Independent Directors and the Influence of Private Equity

There has been a continuing debate over whether the Commission should amend Rule 14a-8 to specifically allow shareholders to include in management's proxy statement certain proposals relating to the election of directors.  The proposals that have caused the most controversy have been bylaws that would require management, in certain circumstances, to include in its proxy statement nominees for the board that were submitted by shareholders.  The Second Circuit has construed the Rule to permit these types of bylaws, although the only one put to a vote so far failed.

The debate implicates a number of important issues, particularly the role of the SEC in the corporate governance process, a topic I have addressed in a paper, Corporate Governance, the SEC, and the Limits of Disclosure, which can be foundhere.  In addition, however, it raises a fundamental question about membership on the board.  Right now directors are nominated by the board, with the CEO likely to have considerable influence over the process.  To the extent a director wants to stay on the board, he or she must keep the nominating committee and presumably the CEO happy.  Thus, directors often have greater incentive to act in the best interests of the CEO than shareholders. 

The complaints about shareholder nominees frequently center upon the perceived divisiveness that may result from a divided board of directors.  Put aside that this is always the complaint whenever anyone proposes something that will tamper with the status quo of the board. 

We therefore find it of interest to note a number of recent instances where private equity funds are investing into companies and insisting on a board presence.  This occurred in connection with Palm, Inc.  Palm agreed to sell a 25% interest (in the form of convertible preferred stock) to a private equity firm, Elevation Partners.  As part of the investment, Elevation Partners received three seats on the nine person board.  Two of the directors are from Elevation Partners, one is a former official at Apple.  A description of the qualifications are included in the Palm proxy statement here.  It is not clear whether Elevation Partners has a permanent right to three directors.  In any event, the board of Palm will now include three new members that are likely to have a strong shareholder perspective. 

Other recent examples?  Freewave, a company in Boulder, Colorado, received financing from TA Associates, with a principal of TA joining the board.  Oak Investment Partners received a board position in return for its $25 million investment into Franklin & Seidelmann Subspecialty Radiology.  So did Oaktree Capital Management, LLC and MTS Health Investors, LLC  in return for their investment in Alliance Imaging.  All of these deals were announced in the last month.  Nor was it the only way to do it.  The private equity firms could just have easily settled for a board observer who could attend but not vote.  Instead, they wanted actual participation in the decision making process.

These are anecdotal examples.  Still, they suggest that private equity investors see the advantage of having shareholder advocates in the board room, without relying on the "independent" directors designated by management.