July 2003

SRI Tilted Indexes Gain 1%

A simulation by Innovest for a major US pension fund found that a slight “tilt” toward certain SRI criteria resulted in gains averaging 1% for five of six portfolios, with the one fund only underperforming by 0.04%.

The Innovest results directly contradicted the findings of a recently publicized study from the Wharton School at the University of Pennsylvania. That study concluded that including socially responsible investment factors could cost active investors as much 3.6% per annum in lost performance.

Bijan Foroodian, Innovest’s Director of Quantitative Analysis says “The Wharton study appears to be fundamentally flawed” since it compares the performance of broadly – based SRI funds with a group of 28 mainstream equity funds, of which fully 17 are real estate funds. “Given the enormous differentials in the risk/return characteristics of these two different types of investments, this comparison is, at best, disingenuous.”

Additionally, Innovest points to the Wharton study’s primary focus on social funds practicing exclusionary, negative screening as falling short of more advanced techniques used in the construction of social conscience criteria. Instead, SRI portfolios designed to maximize performance should be stressing positive screens and must discriminate among the various social performance metrics; clearly they do not all have equal financial impact.

Going forward, there is every reason to believe that this “SRI premium” will become even larger in future. The Innovest simulation identifies six powerful global “mega-trends” which can be expected to further increase the importance of SRI factors:

  1. Changing demographics for both consumers and investors, substantially increasing the saliency and financial stakes of companies’ environmental and social performance.
  2. Tightening national, regional, and global regulatory requirements for stronger performance and disclosure on SRI issues.
  3. Growing pressures from the international non-governmental organizations (NGO’s), armed with unprecedented resources, credibility, and global communication platforms.
  4. A substantial broadening of the purview of what is considered to be the legitimate fiduciary responsibility of investors to include addressing companies’ social and environmental performance. (In the U.K. and a number of other European countries, this enlarged view of fiduciary responsibility has been enshrined in law).
  5. The globalization and intensification of industrial competition, particularly into emerging markets, exponentially increasing the level of environmental and social risk for major corporations and investors.
  6. A growing inclination – and capability – among major institutional investors for shareholder activism on environmental and social issues.

See executive summary of the report “New Alpha Source for Asset Managers: Environmentally-Enhanced Investment Portfolios” or contactPeter Wilkes.

Morgan Stanley to Shareholders: It Depends on Your Definition of Win

Among Morgan Stanley’s problems is an investigation announced by Spitzer and Massachusetts Secretary of State William Galvin of their mutual fund sales practices, with an eye towards whether the firm improperly pressured brokers to sell their house funds to investors.

Now a shareholder, Walter Baer, is alleging that the brokerage firm squelched the outcome of a vote on one of its funds — Latin American Discovery Fund. Baer’s proposal was to convert this closed-end fund into an “interval” fund — such funds make tender offers to buy back shares on a regular basis but do not trade, as do closed-end funds — in the belief that this would help eliminate a persistent discount to its net-asset value.

Barron’s Online points out that Baer is a senior analyst at Rand Corp. He was among the first to call for the federal government to establish the now-famous “do-not-call” list, banishing unwanted telemarketers, and to write research on e-mail. In the 1980s, he was chief technology officer for Times Mirror…maybe more than Morgan Stanley had bargained on.

According to Baer’s tally, his proposal won 61% of the votes cast (47% of all shares outstanding) — but the press release issued by Morgan Stanley on June 13th states: “The Fund noted the results of the voting on a stockholder proposal to recommend that the Board of Directors act to adopt interval-fund status for the Fund. Less than a majority of the Fund’s outstanding shares, and less than a majority of the shares represented at the annual meeting, voted in favor of this proposal.” (see Yahoo!)

According to Baer, “Morgan Stanley resorted to an irrelevant apples-to-oranges comparison with the shares ‘represented at the meeting,’ in an attempt to use smoke and mirrors and avoid properly conveying the voting outcome in their press release.” “They lost, but chose to ignore it.” For shareholder proposals the outcome is decided based on the number of people who actually cast a vote — not the number of votes present, which often includes broker non-votes, a much larger denominator.

Baer concedes: “They’ve done nothing illegal. I just believe it’s misrepresenting what the shareholders voted for. And Morgan Stanley would be well advised to take a vote of 61% of shares cast seriously, particularly at a time when people want improved corporate governance .”

In a reply to Baer, fund president Ronald Robison wrote a letter: “In general, it is unlikely that the Board of Directors of a Fund will accord a proposal any significant weight unless it is approved by the holders of a substantial majority of the Fund’s outstanding shares.”

Other shareholders were stunned. “Will Morgan Stanley CEO Phil Purcell, on the board of these funds, choose to ignore this matter, coming so soon after he and Morgan Stanley ran into hot water for their cavalier attitude about the monumental $1.4 billion Wall Street settlement?” asks another longtime closed-end fund investor and shareholder in the fund, Adam Shapiro of Advantage Capital Management.

Their action, or inaction, certainly lends support to the SEC’s suggested changes to regulations that address how corporate boards are nominated. Morgan Stanley seems intent on being among the first to pull the SEC’s trigger. (Greener Pastures: Votes Cast Aside, Barron’s Online, 7/21/03)

Praise from the Capitalist Tool

Forbes praises CorpGov.Net for its “unbridled linkfest and no annoying product promotions.” We won “Best of Web, while The Corporate Librarywon 1st place as category favorite. We can’t think of a better site to trail. In fact, we’re please to ever be mentioned in the same breath with The Coporate Library. We’ll never have their resources but continue to belive there is room for many in this field. See reviews.

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Canadian Companies Win Highest Overall Governance Rating

GovernanceMetrics International (GMI), an independent governance ratings agency, rated 1600 global companies from 15 countries. Seventeen companies – fifteen US and two Canadian, received scores of 10.0, GMI’s highest rating (see below).

