduce the number of traditional proxy fights. It is not being duly considered that 50% of the vote is still required to elect alternative nominees, whether on the company proxy via proxy access or on an alternative slate proxy. When the limited amount of director representation allowed under proxy access is coupled with the access rule’s restrictions against subsequently seeking additional representation (even when the additional director numbers comprise far less than change of control), the benefits of proxy access are not compelling when compared to the board representation with no strings attached available for the same 50% majority vote.

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Proxy Access: Private Ordering with High Threshold Minimums

Since filing the initial 21st century petition for proxy access in 2002 with Les Greenberg, I have written extensively on the need. With the 3-2 vote by SEC commissioners, as most expected, it will soon be a reality… in time for at least a portion of the 2011 proxy season. What we proposed back in 2002 was essentially what the Chamber, BRT and other rear-guard organizations have been calling “private ordering.” Let each company decide. Of course, ours was based on what shareowners would propose and pass, not simply on what an entrenched board and management might install without a shareowner vote.

As reported elsewhere, Proxy Access Is In (Lucian Bebchuk and Scott Hirst, Harvard Law School, 8/25/10).

Under the rule, a shareholder (or shareholder group) would need to hold more than 3% of the company’s shares for more than 3 years to be eligible to use the rule to place director candidates on the corporate ballot. These eligibility requirements, together with the rule’s procedural requirements, will place substantial limits on its use. (To illustrate, according to data put together by CalPERS, the 10 largest public pension funds together hold less than 2.5 percent at Bank of America, Microsoft, I.B.M. and Exxon Mobil.)

It should also be noted, the “First to File” rule was replaced with a “Size Matters” rule. As Bebchuk and Hirst indicate, “To the extent that these limits prove excessive, we hope that the SEC will reconsider the thresholds set today.” The limits are excessive but the SEC also voted to amend Rule 14a-8 to enable shareowners to include, on corporate proxies, proposals related to election and nomination procedures, like we could for many years until the SEC reinterpreted that rule, without a rulemaking or even notice, to prohibit such proposals. AFSCME v AIG led to a brief window of opportunity for shareowners when the court overturned that illegal action by the SEC. However, under Cox, the SEC they then changed the rule to prohibit private ordering by shareowners, even suggestions for private ordering, which is essentially what nonbinding resolutions do.

It is very important to have a base threshold. The new Rule 14a-11 puts entrenched managers and boards on notice that they are slightly more likely to be held accountable. Shareowners may be able to nominate and elect up to 25% of the board. While that doesn’t give them any real power to move the corporation in a different direction without the consent of the already entrenched, at least they’ll have a front row seat and will be able to make arguments, if they can get a second. Existing board members might just begin to get the feeling they are accountable to shareowners… not just fellow board members and the CEO.

One of the most important clarifications regarding the revised Rule 14a-8 is contained in footnote 674 of the release, concerning what is meant by a proposal under 14a-8 that may “conflict” with 14a-11.

Under the Proposal, Rule 14a-8(i)(8) would allow shareholders to propose additional means, other than Rule 14a-11, for inclusion of shareholder nominees in company proxy materials. Therefore, under the Proposal, a shareholder proposal that sought to provide an additional means for including shareholder nominees in the company’s proxy materials pursuant to the company’s governing documents would not be deemed to conflict with Rule 14a-11 simply because it would establish different eligibility thresholds or require more extensive disclosures about a nominee or nominating shareholder than would be required under Rule 14a-11. A shareholder proposal would conflict with proposed Rule 14a-11, however, to the extent that the proposal would purport to prevent a shareholder or shareholder group that met the requirements of proposed Rule 14a-11 from having their nominee for director included in the company’s proxy materials.

What the SEC has done is establish “private ordering” with a very high floor. Within a few years, we can expect to see 100s of proposals calling for more reasonable thresholds and holding periods, as well as allowing a greater proportion of shareowner nominees. Corporate governance activists have been given a new focus. Just as we have been struggling to obtain majority vote standards, we will now be fighting for more reasonable nomination requirements. To the John Cheveddens and Ken Steiners of the world I say, “Time to gear up; may a thousand access proposals bloom.” Start with small companies where the SEC has delayed implementation of Rule 14a-11 and where, on average, corporate governance reforms are furthest behind. Have an access proposal ready for next year? Please share it.

See also Pesky shareholder activists gain influence: After years of battling futilely to rein in corporate boards, ‘gadflies’ are winning votes, LATimes, 8/23/10; Speech by SEC Chairman: Opening Statement at the SEC Open Meeting; SEC Approves Final Proxy Access Rule, RMG, Ted Allen, 8/25/10; In 3-2 Vote, SEC Finally Adopts Proxy Access Rule, Compliance Week, 8/25/10; Social Investment Forum Welcomes Federal Proxy Access Rule, 8/25/10; press release, Shareowners.org, 8/25/10; ProfessorBainbridge, 8/25/10; The Conference Board blog, 8/25/10; S.E.C. Makes Access to Proxy Ballots Easier, NYTimes, 8/25/10; Jim Hamilton’s World of Securities Regulation, 8/25/10; Activist Shareholders Get a Louder Voice, Sarah Morgan, SmartMoney, 8/25/10; The SEC Adopts Proxy Access, theCorporateCounsel.net/Blog, 8/26/10; The Promise of Access, theRacetotheBottom, 8/5/10. And here’s a paper of mine published by the Corporate Board in July 2003, Toward Democratic Board Elections; Proxy Access & Shareholder Citizenship: The Quest for Inclusion, Marcy Murninghan, 8/26/10.

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Corporate Board Member

Several interesting articles in the current issue of Corporate Board Member. Nice to see coverage there of the Proxy Disclosure blog by Mark Borges, part of the CompensationStandards.com group. Borges spend four years as special counsel at the SEC’s office of rulemaking before joining the Mercer consulting firm. Regarding the new pay disclosure rules,

In the first year especially, it benefits you to be a little bit more explicit. Presumably, if you establish a strong baseline it will keep things in check.

In an article on Best- and Worst-Paid Boards Among the S&P 500, interesting to see Republic Services paid the highest and total shareowner return was 17% in 2009, whereas Fastenal paid the least and shareowner return was 22%. Thankfully, most of the five high paid runner up boards did better for their shareowners than did the five runner up low paid boards.

That article was followed by one by Bruce Ellig who argues that most board members aren’t paid enough. At least part of the basis of his argument is that directors should be paid something close to the same rate per day worked as the CEO. Ellig also argues agains paying board members in stock options, in part because the

terms are either too short for a meaningful measurement or longer than the company might wan to tacitly commit to a director’s continuing on the board.

One answer to a series of questions caught my eye. Who should approve director pay?

Shareholders—but they don’t. Instead, boards typically approve their own compensation, possibly after an analysis by an outside consultant that the board itself paid for. Doesn’t this seem strange? The CEO doesn’t approve his pay package, nor does anyone else in the company. Why should the board members?

The situation wasn’t always like this. Until relatively recently, company insiders were the big majority on boards, and they didn’t collect retainers. But they did vote on how much to pay the few outsiders among them. Reforms have reversed this to where unpaid insiders are few and the paid outsiders set their own pay.

They shouldn’t, of course. Shareholders should be asked to approve the package of director retainers, annual incentives, and stock awards, along with the formulas used to calculate them. This kind of transparency, the same that’s demanded by advocates of a say on pay for executive comp, should include a narrative in the proxy describing how the board put together its compensation figures.

Giving shareowners a say over the pay or directors makes much more sense than giving shareowners a say over CEO pay. Directors in a sense report to shareowners, CEOs do not.

Also interesting to me is the article How’s Your Company Really Doing? I’ve been a long-time proponent of measures like economic value added, EVA. Now “EVA Momentum” addresses some of the problems inherent in EVA like ratios that can be gamed and turnaround situations where companies are or were losing money. Of course past momentum doesn’t necessarily reflect what investors expect about performance going forward but it looks like a useful measure for both board and investors to consider.

Julie Connelly argues Proxy Access: Worth Little More Than a Hill of Beans. I wouldn’t go that far buy it is clear that proxy solicitors, attorneys, public-relations counsel and even pay for director candidates may cost a whole lot more than writing, printing and mailing your own proxies. Maybe so, but I think shareowners will actually be less confused by proxies that list more than one candidate for some positions than they are when getting two proxies for the same company. I think that may up the retail vote. Connelly notes,

Nickolay M. Gantchev, an assistant professor at the Kenan-Flagler Business School of the University of North Carolina at Chapel Hill, studied 1,492 campaigns launched by 200 hedge funds between 2000 and 2007. He discovered that fewer than 5% turned into actual proxy contests. Either the dissidents went away or the warring parties reached some kind of agreement.

Will proxy access encourage a significant increase in worthy board candidates? It could, because some portion of their expenses will be defrayed by the company. But board-nominated directors will still have the edge. The board’s real challenge is to put together the best team it can. And to extol the value of that team in, yes, the proxy.

Finally, one tidbit in a side-bar surprised me. In Mind Your Manners in China’s Boardrooms, Craig Mellow notes it is sometimes tricky for foreigners serving on Chinese boards to avoid sounding bossy. On the other hand, he quotes something refreshing from Susan Wang, who sits on the audit committee of Suntech Power,

They may not like pushy foreigners, but they’re freewheeling in offering dissent. “They’ll actually commit to paper a remark like ‘I totally disagree with this strategy,’” says Wang. “Directors are far more cautious on U.S. boards.”

That’s behavior I’d like to see more of here in the US.

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Attention SEC Commissioners: Read Compliance Week Before Deciding on Access

I hope Commissioners read How to Improve Governance at Small Companies by Stephen Davis and Jon Lukomnik, Compliance Week, August 10, 2010. They’ll soon be making a decision with regard to proxy access. As I’ve mentioned on this blog several times, small companies shouldn’t be exempted… that’s where much of the abuse in corporate governance occurs. I’ve lost money at several companies where the founder got a sweetheart deal with the board on retiring that essentially drained the companies of future revenues for years.

Davis and Lukomnik point to P&F Industries, a maker and importer of pneumatic tools and builders’ hardware. The founder passed the job of CEO onto his son, Richard Horowitz, and the board has awarded $13.5 million in cash compensation during the last 10 years, more than twice the $6.3 million in cumulative profits.

They go on to describe efforts by two shareowners, Andrew Shapiro of Lawndale Capital Management and Timothy Stabosz, to make a difference. While they’ve apparently made some headway, they might have been able to do much more with proxy access. Shapiro is quoted in the article:

It’s a great example of why small companies ought not be exempted. Proxy access could have helped me in the case of P&F because there is such a substantive retail base.

They also quote Stabosz:

The story of P&F industries is a story of no one attending shareholder meetings in past years.

Shareholders need to act like shareowners. They are much more likely to do so if they have the tools needed to hold board members accountable. Proxy access could be the best tool in the box.

Disclosure: The publisher of CorpGov.net, James McRitchie, has investments with Diamond A Investors L.P. headed by Andrew Shapiro.

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CII's Most Recent Comment Letter on Proxy Access

SEC Set to Open Up Proxy Process (WSJ, 8/5/10) As reported last week, the meeting is apparently scheduled for August 25.

Under the language being drafted, shareholders would have to own a 3% stake in a company for at least two years to qualify.

As I write this, the SEC still has not confirmed the August 25th meeting date. However, I did spot this August 3rd letter from CII, which reiterates their position that access be based on

at least three percent of a company’s voting stock, to nominate less than a majority of the directors. Eligible investors must have owned the stock for at least two years.

