July 2002

Last Chance to Comment on NYSE Proposed Changes to Listing Standards

The New York Stock Exchange released recommendations from its Corporate Accountability and Listing Standards Committee, which propose new standards and changes in corporate governance and disclosure practices of NYSE-listed companies.See press release. See written comments. Write to help restore investor trust and confidence. Comments are due on August 1st. Below is this editor’s comments.

Dear Ms. O’Neill, Mr. Levin, Mr. Panetta, & Mr. McCall:

This is to support the New York Stock Exchange’s (NYSE) proposed changes to its listing requirements and to suggest additional changes to enhance corporate governance standards.

I am an individual investor and the editor of Corporate Governance, an Internet publication at Corpgov.Net, which I established in 1995 to provide research and advice to governments, boards, unions, institutional investors and individuals on improving corporate governance.

NYSE Proposed Changes

Shareholder Votes on Equity Compensation & Broker No-Votes: I strongly support the NYSE’s proposal to require shareholder votes on this highly contentious issue. The right to vote is an important democratic right. However, the proposal would be improved by prohibiting all broker votes on any subject unless the broker receives prior instruction from their customer. When companies need shareholder approval, management has come to rely on broker votes because, unfortunately, brokers tend to blindly vote on the side of management.

Board Independence: I support your recommendation that independent directors must comprise a majority of board members. However, the proposal could be substantially strengthened by joining with me in petitioning the SEC to permit shareholders to use Shareholder Proposals for the purpose of electing directors.

Directors do not become independent just because they have no economic ties to the company beyond their job as a director. Disinterested outsiders can mean uninterested outsiders. The key is not “independence, ” arbitrarily defined, but whether a director’s interests are aligned with the shareholders. If a director is to represent the interests of shareholders, they must share those interests. Moreover, they must be intimately familiar with those interests. Put simply, they must be shareholders, nominated and elected by and accountable to shareholders.

Additional Areas for Consideration

1. Listed companies should be required to include their corporate governance policies and conflict of interest policies in their proxy statements. If they waive those policies at any time, that should be disclosed, along with the reasons for the waiver.

2. Any online proxy voting system should be required to include all proxies circulated by all parties. Both sides in a proxy contest should have access to the cheaper and more accurate system for counting votes available through ADP. All votes should be counted the same way, especially if there is any form of shareholder initiative, from a proposal to a contest.

3. Social and environmental risk should be classified as “material” and be mandated for disclosure to protect investors from the adverse impact of undisclosed liabilities, obligations, and impairments. Research demonstrate a link between financial performance and environmental performance. Outstanding cases/complaints, and number of aggregate violations found by the National Labor Relations Board, Department of Labor, Equal Employment Opportunity Commission and the Office of Federal Contract Compliance Programs should also be included.

4. Require options to be expensed. Options are a form of compensation that clearly have value. A representation of that value should not remain hidden in the footnotes of financial statements. In the year 2000 options resulted in a 9% overstatement of earnings by the S&P 500. Among information technology firms in the S&P 500 the average overstatement due to the cost of options was 33%. The total cost to shareholders was $284 billion in dilution.

5. Split the roles of chair and CEO. How can the board act independently if the CEO sets the agenda? The “lead director” concept was a half way measure that appears to confuse many and hasn’t caught fire. A McKinsey survey of more than 180 US directors representing 500 companies suggested that more than two-thirds believe the board should split the role of chief executive and chairman. Let’s give them what they want and need to do their jobs.

Thank you for this opportunity to share my views on the NYSE proposals.

Corporate Governance Fund Report Debuts

The Corporate Governance Fund Report (CGFR), a monthly newsletter that track funds and investments aimed at improving or rewarding the corporate governance practices of the invested companies, emerged in July with a free trial offering. The editor/publisher is Maureen Nevin Duffy, perhaps best known as the founding editor of the Journal of Performance Measurement. The debut issue discusses Herbert Al Denton, who led dissidents at ICN Pharmaceuticals’ shareholder vote – a 3 – 1 landslide. (In the interest of full disclosure, the Editor of CorpGov.Net is an ICN shareholder.) The issue also discusses Guy Wyser-Pratte’s recent initiatives at German engineering/defense contractor Babcock Borsig, Brazilian activists and funds. Most interesting to this reader was the most comprehensive list of proactive investors’ funds worldwide that I have seen.

CGFR’s mission is to “follow and analyze the activities of investors seeking better Corporate Governance. These investors are agents for change, whether they bear the label ‘active investors,’ ‘relational investors,’ ‘value investors,’ ‘proactive investors,’ ‘head bashers’ or ‘institutional investors.’ They pack the potential of restoring trust in our capital markets. They are Pushing Back!” We look forward to Ms. Duffy’s future reports from the front lines.

Angelides Take Another Bold Move

Congressional efforts to stop tax evading corporations from moving offshore have stalled. Yet, California’s Treasurer Phil Angelides won’t be deterred. He announced that his office will no longer invest in US companies that move to offshore tax havens. Angeledies also urged CalPERS and CalSTRS to divest $752 million worth of investments from such expatriates. “These are American companies doing business in this country, living here, enjoying all the fruits, yet they do not want to abide by our rules. Where does it stop?”

