January 2005

Pension Funds Come Out Swinging
Several hours before President Bush made Social Security reform the cornerstone of his State of the Union address, California Treasurer Phil Angelides, New York Comptroller Alan Hevesi, North Carolina Treasurer Richard Moore, corporate governance expert Nell Minow, and acting CalPERS President Rob Feckner held a press conference to criticize Governor Schwarzenegger’s plan to privatize all of California’s public pension funds.

The Governor had recently announced he would wage a “national battle” and would raise $50 from donors around the country “to help us fight this battle.” In his prepared remarks, Angelides pointed out that scandals at Enron and WorldCom alone cost CalPERS and CalSTRS more than $1 billion. California’s pension funds have been key leaders, exercising “their marketplace strength to push for reforms such as curbing excessive executive pay, strengthening accounting standards, increasing transparency, and opening corporate board elections to shareholders.”

Three years after scandals rocked Wall Street and investors and taxpayers lost trillions – while former WorldCom CEO Bernard Ebbers and former Tyco CEO Dennis Kozolowski face trial – corporate interests, with Schwarzenegger as their ally, are leading a counter-attack against recent reforms and the public funds that helped to enact them.

Angelides pointed out that although Schwarzenegger claims California’s pension plans are a “looming train wreck,” at CalSTRS alone Schwarzenegger’s “reform” plan “would cost the State and local school districts $5.9 billion over the first ten years.” Obviously, the motivation isn’t saving money. Angelides attributed it to a broader effort to “silence the voice of reform and weaken the ability of shareholders to hold corporate directors and managers accountable” by breaking the strong voices of California pension funds into millions of pieces.

Angelides named Grover Norquist, president of Americans for Tax Reform, and Stephen Moore, president of the Free Enterprise Fund, as two of the free-market enthusiasts pushing Wall Street interests. He provided quotes from both and from Jon Coupal of the Howard Jarvis Taxpayers Association that point to the corporate governance policies of CalPERS and CalSTRS as the overriding issue and the real reason for “pension reform.”

The tone of the press conference was one of preparation for battle, as well it should be. In his most inflammatory remark, Angelides said that Schwarzenegger’s plan looks like it was put together “by a bunch of right-wing ideologues and convicted CEOs out on parole.”

Richard Moore emphasized the reason public pension funds are involved in corporate governance is to obtain better returns, that parts of corporate America were stealing, that some mutual funds had been getting kickbacks, that administrative costs for DC plans would be at least seven times DB costs, and that it was hypocritical of CEOs to demand DC plans for public employees because they have kept their own DB plans.

Nell Minow said removing public pension funds from the equation is a bad idea. Corporate funds face too many conflicts of interests. Public funds play a crucial role in keeping corporate officers in check, something that can’t be done by atomized individuals. “If we remove the one category of investor that is independent enough to be fair and big enough to be effective, there will be no one left to provide the oversight that is and essential element of the capitalist system,” she said. Minow concluded by noting that much of what has been accomplished by public funds has been a result of their actions involving individual companies.

During the question and answer period Angelides opined that, in appealing to voters, many of whom have lost DB plans, Schwarzenegger “wants to pit the struggling against the struggling.” He listed a number of accomplishments driven by public pension funds including greater disclosures, more transparent accounting procedures, new standards of board independence, Sarbanes-Oxley, and he vowed to continue the fight.

3rd Annual Investment Adviser Compliance Forum
May 16-17, 2005
Harvard Club, New York City
To register call Financial Research Associates at 800-280-8440.
This event features an all-star faculty that will provide a cornerstone meeting for investment advisers and compliance officers to get up to speed on the shifting regulatory landscape. 
2005 Forum Highlights:

• Identifying and Mitigating Conflicts from the SEC’s Point of View
• Sales Practices and Licensing Issues ¬- Performance Advertising
• Compliance Best Practices
• Code of Ethics – A Practical Guide
• The Nuts and Bolts of the SEC’s Risk-Based Exam Program
• Books and Records Comprehensive
• Update from the SEC: The New IA Surveillance Program
• How Litigation Trends Affect IA Compliance
• Best Execution, Brokerage Practices & Changes to Soft Dollar Requirements
• Implementation of the New Compliance Rule
• Testing Your Compliance Policies and Procedures
• Adviser Disclosure Requirements

WorldCom Director’s Pay a Price for Looking the Other Way

New York’s State Common Retirement Fund alleged the WoldCom board of directors had been “utterly derelict in carrying out its most basic functions” providing “no internal checks and balances on WorldCom management” and was “completely beholden to management.” More importantly, the Fund insisted that directors pay a significant portion of the settlement. In an unprecedented move, 10 former directors agreed to pay $54 million, including $18 million out of their own pockets.

