News from January 2003. The news is free; your purchases from Amazon help us pay the bills. Search: All Products Books Popular Music Classical Music Video Toys Consumer Electronics Keywords: January 2003 Fannie Mae Assigned 9.0 Governance Score Standard & Poor's Corporate Governance Group assigned a corporate governance score (CGS) of 9.0 (out of 10) to the Federal National Mortgage Association (Fannie Mae), the country's largest provider of housing finance and the second largest company by assets. Standard & Poor's began ranking U.S. companies in late 2002, after conducting evaluations elsewhere since 2000. Fannie Mae is the first U.S. company to publish its governance score from Standard & Poor's. The company scored strongly or very strongly in each of the four areas Standard & Poor's reviews as part of the corporate governance scoring process: ownership structure and influence, financial stakeholder rights and relations, financial transparency and information disclosure, and board structure and process. The company scored highest for its board structure and processes, with a highly independent board. In the area of financial disclosure, despite the company's historical exemption from registering and filing disclosures with the SEC, Fannie Mae's voluntary disclosures generally meet--and in some cases exceed--those of its SEC-registered peers. Under ownership rights and stakeholder relations, the company's strengths include an unclassified board, a positive shareholder proposal policy, and shareholder-friendly provisions that allow owners to convene special shareholder meetings. Weaknesses include shareholders' inability to vote for the five presidentially appointed directors given the company's unique corporate status as a government-sponsored entity. Fannie Mae's ownership structure and influence was judged strong because as a widely held company with small management and director shareholdings, conflicts of interest or undue influence from stakeholders were assessed as unlikely. According to Standard & Poor's, CGS scores are comparable on a global basis, since they reflect the actual governance practices of companies irrespective of law, securities and other regulations, and accounting requirements. (Fannie Mae Assigned Standard & Poor's First Public U.S. Corporate Governance Score) PBGC Troubles Continue The Pension Benefit Guaranty Corporation, which insures the pensions of 44 million Americans, is expected to announce a deficit of $1-2 billion. The New York Times reports the agency has burned through its entire $8 billion surplus in one year. The bleeding isn't about to stop either. US Airways, United Airlines and Kmart are among many companies with large underfunded pension plans that struggling to emerge from bankruptcy. The agerave pension of S&P 500 companies ended 2002 underfunded by $323 billion (69% of asstes). A retiree whose plan is taken over by PBGC gets paid, but the maximum is about $3,600 a month for those older than 65 and less for those who are younger. The last time a three-year bear market coincided with low interest rates was 1939 to 1941and PBGC wasn't in existence then. We expect there will be more pressure on the agency to charge premiums based on the riskiness of a company's pension portfolio. ($8 Billion Surplus Withers at Agency Insuring Pensions, 1/25/03) SEC Rulemaking Update The SEC adopted regulations requiring companies to disclose any instances when their earning reports fail to comply with national accounting standards and to certify such reports that are neither untrue or misleading. The rule will shed greater light on the use of pro forma earnings, which allow companies to exclude certain one-time costs, such as merger expenses, from financial results. Other rules adopted by order of the Sarbanes-Oxley Act require listed companies to publish codes of ethics and too indicate whether they have a financial expert on their audit committees, or to explain why they don’t. The rule also expands the definition of “financial expert” to include individuals with experience analyzing financial statements and in supervising or evaluating people who prepare them. The SEC also adopted a rule that prohibits executives and directors from selling company shares during periods when rank-and-file employees are not permitted to sell their 401(k) shares. (see press releases) Assets Plummet The headline on the front page of the latest issue of Pensions&Investments says "Assets of top 200 retirement funds plummet 24% over the past two years." (1/20/03) Assets were down 11% between Sept. 30 and a year earlier and down 24% from two years ago to $3.2 trillion. CalPERS remained the largest with $128.7 billion. The Federal Retirement Thrift Investment Board was second with $96 billion and New York State Common Retirement Fund dropped to third with 95.9. According to P&I, employer contributions to DB plans in the top 200 actually dropped by 10% in the last year, while payouts increased by 6%. Many firms started making huge contributions in the final quarter to start making up the difference. Federal statutes mandate funding levels for corporate plans, but there's no single mandate that applies to state and public plans. Governments will, therefore, have some flexibility to deal with the problem but delays could result in lower bond ratings and higher taxes. According to a report by Wilshire Associates last August, 51% of state retirement systems were underfunded. Underfunded plans had assets equal to only 83% of liabilities, yet many states will probably propose borrowing from their pension funds. Boards Need Training to Harness Differences "While productivity was the competitive differentiator of the industrial economy, diversity, dissent and difference are the competitive differentiators of the new economy. It is the clash of ideas that sparks creativity and drives innovation. What the 21st century boards need most is the training to harness dissent." This was stated by Dr Madhav Mehra, President World Council for Corporate Governance, while welcoming the recently published Higgs Report. The Council called it "a monumental step forward to improve the effectiveness of corporate boards and enhance competitiveness of UK corporations." The Council has been critical of the box ticking approach to corporate governance followed by US model. Dr Mehra said, "Higgs report comprises recommendations that are starkly practical, pragmatic and steeped in common sense. He should be complemented for his attention to detail and recommending crucial reforms to remove the conflicts of interest which have not been addressed by previous committees and which the Council has been campaigning for quite some time. The independence of directors is the corner stone of good corporate governance. The report’s focus on bringing diversity in the board, transparency in recruitment, rigorous evaluation process and continued professional development is most timely." Dr Mehra claimed that the increasing mismatch between the board’s expectations and customer aspirations was due to the fact that while boards were dominated by white males nearing retirement, the markets were being driven by teenagers and those in their twenties. The biggest enemy of the British business today is the lethargy in innovation. "The diversity in experience, skill, gender, age and ethnic background will help make boards more innovative," said Dr Mehra. Dr Mehra asserted that there was an urgent need to limit the number of directorships any individual can hold. "With the increased demand for non executive directors and the limit being extended to only full time executive directors, companies would be pressured to go for consultants, advisers and accountants for appointment as non executives. With no limit having been prescribed for these individuals, corporations will have non-executives who have little time to perform their roles bringing back last year’s controversy sparked by Lord Young about the ineffectiveness of non executives. Unfortunately, lot of us still believe we can effectively manage non executive directorships of half a dozen companies or even more." Dr Mehra cautioned against excessive emphasis on higher salaries in the hope of attracting higher calibre non-executives. He said widening the selection criteria would enhance the pool and make more qualified people available whereas increasing the remunerations would be counter productive and make non-executives no different from executives. Stephen Timms, the UK Minister for E-Commerce and Competitiveness who is also in charge of Corporate Social Responsibility has consented to deliver the keynote address at the 4th International Conference on Corporate Governance being organized in association with Commonwealth Business Council from 15-16 May 2003 at the Royal Horticultural Conference Center, Westminster. The theme of the conference "Corporate Governance Challenges in the Emerging Economies." "Fools" Get Active The Motley Fool provides advice to shareholders and doesn't take itself too seriously. Yet, today they broached a serious issue. Commenting on yesterday's victory at the SEC to require disclosure of votes at mutual funds, Bill Mann noted, "there's a heavy correlation between the rising percentage of corporate assets controlled by mutual funds and the most recent drop in professional standards at U.S. corporations. In such an environment, where a large portion of ownership is disinterested, why wouldn't executives take advantage of the situation? And for individual investors, who watch as the corporate looting of shareholders takes place without so much as a peep from most big institutions, is there an outlet for their frustration other than just to sell?" The answer is, of course, yes. They point to a site operated by the University of Cincinnati Law School, which spells out the procedures. They also announced their intention to set up a separate discussion board on Fool.com to assist those who wish to write shareholder proposals. We heard rumblings from them before and hope this one pans out. I'm sure they can help activate investors and turn them from speculators to something more of an ownership mentality. (The Power of an Activist , 1/24/03) Back to the top Pensions Subject to Audit Pennsylvania Auditor General Robert P. Casey, Jr. has asked Commonwealth Court to enter a declaratory judgment that the Auditor General has the legal authority to conduct special performance audits of the state's two major pension funds for