On March 14, 2007, the shareholders of Hewlett-Packard Company entered the history books. The act that landed them there was simply voting on a proposal to give them the power to directly nominate candidates for election to the HP board of directors. At first blush, this act hardly seems monumental. But viewed in the context of more than 60 years of political struggle by shareholders of various stripes, just reaching the point where HP shareholders could vote on the question was a long time coming.
As it happens, they voted down the proposal. Although only 39 percent of voting shareholders favored the proposal, Richard Ferlauto, director of Pension and Benefit Policy for the Department of Organizing and Field Services of the American Federation of State, County, and Municipal Employees (AFSCME), which is part of the pension investor team that filed the HP proposal, states that the proposal "did very well. Consider that we got the same percentage of the vote as that opposing Eisner at Disney." Agreeing, Clark McKinley, spokesperson for the California Public Employees Retirement System (CalPERS), which supported the proposal independently of the team, called the vote "a great step forward."
Barriers to shareholder nominations have long been entrenched in rules of the Securities Exchange Commission (SEC) as well as in bylaws enacted by corporate boards. Corporate boards have traditionally reserved for themselves not only the power to nominate candidates for board elections, but also the right to advocate on behalf of those candidates in the company's proxy statement sent to shareholders. SEC regulations adopted in 1976 that codified existing policies have allowed corporate boards to impose these restrictions. According to a September 2006 decision of the federal Second Circuit Court of Appeals, the SEC did so in the name of preventing what it calls "contested elections" (The SEC considers an election "contested" if either there is a campaign for or against a management nominee for the board, or a proposal that would require a company to include a shareholder nominee in the company's proxy. A "proxy," short for proxy solicitation, includes a ballot on which shareholders vote on issues before a shareholders meeting at which they are not in attendance and a proxy statement, which advocates voting for or against a particular proposal or candidate. The SEC considers contested corporate board elections to be bad enough to justify imposing a requirement that all such campaigns and proposals be the subject of a proxy statement separate from the company's proxy statement.)
The combined effect is that shareholders have not been allowed to nominate board candidates to be placed on the company's proxy. In contrast with SEC rules, state incorporation statutes, such as the Delaware law under which HP is incorporated, do not block nominations by shareholders. Similarly, the laws of most developed countries do not limit shareholder nominations.
That state of affairs in the United States ended with the Second Circuit's 2006 decision. The Second Circuit sided with the pension investor team in its suit against the insurance company American International Group (AIG). AIG had attempted to exclude the team's shareholder nomination proposal from AIG's proxy statement. The pension investor's proposal was to establish a procedure under the AIG bylaws for shareholders to directly nominate candidates to the company's board; the candidates' names would appear on the proxy ballot along with a statement by the nominator. Until the ruling, the SEC had allowed corporate boards to prevent proposals of that type from even being included on the proxy ballot sent to shareholders. As Ferlauto recounts, after the judges ruled that the SEC's regulations on the issue in fact prevented AIG from doing that,, the AIG board voluntarily allowed the winners in the suit to informally participate in the board's nominating process.
Encouraged by the ruling, the pension investor team filed more proposals last December, including the one with HP. This time, when HP requested that the SEC support keeping the proposal off its proxy, the agency declined to issue a letter in response. Thus, when HP went forward with blocking the proposal, AFSCME and the pension investor team filed suit, with the Second Circuit decision in hand. HP then capitulated, allowing the historic shareholder vote last month.
What was at stake in these tactical skirmishes, of course, was money. Other SEC rules allow shareholders nominating a candidate to send their own proxy statement to other shareholders asking for support, but at their own expense. Meanwhile, the board can send out the statement giving its nominations at company expense. This rule acted in effect like a huge tax on shareholders' statements advocating their nominees.
A good illustration of this tax is CalPERS's limited effort on behalf of the HP proposal, which was subject to the same rule. Clark McKinley says that CalPERS mailed a separate 3-page proxy statement to the 7,500 HP shareholders owning the largest number of HP stocks, and placed ads in the media addressed to remaining shareholders. Even this limited effort cost several hundred thousand dollars. McKinley notes that sending the proxy to all shareholders -- that is, contacting all holders of the nearly 3 billion shares of HP for the recent vote -- "would be prohibitively expensive. It is just not done."
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The strategic motivation for the pension investor team is perhaps different from the heady calls a generation ago for access to corporate boards. Back then, the goal was to democratize the industrial policy that the corporate boards effectively set when they made their own business decisions. The aim now, Ferlauto says, is increasing management accountability in the wake of the wave of corporate scandals that began with Enron and WorldCom.
