3.1.2 History of US corporate governance

A noticeable characteristic of the US corporate world is the separation of ownership and management. Of course, at the start of the 19^th century the US too had many family companies that were managed by their owners. As the century progressed, however, share ownership began to spread and often the shareholdings were so small and diverse that management of the corporation had to be lelt to a professional manager.

There were several reasons for this early widespread share ownership:

All of this caused a rapid increase in the number of listed stock exchange companies, in which share ownership was separated from management. The New York Stock Exchange had 31 listed companies in 1830, mostly railroad companies. By 1859 many more were listed of all kinds of industries. Already by 1857 many Europeans were investing in US shares.6 Share ownership became really widespread. Even John Rockefeller, the founder of Standard Oil and the richest man in America, ended up by owning only a fraction of the outstanding stock in Standard 0i1.7

The urgent need to raise enormous sums as a result of the American Civil War was instrumental in the development of mass markets in securities.8 Another development of the Civil War was that President Abraham Lincoln was able to do deals with US entrepreneurs who helped the government finance the war and in turn received facilities to rapidly open up the West. From that time on US corporations used the title "President' for the heads of their corporations. They saw themselves running their own empires. This mindset betrayed a tension between "big business" and the Federal Legislation, which continues until today. The states deal with corporate law. The Securities Act 1933, the Securities Exchange Act 1934, Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act of 2010 are the exceptions.9

One of the first mega enterprises was the New York Central Railroad, which ended up in the hands of the famous "Commodore" Vanderbilt. He acquired several railroad corporations, but encountered strong opposition when he tried to buy the shares of the Erie corporation from management. Every time a judge gave a favourable judgment for Vanderbilt, Erie's management found another judge to give an opposing judgment. Indeed, the management even went so far as to leave the offices in New York with all the cash and move to New Jersey, together with 125 armed men and even some canons for protection!

Later Jay Gould became owner of the Erie railroad bridge corporation and wanted to buy more railroad corporations. He found a friendly judge ready to dismiss Mr Ramsey, the director of one of his targets, but Ramsey found another judge who dismissed the other directors. This led to a brawl involving about 800 armed men, among whom were the "Bowery Boys", who had left the slums of New York to protect the interests of the Goulds. The takeover fight ended with a merger of the Delaware and Hudson railroads. At this stage, the ways entrepreneurs tried to gain and keep control of corporations had become too rough. A more peaceful disciplinary mechanism was put to work. On behalf of the investors, a merchant banker was added to the board of the companies to look after their interests. This was a soit of "corporate governance" avant la lettre, a form of supervision.10

In the last quarter of the 19^th century a great wave of mergers swept through the manufacturing sector. Nothing like it had ever been seen before. This involved an unparalleled process of horizontal consolidation, i.e. simultaneous mergers of many or all competitors in an industry into a single, great enterprise.11 These monopolies led to protests and in 1890 the US enacted the Shearman Anti-Trust Act.12 Whereas before 1897 mergers had been initiated only by industrialists, after this date they were increasingly started by financiers in a highly efficient national capita! market. This increased the number of mergers.13 The largest of these merged enterprises was US Steel, a "trust of trusts". After the listing of US Steel, the average number of daily share sales increased from 2 million to 3 million When first listed in 1901, US Steel had a market value of US $1.4 billion. This boosted the power of the emerging stockbroking houses, which could ensure that the large amounts of securities required were placed with the public, first and foremost by the firm of J. Pierpont Morgan.14

It was the practice for partners in investment banks, which had arranged the floating of the bonds and preference shares, to be given a position on the board of the company in order to supervise the board of directors and protect the interests of their clients, the investors. As some of these bankers accumulated numerous directorships they obtained exclusive power, particularly with the growth of trusts. This was referred to as "Morganization" after J. Pierpont Morgan. It also came to be known as "financial capitalism". The Clayton Act of 1914, the second Anti-Trust Act after the Shearman Act of 1890, was meant to curb the size of these huge concerns. American enterprises had become larger than their European counterparts. By 1914 US industrialists had launched a wide variety of new products in the global market such as the telephone, portable camera, phonograph, electric street car, automobile, typewriter, pass-enger lifts in houses, machine tools. American manufacturers reigned supreme in every one of these fields, just as in the automobile industry, and in several they were monopolists.

