February 2007

European Governance Regimes Converge but National Differences Persist

There is increasing convergence towards a Europe-wide conception of good corporate governance but significant differences between individual markets persist, according to a major study of European governance practices.

Based on analysis of 289 companies across 15 countries, the European Corporate Governance Annual Review is the most comprehensive assessment of governance practices across Europe available. Drawing on research and data gathered by the partners of the European Corporate Governance Service (ECGS), the Review aims to provide a thorough overview of all the major corporate governance trends in Europe.

Key findings include:

  • 84% of European company boards in our sample have a separate chair and CEO
  • 73% of companies have a one-tier board, 27% have a two-tier board
  • 27% of companies have employee representation at board level
  • 42% of companies require the approval of the remuneration report and/or policy by shareholders
  • 25% of European companies make use of differential voting rights
  • 92% of the FTSE Eurofirst companies do not employ share-blocking

Looking more specifically at board structure it is predominantly French and Swiss companies that still have combined chairman and CEO roles. Overall 69% of European directors are elected on an individual basis, the remainder being elected on a collegial basis. But only 12% of European directors in their sample face annual re-election. 43% of the members of European boards can be considered independent by ECGS standards. The Netherlands, Finland and Switzerland are the best performing markets in this respect.

Turning to remuneration arrangements, only 42% of companies require the approval of the remuneration report and/or policy by shareholders, although the mechanics of the shareholder vote vary between countries. In addition 48% of the companies in the sample clearly disclose performance conditions for long-term incentives for executives.

In terms of shareholder voting levels ECGS analysis shows that the United Kingdom and Spain remain at the top of the league table with nearly two thirds of shares being voted in these markets. German shareholders responded to an eight year low in voting turnout in 2005 by voting more shares in 2006 than at any time since 1998. However French and Italian turnout figures have declined from previous year peaks.

Alan MacDougall, managing director of PIRC, the managing partner of ECGS, said:

When ECGS started in 2002, there were few widely accepted corporate governance standards on a European level and there were several different approaches to best practice in Europe. However the market has changed significantly over the last few years. Firstly, most of the major markets have introduced principle-based corporate governance regimes, adopting local best practice codes which are implemented through a ‘comply or explain’ approach. Secondly, we have seen the introduction of Europe-wide regulation by the European Union, of which the most notable example is the Shareholder Rights Directiveapproved in 2007.

This simultaneous development of bottom-up best practice codes and top-down European regulation has significantly altered the context and comparability of corporate governance in Europe and makes it possible to start speaking about ‘European corporate governance’ albeit within what is still a diverse set of corporate legal environments in the various discrete European capital markets.

See also European Corporate Governance Forum.

More to Follow Aflac

WSJ reports that Pfizer and Schering-Plough may follow Aflac by agreeing to allow shareholders to vote on executive compensation, beginning in 2009. Both are part of a group, which also includes AFSCME, CalPERS and AIG discussing the idea.

One sticking point: How to give shareholders a voice on elements of a pay package that companies are legally bound to pay, such as an executive’s deferred compensation? “You create an expectation that you can do something about it” if investors reject the package, says one person close to the situation.

It also reports that following the UK model may not have the desired impact. “We have better disclosure and better accountability,” says Ian Jones, head of responsible investment at Co-operative Insurance Society Ltd., an insurance company with about $40 billion under management. But “I don’t think it’s had much effect on the amount of remuneration.”

Stephen Davis, says the advisory vote has strengthened the link between pay and performance. Companies and investors are on a learning curve, but the vote appears to have helped shift severance packages payouts from a three-year period to one-year pay-outs. But he says directors worry that investors reviewing dozens of pay plans are issuing “cookie-cutter” judgments rather than evaluating packages individually.

UK investors are among those pushing U.S. companies to adopt the advisory vote. In January, a group of 13 institutional investors, nine British, wrote SEC Chairman Christopher Cox to endorse the practice. The group, which collectively has $1.5 trillion under management, said the votes would bolster communication between shareholders and directors, better link pay with performance and “provide a counter-weight” to rising executive pay. Companies in Australia, Sweden and the Netherlands also grant shareholders a vote on pay. (Shareholders Push For Vote on Executive Pay, 2/26/07)

Monitoring Works

Morgan Stanley found that an equally weighted index (that is, an index in which each stock has equal weight) of European companies with a minimum 50% family stake outperformed the Morgan Stanley Capital International Europe index by an average of 16% annually from 2001 to 2006.

Credit Suisse examined companies with a minimum family stake of 10% and market cap of at least $1 billion. On average, these companies outperformed the pan-European Dow Jones Stoxx 600 Index by 1.9% a quarter, or 8% a year, from the end of 1996 to the end of 2006. Credit Suisse found a similar pattern in the US.

Analysts say that because family dominance means companies can promote long-term strategy over quarterly results, their shares often do better than peers. A focus on the core business rather than “trendy, short-lived” strategies is a factor, says Hervé Prettre, head of commodities and equities trading research at Credit Suisse. (Embracing Family Values, WSJ, 2/26/07)

I’d like to see similar research on all companies with a 10% shareholder. The driver may just be a shareholder with enough invested to make monitoring worthwhile, rather than family involvement.

Don’t Toss Proxy

Efforts to rein in CEO compensation have spawned 239 proposals, up from 175 in 2006, according to a mid-February ISS analysis. Nearly 1 in 4 of all 984 proposals filed at public companies this year addresses executive compensation.

“Sarbanes-Oxley essentially empowered directors” to oversee management more effectively, says Carol Bowie, of ISS. “But shareholder empowerment is what’s going on right now…. We are seeing directors respond to shareholders, and directors don’t like to get low votes [on annual meeting agenda items]. So they respond to that.”

