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Financial Reform Needs to Protect Investors

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By Lisa Woll and Joe Keefe

Senate Banking Committee Chairman Chris Dodd (D-CT) has introduced comprehensive financial reform legislation that will soon go to the Senate floor for debate. The Dodd bill creates a consumer protection watchdog, a financial oversight council to monitor systemic risk and a new office to oversee credit rating agencies. It allows federal regulators to impose strict requirements for capital, leverage, liquidity and risk management as companies grow in size and complexity. It also gives federal regulators the authority to unwind "too big to fail" firms before they cause another financial crisis. These are all important reforms.

The Dodd bill also contains several other vital provisions that have been priorities for the sustainable investment community, as they will empower shareholders to play a greater role in overseeing corporate governance and holding boards and managers accountable:

• Proxy access: The Securities and Exchange Commission needs clear authority to require companies to include director nominees from shareholders in their proxy statements. This "proxy access" will give shareholders a much needed tool to hold corporate boards and managements accountable.

• "Say on pay": One of the best ways to curb excessive compensation and perks for corporate CEOs and managers is to give shareholders a "Say on Pay." In the aftermath of the financial crisis, shareholder support for "Say on Pay" resolutions has been strong. In 2009 alone, 76 proposals came to votes and averaged 46 percent support, with 24 majority votes recorded. Some 65 companies have voluntarily adopted "Say on Pay" policies, including some of America's largest and most well-known firms - Aflac, Colgate-Palmolive, Intel, Ingersoll-Rand, Motorola and Microsoft.

• Majority voting: Directors should receive support from a majority of voted shares in order to be elected, as opposed to the current plurality standard that allows uncontested directors nominated by the existing board to win election with a single vote. According to the California Public Employees' Retirement System (CalPERS), about 71 percent of S&P 500 companies and 50 percent of Russell 1000 companies already have adopted some form of majority voting standards for director elections. Shareholder proposals on majority voting have a long history of strong support, and CalPERS is filing 58 resolutions this year alone at U.S. companies.

• "Clawback" provisions: Shareholders should be able to retrieve compensation from executives if the compensation was based on inaccurate financial statements or other fraudulent acts, and many U.S. companies already have acknowledged that this is a good governance practice. According to CalPERS, about 40 percent of S&P 500 companies already have "clawback" provisions, as do about 30 percent of Russell 1000 companies.

These are all positive features of the proposed legislation and it is critical that they remain in the final bill and not be negotiated away as bargaining chips.

The legislation could be improved as well. For example, the proposed "Consumer Financial Protection Bureau" would be housed within the Federal Reserve, a disappointment given the Fed's less-than-stellar track record in protecting consumers from predatory financial institutions. As Elizabeth Warren, Chair of the Congressional Oversight Panel on bank bailouts has argued, financial institutions in recent years - not only banks but mortgage companies, insurance companies, pay-day loan companies and others - have generated billions of dollars in profits through "deceptive and dangerous terms buried in the fine print of opaque, incomprehensible, and largely unregulated contracts." A strong, independent Consumer Financial Protection Agency is necessary to put an end to this predation.

The Senate should also support an amendment offered by Senator Robert Menendez (D-NJ) requiring companies to disclose the median annual total compensation of all employees except the CEO, total annual compensation of the CEO, and the ratio of median employee annual total compensation to that of the CEO. The sustainable investment community strongly supports greater corporate disclosure, and this amendment would assist investors in identifying companies with better compensation and governance practices.

What is at stake here is nothing less than the long-term sustainability of our nation's financial system, not to mention restoring investor confidence in its basic fairness. That will be no small task, given that U.S. investors are still down about 25 percent from where their portfolios were ten years ago.

Moreover, some on Wall Street, led by the U.S. Chamber of Commerce, seem to have already forgotten the lessons of the financial crisis. Just two short years after lax regulatory oversight and reckless risk taking by Wall Street led to the worst financial meltdown in generations, a bevy of special interests are now opposing key elements of financial reform, dusting off the usual arguments that improved regulation and oversight will somehow stifle innovation and undermine our free enterprise system.

The fact of the matter is that the smooth functioning of capital markets requires checks and balances on excessive risk taking and leverage, runaway executive pay, misaligned incentives and predatory financial practices. This was a wholly preventable financial crisis that never would have happened had an adequate regulatory regime been in place. And yet it has resulted in millions of lost jobs, millions of foreclosed homes and trillions of dollars in investment losses for ordinary Americans. If we are going to prevent future crises then we need to rein in Wall Street excesses, empower shareholders and make sure that boards exercise proper oversight over corporate managers.

Senator Dodd's legislation is clearly a step in the right direction. As it moves to the Senate floor, we hope not only that efforts to weaken the bill will fail but that Congress will ultimately pass a strong regulatory reform package that protects investors and helps restore confidence in financial markets.

Lisa Woll is CEO of the Social Investment Forum (www.socialinvest.org). Joe Keefe is President and CEO of Pax World Management LLC, investment adviser to Pax World Funds (www.paxworld.com).