public employees. In a press release, Casey said he took the action after the Funds' high-priced lawyerî said that "neither PSERS nor SERS will be producing any documents in response to your invalid subpoenas." (Keystone State Pension Audit Fray Continues Escalating, PlanSponsor.com, 1/23/03) Hands Off! CalSTRS, the $94 billion California State Teachers Retirement System, has rebuffed Governor Gray Davis' proposal to divert $500 million away from the pension fund and into cash-strapped state coffers. Davis has proposed cutting the state contribution from $555 million to $55 million this year to a CalSTRS fund that tops off the pensions of older retired teachers, according to Reuters. "The ultimate obligation that our board has is to California teachers," said California State Teachers Retirement System spokeswoman Sherry Reser, explaining the board's decision to stand up to the governor. (Calif. pension fund rejects governor's asset plan, Forbes.com, 1/23/03) Financial Times Reports "SEC ruling deals blow to mutual funds" The Times called it a "victory for corporate governance advocates, who say the change is needed to prevent conflicts of interest that might lead fund managers to vote in their own interests. Harvey Pitt is quoted saying they rules are "fundamental and unassailable principles" of corporate governance. The rules, approved in a 4-1 vote, require mutal funds to disclose policies and procedures used in proxy voting and force release of voting records. The mutual fund industry maintains the obligation will cost them millions and will distract them from the job of stock picking. (Ed. Maybe they will now see corporate monitoring as an equal part of their job.) The final rule call for annual disclosure rather than semi-annual as previously proposed. SEC commissioner Paul Atkins, who cast the dissenting vote, said "the rules will impose costs on funds that will decrease shareholder returns." (1/23/03) Atkins is quoted by Forbes saying, the rule "takes a sledge-hammer to a corporate governance issue that is very nuanced." About half of all U.S. households own shares in mutual funds, which are investment pools that buy and sell securities. Fund companies manage about $6.6 trillion in assets. The SEC said it received a record-setting number of comments from the public -- over 8,000 -- on the proxy disclosure proposal and that most were supportive. "We're just hopeful that under new leadership the SEC will take a second look at how the proxy vote disclosure is working within the next 12 months," Fidelity spokesman Vin Loporchio said. AFL-CIO Secretary-Treasurer Richard Trumka called Thursday's vote a "long-overdue victory for millions of working families who invest their retirement savings in mutual funds yet are kept in the dark as to how mutual funds use their money to influence corporate elections." Don Phillips, managing director of Chicago-based fund-rating service Morningstar, said "It's the industry's own fault they got backed into this corner," Phillips said. "If Fidelity managers and other fund managers were expressing outrage as investors were when these scandals were breaking, the fund industry might have been able to distance themselves from the problems of Wall Street." (CBS.MarketWatch.com, SEC votes to force proxy disclosures, 1/23/03) The commissioners withdrew a provision that would have forced funds to highlight any votes contrary to their overall policies. Funs are now required to annually disclose by the end of August, to the SEC or on their Web sites, an accounting of how they voted on corporate proxy questions in the 12 months ended June 30. “This is indeed an excellent day for transparency and accountability,” Commissioner Harvey Goldschmid said. the Investment Company Institute, the largest mutual fund industry trade group, said the rule puts “substantial new costs and burdens” on funds, without “any evidence of need or benefit to fund shareholders.” Pitt, who championed the plan, sharply criticized opponents. “There are conflicts of interest in the way votes are exercized. … In my view, disclosure is the preferred alternative to structural change,” he said. “I think that this is a modest proposal, not an overextension of regulatory authority.” (Mutual funds must disclose proxy votes, Chicago Tribune, 1/23/03) The SEC "modified its earlier proposal so that fund companies will be required only to make the voting information available on the Internet, not to mail the material to shareholders, according to the Toronto Globe and Mail. ICI spokeswoman Elizabeth Powell estimated the cost at $900 million over 20 years. (Funds must disclose proxy votes, 1/23/03) The ICI has said it is unclear whether electronic disclosure would be feasible and less burdensome than mass mailings, according to a report in the Seattle Times. (SEC Acts to Require Fund Proxy Disclosure, 1/23/03) Writing for the Financial Times, Ingo Walter, a professor of applied financial economics at the Stern School of Business, New York University, says: "Disclosure of proxy voting patterns may not increase fund managers' economic incentives to invest in active monitoring and governance. But greater transparency cannot hurt; and it may encourage industry-wide reforms that would alleviate the problem. That would surely represent an improvement not only for fund managers themselves but also for the investors who are their clients." (Shed light on the passive investor, 1/23/03) "Every claim the ICI has made about this proposal has turned out to be wrong or misleading," says Mercer Bullard, securities law professor at the University of Mississippi and founder of Fund Democracy, a mutual fund shareholder advocacy group. "The fund industry has a self-inflicted black eye over this." (SEC Forces Funds to Disclose Proxy Votes, TheStreet.com, 1/23/03) The SEC's next hotly-contested issue is their proposal that funds disclose their full holdings quarterly, rather than just twice a year in often-stale shareholder reports. The vote on that issue, which Vanguard has backed, will follow the closing of a public comment period on Valentine's Day. (Tell Us More: Funds Will Disclose Proxy-Voting Record and Policies, WSJ, 1/23/03) Back to the top SEC Votes to Require Vote Disclosure The following statement was issued today on behalf of the Social Investment Forum by Timothy Smith, president and chair of the Forum and also senior vice president and director of social responsible investing at Walden Asset Management: "Socially and environmentally responsible investors hail today's important decision by the Securities and Exchange Commission (SEC) to protect the rights of all investors by requiring meaningful disclosure of proxy voting by mutual funds and investment advisors. In taking this action, the SEC has empowered investors with the right to information that can be used to evaluate the commitment of mutual funds and investment advisors to good corporate governance and long-term shareholder value. For years now, Social Investment Forum members have called for disclosure of proxy votes and voting guidelines. Forum members were the first firms in the nation to voluntarily make such disclosures. In fact, all of the U.S. mutual fund companies that currently disclose both their guidelines and voting decisions publicly are members of the Forum. Our members have done so voluntarily because they understand that mutual funds have a fiduciary duty to vote proxies in a manner that is consistent with the best interests of their shareholders and clients. It is important to remember that corporate scandals like Enron, Tyco, and WorldCom were not caused by executive greed alone. Mutual funds were among those who approved Enron's board of directors, supported CEO compensation packages, and voted against numerous corporate governance measures that may well have prevented some of the abuses we've recently witnessed. The SEC's action today tears away the cloak of secrecy that up to now has shielded mutual fund proxy voting from much-needed public scrutiny. The SEC action is good for investors and it is a good thing for the mutual fund industry, including those companies that do not yet appreciate that fact. There is mounting evidence that attention to shareholder rights, including social and corporate governance issues, is linked to long-term corporate performance. When all mutual funds reveal how they use proxy votes, enabling shareholders to know what is being done in their name, we expect to see a contribution to long-term shareholder value. We recognize that some of the industry opposition to this SEC action will not disappear today. There will be those who continue to argue that the Commission's rule is costly and cumbersome. But these arguments are the same ones that are raised by industry in knee-jerk opposition to any new disclosure proposal. And the objections simply do not hold water when it comes to the SEC rule adopted today. Based on their many years of experience, the mutual fund and investment advisor members of the Social Investment Forum already know that this kind of disclosure is inexpensive to implement and can be presented to investors in an easily understood fashion. More and more investors today understand the importance of good governance, ethics and corporate citizenship in the companies in which they invest through mutual funds. They want to see if mutual funds 'get it' and are voting thoughtfully and conscientiously on their behalf. Today's action by the SEC finally makes that possible." CONTACT: Timothy Smith, (617) 726-7155. During the streaming audio news conference sponsored by Pax World Funds, I asked participants what would be their next step. Would there be movement to open the corporate proxy to director nominees from pension and mutual funds? Michael Garland, from the AFL-CIO, indicated they were looking at that since the current requirements make it very expensive to run candidates not nominated by companies themselves. Both Tim Grant, of Pax World, and Mercer Bullard, of Fund Democracy, indicated their organizations would likely participate in any such drive. The news conference will be available for replay at paxfund.com. Snow Disclosures Treasury secretary nominee John W. Snow disclosed assets worth between $77 million and $295 million. The Corporate Library is decrying perks in Snow's executive compensation package that include access to country clubs, the CSX-owned Greenbrier resort, car services and the "reasonable and occasional use of company aircraft . . . for the remainder of his lifetime." "While he talks a good game on corporate governance, his record does not live up to the rhetoric," said Nell Minow. Minow also said Snow was serving on Verizon's board when the telecommunications company gave CSX $700,000 for the right to lay cable along CSX tracks. (Snow Discloses His Assets, Pay, WashingtonPost.com, 1/23/03) Family Ties Asia Times writer, Gary LaMoshi, points out the problem with corporate governance in Asia is that most controlling shareholders are founding families or governments. "An institution or raider wants to build up the value of the company and sell it. A founding family generally wants to keep control and use it to run the company. An independent board of directors that did its job properly might threaten the family's prerogatives. It might insist that all those nephews holding corporate-vice-president portfolios hit the road in the name of shareholder value. That move would not only subvert the rationale for family control but sow discontent that might endanger it. When families aren't the controlling shareholders in Asia, governments usually are. Profits are not the top priority. Even honest regimes often use state companies to support political priorities - one reason for their legendary inefficiency - such as building a plant in an economically depressed area and keeping unprofitable factories at work to prevent unemployment. In less honest situations, state companies give politicians ample patronage opportunities, and can provide a host of services to ruling parties, including campaign funds from the corporate till or the pockets of managers who owe their jobs to government leaders. Family or government, Asia's controlling shareholders are much more interested in the control part than the shareholder part of their titles." Until they are more interested in shareholders, they will probably see few activist funds, such as CalPERS, investing their money where their rights aren't protected. For now, finding investors doesn't appear to be a problem in many family and/or government dominated firms in Asia. (Unraveling the corporate governance mystery, 1/24/03) Proportion of Stockholders Continues Climb More than half (51.9%) of US households owned stock in 2001 (directly or indirectly), the largest percentage ever, and up from 48.9% in 1998, according to the Federal Reserve. Households' stock holdings had a median value of $34,300 in 2001, up from $27,200 in 1998. The vast majority (89.6%) of upper-income households held stock, while just 12.4% of the bottom 20% of earners did, according to the report. 11th-Hour Bid Fights Proxy Disclosure The Investment Company Institute, which represents fund groups, shipped 932 page books to a dozen news organizations in a last minute attempt to show that forcing fund companies to chronicle their proxy votes would require onerous time and expense. Advocates of disclosure argue that mutual funds have a responsibility to report their votes to their 95 million US customers. The AFL-CIO, Pax World Funds and Fund Democracy will hold a telenews briefing at 11:30 a.m. on Thursday, January 23, 2003, to comment on expected action by the Securities and Exchange Commission (SEC). The live, two-way phone-based news conference will be held at 11:30 a.m. EDT on January 23rd at 1-(888) 413-5356. Use ID number 66953 or ask for the "SEC mutual fund rule" news event. Speakers will be: Thomas W. Grant, President, Pax World Funds, home of the oldest socially and environmentally responsible mutual fund in the United States. Pax World launched a Web site which generated more than 1,000 emails to the SEC's comment file in support of the rule proposal. Richard Trumka, Secretary-Treasurer, AFL-CIO who first petitioned the SEC in December 2000 for a rule forcing mutual funds to disclose their proxy votes. The AFL-CIO again petitioned the SEC in July 2002 and launched a campaign to educate investors on the consequences of mutual funds' secret proxy voting. Mercer Bullard, Founder and President, Fund Democracy, a mutual fund shareholder advocacy group. Bullard also is a securities law professor at the University of Mississippi. In the event that the SEC action is delayed, the conference call will be rescheduled on Thursday. For updates, contact Stephanie Kendall at 703/276-3254 or skendall@hastingsgroup.com. A streaming audio replay of the news event will be available as of 4 p.m. EDT on January 23rd at MutualFundProxyVotes.com. Back to the top Building Trust That's the theme as business leaders converge on Davos. It's the world's only non-governmental organization that represents 1,000 transnational corporations. Davos also invites and attracts hand-picked representatives from the world of anti-globalism, environmentalism, unionism and socialism. This year a keynote address will be given by Brazil's first elected leftist president, Luis Inacio "Lula" da Silva. Washington is sending Colin Powell and John Ashcroft. "Building Trust," with a war looming and CEOs in handcuffs, seems a tall order. "The greatest challenge for capitalists is that there are no icons left anywhere and right now the only common value, or solution, is need for transparency," says Diane Francis of the Financial Post. (Grave challenges face Davos leaders, 1/21/03) Pension Fund Levels Drop Between 1996 and 1999, the funded ratio for Towers Perrin’s benchmark pension plan, based on projected benefit obligations, grew from 85% to 131%.  In subsequent years, the benchmark plan’s funded level dropped to 80% as of year-end 2002, the lowest level since 1993. The benchmark plan’s portfolio reported a -9.0% return for 2002, following a -3.6% return for the prior year.  A more conservative 40% equity portfolio reported a -3.1% return for 2002, while a more aggressive 80% equity portfolio reported a -14.7% return. With funding levels comparatively low, Towers Perrin said a typical plan sponsor would have to cope with increasing pension expenses and required asset contributions. (Towers Study: Pension Funding Level Lost 20% in 2002, PlanSponsor.com, 1/22/03) According to Institutional Investor Magazine (Shifting Gears, 1/20/03), corporate pension funds are in their most precarious financial straits since the 1970s. As of September 30, 2002, the average corporate pension plan was only 77% funded...down from 132% in March 1999. Corporate defined benefit plans must make up a combined deficit of $243 billion, the biggest on record. In June, Nestlé USA decided to allocate 5 percent of its $1.7 billion in pension assets to a hedge fund of funds, the first of its kind in the portfolio. Companies are reducing their expected rates of return. "In a world where even the ten-year bond is yielding less than 4 percent, an 8 percent return assumption is very aggressive," says actuary Jeremy Gold, who runs New York-based consulting firm Jeremy Gold Pensions. ERISA requires companies to keep their plans at least 90 percent funded. If funding falls below that level, corporations must make contributions to bring it back up, usually over a period of three to five years. Institutional Investor reports that 65.6% of respondents to this month's Pensionforum "aim to make a net contribution to their plans in 2003. And the pain is only beginning: 52.2 percent of respondents say they expect annual contributions to increase over the next three years." Equity Fund Outflows Continue Money market funds lost $37.2 billion in December, followed by equity funds recording an outflow of $5.5 billion.  Bond funds posted an inflow of $4.2 billion, according to data by Lipper, Inc. For the year, equity funds recorded six outflow months in the last seven and finished with their first net outflows since 1988. Money funds also recorded net outflows for 2002. Bond funds amassed their greatest net inflows for any year, breaking the old record of $120 billion set in 1986. (December Down Month For Equity, Money Market Fund Inflows, PlanSponsor.com, 1/22/03) BookBites We've added a new section to our library. BookBites will provide brief reviews of books recently received at CorpGov.Net. This month's featured volume is The Human Face of Corporate Governance, by Lynn McGregor, which requires a bit more reflection on the part of readers than the usual fare. Bogle on the Promise of Mutual Funds The January edition of Fortune magazine carries an interesting article on Vanguard’s founder John Bogle, “Saint Jack on the Attack.” It recounts how Vanguard became the only major mutual fund company controlled by its shareholders. Bogle is disappointed that mutual funds have shifted their emphasis from long-term investing to short-term speculation. Instead of offering a cheap, relatively safe entree into the market, the industry has focused on risky specialized funds that burn out quickly. "They're not stars but comets." Charges continue to rise, from an average of about 0.75% of assets each year in the 1950s to almost 1.6%, while fund the holding period has dropped from 16 years to 2 1/2 years. Bogle points out that 1984-2001, when the S&P 500 14.5%/year, the average equity mutual fund rose 11.5%, but after expenses investors made 4.2% a year…maybe 3% by the end of 2002. That's less than the inflation rate. Fund managers have done great but investors have not. The result? More money is being pulled out of equity mutual funds than is flowing in for the first time in 14 years. The dream he expressed in Bogle on Investing: The First 50 Years is that mutual fund managers, because they possess "greater knowledge of finance and management than the average stockholder," could exert a healthy controlling influence on corporate behavior. “People will not act contrary to their own economic interests forever," he believes. The Washington Post has joined in editorializing in favor of the SEC’s disclosure regulations ("Our Money, Our Votes," 1/21/03). Requiring funds to make their votes public would reveal potential conflicts of interest. Costs, given the size of the industry, don't seem terribly daunting. While disclosure may subject them to lobbying by labor unions and others, they are already subject to such pressures from management. Disclosure of proxy votes may not bring mutual funds under the control of shareholders but it could certainly increase their influence and perhaps it would help shift the focus of fund managers from stock picking to corporate monitoring. Who does Bogle think is doing a good job of stewardship? Capital Group (the American Funds family), Clipper, Dodge & Cox, Longleaf, Vanguard, and TIAA-CREF Top Five Social Investing News Stories of 2002 iShareowner.com recently reported the top 5 stories of 2002, which "exposed many underlying SRI strengths." Corporate Governance Reforms - Sarbanes-Oxley, NYSE SRI Mutual Funds Weather the Bear Market - According Lipper, between January and June 2002 there was a net outflow from U.S. diversified funds of approximately 9.5% but a net inflow of 3% during the same time period. Community Investment Pays - National Community Capital Association (NCCA) found that community development financial institutions (CDFIs), which serve low- and middle-income communities, have a better payback rate than commercial banks. Shareowner Action Successes - the highest shareowner vote ever on a social policy resolution. CBRL Group (the parent company of Cracker Barrel) annual meeting, 58% of voting shareowners supported a resolution that called for the adoption of an equal employment opportunity (EEO) policy that bars sexual orientation discrimination. SRI Continues to Expand Internationally - New requirement that Australian investment firms disclose environmental and social considerations. Back to the top SRI Funds Portfolio 21, which invests in companies that "have made a commitment to environmental sustainability and have demonstrated this commitment through their business strategies, practices and investments," says it outperformed its benchmark, the MSCI World Equity Index as well as the S&P 500 during calendar year 2002, as well as for the three years since its inception on September 30, 1999. The MSCI World Equity Index experienced a 19.54% loss in 2002, while the S&P 500 fell 22.10%. The Portfolio 21 fund declined 19.05%. "We have searched the world for companies that exhibit the environmentally sustainable practices that are at the heart of our mutual fund investing strategy," said Portfolio 21 Co-Founder Carsten Henningsen. The Sierra Club is harnessing its name recognition and expertise on corporate environmental performance by launching the Sierra Club Stock Fund and the Sierra Club Balanced Fund, managed by San Francisco-based Forward Management. Both funds use screens, which originally developed for use with the Sierra Club endowment's equity investments, to exclude companies with poor environmental performance. The Sierra Club Mutual Funds will apply a total of 19 screening criteria related to areas such as the production of nonrenewable energy, nuclear and chemical waste management, contribution to global warming, and manufacture or distribution of military weaponry. (Sierra Club Launches SRI Mutual Funds, SocialFunds.com, 1/15/03) With corporate frauds all around them, "investors burned by the scandals felt a [socially responsible investment company] would be paying attention to these issues," said Tim Smith, president of the Social Investment Forum and senior vice president of Walden Asset Management in Boston in a recent interview at philly.com. The best practice for socially motivated funds is to combine screening for unfit companies with advocacy to change companies' behavior. "Investors know that a clean portfolio is an illusion," Smith said. Re-Emerging Markets Greenwich Associates reports that about 25% of defined benefit plans, both public and corporate, owned emerging market stocks in 2001. Ownership is concentrated among the very largest plans—$1 billion and more in assets. For those pension plans that make a separate allocation, typical holdings top out at 3% to 5% of total plan assets. Prices of emerging market equities have fallen faster than their counterparts in the US and Europe for the past three years. However, they posted better than 50% returns in 1991, 1993, and 1999 and are now getting another look. Since emerging markets are considered less efficient, investment managers can add more value through security selection. In the early ’90s, emerging market price-earnings multiples were higher than in the US; today, they are at 10-year lows. The "most notable new mandate of 2002" was the $1 billion of emerging market equity assets that CalPERS is shifting from indexed to active management in order to place greater emphasis on emerging countries’ labor practices, civil rights, and financial transparency. (Plansponsor.com, 1/21/03) Few in Florida Opt Out of DB Plan Florida State Board of Administration (FSBA)—which oversees the 615,000-participant Florida Retirement System (FRS)—says participants are "scared to death;" few have opted to join the FRS’s new defined contribution plan. Employees who join the defined contribution plan can retire with more money, if they fare well in the market. Participants are wary: The FRS defined benefit plan has about $84 billion in assets and 600,000 participants, while the new Investment Plan had only about $145 million in assets and 15,000 participants as of late November. Florida's actuaries originally estimated that about 200,000 participants and $13 billion in assets would move into the new plan but, this past spring, they lowered those estimates to 144,000 participants and $4.5 billion in assets—and the projections may take several years to realize, FSBA officials say. According to Kevin SigRist, senior investment officer for defined contribution programs at the FSBA, participants have said, "I have already felt so much pain from the market going down, why would I take on more risk?” (Plansponsor.com, Game Plan: A Cloud Over The Sunshine State, 1/21/03) Shareholder Activism to Drive Reforms The Financial Times says that rising shareholder activism will drive the reforms of British boardrooms proposed by the recent review led by Derek Higgs. Since the Cadbury report in 1992, corporate governance reforms in the UK have been based on voluntary compliance, with an explanation for noncompliance. For example, most firms have moved to split the roles of CEO and chair. This time the government has indicated it intends to review progress in two years and enact legislation if needed. A survey of some 523 companies by Pension Investment Research Consultancy (PIRC) found only 34% believed they fully comply with the combined code. One of the central recommendations of Higgs was that at least half the board be comprised of independent non-executive directors. Yet, PIRC found only 20% of boards met that standard. George Cox, director-general of the Institute of Directors, is quoted saying "one of the reasons the UK has been able to avoid an Enron-like crisis is that we had our crises 10 years ago with companies like Maxwell, Polly Peck and Blue Arrow and put in reforms to deal with them." (Shareholders will apply poll pressure, Financial Times, 1/19/03) According to the report: Non-executive directors should be in the majority (counting the chairman as non-exec). A senior non-executive director ought to be designated. Non-executives should meet key investors without the presence of executive directors. Non-executives ought to be paid at a level similar to lawyers and accountancy advisers A non-executive director should normally be expected to serve two three year terms, although a longer term will exceptionally be appropriate Davis Backs Brown Gov. Gray Davis declared his support for Willie Brown's bid to be elected president of the California Public Employees' Retirement System, calling the San Francisco mayor his "anchor tenant" at the powerful pension fund. (SFGate.com, 1/15/03) Institutional Investors Must Get Onboard A recent survey by PricewaterhouseCoopers found that 60% feel that public trust in the market will only be restored by fundamental changes instituted by the institutions themselves. The problem is that only 7% see management taking the lead. Most investors agreed that they would punish companies that fail to act. Some 40% said the cost of capital would be higher; 19% said they wouldn't buy sock in companies that had not reformed its governance. (Wall Street Must Lead by Example, Investor Relations Business, 1/13/03) Mutual Secrecy The heads of Fidelity and Vanguard joined forces in a Wall Street Journal oped opposing the current SEC rulemaking proposal on mutual fund proxy disclosure that received overwhelming support from commentators. "Simply put, we believe that requiring mutual-fund managers to disclose their votes on corporate proxies would politicize proxy voting. In case after case, it would open mutual-fund voting decisions to thinly veiled intimidation from activist groups whose agendas may have nothing to do with maximizing our clients' returns." The fund representatives point out that "pension funds, insurance companies, foundations, bank-trust departments and other investors would retain their rights of confidentiality. The effect would be to make mutual funds the prime pressure point for every activist group with a political or social ax to grind with corporate America." Instead, they call for more oversight from the SEC to ensure mutual funds are following their own proxy guidelines. Yet, such guidelines are often so broad as to be literally unenforceable. In our opinion, the answer isn't more oversight from government regulators. Disclosure will give shareholders the tools to do the job themselves. And to be fair, why not require it for all institutional investors? (No Disclosure: The Feeling Is Mutual, 1/14/03) Proxy Warriors According to the January edition of Institutional Investor Magazine, "hedge funds that buy, bluster or bully their way onto company boards are the new shareholder activists. What's more, these inside agitators are stirring other investors to act." Stephen Taub's "Proxy Warriors" goes on to write, "they are becoming the ultra-assertive inside agitators of shareholder activism -- getting in the faces of top corporate executives; filing 13(D)s after gaining control of 5 percent or more of a company's stock and boldly stating their bill of grievances; aggressively badgering companies to rescind takeover defenses, like poison pills and staggered boards; pushing top managers to seek outside buyers, recapitalize their companies or repurchase shares; and often running for company boards themselves to champion reform from within. Hedge funds are free to pick battles where they please Mutual funds are often part of large corporations themselves. They generally shy away from disturbing corporate management for fear of being cut off from information flow or losing customers for their pension and 401(k) services. Activist hedge funds mentioned included Highfields Capital, Steel