[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
CORPORATE GOVERNANCE AND
SHAREHOLDER EMPOWERMENT
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS,
INSURANCE, AND GOVERNMENT
SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
SECOND SESSION
----------
APRIL 21, 2010
----------
Printed for the use of the Committee on Financial Services
Serial No. 111-125
CORPORATE GOVERNANCE AND SHAREHOLDER EMPOWERMENT
SHAREHOLDER EMPOWERMENT
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS,
INSURANCE, AND GOVERNMENT
SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
SECOND SESSION
__________
APRIL 21, 2010
__________
Printed for the use of the Committee on Financial Services
Serial No. 111-125
U.S. GOVERNMENT PRINTING OFFICE
57-743 WASHINGTON : 2010
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HOUSE COMMITTEE ON FINANCIAL SERVICES
BARNEY FRANK, Massachusetts, Chairman
PAUL E. KANJORSKI, Pennsylvania SPENCER BACHUS, Alabama
MAXINE WATERS, California MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina RON PAUL, Texas
GARY L. ACKERMAN, New York DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California WALTER B. JONES, Jr., North
GREGORY W. MEEKS, New York Carolina
DENNIS MOORE, Kansas JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts GARY G. MILLER, California
RUBEN HINOJOSA, Texas SHELLEY MOORE CAPITO, West
WM. LACY CLAY, Missouri Virginia
CAROLYN McCARTHY, New York JEB HENSARLING, Texas
JOE BACA, California SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia RANDY NEUGEBAUER, Texas
AL GREEN, Texas TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois JOHN CAMPBELL, California
GWEN MOORE, Wisconsin ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota KENNY MARCHANT, Texas
RON KLEIN, Florida THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio KEVIN McCARTHY, California
ED PERLMUTTER, Colorado BILL POSEY, Florida
JOE DONNELLY, Indiana LYNN JENKINS, Kansas
BILL FOSTER, Illinois CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana ERIK PAULSEN, Minnesota
JACKIE SPEIER, California LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York
Jeanne M. Roslanowick, Staff Director and Chief Counsel
Subcommittee on Capital Markets, Insurance, and Government Sponsored
Enterprises
PAUL E. KANJORSKI, Pennsylvania, Chairman
GARY L. ACKERMAN, New York SCOTT GARRETT, New Jersey
BRAD SHERMAN, California TOM PRICE, Georgia
MICHAEL E. CAPUANO, Massachusetts MICHAEL N. CASTLE, Delaware
RUBEN HINOJOSA, Texas PETER T. KING, New York
CAROLYN McCARTHY, New York FRANK D. LUCAS, Oklahoma
JOE BACA, California DONALD A. MANZULLO, Illinois
STEPHEN F. LYNCH, Massachusetts EDWARD R. ROYCE, California
BRAD MILLER, North Carolina JUDY BIGGERT, Illinois
DAVID SCOTT, Georgia SHELLEY MOORE CAPITO, West
NYDIA M. VELAZQUEZ, New York Virginia
CAROLYN B. MALONEY, New York JEB HENSARLING, Texas
MELISSA L. BEAN, Illinois ADAM PUTNAM, Florida
GWEN MOORE, Wisconsin J. GRESHAM BARRETT, South Carolina
PAUL W. HODES, New Hampshire JIM GERLACH, Pennsylvania
RON KLEIN, Florida JOHN CAMPBELL, California
ED PERLMUTTER, Colorado MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana THADDEUS G. McCOTTER, Michigan
ANDRE CARSON, Indiana RANDY NEUGEBAUER, Texas
JACKIE SPEIER, California KEVIN McCARTHY, California
TRAVIS CHILDERS, Mississippi BILL POSEY, Florida
CHARLES A. WILSON, Ohio LYNN JENKINS, Kansas
BILL FOSTER, Illinois
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
C O N T E N T S
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Page
Hearing held on:
April 21, 2010............................................... 1
Appendix:
April 21, 2010............................................... 47
WITNESSES
Wednesday, April 21, 2010
Allen, James, Head of Capital Markets Policy, CFA Institute...... 20
Brier, Thomas F., Deputy Chief Investment Officer and Director of
Corporate Governance, Pennsylvania State Employees' Retirement
System......................................................... 12
Cutler, Alexander M., Chairman and Chief Executive Officer, Eaton
Corporation, on behalf of Business Roundtable.................. 14
Irwin, Hon. Steven D., Pennsylvania Securities Commissioner, and
Chairman, Federal Legislation Committee, North American
Securities Administrators Association, Inc. (NASAA)............ 8
Rees, Brandon J., Deputy Director, Office of Investment, AFL-CIO. 16
Smith, Gregory W., Chief Operating Officer and General Counsel,
Colorado Public Employees' Retirement Association.............. 11
Smith, Robert E., Vice President, Deputy General Counsel, and
Assistant Corporate Secretary, NiSource, Inc., on behalf of the
Society of Corporate Secretaries and Governance Professionals.. 18
APPENDIX
Prepared statements:
Kanjorski, Hon. Paul E....................................... 48
Allen, James................................................. 49
Brier, Thomas F.............................................. 53
Cutler, Alexander M.......................................... 64
Irwin, Hon. Steven D......................................... 300
Rees, Brandon J.............................................. 312
Smith, Gregory W............................................. 319
Smith, Robert E.............................................. 339
Additional Material Submitted for the Record
Kanjorski, Hon. Paul E.:
Written statement of the Investment Company Institute (ICI).. 380
Written statement of Carl C. Icahn........................... 391
Written statement of Tom Gardner, CEO, The Motley Fool
Holdings, Inc.............................................. 396
Castle, Hon. Michael:
Written statement of various undersigned groups.............. 399
Hensarling, Hon. Jeb:
Written statement of the Center On Executive Compensation.... 401
Allen, James:
Addendums to written testimony............................... 407
Rees, Brandon J.:
Additional information provided for the record............... 409
CORPORATE GOVERNANCE AND
SHAREHOLDER EMPOWERMENT
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Wednesday, April 21, 2010
U.S. House of Representatives,
Subcommittee on Capital Markets,
Insurance, and Government
Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:04 a.m., in
room 2128, Rayburn House Office Building, Hon. Paul E.
Kanjorski [chairman of the subcommittee] presiding.
Members present: Representatives Kanjorski, Sherman,
Hinojosa, Baca, Maloney, Bean, Perlmutter, Carson, Adler,
Kilroy, Kosmas, Peters; Garrett, Castle, Manzullo, Hensarling,
Campbell, and Jenkins.
Also present: Representative Ellison.
Chairman Kanjorski. This hearing of the Subcommittee on
Capital Markets, Insurance, and Government Sponsored
Enterprises will come to order.
Pursuant to the committee rules, each side will have 15
minutes for opening statements. Without objection, all members'
opening statements will be made a part of the record.
I ask unanimous consent that Mr. Ellison, a member of the
full Financial Services Committee, be allowed to participate in
today's subcommittee hearing and to offer an opening statement.
Without objection, it is so ordered.
Good morning. Today, we meet to consider several thoughtful
bills that seek by various means to correct the imbalance of
power between investors and management. For far too long at too
many public companies, corporate executives have had the upper
hand.
The financial crisis revealed at times vividly and
shockingly how all too frequently corporate management and
boards failed to consider the long-term interests of their
shareholders. As a result, innocent investors incurred
monumental losses, even while corporate chieftains escaped the
inferno unscathed, usually by golden parachute.
It is clear that the deck was stacked, especially when you
consider that Wall Street bankers took home enormous paychecks
while the taxpayers got stuck with the bill. We now need to
chart a different course. Congress must act to democratize
corporate governance rules so that investors have a greater say
in the companies that they own.
First and foremost, we ought to provide shareholders with
easier means of getting directors nominated. Also, we should
act to improve transparency by requiring many institutional
investment managers to disclose how they vote on shareholder
proxies.
In the run-up to the crisis, excessive leverage and risk-
taking became the norm on Wall Street. These decisions flew in
the face of financial stability and lacked a fundamental level
of good judgment. We can fix this problem by requiring public
companies to form independent risk management committees with
prescribed functions and duties.
While the ideas in each of the bills before us are well-
intended, we also need to carefully examine each proposal. As
for the appealing idea of separating the role of chairman from
that of chief executive officer, we should explore how such a
policy will affect small companies.
Requiring majority voting for uncontested directors also
appears a worthy goal, but we must determine if it could
produce inadvertent problems, especially if too few
shareholders vote.
As part of last year's debates on the Wall Street Reform
bill, our committee has already acted to improve corporate
governance laws. As passed by the House, H.R. 4173 contained
important provisions on proxy access and executive pay. It is
my hope that the Senate will act with all deliberate speed on
its reform legislation so that these important corporate
governance reforms can become law.
In the meantime, we must advance the debate about how we
can further enhance corporate governance through increased
transparency, better executive accountability, and greater
shareholder rights.
In this regard, I look forward to the testimony today and
thank the witnesses for appearing.
I would also like to thank Congressman Peters, Congressman
Ellison, and Congresswoman Kilroy for their hard work on these
important policy matters.
The gentleman from New Jersey, our ranking member, Mr.
Garrett, is recognized for 4 minutes.
Mr. Garrett. I thank the chairman. I thank all the
witnesses today. An angle that I have taken to consider the
multitude of pieces of legislation and proposals put forward
since the recent financial crisis is how do each one of these
proposals actually address one of the underlying causes of the
financial crisis?
So far, it has not been demonstrated to me convincingly
that broadly speaking, the crisis was a result of corporate
governance, a weakness in corporate governance, and more
specifically, I remain to be convinced that the particular
proposals put forward in Congressman Peters' bill and the other
related proposals would have either prevented the current
crisis or would in fact be a net positive for corporations
going forward.
Just as an aside, philosophically speaking, being the
chairman and founder of the Congressional Constitution Caucus,
I am really hesitant to over turn 150 years of precedent in
which corporate governance has been decided at the State level.
I am also very weary of the Federal Government taking on
new tasks not envisioned by our founding fathers, especially
when the States have shown they are basically perfectly capable
to address these situations.
The proposals that are being marketed by the supporters as
remedies to the financial crisis, I think we really do need to
keep in mind that they would apply to all companies, all public
companies, big and small, financial and non-financial as well.
Creating this one size-fits-all-mandate, for instance, with
a proposal that mandates that every public company have a
separate chairman and CEO, that is really not an appropriate
so-called ``solution'' for many of the companies out there.
The thing about practical examples of that, some of the
great business leaders in modern times, people like Bill Gates,
Warren Buffett, Sam Walton, they have all held the same role at
the same time and they have done pretty well at it. They
created billions of dollars for shareholder values while also
creating literally millions of jobs for this country.
Most companies, I think, are happy to provide a rationale
for having the same person hold both positions, if that is what
the particular board thinks is best for that company.
Again, no mandate that each and every company must separate
the two roles is going to be an appropriate policy solution for
every company. Besides, many of the proposals being put forth
are already being adopted, I guess you could say, organically
by many of the companies out there. In some cases, a resounding
majority of the stockholders of the companies out there are
taking these views.
We also need to remember that board members have a
fiduciary duty to set corporate policy and make decisions based
on creating long-term value for the firm, and with the recent
corporate scandals now in the spotlight, pressures are on board
members more than ever to do just that, and to do the right
thing on behalf of the companies they serve.
Giving increased powers to certain shareholders in a
corporate policymaking process on the other hand, while it may
be well-intentioned, I am sure, could actually have the
unintended consequences of serving interests of more short-term
goals while also introducing other agendas not directly
associated with the best interest of that particular company
into its corporate governance decision-making process.
When you think about it, this would really be an ironic
outcome indeed, since the focus would now be on short-term
gains as often cited as a contributing cause of the recent
financial crisis.
In addition to the proposals contained in this legislation
under consideration today, there are other areas, such as the
role played by proxy advisor services, as well as proposals to
increase retail shareholder voting, and direct communication
with shareholders. I will be interested to hear from the panel
before us later on.
In conclusion, at a time when the number one priority of
this Congress should be enacting policies that create jobs, I
fear that many of the proposals put forth in the legislation
under consideration at today's hearing, as I said before, that
I am sure are well intended, will have the unintended
consequences of hurting the long-term ability of firms to do
just that, create jobs, to thrive, either because of
inappropriate one-size-fits-all policymaking or increased focus
on short-term goals.
Finally, yet another increase in the Federal Government's
role in our economy, especially at the SEC, which has really
yet to demonstrate that it can perform its primary role of
protecting investors, also does not seem to be the best
prescription for fixing our economy's long-term health.
With all that being said, I look forward to hearing all the
witnesses today.
Chairman Kanjorski. Thank you, Mr. Garrett. We will now
hear from Mr. Peters from Michigan for 3 minutes.
Mr. Peters. Thank you, Mr. Chairman. Thank you, Chairman
Kanjorski, for holding today's hearing to discuss legislation
that I believe would be not only important to improve corporate
governance but also lead to a more stable economy as well.
During the 111th Congress, this committee has held numerous
hearings to investigate the causes of the collapse of the
financial sector in the fall of 2008. While there were many
contributing causes of the financial crisis, I believe that one
significant cause was the failure of corporate governance of
shareholders, including over 100 million Americans who own
stock either in individual accounts or through a mutual fund,
who have lost trillions of dollars in savings as a result.
However, corporate governance is an issue that affects the
entire economy, not just the financial sector. While some of
the most egregious examples of excessive risk-taking and
compensation have been found on Wall Street, there are plenty
of other examples in other companies as well.
I spent 22 years in the private sector and I believe the
best and most effective regulation is self-regulation. That is
why I believe we should empower shareholders, the company's
true owners, to hold corporate boards and management more
accountable and help them better align their priorities with
long-term value.
As Members of Congress, we are held accountable to our
constituents through meaningful democratic elections. However,
in many corporations, management slates run unopposed and large
long-term shareholders lack the ability to nominate their own
candidates. Even worse, these nominees are elected even if a
majority of shareholders vote against them.
The current system of electing boards of directors, holding
executives accountable and overseeing executive compensation is
rigged against shareholders and in favor of management. The
balance of power simply must change.
