Shareholders Unite! How an SEC Ruling Could Bring Democracy to the Boardroom

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boardroomWhile the recession represents a recent high-water mark for bad corporate leadership, questionable boardroom decisions are nothing new. For years, newspaper headlines have been filled with tales of environmental irresponsibility, skyrocketing executive paychecks, and other shortsighted moves that have infuriated investors and lowered stock value.

Unfortunately for shareholders, corporate governance laws are skewed strongly in favor of boardroom incumbents, making it all but impossible for people who own stock to influence their investments. Recently, however, the Securities and Exchange Commission passed a new "shareholder access" rule, which could have long-lasting effects on the way that America's businesses make decisions.

On the surface, the new rule seems minor: historically, ballots for corporate elections have only had to include the board-approved nominees; under the new rule, however, shareholders who have owned 3% of the shares in a company for three years or more can place their own candidates on corporate ballots. This may not sound like much of a change, but this seemingly-inconsequential rule has inspired furious yowling from the precincts of America's corporate establishment.

In an editorial, The Wall Street Journal warned that "union funds and other politically-motivated causes" could now "force mom and pop to support causes they otherwise would not." This, the editorial ominously suggested, was comparable to what Peter Drucker called "Pension-Fund Socialism." And the Journal was not alone in its attack: one critic was quick to offer strategies that corporations could use to thwart shareholders who are bent on influencing governance. Another warned that pension funds, a potential source of corporate opposition, could be controlled by politicians and other outsiders. Perhaps the most surprising rebuttal came from a pundit who argued in favor of "rational apathy," claiming that "[f]or the average shareholder, the necessary investment of time and effort in making informed voting decisions simply is not worthwhile."

Shareholder Revolt

Part of the reason that the SEC's action has inspired such vitriol is because this rule change could be the first chink in a governance system that, in many cases, is completely closed off to outside influence. Angry stock owners who seek to improve their companies generally must resort to "shareholder revolts," in which they gang together to change the policies of a company. For example, in 2006, Nelson Peltz led Heinz shareholders in a rebellion that netted them two seats on the board -- and ultimately helped improve the company's bottom line.

But most revolts don't go anywhere: in 2005, for example, more than 55% of Halliburton's shareholders, upset about the huge golden parachutes that were being given to departing executives, passed a rule that required shareholder approval for large corporate severance packages. However, despite the majority in favor of the proposal, Halliburton's (HAL) board of directors refused to enact the change.

Three years later, the Rockefeller family led a shareholder revolt at Exxon (XOM) the company that John D. Rockefeller started. Their campaign, which was aimed at increasing renewable energy investments, received a large number of shareholder votes, but was ultimately unsuccessful.

Buying an Election

One major reason that these campaigns failed is because shareholders don't really have any direct say in corporate governance. Nell Minow, editor and chairwoman of The Corporate Library, points out that under SEC laws, shareholder resolutions and other advisories to the board cannot directly address a company's actual business. For example, BP (BP) shareholders cannot advise the company to stop drilling in the Gulf of Mexico. More importantly, shareholder proposals are only advisory, which means that the board of directors is permitted to completely ignore them.

To get a real voice in corporate governance, angry shareholders need to elect members to the board of directors. But elections are strongly skewed in favor of the status quo. To begin with, campaigners must get hold of shareholder lists in order to send out ballots, yet even this relatively minor first step generally requires an expensive courtroom battle. Having passed that hurdle, dissidents then have to print and mail millions of ballots, hire proxy solicitors to convince large stockholders, and take out newspaper and magazine ads to sway stockholders into voting their proxies rather than throwing them away.

According to Minow, these campaigns can cost upwards of $15 million, which means that few individuals can privately fund them. On the other hand, institutional investors like pension funds are often legally barred from spending shareholder money on company elections. For boardrooms, this is effectively a ticket to autocracy, as only extremely deep-pocketed independent investors like Norman Peltz can challenge the rule of the board of directors. What's more, corporations attempting to fight these insurgencies have access to their company's full treasuries, putting them in the odd position of using shareholder funds to fight against shareholder campaigns.

Enter the SEC

Under the new shareholder access rule, this playing field will be leveled, at least a bit. In many cases, dissident shareholders will no longer have to take corporations to court in order to get access to shareholder lists; with access to company ballots, the don't need to print and mail their own proxy ballots. Despite this significant change, the rest of a typical campaign -- including hiring proxy solicitors, taking out ads, and launching other promotions -- will still be expensive. For that matter, even with the rule change the corporate governance structure remains strongly skewed in favor of the status quo. After all, there aren't that many private citizens who own 3% of a company, and gathering together coalitions of long-term stockholders who are interested in major corporate change is an uphill battle.

But even if it is not the wild-eyed radical departure that The Wall Street Journal predicts, shareholder access is still a crack in the largely closed system of corporate governance. Minow puts this in perspective, noting that the law in Delaware, where many corporations are based, enables directors who run unopposed to be re-elected to their seats, even if they only receive one vote. This has some stunning effects: as Minow points out, "Thus far in 2010, 81 directors at 47 companies have received votes of 'no confidence.' Only five have resigned." If dissident shareholders could put their own candidates on corporate ballots, these unimpressive directors would no longer be able to run unopposed, and could -- in theory, at least -- be kicked out.

To give an idea of how this would affect corporate governance, one need look no further than the unsuccessful Rockefeller and Halliburton campaigns. In the first case, the Rockefeller family was able to convince 31% of Exxon's shareholders to vote for a proposal that would limit Exxon's greenhouse gas emissions, while 27.9% voted for a proposal to increase investment in renewable energy. Although these votes were not enough to pass the resolutions, under the new SEC rule, they would likely be more than sufficient to get an energy-conscious member placed on the ballot for yearly elections. Similarly, if 55% of Halliburton's stockholders were willing to make a stand against golden parachutes, it stands to reason that they could put at least one like-minded member placed on the ballot and elected to the board of directors.

What Happens Next

The quest for shareholder access to corporate decision making is hardly new: in 1970, Charlie Pillsbury, scion of the famous flour family of the same name, tried to mount a shareholder revolt at Honeywell Corporation. His three-year battle ended with a Minnesota Supreme Court ruling that his request for access to Honeywell's shareholder roster was not "proper," meaning that the policy changes that he sought were not in the best interests of Honeywell.

Forty years later, the argument is still in use: many critics of the SEC rule change have claimed that dissident shareholders will promote irrational policies that run counter to the business interests of their companies and could cause a drop in stock value. Yet Pillsbury, now executive director of Mediators Beyond Borders and a distinguished visiting fellow at Quinnipiac University School of Law, argues that poor governance is also not in the best interests of many companies -- and can have a negative effect on shareholder value. In the case of BP, for example, he points out that "If I were a shareholder of BP, I would look at environmental responsibility issues. BP's failures as an environmental steward have been bad for business." Similarly, Target's (TGT) recent decision to fund a political group in Minnesota "has been bad for business and for employee morale."

The central critique of the new SEC ruling is that shareholders are not smart enough -- and, ironically, not invested enough -- to choose the best policies for their companies. However, over the past two years, scandals have rocked BP, Target, Hewlett Packard (HPQ), Merrill Lynch, Lehman Brothers, AIG (AIG), Halliburton, and dozens of other companies. In context, it is unclear if the professional decision-makers that stockholders pay to manage their companies are acting in the best interests of their employers.
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