The SEC appears to be endorsing the 3% threshold and 2 year holding requirement of CII. While it isn’t clear how the SEC’s final rule will handle proxy access at small companies, in my opinion that is where it is most needed.

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Access to be Waived by CalSTRS and Relational at Occidental

As reported by RiskMetrics and others, CalSTRS and Relational Investors “are threatening to wage a proxy fight at Occidental Petroleum over the oil company’s compensation practices and the board’s failure to abide by its retirement policy or announce a succession plan for its long-serving chief executive and chairman.” (CalSTRS and Relational Seek Four Board Seats at Occidental, 8/3/10) Interesting that they plan to nominate four to the 13 member board. That puts them above the 25% limitation expected to be imposed by the SEC’s proxy access rule. Why not nominate three and do it on the cheap?

See also, SEC Set to Open Up Proxy Process (WSJ, 8/5/10) Meeting is scheduled for Aug. 25. “Under the language being drafted, shareholders would have to own a 3% stake in a company for at least two years to qualify.” While it isn’t clear how the SEC’s final rule will handle proxy access at small companies, in my opinion that is where it is most needed.

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NYTimes Plugs Currently Proposed Proxy Access Thresholds

Yesterday’s New York Times editorial favors the 1, 3, and 5% thresholds for proxy access advanced by the SEC’s proposed rulemaking.  (Putting Investors First)

To get nominees on the proxy-card ballot, shareholders would have to own their shares for at least a year and would need substantial ownership stakes of at least 1 percent for large firms and 5 percent for small firms. Shareholder candidates could compete for a limited number of seats, ensuring that they could not wrest control from current boards.

Now that Dodd-Frank gives clear authority, we fully expect proxy access rules to be in place for next year. If it happens this month, it will have been eight years since Les Greenberg and I petitioned the SEC for the change. Of course, our proposal would have opened the floodgates to many more “contests,” since we essentially proposed the same $2,000 and one year threshold that existed before the SEC changed the rules without going through a rulemaking when it appeared that shareowners would be winning access proposals. (Populism Begins in the Boardroom) According to the NYT:

If it stands firm, the S.E.C. will begin to level the playing field in board rooms and gain public trust in the agency’s ability and willingness to carry out financial reform in the best interests of investors.

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Proxy Access Avoidance: Subversive or Accelerating Preemption?

The other day I included mention of a project by J.W Verret (Truth on the Market) who promises 16 posts in a series of strategies on how to avoid complying with proxy access once it is enacted. His postings are defended by someone I normally consider at least somewhat rational, Stephen Bainbridge. One of Verret’s latest, suggests that if directors are elected through proxy access at a company, the majority board members could set up an executive subcommittee to do all the substantive work of the board, thus freezing out directors nominated and the elected by shareowners from any significant decisions.

To me, this smacks of a violation of the duty of good faith. After working on proxy access for so long (Les Greenberg and I submitted our original petition in the summer of 2002), Verret’s tactics seem especially venal to me, so I posted a bit of a rant (New Resources: Sustainability Quotes, Crisis Timeline, Cal Corp Law & Proxy Access Avoidance and here in response to Bainbridge.

Verret apparently plans 13 more posts on the subject, although he posted something of an answer to critics on July 29th (Corporate Blog Smack Down 2010 over my Proxy Access Defenses). Those critics were Nell Minow (see Another Misguided Piece from Professor Bainbridge) and J. Robert Brown (Access and a Desperate Response). Both are well worth reading.

It looks like Bainbridge may be entering with a series of his own recommendations. For example, see Using Board Qualifications to Defang Proxy Access, 7/29/10, where he proposes companies could limit directors to those holding $250,000 worth of stock. As one commentator wrote,

How would this work in practice when most companies simply grant new directors sufficient shares of stock to meet their minimum ownership requirements within the required period of time (e.g. five years)? A board would be hard pressed to do so for all its members except for those elected via access.

Of course, in most cases involving proxy access we can expect the company to be under some financial distress, since shareowners aren’t likely to invoke access at a company that is doing well. If Bainbridge is expecting all director’s to pony up their own funds to purchase substantial shares in the company, he may not only be limiting access candidates but others as well. For example, I was once asked onto a board where the company was entering bankruptcy. Both nominating committees and shareowners seeking access would likely be blocked by Bainbridge’s suggestion.

Part of me says we shouldn’t give the ideas of Bainbridge or Verret to circumvent proxy access laws any more publicity, since maybe there are company leaders crazy enough to take their advice. However, after reading Brown response, I’m almost thinking that any such challenge may just add strength to the movement for greater shareowner democracy because it would likely lead to further preemption of Delaware law, should the courts there go along with these “defenses.” Dodd-Frank gives the SEC broad authority regarding proxy access requirements. Circumvention could easily lead to a real push for further access and to more than 25% of the seats.

In yesterday’s post (Proxy Access Blog Wars, And Introducing PA Defense #4), Verret recommended that boards adopt instant runoff voting (IRV) for their elections, which he calls the “Chinese Menu Ballot.” (One might assume from the name that he would require choices from various columns, whereas in fact, he call for IRV type ranking, so I am somewhat confused by the name he uses.) He appears to argue in favor of IRV, since it “would in some circumstances eliminate candidates for which a majority of shareholders have a strong preference against.” I find myself in actual agreement with this recommendation. I too, want consensus candidates and think IRV has a great many advantages for corporate elections. (see my May 2003 comment letter to the SEC)

In fact, for many years I have been advocating that CalPERS use IRV in its own elections. Several local governments already use IRV. Once the Secretary of State certifies ballot counting equipment at the state level, I think it is highly likely that CalPERS will adopt it for their board elections. Once they do, they may become strong advocates for IRV in contested corporate board elections.

Verret promises to “save the best for last.”

The final two defenses I will offer stand to completely subvert any of the benefits of proxy access.  The final two defenses I will propose will ensure that no investor will have any remaining incentive to nominate directors onto the corporate proxy under the SEC’s proxy access regime, and they will be certain to withstand challenge in both Delaware and the federal courts.

We’ll see. In the meantime I hope for more constructive suggestions, like post #4, for the posts in between.

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New Resources: Sustainability Quotes, Crisis Timeline, Cal Corp Law & Proxy Access Avoidance

Quotes – The Business Case for Sustainability & CSR Reporting: Selected Quotes from the Business Community July 2010. Tim Smith of Walden Asset Management, offered up  a helpful resource providing a selected set of quotes from CEO’s and company CSR reports on the business case for Sustainability and CSR reporting highlighting how they contribute to shareowner value.   Business leaders explain in their own words why their companies are stepping up on Sustainability issues and how they contribute to the business and its bottom line. The research was done by Carly Greenberg, a Summer Associate at Walden and a student at Brandeis University. You can download it from the Socially Responsible Business/Investments section of our Links page.

Sullivan & Worcester recently announced a free resource for law and corporate librarians, researchers and reporters. The Financial Crisis Timeline is a full chronological directory of the Federal Government’s actions relating to the financial crisis since March 2008. Links take the user to government press releases or government web pages.  You can also find on our Links page in the History section, for future reference. (Hat tip to Dan Boxer, University of Maine School of Law)

Keith Bishop, a partner in Allen Matkins, recently started a blog devoted to California corporate and securities law issues. For future reference, you can find it on our Links page in the Law section. As I recall, Bishop first came to my attention after 1991, when the Rules Committee of the California Senate appointed him the Senate Commission on Corporate Governance Shareholder Rights and Securities Transactions.

For companies seeking to aviod proxy access, J.W Verret (Truth on the Market) posted the second of two strategies. Proxy Access Defense #1 involved adopting poison pills.

In Selectica, summarized by Pileggi here, the Court held valid a poison pill with a 4.99% trigger.  At first glance this seems to be a great twist for those of us who remain skeptical of the federal government’s intrusion into this foundational issue of state law.  Boards could just lower the pill trigger to 4.99%.  Then even to the extent shareholders could afford to obtain a 5% interest in a company, those who did not already own a 5% interest at the time of the pill’s adoption would not be able to obtain an interest sufficient to nominate onto the corporate proxy.

Even after enactment of Dodd-Frank, Verret speculates this tactic might work at most companies, since the threshold being considered by the SEC for small companies is 5%. The latest strategy offered up by Verret in Proxy Access Defense #2 is even more insidious:

The Delaware General Corporation Law gives the board and the shareholders the co-extensive authority to adopt bylaws setting the qualification requirements necessary to become a director.  There is very little case law interpreting this provision, other than the general rule from Schnell v. Chris-Craft that powers granted to the corporation may not be used in an inequitable manner.  Qualification requirements based on experience, education, and other background-like variables would likely survive scrutiny, particularly where they are adopted well in advance of a threatened proxy fight.

The key element in such a bylaw would be that the Board would serve as the ultimate interpreter of the provisions.  For example, a qualification provision could require directors to have 20 years of experience at a comparable company in the same line of business.  The Board, then, would determine whether that requirement has been met, and only after the proxy contest has actually happened.  Under the holding in Bebchuk v. CA, a shareholder challenge to such a facially neutral bylaw would likely not even be justiciable until a shareholder nominee actually won the contest.  And yet, the prospect that the Board will invalidate the director may discourage nominees in the first instance.

I wonder if Professor Verret also offers advice on how to circumvent tax codes, the Occupational Safety and Health Act, or the Americans With Disabilities Act. Harvard must be pleased to have such a distinguished scholar. Hopefully, most companies will seek to work with their shareowners but I suppose there will always be companies like Apache that may find Verret’s strategies appealing. No, I’m not adding these posts to our Links page. Hopefully, they will fall under the category of fantasy.

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Populism Begins in the Boardroom

There is an intriguing place where we might begin the work of a renewed economic populism: in corporations, not the capital. If the goal of populism is the amelioration of life for the many, then President Obama could strike a confounding (in a good way) pose by calling on the private sector to take up an idea put forward this week by Fareed Zakaria: unleash a corporate stimulus. “The Federal Reserve recently reported that America’s 500 largest nonfinancial companies have accumulated an astonishing $1.8 trillion of cash on their balance sheets,” Fareed writes. “By any calculation (for example, as a percentage of assets), this is higher than it has been in almost half a century. And yet, most corporations are not spending this money on new plants, equipment, or workers…[Such] investments would likely have greater effect and staying power than a government stimulus.” A populism that begins in the boardroom—that would really be change we could believe in. (The Right Kind of American Populism and Obama’s CEO Problem, Newsweek, 7/12/10).

I’m not sure Obama has the power to get the private sector to start spending. Congress certainly didn’t do a good job of tying bank bailouts to bank loans. However, I certainly agree with Jon Meacham and Fareed Zakaria, populism could begin in the boardroom.

Imagine a political system in which the incumbents get to select all election candidates, and voters have no choice but to vote for these nominees, or not vote at all. Such “democracy” rules the US proxy process by which investors elect corporate board members. Now, an “open ballot” movement among big shareholders is working to shake up how boards are elected.

The Magna Carta was drafted in response to the excessive use of royal power, while the move for proxy access stems from the abuse of power by management at Enron, WorldCom, Tyco and others.

The first clause of the Magna Carta guarantees “freedom of elections” to clerical offices of the English church to prevent the king from making appointments and siphoning off church revenues. A shareholder’s Magna Carta would prevent managers from having undue influence over corporate boards and will prevent them from using corporate coffers as their personal bank accounts.