Last December, the House passed the Wall Street Reform and
Consumer Protection Act, which contained a number of provisions
that will improve corporate governance. For example, it will
give shareholders a vote on corporate compensation packages, it
has improved disclosure of performance targets, and also
includes language that would give the SEC authority to
implement its proxy access rules.
Soon, the Senate will be taking up comprehensive corporate
governance reform legislation on its own. This legislation
introduced by Senator Dodd contains a corporate governance
title which includes many of the provisions which are in H.R.
2861, the Shareholder Empowerment Act.
We all agree that our corporations and boards need to focus
on building long-term value for our shareholders. I introduced
H.R. 2861 because I strongly believe that it is the
shareholders themselves who should have the power to oversee
large complex institutions and hold corporate boards and senior
management accountable for their mistakes and mismanagement.
I look forward to hearing the testimony of the witnesses,
and I would like again to thank Chairman Kanjorski for holding
this hearing today, and I look forward to working with him to
enact meaningful, comprehensive corporate governance
legislation.
Thank you, Mr. Chairman.
Chairman Kanjorski. Thank you very much, Mr. Peters. Now,
we will hear from the gentleman from Delaware, Mr. Castle.
Mr. Castle. Thank you, Mr. Chairman, for holding today's
hearing. Corporate governance is an important issue to me and
to this committee. I appreciate the opportunity to review
current proposals and hear from experts on the impact of
altering existing corporate governance laws.
Some believe that corporate governance should be examined
in response to the financial crisis, while others have
expressed their intentions to add these sweeping changes onto a
legislative response to a recent Supreme Court ruling on
campaign finance.
I believe that regardless of the legislative vehicle being
discussed to push these issues forward, we must be especially
careful when considering proposals that intrude on the province
of State laws without taking into account their long-
established histories and leadership on corporate matters and
their ability to quickly respond to emerging issues.
I understand that many of today's witnesses will be
commenting on Mr. Peters' Shareholder Empowerment Act, which
includes provisions to increase investor influence over
corporate boards by allowing investors to dominate a candidate
on the corporate proxy statement.
The Peters' bill also deals with the issue of requiring
directors to receive majority voting.
I am interested in learning from today's witnesses their
comments on the underlying concerns here that the proposed
legislation is intending to respond to, and the efforts already
under way to address some of these issues.
For example, States have already begun to respond to the
proxy access concerns by clarifying the authority of companies
and their shareholders to adopt proxy access and proxy
reimbursement bylaws.
Similar changes are under consideration in the Model
Business Corporation Act. Furthermore, shareholders already
have the ability to place majority voting proposals on the
proxy and 75 percent of boards now have some form of majority
voting for directors.
I look forward to the testimony of today's witnesses and I
yield back the balance of my time, Mr. Chairman.
Chairman Kanjorski. Thank you very much, Mr. Castle. We
will now hear from the gentlelady from Ohio, Ms. Kilroy.
Ms. Kilroy. Thank you, Mr. Chairman, for your leadership on
this issue and for the hearing this morning.
Today, we are taking a look at several proposals that will
help strengthen corporate governance rules, an important
undertaking, especially after what I learned yesterday at the
hearing on Lehman Brothers.
I look forward to hearing from the witnesses today, but I
want to touch briefly on an exchange I had yesterday with Mr.
Anton Valukas, the court-appointed examiner for the Lehman
bankruptcy.
I asked Mr. Valukas whether Lehman's board of directors had
a responsibility to stop Lehman's senior managers from ignoring
their own risk management system to pursue reckless and
dangerous risks. Mr. Valukas replied that the risk management
process Lehman had in place was good, although it was exceeded
some 30 times in a short period of time, and thus, under the
business judgment rule, Lehman could go forward with their
risky bets.
Mr. Valukas went on to say that it is the regulators'
responsibility to step in when management is making a decision
that could have such dire consequences for the larger economy,
and I agree, but a first line of defense should come from the
risk management directors and the boards of directors of these
companies, who should have asked the right questions, who could
have stopped management from taking those excessive risks that
threatened the company and as we witnessed, the economy on the
whole.
For too long, the boards of these financial firms have
rubber-stamped their managerial decisions and for too long,
corporate governance rules have been skewed in a way to
preserve the status quo, to prevent shareholders from having a
greater voice in how companies do business.
The proposals we will discuss today could enhance
transparency, increase shareholder power, improve management
accountability, and enhance corporate governance.
Thank you, Mr. Chairman, for your leadership on this
important issue. I yield back the balance of my time.
Chairman Kanjorski. Thank you very much, Ms. Kilroy. Now,
we will hear from the gentleman from Texas, Mr. Hensarling, for
4 minutes.
Mr. Hensarling. Thank you, Mr. Chairman. Coming into this
hearing, as I come into many other hearings, I recall the
President's Chief of Staff, Rahm Emanuel's, infamous adage,
``Never let a serious crisis go to waste; it allows you to do
things that you could not previously do before.''
I see so many different ideas and pieces of legislation,
some of which may be meritorious, all trying to be shoe-horned
in on the idea that somehow this will prevent the next great
economic crisis.
I have looked at the underlying causes. I respectfully
disagree with the gentleman from Michigan. I am trying to
figure out where the corporate governance issue is.
I believe there are some very legitimate corporate
governance issues that we need to discuss as a society. Having
said that, I am not exactly certain that the Federal Government
is somehow uniquely qualified to mandate best practices for
corporate governance.
I think occasionally, if we look at the record in the
underlying causes of our financial debacle, frankly, it was a
lot of Federal legislation and Federal regulators. Who was the
one who came up with the brainchild of having Government-
Sponsored Enterprises, be able to privatize their profits,
socialize their losses, and then give them affordable housing
and tell them you have to loan money to people to buy homes who
ultimately cannot afford to stay in those homes.
Maybe it was the bright people who came up with the idea
that we ought to create an oligopoly in rating agencies. We
know where that got us.
Maybe it was the fine regulators at OTS who could have
stopped AIG but did not. They had the regulatory authority we
learned yesterday. The SEC had full regulatory authority to
have Lehman account for their Repo 105 transactions, they did
not. The SEC could have stopped them. They could have had
Lehman Brothers reserve more capital, and lower their leverage,
but they did not do it. Maybe it was those Federal people who
came up with those great ideas. Maybe it was the bank
regulators who said if you will concentrate your statutory
capital in Fannie Mae and Freddie Mac, all will be fine.
My point is as one who has spent a number of years in
private enterprise and a number of years in government, I have
not found that people in government are somehow uniquely
smarter or more insightful than those in private business.
Again, I believe there may be some legitimate debates over
certain aspects of these proposals. To think that at this time
that number one, corporate governance issues are somehow at the
heart or even a significant contributing factor to the economic
crisis, I just have not seen the evidence. I have an open mind.
I just do not have empty mind.
Second, to somehow think that the Federal Government is
best positioned to make these decisions, particularly at a time
when the Nation still has high unemployment, still a
generational high, here is one more great uncertainty, one more
great cost, one more great mandate to be thrown on the job
creating sector in America, that perhaps maybe the Federal
Government ought to let it do its business and get about
creating jobs, which I think most of our constituents would
agree, job number one ought to be creating jobs.
Instead, here is yet another Federal takeover. Here are
more Federal mandates that are going to harm jobs. Again, if
this was just restricted to Wall Street, I just question why is
the proposal going to impact every single publicly held company
in America?
Again, it is a huge overreach that could have devastating
unintended consequences yet again on an economy that is
struggling to create jobs.
I approach this particular proposal with a lot of
skepticism. Mr. Chairman, I yield back the balance of my time.
Chairman Kanjorski. Thank you, Mr. Hensarling. Now, we will
hear from Mr. Baca for 1 minute.
Mr. Baca. Thank you very much. I want to thank Chairman
Kanjorski and Ranking Member Garrett for calling this hearing.
I also want to thank all of the witnesses for being here today
and offering your insights.
Finally, I want to commend Mr. Peters, Mr. Ellison, and Ms.
Kilroy for their hard work on this issue.
The events of the past years demonstrate the flaws in
corporate structure and its governance. Too often, decisions
are made by a select few without paying any regard to the
interests or views of the shareholders.
While the arguments of corporate efficiency is offered as a
justification for the way things are done, I would point simply
to September 2008 and its aftermath to show what this narrow-
minded thinking can cause.
Corporate boards find themselves in the position and are
unresponsive to shareholders' demands. Even if the shareholders
want to change the structure, proxy rules and the corporate
election process are often too expensive to be able to
accomplish anything.
Last year, the committee and this chamber took major steps
to enact some of these changes, and hopefully these will be
able to pass financial regulatory reform law soon.
During this hearing, I will be interested to hear the
reforms we need with regard to proxy access and corporate
accountability. I also am eager to talk about the increased
diversity within the boardrooms, allowing for more accurate
representation, not only of the shareholders, but the market in
which these corporations operate.
I want them to look like what America looks like as well,
and we do not see that.
Again, I want to thank the chairman and the ranking member
for their leadership on this issue. It is about time that we
had oversight and accountability, and if we did not have
government intervention, then we would not be here right now if
there was not too much greed.
I respect the gentleman's comments. Yes, we do have higher
unemployment, and we have had Federal mandates, but sometimes
we need these Federal mandates to make sure there is
accountability and oversight, and we are doing what is right
for the American people.
Thank you. I yield back the balance of my time.
Chairman Kanjorski. Thank you very much, Mr. Baca.
Mr. Ellison has not arrived yet, so we will try to reserve
some of his time that can be expanded when he comes for
questioning.
Now, we will go to the panel, and I want to thank you all
for appearing before the subcommittee today. Without objection,
your written statements will be made a part of the record. You
will each be recognized for a 5-minute summary of your
testimony.
First, we have the Honorable Steven D. Irwin, commissioner,
Pennsylvania Securities Commission.
Mr. Irwin?
STATEMENT OF THE HONORABLE STEVEN D. IRWIN, PENNSYLVANIA
SECURITIES COMMISSIONER, AND CHAIRMAN, FEDERAL LEGISLATION
COMMITTEE, NORTH AMERICAN SECURITIES ADMINISTRATORS
ASSOCIATION, INC. (NASAA)
Mr. Irwin. Chairman Kanjorski, Ranking Member Garrett, and
members of the subcommittee, the single most important task
which confronts legislators and securities regulators is
restoring public faith and confidence in American financial
institutions.
Without a fair and honest landscape through which retail
investors can work toward their financial goals, their activity
will continue to suffer dramatic contractions.
The loss of public confidence can be seen from our up-close
and personal experiences with many who have withdrawn from the
securities market.
The Pennsylvania Securities Commission conducted nearly 500
investor education presentations to residents in 62 counties
during the last 2 years alone. Attendees related that they are
worried about a secure retirement or paying for a child's
education. Many complain about their losses because of
decreasing value of stocks, and others indicate fear of getting
involved in the stock market altogether. Those who pulled out
their money in order to not subject it to any more risk remain
afraid to get back in.
Beyond anecdotal concerns, the data substantiate that
investor distrust is an ongoing phenomenon. The 200 day moving
average volume on the New York Stock Exchange now is 1.2
billion shares. It is down nearly 25 percent from a year ago.
As stock prices have risen over the past year, the lower
volume of trading evidences that main street investors have
largely stayed out of the market.
Investors have not lost confidence because of a single
event, but because of serial market abuses, from mutual fund
timing schemes and misrepresentations concerning auction rate
securities to Madoff's and Stanford's ponzi schemes.
No one solution can restore investor faith and trust.
However, this hearing builds on several significant steps
already taken by this subcommittee and the full House in
addressing the dangers to the U.S. economy.
Businesses have evolved from a world where decision-makers
as owners of their enterprises were responsible to theirselves
and felt a sense of duty to their communities. Growth of
enterprises and involvement of public investors led to a
separation of ownership from control. From that separation,
emerged disagreement over what constitutes fair compensation
for management.
Traditionally, government has not involved itself in the
process whereby compensation is set. The present crisis has
spotlighted a lack of input by shareholders into executive
compensation in publicly held entities. Sadly, the line between
fair and negotiated compensation and corporate looting and
breach of fiduciary responsibility can be difficult to define.
It has been a struggle to infuse good governance measures.
Officers frequently can control board selection with compliant
directors' approving compensation packages that are designed by
friendly independent consultants. Under this circumstance,
conflicts of interest are ripe.
Executive compensation has long thirsted for objective
scrutiny. It is a component of corporate governance that seems
understandable to the less sophisticated retail investor for
whom it serves as a barometer of internal restraints and
effective stewardship.
A lead position in management does not bestow entitlement
to hoard profits from shareowners. Growth and productivity
demand, of course, an abundance of inducements for creativity
and high level of performance.
At the same time, inducements must be tied to actual
production of long-term value for shareholders, rather than to
manipulation of financial results for the short-term.
In this regard, we applaud the SEC's recent efforts to
allow for greater shareholder access to information,
particularly amendments to proxy rules that require disclosure
of risks arising from compensation policies.
In 2007, State securities regulators adopted a resolution
on disclosure concerning executive compensation and conflicts
of interest underlying the process by which it is approved.
The person in the street sees salaries of corporate
decisionmakers steadily increased to a level viewed as obscene,
while at the same time, the companies paying these salaries
diminish in value.
Ultimately, the funds to pay managers come from the owners
of the corporation, the shareholders. A dollar doled to the
manager in the form of augmented salary, bonus or stock options
is a dollar less in corporate assets.
The balance sheet should reflect the addition of a dollar
or more of corporate value before it is paid.
The little power shareholders have to influence executive
compensation lies now in their right to sell their shares. An
effective counter weight must avail them legal strategies that
will enable them to press the issue.
In order to have any material bearing, shareholders must
have relevant and complete information. Sunlight is a renowned
disinfectant, but disclosure cannot be the sole remedy.
Shareholders possessing the knowledge and skills to do so
must undertake independent analysis and aggressively articulate
their concerns. They cannot stick their heads in the sand and
ignore compensation abuses.
Even with an evolution in corporate governance, financial
regulatory reform will not regain the trust of Main Street
unless Congress embraces extending fiduciary duty to all
professionals who provide advice to investors.
