Will New Proxy Rules Pose Board Risks?

While some experts bet they won't, D&O insurers suggest policies are worth a review.

Like all rules empowering minority shareholders, the new proxy-access regulations from the Securities and Exchange Commission present some worries for companies. But will the measures — which ease the way for dissidents to nominate board candidates and to bring proposals to a vote — necessitate changes in corporate directors’ and officers’ (D&O) insurance, such as increasing protection limits?

Very possibly, in the view of Carol Zacharias, senior vice president and deputy general counsel for the ACE Group of companies, a major insurer. She concedes that at this point, while meetings are still going on with corporate risk managers, CFOs, board members, and others, “we’re not sure the risk is changing.” But, she adds: “We’re waiting and watching, looking for the potential for litigation.” For one thing, the number of disputes between companies and shareholder groups could proliferate and knock stock values down — a common cause of investor lawsuits that name board members and directors.

“I think that’s far-fetched,” counters Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. “All the one new rule says is that institutions [that qualify] can nominate a new member to the board.” The only real impact of that rule, and of the other rule easing the way for proxy proposals, “is that they will probably create greater pressure for companies to negotiate” with minority holders, contends Elson.

“I’m skeptical that D&O insurance is going to be affected by this,” says Timothy Hearn, a partner at Minneapolis-based law firm Dorsey & Whitney, who notes that minorities only earn the right to easier proxy access under the new Rules 14a-8 (for proposals) and 14a-11 (for board nominees) if they hold 3% of the company’s shares for three years. “Maybe we’ll see an uptick in activity” by minority shareholders, he says. But declining share prices would only result from “perceived risks about the stability of the company, and I don’t see that as a likely result” of shareholders getting easier proxy access, adds Hearn.

Rather, the appearance of “people on the board who [an insured company] didn’t choose, and who may not be very sophisticated” could conceivably increase costs for insurers, says Hearn, if board risks associated with having unsophisticated individual directors rise. “I can see D&O insurers being nervous about that.” But such cost issues shouldn’t affect the insured companies. Besides, he adds, because three years of stock ownership is required of the qualifying minorities, “my guess is that we will not get completely harebrained people going on boards of directors.”

In any event, the idea of a company expanding its insurance to deal with potential proxy disputes “is just backwards,” says Nell Minow, co-founder of The Corporate Library, which supports shareholder rights. “For a company, prevention is the best policy. And that means getting in touch with your largest shareholders and working with them.”

Hearn, like Elson, expects that the biggest effect of the proxy-access measures will be more negotiations between companies and minority holders — as soon as companies see, through Schedule 14-N notices, that investors are banding together to qualify as owning 3%. “For the companies, it’s a warning shot,” Hearn says.

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