Senator Charles Schumer (D, NY) recently introduced legislation addressing a number of controversial issues in corporate governance. The bill, titled the "Shareholder Bill of Rights Act of 2009," would require:
- the annual election of directors, thereby eliminating "staggered" boards;
- the election of directors by majority vote in uncontested elections, the resignation of any director not re-elected in an uncontested election and the acceptance of that resignation by the board;
- an independent chairman of the board who has never served as an executive officer of the issuer;
- a public company to permit shareholders or groups of shareholders who have beneficially owned at least one percent of the company's outstanding voting stock for at least two years to include nominees for election to the company's board of directors in the company's proxy statement; and
- nonbinding shareholder votes on executive pay and, in connection with mergers and other business combination transactions, golden parachute arrangements if they had not already been subject to a shareholder vote.
Separately, on May 20, 2009, the Securities and Exchange Commission voted three to two to propose changes to the federal proxy rules to permit shareholders to nominate directors and to include such nominees in the issuer's proxy statement. The proposed rules, which have not been published, were summarized at an SEC open meeting as including the following elements:
- the shareholder must have been a shareholder for one year prior to submitting the nomination, and the nomination must be accompanied by a representation that the shareholder intends to hold the shares through the date of the meeting;
- the shareholder must have a minimum percentage share ownership (tiered according to the size of the company):
- 1% ownership is required for large accelerated filers
- 3% ownership is required for accelerated filers
- 5% ownership is required for non-accelerated filers;
- the shareholder must represent that it does not intend to seek to change control of the board; and
- the issuer is only required to include nominees for 25% of the board of directors or one director, whichever is greater.
These actions closely follow the adoption by the State of Delaware of amendments to its corporate laws addressing proxy access by permitting, but not requiring, companies to provide such access. In addition, the bill comes at a time when the public has been debating whether financial institutions that have received TARP funds should be subject to limitations on executive compensation. Senator Richard Durbin (D, Ill.) also introduced a bill on May 7, 2009, proposing an amendment to the Securities Exchange Act of 1934 ("Exchange Act") to cap executive compensation at 100 times the average compensation for all employees in a given year, unless not less than 60 percent of shareholders approve the compensation. This timing indicates that Congress does not intend to allow regulatory agencies and state legislatures to drive the discussion of these corporate governance issues, but rather, intends to be an active participant in their resolution, and the proper roles of Congress, the SEC and the state legislatures in corporate governance matters is certain to be the subject of considerable discussion.
Corporate Governance Standards
The most controversial provisions of Senator Schumer's bill require national securities exchanges, within one year of enactment, to prohibit the listing of any security of an issuer that is not in compliance with the provisions of the bill relating to (i) the annual election of the full board of directors, (ii) voting standards in elections of directors and (iii) the independence of the chairman of the board of directors. Those provisions would also require listed companies to establish and maintain a risk committee of the board of directors.
Annual Elections of Directors. Under the bill, each member of the board would be subject to annual election by shareholders, thereby eliminating staggered boards currently permitted by state law.
The elimination of staggered boards, which provide for multi-year terms with only a portion of the board (usually one third) being elected every year, has been a goal of shareholder activists for some time. Many companies maintain a staggered board because it reduces board turnover, thereby enhancing stability in the management of the company. Additionally, a staggered board provision allows a company to more carefully consider a potentially coercive proposal from a shareholder whose interests may diverge from those of the company and the other shareholders. Shareholder activists claim that, because a staggered board requires two annual meetings to change a majority of the board, this governance structure entrenches the board, to the detriment of the shareholders.
Majority Vote in Uncontested Elections of Directors. The bill would require in uncontested board elections that directors be elected by a majority of the votes cast as to each nominee. If any board member does not receive a majority vote in an uncontested election, the director must tender, and the board must accept, his/her resignation. In contested board elections, where the number of nominees exceeds the number of directors to be elected, directors would be elected by plurality vote.
The plurality standard has been adopted by many states (including Delaware) as the default standard to protect against failed elections. The plurality standard ignores "against" or "withheld" votes in uncontested elections, permitting directors to be elected by less than a majority of shareholders. In 2006, Delaware amended its law to allow the adoption of charter or bylaw provisions that set the necessary votes required for any matter, including director elections. This amendment did not affect the default plurality standard; however, it did provide that the board would be unable to amend or repeal a bylaw provision adopted by shareholders which specifies the votes necessary for director elections. Delaware law also allows director resignations conditioned upon the director failing to receive specified votes for reelection to provide that such resignations are irrevocable.
Independent Chairman. The bill would require each issuer to provide in its governing documents or in a public statement of corporate policy that the chairperson of the board shall be independent under SEC and stock exchange rules and shall not have previously served as an executive officer of the issuer.
If enacted, this provision would prohibit combining the positions of Chairman and CEO. Despite recent calls for this practice to end, many public companies continue to combine the two roles and proxy advisory firms generally have not objected to the combination as long as other corporate governance guidelines are followed. The provision also will end the practice whereby the retiring chief executive assumes the position of board chair. A former CEO could remain a member of the board, but could not serve as chair, the position that traditionally has the most control over the flow of information to the board, including the power to establish the agendas for board meetings.