Reform must prevent abuse of the process by which capital
is raised by those more interested in soliciting funds than
promoting legitimate enterprises.
Straightforward disqualification of repeat offenders of the
rules of the game is a logical deterrent to such abuse.
In closing, the unique experiences of my fellow State
securities regulators on the front lines of investor protection
have provided the framework for my testimony this morning. We
commit to continuing to work with the subcommittee to afford
the investing public the needed security to return to our
capital markets.
Thank you, Mr. Chairman.
[The prepared statement of Commissioner Irwin can be found
on page 300 of the appendix.]
Chairman Kanjorski. Thank you, Mr. Irwin.
Next, we will have Mr. Gregory W. Smith, chief operating
officer and general counsel, Colorado Public Employees'
Retirement Association.
Mr. Smith?
STATEMENT OF GREGORY W. SMITH, CHIEF OPERATING OFFICER AND
GENERAL COUNSEL, COLORADO PUBLIC EMPLOYEES' RETIREMENT
ASSOCIATION
Mr. Gregory Smith. Thank you, Chairman Kanjorski, Ranking
Member Garrett, and members of the subcommittee. Good morning.
I am Greg Smith, chief operating officer and general
counsel of the Colorado Public Employees' Retirement
Association. I am pleased to appear before you today on behalf
of Colorado PERA and our membership of over 460,000 current and
past public servants of our State.
Because Colorado is one of the first States to address the
sustainability of its pension plan as a result of the 2008
crisis, each and every one of our members has sacrificed
through reduced benefits, including our retirees.
We are responsible for investment over $34 billion in
assets on behalf of our members for the exclusive purpose of
providing retirement benefits.
Our obligation to pay benefits extends not only to today's
retirees but ultimately to those newly hired public servants
who will work a 35-year career and then draw a monthly benefit
for 20 or more years in retirement.
As a result, our investment time horizon extends over 50
years. We and our peers are the market's long-term investors,
and the protection of a marketplace that promotes the creation
of shareholder value for the long-term is imperative to the
success of our mission.
We should not be required to simply exercise the Wall
Street walk and abandon our investment because management is
undermining shareholder value or acting in their self-interest
to the detriment of shareholders.
We should be entitled as the owners who have put our
capital at risk to insist that management be held accountable.
This is not an unreasonable expectation, and the mechanism to
accomplish this accountability is improved corporate
governance, beginning with the creation of alignment between
shareholder interests and the board of directors.
As an owner of the Nation's largest and most prominent
corporations, our fund is strongly aligned with corporate
America. We have every interest in its long-term success and
profitability.
However, Colorado PERA firmly believes that the global
financial crisis represents a massive failure of board
oversight as well as regulation. Our members have paid a steep
price for these failures.
Clearly, boards of directors failed to adequately
understand, monitor, and oversee enterprise risk and corporate
strategy. Far too many boards structured and approved executive
compensation programs that motivated excessive risk-taking and
yielded outsized rewards for short-term results.
These failures of board oversight are the most recent
demonstration that too many boards are dominated by management
and have lost sight of the obligation to shareholders.
We respectfully suggest that at its core, this is the
result of the fact that shareholders effectively play no role
in the selection of directors and have no ability to remove
directors.
We are denied the basic tools that shareowners around the
world, including countries with far less developed capital
markets than ours, have long been provided. Rights such as
requiring directors to be elected by a majority vote, giving
investors an advisory vote on executive pay, and providing
long-term owners modest vehicles to nominate directors on the
company proxy card. Their absence significantly weakens the
ability of shareowners to oversee corporate directors, their
elected representatives, and hold them accountable.
Turning to the content of the House bills advancing
corporate governance reforms, we strongly commend the House for
affirming the SEC's authority to provide proxy access in the
Wall Street Reform and Consumer Protection Act of 2009.
In addition to that affirmation, the government's
improvements that Colorado PERA believes would have the
greatest impact and therefore should be considered by the House
include: requiring directors in contested elections to be
elected by a majority of the votes cast; enhancing executive
compensation disclosures; providing investors with an advisory
vote on pay; ensuring compensation consultants provide
independent advice; strengthening Federal clawback provisions
for unearned pay, and requiring corporate boards to be chaired
by an independent director.
As the House considers steps to enhance corporate
governance and empower shareowners, Congress must remember that
boards are the first line of defense against the risks and
excesses that led to the global financial crisis.
Vigorous financial regulation on its own cannot solve many
of the issues that contributed to the crisis. Regulators and
investors must be given stronger market based tools to
guarantee robust oversight and meaningful accountability of
corporate managers and directors.
House Bill 2861 consists of all of these provisions that I
have identified, and we strongly support the principles set
forth in that bill.
Thank you for the opportunity to appear and we look forward
to answering your questions.
[The prepared statement of Mr. Gregory Smith can be found
on page 319 of the appendix.]
Chairman Kanjorski. Thank you very much, Mr. Smith.
Next, we have Mr. Thomas F. Brier, deputy chief investment
officer and director of corporate governance, Pennsylvania
State Employees' Retirement System.
Mr. Brier?
STATEMENT OF THOMAS F. BRIER, DEPUTY CHIEF INVESTMENT OFFICER
AND DIRECTOR OF CORPORATE GOVERNANCE, PENNSYLVANIA STATE
EMPLOYEES' RETIREMENT SYSTEM
Mr. Brier. Good morning, Chairman Kanjorski, Ranking Member
Garrett, and members of the subcommittee. Thank you for
inviting us to appear at the committee this morning.
Established in 1923, the Pennsylvania State Employees'
Retirement System is one of the oldest and largest pension
funds in the United States. We have over 220,000 members, and
over the past 10 years, have paid out approximately $18 billion
in benefits to workers in Pennsylvania and retirees.
Like Colorado PERA and other pension funds, we are long-
term investors with significant passive investment strategies.
As a result, we have been a long time proponent of good
corporate governance.
One common element in the failure of Lehman Brothers, AIG,
Fannie Mae, and many other companies implicated in the
financial meltdown was that the boards of directors did not
hold management sufficiently accountable. They failed to
control management's excessive risk-taking. They did not
prevent compensation plans from encouraging a ``bet the ranch''
mentality.
As famed investor Warren Buffett observed in his most
recent letter to Berkshire Hathaway shareholders, ``A board of
directors of a huge financial institution is derelict if it
does not insist that its CEO bear full responsibility for risk
control.
``If he is incapable of handling that job, he should look
for other employment, and if he fails at it, with the
government thereupon required to step in with funds or
guarantees, the financial consequences for him and his board
should be severe.''
After describing the half a trillion dollars that investors
lost in just these companies, Warren continued, ``CEOs and in
many cases, directors, have long benefitted from oversized
financial carrots; some meaningful sticks now need to be part
of their employment picture as well.''
SERS, like many other long-term investors, believe that two
fundamental corporate governance improvements could provide, in
Mr. Buffett's words, ``meaningful sticks,'' necessary to
improve the oversight of CEOs by corporate boards, and
therefore significantly reducing the likelihood of a repeat
session like this.
There are two improvements that we think do the heavy
lifting going forward, and they are proxy access and majority
voting. First, proxy access. Federal proxy rules have
historically prohibited shareholders from placing names of
their own director candidates on public company proxy cards for
consideration by their shareholders.
As a result, incumbent directors who fail in their
oversight responsibilities have little reason to change their
behavior because it is highly unlikely they can be replaced or
even challenged by an alternate board of candidates.
Fortunately, due to the extraordinary leadership of this
subcommittee and the full Committee on Financial Services, and
the SEC, proxy access will soon become a reality.
As you may recall, in June of 2009, the SEC issued a
thoughtful proposal providing for an uniform measured right for
groups of significant long-term investors to place a limited
number of nominees on the company proxy card.
After very careful consideration of input received in
response to two separate comment periods, the SEC appears
poised now to provide a final uniform proxy access rule that we
believe responds to the demands of long-term investors.
Importantly, this subcommittee and the full Committee on
Financial Services had the foresight to include a provision in
the Wall Street Reform and Consumer Protection Act that
reaffirms that the SEC has the unambiguous authority to issue
their final proxy access rule.
We again commend the subcommittee for their leadership in
pursuing this provision. We are pleased the provision is
strongly supported by the Administration and is a critical
element of regulatory reform.
The second corporate governance improvement we believe is
necessary is the requirement that all public companies adopt a
majority standard for director elections.
Currently, most companies elect directors in uncontested
elections using a plurality standard, by which shareholders may
vote for but cannot vote against a nominee. Shockingly, a
derelict corporate director can still win re-election by simply
receiving one vote under a plurality standard, a single vote.
They could actually vote for themselves.
As a consequence, unseating poorly performing directors is
virtually impossible. The Shareholder Empowerment Act of 2009,
one of the bills referenced in connection with this hearing,
includes a provision that requires the Commission to direct the
stock exchanges to prohibit the listing of any security of any
issuer if the company does not adopt majority voting. We
generally support that provision.
The benefits of requiring all publicly listed companies to
adopt a majority vote standard are many. It would democratize
the corporate electorial process and put real voting power in
the hands of long-term investors, like SERS, and make boards
more accountable to shareholders.
On behalf of SERS and the tens of thousands of employees
who depend on us for their retirement security, we respectfully
request your support for prompt adoption by all public
companies of both proxy access and majority voting.
Thank you, Mr. Chairman, for inviting me to participate in
this hearing. I look forward to answering any questions you may
have.
[The prepared statement of Mr. Brier can be found on page
53 of the appendix.]
Chairman Kanjorski. Thank you, Mr. Brier.
Now, we will have Mr. Alexander M. Cutler, chairman and
chief executive officer of Eaton Corporation.
Mr. Cutler?
STATEMENT OF ALEXANDER M. CUTLER, CHAIRMAN AND CHIEF EXECUTIVE
OFFICER, EATON CORPORATION, ON BEHALF OF BUSINESS ROUNDTABLE
Mr. Cutler. Thank you, Mr. Chairman, and members of the
committee. Good morning. My name is Sandy Cutler, and I am
chairman and CEO of Eaton Corporation. I am also chairman of
the Business Roundtable Corporate Leadership Initiative.
I have been chairman and chief executive officer of Eaton
for 10 years, and I serve on 2 other for-profit boards, as lead
director on one of those boards, and it is from this experience
that I speak to you this morning.
We at the Business Roundtable support an examination of
both corporate governance and financial regulatory reform, but
believe that each are important enough on their own merit to
deserve separate consideration. Combining the two in the
pending legislation permits public anger about the financial
crisis to substitute for a fact-based examination of our
corporate governance system.
Substantial changes have indeed occurred during the past
decade in corporate governance. Companies have taken a number
of voluntary actions; and State legislatures, the SEC, and the
New York Stock Exchange have adopted a number of statutory and
rule changes.
We are pleased that the Business Roundtable has been at the
forefront of efforts to improve corporate governance through
support of many of these initiatives.
Just this week, we are releasing our most recent list of
principles of corporate governance. These changes have resulted
in more independent boards and board committees; improved board
practices; and the adoption of majority voting by a large
number of companies.
As you know, the change in majority voting was facilitated
by amendments to a Delaware corporate statute and the Model
Business Corporation Act, which is followed by 30 States.
Other important changes have included the New York Stock
Exchange prohibition of broker voting in uncontested director
elections effective at shareholder meetings after January 1st
of this year, and the SEC's recent adoption of a number of
disclosure enhancements that address several of the concerns in
the proposed legislation, including those related to board
leadership structure, risk management, and board oversight.
I would like to focus my comments today on proxy access, as
we view it as an ill-conceived attempt to improve corporate
governance. Indeed, rather than empower shareholders, we
believe it would deprive them of important choices and have
serious potential adverse consequences.
The proxy access provision of the Shareholder Empowerment
Act would require the SEC to issue proxy access rules
permitting shareholders owning as little as 1 percent of the
company's securities for at least 2 years to nominate director
candidates in the company's proxy materials.
Clearly, director accountability to shareholders is
extremely important, but a federally-mandated proxy access
right is not the most effective way to achieve this goal.
Moreover, a proxy access rule could exacerbate the short-
term focus that is widely considered to be a contributing
factor to the financial crisis.
The process of frequent election contests could cause
directors to focus on structure and stock price rather than
invest for the creation of long-term value. In addition, proxy
access would permit shareholder activists with very limited
stock holdings in the company to pursue special interest
agendas to the detriment of the majority of the shareholders.
Even if special interest directors do not get elected, the
company and its shareholders will have been forced to bear the
costs and suffer the distraction of a time-consuming and
expensive proxy contest.
Finally, a federally-mandated proxy access right would
preclude companies and their shareholders from taking advantage
of the recent State proxy access enabling statutes to adopt
customized proxy access procedures that suit their needs.
Today, contemporary boards of directors use a variety of
tools and processes to see that qualified directors are
presented to the shareholders for re-election.
They strategically review skill matrices of current
directors. They carefully assess forward-looking skill
requirements on the board, such as audit committee financial
experts. They see if the relevant knowledge is present to
provide guidance, counsel, and oversight.
They undertake vigorous evaluations of the board, its
committees and individual directors, and they disclose to
shareholders their criterion for board membership along with
the qualifications and experience of nominated directors.
It is difficult to understand how an outside process
conducted without board involvement, as proposed under a proxy
access regime, will not fall short of this thoughtful and
informed process.
Before closing, I want to mention three other issues
related to proxy access that the proposed legislation does not
address: concerns about the current shareholder communication
system; the integrity of the proxy voting system; and the
influence of the proxy advisory services. All of these have
been addressed in more detail in my written testimony.
We are pleased that the SEC is beginning a study of these
issues, but they need to be resolved before a proxy access
regime is implemented.
In closing, let me emphasize that the Business Roundtable
is committed to effective corporate governance practices.
However, we must be careful not to impose one-size-fits-all
solutions that undermine the ability of shareholders and their
boards of directors to govern themselves effectively.
We stand ready to work with this committee, and I would be
happy to answer any questions. Thank you very much.
[The prepared statement of Mr. Cutler can be found on page
64 of the appendix.]
Chairman Kanjorski. Thank you very much, Mr. Cutler.
Now, we will hear from our next presenter, Mr. Brandon J.
