Broad Shareholder Democracy Legislation Introduced in Congress

Comprehensive corporate governance legislation has been introduced in the House that would require a shareholder advisory vote on executive pay, allow shareholders to nominate a candidate for director on management’s proxy card, and eliminate uninstructed discretionary broker votes in uncontested elections that allows fund managers to vote on investors’ behalf. The Shareholder Empowerment Act of 2009, HR 2861, would also require that a board chair be completely independent from executive management, thereby prohibiting the CEO from concomitantly serving as chair of the board.

The Act would stop golden parachutes to executives terminated for poor performance. It would also curb excessive risk taking of the sort that led to the financial crisis by requiring shareholders to be informed of the performance targets being used to determine bonuses and other incentives. The Act even includes clawback provisions allowing the recovery of executive bonuses or other payments awarded on the basis of fraudulent or faulty earnings statements. The company must have a policy on reviewing this type of variable incentive compensation; and the policy should require recovery or cancellation of any unearned payments to the extent that it is feasible and practical to do so.

Under the plurality voting standard that is the default standard in most corporation codes, the candidate receiving the most votes for director is elected. In uncontested elections, shareholders can protest a candidate for director by withholding their vote, but there is no mechanism for opposing a candidate, even one vote is enough to win.

The legislation would require a candidate for the board in an uncontested election to receive votes from a majority of shareholders; and would also require a candidate running unopposed for election to resign if he or she failed to obtain majority shareholder approval.

Currently, companies can keep shareholder nominees for director off the proxy ballots. The measure would give shareholders that have held at least one percent of a company’s shares for one year access to the proxy to nominate director candidates.

Under the legislation, any compensation adviser hired by the company must be independent and must also report solely to the full board of directors or the compensation committee. Moreover, companies are prohibited from agreeing to indemnify or limit the liability of compensation advisers. The SEC is directed to implement this provision within one year.

In doing so, the SEC must consider a number of factors pertaining to the compensation adviser’s independence. The legislation states that the SEC must consider the extent, as measured by annual fees and other metrics, to which the adviser or advisory firm provides services in conjunction with negotiating compensation agreements with the company’s executives, as compared to other services that the adviser provides to the company or executives. The SEC must also consider whether individual advisers are permitted to hold equity in the company; and whether an advisory firm’s incentive compensation plan links the compensation of individual advisers to the firm’s provision of other services to the company.

The legislation also directs the SEC to adopt rules requiring additional disclosure of specific performance targets that companies use to determine a senior executive officer’s eligibility for bonuses, equity and incentive compensation. The Commission must consider methods to improve disclosure in situations where it is claimed that disclosure would result in competitive harm; including requirements that the company describe its past experience with similar target levels, disclose any inconsistencies between compensation targets and targets set in other contexts, submit a request for confidential treatment of the performance targets under SEC rules, or disclose the data after disclosure would no longer be considered competitively harmful.

Under the legislation, the chair of the board of directors must be an independent director who has not previously served as an executive officer of the company. The legislation defines an independent director as one who during the preceding 5 years has not been employed by the company in an executive capacity; has not been an employee, director or owner of greater than 20 percent of the beneficial shares of a firm that is a paid adviser or consultant to the company; has not been employed by a significant customer or supplier; has not had a personal services contract with the company, or with the chair, the CEO, or other senior executive officer; has not been an employee, officer or director of a foundation, university or other non-profit organization that receives the greater of $100,000 or 1 percent of total annual donations from the company; has not a relative of a company executive; has not part of an interlocking directorate in which the company’s CEO or another executive serves on the board of another company employing that director; and has not been engaged in any other relationship with the issuer or senior executives that the Commission determines would not render that director an independent director.