Think markets and proxy contest are the answer? Who has enough to buy BP? Even after much of the wealth has been destroyed, the takeover and transition of poorly governed corporations back to profitability is also expensive, generally estimated to range between two to four percent of the value of the firm. There may be very heavy transaction costs for employees through layoffs, lost wages, increased divorce and suicide rates, as well as to communities in the form of lost taxes and charitable contributions. In contrast, the cost of proxy driven changeovers have run considerably below one percent.

In August of 1977, the Business Roundtable recommended “amendments to Rule 14a-8 that would permit shareholders to propose amendments to corporate bylaws, which would provide for shareholder nominations of candidates for election to boards of directors.” Their memo noted such amendments “would do no more than allow the establishment of machinery to enable shareholders to exercise rights acknowledged to exist under state law.” Now the BRT seems to think proxy access will be the end of the world.

In “Toward Democratic Board Elections,” published by The Corporate Board (7-8/2003) I noted, “After years of allowing shareholder proposals concerning elections, the SEC in 1990 issued a series of no-action letters ruling that proposals concerning board nominations could be excluded. Proposals by institutional investors were beginning to win majority votes. Perhaps the SEC realized failing to issue no-action letters could soon have consequences.” The court in AFSCME V. AIG came to the same realization three years later.

Competition for board positions has traditionally stimulated share value. Researchers have found that firms with stronger shareholder rights had higher firm value, higher profits, higher sales growth, lower capital expenditures, and fewer corporate acquisitions. Investors who bought firms with the strongest democratic rights and sold those with the weakest rights would have earned abnormal returns of 8.5 percent per year during a sample period.

It is paradoxical that the standard justification for autocratic practices in industry is its alleged efficiency, since empirical research results do not support that conclusion. Increased rank-and-file responsibility, increased participation in decision-making and increased individual autonomy are all associated with greater personal involvement and productive results.

The keys to creating wealth and maintaining a free society lie primarily in the same direction. Both require that broad-based systems of accountability be built into the governance structures of corporations themselves. By accepting the responsibilities that come with ownership, pension funds and other institutional investors have the potential to act as important mediators between the individual and the modem corporation. Indeed, populism that begins at the boardroom could change populists could believe in.

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CorpGov Bites

Opinion: Business to Blame for Anti-Business Mood, Marty Robins, Special to AOL News, 7/8/10. Where management was utterly disengaged from the business at hand, is it any wonder the public, and lawmakers, are demanding more regulation of the economy… resistance to good-faith efforts to improve governance by bolstering management oversight doesn’t endear business to society. Marty Robins also writes an occasional guest post to CorpGov.net.

Could your company outperform its competitors by 85% in sales growth and 25% gross margin? A group of Gallup clients achieved this competitive advantage by applying our behavioral economic principles. (Applied Behavioral Economics: The Next Discipline)

The idea that the human mind is based on an internalised statistical decision making algorithm is one we’ve met before. It’s a research fallacy which each successive generation of academics falls into by firstly using their latest research tools – statistical analysis packages, digital computers, etc – as metaphors for the way the mind works and then assuming that this is the way the mind actually works. There is a huge behavioural bias behind behavioural finance but it’s not the experimental participants who are subject to it, but the experimenters. (Behavioural Finance’s Smoking Gun)

Filing Deadlines and Proxy Solicitors – Checklist from The Activist Investor.

“We have recommended that internal audit should be outsourced rather than in-house because internal audit in-house is always dependent on the management of the company. Internal audit from outside will always be better, and then it should be given to chartered accountants,” ICAI President Amarjit Chopra told India’s the Economic Times (ICAI for compulsory outsourcing of internal audit functions, 7/8/10).

Not much new in the following but certainly glance-worthy:

  • Proxy Access Defense #1, Truth on the Market
  • Investors: be careful what you wish for, FT, 7/5/10. Can any of the players really afford the time or resources required to make engagement a reality?
  • The Future of the Board of Directors, Martin Lipton, Harvard blog, 7/6/10. We should recognize that the purpose of corporate governance must be to encourage management and directors to develop policies and procedures that enable them to best perform their duties (and meet our expectations), while not putting them in a straight jacket that dampens risk-taking and discourages investing for long-term growth and true value creation. (CorpGov.net: Short-term shareowners are handing out the straight jackets.)
  • Proxy Access: A Sheep or Wolf in Sheep’s Clothing? I sometimes feel the same way about some Stanford University research as some of them seem to think about proxy access, a wolf in sheep’s clothing, although this latest bit doesn’t seem to say much.
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Directors Elected Through Proxy Access

With the enactment of the financial regulation bill with its drastic improvement in proxy access terms appearing imminent, it is important to reflect on how corporate governance devotees need to respond. Specifically, we need to acknowledge that enhanced access is only one step –albeit a huge step – of the journey toward better governance, and that the performance of the newly empowered candidates and directors is equally important.

Simply getting non-management candidates onto proxy cards and boards will not suffice if such persons do not play a meaningful role in improving decision-making by holding management accountable and bringing about better decisions. In the first instance, this means that all candidates need to be thoroughly educated as to their substantive and procedural obligations, and willing to follow through accordingly.  “Directors’ colleges,” if they are developed by organizations such as CALPERS, CalSTRS and TIAA-CREF for potential candidate pools, could be an excellent place to start.

While there is no shortage of good quality handbooks for this purpose which can and should be utilized, such as the Corporate Director’s Guidebook promulgated by the American Bar Association and http://www.tankless.com/assets/files/governanace/SKYE_Corporate_Governance.pdf [example of a specific company’s effort, emphasizing securities law] and http://www.flofr.com/banking/forms/dfi_directorhandbook08.pdf, [pertaining specifically to financial institution directors], especially with respect to the mechanical part of the job, they are far from sufficient. What is critical is that everyone on a board, genuinely participate in the substantive consideration of each material matter which is presented, and insist that all material matters be presented, and that appropriate consideration be given on an ongoing basis of whether prior decisions remain correct for the firm.

The focus must be on the quality of the decisions which emanate from boards. All directors, whether representative of minority holders or otherwise, must have or commit to promptly develop sufficient expertise in the matters pertaining to their firm’s business and industry in order to pursue their candidacy. More importantly they must use that capability. Simply causing the empanelment of candidates proposed by unions, pension funds, hedge funds or any other constituency will not of itself result in any improvement of board performance.

This means being willing and able to responsibly and knowledgably challenge management as to matters of business strategy in order to ensure a full vetting of material decisions, whether they are nominally in the ordinary course or involve traditionally characterized “major corporate transactions.” This requires not only using and understanding, but also critiquing the briefing books supplied by management, as well as recognizing their limitations and demanding additional material where needed.

In recent years, especially in the financial sector, we have seen far too many debacles result from either gradual changes in strategy or sudden changes outside the M&A or financing areas, not addressed in a meaningful manner by boards.

Prof. Eric Pan has written an excellent discussion of the board’s duty to monitor and how it needs to be implemented and refined, the current version of which is at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1593332. The author of this post has also suggested an additional focus by boards on outcomes instead of process, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1570111

All directors must remain cognizant of where their organization is – per financial statements – and where it appears to be headed, and push management to justify actions which appear to defy common sense, are not well supported or do not pass the “smell test.” Where it appears that major changes are afoot, but the board has not been properly consulted, someone needs to speak up.

Even where there is no doubt as to the use of proper process contemplated by statute or by Smith v. Van Gorkom, Revlon, etc., directors must keep in mind whether the decisional outcome of this process makes sense in the broader context.

Similarly, where it appears that a decision which was previously and properly made is no longer appropriate on account of changed circumstances, new information or simply is not working out as hoped, someone needs to speak up before it is too late for the individual firm or the economy.

Proxy access is a powerful tool in the effort to improve governance, but like all other tools, it must be used judiciously, but vigorously when necessary, and in conjunction with other appropriate tools.

Publisher’s Note: Thanks for guest post from Martin B. Robins, an adjunct professor in the Law School of Northwestern University. He is presently, and for the past 10 years has been, the principal of the Law Office of Martin B. Robins where his practice emphasizes acquisitions and financings, technology procurement and licensing, executive employment and business start-ups. The firm represents clients of all sizes, from multinational corporations to medium sized businesses to start-ups and individuals.

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Proxy Access Update

A recent report from the Altman Group provides the best short update on proxy access that I have seen. They recommend to clients that “the Rubicon has been crossed. It is time for companies to start thinking about conducting over coming months detailed Governance Risk Assessments examining the challenges that are likely to be presented by shareholders taking advantage of a proxy access rule in the 2011 proxy season.” The main summary of their report is as follows:

U.S. House and Senate negotiators agreed last week to use language in the financial reform bill that will grant the SEC the authority to issue rules on proxy access, but without eligibility or other specific criteria defined by the U.S. Congress. House negotiators rejected efforts led by Senators Christopher Dodd and Charles Schumer to constrain the SEC’s rule-making on proxy access by defining certain eligibility criteria. Sen. Dodd, in a provision detailed in the Senate’s “Counter-Offer” of June 16, had initially pressed for amending: “Section 972 Proxy Access of the base text so that only shareholders that have owned not less than 5% of outstanding shares for not less than 2 years have access to the proxy.” http://banking.senate.gov/public/_files/TitleIXcounter.pdf When House negotiators resisted (the 5% level in particular), Sen. Schumer floated an alternative proposal of 3% of O/S held for 3 years + a requirement that a shareholder nominating a director under proxy access provisions would have to maintain an ownership stake for 2 years following the meeting at which their nominee was elected to the board. The latter proposal marked a turning point in the process. House negotiators ended up rejecting all efforts to define eligibility criteria. House Financial Services Chairman Rep. Barney Frank reportedly remarked that “sentencing people to own shares is an odd concept” (Dow Jones, June 24).

Ted Allen provides the most comprehensive coverage with regard to corporate governance provisions. (Lawmakers Release Final Text of Financial Legislation, RiskMetrics, 6/28/10)

Lawmakers Release Final Text of Financial LegislationYou can find a link to the conference report on the financial reform bill at http://financialservices.house.gov/Key_Issues/Financial_Regulatory_Reform/conference_report_FINAL.pdf. More from Morrison & Foerster at Reconciliation: A Summary Scorecard on Regulatory Reform (Part I) and on the larger bill at Lawmakers guide Dodd-Frank bill for Wall Street reform into homestretch, Washington Post, 6/26/10. See also, SEC Will Have Hands Full Once Financial Reform Passes, The Conference Board, 6/22/10.

However, there is also a reminder that it ain’t over til its over. Bill can’t bank on Brown’s support, The Boston Globe, 6/26/10. Senator Scott Brown, a Massachusetts Republican, said he was withholding support, citing $19 billion in new bank taxes inserted at the last minute. And there’s this from the Wall Street Journal, 6/28/10:

The Business Roundtable, a Washington group that represents big-company CEOs, said Friday it would keep urging the SEC to limit proxy access to shareholders who have held a 5% stake for at least two years. “We will continue our very strong advocacy,” said Alexander “Sandy” Cutler, CEO of manufacturer Eaton Corp. and head of the Roundtable’s Corporate Leadership Initiative… The SEC is considering scrapping the tiered approach and instituting one stake level for all companies, according to a person familiar with the discussions. The Council of Institutional Investors, a powerful association of pension funds, has proposed requiring a 3% stake for two years at all firms. Lawmakers did agree to let the SEC exempt smaller firms, which corporate lobbyists said they would urge.

Of course, it is at small businesses that shareowners generally need the most help, since there are few active institutional investors involved. I guess the’re not too big to fail, or screw their owners.