Rees, deputy director, AFL-CIO.
Mr. Rees?
STATEMENT OF BRANDON J. REES, DEPUTY DIRECTOR, OFFICE OF
INVESTMENT, AFL-CIO
Mr. Rees. Thank you, Mr. Chairman.
Corporate governance reform is absolutely needed in
response to the financial crisis. Mandatory corporate
governance rules benefit all publicly traded companies by
enhancing investor confidence in our capital markets.
Stock market investors have just suffered the worse decade
since the Great Depression. During the past 10 years, the S&P
500 companies' stock prices have declined 24 percent. Needless
to say, the retirement savings of America's workers have been
decimated.
At the beginning of this lost decade, shareholders suffered
the corporate accounting scandals at Enron, WorldCom, and
hundreds of other companies. More recently, we have been
battered by the collapse of Lehman Brothers, Bear Stearns, and
the resulting financial crisis.
Corporate governance failures are the primary cause of this
lost decade for investors. We blame boards of directors for
failing to focus management on the long-term, for failing to
prevent malfeasance by executives, and for failing to properly
manage risk.
Nowhere is the breakdown in corporate governance
accountability more apparent than on the issue of executive
compensation. CEO pay has never been higher than in the past
decade. Last year, S&P 500 CEOs received $9.25 million on
average. Executive pay is the mechanism by which CEOs have
become captive to short-term market forces.
The collapse of Bear Stearns and Lehman Brothers provides a
dramatic example of what is wrong with executive pay. Between
2000 and 2008, the top 5 executives at Bear Stearns pocketed
$1.4 billion in cash, bonuses, and equity sales. Lehman
Brothers' executives took home $1 billion. Shareholders got
nothing.
As is required in other countries, American companies
should give their shareholders a say on pay. An annual vote on
executive compensation would encourage boards to be more
proactive in seeking out shareholders' views.
As a result, best practices in executive compensation would
disseminate more quickly. Ultimately, it is the job of the
board of directors to set fair executive pay packages, to
prevent malfeasance, and to manage risk.
We believe that boards of directors have been too
complaisant in their duties. Existing corporate governance
mechanisms simply fail to adequately hold boards of directors
accountable.
The election of directors is one of the fundamental rights
of stockholders, but too often, withhold votes against director
nominees are ignored. Last year, over 90 directors at 50
companies failed to receive majority support for their
election. Every one of these directors was seated despite their
shareholder opposition.
Replacing plurality voting with majority vote at director
elections is valuable. However, majority voting alone cannot
adequately reform the director election process.
Half of all publicly traded companies are incorporated in
Delaware. Under Delaware's hold over rule, incumbent directors
remain on the board even if they are not re-elected by majority
vote.
To make director elections more meaningful, long-term
shareholders need to have equal access to the proxy. Equal
access to the proxy will set ground rules for shareholder
democracy. It will limit the advantage of incumbents who now
have unlimited access to the corporate treasury to finance
their proxy solicitation.
Equal access to the proxy will open up boards of directors
to divergent viewpoints. Debate should be welcomed in corporate
boardrooms, not feared.
A director whose nomination depends on a backing of a long-
term institutional investor and not his fellow directors can
play that role. That is the goal of proxy access.
Now that the SEC is preparing to issue a proxy access rule,
the opponents of reform have put forward the idea of voluntary
proxy access. According to these so-called private ordering
proposals, companies should be able to opt in or to opt out of
equal access to the proxy. There are two major problems with
such proposals.
First of all, companies have stacked the deck to prevent
shareholders from adopting proxy access. Nearly half of all
companies in the Russell 3000 Index restrict the ability of
shareholders to amend company bylaws or they have dual class
stock voting.
If proxy access is made voluntary, only those companies
that already have good corporate governance will adopt proxy
access. Those companies with entrenched boards will resist
proxy access.
Secondly, allowing companies to opt out of proxy access
sets a dangerous precedent. Proxy access is about the Federal
regulation of proxy solicitations, not about State corporate
laws, and for the past 75 years, our Federal proxy solicitation
regulations have been mandatory.
Corporate governance reforms such as equal access to the
proxy can be a potent tool to focus companies on sustainable
value creation. For these reasons, director elections must be
open to long-term investors through proxy access.
Thank you, Mr. Chairman, for considering my views.
[The prepared statement of Mr. Rees can be found on page
312 of the appendix.]
Chairman Kanjorski. Thank you very much, Mr. Rees.
Now, we will hear from Mr. Robert E. Smith, vice president,
deputy general counsel, and assistant secretary, NiSource, on
behalf of the Society of Corporate Secretaries and Governance
Professionals.
Mr. Smith? That is quite a title, Mr. Smith.
STATEMENT OF ROBERT E. SMITH, VICE PRESIDENT, DEPUTY GENERAL
COUNSEL, AND ASSISTANT CORPORATE SECRETARY, NISOURCE, INC., ON
BEHALF OF THE SOCIETY OF CORPORATE SECRETARIES AND GOVERNANCE
PROFESSIONALS
Mr. Robert Smith. Thank you, Mr. Chairman.
As stated, my name is Bob Smith, and I am vice president,
deputy general counsel, and assistant corporate secretary of
NiSource.
NiSource is an energy holding company whose subsidiaries
engage in natural gas transmission, storage, and distribution,
as well as electric generation, transmission, and distribution.
In my position at NiSource, I am responsible for the
company's corporate group, which provides legal advice on
general corporate matters, finance matters, securities matters,
governance matters, and similar subjects.
I also serve on the board of directors of the Society of
Corporate Secretaries and Governance Professionals. The Society
is a professional association founded in 1946 with over 3,100
members who serve more than 2,000 companies.
The Society's members are responsible for supporting the
work of the companies' boards of directors and their committees
and the corporate governance and disclosure activities of the
companies.
I am here today in my capacity as a director of the Society
and I very much appreciate the opportunity to participate in
this hearing and to provide input on behalf of our diverse
membership, diverse across industry and diverse across market
capitalization.
The Society strongly believes in and has consistently
supported good governance practices, which include the right of
shareholders to have an effective vote in the election process
and the ability to recommend persons for nominations to the
board of directors.
As potential governance legislation is contemplated, it is
important that we recognize that we are currently in the midst
of a corporate governance sea change.
Over the past decade, this sea change is blatantly evident
through the many leading practices that have trended toward
mainstream or widely accepted adoption by public companies.
These changes in governance practices have generally been in
the form of enhancements to shareholder involvement,
shareholder input, or shareholder information.
It is important to note that these practices are empowering
shareholders and have occurred without legislative involvement,
as individual company shareholders have determined what is best
and what is appropriate for their individual companies.
Examples of this organic shareholder empowered governance
evolution includes development in such practices as majority
voting, independence of directors, policies regarding
independent compensation consultants, elimination of poison
pills, declassification of board member terms, clawbacks and
incentive compensation plans, separation of chairman and CEO,
and stock ownership guidelines for directors and officers.
Adoption of governance policies addressing matters such as
these clearly show that shareholders are having a voice in the
governance of companies.
Of equal importance is the observation that not all
companies or shareholders have deemed it appropriate to adopt
policies addressing these matters.
This is the essence of true shareholder empowerment, the
ability for shareholders to choose whether governance issues
should be addressed and if so, how they should be addressed at
their individual companies.
This is in fact the great irony behind the various pieces
of legislation now being proposed as they intend to empower
shareholders, but they actually force all shareholders to adopt
specific provisions in an identical way, whether the
shareholders want it or not.
This is why the Society hopes to ensure that the
shareholder proposal process remains the vehicle for
shareholder communication, for shareholder change, and for the
promotion of shareholder choice, true shareholder choice,
rather than forcing the hot reactionary issues of the day on
all issuers and shareholders regardless of shareholder desire
or need.
It is also important to make sure that any legislative
reaction should protect shareholder value through avoiding the
creation of potential mismatches of influence by short-term
investors with the long-term growth and value creation
strategies of public companies.
Looking at major provisions of the proposed legislation, I
will just touch on a couple really quickly, majority voting,
for instance. Without legislative regulatory requirements, the
adoption of majority voting has been a significant trend.
In fact, according to a CalPERS release last month, as of
September 2009, approximately 71 percent of S&P 500 companies
and 50 percent of Russell 1000 companies had already adopted
some form of policy for director resignations or majority vote.
This is a prime example of companies hearing shareholders'
concerns and addressing those concerns utilizing the current
proxy proposal and communication structures.
To legislate majority voting when shareholders have in fact
been empowered to address their concerns in this area is both
unnecessary and would disempower the shareholders of companies
that have determined that majority voting is not an issue they
desire to address at their companies, by in fact voting against
majority voting proposals.
I would welcome the opportunity to discuss other issues
that are in the legislation, but in conclusion, true
shareholder empowerment allows all shareholders to choose what
is best for their respective companies, not forcing
shareholders to accept rigid schemes regardless of whether they
want them or not.
Legislation should be thoughtfully enacted only where there
is clear consensus and empirical evidence that change is needed
and that such change would support the long-term interests of
all shareholders.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Robert Smith can be found on
page 339 of the appendix.]
Chairman Kanjorski. Thank you very much, Mr. Smith.
Finally, we will hear from Mr. James Allen, head of capital
markets policy, CFA Institute.
Mr. Allen?
STATEMENT OF JAMES ALLEN, HEAD OF CAPITAL MARKETS POLICY, CFA
INSTITUTE
Mr. Allen. Good morning. I want to thank Chairman
Kanjorski, Ranking Member Garrett, and all the members of the
subcommittee for asking us to come speak to you today.
My name is Jim Allen, and I am head of capital markets
policy at CFA Institute. For those of you who are unfamiliar
with the CFA Institute, we are a nonprofit membership
organization with more than 100,000 investment analysts,
advisors, portfolio managers and other investment professionals
throughout the world.
Our members are generally involved, therefore, in investing
the savings and retirement funds from millions of Americans and
others worldwide.
We are probably best known for administering the 3 year
testing program that leads to the awarding of the chartered
financial analyst or CFA credential. More than 5 years ago, as
part of our education program, we incorporated corporate
governance factors into those global exams, and more than
100,000 candidates throughout the world have been tested on
these issues ever since.
At the CFA Institute, we have a fundamental belief that
what is good for investors is good for financial markets in
general. This view is inherent in our code of ethics and
standards of professional conduct that applies to all of our
members wherever they reside in the world, and it has also
informed the positions we have advocated to regulators and
legislators globally over the years.
We have long supported strong corporate governance
structures under the belief founded in research that well-
governed companies perform better over the long-term than those
that are not well governed.
While we want to ensure shareowners have an effective
voice, we also do not want to interfere unreasonably into
corporate boards. This requires a finely tuned balance of
interests and reasonable restraints on both investors and
corporate issuers.
As noted in my written testimony, we believe that corporate
governance failures on the part of financial institutions play
an important but by no means exclusive role in the financial
market paralysis that began in August of 2007.
Senior executives, board members, and regulators alike
failed to appreciate the potential risks coming from large
concentrations of high-risk loans funded through highly
leveraged structures and unreliable wholesale funds.
I would like to note that many of the proposals made in
these three bills deal with issues which we have long supported
as needed to prevent these kinds of failures.
Two such provisions are legislative efforts for majority
voting and greater proxy access for shareowners. We believe
these two changes are the most critical and most needed to
ensure that shareowners have the ability to hold their board
members accountable.
Likewise, we support say on pay as a means of increasing
board accountability. Nearly 81 percent of our members
responding to an October survey said they support a non-binding
vote on executive pay. This view is due in large part to how it
has worked where it has been adopted.
Indeed, our members in the U.K. and Australia say such
provisions increased board attention to investor perspectives
and helped reduce the rate of increase in executive pay by half
in the first year after adoption by U.K. companies.
We also believe that better and more relevant disclosures
about executive pay will increase board accountability and have
supported regulatory efforts in this regard.
Looking ahead, we are working with the Blue Ribbon Panel to
develop a template to guide companies as they write their
compensation discussions and analyses in the future.
Legislation to mandate chair independence, on the other
hand, is something we do not support, as we are concerned that
it may trade the knowledge and expertise of corporate insiders
for a functional independent figure head. Rather, such matters
are best left to boards and shareowners to decide.
When a CEO is also chair, we believe that independent board
members should have the opportunity to appoint a lead director
to chair meetings of independent directors and address issues
involving potential conflicts with management.
Finally, we are uncomfortable with proposals to have the
SEC certify every member of the board for each of the thousands
of companies trading publicly. Such a monumental effort would
divert valuable SEC resources from the Commission's existing
mandate and could have undesirable effects on board membership.
Mr. Chairman, I ask consent that in the record, these
documents relating to items on corporate governance that we
have published over the years be allowed to be entered into the
record, and we also want to amend our written proposal to
include the data from our member survey.
Chairman Kanjorski. Without objection, it is so ordered.
Mr. Allen. I thank you for your time, and I am willing to
answer any questions that you may have.
[The prepared statement of Mr. Allen can be found on page
49 of the appendix.]
Chairman Kanjorski. Thank you very much, Mr. Allen. Thanks
to the entire panel. That was a lengthy panel, but certainly
insightful.
As usual, we are going to pick on the minority. Mr. Cutler,
I am looking at you.
[laughter]
Chairman Kanjorski. No. I am impressed. First of all, let
me tell you, I have always been a proponent of the idea of
self-regulation, and hopeful that any type of organization
could rely on its own internal values to guide its actions.
I have seen, however, fundamental changes in the corporate
structure and the ownership of the corporate structure, and by
analogy, I would draw to the union movement. I am sure, as a
capitalist, that gets your attention.
As you recall, about 3 or 4 decades ago, there was at least
across the land a cry that unions had lost their democratic
processes, and therefore, there was a denial of the democratic
process to the average union member, and this Congress, after a
hesitancy, and a rightful hesitancy, finally did enact the
Landrum-Griffin Act.
The Landrum-Griffin Act could be criticized for some
things, but clearly, it imposed upon the union movement
democratic processes, that the members could be guaranteed they
would have a right to meet at conventions. They would have a
right to free speech. They would have a right to not be put
upon for their actions or thoughts in regard to their union
activities.
