Securities and Exchange Commission Chairman William H. Donaldson yesterday endorsed staff recommendations that would make it easier for shareholders to elect their own representatives to corporate boards of directors.
The SEC staff earlier in the day released a study recommending that the ballots sent out by some companies be required to list -- in addition to management's nominees -- directors proposed by major shareholders. The agency hopes to issue proposed rules for public comment by the end of September and a final rule a few months later.
"This has been debated for too long as far as I'm concerned," Donaldson said in a meeting with reporters and editors of The Washington Post. "It's a real, necessary companion piece to a much bigger picture that I see: a shift, a correct shift, away from a dominance by corporate executives and back to the board."
Investor groups have charged that scores of corporate wrongdoings that shattered investor confidence might have been avoided or uncovered earlier if directors had been more independent and aggressive in questioning management. The goal of the new rules will be to create a system in which "the board hires a chief executive, not the other way around," Donaldson said.
Under current rules, shareholders can walk into an annual meeting and nominate someone for a director's seat, but that effort is unlikely to succeed because most shareholders vote by mail. That leaves protesting shareholders with two alternatives, either withhold their votes or mount a costly and time-consuming fight for an alternative board.
Some shareholder groups say this action will give investors more power to force corporate reforms than any other change adopted by Congress or the SEC in response to a series of corporate scandals over the past 18 months. "It is clear the commission is serious about doing well by investors." said Sarah Ball Teslik, executive director of the Council of Institutional Investors, a trade group representing pension funds and other large shareholder groups. "There is nothing in the last 20 years the SEC has done that will be as important."
Securities lawyers, however, say chief executives fear shareholder-nominated directors could make it harder for them to run their companies. Corporations have argued that boards might be paralyzed by a few dissidents or individuals obsessed with one issue, such as the environment.
Donaldson said he was not swayed by the protests. "Frankly, I have been unimpressed with some of the arguments," he said. Sources say the other SEC commissioners, two Democrats and two Republicans, also support the staff recommendations.
Nell Minow, editor of the Corporate Library, a corporate governance research firm, predicts that businesses will try to derail the effort. "We can expect the corporate community to pull out all the stops to slow this down, including a challenge in the courts about whether the SEC even has authority to do this instead of leaving it up to the states," Minow said.
The SEC has considered similar moves since the 1940s, most recently in 1977, but has never acted until now. Donaldson and SEC staff members point to the altered environment, which includes more individual investors, as well as technologies such as the Internet that will make it easier and cheaper for companies to make the change. In addition, some institutional investors have gotten so big they cannot express displeasure with a company by selling their shares without causing serious market disruptions.
Donaldson said the change is crucial to "restoring investor confidence" and increasing corporate accountability. He said he was "horrified at some of the stuff that goes on on Wall Street, horrified and mad."
The staff report recommended that the proxy process be changed in two areas -- disclosure and the nominating process. It said the rules should require companies to disclose the process they go through to select directors. And it recommended that a company be required to let investors use its proxy to nominate directors if the corporation has a history of certain, specified behavior -- for instance, if it has ignored proposals endorsed by a majority of shareholders or has had a large percentage of shareholders who routinely withhold their votes.
The nominating shareholders would have to constitute a certain percentage of investors, although the level has not yet been decided. Proposals so far have ranged from 1 to 5 percent. And they would have had to be shareholders for a specified time, probably a year or more. Shareholder-nominated directors also would be limited in number, possibly even to one per board.
Evelyn Y. Davis, a shareholder activist for 40 years, fears the proposal could backfire, eventually leading the SEC to mandate a similar percentage of votes be obtained before putting any shareholder proposal on the proxy ballot. She said she thinks a better way to make current directors more responsive to shareholders would be for the SEC to limit director terms to six years and to require firms to adopt any proposal that wins a wide majority vote.
Meanwhile executives of the Business Roundtable, an organization representing chief executives of the country's largest companies, argued that they have been so swamped with changes mandated by the Sarbanes-Oxley legislation enacted last summer and new rules that have been proposed by industry's two self-regulatory groups, the New York Stock Exchange and the NASD, that they need more time before regulators impose additional regulations.
But Donaldson met with the group two weeks ago to tell them they had lost their battle, according to sources familiar with the talks.
Yesterday a spokesman for the Business Roundtable said that its members support enhanced disclosure but remain wary of proposals to give shareholders more access to the proxy. "We will have to wait to see the details," said the organization's president, John J. Castellani.
Donaldson said the SEC will make sure safeguards are in place to prevent the rules from being used to mount a takeover of a company or from upsetting the mix of expertise and backgrounds some corporations strive hard to create on boards. He also said the rules would be written to avoid conflicts with state laws.
The SEC announced in mid-April that it would review the nominating process, after turning down a request from a union pension plan to require Citigroup to include in its proxy this year a proposal to permit holders of 3 percent or more of a company's shares to nominate directors through the company proxy.
"This is a positive step towards making boards of directors more accountable to long-term investors," AFL-CIO President John Sweeney said in a prepared statement. "The retirement savings of America's working families have been harmed by the failure of boards of directors to prevent wrongdoing at Enron, Worldcom and other scandal-plagued companies. We call on the SEC Commissioners to quickly adopt new proxy rules and end the self-perpetuating system that permits incumbent boards to hand-pick director candidates."