The ongoing turmoil on Wall Street is providing activist shareholders and Democratic lawmakers a historic opportunity to push reforms that could help alter the prevailing U.S. corporate governance model from one that is director-centric to one that is more shareholder-centric.

While the proposed reforms would be welcomed by good-governance advocates, corporate advocates and other observers are warning of unintended consequences from “hasty” congressional decisions as lawmakers race to shore up an economy weighed down by the credit crisis.

Provisions allowing for proxy access, or the ability of shareholders to nominate corporate directors, and non-binding votes on executive compensation, were contained in a draft bill sponsored by House Financial Services Committee Chairman Barney Frank of Massachusetts. That bill also would limit senior executives’ compensation by excluding incentives for those who take risks deemed “inappropriate” or “excessive,” allow for “claw backs” of ill-gotten gains by executives, and bar severance payments to executives.

A companion draft bill in the Senate, put forward by Christopher Dodd of Connecticut, chairman of the Committee on Banking, Housing, and Urban Affairs, similarly would restrict some forms of executive compensation, though it did not contain a “say on pay” or proxy access provision. Provisions of both Democratic bills apply only to those companies seeking aid under the proposed $700 billion bailout program.

Dodd announced on the afternoon of Sept. 25 that negotiators had reached agreement on "fundamental principles" and that a final bill could be ready within days, but details on governance provisions were not disclosed. Reports indicate that the Bush administration had agreed to some restrictions on executive compensation at companies participating in the bailout.

This is “good governance coming in through the federal backdoor,” said veteran Washington attorney John Olson, a partner at the law firm of Gibson Dunn & Crutcher. Olson predicted on Sept. 24 that a final bill may contain a “say on pay” provision, though proxy access is not likely to be included.

According to Olson, supporters of access will have to wait, though potentially not for long. Democratic presidential nominee Barack Obama and Republican presidential nominee John McCain “will likely support access and appoint a [Securities and Exchange Commission] chairman who will push for it,” said Olson. “Both have run fairly populist campaigns, so there’s a fairly high likelihood they will appoint someone who will get it through.”

Other observers share Olson’s skepticism of any final bill containing language allowing for access, while still others question the wisdom of legislating governance reforms. “I don’t think putting the [governance] provisions into the bill is a good idea,” University of Delaware professor Charles Elson told Risk & Governance Weekly. “These issues are complicated, and to add them through the bill in a rush is not necessarily thoughtful.”

According to Elson, “say on pay” and access are issues that “need to be settled through hearings and debates” and that the appropriate process for putting in place such mechanisms for shareholders is effectively being “leapfrogged.” That, he said, may hinder reform efforts down the road.

“Look at claw-back provisions under Sarbanes-Oxley,” Elson said, arguing such provisions were put together hastily, and that observers would now be hard pressed to find cases where those provisions were used successfully.

“Federalizing this issue and leaving federal courts to resolve such concerns is not the way to go,” said Elson. “They would not be able to create the consistency of the approach that you see in Delaware, and, ultimately, that would lead to less accountability for shareholders.”
Elson called this week’s dealings on Capitol Hill the most fluid situation he’d ever seen and that it was “anybody’s guess” as to how a final bill might look.

Still, activists were hopeful that the window of opportunity presented by the bailout would not close without significant reforms being legislated, including proxy access.

“One of the critical aspects for us in dealing with this is that there be a strengthening of the governance at these companies so this doesn’t happen again,” said Daniel Pedrotty, director of the AFL-CIO’s Office of Investment. “We need tools to hold boards accountable, and central to that is ‘say on pay’ and proxy access.”

Pedrotty agreed with the need to approach any governance-related legislation deliberately, though he dismissed claims that the House bill did not do so. “The sky will not fall as a result of these reforms, and claims to that effect are just not credible,” he said.

Richard Ferlauto, director of pension benefit policy at the American Federation of State, County, and Municipal Employees (AFSCME), said Sept. 23 that he anticipates that the final bailout bill will include some limits on “golden parachute” payments and a claw-back provision. “It’s pretty clear there is bipartisan support to demand some reciprocity [from financial firms] on the pay issue,” he told Risk & Governance Weekly.

Ferlauto recalled that AFSCME went to court to try to get access procedures in place at American International Group, which was taken over by the U.S. government on Sept. 16. After the union fund won a 2006 court ruling, investors were allowed to file access proposals in 2007, but the SEC barred those resolutions before the 2008 proxy season. “With independent board leadership at AIG, some of this mess could have been avoided,” Ferlauto said.

Regardless of what happens with the bailout bill, Ferlauto said he expects Congress will consider legislation to address “say on pay,” claw-back provisions, and possible caps on deferred compensation early next year. In the long run, the bailout debate “gives a tremendous impetus to ‘say on pay’ as a market-wide response,” he said. He also is hopeful that Congress will approve access legislation in the future. “Proxy access is an essential part of these reforms,” Ferlauto noted.

Support for the House and Senate bills from investors more broadly were noticeably tempered with respect to the “say on pay” and proxy access provisions. In a Sept. 23 press release, the Council of Institutional Investors made no mention of either provision, or expressed support for the House bill over the competing version in the Senate, which lacks those reforms. The council’s corporate governance guidelines have long backed proxy access and call on companies to give investors an annual, non-binding vote on compensation. In its statement, however, the council did indicate it supported congressional efforts to curb pay at those firms benefiting from the bailout.