Commentary: A Fighting Chance for Boardroom Democracy

The SEC is examining ways to give investors more of a say. That could help curb directors' abuses of power

The ritual is as much a rite of spring as baseball opening day. Boards nominate director candidates and shareholders dutifully vote for them. Sure, in a handful of cases, shareholders withhold their votes to express displeasure. But the incumbents rarely take the hint and leave. And, short of a messy and expensive proxy contest, it's nearly impossible to get rid of a director except in the most egregious cases.

Corporate executives and directors may be about to get a nasty shock. As part of a broad review of the proxy process, the Securities & Exchange Commission is considering ways to shore up boardroom democracy -- and allowing investors to more readily nominate and vote for their own candidates is suddenly on the table. "This is direct democracy," says John C. Coffee Jr., a law professor at Columbia University. "I think corporate managements are very worried."

The SEC, deeply divided over the issue, aims to have an initial proposal by July 15. Big shareholders aren't waiting around to submit their own ideas. The AFL-CIO, for example, suggests that shareholders be allowed to nominate board candidates alongside official nominees on the proxy. But it won't be an easy fight. Not only is Corporate America against the shift, for 60 years the SEC and Congress have opposed giving shareholders more clout.

But this time around, the SEC shouldn't balk. The disasters at Enron (ENRNQ ) WorldCom, and elsewhere happened in part because of directors' failure to properly play their oversight role. Democracy in the boardroom could lead to more effective corporate governance by forcing directors to be more accountable -- something recent reforms have done with only limited success. Allowing shareholder nominees on proxies could ensure that those who shirk their duties would face real consequences. For example, directors might think twice about giving an undeserving CEO a bonus if a shareholder nominee was waiting in the wings.

To understand why change is so long overdue, consider how the system now works -- or doesn't. Investors who don't think directors are doing their jobs have two choices: spend millions on mailings and legal fees in a proxy fight or accept the same old faces around the boardroom table. And forget about getting boards to take shareholder resolutions seriously. Even if one wins a majority vote several years running, directors usually ignore it.

Under the AFL-CIO proposal, the most detailed so far, board critics would be able to get their candidates on the ballot. Shareholders or groups with at least a 3% stake would be permitted to nominate candidates for no more than a third of the directors standing for election. Those candidates would automatically go on without an expensive proxy fight. Says Ann Yerger, deputy director of the Council of Institutional Investors: "It's clearly an idea whose time has come."

Trouble is, while individual SEC commissioners have publicly supported the idea of opening up proxy voting, the agency is, in fact, deeply divided over shareholder democracy. Critics within the SEC fear unintended consequences. Proxy elections would force companies to spend time and money campaigning for their nominees, for example, taking attention away from business. And since companies would have to pay for printing and distributing proxy materials for outside candidates, shareholders could theoretically use the company's own resources against it in a takeover battle. A bigger worry: Once elected, labor reps or social activists may push special-interest agendas that conflict with the broader interests of the company or other shareholders.

An SEC insider says compromises are inevitable. The 3% ownership threshold might be raised to discourage shareholders from nominating candidates on every whim, for example. "There are a number of issues to work through -- practical, legal, and philosophical," says the insider.

Direct shareholder nominations will not fix all that ails Corporate America. But SEC Chairman William H. Donaldson has an historic opportunity. In one bold stroke, his agency can give greater voice to America's frustrated investors and improve accountability in the boardroom. Your call, Mr. Donaldson.

By Louis Lavelle

With Mike McNamee and Amy Borrus in Washington

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