Partners II, Newcastle Partners, which has done several proxy battles alongside Steel Partners II, Financial Edge Fund, Seidman & Associates, Ramius Capital Group, P. Schoenfeld Asset Management, and ValueAct Capital Partners. Back to the top Will Donaldson Keep Up the Pace of Reform? Recent reforms include the following from Sarbanes-Oxley and NYSE: Creation of a public accounting-oversight board to oversee the auditing of public companies, and restrictions on the consulting services that auditors can offer clients. CEOS and CFOs must sign off on annual and quarterly reports; bonuses must be returned if fraud results in an overstatement of earnings. Majority of independent directors. Regular meetings of non-executive directors without company's management. Presiding director's name must be made public. Compensation, nominating, and audit committee, to be composed entirely of independent directors. Audit committee must be chaired by “financial expert,” with accounting or similar background. Corporate-governance guidelines must setting out provisions for annual evaluation of board and CEO. According to The Economist, companies still have a way to go. A 2002 survey by the Investor Responsibility Research Center (IRRC) found that 13% of companies listed on the NYSE did not even have a majority of independent directors. About 20% of companies on the NYSE don't even have a board-level nominating committee, independent or otherwise. The system is broken and most directors seems to recognize it; 69% of directors of large American companies told a recent poll by McKinsey they backed the idea of splitting the role of CEO and board chair. Paul Gompers, Joy L. Ishii, and Andrew Metrick looked at 1,500 firms in the 1990s and found those that were most responsive to shareholders would have enjoyed returns 8.5% a year higher than those run as management dictatorships. ("Corporate Governance and Equity Prices," Quarterly Journal of Economics, forthcoming in February 2003.) The surest way for governance to improve is for investors to demand it. According to The Economist, “institutional investors, who have the muscle to make a difference, still often shut their eyes.” Many do so because they don't want to lose fees from running corporate pension and 401(k) funds. What remains? Here's a list Robert Monks sent out to evaluate SEC Chairman designate Bill Donaldson. Monks asks where Donaldson stands on the following: Requiring that mutual funds (subject to the 1940 Act) disclose publicly how they voted portfolio company shares. Aside from Pitt's proposed rule, it is sad to report that the SEC has been a subsidiary of the Investment Company Institute for the last thirty years (and probably longer ). Some 6000 people supported Pitt's proposal, ICI opposed it - surprise! How does Donaldson see it? Pitt proposed eliminating the "ordinary business" exclusion from the right of shareholders to propose resolutions for inclusion on the company's annual proxy statement. This had been the device with which the imaginative and persistent corporate bar has used to "gut" the importance of section 14(a) of the 1934 Act. It has been said: "If the SEC requires the resolution be included, it cannot have significance; if the resolution has significance, it will be excluded." How does the chairman designate feel about this? There is a shareholder initiative asking that the Commission consider allowing the proposal by shareholder of nominees for the board of directors. This would allow the "independent" directors, so beloved by rule makers, and so absent from boards. Imagine a board member produced by a process other than self perpetuation. The very idea! Does the chairman designate believe in this amount of independence? (see Shifting power; The way we govern now; Insert steel; 1/9/03, The Economist.) (see also Capitalism Without Owners Will Fail by Robert A. G. Monks and Allen Sykes.) In the Company of Owners Joseph Blasi and Douglas Kruse have chronicled the links between employee ownership, participation and increased productivity for many years. Now they have joined with Aaron Bernstein to take a look at stock options. Their conclusion: greedy CEOs have hijacked what could be one of the most important business innovations in decades: stock options for all employees. In the Company of Owners: The Truth About Stock Options, authors Blasi, Kruse and Bernstein argue that options should be offered to all employees, not just upper-level executives. Employees hold a 19% stake in the "High Tech 100," the 100 largest public companies that derive more than half of their sales from the Internet. Even after the dotcom bust, most are ahead. That's much different than most corporations, where about 30% of options go to the top five executives. The remaining 70% is spread narrowly to about 5% of the highest paid employees. Only about 6% of firms offer most of their workers options on a regular basis. When they do, it can be a powerful force, "bringing about a more productive company and, ultimately, rewarding employees and outside shareholders alike." Employee ownership lifts a company's productivity by 4% and total shareholder returns by 2%, according to their analysis of more than 70 economic studies done on the subject in the past two decades. Conversely, there's little evidence that companies perform better by granting huge ownership that executives have claimed for themselves. They argue that investors who surrendered a large portion of ownership to top executives could have gained much more if their companies had shared the wealth with average employees and an ownership culture. NACD Membership Rising Roger Raber, president and chief executive of the National Association of Corporate Directors in Washington, says that his organization’s membership had risen 37% through November, to 4,000. By contrast, membership at the 25-year-old organization rose only 15% during all of 2001; 20% in 2000, and 10% in 1999. The increase has been most pronounced among large public companies, Mr. Raber notes. His group also is experiencing an increase in customers for its board education programs. Those programs are tailored to companies of all sizes and types of industries.  Among the most popular programs: financial competency, audit committee quality and independence, director professionalism, and the role of compensation and governance committees. Ethics Concerns Remain Individual investors' trust in the ethics of Corporate America remains dismally low, according to the Investor Confidence Index conducted by Rating Research LLC. Only one in twenty (5%) investors claim they are "very confident" that, in general, the senior leadership of publicly traded companies engage in ethical business practices. Almost one-half (45%) of investors say they are either "not very confident" or "not at all confident" in senior leadership's ethical business practices, although this number is lower than the high of 56% reached last August. "Despite efforts by the government and many companies to restore investor confidence and somewhat less media attention on corporate scandals, investors appear largely unmoved,"said Matthew Mole, co-founder of a Rating Research. The Rating Research Investor Confidence Index includes interviews with approximately 500 investors. The most recent survey was conducted December 12 - 15, 2002. The number of investors who claim the actions taken by the government to address corporate corruption have had no impact on their confidence in investing their own money is three times as large as the number who claim the government's actions have increased their confidence (62% say "no impact" versus 19% who express "increased confidence." According to the survey results, efforts by companies to fortify their corporate governance guidelines are either not well understood by investors or deemed minimally effective. While one-fourth of investors (25%) claim stricter guidelines for corporate governance policies and procedures increased their confidence in investing in publicly traded companies, more than one-third (36%) claimed they "didn't know enough about corporate governance to offer an opinion" and three-in-ten (30%) believed stricter guidelines had no impact. The most recent study also validated investor interest in independent ratings on companies' ethics. More than one-half of the investors polled (53%) state that having available ratings on the ethical business practices of publicly traded companies will increase their confidence in their own investment decisions. Investors clearly state, however, that the independence, objectivity and integrity -- in short, the credibility -- of the organization providing the ratings is key. PA Audit Sought PlanSponsor.com reports that Pennsylvania’s Auditor General has issued subpoenas to the chairpersons of two state public-employee pension funds; a move he says is necessary to proceed with audits of the funds' contracts with investment firms. The subpoenas went to officials of the State Employees' Retirement System and the Public Schools Employees' Retirement System. Auditor General Robert Casey, saying that the funds "arrogantly refuse" to cooperate with audits he has tried to conduct since August, held they now have until January 17 to turn over all documents he has requested or risk being sued in Commonwealth Court. The funds informed Casey that they would not supply any documents related to 18 categories of requested material. According to a Philadelphia Inquirer report last month, the two funds have lost almost $30 billion over the past two-and-a-half years. (PA Auditor General Subpoenas Public Pension Funds, 1/9/02) Back to the top Commission Seeks Public Trust The Conference Board's blue ribbon Commission on Public Trust and Private Enterprise released their much anticipated report to generally favorable reviews. As their report notes, 79% of those recently surveyed believe the practice of corporate executives taking improper actions to benefit themselves at the expense of their corporation is “very or somewhat widespread.” Since the recommendations of the report are largely an appeal to man’s better nature, with some reasonably good details, I doubt it will do a great deal to restore investor confidence. Even if widely implemented, confidence might only be restored temporarily. Since the measures are largely voluntary, they could easily melt away as the current crisis wanes. The Commission wisely sought to “strengthen the independence and role of