While Angelides has taken a bold step; is it the right one? True, governments and government employees shouldn’t be supporting companies that undermine our tax base. Selling off these firms makes news when the action is taken but this step should be a last resort. We won’t have as much influence with expatriate firms when we aren’t shareholders.

CalPERS and CalSTRS shouldn’t be bullied into selling. They should submit shareholder resolutions or bylaws amendments to every expatriate firm in their portfolios to require them to move back. They should work with the Council of Institutional Investors, the Social Investment Forum and other investor groups to ensure our voices are heard. Additionally, they should more fully utilize their own internet sites. Every member should be able to track their individual portfolios online and should receive advice from CalPERS and CalSTRS concerning how to vote on upcoming corporate proxies.

Hush Money Draws Attention to Greenmail

One early morning in 1984 California Treasurer Jesse Unruh read that Texaco had repurchased almost 10% of its own stock from the Bass brothers at a $137 million premium so that Texaco’s top brass could avoid loss of their own jobs in a takeover. That action stirred resentment and woke a slumbering giant. The California Public Employees Retirement System began its long involvement with corporate governance issues.

Computer Associates denies their recent payment of $10 million to Sam Wyly is greenmail because they didn’t buy his stock; he simply agreed not to wage a proxy fight. Whatever it’s called, it’s still stealing from shareholders to entrench management. This time shareholders are already awake. The Sarbanes bill is only the opening shot; let the shareholder revolution begin!

IOSCO Recommends OECD Principles for Emerging Markets

The Emerging Markets Committee of the International Organisation of Securities Commissions (IOSCO) has recommended that its members foster good corporate governance through legislation, regulations and codes of good practices using the OECD’s “Principles of Corporate Governance” as a benchmark.

• Read the IOSCO press release.
• Read the speech made by Bill Witherell, OECD Director for Financial, Fiscal and Enterprise Affairs, at IOSCO 2002, Istanbul, 24 May 2002: Corporate Governance and the Integrity of Financial Markets: Some Current Challenges.
• More information on corporate governance at the OECD

Consult the 2nd Edition of the Corporate Affairs Newsletter, offering articles on the launch of the White Paper on Corporate Governance in Russia and insights on accounting and audit conflicts. The newsletter also provides information on the corporate governance programme in Romania.

Six Ways to Improve Corporate Governance

Republicans and Democrats are stumbling all over each other to show who can be toughest with corporate “wrongdoers.” The Senate and House have passed competing legislation calling for everything from 20-year jail terms and extended statutes of limitations to new accounting rules and oversight boards. Many of the reforms are good but others are more for show. The 20-year jail terms, for example, will require proving intent to defraud and you can bet the defendants will have some of the best lawyers money can buy. Here’s a list of six reforms, the first has been widely discussed but many of the others have received too little consideration.

1. Require stock options to be expensed. Expensing options is supported by Federal Reserve Chairman Alan Greenspan, Senator John McCain, Citigroups’s Sanford I. Weill, billionaire investor Warren Buffett and the several of the companies on whose boards he sits, such as Coca-Cola and the Washington Post.

   Unions, representing groups ranging from sheet-metal workers to the Teamsters, have filed 11 shareholder resolutions focusing on expensing stock options that will be voted on from September to November. This fall’s action is a practice run for 50 and 60 companies to be targeted next year. It is a winning issue for unions, a losing one for those seen as “fat cat” CEOs.

   Options are a form of compensation that clearly have value. A representation of that value should not remain hidden in the footnotes of financial statements. In the year 2000 options resulted in a 9% overstatement of earnings by the S&P 500. Among information technology firms in the S&P 500 the average overstatement due to the cost of options was 33%. The total cost to shareholders was $284 billion in dilution.

   “How many legs does a dog have if you call the tail a leg? Four. Calling a tail a leg doesn’t make it a leg,” said a wise Abraham Lincoln. Shareholder activist Robert Monks has related this analogy for years and it still holds up; our accounting standards recognized the truth.

   The culture of greed has overcome even our youngsters. A Junior Achievement survey, reported in Across the Board, found that 34% of teenage girls believe they will be earning $1 million/year by the time they are 40. Among teenage boys, it was 65%. In actuality, less than 5% of households have a $1 million in total assets, let alone earning that much every year. It’s the lottery/options/superstar mentality…let’s get back to reality.

   If shareholders had a larger role in setting the pay of corporate executives, we would see greater use of restricted stock that can’t be sold until at least two years after the executives leave office. This form of golden parachute would only pay off only if the CEO has laid a firm foundation for the firm’s long term future, instead of simply concentrating in jacking up stock prices so they can cash out options in any given quarter.

2. Permit direct nomination of board members by shareholders. The current process, where shareholders coercively ratify incumbent nominees is plainly not an “election.” Running an independent nominee or slate using the solicitation process is prohibitively expensive, except in the most unusual circumstances. Why should shareholders be required to run candidates by paying for an expensive solicitation, while current management uses our funds to tout their candidates on the company proxy?