In summary, the large railroad companies and the later other industrial enterprises too made use of the possibility of raising capital from the public in bonds and shares.

As the ownership of companies passed from the hands of just a few entrepreneurs to a wider public, corporate governance issues were raised. How could the board attract capital at the right price if the investors did not receive the right information? New capital could be raised by selling the investors preference shares or convertible bonds which gave a fixed interest or dividend. But in order to place ordinary shares the public needed sufficient information if they were going to invest their money.

The second problem was the classic agency question. How could investors get sufficient assurance that the board would act in their interests? This problem was solved by appointing financial intermediaries as supervisors. J. Pierpont Morgan was the first of such financial supervisors.15

A market for ordinary shares of fluctuating value needed more disciplinary mechanisms than an investment banker on the board. As long as stock exchange prices were going up there was not a problem. In the 1920s no one worried and there were hardly any laws governing securities. The situation changed only after the Great Crash in 1929 and the introduction of the economie programmes and securities laws by the administration of President Franklin D. Roosevelt onder his "New Deal".

The shareholder base had spread to include many small shareholders. Between 1920 and 1929 the number of shareholders investing through the NYSE doubled from 14.4 million to 30 million 16 This pushed up share prices. However, in the Great Crash of 1929 share prices plummeted by 83%. The Great Depression of the 1930s spurred a public debate about corporate reform and formed the backdrop for the first federal securities laws. Franklin D. Roosevelt created the Securities and Exchange Commission (SEC) and introduced the Securities Act of 1933 and the Securities Exchange Act of 1934. Neither of these Acts addressed the need for independent directors or changes of corporate boards. Instead, Congress crafted a robust disclosure regime to empower investors through provision of information. It required independent auditors for listed companies to ensure reliability of information, and introduced a series of changes in proxy and takeover procedures.17

The crisis also led to the passing of the Glass-Steagall Act of 1933. This Act separated investment banking from commercial banking. It was a wise decision and, in hindsight, it might have been better if this legislation had not been repealed in the 1990s.

From the 1920s and 1930s onwards a managerial hierarchy developed. Berle and Means famously identified the separation between ownership and control and the potential for divergence of interests between owners and managers.18 They argued that managers should administer corporate assets not in their own interest, or in some form of ambiguous public interest, but as trustees in the best interests of shareholders as the owners of the corporate enterprise. Although lip service was paid to their proposal, scholars, practitioners and regulators gradually came to agree that the imposition of a monitoring function of the board of directors, including outside directors, could serve as an effective antidote to what economists dubbed "agency costs" arising out of the separation between ownership and control. Such was expected in theory. In reality, outside directors were no more than decorative figures beholden to the imperial CEO. These outside directors were usually the baraker, the lawyer and the accountant friends of the CEO or a representative of a customer or supplier. The CEOs were a close-knit group. They generally had much the same type of training, often attending the same group of schools. They joined the same professional societies and read the same journals. As their role came to require more narrowly specialised expertise, they became increasingly independent of the owners. The managers soon controlled the destiny of the enterprises by which they were employed. A sociologist called this the "managerial revolution". Lawyers saw the "corporation" becoming an institution. Economists saw the "Economie Theory of Managerial Capitalism" at work.19

The number of small shareholders grew once again in the 1950s.20 In the 1960s yet another wave of mergers produced conglomerates such as GE. The merger mania reached its pinnacle in 1968 with for example the tender offer by Gulf & Western for Sinclair 0i1.21