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Access is Back, Majority Vote to be Battled Company by Company

Lawmakers Reach Deal on Proxy Access by Ted Allen on June 25, 2010 12:03 AM. “In the end, the lawmakers essentially went back to where they started and will allow the SEC to hash out the many thorny issues related to proxy access.” “The SEC’s current draft rule, which was issued last June, calls for a sliding ownership threshold for investor groups that ranges from 1 to 5 percent depending on a company’s market cap, and would impose a one-year holding period. The commission may consider a final rule as early as next month.” Thanks to Allen for keeping a close eye on this important legislation.

I’m also told there was one additional line that the SEC can, at its discretion, exempt certain small businesses from proxy access requirements. Mandatory say-on-pay moves to biannual or triennial at company’s option; exemption from SOP for “small issuers.” No majority vote standard will be required. (The House-Senate Reconciliation Reaches the Finish Line: The “Proxy Access” & “SOP” Results Are In, 6/25/10… also excellent coverage by Broc Romanek at TheCorporateCounsel.net)

Here Are The Key Points You Need To Know About Today’s Big Financial Regulation Agreement, BusinessInsider.com, 6/25/10. House and Senate Agree on Finance Overhaul, NYTimes, 6/25/10. Now I wait for some group like theRacetotheBottom.org to do a complete dissection of the bill. It looks like we won much more than we lost thanks to all those calls and emails.

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House "Compromise" on Proxy Access

Thanks to Ted Allen of Risk Metrics for his continuing coverage of the financial reform legislation. (House Lawmakers Propose Compromise on Proxy Access, 6/24/10) Today he reports that, as expected Rep. Barney Frank said House lawmakers won’t support Senator Dodd’s proposal to impose a 5% ownership threshold and a two-year holding period on investors who seek proxy access.

Frank said the House would agree to insert instructions in the bill to direct the SEC to consider the need for a holding period and a minimum ownership stake. Dodd will soon to present a revised offer on proxy access.

Today is supposed to be the final day of conference committee negotiations on the 2,000-page financial reform legislation. Besides proxy access, there are other contentious issues to be resolved, including whether to adopt a “Volcker rule” to restrict proprietary trading by banks and to force banks to spin off their derivative trading operations. Lawmakers also are discussing SEC funding and whether to extend fiduciary duty obligations to broker-dealers.

I think we can all readily embrace Frank’s “compromise.” Will the Senate?

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Manifest's e-mail to Valerie Jarrett

June 17, 2010 to [email protected]

Good morning Ms Jarrett;

My name is Sarah Wilson, I am CEO of Manifest, a European proxy voting agency based in the United Kingdom. We act on behalf of a range of international investors ranging in size from small public pension funds to major European Sovereign Wealth Funds, in total a a community of investors representing assets in excess of US$3.trillion. Our clients take their responsibilities as long-term, diligent share-owners very seriously. We like they, are members of bodies such as the International Corporate Governance Network and the UN Principles for Responsible Investment. Manifest has significant experience in the proxy field, our firm has been operating since 1995, and we have actively participated in regulatory reforms in the UK and Europe with one view: to facilitate informed and responsible share ownership.

With this in mind we feel compelled to write to you and your colleagues to encourage the Obama Administration not to implement a 5% ownership threshold and a two-year holding
period for investors to nominate board directors on corporate proxies. We share the view of the ICGN that this would be extremely detrimental to the attractiveness of the US market from overseas investors. Furthermore, at a time when investors are being asked to step up to the plate and exercise diligent ownership oversight on their equity holdings, it would represent a retrograde step for US and global corporate governance.

Manifest is not as an activist with a short-term outlook, we speak as an organisation with long-standing practical experience of the mechanics of share ownership that believes that there should be a strong linkage between the economic and democratic process. With this experience, we see a number of practical problems with the proposals as currently drafted. We would therefore like to bring a number of points against these proposals to your attention for your active consideration.

1. The Ownership Threshold is Too High
Let me be clear, Manifest is no advocate of gadfly shareholders with single issue agendas to pursue. That would indeed be a reasonable basis for setting a high ownership threshold. However, the proposed threshold is being set too high to be remotely useful, particularly for larger companies, by the informed and thoughtful investing community which we work for. Ownership thresholds have been debated at length by the SEC and the arguments for the lower threshold thoroughly reviewed and understood. We therefore strongly encourage a lower ownership threshold, such as 3% for all companies, and in particular with market caps greater than $10 billion. It is also essential that shareholders should be able to work collectively as owners, it is therefore imperative that the ownership threshold can be met by multiple owners, not merely one.

2. The Ownership Period is Too Long
The right to vote is a fundamental human right which we tinker with at our peril. Would we suggest that the right to vote or be involved in democratic processes would only every be granted to individuals that have lived in a particular constituency for two years or that have an income above a certain threshold? Hopefully not. The right to vote, to representation and to holding those representatives to account is surely core to the concept of all democracies?

As the credit crisis has show us, boards that are left unaccountable can wreak havoc. Ineffective boards are not just a tax on shareholders, they are a tax on global economies. At the heart of the rift between the UK and the Thirteen Colonies was the concept of “no taxation without representation”.  If shareholders are to be taxed by agency costs then it is only reasonable for them to request representation. Without effective and accountable representation, shareholders rights are diminished and our economies pay a steep price.

3. Proof of Ownership is Tortuous to the Point of Impractical
We would also like to highlight the operational difficulties that the owners of US companies face in both proving their ownership and exercising their franchise. Two recent cases in your courts, Apache vs. Chevveden and Kurz v Holbrook, demonstrate that the property rights of investors (i.e. share ownership and voting of proxies), are heavily curtailed by a proxy plumbing process that is no longer fit for purpose in a internet-enabled investing world. Valuable time, effort and opportunity cost will be lost by market participants who will find themselves drawn in to protracted debates about who is or is not an owner/entitled to act. We encourage you to give weight to the SEC’s efforts to overcome these obstacles and bring about reforms which allow more timely and effective proxy voting and investor/issuer dialogue.

4. International Investors are Responsible Investors
Proxy access may represent a step into the unknown for many corporations. It is understandable that they would be concerned about being held hostage to special interest groups. These fears are based on fear itself and not on the real world experiences of global public markets which offer proxy access. International investors now own close to one fifth of the share capital of US listed companies, they are also active owners in other global trading markets. In the overwhelming majority of cases, shareholders are very supportive of their investee companies in which they have invested significant amounts of capital. They see significant responsibility associated with their ownership rights. Indeed in a market such as the UK, which has very permissive shareholder rights, these rights are rarely exercised in a negative way and both proxy battles and shareholder resolutions are extremely rare. Under UK company law, for example, 100 shareholders holding shares in a company with an average sum, per shareholder, of not less than GBP100 par value, can requisition a motion at the company’s annual general meeting (without any qualifying holding period). The number of such motions (resolutions) in the UK this year has been under 6, interestingly two of which were resolutions related to the environmental impact of exploration activities of two oil companies, Shell and BP.

Your Government stands at a major crossroads in financial reform and both the markets, as well as ordinary voters, will look to you to set the highest possible standards of probity in the financial industry. We urge you to grasp this opportunity to let investors play their part in ensuring the continued success of global capital markets.

Thank you for your time and consideration of our views, it is much appreciated.


Sarah Wilson, Chief Executive
FN Top 100 Most Influential Women in Finance 2009
Manifest | 9 Freebournes Court | Newland Street| Witham, Essex| CM8 2BL | England

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Proxy Access: Monday AM

The Huffington Post appears to have the latest coverage, White House Flip Flops On Reining In CEO Pay, 6/17/10. I watched the televised Conference Committee where Chuck Schumer failed (on a vote of 4 to 8) to delete Dodd’s amendment that basically guts proxy access by limiting it to one 5% shareowner, an impossibly high threshold as most companies.

House Speaker Nancy Pelosi and Barney Frank are still stand strong against the effort by Dodd and the Business Roundtable to water down the proxy access provisions. The New York Times ran an editorial, Congress Defends the Big Guys (6/19/10). The bill that was supposed to restore confidence in the financial sector and business in general appears to be coming apart at the seams:

  • Exempt most publicly traded companies (worth less than $75 million) from a SOX anti-fraud auditing requirement.
  • Keeping boards safe for cronies by gutting proxy access.
  • Self-funding for SEC now in question.

So, as of early this morning our best understanding is that the House Conferees will reject the Senate counteroffer language on proxy access (the newly inserted 5% language). However, until that actually happens, it continues to make sense to contact the House conferees requesting that they reject the Senate language, and get in letters to the Senate Conferees protesting the 5% language.

Assuming, the House conferees reject the Senate language, the issue goes back to the Senate conferees.  Then we need to turnaround Senators Dodd, Johnson and Lincoln.  Senators Bayh and Warner also appear to be critical.  Until we learn more, I would advise continuing to call Obama’s point person for the Administration, Valerie Jarrett through the White House switchboard at at (202) 456-1414 and by email to [email protected].

Tell her how unhappy you are with with the White House interference on the crucial issue of proxy access. Express strong opposition to the Senate’s amendment imposing a 5% ownership threshold for shareowner access to the proxy.  Tell Jarrett and the White House to support the original language passed by both houses of Congress simply affirming the SEC’s authority to issue a proxy access rule.

I’ve written several times to committee members, staffers, etc. Here’s a quick version:

Please oppose the Dodd amendments to the conference committee bill on financial reform.  A 5% threshold by an individual investor will almost never be met by large diversified institutional investors since even the larges rarely hold more than about 1/2% of the shares of large companies. Shareowners need to be able to form groups to nominate directors using the corporate ballot.  Reject the Dodd amendment and take a step towards reducing entrenched boards and CEOs.

I break them into clusters so my outbasket doesn’t get clogged. Send e-mails to the following

[email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected],

[email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected],

[email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected], [email protected]

Proxy access is the most important reform in the bill. It would begin to provide shareowners with the tools to end cronyism and hold directors accountable. Directors are supposed to represent shareowners. All too often, they represent CEOs and their own entrenched interests. We need the SEC to be able to move forward with proxy access. Please take a few minutes for a phone call and an e-mail and be sure to include your contact information in your e-mails.

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CII Adds Voice to Outrage re Gutting of Proxy Access

The Council of Institutional Investors sent out an alert today, which reads in part as follows:

All Council members opposed to the Senate’s proposed 5% ownership requirement for proxy access are strongly encouraged to call and email White House advisor Valerie Jarrett TODAY.
As a senior advisor to President Obama, Jarrett has significant influence over the ongoing House-Senate conference committee negotiations, particularly regarding the proxy access provision of the base text (section 972).

To support proxy access, call the White House switchboard at (202) 456-1414 and request to be connected to Valerie Jarrett’s office.  If you cannot reach Ms. Jarrett, we encourage you to leave a message expressing your strong opposition to the Senate’s amendment imposing a 5% ownerhsip threshold for shareowner access to the proxy.  Tell Jarrett and the White House to support the original language passed by both houses of Congress simply affirming the SEC’s authority to issue a proxy access rule.  Be sure to include some brief information about your fund as well as your contact information.  You can also send Ms. Jarrett an email at [email protected].

Tell Valerie Jarrett and the Obama administration to publicly oppose the Senate’s proxy access amendment imposing a 5% ownership requirement.  Encourage them to call upon House and Senate conferees to reject this harmful change.

According to an earlier report in the Huffington Post (White House Guts Reform To Protect CEO Pay, 6/17/10), Jarrett is the administration’s liaison to the Business Roundtable. Three of their sources said Jarrett was behind the effort to strip any teeth from the proxy access provision; their other two sources were unsure. Please add your voice to those of the Council. The Obama administration needs to know credibility will evaporate if proxy access is gutted, especially at their request.

