Regaining Corporate Governance Balance

Those who believe that U.S. corporate governance reform efforts have been moving too fast and too far off course [1] need to focus carefully on the current state of play.  We are at a moment in time when it may be possible to achieve a more balanced outcome from Washington than seemed likely only a few months ago.  However, this moment can easily turn into a missed opportunity if it is not recognized and the effort to take advantage of it is not pursued.

The Current Environment

On the political front, certain potentially moderating circumstances may have developed.  2010 has seen the Democrats lose their 60 vote, filibuster-proof majority in the Senate and, in the face of a heated national debate, achieve passage of significant federal health care reform legislation that may have repercussions in the mid-term elections this coming November.

However, populist ire at U.S. government bailouts of banks and financial institutions continues to resonate.  It remains to be seen whether and to what extent this will be a counteracting force in support of expanded federal government regulation.

The question of how these political circumstances, among others, will play out is particularly relevant to the shape of corporate governance reforms being considered by the U.S. Congress.  There have been numerous bills introduced over the past year, and the House of Representatives addressed certain corporate governance/executive compensation topics in The Wall Street Reform and Consumer Protection Act passed in December 2009.  The key battleground now is Senator Dodd’s (D-CT) current version of The Restoring American Financial Stability Act of 2010, approved by the Senate Banking Committee in March and expected to be considered by the full Senate in the coming weeks. [2]

Although the Dodd bill deals principally with financial regulatory reform, it also addresses corporate governance matters ranging from proxy access to “say on pay” to majority voting in director elections.  This version of the Dodd bill steps back from some provisions contained in an earlier version of the bill circulated in November 2009.  In particular, the bill no longer contains a prohibition on classified boards unless approved by shareholders or a requirement of a “say on pay” shareholder vote on “golden parachutes.”  With respect to proxy access, the latest version shifts from requiring the SEC to adopt rules providing for proxy access to simply authorizing the SEC to adopt them.  While on its face this shift also seems to reflect a stepping back, as a practical matter, given the favorable views of a majority of the SEC regarding proxy access, the more limited legislative language likely will be sufficient to assure some form of proxy access rule, particularly by mitigating potential legal challenges to an SEC proxy access rule based on a claimed lack of statutory authority.

For the Dodd bill to be approved by the Senate, the Democrats will need to obtain the support of at least one Republican senator, and public statements by Senator Dodd indicate that his goal continues to be to present the Senate with a bipartisan bill forged through negotiations in the coming weeks. [3] The White House is pressing for financial regulatory reform legislation to be on the President’s desk by Memorial Day.

The timing point seems clear — the time to focus attention on shaping the content and scope of potential new federal regulation in the corporate governance arena is in the very near term.

What’s Possible?

In the current political environment, including the high priority being placed on financial regulatory reform, there seems to be some hope for progress towards a better balance on the corporate governance front than currently reflected in pending legislation.  A concerted and immediate effort by proponents of balanced corporate governance reform could yield positive results.  Some possibilities include:

• Proxy Access.  The advocates for and against proxy access remain deeply divided.  But three points seem clear.  First, any system that purports to enhance shareholder “choice” should respect the ability of shareholders to choose to “opt out” or otherwise vary the terms of any proxy access framework.  Second, if proxy access results in annual election contests becoming the norm for a large number of public corporations, the challenge of overcoming the short-termism that contributed to the economic and financial crises may increase significantly.  Third, proxy access presents the risk of being used as a vehicle for certain parties to pursue agendas that are not necessarily in the best long-term interests of all shareholders.  A balanced reform effort should leave proxy access to be addressed on a company-by-company basis or, if it includes proxy access at all, should require that any SEC rules respect the validity of private ordering by allowing companies to opt out of, in whole or in part, any SEC default proxy access scheme.
• Majority Voting.  In just four years’ time, majority voting in uncontested director elections has become the standard at a majority of large companies.  Whether this standard makes sense for the remaining companies, especially many of the mid-cap and small-cap companies that continue to employ a plurality voting standard in uncontested director elections, should be left to the boards of directors and shareholders of those companies.  Moreover, the experience of the last few years indicates that this is not an area where federal intervention is required.
• “Say on Pay.”  Although an increasing number of public companies have agreed to provide shareholders with a non-binding, advisory vote on executive compensation matters, many other companies continue to believe that “say on pay” is an inappropriate intrusion into the decision-making of boards of directors and board compensation committees.  In addition, some companies adopting “say on pay” have opted for biennial or triennial variations, while others have adopted annual “say on pay.”  Accordingly, this appears to be another area where private ordering should be respected so that companies, boards of directors and shareholders can gain experience with the variations and determine what works best on a company-specific basis.  Moreover, any mandatory “say on pay” requirement resulting in thousands of public companies seeking annual advisory votes on executive compensation should only be undertaken, if at all, following a further examination and review of the entire shareholder communication and proxy voting system, including the role of proxy advisory firms.
• “Clawback” Policies.  Again, the data indicates that policies for the recoupment of executive compensation paid on the basis of financial results that are subsequently restated due to improper conduct have been adopted by a large number of public companies.  Rather than a one-size-fits-all, prescriptive approach, statutory reform should encourage companies to consider whether a clawback policy is appropriate under the circumstances.

Timing May Be Everything

While, as noted above, many of these issues have been and continue to be addressed through board and board committee actions, shareholder initiatives and permissive state regulation, the key point is that the decisions are company-by-company and the source of change is not a one-size-fits-all rule imposed from Washington.  Maintaining that decentralized model for determining the governance of publicly traded business corporations is a genuinely important goal. [4] The legislative window of opportunity for the voices supporting balanced corporate governance reform seems about to open — but perhaps only for a short time.  Hopefully that opportunity will be taken.

Endnotes

[1] See U.S. Corporate Governance Today: A Reshaping of Capitalism, by Peter Allan Atkins (July 27, 2009) at http://www.skadden.com/content/Publications/Publications1848_0.pdf; Raising the Bar – A Post-Script, by Peter Allan Atkins (December 14, 2009) at http://www.skadden.com/content/Publications/Publications1943_0.pdf.
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[2] The bill was approved by the committee on a 13-10 party-line vote. In an effort intended to allow the two parties ultimately to reach a bipartisan compromise, Senators Dodd and Shelby (R-AL) (the ranking Republican member of the committee) agreed to have the committee vote on the bill without considering the hundreds of amendments offered by Senators of both parties and, thereby, avoid polarizing debates that would make compromise more difficult to achieve. Senator Dodd has expressed “hope that shortly after [the Senate’s] return [in] the second week of April that [the bill] will come to the [Senate] floor.”
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[3] Reaching a bipartisan compromise will be difficult in light of the widely divergent views on the corporate governance provisions of the bill. For example, in the Senate Banking Committee markup hearings on March 22, 2010, Senator Schumer (D-NY) stated that “the best way to rein in runaway executive compensation and excessive risk-taking by major institutions is to empower the firms’ shareholders, and ensure that corporate boards fulfill their oversight responsibilities.” On the other side, Senator Shelby stated “[t]his bill also contains a number of provisions that are unrelated to the crisis, including the so-called corporate governance provisions that would impose costs on shareholders and empower special interests.” Nevertheless, the corporate governance provisions constitute a small part of the overall financial reform bill. Press accounts suggest that Republicans may settle on a strategy of agreeing to proposed provisions on a consumer protection agency in exchange for Republican modifications to other aspects of the bill.
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[4] See footnote 1.
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