The news came on the same day a preliminary settlement was announced requiring 10 former Enron Corp. board members to pay $13 million of their own money to resolve an investor lawsuit over the energy giant’s 2001 meltdown. The $13 million payout by former board members at Enron would be part of a larger $168 million settlement with the Regents of University of California, who were the lead plaintiffs on a class action lawsuit.

If anything will make directors think twice about dereliction of duties, this should do it. It “will likely have a jarring effect on anyone serving, or considering serving, on the board of a public company.” Directors who were paid about $35,000 a year are now liable to pay out millions. (Commentary: Ex-WorldCom Directors Agree to $54 Million Settlement by Bruce Carton, Executive Director, Securities Class Action Services, ISS Friday Report, 1/7/05)

The amount is said to total 20% of the directors’ aggregate net worth, not counting their primary residences, retirement accounts and certain joint marital assets. But Dan Ackman, writing for Forbes.com, says “Of course, if you exclude primary residences, retirement accounts and certain joint marital assets, most people, even fairly well-to-do people don’t have much of a net worth at all, so taking those categories out of the mix would seem to render the 20% figure fairly meaningless.”

“If company directors perceive the WorldCom settlement as a warning, then it’s a warning,” according to Ackman but class action suits recover only a pittance of what has been lost. Indictments for fraud have also leveled off. “Despite WorldCom and Enron all the whining and crying about Sarbanes-Oxley, the numbers underneath seem to show that the real story is business as usual.” (Accounting For The WorldCom Deal, 1/6/05)

The consensus, however, seems to be that it will have an impact. Charles Elson, director of the Center for Corporate Governance at the University of Delaware said, “directors will certainly seek to avoid any conflicts of interests like the plague. But will anybody want to serve on a board? That’s the question.” Roger Raber, president and CEO of the National Association of Corporate Directors said, “WorldCom was an egregious example, but now, if something goes wrong anywhere else, they’ll go after the directors. That’s a terrible precedent to set.” (WorldCom settlement could have long-reaching effect on corporate boards, Canada.com, 1/9/05)

Yet, what is so terrible about holding directors personally accountable for their actions? Why should insurance companies pay for what the New York’s State Common Retirement Fund characterized as utter dereliction of duties? “If directors want to play cheerleader, there’s a price to pay,” warns Patrick McGurn, special counsel to Institutional Shareholder Services. “Being a director isn’t what it used to be. But maybe, at last, it’s what it should be, wrote Daniel Kadlec for Time Magazine. (A Wake-Up Call For Directors, 1/17/05)

Ten former Enron directors also agreed to pay $13 million of a $168 million settlement from their own assets to settle litigation brought by shareholders whose investments were wiped out after the failed U.S. energy giant’s 2001 bankruptcy filing. In the Enron case, $60 billion of shareholder valuee wiped out. The out-of-pocket settlement by directors equaled 10% of their pretax profit from Enron stock sales. According to Lucian Bebchuk, a professor at Harvard Law School and co-author of Pay Without Performance, “the settlement hardly heralds a new era in which directors who fail to act in shareholders’ interests pay the price. If even Enron’s board members are treated this gently, then other corporate directors can rest easy.” (see NYTimes, 1/17/05, What’s $13 Million Among Friends?)

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Halliburton Resolution Still Under Contention

The American Federation of State, County and Municipal Employees Pension Fund (AFSCME) has urged the SEC to reject Halliburton’s request to exclude from its proxy a proposal (submitted with the Connecticut Retirement Plans and Trust Funds, New York City Employees’ Retirement System, and the New York City Teachers’ Retirement System) giving Halliburton shareholders the right to nominate up to two directors to the firm’s 11-member board. In mid-December, Halliburton asked the SEC staff for assurances that it might exclude the proposal from consideration. It is still pending no-action review by SEC staff

AFSCME’s shareholder rights efforts at Halliburton follow the pension system’s similar moves at Walt Disney. SEC staff announced in early December that it would not allow Disney to block a shareholder director nomination resolution but later reversed itself, decreeing the proposal may be excluded from a vote by Disney shareholders.

