April 2004

Self-Dealing at CalPERS

That appears to be the accusation of Neil Weinberg’s article,Sanctimonious in Sacramento, in Forbes magazine. This proxy season it is opposing some or all directors at 90% of the firms whose shares it owns. Yet, Weinberg contends “if the pension fund itself were held to the same standards it demands of corporate America, the board of Calpers might have to fire itself.”

State Treasurer Philip Angelides, Willie Brown, former San Francisco mayor, and former director Kathleen Connell, who was State Controller at the time, are all accused of accepting campaign funds from those doing business with CalPERS. According to the article, 18-year board veteran Charles Valdes chaired a philanthropy in the late 1990s that solicited donations from money managers who worked for CalPERS. Board member Kurato Shimada, took two years off through 2001 to work for a marketing firm lobbying CalPERS.

The article also cites CalPERS’ reluctance to disclose information on private equity investments and attempts by the board to entrench itself through election rules which favor incumbents. Our opinion? Yes, the CalPERS board isn’t perfect…but they are certainly moving in the right direction. Many of the transgressions cited are many years old and are less likely now. Yes, the CalPERS board has various conflicts of interest. However, few could argue that it is more open to such conflicts than pension funds of other states, which are often controlled by a single politician.

Yet, improvements can be made. Contributions to politicians by those doing business with CalPERS could be more limited, but the same could be said for political reform in general. The ban on lobbying a former employee could be lengthened to two years, instead of one. And, CalPERS’ own election rules could be reformed to at least require directors to be elected by a majority of those voting (one former director was elected by less than 6% of voters).

Corporate Governance Hedge Fund in Works

According to the Financial Times, shareholder activist Robert Monks is planning to launch a dedicated corporate governance hedge fund. (Shareholder activist to launch corporate governance hedge fund, 4/27/04)

The fund will short some of the world’s worst governed companies and is expected to be managed by John Higgins of Ram Trust Services, which currently runs $200m of assets on behalf of wealthy clients. An equal weighting of long and short positions is anticipated. “We are essentially trying to measure human capital,” said Higgins. Value added is expected to come from a careful analysis of corporate governance standards and practices, rather than market timing.

We wish them every success and will be looking into take a position in the fund if affordable.

Environmental and Sustainable Investing: The CalPERS Way

Highlights of a speech by Sean Harrigan President California Public Employees’ Retirement System at the Ceres Conference Boston, Massachusetts April 15, 2004.

No question, climate risk is a financial and a health security issue that affects everyone, including our 1.4 million CalPERS members and their families. CalPERS’ recent action has produced an unexpected result. Literally hours after we voted to commit $200 million in private equity funds to environmental investing, businesses began to knock our doors down with ideas and interest.

Our private equity staff just completed a year-long study of risks and rewards of investing in this area…and reached the following conclusions: That prospects for generating good long-term investment returns are excellent – long term. That the opportunities are both close to home in California and worldwide. Staff also found that leadership is being demonstrated in other states and in other countries. They are “green investors” – investing from both from an R&D standpoint and from a consumption standpoint.

These developing green technologies also suggest an opportunity to create new fair wage jobs. These new emerging companies can lead to thousands of new jobs in California.

Regulatory agencies are continuing to drive many present opportunities – and they are responsible for accelerating the development of new technologies and creating market opportunities. The Kyoto protocol is one of the most over-arching and influential drivers of environmental regulations. It has already had a substantial effect on world regulation. And in Europe and Japan, strict emissions standards combined with strong incentive programs have contributed to the growth in technology opportunities and markets.

Also helping to push along advances in green technologies are all the requirements designed to improve the quality of air we breathe, the water we use, and the soil that nourishes our agricultural crops. Again, these are opportunities that will be ripe for investment.

According to the market research firm Clean Edge, the current clean technology environmental market represents only 2% of the venture capital market. So today, when you compare it to other sectors, it is a new and emerging sector within the capital venture market. It is simply not possible to drop $200 million into the private equity markets quickly. We are thinking about hosting a conference in Sacramento in which we could attract investors from around the country and the world who may be interested in this area and who might be interested in working with us.

