October 2006

Broker Vote to End in 2008

The New York Stock Exchange moved to eliminate discretionary broker voting on the election of directors as of 2008. The NYSE, operated by NYSE Group Inc. of New York, filed the proposal with the Securities and Exchange Commission in Washington, which must approve it before it can be finalized.

Currently, brokers can vote on certain routine proposals if the owner of the stock has not provided any voting instructions to the broker at least 10 days before a scheduled meeting. “The goal of the NYSE has been to not allow the broker to vote on any proposal that substantially affects the rights of shareholders,” NYSE president and co-chief operating officer Catherine Kinney said in a statement.

“The election of directors is the most important shareholder franchise,” said Proxy Working Group Chairman Larry Sonsini in the release. The Proxy Working Group also recommended improving communication about the proxy process, and three subcommittees are currently working on issues related to that, including examining the structure and amount of fees paid by issuers connected with proxy solicitations. (NYSE moves to abolish broker voting, Investment News.com, 10/24/06)

The issue has resonated at several high-profile annual meetings in recent years, including those at Pfizer Inc. (PFE) and Home Depot Inc. (HD), where activists waged campaigns to withhold votes from directors over pay issues. In those cases, the tally of “withhold” votes fell well short of the 50% mark and wouldn’t have topped that threshold even if the broker vote had been excluded. By contrast, leaving out the broker votes would likely have made a difference in the contentious 2004 election of then-Chairman Michael Eisner at Walt Disney Co. (DIS).

“It’s certainly a step in the right direction,” said Ann Yerger, executive director of the Council of Institutional Investors in Washington. The plan would restore “some integrity” to the director-election process, she said, because allowing broker discretionary voting for directors was the equivalent of saying that “ballot boxes should be stuffed” in favor of management-backed candidates. (NYSE to eliminate discretionary broker voting, MarketWatch, 10/24/06)

Blog News

Seeking Alpha provides stock market opinion and analysis from blogs, money managers and investment newsletters.

ISS launched a designed to leverage the expertise of its own corporate governance experts as well as others in the industry to share knowledge and exchange viewpoints about key corporate governance issues facing investors, corporations and their directors. The Fall schedule includes interviews with a number of experts on a wide-range of topics. The first interview in the Governance Leadership Interview Series features Doug Cogan, ISS’ Deputy Director of Social Issues Services, discussing why environmental and social issues are gaining traction among mainstream investors.

TheCorporateCounsel.net and DealLawyers.com present “Shareholder Access and By-Law Amendments: What to Expect Now,” November 15, 2006. Join experts, including:

  • Rick Alexander, Morris, Nichols, Arsht & Tunnell
  • Richard Ferlauto, Director of Pension and Benefit Policy, AFSCME
  • Richard Koppes, Of Counsel, Jones Day
  • Professor Brett McDonnell, University of Minnesota
  • Beth Young, Senior Research Analyst, TheCorporateLibrary.com

Also from TheCorporateCounsel.net Blog: Survey Results: More on Regulation FD and Sample Director Confidentiality Agreement.

The thing that prompted Ford’s pending restatement all the way back to 2001 was a comment letter received by the SEC. (footnoted.org, 10/24/06)

Microsoft Targeted

Empowering small shareholders: a comparison of three instruments, which appears in the September issue of Corporate Governance: An International Review, looks at proxy investing, proxy voting institutions and infomediaries. The working of each instrument is discussed with special emphasis on the problems of information gathering and coalition forming. Subsequently, each instrument is analyzed with respect to appropriateness, costs and effectiveness. No instrument turns out to be clearly superior to the others. Although proxy investing is the most popular concept among small (individual) shareholders at present, the long-run potential of proxy voting institutions and infomediaries may be higher.

The article ends with a call for both non-profit organizations and governments to stimulate experiments with proxy voting institutions and infomediaries for small shareholders. Here, I would remind shareowners of Microsoft of their opportunity to support hiring an infomediary by voting in favor of Mark Latham’s proxy advisor proposal on the current proxy. Will shareholders take advantage of this mechanism to decrease the cost of information gathering and enable shareholders to make informed choices?

Roots of Activism

I ran across an interesting paper by Richard Marens, an assistant professor at California State University, Sacramento. In Inventing Corporate Governance: The Mid-Century Emergence of Shareholder Activism, Marens traces the roots of shareholder activism back to Lewis Gilbert and others. Marens notes that Congress endorsed the relatively uncontroversial notion of corporate democracy, declaring that “fair corporate is an important right that should attach to every equity security bought on a public exchange.” With the recent AFSCME v. AIG decision, we might be on the verge of shareholder democracy…a good time to look back at the Securities and Exchange Act of 1934.

Because of Lewis Gilbert, shareholder resolutions are included on the proxy. That right was codified in 1942 so that shareholders could police potential “fraud and mismanagement” in the companies they owned. In the SEC v. Transamerica Corp., 1947, Gilbert got the court to write, “a corporation is run for the benefit of its shareholders and not that of its management.”

The Gilberts pushed issues such as:

  • Ending staggered boards
  • Appointing independent outside directors
  • Separating the chair from the CEO
  • Connecting director and executive pay with performance
  • Shareholder approval of company auditors and stock options for executives
  • Requiring directors to own company stock
  • Representation on the board for shareholding groups through proportional representation

Up until 1987 Lewis Gilbert was 0-for-2000 on his shareholder proposals. Then he was quoted in a WSJ article on the majority vote at Chock Full O’Nuts Corp. on 1/30/87. Gilbert said, “It’s the first time we won against management in 50 years.”