Canadian companies had the highest overall average rating of 7.2 followed closely by the UK, US and Australia. Companies with overall global ratings of 7.5 or more, which GMI considers above average, are almost exclusively from these four countries. In continental Europe, French companies scored the lowest with an average of 4.1, but the lowest governance performance of all was Japan, where the average rating was 3.5.

Even though US and Canadian firms scored well overall, there are still five companies from these two countries that received a global rating of 3.0 or less, which GMI considers well below average. This indicates that despite a strong legal and regulatory framework, companies can still satisfy basic requirements but represent a governance risk to shareholders. Sixteen companies received GMI’s lowest rating of 1.0; of these, ten were Japanese, two were French, two were Dutch, and one Swiss and one American.

The highest scoring industries globally were Utilities (average rating of 7.0), Energy (6.9) and Insurance (6.8). The poorer performers were Construction (4.9), Autos (5.6) and Media (5.8). Not surprisingly, more regulated industries tended to have better governance practices overall, although GMI would have expected Financial Services as a regulated industry to have had better ratings overall than the 6.1 the industry achieved.

Noticeable differences were found in how companies performed in particular categories. In the area of potential dilution, Japanese companies scored well since stock options are generally not a feature of compensation practices in that country. On the other hand, of the 483 companies in the ratings universe with potential options dilution of 15% or more, all but seven were American. In financial disclosure, Japanese and European companies tended to score lower than US, Canadian, UK and Australian companies because of fewer disclosure requirements. In addition, 21% of the companies in the ratings do not report their accounts under US GAAP or International Accounting Standards practices, but under purely local standards. These companies are predominately Japanese and Continental European.

European corporations outperform in the area of broader stakeholder relations. In environmental, labor and social matters, European companies have far better practices and disclosure policies than US companies and consistently score better in this category.

GMI’s Chief Executive Officer, Gavin Anderson said, “among the myriad of questionable practices we found are a chairman and president who were forced to resign because of bid rigging, but have now been re-hired as advisors; directors who sit on as many as fourteen public company boards as well as several committees; one director who collects a $600,000 annual consulting fee on top of his director fees, and one firm that does not designate either executive directors or a CEO and thus regulations relating to directors remuneration do not apply to them. What our ratings help determine is the culture of accountability and integrity at companies. We know from a number of studies that shareholders will pay a premium for companies with good corporate governance.”

GMI’s rating system incorporates more than 600 data points across seven broad categories of analysis, including board accountability, disclosure, executive compensation, shareholder rights, ownership base, takeover provisions and corporate behavior and social responsibility. Subscribers to GMI are able to view a company’s overall rating, section ratings and several pages of written analysis. The firm also utilizes a “red flag” alert to identify areas that it believes investors should pay particular attention to.

Companies with a global score of 10 (highest rating) were:
Alcan Inc. (Canada)
McDonald’s Corporation (US)
BCE Inc. (Canada)
Petroleum Corporation (US)
ChevronTexaco Corporation (US)
PepsiCo, Inc. (US)
Chubb Corporation (US)
Pfizer Inc. (US)
Colgate-Palmolive Company (US)
Pinnacle west Capital (US)
E.I. DuPont de Nemours & Co. (US)
Praxair Inc. (US)
Eastman Kodak Company (US)
SLM Corporation (US)
Exxon Mobil Corporation (US)
The Allstate Corporation (US)
Gillette Company (US)

Editor Calls on CalPERS Board Members to Pay Back Excess Payments

California’s Assembly Appropriations Committee should pass AB 1428 (Levine), which deletes the current limit on reimbursements paid to employers of CalPERS’ elected Board members for an employee to replace the board member while that member attends to board duties. However, before voting the bill out of Appropriations, CalPERS should submit a plan to recover excess reimbursements paid to CalPERS Board members since September 2000.

At that time, contrary to Government Code, section 20091, which limits the compensation of Board members for attendance at Board meetings to $100, the Board increased the compensation to $400 per meeting. According to an article at the time in the Sacramento Bee, “with an average of 75 meetings a month, certain board members’ compensation will increase to a yearly average of $30,000 from around $7,500 a year for service on the CalPERS board.” The Bee reported at that time that “five board members are eligible for the $400 per meeting rate. They are: Robert Carlson, William Rosenberg, Mike Quevedo, Joseph Thomas and Willie Brown.” (See CalPERS board votes itself big pay increase, 9/21/00)

Additionally, contrary to section 19820, subdivision (a) of the Government Code, which limits travel reimbursements for Board members and employees, as determined by the Department of Personnel Administration (DPA), the Board adopted an expense reimbursement policy that exceeded those authorized amounts.

On January 30, 2003 the Court of Appeal, Third District, upon action by the State Controller, ruled the Board had exceeded its authority with respect to these and other expenditures. The California Supreme Court then upheld that ruling. (Westly v CalPERS)

Raising the reimbursements paid to employers of CalPERS’ elected board members, as AB 1428 would authorize, is reasonable. Board duties should consume more than 25% of the time of Board members. Neither would I be concerned if the Board sought legal authority to raise their per meeting reimbursement.

However, no member of the Board should receive a financial benefit from violating existing laws. CalPERS should recover excess amounts paid to Board members.

