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Weekly UpdatesTHE SEVERITY and rapidly developing nature of last fall's financial crisis seemingly overwhelmed any serious focus on corporate governance as more immediate issues took center stage. In the spring of 2009, with the securities and credit markets seeming to reaching a new--albeit relative--calm, the emphasis was quickly turning, and a renewed focus on corporate governance and proxy voting is emerging. The new administration, new Congress, and new SEC chairman, buoyed by investor anger and a growing demand for change, are poised to bring in a new era of corporate governance and proxy voting reform.
The SEC's full agenda
Within a month of Chairman Mary Schapiro's swearing-in, the SEC began acting on a controversial New York Stock Exchange proposal that had been pending since 2006. Currently, in the absence of specific instructions from their investor clients, brokers can exercise their own discretion in voting for the election of directors. The New York Stock Exchange proposed to eliminate broker discretionary voting for director elections.
Many arguing against the proposal raise the concern that the new rule would make it considerably more difficult for companies to achieve a quorum at annual meetings. These commenters also argue that the Commission needs to conduct a comprehensive reexamination of the entire proxy voting process, not just uninstructed broker voting in isolation. Those in favor of the proposal generally argue that eliminating the broker vote enhances the integrity of proxy voting by, for example, ensuring that the election of directors is determined directly by those holding the economic interest in the company. On July 1, 2009, the SEC approved the proposal, which becomes effective January 1, 2010.
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At a meeting on May 20, 2009, the SEC voted three to two to propose a new rule and rule amendments that, if approved, would provide large shareholders of reporting companies, including investment companies, access to the corporate proxy for the election of directors. A shareholder or shareholder group with the required ownership interest in the company would be entitled to nominate the greater of 25% of the company's board or one nominee. For large accelerated filers, the shareholder or shareholder group would need to own at least 1% of the company's stock; for smaller accelerated filers, the ownership would need to be at least 3%; and for non-accelerated filers, the ownership would need to be at least 5%. The proposal includes a number of other provisions, including that shareholders must have held their shares for at least one year and that the shareholders certify that they are not seeking to change control of the company. The proposal would also impose greater disclosure requirements with regard to the proponent and the nominee(s).
In an April 6,2009, speech before the annual meeting of the Council of Institutional Investors and in a statement issued on June 10, 2009, Chairman Schapiro outlined an aggressive agenda, focused principally on greater disclosure around corporate governance. Several of the initiatives were proposed by the SEC on July 1, including enhancing disclosure concerning the experience, qualifications, and skills of director nominees, and requiring boards to disclose the rationale behind their particular leadership structure--whether that structure includes an independent chair, a non-independent chair, or a combined CEO/chair.
At its July I meeting, the SEC also proposed revisions to aspects of the controversial 2006 Compensation Discussion and Analysis rule. In light of last year's market turmoil and concern that compensation structures promoted excessive and irresponsible risk-taking, Chairman Schapiro has questioned whether the disclosure was achieving the objective of providing shareholders with the most relevant information.
The SEC's increasing focus in this area is not limited to rulemaking. On May 8, 2009, the SEC charged an investment advisor with violating its proxy rules for not sufficiently describing its voting policies and procedures and not disclosing a material conflict of interest. The SEC settled an administrative procedure with INTECH Investment Management LLC and its former chief operating officer after INTECH agreed to pay a penalty of $300,000 and its COO agreed to pay $50,000.
The SEC found that, after receiving complaints about its proxy votes from some of its union-affiliated clients about its pro-management proxy votes, INTECH selected a third party to vote all of its client proxies in accordance with the voting recommendations of the AFL-CIO. At the same time, it was participating in the annual AFL-CIO Key Votes Survey that ranked investment advisers based on their adherence to the AFL-CIO recommendations on certain votes. The SEC found that INTECH's policies and procedures did not include how the firm would address material potential conflicts of interests and did not sufficiently describe its voting policies and procedures to clients.