Given recent scandals, another unsurprising result of the Second Circuit's decision is that individual shareholders will now find more proposals worth voting for on their companies' annual proxy ballots. Hoping to add to its string of victories on this issue, Ferlauto states that the team is planning a new round of proposals for this fall's cycle of annual stockholder meetings. They plan to target companies whose officers backdated stock options.
Before the results of that new round are known, however, the SEC is likely to weigh in again on the question. The Second Circuit itself acknowledged that the SEC can blunt the impact of its decision, merely by amending its rules. SEC staff responses to questions suggest that the SEC is not content with the Second Circuit decision. The SEC's point of departure may be its 2003 proposed rule that would have mandated direct nomination of candidates by shareholders in circumstances much more limited than the proposals filed with AIG and HP. The Washington Post has reported that new SEC Chairman Christopher Cox has expressed his intention to have a proposal out in time for this fall's cycle of annual meetings and associated proxy solicitations.
Congress is also getting on the bandwagon. Staff for Rhode Island Senator Jack Reed confirm a Reuters report in March that the Senate Banking Committee's Subcommittee on Securities, Insurance, and Investment, chaired by Reed, will hold a hearing this summer on the issue of proxy access for shareholder nominations.
A key point of contention concerns the minimum number of shares the shareholder or holders must own in order to be eligible to nominate a candidate for a seat on the corporation's board. The 2003 SEC proposal required ownership of 5 percent of the company's outstanding stock; the team's proposals require 3 percent, while the laws of most developed countries do not impose a minimum. Jon Lukomnik, co-author of The New Capitalist: How Citizen Investors are Reshaping the Corporate Agenda and managing partner of Sinclair Capital LLC, argues that some threshold is necessary as one means of preventing abuse of shareholder nomination power by corporate raiders.
Lukomnik acknowledges that in a large corporation with billions of shares held by tens or even hundreds of thousands of investors, a threshold inherently limits the nominating power almost exclusively to institutional investors -- employee pension funds as well as mutual funds. Theoretically, he says, the internet has the potential for regularly bringing together large numbers of holders of small quantities of stock behind a nominee.
Lukomnik explains that exercising the power of ownership takes effort, whether proposing the right to nominate, exercising that right, or voting on nominees in the board election itself. "How many individual investors want to sift through proxy solicitations for 20 different companies in which they might own $1,000 in stock just to find the proposals to vote on, and plow through 80 pages of proxy statements to find what proponents of a proposal have said?" he asks rhetorically. At the same time, both he and Ferlauto stress that the effort to gain nomination power and related efforts have a crucial aim: reviving accountability in the boardroom. If a 2003 Harris Interactive poll commissioned by AFSCME is any indication, such an aim is widely held. 90 percent of individual shareholders polled believe corporate scandals have damaged investor confidence in the stock market, and 80 percent favor direct shareholder nomination of candidates for election to corporate board seats.
Once motivated and informed, these disgruntled individual investors could have a big effect on the votes, Lukomnik says, given that they own around 35 percent of shares outstanding in publicly traded corporations. Ferlauto prefers to call them "shareowners." The term, he says, better reflects their status as owners of the corporation, who currently have very little power to control what they own. "Corporate managements often argue that directors acting as agents for the shareowners are much more able to judge business decisions, but leave out the part that they are essentially selected by the management."
Some institutional investors, such as CalPERS or AFSCME, have their own staffs for putting together proposals, finding nominees, or deciding how to vote on proposals and candidates. Others pay professional investor advisors. Individual shareholders, however, have limited ability to hire staff or access pricey investor advisors.
For individual investors considering alternative candidates in board elections, Lukomnik points out that CalPERS posts its recommended votes online a week before the deadline for sending in the proxy ballot, "to allow individual investors to piggy back on their votes." Investors can obtain information regarding current governance issues on other websites, such as corpgov.net. But those resources generally require sifting through extensive Web pages to find specifics on a particular proposal. It remains to be seen how the potential of individual shareholders can be more effectively harnessed to increase accountability in corporate boardrooms.
Equally important to the expansion of shareholder nomination power are the votes cast by mutual fund managers. According to Lukomnik, since 2003, when the SEC began requiring mutual fund managers to publish how they vote on shareholder proposals, the rate at which they have voted with managements' positions has decreased. He cites the example of Vanguard Funds. Vanguard announced in 2003 that after it changed its policy in response to the regulation, its percentage of votes for management candidates fell from 90 percent in 2002 to 29 percent. "If you want to see a revolution," he says, "have 10,000 mutual fund investors write to their fund managers demanding that they vote a certain way on shareholder proposals."
In other words -- shareowners united will never be defeated.
Charles Murn is a legal writer in Washington, D.C.
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