UK Corpgov Redraft

The independent Financial Reporting Council has given the go-ahead to a redraft of the code to take into account the boardroom reforms recommended by the Higgs Review. The main reforms include:

  • At least half a board should be comprised of independent directors.
  • Roles of CEOs and chair should be split except in exceptional circumtances (they must first consult with shareholders. Higgs wanted to end this.)
  • A senior independent director should be available to shareholders if they have concerns which contact through the chairman or executives has failed to resolve.
  • Boards should undertake a formal and rigorous annual evaluation of its own performance of its committees and individual directors.
  • Insitutional shareholders should avoid a box-ticking approach to assessing a company’s corporate governance.
  • Companies should adopt rigourous, formal and transparent proceedures for the recruitment new directors to the board.
  • No individual should be appointed to a second chairmanship of a FTSE 100 company.
  • After a non-executive director serves six years – two three-year terms – on a board, their continued appointment should be subject to a “particularly rigorous review”. After nine years on a board, non-executive directors should be subject to annual re-elections and they may no longer be considered independent.
  • Boards should not agree to a full-time executive director taking on more than one non-executive directorship in a FTSE 100 company nor the chairmanship of such a company.
  • Chairmen can continue to chair committees set up to approve who should join their company’s board. Higgs wanted to ban this practice.
  • Meetings of independent directors without the chair present was limited to once a year, curbing Higgs’ recommendations. (Corporate governance redraft gets go-ahead, FT.com, 7/23/03)

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Quotes from the Pundits

When asked about the number of targets expected under possible SEC rules on CNBC (Shareholders may get bigger say at companies, 7/15/03) the following exchange took place:

“Murray: I know you haven’t worked out the details of this yet and you’ll be doing that through the rest of the year, but if you just intuitively … if you look at the Fortune 500 right now, are we talking about 100 of those companies that might be eligible for this kind of action, are we talking about 10 of those companies? I mean, what’s the magnitude of number of companies that you think might be subject to this new rule?

Donaldson: It’s not 10, but it’s probably well over 100.”

Therefore, Donaldson appears to believe that more than 1 in 5 companies in the Fortune 500 will face election contests under the SEC’s proposal to allow shareholders to place director nominees on the corporate ballot. That to me is an astonishing estimate. According to the Investor Responsibility Research Center, of more than 800 shareholder proposals filed last year, just under 100 received majority votes. That’s a ratio of 1 to 8 companies.

Carol Bowie, IRRC’s director of governance research, said “This is something that has vexed investors of late,” she said. “They are, after all, the owners of the company.” (Voters might nominate boards, Ohio.com, 7/16/03)

Contrast the above with Ann Yerger, deputy director of the Council of Institutional Investors, who called the move “a very positive step for investors.” She suggested that pension funds and other large investors likely would only have to press through the corporate board changes in a few, unusual cases of unresponsive corporations. (AP, SEC Considers Investor ‘Democracy’ Plan)

”This proposal is about real independence,” says Nell Minow of the Corporate Library. It ”goes to the heart of corporate governance because it interrupts the current ‘closed-loop’ system of director selection and communication. If this proposal survives the many stages necessary to become law, its greatest significance will be in its value as a deterrent.”

Says Jerry Davis of the University of Michigan Business School, ”This will make corporate director elections look less like elections in North Korea.” (USAToday.com)

“The fact that this would be progress says a lot about the extent to which the term “shareholder democracy” is an oxymoron, said Floyd Norris in the New York Times, A Small Move to Shareholder Democracy. “The S.E.C. is still unwilling to take democracy to the limit, which would mean letting shareholders vote the incumbents out even if no one was willing to finance a full-scale proxy fight.”

“It is clear the commission is serious about doing well by investors.” said Sarah Ball Teslik, executive director of the Council of Institutional Investors, a trade group representing pension funds and other large shareholder groups. “There is nothing in the last 20 years the SEC has done that will be as important.”

“We can expect the corporate community to pull out all the stops to slow this down, including a challenge in the courts about whether the SEC even has authority to do this instead of leaving it up to the states,” Nell Minow, editor of the Corporate Library, said.

Evelyn Y. Davis, a shareholder activist for 40 years, fears the proposal could backfire, eventually leading the SEC to mandate a similar percentage of votes be obtained before putting any shareholder proposal on the proxy ballot. She said she thinks a better way to make current directors more responsive to shareholders would be for the SEC to limit director terms to six years and to require firms to adopt any proposal that wins a wide majority vote.

“This is a positive step towards making boards of directors more accountable to long-term investors,” AFL-CIO President John Sweeney said in a prepared statement. “The retirement savings of America’s working families have been harmed by the failure of boards of directors to prevent wrongdoing at Enron, Worldcom and other scandal-plagued companies. We call on the SEC Commissioners to quickly adopt new proxy rules and end the self-perpetuating system that permits incumbent boards to hand-pick director candidates.” (SEC Chief Supports Plan to Aid Investors, washingtonpost.com, 7/16)

Phillip Goldstein of Opportunity Partners LP says he is opposed to additional disclosure about the nominating process “unless the company makes public actual transcripts of the nominating committee meetings. Otherwise, it will just be sanitized junk disclosure that is of no value to anyone except the overpaid lawyers that prepare it (and maybe regulators). Or, does anyone expect to see disclosure that says: ‘I chose my old college roommate or my golf partner or a washed up
politician than can help us lobby for tax breaks?'” Additionally, “Just curious what the possibility is that incumbents might actually conclude in good faith that the challengers would be better stewards of the company and consequently determine not spend lots of shareholder money to keep their seats? If that has ever happened, I would like to know which board made that determination. Perhaps you could pose that question to the Business Roundtable.”