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I Think I'm Going to be Sick: Obama and Proxy Access

According to the Hufffington Post (White House Guts Reform To Protect CEO Pay, 6/17/10), the White House is behind the latest move to kill proxy access at the request of the Business Roundtable.

When questioned on the issue, a White House spokesperson responded: “It was not part of our original proposals, and we have not taken a position explicitly.”

However, Two months ago, Deputy Secretary of the Treasury Neal Wolin addressed the Council of Institutional Investors and explicitly supported the provision.

The Senate bill will make clear that the SEC has unambiguous authority to issue rules permitting shareholder access to the proxy. We support that proposal…  the principle is clear: long-term shareholders meeting reasonable ownership thresholds should have the ability to hold board members accountable by proposing alternatives and making their voices heard.

If Valerie Jarrett, a senior White House adviser and the administration;s liaison to the Business Roundtable is behind this latest move, Obama can only regain credibility by firing her and advocating proxy access provisions be retained in the conference committee bill. We can’t all move to Canada.

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Conference Committee Threatens Proxy Access

According to the latest update from the Social Investment Forum conferees are meeting now to discuss the 5% proxy access provision the Senate offered yesterday.  This is a “backroom” maneuver, given that this provision is not in EITHER the House or Senate bill, and CII, SIF and Americans for Financial Reform, among others, strongly opposes this. (see the SIF page for continuing coverage)

Word is Senate Banking Chairman Christopher Dodd (D., Conn.) is pushing to set a threshold for shareholders to gain so-called proxy access to nominate their own candidates in corporate elections, requiring a shareholder to own at least 5% of outstanding shares for at least two years, according to a summary circulated by Dodd’s staff. We are not sure if the use of the singular “shareholder” is intended.

Either way, if Dodd prevails, it would be a win for the business community, which vehemently opposes granting shareholders proxy access. The underlying bill dictates no such threshold. Rather, it would explicitly empower the Securities and Exchange Commission to write a rule granting shareholders proxy access. See also, Senate Seeks to Drop Majority Voting From Reform Bill and Weaken Proxy Access, RMG Insight, 6/17/10.

Please take 5 minutes and send an email to the following people (who are either working to remove this provision or are in leadership positions on the issue and need to hear opposition).  You can email them all at the same time or separately.

[email protected]
[email protected]
[email protected]
[email protected]
[email protected]

“In a surprise move, because the provision is not in the Senate or House bill,  the Senate made an offer yesterday to the House imposing a five percent ownership threshold for shareholder access to the proxy.  The House and Senate passed bills were virtually identical in reaffirming the authority of the SEC to issue rules, leaving the details to the agency to work out.  Proxy access gives long-term shareholders the power to hold directors accountable. The five percent threshold all but negates proxy access because even the largest institutional investors generally do not have that level of ownership in any one company.  The House should reject the Senate offer.  We appreciate your support.”

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CEOs Running Scared in Washington

Businesses have intensified their efforts to kill the “proxy access” provision of the Senate’s financial regulation bill. Forty CEOs lobbied in Washington, DC last week alone.  “This is our highest priority,” said John Castellani, president of the Business Roundtable, which represents 170 chief executives. Last week alone, Castellani said, 40 chief executives were in town visiting Capitol Hill about proxy access, since they see it eroding their power.

“This hinges on senators recognizing the fact that boards in too many companies like Citigroup or AIG really failed in their responsibilities here,” said Daniel Pedrotty, director of the AFL-CIO Office of Investment. With proxy access, shareholders would be able to send a strong message to management if they weren’t happy with a company’s strategy, for instance, in managing risk or charting growth.

Currently, shareowners must pay thousands, sometimes millions, of dollars to run candidates that aren’t selected by current CEOs and boards. Proxy access would force companies to add shareowner nominees to the corporate proxy, at minimal cost, allowing them to comprise up to 25% of boards… if a majority of other shareowners agree with their picks. That still leaves current boards in control but the mere idea that some directors could be replaced has CEOs worried.

Senators Thomas R. Carper (D-Del.) and Bob Corker (R-Tenn.) have introduced amendments that would cut proxy access from the bill, but there are more than 250 other proposed amendments as well. It is hard to know which will get heard. Castellani said the BRT has gotten a sympathetic hearing from several Senators.

Jeff Mahoney, general counsel at the Council of Institutional Investors, said fears are overblown. “Just because you put someone on the proxy card doesn’t mean they’ll be elected,” he said. “At the end of the day, no one is going to get on the board unless most of the owners of that company want that.” (CEOs from far and wide band against financial bill provision, The Washington Post, 5/14/10.

Robert Sprague and Aaron J. Lyttle analyze the development of current corporate governance standards and examine whether the current financial crisis can provide an avenue for change. They find that a “significant shortcoming of the shareholder primacy norm, as supported by the business judgment rule, is that corporate directors and officers have a plain incentive to maximize short-term profits, possibly, as in the case with Citigroup, at the expense of the overall viability of the firm.”

There is one critical assumption underlying the discretion provided to corporate directors and officers under the business judgment rule—if shareholders are displeased with directors, and the officers they hire and supervise, the shareholders can elect new directors. This replacement power is especially important when director decisions are insulated from judicial review due to the business judgment rule.

Unfortunately, that ability is largely an illusion. Shareowners have very little input into electing directors, since in most cases all they can do is vote for or withhold their vote from management’s candidates. Sprague and Lyttle conclude, “The most viable possible revision to corporate governance in the United States is to allow shareholders access to proxies to nominate alternative directors.” (Sprague, Robert and Lyttle, Aaron J., Financial Crisis: Impetus for Restoring Corporate Democracy (January 26, 2010). Midwest Academy of Legal Studies in Business Conference Proceedings, 2010. Available at SSRN: http://ssrn.com/abstract=1529733)

Martin B. Robins would take a complimentary but different approach, reversing the present burden of proof placed on plaintiffs in actions alleging breach of a directors’ duty of care under certain circumstances. (Require Affirmative Proof in Specified Circumstances of “Too Big to Fail Companies” in Order to Meet the Business Judgment Rule)

We need a legal regimen which forces directors at systemically important firms to familiarize themselves with what management is doing, and ask the tough questions of management before policies are implemented, to see if the downside risk of those policies is understood (or has been considered at all) and to change course when even an originally well conceived strategy is no longer suitable. Ultimately, we need to force directors to consider on an ongoing basis whether their firms’ managements should be in their positions at all, in order to screen out dishonest, reckless or incompetent persons.

Elsewhere, Robins argues, “pending bills only divert the focus from holding responsible those making the decisions requiring resolution and encourage more bad decisions.” (ROBINS: Financial regulations miss the target, The Washington Times, 5/13/10)

Although far from the recommendation of Robins, thecorporatecounsel.net/Blog reports on two amendments to the Dodd bill that “would significantly expand the disclosure obligations of ’34 Act companies – principally because they contain no meaningful disclosure thresholds (i.e. materiality), and in the case of the Byrd Amendment, would significantly expand the bases upon which directors and officers may be found personally liable for failures to disclose.” (Drilling Down Into the Dodd Bill Amendments: Personal Liability for Directors and Officers!, 5/14/10)

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Stanford Rock Center Proxy Access Forum

Proxy Access Panel

The Arthur and Toni Rembe Rock Center for Corporate Governance at Stanford University has quickly emerged as a focal point for conferences and seminars, research, and the development of new educational and course materials. The May 6th Proxy Access Forum was the latest iteration of the fine work being done at the Center.

My disclaimer: I don’t take notes quickly enough to get quotes. What follows are a few highlights of what I thought were some of the important messages conveyed by each of the panel participants and the moderator. I left them in note taking fashion, so there can be no confusion these are my impressions (and because it is quicker for me), rather than the fully articulated sentences of the speakers. Although there was a great deal of back and forth dialogue, it was easier for me to just place thoughts under the persons name, rather than trying to capture the interactive dynamics. Within a couple of weeks, you’ll be able to watch the event on the Center’s internet site under May 2010. I highly recommend it.

Both Paredes and Friedman provided their own standard disclaimers. They were expressing their own opinions, not those of the Securities and Exchange Commission or the SEC Investor Advisory Committee.

Troy A. Paredes, SEC Commissioner.  Voted against proposal. Objected to a-11

Troy Paredes

(mandatory) not opt-in a-8 (private ordering). Seeks balance between federal and state roles. Disclosure requirements of SEC are complementary to though control through state. Long-standing enabling approach of states vs prescriptive (mandatory one-size-fits-all) under federal. Different governance regimes optimal. Embraces private ordering provisions implemented by DE… Proxy access and expense reimbursement. His other concerns are for workability.  Opportunity costs for staff. Proxy access will divert scarce SEC resources. Has some doubt proposal will increase shareowner value.  Having input us helpful and gives us a lot to think about. Long history around this issue.

Francis (Frank) S. Currie, Davis Polk & Wardwell LLP – Regrets overly hard

Frank Currie

positions taken by the business community against opt-in proposals introduced previously at the SEC under the previous administration. Objects to one-size-fits all approach. While companies are allowed to innovate under a-8, they can’t make access harder.  We’ll see if the final regulations are softened. Rumor is the Commission will take a hard line. Concerned with SEC as referee.  Explaining how it works at our company will take a lot of time. DE approach much more workable. Use experience of companies to come up with a best process. However, with all the scandals and public anger, the SEC is unlikely to soften.

Advice for companies. Study proposal in great detail. How mechanics effect what company already has in place…. like advance notice provisions.  Do they clash?  Your own rules on what candidates should look like. How many boards serve on?  Rules might only apply to company nominees. Companies will need new timelines, taking into account possible shareowner nominees. Companies should be working on knowing their shareholders. Are they happy, unhappy? Why? Engage in a dialogue. Most are only going to be looking to proxy access as a nuclear weapon. Talk to them about new disclosures in place this year about why candidates selected by nominating are the best qualified. The whole way of running against a short slate makes difference; much more like a contest. Shareowners already have a lot of new weapons… broker votes gone, easier to withhold nomination with majority vote. We’ve already achieved overall balance, since these other corporate governance reforms alredy enable dialogue.  High degree of uncertainty is reason for shareowner value going down when proxy access is considered. (reference to “The Regulation of Corporate Governance.”

Abe M. Friedman, BlackRock, Inc. Has 17 staff responsible for voting. Written guidelines. Vote in best economic interest of shareowners. Re proxy access,

Abe Friedman

supportive. The right is critical… no question in my mind. Best place to nominate is in the nominating committee.  When you buy, you give up the right to hear decisions made in public. Board sessions are in a competitive market, so are private. Checks and balances slow in government… to make sure rights are protected and deliberative. Our companies, we want them to turn on a dime. In a well functioning company, we want directors nominated in the nominating committee because directors have the information and know what goes on in board meetings.

However, we also know that some boards fail. Not that they tried something that didn’t work, but they’re doing things in the interest of CEO, board member, etc. not in the interest of shareowners.  In those cases, shareowners need a new voice. Proxy contests are very expensive and cumbersome. Favors a-11. But think right should be used only when there is some triggering event. That doesn’t seem to be the direction we’re going though. Now we’re pushing for a high enough threshold, 2 years holding to not make proxy access too easy.