Mandatory Proxy Access for Director Nominations
Senator Schumer's bill would also require the SEC to establish rules relating to the use by shareholders of proxy solicitation materials supplied by the issuer for purposes of nominating directors. Presently, a shareholder may propose a slate of director nominees but would be required to prepare and disseminate to shareholders, at substantial cost to the nominating shareholder, its own proxy materials.
The shareholder (or shareholder group acting by agreement) would be required to have beneficially owned at least one percent of the voting securities of the issuer for at least the two-year period preceding the date of the next scheduled annual meeting of the issuer. The bill does not limit the number of shareholder nominees. Thus, where a staggered board does not exist, it would be possible for a 1% shareholder to nominate a full slate of directors and replace the entire board of directors utilizing the company's proxy statement. This would effect a dramatic change in the cost and method of election contests.
As discussed below, the SEC recently announced its intention to propose changes to the federal proxy rules to permit shareholders to nominate directors and to include such nominees in the issuer's proxy statement. It remains unclear whether, in light of the filing of Senator Schumer's bill, the SEC will proceed with its rulemaking effort on proxy access and how the SEC's proposal will be reconciled with the provisions of Senator Schumer's bill.
The Delaware General Assembly has recently adopted an addition to the Delaware General Corporation Law, effective August 1, 2009, which expressly authorizes a Delaware corporation to adopt a permissive bylaw that would grant shareholders the right to include director nominees in the corporation's proxy statement. The new provision further allows Delaware corporations to provide lawful procedures and conditions within the bylaw itself to limit the right of access to company proxy materials. Senator Schumer's bill does not contain such a provision and responds to the actions of the Delaware legislature in a way that does not challenge directly the power of state legislatures to regulate the internal governance of corporations, but relies on the power of Congress and the SEC to regulate the solicitation of proxies, as reflected in the Exchange Act.
Shareholder Approval of Executive Compensation
The bill would also require that any proxy statement for a shareholder meeting for which the SEC rules require compensation disclosure must contain a separate resolution, subject to a nonbinding shareholder vote, to approve the compensation of executives as disclosed pursuant to the SEC's compensation rules. The bill provides that the vote would not be construed as overruling a board decision, creating or implying any change to current board fiduciary duties or restricting or limiting the ability of shareholders to make executive compensation proposals for inclusion in the proxy materials. The implementing regulations will need to address the many details not included in the legislation.
Although shareholder "say on pay" has not been mandated by the SEC, SEC Chairman Schapiro and SEC Commissioner Walter have each expressed their individual support for these provisions. In addition, the SEC has issued an interpretive release regarding "say on pay" requirements found in Section 7001 of the American Recovery and Reinvestment Act of 2009 (the "Act"). The Act amends the Emergency Economic Stabilization Act to require annual "say on pay" shareholder votes for those companies who receive TARP funding for so long as the obligations arising from the receipt of such funds remain outstanding.
The bill would also require, in any proxy material for a shareholder meeting that concerns an acquisition, merger or sale of assets, that the person making the solicitation disclose any agreements or understandings that such person has with the principal executive officers of the issuer (or of the acquiring issuer, if the issuer is not the acquiring issuer) concerning any type of compensation (present, deferred or contingent) that is based on or related to the transaction and that has not been subject to a shareholder vote. This provision also requires a separate nonbinding shareholder vote approving such agreements or understandings.
The nonbinding character of the votes on compensation under the bill may be illusory in application. While shareholder disapproval of executive compensation will not be binding, boards may feel pressure to modify compensation practices in response to a negative vote in subsequent years. Moreover, the power of various proxy advisory firms will almost certainly be enhanced, and compensation committee members may become subject to negative recommendations from proxy advisory firms based on shareholder disapproval of executive compensation.
If adopted, the provisions in the bill would generally become effective one year after the date of enactment. The bill would require the SEC to adopt implementing rules within one year of the date of enactment.
SEC to Issue Proposed Rules on Proxy Access for Director Nominees
On May 20, 2009, the SEC voted three to two to propose changes to the federal proxy rules to permit shareholders to nominate directors and to include such nominees in the issuer's proxy statement. Under the SEC's proposed rules, which have not been published, the shareholder must have been a shareholder for one year prior to submitting the nomination, and the nomination must be accompanied by a representation that the shareholder intends to hold the shares through the date of the meeting and that the shareholder does not intend to seek to change control of the board. The shareholder must have a minimum percentage share ownership (tiered according to the size of the company): 1% ownership is required for large accelerated filers; 3% ownership is required for accelerated filers; and 5% ownership is required for non-accelerated filers. The issuer is only required to include nominees for 25% of the board of directors or one director, whichever is greater.
Since 2003, the SEC has considered multiple proposals addressing shareholder proxy access. In the SEC's prior consideration, heated discussions were held among interested parties regarding the proper ownership threshold and holding period for the proxy access rule. Most issuers favored a five percent ownership level, so as to be consistent with existing ownership disclosure requirements in Section 13(d) of the Exchange Act and related regulations. Predictably, hedge funds, shareholder activists and unions favored a one percent level.
These recent events have broad implications for federal-state relations in the corporate governance area. We encourage Congress and the SEC to consider the legitimate concerns of issuers and their managements and boards of directors rather than overreact to the failures of a few with a populist measure. To do otherwise may impede effective corporate governance and discourage U.S. enterprises from raising capital in the public marketplace.