August 2005

Directors Compensation Up

Compensation for directors of large US companies was up18% in 2004, according to Mercer Human Resource Consulting. The study, which analyzed 2005 proxy statements, found median total direct compensation (pay for board service, committee service, and equity grants) for board members at 350 large, publicly traded firms has increased by almost 50%, from $105,000 to $155,000 over the last four years. The study also found that the use of stock options as a part of director compensation has declined greatly while restricted stock has increased in popularity.

Equity represents 55% of total direct compensation in 2004, up from 51% in 2003. Board retainers increased 25% from $40,000 in 2003 to $50,000 in 2004. Use of lead directors and non-employee chairmen has increased dramatically in recent years. 47% of the Mercer 350 companies reported ownership guidelines in 2004. This is the third consecutive year of double digit increases, up from 37% of companies disclosing guidelines in 2003 and 25% in 2002. Most companies express their guidelines as a multiple of their annual retainer – five times the annual retainer being the most common.

Although still relatively small, the number of Mercer 350 companies disclosing holding requirements was up from approximately 5% in 2003 to 8% in 2004. Among this group, the holding period is split evenly among (a) a one-year minimum, (b) until retirement from the board, and (c) until ownership guidelines are met. Based on these trends, Mercer expects to see the following changes in director compensation:

  • Retainer levels for board service will continue to increase as companies eliminate board meeting fees and shift the value to fixed annual retainers.
  • Committee meeting fee levels will remain constant, but their prevalence will decrease as companies shift to committee member retainers.
  • Committee chair retainers will continue to increase in value and prevalence. But the distinction among committee chairs will lessen as the demands of Sarbanes-Oxley compliance, FAS 123R, and deferred compensation reform diminish.
  • The lead director role and responsibility will expand and become more transparent. In turn, additional compensation will be more prevalent and premiums will increase.
  • Equity compensation will be delivered through full-value shares, rather than options. In addition, the balance between cash and equity will remain roughly equal.
  • Stock ownership guidelines and holding requirements will continue to increase in prevalence as companies continue to react to shareholder concerns. The practice of basing guidelines on a multiple of the annual retainer will diminish in favor of a multiple of the annual equity grant. (Perspective: Director compensation trends, Mercer, 8/23/2005)

To override an initial ISS negative vote recommendation, a company must demonstrate (and disclose in its proxy statement) that its director compensation program contains all of the following:

  • Minimum director stock ownership requirement of three times annual cash retainer,
  • Minimum three-year vesting schedule or mandatory holding/deferral period,
  • Balanced mix of cash and equity or longer vesting if the mix is equity-heavy, and
  • Retirement benefits or perquisites for non-employee directors.

CalPERS OKs Limited Investment in Black-Listed Countries

The Board approved a policy allowing investments in international pooled real estate funds that have up to 25% of their assets invested in countries excluded from thir permissible country list, including China and Eastern European countries. Up to $650 million may be invested in such pools despite poor labor standards, according to a report in the 8/22/2005 issue of Pensions & Investments. (CalPERS OKs Some Real Estate Investments Off Country List)

Maxim Forgives Loans

The board of directors of Maxim Pharmaceuticals voted to forgive a $2.8 million company loan to its chief executive and potentially pay certain taxes or tax penalties on the money. Let’s hope this provides an example to other firms that strongly discourages them from making loans to senior officers.

Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware, said the Maxim board’s action underscores the “toxic” nature of corporate loans to executives. “It’s like mixing oil and vinegar,” said Elson. “The board is put in the position of being a banker, and it becomes a mess.” “It is unfortunate that they (Maxim’s board) find themselves in this situation,” Elson added. “But the ones who really have the problem are the shareholders. It’s the shareholders’ money.” (Maxim’s board forgives loan it made to boss, San Diego Union-Tribune, 8/27/2005)

Audit Problems Persist

A survey by the Center for Strategy, Execution and Valuation at DePaul University’s Kellstadt Graduate School of Business commissioned by Grant Thornton LLP of chief financial officers, controllers and treasurers from public and private companies across the US found:

  • 85% of the CFOs favor uniform global accounting standards
  • 89% support adoption of a principles-based approach to accounting standards
  • 79% think the current reporting model needs to be updated
  • 77% believe that there is too great a concentration of public audits by the Big Four accounting firms, which audit 97% of public company revenues
  • 76% agree stock options should be expensed
  • 74% consider it appropriate for an accounting firm to do both audit and tax work for a company
  • 63% see a “realistic chance” that one of the Big Four firms could fail within the next three years, and if it that happens, 78% don’t think the other three firms could adequately handle the business
  • 65% of senior financial executives say it’s now harder than ever to attract new directors to their boards.