RiskMetrics’ power is exaggerated. Most investors take research from multiple firms.  Shareowners can’t make a decent proposal within the 500 words limitations, so opt-in procedures for proxy access can only be written by companies. Frank wanst companies to design; Joe wants shareowners to design… but shareowners can’t.  The idea that the combination of a-11 and a-8 is only going one way is a red herring because what shareowners are going to vote for reducing their rights? We need to ensure a good basic rule.  The cost of private ordering would be enormous… cost of putting it together at each company and litigating.

In response to comment from audience: It isn’t hard to find directors. Lots of people willing to serve.  There is no doubt shareowners have made progress. There are fewer interested party transactions. What we need are a few basic rights: majority voting, end to or right to vote on poison pills, inject voice in boardroom. Few things. He doesn’t think say on pay is one of the critical few.

Anne Sheehan, CalSTRS.  Briefly described CalSTRS… teachers. Holdings aren’t

Anne Sheehan

as large as BlackRock but votes 7,000 issuers a year. Ability to nominate is ultimately what this is all about. Average holding is 14 years. Would use it rarely, after massive failure. Now option is to withhold vote from director.  Many companies going to majority vote standard. But if a company fails to do anything, we need that access right. We talk to companies. They would have heard from us for years before we are nominating directors. 21 resolutions filed, all but 5 resolved. Ultimate tool in tool chest. We entrust directors to run the business.  S&P 500 majority vote, not smaller companies. Last year shareowners voted against directors but boards didn’t accept resignation or allowed them to continue. Companies can already enact proxy access, but few have. CalSTRS is asked by nominating committees for recommendations and, along with CalPERS, they are building a database of potential directors based on a broad diversity of skill sets.

Joe Grundfest, Stanford. In the proxy access debate, I’m a strong agnostic for what type of access should be allowed at each company. Socially optimal result

Joe Grundfest

should allow each group of shareowners to design the best proposal for their company. He almost hopes SEC does adopt a-11 so that he can file a brief questioning rational basis for their decision. If shareowners are smart enough to elect, why not smart enough to set the rules? First thing he will read the final rule for is the basis for the standards a-11.  He looks forward to litigating. Six cases challenged at the SEC for setting arbitrary standards, six cases lost.

In response to Sheehen, there are corporations where companies kept directors after losing majority votes but they made changes, like getting rid of a staggered board. Shareowners may have actually wanted to end staggered boards more than they wanted to remove specific directors, so they accomplished something. Life expectancy of CEO at company much reduced when shareowners are ignored. The closer the SEC gets to proxy access, the more stock goes down, so most shareowners don’t view it as a plus.  The SEC’s own questions in the rulemaking pointed to the error of their ways. Questions were more concerned with the ease of getting a nominee on the proxy, rather than the need for change at companies. The most obvious thing to do to create more defensible benchmarks in regulations is ask shareowners what they want. The SEC could have then weighed responses based on the size of a respondent’s holdings. A scientifically designed sample would have provided a better starting point and a much more defensible rule.

During the Q&A, I briefly raised some objections to the methodology and conclusions of the event study, “The Regulation of Corporate Governance” by Prof. David Larcker.  Although the change in Delaware code to facilitate proxy access, through opt-in, may have been a preemptive strike aimed at weakening the need for the SEC’s rule, I didn’t think it should be seen as an event that would reduce the likelihood of a-11. (Sidebar: I take a very skeptical view of event studies, based on price fluctuations around introducing a bill or initiating a rulemaking because so many of these initiatives fail… maybe I should take a more careful look at the study but even if proxy access is associated with lower stock values in the short-term, that wouldn’t convince me that access wouldn’t be positive in the long run. As a rule is introduced, shareowners are concerned with uncertainty and additional expenses of more contests. Once a rule is in place, it is unlikely to be used with much frequency but the tool yields dividends to shareowners because it has a deterrent effect.)

The real point I tried to raise was the idea that since the business community was so concerned with being forced into expensive proxy contests if proxy access goes through, they should advocate amending the rule limit or eliminate active proxy solicitation. Limits on campaign spending would also be good for shareowners, since expenditures largely come out of corporate treasuries, reducing the money available for dividends or expanding the business. There didn’t seem to be a any takers. Both Currie and Parades seemed to favor reimbursing challengers for their solicitation expenses when they achieve some minimum threshold of the vote.

I also expressed my objection to one of the ideas offered up in the background paper prepared with the Forum. (see Stanford Rock Center Proxy Access Reform Paper)

Corporations, corporate law firms, and publicly traded companies have generally maintained that each nominating shareholder or shareholder group should only have one nominee, as opposed to the SEC’s proposal to permit a qualifying shareholder to have multiple director nominees. Accordingly, the final Rule 14a-11 could have a single nominee per shareholder requirement.

I said that even though I thought I had been following the discussions on proxy access, I hadn’t heard much discussion of this possibility and thought it didn’t make sense, since one investor or group would be more capable to recommending nominees that fit, both with the remaining board and with each other, with regard to skills and experience. Currie clarified that the idea wasn’t necessarily one that would be taken up in Commission amendments but they included it simply because it was contained in a large number of comments.

Another great event, attended mostly by Stanford students who didn’t add much to the dialogue. Maybe Stanford students will take these forums less for granted in the future and will come better prepared with questions based on a more thorough reading of the related materials. I can’t help thinking the event would have packed the house at Harvard, with students coming from all over the Boston area.

When I studied at Boston College, we sometimes had more students at Harvard sponsored events than Harvard did. I suppose our interloping was helped along by something like a precursor to the Boston Consortium. The fact that we could take classes at any member university probably helped.  Students from all over the Bay Area should be taking advantage of future events at the Arthur and Toni Rembe Rock Center for Corporate Governance. And other than the panelists, where were the Bay Area investors, directors and CEOs? At least at last night’s event there were a smattering (from Intel and ICGN; both contributed to the dialogue). Hopefully, more will attend over time.

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Rock Center Proxy Access Forum

The Rock Center for Corporate Governance at Stanford University is hosting a panel discussion on May 6th with SEC Commissioner Troy A. Paredes and relevant constituencies to discuss the SEC’s proxy access proposal and how it will play out.

A summary of the SEC proposal, highlighting the principal controversies raised by various commentators and interest groups, and prepared by a group of Stanford Law School students in conjunction with Davis Polk & Wardwell LLP, is available, along with the SEC proposal here.

Professor Joseph A. Grundfest will moderate the discussion. Speakers include:

  • The Hon. Troy A. Paredes, Commisioner of the U.S. Securities and Exchange Commission
  • Francis S. Currie, Partner, Davis Polk & Wardwell LLP
  • Abe M. Friedman, Global Head of Corporate Governance and Responsible Investment, BlackRock, Inc.
  • Anne Sheehan, Director of Corporate Governance, California State Teachers’ Retirement System

This event is free and open to the public; registration is requested. The background paper speculates on potential outcomes, including the following:

  • The one-way versus two-way opt-out debate has become the primary remaining ideological battle before the SEC as it considers the structure of its final rule. An alternative opt-out proposal advanced by a number of opt-in proponents is to suspend operation of the SEC’s proxy access rule for companies who agree to pay for the cost of independent director solicitations by qualifying shareholders.
  • It would not be surprising if the SEC increased some ownership thresholds in its final rule.
  • The SEC may well adopt a two-year holding period in its final rule.
  • It is expected the SEC may require or permit related disclosure requirements so that shareholders are presented more complete information.
  • We expect the “first-to-file” aspect of the proposal to change to some variation of a “largest shareholder” rule.
  • The final Rule 14a-11 could have a single nominee per shareholder requirement.
  • We expect that the SEC may adopt suggested modifications to bar shareholders from making nominations for a period of 1 to 3 years if their candidates fail to 10% to 30% of the vote in order to prevent them from repeatedly forcing the company “into an expensive contested election or governance proposal, even if the vast majority of other shareholders opposed such actions.”

I certainly hope the SEC doesn’t yield to an opt out provision. The ownership levels proposed are already onerous, especially at small companies where institutional investors are scarce and entrenched boards are not uncommon. I expect a two-year holding period and for the SEC to move from first to file to something like the “lead plaintiff” provisions of the Private Securities Litigation Act of 1995, which favors large shareowners. Regarding the need to require additional disclosures, that tactic was used previously… to require more information for a short slate than for an actual contest. Any additional requirements should be minimal.

I don’t recall previously seeing the argument that shareowners be limited to a single nominee. No logic is provided for this recommendation, other than “Corporations, corporate law firms, and publicly traded companies have generally maintained that each nominating shareholder or shareholder group should only have one nominee.” That certainly isn’t compelling to me and I don’t expect Commissioners to find it so either. Allowing a single shareowner or group to nominate more than one director is more likely to result in a board with balanced talent, because qualifications can be better weighed in context.

Regarding the need to set voting thresholds and/or to bar resubmissions because of a fear of wasting corporate assets on expensive elections, a better solution would be to severely limit the amount that both sides can spend on such contests. Decades ago Lewis Gilbert recommended limiting the amount a company and insurgents can spend on a proxy fight, based on size of the company and number of shareowners, so as to not drain corporate treasuries. Nothing “forces” management to make these short slate contests, which don’t change control of boards, into “expensive contested elections.” Since the money they spend to entrench themselves comes out of the corporate treasury and potentially reduces shareowner value, both shareowner sponsors and the companies facing such “contests” should be barred from hiring solicitors to create expensive contests. Let shareowners decide based on the information contained in the proxy and on respective websites. Your thoughts?

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Parallel Universes Undercuts its Own Arguments

In his article The Parallel Universes of Institutional Investing and Institutional Voting, Charles M. Nathan appears to pine for the days when institutional investors took the “Wall Street Walk” if they disagreed with management on governance issues. T. Boone Pickens Jr’s response to that perspective:

That’s like the gardener telling the estate owner, “If you don’t like the way I take care of your property, sell it and move out.” That’s not the way the real world works.

Nathan’s major point is that institutional voting, for the most part, is no longer done by money managers, and is, instead, often handled by a separate internal voting function or is essentially outsourced to third-party proxy advisory firms. Because of the economies of scale, most resort to largely one-size-fits-all voting policies based on perceived corporate governance best practices, without reference to the particulars of each company’s situation. Therefore, firms should develop parallel systems to communicate with the two very different constituencies.

On the other hand, he also advises corporate governance specialists on the investor side to move to a more nuanced approach, recognizing the legitimate need for variation in corporate governance specifics in the context of more than 10,000 public companies in the US that exist in different sectors and different stages of development. That’s constructive advice. Unfortunately, Nathan also includes some very bad advice, such as the following:

The corporate governance community should recognize that it does not need and should not want to talk to the operating and financial management of a company because the voting decision makers are, by design, not involved with measuring the company’s operating and financial performance.

That advice is absurd. Many in the “parallel universe” of corporate governance are actually housed within the investment framework of their organizations. This is certainly true of CalSTRS and CalPERS. The CalPERS Corporate Governance team executes an annual process that identifies approximately 15 to 20 companies in the domestic internal equity portfolio that exhibit poor economic performance and corporate governance.

Nathan grasps the drive by shareowners to move the board from a “trustee model of a effectively self-perpetuating board” to “an assembly of annually elected representatives who are directly accountable to their electorate.” Yet, he believes “proxy access doesn’t involve investment decision makers but rather is the province of voting decision makers.”

While it may be helpful to recognize these functions governance and investment functions are often somewhat specialized, there certainly is frequent communication between the two functions on the investment side. Proxy access isn’t just “good governance.” For many, like myself, proxy access is one more mechanism to correct the “self-perpetuating board” that Nathan mentions. Many object to the ever increasing share of profits doled out to executives, up from 5% to 10% of the total.  Directors that are directly accountable to shareowners may work harder for investors than the CEO. That would be a plus.