The year’s raft of pay-related initiatives almost exclusively target firms that have performed weakly.

“I don’t think that, as an individual investor, unless you’re [billionaire activist] Carl Icahn, you’re going to have much impact,” says Jay Eisenhofer, a Wilmington, Del., lawyer who represents institutional shareholders and is author of Shareholder Activism Handbook (Aspen, 2005). “It’s just not a realistic sort of goal…. You’re much more likely to have an impact by having an association with an institution and influencing them to take action.”

Stakeholders are organizing with hopes of steering institutions to use their stock to advance an agenda. The Christian Science Monitor cites retirees from Verizon and Qwest Communications, for instance, labor unions and the Sierra Club. Amnesty International is beefing up its year-old Share Powercampaign, which equips activists in about 30 groups with tools and strategies to nudge institutions to vote with human rights in mind.

Bart Naylor, of Capital Strategies Consulting, says, “It remains disappointing to me how much the average guy remains oblivious to the fact that the major force shaping public policy in America is the corporation.” “And the one time that the average guy has something to say something about that, he is throwing that chance into the trash.” (Activists put CEOs in a fishbowl, CSMonitor, 2/26/07)

Pension Security Institute

Three pension fund organizations created the National Institute on Retirement Security, a not-for-profit research and education organization. The Council of Institutional InvestorsNational Association of State Retirement Administrators and National Council on Teacher Retirement filed Monday to incorporate NIRS as a 501(c)(4) not-for-profit organization, based in Washington.

The new entity, whose working name under development was Pension Security Institute, is “dedicated to conducting research and education programs to foster a deep understanding of the traditional pension system in the U.S.,” the statement said.

The Council agreed to provide $600,000 and NASRA and NCTR $100,000 each for first-year funding of the new institute, said Jack Ehnes, CII chairman and CEO of the $157.8 billion California State Teachers’ Retirement System, Sacramento.

The new group will not be involved in political lobbying or campaigns, Mr. Ehnes said.

The institute’s seven-member board will consist of the two members each from the CII, NASRA and NCTR, including the executive directors of each of the three organizations: Mr. Ehnes; Steve Yoakum, president of NASRA and executive director of the $26.2 billion Public School Retirement System of Missouri, Jefferson City; and Meredith Williams, president of NCTR and executive director of the $37.9 billion Colorado Public Employees’ Retirement Association, Denver. A seventh director will be selected by the six board members.

CalPERS Loses Millions

CalPERS’ restrictions on its emerging markets portfolio, which blacklist counties has cost the fund 2.6% in performance since they went into effect almost five years ago, according to a staff memo.

Since April 2002, CalPERS’ custom emerging market benchmark had a standard deviation of 19.5%, compared with 18.5% for the unconstrained FTSE All Emerging index, the staff memo explained. From April 2002 through December 2006, the CalPERS benchmark returned 22.8% on an annualized basis, 2.9 percentage points short of the FTSE All Emerging index.

Elsewhere, CalPERS officials are considering investing $300 million to $500 million in emerging markets corporate governance funds.

Staff hopes to earn an attractive risk-adjusted return as well as improve corporate governance practices at companies based in countries with substandard practices, a memo to the board said. The investments would not be limited to countries meeting CalPERS’ eligible emerging markets standards. (Country restrictions cost CalPERS plenty, P&I, 2/19/07)

SEC Studies Access

SEC Chair Christopher Cox commissioned a study of how Europe and other foreign jurisdictions handle shareholder voting rights, such as proxy access. (SEC Looks Abroad on Shaareholder Voting Rights, MSNBC, 2/23/07)

Hedge Fund Activism

A survey “Hedge Funds and Governance Targets,” by William Bratton found that hedge funds have an enviable record success in getting targets to accede to their demands, using the proxy system with remarkable, perhaps unprecedented, success. If the pattern of intervention persists in time, expands its reach, and maintains the present high level of governance success, then the separation of ownership and control becomes a less acute problem for corporate law. But such a change will occur only to the extent that clear cut financial incentives encourage an expanded field of intervention.

The financial results also show that hedge fund activism is a more benign phenomenon than its critics would have us believe. Hedge fund interventions neither amount to near-term hold ups nor revive the 1980s leveraged restructuring. Short term investments are rare. Large cash payouts have been made by only a minority of the firms surveyed, and borrowing has been the mode of finance in only a small minority of the payout cases.

Hedge funds were successful in getting corporate governance concessions in the midst of hostile takeover or proxy contest threats. Bratton found that 84% of the funds were successful in gaining some form of concession from a corporate board after a threat. In these cases, the hedge fund received settlement with a board seat, settlement without a board seat, a proxy contest with a board seat, the sale of the target, a cash payout, or sales of a significant asset. “The funds make good on their proxy threats,” Bratton said. “This is not cheap talk.”

Frank Pay Proposal

Congressman Barney Frank, chair of the House Committee on Financial Services, could introduce legislation allowing shareholders an advisory vote on executive pay packages, as they have in the UK, according to Forbes.com.

“The CEO picked them; they picked the CEO. I think it’s reasonable to say that the relationship between the board and the CEO is such a close relationship that it does justify treating this as an exception,” Frank said. He also indicated his support for proxy access. “I would hope that the SEC would promulgate a rule that would allow for proxy access…Shareholder democracy is one of the basic justifications for capitalism. (This Man Wants Your Money, 2/22/07; Frank: Exec pay legislation coming soon, BusinessWeek, 2/20/07)

Is 200 Hours too High?