Throughout the 1940s, 50s and 60s the SEC was unsuccessful in its efforts to have amendments to the federal securities laws passed and in getting existing laws to be interpreted in the sense that independent directors for listed corporations would be required by law.22 However, though legislative reform had not yet materialised, the notion of directors' independence began to gain attention during this time. William 0. Douglas, who served as chairman of the SEC and later as Justice on the Supreme Court, was an early and influential advocate of the need for independent directors.23 In 1956, the New York Stock Exchange recommended that listed companies include at least two outside directors on their boards to help ensure prompt and full disclosure of corporate information.24 In 1966, the Standard Oil Company of New Jersey nominated outside directors for the first time. In the mid-1960s and throughout the 1970s, public debate on corporate governance resumed in the context of the Vietnam War and the Watergate scandal. Director independence increasingly came to be seen as the crucial element that would help the board to monitor management, promote honesty and prevent the recurrence of corporate malfeasance. Public confidence in business had been thoroughly shaken by the perception of a corrupt alliance between corporate managers and political officials, and accusations of corruption pervaded all levels of society — not just the White House or the government, but inside corporations and within boardrooms. The growing stagflation and the long bear market gave stockholders a further reason to seek changes in the prevailing corporate governance regime.

From the early 1970s onwards, the SEC and the stock exchanges began to embrace the concept of the board as a monitor of management and demanded ever greater director independence.

In 1972, the SEC issued a release that concluded with the statement that "the Commission endorses ... the establishment by all publicly-held companies of audit committees composed of outside directors." In 1973, the New York Stock Exchange strongly recommended that each listed company form an audit committee, preferably composed exclusively of independent directors. In 1974, the SEC restated its support for independent audit committees by amending its rules to require disclosure of the existence or absence of an audit committee in proxy statements, i.e. information packets put together by officers of corporations and sent to all shareholders of corporations for the board to obtain proxies from shareholders for general meetings of shareholders. In 1976, in response to the SEC's investigation into questionable corporate payments and practices, prompted in particular by the uncovering of falsified corporate records and the use of slush funds, the chairman of the SEC suggested that the New York Stock Exchange (NYSE) "take the lead in this area by appropriately revising its listing requirements, thus providing a practical means effecting important objectives without increasing direct government regulation."25 On 9 March 1977, the SEC approved the new Stock Exchange rule requiring all listed domestic companies to establish and maintain audit committees comprised solely of directors independent of management and free from any relationship that would interfere with their exercise of independent judgment as a committee member.

In April 1977, the SEC announced that it would hold public hearings into shareholder communications, shareholder participation in the corporate electoral process, and corporate governance in general.26 In the opinion of the then SEC chairman Harold Williams, it was important for boards to be able to operate independently of management. Accordingly, he proposed a series of rules aimed to facilitate the restructuring of boards and make them fully independent. At the very least, Williams believed, the nominating, compensation and audit committees should be composed entirely of independent directors.27 However, the SEC had no statutory authority to regulate the composition or membership of boards, or even committees, because corporate law is left to the individual states. As a result, Williams proposed that all corporations subject to the SEC's proxy mies should label directors as either "independent" or "affiliated". However, the proposal was considered too sweeping — there had not been any expectation that directors needed to be independent, and labelling them as such or as affiliated was deemed an unnecessary intrusion. The proposed disclosure requirements elicited a wave of protests from the business community. It should be noted that although the SEC chairman fully supported a shift towards greater independence of directors, he did not favour federal legislation mandating such a change.

The failure of Penn Central in 1977 was one of the major scandals of the time. The outside directors had been very lax.28 As mentioned above, in March 1977 the SEC approved the general obligation introduced by the New York Stock Exchange for domestic listed companies to have audit committees composed of independent directors. Even then, however, the SEC would not propose that this be included in federal legislation.

All the same, this marked the beginring of a shift in the main role of the board from supporting and advising the CEO to overseeing and guiding the CEO, senior management and corporate operations. The board's function changed from advising to monitoring. The wave of reform in the 1970s marked the birth of the concepts "independent director" and "corporate governance". The term "corporate governance" was already used in the US in 1977.29 As a corollary of the shifting role of the board, arguments for having a chairman separate from the CEO began to surface.