The SEC’s 2003 shareholder access proposal is still under consideration but faces intense opposition from business groups, whose members fear losing not only power and control, but also their jobs. While a rule is being considered, the SEC often lets shareholder proposals proceed, if they closely mirror the proposed regulation’s provisions.

This season, the SEC staff has repeatedly rejected proposals to give shareholders a greater voice in nominating corporate directors at Qwest Communications and Verizon Communications. However, according to AFSCME, drafting problems the SEC staff identified with the Qwest, Verizon and Disney proxy access proposals “are not present” in the resolution drafted on behalf of Halliburton shareholders. The Halliburton proposal specifies that an individual or group of shareholders would be eligible to nominate directors if they have owned more than 5% of outstanding shares for at least two years, exactly the same high threshold used by the SEC in its rulemaking proposal.

Gerald W. McEntee, Chairman of the AFSCME Employees Pension Plan, said “AFSCME Plan proposals are aimed at giving shareholders the voice they have been denied by insisting that failed boards be more responsive to investors. Until the SEC proposes a workable proxy access rule that is fair to investors, the Plan will push for the right to nominate directors, company by company. In 2005 we will be focusing on nominating rights, excessive pay, ignored majority votes, and insular boards that continue to show a lack of director accountability to shareholders.”

AFSCME submitted proposals at 19 companies, according to their press release. Notably, one seeks to establish a shareholder majority vote committee at Maytag because the board has not implemented multiple majority votes to declassify its board. AFSCME’s proposal would amend Maytag’s bylaws to require the creation of a board committee that would meet with shareholder proponents pursuant to any unimplemented majority vote. (see AFSCME press release)

Split Roles Pay

According to Richard Bernstein, chief U.S. strategist at Merrill Lynch, companies in the top 100 of the S&P 500 with split chairman and CEO outperformed those that combine the roles during the last decade. Corporations with split roles posted a 22% annual return since 1994, outpacing the 18% return earned by firms that did not. (Independent Board Chairs Remain a “Priority,” mentioned again in the 1/7/05 ISS Friday Report)

Push Back Escalates

California Assemblyman Keith Richman filed a ballot initiative to establish a 401(k)-style pension plan for public employees in California. The proposal calls for all new public employees of state and local governments hired after July 1, 2007, to be offered only a defined-contribution plan, rather than the traditional defined benefit pension plan.

California Governor Arnold Schwarzenegger said that “Like the budget itself, our state pension system is another financial train on another track to disaster,” in his second annual address to the legislature, where he endorsed plans to phase out the state’s defined-benefit public pensions in favor of defined-contribution plans similar to 401(k) retirement plans in the private sector.

He failed to mention that 80% of the Fotune 100 companies have a defined befit plan. The average pension benefit paid by CalPERS is less than $20,000 a year for employees with nearly 20 years of service. Most public sector workers make less than they would in the private sector. Their “fat” pension benefits are basically a form of deferred compensation.

The movement is an attempt to do away with Ameirca’s top corporate watchdogs and to channel millions of dollars to money market managers. It has nothing to do with saving taxpayer money.

Executive Confidence Wanes

A year-end survey of some 16,500 executives from 148 countries shows a significant drop in confidence. Competition is intensifying, especially in pricing. Even so, most plan to hire and pursue new markets. “The McKinsey Global Survey of Business Executives, November 2004” also poses several questions on strategy, including what factors count most when companies invest in the emerging world and how they divide their focus between short- and long-term strategies.

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Costco Vote

A resolution filed by Christian Brothers Investment Services, Domini Social Investments, Sierra Club Mutual Funds, Adrian Dominican Sisters, and other shareholders, at Costco Wholesale appears on the proxy ballot as #4 “Shareholder Proposal Relating to a Land Procurement Policy.” It asks the company to report on the development of a policy for land procurement and use that incorporates social and environmental factors.

The proposal stems, in part, from a 2001 incident in Cuernava, Mexico where the site of a new store contained what many believed to be an architecturally significant hotel, the Casino de la Selva, that had long been an artistic center and contained renowned murals. Residents were also concerned about the loss of the hotel’s wooded grounds, the presence of pre-Columbian artifacts at the site, and the project’s impact on traffic.

Thousands of Cuernavacans reportedly demonstrated against the project in 2001 and a federal lawsuit is pending in Mexico against the authorities who approved Costco’s project.