How much time do directors spend to adequately do their jobs? Broc Romanek was quoted in an Indy Star article as estimating 200 hours or more a year. The article focused on the current President of Purdue University, Dr. Martin Jischke, who serves on three boards. The President is quoted in the article as saying that Romanek’s 200 hour estimate “sounded high.” Romanek’s response demonstrates It’s Simple Math (Even for University Presidents).

Pension Funds Urge Access at HP

CalPERS and CalSTRS, the nation’s two largest public pension funds which own of more than $1.2 billion in stock at Hewlett-Packard Company, asked HP shareowners to pass a proposal on the company’s March 14 ballot that would give shareowners a voice in nominating independent directors.

“By passing Proposal 3 on the ballot, owners of the company can meaningfully exercise their right to achieve strong corporate governance that fosters democracy, director accountability and long term value creation,” said Rob Feckner, President of the Board of Administration for CalPERS.

“Without access, it’s a one-sided nomination process which leads to a disconnect between what shareowners expect and want and what corporate boards deliver,” said CalSTRS Executive Director Jack Ehnes.

Shareowners will vote on the resolution at the company’s annual meeting on March 14, 2007, in Santa Clara, California. As a change in bylaws, the proposal will require two-thirds of the outstanding shares entitled to vote. Proposal 3 on HP’s proxy card was submitted by the AFSCME Employee Pension Plan, the New York State Common Retirement Fund, the Connecticut Retirement Plans and Trust Funds, and the North Carolina Equity Investment Fund Pooled Trust. (press release, 2/20/07)

Governance Reform Through Voter-Funded Media

Media reformers, political campaign finance reformers and corporate governance reformers are all trying to solve the same problem: how to make elected leaders more accountable to voters. Solutions proposed in those different arenas can be hybridized to create a more potent and farreaching reform mechanism.

Several researchers have independently designed similar systems for reducing the voters’ freerider problem, by letting voters allocate collective funds to pay for improved information. Some designs originated in the field of corporate governance, to help investors in publicly traded corporations vote their shares more effectively. The potential for adapting those systems to help voters in civic politics was also cited. Other designs originated in civic politics, as campaign finance reform: public funds allocated by voters could counterbalance special-interest contributions to political campaigns. Likewise, these ideas have been adapted as a proposal for corporate governance reform. A similar proposal for media reform would allow each taxpayer to direct some government funds to any nonprofit news medium, since existing media seem to provide inadequate public-interest news.

Read Mark Latham’s article “Proxy Voting Brand Competition,” published in The Journal of Investment Management, First Quarter 2007 issue. See also implementation of the world’s first voter-funded media (VFM) system during the University of British Columbia’s student council election.

Owners Gaining

“Slowly, incrementally, U.S. corporations’ owners are gaining control of what they own,” writes Geoff Colvin, Fortune magazine’s senior editor at large. Until 1993 institutional shareholders couldn’t legally pick up the phone and talk to more than ten others about a company in which they all held shares unless they first filed voluminous SEC forms. Then the rule was changed.

Another new rule forced more detailed disclosure of CEO pay, sparking public outrage and a law restricting the corporate tax deductibility of CEO salaries. Then came requirements that boards must consist mostly of independent directors and must meet regularly in so-called executive sessions. In 2003 SEC rules began requiring mutual funds to report how they vote their shares in all companies whose stock they own. That led to a reduction in default votes in favor of management.

The next CEO-humbling trend is clear. The No. 1 shareholder proposal at this year’s annual meetings would require directors to be elected by majority vote. (Are CEOs losing their power?, CNNMoney.com, 2/20/07) Next year’s trend, proxy access.

Best Companies

“The 100 Best Corporate Citizens” list was released by CRO (Corporate Responsibility Officer). Compiled by KLD Research & Analytics, it measures companies’ good citizenship by weighing their performance according to eight criteria: community, corporate governance, diversity, employee relations, environment, human rights, product, and total return on investment (averaged over three years).

Green Mountain Coffee Roasters took the top spot for the second year in a row. Rounding out the top 12 are Advanced Micro Devices, Nike, Motorola, Intel, IBM, Agilent, Timberland, Starbucks, General Mills, Salesforce.com, and AppliedMaterials. (100 Best Corporate Citizens 2007)

Non-Profit Corporate Governance Reform

The Weinberg Center for Corporate Governance at University of Delaware will present a free panel discussion hosted by Charles M. Elson, Edgar S. Woolard, Jr., Chair in Corporate Governance on April 5, 2007, 9:30 am ~ 11:30 am at 125 Alfred Lerner Hall. To register, contact Alba Bates, Administrative Assistant at 302-831-6157. Guest panelists include:

  • Carolyn Brancato, Senior Fellow and Director Emeritus, Governance Center and Directors’ Institute, The Conference Board
  • Joel Fleishman, Director, Samuel and Ronnie Heyman Center for Ethics, Public Policy, and the Professions; Director, Foundation Strategy and Impact Research Program, Duke University
  • The Honorable Harvey Goldschmid, Dwight Professor of Law, Columbia Law School, Former Commissioner and General Counsel, Securities and Exchange Commission (SEC)
  • Sheffield Hale, Chief Counsel, American Cancer Society
  • The Honorable Jack Jacobs, Justice, Supreme Court of Delaware
  • Bonnie McElveen-Hunter, Chairman, American Red Cross
  • Hugh Durden, Chairman, Alfred I. duPont Testamentary Trust
  • Roger Raber, CEO, National Association of Corporate Directors
  • Tina Van Dam, Director of the Governance Center and Directors’ Institute, The Conference Board

Democratic Corporate Governance Must Blossom From Below

James Rose, editor of CG Asia, questions the often heard logic that market-based freedoms like permanent normal trading relations will inevitably lead to democracy. “Why on earth would an established large corporation, Chinese or foreign, want a questioning and skeptical stakeholder constituency when the alternative is a compliant and cowed population? Why would overpaid and underworked executives want the spotlight of scrutiny?…The United States knows exactly what it is doing. As long as its investors, consumers and manufacturers gain from China’s boom, no-one from the White House outwards wants or needs any political freedom in China, Rose writes.

“The issue is not therefore what a few bureaucrats and eggheads in the United States or in China should do, for they will do little. The status quo suits them too well. It is more about what 1.3 billion people will do. History shows that when freedom is not given, or its holders are tardy in sharing it, it is often taken anyway. The nature of won freedoms in China and the pace of the inevitable weakening of the CCP in the face of various forces is therefore of greater importance.” (Freedom up for grabs, The Standard, 2/20/07)

WSJ Prompts Individuals to Vote

“Corporate elections aren’t just for pension funds and ther big investors. Increasingly, even small shareholders can influence corporate matters, such as who sits on the board of directors,” says theWSJ. (Your Vote Can Count In Company Elections, 2/18/07) Only 40% to 45% of individual investors vote in any given proxy season, vs nealy 100% of institutional shareholders who are bound to vote to meet their fiduciary duty.

They remind readers that “if you own shares through a brokerage firm and fail to cast your ballot, your brokerage firm can vote for you on certain issues, like director elections.” The number of contested board elections jumped 30 in 2004, to 40 in 2005 and to 89 in 2006, according to SharkRepellent.net, a Web site devoted to corporate takeover defenses, which started tracking this data in 2001. This year there are 43 and the season has just begun.

Liability Extended

A 2006 study of 48 companies that announced they were under investigation for backdating found that the scandal has caused those firms to fall in market value by an average of 8 percent, according to researchers at the University of Michigan. (Court Decision Boosts Options-Backdating Lawsuit,Chicago Tribune, 2/13/07)

In two rulings issued this month, Chancellor William B. Chandler III of the Delaware Chancery Court made it clear that the backdating of options was illegal. That was no surprise, but he went on to say that the same applied to ”spring loading,” the practice of issuing options just before the release of good news.

”It is difficult to conceive of an instance, consistent with the concept of loyalty and good faith, in which a fiduciary may declare that an option is granted at ‘market rate’ and simultaneously withhold that both the fiduciary and the recipient knew at the time that those options would quickly be worth much more,” Chancellor Chandler wrote. It is possible that a decision to issue spring-loaded options ”would be within the rational exercise of business judgment,” he wrote. But, he added, that could be true only if the decision were ”made honestly and disclosed in good faith.” No such disclosures were made by spring-loading companies.

He also ruled that companies could not use the statute of limitations to avoid such suits. Even if the options were issued years ago, the fact that the directors hid the practice means that they can be sued now, when the facts have come out. (Option Lies May Be Costly For Directors, Floyd Norris, NYTimes, 2/16/07) (Delaware Ruling Lights Way for Stock-Option Backdating Suits, FindLaw, 2/9/07) (Ribstein on Tyson Foods, ProfessorBainbridge.com, 2/8/07) (Tyson Stock Grant Timing Issue In Court Case, The Morning News, 2/8/07)

Lobbying begins for ‘Proposal No. 3′

No-one yet has forecast the potential support for the proposal, to allow shareholder access to the proxy, which will come to a vote on March 14 at HP’s annual meeting. ‘It’s still too early,’ says Sarah Cohn, director of communications for ISS. AFSCME believes the proposal would need 50% of shareholder votes to succeed while HP contends the benchmark is two thirds of all votes. (Pension funds get access issue on HP’s proxy ballot, IR Magazine, 2/13/07)

Backdating Valuation Delay Requested

In a 2/5/07 letter to the SEC’s chief accountant, CII urged the agency to delay approving other market-based valuation methods for at least a month to give investors more time to analyze Zions’ plan. Under Statement 123R, which applies to the first fiscal year that started after June 15, 2005, companies have significant leeway in the models they use to calculate option values. Issuers also have flexibility in the assumptions they make about the various factors, such as expected option-term length and stock price volatility, that are used as inputs for these models.

Last June, Zions held an auction with investors to derive a market value for those securities that was about half that derived from academic models, according to WSJ. SEC Chief Accountant Conrad Hewitt approved Zions plan in a 1/25/07 letter, subject to “several tweaks,” Evan Hill, a company vice president, told the Journal. Hill said Zions plans to hold an auction after it grants another set of stock options in May and will seek to use that value to determine its stock option expense for the 2007 fiscal year. Hill said the process will be open for investors to review. (Options Valuation Sparks Concern, ISS Corporate Governance Blog, 2/16/07)

IRS on Backdated Options

The IRS launched a new initiative for rank and file employees that unwittingly received backdated stock options. Under the voluntary initiative, companies are allowed to pay the 20% penalty plus interest tax owed by employees. However, they are not allowed to pay for the taxes on backdated options for Section 16 officers and other insiders and directors. This relief is available only for options that vested in 2005 and 2006 and were exercised last year – and the amounts paid to cover these additional taxes will be treated as compensation income for those employees in 2007 tax year. For companies that plan to participate in the program, they must notify the IRS by February 28th and notify the affected employees by March 15. If they do decide to participate, companies will be expected to provide detailed information about the backdated options, including the tax calculation sufficient to allow the IRS to determine that the Treasury received all taxes owed. (NASPP AlertIRS offers options relief, Mercury News, 2/9/07)

