September 2003

Investment in Asia and Emerging Markets Up

Global investors have begun to move back into Asian markets, with $14 billion (US) dollars pumped into China, Hong Kong, Taiwan and Singapore in the first 8 months of 2003, compared with less than $10 billion raised during all of 2002. Cross-border capital flows into developing countries plunged from almost $300 billion in 1997 to just $110 billion in 2002. Now, mutual funds, insurance companies, and other big institutional investors from Europe and the U.S. are channeling fresh money into emerging-market equities and bonds. The Institute of International Finance, the Washington (D.C.)-based association of leading international commercial and investment banks, now predicts that capital flows will rise to around $160 billion this year.

Do the Opposite

A September 26, 2003 editorial from the St. Petersburg Times tells of taking contrary investing to an absurd conclusion. The state of Florida’s $92-billion employee pension fund is investing in Edison Schools Inc., the private education management company whose stock plummeted from $36.75 a share in 2001 to 15 cents last year. What were they thinking? The editorial asks, “Was there no Enron stock left to buy?”

The Edison buyout not only carries considerable risk but it puts members of the fund (half of whom are teachers) in a very uncomfortable position.

House Democratic Leader Doug Wiles said, “This transaction will risk the hard-earned savings of Florida’s public employees on a private company that has lost millions of dollars, is deeply in debt, has been subject to SEC scrutiny, and is being sued by its shareholders for misleading accounting and disclosure practices. . . Our public employees have dedicated their lives to public service and I’m certain that the majority would not approve of a significant investment in a business that seeks to eliminate their own jobs.”

Amen. (Investing in irony, 9/26/03)

Shareholders More Active Around the World

The Economist Intelligence Unit (EIU) reports that 74% of 310 senior asset managers polled around the world said shareholders were becoming more active in influencing how companies they own are operated. Once rubberstamp boards have become more assertive. Top management is also now spending more time on corporate governance issues than it did a year ago. Asset management companies have also beefed up their corporate governance teams, launching funds to specifically press companies on governance issues. The report noted that the appearance of greed by executives was very damaging to company reputations and that shareholders were likely to demand pay that properly reflected performance. (More Investors Worldwide Becoming Governance Activists,, 9/25/03)

Public Funds Get Serious

CalPERS, CalSTRS, AFSCME, the New York State Comptroller and the Connecticut State Treasurer’s Office took a full page ad in the Wall Street Journal, urging the SEC to give American investors greater access to corporate election ballots, calling it “the next critical step of corporate reform.”

“When boards control their own membership, directors can be unaccountable and inattentive — opening the door to abusive executive compensation, fraud and other misconduct,” the ad says. “If properly drafted, the SEC’s new rules will give shareholders the ability to use proxy materials to elect truly responsive directors, leveling the playing field with board-nominated candidates.”

The ad points to a Harris Poll of 1,030 adult investors funded by AFSCME showing that 84% want access to the company proxy to nominate and elect directors.

According to the ad, the rules should “protect against frivolous challenges by requiring significant shareholder involvement, protect against corporate raiders by limiting involvement to long-time shareholders, protect against hostile takeovers by limiting the number of investor-nominated candidates to less than a majority, and protect against unresponsive boards by giving investors timely access to the ballot.”

Speaking of board members who failed to fulfill their responsibilities, Connecticut State Treasurer Denise Nappier says, “shareholders need a process that allows them to replace those board members and install qualified replacements.” New York State Comptroller Alan G. Hevesi, sole trustee of the $106 billion New York State Common Retirement Fund said, “The ability of major investors to select board nominees has to be established in a clear and direct way without damaging barriers and impediments.” AFSCME President Gerald W. McEntee says, “Now is the time to get corporate elections out of the back room and onto the proxy ballots where they belong.”

Contacts: CalPERS, Brad Pacheco, 916-326-3991. CalSTRS, Sherry Reser, 916-229-3258. AFSCME, Cheryl Kelly, 202-429-1145. New York State Comptroller, 518-474-4015. Connecticut State Treasurer’s Office, Bernard Kavaler, 860-702-3277.

Investors Deserve a True Voice in Board Elections

American Federation of State, County and Municipal Employees (AFSCME), AFL-CIO, released two polls providing new insight into corporate board elections on the eve of an SEC rule making to enhance proxy access for director nominations. The key findings of the Harris Interactive survey of more than 1,000 individual investors, show:

  • Eighty percent think there should be a process to allow shareholders to nominate candidates for boards of directors;
  • Ninety percent agree that corporate misconduct has weakened investor confidence in the stock market;
  • More than half of the shareholders agree that corporate management is not in the best position to decide who should be nominated to the board of directors.

A large majority of these investors also believe shareholders should have access to corporate proxy materials to nominate board member candidates rather than leaving the decision solely in the hands of corporate management. Currently, any shareholders who want to challenge an incumbent board member has to pay hundreds of thousands, even millions, of dollars to run their own candidates.

AFSCME says new rules being considered by the SEC should adhere to the following principles:

  • Access to the proxy should be granted when an investor group with substantial ownership in the company seeks to nominate a director.
  • Investors should be long-term shareholders with the long-term interests of the company in mind, not short-term market manipulators.
  • This right should be available to elect less than a majority of investors-the new rules should not assist hostile takeovers but rather should be a tool to reform corporate boards to make them more accountable to shareholders.
  • Investors must be able to use these rules in a timely manner so that they will impact corporate conduct in the shortest period of time possible.