See “SOX Makes Director Recruiting Tougher Than Ever,”, 8/26/2005. I wish they had asked if these senior financial officers favored having auditors selected by the exchanges, as recommended by David Skeel in his book Icarus in the Boardroom, or having them selected by shareholders, as recommended by Mark Latham of the Proxy Monitoring Project. As long as they are chosen by corporate officials, we expect problems to persist.

India’s Passage to Prosperity

Good corporate governance alone is not enough. Arvind Panagariya’s “A Passage to Prosperity” in the 7-8/2005 edition of the Far Eastern Economic Review recommends four badly needed reforms.

  • Repeal or reform the Industrial Disputes Act, which prohibits firms that employ 100 or more workers from firing them “under any circumstances,” according to Panagariya. The law deters domestic and international firms from entering labor-intensive manufacturing. White-collar workers, apparently, don’t enjoy such protections, thus the disproportionate rise of India’s service economy.
  • Bring down the deficit, which is currently 10% and absorbs too much of savings.
  • Infrastructure improvements. Compare airports in Delhi with Shanghai.
  • Increase education. Only 6% of Indians between 18 and 24 go to college. Competition for scarce resources has brought annual employee turnover in IT to 50% and has doubled salaries in less than two years. Unfortunately, “the proportion of GDP spend on higher education have progressively declined over the last several decades.” He calls for the entry of private universities and the introduction of fees in public universities for those capable of paying.

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Majority Voting Gains Support

On 8/10/2005 Blog reported that two more companies have entered the fold:

  • Circuit City’s corporate governance guideline: “Any Director nominee in an uncontested election for whom greater than 50% of the outstanding shares are ‘withheld’ from his or her election shall tender his or her resignation for consideration by the Nominating and Governance Committee. The Nominating and Governance Committee shall recommend to the Board the action to be taken with respect to such resignation.”
  • ADP’s bylaw amendment: “The directors shall be elected by the vote of the majority of the shares represented in person or by proxy at any meeting for the election of directors at which a quorum is present, provided that if the number of nominees exceeds the number of directors to be elected, the directors shall be elected by the vote of a plurality of the shares represented in person or by proxy at any such meeting.” (No risk trial to

Islands of Democracy

Schlumberger Ltd., an oil-field-services company with 52,000 employees spread over 80 countries, has created what a recent Wall Street Journal article called 23 “communities of practice,” ranging from chemistry to well engineering, with about 140 special-interest subgroups, and counts more than 11,750 employees as members. Schlumberger allows these island of peer review democracy to elect their own leaders.

In the example provided in the article, a geological engineer elected to leadership of the company’s rock-characterization community “spends 15% to 20% of his time organizing an annual conference and occasional workshops, overseeing the group’s Web site, coordinating subgroups and the like.”

Members post CVs to an internal intranet to identify themselves to each other. “Each nominee had to be backed by at least one other community member and by his or her manager, who was consenting to let the subordinate devote a chunk of time to the endeavor. Turnout in early elections was an impressive 60%, but it since has fallen to 30%. Leaders are elected to a one-year term and can be re-elected only once. In all, more than 275 employees serve as elected leaders of communities or subgroups.” (Motivating Workers By Giving Them a Vote, 8/25/2005)

As we have noted on this website for ten years, there are benefits to democratic corporate governance both at the board level and the “shop floor.” Schlumberger may have a model worth replicating.

Ohio PERF May Create Target List

As reported by Pensions & Investments (August 23, 2005), Ohio Public Employees’ Retirement System, is considering developing a focus list of companies to target for corporate governance action, said Lori F. Hacking, executive director of the $64.5 billion system. “We’ve never done that before,” she said, adding that staff is still developing the idea to possibly bring to the board for its consideration. “We are trying to upgrade our corporate governance program and presence.”

CEO Pay Abuses

The 5 most outrageously overpaid CEOs, according to MSN Money, 8/24/2005.

• Top honors go to Patrick Nettles at Ciena (CIEN, news, msgs). His shareholders have been virtually wiped out — losing 93% in the past four years. His compensation over that period: $41.2 million.

• Jure Sola, the CEO and chairman at Sanmina-SCI (SANM, news, msgs) collected $26.4 million during the past four years while Sanmina shares fell 78%. The bulk of Sola’s pay came in the form of a performance bonus of $19.9 million, paid for hitting one recent quarter’s targets.

• Sun Microsystems (SUNW, news, msgs) paid Scott McNealy, its CEO, chairman and founder, $13.1 million a year over the past four years, even as Sun’s shareholders lost 76% of their money.

• Shares of supermarket chain Albertson’s (ABS, news, msgs) fell 39% over the past four years. Despite this dismal record, Albertson’s CEO and Chairman Larry Johnston collected a total of $76.2 million in that time.