Marens also discusses:

  • Wilma Soss, founder of the Federation of Women Shareholders, who pushed appointing women directors, arguing the policy was both ethically sound and an exercise in good business sense.
  • James Peck, with the Congress of Racial Equality, spent three years battling Greyhound for the right to place a resolution raising the issues of integrating bus seating in the South.

According to Marens, we may have come full circle, only this time “we may see new champions of outside investors rallying the troops freely and instantaneously over the internet and charging ahead with the force of institutional investors behind them.” Let’s hope so. John Cheveddan, the latest incarnation of Gilbert, is sure winning a lot more contests. Who’s coming up next?

Ira M. Millstein Recommends

Anatomy of Corporate Law – Reinier Kraakman et al.
“The seven academics who wrote Anatomy have written a book which really sets out the differences in corporate law among different countries and the fact that this power push-pull between management and shareholders has practical results.”

Political Power and Corporate Control: The New Global Politics of Corporate Governance – Peter A Gourevitch and James Shinn
“One of a kind. [The book’s authors] take some countries apart piece by piece and show you exactly how power has shifted from management to shareholders and vice versa. What institutions were involved in each country to make that happen? How did that happen? Who had political power? Who was able to make the law bend in one direction or another? I found this book fascinating.”

The Accountable Corporation – Marc J. Epstein and Kirk O. Hanson
“An overview of what’s been going on in corporate governance for years. And if you want to catch up on the state of [corporate governance] in the world, it’s the place to begin.”

The New Capitalists: How Citizen Investors are Reshaping the Corporate Agenda – Stephen Davis, Jon Lukomnik, and David Pitt-Watson
“This new book talks about the fact that we, you and me, really own corporate America because we are the beneficiaries of the intermediaries that hold the stock. We own the mutual funds. We are the pensioners. The plea that Davis makes is that, for heaven’s sakes, these intermediaries should be operating in our best interests because the ownership of America is now spread out among all of us.”

The Battle for the Soul of Capitalism – John C. Bogle
“A book which describes the conflict of interest that major stockholders, to wit, the mutual funds have, and why they have consistently voted for management over the years. Mr. Bogle’s explanation is simple: The mutual funds do considerable business with many of the companies in their portfolios, and hence hesitate to vote against management. This is a failing of the system because these big funds, which own so much of corporate America should be voting in the best interests of beneficiaries, rather than in their own commercial interests. It exposes a real hole in corporate governance and the need to search for some remedy.”

The Company: A Short History of a Revolutionary Idea – John Micklethwait and Adrian Wooldridge and Gangs of America: The Rise of Corporate Power and the Disabling of Democracy – Ted Nace
“These last two books will present the best and the worst cases for the corporate form. Wooldridge tells you why the corporation is the optimum organizational form, and how it’s improved the lot of the world. “Gangs of America” tells you why the corporation is a dangerous instrument and describes some of the outrages it has performed over the course of years. You have to read them both because they are both right, even though perhaps overstated to make their respective points. The corporation is at one time a wonderful thing, but can be a dangerous thing. When you read both books, you realize that with the corporation form you have not only an instrument of marvelous potential but also an instrument for potential harm. And why solid corporate governance, with the improvements we are researching at the Yale Center for Corporate Governance and Performance is essential to achieving the Wooldridge view.” (from WSJ, Recommended Reading, 10/9/06, subscription required)


Average annual pay is $10.5 million, as reported in BusinessWeek. That’s 369 times average worker pay of $28,310. In 1970, the multiple was 28:1, a ratio that would set today’s average $374,800. If we froze CEO pay and workers were guaranteed a 4% annual pay raise, we’d get back to that 28:1 ratio in only 66 years…oops, I’ll be dead by then. (Worker vs. CEO Pay: Room To Run, 10/30/06) The same issue carries articles on higher CEO turnover (The Great CEO Exodus) and the inclusive approach of India’s Karma Capitalism.

Interlocking Directors Cited

The Corporate Library finds new evidence that the practice of backdating stock options may have been spread by word of mouth through the network of directors sitting on the boards of more than one company. Director interlocking relationships now appear to be the most important governance characteristic and indicator of backdating problems. (Stock Options Backdating Activity Spread by Word of Mouth, 10/19/06)

CEO Turnover

An unprecedented 152 U.S. chief executives–or 7.6 per business day-left their posts in September, according to executive recruiting firm Challenger, Gray & Christmas. Overall, 1,112 CEOs have stepped down through Sept. 30 of this year, up 10% from the same period last year. At this rate, the total number of CEO changes this year will easily surpass 2005’s record of 1,322, which was twice the total in 2004, according to an Oct. 10 report by Challenger. (A Record Year for CEO Ousters, ISS Corporate Governance Blog, 10/20/06)

Blame the Worker

“So many salvos have been fired at senior executives by shareholder activists and regulators seeking corporate governance policies and accounting methodologies that basic management policies at the bottom of the company pyramid may be getting short shrift,” writes Thomas Kostigen for MarketWatch. Three factors, The Enthusiastic Employee says, lead to better employees: equity, achievement and camaraderie. (Service with a smile?, 10/20/06)

All the King’s Horses and All the Kings Men

Part of the SEC staff “wants to put Humpty Dumpty back together,” an SEC attorney reported to Directorship, meaning continuing the policy of not forcing companies to place shareholder nominations on proxy statements. Other staffers want to support shareholder activist groups in requiring companies to list shareholder nominees. Cox is reportedly scrambling to find a consensus solution before their December 13 meeting. (SEC Bitterly Divided Over Shareholders Nominating Directors, 10/06)

