SEC Lets Shareholders Act Like Owners – To A Point

A new rule that gives public company shareholders the power to nominate their own directors is not going to turn boardrooms into union halls, nor is it going to revolutionize corporate governance.

A best-case scenario is that making directors more accountable to shareholders will finally put a brake on senior-executive compensation, which has spiraled out of control for two decades. This is not to say that talented managers of large, complex enterprises are not worth a lot of money; clearly, they are. But too many corporate compensation schemes divert profits from shareholders, who bear all the financial risks of ownership, to managers, who are ultimately contributing their time and effort just like any factory worker.

Does $50 million buy a more-capable CEO than $10 million? If it doesn’t, then shareholders of a company that awards a $50 million compensation package to its chief executive are being overcharged. Those shareholders deserve a chance to put more-diligent directors on their board. This is doubly true if a company’s compensation package encourages managers to risk the enterprise’s long-term financial stability in pursuit of short-term gains and spikes in the stock price that can make gigantic paydays possible.

Though reining in runaway compensation is a best-case scenario, I suspect that the new rule will more often have no significant impact, either on the makeup of a corporate board or on the way companies are actually run – even in cases where some old stalwarts are removed and new faces are added.

Yet the new regulation, which the Securities and Exchange Commission recently adopted on a 3-2 vote, has generated controversy far more intense than the modest results it is likely to produce might suggest. The SEC merely allows investors or groups of investors, who own at least 3 percent of the company’s stock for at least three years, to nominate candidates for up to 25 percent of a board’s seats. It does not permit investors to replace a majority of directors in a single election, nor does it ensure that any new directors are actually going to be elected.

It’s hard to see what all the fuss is about. The SEC is merely taking a small step toward allowing the people who own a company to actually have a voice in how it is run. Walter Van Dorn, a corporate lawyer with Sonnenschein Nath & Rosenthal, pointed to the 3 percent for 3 years rule as the primary reason companies shouldn’t be alarmed. “That’s a lot of stock and a lot of money. You’d have to be a pretty serious shareholder to begin with,” he recently said to the Los Angeles Times.

Yet David Hirschmann, who heads the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, complained that “Using the proxy process to give labor unions, pension funds and others greater leverage to try to ram through their agenda makes no sense.”

The executive director at the Millstein Center for Corporate Governance at Yale University’s School of Management, Stephen Davis, is one of several observers who has argued that the SEC’s new rule, in conjunction with its decision to give investors a vote on the level of their CEO’s pay, may push the U.S. toward a business model closer to that of the U.K. He says the vote on pay itself isn’t as important as the fact that the arrangement stimulates communication between boards and investors.

Davis also said that, at least in the U.K., the system seems to lead to salaries more closely aligned to performance. “There is less pay for failure there,” he observed.

A court challenge to the SEC’s decision is still possible. But the agency’s position was strengthened by the financial regulatory overhaul legislation that President Obama signed this summer. That law specifically authorized, though it did not require, the SEC to empower shareholders to nominate directors.

In the end, a system in which management is accountable to the board of directors and the board is accountable to shareholders will lead to companies that are, if not better managed, at least managed the way their owners want. That ought not to be a controversial proposition.

About Larry M. Elkin 534 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

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