During the 1960s public offers for shares were not regulated. Bidders used "creeping mergers" and "surprise offers". Offers were often announced after stock markets closed on a Friday, with the period open for acceptance set to close early the following week, sometimes even on the Monday, with the announcement that the bidder had already "secretly accumulated" a holding of 25 or 30%. These so-called "Saturday night specials" were feit by Congress to thwart efforts to give shareholders adequate information and time to come to a well-considered decision. In 1968 Congress responded by amending Sections 13 and 14 of the 1934 Securities Exchange Act. Much of the legislation focuses on disclosure and contains obligations to register when acquiring more than 5% of a listed corporation and procedural and substantive mies on timing and the content of bidding documentation. This legislation is called the Williams Act.30

Public share offers continued in the 1970s. Hyperinflation in the 1970s meant that "hard as sets" of many companies were more valuable than the goods they produced. It became profitable to buy corporations for their assets, i.e. asset picking. Inflation also led to lower stock prices. Many mature businesses were no longer growing, but were still generating cash. Furthermore, institutions owned a larger percentage of shares and many institutions were keen to maximise the value of their investments. Attitudes toward debt changed as the US became more debtor-oriented. The availability of credit and the growth of the high yield "junk" bond market made money more easily available. Bidders could borrow to finance tender offers, making even large corporations vulnerable. Attitudes towards public share offers changed. Investment banks, law firrns and even corporate executives, who had once viewed the business of unfriendly public offers as unseemly could no longer resist the high fees or success of many early takeovers.31

A policy debate developed on whether hostile offers were beneficial to corporations and the economy as a whole and whether the boards of target corporations should be active in the process and should have defence mechanisms at their disposal to be able to stall or block hostile tender offers. The arguments pro and con and the case law accepting defence mechanisms as in the Unocal and Paramount v. Time are discussed below in 3.7.3.2. The jurisprudence that is the basis for American corporate law is largely influenced by the Delaware Chancery Court of 5 chancellors and the Delaware Supreme Court; see for a detailed exposition in 3.1.3(a)E.

From 1980 to 1996 large institutional investors nearly doubled their portion of ownership of US listed corporations from 30% to over 50%. From 1990 onwards the pattere of corporate governance activity started to change again. Hostile takeovers declined substantially. New corporate governance mechanisms began to play a larger role, particularly executive stock option plans, by which directors acquired more shares, and a greater involvement of boards where many directors now held larger parcels of shares.32

Institutional investors promoted stronger supervision and monitoring by the board and its independent members, especially through its composition. They realized that the cost of simply changing the board in order to make the company listen to them would be less than mounting a big takeover battle. "Fix the board" became the theme. However, it was not easy for institutional investors to clean up boards because the 1992 proxy rules made it very difficult to organize a proxy contest. It was and still is nearly impossible for shareholders to get a candidate for the board nominated or put on the ballot without bearing the costs of a proxy fight.

Shareholders increased pressure by criticising CEOs year in, year out, on items such as underperformance and overcompensation. In 1993 the board of directors of General Motors ousted its chairman/CEO and made a landmark decision to split the functions of chairman and CEO by appointing a nonexecutive chairman and a separate CEO. Within three months three other listed companies followed suit. The SEC helped by permitting shareholders to include their criticism on the CEO 's compensation on the proxy ballot as a non-binding opinion.

In April 1994, the GM board published its "Corporate Governance Guidelines", which were dubbed by the media as "Magna Carta for Directors".33 It would become a watershed document in US corporate governance opening up more possibilities for shareholders to have influence on the boards of companies. The GM guidelines focused on strengthening the role of an independent board of directors through the adoption of improvements ranging from executive sessions to annual board evaluations. CaIPERS, the largest pension fund of California government employees, which had and has an important shareholders activist role, took the initiative to give corporations grades "A+" to "F" based on compliance with the GM guidelines.34 The SEC supported the idea that an ideal board would consist, except for the CEO, of members completely independent of management.35

The institutional investors introduced the concept of "relationship investing", a new form of "financial capitalism" directed at long-term investing. They were optimistic about the increase of monitoring by independent directors.36 Several newly energised corporate boards, led by independent directors seeking to become more involved in overseeing the direction of their corporations, saw their CEOs depart. Behind these more active boards were often major institutional investors. Such a development was sometimes called "political governance". However, there was no institutional basis yet for this shareholder influence. It ran into strong opposition from traditional boards based on legal arguments and from executive management groups, such as that of the Business Roundtable, a meeting of CEOs of the largest corporations which was well advised by capable lawyers such as Martin Lipton.