CalPERS Joins CalSTRS Against Pay-to-Play

CalPERS is to be congratulated for taking a cue from CalSTRS in agreeing to crack down on “pay-to-play” practices. According to the Sacramento Bee’s Gilbert Chan, CalPERS officials plan to build off regulations proposed by CalSTRS trustees who ordered staff to “craft regulations to limit campaign contributions to $250 and gifts to $50 for trustees, the governor and gubernatorial candidates. It also wants to develop reporting standards and sanctions on firms that violate the rules.” (CalPERS looks at tough donor limit), Sacramento Bee, 10/18/06)

The spin is that “we tried it before and the court rejected it,” according to board member Chuck Valdes. Yes, they “tried it” but many questioned the motives behind the 1998 move, which came after a series of articles in the Bee and LATimes. Since CalPERS didn’t adopt the policies as regulations, they knew they didn’t carry the force of law. At the time, many observers believed they were crafted to get the press off their backs and as an act of retaliation against Controller Kathleen Connell for publicly chastising some CalPERS board members for accepting luxury dinners and expense-paid overseas travel junkets from money managers. (CalPERS Sued Over Donation Regulation, Pensions & Investments, 9/7/1998)

When the courts rejected the policies, they did so not on the basis that free speech rights were abrogated by those who wanted to buy access, but because the board failed to follow the law. The Administrative Procedure Act specifies the process for adopting regulations but the board apparently didn’t feel the need to put their policies into regulations. See the determination I obtained from the Office of Administrative Law, petition to CalPERS to adopt the CalSTRS proposal, and flyer to CalPERS members.

Under Feckner’s leadership, the current board appears more likely to do the right thing. I say, trust but verify.

CEOs as Independent Directors

In 1990, out of the largest 500 American companies, 358 active CEOs served on outside boards filling 794 seats. As of June 2006, only 265 served on an outside board filling 376 seats, a 53% decline. CEOs who continue to serve have reduced their seats by 36%. Service on outside boards for CEOs of the largest 100 companies went from almost 90% to less than 60%.

Jim Drury, founder and CEO of search firm JamesDruryPartners, argues companies need to make outside board service a priority for their own CEOs. “CEOs learn a lot when serving on boards other than their own. After all, many companies deal with the same issues: international expansion, global sourcing, product innovation, technology enhancement. When a CEO gains an inside look at how other companies handle these crucial problems, she can be a more effective leader in her own firm. And CEOs can work more effectively with their own boards if they’ve experienced life on the other side of the table.” “With CEOs abandoning the boardroom, it’s time for reformers to remember that ‘too much of a good thing is never a good thing.’” (Boardroom Brain Drain, Forbes.com, 10/16/06)

Directorship views the picture from a somewhat different perspective. “The good news is that once a nominating committee is willing to look beyond the traditional specifications, the pool of talented potential directors widens considerably.” One obvious source of supply is the cohort of recently retired CEOs; another is active CFOs and the retired managing partners of the big accounting firms. Women and minorities are viewed as a third source. “The emphasis on skill sets is steering some nominating committees toward candidates with particular expertise rather than particular titles.” “With boards under pressure to represent shareholders’ interests more visibly, some observers think the universe of investor relations professionals could be a future source of potential directors.” “A seat on the board of a public corporation is increasingly seen as necessary training for up-andcoming executives.” (Who Will Sit on Tomorrow’s Boards?, Directorship, 10/06)

Shaping Strategy from the Boardroom, argues that CEOs should have more influence over who sits on the board, not less. Nominating committees have been given too much control over board composition. CEOs should have more say in picking directors who know the business. But boards should be more involved in driving corporate strategy. Boards must also make strategy as important as compliance when they manage their work and reform their processes. Industry expertise may be more important than previous board experience. (The McKinsey Quarterly, 10/18/06)

Many reformers would be happy to have CEOs of their companies sit on another board to get such cross-fertilization of ideas, if the CEO of their board is nominated by shareholders of the other company. Board loyalties tend to be to those who brought them to the dance (to paraphrase Nell Minow). Its about time that at least some of the invitations go out from the owners.

Insights from Morgenson

Gretchen Morgenson’s 10/15/06 NYTimes article, Fresh Air For Board Elections?, provides additional insights into the SEC’s delay in addressing proxy access.

She shares speculation from Stephen Davis, editor of Global Proxy Watch. “A rule by the SEC vetoing proxy access would be yet another piece of evidence Democrats could use to argue that Republicans really just care about the corner suite rather than the investor on the street.” And if Democrats take over the House, ”Barney Frank has got a record that certainly would not support measures such as the SEC is contemplating to block board accountability,” Mr. Davis said. Perhaps Christopher Cox chose to avoid putting into effect a rule that would alienate the potential new boss, he added.

Given the delay, chances are very good that Hewlett-Packard’s proxy won’t be the only one next year which includes an access proposal.

Morgenson concludes (chopped off in the Arizona Republic version), “If a majority of investors support proxy access proposals that appear on ballots next year, they will send a crucial message to all those opposing the concept — entrenched executives, inattentive directors and the Business Roundtable, for example. That message is that the managers of corporate America have had the upper hand over their owners for way too long. It is time for shareholders to show them who’s boss.”

But those opposing the concept know that already, don’t they? CEOs, inattentive directors, and the BRT already got that message when the SEC’s watered-down rule on proxy access got more support than any other rulemaking in their history. The BRT doesn’t need a wake-up call. Their CEO members are already involved in a pitched battle to retain power. They killed the proxy access proposal. They tried to kill defined benefit plans for public employees in California. It appears they will do whatever necessary to keep what they have.