Now, we have come to corporate activity. Up until now, we
granted the presumption that corporations, shareholders,
owners, directors, and management could be relied upon to act
responsibly, but I would call to your attention two things that
have changed significantly.
Throughout the testimony, if you listened to the entire
panel, they all talked about the shareholders. In so many
instances, there are not any more single shareholders. These
are conglomerations of agencies that represent pension funds of
individual investors that are lumped together.
The managers of these funds really are interested in the
return on investment and are not particularly disturbed by
democratic or non-democratic activities of American
corporations. They could really care less if the return is
sufficient to pay the pension or whatever else is necessary in
that fund.
There was a time in the 1929 crash that we could say look,
it is your money, you can put it anywhere you want to, and if
you want democratic processes, you can vote accordingly or take
your money and get out of the corporation.
Today, if I am part of a pension fund, as in the House of
Representatives, I think it is Fund C, that has the common
stock fund, I cannot vote my common stock. I do not even know
who is voting it and I do not know what corporations they are
putting it into.
The only thing I get to be told is once a year whether or
not I have made an increase in value or a loss in value.
Usually, I do not pay a lot of attention to it. Of course, I am
not in that fund because of my role here at the committee.
You do give it attention at the end of the year if you get
a 30 percent loss and suddenly you are asking the pertinent
question, why did that happen? You may find out, as one witness
described the Moody operation, when they made a presentation to
the board of directors, they were inconsequential in terms of
understanding what their role was, and just absent of all the
suggested thought processes that you expect from responsible
board members.
If you had listened to the testimony yesterday of some of
the chief executive officers and others and members of the
board of Lehman Brothers, it was a little bit startling.
We had a CEO who was paid a poor salary given today's
monies. I think in 2007, he only received $72 million. You
could not expect him to pay a great deal of attention to his
job or attention to whether he was working for the benefit of
the shareholders or not.
He said he just did not know any of these things were
happening. He was not aware they were doing repos, 105 repos.
He was not aware of the fact that so many things were being
done.
Now, what I have concluded is really we are at the Landrum-
Griffin Act, if you will, with corporations. Are we going to
impose here through government new standards, and granted,
probably uniform standards as opposed to particularized rights
of decision, how to run one single corporation over another?
Are we going to do that or are we going to ignore the fact
that there are a large number of American people who are
investors and owners directly or indirectly in American
corporations who do not feel they are getting adequately
represented, where huge bonuses can be paid of billions of
dollars, and no shareholder payments or dividends are paid out.
We are not casting aspersions on your activities as a CEO.
I am sure you are above and beyond any of those criticisms.
Obviously, there is a percentage of corporate leadership in
America that has failed. This committee, it seems to me, is
called upon to decide where are we going.
I have eaten up all 5 minutes. I am not going to get much
of a chance to get an answer from you. I will try to pick it up
in my next set of questions. I want to hear from my ranking
member from New Jersey. I am sure he has the answer to some of
my questions.
[laughter]
Mr. Garrett. Thank you. I can give you some answers. I want
to thank the panel. I do appreciate the comments and the
testimony here today. I share some of the concerns.
Mr. Smith, you laid them out, and the others did, too, but
I think you laid out some of the concerns we have about some of
these things.
Let me just throw out some things. One of the takeaways I
get from this and the impression I get from a number of the
panelists was that we are in this financial crisis situation
and we can look to corporate governance as being a root cause
of it. I, as you heard in my opening testimony, have a question
on that.
Let me go with this simple question. To the extent that
business, Wall Street, was a cause of the problem, and of
course, there is debate as to the extent of their cause and
regulators being the other part of it, but to the extent that
Wall Street was a cause of the problem, I note that the
legislation that we are looking at would go much further than
regulating with corporate governance Wall Street.
Ninety-eight or 99 percent of public companies are non-
financial institutions. Answer this question, if we are trying
to attack the problem, which is Wall Street, why are we also
addressing the other 98 percent of the public companies with
this legislation? Was I clear on that?
Mr. Cutler. Could I make an attempt at that, and also the
previous comments, and try to combine them?
Mr. Garrett. No, go with mine.
Mr. Cutler. These arguments, many of these arguments on the
issues of corporate governance date back some 20 years. They
have been around for quite a long time period.
I think what is very important to keep in mind at this
point is we have come through a terrible financial crisis but
there has been no evidence in any country that you can regulate
the economic cycle.
I think we have to recognize there are cycles in economies.
They are aggravated by different crises that have occurred
around the world over time, but the heart of those is not
corporate governance. It is the economic cycle.
There are abuses that occur around the world at different
times, but I would say the solution that we are trying to solve
for here is we have two fairly distinct events: one, an
enormous issue of international financial regulatory reform and
it is not just in the United States; and two, a number of the
corporate governance proposals that are being proposed did not
stop, although they are in place in other countries, they did
not stop the economic cycle and the financial regulatory reform
from occurring in those countries.
Mr. Garrett. Thank you. I only have 5 minutes.
Mr. Rees?
Mr. Rees. Yes, thank you. I would point out that it is not
just Wall Street. For the past 10 years, the stock market, as
measured by the S&P 500, has performed negatively. Investors
lost money over 10 years. That is money that our pension funds
depend on in order to pay for the retirement security of
America's working families.
Corporate governance was the root cause not just of the
financial crisis, but the corporate accounting scandals, the
stock option back dating scandals, a whole bevy of scandals
over the past decade.
We have to remember that corporate governance failures
drove those scandals.
Mr. Garrett. If you are telling me that the funds you are
invested with have done poorly over the last 10 years, then I
would have a question on your investment advice with regard to
those funds. Up until the crisis that we have had just now, I
think the markets have done amazingly well, if you look over
time.
The question that I have also is, do you find yourselves
potentially in a conflicted situation here? I do agree with you
on your point where you say we need to take a long-term look at
these things.
You are in a conflicted role when you are looking for the
long-term interests of the stockholders in these things versus
the short-term interests of your membership. Is that not
correct?
Mr. Rees. Absolutely not. Our members depend on companies
to invest for the long-term to create jobs, and I am shocked to
hear that other members of this panel think that shareholders
who own one percent of the stock of companies should not be
able to nominate their own directors.
Mr. Garrett. That was not my question, but thanks.
The question is, if you are out there trying to get jobs
for your employees today, that may at certain times, I would
think, run at cross purposes with the idea of increase in
shareholder value over the long term.
What about where those jobs are located? That thought just
pops into my head, when it comes to the issue of creating jobs,
is it maybe better for shareholder value in certain
circumstances, nothing that I encourage by any means, but in
certain circumstances, maybe it would be better for those jobs
not to be in the neighborhood of where your particular union is
in your State, for State funds and what have you, or out of the
country.
What happens then when it is an issue of local jobs versus
long-term investment? Which side do you come down on, long-term
shareholder value or the jobs for your union members?
Mr. Rees. We come down on the side of long-term
shareholders, because that is in the best interest of employees
of those companies.
Mr. Garrett. Even if those employees may no longer be here
in the area of my State?
Mr. Rees. We have a different view of how companies should
be managed. We believe that it should be based on the long-term
interests of the company and its stakeholders, including
shareholders, and we are not getting that from the current
system. We are not getting that.
We are getting ``short-termism '', driven by excessive CEO
pay and a focus on the short-term, not the long-term. That is
why shareholders need to have a greater voice in corporate
governance.
Mr. Garrett. Do the membership of the unions have the same
ability to have that interest and governance of the unions as
far as executive pay and the other things we are looking for
here in this legislation? Do they have that say?
Mr. Rees. Yes. Our officers are directly elected by the
membership of the organizations, unlike corporations where the
CEOs are appointed by a board.
Mr. Garrett. Is their compensation set by membership?
Mr. Rees. It is fully disclosed.
Mr. Garrett. I know. Does the membership get to vote on
compensation? I do not know.
Mr. Rees. Yes, they do.
Mr. Garrett. In all instances, they vote on the
compensation?
Mr. Rees. They vote on the compensation policies through
the democratic processes that the unions have established and
are required to have under the Landrum-Griffin Act.
Mr. Garrett. Thanks.
Chairman Kanjorski. The gentleman from Colorado, Mr.
Perlmutter.
Mr. Perlmutter. Thanks, Mr. Chairman. I appreciate my
friend from California letting me jump ahead. I have to get out
of here.
Mr. Cutler, my questions are simpler. In your company--I am
not sure, what does your company do, Eaton?
Mr. Cutler. We are a diversified manufacturer of electrical
equipment, aerospace equipment, hydraulic equipment, and
automotive and truck equipment.
Mr. Perlmutter. How does your company go about choosing a
member of its board?
Mr. Cutler. Our board of directors' nominating committee
and governance committee does that work. As I mentioned before,
they put together skill matrices in terms of what the current
skills on the board are. They look at the strategic plan and
the issues facing the company as they see it over the next
couple of years, and identify the skills that they then want to
seek.
They use an outside consultant to do the initial
interviewing, and then they make the nomination and give it to
the shareholders for election.
Mr. Perlmutter. Do you or does your company require any
kind of knowledge on the part of your director, either before
he is nominated or once he or she becomes a member on corporate
governance? Is there any kind of education class?
How does your company go about making sure you have the
best directors, some of whom may have to stand up to you on a
decision or two that you want to make?
I think in my experience, sometimes boards really play a
very docile role.
Mr. Cutler. My experience in serving on three boards
currently, and acting as the lead director on one of them, is
that is a view which is quite dated. A mass of changes have
occurred in this area.
I think if you simply look at what has happened to the
tenure of CEOs, and BRT is one subset, it is about 4 years
right now. This idea of entrenched management is a backward
looking issue.
If you look at board turnover, you would find last year,
and I believe the number was over 60 percent, of our boards had
at least one member turnover. I think it was just over 50, I
would have to confirm that number, for two members.
You are seeing turnover occurring on the boards. I can tell
you from my own experience, my own directors at our company
have no problem in not only standing up but taking very
different views than those of management. It is a very healthy
exchange.
Mr. Perlmutter. Is there some kind of continuing education
component that you have with your directors?
Mr. Cutler. Yes, our policy is that our board does have a
continuing education requirement through accredited education
courses outside of the company. We also twice a year conduct
internal training on specific functional issues, and to come
back to your earlier question, part of the criterion that our
board examines when they look at a man or a woman as a
potential candidate as a nominee for our board is not only
their breadth of business experience, but have they served on
boards, do they have governance experience, have they been
around these issues?
Mr. Perlmutter. Thanks. I would like to ask the two Mr.
Smith's the same question: Mr. Smith of NiSource; and then my
friend, Mr. Greg Smith, from Colorado.
Mr. Robert Smith. Thank you. I will speak on behalf of the
Society members. The Society has noticed and we have seen as
Mr. Cutler pointed out a big sea change in the governance
arena, and the docile board connotation really does appear to
be a thing of the past for most companies.
There could be some examples of outliers in that area, but
there is a much more active board. This is seen through a move
to independence, if you look at the number of independent
directors on public companies, that number has increased
dramatically over the last 10 years.
It comes as a result also even recently as a result of new
disclosures that are being required. There are new disclosures
that are being required by the SEC on executive compensation
analysis. Is there excessive risk in the executive compensation
plans of the company. It comes in the disclosure on risk
management.
Mr. Perlmutter. Let me stop you for one second. Do you have
a corporate governance kind of education policy or anything
like that at your company?
Mr. Robert Smith. At our company, we do encourage the board
members to obtain outside education.
Mr. Perlmutter. Greg Smith, please.
Mr. Gregory Smith. Thank you. We are always excited to hear
when there are corporations, and we certainly acknowledge there
are many corporations in corporate America who have adopted
good policies and are taking up good practices.
Unfortunately, they are not all that way. We think what
they have demonstrated, these ones that do have good
accountability, that have good corporate governance, is that it
works well, and in fact, it does not make the sky fall. It does
not make management fail in its role. It does not tie the hands
of corporate America.
In fact, it empowers both the corporations and their
shareholders to advance toward greater shareholder value.
In our organization, we certainly have education for our
trustees who are in a similar role, and in our management, we
certainly are focused on the constant education toward better
corporate governance and better responsibility and
accountability to our stakeholders throughout the State of
Colorado.
Mr. Perlmutter. Thank you. Thank you, Mr. Chairman.
Chairman Kanjorski. Thank you, Mr. Perlmutter. Now the
gentleman from Delaware, Mr. Castle.
Mr. Castle. Thank you, Mr. Chairman. I am concerned that
the proposals that we are discussing here today and the
legislation we are discussing today may exacerbate the problem
of short-termism, and not mitigate it as all of you have
indicated you would like to see happening.
Just some statistics we have picked up: annual stock
trading turnover on the New York Stock Exchange was 36 percent
in 1980; 88 percent in 2000; 118 percent in 2006; and 123
percent in 2007.
This data, of course, suggests that trading speculating has
replaced investing as the principal goal of stockholders or in
other words, short-termism.
Since some of your operations own so many shares, your
pension funds might be responsible at least in part for the
staggering increase in turnover. For those who are involved in
that, Mr. Greg Smith, Mr. Brier, and Mr. Rees, I would assume,
do you know the average turnover of your investments? if you do
not have the data available, I do not expect you necessarily
would here, but could you supply that to us in writing after
this hearing?
Do you have any comments on that, Mr. Rees?
Mr. Rees. Yes. I would be happy to get you that
information. I can say that union-sponsored pension plans tend
toward long-term strategies and are passive Index investors.
We agree that there is a short-termism problem on Wall
Street and in the stock exchanges. We joined with the Business
Roundtable to sign the Aspen Institute Principles for long-
termism, to encourage long-term investors.
I would note that proxy access as currently contemplated by
the SEC requires that shareholders to nominate directors must
have held their shares for at least 1 year, and we have
encouraged the SEC to consider a 2 year holding requirement.
Mr. Castle. Let me go to the others, so I can ask some
other questions, if I may. Mr. Brier, do you have a response to
that?
Mr. Brier. We would be delighted to supply that information
for you also. We do get a large proportion of our exposure
through the Index products, so we are permanent owners. We have
our active management as well. We will be delighted to supply
that.