• Under CEO Peter Dolan’s watch at Bristol-Myers Squibb (BMY, news, msgs), shareholders have seen the stock decline by 48% over the past four years. Dolan took home $41 million.

All Majorities Not the Same

Broc Romanek’s blog at notes that “Disney’s standard parallels the ‘Pfizer’ guidelines (ie. based on a majority of votes cast); whereas Office Depot’s standard requires a withhold or against from ‘a majority of the Company’s shares.’ That sounds like it means a majority of outstanding shares would need to withhold, which is a higher standard – and arguably not even a ‘majority vote’ standard because a majority of those voting could withhold and yet not trigger the guideline. If Office Depot sticks with that type of standard, I wonder if they are going to add an ‘against’ box to their proxy card? His further writings provide some insight on these and other issues.

Icarus in the Boardroom

America loves risk-taking CEOs, but when such behavior crosses over to boardrooms it could have massive consequences because of the growing scale of businesses and society’s greater dependence on equity markets. Icarus in the Boardroom: The Fundamental Flaws in Corporate America and Where They Came From, by David Skeel draws on Greek mythology to present a candid warning aimed at corporate directors and anyone concerned with our economic future.

Trapped in a labyrinth of his on construction, Dedalus made wings for himself and his son Icarus. He warned Icarus not to fly to close to the sun but Icarus got carried away, failed to heed the warning, and plunged to his death after the sun melted the wax that held his wings together. Similarly, the corporation is a powerful human innovation, but is dangerous if not used properly.

But this book isn’t about businesses being “socially responsible,” in the normal sense of health, peace, or global warming. Instead, Skeel is concerned with the impact that corporate failures can have on the economy as a whole. From that standpoint, Icarus in the Boardroom offers excellent advice on creating a sustainable business climate, getting to the source of problems instead of the symptoms.

He attributes several recessions and the Great Depressions to an ”Icarus Effect,” brought on by three factors:

  • Excessive and sometimes fraudulent risks
  • Competition (or, rather, tendencies toward monopoly)
  • Increasing size and complexity

The bulk of the book is devoted to a short history of the corporation followed by an excellent treatment of these three thematic factors and corporate failures though US history. He explains how government has responded to Icarus effects and how corporations have worked to first adapt, then often to circumvent or unravel government’s attempt to save us from corporate excesses.

In general, “the lobbying might of corporate managers, and the power of their political contributions, is too great for even relatively minor reform to succeed,” he notes. However, the wake of financial scandals provides an opportunity to “change the political calculus.” We witnessed such changes after the 1929 crash when reforms like creating the Securities and Exchange Commission stopped short of federalizing corporate law.

More recently we enacted Sarbanes-Oxley to address the scandals of Enron, WorldCom and Tyco. Where did we stop short this time? Skeel advises that we partially addressed fraudulent risk but left the other Icarun factors largely untouched. Among Skeel’s many recommendations:

  • Conflicts of interest. Having auditors selected by a committee made up of “independent” board members does little; they’ll still be reluctant to choose an auditor who will rock the boat. Stock exchanges should assign and police auditors.
  • Securities analysts. “If exchanges were required to assign a securities analyst to every listed company – and pay the analysts from companies’ listing fees – investors would know that there was at least one (unbiased) analyst covering every listed company.”
  • SEC’s proxy access proposal, which wasn’t dead when Skeel wrote the book. Skeel favors it but warns that shareholder activism “often won’t curb problematic behavior if the behavior in question is profitable to the corporation.” As an example, he cites the fact that Tyco shareholders overwhelmingly rejected a proposal to move its domicile back to the US from Bermuda. Shareholders wanted to keep saving on taxes regardless of the negative impact on the larger society.
  • Special purpose entities (SPEs). Instead of treating them under “enterprise liability,” as advocated by Adolph Berle in the post-New Deal era, Skeel takes a middle approach. Auditors and regulators should “focus on whether the spirit of the SPE status is being violated. SPEs that are not truly separate from the overall company should be denied separate treatment for accounting purposed.”

“Ordinary Americans no longer see corporations as ‘other,’” because more than half now own stock (directly or indirectly). As defined benefit plans dwindle and 401(k) participation increases, Americans have come to see their own stakes, however small, as tied to those of corporations. Skeel cites an important study by Dallas Federal Reserve Economists John Duca and Jason Saving that found “a direct correlation between stock ownership and the Republican vote in recent Congressional elections. As stock ownership goes up, so does the Republicans’ share of the Congressional vote.” It’s no wonder President Bush keeps pushing privatization of Social Security.