   The current system is worse than voters trying to run a state government by proposition. We need our own elected leaders on corporate boards. The idea of requiring a majority of “independent” directors is a half way measure. Historically, the chief executive serves as the chief recruiter for board vacancies. Board members can be “independent” and still owe their jobs to the CEO; that’s not independence. Board members who are actually nominated and elected by shareholders will be accountable and will, in turn, hold the CEO accountable. (see“Independent” Directors = Oxymoron)

3. Require institutional investors to report their voting policies and their votes in corporate elections. In 1988 the Department of Labor (DOL) set forth the opinion that, since proxy voting can add value, voting rights are subject to the same fiduciary standards as other plan assets (see “Avon” letter). The same standards of trust law also hold for mutual funds, as clarified by SEC Chair Harvey Pitt, in a letter dated 2/12/2002. However, if votes are not disclosed, how can these standards be enforced? How do we know when the money managers are voting in our interest if we never know how they vote?
4. Split the roles of chair and CEO. How can the board act independently if the CEO sets the agenda? The “lead director” concept was a half way measure that appears to confuse many and hasn’t caught fire. A McKinsey survey of more than 180 US directors representing 500 companies suggested that more than two-thirds believe the board should split the role of chief executive and chairman. Let’s give them what they want and need to do their jobs.
5. Election reform via instant runoff voting (IRV). Government elections need to be reformed if business is to shift its focus from earning the most money possible for CEOs to maximizing total returns. Doubling prison terms for dishonest CEOs means little if none are convicted. Big government can’t balance big business because both major parties will remain beholden to their largest contributors. Voting for third party candidates is wasting your vote. IRV would encourage candidates take real stands on the issues because voters would be voting for their favorite candidate without fear of wasting their vote or helping elect their least favorite candidate.

   Less than half of those eligible vote in presidential elections. During off years, only about 35% vote. In last December’s special election in San Francisco less than one in six registered voters participated. The poor and middle class feel disenfranchised. In plurality voting systems, typical in the US, candidates can win with less than a majority when there are more than two candidates running for the office. IRV ensures that the winner enjoys true support from a majority of the voters, rather than from a simple plurality.

   Used for major elections in Australia, Ireland, Great Britain, and soon in San Francisco, IRV accomplishes the goals of a traditional runoff election in one efficient round of voting. Voters indicate both their favorite and their runoff choices by ranking candidates in order of preference. If no candidate wins a majority of votes, the first-choice preferences of the last-place candidate’s supporters are eliminated and their second choices are used instead. If there still is no majority winner, the first choices of those voting for the next-to-last candidate is discarded in favor of their second-ranked choices, and so on, until a majority winner is determined. (see the Center for Voting and Democracy)

6. Eliminate broker voting. Currently, if shareholders don’t vote their proxies within 10 days of the annual meeting, their brokers will vote for them…always in favor of management’s recommendations. The Council of Institutional Investors has opposed the use of broker votes for anything except achieving a quorum for a shareholder meeting and has urged the SEC to prohibit broker voting without client instructions. When will the SEC listen? Its time we all urged this action.

Conflict of Interest at CalPERS

CalPERS directors are involved in potential conflicts of interest that threaten to erode the fund’s sterling image, according to a report by Sharon L. Crenson of the Associated Press. Five members of the board owned stocks also held by CalPERS in 2001, according to the latest state records. Three board members have received thousands of dollars in political campaign contributions from companies CalPERS invests in. I say that even though CalPERS is one of the best, there’s much more beneath that surface. Keep digging. (see Potential Conflicts of Interest at Nation’s Largest Public Pension Fund, 7/16)

PlanSponsorEvents

Many retirement plan sponsors don’t believe or don’t realize that they are responsible for their plan’s investment performance. Surprise! You may find yourself facing personal liability if participant investments turn out badly. Members of corporate pension committees and plan sponsors who – in light of the recent Enron controversy and other litigation —  are concerned about their responsibilities under ERISA might consider signing up for a class.

Ugly Americans?

In the latest issue of Ralph Ward’s Boardroom Insider, Ralph gives thanks that he hasn’t spoken to any international groups on corporate governance for a few months. When he did so in India earlier this year, post-Enron comments could be summed up as “How dare the US try to tell us how important good governance is.” Ralph notes that “in less than a year, US corporate governance has gone from a light shining on the hill of global commerce to become an ‘ugly American’ outrage, calling into question a decade of economic growth.”

He concludes that “America has always been, for good or ill, a nation based on pushing the envelope. The good side of this has been a willingness to gamble on creating wholly new industries, and personally staking everything on an entrepreneurial pipe dream — to create fortunes out of nothing. Yet the dark side has also been a talent for creating fortunes out of nothing — and skipping town with the cash before anyone got wise.”

Of course, many on the speaking circuit, Ralph included, are not out to impose America’s values on others. Certainly, I don’t feel in a position to do so. First, I can barely keep up with cutting edge developments in the US, let alone all the other countries of the world. I try to point to some of our successes, failures and what we are working on to push the envelope. My hope is that by sharing, others can learn from our experience.

And, of course, we can learn from the experience of others. Asian corporate governance, especially in Korea, appears to have taken a great leap forward as a result of reforms put in place after the 1997-98 financial crisis. This is reflected in a healthier market. Morgan Stanley’s Far East Index (ex-Japan) gained 8.9% in US dollars so far this year, whereas the Dow and S&P 500 have dropped 12% and 19.8% respectively.

Let’s look at another indicator, financial leverage. Salomon Smith Barney recently reported that in Asia the ratio of average credit to gross domestic product fell from 123% in 1997 to 114% in 2001. In the US, it has gone from 204% in 1994 to 288%.

Kwong Ki-Chi, chief executive of the Hong Kong Exchanges, told a business seminar recently, “There is now some suggestions in the U.S. that the share option scheme should be approved by the shareholders.” “In Hong Kong, we already require share options to be approved by shareholders.” Of course, use of options isn’t as pervasive in Asia, so CEOs are less prone to take a short-term view for personal gain.

If there is an “Ugly American” phenomenon, based on the arrogant imposition of American systems of corporate governance, surely recent events have humbled the perpetrators. Surely we have much to learn from each other. (Statistics taken from a 7/11 Reuters report entitled “Asia no longer ‘bad boy’ of corporate governance, by Sabyasachi Mitra.)

The Worsening Crisis of Confidence on Wall Street: The Role of Auditing Firms

A new study of the above title by Weiss Ratings found that auditing firms gave a clean bill of health to 94% of the public companies that were subsequently cited for accounting irregularities. The companies in the survey dropped from a total peak market value of $1.8 trillion to only $527 billion, an aggregate shareholder loss of almost $1.3 trillion. Of the Big Five firms, PricewaterhouseCoopers came out best.. (Survey: Auditors Don’t Spot Problems, CFO.com)

ICGN Urges Action

The International Corporate Governance Network (ICGN) whose members hold more than $10 trillion in assets — calls for:

• more board independence as a way to improve transparency and protect shareholder interests
• full publication of the salaries, short and long-term incentives and other benefits for all main board directors
• shareholder vote on remuneration at companies’ annual meeting
• rein in the use of options because they tend to reflect more general economic conditions rather than management.

“Investor inactivism has been an aider and abettor in what has happened,” Peter Clapman, ICGN chairman and senior vice president of the College Retirement Equities Fund (TIAA-CREF) says. “If an investor thought previously that corporate governance did not have to affect the bottom line or fund performance, that view has been dashed now.” (Investor Group Seeks Cuts In Executive Compensation, WSJ, 7/11/02)

Bleeding Continues

The President’s long awaited speech called for stricter enforcement, tough penalties and more disclosure. He called the Senate “to act quickly and responsibly so I can sign a good bill into law” but, according to the Wall Street Journal, his “aides suggest they’re hoping to water down whatever passes.”

Tough talk, but he failed to address many of the most basic issues, such as expensing options. Individual investors were told to take proxy voting more seriously but Bush didn’t say anything about the fiduciary duty of institutional investors to disclose their proxy policies and votes. Small individual investors aren’t going to police corporate “wrongdoers.”

Stocks began the day higher but sank steadily after Bush’s speech. Will his tough talk stave off more sweeping reforms? That seems to have been the purpose but we may be on our way to our first corporate governance led recession, if the bleeding doesn’t stop. Moral exhortations to CEOs won’t work, especially coming from a president who refused to make the record of his own transactions at Harken and the SEC investigation public. (see Bush Crackdown on Business Fraud: Is Sure Signal That New Era Is Here (WSJ Online, 7/10/02, and discussion forum) Learn more about the first MBA White House at George and Dick’s Amazing Corporate Misadventures and Bush: Corporate Confidence Man.

New Corporate Paradigm?

After Enron, WorldCom and dozens of other frauds, the time may be ripe for a new corporate paradigm. Certainly, mistrust of the current system is at an all time high…at least during my 54 year lifetime. Marjorie Kelly’s The Divine Right of Capital offers insights in a readable style (favorably compared to Tom Paine by one prominent reviewer) and the beginnings of a viable alternative. Instead of maximizing the return to shareholders, corporations should be maximizing total return…a concept we have been advocating here at CorpGov.Net since 1995. Total return here implies the long term efficient use of all resources, both natural and human. Of course, at the heart of the efficient use of resources is the need to recognize humanity as part of nature, not separate from it.

The aim of her book is to start a dialogue about the “core problem of capitalism.” Bloated CEO pay, sweatshops, stagnant wages, corporate welfare, environmental indifference and, I would add, the unraveling of political democracy, are all symptoms. “They spring from a single source: the mandate to maximize returns to shareholders.” Kelly argues that “this mandate amounts to property bias, which is akin to racial or gender bias. It arises from the unconscious belief that property owners, or wealth holders, matter more than others.” We have yielded control to an economic aristocracy.

“Civilization has crossed a great divide in history, from monarchy to democracy. But we have democratized only government, not economics. Property bias keeps our corporate worldview rooted in the predemocratic age.”

Corporations used to be chartered for social purposes, as well as to bring a profit to investors. Today they seem out of control. Too many are focused on pumping up the price of their stock, rather than creating real value. Most of the enormous wealth generated by corporations is channeled to a very small number of investors. Kelly points out that between 1976 and 1997 the top 1% doubled their share of household wealth in the US from 20% to 40%.

Contrary to popular opinion (I wonder if most people really are this misinformed), “investing” in the stock market is really speculating; 99% of the money invested in stocks simply represents a bet on future growth. The stockholder isn’t providing capital to a company but is buying shares from another stockholder, gambling that the price will rise. Only about 1% of stock sold (mostly during initial public offerings) actually finds its way to the corporation itself. The vast majority of corporate capital comes from retained earnings, not from the sale of stock.

A more accurate description of “investors,” according to Kelly, would be “extractors.” Most investors contribute nothing to the company. Instead, they are buying the right to extract wealth from it. Looking at the other stakeholders, such as suppliers and the community, one group stands out…employees. Employees and investors and present an interesting comparison.

Employees typically invest a great deal in the companies they work for in terms of what Margaret Blair calls “firm specific human capital.” They develop knowledge and skills, much of which is specific to their individual firm’s operations. In addition, employees often have 401(k) or other investment plans that are overweighted in their employer’s stock. In contrast, most shareholders have a relatively small proportion of their investments in any one company because they recognize the reduced risk of a balanced portfolio.

The fiduciary duty of directors is to maximize the wealth that can be extracted from the corporation by shareholders, typically in the form of dividends, buy-backs or increased share value. Fundamental to standard operating procedures is the idea of minimizing expenses such as wages and income to employees. Even though employees have a greater stake in the coporation’s success, they have no formal say as employees in corporate governance…no vote for the board of directors. Kelly argues employees are not treated as corporate citizens, in the current model, but as subjects. In today’s paradigm, you either own property or you essentially are property.

Kelly gives the interesting example of St. Lukes, an ad agency spun out of Chiat/Day where employees refused to be sold with the company. Without its employees, the ad agency was worthless, so the new owners sold out to employees for $1 and a percentage of profits for seven years. (see The Ad Agency to End All Ad Agencies, FastCompany.com)

Although we have made some progress in addressing racism and sexism, we’ve only scratched the surface of wealthism. There wasDorr’s Rebellion in 1842. But since owning property was largely abolished as a requirement for voting, the issues surrounding wealthism have largely gone unaddressed.

Kelly argues the socially responsible investment movement, while in the right direction, doesn’t go far enough, since outperforming other investments is still the measure of success. In her vision, other measures matter…good wages, schools and a healthy environment. Wealthism is the key to many separate problems, just as sexism and racism are key in resolving many others.

Kelly argues that efficiency is best served when gains go to those who create wealth. Indeed, almost all the studies I have read conclude that democratically run companies, where decision-making and profits are shared, are better at producing wealth than the typical corporate model, which more closely resembles a dictatorship. Diversity and democracy pay, but most of those who run corporations and many shareholders are not interested in creating wealth most efficiently. They are happy to settle for less efficiency, if it will disproportionately increase their own power and wealth.

Kelly’s revelation that stock trading doesn’t raise corporate capital isn’t new. In 1967 Louis Kelso and Patricia Hetter wrote, “less that half of one percent of aggregate new capital formation during the eleven years 1955-1965 came from newly issued stocks, while 99.5% was financed through internal sources and through issuance of debt securities that in due course must be repaid from internal sources.” (Two-Factor Theory: The Economics of Reality. See also Democracy and Economic Power) Kelso, and his longtime ally Senator Russell Long, truly made a difference through the invention and popularization of employee stock ownership plans (ESOPs). Today, 8.8 million employees participate in 11,000 plans with assets valued at 400 billion. Want more information on how ESOPS can be made even more productive through employee involvement? Contact the National Center for Employee Ownership (NCEO).

Maybe Kelly’s book and her energy can help take these prior efforts to the next level. Some of her more interesting ideas include the following:

• Create a Federal Employee Ownership Corporation to promote employee ownership like Fannie Mae and Freddie Mac promote home ownership.
• Require a majority vote of workers for mergers, acquisitions or hostile takeovers.
• Bar corporate felons from federal contracts. The Clinton administration enacted a rule to bar recidivist businesses with a record of breaking labor or environmental laws from getting government contracts. The Bush administration overturned it immediately on taking office. Kelly suggests the idea be extended to include a ban on campaign financing and lobbying for such corporate offenders.
• Reaffirm the right of the people to revoke corporate charters.

A word of caution; I’ve met corporate governance scholars who have read Kelly’s book and refuse to even discuss it because the book doesn’t fit the current paradigm. I, for example, have spent years believing that if employees would just take more control of their pension funds, corporate executives would be held accountable to standards that more closely reflect our long term interests. Sure, 10% of the wealthiest families may hold 62% of the value of all pension accounts (they did in 1992), but many average Joes and Janes at least have some voice in how this money is invested and how companies owned by their pension fund are governed. Some, like the members of CalPERS, have a direct vote in elections for board members. Others vote for union officials who sit on pension fund boards or appoint those who do. Such votes aren’t in proportion to holdings, so pension funds tilt more towards democracy than traditional shareholdings.

How do I reconcile Kelly’s vision with mine? We’re both headed down a road in the same basic direction to a more efficient model of corporate governance. No one has a monopoly on how to get there but working together should make the going a little easier for all of us.

