Houdini could teach the SEC a thing or two. Yes, the great magician is dead; but, then again, so is the SEC’s draft proposal on proxy access. Or, at least it soon will be, given its convoluted triggers, heavy lobbying against it by the business roundtable, a threatened lawsuit should the SEC go ahead, and—most importantly—the unwillingness of investors with capital at risk to wait for it.

While alive, however, both Houdini and the proposal were masters of misdirection: the art of making the audience look in one direction while the action happened elsewhere.

Two-Headed Red Herring

Proxy access may be the single most controversial issue pending before the SEC.

The crux of the matter is simple—should shareowners be able to nominate directors directly on the company proxy?

Some shareholder activists point to the board’s role as fiduciaries for shareholders and say, “Of course; the principles of shareholder democracy demand such representation.” Most corporate officials, on the other hand, look at the functioning of boards and say, “Of course not; the need for long-term thinking requires directors to be insulated from political pressures.”

However, the SEC’s cumbersome proposal—known officially as Rule 14a-11—is not just a red herring, but a two-headed one.

First, it attracts attention to the regulator rather than the market: the SEC is only a rule-making body, and interested observers would be better served by paying attention to the action on the field, than to the referees.

Second, it focuses the discussion on how directors are placed into nomination, rather than how they’re elected. That’s what astute, plugged-in shareholder and corporate players now are battling over, since—in the end—that’s what truly matters.

Directors at U.S. corporations are elected via plurality, not majority. As long as one vote is cast for a director, he or she is elected, even if 99 percent of the shares vote against. That doesn’t sit well with shareowners, who like true majority elections; in fact, majority elections are the rule in most other markets around the world. Truth be told, justifying non-democratic elections discomforts corporations as well, but they believe that foreign markets don’t have the same number of takeovers and litigation. Given that, they worry that unbridled democracy might be misused by special interests in ways unknown in other markets.

Market-Based Developments

The SEC can’t directly regulate corporate elections, which are a matter of state law. Rather than wait for the SEC, institutional investors are thinking about direct action at targeted companies. At a recent conference sponsored by the State of Delaware and the International Corporate Governance Network, various shareholders publicly wondered if a demand to amend corporate bylaws to adopt the 50 percent threshold should be an arrow in their quiver in 2005. Delaware Vice Chancellor Stephen Lamb confirmed that a bylaw requiring directors be elected by 50 percent of the shares voting was legal under Delaware law.

In fact, the United Brotherhood of Carpenters and Joiners introduced 14 such shareholder proposals in 2004, according to the Investor Responsibility Research Center. Those resolutions garnered votes as high as 18 percent—a healthy percentage for a new issue, given that institutional owners often need to see an issue for a few years until they gain comfort and amend their proxy voting guidelines to vote for it.

Nor is the majority vote resolution the only tactic in the battle over who gets to select and elect directors.

Nell Minow, editor of The Corporate Library, argues that “the single most important [corporate governance] development” in 2004 was the agreement between Marsh & McLennan and four major pension funds to appoint former U.S. District Attorney Zachary Carter to Marsh & McLennan’s board. Coming in "close second" was the recent announcement that a subsidiary of AIG will give discounts on director and officer liability insurance to companies given a clean bill of health by Kalorama Partners, the consulting firm run by former SEC Chairman (and Compliance Week columnist) Harvey Pitt.

“Those two purely market-based developments will have greater effect than anything the SEC could have done,” to change the dynamics of director elections, Minow argues. “With or without the rule, changes are happening. The mechanisms for choosing directors will be permanently different.”

John Wilcox, vice chairman of Georgeson Shareholder Communications, also argues that the marketplace, not the SEC, was where the action was, is, and will be. As reported by Compliance Week throughout the year (see box at right), shareowners effectively used “just vote no” and “withhold” campaigns to create change in corporate boardrooms.

And Wilcox said he expects more such efforts in 2005. “These campaigns are exempt—the shareholders are not seeking proxy voting authority, so generally do not have filing requirements. [It’s the] ability to wage guerilla warfare, which is highly effective as a tactic, while management is forced to walk in lockstep with all the SEC requirements.”

While Wilcox refused to cite specific cases, Roy Disney and Stanley Gold used such tactics last year at Disney. It’s not a coincidence that Disney now has a new chairman and a timetable for a new CEO.

Somehow it seems appropriate that Disney–the “magic” kingdom–is the poster child for reality trumping illusion, as far as corporate director elections are concerned.

And there’s a lesson in that for corporate executives: The increased institutional investor focus on how directors are nominated and elected is reality. Executives should face it head-on, rather than fall prey to classic SEC misdirection; that is, waiting for the Commission to issue a rule, or hoping it goes away.

The truth is that the SEC lacks Houdini’s gifts. The master illusionist, for example, still has true believers awaiting his return from the grave some three quarters of a century after he died. But key corporate governance players are ignoring the SEC’s 14a-11 proposal and moving on to what really matters, even before it’s officially pronounced dead.

This column solely reflects the views of its authors, and should not be regarded as legal advice. It is for general information and discussion only, and is not a full analysis of the matters presented.

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