However, if shareholoders are able to win access at a few companies next year, AND if that causes the American public to realize just how undemocratic corporate elections now are, that just might lead to a real public outcry if the SEC tries to put the genie back in the bottle.

Diehr Keeps CalPERS Seat

Incumbent George Diehr fended off two challengers to retain his seat representing 250,000 state employees on the CalPERS Board. Only 16% bothered to vote. Perhaps that’s a sign they were satisfied with the current board or perhaps it is because board members at CalPERS almost never lose, so why bother voting? Coverage of these important elections in the press is almost nonexistent. (Don’t overlook CalPERS election)

Diehr, who was endorsed by the largest union, SEIU 1000, received 51% of the vote, barely avoiding a runoff. Howard Schwartz, a CalPERS attorney with endorsements from seven unions, finished second with 32% percent. James McRitchie, a state ethics officer, the publisher of CorpGov.net, and a long-time labor activist with no union endorsements, received 17% percent of the vote. (CalPERS incumbent fends off challenge, Sacramento Bee, 10/14/06)

Based on prior estimates by each candidate, it appears Diehr’s campaign spent about $20 per vote, Schwartz’s about $2.40 and McRitchie’s (based on actuals) about $0.82. Figures probably do not include “in-kind” union contributions. As the biggest loser, I feel the cost was well worth the opportunity to raise several issues. (news)

SEC Delays Access Discussion

The SEC’s open Commission meeting scheduled for October 18 will no longer discuss Shareholder Access to the Proxy to address the AFSCME v. AIG decision (Sunshine Notice). That discussion has been rescheduled to 12/13/06 (release). The delay may reflect the inability of the SEC’s five commissioners to reach consensus, despite weeks of internal debate.

The 12/13/06 meeting will also address Internet proxy delivery and modifying the controversial Section 404 of 2002’s post-Enron Sarbanes-Oxley reforms. Regarding access, CII issued a press release applauding the Securities and Exchange Commission “for letting the Second Circuit Court’s ruling in AFSCME v. AIG stand, allowing resolutions on proxy access to be presented to shareowners. This is great news for investors.” “We look forward to working with the SEC to help craft a sensible and effective rule that safeguards the interests of long-term shareowners without being unduly burdensome to business.” (Council of Institutional Investors Lauds SEC Move on Proxy Access, 10/12/06)

CalPERS and CalSTRS were similarly upbeat. CEOs Fred Buenrostro and Jack Ehnes issued a joint statement: “We commend Chairman Cox for his decision to go forward with a deliberative rulemaking process on the use of the proxy to nominate corporate directors.  We are confident it will result in a thoughtful rule permitting reasonable, fair shareowner access. CalPERS and CalSTRS look forward to a full and complete opportunity to provide feedback on a rule that all shareowners and Corporate America will live by in the future. The ability to elect, nominate and hold directors accountable are the cornerstones of shareowner rights.  Any new proposals should be handled with the utmost care and considered by all market participants.”

Directorship Editor in Chief Bill Holstein’s editorial on the SEC and Rule 14a-8 said “sources familiar with the thinking of SEC Chairman Chris Cox” say “the SEC will defend its most recent interpretation of the obscure Rule 14a-8(i)(8)…He has to tilt to one side or the other, and he has chosen to defend the status quo.” (SEC to Disappoint Activist Shareholders, 10/5/06)

“By pushing past November, Cox keeps Congress out of the game,” said ISS’ Patrick McGurn. “He also pushes commission action past the scheduled filing deadlines at most companies with Spring annual meetings. It looks like we’ll see some access proposals on ballots during the 2007 season.”

ISS Governance Weekly reports that former SEC Commissioner Harvey Goldschmid said, “it would be a tragic mistake to simply turn the clock back.” Coleman Stipanovich, executive director of Florida’s State Board of Administration, warned that “any action by the commission to reverse the decision of the court in AFSCME will be perceived by the investing public as decidedly anti-shareowner.”

ISS further reports that Office Depot CEO Steve Odland, who chairs the Business Roundtable (BRT) wrote in a Sept. 29 letter, “There is nothing in the AFSCME decision that requires the SEC to engages in a notice-and-comment rulemaking to maintain its current interpretation of Rule 14a-8(i)(8), and we encourage the SEC not to do so.” Thomas Lehner, director of public policy at the BRT, is “asking the SEC to reaffirm its current standard,” he told Governance Weekly. (SEC Delays Access Hearing, 10/13/06)

CEO Pay Reviewed

The 10/12/06 edition of the Wall Street Journal included an excellent review of CEO pay by Joann S. Lublin and Scott Thurm, Behind Soaring Executive Pay, Decades of Failed Restraints. The author cover a period from President. Franklin D. Roosevelt’s 1936 State of the Union address, when he railed against “entrenched greed” at American corporations, to the growth of options, golden parachutes and restricted stock.

CFO.com also tackles the subject in CEO Pay is Too High, Directors Say, 10/12/06. Nearly 40% of directors believe CEO pay is “too high in most cases,” according to the 10th annual Corporate Board Effectiveness Study conducted by the Center for Effective Organizations at the University of Southern California’s Marshall School of Business and Heidrick & Struggles. 64% said that they expect to see continued rises in CEO cash compensation. 58% expect an increase in stock-based compensation.

CalSTRS Takes Leadership Role

As indicated previously, James McRitchie, the Publisher of CorpGov.net recently petitioned the CalPERS Board to adopt regulations similar to those proposed by CalSTRS limiting gifts and campaign contributions. Additionally, the petition requests CalPERS to set forth in regulations requirements that members of the board of administration comply with the same governance standards CalPERS attempts to impose on corporate boards. (CalPERS Petitioned on Gifts Campaign Contributions and Governance) During an October meeting, CalPERS members will get an informational briefing on CalSTRS Conflict of Interest and Disclosure Proposals.