We are also cognizant of the fact that short-term trading
is a problem. We are looking to the SEC when they address this
issue, and they had two open comment periods--
Mr. Castle. You are saying the problem is not something you
have helped create; is that correct?
Mr. Brier. Pardon me?
Mr. Castle. The problem is not something that you, your
operation, has helped create?
Mr. Brier. I would supply the information on trading, but
we have a tranche of permanent capital that we have in Index
funds. We cannot really sell those shares. We have a very
active corporate governance and proxy voting policies and we
publish that on the Web and we try to be best practices as
fiduciaries. Because of that permanent tranche, we are long-
term holders.
Mr. Castle. Okay. Mr. Greg Smith?
Mr. Gregory Smith. I will be happy to provide that
information. I also am a co-chair on the Council of
Institutional Investors, one of the largest accumulations of
public pension plans, corporate pension plans, Taft-Hartley's
in the world.
Based on our examination of our membership, I would be
extremely surprised if you found that pension plans are the
source of short-termism.
Mr. Castle. You will try to get me the information?
Mr. Gregory Smith. Absolutely.
Mr. Castle. That would be great, if you could.
Let me ask Commissioner Irwin a question. For 150 years, we
have had a State corporate law system that has allowed
directors and shareholders to continually change the organic
governance system for corporations.
Over the past several years, we have seen three-quarters of
the S&P 500 companies adopt majority voting, ending staggered
boards in a large number, separating CEO and chairman roles,
all without government mandates.
If reforms are already happening at the organic level, why
should we want to marginalize directors and shareholders and
empower Washington bureaucrats?
The decade has seen the entrance of government into
corporate governance and the corresponding fall of public
companies in the United States and a rise in public companies
around the rest of the world.
Are we legislating away our economic advantages to score
short-term political gains? You are, of course, involved at the
State level. I would be interested in your comments on that.
Mr. Irwin. Certainly, Congressman Castle, it is a difficult
question. I am not saying that--I believe that corporate
governance issues were the cause of the crash and the melt
down.
Clearly, some of the things that we are talking about will
instill a much greater sense of security and trust that will
bring people back, the retail investor on Main Street back, to
the capital markets.
Mr. Castle. My question is, is this not happening anyway,
so why do we need to do this as a Federal legislative mandate?
Mr. Irwin. One reason, we have national exchanges, and you
have heard from some members of the panel that they invest
across an Index, so everybody who is listed on an exchange is
going to have investment of substantial assets from people
investing without any control by them individually, but by
their pension funds.
We ought to have a minimum level of expectations as to
disclosure, as to such things as executive pay and other
things, so that there is that kind of integrity and trust that
will cause those investors to return.
Mr. Castle. Unfortunately, my time is up. I yield back.
Mr. Irwin. Obviously, we are the States. We do not really
advocate preemption. We believe that whatever the rule is, we
have to ensure that the States have the right to enforce the
rule, even if it is a Federal rule.
Mr. Castle. Thank you.
Chairman Kanjorski. Thank you very much, Mr. Castle. Now,
we will hear from the gentleman from California, Mr. Sherman.
Mr. Sherman. I would also like to respond to the gentleman
from Delaware. We have just had this great catastrophe, and in
the wake of that, everybody has gotten religion. Everybody has
reform and board members are going to classes.
If we are lucky enough to go 10 years without a
catastrophic crisis and scandal, all this will end. People will
return to their old ways. That is why I think we have to
institutionalize the lessons of the last 2 years, rather than
expect that this wave of caution is going to persist.
We have seen this after every bubble, everybody is really
cautious a year or two after the bubble explodes.
State law has traditionally governed such issues as how
long a term can a director have, do you have staggered terms,
do you have cumulative voting, do you mandate cumulative
voting?
What we have seen for the most part, and there are some
exceptions to this, is a race to the bottom. Every State says
ah, there may be franchise fees for us if we could just get
those corporations to incorporate here, and then when they go
bankrupt, we get to do the bankruptcy work, too.
The question is, should we at the Federal level establish a
floor of minimum rights for minority shareholders that have to
apply to all publicly held companies.
One of these issues is cumulative voting, a system where
even if there is a group of shareholders that has 51 percent of
the shares, they do not necessarily get 100 percent of the
board seats. If there is a group that has 10 or 20 percent of
the shares, they get a board seat.
Mr. Rees, should we as a matter of Federal law compel
cumulative voting so that a minority of shareholders, not a
tiny minority but a 10 or 20 percent minority, can get
themselves at least one seat on the board?
Mr. Rees. The Federal Government, since the passage of the
1934 Securities and Exchange Act, has set and regulated the
proxy solicitation rules, and has clear authority to do that,
and I believe can do things like proxy access through that
authority.
Your question regarding cumulative voting, cumulative
voting is another means to empower shareholders to have board
representation. I think it is something that is worthy of
consideration. I would think it would need to be done through
stock exchange listing standards because these are national
exchanges.
At this point, I think proxy access is the way that the
Federal Government should set the ground rules for proxy
solicitations.
Mr. Sherman. I think there is a tendency for all of us to
just buy into the traditional division between State and
Federal and that is the Federal Government controls the proxy
statement, the States control the corporations code.
I am not sure that has worked all that well, certainly not
over the last 2 years. It is the long-established tradition.
Mr. Rees, how would we see corporation behavior change if
we did have the kinds of proxy access rules that you are
advocating?
Mr. Rees. I strongly believe that just one independent
thinker on a board of directors can have a profound effect on
how well that board governs the corporation. I believe what is
important is not the nominal independence of directors or the
nominating committees that select those directors, but it is
the independence and spirit and the process.
The process that proxy access would provide is for a
director to be nominated, not dependent on the goodwill of his
fellow directors, but by the backing of a large institutional
investor. I believe that is a very healthy process that needs
to be implemented.
Mr. Sherman. I think you just made the case for cumulative
voting since you set forth the advantage of having a 10 or 20
percent group of shareholders able to elect that one
independent director.
Mr. Irwin, I see you are the securities commissioner. I do
not know if you are the corporations commissioner. How long a
term of office can a director have if his corporation is clever
enough to incorporate in the most lenient State? Any idea?
Mr. Irwin. I am not the corporations director. I apologize.
I cannot answer that question.
Mr. Sherman. I have seen 3 years, I have not seen longer. I
have seen 3 years with staggered terms. That is usually thought
to be a defense against minority shareholders, that and the
absence of cumulative voting.
Mr. Chairman, I see my time has expired. I hope we set
minimum national standards for empowering minority
shareholders. I yield back.
Chairman Kanjorski. Thank you very much, Mr. Sherman. We
will now hear from the gentleman from Texas, Mr. Hensarling.
Mr. Hensarling. Thank you, Mr. Chairman. Before I begin my
questions, I would ask unanimous consent that testimony from
the Center On Executive Compensation prepared for this hearing
be entered into the record.
Chairman Kanjorski. Without objection, it is so ordered.
Mr. Hensarling. Thank you, Mr. Chairman.
I think it was you, Mr. Brier, or several of you who used
the phrase ``excessive risk-taking'' in describing investment
strategies or business strategies of certain failed firms. That
was you? Can you define ``excessive risk-taking'' versus risk-
taking?
Mr. Brier. I think American capitalism as a brand took a
massive hit when the global financial system melted down and
Lehman's demise. I think that is a case study of the entire
investment banking industry failing to recognize the
counterparty risk that was within the system.
I think it is endemic to the entire financial services
industry.
Mr. Hensarling. What is the difference between risk-taking
and excessive risk-taking?
Mr. Brier. I would say an excessive risk is one that brings
it to bankruptcy. I think it is clear that an excessive risk
brought several--
Mr. Hensarling. Is there a company that enters into Chapter
11 today that engaged in excessive risk-taking?
Mr. Brier. I would say if they technically defaulted on
their obligations, they failed to manage risk properly. There
are market forces as well.
Mr. Hensarling. I have seen statistics from either SBA or
NFIB that approximately 80 percent of all small businesses fail
within 3 years. Does that mean they engaged in excessive risk-
taking because they failed?
Mr. Brier. I think there are market forces in place. I
think the concern here is the misalignment of executive
compensation and risk-taking within the financial industry and
other parts of the insurance industry.
I think there is a failure to recognize. AIG is a case
study on this. They had an unit based in London because there
was no oversight that was literally--
Mr. Hensarling. Let's talk about AIG for a moment here and
some of these other firms. Again, the problem I am having here
is trying to figure out--I am unacquainted with having a rate
of return without having some risk attendant to it. It is when
do we cross into that red area that says excessive risk-taking.
To some extent, I am concerned are we as policymakers on
the road turning over this definition of ``excessive risk-
taking'' ultimately to the Federal Government. Is that the road
we are on?
If so, was it excessive risk-taking by Members of Congress
and Federal regulators, again, to set up Government-Sponsored
Enterprises to essentially create a monopoly in the secondary
housing market, and then give them ever increasing affordable
housing initiatives that have now cost taxpayers $130 billion,
and it continues to rise.
Was it excessive risk-taking to have Federal bank
regulators tell banks that they could concentrate their
statutory capital in Fannie Mae and Freddie Mac paper, that
they thought it was riskless and it turned out to be the most
risky asset they had.
The point I am making is I am not really sure there is a
monopoly of wisdom here on exactly what is excessive risk-
taking.
Let's talk about executive compensation. It seems to be
Wall Street firms failed. Executives made obscene compensation
packages, therefore, we must regulate compensation packages.
There are a lot of obscene compensation packages out there.
Again, I have an open mind, but I am looking for the evidence
that of the Wall Street firms that did not fail, where is the
distinction in the compensation packages?
I have seen a study submitted that came out of Ohio State
University that says, ``When we look at the subset of the 54
banks that received TARP funding in our dataset, we find there
is no statistically significant difference in the relation
between dollar equity incentives and returns in the sub-samples
of TARP and non-TARP recipients.''
I have seen a paper from the American Enterprise Institute:
``If bankers were being lured by their bank's compensation
systems and acquiring risky but lucrative assets, they should
never have bought AAA bonds, which they did.''
I have a study coming out of George Mason University
comparing the compensation of banks determined healthy enough
to repay their TARP funds to compensation of banks likely to
need additional injections of capital that reveals little
difference in their executive compensation approaches.
At least the academic studies I have seen do not make the
case for the nexus, and even if it did, we have again
legislation before us to impact every single public company in
America, for which I do not quite understand the rationale.
One quick last question for you, Mr. Rees, and your
exchange with Mr. Garrett. Is there a Federal mandate that
forces rank-and-file members to vote on the compensation of
your union executives?
Mr. Rees. There is not a say on pay mandate for union
members to vote on executive compensation.
Mr. Hensarling. Thank you.
Mr. Rees. That being said, union executive compensation is
not what helped cause the financial crisis and it is not what
has caused 10 years of stock market underperformance that has
damaged workers' retirement savings.
Mr. Hensarling. The executive compensation at American
Airlines, Dean Foods, and other large employers in Dallas,
Texas did. Thank you.
Chairman Kanjorski. The gentleman's time has expired. Mr.
Ellison, since you were unable to make your opening remarks, we
will attach an additional 3 minutes to your 5 minutes. Go
ahead, sir.
Mr. Ellison. Thank you, Mr. Chairman, for holding this very
important hearing. I really appreciate it.
Here is my statement which I will also submit. Chairman
Kanjorski, Ranking Member Garrett, and members of the Financial
Services Committee, thank you for holding this important
hearing on corporate governance.
Clearly, new financial regulations should focus on enhanced
consumer protection, identification of systemic risks, and
enforcement of rules by aggressive regulators, but we are here
today to discuss another crucial element to our approach,
corporate structural relationships among shareholders,
officers, and directors that generate outcomes in areas such as
profitability, risk creation, and compensation.
Corporate governance changes seek to beneficially alter the
nature of the corporate behavior and therefore address
potential causes of economic injustice at a root level.
The bill I introduced, H.R. 3272, makes several proposals
designed to strengthen the rights of shareholders and mitigate
corporate risks.
As a preliminary matter, I would also like to emphasize
that jurisdictionally, the bill also affects companies that
issue securities subject to Federal regulation of the
Securities and Exchange Act of 1934.
The first element of the bill is the requirement that the
chairman of the board be independent and not serve as an
executive officer. The goal with this provision is to reinstate
the traditional divide between directors and officers, with the
hope that the divide will promote increased board oversight and
scrutiny of decisions of officers.
As we are all aware, many companies in recent years have
fused the director and officer relationship, especially through
the combined title of chairman of the board and chief executive
officer. Separation of the chairman of the board from officers
should promote independence.
Later on, I will ask members of the panel to offer their
views on this topic.
The bill provides for the establishment of an independent
risk management committee to oversee risk management policies
and an independent compensation committee to oversee and review
compensation practices.
Related to risk management, the bill also creates a
position of risk officer to establish, evaluate, and enforce
risk management policies. I believe that a risk management
committee and a compensation committee are crucial first steps
that will force a company to approach these matters with the
care, diligence, and scrutiny that they deserve.
The hope is that companies will realize that risks within
the company have the potential when aggregated with other risks
from other companies to create broad-based risks that can
further impact the company itself.
Companies at the front line of business activities must be
more vigilant about risks.
With regard to compensation, my hope is that compensation
committees will think about compensation practices throughout
an entire firm and not just for upper level executives. The
simple fact that we speak about compensation in terms of
executive compensation and not compensation for everyone else
probably suggests that we have a serious problem.
As we are all acutely aware, upper level executives are
paid at levels or orders of magnitude higher than average
employees and the trend has become more asymmetrical over time.
While the government is not in the business of setting
wages, a legal requirement such as a compensation committee
should inject additional scrutiny into a review of
compensation.
Additionally, in terms of compensation, the bill requires a
non-binding shareholder vote to approve executive compensation
when proxy solicitation rules require compensation disclosure.
This is simply one of the many proposals currently on the
table related to shareholder review of compensation.
Shareholders, as the owners of companies, should have the
right to ensure that their ownership stake is used to pay wages
that promote the profitability of the company.
Executives should not be able to drive companies into the
ground and walk away with millions. The shareholders, if given
the opportunity to review compensation, would not allow this
practice to continue.