Later the same day, Sean Harrigan, president of the Board of Administration of CalPERS, testified before the Senate Committee on Banking, Housing and Urban Affairs. Harrigan suggested strengthening, auditor independence, financial reporting, federal securities laws, and the resources of the SEC, including: enforcing an outright ban on audit firms performing non-audit services; developing internal controls over financial reporting; giving the SEC a greater degree of independence from the federal budget process; and studying whether the SEC should have additional authority to ban individuals from serving as an officer or director at public companies convicted of misconduct.

Harrigan told the committee that the single most important reform that everyone should support is the ability of shareholders to have access to the proxy to nominate directors.

“At the heart of many problems that face investors is a lack of accountability of board members to the owners of the corporation,” Harrigan said. “The root causes of problems like abusive executive compensation, lack of oversight that helps permit fraud and plain old poor performance is the lack of accountability of board members to their owners. A reasonable and balanced approach to providing investors with greater access to management’s proxy statement will directly address this problem.”

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Davis Signs Governance Reforms

Governor Gray Davis signed legislation to increase corporate accountability and rebuild public trust by cracking down on corporate fraud and establishing a whistle-blower protections.

  • AB 1031 (Correa) aligns state law with the federal Sarbanes-Oxley Act of 2002 by increasing criminal penalties for securities fraud to $25 million, making it illegal to destroy documents during a securities fraud investigation, and strengthening the Department of Corporations’ authority over stockbrokers and investment advisers.
  • SB 523 (Escutia) requires major corporations and publicly traded companies to quickly report important false or misleading statements made by corporate officers to shareholders and authorities or face $1 million fines.
  • SB 777 (Escutia) protects whistle-blowing workers alerting authorities about illegal practices from retaliation, establishing a $10,000 fine for each violation. (Davis signs reform package,SacBee, 9/23/03)

“Crown Jewel” of Corporate Reform

In an Op-Ed piece available through Institutional Investors’ CalPERSWatch, Sean Harrigan says access to the proxy is the “crown jewel of fundamental reform in America.” CalPERS objects to the trigger event requirement the SEC has indicated they may include in their proposed rules to allow shareholders to nominated directors. However, if the SEC feels compelled to include a trigger event, Harrigan appears to recommend the following:

  • Companies with a proven record of anti-shareowner behavior, such as not implementing shareowner proposals which pass by a majority vote.
  • Companies that either make any material restatements, are subject to any SEC enforcement action or are subject to a meaningful withhold vote for any incumbent director.
  • Chronically underperforming companies.

Reed to Help Sort Out NYSE

John S. Reed, former chairman and co-chief executive officer of Citigroup, will take over leadership at the NYSE and will they try to sort out how the exchange will be governed. He’ll be paid $1. “At the New York Stock Exchange, we are talking about a board with a combined chairman and C.E.O., with a conflicted board that was mainly handpicked by the chairman and we are talking about excessive secrecy,” said Stephen Davis, president of Davis Global Advisors. “For all the hue and cry about poor governance at the exchange, these kinds of sleepy boards are commonplace all across the nation.”

While the conflicts at most companies are largely between the interests of management and those of shareholders, at the NYSE it is between the commercial interests of its members and the investing community at large. The exchange proclaims that its “ultimate constituency” is the investing public but investors are given no role in selecting directors. Actually, that doesn’t sound all that different from most corporations. There is at least some hope that may change. (In String of Corporate Troubles, Critics Focus on Boards’ FailingsNYTimes, 9/21/030

The Corporate Governance Alliance Digest

We’ve added The Corporate Governance Alliance Digest to our list of “Stakeholders.” The Digest is published by Eleanor Bloxham, pioneer of economic value management & author of Economic Value Management,and John M. Nash, founder and President Emeritus of the National Association of Corporate Directors. Following are a couple of tidbits from the latest edition:

The Digest surveyed its readers, “What % of Boards do you think are effective and what are your criteria for effectiveness?” Readers said 10% of public companies; 30% of private companies; and 60% of non-profit boards are effective.

Criteria for effectiveness included: Separate CEO and Chair and only 1 executive on the Board. Objective director selection process. Up-to-date and expanded charters for the Board and its Committees. Formal Board/Committee/Individual evaluation process conducted annually. Standing Governance and Strategic Review Committees. Formal CEO evaluation process by the full Board. Committees staffed entirely by independent directors, with a very strict definition of independence, i.e., beyond regulatory requirements. Regular retention of outside advisors. Adequate D&O insurance. Budget for director education, development, and skill set upgrading. Diversity of experience and expertise of the directors, combined with the quality of their boardroom interactions such as openness and direct but respectful challenging of management.

Here’s another item from the Digest which reported on a survey by the Institute of Internal Auditors, which attempted to determine what, if anything, companies were doing related to training of the board of directors. Based on 125 responses (over 80% from US based companies) to the question “Do your Directors receive periodic training related to their performance as a member of the Board?” 22% said yes, it is required by the board, 24% said yes, it is something they do on their own, and 53% said no, they did not receive periodic training.