While the press covered proposed limits on gifts and donations (Limits on Firms’ Donations to California Pension Panel Eyed, LATimes, 9/8/06), I hadn’t see any coverage of other issues:

CalSTRS is considering adopting a number of policies to supplement the communications disclosures rules required by statute.

  • First, CalSTRS is considering extending the disclosure requirement to transaction decisions that are delegated to staff.
  • Second, CalSTRS is considering adopting a new policy based on a practice adopted by the Teachers’ Retirement System of Texas that would require investment staff and consultants to disclose to the General Counsel communications initiated by a Board member where the Board member was advocating for a specific outcome regarding an investment transaction. Those communications would be disclosed to the Board if and when, in the judgment of the Chief Executive Officer, they may be material to the Board’s deliberations.
  • Third, CalSTRS is considering adopting a stand alone “undue influence” policy that would prohibit a Board member or third party from exercising undue influence on any CalSTRS staff or Board member. Undue influence is defined in the draft proposal “as the employment of any improper or wrongful pressure, scheme or threat by which one’s will is overcome and he or she is induced to do or not do any act which he or she would not do, or would do, if left to act freely.”
  • Finally, CalSTRS is considering, at the Treasurer’s request, a policy change to require disclosure of any communications between the Governor and his or her appointed CalSTRS Board members regarding CalSTRS matters.

CalSTRS is also considering requiring its investment managers, general partners and similar entities to disclose the existence of any relationship with placement agents that may receive a fee as a result of a CalSTRS investment. The CalSTRS September agenda item notes that CalSTRS conducted a survey of eight large public pension systems. The survey found that two funds had banned the payment of placement agent fees, four systems require the disclosure of placement agent relationships and the fees paid, and the other two funds had some form of formal or informal policy regarding the reporting of some placement agent information.

CalSTRS appears to be taking the lead from CalPERS with regard to board ethics. Will CalPERS simply “wait and see” or will they take their own initiatives? The above information is scheduled to be strictly informational. Let’s hope they move forward with substantive proposals or at least their own research soon.

CalPERS Staff Seeks Delegation Re Director Nominations

Empirical research has documented staff’s successful engagement of companies through the Focus List Program and its positive impact on the Total Fund. An expansion of delegated authority to the Focus List Program and non-Focus List Program company engagements will provide staff the resources necessary to interact more effectively with portfolio companies and to potentially have a greater positive effect on the Total Fund.

Staff recommendations seek to expand the Corporate Governance engagement process at:

(1) Focus List Program companies by providing for the ability to nominate up to two directors at individual Focus List and Monitoring List companies.
(2) Up to ten non-Focus List Program companies per fiscal year by providing for the ability to use those engagement tools currently available for Focus List Program companies in addition to the ability to nominate up to two directors at the ten individual companies.

If staff recommendations are accepted, expect to see CalPERS’ influence in corporate governance expanding through quiet diplomacy and also by pushing shareholder nominees. This move would be all the stronger if the SEC decides to let the AFSCME v. AIG decision stand, although that appears unlikely.

Westly Seeks More International Options

California State Controller Steve Westly proposes that CalPERS relax its rules on investing in emerging markets. Currently, various countries are blacklisted based on a combination of market factors and country factors involving political stability, human rights and labor practices.

Westly’s letter argues, much as I have done for the last several years, that investing in “select public companies – those serving as models for governance and operations – could act as a catalyst to improve political and economic conditions. This approach would also enable us to reduce investment risks and take advantage of global economic growth.”

Westly mentions his previous efforts to allow investments in companies which trade on exchanges with strong investor protections, and urges the Committee “to move forward in this direction through a pilot initiative.” He then goes on to urge investments in public companies if they adhere to the Global Sullivan Principles, International Labor Organization standards and the United Nations principles for responsible investment.

I hope these elements are taken in combination. I would hate to see investments based on adherence to the Sullivan Principles, without adequate investor protections.

Blue Growth

According to Blue Investment Management LLC, a New York-based investment adviser, stocks of US companies that contribute more money to Democrats than to Republicans have significantly outperformed both the Standard & Poor’s 500 Index and shares of Republican-leaning companies over the past five years.

An index of 76 companies in the S&P 500 meeting certain ethical criteria and favoring Democrats — “blue” stocks — would have topped a group of about 380 Republican “red” stocks by 15.6% annualized over the five years through August.

The study required companies to meet a set of ethical standards common to socially responsible investing, such as corporate governance, environmental sensitivity, workers’ rights and avoidance of products including tobacco and weapons. Then the researchers layered in the political contributions of S&P 500 companies and their three highest-ranking executives over the past decade, based on publicly available records. To this publisher, that sounds like comparing apples to oranges; there may be very little correlation with political support.

The timing of the research paper coincides with two like-minded mutual funds that Blue Investment Management expects to introduce on Oct. 17, the Blue Large Cap Fund and Blue Small Cap Fund. (Stock research could leave GOP feeling blue, MarketWatch, 10/10/06)

Hard Ball

Hedge funds involved in hostile exchanges with target compaies generated stock price increases of 5-7% in the 1st twenty days. In contrast, those with friendly exchanges brought no signficant rise, according to a study by Wei Jiang and others as reported in Business Week. “No evidence backed up CEO complaints that hedge fund activism destroys value or focuses only on the short term. (Play Tough, the Market Will Love it, 10/16/06) I’d like to see a comparison of the two styles over one or two years.

