July 16, 2015

Our Mini-Theme: Corporate Governance Challenges Beyond Board/Management Structure

Holly J. Gregory

The Corporate Governance Committee of the ABA’s Business Law Section presents three articles in this issue of Business Law Today. While the board/management relationship has received considerable attention in the past decade, corporate governance questions also include shareholder, creditor, and internal board matters, which these articles address. 

The mission of the Corporate Governance Committee is to promote and support effective corporate governance, domestically and internationally, for business and nonprofit enterprises by (1) developing resources and providing thought leadership; (2) creating networking opportunities; and (3) facilitating a forum for the exchange of legal and practical information and insights on emerging governance and governance-related policy issues for the benefit of attorneys, including both outside and in-house counsel, and other governance professionals. 

A few decades ago, most lawyers and clients might have considered the practice of corporate governance to consist of little more than ensuring that the company’s minute book was up to date. The board of directors – often a hand-picked group of the CEO’s friends and allies who could be relied upon to approve the CEO’s actions – was considered to be decorative but useless, like “parsley on fish.” 

A few major corporate collapses later, and the painful loss of billions of dollars of shareholder wealth later, the importance of good corporate governance processes was made clear to shareholders, boards, managements, and policy makers. 

The 2002 Sarbanes-Oxley Act (and the CEO/board chair disclosures required in the 2010 Dodd-Frank Act) targeted governance practices and structures to promote board independence from management, with the goal of promoting the independence of the board from management so as to reduce the likelihood that management would undertake risky or self-interested choices that could harm the company. 

Over the past decade, there have been increasing efforts by shareholders to promote additional board independence practices. Matters initially promoted as shareholder proposals, such as shareholder approval of executive compensation or the requirement for a director to get a majority vote in board elections, are now legally required or generally accepted. 

Through the collective efforts of large institutional investors, including public and private pension funds, shareholders at a number of companies are likely within the next several years to gain the power to nominate a proportion of the board without undertaking the expense of a proxy solicitation. By obtaining proxy access (the ability to include shareholder nominees in the company’s own proxy materials), activists and other shareholders will have an additional weapon in their arsenal to influence board decisions. 

While proxy access has been the subject of shareholder proposals for several years, 2015 appears to be a turning point, with a significant increase in shareholder proxy access proposals and the negotiation and voluntary adoption by companies of proxy access. 

Although proxy access initiatives have had limited levels of success in prior years, shareholder support increased in 2015 as proponents began to focus on the three percent ownership threshold and three-year holding requirement first promoted by the SEC (the “three percent/three-year standard”). The three percent/three-year standard had been adopted in an SEC rule in 2010. That rule was overturned by the U.S. Court of Appeals for the District of Columbia Circuit, which found procedural errors in the SEC’s adoption of the rule. 

In 2015, public pension funds, encouraged by major investors such as TIAA-CREF and their industry group, the Council of Institutional Investors (CII), undertook an initiative to promote proxy access. As a practical matter, that initiative was reinforced in 2015 by proxy advisor policies that discouraged corporate efforts to defend against proxy access proposals, and by the SEC staff’s decision to withdraw from providing no-action relief where a company offered its own competing proposal.

  • The article, “Recent Developments Related to the SEC’s Shareholder Proposal Rule,” by Elizabeth A. Ising and Kasey L. Robinson, describes significant developments around shareholder proposals during 2015, including the SEC staff’s choice not to weigh in on the ability of a company to exclude competing shareholder proposals.

It remains to be seen what impact the implementation and operation of proxy access will have on corporate governance. At companies where proxy access is adopted, boards and management may become more focused on the quality of shareholder relations, communications, and engagement, in an effort to avoid the imposition of one or more proxy access directors. 

Absent a proxy contest or proxy access nomination, a board has the opportunity to ensure that its composition is aligned with its view of what the company needs for effective oversight. This is not a simple matter given the mosaic of skill sets, experience, and diversity that is needed on a board. There is, however, the potential for tension between the independence goals of proxy access and the goal of optimizing the board’s mix of directors. 

An elected proxy access director will owe the same fiduciary duties as the other directors, though some may view proxy access directors as potentially having an allegiance to the nominating shareholder’s interests. Depending on the circumstances, there may be a greater risk that the proxy access director is viewed by the rest of the board as an outsider or even an adversary.

  • The article, “Overcoming the Challenge of Director Misconduct,” by Elizabeth M. Dunshee, Jayne E. Juvan, and Christian Douglas Wright, discusses the issues that arise when a member of the board disrupts the board’s operations. 

In addressing corporate governance questions, the ultimate goal is to promote and maintain the health of businesses. When a company encounters financial distress, however, the board’s fiduciary duties may expand beyond the basic obligation to shareholders.

  • The article, “When the Tides Turn: Fiduciary Duties of Directors and Officers of Distressed Companies,” by Monique D. Hayes, discusses the duties of a board as a company enters the “zone of insolvency.”

Additional Resources

For other materials on this topic, please refer to the following. 

Business Law Section 2015 Annual Meeting 

Program: Shareholder Proposals in 2015 and Beyond

Thursday, September 17, 2015, 10:30 AM – 12:00 PM
Presented by Corporate Governance. Co-sponsor: Federal Regulation of Securities

Program: Board of Director Composition: Before, During and After a Bankruptcy

Friday, September 18, 2015, 8:30 AM – 10:00 AM
Presented by Corporate Governance. Co-sponsor: Business Bankruptcy

Program: International Developments with Respect to Shareholder Rights and Implications for U.S. Companies

Saturday, September 19, 2015, 2:30 PM – 3:30 PM
Presented by Corporate Governance. Co-sponsor: Federal Regulation of Securities 

ABA Web Store

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General counsel are being called upon to advise their upper management on matters far beyond the traditional suite of issues. This In the Know CLE program, Hot Corporate Governance Issues Facing General Counsel, provides an overview of the current landscape of corporate governance issues facing general counsel.

Holly J. Gregory

Holly J. Gregory
Chair, Corporate Governance Committee