Council of Institutional Investors Urges Senate Banking Committee to Craft Strong Corporate Governance Provisions

As the Senate Banking Committee moves toward mark up of a financial reform bill, the Council of Institutional Investors urged the two senators working on corporate governance to produce strong provisions favoring shareholder access to the election of directors, as well as other measures such as clawbacks of executive pay. In an effort to report a bi-partisan bill out of committee, Chair Christopher Dodd has paired off Republican and Democratic Senators to work on different titles of the Restoring American Financial Stability Act. Senator Chuck Schumer (D-NY) and Senator Michael Crapo (R-Idaho) are working on the corporate governance title. The Council’s letter to Senators Schumer and Crapo was informed and drew upon a report of the Investors Working Group, which is co-chaired by former SEC Chairs William Donaldson and Arthur Levitt, and includes former CFTC Chair Brooksley Born.

In the letter, the Council first set forth the broad principle that the global financial crisis was caused, in part, by a massive failure of corporate governance; and that shareholder-driven market discipline is critical to legislative reform of the financial system. The Council then said that the federal proxy rules for the election of directors are flawed because they prohibits shareholders from placing the names of their own director candidates on proxy cards. Rather, in the United States, unlike most of Europe, the only way that shareowners can run their own candidates is by waging a full-blown election contest and printing and mailing their own proxy cards to shareowners. For most investors, that is onerous and prohibitively expensive.

In the Council’s view, a measured right of access would invigorate board elections and make boards more responsive to shareowners, more thoughtful about whom they nominate to serve as directors and more vigilant in their oversight of companies. Thus, while the primary role of shareowners is to elect and remove directors, the proxy rules erect major roadblocks that bar the way. In light of this, the Council recommends that the federal securities laws be amended to affirm the SEC’s authority to promulgate rules allowing shareowners to place their nominees for directors on the company’s proxy card.

According to the Council, another problem in the proxy voting system is that relatively few U.S. companies have adopted majority voting for directors. Most public companies elect directors using the plurality standard, by which shareowners may vote for, but not against, a nominee. If shareowners oppose a particular nominee, they may only withhold their votes. As a consequence, a nominee only needs one “for” vote to be elected and unseating a director is virtually impossible. Plurality voting in uncontested situations results in “rubber stamp” elections.

The Council urges legislation supporting the election of directors by a majority of the votes cast in uncontested elections. In the Council’s view, majority voting in uncontested elections ensures that shareowners’ votes count and makes directors more accountable to shareowners. At the same time, plurality voting for contested elections should be allowed because investors have a more meaningful choice in those elections.

The Council also urged adoption of the corporate governance principle that the board chair and CEO positions be separate on a comply or explain basis. Thus, boards of directors should determine whether the chair and CEO roles should be separated or whether some other method, such as lead director, should be used to provide independent board oversight or leadership when required. Boards of directors should be encouraged to separate the roles of chair and CEO or explain why they have adopted another method to assure independent leadership of the board. The current Chair’s mark contains language directing the SEC to issue rules requiring a company to disclose in its annual proxy statement the reasons why it has chosen the same person to serve as chair of the board of directors and CEO or different individuals to serve as board chair and CEO.

In its letter, the Council also encouraged the Senators to enhance federal clawback provisions on unearned executive pay. Clawback policies discourage executives from taking questionable actions that temporarily lift share prices but ultimately result in financial restatements. Senior executives should be required to return unearned bonus and incentive payments that were awarded as a result of fraudulent activity, incorrectly stated financial results or some other cause. The Sarbanes-Oxley Act required boards to go after unearned CEO income, said the Council, but the Act’s language is too narrow. It applies only in cases where misconduct is proven, which occurs rarely because most cases result in settlements where charges are neither admitted nor denied, and only covers CEO and CFO compensation. Also, federal courts have refused to allow this provision to be enforced by a private right of action.

The Chair’s mark currently requires the SEC to issue rules directing a company to implement a policy providing that, in the event of an accounting restatement due to the material noncompliance with any financial reporting requirement under the securities laws, the company will recover from any current or former executive officer who received incentive-based compensation during the preceding three years, based on the erroneous data, in excess of what would have been paid to the executive under the accounting restatement.

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