“The increasing identification between ordinary Americans and corporate America is perfectly understandable, but beneath it lurks a terrible irony: at the same time as our passion for real reform has declined, the risks have radically increased,” writes Skeel. In the past, investing in stocks was an activity largely limited to the rich who could afford to speculate. Now stocks have become the investment of choice for “life” savings and retirement.

With so many of us now dependent on corporate performance, let’s hope it doesn’t take another Great Depression before American’s wake up to the need for reforms of the type outlined by David Skeel. However, most of Skeel’s recommendations will require national reforms. With the US Chamber of Commerce spending more than $53 million a year lobbying against such changes, what is an enlightened board member to do (other than terminating membership in the Chamber)? Try the following:

  • Independent auditors and treatment of SPEs. From a shareholder’s prospective, Mark Latham’s proposal for auditor independence based on shareholder vote could provide an answer to both these problems. Currently, shareholders vote on the auditor but they are given no choice. The vote is a meaningless rubber stamp of the audit committee’s selection. Allowing alternatives to be listed on the proxy and then having them voted on by shareholders would provide a serious incentive for audit firms to build reputations around reports which reveal inefficiencies as well as certifying to Generally Accepted Audit Standards geared toward disclosures to stock purchasers, rather than owners. Unfortunately, the SEC has continuously issued no action letters ruling Latham’s proposal deals with “ordinary business,” even though that contention appears absurd given Arthur Anderson’s role in Enron’s demise. However, nothing prevents an enlightened board from implementing this method of audit selection, which clearly is superior to current methods from the standpoint of reducing conflicts of interest.
  • Securities analysts. Again, I would turn to one of Mark Latham’s proposals to allow shareholders to select a proxy advisor to be paid for by the corporation. Instead of advising shareholders when to buy and sell, the advisor would be recommending ways to fix the corporation to make it more efficient in generating wealth, as well as analyzing issues on the next proxy.
  • SEC’s proxy access proposal. While the SEC proposal is dead until the US elects a new President, the options for enlightened directors are not closed. For example, Pfizer and then Disney recently voted to require that directors be voted by a majority of votes cast. Ashland agreed to solicit director candidates from major shareholders and to nominate a qualified candidate for election to the board. Shareholders of Microtune can nominate one director beginning in 2005 at the annual meeting and a second director at the annual meeting in 2006. See also Apria Healthcare’s innovative policy allowing shareholder to place nominees on the proxy under limited circumstances.

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Chamber Opposes Majority Vote

As we reported in June, the American Bar Association (ABA) Committee of Corporate Laws issued adiscussion paper on majority elections for corporate directors and invited public comment by 8/15/2005 to: E. Norman Veasey.

Support among shareholder proposals for a majority election standard continues to grow, winning a 43% average level of support at over 50 companies this season. A recent (8/18/2005) ISS Friday Report (Business Groups Defend Plurality Elections), carried excerpts from a letter submitted by the US Chamber of Commerce, which spent more than $53 million on lobbying in 2004:

We are aware of certain activists and interests groups who wish to use the election of directors to further union, environmental, social and other objectives…We are also aware of certain academic commentators who believe that the plurality system is an insufficient expression of ‘shareholder democracy.’ We are not aware, however, of substantial concern among fund managers and other investors who inject most of the money into the system.

As we reported last month, the Council of Institutional Investors, representing $3 trillion in assets, posted its June 15th letter to Veasey on their website indicating their clear support for an initiative that would “presumptively provide for the election of directors by a majority of votes cast for and against, unless otherwise provided in the certificate of incorporation or the bylaws.” “The benefits of this change are many: it democratizes the corporate electoral process; it puts real voting power in hands of investors; and it results in minimal disruption to corporate affairs—it simply makes boards representative of shareowners.”

Majority voting for directors already is standard practice in United Kingdom, France, Germany and other European nations. And a few U.S. companies—Best Buy, Hercules, Lockheed Martin, Potlatch and U.S. Bancorp—currently provide for director elections by majority vote.

Pfizer Inc., Office Depot Inc., Automated Data Processing Inc., and Walt Disney Co. have also recently adopted similar policies. The Chamber must have known a majority requirement has widespread among owners when they issued their statement, yet they claim to be unaware “of substantial concern among fund managers and other investors who inject most of the money into the system.” Are they putting their head in the sand or is there a nuance here? Maybe they value the opinion of those who place the stock orders over the opinions of owners and fiduciaries? I’ve asked the Chamber to clarify the basis for this comment, but so far have only received an automated receipt of the question.

ISS submitted comments which included the following statement: “Majority voting will provide for the missing element of board accountability to shareholders. In doing so, the standard will confer upon owners a new level of responsibility to determine the members of the board. We are confident that shareholders will exercise that responsibility wisely, for the benefit of themselves and the corporate issuers they own.”