Political Contributions Get Attention

As the 2007 proxy season begins, one of the major conversations at shareholder meetings will center on companies’ disclosure of political giving. The tangled web of political contributions is often difficult for shareholders to follow. Many companies give money directly to candidates and campaigns, and make indirect contributions through trade associations and other tax-exempt organizations. This season, institutional investors and allied shareholders have filed 43 resolutions asking companies to report on how the money from their corporate treasuries is spent on politics. (Read Shareholders Ask Companies for Transparency on Corporate Political Giving at SocialFunds.com)

Shareholders Sacked

Cassandra Toroian, writing for The Bulletin, point out that Goldman Sachs, which went public a couple of years ago, announced in an SEC filing that it would hand out over $16.5 billion in compensation for the year 2006. CEO Lloyd Blankfein earned an extra $53.4 million; 11 other execs got a combined $150 million in bonuses. Toroian asks why they are handing out “what rightfully belongs to the shareholders as bonuses to management?”

“If the board at Goldman Sachs, for example, had actually just held comp levels to the same as 2005, the extra revenues generated by the company would have resulted in approximately another $5 per share in EPS for shareholders. For Goldman, which is trading at about 10X earnings, we estimate this extra $5 in earnings would equate to at least another $50 in the stock price. Imagine that…we all know there is great money working on Wall Street – but at least be a little more discreet about it.” (Open Letter To Wall Street CEOs, 2/15/07) Disclosure: James McRitchie, the publisher of CorpGov.net, is a shareholder of Goldman Sachs.

SEC May Retreat on Mutual Funds

WSJ reports the SEC is considering backing off its proposal to split CEO and chair roles at mutual funds. The “compromise” would require mutual fund boards to be overseen by independent chairmen. However, a fund would be exempt from that rule if it has a supermajority of independent directors on the board, a lead independent director and meets other requirements. The Investment Company Institute says 80% of funds have boards with 75% of their members not from the industry. (SEC Considers Fund-Board Compromise, 1/15/070)

Related-Party Transaction Procedures and Policies, survey results posted by TheCorporateCounsel.net Blog.

Aflac Shareowners to Vote on Compensation

Aflac will become the first major U.S. company to give shareholders an advisory vote on executive compensation packages beginning in 2009, after a proposal last year by Boston Common Asset Management.

At least 50 companies will have votes on say-on-pay at shareholder meetings, up from seven last year, according to ISS. HP shareholders will vote on a proposal that would allow shareholders access to the proxy for the purpose of running board candidates. The SEC recently declined to act on HP’s request to keep the measure off the ballot, and shareholders are scheduled to vote on it at a March 14 meeting.

Rep. Barney Frank (D-Mass.), chairman of the House Committee on Financial Services, said yesterday that he will hold a hearing March 8 on strengthening the role of shareholders in setting executive compensation. (Score One for Dissent, Washington Post, 2/15/07)

A diverse network of shareholders called on over 40 companies in 2007 to adopt a non-binding advisory vote on executive compensation. Shareholder votes on executive compensation are currently required in the U.K., Australia, and the Netherlands, and in 2006 Swedish companies began using advisory votes on executive compensation. A growing number of investors believe that advisory shareholder votes on executive compensation encourage pay for performance practices and increase communication between shareholders and directors on executive compensation. (Aflac Adopts Shareholder Vote on Executive Compensation, SocialFunds.com, 2/14/07)

I can’t help thinking the will encourage Aflac’s CEO and board to think harder about how they will justify future pay packages. That seems like a good thing.

ASrIA Finds Companies at Risk

After a decade of global market debate about the impact of toxic chemical risks, the issue is now poised to have a more systematic impact on Asian listed companies, placing Asian investors at risk. A project funded by The Sigrid Rausing Trust (Toxic Chemicals — Asian Investors are At-Risk, January, 2007) found the impact of ignorance could prove high as many of Asia’s largest listed sectors have high and unmonitored risk exposures. Using FTSE’s Asia ex-Japan All Cap index as a benchmark, they found that “as much as 70% of the investible market is potentially exposed to toxic chemicals risk ranging from product liability to credit risks. This surprisingly high figure reflects some Asia-specific issues and the finance and heavy industry orientation of Asia’s equity markets.” ASrIA reaches two fundamental conclusions:

  1. New Government Strategies Needed The question of toxic chemicals and human health is a rapidly emerging, high impact issue in Asia due to rising consumer and public awareness and the impact of global competition and policy changes. Although the key issues are not well understood by consumers and market participants, new scientific and legal developments will act as a driver for awareness across the region. At the same time, Asian governments will come under growing pressure to respond to regulatory leadership from the E.U. and sporadically from the U.S. These efforts will encourage Asian governments to think more strategically about drivers for industry reform and regulatory enforcement; and
  2. Investor Information Gap Asian investors have little systematic understanding of the toxic chemicals issue. This gap in knowledge creates an opportunity for those investors capable of identifying previously ignored drivers for sector leadership and unanalyzed sources of risk. As a result, sustainability investors may have an advantage in applying research findings developed in other markets to Asian markets. At the same time, banks and mainstream investors may need to assess their risk management tools to fill the gap in market knowledge. One challenge for portfolio managers is the fact that toxic chemical-linked risks have the potential to transform some normally low beta assets into high beta assets when companies discover that steady cash-flow products can give rise to significant liabilities.

ASrIA is seeking applications for the position of Associate Director (AD).

Worries Over Coming Democracy

The March/April Corporate Board Member magazine carries an article on the convergence of several governance reforms by Rob Norton, former Executive Editor at Fortune magazine. What Your Activist Shareholders Want Now describes common fears of CEOs and their support systems.