the board with appropriate check and balances on the power, actions and performance of the CEO.” However, their solution is more timid than bold. With regard to who will run the board, they came up with three options and an essay contest. Alternative 1: The Commission urges companies to carefully consider separating the offices of Chairman of the Board and CEO. Alternative 2: The roles of Chairman and CEO should be performed by two separate individuals. If the chairman is not "independent" according to strict stock exchange definitions, a "Lead Independent Director" should be appointed. It is essential that non-CEO chairmen not have any relationships with the CEO or management that compromises their ability to act independently. Alternative 3: Where boards do not choose to separate the Chairman and CEO positions, or where they are in transition to such a separation, a "Presiding Director" position should be established. If none of these alternatives are suitable, the company should write an essay explaining how the board structure adopted achieves strong, independent board leadership. I would hope most mature corporations would adopt one of the first two alternatives but the pessimist in me says we won’t even get the essay. Of course, a split chair/CEO is no guarantee boards will look out for shareowners, as evidenced by Enron, WorldCom, and Global Crossing. However, it is a step in the right direction. With regard to shareowners more directly, the Commission notes they “should act more like responsible owners of the corporation.” Given the increasing rates of stock turnover, this would be a challenge under any circumstances. Average turnover on the NYSE have gone from 19% in 1970 to more than 100% in 2001. On the NASDAQ it was 288% in 2001. If indexed funds were removed from the equation, those rates would be substantially higher. Here's where I most sypathize with the Commission. It really shouldn't be an organization largely composed of CEOs that attempts to restore investor confidence trhough a list of corporate best practices; it should be investors themselves demanding enforceable changes. John Bogle, founder and former chairman of Vanguard Group Inc., asserted that a reduced tax on stock that is held, for say five years, would encourage institutional investors and management to get out of the "rent-a-stock-business." A major part of the Commission's solution lies in giving stockowners “the ability to participate in the corporation’s election process through involvement both in the nomination of directors and in the proposals in the company’s proxy statement about business issues and shareholder concerns regarding governance of the corporation.” Maybe if shareholders have a voice, they will hold shares longer. The Commission properly notes that under current SEC rules, “management is not required to include a shareowner’s nomination for a board position in the company’s proxy materials.” The only alternative is for shareowners to pay for a proxy solicitation, a process the Commission admits is “usually prohibitively expensive.” Unless the incumbent board voluntarily includes shareholder nominees, “shareholders have no meaningful way to nominate or elect candidates short of waging a costly proxy contest.” Additionally, management can omit shareowner proposals that relate to “ordinary business,” even though these proposals are often of considerable importance. Their solution? Nominating committees and management “should actively encourage constructive shareowner input.” The Commission recommend's direct discussions. “Only after this avenue has been exhausted” should shareowners go “directly to the corporation’s owners through the proxy process to nominate directors or submit business proposals.” When I first read the above I thought okay, now we're getting somewhere. If, after a letter or two and perhaps a conversation or two, a shareowner’s concerns are still not addressed, the Commission would recommend the issue or candidate be placed on the corporation’s proxy, as our proposal SEC Rulemaking Petition File No. 4-461 envisions. Instead, the Commission recommends that a corporation “Consider factors such as length of time or ownership in assessing the gravity of recommendations including shareowner nominees or proposals in proxy material.” “Boards should not (automatically) preclude proposals made by smaller, individual shareowners.” “The procedures for receiving shareowner nominations and proposals should include, where appropriate (one of the Commission’s favorite phrases), meetings of shareowners with the nominating/governance committee or its representatives.” Boards should “give serious consideration” to adopting shareowner proposals that receive a significant number of votes cast.” (call me naïve but I thought most boards actually do that now) If “the board chooses not to implement a proposal that receives a substantial percentage, even if less than a majority of the votes cast, it should publicly disclose its reasons for its actions. (They should put out a press release.) (The underlines and cynical parentheticals are those of CorpGov.Net’s editor.) The Commission’s report does represent progress. Who can disagree with one of the more typical recommendations? “Corporations should work to support responsible behavior and build environments in which employees take the initiative to address misconduct rather than waiting until after the damage is done." If corporations put such mechanisms into place, we would all be better served. While many of us would have liked to see something stronger, especially in terms of recommended enforceable standards, the report does address a fairly wide range of issues and moves moderately in the right direction. Given that the Conference Board’s members represent the senior executives at about 3,000 companies, some of the recommendations, such as that calling for a split chair/CEO, are groundbreaking. When will we see a similar panel sponsored by the Council of Institutional Investors? Only an organization controlled by investors can really come up with recommendations to restore investor confidence. Their last major press release of several recommendations was back in August of last year. They said "it's a time for reforms with real teeth." The Securities and Exchange Commission must have a full roster of strong, independent-minded Commissioners in place. The backgrounds of SEC Commissioners should be broad and varied. Commissioners shouldn't come predominantly from the accounting profession. Auditors must be prohibited from providing most non-audit-related services to audit clients, and a strong, full-time, independent industry oversight board need to be put into place. Companies should be required to provide details on the relationships between directors and the companies on whose boards they serve. The Nasdaq Stock Market, the New York Stock Exchange and other exchanges should be required to adopt identical, strong corporate governance listing standards, including stringent requirements for independent directors and a tough definition of "independent." Recommendations drafted by the New York Stock Exchange's Corporate Accountability and Listing Standards Committee should be considered minimum requirements, and both exchanges should be urged to consider tougher standards. In addition to shareholder votes on stock option plans, stock options should be expensed on corporate income statements. When will institutional investors demand that owners be able to place nominees on the corporate ballot? That and disclosure of votes are the cornerstone reforms needed. Shareholder confidence will be restored when shareholders have the information to know when their interests aren't being addressed and the power to remove poorly performing directors from office. One positive outcome of the Commission's report is that it can be cited as an authoritative source. Shareholder activist John Chevedden, for example, recently wrote to inform me that GE filed a brief with SEC to suppress from the GE 2003 shareholder ballot a shareholder proposal to separate the offices of Chairman of the Board and CEO. Let's hope the SEC considers the Commission's report and does not issue a no action letter. The ISS Friday Report included some reactions to the report, a few of which are reproduced below: Paul Lapides, director of the Corporate Governance Center at Kennesaw State University, told the Friday Report that the three-pronged recommendation didn't go far enough. "The presiding or lead-director concept is a baby step toward separating the chair and CEO," he said. "We have a marketplace that has very little confidence in corporations, and one of the ways to restore confidence is to take action and do something different, and [the split] is something that has the potential to begin to restore confidence." You're not going to get revolutionary recommendations from the Conference Board," Lapides concluded. "They don't go far enough, but I think they move in the right direction." "I don't believe that we should treat short holders and long holders differently," said Charles Elson, director of the Center for Corporate Governance at the University of Delaware, said in another interview. "I've always believed that the real problem is executives and directors selling stock short, not investors." James McRitchie, the editor of CorpGov.Net who submitted an SEC rulemaking petition last summer calling for increased shareholder access to proxy ballots, told the Friday Report that he was disappointed that the commission didn't recommend a specific ownership threshold for shareholder access to proxy ballots. "But at least it's a microstep in the right direction," he added. Back to the top Ford Family Conflicts of Interest to be Prevented? The following shareholder proposal was recently submitted by John Chevedden: Establish an independent committee to prevent Ford family conflicts of interest with other shareholders Ford shareholders request a bylaw to establish a committee of independent non-family directors to evaluate (before the fact if possible) and make recommendations regarding any question of conflict of interest between Ford family shareholders and non-family shareholders. The standard of independence would be modeled on the standard of the Council of Institutional Investors located at www.cii.org under Council Policies, Corporate Governance Policies: "A director is deemed independent if his or her only non-trivial professional, familial