Proxy Access: Be Sure Your Board Is Ready

Last week, the Securities & Exchange Commission handed down its long-anticipated decision on the proxy access proposal. The new rule enables a group of shareholders who have held 3 percent of a company's stock for at least three years to nominate board members, so long as the shareholder slate would not end up replacing 25 percent or more of the current board. While legal challenges to the new rule still lie ahead, nominating and governance committees of U.S. public companies need to consider the practical implications of proxy access on the composition and functioning of their boards. Excepting an exemption for smaller companies, which have been given a three-year hiatus before the new provision applies, the rule will be in place by the proxy season of 2011. Here are some practical considerations that may help boards get ready:

Address evident gaps in board composition. Last year's proxy disclosure rules forced companies to outline the reasons why each director was being nominated; specifically what background or expertise each brought that was deemed useful to a board's makeup. For many boards, the focus of this exercise was simply to engage legal experts in wordsmithing a renomination rationale for current directors, rather than addressing gaps in board composition itself. Some obvious composition issues that can attract both shareholder activist and media attention include:

lack of outside directors with industry experience;

lack of chief executive officer or senior executive experience at a public company of similar complexity to your own;

no international directors on a board with significant global operations; and/or

a situation where it has been several years since a new director graced the board table.

If your board has these or similar issues, the time to address them is now—not when a 3 percent shareholder comes knocking at your door next spring with a board nominee. For example, if you have minimal industry expertise on your board, adding one or two new board members in the next few months puts your board in a far better position in the event that a shareholder decides to use the proxy access provision to put forward a candidate with an industry background. Taking this step can't prevent a 3 percent shareholder from putting forth a candidate under the new rule. It does put your board in a better negotiating position with shareholders and in defending your slate of candidates should the matter come to a vote. An institutional investor that sees you've recruited capable board members to fill obvious gaps and strengthen the board may even cross you off the target list and focus on another company.

Since I began writing this column three years ago, I have been contacted almost weekly by people asking how to go about serving on public company boards. These are seldom mid-level managers, academics, or disillusioned lawyers seeking a second career in the boardroom. They are nearly all current and former CEOs, chief financial officers, and other C-suite executives at both large and mid-cap companies. Many have never before served on a public company board and they complain of being "screened out" by search firms that claim their board clients are unwilling to nominate first-timers. Spencer Stuart's 2009 Board Index bears out this phenomenon, noting that less than 20 percent of director positions filled last year in the Fortune 500 went to first-time directors.

The upside, however, is that nominating committees willing to go beyond the conventional director pool and put more effort into finding and mentoring a new board member who has never sat "on the other side of the board table" have significant opportunities to find terrific new directors—and to bring on active executives, who are often a welcome addition to a board primarily comprised of retirees.

Revisit your director orientation program. Whether you choose to address board composition proactively or are forced to react to a shareholder candidate, the bottom line is that proxy access is likely to result in new directors entering the boardroom. As such, nominating/governance committees would do well to revisit their director orientation programs. Regardless of how a new director joins your board, he or she will be in a better position to contribute to board discussions and decisionmaking after getting a comprehensive orientation about the company, its business, competitive landscape, and people.

Learning about a new company, especially if a board member comes from outside the industry, can be challenging. Fortunately most companies have moved past the practice of handing new directors a binder and instructions to show up at the next board meeting. A full day or two at company headquarters meeting with the CEO and other executives is now the norm. While this is always a good idea, it can be somewhat overwhelming for a new director.

For this reason, many boards are now dividing director orientation into two phases: An initial session either before or just after directors attend their first meeting is followed by a second session six to nine months later. The follow-up session is valuable because new board members have by then had a chance to pursue a learning curve. They will often have different questions at this stage than at the outset, yet they'll still find it valuable to have a private day of orientation to ask those "dumb questions," exploring answers in detail rather than spending time on them during a board meeting.

Be sure to include site visits in your orientation program if your business lends itself to this practice. Touring a plant, spending an afternoon in a franchise operation, or visiting research labs can provide a far greater sense of the business to any new director than could months of PowerPoint presentations in a boardroom.

Even if proxy access doesn't become an issue for your board, reviewing board composition—identifying gaps and taking steps to identify candidates to fill them—and updating your director orientation program can still be a valuable exercise for your nominating/governance committee. Doing these things will not only put you in a better position to respond if a proxy access proposal comes forward, it may inspire some excellent ideas your board will want to explore in any event.

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