Better Governance = Better Credit

Governance practices impact on credit ratings, according a review of 27 major U.S. financial institutions by Moody’s Investors Service. For example, Moody’s noted that governance practices contributed to Wells Fargo Bank’s upgrade to Aaa in 2003, as well as Sovereign Bancorp’s change in outlook to positive from stable in 2005. (For Banks, Better-run Means Better-rated,, 8/17/2005)

France/US Rock/Hardplace

US companies that do business in France are in a tough bind: If they set up anonymous whistleblowing hotlines to comply with Sarbanes-Oxley, they risk fines from data protection authority Commission Nationale de l’Informatique et des Libertes, or CNIL, which sees such anonymous tip lines as unnecessary America-style impositions on its current fraud reporting methods. If they don’t set up the hotlines, they risk U.S. civil or criminal penalties for violating Sarbanes-Oxley. (US firms find fraud hotlines too risque in France,, 8/17/2005)

CalPERS Effect Shrinking

Wilshire Associates told CalPERS the $190 billion fund’s annual target list of underachievers generated an extra 15.3% in stock value over a five-year period, a dramatic drop from 54% in 1995. They hypothesized that CalPERS was less aggressive with its governance campaign in the late ’90s, and the bear market drove investors to more blue chip-type stocks, making it tougher and longer for ailing companies to regain stock market value. (Study sees less reward for CalPERS’ activism, Sacramento Bee, 8/16/2005) I think a more likely explanation is that low hanging fruit is harder to find.

How to Get on a Corporate Board

Since beginning in 1995, one of the most common questions we get from readers is: “How do I get on a corporate board? Now, Directors & Boards devotes almost an entire issue to that subject. Even John C. Whitehead’s article “The Virture of Quiet Leadership” and the interview with him, while not directly on topic, offer insight. Being a leader is one of the prerequisites of getting on a board and the former co-chair of Goldman, Sachs & Co. offers sound advice. The core article on the subject, however, is by Norman R. Augustine, former CEO of Lockheed Martin. A few of his tidbits are as follows:

  • Make noteworthy contributions. If you can’t be a Nobel laureate, “develop a deserved reputation as a constructive, selfless individual with sound judgement who can work in a collegial fashion even while taking issue with positions held by others.”
  • Deep commitment to ethical behavior and unbending discretion.
  • Broad experience with specific skills needed by boards, such as financial expertise.
  • Solicit the assistance of head hunters.
  • Write to the chairs of nominating committees (although rarely successful for unknown individuals).
  • Let as many people as possible know of your interest.
  • Target smaller companies or foreign companies seeking to add a U.S. member.
  • “Start a company of your own and elect yourself chairman.”

Ann McLaughlin Korologos, former Secretary of Labor, offers advice of common misconceptions about board service. Roger W. Raber, CEO of the National Association of Corporate Directors offers:

  • Achieve a track record in your profession.
  • Network in your industry
  • Network in governance circles (join the NACD and put your resume in their registry.
  • Network with director recruiters.
  • Publish in Directors & Boards on the NACD’s Directors Monthly.
  • Serve on a nonprofit or small private company board.
  • Know thyself.

That’s the tip of the iceberg. For much more, see the Third Quarter edition of Directors & Boardsmagazine.

Excellent Proposal Needs Major Endorser

The Corporate Monitoring Project‘s Mark Latham scored a very respectable 11.4% affirmative vote for a recent proxy advisor proposal. Similar to previous resolutions by the Project, it called on Metro One Telecommunications to hire a proxy advisory firm for one year, to be chosen by shareowner vote. The Board would take all necessary steps to hold the vote at the year-2006 shareowner meeting, with the following features:

  • To insulate advisor selection from influence by the Company’s management, any proxy advisory firm could put itself on the ballot by paying an entry fee, declaring the price (no more than $8000) for advisory services for the coming year, and providing the address of a website describing their proposed services and qualifications.
  • The winning candidate would be paid its declared price by the Company, and make advice freely available to all Company shareowners for the subsequent year, on all matters put to shareowner vote except director elections. (Advice on director elections is excluded to satisfy SEC rule 14a-8(i)(8).)
  • Performance of the advisory firm would not be policed by the Company’s management, but rather by gain or loss of the advisor’s reputation and future business.
  • Brief summary advice could be included in the Company proxy, with references to a website and/or a toll-free phone number for more detail.
  • The decision of whether to hire proxy advisory firms in later years would be left open.

We believe this type of proposal should make up a key part of any long-term strategy by shareholders seeking governance reforms at specific firms. Proposals submitted in the year following passage of such a resolution would be likely to receive more favorable reception if endorsed by the impartial corporate monitor. All it would take for these proposals to take hold would be adoption by an influential pension or mutual fund.

