Board, Interrupted

New SEC rules will give investors clout with companies that ignore them

Time Warner Inc. (AOL ) dodged a bullet earlier this year when a labor pension fund sought to inject a jolt of democracy into board elections. Angered by the media giant's accounting scandals and troubled 2001 merger with America Online, the fund submitted a shareholder resolution to let investors nominate directors. Management blew it off, citing Securities & Exchange Commission rules that let companies control board contests.

Not for much longer. By next year's proxy season, Time Warner -- and a host of other targets of activists, from Lockheed Martin (LMT ) to Maytag (MYG ) -- will -- will face new SEC rules that make it easier for shareholders to get their candidates on the official ballot. "There should be some measure of shareholder participation in the selection if there is evidence that the wishes of a large number of shareholders are being ignored," SEC Chairman William H. Donaldson told senators on Sept. 30. The new rules, expected to be approved and put out for comment on Oct. 8, are potentially some of the most far-reaching post-Enron reforms. Says Richard H. Koppes, a corporate governance lawyer at Jones Day in Sacramento: "This goes to the heart of corporate power."

Challenges to official director slates will likely be rare, but the mere threat of them could weigh heavily on management decisions. Opening access to the proxy will boost the clout of institutional investors, put teeth in shareholder resolutions, and shake up sleepy boards. First casualties: poison pills and other takeover defenses that investors hate because they depress stock prices.

TRIGGER TIME. Corporate America is fiercely opposed to opening up the proxy, so the SEC is treading carefully. Under its plan, contested elections are likely to be approved only at the most unresponsive companies. The agency envisions a two-step process, requiring a trigger that shows management is ignoring shareholder wishes before activists can nominate their own candidates. A vote to allow outside nominees or a big vote against a director nominated by management would be enough. The SEC may also allow elections at companies that ignore shareholder proposals backed by majorities, votes that are merely advisory now.

Those requirements could trip up many corporate icons. Lockheed Martin Corp., for example, kept former Enron director Frank Savage even after an impressive 28% of shareholders voted to boot him off the board. Boeing Co. (BA ) has agreed to repeal only one of three antitakeover measures that shareholders have twice voted to dump. Overall, fewer than a dozen of the record 155 governance resolutions from investors passed this year have been adopted by managements, according to the Investor Responsibility Research Center.

Already, some companies are responding to the heat. Alcoa (AA ), Tyco International (TYC ), and Hewlett-Packard (HPQ ) made concessions on golden parachutes after shareholders voted to curb CEO pay. Says Carol Bowie, IRRC's director of governance research: "Ignoring shareholder votes isn't a viable option anymore." Nor is a nonchalant attitude toward selecting directors. The plan could prod companies to be more careful about whom they pick.

CEOs fear the changes will put them at the mercy of investors -- and could force them to adopt policies they don't believe are in the company's best interests. "No good director wants to run in a contested election. You would do everything to avoid it," says Henry A. "Hank" McKinnell Jr., chairman and CEO of Pfizer Inc. (PFE ) Studies show that poison pills and staggered boards result in higher takeover offers, says a top Maytag official, explaining why its board hasn't complied with shareholder votes to ditch such measures.

Business will lobby hard for the SEC to limit shareholders' ability to nominate candidates. But labor and public pension funds, on a roll after helping to topple New York Stock Exchange Chairman Richard A. Grasso, will be agitating just as vigorously for easier access. That leaves the SEC walking a fine line between empowering investors and alienating business. Shareholders will still have to clear hurdles to get their candidates on the ballot -- but they won't be running into brick walls.

By Amy Borrus in Washington, with bureau reports

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