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Hedge Funds Can’t Mess Up Worse Than Bob Rubin

Date: Friday, November 13, 2009
Author: David Reilly, Bloomberg.com

One of the amazing things about attempts to overhaul the financial system is that some fixes are so simple and obvious, yet still so difficult to enact.

A prime example is buried deep within the 1,136-page, financial-reform legislation unveiled this week by Senate Banking Committee Chairman Christopher Dodd. It is a proposal to let shareholders nominate directors to corporate boards. The draft bill goes on to say votes for these positions shouldn’t resemble a Soviet-era election.

This isn’t radical stuff. Shareholders are the owners of companies and it is high time they have a greater say in how they are run. For years, though, corporate executives and their supporters have beaten back attempts to make boards accountable.

It’s a fair bet that the proposals contained in Dodd’s draft, as well as similar amendments to a House reform bill, will face a fight.

Opponents will raise old arguments that greater shareholder democracy only enables greedy hedge funds, speculators and special-interest groups with environmental or union affiliations to storm the corporate barricades.

Never mind that corporate boards as we know them were willing accomplices in the mismanagement and fraud that led the financial system and economy to the brink of ruin. Directors sleep-walked through meetings, lavished CEOs with outsized pay and perks, and failed to take heed of the risks building up on their watch.

Rubin, O’Neal

When things started to blow up, top executives pulled the rip cords on their golden parachutes, directors skulked away and taxpayers were saddled with the losses. The tenure of former Treasury Secretary Robert Rubin as a director and senior counselor of Citigroup Inc., and the forced but lucrative departure of Stanley O’Neal as CEO of Merrill Lynch & Co., are but two examples.

Meanwhile, shareholders can do little about the sorry state of affairs in America’s boardrooms. Proposing directors to oppose management’s pals involves long, costly proxy battles. And there is usually no way to vote against a director running for re-election; withholding a vote usually doesn’t do anything.

That needs to change. The proposals in Dodd’s legislation are a start, even if some are timid. The draft, for example, doesn’t require companies to split the roles of chairman and CEO. It only calls on them to explain why they don’t.

Say on Pay

Nor does his plan give shareholders much muscle in trying to limit executive compensation. Investors would be given a so- called say on pay through a vote, yet their decision wouldn’t be binding on the company.

Still, the legislation may give the Securities and Exchange Commission legal cover to go ahead with proposals it is considering regarding director elections. Previous SEC attempts on this front have faltered, in part, due to threats of legal challenges to the agency’s ability to enact federal corporate- governance rules that may supersede state laws.

Dodd’s bill also requires that directors receive a majority of votes cast. As things stand, directors often only need a plurality. This means a director can be re-elected with just one vote if other shareholders exercise their only other option, to abstain.

Getting Riled

This isn’t earth-shattering stuff although it does get some folks riled up. The SEC has received hundreds of comment letters in response to its own proposals.

Yet those don’t let just any shareholder start meddling in boardroom affairs. The SEC would require that shareholders looking to nominate directors hold a certain percentage of stock depending on the size of the company. Shareholders also would have to show they have owned stock for a period of time, say one year. Nor could shareholders take control of a board.

One caveat: while requiring the SEC to take up the issue of giving shareholders greater say over directors, the Dodd bill doesn’t set minimum requirements for what the agency ultimately adopts.

In spite of the common-sense nature of these proposals, supporters of the present dysfunctional system still argue that the changes will ruin American business.

A memorandum on the legislation prepared by lawyers at Wachtell Lipton Rosen & Katz, and posted in part on a Harvard Law School corporate-governance blog, argued that giving shareholders greater say over boards will only increase short- term pressures on companies from “shareholder activists and hedge funds.”

Another argument is that the federal government shouldn’t override state laws. Funny how the folks who don’t want the federal government big-footing states in this regard tend to be in favor of pushing states aside when it comes to regulating banks or insurers.

Couldn’t Be Worse

Here’s something else to consider. Let’s say opponents of greater shareholder democracy are right. And let’s assume that hedge funds and union-backed pension funds run amok, dictating that boards hew to short-term profit goals or ideological agendas.

Would they actually do more damage than has already been inflicted by imperial CEOs backed by obsequious and crony-filled boards? At last count, the U.S. has lent, spent or guaranteed almost $12 trillion to keep banks, Wall Street and the economy afloat, according to the latest Bloomberg estimates.

Even the hedge-fund hordes supposedly waiting to swarm corporate boards won’t stick taxpayers with that kind of bill.

(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)

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To contact the writer of this column: David Reilly at dreilly14@bloomberg.net