Ohio Pension Reforms

Ohio legislators are working on a bill that would subject the state’s $107 billion public employee pension funds to more ethical, legal, and financial scrutiny. Possible provisions include:

  • authorizing the Ohio Retirement Study Council – a legislative oversight committee – to hire a criminal investigator to examine spending at the five funds
  • require the filing of financial disclosure statements with the Ohio Ethics Commission for all pension board members and certain staff members
  • require regular performance audits of each retirement system
  • ethics and travel policies for all five public employee funds
  • provisions to remove pension board members who misspend money
  • give retirees more representation through a change in the composition of several fund boards.

The move came after questions were raised earlier in the year about the spending practices at the State Teachers Retirement System (STRS).  Among the alleged excessive expenses were:

  • a $94.2-million office building adorned with $869,000 in artwork
  • generous fringe benefits for STRS employees
  • frequent out-of-state travel for pension board members
  • $14 million in employee bonuses. (Ohio Lawmakers Drafting Pension Reform Bill,, 9/18/03)

Ohio Pension Chair Steps Down

The chairman of the Ohio Police and Fire Pension board resigned yesterday after the state’s largest police organization called on him and two other trustees to step down over travel expenses. Dayton firefighter David Harker resigned because he had difficulty dealing with the pressure generated by news stories about the travel expenses, according to the Cleveland Plain Dealer. The Dayton Daily News reports that, trustees spent about $612,000 on travel and expenses at seminars and meetings in places including Las Vegas, Lake Tahoe, Palm Springs and Key West since 1998 on travel and expenses at seminars and meetings in various places. Cleveland police Detective Robert Beck, who was also criticized for the expenses, will take over as the fund’s new chairman.

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More Pressure on Grasso

Four of America’s largest public pension funds — two in California, one in New York and one in North Carolina, with combined assets of $401 billion — asked Grasso to step down. They asserted his $139.5 million deferred-pay package is too much, particularly amid efforts by U.S. companies to shore up their governance standards as the nation’s stock markets recover from an unprecedented period of corporate fraud.

“This pay package is out of line and it’s part of a sickness of culture in this country where too many at the very top have forgotten what’s right and fair in the American economy and what average workers make in this country,” argued California state treasurer Phil Angelides, who along with the heads of the California Public Employees’ Retirement System (or CalPERS) and the head of the California State Teachers’ Retirement System expressed their dismay to Mr. Grasso in a letter Tuesday. They asserted that it would take an average American 5,200 years working a 40-hour workweek to receive the money Mr. Grasso has received.

The NYSE is supposed to represent the interests of investors. In their letter to Mr. Grasso, the California pension funds and Mr. Angelides said: “The pay package sends the wrong signal at this critical time when public and private sector leaders must be steadfast in their commitment to restoring the credibility of our financial markets.” They added: “It is particularly troubling that the most substantial amounts paid under the agreement were for a time period when the NYSE fell short of its central regulatory mission, as Americans endured the greatest wave of corporate scandals since the market manipulations of the 1920s.”

In addition to his retirement package, Mr. Grasso received a $30.5 million pay package in 2001, nearly equal to the Big Board’s net income that year. Mr. Grasso’s 2001 pay included a one-time $5 million bonus for the leadership role he played in re-opening the exchange after the Sept. 11 terror attacks. Now, his decision to accept that money is under attack. Mr. Angelides said he wasn’t aware of one firefighter or one police officer or even the mayor of New York “or anyone else having gotten a $5 million bonus for doing the right thing by America.” (Large Investors Issue Call
For Grasso to Leave NYSE, 9/17/02, WSJ

Epilogue: Grasso resigned as chairman and chief executive of the NYSE on 9/17/03 after the board voted 13 to 7 during a conference call to ask him to resign in order to restore investor confidence in the world’s largest stock market.

Five years ago Grasso was a member of the board of Computer Associates International and witnessed investor fury when the company tried to pay its senior executives more than $1 billion in stock. You’d think he might have learned from that experience. Grasso fought for more than two weeks to preserve his job and a lump-sum payment of nearly $140 million, even agreeing to forgo an additional $48 million he was “entitled to receive” over the next four years.

Oh the sacrifices some people are willing to make; but it was too little, to late. By handpicking members of his own the compensation committee that set his pay, Grasso set a poor example for companies the NYSE “regulates.” Grasso’s resignation marks an end to an embarrassing episode for the exchange but I hope it doesn’t end the controversy over how the exchange should be run. Conflicts of interest at the NYSE should be minimized. Critics have argued the SEC should divide the NYSE into two institutions, one to manage the exchange and one to regulate it, following the model of the Nasdaq and NASD. Will that be part of the plan the NYSE submits this fall? I’d like to see something more creative, with actual investor advocates sitting on the board. Let’s get rid of NYSE’s constitutional provision that requires that securities industry representatives take up 12 of the 27 seats on the board.

Role Reversal in Warning at CalPERS

If you want CalPERS investments, don’t take our members’ jobs. That’s the message from CalPERS as the board considers restricting investments in companies that take over government services, putting at risk the jobs of its 1.4 million members. Charles Valdes, a trustee with the $145 billion pension fund who has often blasted “socially responsible investing” is quoted in the Sacramento Bee saying “We shouldn’t have any part of that.”

On the other hand, State Treasurer Phil Angelides, who touts triple bottom line investment strategies cautioned his CalPERS colleagues about hamstringing the fund. “This policy could be fraught with peril. It’s very important … that we retain access to the top-tier investors in this country,” Angelides said. “We have to be very careful about how we fight this. There may be instances where jobs can be best provided by the private sector.”