Speak Loudly and Carry a Small Stick

Gorge W. Bush is “deeply concerned” and will “hold people accountable,” but his words provide the reassurance of an accounting certification by Arthur Andersen. Six months since the president promised “a lot of government inquiry into Enron,” we’re getting a prominently billed speech on corporate governance. As Frank Rich noted in a New York Times editorial, “Playboy has done a better job of exposing the women of Enron than the Bush administration has done at exposing its men.” “The sight of a corporate crook being led away in handcuffs, Giuliani-style, would do far more to restore confidence in Wall Street than any more presidential blather.”

Why the slow pace in locking up America’s corporate “wrongdoers?” Frank Rich thinks it has something to do with the fact that several of those who profited from Enron work at the White House. Fellow Times editorial writer Paul Krugman, notes that Bush profited by exactly the same accounting misdeeds at Harkin as were used by Enron a decade later. (Yes, Arthur Andersen was the accountant.) (see Succeeding in Business, NYTimes, 7/7/02)

“WorldCom is a political boon to the president because it allows him to moralize about epic-scale crime without mentioning Enron, Halliburton or Harken,” writes Rich. The rise of Enron and the corrupt Bush presidential dynasty have been compared to that of the Harding administration’s Teapot Dome scandals.

Bush has already voiced opposition to expensing stock options, one of the simple fixes endorsed by Alan Greenspan and Warren Buffett. His Treasury Department, according to Newsweek, is hard at work stifling legislation that would end offshore shelters that allowed Enron (with 800-plus such entities) to evade taxes in four out of five years.

I look forward to his major address to the nation on corporate governance issues. Unfortunately, just when the country is looking for a Teddy Roosevelt to “speak softly, but carry a big stick,” we’re likely to witness just the opposite. (All the President’s Enrons, Frank Rich, NYTimes, 7/6/02)

Nader Offers to Organize Individual Investors

People want to make corporate bosses to pay back their ill-gotten billions to laid-off workers and pensioners. “They want to see these corporate crooks convicted and sent to jail,” Nader said. HE offered to help organize individual investors to pressure the White House, Congress and the Securities and Exchange Commission to bring justice and honesty back to the market. “Greed, unrestrained by the rule of law, knows no boundaries,” he said. “Greed has pushed the envelope.”

Nader called on the SEC to reopen its 1991 investigation into President Bush’s insider sale of $850,000 worth of Harken Energy shares in June 1990, just two months before the shares plunged. See White House defends Bush SEC filing. He also suggested other top executives in the administration, including Vice President Dick Cheney, should abe investigated by the SEC for contributing to accounting irregularities.

For reform to be meaningful, it must restore real independence to corporate auditors and must create a strong and independent oversight body for the accounting industry, Nader said. (Nader calls for investors movement: Rationale is to give the little guy a ‘seat at the table,’ CBS.MarketWatch.com, 7/5/2002)

Cracking Down on Corporate Crime

First, the Federal Bureau of Investigation should be required to compile an annual report on corporate crime in American, to accompany its current Crime in the United States report, which is unfortunately confined to street crime.

Second, the federal government should refuse to do business with companies that are serious and/or repeat law breakers, as well as deny other privileges (for example, granting broadcasting licenses) to corporate criminals. This would involve some new or strengthened laws and regulations, as well more stringent enforcement of debarment, contractor responsibility and good character laws now on the books. States and local governments should adopt similar measures.

Third, whistleblowers and private citizens should be able to enforce laws regulating corporate conduct. One way to facilitate this enforcement approach would be to expand and creatively adapt the False Claims Act, which currently enables whistleblowers to initiate lawsuits against entities which have defrauded the government, and which reclaims for the government every year hundreds of millions of dollars stolen by unethical contractors. (Russell Mokhiber and Robert Weissman)

Investment Bankers to Meet New Requirements

California Treasurer Phil Angelides called on investment banking firms and money managers to follow new conflict-of-interest guidelines or face the loss of billions of dollars in government investment business. Investment bankers must sever links between their corporate business deals and their payments to stock analysts; they must create a review committee to approve all research recommendations; and they must monitor their own progress. Money managers who provide advice to the California Public Employees’ Retirement System and the California State Teachers’ Retirement System will have to follow the guidelines if the boards of the pension funds agree.

“CalPERS and CalSTRS lost $850 million on WorldCom alone,” Angelides said. “These are not sustainable losses.” The investment protection principles are patterned after a May agreement between Merrill Lynch & Co. and New York Attorney General Eliot Spitzer following allegations that that company’s investment advice was tainted by conflicts of interest. Angelides oversees California’s $50 billion Pooled Money Investment Account, which is the checking account for state government and more than 3,000 local jurisdictions.

CalPERS Calls Members to Action

CalPERS is urging its 1.3 million members and all investors to push passage of S 2673, the Investor Protection Act of 2002. CalPERS posted sample letters for organizations and individual investors to fax to their Senators on its Shareowner Forum. “There is currently a crisis of confidence with the accounting industry,” said James E. Burton, Chief Executive Officer for CalPERS. “The independence of accounting firms that audit financial statements of public companies must be beyond reproach. The conflicts of interest that are prevalent throughout the accounting industry have fueled the erosion of investor confidence. Nothing but a ‘bright-line’ ban will end the inherent conflicts created when an external auditor is simultaneously receiving fees from a company for non-audit work,” Burton said.

