Let's Fix Director Nominations

This article is part of an ongoing series about the Shareholder Bill of Rights currently in Congress. Together, we can ensure that this bill truly represents our interests as shareholders and individual investors.

Take a quick glance at the resumes of the now-defunct Lehman Brothers board. You’ll see an impressive smattering of Ivy League graduates and senior-level executives with decades of management experience at companies such as Goldman Sachs (NYSE: GS  ) , IBM (NYSE: IBM  ) , and Halliburton (NYSE: HAL  ) .

This was not a board of stupid people. And yet they let the company over which they presided pursue a truly stupid course of business.

Second-grade arithmetic was all that was required to recognize that letting Lehman leverage 30-to-1 exposed shareholders to disaster. All it would take was a mere 3.3% dip in the value of the company’s assets to wipe out the company.

In the end, that’s exactly what happened. 

The current situation
What went wrong at Lehman? Why didn’t the board do its job?  

This group of highly educated and successful people -- the very people elected to the corporate board to provide oversight over management and ensure that the company operated with shareholders’ best interests in mind -- failed. Big time. Instead, in the words of Lehman CEO and Chairman of the Board Richard Fuld, the board was “wonderfully supportive” of him.

“The board … had served too long, was too out of touch with massive changes in the industry, had too little of their own net worth at risk and was too compromised for rigorous independent oversight,” Nell Minnow of the Corporate Library told the House committee investigating Lehman’s collapse. One Lehman board member put it more bluntly: “Our board is a joke.”

One provision of the Shareholder Bill of Rights Act would allow a shareholder or a group of shareholders to actually put competing candidates on the company ballot.

Typically, the current board is responsible for nominating new members. In practice, management often gets a strong say in who gets picked to represent shareholders on the board. While shareholders can wage proxy battles to elect their own candidates, as they have done recently with varying success at companies like Yahoo! (Nasdaq: YHOO  ) and Target (NYSE: TGT  ) , it’s a relatively rare and costly process. Many experts believe that the sometimes insular way directors are nominated presents its share of problems.

When we asked Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) CEO Warren Buffett for his thoughts on the subject, he told us that many directors love the job for the salary and sociability and are afraid to challenge management on important issues like executive compensation that might get them kicked off the board or prevent them from being invited onto other boards. There's a lot of money at stake; last year, the average compensation for an S&P 500 board member was more than $217,000.

Unless shareholders are empowered to hold directors’ feet to the fire, boardrooms will continue to be populated by people who have all the incentive in the world not to rock the boat -- even when confronted with dumb business decisions, as occurred with Lehman.

What the bill would do
That brings us back to the current proposal in front of Congress. The idea behind the bill is to make it easier for ordinary shareholders to get representation on boards of directors.

In particular, the bill calls upon the SEC to establish rules allowing any shareholder or group of shareholders that has owned 1% or more of a company's voting securities for at least the two years preceding the company's next regular annual meeting to nominate candidates for the board using the company's own proxy materials. That would make challenging a current board a lot simpler than it is now.

The pros and cons
Favoring the bill is the moral argument that the owners of a business should have the right to propose their own representatives. Also, this proposal could make boards more responsive to investor interests, possibly avoiding future situations like that of Lehman, in which directors were primarily interested in pleasing the CEO they were supposed to oversee. Lastly, a more democratic process could lead to higher-quality boards if shareholders were given a choice among candidates.

The biggest drawback is the possibility that shareholders could nominate an individual with intentions other than creating long-term value and improving the health of the business. Speculators and corporate raiders could have interests different from yours or the company's, yet under the proposed legislation, many would have the right to nominate their own candidates.

By requiring nominating shareholders to own a significant stake for at least two years, the bill does a good job of addressing these concerns. John Bogle, a prominent critic of stock market speculation, told us he supported this measure, though he would prefer to see a longer minimum holding period.

One thing that might be missing from the legislation is the requirement that nominating shareholders clearly disclose in the company proxy who they are, and any hedging or short positions they might have in the company. For example, shareholders would want to know if the group nominating a board candidate has more to gain if the company fails than if it succeeds. If shareholders could easily see this information, they could simply choose not to vote for compromised candidates.

If this legislation passes, you’ll likely have more choices of whom to elect to the board. Hopefully shareholders will step up to the plate and nominate good candidates.

Shareholders, be heard!
We want the Shareholder Bill of Rights to come from all of us. So cast your vote in the online poll below or post your comments at the bottom of this article (or any other in this series). Or send us an email at ShareholderRights@fool.com. Let’s all tell Wall Street and Washington what rights we shareholders really need.

Ilan Moscovitz owns shares of Berkshire Hathaway, which is both a Motley Fool Inside Value and Motley Fool Stock Advisor recommendation, as well as a Fool holding. The Motley Fool is investors writing for investors.


Read/Post Comments (5) | Recommend This Article (21)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 02, 2009, at 7:17 PM, dikrew wrote:

    I belong to a professional association of thousands of members. I get to vote annually for the governors of the assn. I get a folder naming them, listing their accomplishments, where they work, etc. I usually don't know any of them from Adam or Eve. How do I choose? None of their biographies says: "Just got out of jail" or "Suspected pedophile".

    I suspect letting anyone nominate directors could become a similarly difficult exercise for voters. I don't like the current system of cronyism but I can't visualize meaningful campaigns by nominees for the posts.

    It's a dilemma! I voted above for allowing shareholders to nominate board members. I guess it's a matter of choosing the lesser of evils.

  • Report this Comment On October 02, 2009, at 8:18 PM, Sail285 wrote:

    I agree with the ability of shareholders to nominate board members but I also agree that disclosure by the shareholder or group of shareholders must be required. The disclosure should be under and subject to SEC regulations and penalities. I also think that a longer holding period would be better but this provision would be hard to prove and to enforce.

  • Report this Comment On October 02, 2009, at 8:59 PM, standandcounted wrote:

    warren buffet hit it on the nose..bullzi hit ,i was at a meeting one time and asked the CFO what was being done to stop the heavy bleeding the company was doing for the past ten years ...the director laughed he tought it was funny and the CFO said thats just a fact of buisness and said that is no plan to stop the bleeding and their pay checks to take home was unreal,when i left to go home i called my broker the next day to sell...the CEO unloaded all his shares and the stock price fell like a rock and i lost big time i hope that the director lost his shirt too but i doubt it ,he may have sold as well

  • Report this Comment On October 09, 2009, at 9:06 PM, fromunder wrote:

    given that the sec complains of be under staffed currently,and unable to properly perform the duties assigned to them, adding another duty to perform might prove to be a disaster. just look at how they handle naked short selling and failure to deliver. they simply sweep it under the carpet and say ,what problem.

  • Report this Comment On October 13, 2009, at 1:54 AM, FoolishTroll wrote:

    I also belong to a professional association with thousands of members and we too vote annually for our choice of directors. There aren't any bios other than perhaps their names and positions. It is really voting in the blind, or a name you've heard somewhere. But, being responsible to vote for directors on each of my stocks, even if there were adequate information or campaigning for the positions, I can't imagine how that would ever work. Does anyone seriously have the time to devote to actually researching who should get their vote in each of these elections? And having the SEC oversee this.....that seems crazy given their recent history of failure in their current responsiblities....

    I agree the system is broken.....don't have the answer on how to fix it...don't think this is it though.

Add your comment.

DocumentId: 998960, ~/Articles/ArticleHandler.aspx, 4/16/2014 9:06:16 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement