Shareholders Unite! How an SEC Ruling Could Bring Democracy to the Boardroom

boardroomWhile the recession represents a recent high-water mark for bad corporate leadership, questionable boardroom decisions are nothing new. For years, newspaper headlines have been filled with tales of environmental irresponsibility, skyrocketing executive paychecks, and other shortsighted moves that have infuriated investors and lowered stock value.

Unfortunately for shareholders, corporate governance laws are skewed strongly in favor of boardroom incumbents, making it all but impossible for people who own stock to influence their investments. Recently, however, the Securities and Exchange Commission passed a new "shareholder access" rule, which could have long-lasting effects on the way that America's businesses make decisions.

On the surface, the new rule seems minor: historically, ballots for corporate elections have only had to include the board-approved nominees; under the new rule, however, shareholders who have owned 3% of the shares in a company for three years or more can place their own candidates on corporate ballots. This may not sound like much of a change, but this seemingly-inconsequential rule has inspired furious yowling from the precincts of America's corporate establishment.

In an editorial, The Wall Street Journal warned that "union funds and other politically-motivated causes" could now "force mom and pop to support causes they otherwise would not." This, the editorial ominously suggested, was comparable to what Peter Drucker called "Pension-Fund Socialism." And the Journal was not alone in its attack: one critic was quick to offer strategies that corporations could use to thwart shareholders who are bent on influencing governance. Another warned that pension funds, a potential source of corporate opposition, could be controlled by politicians and other outsiders. Perhaps the most surprising rebuttal came from a pundit who argued in favor of "rational apathy," claiming that "[f]or the average shareholder, the necessary investment of time and effort in making informed voting decisions simply is not worthwhile."

Shareholder Revolt

Part of the reason that the SEC's action has inspired such vitriol is because this rule change could be the first chink in a governance system that, in many cases, is completely closed off to outside influence. Angry stock owners who seek to improve their companies generally must resort to "shareholder revolts," in which they gang together to change the policies of a company. For example, in 2006, Nelson Peltz led Heinz shareholders in a rebellion that netted them two seats on the board -- and ultimately helped improve the company's bottom line.

But most revolts don't go anywhere: in 2005, for example, more than 55% of Halliburton's shareholders, upset about the huge golden parachutes that were being given to departing executives, passed a rule that required shareholder approval for large corporate severance packages. However, despite the majority in favor of the proposal, Halliburton's (HAL) board of directors refused to enact the change.

Three years later, the Rockefeller family led a shareholder revolt at Exxon (XOM) the company that John D. Rockefeller started. Their campaign, which was aimed at increasing renewable energy investments, received a large number of shareholder votes, but was ultimately unsuccessful.

Buying an Election

One major reason that these campaigns failed is because shareholders don't really have any direct say in corporate governance. Nell Minow, editor and chairwoman of The Corporate Library, points out that under SEC laws, shareholder resolutions and other advisories to the board cannot directly address a company's actual business. For example, BP (BP) shareholders cannot advise the company to stop drilling in the Gulf of Mexico. More importantly, shareholder proposals are only advisory, which means that the board of directors is permitted to completely ignore them.

To get a real voice in corporate governance, angry shareholders need to elect members to the board of directors. But elections are strongly skewed in favor of the status quo. To begin with, campaigners must get hold of shareholder lists in order to send out ballots, yet even this relatively minor first step generally requires an expensive courtroom battle. Having passed that hurdle, dissidents then have to print and mail millions of ballots, hire proxy solicitors to convince large stockholders, and take out newspaper and magazine ads to sway stockholders into voting their proxies rather than throwing them away.

According to Minow, these campaigns can cost upwards of $15 million, which means that few individuals can privately fund them. On the other hand, institutional investors like pension funds are often legally barred from spending shareholder money on company elections. For boardrooms, this is effectively a ticket to autocracy, as only extremely deep-pocketed independent investors like Norman Peltz can challenge the rule of the board of directors. What's more, corporations attempting to fight these insurgencies have access to their company's full treasuries, putting them in the odd position of using shareholder funds to fight against shareholder campaigns.

Enter the SEC

Under the new shareholder access rule, this playing field will be leveled, at least a bit. In many cases, dissident shareholders will no longer have to take corporations to court in order to get access to shareholder lists; with access to company ballots, the don't need to print and mail their own proxy ballots. Despite this significant change, the rest of a typical campaign -- including hiring proxy solicitors, taking out ads, and launching other promotions -- will still be expensive. For that matter, even with the rule change the corporate governance structure remains strongly skewed in favor of the status quo. After all, there aren't that many private citizens who own 3% of a company, and gathering together coalitions of long-term stockholders who are interested in major corporate change is an uphill battle.

But even if it is not the wild-eyed radical departure that The Wall Street Journal predicts, shareholder access is still a crack in the largely closed system of corporate governance. Minow puts this in perspective, noting that the law in Delaware, where many corporations are based, enables directors who run unopposed to be re-elected to their seats, even if they only receive one vote. This has some stunning effects: as Minow points out, "Thus far in 2010, 81 directors at 47 companies have received votes of 'no confidence.' Only five have resigned." If dissident shareholders could put their own candidates on corporate ballots, these unimpressive directors would no longer be able to run unopposed, and could -- in theory, at least -- be kicked out.

To give an idea of how this would affect corporate governance, one need look no further than the unsuccessful Rockefeller and Halliburton campaigns. In the first case, the Rockefeller family was able to convince 31% of Exxon's shareholders to vote for a proposal that would limit Exxon's greenhouse gas emissions, while 27.9% voted for a proposal to increase investment in renewable energy. Although these votes were not enough to pass the resolutions, under the new SEC rule, they would likely be more than sufficient to get an energy-conscious member placed on the ballot for yearly elections. Similarly, if 55% of Halliburton's stockholders were willing to make a stand against golden parachutes, it stands to reason that they could put at least one like-minded member placed on the ballot and elected to the board of directors.

What Happens Next

The quest for shareholder access to corporate decision making is hardly new: in 1970, Charlie Pillsbury, scion of the famous flour family of the same name, tried to mount a shareholder revolt at Honeywell Corporation. His three-year battle ended with a Minnesota Supreme Court ruling that his request for access to Honeywell's shareholder roster was not "proper," meaning that the policy changes that he sought were not in the best interests of Honeywell.

Forty years later, the argument is still in use: many critics of the SEC rule change have claimed that dissident shareholders will promote irrational policies that run counter to the business interests of their companies and could cause a drop in stock value. Yet Pillsbury, now executive director of Mediators Beyond Borders and a distinguished visiting fellow at Quinnipiac University School of Law, argues that poor governance is also not in the best interests of many companies -- and can have a negative effect on shareholder value. In the case of BP, for example, he points out that "If I were a shareholder of BP, I would look at environmental responsibility issues. BP's failures as an environmental steward have been bad for business." Similarly, Target's (TGT) recent decision to fund a political group in Minnesota "has been bad for business and for employee morale."

The central critique of the new SEC ruling is that shareholders are not smart enough -- and, ironically, not invested enough -- to choose the best policies for their companies. However, over the past two years, scandals have rocked BP, Target, Hewlett Packard (HPQ), Merrill Lynch, Lehman Brothers, AIG (AIG), Halliburton, and dozens of other companies. In context, it is unclear if the professional decision-makers that stockholders pay to manage their companies are acting in the best interests of their employers.

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To chascrider - Very good post. Some posters say that if you don't like the company, don't invest. I disagree. Like with everything else, personal responsibility comes into play. Stockholder owned companies in our free market economy are vital. We are all in this together. Note the number of persons who have a significant portion of their retirement income dependent on stock investments, either directly or indirectly. I check proxy statements and for the last two years vote freely against incumbent directors for one reason or another - usually serving on too many boards (more than three), serve or have served on the board of a big financial institutions, etc. Stockholders, it is time to take our companies back from the self serving directors and top management. I am in contact with Alliant Energy regarding their policy of not prorating the annual fees paid to directors when the director does not serve a full term. Seems like common sense, right? Well, Alliant recently let a director keep a full years pay after resigning half way thru his term. That is not right! Poor judgement like this has to be brought out into the open. Directors in many respects are like politicians, they like to do things their way and don't want to be transparent about their lack of common sense fiduciary responsibilities. I thank a newspaper reporter for having initially reported this inappropriate decision by the Alliant Board. Many stakeholders are organized - big business, consumer groups, big unions, big governement, etc. Shareholders are not organized and I think we have to have some degree of cohesiveness to get our message across to the general public, hopefully, educating the general public on how investing can benefit us all, and how necessary it is for shareholders to be active and ensure directors are carrying out their fiduciary responsibilities in a prudent manner. I would like to complement the SEC on this one small step forward and also Nell Minow and her organization for the help it provides in evaluating directors' performance.

October 06 2010 at 4:45 PM Report abuse rate up rate down Reply

When did the rule change, here we go, the reason a stockholder is a stockholder is that the stockholder makes a financial investment in the company, in return, the stockholder gets a dividend, if lucky, and a vote/proxy on how the company is run for success. This basic principal changed, where was the SEC then? Asleep. the law and rule is there, the SEC just forgot to enforce it. Explains Bernie Made-off (with people's money) too!! The SEC is a complete failure. One of the reason people got out of wall street investing is because a. The CEO's grabbed all the money and power, 2. The stockholder's were left with dwindling dividends, or worthless stock (AT&T, Bethlehem Steel, Enron, Merrill Lynched ) while they watched the ceO walk away with millions , with that the confidence erroded. This is a half ditched attempt to get people to start investing in Wall Street again. NOPE I learned my lesson, I will never again invest in the market. After the the 2007 & 2008 slide into oblivion my stock portfolio was 1/2 of it's value. My neighbors was a negative. That was the red flag for me, I cashed out. And never looked back.

October 06 2010 at 1:49 PM Report abuse rate up rate down Reply

Based on a Federal law suit filed this week challenging the new rules, the SEC has stayed the implementation of the new rules. Because of the slow court calendar, we in the securities bar do not expect that the new rules will be in effect in time for the 2011 proxy season, which falls primarily in May-June 2011.

October 06 2010 at 1:45 PM Report abuse rate up rate down Reply


October 06 2010 at 1:38 PM Report abuse -1 rate up rate down Reply

This is a very small step in the right direction. As things stand now public companies are run primarily for the benefit of the officers and directors with little thought given to the shareholders, the true owners of the company. This despite the fact officers and directors have a fiduciary duty to act in the shareholders best interests. We need some class actions brought on behalf of shareholders against officers and directors of publicly traded companies who breach their fiduciary duty to shareholders every time they put their personal interests ahead of the interests of shareholders or mismanage companies. Where are the class action lawyers when you need them?

October 06 2010 at 12:05 PM Report abuse +1 rate up rate down Reply

This wasnt passed for the Shareholder, this was passed to give Unions more power on Boards and if nothing else will more than likely hurt Shareholders. Boards should have liability to all Shareholders. They are paid generously and they have to take their responsibilities to Shareholders seriously. They didnt during the 2000's which is why Boards and Management took out Billions and Shareholders got nothing. Thats what should change, not the addition of still another hungry mouth to the Board to grab what they can from Shareholders. If Corporate US isnt careful they wont have Shareholders. We can now go anywhere in the world. We dont have to stay here. Aren't ETF's a blessing.

October 06 2010 at 11:57 AM Report abuse rate up rate down Reply

Three Cheers for the SEC, shareholders will have an impact on the Ego of CEOS, If I can do it will become "Should I Do It" ? Funny how the C Corp. has been forced to be more responsive to owners and the self-serving power of Directors and CEO types who get lost in the proccess to grow and prosper. Golden Parachutes should be abolished, any candidate who mentions one will be striken from the short list...........finally !

October 06 2010 at 11:53 AM Report abuse +2 rate up rate down Reply

What can't a shareholder simply sell their stock if they are unhappy with the companies performance? To work under the assumption that stock holders can do a better job is truly flawed. I only wish that every strong company out there goes private--then we will see where the so called stock holders put their money!

October 06 2010 at 11:48 AM Report abuse -1 rate up rate down Reply