In the 1990s the US administration did not create "soft laws" for better governance. Soft laws, unwritten rules, do not fit in well with US legal culture. Institutional investors therefore resorted to two methods: presenting shareholder proposals at the company's meeting of shareholders and jawboning boards of directors to push for a change in management or strategy.37

However, "political governance" by shareholders, often activated by institutional investors, did not really work yet. In the 1990s it did not matter so much, because stock prices continued to rise whether management was onder- or outperforming. Another idea took hold: rather than trying to discipline directors by wielding a "stick" it might be better to offer them a "carrot" in the form of stock option plans. In the UK the Greenbury Report discouraged this, at least for independent directors. The British were convinced that independent directors should not have options because this would endanger their independence. In the US, however, option plans for directors seemed to solve the "problem of controlling directors". This would have directors promote "shareholder value". The Business Roundtable — the association of CEOs — moved from promoting the interests of the stakeholders to those of the shareholders.38

The Enron, Tyco and WorldCom scandals of 2001 and 2002 showed once again that higher compensation packages for directors — the "carrot" — is no guarantee of better management.

On 20 July 2002 President Bush signed the Sarbanes-Oxley Act into law, and shortly afterwards the NYSE and NASDAQ followed suit with new detailed corporate governance regulations that built upon the Sarbanes-Oxley independent director requirements. These have to a great extent changed US boardroom discipline and boardroom dynamics. These changes were instigated by the Sarbanes-Oxley Act. Some are positive, but there are many negative consequences. The Act goes into such detail that it promotes "check the box" practices. It forces boards to "recognize all the trees, but lose sight of the forest". The Act has also created substantial extra administrative costs, which is a burden for US and foreign corporations listed on the US stock exchanges and has prompted a number of foreign listed companies to leave NYSE and NASDAQ and move to the London Stock Exchange. Hereunder I focus on the US emphasis on independence of directors and the recent change in the requirements of process in board meetings.

The Sarbanes-Oxley Act dramatically changed the nature of federal securities laws with regard to corporate governance by directors. Significantly, SarbanesOxley requires that all listed companies maintain wholly independent audit committees comprised solely of outside directors. This was an important breakthrough since it contrasts with the principle that federal law should not deal with the interaal organization of corporations. Reflecting a more tangible and robust definition than in the past, the term "independence" was defined as meaning that no members of the committee may accept any consulting, advising or other compensatory fee from the company or its affiliates, or be an affiliated person of the corporation or any subsidiary.39 In fact, this definition of independence was stricter than prior stock exchange listing requirements for audit committee members, which only required that members be free of relationships that might "interfere with their exercise of independent judgment as committee members".40 Beyond just requiring that the audit committee consist of independent directors, Sarbanes-Oxley introduced several reform measures designed to structurally empower board members to remain independent. Section 204 of the Act requires auditors to report directly to the audit committee instead of to the management. Additionally, the audit committee was granted full authority to engage independent counsel and other advisors and be adequately funded, as well as to establish procedures for receiving, retaining and treating complaints and anonymous tips. Whistleblowing regulations were also introduced.

Furthermore, the NYSE Corporate Accountability and Listing Standards Committee issued a report of recommended changes to listing standards on 6 June 2002, nearly two months before Sarbanes-Oxley was signed into law, thus affording legislators the benefit of taking note of the exchange's broader requirements for board independence. The changes recommended in the report were soon approved by the SEC and adopted on 16 August 2002. Under the NYSE standards, an "independent director" is one who has no material relationship with the listed company. The NYSE also required listed companies to have a majority of independent directors.41 Additionally, listed companies were required to have nominating and compensation committees composed entirely of independent directors, and to hold regularly scheduled executive sessions, without any executive, of the board chaired by a lead director or independent chairman.

The recent financial crisis has once again prompted a re-evaluation of corporate governance. Outside directors have failed to provide the oversight that optimistic forecasters expected. Unaffiliated directors may not have the expertise or access to information that would permit effective supervision of corporate management.

A significant indicator of the growing role of the board as an independent player in corporate governance was the change in composition of the board. Whereas in the 20^th century directors were typically members of management or otherwise closely linked to management (e.g. lawyers, investment bankers or other advisors of the company), board membership in the 21^st century reflects a significant majority of independent directors. In 1950 only 20% of directors of large public US company boards could be deemed independent, but by 2005 average independent director representation had reached 75%. A typical board is now composed of the CEO and about 8 or 9 independent directors.

