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Boardroom Defenestration
As Proxy Season Heats Up, Companies Consider Rules To Boot Unwanted Directors
By Dennis K. Berman
The Wall Street Journal
Thursday, March 16, 2006

As annual meeting season heats up, many corporate boards are adopting rules that could make it easier to shove out unloved directors, rein in executive pay and even put companies in play for acquisitions.

The wave of rules changes -- which have already hit companies like Pfizer Inc., Intel Corp. and Motorola Inc. -- require that directors be approved by majority vote in annual board elections, which is known as proxy season.

The rules essentially give shareholders a new chance to say "no" in what has historically been a very one-sided affair.  Simply, majority voting requires that a director up for election or re-election must receive approval among the majority of votes cast in elections.  At most companies today, a director must win more votes than any other candidate.  Since most director elections are uncontested, a director can win just one "yes" vote, while the rest of votes are cast as withheld, and still win a seat on the board.  (Many shareholders, of course, never even bother to cast votes.)

"Boards were structured to be insulated from shareholders.  We're getting at that power equation," says Richard Ferlauto, director of pension and investment policy for the American Federation of State County and Municipal Employees, AFSCME, a union that has been pushing for election changes.

The shift toward majority voting shows how the corporate landscape is still changing in the wake of the financial scandals that rocked the corporate sector earlier in the decade.  Having already pressured boards to dump CEOs, scuttle merger deals, and buy back shares, shareholder activists are now looking to institutionalize their growing power in the fine-print rules that subtly guide a company's decision-making.

In the weeks ahead, battles over majority voting will take place at the annual meetings of companies like Qwest Communications International Inc. and Morgan Stanley.  Both companies have urged their shareholders to reject majority voting proposals.

Another battle was fought yesterday at Hewlett-Packard Co.  Last year, H-P announced rules that moved in the direction of majority voting.  Now the company is trying to block efforts by AFSCME to formalize those steps with a ballot measure on majority voting that was set for yesterday.  (Results were not available.)  H-P sought the Securities and Exchange Commission's approval to keep the measure off the annual ballot.  That was rejected by the SEC, and the company now is advising shareholders against voting for the measure.  In the notice of the annual meeting it sent to shareholders, the company said the rules it put in place last year were enough.

An unusual set of allies are pushing for change at H-P and elsewhere.  Labor unions representing carpenters, sheet metal workers and other trades have been the most active in advancing the proposals.  Importantly, the unions have found allies in powerful investors, like hedge funds and other large pension funds, which see the majority-rule provision as a way to gain leverage to challenge managers and directors who aren't producing sufficient shareholder returns.

For unions, the majority voting rules represent an opportunity to rein in executive pay and have more say inside the boardroom.  Unions have publicly griped about these issues for years, only to be largely ignored.  Now that their efforts are aligned with other shareholder activists, their proposals are taking on an air of inevitability, lawyers note.

Over 120 companies have some form of majority voting in place, according to the Council of Institutional Investors, with 73 of them adding the changes over the past 14 months in response to the campaign.  Trade unions are targeting another 120 companies during this year's proxy season, according to a list prepared by the carpenters' union.  Last year such proposals won approval among 43% of shareholders voting in annual ballots, up sharply from 13% approval in 2004.

"This is going to be the hot issue" during the traditional proxy season of board elections, shareholder proposals and annual meetings, says Shirley Westcott, managing director of policy at Proxy Governance Inc., an advisory firm to institutions.  "It's been a surprise hit among the activist community, which has made this their primary issue."

Some attorneys are skeptical that the new rules will have a sweeping effect across the market, noting that it will be hard to mobilize dissent at large companies with widely dispersed shareholder bases.  The Institutional Shareholder Services, a proxy advisory firm, says only 14 out of 14,000 board candidates were rejected by a majority of votes cast in 2005's elections.

But Walt Disney Co.'s boardroom battles in 2004 -- which led directors to strip CEO Michael Eisner of his chairmanship and to his subsequent corner-office exit -- show how the landscape might be changing more than some expected.  When Mr. Eisner came up for board re-election in 2004, 45% of votes cast were withheld.  Since that stunning rebuke, Disney has required that directors receive the majority of votes.

Motorola is another example.  Last year, Motorola's board battled against a majority rule proposal by the United Brotherhood of Carpenters and Joiners of America, which used its 38,200 Motorola shares as a springboard to propose the measure.

The board, in mailings to shareholders, argued the rule could deter strong board candidates and raise the cost of holding board elections.  It defeated the union measure by a narrow margin of 50% to 46% among votes cast.  But earlier this month, Motorola's board changed course, saying that the rule would "enhance the company's corporate governance policies" and announcing it will adopt the measure in May.

Without an organized campaign, nearly all boards receive hefty voting majorities from their holders.  But situations have arisen in recent years that show how new voting rules could have a big impact.  And they point to future strategies for activists.  Using the majority-voting rules, they needn't wage expensive proxy campaigns to replace board members.  They can wage a potentially cheaper effort to vote against directors, and simply destabilize a board to press for demands.

Career Education Corp., one of the nation's largest operators of for-profit colleges, is another example of these trends beginning to take shape.  Last year, Steve Bostic, an entrepreneur in the education industry, waged a proxy fight against the company's management after he complained that the company's shares were suffering from lawsuits alleging that the company's schools used high-pressure sales tactics and falsified job placement rates.

Almost two-thirds of the company's shares were cast with Mr. Bostic and voted to withhold support for Career Education's slate of directors.  Because there was no majority voting rule in place, it wasn't enough to replace the directors.  But last month, the company agreed to adopt the voting measure for directors.  "We believe majority voting is simply good corporate governance," says a Career Education spokeswoman.

With majority-voting rules in place, activists will be "able to extract some concessions from management before a proxy fight and declare victory," says Cravath, Swaine & Moore attorney Scott Barshay.  "Directors don't want to be embarrassed."

Some executives and directors are reluctant to challenge the proposals too aggressively, for fear of being labeled as unresponsive to investors.  While a number of them have watered down the rule changes being sought, most attorneys are counseling their corporate clients to accede to the shareholders' wishes, largely because it's hard to stand behind directors who get less than majority support.  "If you have a proposal, just live with it, adopt it and take the high ground," says Chuck Nathan, an attorney at Latham & Watkins in New York.

The proposals could have important implications for executives, says Mr. Nathan.  In particular, he says, the combination of such rules and proposed toughened federal standards on disclosure of executive pay will help add clarity to complex executives pay packages, he says.  Once investors begin to see the extent of executive pay, they could start calling for the removal of compensation committees that approved the pay deals.

Write to Dennis K. Berman at