Nathan cries that any attempt at accommodation to the demands of the corporate governance community becomes “merely a prelude to another round of demands.” Yet, he must recognize how far we are from that goal of “directly accountable” directors. Even if the SEC’s proxy access rule is finalized, it only facilitates direct accountability for 25% of the directors at companies; the other 75% can remain “self-perpetuating.”

He also loses credibility with retail investors when, in a footnote, he describes the “groundswell” to develop “client directed voting” as one that would allow a default voting pattern of “for or against management’s recommendations or to vote in proportion to all other shareowners.” Any client directed voting that doesn’t include allowing investors to build their own systems of default, based on the votes of institutional investors announced on sites like ProxyDemocracy.org or by advocates on sites like MoxyVote.com, should be flatly rejected.

Although the thrust of the article is to encourage companies to constructively engage in dialogue with what Nathan sees as separate corporate governance constituency, he frequently undermines his own arguments. That’s too bad because flexibility and dialogue are certainly needed on both sides.

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Senate Banking Gets Message From Investors

Members of the U.S. Senate Committee on Banking, Housing, and Urban Affairs were sent a AFRtoSenateLetterJan20-2010 from signatories representing a broad coalition of investors and market participants (including the publisher of CorpGov.net) urging them to require proxy access and majority votes for director elections.

We believe Congress should adopt director election reforms in two ways: (i) shareholders should have the ability to nominate directors through inclusion of their nominees in the company ballot and proxy materials and (ii) directors should not be elected unless they receive majority support from shareholders who cast their votes.  These are fundamental rights that should be available to shareholders in the US.

Signatories included academics, religious groups, CSR/SRI funds, investment advisors, consumer protection, unions, foundations, and the Council of Institutional Investors (CII). Several who signed are also members of the SEC’s relatively new Investor Advisory Committee, in fact, fully half the members of that Committee signed.

In a separate letter to the SEC, dated January 14th, CII stated:

When the fog of various myths about proxy access and “private ordering” is dispelled, it becomes clear that only a uniform, federal proxy access rule can truly remedy the deeply flawed director election process and empower investors to hold boards accountable. As the SEC reviews this second round of public comments, we urge the Commission to reject the following myths about its proposed proxy access rule.

Their letter goes on to address the myths that changes to state law makes a federal proxy access rule unnecessary, that proxy access will subsidize investors leading to excessive nominations or election of “special interest” directors and that shareowner opt-out is an “investor choice” approach to proxy access. Each myth is dispelled with excellent arguments. I urge readers to read the letter directly, posted here: CII1-14-10ProxyAccessCommentLetter.

See also their November 18, 209 letter to U.S. Senate Committee on Banking, Housing, and Urban Affairs:

Majority Voting for Directors. At most U.S. public companies, directors are elected by a plurality of votes cast, rather than by a majority. Since nearly all director elections are uncontested, plurality voting results in “rubber stamp” elections and directors who are accordingly less accountable to shareowners. As mandated by the discussion draft, majority voting in uncontested elections ensures that shareowners’ votes count and makes directors more accountable to the company’s owners.

In an email to me yesterday, Anne Simpson, Senior Portfolio Manager for Corporate Governance at CalPERS, noted:

We think it is vital that proxy access get passed without an opt out provision, which is being floated as a compromise… a dangerous precedent. Imagine if companies could opt out of producing financial statements? Or pay disclosure? If directors cannot be removed, and they cannot be replaced, then we have a rotten core… system.

She goes on to emphasize the importance of the SEC being “kept on track.”   More comments from the people whose savings are at stake “would surely be good.” She then includes a copy of their letter of January 19th offering comments on the reports and data sources cited in the SEC’s latest consultation concerning proxy access.

Again, like the CII letter addressing myths, this is one that should be read by everyone concerned with proxy access, since it addresses arguments put forth by the Business Roundtable. Obviously, many of their CEO members would rather continue hand-picking their boards.

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Proxy Access: The Letters Are In

The deadline was August 17th, so the comment letters on proxy access have all been filed and posted. Many are well worth reading. If you don’t see yours posted, you might want to resubmit it.

TIAA-CREF, one of the more conservative shareowner activists, calls on the Commission to raise the threshold to 5% for shareowners at all companies, regardless of size. Additionally, they want to require a two year holding period and recommend instead of the “first in” approach, nominations should go to the largest owner or and (here they get creative) to the shareowner or group that has held their shares the longest. They voiced opposition to reimbursement: “Reimbursement of expenses could be used to facilitate the election of special interest directors. Reimbursement also encourages fighting and proxy contests to achieve representation at the distraction of directors rather than dialogue and productive change.” Instead, they favored “incentives for a meeting between shareholders and the board in order to identify director candidates who are acceptable to both parties… Ultimately, the best possible outcome is to avoid a proxy contest altogether… We believe that the nominee should receive at least 20% of the vote in order to be re-nominated in subsequent years.”

Cornish Hitchcock, writing on behalf of the LongView Funds warns against a state-law carve-out, praising the merits of a uniform system. Like TIAA-CREF, the LongView Funds would like to see the required holding period extended to two years and nominations going to the largest nominator.

J. Robert Brown, of theRacetotheBottom.org, offers a spirited rebuttal to comments by the Delaware Bar Association regarding their argument in favor of private ordering. “The evidence in fact suggests that in the absence of a federal requirement, companies will opt for a categorical rule denying access.” “Evidence suggests that management’s control over the drafting process and its ability to rely on the corporate treasury eliminate any real prospect of private ordering. Instead, when matters are made discretionary, they result in a categorical rule that favors management.” “The only way to ensure meaningful access to the proxy statement is to adopt a federal rule that institutes the requirement.”

Lucian Bebchuk’s letter, signed by 80 professors, favors the rulemaking and notes, “no matter how moderate eligibility or procedural requirements may be, shareholder nominees must still meet the demanding test of getting elected before they can join the board. A shareholder nominee will join the board only if the nominee obtains more votes than the incumbents’ candidate in an election in which incumbents, but not the shareholder nominee or the nominator, may spend significant amounts of the company’s resources on campaign expenses.”

As expected, the Shareholder Communications Coalition, comprised of the Business Roundtable, the National Association of Corporate Directors, the National Investor Relations Institute, the Securities Transfer Association, and the Society of Corporate Secretaries & Governance Professionals sent a letter opposing the rulemaking “until the Commission: (1) completes its intended examination of the proxy system; and (2) promulgates new regulations to modernize and reform this cumbersome and expensive system.” “A shareholder nomination process that operates in a proxy voting system that cannot produce an accurate and verifiable vote count will do little to improve the overall
corporate governance system.” I just can’t help making a snarky comment. So we should just go with the current system that elects incumbents based on inaccurate and unverifiable voting results until we can ensure the system works properly

Broadridge submitted a letter discussing various technical issues. Great for those who want to get into the weeds.

Writing on behalf of Sodali, a global corporate governance consultancy, John Wilcox asks: “Is Rule 14a-11 is sufficiently deferential to the traditional role of the states in regulating corporate governance?; and (2) Does the proposal achieve the Commission’s goal of removing burdens that the federal proxy process currently places on the ability of shareholders to exercise their basic rights to nominate and elect directors?” His analysis answers with a resounding yes.

Eleanor Bloxham, of the Value Alliance and Corporate Governance Alliance notes that “having an orderly, ongoing process for shareholder to nominate directors may produce improvements in shareholder returns. Certainty, competition in the process for board seats could, I believe, produce better candidates.” She addresses the issue of affiliation and loyalty, Bloxham recommends each candidate be required to prepare a statement as part of the proxy process that would stipulate that the candidate understands that as a director, if chosen, their  obligations are to act in the best interests of all shareholders, including minority shareholders, and to act without preferential treatment related to who may have nominated them.”

As I have previously mentioned, I signed on to a letter from the United States Proxy Exchange (USPX), endorsed by members of the Investor Suffrage Movement, Robert Monks, John Harrington and John Chevedden. Glyn Holton did a great job of putting together sixty-nine pages of comments. I urge everyone to read our common sense approach outlining the democratic option, the need for deliberation and the reasons for our recommendations, which include:

  • Mandating a federal standard that take precedence over state laws.
  • Placing all bona fide candidates on a single management distributed proxy card.
  • Not encouraging a system where corporations are willing to
    reimburse expenses shareowners incur in conducting a proxy contest, since this will only escalate costs paid by shareowners.
  • Don’t place an overt limit the number of candidates shareowners are able to nominate. If limits are need to keep the pool manageable:
    • limit individuals to five for-profit corporate boards
    • charge a modest fee
    • require a system of endorsements
    • require all candidates to file pre and post election estimates and accounting of all campaign expenditures
  • Reduce the focus on control by establishing a system that will encourage diversity. “Corporate democracy will allow shareowners to take ‘control’ away from an entrenched board and not give it to any one faction.”
  • Eliminate the arbitrary and elitist proposed thresholds, opting instead for the time-tested $2,000 of stock held for a year. “The challenge should reside in winning the election, not in making the nomination.”
  • Increase candidate statements to 750 words and specified space for graphics that can address any issue related to the election, including short-comings of the current board.
  • Measures to ensure board members nominated by shareowners are not marginalized.
  • Implementation of a broad safe harbor for individual director
    communications with shareowners.

After we had already sent the USPX comment letter, I recalled a few additional issues and sent in my own letter as an addendum, recommending the following:

  • Amendments to Rule 14a-8 also clarify that shareowner resolutions can seek to collectively hire a proxy advisor, paid by for with company funds, that isn’t precluded from offering advice on board elections.
  • Require that companies must allow shareowner resolutions to be presented during the business portion of the annual meeting.
  • An override mechanism on Rule 14a-8(i)(5) (Relevance) and (i)(7) (Management Functions).

Dozens of studies in communications and organizational behavior find current corporate structures to be inefficient. Most decision-making structures, including those now governing corporations, are designed around status needs related to dominance and control over others. They are not designed to maximize the creation of wealth for shareowners or for society at large. In order to gain higher status, individuals seek to dominate more and more people. This dynamic moves the locus of control inappropriately upward. In order to generate more wealth, we need to take advantage of all the brains in our companies, as well those of concerned shareowners. We can do so by making corporations more democratic, top to bottom.

Now, we eagerly await the Commission’s action. If they are slow in finalizing the proposed rules, I hope it is because they carefully read our letters and are rewording them to require more, not less, democracy.

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A Primer for Boards

Cornelis A. de Kluyver, an academic and practitioner with global experience, has written A Primer on Corporate Governance published by Business Expert Press. While not nearly as extensive as recent textbooks by Bob Tricker or Monks and Minow, this is a quick read that provides most of the basics for future directors and those who work with them.

He very briefly reviews the history of corporations, rise of fiduciary capitalism, recent moves to federalize corporate governance, various conflicts of interest, and provides a thumbnail international sketch. However, his short explanations sometimes over simplify. For example, in reviewing director duties he states, "the primacy of shareholder value maximization wa affirmed in a ruling by the Michigan State Supreme Court in Dodge vs. Ford Motor Company.