  • The decline of the staggered board. Worries are that “someone going on the board of a major corporation faces a period of orientation, of learning the business.”
  • The rise of majority voting. “Most individual shareholders are unlikely to have enough information about new nominees to decide whether to vote for or against them, and in the case of renominations have little ability to gauge the past performance of individual directors.”
  • Activist shareholders attempting to gain board seats. “The voting tendencies of shareholders with short-term objectives ‘may result in additional and undesirable pressures upon management to maximize short-term gains at the expense of long-term wealth.’”
  • The end of the “10-day rule.” “Since individual investors tend to be apathetic about voting their shares (as few as 40% bother to vote, according to the Society of Corporate Secretaries & Governance Professionals), while institutions are more punctilious (about 90% vote), the change could have a significant effect on the number of shares cast in favor of director slates—more than enough to sway an election where activist shareholders are voting against management recommendations.
  • Renewed attempts to give dissidents direct access to the proxy. If the SEC backs direct access for shareholders (or, I would add, lets AFSCME v AIG stand), “The balance of power between dissidents and incumbents will certainly shift.”
  • Electronic proxy voting. “While there is no way of knowing how online proxy voting might play out in practice, one prediction seems safe: Most people are far more likely to write an angry e-mail than they are to write an angry letter or make an angry phone call.”

The major concern is that “the more politicized boards become, with some directors representing special interests and others put in place by a single investor, the less likely it is that they will be able to operate in the best interests of all shareholders.” Some argue the result of more democratic boards could be “less creative, more conservative behavior, since few board members will risk thinking outside the box and being wrong.”

While these concerns shouldn’t be dismissed out-of-hand, it is important to remember that directors must be elected by all shareholders and the have a fuduciary duty to all shareholders. The answer is not to turn back the clock.

To ensure shareholders are fully informed, we need better informed investors. As noted byVoterMedia.org, “we can improve both financial and social performance of corporations by making management more accountable to shareowners. Voter-funded media would provide that accountability through independent professional monitoring of management, enabling us shareowners to exercise our voting power more effectively…Proxy advisory firms such as ISS and Glass Lewis fulfill some of that monitoring role now, but are limited by inadequate funding. We propose paying them with corporate funds allocated by shareowner vote, so that advisory firms would become voter-funded media. We shareowners would be willing to pay more as a group than we now pay one at a time.”

Also worth considering to ensure against short-termism is an idea from Harvard professor Guhan Subramanian, “give shareholders exactly what they want without eliminating the staggered board: shift the staggered board from the charter to the bylaws. That would allow a hostile bidder to dismantle the staggered board through a bylaw amendment and put its offer to shareholders in a single proxy contest. For the 99.5 percent of United States public companies that are not subject to a hostile takeover bid in a given year, directors would continue to be elected to staggered, three-year terms.” (Board Silly, New York Times, 2/14/07) As of 2/5/07, ISS was tracking more than 40 proposals to declassify boards. Targeted firms and shareholders alike should consider Subramanian’s alternative.

From Peter Kinder, of KLD Research & Analytics, who says it can take years to really understand the operations of company:

Classified boards provide stability, institutional memory. They also afford directors the time to get to know their companies…De-classifying the boards of publicly-traded companies has had the intended consequence — as the literature shows — of increasing shareholder value because they’re easier to flip. The correlation between making it easy to peddle a Fortune 500 company and ‘good corporate governance’, as I’ve understood the term, has eluded me.

It has also had the unintended (I think) consequence of weakening the board in relation to management. To a large extent, a director’s re-nomination is at the pleasure of the CEO. A one-year term does not allow for much of time’s healing benefit following a board room battle. So, the troublesome board member’s seat is at risk.

(Consider in this light the notion of ‘long-term investors’ voting for de-classified boards.)

So, Prof. Subramanian has, I believe, devised an elegant solution to a problem that has given ‘corporate governance’ a very black eye. Now let’s see who supports the notion with shareholder resolutions.

And finally, see Why is the Public Corporation in “Eclipse”? by Larry Ribstein, where he discusses the rise of private equity, the decline of the public corporation, the decline of takeovers, and the rise of “shareholder activism.”  He conclude that Lipton may have been at least partially responsible for the problems he describes, and that shareholder activism might not be a threat to the public corporation, but rather what’s propping it up.

Get Outside Perspective

Ralph Ward’s Boardroom Insider is a great little monthly for directors, CEOs, those who work with corporate and nonprofit boards (corporate secretaries, corporate counsel, support staff, and consultants), and those who are board prospects. In the January issue, Ward asked his readers – what is the one thing you most often find corporate boards are in the dark on? Those answering included Charles Elson, Richard Koppes, and James Pitts. You’ll have to subscribe to find out what they said.

From Stephanie Joseph of Directorsnetwork.com, “I’ve actually been quite impressed with how much directors seem to know about the businesses of their companies. What concerns me is when they don’t know what’s contained in analyst reports, and the ISSGMI and Corporate Library ratings. This information is publicly available, and should be read and questioned by board members.”

Agreed. These are vital sources of information. Every CEO and every board member should be reading such reports on their own company and on those of their competition. A board subscription to Ralph Ward’s Boardroom Insider wouldn’t hurt either.

