SEC Acts on Behalf of Investors

The Securities and Exchange Commission is pushing ahead with rules designed to give investors more influence over the nomination of corporate board members, a long-cherished goal of shareholder advocates who see it as a potent check on management misconduct.

A formal proposal for new rules may be ready in September, SEC Chairman William H. Donaldson said Tuesday. He described the effort as the agency’s “next step” in a series of reforms designed to rebuild the public’s faith in corporate America after a wave of scandals.

“An effective proxy process has never been more important to restoring investor confidence,” Donaldson said, referring to the official “proxy” materials that companies mail to shareholders for annual director elections.

Donaldson’s remarks, backed up by a new SEC staff report, were greeted with some enthusiasm by shareholder groups, including large pension funds and unions.

“It looks like a legitimate effort to go in the direction of some meaningful access for shareholders to select directors,” said Sarah Teslik, executive director of the Council of Institutional Investors.

But business groups remained wary, concerned about the cost of implementing new rules and the effect they may have on corporate governance.

Both sides will be watching closely in coming weeks as the SEC drafts its proposed rules. The final details will determine whether the agency dramatically overhauls the way directors are nominated -- or limits itself to a much narrower change.

For decades, advocates of corporate democracy have sought greater influence over board nominations, a process tightly controlled by management. Opening up the process, the advocates maintain, would make boards less dependent on management and more accountable to shareholders, shattering a culture in which directors may feel beholden primarily to the managers who selected them.

Under current rules, shareholders who want to oppose management’s slate of board candidates must finance the campaign themselves and mail separate ballots to shareholders.

“As recent events have shown, even boards with formally independent directors on key committees have not provided adequate safeguards for the protection of shareholder interests,” a group of pension funds that included the California Public Employees’ Retirement System said in a letter to the SEC.

“The failure of governance has cost public pension funds billions of dollars in losses, as evidenced by failures at Enron [Corp.], WorldCom [Inc.], Tyco [International Ltd.] and other companies.”

However, business groups warn that giving investors greater access to proxy ballots could carry unforeseen dangers. Some argue it could lead to frequent, chaotic election struggles and provide an unmerited platform to shareholders with a narrow agenda that is not in a company’s best interest.

Some also have questioned the SEC’s legal authority to regulate an area in which the states have traditionally played a major role.

“This is something the SEC should be very careful about,” said Keith Bishop, former commissioner of the California Department of Corporations and an attorney with Buchalter, Nemer, Fields & Younger in Newport Beach.

“While shareholder democracy sounds good, we’re not dealing with the political system. We’re dealing with businesses. And the guiding principle should be what’s most efficient for the businesses.”

In the coming weeks, the SEC will wrestle with the basic details of who might be given the ability to nominate board members, and under what circumstances.

For instance, the agency may decide to limit the ability to nominate directors to shareholders who own a significant portion of a company’s stock -- proposals have ranged from 3% to as high as 10%.

In addition, the SEC staff suggested other tests, including providing evidence that a company’s management has ignored shareholder resolutions in the past, or that significant numbers of shareholders have boycotted board elections. A large number of abstentions might be a gauge of disaffection, because shareholders do not have the option of voting “no” under current rules.

Also Tuesday, Donaldson said the SEC would move forward with a less controversial proposal that seeks “more robust” disclosure by corporations about the nominating process that firms use to elect board members.