A “New Opening” for Investors
Submitted by: Ted Allen, Publications
With the election of Barack Obama, investor activists are
hopeful that his administration will open the door to advisory
votes on executive pay, proxy access, broker voting reform, and
greater attention to environmental and social issues.
“It’s a significant new opening for investors who are concerned about ESG [environmental, social, and governance] issues,” Tim Smith, a senior vice president at Walden Asset Management, told Risk & Governance Weekly. “It’s not just a rehearing; it’s an opportunity to have a partnership to move forward.”
These reforms, along with greater U.S. regulation of financial markets, appear increasingly likely after this week’s election of Obama, a Democratic senator from Illinois who sponsored “say on pill” legislation. So far, it appears that governance reforms may get significant support in Congress, where the Democrats expanded their majorities in both chambers. In addition, the global financial crisis and the controversial bailout of Wall Street firms have inspired both Democrats and Republicans to call for a crackdown on executive pay abuses. The new year likely will bring a wave of governance and regulatory reforms that go beyond those adopted in 2002 in response to the accounting scandals at Enron and WorldCom.
Activist investors are looking forward to a change in leadership at the Securities and Exchange Commission. Chairman Christopher Cox plans to leave when the Bush administration’s term expires in January, so the new president will name a new chairman to join the two Democrats and two Republicans already on the five-member commission. Given the public attention to the financial crisis, Obama likely will focus on the SEC soon after he names a new Treasury secretary.
“A lot of reforms that have been stonewalled at the SEC will finally see the light of day,” noted Michael Garland, director of value strategies at the CtW Investment Group, the investment arm of the Change to Win labor coalition.
Several investor activists mentioned former Commissioner Harvey Goldschmid as their choice to lead the commission. Goldschmid, who served on the SEC from 2002 to 2005, is now a law professor at Columbia University. Other potential candidates who have been mentioned in press reports include current Commissioner Elisse Walter; New Jersey Governor Jon Corzine; New York Attorney General Andrew Cuomo; Damon Silvers of the AFL-CIO; John Olson, a partner with Gibson, Dunn & Crutcher; Mary Schapiro, a former SEC commissioner who is CEO of the Financial Industry Regulatory Authority; and Robert Pozen of MFS Investment Management.
The agency’s “fundamental role is investor protection, and we need to have a chairman who is committed to that mission,” Garland told Risk & Governance Weekly.
Other activists also expressed hope that the SEC will become a more “robust” advocate of investor rights. They generally support a proposal, which Chairman Cox has endorsed, to have the agency take over the functions of the Commodity Futures Trading Commission, as long as the SEC’s enforcement authority is not diluted.
Investors expect that the new Congress will move quickly in January to approve legislation to require public companies to hold an annual advisory vote on compensation. The House passed “say on pay” legislation in 2007 with some Republican support, but Obama’s companion bill stalled in the Senate.
Richard Ferlauto, director of corporate governance and pension investment at the American Federation of State, County, and Municipal Employees, said Congress may include “say on pay” as part of a broader compensation reform bill. Garland said he hopes there will be a “broad discussion of how to reform executive pay to avoid the perverse incentives that enabled the Wall Street meltdown.”
Such legislation would likely mirror the financial industry bailout bill and limit “golden parachute” severance payments while broadening “claw back” provisions to recoup bonuses based on financial results that are later restated. The bill also might require enhanced disclosure of compensation consultant conflicts, impose new restrictions on deferred compensation, further limit the funding of supplemental exectutive retirement plans, and tighten the U.S. tax code’s definition of performance-based pay (that is exempt from deductibility limits.) Some of these provisions were included in a bill authored by Senator Hillary Clinton of New York, who also ran for president and likely will remain influential under an Obama administration.
“A comprehensive pay reform bill would be really symbolic of the new administration trying to create equity between Wall Street and Main Street,” Ferlauto said. “It should have bipartisan support.”
In addition to new legislation, the SEC “has to be much tougher” on compensation disclosure, noted James Cox, a securities law professor at Duke University. Rather than just write letters to several hundred companies as the SEC did in 2007, he said the commision should find an egregious example of poor disclosure, reject that filing, and require the deficiencies to be corrected within 10 days or else halt trading of the firm’s shares. “The SEC would only have to do that once--that would send a message,” he said.
Board Election Reforms
Investors and governance observers expect that the next SEC chairman will revive a New York Stock Exchange (NYSE) proposal to end the counting of "broker votes" (i.e., shares where clients have given no voting instructions) in uncontested board elections. Such shares frequently are voted for management and can depress the impact of “vote no” campaigns. Activist investors support that rule change, which has languished at the SEC since 2006. However, the NYSE may withdraw its current proposal and replace it with one that includes more flexibility (mirror voting, for example), which some brokers and corporate interests favor.
Ferlauto, Garland, and other activists hope that the new SEC chairman will revive proxy access—the right of investors (who own a minimum stake, such as 3 or 5 percent) to place board nominees on management ballots. That issue, which has been debated for decades at the SEC, has been on hold since November 2007, when the agency’s Republican majority voted to allow companies to omit shareholder proposals that seek access bylaws. “I think the new chairman has to take that on,” Professor Cox noted. In a recent posting on his “The Race to the Bottom” weblog, University of Denver Professor J. Robert Brown said, “access will likely return to the top of the agenda.”
Ferlauto said a proxy access provision may be included in compensation legislation or a broader bill to overhaul the SEC. He said lawmakers may “marry” access to “say on pay” to provide a shareholders a means to remove compensation committee members who are unresponsive to investor concerns.
Professor Cox said he expects the SEC also will move forward with rules to improve transparency at credit rating firms. He also said that Congress may explicitly give the agency the authority to require hedge funds to register and submit to inspections. The SEC adopted a hedge fund rule in 2004, but it was invalidated by a federal appeals court in 2006. The agency also has asked for greater authority to regulate credit default swamps.
Walden's Smith said he expects the SEC will become more sensitive to climate change risks and other environmental and social issues. A coalition of state pension funds has urged the SEC to mandate more disclosure of ESG risks. (For more details, see this week’s “SEC Spotlight” section.)
2009 Proxy Season
At the same time, Obama’s election most likely will not have a significant impact on shareholder filings for the 2009 proxy season. Many of the filing deadlines for early 2009 annual meetings are this month or December, so investors will have to submit most of their resolutions before the new president and Congress take office.
Ferlauto said he expects that investors will file about the same number of “say on pay” proposals as in 2008, when more than 75 resolutions went to a vote. “We’re filing proposals to keep the momentum up [for legislation].” He said that investors likely would have filed 20 percent more proposals for 2009, but a number of financial firm targets (such as Washington Mutual and Wachovia) no longer are independent companies. His union plans to file eight to 12 new proposals that seek a two-year holding period (after a CEO retires or otherwise leaves the firm) for equity awards.
Smith said he expects to see new proposals filed at banks and credit card issuers that seek to reform their consumer lending practices. Garland said he hopes that the SEC will take a new look at other shareholder proposals that seek to address the credit crisis. Before the 2008 proxy season, the SEC staff allowed companies to omit most of the new proposals that sought compliance committees, mortgage risk reports, better CEO succession planning, and other measures.
“I think the SEC needs to revisit those proposals,” Garland. “Anything [the new chairman] can do to instill confidence in the market is important.”
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