Shareholders Shift Focus to Fundamental Rights

Activist institutional shareholders shifted their focus to pressing for investor rights to elect directors and influence executive compensation and spent less time on removing anti-takeover measures, according to SEC numbers. The change in focus indicates their movement is making a difference in corporate governance, according to Martin Dunn, deputy director of the agency’s Corporate Finance division. Dunn acknowledged the agency will likely take its time in drafting these regulations. He expects them to be adopted in time for the 2008 proxy season, beginning that year in March. “This gives the commission time to be thoughtful and get it done in 2008,” he said in an interview. (Activist Shareholders Focus on Director Election and Executive Compensation Issues, The Deal, 2/14/07)

SEC to “Protect” Investors

The SEC is taking steps to “protect” corporations, executives and accounting firms from shareholder lawsuits that accuse them of fraud, reports the New York Times. First, the commission filed a brief in the Supreme Court urging adoption of a legal standard that would make it harder for shareholders to prevail in fraud lawsuits against publicly traded companies and their executives.

The commission, reportedly seeks to move the standard from a need for investors to show whether the accusations, if true, would permit “a reasonable person” to infer that the company and the executives “acted with the required intent” to a higher threshold and that would require investors to show by evidence “a high likelihood” that the defendant possessed the intent to violate the law.

Second, the SEC is considering ways to protect accounting firms from large damage awards in cases brought by investors and companies. Cox said the consolidation in the accounting industry had prompted both Congress and the commission to consider ways to “prevent the demise of another firm.”

The Times article concludes with the following observation: “After reading the brief, one has to wonder if the S.E.C. is now on the side of the defense bar,” said Professor Fisch, who is a visiting professor this semester at the University of Pennsylvania School of Law. “This does not read like an S.E.C. brief since it does not articulate anything about the commission’s experience in the area. It reads, instead, like a litigant’s brief.” (S.E.C. Seeks to Curtail Investor Suits, 2/13/07)

Personally, I’d feel better if the Commission had consulted extensively with John C. Coffee. See hisGatekeepers: The Role of the Professions in Corporate Governance for why the watchdogs didn’t bite.

Retirement Plans Back Hedge Funds

For the year ending 9/30/06 , assets of the largest 1,000 US retirement plans rose 8.4% to $6.488 trillion, following gains of 12% the prior year. Assets of the 200 largest funds grew 8.6% to $4.91 trillion compared with 12% the year earlier. Investment in hedge funds for the top 200 increased by 63% to $27.4 billion. (Slower growth? No worries, FinancialWeek, 1/29/07)

Course Offering on ASX Rules

Australia’s first post-graduate diploma course on Australian Stock Exchange (ASX) Listing Rules has been launched by Tribeca Learning and Corporate Compliance Partners (CCP). There are more than 1 million companies; . The course is aimed at the company secretaries, directors, senior executives, legal professionals and company officers of the 2000 firms listed on the ASX.

Option Expenses

Recent ISS research found the average S&P 500 company may report option expense under FAS 123R nearly 30% lower than calculated by ISS. Join ISS’ Patrick McGurn and Jeffrey Mahoney of the Council of Institutional Investors on Thursday, February 15, 2007 at 1:00 pm EST for a Webcast on options expensing. Register.

Board Entrenchment

The rise of the activist investor: Peril or Panacea? There is currently much debate about the proper role of shareholders and boards of directors. President Bush has assailed boards for condoning excessive executive compensation; activist shareholders like Carl Icahn are assailing boards for putting their own interests before shareholders; and Marty Lipton is warning that our system of capitalism is endangered. Which is right? The subject holds important lessons for all CEOs, board members, and investors.

Hear Kevin Cameron, President of Glass Lewis, on Thursday, March 15, 2007 from 7:30 AM to 9:00 AM, at the California Chamber of Commerce, 1215 K Street, 14thFloor, Capitol Room, Sacramento, CA 95814. Sponsored by NACD, Northern California ChapterRegister.

Defenders of Status Quo Get Shrill

Gretchen Morgenson critiques a speech Martin Lipton delivered at the 25th annual Institute on Federal Securities in Miami. Lipton, inventor of the poison pill, opined “We cannot afford continuing attacks on the board of directors. It is time to recognize the threat to our economy and reverse the trend.” “Many director candidates are declining to serve on boards,” he said, “due to the unpleasantness of filling out extensive questionnaires to enable appropriate disclosures and qualification determinations.”

Morgenson retorts, “If shareholders are wreaking such havoc in the boardroom by, for example, filing nettlesome lawsuits against able directors, wouldn’t the costs of directors’ and officers’ liability insurance be skyrocketing as a result? Yes. But instead they have plummeted…almost 40 percent in 2005, dropped an additional 10 percent last year and would probably decline again this year.”

She concludes: “Greater shareholder involvement in director elections and other board matters is coming, in part because so much wealth has been destroyed at companies with lax oversight. Mr. Lipton’s fear-mongering about its consequences will please his corporate clients, but it won’t stop the train.” (Memo to Shareholders: Shut UpNYTimes, 2/11/07)

Business Week reports that SEC commissioners remain hopelessly split on proxy access after the AFSCME v AIG decision. Chairman Christopher Cox said “the Commission is taking advantage of this opportunity to consider more fully the questions raised by the court decision in their broader context, and to work on crafting a carefully considered proposal that will ensure there is one, clear rule to protect investors’ interests in all jurisdictions during the next proxy season.”

Shareholders “are exploiting the court decision to broadly reopen the issue,” says Thomas Lehner, director of public policy for the Business Roundtable. “The fundamental issue here is ‘Who decides how corporations are governed?’ The choice is between special-interest shareholder groups that have agendas, or preserving the right of boards to make management decisions.” (HP Fight Forecasts Stormy Proxy Season, 1/24/07)

Cox doesn’t seem too likely to oblige. “We have any number of special committees telling us that in order to be more competitive, the U.S. has to sharpen its edge,” the SEC chief says. That means not only lightening the regulatory load “but also making sure that shareholder rights are thoroughly respected. (Proxy-Season Gridlock At The SEC, BusinessWeek, 2/19/07)

A growing chorus believe shareholders, the legal owners, should be the ultimate “deciders,” not the Business Roundtable, which represents the special interests of 160 CEOs. Their agenda is perfectly clear – continued dominance of corporate boards.

