Davis Polk & Wardwell Newsflash

Senator Schumer Proposes Key Governance Changes for U.S. Public Companies

May 27, 2009

Senator Charles Schumer recently introduced a bill, The Shareholder Bill of Rights Act of 2009, which if adopted would impose new corporate governance requirements on U.S. public companies.  Key corporate governance standards for U.S. public companies would shift from the purview of the states (primarily Delaware) to the federal government.  On its face, the Schumer bill reflects a one-size-fits-all approach to corporate governance, although the Securities and Exchange Commission has been given explicit authority to exempt certain categories of companies.  Senator Schumer views the new requirements as a way to provide a “greater voice to shareholders” and more board accountability, following what he identifies as a period of widespread corporate governance failures in the United States, especially among financial institutions.  It seems likely that whether or not adopted in its current form, the Schumer bill will generate Congressional hearings as well as public and academic commentary.  The bill’s link between failures in corporate governance and the financial crisis reflects a view held by many in Congress and among some public commentators, although parts of the bill are likely to be controversial.

The Schumer bill would leave the SEC and the listing stock exchanges with the task of drafting rules to implement its requirements within one year from the date of enactment.  It also provides the SEC and the exchanges with the ability to provide for transition and cure periods.  The provisions related to the proxy rules discussed below (“say-on-pay” and “proxy access”) would apply to U.S. listed public companies, but unlike the requirements of the Sarbanes-Oxley Act, these provisions would not apply to foreign private issuers listed in the United States.  Provisions discussed below that are not related to the proxy rules would apply to all companies listed in the United States, although the bill would allow the SEC and the exchanges to exempt issuers “based on the size of the issuer, market capitalization, public float, number of shareholders of record, or other criteria.”  This specific exemptive authority would give the SEC and the exchanges flexibility to determine the scope and breadth of these rules while figuring out how to mesh the bill’s corporate governance mandates with state law and other existing requirements.  In the past, the SEC and exchanges have used similar authority to exempt IPO companies, smaller issuers and foreign private issuers from U.S. corporate governance requirements on a temporary or permanent basis.  Many believe it would be appropriate for the SEC and exchanges to do the same here.  Given the experience of the Sarbanes-Oxley Act implementation, where the SEC refused to make exemptions from some controversial requirements, it could be useful for representatives of small-to-medium-sized companies and foreign private issuers to weigh in on the bill at the hearing stage.

Specifically, the Schumer bill would require:

“Say-on-Pay” and Approval of Golden Parachutes for Companies Subject to U.S. Proxy Rules

The Schumer bill would require a company’s executive compensation, as disclosed in its proxy statement pursuant to SEC rules, to be subject to a non-binding shareholder vote.  This would impose on all U.S. public companies a shareholder vote requirement consistent with the requirement recently imposed on institutions that participate in the Troubled Asset Relief Program (“TARP”).  In any proxy solicitation concerning a merger or similar transaction, golden parachutes and other compensatory arrangements for principal executive officers that are tied to the transaction, other than those already voted on by shareholders pursuant to “say-on-pay” in the ordinary course, would also be subject to a non-binding shareholder vote.

While it is too soon to predict the fate of the Schumer bill as a whole, this aspect of the bill seems most likely to become adopted in some form.  Legislation mandating “say-on-pay” previously passed the House and was part of Senate legislation introduced by former Senator Obama.  SEC Chairman Mary Schapiro has also expressed support for say-on-pay.  Proponents of say-on-pay shareholder proposals have been highlighting the proposal’s success at about a third of the companies that have voted on this issue so far this proxy season, causing many to argue that the momentum on this issue has shifted.  Apple conceded that legislation is inevitable in the near term, when it became the twenty-second company to voluntarily adopt say-on-pay after shareholder proposals on the topic passed two years in a row.  In addition, because TARP companies are now subject to say-on-pay, management proposals adopting say-on-pay have been included on hundreds of ballots this proxy season.

Proxy Access for Companies Subject to U.S. Proxy Rules

The Schumer bill would direct the SEC to issue rules providing shareholders with the ability to include director nominees in U.S. public company proxy statements.  Any SEC rules adopted to provide proxy access would need to require the nominating shareholder or group to have beneficially owned at least 1% of the voting securities of the issuer for at least two years preceding the company’s annual meeting.