A review of 1,200 U.S. companies in the System’s stock portfolio during the 2002 proxy season indicated that more than half of the audit firms’ revenues were derived from non-audit services.

“We consider this unacceptable and a significant impediment to objective and independent auditing,” added Burton. The Act also calls for creating an oversight board for regulating accounting firms that audit public companies that would represent the interests of investors, and those whom investors rely upon. CalPERS believes that this new body must have the power to investigate, adjudicate and discipline the industry through authority set by Congress, as well as have an independent funding mechanism. CalPERS has estimated that its unrealized and realized stock and bond losses in WorldCom total more than $580 million.

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WorldCon, WorldRot

Booking fees associated with its use of third-party network services and facilities as capital expenditures, instead of expenses, was a $3.85 billion fraud. Obviously, civil and criminal penalties for committing accounting fraud are not strong enough to deter such crimes. Will an SEC call for CEOs and CFOs of large companies (revenues totaling more than $1.2 billion) cure the problem? I doubt it. In spite of the Enron debacle, the SEC continues to allow corporate management to exclude from the proxy a proposal for shareowners to select the auditor by vote. The SEC deems auditor selection to be an “ordinary business” decision that shareowners should not consider undertaking.

“The wider implications of the WorldCom debacle will not be shrugged off so lightly,” says Tom Holland. Foreign investors owned $1.75 trillion in US equities, nearly 13% of the outstanding capitalization, as of March 2002. During the last 3 months global capital flows have pushed up the yen by nearly 12% against the dollar. “Even if only a small percentage of that capital is reallocated to Asia, the effect on relatively illiquid regional currencies and stockmarkets could be significant.” (World Con, Far Eastern Economic Review, 7/11/2002)

But taking money overseas may yield no better results in the long run. A research paper by Christian Leuz, Dhananjay Nanda, and Peter Wysockia studying investor protection regulations in 31 countries shows that accounting abuses such as self-dealing are far worse in Continental Europe and Southeast Asia than in the US. (Feeling Burned by Accounting Scams in the U.S.? Just Look Overseas, Knowledge@Wharton Newsletter)

Joint Venture Consequences

Unocal will stand trial late September for alleged human-rights abuses committed by the government of Burma, the oil giant’s joint-venture partner in the development of a gas field. “Companies are going to have to take more account of the social consequences of their operations,” says Stephen Davis, who editsGlobal Proxy Watch. “We’re asking for $1 billion,” says Terry Collingsworth, head of the International Labour Rights Foundation, which filed the case against Unocal.” “Unocal’s involvement in Burma acts as a poison pill,” says Simon Billenness, a consultant to U.S.-based Trillium Asset Management. “Unless a company adopts a human-rights policy that is transparent, you’re going to face greater risk of damage to your business, your stock price, your image and your brand.” (The Era of Responsibility, Far Eastern Economic Review, 7/11/2002)

Banking Governance Questioned

Mike Mayo, an analyst at Prudential Financial, says four out of five chief executives at the 30-odd banks that he examined are also their chairmen. One out of four board members has a financial relationship with his bank. At FleetBoston Financial and SunTrust, only half of the directors can be considered independent. Of the fees banks paid to external auditors, 70% were for services other than auditing, such ad providing consulting and tax advice. (A murky sort of pond life, 7/4/2002,The Economist)

CFO Qualifications

Only 20% of CFOs in a recent survey were found to be Certified Public Accountants; 35% had MBAs, and 5% had both qualifications. Only 1% of high-school students want to major in accountancy, compared with 4% in 1990. According to a recent article in The Economist, “an accountancy training encourages respect for numbers; an MBA breeds creativity.” Maybe its time to get back to counting beans. Their advice? “Appoint a CFO old enough to remember the trade.” “Bring in a foreigner. ‘In Britain, finance directors seem to be more loyal to their practice than to their firm,’ observes Frank Schroeder. Now president of DBM Europe, a human-capital consultancy.”

Unfortunately, “Chief executives clearly want a CFO who will be part of the team. If he isn’t, he goes. A survey by CFO magazine in 1999 found that 39% of chief executives had fired their last CFO, and 75% had hired the current incumbent—40% of them within the previous three years.” And from Nell Minow comes the advice for audit committees to hold at least some meetings without the CEO and take part in hiring and firing of CFOs. If CFOs were required to be CPAs, just as a general counsel must have passed the bar, the numbers might be presented more honestly. (Too creative by 50%?, 7/4/2002)

Martha Stewart Isn’t Alone

George W. Bush “has more familiarity with troubled energy companies and accounting irregularities than probably any previous chief executive,” according to Chuck Lewis of the nonpartisan Center for Public Integrity. As reported in the Wall Street Journal on March 4, 2002, Bush sold off two-thirds of his stake in Harken Energy, for $848,000 (about four times bigger than the sale that has Martha Stewart in hot water). The law required prompt disclosure of insider sales but Bush neglected to report his transaction to the SEC for 34 weeks.