Wind generating capacity is expected to expand 15 times over in the next 20 years. The annual production of solar power has grown 150 percent in the last three years. Photovoltaic cell installations have increased by 450 percent in Germany over the last six years, and sales for fuel cells that power large generators are expected to reach $25 billion here by the year 2020. With all of this in the pipeline, is it any wonder why CalPERS is so interested in this program?

Later this year, I anticipate our staff will bring forward an analysis and possible recommendation regarding an “environmental governance” program. Similar to our corporate governance activism, this initiative could mean we would actively encourage companies — through dialogue, shareholder resolutions and other actions — to reduce environmental risks and liabilities.

We have begun to undertake a major audit of all of our real estate investments. We’re going to look behind the marble floors and fancy elevators and million dollar views of these buildings to see if they are doing all they can to use clean energy, be more efficient in their use of water, just to name a few, because we know they can reduce long-term costs.

We own 16 million square feet of office space and 96 million square feet of industrial space. I read recently that real estate companies with above average energy management performance tended as a group to outperform below average companies by about 34 percent. If that is true, we should be acting on this recommendation. Again, it certainly seems to make sense – both as an investor and in environmental terms.

In conclusion, I believe we have the know-how and technology to address climate risk, and we can do so while enhancing investment returns. But what we need today is the other important ingredient: leadership. We need investors, we need companies and we need policy makers to stand up and be counted.

It is gratifying to know that we may achieve our financial goals and also help repair the world’s fragile environment. We call this the double bottom line – achieving market rates of return while achieving a good result for the world community.

THE CORPORATION: Coming to a Theater Near You

Mark Achbar, co-director of Manufacturing Consent: Noam Chomsky and the Media, teamed up with co-director Jennifer Abbott and writer Joel Bakan to examine the far-reaching repercussions of the corporation’s increasing preeminence. Based on Bakan’s book The Corporation: The Pathological Pursuit of Profit and Power, this film is a critical inquiry into the corporation’s inner workings, history, controversial impacts and possible futures. Featuring interviews with Noam Chomsky, Michael Moore, Howard Zinn and many others, THE CORPORATION is coming to a movie theater near you. See it soon.

Uniform Dilemma

About 200 shareholders gathered for PG&E Corp.’s annual meeting nine days after the end of PG&E’s three-year utility bankruptcy. Shareholders were not thrilled with the suspension of dividends or the company’s $84 million retention-bonus program. After being named by Business Week as one of the worst executives of 2003, CEO Robert Glynn’s earnings of more than $17 million added insult to injury.

However, topping it all off was that while a number of shareholders were attempting to ask questions, Glynn essentially closed down the annual meeting with the introduction of 11 PG&E employees, most in uniform, who had recently been on active duty in the military. Shareholders found themselves in a dilemma, going along with the ploy or appearing to be rude to our military by insisting on their once-a-year right to ask questions. It isn’t appealing when politicians wrap themselves in the flag; it is even less attractive when CEOs do it.

The Corporate Library

I don’t imagine Newsweek often quotes Time magazine but our “competition,” The Corporate Library is so good we can’t fail to acknowledge the great job they’ve been doing of covering news in their weekly news briefs. Here are just a few recent highlights:

• Pay for CEOs at 70 of the largest 100 US firms rose to USD14.1 million on average in 2003, according to data compiled by Bloomberg. This means that the average CEO pay is equivalent to 384 years of average US employee’s USD36,764 and 525 years of a production worker’s USD26,902 average. Total CEO pay, including stock options, bonuses, salaries and other awards rose 7.5% in 2003.
• Citing a study by David Yermack, a New York University professor, that found personal use of company aircraft is “associated with severe and significant underperformance of their employers’ stock,” averaging 2% around the date of initial disclosure. Use of private aircraft by corporates jumped from an annual rate of 9 percent in 1993 to over 30% in 2002. “One might conjecture that the chief executives who consume excessive perks might be less likely to work hard, less protective of the company’s assets, or more likely to tolerate bloated or inefficient cost structures,” he said. The study looked at 237 companies in the 2002 Fortune 500.
• A recently-released survey of the top 4000 public US firms by Deloitte & Touche found that 83% had an established code of ethics. Twenty-five percent, however, are not actively monitoring compliance. Only 55% had an ethics officer. Slightly more than half said ethics and compliance concerns were addressed with their board only after failure occurs. Ninety percent include shareholders, suppliers, customers and other related parties in their ethics codes, but only 52% actually give out the codes to these parties.
• A new study by Independent Remuneration Solutions (IRS) found heads of the 10 biggest UK firms saw their pay packages grow by more than 12 times the rate of inflation for 2003 at 24%. Base salaries, said the IRS, accounted for only 16% of total remuneration, with the rest coming as bonuses, share options and pension contributions.