Capitol Hill's approach
There is also a great deal of activity on Capitol Hill. Much of it had been occurring behind the scenes, but on May 19, 2009, that changed when Senator Charles Schumer (D-NY) introduced the Shareholder Bill of Rights Act of 2009. Though consistent and even overlapping with many of the SEC's initiatives, it is more prescriptive in several areas. For example, rather than taking an enhanced disclosure approach as it appears the SEC will be doing with regard to the leadership structure of boards, Sen. Schumer's legislation would require separation of the chairman and chief executive officer.
The Shareholder Bill of Rights, if adopted, would also require an advisory vote on executive compensation, that all boards be declassified and adopt majority voting, and that boards create a separate risk committee. Another important provision of Sen. Schumer's bill is that it would provide that the SEC has the authority to grant shareholders access to the corporate proxy for purpose of nominating directors. This is considered important by many because serious questions remain regarding the SEC's authority in this area.
In the House of Representatives, Michigan Democrat Gary Peters introduced a similar bill in June known as the Shareholder Empowerment Act of 2009.
Delaware weighs in
Important developments in 2009 concerning proxy voting and the election of directors are not limited to initiatives at the federal level--Delaware is also weighing in. Effective Aug. 1, 2009, the Delaware General Corporation Law is amended in a number of important respects. These include allowing a corporation to include in its bylaws provisions that would provide greater shareholder access to the corporate proxy and provisions to provide for reimbursement of reasonable proxy solicitation expenses incurred by a shareholder.
The 2008 and 2009 proxy seasons
For all the shareholder furor expected this proxy season over corporate bailouts, deficient board oversight, and generous pay packages, this year's crop of annual meetings may end up being mere sideshows while the main event is being conducted in Washington. The extensive governance reforms being proposed by Congress and the SEC may very well render moot many shareholder campaigns through mandates on board structure, board elections, and compensation.
One observation, however, on this year's shareholder resolutions persists from past years: based on voting outcomes (see table), shareholders themselves remain divided on a number of these measures and the need to apply them universally across all companies. This leaves open the question that, if empowered with expanded rights such as proxy access, how will they be used and by what shareholders?
The one regulatory reform largely regarded as a "done deal"--say on pay--is again the most prolific shareholder proposal, with some 100 filed, as in 2008. But while average support appears to have risen to about 46% from 41% in 2008, approval by a majority of investors remains elusive, occurring so far at only 16 companies out of approximately 66 voted on. This year's unexpected road test of say on pay at the 400 TARP recipients is also not likely to lend much insight on its utility as a board/shareholder communication vehicle. With shareholders caught unprepared to either engage companies or scrutinize hundreds of CD&As, this year's pay advisory votes may amount to little more than a rubber-stamping exercise or a dependence on proxy advisors, who themselves may reach differing conclusions on a company's pay due to variations in their compensation models.
Connecting pay and performance remains at the heart of the compensation debate. The financial crisis, however, underscored the importance of tying incentives to sustained long-term performance rather than encouraging short-term risk taking. To this end, the AFL-CIO and American Federation of State, County and Municipal Employees (AFSCME) introduced two new resolutions this year, largely at financial institutions: (1) that executives retain 75% of stock from equity awards for two years past their tenure, and (2) that annual bonuses be escrowed for three years before being paid out. Wall Street firms--now bank holding companies--have similarly come to terms with perversions in their incentive structures. In an April speech, Goldman Sachs Chairman and CEO Lloyd Blankfein recommended deferred exercise of equity awards and the retention of stock until retirement.
Extravagances, be it in office decor or corporate jets, contribute to the public outrage toward executive compensation, and this year's pay taboo--the "golden coffin"--is no exception. Cited in a 2008 Wall Street Journal article, death benefits can result in windfall payouts, and not just compensation earned over the executive's tenure but years of continued salary and bonus and other quirks, such as retention, non-compete and auto allowance payments. Many companies targeted have responded by eliminating, capping, or explaining their benefits (such as in lieu of company-funded life insurance).
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