As Financial Reform Looms, Directors Ponder Implications

As efforts to revamp U.S. financial regulation move closer to the finish line, a panel of current and former Securities and Exchange Commission officials recently offered their thoughts on what the new regulatory landscape will mean for corporate board directors.

A House-Senate conference committee began work last week to reconcile the differences in the financial reform legislation passed by both chambers. Lawmakers have said they hope to wrap up work on the final bill in this month, so it can be signed into law before the July 4 holiday.

Much of the debate surrounding the sweeping reform bill has focused on large issues, such as consumer protection, the so-called “Volcker rule” to ban some financial institutions from proprietary trading, and regulation of over-the-counter derivatives. But that aside, the legislation still has profound implications for corporate boardrooms as well, according to the panel of SEC officials, who spoke June 8 at a conference hosted by the National Association of Corporate Directors.

Atkins

In combination with other recent developments, such as the increased power of proxy advisory firms, the adoption of majority voting to elect directors, and the ban on broker-dealer votes in director elections, the result is “truly a sea change in the relationship between shareholders and their corporations,” said former SEC commissioner Paul Atkins, now a managing director of Patomak Partners, a compliance consulting firm.

Richard Roberts, another former SEC commissioner who served in the early 1990s, said the risk-management duties of board directors “is going to be vastly different. You’re supposed to be able to see what’s coming down the road.”

Exactly which governance provisions will make it into the final legislation remains unclear, but the most significant of them are:

a provision re-affirming the SEC’s power to require companies to give shareholders access to the proxy statement;

another requiring the SEC to set rules that allow companies to claw back executive pay based on inaccurate financial statements;

non-binding shareholder advisory votes on executive compensation;

a majority-vote threshold for directors running in uncontested elections.

None of those concepts are particularly new; the good-governance crowd has wanted all of them for years. A federal mandate imposing them across all public companies, however—that’s news.

Nazareth

“There is potentially a fair amount of hard coding in the legislation, with respect not only to provisions that would apply across the board to companies large and small, but also regulation being imposed without regard to what will be done across the Atlantic,” said former SEC Commissioner Annette Nazareth, a partner in the law firm Davis Polk & Wardwell.

For directors, Nazareth said the combination of majority voting and the broker-vote ban together “could be significant.”

“Some people are more concerned about the majority vote provision than proxy access because of the practical implications of getting a vote.”

—Annette Nazareth,

Partner,

Davis Polk & Wardwell

“Some people are more concerned about the majority vote provision than proxy access because of the practical implications of getting a vote,” she said.

Atkins also worries about the majority-vote rule. “It actually will cost money to try to put someone on the ballot,” he said. “It’s basically a ‘Just say no’ campaign. It’s much easier and cheaper now to selectively rally institutional investors to make changes.”

The panelists (like most people) also expect the SEC to pass some form of shareholder proxy access as soon as Congress gives the agency legislative cover to do so. The Commission already has one proposed proxy-access rule sitting on the sidelines, presumably awaiting Congressional action to prevent legal challenges promised by an unhappy business community.

Chairman Mary Schapiro said as much last week, in public remarks she made during a speech in Washington. Schapiro said she’s committed to bringing a proxy-access proposal to a vote before the full Commission “within a timeframe that would put the rules into effect for the 2011 proxy season.” That most likely means a vote by the end of this year.

When proxy access does happen, Nazareth predicted that the SEC staff “will be very busy for many years answering questions about it.”

The provision related to clawback policies also “could be pretty prescriptive and problematic” for boards, she said.

Broader Reforms

Nazareth noted that the integrity of the proxy voting process will also get more scrutiny when a promised SEC concept release on “proxy plumbing” issues arrives. The timing of that release is hazy; it was due out during the first half of this year. At an event last week, Meredith Cross, director of the SEC’s Division of Corporation Finance, said that the Commission likely won’t publish specific rule proposals—which come after a concept release is published and feedback reviewed—until 2011.

Breheny

Brian Breheny, deputy director for legal and regulatory policy at Corporation Finance, said at the NACD panel that the SEC staff has nearly finished its study of the issues to be addressed in the concept release. Those topics include shareholder communications, the role and regulation of proxy advisory firms, companies’ ability to communicate with investors, the accuracy of voting results, and ways to improve investor participation. The release would seek input on those issues, but wouldn’t be a rulemaking proposal.

Breheny encouraged directors to “rethink the traditional responses to requests by shareholders to participate more fully in the governance of companies.”

“Don’t board members want to talk to shareholders?” he asked, questioning the need for recent staff guidance on Regulation Fair Disclosure.

Breheny was referring to a Compliance & Disclosure Interpretation the SEC published June 4, issued in response to a recommendation by an SEC investor advisory committee to address complaints that some companies were using Reg FD as an excuse to avoid engaging with shareholders.

The guidance clarifies that Reg FD, which bars the selective disclosure of material non-public information, doesn’t prevent directors from speaking privately with shareholders.

“Reg FD was never intended to stand in the way of those conversations,” Breheny said. “Are people using the reg as an excuse? Are you OK with that?”

He also questioned why some boards are fighting shareholder say-on-pay proposals, noting that the SEC received 24 requests from companies last proxy season to keep such proposals off the proxy statement. “Are board members really against giving shareholders a non-binding vote on executive compensation disclosure?” he asked.

Pointing to controversy over recent changes to require companies that take government bailout money to hold say-on-pay votes and to ban broker-dealer votes in director elections, Breheny said: “I understand that the final chapter on these changes hasn’t been written yet, but the initial impact doesn’t seem to be as dire as people predicted.”

Atkins criticized a provision in the legislation that would create an Office of the Investor Advocate within the SEC, which he said would push unions’ governance wish lists, not investors’ interests.

The “stuff coming out of Congress doesn’t really focus on why we got into the financial crisis in the first place,” Atkins said. “None of it had to do with corporate governance. It’s more of a union agenda and what the SEC is pursuing.”

That sentiment was echoed by Alabama Republican Rep. Spencer Bachus. Speaking later at the same event, he cautioned that the legislation will have “unforeseen consequences and collateral damage.”

If the governance measures in both bills are incorporated in the final version of the legislation, Bachus said investors “with the narrowest agendas and the loudest voices will rule the day, and corporate law will be federalized.”

Bachus told Compliance Week that a Supreme Court ruling on the constitutionality of the Public Company Accounting Oversight Board—which is due any day now—“may be one of the last opportunities we have to take a deep breath and not take some of the radical measures contained in the legislation.”

“I am hopeful that the Supreme Court will say Congress has over-reached,” he said.