In board meetings due process is very important. The board must be well informed, take time to receive good outside advice and debate all alternatives before coming to a well-reasoned decision.

Financial institutions were mostly passive at the turn of the century. They are profit driven and do not want to spend money on corporate governance. Legally they had hardly any rights and a number of impediments. Many listed companies had defence mechanisms, including staggered boards, where only 1/3 of all directors were up for re-election each year. Shareholders rarely went to shareholders meetings. They gave proxies to brokers. It was prohibitively expensive to start a proxy fight against the board's proposals. A proposal of shareholders could only be initiated in "precatory" language, that would not bind the board.49 Nearly all nominations of the board for director positions were pushed through, because of the pluralist voting system, where any nominated director would be voted in, if he had more positive votes than any other candidate. In absence of votes for another candidate one vote was enough. Because of the broker proxy system most voters would not vote. In the Disney saga, in 2004, there were 11 nominated directors for 11 places, who all got in as directors. This caused shareholder activists to push for a change from the traditional plurality standard to majority voting, where a director who receives less than 50% of the shareholders' positive votes, resigns voluntarily. In some companies this voluntarily resignation is binding, but in others the board may refuse to accept the resignation.50 From 2004 mainly government employee pension funds, such as CaIPERS and TIAA-CREF, both active since 1992, became the torch bearers for change on voting issues. Voting advisory companies like Risk Metrics, now renamed Institutional Investor Services, were able to coordinate the votes of the traditionally silent majority, which gave shareholder activists substantial influence. There are three methods to push through: urging other shareholders to vote in line with the activist with the help of voting advisors, one-on-one meetings with the board and shaming the directors via the media.51

The credit crisis has taught us more lessons and there will be additional changes to come. The Dodd-Frank Act, signed by President Obama on 21 July 2010, not only makes dramatic reforms to the fmancial regulatory system in the US but also contains a number of significant provisions relating to corporate governance and executive compensation of all listed companies.

The Dodd-Frank Act (the Act) settles many highly debated aspects of corporate governance by setting out more additional requirements to be met by directors. On most items the Act directs the SEC to make further regulations for detailed requirements.

The SEC issued a proposal in 2009, which provoked considerable debate and criticism from corporate circles. Now the Act, in an amendment to Section 14(1) of the Securities Exchange Act 1934, authorises, but does not require, the SEC to adopt rules on free proxy access, but makes an exception "if it disproportionately burdens small issuers". "Issuers" herein means "listed corporations". Shareholders have for a long time had the right to elect directors but in practice they could only vote for or against the board's nominations mentioned on the company's proxy statement. If shareholders wished to nominate a director, they had to go through the huge expense of filing their own proxy statement, which made their right to elect directors rather limited. This new proxy access will give large shareholders a strong instrument. The proposed rule would establish the right to nominate a director on the corporation's proxy card (i.e. at no cost). The proxy card is issued by the corporation to shareholders at their documented request months before the AGM together with the board's proxy material. The shareholders will have the right to nominate a director, if those shareholders (or groups of shareholders) hold at least 1% of the company's shares for a period of at least one year (this applies to the largest companies, while higher ownership thresholds apply to smaller companies). Access to the proxy card would be of no use to a shareholder seeking to change control of the company (i.e. on the continuing assumption that boards can defend themselves against hostile takeovers) and there are various disclosure and qualification requirements. Up to 25% of a board could be installed through this proxy access in any one year. Following debate, the thresholds have been raised. Indeed, on 25 August 2010 the SEC issued a regulation that proxy access is only open to shareholders (or groups of shareholders) holding at least 3% of the company's shares for a minimum period of 3 years.52 The 3% requirement is comparable to the Dutch proposals for the right of shareholders to add items to the agenda. There is still strong opposition against this proxy access rule. The Business Roundtable has started litigation in the Federal Court of First Instance of Washington DC, asking the court to declare the whole rule unconstitutional. The second agreement against the measure is that no cost benefit appraisal was made. As of 1 July 2011 this litigation is still pending. US corporate governance specialists have informed me that the corporate world is afraid that large pension funds may be able to push through the nomination of union members as candidates for membership of the board or that hedge funds may be able to push through the nomination of one of its representatives. The worry is that the board will no longer serve the interests of the shareholders as a whole, but each director will only take care of special interests. They add that this debate about nominating rights is a separate issue from the debates about plurality vs majority voting and staggered boards. These two issues are not dealt with in the Dodd-Frank Act, but are a hot topic of debate in many shareholders meetings in 2011. These issues are described below after some items of the Dodd-Frank Act.