According to Paul Krugman’s recent OpEd piece in the New York Times (Everyone Is Outraged, 7/2/2002), “an internal SEC memorandum concluded that he had broken the law, but no charges were filed. This, everyone insists, had nothing to do with the fact that his father was president.”

It took Nixon to go to China. Maybe Bush, Cheney and Pitt have the insider knowledge it takes to stop accounting fraud and corporate crime. For more, see Bush Family Value$, September/October 1992, Mother Jones and Bush And The Corporate Crime Wave: Part of the Solution or Problem? File Under “Takes One to Know One.” June 27, 2002, The Daily Enron.

Bush may be calling for reform but he is unlikely to call for severing links between investment bankers and analysts, strengthening auditor independence by banning consulting for accounting clients, or requiring that options be expensed. Without these reforms, let alone opening up the board nomination process, investors aren’t likely to head back into the market.

Public confidence in Big Business is at its lowest since 1981, according to the latest Gallup Poll. Bruce Nussbaum, writing for BusinessWeek says that “a growing buyers’ strike in the stock market, the flight of money into housing, and the rising price of gold all indicate that the early stages of a panic may be building… if the corporate crime wave leads people to pull back from the stock market, the economy could sink into a double-dip recession.”

“Markets can work only if information is honest, rules of the game are clear, and people follow them. Realizing that this isn’t the case today has left many Americans doubting their own futures and jeopardizing the future of the economy.” (Can Trust Be Rebuilt?, BusinessWeek, 7/8/2002)

Governance Leader, TIAA-CREF, Faces Shareholder Resolutions

Based on longstanding dissatisfaction with TIAA-CREF’s weak external and internal corporate governance policies, the attachedshareholder resolution requesting a shareholder vote on separation of the CEO and Chairman of the Board positions has been submitted to TIAA-CREF. Additionally, a secondParticipant Proposal has been submitted concerning issues related to social and environmental responsibility, proxy voting and governance efforts. No decision has been made as of July 2nd regarding whether TIAA-CREF will omit or include the resolutions in its fall proxy material. Like corporate shareholder resolutions, those to mutual funds are advisory but can send a strong message. (The hyperlinks have been added by James McRitchie, Editor, Corpgov.Net, in order to provide readers additional information.) To discuss the 1st proposal, contactDavid E. Ortman. To discuss the second, contact Curt Verschoor.

Governance & SRI Resolutions Get Votes

SocialFunds.com and IRRC report that shareowner proposals concerning corporate governance socially responsible investing (SRI) are getting record votes post-Enron.

The central corporate governance issue is conflicts of interests by auditors. So far this year, 12 resolutions addressing the issues have received an average 30% support. Union funds initially submitted 29 auditor proposals, with 17 filed by the Carpenters. First out of the box was Walt Disney, in February, where 41% of voting shareowners supported the proposal. That strong showing early on led at least 11 companies to agree to new policies in order to have proposals withdrawn. Pacific Gas & Electric shareowners registered the highest vote, at 47% of votes cast.

“Golden Parachutes,” lucrative separation packages for executives, have received an average 40% support, based on results from 13 of the 19 golden parachute resolutions voted so far, up from last year’s average of 31% on 13 such resolutions. Board independence proposals also getting 29%, up 23% last year.

Votes for SRI proposals are up, as well. In each of the last 2 years, less than 15 of more than 150 social and environmental proposals received more than a 15% vote. This year, 17 resolutions have already so, with only 100 taken up so far.

Fall From Grace

The United States runs a huge trade deficit, which has been covered by a net inflow of $1.3 billion in foreign investments every day, according to Edmund L. Andrews, in writing for the New York Times. (U.S. Businesses Dim as Models for Foreigners, 6/27/2002) The dollar has been falling in relation to the Euro and Yen but Andrews says the more enduring impact may be a revolt against the “American model,” which “emphasizes bare-knuckle competition, aggressive deal making, a high level of public disclosure and fantastic rewards for executives who deliver the goods.”

“European leaders are also pushing for greater acceptance of their auditing rules, known as the international accounting standards, as an alternative to American rules. The great virtue of the international accounting standards, which all European Union companies will have to adopt by 2005, is that it is a simple and fairly compact list of basic principles. The American system, by contrast, is made up of volumes and volumes of decisions reached over the years on the finest nuances and shadings of every issue.” A survey by UBS Warburg and the Gallup Organization found that only 32% of European investors now rank the United States as the most attractive market in the world.

A recent survey by the Pew Research Center for the People and the Press found that President Bush’s approval rating on the economy had slipped to 53% from 60% in January. Only 30% of the public sees the economy improving over the next 12 months, down from 42% a year ago, and a third said the president was doing all he could to improve economic conditions, down from 48% six months ago.

VIP Rollout

After a year of successful cooperation with three of the six biggest German asset managers, the Association of Institutional Shareholders (VIP) is now able to expand their activities to the whole of Europe. As a first step to global and cross border transparency VIP made up a list of the dates of the annual general meetings of all EuroStoxx companies for the years 2002/2003. The second step will be completing it with all DJSI dates. This chronological and alphabetical list will be regularly updated according to the latest information at vip-cg.com.

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