Overpay Extends Many Levels

Researchers looked at average pay at 120 corporations. Companies with bloated CEO pay also tended to have bloated pay several layers down. “If a CEO was also chairman of the board, he and his staff wrere more likely to be overpaid.” (Business Week, I’ll Have What He’s Having, 10/16/06)

That reminded me of something I reported back in the early days of CorpGov.Net. Steve Werner and Henry Tosi did a study entitled “Other People’s Money: The Effects of Ownership on Compensation Strategy and Managerial Pay,” which appeared in the Academy of Management Journal, Vol 38, No 6, 12/95, pp 1672-1691.

In “owner-controlled” firms the size of the bonus and basis for distribution was correlated with improvement in firm performance; no such correlation was found in “management-controlled firms.” However, such firms paid their CEOs 29.5% more. The interesting finding, to this reader, is that not only are CEOs being paid more without shareholder oversight but that inflated compensation extended to the next 5 layers of management so that 6 layers of management averaged 9% higher pay. This finding makes CEO pay a much bigger issue.

P&I Calls for Open Access

An editorial in the prestegious trade publication, Pensions & Investments says: “The pool of executives from which directors are chosen needs an infusion of new blood to improve the breed. And directors must be made to answer more directly to shareholders.”

In addition to unequivically calling for shareholder access, P&I suggests the SEC could require majority vote of directors. “That would make it difficult for single-agenda candidates to be elected to the overall detriment of corporate performance.”

P&I also reports former SEC chair Harvey L. Pitt told the Council of Institutional Investors at its September conference that shareholders should be allowed to establish procedures to nominate directors through access to the corporate proxy ballot. (Time for access, 10/2/06)

Boards Think CEOs Have Less Control

In the 10th Annual Corporate Board Effectiveness Study, conducted by the Center for Effective Organizations at the University of Southern California and Heidrick & Struggles, “nearly 40% of directors surveyed believe that CEO pay is too high in most cases,” a significant increase over prior years’ study results. An overwhelming majority (81%) favor increasing the link between CEO pay and performance.

Despite the new SEC disclosure regulations and the fact that they expect to be spending more time addressing CEO compensation issues, 64% of directors expect to see continued increases in CEO cash compensation. Fifty-eight percent expect an increase in stock-based compensation. And, 85% say they expect to see the linkage between compensation and performance increase.

Additionally, the survey finds a significant power shift in the boardroom, with 81% of directors reporting that CEOs have “less control over their boards” than before. Yet, in my assessment of the survey findings, directors appear to lack the will to impose real oversight, since nearly 50% say mandatory shareholder approval of executive compensation plans would have the greatest impact on lowering CEO compensation packages. Shareholders can apparently do what directors can’t. That’s further evidence of the need for proxy access. When shareholder can propose their own directors, directors will have backbones.

In other study findings, the majority of directors (84%) say that boards are spending more time on “monitoring activities and less on strategy.” Shaping long-term strategy is an area where 41% of directors believe there is room for improvement. Seventy-five percent of boards now have an independent director who serves as lead or presiding director — a dramatic increase from 49% in 2003 and 32% in 2001. (Study Reveals Major Power Shift Underway in U.S. Corporate Boardrooms, 10/4/06)

Post-Season Wrap

ISS released its report of key issues and voting statistics from the 2006 proxy season.

Withhold recommendations fell to 15% of director nominees at US companies, versus 17% in 2005 and 20% in 2004. Majority voting in board elections is on a tear, with more than 180 companies adopting new standards, most using the Pfizer model of director resignation under a plurality standard.

Backdating stock options was ranked by institutional investors as most problematic pay practice. A majority of survey participants (78%) thought the optimal remedy would be to recoup the windfall associated with the backdating.

21 proxy contests went to a vote this year, versus 18 in 2005, and 19 in 2004. A clear majority (63%) of ISS clients think industries in the US face significant exposure to financial risk from environmental issues and changes in environmental regulations, with energy firms facing the most exposure.

The number of companies in Japan and France adopting takeover defenses increased, German legislation seeks to end share blocking, and the UK revised its Combined Code. (see press 10/5/06 release and scorecard)

CorpGov.net In the News

CEO boosts Lilly holdings, Indianapolis Star, 10/4/06; Family Firms Have Unique Risks, Benefits, Washington Post, 10/4/06; CalPERS Petitioned on Gifts Campaign Contributions and Governance, press release, 9/19/06. 

Whose Company?

Nice article in October 9, 2006 BusinessWeek by Jack and Suzy Welch…Whose Company Is It Anway? I like the answer: “A company is for its shareholders. They own it. They control it.” Concluding with, “A company exists to serve the people who elect the board of directors, which, in turn, picks the management that drives the company. It is for its owners.”

But do the shareholders elect the board or simply ratify the board, whose choice is all too often substantially influenced by management? We tried to obtain proxy access and ran into a brick wall known as the Business Roundtable, composed of 160 CEOS. The same group recently stopped broker voting reforms. Whose company is it? The balance of power still has not shifted from management and boards to shareholders.

California to Allow Majority Voting

SB 1207 (Alarcon) was passed and signed by Governor Schwarzenegger. The bill, sponsored by CalPERS and CalSTRS, allows the use of majority voting to elect a member of the board of directors of a publicly-traded, California corporation, in an uncontested election. The new law takes effect on January 1, 2007. Originally, the bill would have made majority voting the default standard for California corporations.

Existing law in California requires plurality voting, candidates for corporate boards receiving the highest number of affirmative votes, up to the number of directors to be elected by those shares, are elected.

