Corporate Governance

The Myth of an Independent System for Nominating Directors (and Another Reason Why Shareholder Access Is Necessary) (Part 2)

By J Robert Brown Jr.

The NYSE requires listed companies to have a nominating committee that consists entirely of independent directors.  See Rule 303A.04.  Nasdaq does the same. 

The purpose of the Committee, according to the NYSE is, "at minimum," to:

• identify individuals qualified to become board members, consistent with criteria approved by the board, and to select, or to recommend that the board select, the director nominees for the next annual meeting of shareholders; develop and recommend to the board a set of corporate governance guidelines applicable to the corporation; and oversee the evaluation of the board and management;

See 303A.04.  The NYSE Rule requiring an independent nominating committee includes some commentary.  The commentary provides that "n]ew director and board committee nominations are among a board's most important functions." 

In adopting the requirement, the Commission stressed that the use of an independent nominating committee would "more likely" result in the selection of qualified and independent directors.  As the adopting release noted: 

• The Commission believes that directors that are independent of management are more likely to support the nomination of qualified, independent directors, and that a written document governing the nominating committee is beneficial in that it would describe the process used to identify board candidates and the criteria for selecting or recommending those candidates.

Exchange Act Release No. 48745 (Nov. 4, 2002). 

But while regulating membership, the rules do not specifically address the influence of the CEO.  The NYSE rule does not, for example, preclude directors on the nominating committee from consulting with the CEO.  Indeed, in the description of the Compensation Committee, the commentary specifically notes that the independent committee structure is not intended to preclude "discussions" with the CEO.  See NYSE Rule 303A.05  ("Nothing in this provision should be construed as precluding discussion of CEO compensation with the board generally, as it is not the intent of this standard to impair communication among members of the board."). 

SEC disclosure requirements to some degree try to address the issue.  Item 407 of Regulation S-K requires that the proxy disclose, for any nominee, the "categories of persons or entities" recommending the nominee, including any nominee recommended by the CEO or other executive officer. 

At the time of adoption, the provision was criticized by commentators.

• these commenters objected to naming the specific source on the basis that this disclosure could have a "chilling effect on the search process," would be immaterial, and could imply that a nominee was unqualified to serve on the board based solely on the position held by the individual (e.g., the chief executive officer) who originally recommended the nominee.

Exchange Act Release No. 48825 (Nov. 24, 2003).

While providing some information about the source of a nominee, the provision does not, for example, reach other types of influences.  The CEO could, for example, provide views on particular nominees that he/she did not actually submit.  The CEO could provide guidance on how to go about finding appropriate nominees without actually submitting names.  Moreover, directors on committees, if connected to the CEO, could be fully aware of other possible candidates whom the CEO might support.  In other words, there is really nothing in the current approach that prevents CEO influence on the nomination process. 

The recent controversy surrounding the selection of nominees to the board of HP illustrates some of the concerns that can arise in this area.  That will be addressed in the next post.   ?

Full post as published by The Race to the Bottom on March 14, 2011 (boomark / email).