If they move forward they will be following the lead of similar restrictions at New York City and Ohio based funds. This would be a tough policy for boar members to oppose because it is an issue so crucial to CalPERS members. Outside money managers oversee more than 300 private equity funds with about $21 billion in investments or commitments from CalPERS.

“Privatization efforts by companies seeking profit from public services represents a significant threat to CalPERS participants,” says Dennak Murphy, a director with the Service Employees International Union (SEIU) which represents 225,000 public and almost 500,000 workers in total in California.

An SEIU report to CalPERS says the pension fund has invested $880 million in seven limited partnerships that have stakes in companies specializing in privatization. One of those companies provides services for six California prisons. An additional $2.1 billion is invested in 21 funds that have a record of investing in these businesses.

“It’s happening all over the place,” Murphy said Monday. He said companies like New York-based Edison Schools Inc., which operates charter schools in California, were originally funded with private equity investments. Edison Schools, a publicly traded company, plans to become a private venture this fall.

“I could not be more opposed to contracting out (government services),” said state Controller Steve Westly, a CalPERS board member. “This is a red herring issue — people who promise to save millions of dollars. It comes on the backs of people who have their health care taken away.” (Pension Trustees May Get Tough, Gilbert Chan, Sacramento Bee, 9/16/03) (see also editorial, CalPERS oversteps, Sacramento Bee, 9/17/03)

The move comes at the same time that the board of directors of the California State Employees Association (CSEA) has scheduled a vote on disaffiliation from SEIU. The current president of CSEA is expected to be ousted in November; getting the board to disaffiliate from SEIU may be his last major act of desperation to stay in power. Valdes, who has historically been on the side of the old-line leadership at CSEA, may be trying to reposition himself, fearing that without SEIU support he will not be reelected in 2005.

There are good reasons for limiting CalPERS investments in companies that take jobs away from public employees. The CalPERS board will have to balance its duties to the public and to its members. When they do, they’ll find a way to serve both.

Ralph Ward Predicts Professional Directors

“Director education programs are booming, but I predict that this is just the beginning of a movement toward professionalizing the job of director,” says board guru Ralph Ward and author of Saving the Corporate Board. “Within a few years, investors, courts and regulators will be looking closely at how many hours of training your board members have accumulated. Getting serious on sending your board back to school now will keep you ahead of the curve.”

The September edition of Ralph Ward’s Boardroom INSIDER offers advice on establishing a chief governance officer, how to get the most our of boar training, outsourcing the boards busy work, getting regular updates on ethics issues, and how technology is changing the information going to corporate directors

DJSI Adjusts

Dow Jones Sustainability Indexes (DJSI) added more than 50 new constituents in its yearly adjustment, including Toyota (ticker: TM), which jumped into the leader position for the automobile sector, and Hewlett-Packard (HPQ). More than 40 companies, including DaimlerChrysler (DCX) and Bank of America (BAC), were deleted. The DJSI World Index covers the top 10 percent of largest 2,500 companies in the Dow Jones World Index.

Toyota earned the leading position on the DJSI World Index in the automobile industry due to strong eco-efficiency performance, a proactive greenhouse gas (GHG) mitigation strategy, and high corporate average fuel economy. The Japanese car manufacturer also exhibited best practice in managing lower-carbon technologies, such as hybrid and fuel-cell technology, and maintains a strong life-cycle management of its products. DaimlerChrysler was dropped because of poorer fuel economy, the lack of a systematic CO2 strategy, and comparatively lower improvement in the eco-efficiency of operations.

Over this past year, the DJSI World increased by 23.1% while the DJ World Index went up by 22.7% and the MSCI World rose by 21.2%. (, William Baue, 9/12/03)

Redefining Directorship

“For the first time, governance is as much about compliance as it is about board and corporate performance. Now is the time for action, yet there are still more questions than answers as directors begin to implement boardroom reforms.” Answer these questions and more at the NACD 2003 Annual Corporate Governance Conference, which bills itself as the premier gathering of both public and private company board members for more than two decades. Agenda.

IRRC Teams with Glass, Lewis & Co

Investor Responsibility Research Center and San Francisco’s Glass, Lewis & Co. are billing their new proxy voting service as a conflict-free option, in contrast to that offered by Institutional Shareholder Services.Dow Jones Newswires, September 4, 2003. The introduction of competing services in the marketplace may benefit institutional investors by giving them access to a diversity of opinion. Ms. Soulé, of Glass & Lewis, thinks that many institutional investors, particularly the larger ones, will buy both sets of recommendations before deciding on how to vote their proxies. The Voting Agency Service can decouple the recommendations from the voting mechanism, allowing clients to vote against Glass Lewis’ recommendation while still retaining IRRC’s voting services.

Sixth Director Training and Certification Program on October 8-10, UCLA

More than a dozen world-class subject matter experts will cover every aspect of being a successful corporate director. This two-day intensive director-level educational event is designed for executives, directors, and officers of private and public companies. For more information, seeDIRECTORS.ORG.

Five Indian Cos Rank High

Five Indian companies rank high in a recent Corporate Governance Poll published in the latest issue of Asiamoney magazine.

