This Corporate Reform Falls Far Short


By Louis Lavelle When shareholder activists first advanced the idea of new rules to make it easier for stock owners to run for corporate boards, the goal was simple -- the owners of publicaly traded companies might actually elect their own representatives, instead of having them chosen by management.

A call for more democracy? Yes. A vision of corporate utopia? Maybe. But what reformers got instead is a poor excuse for reform. On Oct. 8, the Securities & Exchange Commission proposed new rules that pay lip service to the notion of shareholder democracy, but little else.

As the SEC proposal is written now, the hurdles are far too onerous.

The rules would allow shareholders to place nominees on the company proxy after a so-called "triggering event" takes place. There are two: if more than 35% of shareholders withhold their vote for a sitting director, or if shareholders owning 1% of the company's voting stock for at least a year propose a resolution initiating the process to place a candidate's name in the proxy.

RARE OCCASIONS. For the next step, actually placing a candidate's name in the proxy, the bar is even higher: Shareholders owning more than a 5% stake for at least two years would need to support the nominee, who would then need to receive more than 50% of the votes cast at the annual meeting. Even then, democracy would have its limits. Shareholders could get only one nominee for a board with 8 or fewer directors, 2 for a board with 9 to 19 directors, and 3 for a board with 20 or more members.

Unions, pension funds, and corporate-governance experts see little to work with in the SEC plan. It's rare that 35% of shareholders ever withhold their vote from a director. According to the American Federation of State, County & Municipal Employees, of the 100 companies where shareholder resolutions actually got a majority of votes this year, only five saw "no" votes against directors that exceeded 35%. Even Lockheed Martin (LMT) shareholders managed to muster only 28% of the votes last year to boot controversial director Frank Savage from that board -- and he was a director at Enron when the company imploded.

Getting 1% of those holding outstanding shares to support a nominating process for shareholder board members is equally difficult. At Wal-Mart (WMT), for example, just six large shareholders have holdings exceeding 1% -- everyone else would have to team up to propose the resolution, then get half of all shareholders to vote for it. "You'd have to herd cats," says Richard Ferlauto, AFSCME's director of pension investments.

ELECTORAL BATTLEGROUND. If pulling together a 1% ownership stake sounds tough, imagine trying to organize shareholders who have owned 5% of the company for at least two years to place a nominee's name on the proxy. AFL-CIO President John J. Sweeney says such a requirement "would make it difficult for even the largest investors to [nominate candidates] and impossible to do so in a timely manner."

While Sweeney and other critics of the SEC proposal are loath to admit it, making this procees too democratic would backfire. Some restrictions are necessary -- to a point. No one wants corporate proxies to become an electoral battleground every year over the most minor of dissident issues. Companies would be paralyzed.

Then again, the hurdles to corporate democracy shouldn't be so high that they turn into roadblocks. Nobody benefits from a rule that doesn't accomplish what it sets out to do.

FIRST STEP. Here's a better idea: Shareholders should be permitted to nominate board candidates on the proxy whenever there's major financial restatement, bankruptcy, or a formal investigation into wrongdoing at the company. In short, whenever there's evidence that the board has been asleep at the switch, shareholders should have the right to take steps to protect their assets.

And why stop there? How about allowing investors to nominate candidates whenever boards repeatedly ignore shareholder resolutions that win more than 50% of the vote? That would certainly discourage sitting directors from flouting the will of the majority.

The SEC deserves credit for taking a first step toward an important reform, but it's no more than that. The agency should ignore the doomsday scenarios put forth by the business community and adopt a rule that shareholders can actually use to enhance corporate governance. Lavelle covers management for BusinessWeek in New York


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