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October 2010

Investor Protection – Shareholder Nominees As Directors

By Uday Chitale
Murtuza Vajihi
Chartered Accountants
Reading Time 4 mins

Accountant Abroad

A new rule in the US makes
it easier for minority investors to remove

profligate and ineffective board

We have witnessed in recent
times how SEBI has been introducing measures to regulate market players in its
quest to protect small investors. There has been some speculation that the
regulator may introduce provisions to force companies to appoint directors
representing small investors and employees. In this context the following report
on the fallout of a new SEC ruling allowing investor nominees for board
positions makes interesting reading.

The Securities and Exchange
Commission, the US securities market regulator, recently voted in favour of a
proposal that requires companies to put candidates nominated by investors on the
proxy statements sent to stockholders before director elections. Such candidates
can be put up by investors or groups that will be eligible to offer nominees.
The new regulations will let investors owning 3% of a company nominate directors
on corporate ballots, a step that may help shareholders oust board members
accused of non-performance and a failure to boost shareholder value.

The SEC acted in response to
investor complaints that company-selected directors failed to rein in
compensation and risk-taking that led to more than $ 1.79 trillion of writedowns
in the financial sector during the credit crisis. Business groups, including the
US Chamber of Commerce, have fought the change, arguing that labour unions and
pension funds will misuse the threat of proxy fights to seek concessions that
would harm companies.

SEC chairperson Mary
Schapiro said before the vote : “These rules reflect compromise and weighing
competing interests; as with all compromises, they do not reflect all the views
of any one person or group. They are rational, balanced and necessary to enhance
investor confidence in the integrity of our system of corporate governance.” The
SEC has considered permitting so-called proxy access since 2003, only to back
away in the face of opposition from corporations and concern that the agency
would lose a law suit.

The Chamber of Commerce, the
nation’s biggest business lobby, is weighing the possibility of filing a
lawsuit. The organisation had worked with Washington-based lawyer Eugene Scalia
about a year ago to analyse the SEC’s rule-making process on the matter.

“Using the proxy process to
give labour unions, pension funds and others greater leverage to try to ram
through their agenda makes no sense,” David Hirschmann, chief executive officer
of the Chamber’s capital markets unit, said in a statement. The business lobby
“will continue to fight this flawed approach using every method available.” he
said. Scalia, a partner at Gibson Dunn & Crutchei; has won suits against the SEC
over rules for mutual funds and fixed-indexed annuities on the grounds that the
agency made procedural missteps in writing regulations.

Under the SEC’s proxy access
rule, shareholders will be able to nominate at least one director and as much as
25% of a company’s board. Investors will be required to hold the minimum amount
of stock at least through the date of the election, and couldn’t use the rule if
they hold the shares for the purpose of changing control of the company.

“Smaller reporting
companies” with less than $ 75 million in market capitalisation will be exempt
from the rule for three years, the SEC said. Nominating dissident directors
previously required that shareholders mail a separate ballot with the names of
competing candidates and persuade other investors to vote along with them.
Activist investors such as Carl Icahn and Nelson Peltz have waged proxy fights
to get their candidates elected to boards of companies they said were

Various institutional
investors and the bodies representing pension and labour funds have opined to
the effect that the process was time-consuming and too expensive for all but the
wealthiest shareholders. One of the lessons of this current economic downturn is
to be mindful that governance is a significant risk factor and the new
regulation that affords greater accountability will go a long way towards
mitigating that risk. However, the rule won’t necessarily cut costs for
investors because of filing requirements the SEC has mandated. The legal costs
for meeting the process may ultimately be as much as the printing costs sought
to be avoided.

As for possibilities of
litigation arising out of the new rule, one view is that the SEC is susceptible
to litigation, because the rule doesn’t allow shareholders to reject proxy
access if they don’t want it or set “different parameters for ownership
thresholds and holding periods”. There is room for a very serious legal
challenge on the grounds that the rule is internally inconsistent. It will be
interesting to see how investors respond to the new opportunity handed out to

(Source :Bloomberg/Financial Express, 30-8-2010—
excerpted & edited report)

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