As a Costco shareholder, the publisher of CorpGov.Net endorses the proposal and believes Costco would enhance its reputation and substantially reduce the likelihood of future liabilities by requiring future property acquisitions and site development projects be subject to the equivalent of a review under the California Environmental Quality Act (CEQA), in addition to meeting any local requirements. Such a review would disclose how Costco has assessed and addressed potential impacts to air, water, noise, geology, traffic, biological resources, aesthetics, cultural resources, and several other factors. Any such process should invite and address public comments.

As Costco expands to other countries, such a process will establish their reputation as a retailer that is concerned with its customers and their environment. It would build good will and guard against potential liabilities. Please join us in voting in favor of this shareholder resolution.

Marionette Directors

The current Saudi corporate form of organization is unworkable, according to Abdelmenem Jamil Addas, a professor of financial markets, at the College of Business Administration in Jeddah. Boards of directors, elected by shareholders and acting as fiduciaries on their behalf, were supposed to keep executive managers accountable to their fiduciary duties of care and loyalty while allowing them great discretionary power over the conduct of the business.

Unfortunately, according to Addas, “directors are ‘merely marionettes’ driven by the CEO. Whenever an institution malfunctions as consistently as boards of directors have in nearly every major Saudi corporation it is futile to blame men. It is the institution that malfunctions.” The professor appears to call an end to speculation and a return to the dignity of honest trade merchants. (Are You Sure You Want to Take Your Company Public?MENAFN.COM, 1/3/04)

CalPERS Bashing

Several newspapers picked up an Associated Press item, starting the new year off with an article about businesses going after public pension funds and especially CalPERS. Recent criticism includes:

• Published comments by officials at the American Enterprise Institute, a conservative think tank, that public pension funds shouldn’t get voting rights with their stock holdings and that their “intrusions” must be stopped with possible legal action.
• A report by the Center for Security Policy, a group of former Reagan administration officials and conservative business interests, that raised questions about the practices of the nation’s top 100 public pension funds. It said they’ve invested $188 billion in foreign companies that do business with “terror-sponsoring” nations.
• The Business Roundtable, a group of CEOs, many of them major financial supporters of President Bush, helped block a proposed SEC rule change giving pension fund and other shareholders rights to nominate corporate directors.
• Some state legislators are also siding with business. California Republican Assemblyman Keith Richman recently introduced ACA 5that would eventually weaken CalPERS’ clout over time, requiring new state employees after 2007 to use individual retirement accounts. Aides deny it’s an attack on CalPERS’ influence nationally. “Assemblyman Richman is trying to reform California’s pension system because we are making commitments to employees now that we cannot pay for in the decades ahead,” said Dan Pellessier, Richman’s chief of staff.

Alongside such moves, The Wall Street Journal dubbed CalPERS, a national leader in corporate governance activism, a “corporate scold,” while Business Week called it “the pension fund that cried wolf.” (Businesses rein in activist pension funds, The Seattle Times, 1/1/04) What these articles don’t provide is adequate background on the California pension debate. That can be found on the California Professional Firefighters site.

Director Emeritus: Growing Trend

Corporate Board Member Magazine reports findings of The Corporate Library,107 former board members now hold the title of emeritus or honorary director, compared with 60 in 2003…and that’s just those reporting. Dan Dalton, director of the Institute for Corporate Governance at Indiana University’s Kelley School of Business, says many companies don’t disclose emeritus directors in their regulatory filings.

Lack of disclosure is legal, since they don’t vote and SEC rules don’t address them. Nor do directors emeritus face any specific requirements to file insider reports for stock trades, or any other restrictions. Frequently used in mergers or to ease out a company founder, the job usually offers directors the opportunity to keep their unvested options, restricted stock grants, health insurance, and other financial benefits. But Nell Minow, of The Corporate Library wants to know who they work for and what their duties are. “We have a very clear idea of the obligations and authority of directors. But we’re really in uncharted territory with the director emeritus.”

Minow worries that a company founder may chill debate. Advocates of emeritus directors cited in the article advise companies to build the position into the company’s bylaws or create a formal emeritus program that spells out the job description and compensation, including such specifics as how many meetings they’re expected to attend. Additionally, they should be required to adhere to the same blackout periods and trading disclosures required of its regular directors and insiders. (seeBoom Times for the Director Emeritus by John R. Engen)

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Frank is Doing Fine

Like we were worried. He leaves a $9 billion hole in Fannie Mae’s financial ledgers and takes a $1.3 million/year for early retirement. Peter Flaherty of the National Legal and Policy Center says “Let me get this straight. Raines apparently cooks the books, brings disgrace to the company, and imperils Fannie Mae’s standing with regulators, the Congress and administration. So for his punishment he is made wealthy for the rest of his life?”