Chamber Protects Mutal Fund Insiders

The U.S. Court of Appeals for the District of Columbia delayed implementation of SEC mutual fund governance rules while the court considers the latest challenge by the U.S. Chamber of Commerce. The rules require that board chairs and 75% of fund directors be “independent.” Adopted in June 2004, the court sent the rule back to the SEC in June this year for reconsideration of costs that would be incurred by fund companies and also ordered the SEC to consider alternatives to rule. A study by the SEC released about a week later before Donaldson left concluded the financial burden would be minimal. The Chamber of Commerce then filed a second suit against the rule that was due to take effect in January 2006.

Disney Decision

In a 174-page ruling, Chancellor William B. Chandler III ruled that yes, the $140 million severance package was ‘breathtaking.’ But no, it did not constitute an outright breach of duty by Disney’s board of directors. Attorneys for shareholders who sued the board said they would appeal the ruling. The plaintiffs had sought damages of more than $260 million from directors, which would have gone into the company’s treasury.

“This creates an aura of ambiguity at a time when boards and corporate leaders need to have a bright line of proper conduct drawn for them,” Jeffrey Sonnenfeld, a senior associate dean of the Yale School of Management told the Wall Street Journal. He called the Ovitz ruling a “stunning reversal” of a 1985 case in Delaware, Smith v. Van Gorkom, which shook the corporate world by challenging the standards for informed decision-making by boards.

Chandler did rebuke the directors, saying their conduct “fell significantly short of the best practices of ideal corporate governance.” He also criticized Eisner who “enthroned himself as the omnipotent and infallible monarch of his personal Magic Kingdom” and who “stacked his…board of directors with friends and other acquaintances who, though not necessarily beholden to him, were certainly more willing to accede to his wishes.”

“The redress for failures that arise from faithful management must come from the markets….and not from the court,” Chandler wrote. He also made a distinction between governance and Delaware law, saying, “The standards used to measure the conduct of fiduciaries under Delaware law are not the same standards used in determining good corporate governance.”

In his ruling, Judge Chandler also noted that ideas of the role of directors changed significantly after scandals at Enron, WorldCom and elsewhere. It would be unfair to apply today’s standards to past conduct. “This court strongly encourages directors and officer to employ best practices,” he wrote, “as those practices are understood at the time a corporate decision is taken.” He continued that “Delaware law does not – indeed the common law cannot – hold fiduciaries liable for a failure to comply with the aspirational ideal of best practices.” (Big Pay Packages May Fade After Ruling on Ex-President of DisneyNYTimes, 8/10/2005) (Judge Backs Disney Directors In Suit on Ovitz’s Hiring, Firing, WSJ, 8/10/2005)

“Shareholders can sell their stock,” but as disappointed shareholder activist Les Greenberg notes, “not a mention that shareholders should have a viable means to replace directors through the proxy process.  Now that shareholders have been informed that the BOD ‘underperformed,’ how can they be held accountable for their ‘bad management?'”

Ironically, another Chancery court judge, in denying Roy E. Disney’s request to publicly disclose documents that he obtained pursuant to a Shareholder’s inspection rights, stated, “There are other avenues for bringing directors to account for their mismanagement, most notably by contesting elections and by instituting derivative litigation.” (Roy E. Disney v. The Walter Disney Company, Delaware Chancery Court, Case No. 380 2004, Opinion on Remand 6/20/05, Page 13)  “In the real world, those ‘avenues’ are currently insurmountably barricaded,” according to Greenberg.

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The Monitor

The Monitor was developed by corporate governance firm Glass Lewis & Co., headed by Greg Taxin. It’s a web-based product that utilizes corporate disclosures to alert customers to early warning signs that could spell trouble like slowdowns in cash conversion, changes in accounting policies, CFOs or auditors and irregular insider-trading patterns. Cost starts at $25,000 and is dependent on the number of users.

Barron’s Online reports, “Of the 10% worst-performing companies in any quarter between June 1, 2003, and March 31, 2005, about 49% were the subject of a Monitor alert during the preceding six months, according to the company. On average, those stocks lost about 27% of their value during that quarter.”

If they can keep up that rate of predictability, we expect a lot of subscribers. (An Early-Warning System For Investment Dangers, 8/8/2005)

Forums to Unite Investors

Amnesty International USA (AIUSA) launched Share Power to facilitate the ability of individuals to voice their concerns to institutions that hold investments and are required to vote proxies on their behalf.