Andrew Shapiro, President of Lawndale Capital Management, LLC reminds us that his “substantial experience in board situations in need of change” led him to call for open access for nomination of a majority of the board less one director. “Having a small % of the board, especially only one director is more symbolic than practical in application. For any director’s motion in the board room to even be considered, it needs a second and for real change to be taken seriously, there has to be a meaningful chance of such board motions to pass. This is exactly what hamstrung Guy Adams during his short stay on Lonestar’s board. We further commented on the use of triggering events, but the starting point was always a shareowner slate of a majority of the board less one director with the triggering event opening up the entire board slate for shareowner access for nominations. If shareowners have been abused so much that a proposal that garnered a majority vote is ignored, then shareowners (or at least that proponent) should have the fundamental right, a whole year later, to propose on the company’s proxy a slate for the majority of the board that will be responsive to the will of the company’s owners. It is through this ultimate power to elect a majority that a likely compromise and real reform is achieved.”

More from the Wall Street Journal (UPDATE: Shareholder Advocates Applaud Proxy-Access Plan, 7/16/03) “We’re supportive of efforts to expand shareholder access to proxies,” said Barbara Roper, director of investor protection at the Consumer Federation of America. “If they can give shareholders more say in the companies they own, more power to them.”

“I think it’s like a nuclear bomb, to be used only as a last resort,” said Nell Minnow. Minnow figures companies will bend over backwards to avoid setting off any of the proposed “triggers.” “Corporations are so horrified by this prospect that they’re trying to come up with alternatives to make shareholders happy,” Minnow said.

Use of “triggers” will limit shareholder proxy access to troubled companies whose directors aren’t doing their job, Teslik predicts. Minow agrees, saying “The impact will not be felt in Ralph Nader being nominated for 10 boards,” but in how companies handle their own nominations.

AFL-CIO deputy general counsel Damon Silvers praised the SEC for tackling the controversial proxy access issue. “They’re taking it seriously,” said Silvers.

The WSJ reports that business groups are unhappy with the proposal. If the SEC approves it, Minnow expects they will immediately challenge it in court. However, Teslik noted that “State law governs corporations but securities laws govern proxies.” She said the SEC proposal shouldn’t be viewed as a matter of state law because “it’s not about nomination, it’s about who has access to the proxy.”

In the 7/18/03 ISS Friday Report, Robert Todd Lang, a partner at Weil, Gotshal & Manges questions “What happens if three different shareholders who are qualified come up with short-slate proposals for nominees?” “The math on that is horrendous. . . . I’m sure [the SEC is] working on it, and I’m sure that everybody’s going to be watching to see what they propose.”

Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware, said dialogue between shareholders and companies will fail less often once the rule is passed. Elson cited new independence requirements on boards and nominating committees mandated by the SEC and the stock exchanges. “If someone comes to you with a large enough holding, to an independent nominating committee, you’re going to listen,” he said.

Likewise, Peter Clapman, senior vice president and chief counsel for corporate governance at TIAA-CREF, said shareholders would bring their gripes to the independent directors instead of mounting a laborious nomination effort. “Apart from the nomination process, you’re going to see shareholders enlarging the communication process with the board.” Nevertheless, if shareholders move to nominate their own candidates, look out, Clapman said. “For TIAA-CREF to do this, for us to undertake it, we would do it to win.” Because only the most serious shareholders would attempt it, they would nominate stellar candidates, such as people with top industry credentials, and back the effort with a coalition of shareholders, he added.

Writing for Forbes magazine, Dan Ackman (Proxy Reform Should Be Across The Board, 7/16/03) advises the Commission to “do more by cutting away the weasel aspect of the staff report that says that perhaps the new process should only kick in if there have been ‘triggering events’ indicating that shareholder ideas haven’t been taken seriously. Suggestions that outside shareholders should also be allowed to nominate a limited number of board members should also be abandoned. If democracy is good, it should apply across the board.”

Thomas W. Joo, of the University of California at Davis, says that “unlike the rank and file and grassroots activists, those big players (who can meet the proposed SEC thresholds) already have informal pull with boards–and they failed to exercise that pull to rein in the risky and/or illegal conduct of Enron, WorldCom and others. Furthermore, because failure to respond to shareholder proposals will be one factor in granting access to the proxy, the proposal may trigger greater management resistance to proposals–both by exclusion from the corporate proxy under 14a-8 and by opposition to proposals on the proxy or independently submitted.” However, he also notes that “in light of the political pressure the SEC faces from the business community, and in comparison to the unimpressive Sarbanes-Oxley Act, the proposals are encouraging. The political reality is that incremental reform is the best we can hope for.”

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On SEC Staff Recommendations for Board Election Reforms: Statement of the Social Investment Forum

“The Social Investment Forum supports the release of the July 15, 2003 U.S. Securities and Exchange Commission (SEC) staff recommendations regarding shareholder selection and nomination of representatives to corporate Boards of directors, and the possibilities it opens for increased shareholder access to corporate proxies and increased shareholder rights.

We appreciate the SEC for taking steps that underscore what an increasing number of investors have come to recognize — that the current rules for Board elections do not work, and do not result in Boards that are accountable to and represent the interests of shareholders. The Social Investment Forum believes that the significant lack of shareholder access to the corporate proxy — when combined with the self-perpetuating boards that are often insulated from investor accountability — is a significant obstacle to preventing future corporate abuses and restoring investor confidence.

The Social Investment Forum supports:

  • The report’s recommendation for increased disclosure and transparency of nominating committees and their processes, as well as improving communications between shareholders and the Boards that serve them.

  • The call for greater shareholder access to the company proxy, providing shareholders with the ability to more easily nominate diverse candidates, as opposed to a separate proxy for the election of directors, which would be too burdensome to shareholders. The Forum recommends that all Board nominees, including shareholder nominees, should be afforded the same resources and opportunities to reach shareholders and discuss the merits of their candidacies. In addition, all Board nominees should disclose material, familial, professional, and financial relationships.

  • The opportunity for shareholders to vote “yes” or “no” for a director and not just “yes” or “abstaining.”

  • Greater opportunities for shareholders to communicate with their Board of Directors.