According to a December 27 Form 8-K filing with the Securities and Exchange Commission, Raines is entitled to:

• “Deferred compensation” of $8.7 million.
• Stock options currently worth $5.5 million, and potentially millions more.
• “Performance Share Payouts” through 2006, potentially worth millions more.
• A monthly pension of $114,393 for the rest of his life, and for the life of his spouse should she survive him.
• Free medical and dental coverage for the rest of his life, as well as for his wife for the rest of her life, and his children until age 21.
• Free life insurance in the amount of $5 million until age 60, and $2.5 million thereafter.

Raines said that, “By my early retirement, I have made myself accountable.” Flaherty reacted by saying, “It is like Enron and Tyco never happened. I cannot even fathom the level of arrogance and self-delusion necessary for Raines to claim he’s been made accountable for his mistakes.” Flaherty continued, “The OFHEO regulators have taken the right step in reviewing Raines’ compensation. But if Fannie Mae executives inflated profits to increase their own bonuses, that is fraud. Political connections should not insulate corrupt executives from criminal prosecution, if it is warranted.”

“This is not a case of foolish or captive directors rewarding a failed executive with a golden parachute. Fannie Mae is not really a private company. It has been granted advantages in the marketplace by Congress that are worth billions of dollars. Raines is not only fleecing Fannie Mae, but also the taxpayer.”

“Raines was never really a private-sector corporate executive. His CEO position was more of a political plum. Most of his career was spent in political appointments or at Fannie Mae itself.

I guess joining the Institute for Corporate Ethics at the University of Virginiadidn’t help. Raines gains little sympathy from this publisher. Even before this recent scandal, I was upset with his strident opposition to the SEC’s proxy access rule.

Raines will rebound by returning to a top position in public service or business, his supporters said. ”This is a bump in the road — I’m sure Frank will find his way,” Leon Panetta said. Raines is a director of PepsiCo, Pfizer, and is co-chairman of the Business Roundtable. (The rise and fall of Fannie Mae’s Franklin Raines, The Morning Call, 12/30/04) Also see The Five Dumbest Things on Wall Street This Week by George Mannes, TheStreet.com, 12/31/04.

Buffett Probed

Berkshire Hathaway, controlled by Warren Buffett, says the SEC has requested information from its General Re insurance unit about the sale of products that can be used by companies to smooth earnings.

They are reportedly examining the sales of “finite” insurance products, which allow insurers to spread their risk of loss, allowing other insurers to take on additional risk in exchange for additional premiums. If the insurer agrees to return premiums at a later date, the product is considered a loan in violation of accounting rules.

Since Buffett has been a vocal critic of accounting manipulation, his reputation is on the line. (SEC probes Buffett insurer, The Sydney Morning Herald, 1/1/2005)

Calvert Publishes Sustainability Report

Calvert, published its first Sustainability Report using Global Reporting Initiative (GRI) guidelines. The 50-page report detailing Calvert’s economic, social and environmental performance is available on the firm’swebsite.

“For years, Calvert has advocated greater disclosure and transparency on the part of the companies we invest in. We believe social and environmental disclosure is not only relevant but highly material to investors” says Barbara J. Krumsiek, President and CEO of Calvert. “We therefore felt it was important to report to Calvert’s shareholders and other stakeholders on how we are discharging our own social and environmental responsibilities.”

Calvert is the first US-based socially responsible mutual fund firm and one of only a small number of US-based financial services companies to publish a Sustainability Report following the Guidelines. It attempts to integrate the GRI Guidelines with the company’s own social and environmental criteria, which it uses in researching corporate performance for its own portfolio selection purposes. The report focuses on Calvert’s performance in seven issue areas:

1. corporate governance and business ethics;
2. workplace issues;
3. environment;
4. product safety and impact;
5. international operations and human rights;
6. Indigenous Peoples’ rights; and
7. community relations.

“As so much of our business involves assessing the social and environmental performance of others, it was a natural progression for Calvert to turn the mirror on ourselves,” says Ms. Krumsiek. “We hope it enables our shareholders, clients and other stakeholders to learn more about how we conduct our business and how we measure our progress towards corporate social responsibility and sustainability. We also hope that it encourages other companies – in our sector and beyond – to rise to the challenge of transparency and sustainability reporting.”