  • Bharat Petroleum
  • Reliance Industries
  • Hindustan Petroleum
  • Castrol
  • Hindalco

Nonpublic CFOs see value in adopting new accounting standards

Should privately held companies apply corporate governance standards that are mandated for publicly traded companies to their own businesses? Many financial executives from nonpublic companies say yes. In a new survey commissioned by Robert Half International, 1,356 CFOs from privately held companies to address the issue of governance. Thirty-eight percent of CFOs said private firms would benefit from implementing the same practices as are required of public companies under the Sarbanes-Oxley Act of 2002; 38 percent of respondents were undecided. (White Paper Examines Corporate Governance Trends Impacting Private Businesses,, 9/12/03)

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NYSE Overhaul Needed

A former chairman of the New York Stock Exchange, James Needham, joined criticsin calling for a clean sweep of the boardroom as the best way of quelling the growing storm over the $139.5 million Grasso received in accrued benefits and savings. Needham was chairman from 1972 to 1976. Needham likened the appearance of the board’s handling of Grasso’s pay to the problems at Enron, where directors’ conflicts of interest and a lack of awareness of company operations became evident when that company collapsed in scandal in 2001.

In a July report, the Council of Institutional Investors outlined a number of troubling connections among NYSE management and board members, and found few rules to prevent conflicts.

“The more research we did, the more connections we found,” Austin Brentley, manager of corporate governance affairs at the Council said.

Whether the chairman influenced decisions over his compensation – and Grasso has insisted he didn’t – the arrangement smells rotten, said Nell Minow, editor of The Corporate Library.

“If you asked me what’s the best guarantee we’ll have some kind of pay abuse, I’d say first you let the CEO pick all of his directors, and then you make it so they don’t have to disclose his pay,” Minow said. “It’s a recipe for disaster.” Minow said the most urgent reform needed at the NYSE was a complete overhaul of how board members are selected for their two-year terms, to ensure that the process employs the same level of disclosure required for public companies, possibly with SEC oversight. (The Star Online, 9/16/03)

Floor traders were putting together a petition calling for Grasso’s ouster. We’re looking for the final NYSE report on corporate governance reform in early October” as part of a broad review, said an SEC spokesman.

Access Denied?

In “Access denied!” Hoffer Kaback (Directors & Boards) argues that once having elected a board, how can shareholders then seek to challenge a board’s “considered decision” of nominating a slate through a company proxy that is, itself, in large part the formal product and document of those same board members in their capacity as representatives of those shareholders. Kaback sees this as an “analytical pretzel,” where “self-referential, circular, and renvoi problems “ are “troubling.”

I don’t think you’ll find many Americans who agree that voters shouldn’t be able to challenge the considered decisions of their elected officials. Grousing about politicians, threatening impeachment and even recall are time honored traditions. Why should it be any different for boards of directors?

The more fundamental flaw in Kaback’s argument is that board members were never elected by shareholders in the first place, so they aren’t really challenging their elected representatives. Instead, they are challenging board members who are likely to have been either chosen or blessed by the CEO, a former CEO, or an “independent” committee whose members may or may not be the CEO or former CEO’s college roommates, dentists or other close friends. In any case, shareholders will have had as little input into determining the actual directors as voter in North Korea have over selecting their “elected” officials.

In a prior article, “The Albanian Candidate” (Winter, 2001), Kaback lamented the dearth of information about candidates and the lack of opportunities for shareholders to question and evaluate them. Now he’s having doubts about the SEC’s possible move to allow “common shareholders” to make nominations and have those nominees included on the company proxy, “notwithstanding that such candidates would be running against the director-nominees endorsed by the company (acting through its nominating committee and full board).” Yet, how better to end the “Albanian” syndrome? If board nominated candidates face actual contests, we can be sure there will be a wealth of information on all candidates and plenty of services available to help shareholders evaluate them.

Additionally, I don’t think Mr. Kaback need worry about “common shareholders” placing nominees on company proxies. According to anISS Friday Report (9/12), SEC Commissioner Roel Campos told theCouncil of Institutional Investors that the SEC proposal slated for release in October will be open to shareholders holding at least 3 percent, and maybe 5 percent. They’ll be able to nominate up to two or three director candidates, but not more 20 percent of a company’s board after a trigger event, such as a 20% withhold vote against a director or a board refusing to act upon a majority vote on a shareholder proposal.

Mr. Kaback notes that if the SEC acts to “recreate the proxy world,” “corporate elections as we know them will forever be transformed.” Yes, they’ll include an ounce of democracy.

Average is Best?

According to a recent study of 1,600 firms by GovernanceMetrics International Inc., companies with the worst corporate governance ratings returned 5.4% for the 12 months ended Aug. 12, compared with 11% for all stocks rated. The Dow Jones Industrial Average gained 9.7% in the 12 months ended Aug. 12. Over three years, the worst corporations lost an average of 13% a year compared with a loss of 1.8% for all companies. The Dow Jones industrials lost an average of 3.7% annually during that period. Highly rated firms beat those currently rated near the bottom over five and 10 years as well.

