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In the brouhaha generated by the dramatic increase in measures aimed at ensuring better corporate governance, we now see the old bogey of greater shareholder participation in the election of directors. This animal has been seen before and was put out to pasture, for there were few sensible ways by which shareholders could be given greater access to the election process without compromising efficiency and cost. The Securities and Exchange Commission (SEC) signalled in a press release this summer an intent to consider it afresh, with a possible view to legislation that allows shareholders access to the proxy process to elect their nominees. At the heart of the debate is the argument that the situation as it exists today gives a shareholder who is dissatisfied with the directors of his company little choice but to embark on a costly proxy battle to put his nominees to vote. The board, however, can rest on the corporate cushion and let its nominees ride right in. There is no doubt that this cannot be allowed to continue; the solution, though, is less clear. Disgruntled shareholders argue that the panacea is to allow them access to the company’s proxy materials. Their proposals run the entire gamut-from including details of shareholders’ nominees in the proxy, to mailing materials that would point at a Web site for information on those nominated by shareholders. In whatever form, its purpose is the same: the company should bear the cost, and the shareholder’s nominee should have a fair fight. The reality Persuasive as this sounds, in practice it is likely to be of doubtful significance in ensuring effective shareholder participation in board elections. It is guaranteed to increase expenditure, waste time and lead to a messy charade. Special-interest groups, board-nominated agents masquerading as shareholder nominees and the slightly disgruntled pensioner could all engage in a battle benefitting no one. In practice, the board nominees would still win. Apart from creating a ruckus, little of tangible value would have been achieved. Quite apart from bringing politics into the boardroom, this alternative runs into other difficulties as well. Shareholders, being diverse, would reflect a diversity of interests in their nominations. This is quite unlike a board, which is at least held in check by its fiduciary duties. And even if these shareholder nominees become directors, there are questions as to independence. This is likely to be a significant issue as the interests of a nominee representing a 1% shareholder may frequently be at odds with that of the company. Some of these concerns may be addressed by appropriate legislation, but it can do no more than add another layer to an already complicated legal regime. Instead of getting distracted by this red herring, shareholders would be wiser to focus on an alternative that can enhance their participation without requiring access to proxy materials and the convoluted regulatory changes that it would require: Shareholders could effectively wield enormous power in board elections if the law relating to nominating committees were changed slightly. This could be along the lines of what has already been set in motion by the New York Stock Exchange and Nasdaq. NYSE recently proposed that listed companies have a nominating committee that is made up entirely of independent directors. The proposed rule also requires nominating committees to have a charter that specifies its purpose-which is primarily to select nominees for the board-and specifies the selection criteria. The Nasdaq proposal also would require the nominating committee to have a majority of independent directors. This is the path that the SEC should follow, requiring all board elections to be on the basis of nominations by a committee of independent directors who may be chosen solely for that purpose. This independent nominating committee should be required to publish criteria for selection on the company Web site and in mailings to shareholders. It should be required to carefully consider all nominations from shareholders, irrespective of share ownership, and should provide detailed reasons for its choices and publish all materials in connection with the process on the designated Web site; the information should be disclosed to the SEC through electronic filings. This would be a powerful tool for shareholders while ensuring that the company gets the best possible leadership. The disclosure of all information will immediately put the nominating committee in the dock if its choices are manifestly wrong. Saddled with duties to act in the best interest of the company, the nominating committee mechanism could be the perfect solution. In our haste to reform, we should take care not to sweep away logic and common sense. The director appointment process has withstood the test of time for good reason; corporate law does not favor full democracy. Corporations are created to earn profits, and a board that is locked in daily battles is unlikely to achieve that. Certainly, there must be improvements if shareholders are not to feel alienated. This can be achieved easily by reforming the nominating committee process without embarking on the extensive legal changes that tinkering with the proxy procedure would bring. Although modern corporations are veritable nation-states, experience with our politicians alone would show us the follies inherent in a mobocracy. Sandeep Gopalan, a Rhodes scholar and former Wall Street investment banker, is studying law at Oxford.

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