The SEC Opens the Boardroom to Unhappy Investors

Corporate Board Member March/April 2004

Feature Story
by Rob Norton

Proposed new rules would make it far easier for dissident shareholders to nominate their own directors. Here are four things boards can do now to get ready for this latest reform.

Adding to the array of new rules imposed on corporate boards over the past two years, the Securities and Exchange Commission is marching down a road of regulatory change that could have a further profound impact on the way boards operate. Under proposals put out for comment last October, shareholders unhappy with the composition of a company’s board will be able, in certain circumstances, to choose and nominate new board members, and companies will be required to put those nominees on the proxy for a vote of all the shareholders. The comment period closed in December, and the SEC is considering the input.

The proposed new rules address longstanding complaints by institutional investors that boards have ignored their suggestions on such matters as anti-takeover measures, excessive executive pay, and board composition. The rules continue the drive toward greater board independence fostered by legislation like the Sarbanes-Oxley Act, as well as previous rule changes by the SEC and new regulations of the New York Stock Exchange and the National Association of Securities Dealers. Says SEC chairman William H. Donaldson: “Board unresponsiveness, sometimes tied to corporate governance weaknesses, demonstrates the need for shareholders to have a more meaningful voice in the proxy process.”

Until now, corporations have controlled access to the proxy-voting process despite periodic efforts to open it up to shareholders. The only way that investors unhappy with a board’s makeup could nominate candidates of their own was to launch a proxy battle—a complicated process that includes mailing out a separate set of proxies and typically costs several million dollars. Since those costs are borne by the dissidents, proxy battles have been rare except in connection with takeovers or buyouts. “The SEC’s proposal is a very significant event,” says Richard Steinberg, principal of Steinberg Governance Advisors in Westport, Connecticut, and formerly corporate governance leader at PricewaterhouseCoopers. “Until now, shareholders needed a large war chest to challenge a board. This takes those big dollar requirements out of the picture and certainly has the potential to make major changes in board composition.”

The SEC isn’t ushering in an era of unfettered shareholder democracy. To ensure that proxy access and nomination authority would be invoked only when a significant proportion of shareholders had shown dissatisfaction with the current board, under the proposed rules one of two “triggering events” would have to occur.