or financial connection to the corporation or its CEO is his or her directorship." John notes, this is the third year that this topic has been on the Ford ballot. It is believed that it won more than 25% approval from the regular shareholders in 2002. The initial reason for the proposal was the Ford Recapitalization Agreement, which was submitted to shareholders at a special shareholder meeting in August 2000. Major institutional investors opposed this Ford plan. The TIAA-CREF teachers retirement fund, and leading state retirement funds in California and New York objected to the recapitulation plan because it put regular shareholders at a disadvantage to members of the Ford family shareholders. As a result of the Recapitalization Agreement the Ford family was allowed to control 40% of the voting power while cutting their Ford stock holdings by 28%. Ford family shares were allowed 16-votes per share compared to the one-vote per share for other shareholders. An additional reason for an independent committee was the 2002 revelation that Goldman Sachs gave hot IPO shares to Bill Ford which resulted in a paper profit of $8 million. Former Enron Chairman Ken Lay and former Tyco CEO Dennis Kozlowski (who fought criminal investigation on another matter) were allowed to buy Goldman IPO shares – though fewer shares than Bill Ford. Mr. Ford’s transaction was among those labeled as "corrupt practices" by the House Financial Services Committee. Furthermore Goldman Sachs Group President John Thornton sits on Ford’s board. The data show how widespread the allocations were to executives of investment-banking clients, such as Mr. Ford at a time when ordinary investors were routinely denied access to IPOs. To protect the rights of non-family shareholders, vote yes for an Independent Committee To Prevent Ford Family Conflicts. Yes On 3. Shift in Good Faith Chief Justice Veasey’s ovservations in the January 2003 issue of the Harvard Business Review, together with recent actions by the Delaware Supreme Court, signal a shift in the definition of "good faith" and a heightened sensitivity to corporate governance issues. Directors face increased exposure to liability in the post-Enron and post-Sarbanes-Oxley Act of 2002 world. The "voluntary" best practice codes, NYSE/NASDAQ listing requirements, Sarbanes-Oxley and common knowledge of the Enron and WorldCom experiences have created a new set of expectations for directors. The Delaware Supreme Court has long have held that “in making business decisions, directors must consider all material information reasonably available.” The bar is being raised concerning what good fait effort directors must make to obtain information that is reasonably available. Section 102(b)(7) of the Delaware General Corporation Law, permits shareholders to protect directors from liability for breaches of the duty of care but not “acts or omissions not in good faith.” Plaintiffs may well ask courts to decide questions such as: Could directors have had a good faith belief that they devoted enough board and/or committee time to oversight in light of the size and scope of the corporation’s activities and – with 20-20 hindsight – what went wrong? Could directors have had a good faith belief that an audit committee of a multibillion dollar multi-national corporation that meets for an hour or two quarterly (and possibly with some members participating by phone) devoted enough time and attention to oversight? Could directors have had a good faith belief that a chief executive officer would have left the corporation or not performed up to his or her potential if he or she were offered less money than the millions or tens of millions of dollars the compensation committee agreed to pay? and could directors who have full time jobs and/or serve on multiple boards (and/or multiple audit committees) have had a good faith belief that their multiple obligations provided them enough time to exercise sufficient oversight over the affairs of each corporation they serve? Chief Justice Veasey urges that compensation committees should have their own advisers and lawyers. That raises the question concerning the extent to which compensation committees can rely upon the corporation’s advisors and lawyers. Should the board as a whole have its own advisors? To what extent will a compensation or audit committee determination not to retain their own advisors and lawyers – based upon cost considerations and/or their confidence in the board’s advisors – face allegations that the failure to do so reflected something less than good faith? From June 2002 through today, the Delaware Supreme Court has issued written decisions in five cases involving the performance by directors of their fiduciary duties. In all cases the Supreme Court held for the shareholders and against directors (reversing Court of Chancery decisions). The above was taken from a recent memo from Weil, Gotshal & Manges LLP. Although this editor attempt to summarize the salient points, readers should contact Weil Gotshal for further information or advice. My conclusion, maybe progress is being made. Adelphia Shareholders File Lawsuit to Require Board Elections The Equity Committee's Co-chairmen, Van Greenfield, managing member of Blue River Capital, LLC and Leonard Tow, are seeking to compel the company to hold a shareholders' meeting to elect directors and to prevent the incumbent Board from influencing the outcome of the election. "Shareholders are entitled to exercise their corporate governance rights and elect a board of directors of their choice. This suit is solely to allow the proper exercising of these rights," according to the co-chairmen. Editor's question, should a company have to be in bankruptcy before shareowners seek input in elections? (NewsAlert, Adelphia Shareholders File Lawsuit Seeking Shareholders' Meeting to Elect Directors, 1/9/03) SEC Audit Proposal The SEC formally proposed rules to enhance the authority and independence of audit committees to implement standards mandated by Sarbanes-Oxley. The proposal would require that audit committees be made up entirely of independent directors; committees would be responsible for the hiring, firing and oversight of the firm's independent auditor, which must report directly to the panel; procedures be in place to allow employees to submit anonymous concerns about accounting matters; would require the committees have authority and sufficient funding to hire outside counsel and advisers. Underfunded Pensions Aggregate pension plan underfunding of 360 companies in the S&P 500 with defined benefit plans is estimated at $243 billion for 2002. Credit Suisse First Boston is predicting that 30 of those companies will have plans underfunded by at least 25% of their current equity market capitalization. One option would be many of these companies to put more of their own stock into their plans but they’re limited 10%. With expected pension expenses of $710 million this year, Delta's defined benefit plan is underfunded by 353% of its market cap at the end of 2002. AMR is underfunded by 601% of its market cap. General Motors is underfunded by about 137% of its market cap. Look out, the sky may be falling. (Institutional Investor, Underfunded Pension Plans May Prompt Cos. To Market, 1/8/03) In a related report, staff pay hikes and investment management fee increases have driven US pension fund sponsors’ operational costs higher by 10% over the last three years. Public funds paid 17% less than corporate funds. (PlanSponsor, US Pension Operating Costs Jump 10%, 1/3/03) State to Raid CalPERS Funds With California facing a $35 billion deficit, politicians are lusting after the large pot of money at CalPERS. Senator Soto (D-Pomona), chair of the Senate Committee on Public Employment and Retirement said, “I realize that we all have a fiduciary responsibility to maximize the return on CalPERS investments, and the best investment that can be made right now with the greatest amount of anticipated return is to invest in California and help the state meet its fiscal responsibilities." Soto's internet site says "CalPERS has been helpful in the past. In 1994, for example, CalPERS and others offered to back $4 billion in 'revenue anticipation warrants' that the state could sell for cash to pay its bills." With President Bush's planned elimination of taxes on dividends, tax-exempt bonds from state and local governments will be in the tank. Why would anyone looking for a tax deduction go for government bonds when stocks offer tax free dividends plus the possibility of capital gains? Back to the top More Coverage of Economic Democracy Business Ethics notes that "reports of our death have been greatly exaggerated." The publication will be transforming to a nonprofit but the magazine will continue to be published, with added coverage of economic democracy issues. Marjorie Kelly's publication continues to be one of only a few worth reading every word from cover to cover. The latest issue covers renewed calls for federalizing corporate charters, 14th Annual Business Ethics Awards, growth stocks for a zero-growth economy, a hypothetical case in ethics (What if Polluting is Legal?) and various short takes and bits. Did you know that 21% of companies have a standing board committee on overseeing corporate responsibility and that Boston college's Center for Corporate Citizenship is going to study them? CEOs who cooked the books earned 70% according to United for a Fair Economy. You'll find plenty to get you thinking (and acting) in each issue. SEBI Examines Multiple Directorships Securities and Exchange Board of India (SEBI) will look at the number of company directorships that a person could hold. SEBI chairman G N Bajpai told reporters that company boards should not be a tea club packed with relatives but should, with assistance of able directors, manage the affairs of the corporations. The market regulator's corporate governance panel, headed by Infosys chairman N Narayana Murthy, will consider various issues including board agenda and reporting requirements. (see Sebi To Review Corporate Governance Practices: Bajpai and SEBI to look into multiple board directorship issue) SEC Fails to Disclose The SEC is less than forthcoming regarding requested disclosures through the Freedom of Information Act. An October report from the Senate Governmental Affairs Committee chastised the SEC for its lax treatment of Enron. "The leeway" from securities laws the SEC gave to Enron through various