Enactment of SB 1207 will allow corporations to amend their bylaws to allow the use of majority voting to elect members. The term of a seated member of the board, where such bylaws have been adopted, who fails to receive a majority vote in an uncontested election will end within 90 days of the election.

Provisions of the new law: allow a corporation that has retained cumulative voting procedures, the right to retain that system and not to be subject also to majority voting in uncontested elections; the vote to change the corporate bylaws must be by vote of all outstanding shares rather than by a majority of votes cast, and; allow boards to reappoint a rejected director if special circumstances, as determined by the board, warrant their retention of the director.

More Studies on Mutual Fund Voting

Thanks to disclosure rules put into place by the SEC under Harvey Pitt, studies of mutual fund voting have dramatically increased because the records are now available. WSJ reports the studies have generally found: 1. The biggest mutual-fund companies overwhelmingly do vote with management, more so than at least one leading independent adviser recommends. 2. They don’t appear to favor companies where they run 401(k) retirement-savings or other investment programs. 3. On select issues — those seen as directly affecting stock returns, such as votes over anti-takeover provisions — fund companies are willing to go to vote against management.

Large funds voted in support of management 92% of the time, whereas the voted in favor of shareholders resolutions 30% of the time. In contrast, during the same period Glass Lewis recommended its clients vote for 80% of management-proposed resolutions and more than half — 53% — of shareholder resolutions.

Shareholder proposals got the most support, at 62%, from Bridgeway Funds and the least support from Fidelity, which backed 10% of such proposals. Mutual funds cast 84% of their votes against “poison pills,” in line with Glass Lewis’ recommendations, which suggested investors approve measures to limit poison pills 83% of the time. In general, mutual funds have been hesitant to support proposals without proven economic benefits. (No Secrets: How Funds Vote Your Shares, WSJ, 10/3/06)

The studies mentioned in the article didn’t cover SRI funds, which are generally much more sympathetic to shareholder resolutions. One lesson is that, in order to get more mutual funds to vote against management, we’re going to need more studies that correlate the actions shareholders request to the increased likelihood of corporate profitability.

Comment on ISS 2007 Proxy Policies

Thanks to Broc Romanek’s TheCorporateCounsel.net Blog, I learned that ISS is seeking comments on its proposed 2007 proxy policies. In the past, input was privately solicited from a small diversified group of market players. Romanek says, “In my mind, this comment opportunity is at least as important as the SEC’s rule-making process. With director elections no longer routine, ISS’ proxy policies are more important than ever.” Get your comments in by October 11th using their handy online forms for each of the following:

Here’s an opportunity for small investors to influence large investors. Let’s be so helpful that ISS makes this experiment an annual event!

Morgenson on SEC Meeting

Gretchen Morgenson notes that “concerns first surfaced when the commission, immediately after the court decision, scheduled a meeting for Oct. 18 to address possible rule changes on proxy access. This lightning-fast move from this normally torpid agency seemed a sure sign that it had decided that the appellate court ruling should not stand as policy — as it would if the SEC did nothing.”

Speculation abounds as to what action the SEC will take. As I have indicated previously, my hope is that they let the decision of AFSCME v AIG stand, so that shareholders can do their own policing.

Morgenson’s most recent musings quote several interested parties, among them:

”Rules that interfere with Delaware’s carefully defined processes threaten to disrupt the whole foundation of orderly corporate governance,” said Gary Lutin, an investment banker at Lutin & Company in New York who advises shareholders on corporate control contests.

“Unfortunately, shareholders do not now have the means to assert market influence,” said Greg Taxin of Glass Lewis & Company. ”A good libertarian would seek an easier way for the market’s participants to order their affairs and provide an oversight mechanism for owners that would help eliminate the call for greater regulation and criminal prosecution.”

The SEC can continue to protect managers and directors from shareholders or, if it follows the advice of Morgenson and others, it can facilitate shareholder oversight by providing the tools needed “to oversee their affairs and fiduciaries, removing those who fail.” (All’s Not Lost, Disgruntled Investors,NYTimes, 10/1/06) The Business Roundtable tells the SEC “the decision in AFSCME is not a reason to reopen debate on the issue of proxy access.”

Investor Environmental Health Network

More than a dozen mostly SRI mutual funds have formed the Investor Environmental Health Network, “working to ensure the companies we invest in are taking appropriate steps to reduce risks associated with the toxic chemicals used in their products.”

Changing practices can shut markets but can also create new opportunities for innovators of safe substitutes. “Companies need to know what’s in their products, what chemicals are in the materials they buy from their suppliers, and they need to invest in “green chemistry” and encourage their suppliers to do so as well.”

One example of the troubles companies can face is E.I. du Pont de Nemours and Company, “which recently settled a lawsuit for more than $100 million associated with its use of the chemical BFA in the production of Teflon® and other products. This was followed with a DuPont settlement of an ERA civil proceeding for $16.5 million, over the issue of the company’s failure to disclose certain information related to health hazards of BFA, and now the company is the subject of a federal criminal investigation. Investors had little forewarning of these developments. The company’s stock price dropped nearly 30% over the last year concurrent with many of these developments.”

Members of the Network are filing resolutions at 11 companies. Two resolutions at Becton, Dickinson and Company and at Whole Foods Market, ask these companies to report on the feasibility of developing safer chemicals policies and practices. Three additional resolutions focus on cosmetics safety at Johnson & Johnson (withdrawn after management agreed to disclosures and meeting), Avon Products, and CVS. The resolution at The ServiceMaster Company, the parent company of TruGreen ChemLawn, asks the company to report on the feasibility of discontinuing the use of synthetic pesticides and substituting natural and non-toxic lawn care services.