Share Power will focus on two specific shareowner resolutions, one at Chevron (CVX) and the other at Dow (DOW). The Chevron resolution asks the company to report on new management initiatives to address health and environmental concerns regarding oil-related contamination by its subsidiary Texaco in Ecuador. The Dow resolution asks the company to report on its accountability for the 1984 gas leak in Bhopal, India at a subsidiary Union Carbide plant.

The Share Power program is not limited to these resolutions and hosts an online forum where participants can track the progress of shareowner advocacy campaigns across the US. For example, participants can post the proxy voting records of institutions to provide others information as fodder for their own campaigning. (Power to the People: Amnesty Launches Grassroots Shareowner Advocacy,

We hope the idea takes off. We also endorse the effort by Andrew Eggers through MyProxyAdvisor to alert investors about how respected institutional investors with a variety of voting philosophies have chosen to vote their shares. You tell MyProxyAdvisor which funds you most agree with and which stocks you own. When they know how a fund you have chosen will vote on a stock you own they’ll send you a free alert. You’ll have a week or two to look at their decisions and cast your own ballot. You could also use this time and information at the Share Power online forum to coordinate efforts to get other institutional investors to vote similarly.

Sovereign Bancorp Bows to Relational Investors

Back in May 2004, Ralph Whitworth of Relational Investors threatened a proxy fight over the issue of extraordinary pay for outside directors at Sovereign Bancorp (SOV) who averaged $313,000. More than a year later, after a review by an outside compensation consultant, the bank relented. Effective 10/1/05 they will instead pay directors $50,000 and award them $50,000 in company stock annually.

Sovereign also will pay the “lead” director and the chairman of the audit committee an additional $25,000. Other committee chairs will receive $15,000. Directors also will be required to own $200,000 worth of company stock. (Sovereign bows to critics of bonus plan, MarketWatch, 8/5/05)

Comments Sought on SOX

SEC Release 33-8599; 34-52189; File No. 265-23 includes a 29-page questionnaire for submission of comments to the Advisory Committee on Smaller Public Companies (“Advisory Committee”). No bright-line definition of what a “smaller” company is for the purpose of this questionnaire is provided, although respondents are asked to indicate the size of their company.

Many of the 20 questions address Sarbanes-Oxley Section 404 and the related SEC and Public Company Accounting Oversight Board (PCAOB) rules regarding management’s report and the auditor’s report on internal control over financial reporting. Other questions address broader corporate governance and listing standards; the relationship of the smaller public company with its independent auditor; and other regulatory provisions of the SEC affecting smaller public companies and accounting issues affecting smaller public companies. Comment deadline on the questionnaire is 8/31/2005. Responses are being posted.

The next meeting of the SEC Advisory Committee on Smaller Public Companies is scheduled for 8/9/2005 in Chicago. Information on accessing the webcast and agenda is included in the Notice of Meeting. (SEC Questionnaire Seeks Small Public Company Input By Aug. 31, FEI)

SRI Effectiveness

WSJ carried an article on 8/3/2005 “Helping Your Portfolio, Not the World,” in which Jonathan Clements writes that although the amount invested in socially responsible mutual funds has grown 137% since year-end 2000, easily outpacing the 24% asset growth for all stock and bond mutual funds, “the results suggest socially responsible investing isn’t changing corporate America.” “If your aim is to reward good companies and punish bad ones, forget playing the stock market. Instead, focus on how you spend your paycheck.”

Shelley Alpern, Director of Social Research & Advocacy

As a specialist in socially responsible investments (SRI), it was almost gratifying to read Jonathan Clements’ column calling attention to the impressive performance of many socially responsible mutual funds. The problem is that Mr. Clements’ assertion that SRI isn’t having an impact on corporate America is demonstrably false; in fact, the influence that such funds are having on companies’ response to climate change, to cite just one example, has been documented in recent months on the Journal’s own pages. (See “Ford to Study How Steps to Curb Global Warming Might Affect It,” by Jeffrey Ball, March 31, 2005; Page D7.) Ironically, several of the funds mentioned by Mr. Clements have been active participants in this and other successful campaigns in recent years, such as the highly successful shareholder campaign to instill sexual orien

It is also worth noting that according to a recent study by the Social Investment Forum that compared the 2004 proxy voting records of ten largest mutual fund families with the ten largest socially responsible mutual fund families, the SRI funds are, by a 2-to-1 margin, more likely than conventional mutual funds to vote against management on corporate governance shareholder proposals, as well as exercising greater independence on resolutions addressing the environment or social issues. Socially responsible mutual funds undoubtedly deliver more to their shareholders than strong financial returns.

In most instances mutual funds don’t change companies by boycotting them, although that can be an effective tool. Most effective change comes by fulfilling basic fiduciary duties, such as conscientiously voting in the interests of your investors, and through dialogue. In those areas SRI funds have a substantially better record than most other funds.