The Act adds a new Section 14B to the Securities Exchange Act 1934 onder the heading "Corporate Governance" and directs the SEC to issue roles requiring US listed companies to disclose in their annual proxy statements the reasons why the company decided to have the positions of CEO and chairman filled by the same person or by separate individuals. This provision of the Act is a repetition and serves to rob in the point, because the SEC had already adopted such roles as part of its December 2009 "proxy disclosure enhancement roles" contained in Item 407 of Regulation S-K. It is clear that the issue of one person being both CEO and chairman is a major point of debate at present. The reporting requirement which the SEC now will have to make mandatory comes close to the UK "comply or explain" rule, see 2.1.2(viii) and 2.2.3(ii).

NYSE rule 452 allows brokers to cast discretionary votes, i.e. they do not need to have specific authorisation from the shareholders they represent, on "routine" matters. "Broker discretionary votes" constitute between 10% and 20% of the votes cast at most companies. This meant that in the past brokers — who are usually influenced by the CEO — had a say in director elections. Rule 452 was amended in 2009 to stipulate that the election of a director is never "routine", and the Act now codifies this requirement through amendment of Section 6(b) of the Securities Exchange Act 1934. The Act goes on to require all stock exchanges to amend their mies to prohibit broker discretionary voting on non-routine matters, including voting on executive compensation matters.

It is because of this provision prohibiting brokers from voting on directors appointments that the SEC has issued a release on other possible ways for issuers to communicate with beneficial owners, so that on the one hand the beneficial owners are well informed and on the other hand they can have more real influence on elections.53

The Act adds a new Section 14A of the Securities Exchange Act 1934, onder which public companies must give shareholders a non-binding advisory vote at least every three years on the compensation of certain executive officers specifically named by function.

In recent years there have been a limited number of say-on-pay votes voluntarily proposed by management. Shareholders will be able to vote on compensation and on whether they wish to vote every one, two or three years. Several companies have already in advance of the law voluntarily adopted sayon-pay votes biennially (e.g. Prudential) and triennially (e.g. Microsoft). According to the Cravath Public Company Alert54 in 2010, three companies — Motorola, Occidental Petroleum and Key Corp. — did not receive majority shareholder approval on say-on-pay votes. The consequence of failed votes on compensation is expected to be that certain directors, particularly compensation committee members, may be the target of "withhold the vote" campaigns and may not be re-elected.

The Act also requires disclosure to shareholders and a non-binding advisory shareholder vote regarding "golden parachutes" for executives in any merger or acquisition transaction requiring a proxy or consent solicitation.

As a complement to the new federally mandated say-on-pay and say-on-golden parachutes votes every institutional investment manager subject to Section 13(f) of the Securities Exchange Act 1934 will now be required to disclose, annually, how it voted. This type of disclosure is already best practice on the websites of investment institutions.

Similar to the public company audit committee requirements added by the Sarbanes-Oxley Act of 2002 to Section 10A of the Securities Exchange Act 1934, the Act has added a Section 10C that addresses the issue of the independence of compensation committees. Although NYSE and NASDAQ require all committees to have solely independent members, there has not previously been a Federal Exchange Act provision to back up the SEC tule regarding independence of compensation committee members. This is the second departure — the first being the section of the Sarbanes-Oxley Act providing for the independence of the audit committee members — from the principle that federal laws should not regulate the interaal organization of corporations. It should be noted that directors affiliated to large shareholders may not be eligible to serve on compensation committees. However, this is not yet included in the definition of NYSE or NASDAQ. Their sole concern is whether the director is affiliated to the listed corporation in question.55

The Act does not require compensation committees to use only independent advisors, but only that independence be considered and that the corporation must pay the advisors.