Finally, H.R. 3272 provides that the SEC will study whether
it should certify members of the board before they are able to
join. Because some may view this as a drastic step, I would
emphasize that this bill simply asks the SEC to conduct a study
to determine the feasibility of such an approach.
Thank you again, Mr. Chairman. Mr. Chairman, if I have any
time left for a few questions, my first question is, I think
certain members of our panel, I am not sure which ones, have
recognized that there is a trend of separating the CEO from the
chairperson of the board.
If you regard this trend as actually happening, why do you
account for it and do you think it simply should be the policy
for publicly traded companies?
Mr. Robert Smith. Thank you. I believe in my opening
remarks I did mention there is an observable trend currently in
our membership towards the separation of CEO and chairman.
Having said that, and why that is occurring, I think it is
occurring for the appropriate reasons, because as shareholders
look at the individual policies and individual practices of
their companies, they are determining a need at that company
for a separation of the chairman and CEO.
It comes through the proposal process. There is a dialogue
that happens with the company. Then in the cases where a
majority of the shareholders would then desire that, it is
passed and implemented.
Having said that, we feel strongly that it should not be
legislated because that disempowers the shareholders to have
that dialogue and it disempowers the shareholders to have the
choice as to whether or not that is the appropriate thing.
As for the example in Mr. Garrett's opening remarks
regarding Bill Gates, under the current Peters' bill
legislation, he would not be able to serve as the chairman of
Microsoft, and it is incomprehensible how that would be in the
shareholders' best interest.
There are examples like that, new companies who are IPO'ing
and coming out, and they have a CEO with a rich history of
knowledge of the company and the industry, and to bring in
someone with zero tenure and to have them then be the
figurehead and the chairman of the company, it does not always
make sense. Sometimes, it does. Sometimes, it does not. That is
why we would recommend it not being legislated, but being a
viable option.
Mr. Ellison. Any other views on this topic?
Mr. Cutler. Yes, I would just add that we agree with that
position and really feel the SEC required disclosure on
leadership structure last year is very appropriate and I think
as you look at the proxies coming out in the 2010 season, you
are seeing companies--the board--specifying what their
leadership structure is and why they chose that structure. We
think that is the appropriate level of disclosure on an annual
basis.
Mr. Gregory Smith. It is disturbing to us in Colorado in
our pension fund that for some reason, the successes that have
occurred across the country in reforming corporate America to
adopt appropriate governance standards has now become the
shield for corporations who have not adopted these standards
and have not taken these progressive steps to say, oh, look, it
is happening already without us being told and forced to do it,
and they are being allowed to hide behind the good members of
our corporate community.
We would suggest that in fact what has happened is the
corporations who recognize and acknowledge their obligations to
shareholders have taken the appropriate steps and for that, we
are thankful, but to suggest that therefore shields those who
have not taken those actions from needing to or relieves the
need for Federal legislation to impose appropriate tools for
shareholders to enforce these principles, these core
principles, it is just a travesty, and it needs to be looked
through and not allowed to be successful in hiding these bad
actors or these failures by other corporations.
Mr. Ellison. That point is well taken. Going back to Mr.
Cutler's point, the fact that some companies have taken the
step, are you submitting to us that should somehow be evidence
that the ones who have not taken it, that means they do not
want it, there are not shareholders who would like to see that
kind of action, but for some reason, are curtailed in some way?
Mr. Cutler. I would just say very briefly that I think it
is a little disingenuous, with due respect to my fellow
panelists, to say people are hiding behind this. Many
corporations have participated in advancing the feeling that
there should be a leadership structure disclosure and the board
should make that appropriate decision for what is right for
that individual corporation in light of some of the factors
that my fellow panelist, Mr. Smith, mentioned.
It may also be an issue in terms of evolution, in terms of
either a new executive or an executive who has is to provide
tutorage for one year.
Chairman Kanjorski. The gentleman's time has expired.
Mr. Ellison. Thank you. I yield back the time I do not
have.
[laughter]
Chairman Kanjorski. The gentleman from California, Mr.
Campbell.
Mr. Campbell. Thank you, Mr. Chairman. I may be unique on
this committee in that I strongly support proxy access.
However, I strongly oppose this particular bill.
I would like to explore with the panel my concerns and see
where you all fall. First of all, let me say that on the
majority voting, I obviously support that. I think there is not
a lot of controversy on that since about 50 percent of public
companies have that now, and I think that is an important part,
proxy access, for it to work.
I also think that if you have these things, proxy access
and majority voting, then shareholders have mechanisms through
which they can express their displeasure with a company short
of selling the stock, and therefore, I believe you do not need
all these other things like executive comp and the chief risk
officer and the board certification, all that kind of stuff.
What I would like to focus on is the proxy access part. My
first question is to those of you on the panel who support
proxy access, my concern with this bill is that it allows the
SEC to set the thresholds of proxy access, and they have
indicated that 1 percent, 3 percent, and 5 percent roughly for
large cap, mid-cap, and small cap companies, are the proper
thresholds.
I believe those thresholds are too low and could result in
a greater problem than not having proxy access for this reason:
if a single shareholder or a group of shareholders who have a
very narrow interest have access to the proxy to express that
narrow interest, then that is not in the best interest of the
shareholders generally.
I understand all the shareholders have to vote the director
in. You could have shareholders that are a union, a supplier, a
customer, or perhaps have an event coming up where although
they are a long-term shareholder, they have a very short-term
focus because they have a sale event that is imminent for some
reason.
Any of those things, particularly in a small cap company, 5
percent share holding is not necessarily a big shareholder and
is not necessarily a huge investment for a lot of particular
institutional players.
For those of you who support proxy access, do you share my
concern, do you believe that larger thresholds, 5, 10, and 20,
something like that, so you have to have an amalgamation of
shareholders that would have to not represent a narrow interest
but would still be not a huge percentage but something like 5,
10, and 20, which is what I support.
Whomever wishes to answer. Mr. Smith?
Mr. Gregory Smith. We have done significant work on that
very issue because we are concerned about exactly what you
raised. As a public pension fund, we certainly see the risks
associated with giving people access to a proxy and the need to
then be informed about who we are voting for on those director
votes.
The realities of who owns shares and how many they own and
how you get to these percentages is very important to
understand.
What we did was do an examination of the top 10 public
pension plans in the country and their holdings in a range of
10 different companies covering a spectrum of cap size.
In that study, what we determined was that there were on
average .86 percent of the shares were held by the top 10
pension funds.
Mr. Campbell. Combined?
Mr. Gregory Smith. Less than 1 percent combining all 10 of
them, the 10 largest had less than 1 percent of the shares. The
highest they had in any of the companies that we examined was
2.86 percent. That is all 10 of them combined. That is the
biggest in the country, biggest in the world.
Mr. Campbell. My time is wrapping up. I know Mr. Rees wants
to say something. I will just ask my second question, which is
for the opponents of proxy access. If thresholds are larger,
does this soften your opposition or change your opposition to
proxy access if there are larger thresholds?
Mr. Cutler?
Mr. Cutler. If I could, unmentioned so far is the position
of hedge funds in corporations, and they are a considerable
multiple of that figure. Obviously, the pressure from hedge
funds for short-term actions to lever up a company to take
actions that are not in the long-term interest of the
shareholders, we believe, or the employees or the customers, is
considerable.
Higher thresholds would help, but our fundamental issue is
that we believe it is an issue of State law, not Federal law.
Mr. Campbell. Mr. Rees?
Mr. Rees. I would make two points. One, that under the
current proxy access rules, many boards of directors would not
qualify because the directors themselves do not hold 1 percent
of the shares outstanding to nominate directors.
My other point would be that under the current proxy
solicitation rules, it is only hedge funds and takeover funds
that are doing proxy fights today. There were 40 proxy fights
last year which were dominated by short-term forces.
Mr. Campbell. I agree with your 2 year threshold,
absolutely, but still, you can have a long-term shareholder
with a narrow or even short-term perspective if the threshold
is too small.
I yield back. Thank you.
Chairman Kanjorski. Thank you, Mr. Campbell. Now, we will
hear from the gentlelady from Illinois, Ms. Bean.
Ms. Bean. Thank you, Mr. Chairman. I have a question for
Mr. Cutler. First, about majority rule. It is my understanding
that in the last couple of years, 63 companies held shareholder
votes on whether to institute a majority vote rule, which
resulted in shareholders of 27 of those 63 companies voting
against it. Other companies did choose to adopt it.
If the purpose of majority voting is to empower
shareholders, what would be some of the reasons that nearly
half of shareholders would vote against requiring it?
Mr. Cutler. I personally cannot speak for what their
specific reasons were. I think the trend is the important one
here. We are seeing a very high number of companies adopting
majority voting, and while we think that is a decision that
shareholders should be making for their individual
corporations, there are situations where the preponderance of
shares may be held by very few shareholders in some firms,
often because they are smaller, and that is why we do not think
there should be a Federal rule requiring it across the spectrum
of all companies.
Ms. Bean. My second question for you is some have suggested
that the risk of proxy access is that it would empower short-
term holders, hedge funds, raiders, for example, to influence
company decisions. Do you believe that could lead to more
emphasis on short-term results as opposed to the creation of
long-term shareholder value?
Mr. Cutler. We do believe that proxy access with those
pressures can exacerbate the pressures that are already out
there, the short-termism, and do not come simply from this
issue of corporate governance, but from the focus on short-term
profits and short-term payouts of cash dividends, etc.
Ms. Bean. Thank you. My next question is for Mr. Smith or
Mr. Rees. If the majority of shareholders at a company did not
want majority voting, is it your understanding the current
proposal would reject that option for them?
Mr. Rees. If I may, I believe that the proxy rules need to
provide minimum standards for the election of directors. I
believe that majority voting is one way to make director
elections real accountability mechanisms.
To the extent that shareholders have not voted in favor of
those proposals this year, I expect that in future years, we
are going to increase demand, but more importantly, you have to
remember that many companies due to dual class voting
arrangements, due to the bylaw restrictions that prohibit
shareholders or require super majority votes to change the
bylaws, shareholders do not currently have the mechanisms to
implement reforms like equal access to the proxy or majority
vote director elections.
Ms. Bean. Would the short answer be yes, their views should
be rejected even if they vote against it?
Mr. Rees. The short view is that shareholders need to have
their votes on director elections respected and that is why we
need majority voting.
Ms. Bean. My next question is, there was an example that
came up, and I forget who mentioned it, that Bill Gates
obviously had been CEO and later chairman of the board, and you
did not hear a lot of folks at Microsoft uncomfortable with
that.
For those who think that this legislation, which would
disallow that, is a good idea, can you explain why?
Mr. Rees. With all due respect, most publicly traded
company CEOs are no Bill Gates, and if they were Bill Gates,
then I think there would be less of a concern about the fact
that most companies in the United States have combined
positions of chairman and CEO.
Mr. Gregory Smith. I would also suggest that had Mr. Gates
had a separate chairman as opposed to his CEO role, he would
have probably functioned quite well within that arrangement,
and he would have communicated well with his board. He would
have disclosed his management objectives and strategy, and he
would have worked with the board chair, an independent chair,
to come up with an agenda that gave the directors the
opportunity to address that strategy.
Nothing would have tied Mr. Gates' hands by having a
separate chair of the board.
Mr. Cutler. What you do run the risk of is legislating out
talent, and that is a danger.
Ms. Bean. I would agree with you. Thank you. I yield back.
Chairman Kanjorski. Thank you very much, Ms. Bean. Now, we
will hear from the gentleman from Illinois, Mr. Manzullo.
Mr. Manzullo. Thank you, Mr. Chairman.
Mr. Cutler, my father-in-law worked for Cutler Hammer for
years, and last year he sent you the 50th anniversary brochure.
It occurred several years ago. You kindly gave him a call and
talked for quite a bit of time with him, and I want to thank
you for taking that time just to spend on one of your former
employees. That is very commendable.
I have a big problem here. Is anybody proposing any
legislation to determine when a corporation should incur a
dividend or take that money and reinvest it into new structures
or companies?
Does anybody see a problem with the Federal Government
making that determination? Or should the Federal Government
simply determine the salaries of everybody at every level of
the corporation, does anybody have a problem with that?
I have a problem to the extent that the Federal Government
that passes a health care bill that does not even know if its
own Members of Congress are covered and has the chief spokesman
going around the country saying nobody will lose their health
insurance, that this august body is telling corporate America
what is the best way to run your board of directors.
Somebody has to come in here and say, if we had passed the
Proxy Voting Transparency Act, the Corporate Governance Reform
Act, and the Shareholder Empowerment Act, that this sage, this
independent director would sit on the board of every major
corporation and be there to stop any type of default on the
part of a corporation.
Can somebody answer that question?
Chairman Kanjorski. Will the gentleman yield?
Mr. Manzullo. Sure.
Chairman Kanjorski. You are asking some interesting
questions. We are trying to establish policies here that could
protect the American people, and since your side of the aisle
just a short number of years ago suggested that all the Social
Security funds of the United States be invested in American
corporations, then all the Social Security--
Mr. Manzullo. Reclaiming my time, I am just making the
statement that just because something goes wrong in the
financial markets, or something goes wrong with the
corporations, that Congress sitting here taking the position
that putting someone independent--how do you determine who is
independent?
What if a creditor gets on the board and he is independent
or he is on the board of another company to which the
corporation owes money and says well, you should do things in
order to prefer creditors first?
I do not think you can get anybody who is truly
independent. Several CEOs sit on other boards themselves. That
is okay because you have collective wisdom. You have lots of
years of people who have seen mistakes, made mistakes
themselves, and wanted to make sure those do not occur again.
I just have a problem with every time something goes wrong,
Congress sitting here trying to make these micro decisions.
Does anyone want to comment on this?
Mr. Cutler?
Mr. Cutler. I think as I mentioned before, the temptation
coming out of any severe financial crisis like we just came
through is the feeling that somehow it could have been
prevented through different forms of corporate governance.
I, myself, feel that we came through obviously a very
damaging recession. We go through cycles, and we have been
through them before, and the focus of financial regulator
reform is that which gets at the core of the issue which caused
the liquidity crisis.
I personally have not seen evidence that the rest of the
damage in the economy that came from that credit crunch came
from poor corporate governance practices.