New Links

We have added a link to the German Corporate Governance Network on our Links page in theInternational Corporate Governance section. Thank you Dr. Gregory Jackson of Corporate Governance Japan for bringing this site to our attention. We added two other links to our NewsLinkspage. One is to Michelle Leder’s, which has been up for years but I missed it. She provides tips on how to read 10-Q’s for signs of aggressive accounting and significant changes, as well as an award winning blog on her own detective work. The second new link on that page is to aCorporate Library blog worth checking in with periodically. Have ideas for new links? Please pass them along to the publisher.

ACGA Update

The Asian Corporate Governance Association (ACGA), a non-profit membership organization dedicated to implementing effective corporate governance practices throughout Asia, has largely completed a newly revised Annotated Links section of their site. Very nice! Their site also contains news and information about their 5th Annual Conference upcoming in Singapore, October 14, 2005, as well as other events in Asia.

Tocqueville at 200

In “Tocqueville at 200” a recent Wall Street Journal editorial badly misinterprets Alexis de Tocqueville’s vision. (7/29/05, page W13) Although concerned about possible tyranny by majorities, central to his democracy are three defining elements: equality of rights, separation of powers, and representatives engaging in public debate.

Tocqueville saw democratic governance “founded in part on the idea that there is more enlightenment and wisdom in many men united than in one alone, in the number of legislators than in their choice. It is the theory of equality applied to intellects.”

He believed democracy would become the frame of reference for governing nearly all spheres of organized activity, including not only the civic associations your editorial mentions but also industry.

We gained rights to ownership, independent of social standing, largely under family run businesses. We gained separation of powers (ownership and control) with the rise of modern corporations and professional managers.

The last element of democratic corporate governance has yet to fall into place. Shareholders and other stakeholders are typically excluded from boards in favor of managers from other companies. Boards function not as bodies representing owners and other stakeholders but as panels of “independent” experts.

Tocqueville recognized “the right to direct the official presumes the right to discharge him.” Mass owners (250 million worldwide and growing) and stakeholder are demanding representation on boards through pension funds like CalPERS, a growing number of mutual funds and NGOs willing to engage in public debate. (Insights into Tocqueville’s thought in this article are largely derived from Democracy in Corporatia: Tocqueville and the Evolution of Corporate Governance by Pierre-Yves Gomez, Unité Pédagogique et de Recherche Stratégie et Organisation and Harry Korine, London Business School, 10/2003.)

Let Exchanges Assign Auditors

David Skeel of the University of Pennsylvania Law School advocates having the NYSE and NASDAQ assign auditors to the firms they list. “If the auditing firms viewed stock-market regulators as their client, rather than the company being audited, they would have a far greater incentive to take a careful look at the company’s accounting.”

While not as elegant as Mark Latham’s proposal for auditor independence based on shareholder vote, Skeel’s proposal would nonetheless address the fundamental problem of allowing companies to select their own auditors, even if selection is done by so called “independent” board members. Skeel cites an experiment that found auditors 30% more likely to find accounting treatment was kosher if they had been hired by the firm they were auditing, rather than by a company doing business with the firm. (Self-Serving Bias, Across the Board, 7-8/2005)

Fix the NASD Arbitration System

An article in the San Diego Union-Tribune relates a story relevant to longtime securities attorney and NASD arbitrator Les Greenberg’s campaign to improve the NASD arbitration process. “A retired nurse turned over her $1.3 million nest egg to a broker who lost more than $900,000 of it. The arbitrators concluded that the retiree deserved restitution, but only awarded her $5,000. As the same time, the arbitrators dinged her $5,600 for the proceeding.” Apparently, this was one of the 55% of arbitration cases the NASD considers a “victory for investors. (Stockbroker losses bring no trials, lots of tribulations, 7/31/2005)

The article later asks, what did the NASD do after the state of California insisted that neutral securities arbitrators disclose all conflicts of interest to participants? “Rather than comply, the NASD sued.” Les Greenberg, who worked with me to try to improved corporate governance by co-sponsoring a proposal that led to SEC’s failed rulemaking, S7-19-03, is once again at it. His rulemaking petition (4-502) would among other reforms:

  • allow arbitrators to be able to research issues on the legal aspects of cases they hear
  • require NASD and NYSE to train arbitrators in relevant law and evaluate their performance
  • require the SEC to take a more active interest in how the NASD administers arbitration cases.

I hope Les has better luck with this reform then we did with the last one. He’s certainly making an historic effort. NASD has now filed a proposed rule change34-52009, with the SEC to provide written explanations in arbitration awards upon the request of customers, or of associated persons in industry controversies. See Les Greenberg’s letter. We urge readers to join with Greenberg in calling for reform.

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July 2005

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