A Securities and Exchange Commission (SEC) proposal to allow investor nominees for boards of the directors on the proxy ballot has set off alarms in the normally somnolent realm of corporate governance. The SEC has already received a record 13,000-plus comments on its proposal. Commissioners have extended the commentary period until March 31, so you can still be heard with an email to the SEC.
Before discussing specifics of the proposal and why Foolish investors should support it, consider the election system that opponents of reform are struggling to preserve.
Incumbent board members control the nominating process. Generally, they think they do a great job so they re-nominate themselves. For vacancies, they invite their pals. The company ballot (printed and mailed at shareholder expense) offers just one candidate per available position. Although investors can accept or reject those candidates, even if 99.99% of shares withhold authority from a nominee, 0.01% affirmative means election.
Investors can nominate their own candidates but those nominees won't appear on the official company ballot. Challengers have to pay for a separate ballot and distribute it to all voters at a huge expense, in accordance with rules established by the incumbents, who are free to sue opponents, again, using shareholder money. Failure to follow those rules to the letter automatically grants all uncast votes to the company's candidates.
That system makes the old Soviet Union look democratic and dissident-friendly. Of those 13,000-plus commentators, the only ones opposing reforms are corporate beneficiaries of the current system, supported by their lawyers, lobbyists, and other paid agents.
The SEC's proposed reforms aren't fruits of glasnost, but a response to the string of corporate scandals that keep coming. At the heart of the outrages at Enron (OTC: ENRNQ), Tyco (NYSE:TYC), WorldCom cum MCI (OTC: WCOEQ), Adelphia (OTC: ADELQ), and others that vaporized billions in shareholder equity, a board of directors neglected its legally mandated fiduciary duty to protect the interests of investors.
Many directors don't take that duty seriously due to their Soviet-style selection. Examine the process for a significant role for investors. You won't find one. That means shareholders can't hold directors accountable.
Since fellow directors rather than shareholders determine who stays on the board -- collecting fat fees and stock-option grants for a few days work a year -- there's a real incentive to make nice with board colleagues, particularly the members of management directors are supposed to be supervising. That reality also undermines director independence rules recently issued by the stock exchanges; even directors that start out truly independent don't stay that way for long. Bottom line: What's a $6,000 shower curtain among pals?
If adopted, the SEC proposal would barely change this rotten system. Investors representing 5% or more of company shares would be able to place one or two director candidates on the company proxy ballot sent to all shareholders alongside management's nominees, but only one year after some "triggering event" such as a 35% withhold vote for a director or the board's failure to act on a shareholder resolution that received majority support.
The rule's conditions and limits are nonsense, but its adoption would help establish two important rights: investor access to the proxy ballot and a meaningful shareholder role in the voting. This rule would bring the proverbial camel's nose into the boardroom toward a system that gives shareholders a real voice and choice in selecting directors to oversee the corporations they own.
Corporate insiders recognize the danger, and a who's who of anti-investor interests have lined up to oppose the reform. You can see chapter and verse in the public comments to the SEC and the transcript of a March 10 SEC Roundtable on the issue. Their arguments, many recycled from the battle against Sarbanes-Oxley accounting reforms, would be amusing if the issue wasn't so important.
The argument that perhaps best illustrates the mix of half-truths, lies, and hubris investors still get from corporate insiders is the assertion that this rule would allow "special interests masquerading as shareholder interests" (in the words of U.S. Chamber Commerce head Thomas J. Donohue) a place on the board.
That's nonsense because:
- The current system already serves a single special interest exclusively -- that of incumbent directors. Insiders don't have a problem with that because they're sure they know what's best for shareholders.
- If shareholders legitimately elect a director, then that director doesn't represent a "special interest" but the owners of the company. One CEO whined that putting an investor nominee on the ballot would be like one country invading a neighbor if they disagree. It's more like a homeowner knocking on her door to ask the butler for a look around. Insiders keep forgetting they work for investors instead of the other way around. Some insiders at the SEC Roundtable even argued, "Corporations are not in business to listen shareholders."
- The SEC rule would simply allow investors to nominate a director on equal terms with management's choices; the rule wouldn't grant them an automatic seat. But corporate insiders have trouble envisioning a system where nomination is not tantamount to election (i.e., one where shareholder votes matter). Insiders contend that fair, honest elections for directors would prevent corporations from functioning. We use elections to choose our political leaders to make life and death decisions, but that system is too risky for corporations.
Whenever investors complain about company practices, insiders offer a simple solution: sell. That not only evades the question, but it's not a practical solution. First, for any number of reasons the investor may not want to sell -- from unwelcome tax consequences to having bought in order to remedy the situation prompting the complaint (such as trying to eliminate a conflict of interest in management or change the composition of the board).
Most importantly, as index investing increasingly becomes part of the landscape, shareholders don't have the luxury of choosing to invest only in companies practicing good corporate governance. They need to insist on better regulation that will force all companies to improve their practices. It takes a lot of chutzpah for Peter Wallison of the American Enterprise Institute to try to excuse bad corporate practices by telling investors, "But of course, you buy an index fund in part for the diversification. You take the good with the bad."
Alternatively, anti-reformers offer several riffs on the "we already get it" theme. Steve Odland, CEO of AutoZone (NYSE:AZO), recounts preaching the gospel of good governance since arriving at the car parts retailer three years ago, and how carefully he and his peers work to listen to shareholders. Like the overwhelming majority of his CEO peers, Odland also serves as chairman of the board at AutoZone. In other words, Chairman Odland supervises CEO Odland.
Even in this supposedly enlightened age, management's board nominees on the latest proxies I received from Oracle (NASDAQ:ORCL) or Applied Materials (NASDAQ:AMAT) included managers past and present, longtime directors who -- unlike investors -- have never risked a dime of their own money in the company, and so-called independent directors with longstanding connections to other officers. There wasn't a single one I could support in good conscience. Insiders might claim otherwise, but these problems aren't fixed (Sabranes-Oxley addresses accounting, not accountability), and it's not just a few bad apples.
Consider recent events at Disney (NYSE:DIS). The real shame isn't that 43% of shares withheld authority from Michael Eisner and embarrassed him into stepping down as chairman; it's that the board bounced Roy Disney after he voiced opposition to Eisner.
Similarly, after Walter Hewlett led the fight against Hewlett-Packard's (NYSE:HPQ) merger with Compaq and won support from just under half the shareholders (no other director had demonstrated that level of investor support), he wasn't nominated for another term.
Put simply, too many corporate insiders profess to welcome sharp-elbowed competition in the marketplace, but think board members should simply nod and agree with whatever the leaders say. Just like it was on the Politburo. Tell the SEC to tear down that wall.
Email the SEC your opinion and join the discussion about the proposal on our News & Commentary board.
Eliot Cohen is managing director of 8 1/2 Global Communications in Hong Kong, and a contributor to publications on three continents; the sun never sets on this native New Yorker's fight for investor rights. He owns shares in Applied Materials and Oracle. You can reach him via email.