We also like their quote of the week: “Corporate scandals of recent years have clearly shown that the plethora of laws of the past century have not eliminated the less savory side of human behavior. Rules cannot substitute for character.” (Alan Greenspan, US Federal Reserve Chairman) From VOL 6 NO 10. Subscribe at News Briefs.

At CorpGov.net, our retort to Chariman Greenspan would be that character cannot be known in advance and all the checkbox rules in the world won’t allow shareholders to hold directors accountable. The recent spate of new laws are mostly window dressing. What is really needed is the ability of shareholders to place their nominees on the corporate ballot, place resolutions dealing with elections in the corporate proxy and take collective action, such as that recommended by the Corporate Monitoring Project. We’d like to see The Corporate Library expand their services. Right now, the site primarily appeals to institutional investors. However, they could play an important role in mobilizing individual investors by facilitating the ability of individual investors to vote by “brand,” as described in Vote Your Stock by Mark Latham.

Vote No on Symbolism

CalPERS shouldn’t be backpedaling. “Warren Buffett is a great director,” said Pat Macht, the head of public affairs at CalPERS, after the huge pension fund cast “a symbolic vote” against him at Coke.

CalPERS had argued that Buffett is not independent because companies he controls do business with Coke and that Coke’s audit committee, of which Mr. Buffett is a member, allowed its auditors to do other work for the company. CalPERS should either hold all directors to the same standard or their policies and votes should allow for exceptional individuals, such as Buffett. We agree with Floyd Norris’ statement in the New York Times (Do Institutional Investors Deserve New Authority?, 4/23/04), “A vote against re-electing a director ought to reflect actual opposition to that candidate.”

CalPERS Adds India as Investment Possibility

CalPERS put India on its investment radar on April 19, two months after it said India failed to meet the necessary standards.  The Board voted to add India, the Philippines and Peru to its list of permissible emerging equity markets, according to a press release.

“These three countries have made significant progress and demonstrated that they now meet our high standards for investment,” said Sean Harrigan, President of CalPERS Board of Administration. “This is an example of our policy having a positive effect in the emerging markets.” CalPERS has around $2 billion invested in emerging market equities, while its total investments are to the tune of $166 billion.

Investment Committee Chairman Rob Feckner expressed support for the emerging country evaluation process and said, “we can and will do more to refine our process so that any emerging country that wants to be responsive to our standards has a timely opportunity to be considered.” The decision to include India and the other two countries was taken after a reassessment of their “scores” based on several parameters, including market efficiency, corporate governance practices, transparency, political stability and the labour practices of the markets concerned.

Sanjay Sachdev, managing director and CEO of Principal Asset Management Company, a leading player in retirement funds, said it would open the floodgates for other such funds to follow. “It’s a re-affirmation of the growth story in India and the steps we have taken to improve our market delivery system,” he said.   (redriff.com, 4/21/04, CalPERS puts India on investment radar)

We see this as a positive step but would like to see CalPERS ranking both countries and companies within countries so that companies with excellent corporate governance are still eligible for CalPERS investments.

Corporate Monitoring Proposals

Proxymatters.com, the proxy discussion site, is asking its readers, “Should shareowners be able to select a proxy advisory firm, paid with corporate funds, to provide research and voting recommendations to the shareowners?”

If you or your firm own shares in Calpine (CPN), Oregon Steel (OS), USEC (USU), or Visteon (VC) you should be aware the Corporate Monitoring Project has shareholder proposals at each company that deserve your attention and support. The premise of each proposal is that individual and institutional investors can coordinate their voting to make corporate management accountable to shareowners. This will increase stock returns, control CEO pay, and balance profits with social goals. The proposals, “Voting Leverage” and “Proxy Advisor,” are variations on the same theme: making shareowner voting more powerful by using competing intermediaries — institutional investors and proxy advisors respectively, to provide advice on proxy issues.