The Social Investment Forum supports the overall direction of the SEC report. The steps taken this week will help corporate Boards better represent shareholders, not just corporate management, and improve corporate governance as well as corporate performance over time. The SEC has clearly heard the concerns of diverse individual and institutional shareholders across the country.

The Social Investment Forum will be watching this process closely. We hope the SEC will take the next important step: issuing rules that promote broad shareholder access to the Board nomination process and to corporate Boards as a whole.”

The Social Investment Forum is the national trade association for the social investment industry. It is dedicated to the concept, practice, and growth of socially responsible investing. The Forum’s more than 500 members include financial planners, banks, mutual fund companies, research companies, foundations, and community investing institutions.

SEC Rules: New Opinion Polling Device or Democratic Corporate Governance?

The “SEC Staff Report: Review of the Proxy Process Regarding the Nomination and Election of Directors” provided background, summarized public recommendations (see also Appendix A to the Review – Summary of Comments), outlined alternatives and made recommendations to the Securities and Exchange Commission for a rulemaking.

Five alternatives for increasing shareholder involvement in the nomination and election of corporate directors were presented by staff and can be summarized as the following:

  1. Require companies to include shareholder nominees in company proxy materials.
  2. Require companies to deliver nominating shareholders’ proxy cards with company proxy materials.
  3. Require greater disclosure by nominating committees.
  4. Require further disclosures regarding shareholder communications with the Board.
  5. Revise Exchange Act Rule 14a-8 to allow shareholder proposals related to the company’s nomination process.

After a lengthy discussion of each of the above alternatives, staff recommended the Commission proceed with a rulemaking based on three major components and cleanup amendments as necessary.

  1. Enhanced disclosure of the nomination process. Require documentation of the criteria committees use to nominate directors and the disposition of nominations from shareholders who have owned a specified amount of stock for a minimum specified period. One of the more interesting provisions would be disclosure of “whether each member of the nominating committee believes that it was in the company’s best interest not to nominate the candidate.

  2. Enhanced disclosure of shareholder communications with board members. Corporations would be required to specify how shareholders can communicate with specific board members or intermediaries. Most helpful would be a recommended requirement that companies disclose the number of times each board member met with shareholders and “any action taken by the board as a result of the communications.”

  3. Staff recommends the rule include provisions for shareholder access to company proxy materials. Shareholders or groups of shareholders would have to meet applicable state, federal laws and listing standards. Nominees would have to meet standards for independence. Shareholders or shareholder groups would have to meet minimum standards with regard to holdings and time held. Limitations would be set on the total number or percentage of shareholder nominees. Additionally, the shareholder nomination process would only be available if one or more “triggering events” occur that objectively “demonstrate deficiencies in the proxy process,” especially thwarting the will of the majority of shareholders.

  4. Cleanup regulations might be necessary regarding solicitation activities by nominating shareholders and groups, ownership and transaction reporting and concerning the definition of an “affiliate.”

Mr. Donaldson and others at the SEC indicated they hope to issue proposed rules regarding disclosures (1 and 2 above) in August. The proposal for nomination of directors by shareholders would talk a little longer, probably until September. The proposed change is not one of “democracy,” Donaldson said but “to give some real power to people who have the right to express their view through a vote.” That sounds a little too much like opinion polling to me.

Taken as a whole, the set of regulations would be at least a step in the right direction. Certainly, enhanced disclosure of the nomination and communications processes could go a long way to ensure shareholder views are heard and considered. However, enforcement appears to be largely though bad publicity and public shaming. Again, we are to depend on the court of public opinion.

Disclosure and transparency are important but power is fundamental. Allowing shareholder access to the corporate proxy would move in the direction of shifting actual power from managers to shareholders. Of course, the devil is in the details. Staff did not recommend specific thresholds or timeframes for holdings. If the Commission moves forward with a rulemaking, we don’t know if the threshold will be $2,000 or 10% of outstanding shares. We don’t know if shareholders will need to hold for one year or two, prior to have a right to nominate. We don’t know if they will be able to elect one member or half of the board.

Most troublesome to this editor is the idea that the shareholder nomination process would only be available after a triggering event like a board ignoring a shareholder vote or shareholders massively withholding votes from management nominees. Imagine telling Blacks or women that you have a right to vote or to run for office but only after we make a finding that you’ve been badly treated. No! Voting and running for office should be viewed as fundamental, triggered by mutual respect for democracy and the rights of others, not by paternalistic nonsense. Shareholders own the company; we shouldn’t have to prove we have been abused prior to exercising power.

If a trigger is going to be mandatory, it should be one that tackles the issue head on, such as a shareholder resolution on whether or not shareholders should be able to place nominees on the corporate ballot. Such a resolution should be put forward, like any other resolution, by any shareholder who has held $2,000 of stock for over one year. Those resolutions can set forth the details on who can nominate, how long nominators have held shares and what proportion of the board is subject to such nomination by shareholders. If the proposals win majority support, they should go into effect.

As Floyd Norris pointed out in a New York Times opinion piece, “Hong Kong’s experience shows, letting people vote for only a minority of the governing council can create frustration when the elected minority turns out to be unable to bring change.” (A Small Move to Shareholder Democracy, 7/16/03) Mr. Donaldson, you’ve taken a courageous step but it isn’t about people being able to express their opinion through a vote; it’s about power and whether or not those who exercise corporate governance will be held accountable.

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SEC to Unveil Shareholder Proxy-Access Plan

Expectations appear low as the SEC is about to unveil staff’s recommendation. “I’m expecting them to take one baby step forward to open discussion on the issue, but even that is an extraordinary step,” Nell Minnow told the Wall Street Journal.