“But good governance doesn’t automatically make you rich,” according to the report in the Wall Street Journal. “While bad governance makes for bad returns, buying companies with top-notch governance won’t necessarily mean higher returns. While the companies that get top governance scores did best during the past three years, corporations with average ratings won the five- and 10-year contests.” (Weak Boardrooms And Weak Stocks Go Hand in Hand, WSJ, 9/9/03)

That seeming anomaly is easily explained. Many companies with the best corporate governance are the recent beneficiaries of intervention by activist shareholders like Ralph Whitworth, Burt Denton, and Andrew Shapiro who have been, in Maureen Nevin Duffy’s terms, “pushing back.” They’ve taken poorly performing companies and turned them around by instituting corporate governance reforms. Ms. Duffy’sCorporate Governance Fund Report is the only publication systematically following these crusaders.

Duffy provides coverage of the recent Council of Institutional Investors meeting. She reports that Ralph Whitworth said everyone knows “you have to dance with the one that brought you to the dance.” When push comes to shove corporate board members are more likely to vote with the one who put them on the board. Shareholders “have to get a ticket to the dance.” Open access to the corporate ballot would provide that ticket. Whitworth contends that none of the now notorious companies like Tyco and Enron would’ve set off a trigger event under upcoming SEC rules. “The issue is to be proactive not reactive. If board members felt truly vulnerable under challenge,” most companies would respond.

Other factors being equal, over the long run, companies with excellent corporate governance will provide excellent returns. That’s what I’m betting on.

National Coalition of Corporate Reform

In a keynote speech at the fall meeting of the Council of Institutional Investors, New York State Comptroller Alan Hevesi, who oversees $90 billion in pension funds, called for investors to form an activist group that will police poorly behaving companies.

The group would pursue its efforts through lobbying, litigation, proxy voting, and intervention in the regulatory process. Hevesi’s proposal to form the NCCR has been endorsed by a number of officials including California Treasurer Philip Angelides, Pennsylvania Treasurer Barbara Hafer, AFSCME International President Gerald McEntee, North Carolina Treasurer Richard Moore, AFL-CIO President John Sweeney, and California Controller Steve Westly. There are also expressions of support from New York State Attorney General Eliot Spitzer, CALPERS Board President Sean Harrigan and New York City Comptroller William C. Thompson, Jr. An organizing meeting for the group is planned for early October.

“The goal of the coalition is to reform corporate governance and restore confidence in the financial markets. NCCR will unite institutional and individual investors, labor leaders, corporate CEOs, elected officials and community leaders in support of a program of corporate governance reforms, regulation and legislation,” Hevesi said. (press release, 9/3/03)

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CREF Faces Shareholder Resolution on Divestment of Gold Mining Companies

On August 11, the College Retirement Equities Fund (pension fund for college/university faculty and staff), which offers the largest singly managed stock account in the word, notified the Securities and Exchange Commission that it was withdrawing its No-action request and would include an amended shareholder proposal requesting a vote at its November 2003 Annual Meeting on divestment of gold mining companies from CREF stock accounts.

CREF had notifed the SEC that it intended to omit the original resolution which also called for a divestment vote on gold mining companies. CREF objected to the focus of the supporting statement on Freeport McMoran Copper and Gold’s environmental and social concerns regarding its gold mining activities in West Papua, Indonesia. In fact, it its letter to the Securities and Exchange Commision, CREF claimed, “The Company is not aware of any debate, media attention, or legislative or regulatory initiatives regarding gold mining.”

In order to rebut CREF’s claim, the amended shareholder proposal contains a new supporting statement documenting environmental and social concerns with a host of other gold mining companies in CREF’s portfolio including Newmont Mining, Placer Dome, Rio Tinto and NewCrest Mining.

In addition, in 2003 CREF shareholders will again have an opportunity to vote on separation of the CEO and Chairman of the Board positions. The separation resolution received over 23% of the CREF vote in 2002. However, the content of the supporting statement that appeared in the 2002 proxy has been challenged by CREF. An amended resolution has also been submitted to CREF and the SEC, but the SEC staff has yet to make a decision.


For both ethical and financial reasons, participants request CREF: 1) To announce that CREF will make no additional gold mining-related investments, and 2) To begin an orderly divestment of all gold mining investments.

Participant’s Supporting Statement

Central banks and international financial institutions hold more than 34,000 tons of gold. This is more than 13 times the annual production of the world’s mines; if sold, these reserves could satisfy gold demand for more than 8 years (current demand is approximately 4,000 tons per year). Of this demand, 85% is typically used for jewelry.

Gold mining companies cause environmental and social impacts.