A resolution filed at DuPont asks the company to report on a prospective phaseout of PFOA. A related resolution at ConAgra Foods, Inc. asks the company to report on policy options for reducing or eliminating the use of PFOA-related chemicals in product packaging. Two resolutions at the primary chemical producers Dow and DuPont do not focus on consumer products per se, but on safer chemicals practices instead.  

“We would like to believe that smart corporate strategists will see the hand-writing on the wall, and position their companies both to avoid future liabilities and to take advantage of the numerous value enhancement opportunities ahead.” Smart investors might do the same by investing with the funds that make up the Investor Environmental Health Network.

The Network appears to be building on the work of the Rose Foundation and especially that of Dr. Richard A. Liroff’s Protecting Public Health, Increasing Profits And Promoting Innovation By Benchmarking Corporate Governance of Chemicals in Products.

Proxy Monitoring Proposal at Microsoft

Mark Latham’s proxy monitoring proposal will be voted on at Microsoft’s annual meeting. The proposal calls for selection of proxy advisors by shareowner vote, paid with corporate funds. I can’t think of a better way to bring self-interested rationality to voting in corporate elections, especially to the votes of individual shareholders and small institutional investors who do not pay for their own proxy advisors. The proposal’s supporting statement explains that it “could also increase competition in the proxy advisory business.”

Also of note, as reported in September 26th The Corporate Monitoring Newsletter:

The U.S. Government Accountability Office is starting a review of firms that offer proxy advisory services and/or corporate governance ratings. They will focus on the potential for conflicts of interest, the degree of competition in these businesses, their impact on the stock market, and questions of SEC regulation of these types of firms.

The University of British Columbia student council is interested in Latham’s proposal to sponsor the world’s first test of voter-directed media funding, in their January 2007 election. The aim is to demonstrate the benefits of this enhanced voter information system at UBC, then spread its application to larger democracies and to corporations.

To subscribe to this important newsletter, e-mail Mark Latham.

CalPERS Healthcare Trust Fund Vetoed

SB 1729 (Soto) would have provided the legal framework for CalPERS to set up a healthcare trust fund for local governments. Arnold Schwarzenegger’s veto message claims “the bill is drafted in a manner that could create new healthcare benefit obligations into the future that do not exist today. I look forward to working with all interested parties on legislation to create a structure for the state and local governments to prefund non-pension post-employment benefits. I am directing my staff and the Department of Finance to work with the parties interested in the bill before the new Legislative session convenes so the Legislature can address this issue early in the 2007-08 legislative session, possibly with urgency legislation. I am confident that by working together, all the interested parties can craft a structure that meets the needs of employers and employees without creating any unintended consequences.”

Over the next two years, states and local governments must start complying with new accounting rules requiring officials to list the long-term cost of health benefits for retirees on the balance sheets and reveal how much is needed to fund the entire obligation. Most governments, including the state, are paying the current year’s health care cost and not setting aside money for the future. In California, some experts estimate the tab could near $100 billion. (Health-care fund expansion vetoed by Schwarzenegger, SacBee.com, 9/30/06)

I am familiar with SB 1729. When CalPERS sponsored language to address the need for a trust fund they included language that would have exempted the board from any oversight by members or the public as rules governing the fund were adopted. The legislature took my suggested amendments to require the normal rulemaking protections.

Over the long term, prefunding healthcare liabilities would allow investment earnings to pay the bulk of healthcare costs, just as they currently pay the bulk of pension costs. However, to do so governments must, as the Governor’s veto message indicates, “create new healthcare benefit obligations into the future that do not exist today.” They do so, by essentially suing themselves in court, creating a scheduled liability of future fixed costs, rather than a liability that can be adjusted during periods of fiscal stress.

However, on the plus side, local governments can issue bonds to fund all or a portion of their plan’s unfunded liability. Investment returns on the retiree medical plan trust funds will often exceed the interest expense on the bonds and can be used to reduce current or future costs. Of course, if they don’t, future plan expenses will be higher than actuarial estimates.

Although local governments can go through this type of court validation process, state governments are not eligible to do so. Perhaps Schwarzenegger will seek amendments to allow the state government access to the same process…or perhaps he will seek to reduce the likelihood of increased healtcare costs by reducing future obligations. We will be watching closely. In the meantime, the huge $210 billion CalPERS fund will grow more slowly than it otherwise might have but will continue to wield clout in the area of corporate governance.

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A copy of the Commission’s press release is available on the SEC’s website.

It is unclear, at this point, what specific amendments to Rule 14a-8 will be proposed. If the proposed amendments will be to change the language of Rule 14a-8(i)(8) to specifically permit the exclusion of “proxy access” proposals, this will mark a huge step backwards. Not only would such amendments deprive shareholders of the needed opportunity to adopt rules that would ensure true corporate democracy at their corporations, but they would signal a disturbing anti-shareholder stance being taken by the SEC itself. As former SEC Chief Accountant Lynn Turner recently commented, the SEC’s meeting on October 18, 2006, notably timed before the November elections, “will give investors a clear cut statement as to whether this Commission is still ‘The Investors’ Advocate’ as then Chairman Douglas stated, or has evolved into another role.”

We strongly urge you to contact the SEC to make known your feelings on “proxy access.” As noted above, the SEC has scheduled a public meeting for October 18, 2006. Details regarding the location and agenda will be released during the week of October 9. We urge you to make every effort to attend. In the meantime, you can contact the SEC directly to voice your opinion on this very important issue.

Hon. Christopher Cox, Chairman

Hon. Paul S. Atkins

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