The SEC is mulling “triggers” that would force a company to open access to its proxy, said Sarah Teslik, executive director of the Council of Institutional Investors. One possibility would give proxy access to stockholders at companies that repeatedly fail to implement shareholder-approved proposals, or otherwise ignore majority votes. Another possibility is to limit shareholders to nominating a single candidate. Concerning thresholds, Minnow said a 5% threshold is about right, but figures if the SEC eases rules on shareholder communication, “you could go up to 10%.”

Teslik thinks a 10% threshold is likely and says, even then the SEC would need to enact additional reforms to discourage lawsuits. If shareholders seeking to nominate candidates are at risk of being sued by like any other corporate raiders, “they won’t do it,” said Teslik. (SEC Expected To Unveil Shareholder Proxy-Access Plan Tues, Dow Jones Newswires, 7/15/03)

Mergers on Rise: Good Sign or Bad?

“When mergers heat up, it tells you that people have confidence in the future,” said Charles Elson, a professor of corporate governance at the University of Delaware. “When merger activity slows down, it tells you that companies are slowing down.” Shareholders should be delighted, right? Maybe not.

A report from the Boston Consulting Group says mergers generally show negative returns. Studying 277 big deals in the United States between 1985 and 2000. Their study confirms the findings of many others. “We found that a full 64 percent of the deals in our sample destroyed value at the time they were announced, and 56 percent continued to do so two years after the deal.”

Maybe rising confidence also leads to complacency. (Big mergers fueling economic optimism: Analysts say deals show confidence in market, San Francisco Chronicle, 7/15/03)


The International Corporate Governance Network opened its ninth annual meeting in Amsterdam with the theme of “Making Corporate Governance Work.” Nearly 400 participants from around the world are expected to attend. Sessions discussed increasing regulation, corporate governance rating tools and securities class actions suits.

Fritz Bolkestein, the European Union Commissioner for the Internal Market, described the EU Action Plan to modernize European company law by increasing transparency and equipping shareholders with better control mechanisms. One urgent priority is to overcome obstacles to cross-border voting, another is to ensure the independence of remuneration and audit committees. But he insisted that the nominating committee should consist mainly of executive directors. Only company managers have the day-in, day-out experience to judge their peers.

That position places him at odds with this editor and probably most of those in attendance at ICGN. (for more information, see the ISS Friday Report, 7/11/03)

SEC Staff to Recommend Shareholders Be Given More Power

The Wall Street Journal reports that Securities and Exchange Commission staff plan to recommend that the agency “move to give shareholders more power in nominating and electing corporate directors.”

In next Tuesday’s report staff plans to recommend that, in limited circumstances, companies should have to place a shareholder-selected board nominee on a company’s official proxy material. Options under consideration include allowing shareholder nominees on the company ballot when a certain percentage of shareholders support a candidate or when a “majority of shareholders” express serious concern about the board’s makeup. (SEC May Give Investors More Nominating Power, 7/10/03)

Women Directors Ensure Better Governance

Research comes from the Conference Board of Canada in a report entitled, “Women on Boards: Not just the Right Thing…But the Bright Thing, co-authored by David Brown, Debra L. Brown and Vanessa Anastasopoulos. Boards with women review five or more non-financial performance measures regularly and explicitly assume 94% of governance responsibilities recommended by the Toronto Stock Exchange (TSE).  All-male boards review and average of 2.5 non-financial performance measures and assume only 72% of the responsibilities recommended by the TSE. The study also shows that 94% of boards with three or more women ensure adherence to conflict of interest guidelines, compared with 68% of all-male boards. Boards with women also scored higher in ensuring adherence to an organizational code of conduct.

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Proxy Access: Presidential Issue?

Writing for Dow Jones, Neal Lipschutz raises the issue of where candidates stand on shareholders’ right to nominate corporate directors. (see Point of View: Proxy Access And The Presidential Race, 7/8/03) “Hard to believe, for sure. But there are early indications that corporate governance may become an issue in next year’s U.S. presidential election and the Democratic primaries that precede it.”

“We’ve come a long way baby,” is my response. Senator John Edwardsrecently announced, “I’ve proposed making sure that shareholders’ nominees for corporate boards can compete with CEOs’ picks on a level playing field.” Edwards would:

  • Allow Shareholders to Nominate Directors. Edwards supports a proposal, now before the SEC, to allow large shareholders and groups of shareholders to nominate board members without waging a costly proxy fight. The SEC staff is expected to make a recommendation by July 15th.
  • Require Institutional Investors to Stand Up for Their Investors. Managers of mutual funds and pension funds have a fiduciary responsibility to represent their investors. Edwards would require fund managers with a substantial investment at stake to exercise the rights of ownership, unless they can demonstrate that doing so is not in the best interest of their investors. He would also require pension plans to disclose their votes on shareowner initiatives, like the SEC recently required mutual funds to do.
  • Fully Enforce the Edwards Amendment to Require Lawyer Accountability. Over the objection of the American Bar Association, Senator Edwards added a provision to the Sarbanes-Oxley Act to require that lawyers representing corporations put the interests of shareholders first. If the lawyers observe wrongdoing by insiders, they are now required by law to report that wrongdoing up the corporate ladder, to the board of directors if necessary. The SEC’s implementing regulations muddled the law’s requirements; Edwards would issue clearer regulations and fully enforce them.
  • Put the “Public” Back into Initial Public Offerings. Some Wall Street bankers have been able to game the system, selling underpriced shares to friends and potential clients that can be rapidly resold for large profits. Edwards would limit sales to insiders and their families and remove regulatory barriers to auctioning IPO shares.

Lipshutz concludes, “With war, homeland security and job losses in a sluggish economy front and center as the big issues for many Americans, it is hard to see the nascent political debate on corporate governance gaining resonance with too many voters. But, then again, there are many individual investors among the electorate, and a lot can happen before full-throttled campaigning even gets under way.”