  • Newmont Mining: The Indonesia government is sending a team to take tailing samples from gold mining firm Newmont in North Sulawesi following a report that cyanide levels in the tailings exceeded the government limit. (Jakarta Post, Moch N. Kurniawan, June 21, 2003). Newmont has admitted spilling mercury at its mining operations in Peru in 2000. “Newmont CEO Parries Environmental Attacks At Shareholder Meeting”, Tom Locke, Dow Jones Newswires, May, 7, 2003)
  • Placer Dome: Indigenous Dayak Meratus of Indonesia, submitted a statement at the Placer Dome Annual Shareholder meeting April 30, 2003, stating that Placer Dome’s proposed gold mine on their lands threaten their environment and their very existence as indigenous peoples. The Dayak Meratus live in the last remaining native forest in Kalimantan, Indonesia, which has enjoyed protected status since 1928. Placer Dome proposes to build a gold mine in the Meratus Mountain Range Protected Forest, violating Forestry Law 41. The Dayaks have already made unequivocal statements opposing this mine. (“Three Communities Protest at Placer Dome AGM,” Report
    from Miningwatch, Canada, April 30, 2003.)
  • Rio Tinto: Rio Tinto operates over 60 mines and processing plants in 40 countries. Rio Tinto owns 90% of the Kelian gold mine in Kalimantan, Borneo, Indonesia. Prior to Rio Tinto’s arrival to Kalimantan, small-scale gold mining was performed by the local population. Around 1989, paramilitary police forced the local miners out of the mines. In 1990, Rio Tinto acquired more land, evicting more people who had to live in shanties. A total of 440 families were displaced from their homes. Some compensation was paid, but it was not adequate to cover losses. (Asia-Pacific Human Rights Network, Corporate Watch, Human Rights Features, July 16, 2001.)
  • NewCrest Mining: The conflict between forest protection laws and mining leases issued in protected areas has created a political storm in Indonesia. Indonesian Ministers and officials fear international legal action if mining is excluded from protected areas. Media reports have linked Indonesian government fears of costly international arbitration to Australian owned projects such as Newcrest’s PT. (“Protected areas international arbitration threat to Indonesia”, Koran Tempo, 3 April 2002 [translation].)

It is unclear how much environmental liability, cleanup responsibility, and remediation costs may exist, and no existing audit contains information on any environmental liability.

Should CREF financially co-sponsor the manufacture and promotion of such
mining activities? If not, vote for orderly divestment.

Submitted by Ann E. Marchand, 7043 22nd Ave. N.W., Seattle, WA 98117

SEC Comment Deadline Draws Near

September 15, 2003 is the deadline for public comments on SEC rulemaking release 34-48301: Disclosure Regarding Nominating Committee Functions and Communications between Security Holders and Boards of Directors. One of the more interesting comment letters was submitted by Mr. David A. Smith. His generously footnoted comments reference source materials and specific regulations in support of points influenced by his ongoing attempts to influence State Street Corporation (NYSE: STT). His efforts and those of others are documented atShareholders Online, a site operated by Patrick Jorstad. I asked Mr. Smith to summarize his thought provoking recommendations for readers of CorpGov.Net. He graciously provided us with the following points:

  1. Require directors to disclose their home addresses in filings with the SEC. Directors of publicly traded corporations should be required to disclose their home addresses in the inside ownership filings they routinely file with the SEC. Directors often substitute the corporate address in these filings for their home addresses, making shareholder communication (and service of process, should a shareholder lawsuit become necessary) more difficult. Implementation of this change would be simple and cost nothing.

  2. Repeal Rule 14a-8(i)(8). Currently, shareholders are barred from using Rule 14a-8 (“Shareholder Proposals”) to propose director nominees. Rule 14a-8(i)(8) permits a corporation to exclude from its proxy materials any shareholder proposal that pertains to “an election for membership on the company’s board of directors.” This means that insurgents must engage in an expensive proxy fight, while incumbents receive a free ride on the corporation’s proxy materials (at shareholder expense). This creates an “artificial, SEC-sanctioned monopoly on the nominating process that is more befitting of Communism than of representative democracy.”

  3. Create a tough, uniform definition of director “independence,” such as that offered by the Council of Institutional Investors, applicable to all directors of all publicly traded companies, without regard to their listing status on a particular stock exchange. When directors with self-dealing transactions and other conflicts of interest populate the nominating committee, shareholders are unlikely to have faith in the nominating process. Just because a committee is populated with “non-employee directors” does not mean they’re “independent.”

  4. Require companies to disclose the names and addresses of rejected nominees and their sponsors. The SEC’s proposed rules would only require a company to disclose the names of a rejected nominee’s sponsors. Requiring a company to disclose the names and addresses of the sponsors and of the rejected nominee would facilitate direct shareholder communication with the insurgents, and would empower shareholders to learn more about the facts and circumstances surrounding the rejected nominee’s candidacy. The SEC currently requires companies to disclose the names and addresses of the sponsors of shareholder proposals under Rule 14a-8, so such disclosure isn’t unprecedented.

  5. Mandate disclosure of the fees paid to third party nominee evaluators. Failure to disclose the fees paid to third-party nominee consultants could lead to at least two kinds of abuses. First, companies might pay exorbitant fees (for reasons largely unrelated to genuinely evaluating the nominees). Second, companies might also pay token fees, to provide a false patina of respectability for their choice of nominees. Mandating disclosure of the fees paid would cut down on the opportunity for mischief.

  6. Base the 3% ownership threshold in the new rules on the number of shares actually voted at the last shareholders’ meeting, not the total shares outstanding. The proposed rules would require a company to disclose that it has rejected a nomination from shareholders owning, in the aggregate, 3% of its outstanding shares. However, the total number of shares outstanding is usually substantially less than the total number of shares that a company reports as actually voted at its last shareholders’ meeting. Basing the 3% ownership threshold on the number of shares reported as actually voted at the last shareholders’ meeting will give corporations added incentive to ensure that proxy materials are received by all shareholders, that proxies are voted, and that all votes are properly “accounted for.” This would also make it easier for smaller shareholder groups to meet the 3% threshold.