New requirements of disclosure on compensation are:

Companies will be required to disclose the relationship between "executive compensation actually paid" and "the financial performance of the issuer", taking into account any change in the value of the shares and dividends of the issuer and any distributions.

Companies will be required to disclose the manner of compensation of all employees of the company (other than the CEO), plus the total compensation of the CEO, and also provide the ratio between the CEO's income and others.

Companies will be required to disclose whether directors and employees are permitted to purchase instruments "to hedge or offset any decrease in the market value of shares" if they have received put options.

The Act creates a new Section 10D of the Securities Exchange Act 1934, which requires listed public companies to implement policies to recapture — or "claw back" — compensation "erroneously awarded" to executives prior to a restatement of the company's financial statements. It applies to all present and former executives and to restatements of accounts for any reason, not only in cases of misconduct. It is therefore very wide-ranging.

It should be noted as background that under Sarbanes-Oxley the SEC has hitherto been empowered to require the recovery of certain compensation from CEOs and CFOs (but no others) in the case of restatements resulting from misconduct.

The change to all executives, i.e. not only the CEO and CFO, and restatement for any reason, not only fraud, broaden its scope greatly. In recent years over 650 companies have made restatements annually. This will make boards rethink their bonus criteria.56

The Act imposes extra compensation-related requirements on "covered financial institutions". Covered fmancial institutions are those financial institutions on a specific list, which are specially supervised by the Federal Government. They are obliged to report to the appropriate federal regulator the structure of all incentive-based compensation arrangements. This is to enable the federal regulators to determine if the compensation structure "provides an executive officer, employee, director or principal shareholder of the covered financial institution with excessive compensation" or "could lead to material financial loss to the covered financial institution". The Act also directs the regulators to adopt rules to prohibit any types of incentive-based payment arrangements that encourage inappropriate risks.

The Sarbanes-Oxley Act has provisions to protect whistleblowers from "discharge, demotion, suspension, threats, harassment or discrimination". As a result, many companies introduced their own intemal guidelines for whistleblowing and ethical treatment. Now the Act establishes a "bounty" programme at the SEC, onder which whistleblowers may be awarded 10% to 30% of the amount the government receives in fmes if the fmes are above $1 million This applies only to "original information". It could give the incentive to the whistleblower not to go to the company first with the information, but to bypass the company and immediately go to the SEC out of fear that the company may report itself, as a consequence of which the whistleblower 's information would not be "original". It is expected that corporate circles will strongly object to this system, which does not promote intemal ethical behaviour.57

Congress passed, and the President signed, the Dodd-Frank Act on 21 July 2010. Its application is in many cases subject to regulatory measures, and it is likely that there will be pressure from corporate circles for the SEC and other regulators to relax implementation to some extent.

Although not an item in the Dodd-Frank Act, many shareholder activists raise the issue that they want the company to delete the staggered board system. By this arrangement directors are not all re-elected each year but one third of directors is re-elected every three years. This is regarded as a semi-protection device. At present, about one-third of listed corporations have a staggered board; see sub-section 3.4.10 and note 138 below.

Many corporations still have a plurality voting system by which a director can be re-elected in case at least one shareholder votes him in, while the other shareholders withhold their votes. Shareholder activists are pushing for a change to majority voting, either irrevocably or subject to board decision. This resignation subject to board decision is called "plurality plus". "Majority voting is the number one issue for the 2011 proxy season at shareholders meetings. This is the year that the focus shifts back from regulatory changes to the annual meetings."58 As an example, in 2010 at a smaller listed company that had majority voting with resignation subject to board decision, activists withheld their votes to re-elect the one-third of the directors that were up for reelection in a staggered board. The reason for the withholding of votes was that the board refused to abandon the staggered board system. The directors, who did not gain the majority, resigned. The board decided to give shareholders their way and deleted the staggered board and reappointed all directors, because there had been no material criticism against the directors.

Lawyers say that many of the Dodd-Frank measures will be contested in court or politically, with the arguments that they are unconstitutional or that there is lack of a cost benefit appraisal.