Microsoft Moves From Options 

Microsoft intends to replace its employee stock option program with one awarding restricted stocks, which vest over a 5 year period. Timing is good since options issued in the last several years are mostly underwater and nearly worthless.  Employees will apparently be cash out their options as well. President Steve Ballmer said, “We want to be a magnet for the best people by paying smarter. We want to attract and retain employees by offering real ownership and great long-term financial incentives.  And we want to ensure that our senior employees’ total compensation is even more closely linked to growth in the number and satisfaction of our customers.”

The firm will record an expense for the restricted stock in future financial statements, and will restate past earnings to reflect the cost of the options. That step may reduce net income estimates for last year by about 32% or $2.74 billion. Although it may cost shareholders in the short run, I expect it will be seen by most as a smart move and should increase the sense of ownership among Microsoft employees who will now face at least some downside risk, as well as upside reward.

At least some other high tech companies can be expected to follow Microsoft’s lead. It should also reduce pressure on Congress to meddle in accounting standards setting. A positive move all around. The Financial Accounting Standards Board has stated its intent to require companies to list the cost of stock options in their financial statements. In 1994, Congress blocked a similar effort. Microsoft’s action might prompt Congress to sit on their hands and allow FASB to do its job.

Governance Editorial Joins Push for Democracy

The June edition of Governance includes an editorial by Michelle Edkins, Director of Institutional Relations, Hermes Focus Asset Management, calling in the SEC to allow separate voting for each director (with for, against and withhold options for each), disclosures should provide information about their “suitability” for the job and the “nomination process should be as professional and robust as that for recruiting a senior executive and should be led by independent directors.” Additionally, “shareholders representing a sizeable ownership stake should be able, easily and cost effectively, to put binding resolutions on the agenda for a general meeting.”

The reason for recommending such weak reforms? “It is most likely that those at the most senior levels of the company will have the best idea of the skills and background needed to take the company successfully into the future.”

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Public Pension/Mutual Fund Differences

“Public pension funds are much more likely than mutual funds or investment banks to support the heavy lifting that drives long-term progress not just for an individual company but for the greater society,” according to Professor Laszlo Tihanyi, a University of Oklahoma colleague who co-authored a study published in the April-May 2003 Academy of Management Journal (AMJ). There were two other co-authors, University of Oklahoma Professor Richard A. Johnson and Arizona State University Professor Michael A.Hitt. Another study, published in the August-September 2002 issue of AMJ, found that pension funds favor internal innovation through R&D, while mutual funds prefer external innovation through business acquisitions. (see Pension Funds and Mutual Funds Influence Their Holdings Differently,Socialfunds.com, 7/1/03)

Corporate ‘Democracy’ on Trial

A Reuters article by Kevin Drawbaugh entitled Corporate ‘Democracy’ on Trial Before SEC is generating some buzz on an accompanyingmessage board (although it has more error messages than real ones). It they keep it up, perhaps it can become a forum for debate on what tactics activists can take to ensure this opportunity doesn’t just blow by like the last time the SEC proposed a regulation to allow shareholders to place the names of director nominees on the corporate ballot. That was 1942. The next time they even seriously looked at the issue was 1977. Opportunities don’t come around every day.

SEC staff will issue their report and recommendations to staff on July 15th. I hope pension funds, mutual funds, unions, environmental groups and others are enlarging their mailing lists and preparing a lobbying campaign.

Prior to the June 13th deadline the California State Teachers’ Retirement System (CalSTRS) devoted a section of its Web site for nine days to instructing visitors on how to send an e-mail to the SEC, along with suggested language. According to a Dow Jones report, the link received 368 hits. Personally, I saw the link and think it could have been far more effective if the message and links had been clearer.

Yet, it was certainly a good first start, especially for CalSTRS, which has long played a poor relation in corporate governance activism to its sister fund CalPERS. Outreach to individual investors could have reached far more if large funds maintained e-mail addresses of all their shareholders, members and other interested parties.

CalPERS, for example, recently began offering e-news services. The SEC would have received a lot more e-mail if CalPERS and others had mechanisms like this in place and had made use of them.

I urge readers to create e-mail news and activist lists and services. Instead of the 600 comments the SEC got on this issue prior to June 13th, let’s ensure any proposed rule on democracy in corporate elections, gets at least 6,000 comments.

Lavelle Favors Open Ballot

Louis Lavelle, who covers corporate governance for BusinessWeek, wrote a commentary for the July 2 edition entitled “Shareholder Democracy Is No Demon.” Lavelle takes on several of the objections of opponents, such as the Business Roundtable and the American Society of Corporate Secretaries:

  • The “divisive” proxy contests predicted by opponents would be rare, given the fact that the typical recommended threshold of 3% “means anywhere from several to several dozen institutional shareholders would have to agree on a candidate slate.”
  • Shareholder democracy would result in “balkanized” boards made up of special-interest directors say critics. Lavelle answers that the ideal board candidate is someone with forceful opinions who isn’t afraid to share them. “What opponents fear probably isn’t a divided board. It’s that groups that have been largely banished from the boardroom — namely labor and environmentalists — might gain a foothold. But given the 3% ownership threshold, candidates advocating a radical labor or environmental agenda wouldn’t be nominated, much less elected.”
  • Unqualified nominees. “Any shareholder nominee would have to be thoroughly vetted to win the support of enough institutional investors to get on the proxy — these are legitimate campaign issues that board-nominated director candidates could raise in the proxy.”
  • Cost of allowing shareholder nominees on the proxy. Even assuming the exaggerated estimates of the American Society of Corporate Secretaries are correct, Lavelle says it would be “money well spent,” about 4% of the average CEO’s pay.
  • “Having more than one candidate for each open seat on the board, investors are told, could create “confusion” among shareholders, who are apparently quite capable of dissecting complex income statements but incapable of choosing between opposing slates.” We’ve had two centuries of democracy in the political, its about time we tried it in business. “The sky isn’t going to fall — despite what Corporate America would have you believe.”Back to the top

Corporate Boards; How Bad Are They?