exemptions appear to have ultimately played a role in Enron's collapse. An exemption the SEC granted Enron in 1997 allowed it to set up many of its dubious overseas partnerships. The exemption meant Enron did not have to comply with any of the provisions of the Investment Company Act of 1940, which regulates companies, including mutual funds, that have more than 40% of their assets in partnerships or subsidiaries in which they do not have a controlling interest. Under the act, Enron would have had to disclose more about its partnerships and its executives would have been barred from investing in them. Insight filed a Freedom of Information Act (FOIA) request with the SEC, asking for all documents related to the exemption, including communications between the SEC and the White House. In a reply sent in May, SEC FOIA Officer Barry D. Walters said he was "withholding approximately 40 pages of internal-staff memoranda, draft, e-mail, chart and handwritten notes." Walters claimed these records were "predecisional" and "exempt under the deliberative-process privilege" to "protect against public confusion that might result from disclosure of reasons and rationales that were not in fact ultimately the grounds for an agency's action." The SEC sent out almost exactly the same response to Judicial Watch, which plans to sue the SEC under the FOIA to get the documents. (SEC Won't Let Sun Shine In, Insight Magazine, 1/6/03) Funds Oppose SEC Disclosure Proposal Richard Teitelbaum, writing for the New York Times (For Funds, Disclosure Is Hardly in Fashion, 1/5/02), notes that "speaking out against full and frequent disclosure is akin to criticizing motherhood." Yet, the mutual fund industry is fighting against the tide by opposing the SEC proposal that would require they disclose their proxy voting policies and how they vote their shares in every corporate proxy contest. The Investment Company Institute, Fidelity Investments, the Vanguard Group and T. Rowe Price are among those opposing the measure. Basically, they argue that it is too costly. What's next, reporting every trade? Robert G. Zack, general counsel of Oppenheimer Funds, wrote that his firm had received just one proxy-related request from a shareholder over the last three years — and it concerned the fund shareholder's employer. Yet, funds that already disclose their policies and votes say its is an inexpensive process. Opponents say disclosure will politicize the process, which will be used for grandstanding, ultimately undermining returns by distracting management from their stock-picking duties. The bottomline is that it is impossible to know if fund managers are voting in the interest of shareholders unless votes are disclosed. If the measure is adopted funds may begin to recognize that governing deserves the same type of effort as stock picking. Independent Directors in India Sucheta Dalal details several concerns with the selection of independent directors in India's Financial Express. (Watching Over The Watchdogs, 1/6/03) "High fees and fat perks are also creating a chicken-and-egg situation. If independent directors are to do their job diligently, they must be paid well, but if they were paid too well, that itself would kill their independence." She rejects the notion that directors should have access to outside expertise and exemption from criminal and civil liabilities under certain circumstances. "Weren't they appointed as independent directors precisely because the company felt that they would bring in their own, rather than hired, expertise to the board?" She rejects proportional representation based on the idea that election of board members by minority investors "may only lead to a cabal of speculators with large investment holdings finding their way to the boards of top companies." Additionally, she rejects nominee directors from development financial institutions (DFIs) and hybrid mutual funds such as Unit Trust of India (UTI) because employees of such institutional investors cannot have access to privileged board information. They have a fiduciary responsibility to protect lenders’ interests, which may be in conflict with company interests. Her solution? "Nobody should be an independent director of more than five companies or for more than five years." "A maximum term of five years, with no scope for re-appointment, would help preserve their independence; it will also force companies to find new persons on their boards and release experienced directors to other companies." Back to the top No More Freebies? A scathing report by Louisiana Legislative Auditor Daniel G. Kyle led the board of the Firefighters' Retirement System of Louisiana to tighten restrictions on accepting gifts from money managers and on travel and expense reimbursements. The report cited $150 golf outings, gifts of books and coffeecake, lunches, very expensive dinners, and similar abuses. "The system should develop a detailed ethics policy that prohibits board members and employees from accepting anything of value, including gifts, golf outings, meals and dinner parties, and any other specific activity that would give the perception that such gifts compromise their fiduciary responsibility," the report stated. State travel regulations provide reimbursement of meals at established rates of $26 per day in-state and $29 per day for out-os-state. Additionally, they prohibit reimbursement for alcohol but the System's General Counsel racked up hefty bar tabs on several occasions and was reimbursed. The board has taken action to "strictly adhere to the state of Louisiana travel regulations." (Louisiana fund embraces new policy on gratuities, Pensions&Investments, 12/23/03) In this editor's experience, such abuses and reforms run in cycles. The solution is eternal vigilance. CalPERS, for example, adopted policies which included very strict reporting requirements after a series of articles appeared in the Los Angeles Times and the Sacrament Bee. The press office ensured the new policies were widely reported in the press. However, after the heat died down, the board quietly repealed the policies and, we expect, abuses have gradually crept back in. 401(k) Plans Decline Participation rates have decline 10% since 1999, deferral rates have dropped to 7% from 8.6% and 8% are extremely or very likely to stop making contributions in 2003. (Discouraged Participants Losing Faith in 401(k) Plans, Pensions&Investments, 12/23/03) REITs Next? Despite overhauls in US governance practices in the wake of a year of scandal, the corporate structures of publicly traded real-estate investment trusts remain a tangled mess, reports the Wall Street Journal. Most REITs were engineered a decade ago to protect founding families from taxes and hostile takeovers," says Beth Young, director of special projects at the Corporate Library. (Takeover Offer Highlights Poor Governance of REITs, online by Dean Starkman at dean.starkman@wsj.com and Robin Sidel at robin.sidel@wsj.com) Skeptical About Corporate Governance Measures Gregory FCA found in a recent survey that many institutional investors are wary of new services designed to measure and rate governance from Standard & Poor's and Institutional Shareholder Services (ISS) and others. More than 80 percent of respondents said that a corporation's quality of corporate governance would influence an investment decision. Just as firmly, those who valued good governance said that a corporate governance rating, alone, would not make them buy or sell a stock. Nor was anyone ready to pay for such information until its value is proven. Most prominently mentioned as improvements were measures for offshore subsidiaries and conflicts of interest involving friends and/or family. Investors, in large part, did not feel that good corporate governance added significant costs. It was the second time in a year that an institutional investor survey by the firm found support for more regulation. (BUSINESS WIRE, 1/2/03) Boards Liable for Excessive Executive Pay BUSINESS WIRE (1/2/03) carried an item on the remarks E. Norman Veasey, the chief justice of the Supreme Court of Delaware, which appear in a roundtable on executive compensation in the January issue of Harvard Business Review. Veasey indicates the courts may be more receptive than they have been to shareholder complaints over executive pay. According to Veasey: "If directors claim to be independent by saying, for example, that they base decisions on some performance measure and don't do so, or if they are disingenuous or dishonest about it, it seems to be me that the courts in some circumstances could treat their behavior as a breach of the fiduciary duty of good faith." Veasey goes on to say: "I would urge boards of directors to demonstrate their independence, hold executive sessions, and follow governance procedures sincerely and effectively, not only as a guard against the intrusion of the federal government but as a guard against anything that might happen to them in court from a properly presented complaint." Minow Evaluates 2002 Nell Minow, the editor of TheCorporateLibrary.com, looks back on 2002 in USA Today and says Nest eggs need closer investor care (12/30/02). Minow notes that institutional investors "are supposed to be governed by the strictest standards ever developed by our legal system." Instead, money managers have "too often acted as enablers for corporate executives' addiction to easy money." Minow calls for public action to ensure enactment of the "only proposed reform that addresses this issue," the SEC proposal that mutual funds disclose their voting policies and votes in corporate elections. "William Donaldson, she says, who was the founder of one of the nation's largest brokerage houses, should not be confirmed unless he is committed to making this crucial reform effective as soon as possible." Something worth writing to Congress about. China Opens to Outside Investment Foreign investors in the People’s Republic of China have been allowed to trade only in the dollar-denominated B-Share market, which makes up a fraction of the traded securities on the Shanghai and Shenzhen stock exchanges. New regulations. effective December 1, 2002, granted unprecedented access to the A-Share. (see Client Alert, Paul Hastings) Back to the top with the Corporate Governance NETwork! Contact: jm@corpgov.net All material on the Corporate Governance site is copyright ©1995- by Corporate Governance and James McRitchie except where otherwise indicated. All rights reserved.