Institutional Investors Weigh In On Financial Reform

Monday, April 5, 2010 - 01:00

Council of Institutional Investors

The Council of Institutional Investors is a nonpartisan association of public, union and corporate employee benefit plans with assets exceeding $3 trillion. Because of this investment, council members have a very significant and long-term commitment to the U.S. markets, and they have been deeply impacted by the financial crisis. Therefore, they have a vested interest in insuring that regulatory gaps and shortcomings exposed by this crisis are repaired.

Several members of the Council shared their views on some of the critical pieces of Senate Banking Committee Chairman Christopher Dodd's new bill to overhaul financial regulation at a press briefing on March 19, 2010. The participants were: Joe Dear, Chief Investment Officer of California Public Employees' Retirement System (CalPERS) and Chair of the Council; Ira Millstein, Senior Associate Dean for Corporate Governance at Yale University; Richard Breeden, former SEC Chair; Anne Sheehan, Director of Corporate Governance for the California State Teachers Retirement Systems; Anne Simpson, Senior Portfolio Manager for Corporate Governance for CalPERS; and Greg Smith, General Counsel & COO of the Public Employees' Retirement Association of Colorado.

The following are excerpts of their remarks:

Dear : Financial market reform is at a critical stage. Senator Dodd's banking committee finally has issued its proposed bill in the wake of the financial crisis. Its goal is to rein in unregulated players and to ensure that U.S. markets are strengthened through transparency and accountability.

We know that it is easy to get lost in the details when marking up over 1,300 pages of legal proposals. Hence, we've asked each of our commentators to limit their remarks to two minutes as they list their priorities. We asked them to focus their attention on where they believe that the committee needs to hold firm or even strengthen its proposals.

Millstein: In my private practice I have counseled with more than 40 corporate boards on corporate governance matters, and I teach the subject at Yale. My experience is clear that better corporate boards do result in better results for shareholders. Reforms should focus on improving the boardroom; methods for refreshing the board by shareholders are very much in order.

Senator Dodd's proposed legislation does not mandate all public companies to adopt procedures for granting proxy access. It doesn't attempt to fix the hurdles which shareholders must overcome to get proxy access. Instead it leaves that up to the SEC, which has been studying the subject for years. The legislation, however, does empower the SEC to promulgate a rule on proxy access. Express authority is necessary to avoid endless litigation on whether the SEC has the power. Authorization is critical if the SEC is to be committed to come to some conclusion on whether shareholders are truly the owners of the corporation.

Now, some have expressed fear about the outcome of an SEC proxy access. They fear that it would upset the boardroom and lead to bomb throwers populating the boardroom. I don't think so. I would hope this view holds for anybody who knows about proxy voting.

First of all, the SEC proposal sets very high standards for anyone to get access. The shareholder's proposal would have to require reams of information about the shareholder as well as reams of information about the nominee. It's not very likely that bomb throwers are going to pass that test, and the penalties from this representation are really significant.

Secondly, and even more importantly, once on the proxy, the nominee must gain the majority vote to be elected to the board. Election isn't assured simply by being on the ballot. Are the pension funds and other long term holders of the company stock likely to vote for candidates who are not credible and capable under the disclosure requirements?

The company has the right to point to the very apparent inefficiencies, if they exist, of any shareholder candidate. The shareholder proposal has a very, very large burden of persuasion to win a majority vote in any election. I have confidence in the long-term shareholders that they will not elect bomb throwers; they want stability. They only will vote for candidates who can make a contribution, and then, only when changing the board is necessary because of a valid business reason. I have confidence that the SEC will monitor this process appropriately.

Breeden: My message today is that improved corporate governance is good for business, good for investors and good for tax payers. Remember that a common element in the failures of Lehman Bros., AIG, Fannie Mae and other firms was that their boards of directors did not control excessive risk taking, prevent compensation systems from encouraging a "bet the ranch" mentality, nor hold management sufficiently accountable.

When boards fail to do their jobs to oversee risk taking and encourage sustainable performance, investors and tax payers both suffered enormously. Accountability is critical to motivate people to do a better job in any organization or activity. An effective board can help every business understand and control its risks, thereby encouraging safety and stability in our financial system and reducing the pressure on regulators, who will never be able to find every problem from outside.