Ralph Ward, editor and publisher of the influential newsletterBoardroom INSIDER and author of a fantastic new book, Saving the Corporate Board, talks to Editor-in-Chief of Financial Executives International’s Jeffrey Marshall about the evolving shape of boards and board practices in Assessing the State of Corporate Boards.

“A board of directors is simply a lousy tool for everything we’re demanding of it nowadays. You elect people who are part-timers, who are amateurs at the corporation, who can give a few hours a month of attention to it – now you essentially want them to act as a new level of auditor, as a cop on the beat for a corporation… You would want them to take a strong personal interest in it, but at the same time they’re supposed to be extremely independent of the corporation.”

“There is an increasing drive toward shareholder democracy – an open ballot for electing board members. Currently, the board itself generally puts forward the slate for election at the next meeting. There is a move afoot to get some SEC and stock exchange regulations to allow investors who own a certain percentage of the company to nominate their own members. I think that is going to be the wave of the future, but how well it will address the underlying problems, I’m not sure.”

Regardless of how they become directors, boards will benefit from the thoughtful recommendations of Ralph Ward, a master of the incremental fix.

News on Open Ballot Measure From Dow Jones

Dow Jones reporters summarize efforts on open access issue in “From Leaflets To Web Sites, Investors Rally On Proxy Issue.” They give well deserved credit to Les Greenberg for posting a couple of hundred messages on chat boards, encouraging readers to send comments to the SEC.

However, they also point out that the Council of Institutional Investors “handed out fliers on the streets of Washington near Metro stations telling passersby about the SEC’s comment period. Shareholder activist Web site eRaider spread the word on its message boards. The California State Teachers’ Retirement System became involved for the first time in corporate-governance outreach, devoting a section of its Web site for nine days to instructing visitors on how to send an e-mail to the SEC, along with suggested language for the missive; the link received 368 hits.” It would be nice to know which of these efforts paid off.

I saw a short note on the CalSTRS site but missed the suggested language for e-mails to the SEC. Outreach to individual investors could have reached far more if large funds maintained e-mail addresses of their shareholders or members. CalPERS, for example, recently began offering an e-news services. The SEC would have received a lot more e-mail if CalPERS and others had mechanisms like this in place and had made use of them.

A couple of probable errors in the Dow Jones article:

  • “The only way for dissidents to reach shareholders with an alternative slate of directors is to launch a proxy contest, which can cost upwards of $25,000.” While I suppose it is possible to run such a low budget campaign, the most frequently cited low figure is $250,000. I think they misplaced a zero.
  • They cite a quote from Bill Patterson and note he is from the “AFL-CIO, which sent a rule-making petition to the SEC earlier this year urging reform of the process.” I don’t think so. The SEC makes it a practice to post petitions for rulemakings submitted to the SEC on their internet site; there is nothing from the AFL-CIO this year on that subject. This is not to take anything away from their efforts, which have been essential in the current reform effort.

One quote was telling: “(SEC Chairman) Donaldson proposed it on his own initiative. The fact that he asked for this review suggests he thinks the idea has merit, and other members of the commission appear sympathetic,” said James Heard, chief executive of proxy adviser Institutional Shareholder Services, which wrote to the SEC supporting more shareholder access to proxies.

Investment Industry Democracy “Feeble”

UK. A committee of MPs is to investigate the way corporate ballots are conducted after the Investment Management Association (IMA) revealed that many fund managers’ votes are “lost” and that investment managers have no way of checking whether their votes on directors’ pay are cast in line with their views. MPs dubbed the investment industry’s attempts at democracy as “pretty feeble.”

The National Association of Pension Funds (NAPF) disclosed that the level of voting by institutional shareholders dipped last year, despite a perceived renewal of investor activism as “rewards for failure” and “fat cat” pay came under the media spotlight. (MPs to investigate ‘lost’ votes on directors’ pay, Times Online, 7/2/03)

Companies Fail to Post Insider Trading

Under the SEC requirements mandated by the Sarbanes-Oxley Act companies must post details of transactions by insiders on their corporate websites or link to individual filings or a list of them on a third-party site like the SEC’s EDGAR database by June 30th. A survey of 300 small- and mid-cap companies by Blunn & Company found that 11% had failed to meet the deadline. (see Best Practices for Insider Trading Information on Your Website and Companies Fail to Heed SEC’s Deadline for Insider Trading Disclosure)

Broker Votes Curbed; Option Plans Must Be Voted

The SEC approved listing requirements requiring listed companies in the United States to gain shareholder approval for new stock option plans, or significant changes to existing plans.

The new rules also prevents NYSE-member brokerage firms from voting on behalf of shareholders in equity-compensation matters unless the shareholders have given voting instructions. Does this signal the beginning of the end of broker voting for most issues? We hope so.  

Loopholes will still exempt some plans from shareholder votes, including:

  • signing bonuses, or “inducement awards,” for new executive hires
  • some plans related to mergers and acquisitions
  • some employee pension plans
  • the exchanges’ non-US. companies.

Prior to the new rules, the NYSE and Nasdaq required shareholder approval for stock-compensation plans for executive officers and directors but allowed corporations to institute broad-based equity compensation plans without such approval. Companies have used that loophole to keep expensive management and director packages under the shareholder radar.

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