Given most individuals’ lack of time and expertise, professional recommendations can often sway their votes. The Voting Leverage proposal (CPN and VC) asks for a study and report on the feasibility of offering a convenient mechanism for individuals to copy the voting decisions of institutional investors on all matters put to shareowner vote except director elections. (Director elections are excluded here to satisfy SEC rule 14a-8(i)(8).). So for example, besides being offered a convenient choice of voting the entire proxy as the board recommends, perhaps shareowners could be offered a similarly convenient choice of voting the entire proxy (except director elections) the same way Domini Social Investments, the Calvert Group, Pax World or CalPERS votes its shares. Shareowners would be able to see how these “brands,” which have considerable research capabilities, vote and could then decide to join them.

Under the Proxy Advisor proposal (OS and USU), the Board of Directors would hire a proxy advisory firm for one year, to be chosen by shareowner vote, paid for with corporation funds. Having shareowners, rather than the Board, choose the proxy advisor would further enhance independence. Shareowners have a common interest in obtaining sound independent advice, but often insufficient private interest to justify paying for it individually (the “free-rider” problem). This proposal would provide owners with independent advice concerning future voting issues at minimal cost.

Both proposals fit nicely with the multi-year process contemplated by the SEC’s rulemaking, Security Holder Director Nominations, S7-19-03. Additionally, if that rule passes, I have hopes that in the future the SEC will allow Voting Leverage and Proxy Advisor proposals to include advice on director elections. That would certainly facilitate the move to corporate accountability. See http://www.corpmon.com for details: text of proposals, annual meeting dates/locations, links to proxies, board critiques of proposals, and proponent responses.

CalPERS Effect

With increasing publicity, such as a recent article in the Wall Street Journal(‘Calpers Effect’ May Give Lift To Underperforming Stocks, 4/20/04), the “CalPERS Effect” could become a self-fulfilling prophecy. The six companies, as follows, targeted by the pension fund last year have outperformed the S&P 500 and largely surpassed their peers: Gemstar-TV Guide International Inc., JDS Uniphase Corp., Manugistics Group Inc., Midway Games Inc., Parametric Technology Corp., and Xerox Corp. (The publisher has investments in Gemstar, see disclosures).

Companies named to its focus list between 1992 and 2001 saw stock gains of about 12% over the three months after being named to the list. Companies targeted by CalPERS between 1987 and 1999 outperformed the S&P 500 index by more than 14% over the five years after being listed. All the publicity around its shareholder activism isn’t hurting the likelihood the CalPERS Effect will continue, and perhaps accelerate, especially if the SEC provides greater access to shareholders to nominate directors. CalPERS would be smart to step up their investments in targeted firms before announcing their list. That way they would get more benefit from their heavy lifting.

Investments Increase

Assets in 401(k) plans increased 22% in 2003, reaching a record $1.795 trillion. That ends a three-year decline, according to the Society of Professional Administrators and Recordkeepers (SPARK). Participation rates were 78% among plans with more than $5 million in assets and 75% among smaller plans.

Exec Comp #1

Executive compensation has emerged as the top corporate governance issue this proxy season, according to a report in AccountingWeb.com. (4/13/04, Executive Compensation Emerges As Number One Corporate Governance Issue)

Institutional Shareholder Services (ISS) is tracking more than 300 pay and stock option related proposals this year and expects record levels of shareholder actions, especially when a disconnect between pay and performance is observed. “Clearly boards of directors have more work to do in producing compensation formulas that will satisfy shareholders and the public, indicates Bill Ide, Sr. Fellow of the Goizueta Directors Institute, which will sponsor their annual Goizueta Directors Institute summit, May 26 and 27 to address the compensation crisis and new mandates that seek to control executive pay.

The Financial Accounting Standards Board (FASB) has proposed that publicly-traded companies record as a compensation expenses all forms of share-based payments to employees, including employee stock options. “The FASB has done compensation committee members a huge favor by leveling the playing field,” states Patrick McGurn of Institutional Shareholder Services. “Now pay panels won’t be handcuffed by the current accounting rules’ bias against performance-based awards. Recent well-publicized changes in compensation practices at Microsoft, GE, IBM and other bellwether firms represent the first wave of the post-footnote reform era.” The FASB proposal is available for comment until 6/30 but a House bill that would block the proposal is gaining support from Republican and Democratic leaders. (Accounting board defends plan to count stock options as expense, Mercury News, 4/20/04) In our opinion, enactment would be a tragedy.

