Today at 10 a.m., Rep. Paul Kanjorski, D.-Pa., chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises, held a hearing on Corporate Governance and Shareholder Empowerment dealing with many of the same issues discussed in our coverage of a proposed Shareholder Bill of Rights. What follows is the official written testimony The Motley Fool submitted to the subcommittee. Post a comment in the comments section below to let us hear your thoughts on this issue.
Testimony From Tom Gardner, CEO of The Motley Fool Holdings, Inc., Before the U.S. House Financial Services Subcommittee on Capital Markets, Insurance, and Government- Sponsored Enterprises, April 21, 2010
Mr. Chairman and members of the Subcommittee, I want to thank you for the opportunity to offer testimony for the public record.
The Motley Fool has a long history of advocacy on behalf of the 63 million American shareholders of public companies. We are a private corporation based in Alexandria, Va., just across the Potomac River from Washington. But we note that we are not an industry or consumer advocacy group, nor are we a political action committee. In fact, we have engaged in legislative or regulatory debate only under two conditions. The first is when we have been asked to provide our expertise, including our service on the Securities and Exchange Commission's Committee to Improve Financial Regulation, or our testimony on the need for greater transparency in mutual fund fees and on the collapse of Enron.
The second is when we have believed the rights of individual investors are at stake, as we did when we publicly pushed for the passage of Regulation Fair Disclosure in 2000. Arthur Levitt, then the Chairman of the SEC, publicly credited The Motley Fool with helping ensure the passage of Regulation FD, marking one of our company's proudest moments.
The Motley Fool views poor corporate governance -- regardless of its source -- as a drag upon our collective prosperity. There is a natural, inevitable tension between the interests of company managements and their outside shareholders. Our interest lies in promoting regulatory and legal regimes that both allow and incent boards of directors to assure that company managements make decisions that optimize the benefit to their shareholders, the owners of their businesses.
We believe that shareholders will benefit most where there is a healthy balance of power between shareholders and management, overseen by the boards. At present, executives at American public corporations can all too often alter this balance of power to their benefit, and to the detriment of long-term shareholders, through their influence over the constitution of corporate boards of directors. Often, management has virtually no checks on its practical ability to appoint the board which then oversees it, which we believe falls woefully short of the ideals of checks and balances upon which our country was founded, and upon which the corporate entity relies. Aspects of this legislation [H.R. 2861] promise to restore some of that balance.
We'd like to address four prevalent corporate governance practices that we feel have failed to serve the long-term individual investor.
First, too many CEOs nominate directors whom they know will be unconditionally gracious in return for the social and monetary benefits of boardsmanship. Despite the reforms of the Sarbanes-Oxley Act of 2002, the world of corporate boards, quite frankly, remains a clubby alliance of mutual back-scratching and groupthink, rather than serving its intended goal of democratic shareholder representation.
The lack of a mandated majority voting structure in uncontested elections is largely to blame for this. Under so-called plurality systems, uncontested directors can keep their seats so long as they receive one vote.
As of late 2009, a record 93 board members failed to receive 50% of votes cast by shareholders during that fiscal year. Yet even in the face of broad shareholder opposition, not one of those 93 directors tendered his or her resignation. As Notre Dame Law School professor Julian Velasco put it, "Incumbent directors are virtually immune to the effects of a shareholder vote. In most cases, it seems misleading to claim that there is any election or right to vote at all."
And let's not forget that 93 is a very small number. Either shareholders were ecstatic with corporate leadership during the year in which boards' profound abdication of responsibility was so publicly laid bare, or the balance of power is skewed so far in management's favor that shareholders are stymied from electing their own representatives. We think the latter.
This practice of suppressing shareholders' voices must end, which is why The Motley Fool supports requiring that all uncontested directors receive majority votes to retain their board seats. In a corporate governance system riddled with flaws, this, we feel, should be priority number 1.
Second, there's never just one cockroach in the kitchen, and shareholders sometimes attempt to remove multiple board members. Yet roughly half of companies traded on major U.S. stock exchanges have erected another barrier to shareholders' reprieve -- so-called staggered boards.
When staggered boards are in place, a majority of shareholders looking to replace directors must overcome enormous institutional constraints. Removing a set of poorly performing directors may take multiple elections and several years, assuming it can be done at all. In cases of incompetent or corrupt leadership, staggered boards ingrain the status quo.
Some have hailed supposed benefits of the staggered-board system, including its ability to stave off hostile takeovers. Yet if majority votes are required in director elections, as mentioned above, we should question whether the deal is truly hostile. By far the most significant implication of staggered boards is prolonged tenures for directors of whom a majority of shareholders may disapprove. To this point, there are verified economic drawbacks of the staggered-board system. A Harvard University study found that "staggered boards are associated with a lower firm value" that is "economically meaningful."
Third, we applaud the SEC's recent ruling to allow the NYSE to end discretionary broker voting in director elections -- whereby brokers vote the proxies of their clients without written instruction. The practice has led overwhelmingly to brokers rubber-stamping management's recommendations. Because a substantial majority of shares are held by brokers on behalf of their beneficial owners, discretionary voting in many cases renders elections moot. We hope to see such a ban enacted into law in the case of director elections and, as a general principle, on other matters of importance.
Lastly, the issue of proxy access in director nominations must be addressed. When management handpicks board nominees, even through the apparent veil of an "independent" nominating committee, it muddies the intended role of corporate directors. A determined CEO can simply repeatedly renominate the same gracious director. Moreover, as Warren Buffett said at last year's Berkshire Hathaway press conference, a lot of directors love the job for the money and sociability, so they aren't going to do anything that gets them kicked off that board or not invited to another board. The average "independent" Lehman director was paid more than $360,000 in 2007 -- a sum that would ingratiate any director to those with the power to hire and fire. Without the ability to nominate their own candidates to company proxies, shareholders don't have a reasonable alternative to the CEO's personal priorities.
That's why we strongly feel that shareholders must be given a legitimate and practical chance to nominate directors.
While The Motley Fool strongly advocates on behalf of the individual investor, blanket shareholder empowerment per se is not what we're after. As the financial crisis made plain, investors often have a short-term investment horizon that can be just as damaging as an entrenched status quo. We believe that empowering long-term shareholders will lead to healthy business practices that are beneficial to all stakeholders, including employees, customers, and even the wider economy.
Therefore, investors with proven long-term time horizons and much at stake should be given priority in nominating directors. Doing so would address the reasonable concern than increased shareholder participation in corporate affairs could cause greater short-term pressures on management and boards. The proposed two-year minimum share holding period would help to ensure that alternatives to management's candidates are vetted by shareholders with the company's best long-term interest at heart.
In the end, these changes to corporate governance are about fairness and oversight. They're about whether a company's owners should be able to elect their own representatives and, by extension, the managers they are hiring to operate their companies, or whether a few senior executives should have the power to select their own supervisors, their own compensation committees, and their own rules, and run others' companies however they see fit.
I appreciate the opportunity to submit public testimony to the Subcommittee, and would be happy to answer any questions from either the Members or their staff.
Signed,
Tom Gardner, CEO, The Motley Fool Holdings, Inc.
On behalf of himself and:
William H. Mann, Motley Fool Asset Management, LLC
Ilan Moscovitz, The Motley Fool
Morgan Housel, The Motley Fool
Anand Chokkavelu, The Motley Fool
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