Unfortunately, he’s not alone in perpetuating this myth. In Why We Should Stop Teaching Dodge v. Ford (pdf, Virginia Law & Business Review, spring 2008), Lynn Stout argues more convincingly that credit for the concept that corporations exist only to make money for shareholders should go to law professors, not the courts. Dodge v. Ford is best viewed as a case that deals not with directors’ duties to maximize shareholder wealth, but with enforcing the fiduciary duty of controlling shareholders to minority shareholders. Because different shareowners have different investment time frames, tax concerns, attitudes toward risk, etc. it is impossible to discern a single, uniform measure of shareholder wealth to be maximized. Additionally:

  • Articles of incorporation typically don’t say they are organized primarily to profit shareholders but, instead, for anything lawful.
  • Similarly, state corporation codes typically provide their purpose is "to conduct or promote any lawful business or purpose" and many authorize corporate boards to consider other stakeholders.
  • Judges routinely refuse to impose any legal obligation on directors to maximize shareowner wealth.

De Kluyver does explore stakeholder theory but concludes shareholder value maximization "will continue to dominate the U.S. approach to corporate law for the foreseeable future," with the courts giving boards increasing latitude.

Elsewhere, he discusses governance reforms and concludes, "There is real danger, however, that the rise in shareholder activism, the new regulatory environment, and related social factors are pushing boards towards micromanagement and meddling." Many of us wish there had been a lot more "meddling" by boards prior to the current financial crisis, but de Kluyver is writing for board members, not shareowners.

Although he appears to reject recent moves to require specific subsets of directors to be independent, he appears to agree they should be more allied with shareowners than with management and that separating the roles of chairman and CEO "gives boards a structural basis for acting independently."

In discussing stock options, de Kluyver notes, "Until recently, many U.S. companies were not very diligent in assessing the cost and value of options and treated options as being cost-free." He says nothing about the Business Roundtable’s campaign to undermine the Financial Accounting Standards Board. An uninformed reader could be left with the impression that CEO’s had no role in this effort to hide costs. Likewise, he says "most of the pressure on boards on the last 25 years has come from shareholders." Hasn’t more pressure come from CEOs who are there providing direction at every board meeting? Even with recent steps empowering shareowners, CEOs still hold more sway over boards, including who is nominated.

In discussing shareowner proposals, de Kluyver says, "One of the most popular shareholder proposals today demands that shareholder be allowed to directly nominate and elected directors rather than work with the slate recommended by the board’s nominating committee." Popular in what sense?

The SEC allowed such proposals for many years until it looked like the proposals would obtain majority votes. Then the SEC, without changing the governing regulations, decided such resolutions violated the rules. That position stood for many years until challenged by AFSCME. When the underground regulations were overturned by the court only about three such proposals were introduced before the SEC, under Cox, banned them through new regulations. Now, under Schapiro, such proposals will again be legal, probably in 2010. To describe "proxy access" proposals in 2009 to be "the most popular shareholder proposals today," without much explanation, seems misleading.

In the book’s epilogue de Kluyver revisits the issue of "proxy access." However, rather than clarifying the issue he informs readers that the SEC considered proposed rules to allow it, but rejected them. Of course this is true, but de Kluyver gives the impression the issue is dead, whereas everyone following this issue has known for years that "proxy access" would be back on the table under a new administration. It would be important to note that majority voting requirements, the end to "broker voting" and proxy access will require boards to cooperate more closely with shareowners.

The book is at its best in borrowing liberally from thought leaders and consensus shaping organizations by providing various lists of best practices: Succession Planning is an Ongoing Process; CEO Selection: Common Board Mistakes; Succession Planning: Best Practices; Red Flags in Management Culture, Strategies, and Practices; 10 Questions About Ethics and Compliance for the Board; Five Questions About Hedging; Enterprise Risk Management: The Board’s New Tool; Executive Compensation: Best Practices, What Defines Best In-Class Boards?,; etc.

Regardless of my nitpicking, de Kluyver gets the big picture right. "The tug of war between individual freedom and institutional power is a continuing theme of history. Early on, the focus was on the church; more recently, it was on the civil state. Today, the debate is about making corporate power compatible with the needs of a democratic society." De Kluyver offers readers information that can help them to become better directors and better corporate citizens.

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Proxy Access

Les Greenberg and I petitioned the SEC for proxy access back in 2002, so we both have a longstanding interest in seeing a proposal move forward. The Council of Institutional Investors said our proposal “re-energized” the “debate over shareholder access to management proxy cards to nominate directors.” (See Equal Access – What Is It?) Of course, AFSCME deserves most of the credit and nothing moved the issue like AFSCME vs AIG. The SEC’s latest attempt, File No. S7-10-09 Facilitating Shareholder Director Nominations, is by far the Commission’s best effort. I’m attempting to formulate myown comments and would welcome your thoughts. (send to [email protected])

On June 11th Greenberg, on behalf of the Committee of Concerned Shareholders, was among the first to submit extensive comments in this round. He argues mutual funds are too conflicted to run dissident director candidates, whereas large pension funds already have the resources but have stayed on the sidelines. The SEC’s proposed percentage ownership requirement are “arbitrary,” without legal basis or precedent. The thresholds will be nearly impossible to meet except “in extremely rare circumstances”… like when a company is in near bankruptcy (my interpretation). Don’t limit the number of shareowner nominees to 25% and stick with the time-tested threshold of $2,000.

Where this would result in more than two candidates per seat, borrow the “lead plaintiff” concept from the Private Securities Litigation Act of 1995 and include a “lead nominator” provision, something we suggested in amendments to our original submission.

With a ‘lead nominator’ provision, there is absolutely no need for a
percentage stock ownership threshold. The ‘lead nominator’ solution would allow Individual Shareholders to act as watchdogs of their investments at 9,000+ corporations that have publicly traded securities. Institutional Investors do not have the interest, desire and/or resources to seek Director accountability on such a scale.

I would love to see the SEC move in this direction. As far as I’m concerned, let’s have contests at every company. Retail investors might then begin to think of themselves as shareOwners, not betting slip holders. They might even begin to vote!

No government agency can match the vigilance of millions of shareowners. We have the incentive; just give us the tools. In most cases, the only extra expenditure for companies would be for slightly expanding the proxy. Mildly dissatisfied shareowners, aren’t likely to be swayed by the arguments of dissidents… unless they are spot on. If they aren’t spot on, the company will just call them nuts and won’t bother with a campaign.

The long-term result would be that many more shareowners like Les Greenberg at Lubys and Eric Jackson at Yahoo would emerge with thoughtful analysis that could benefit all shareowners. Maybe organizations like the American Association of Individual Investors would then focus just a little on how to add value as owners, instead of exclusively on how to pick and trade stocks.

Phillip Goldstein, representing Opportunity Partners L.P., goes even further in raising fundamental issues in his July 16th comments.

Consider two stockholders who are substantially identical in every respect except (1) Stockholder A did not acquire his shares for the purpose of changing or influencing the control of the issuer but has now become convinced that change is needed in the boardroom while (2) Stockholder B, who was arguably more prescient, bought her shares with the intention of eventually proposing just such a change.

Of course, both have a legal right at the meeting to nominate directors but almost all votes are cast through proxies. While page 9 of the rulemaking says “The proxy rules seek to improve the corporate proxy process so that it functions, as nearly as possible, as a replacement for an actual in-person meeting of shareholders,” but the proposed rules disenfranchise Stockholder B, presumably the brighter of the two.

Goldstein argues, “Consequently, the Commission should junk its quixotic attempts to create a Rube Goldberg-like mechanism to balance the interests of various special interest constituencies that are less than committed to truly free corporate elections.” Instead, “The Commission can craft a simple
common sense rule to require that any proxy card that that excludes the name of any bona fide nominee known to the soliciting party is materially misleading and hence a violation of rule 14a-9(a).”

Goldstein’s proposal is straightforward and within the SEC’s current legal authority, whereas the SEC’s proposal may be neither.

I know of no state that requires a holding period or a minimum
investment before a stockholder can propose a nominee. Why then should the Commission discriminate between long and short-term stockholders or between large and small stockholders? More importantly, there is no legal basis to do so…

The Commission should have banned “one party” proxy cards years ago. It is obvious that such a proxy card frustrates the free exercise of voting rights because it results in the “election” of
directors who might not have otherwise been elected if a proxy card with all bona fide nominees was provided to shareholders.

A better model than the proposed “Rube Goldberg-like mechanism to balance the interests of various special interest constituencies that are less than committed to truly free corporate elections,” which includes directors and management, would be to craft a rule more akin to those governing union elections requiring:

Every labor organization refrain from discrimination in favor of or against any candidate with respect to the use of lists of members, and whenever such labor organizations or its officers authorize the distribution by mail or otherwise to members of campaign literature on behalf of any candidate or of the labor organization itself with reference to such election, similar distribution at the
request of any other bona fide candidate shall be made by such labor organization and its officers, with equal treatment as to the expense of such distribution.

Goldstein concludes:

A rule requiring every proxy card to include all known bona fide nominees as well as rules modeled after Section 481 of The Labor-Management Reporting and Disclosure Act of 1959 would ensure “the free exercise of the voting rights of stockholders” and would almost certainly be upheld by a court as a valid exercise of the Commission’s rulemaking authority.

Both Greenberg and Goldstein get to the real issues. I’m afraid too many will be distracted by the hundreds of questions raised by the SEC, the labyrinth of language only an SEC attorney could love, and the need to arrive at a consensus document that all with a vested interest in the status quo can at least live with.

So far, the best start of an analysis I’ve seen in this direction is posted in bits by J. Brown at theRacetotheBottom.org. Brown goes as eagerly into the weeds as a Labrador Retriever. For example, he says language in proposed Form 14N-1, which requires the person signing to certify their shares aren’t held for the purpose of changing changing control,

is unnecessary and likely to provide grist for the litigation mill. Boards may decline to include nominees if they can develop an argument that submitting shareholder has a control purpose. The fact that the director was submitted at all is evidence of some desire to influence control. Anyone with a history of sometimes trying to get control will be an easy target. Moreover, the Commission is not limiting its analysis to the current motivation of shareholders. Instead, they must represent that when they were acquired (one year ago, five years ago), there was no intent to effect a change of control or acquire more than a ‘limited number’ of seats…

To the extent that the agency wants to reduce the use of Proposed Rule 14a-11 for any attempted change in control, it would be enough to provide that nominees may only be submitted by those shareholders who meet the ownership requirements and who are not otherwise engaged in a proxy contest (or in league with anyone who was) under Rule 14a-11. In that way, the issue wouldn’t turn on control but on the number of directors nominated in any given election.

Brown also goes into an interesting analysis of the SEC’s attempt to address exclusion of shareowner nominees through board adopted qualification requirements.

To the extent that a company uses qualifications to exclude a nominee from the proxy statement, it will be in violation of the proxy rules and risk a federal law suit. If the nominee is allowed, the company may nonetheless refuse to seat anyone elected if they violated the board imposed qualification requirements. This in turn may precipitate a law suit in state court over the validity of the qualification requirement.

In another post, Brown criticizes the rush to the courthouse approach, endorsing instead the SEC’s 2003 proposal in this area giving priority to nominees from the largest shareholders. He also express concerns about the proposed threshold, especially with respect to smaller companies.

While the release notes that many companies below $75 million have 5% shareholders, it is also likely the case that these companies more often have controlling shareholders. Thus, the 5% shareholders may already have control of the board. In those circumstances, there may be even greater need to enable minority shareholders to elect their own nominees. This may require a lowering of the percentage.

I look forward to much more from J. Brown. If anyone else is posting comments on the proxy access proposals or is willing to share preliminary thoughts, please let me know. (send to [email protected]) Comments to the SEC are due August 17, 2009. Voice your opinion by sending an e-mail to [email protected]. Be sure to include “File S7-10-09” in the subject line.

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