In testimony to Congress’s Joint Economic Committee, Federal Reserve Board chairman Alan Greenspan said that not expensing stock options gives a distorted view of profitability. The Fed chief acknowledged that the House of Representatives is considering a bill that would defer enforcement of FASB’s rule until the SEC studies its economic impact. Noted Greenspan, “I think it would be a bad mistake for Congress to impede FASB.”

Compliance Week reports that DaimlerChrysler bowed to concerns by voluntarily scrapping its stock option plan for its managers in favor of an incentive pay plan. Board members will earn a variable component that depends on the stock price and the company’s return on sales compared with a peer group, including BMW, General Motors and Toyota, according to published accounts. This means the board members will receive their first bonus in 2009.

“We’re looking at a major overhaul of executive pay programs,” said Steven E. Hall, President of Pearl Meyer & Partners, in a statement. “Companies are acting on investor demands that pay programs be less dependent on short-term stock price movement and more directly related to long-term financial performance as well as real growth in shareholder value.” (Executive Compensation Is 2004’s Lightning Rod, 4/13/04)

Director Independence

The Delaware Supreme Court has affirmed a lower court ruling dismissing a shareholder derivative action challenging the independence of the board of directors of Martha Stewart Living Omnimedia. The court found that four of the six directors were independent, despite holding a friendly relationship with Martha Stewart and conducting a modicum of business interactions with her or her company.

In measuring independence, the court presumed directors were “faithful to their fiduciary duties,” and required the plaintiff “to overcome that presumption” by creating “a reasonable doubt.'” “Allegations of mere personal friendship or a mere outside business relationship, standing alone, are insufficient to raise a reasonable doubt about a director’s independence,” ruled the court. (see Law.com, 4/15/04, Martha Stewart Shareholders Lose In Court)

All the more reason to keep pushing to allow shareholders to place their director nominees in the corporate proxy. That will give us truly independent directors.

A Supplement, Not a Replacement

Joseph Grundfest, Stanford Law School professor and a former SEC commissioner, proposed majority elections of directors as an explicit alternative to the SEC’s proposal to place director nominees on corporate proxies, under very limited circumstances. (see letter of April 12th)

The American Society of Corporate Secretaries (ASCS) and Barclays Global Investors NA (BGI) also signed the letter, which made it “the only perspective that has material support in both the corporate and shareholder communities,” according to the signatories.

“Such a majority requirement would create a strong incentive for corporate nominating committees to confer and consult with shareholders about the identity of nominees,” Grundfest pointed out. “The result will, we believe, be a less confrontational mechanism that constructively engages shareholders in the process of nominating and electing directors.” (ISS Friday Report of April 16, 2004)

James E. Heard, Vice Chairman, Institutional Shareholder Services, wrote to the SEC that ISS continues to believe that the Commission’s proposed Rule 14a-11 should be adopted.

“While we have urged changes in the proposed rule (see our earlier comment letter and our comments at the recent March 10, 2004, Roundtable discussion) we believe that proposed Rule 14a-11, which would provide significant longterm shareholders with a realistic opportunity to have their own nominees for director included in a company’s proxy materials, is a sound proposal.

We also believe that the Grundfest proposal has considerable merit. While it does not offer a means for shareholders to have their own nominees included in a company’s proxy materials, it does provide strong incentives for companies to seek majority-vote election of all directors. Companies that chose to permit directors who failed to receive a majority of votes to serve on their boards would face disclosure requirements that few companies, and few directors, would find attractive. The likely result would be to encourage companies to elect directors by majority, rather than plurality, votes.”

He suggests the Grundfest proposal be considered “as a supplement to, and not a replacement for, the right of shareholders to have their director nominees included in company proxy materials.” We heartily agree.

Lax Tax

In 1940, corporations and individuals roughly split the federal income tax bill equally. Last year, corporate taxes accounted for 13.7%, while individuals paid 86.3%. The majority of companies operating in the United States in 2000 didn’t pay any taxes, according to a recent GAO study. According to the study, 73.3% of foreign-based companies paid no taxes in 2000, and 88.5% paid less than five percent of their U.S. earnings. Among U.S.-based corporations, 63% paid nothing. And a remarkable 93.9% owed less than five percent of their income. Small companies (less than $250 million in assets or gross receipts of less than $50 million) were more likely than large companies to pay nothing.