  7. Require corporations to disclose all changes to their nominating processes or to their governing documents on Form 8-K. Shareholders have a right to know when such procedures or governing documents (e.g., articles of organization, by-laws, etc.) are changed. Mandating that such changes be disclosed on Form 8-K (“Current Report”) would ensure that shareholders learn of them in a timely fashion.

  8. End the SEC’s Special Treatment of the Corporate Bar, such as the provisions of 17 CFR §229.404(b)(4) and §205.7 which provide a special exemption to attorneys with regard to reporting business relationships. Corporate attorneys, who may represent companies before the Commission, should be under the same requirements as anyone else.

Mutual Fund Fraud

Eliot Spitzer, the New York attorney general, found major mutual fund companies engaging in fraudulent after-market trading practices with privileged institutional investors. Canary Capital Partners, has agreed to settle with Mr. Spitzer’s office, returning $30 million in profits and paying a $10 million penalty. While Bank of America’s mutual fund family, Nations Funds, is named most prominently in Spitzer’s complaint, prosecutors also mentioned the names of other major fund companies that had provided similar trading benefits to institutional clients, including Janus, Security Trust Company and the mutual fund division at Bank One.

Academic research has estimated that mutual fund shareholders lose billions of dollars annually due to the trading abuses that are the subject of Attorney General Spitzer’s ongoing investigation. (see Spitzer’s press release, 9/3/03; NYTimes, Mutual Funds Allowed Fraudulent Trading, Spitzer Says, 9/3/03)

Only a few years ago Matthew P. Fink, President of the Investment Company Institute boasted that “over 80 million individual shareholders own mutual funds, nearly one in two households. Our industry opened the capital markets to all investors, and we have done so without scandal, without government bailouts, without betraying the trust and confidence of our shareholders.” (2000 Mutual Funds and Investment Management Conference: Keynote Address) As recently as June 2003 Paul Roye, director of the SEC Division of Investment Management, credited the lack of scandal in the investment company industry to the fact that many funds have compliance officers and effective compliance procedures already in place. Yet, his division found no compliance controls in place as all at some investment company complexes. (Roye Outlines Investment Management Division’s Agenda)

Let’s see if they get religion.

Handy’s Democratic Vision

The Fall 2003 edition of “Strategy + Business,” carries an informative article on one of the gods of modern business literature, Charles Handy. A good summary of Handy’s influence is found in a quote from Warren Bennis, “If Peter Drucker is responsible for legitimizing the field of management and Tom Peters for popularizing it, then Charles Handy should be known as the person who gave it a philosophical elegance and eloquence that was missing from the field.”

Lawrence M. Fisher begins with a stroll in one of England’s small villages where Charles Handy and his wife Elizabeth make their home. He explains that one of Handy’s early insights was that organizations aren’t inanimate objects but vibrant microcosms of human societies. Those who seek to manage companies need to understand the motivations of individuals and how collective behavior determines organizational behavior.

In his second book, Gods of Management, Handy saw us moving from corporate cultures built around the founder (Zeus) and bureaucracy (Apollo) to collaborative teams (Athena) and independent specialists (Dionysus).

Fisher goes on to portray an intellectual journey to the point that now Handy has come to believe that “a company ought to be a community, a community that you belong to, like a village.” “Nobody owns a village. You are a member and you have rights. Shareholders will become financiers, and they will get rewarded according to the risk they assume, but they’re not to be called owners. And workers won’t be workers, they’ll be citizens and they will have rights. And those rights will include a share in the profits they have created.”

And just what would such a company look like? Building on Handy’s work, Brook Manville and Josiah Ober begin to give us the outline in A Company of Citizens: What the World’s First democracy Teaches Leaders About Creating Great Organizations (2003). The authors provide readers with a wealth of information concerning the rise of Athenian democracy and the importance of harnessing the knowledge of people who have an innate desire to have a part in controlling their own destiny.

From citizens paying dramatists with public funds to expose the foibles of institutions and leaders to intricate systems designed to ensure artificial social networks stimulate the exchange of ideas, Manville and Ober present many interesting details. There is much here worth borrowing, from team-based rotating leadership to transparency of information to ensure group decisions had a solid foundation.

They appear to accept Handy’s suggestion, from The Hungry Spirit(1998), that companies should issue two classes of shares – voting shares for members of the company and some major stakeholders – nonvoting shares for more casual or short-term investors. People need to take center stage in terms of rewards and honors at most companies where human knowledge is the prime creator wealth. Handy sees the rights of citizenship being extended in some limited way to part-timers, freelancers, as well as suppliers and investors.

Elsewhere I have written of the need to reassess the role of antitakeover defenses, suggesting that instead of using poison pills, firm specific human capital could be better protected through bylaw amendments that require employee approval of changes in ownership. (see “ATDs Issues Not Simple” in August 2003 News)

Where are we likely to see such democratic companies arise? Based on Handy’s writings, as extended by Manville and Ober, we’ll find them where

  • Companies have a clear sense of their own mission and goals — where the company of citizens believes the goals can best be achieved through collective action.
  • The nature of the work and the performance challenges demand large-scale cooperation and collaboration. Traditional hierarchies may work well enough for routine activities but as work relies increasingly on knowledge, democracy is a better fit.
  • The need for fresh ideas and management approaches require regular changes in leadership.

Perhaps two of the most important factors are relatively high employee ownership and unionization. One indicates commitment to the firm, the other is a crucible of democracy in the workplace.

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