Strengthening accountability for directors requires giving shareholders more choice than exists today about selecting who should serve and if they should be replaced. We should insist on allowing directors who don't do an effective job to be replaced, making boards more responsive to owners of the company. This will allow an earlier intervention when companies get off track. Over the long run this will promote more successful companies and a more resilient economy.

A common theme among the major firms that failed was that boards sat back until it was too late to pull back from the brink. Good governance has proven to be good business, and healthy accountability in corporate governance means lower risk for tax payers.

Finally don't be influenced by the "sky is falling" argument. When I served as chairman in 1992, the SEC adopted amendments to the federal proxy rules that made it easier for shareholders to replace individual directors through a proxy contest. Many in the business community were bitterly opposed to the new rules and argued that they would do permanent damage to the corporate governance process, just as they're arguing today against the proxy access provisions in Chairman Dodd's legislation.

Nearly 20 years later, those rules are used every year in a limited number of situations when boards are ignoring tough problems that need to be resolved. The rules adopted in 1992 helped create a more responsive and balanced governing system, not the dire consequences that opponents predicted. I believe that the same will prove true with the proposed proxy access proposals in the Dodd legislation.

Sheehan : We need to give shareholders the tools to do their jobs by empowering long-term owners of these companies. The regulators only can do so much. They need to be supported by market mechanisms, chief among these are tools to hold boards accountable. The Dodd bill reaffirms the authority of the SEC to introduce rules to allow shareholders access to the proxy. The SEC is consulting on proposed rules with sensible thresholds, holding periods and other measures to foster responsible use by large, long-term owners.

The Dodd bill also provides a step in the direction of majority voting. These two measures are the most critical. Other useful proposals in the legislation include an advisory vote on executive compensation, known as say-on-pay, plus improved standards for the independence of compensation committees and claw-back provisions.

The role of the SEC is to work out the rules on proxy access with appropriate consultations. The job of Congress is to provide authority, or in this case, to reaffirm that authority. Amendments that attempt to interfere with that process should be strongly resisted.

Simpson: We want to ensure that we send a strong message to Senator Dodd's committee. It needs to rein in the wild frontiers of the capital market. We want to ensure that derivatives are brought in from the shadows, fully regulated and traded on exchanges. We know that over-the-counter derivatives were at the heart of the crisis. Gary Gensler commented just last week that some $600 trillion has been spawned by leverage through the derivatives markets. This is equivalent to $12 for every $1 that the global GDP represents through goods and services. We consider the transparency as vital, and exceptions and exemptions must be resisted at all costs.

Furthermore, the approach must be global. We encourage the Dodd committee to make provision to coordinate with other markets, i.e., Europe, Asia and offshore trades, which are fundamental. We consider that the chairman's mark-up needs to tighten up in this respect, and we look forward to supporting amendments of to that effect. Also, don't let credit rating agencies and other key intermediaries in the market evade regulation.

Give regulators the powers of proper oversight. We welcome the provisions to give the SEC independent sources of funding, which would allow it to be the enforcer of the rules that are needed. As Senator Dodd's bill maps out the basics, the committee must not allow the framework to be undermined through the coming amendment process.

Smith: Consumer protection really does matter. Remember where investments come from - savings. They come from ordinary people around this country who channel their money through their pensions, their mutual funds, their college and other family savings. Every penny lost in the financial crisis hurt a family. Voters are looking to Congress to put safety and soundness back in the heart of the system.

Colorado's pension fund, like our peers around the world, lost a great deal of money in the financial crisis. As a result, our general assembly has taken the responsible, but painful, action of reducing pension benefits to all our 470,000 members and retirees. Thousands of ordinary working people saw their retirement benefits reduced. These are the American middle class facing unemployment, home foreclosures and the loss of their savings for retirement.

Those voters will be at the polls in November, and Congress must not be found wanting. The committee should not dilute, undermine or reduce the scope and powers of the Consumer Protection Agency. They must ensure that it has wide authority, independence and enforcement powers that are broadly drawn so it can play a preventive role. Similarly, ensure that the SEC proposals for independent funding are kept intact so that it has the budget and flexibility to enforce the rules that the committee is writing. Laws on the books without a cop to enforce them are of no use. The push to get better coverage of regulatory efforts between other agencies like the FDIC and CFTC must continue. Turf wars must not be allowed to undermine protecting the public. We applaud Senator Dodd's efforts and urge him to give no ground in carrying through this legislation.