Although Enron has heightened concerns about corporate fraud, only 0.75% of business tax returns were audited by the IRS in the past year, down from 2.62% in 1997, according to Syracuse University’sTransactional Records Access Clearinghouse (TRAC). In 2003 there were only12 civil negligence penalties aimed at corporations. Back in 1999, there were 62. During the same period, civil fraud penalties dropped from 247 to 170.

The major corporate scandals of recent years haven’t involved tax abuses, but, as Ackman writes “the legal and political atmosphere would seem to counsel an increase in revenue agency diligence, not a decrease.” (“Free Riders” by Lee Drutman for TomPaine.com and “Firms Often Avoided Taxes,” by Warren Vieth of the Los Angeles Times, and “IRS: Paper Tiger,” by Dan Ackman of Forbes.com)

CalPERS to Nominate

With or without the SEC’s proposed rule that would make it easier for investors to elect directors, CalPERS is “strongly considering” offering up its own board nominations, said William McGrew, an investment officer in Calpers’ corporate governance unit, according to a Wall Street Journal article by Phyllis Plith. (Calpers ‘Strongly Considering’ Running Board Candidates, 4/8/04)

Such talk at CalPERS has gone back at least to the days of Dale Hansen and Richard Koppes but now they appear to be getting serious. One probable candidate would be Ralph V. Whitworth, a principal at Relational Investors LLC, who presses for change at investment targets, in part, by elbowing his way onto their boards. CalPERS already has about $1 billion tagged for Whitworth’s $2.4 billion investment fund.

The prospect is welcomed by veteran activits, such as Herbert Denton, president of New York investment bank Providence Capital Inc. Over the years Denton has helped place 34 individuals on 19 boards as part of a strategy to enhance shareholder value. “I think CalPERS has always been in the vanguard in thinking about corporate governance,” he said. “For goodness sake, they are huge shareholders, they are permanent investors, why shouldn’t they have representation?” “The institutional community owns nearly 60% of the top 1000 companies and they have virtually no direct representation at these companies. It’s insane.”

SEC’s Director Nomination Rule Still Moving

The SEC is now expected to post its revised recommendations for proxy access sometime in May, according to Compliance Week. One possible revision is to increase the threshold for withhold votes from 35% to 40-45%. The other modification many believe is under consideration is the “Advice and Consent” compromise proposal advanced by Joseph Grundfest and Ira Millstein. Under their plan, if a majority of shareholders withhold votes from a candidate for director, the company’s nomination committee must identify a new candidate.

“With this approach nomination committees would have the opportunity to find a candidate that meets both management and shareholder interests,” Grundfest said during the SEC’s recent roundtable. “And dissident shareholders that could be confrontational would not find their way on the board.” Although interesting, it is hard to see how that proposal can be reconciled with the thrust of the SEC’s proposal, which would give a small token of power directly to shareholders. (SEC Poised To Unveil Revised Proxy Access Rule In May, 3/31/04)

CNNfn Interviews Robert Monks

Christine Romans, CNNfn‘s anchor for Street Sweep, led with a question concerning a new trend that outside directors are actually showing up at annual shareholder meetings. Monks indicated that he will be much more impressed when directors are willing to meet with shareholders and discuss the issues. It took many hours and thousands of dollars for Monks to get to the Exxon’s annual meeting to present a shareholder resolution. “I asked if I could ask a question of a director and I was told no.” All he got was his four minutes under the red light.

Jim Hedges appeared to question recent reforms, saying that outside directors “rely solely on management” for information, at the same time they are being asked to sign off on the viability of those statements. “Why on earth would I want to be an external director in a public company?” Monks said that shows the problem with the American model. The board is dependent for information on the very person they are supposed to be evaluating. “What does that tell you? Does it tell that you there is a serious commitment to having a board to carry out the duties that we are told that directors are supposed to do, or does it tell you that a board of directors is largely cosmetic?” (3/31/04 March 31, 2004, Transcript # 033104cb.l06)