A day after Senator Schumer introduced his bill, the SEC voted 3-2 to propose rules giving shareholders who own at least 1% of the voting securities of the largest U.S. public companies the right to include director nominees in a company proxy statement (shareholders of smaller U.S. public companies would also be given access to the company proxy, subject to a higher ownership threshold).  If the Schumer bill becomes law, it would provide specific, federal authority for a proxy access rule, overcoming the objections of commentators who have argued in the past that the SEC lacks the statutory authority to mandate proxy access.  The SEC’s current proposal meets the Schumer bill’s requirements, except that the bill would impose a stricter two-year holding period, which would benefit companies, while the SEC’s proposal contains a one-year requirement.  Although the SEC has issued unsuccessful proxy access proposals on at least two previous occasions, in light of the strong statements expressed in support of proxy access by Chairman Schapiro and two other Commissioners, it appears likely that the Commission will adopt final rules in this area regardless of whether the Schumer bill is ultimately adopted.

See the Davis Polk Newsflash discussing the SEC’s proxy access proposal applicable to U.S. companies.

Independent Chairman

The Schumer bill would also require companies to have an independent chairman of the board who has not previously served as an executive officer of the company.  Whether boards benefit from having an independent chairman is a long-running governance debate, as evidenced by the very public battles at Exxon Mobil last year and Bank of America this year.  Larger companies are more likely to have the CEO performing the chairman function and many U.S. companies argue that independent oversight of management can be ensured through other means, such as having a lead director, a majority of independent directors and/or independent board committees.  In the United Kingdom, by contrast, separation of the chairman and CEO functions is considered best practice.  In the United States, shareholder proposals mandating independent chairmen traditionally have not received majority support.  Based on preliminary results from this proxy season, shareholders have voted to adopt only three of the 11 proposals requiring an independent chairman—one of these being the proposal at Bank of America, which passed by a very slim margin.

Annual Elections

The Schumer bill would require the annual election of each member of the board of directors, eliminating the ability of companies to use a staggered board where only a portion of the board is up for election in any given year.  The existence of a staggered board is considered an important defense against an acquirer that is offering below value, which is particularly important in the United States with its dispersed ownership model, an active market for corporate control and no “takeover code” or “takeover panel” to guarantee the substantive fairness of a transaction.  As a result, this provision is likely to be controversial.  It is worth noting, however, that shareholder proposals requiring board declassification have consistently received strong shareholder support, with most S&P 500 companies already requiring annual director elections.

Majority Voting

The Schumer bill would require each director nominee in an uncontested election to be elected by a majority of votes cast.  Any incumbent director who did not receive a majority of votes would need to tender his or her resignation, which the board would be required to accept—raising the possibility that the company could be left without a functioning board.  In contested elections, directors would be permitted to be elected by plurality vote. 

Majority voting has been a hot governance issue for several years now and many larger companies have already adopted some form of majority voting as a result of shareholder pressure, arguably diminishing the need for this type of legislation.  In addition, there is a growing concern that majority voting policies will lead to disruptive board turnover when coupled with the anticipated elimination of the NYSE broker discretionary voting rules and RiskMetrics Group’s (formerly ISS) increasing willingness to wield its “against” or “withhold” recommendation on discrete issues like perquisite-related tax gross-ups for executives, as has been seen this proxy season.

Risk Management Committee

All companies would be required to establish a risk committee comprised entirely of independent directors.  The committee would be responsible for the establishment and evaluation of risk management practices.  This reflects the view that an absence of stringent enterprise risk management oversight at the board level was a governance failure at financial institutions that contributed to the current financial crisis.  Currently, U.S. public company audit committees are charged with risk management responsibility, though some argue that audit committees are already over-burdened with financial reporting and internal control compliance issues, causing risk management to receive less than due attention.  A mandated risk management committee for all types of companies goes beyond what many have suggested and is likely to be hotly debated.  Some boards may be able to form a separate risk management committee from among existing members.  However, companies with complex risk management profiles may seek additional outside directors to fulfill this responsibility, and finding a large pool of independent directors with the appropriate technical background may be a challenge.

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If you have any questions regarding this newsflash, please contact any of the lawyers listed below or your regular Davis Polk contact.

Richard J. Sandler, Partner
212-450-4224 | richard.sandler@dpw.com

Annette L. Nazareth, Partner*
202-962-7075 | annette.nazareth@dpw.com

Margaret E. Tahyar, Partner 
+33-1-56-59-36-70 | margaret.tahyar@dpw.com

Joseph A. Hall, Partner
212-450-4565 | joseph.hall@dpw.com

Michael Kaplan, Partner
212-450-4111 | michael.kaplan@dpw.com

Kyoko Takahashi Lin, Partner
212-450-4706 | kyoko.lin@dpw.com

Ning Chiu, Counsel
212-450-4908 | ning.chiu@dpw.com

Janice Brunner, Associate
212-450-4211 | janice.brunner@dpw.com


* Admission pending in DC; practicing in DC under the supervision of partners of the firm. 

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