I think the enormous revolution that has been occurring
since 2000 in corporate governance is a trend that we should
continue to see play out, the independent committees, the
improved boards, the independent selection of board members,
the vigorous evaluation on an annual basis of board member
performance. These are all very positive issues, coupled with
the SEC's new disclosures around leadership, around risk. These
are important disclosures that are important for shareholders
to have access to.
Mr. Manzullo. When you look at what happened--you see in
Mr. Paulson's book where he encouraged $20 billion worth of
sales of stock of Fannie Mae and Freddie Mac, knowing full well
that there would be a default on it, and a lot of community
banks got stuck with it.
The Federal Government's role in trying to be independent
and protect the shareholder is not exactly exemplary. Thank
you.
Chairman Kanjorski. The gentleman from Indiana, Mr. Carson.
Mr. Carson. Thank you, Mr. Chairman. This question is for
Mr. Gregory Smith. Among your proposed executive compensation
reforms, you recommend stronger clawback provisions in
legislation.
There is currently language in Sarbanes-Oxley that allows
for clawbacks due to executive misconduct. The definition of
``misconduct'' is really open to interpretation.
Please talk about specific improvements to the language
that could be included in legislation.
Mr. Gregory Smith. The language that is contained in some
of our policies related to clawbacks focus on whether those
clawbacks would be related to misstatements of performance,
misstatements of financials, the ability to claw back because
in fact their performance had been misrepresented. I think that
is really the core of our objectives from a legislative
perspective.
We do not claim to be able to identify exactly what
compensation should be able to be clawed back in every case.
That is going to be a company by company determination, and I
think it is important to recognize that in none of our reforms
have we asked for legislation to set what compensation is going
to be, set a formula for what compensation is going to be, or
set a formula for what compensation can be clawed back.
What is really important is that we have the ability to do
those clawbacks but even more importantly that the shareholders
have a voice in the boardroom to make sure that happens, and
frankly, that it be put in the contract at the outset with that
CEO so that he knows it is going to be clawed back if is
misperforms, he knows they are going to pull those dollars back
if he does not accurately represent what the corporation has
been doing and what the financial condition of the company is.
Mr. Carson. Thank you. I yield back, Mr. Chairman.
Chairman Kanjorski. Thank you very much, Mr. Carson. The
gentlelady from Ohio, Ms. Kilroy.
Ms. Kilroy. Thank you, Mr. Chairman. Mr. Irwin, in your
testimony you indicated that sunlight is the best disinfectant.
Do you think then it would be a good thing to require all 13-S
institutional investors to disclose how they vote their proxy,
knowing how pension funds, unions, hedge funds vote, to add
some transparency to the corporate election process?
Mr. Irwin. My comments today have been as the Federal
legislation chair for NASAA, the North American Securities
Administrators, and our focus has been on executive
compensation.
No one is asking today or NASAA is not, and the States are
not, asking that there be a Federal determination by the SEC or
anyone else or a review of wages or compensation in corporate
governance.
Rather, we suggest that there be review and disclosure so
that shareholders--they are the best regulator of public
companies--have access to the complete information.
Ms. Kilroy. I was simply asking whether institutional
investors should be required to show how they voted their
proxies when there was a proxy vote.
Mr. Irwin. I do not have a position on that, Congresswoman.
Ms. Kilroy. Thank you. Mr. Smith, your group, the Colorado
Public Employees' Retirement Association, I understand you have
adopted a policy for your domestic proxy votes; is that
correct?
Mr. Gregory Smith. Yes, we disclose our proxy votes on a
monthly basis on our Web site.
Ms. Kilroy. Do you think it would make sense to require
this of all institutional investors over a certain size, say
over $100 million?
Mr. Irwin. Obviously, my board of trustees believes that is
an appropriate practice for public pension plans and it is one
that we are proud to be a leader of.
Ms. Kilroy. Mr. Rees, does the AFL-CIO support increased
transparency by disclosure of proxy voting?
Mr. Rees. Yes, we do. We disclose both our guidelines and
our proxy votes, and we believe that all market participants,
all institutional market participants, including hedge funds,
investment managers, and mutual funds--mutual funds are
currently required to disclose their votes--should be.
More importantly, we believe that companies need to
implement those votes when adopted by shareholders, and that is
why we believe governance reforms like majority vote in
director elections are so important.
Ms. Kilroy. Thank you. Mr. Allen, CFA is the sponsor of an
investor working group?
Mr. Allen. Yes.
Ms. Kilroy. Am I correct that the investor working group
supports the central recommendation of the disclosure of proxy
votes?
Mr. Allen. I believe that is correct. I cannot recall
whether that was one of the provisions of the IWG report, but I
do know that is something that the CFA Institute does support;
yes. You are talking about the investment firms disclosing?
Ms. Kilroy. Disclosing how they vote; correct. Or unions or
retirement funds.
Mr. Allen. The idea is the investors in those funds need to
understand how their managers are voting those shares so they
can determine whether or not they want to invest in it.
Ms. Kilroy. Thank you very much. Mr. Smith, some of the
members have questioned whether there should be Federal
regulation or we should have State-by-State determinations and
State-by-State reforms.
How would that affect a large fund like yours if you had
State reforms to deal with?
Mr. Gregory Smith. I have a two-part answer to that
question, if I may. One is the burden placed upon us in
understanding and getting a handle on 50 different States'
rules, it would be burdensome. It would impact our ability to
be effective in our votes, and to carry out what we believe our
fiduciary duty is, which is to vote those shares and
participate in the proxy process.
The question, I think, is one that is extremely important
and one that certainly Colorado PERA hopes to get improvement
on through this process.
Ms. Kilroy. Thank you. Mr. Brier, you were asked earlier to
define ``excessive risk.'' Do you think it is appropriate for
corporations to set up a risk matrix and have a professional
risk manager but then repeatedly, over 30 times in 2 years,
exceed those risk limits, and in fact, when they are exceeded,
just simply increase them and fail to have that risk manager
report to that corporate board?
Mr. Brier. I think the most important answer to that
question is that through a market-based solution of enabling
investors to get access to majority voting and proxy access
will enable them to get a voice in the boardroom. That voice in
the boardroom will focus on long-term investors, like us, risk
management.
I do agree it is an area that one of the difficulties that
long-term investors have is removing directors. You can know
that something is wrong. You can have derelict directors. You
can know that risk management is not under control. You cannot
remove them.
I think this market-based solution where long-term
investors, long-term holders with a significant number of
shares who get access to the proxy, who can use the proxy card
of management who need to then go out and get a majority vote
can get someone on the board to address this risk management
issue.
Chairman Kanjorski. The gentlelady's time has expired. Mr.
Peters?
Mr. Peters. Thank you, Mr. Chairman. Thank you to the
panelists. It has been a very interesting discussion and an
important issue as well.
I just want to address briefly some of my colleagues on the
other side who have used some of the rhetoric that this is
somehow the Federal Government interjecting itself in the
management of companies, I just want to remind my colleagues
that this is far from that.
In fact, it is about empowering the people who actually own
these companies. I think we have forgotten who actually owns
these companies, and that is the shareholders.
To me, that is about as pure of a capitalistic system as
you can have, that you say the people who actually own capital
actually have a say as to how that capital is managed, and hold
those managers accountable to manage it and to increase
shareholder wealth.
This is not about Federal Government takeover. It is not
about the government mandating. It is about the people who
actually own these companies.
I know shareholders are very diverse, including people who
are in IRAs and 401(k)s and pension funds, who are investing
their hard-earned dollars hoping that they have some sort of
security in the future, and want to entrust that their managers
actually have their interests in mind and not any of the short-
term interests.
I want to just touch on a couple of general themes that I
have heard through the debate and then one that I heard from
most of the panelists, that there has been a sea change in how
boards are starting to govern their companies, and they have
been standing up to CEOs and have been more active, and at the
same time we are also hearing that more boards are also
adopting many of the practices that are in this bill and in the
Shareholder Empowerment Act, which I have authored.
Those companies that are standing up to CEOs, are more
enlightened, do understand that good governance also is
correlated with good shareholder performance or good share
performance, to me that seems as if it is pretty good objective
evidence that what is in these bills as has been adopted
voluntarily by companies, that have boards that are more active
in overseeing and holding their management consistent, to me,
that should be strong evidence that we should extend it to all
companies because this is has proven good governance.
No one particular panelist, is that a fair assessment of
why it makes sense for us to move in this direction, because we
actually have objective data from those companies that are
doing it, that it does lead to better governance and better
stock performance?
Mr. Gregory Smith. Certainly, the evidence that we see and
are pleased to have had enough success to be able to generate
that data.
Mr. Cutler. I would say there are selective elements that
you are seeing broadly adopted. I think getting into areas such
as a regulated solution to board leadership, a regulated
solution to risk management, a Federal, not a State-based proxy
access system, and then as we have talked about on another
occasion, the need to address the efficiency and accuracy of
the voting process, are really important concepts.
Without that, we feel there are some additional problems
with the proxy access proposal.
Mr. Robert Smith. I would just add the movement towards
good governance, there is a pervasive attitude to try to vilify
current CEOs at companies, but my observation has actually been
that CEOs within our membership organizations have been some of
the proponents of these changes and of good governance.
There is a trend towards good governance and many of these
same provisions are being implemented and do empower
shareholders, but again, to legislate it so it is a one-size-
fits-all on all companies, it seems to go beyond that, and it
takes away from shareholders' ability to actually decide what
is best for their company.
Mr. Peters. I take a little different view, the fact that
if shareholders should--every company should have the
opportunity to make sure that the managers are caring for their
interests and are looking out for their interests.
It should not be just those companies that happen to be led
by a more enlightened CEO. We are hoping that shareholders from
every company have those protections. That is certainly what is
the goal of this legislation.
Mr. Cutler, we had a chance to meet earlier. I appreciate
having that opportunity. You did bring up some concerns about
the way elections could be hijacked.
If you would just briefly touch on that, and I would like
to have some response from some of the other panelists if they
are equally as concerned.
Mr. Cutler. The elimination of broker vote, which our best
data would indicate that about 15 percent of our average
companies are owned on a retail basis, it has the prospect
without improvements in the communication process today that
assures accuracy of both the communication and voting process
of reducing a number of votes that would be cast in an annual
election.
That coupled with relatively low thresholds for majority
vote and the ability to pool shares or borrow shares holds the
prospect for consortiums of a group of voters coming together
to advance a special interest conclusion.
We are also concerned about the potential for borrowed
shares not being counted accurately, i.e., being double-counted
potentially. That is why we are very pleased, as I mentioned in
my testimony, that the SEC is looking at these issues.
The last issue is the very strong position of proxy
advisory firms today. It is not a transparent process. There
are some indeed conflicts in terms of understanding the vote,
if you want to understand that from a company point of view,
and that you end up paying a fee to get the information, and we
think that consulting agreement is a conflict with the actual
voting process, and the ability of 30 to 40 percent of the
shares being controlled on an institutional vote by the
recommendations--
Mr. Peters. I know my time is expiring. Could I just have a
couple of responses from other folks as to their concerns? Mr.
Rees or the gentleman from Colorado, Mr. Smith?
Mr. Rees. Yes. We believe that we need to have minimum
standards in corporate governance to protect investors.
Otherwise, you will have a phenomenon where only those
companies that have good corporate governance are adopting
reforms, like separating the chairman and CEO, majority voting
and proxy access, and those that are entrenched in unresponsive
boards will be the ones that resist those reforms.
That is why we need minimum standards. Thank you.
Mr. Gregory Smith. I believe also that the borrowed shares
issue is one that has been and is being dealt with by the SEC.
It does not present a threat. The hedge fund risk or the claim
that the raiders will use proxy access to disrupt companies, I
think that is dealt with both by the thresholds required, and
the testimony I provided regarding really where those volumes
of shares could be developed, as well as the holding period.
I do not think there are raiders that want to wait around 2
years for their opportunity to get one board seat. It is just
not a realistic threat.
Mr. Robert Smith. If I may, there are many opportunities
where boards are faced with long-term capital investments that
do not pan out in the short term, and if hedge funds and day
traders and people who have access to corporate votes have the
opportunity to get in and influence it, then that short-term
time horizon can get in the way of those long-term objectives
and change the strategy to an annual focus or something with a
shorter time horizon than a strategic plan would have.
Mr. Gregory Smith. Ultimately, they would require a
majority of the vote in order to accomplish that. We would
still be protected.
Mr. Peters. I yield back. Thank you, Mr. Chairman.
Chairman Kanjorski. Thank you very much, Mr. Peters. Thank
you, Ms. Kilroy. The two of you have done really admirable work
in this field of governance.
The subcommittee chairman wants to thank you. I know the
chairman of the full committee wants to thank you. We are
looking forward to further hearings on this subject. Thank you.
To the panel, we want to thank you for being here. I have
one or two notes I have to make before we recess to dismiss
you.
The Chair notes that some members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 30 days for members to submit written questions to these
witnesses and to place their responses in the record.
Before we adjourn, the following written statements will be
made a part of the record of this hearing: Carl C. Icahn; Tom
Gardner, on behalf of Motley Fool; the Investment Company
Institute; and Susan F. Schultz, president, the board
institute, Inc. Without objection, it is so ordered.
Mr. Castle. Mr. Chairman, I have a letter which we all had
received dated April 20, 2010, to you and Ranking Member
Garrett from a series of entities in opposition to some of this
legislation. I will not read them all: American Insurance
Association; Americans for Tax Reform; Business Roundtable; the
U.S. Chamber of Commerce, etc. I would ask that this be made
with unanimous consent part of the record, if we may.
Chairman Kanjorski. Without objection, it is so ordered.
Any other submissions for the record? We have completed
everything?
[No response.]
Chairman Kanjorski. I want to thank this panel. I hope we
did not pick on anyone in particular, but I gained a lot of
insight from you all. I am certain now we have more confusing
time to spend to resolve this, but we will.
Thank you very much for your public service. We really do
appreciate it.
Thank you and the subcommittee stands adjourned.
[Whereupon, at 12:27 p.m., the hearing was adjourned.]
A P P E N D I X
April 21, 2010
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