The AP reports that “About 10 companies, including Pfizer, Intel Corp., Bristol-Myers Squibb Co., Schering-Plough Corp., American International Group Inc., JPMorgan Chase & Co. and Colgate-Palmolive have formed a working group with AFSCME and Walden to discuss allowing shareholders either ratify or say no to the pay package an executive has already received. (Stockholders jarred to action by CEO exit pay, 1/11/07)

Borrowed Shares

The 2/9/07 WSJ carried an article, “How Borrowed Shares Swing Company Votes” (page one, Jan. 26), which suggests that using borrowed shares for the purpose of “empty voting” is widespread and growing to the detriment of good corporate governance. CorpGov.Net drew attention to that piece.

In a letter to the WSJ, W. Tredick McIntire, who Chairs the Risk Management Association Committee of the Risk Management Association attempts to correct misstatements. The Risk Management Association

hasn’t found it to be common practice for hedge funds, or other U.S. investors, to borrow shares for the purpose of influencing votes. In the case of securities loans made to cover a short sale, we find that the shares are borrowed by the broker responsible for the delivery of shares sold short by its client and that the borrowed stock is delivered to the purchaser. In such cases, the short seller wouldn’t have the right to vote the proxy because the shares normally would have been re-delivered to and re-registered by another purchaser.

Furthermore, a Federal Reserve margin regulation generally prohibits U.S. broker-dealers from borrowing stock other than “for the purpose of making delivery of the securities in the case of short sales, failures to receive securities required to be delivered or other similar situations.” This “Purpose Test” effectively prohibits brokers from lending securities for the purposes the article describes.

It is well documented that securities lending is very important to the efficiency and liquidity of the markets. RMA supports measures that will continue to provide institutional investors with a sense of confidence in how the market functions and how they can exercise their right to vote on behalf of their respective constituents.

Another letter, this from Josh Galper, Managing Principal, Vodia Group LLC says, in part:

the real trouble in “empty voting” is the control that lenders have over their securities. Now, most securities are lent outside the view of the beneficial asset holder, whether pension plan, mutual fund, hedge fund or individual. Most asset holders may know if stocks have been lent if they ask specifically; otherwise, if they are large enough they may simply receive a check at the end of the month. The system leaves little room for proactive decision-making around which securities to lend, what profits are available and what might happen in case of a shareholder vote.

CalSTRS Wins Again

CalSTRS announced a $105 million settlement in a securities fraud case against AOL Time Warner, its accountants, banks, and several former executives. The suit charged that AOL artificially inflated its stock price in 2000 and 2001, prior to its merger with Time Warner, resulting in damages to CalSTRS of approximately $135 million. The pension fund opted out of the federal class-action lawsuit against AOL and the other defendants and filed a separate suit in California state court. If CalSTRS had participated in the class-action settlement, it would have received $15.5 million to $16 million. The settelement comes quickly after a similar settlement with Qwest Communications and its former CEO, who agreed to pay the system $46.5 million. (CalSTRS suit nets $105 million, SacBee, 2/8/07)

Preparing for Proxy Season

TheCorporateCounsel.net offers a free web-cast to its subscribers, “Last Minute Planning for the Proxy Season.” For example, as the 10-Ks and 10-Qs continue to receive a greater focus – both from the SEC Staff and investors – it is more important than ever to get MD&A “right” this year. Another example – how should your proxy solicitation and investor relations strategies change this year, particularly with the new executive compensation disclosures? And loads of additional proxy season guidance. Join these experts:

  • Cathy Dixon, Partner, Weil, Gotshal & Manges LLP
  • Amy Goodman, Partner, Gibson, Dunn & Crutcher LLP
  • Ellen Friedenberg, Partner, Hughes Hubbard & Reed LLP
  • Gloria Nusbacher, Partner, Hughes Hubbard & Reed LLP
  • John Siemann, Managing Director, Georgeson Shareholder
  • Bill Tolbert, Partner, Jenner & Block LLP

Retirement Plan Participants Dip

Participation in employer-sponsored retirement plans—both pension and defined contribution plans—by heads of families declined two percentage points in 2004 to 46.1% from 48.7% in 2001, according to findings by the Employee Benefit Research Institute, the Associated Press reports. (Participation in Retirement Plans Drops to 46.1%, Money Management Executive, 2/9/07)

Strategies to Consider for 2007 Proxy Season

TheCorporateCounsel.net posted a transcript of their popular webcast: “Forecast for 2007 Proxy Season and Strategies to Consider.” Very informative.

Options Expensing Alert

ISS announced the launch of its Options Expensing Alert, a source of stock option expensing data and analysis. The alert provides institutional investors with key grant information and assumptions for companies’ stock-option expense disclosures under FAS 123R, as well as a recalibrated option expense based on a uniform methodology (the Hull-White lattice pricing model), according to a press release.

“Companies on average are disclosing option expenses that are 29 percent lower than calculated by our methodology. But, more importantly for investors, there is a lot of variation out there. We’re seeing ISS-adjusted values that range from 84 percent higher than reported, to 7 percent lower than reported,” said Patrick McGurn, ISS’ Executive Vice President and Special Counsel.

Directors Go Digital

Keith Ecker describes Kodak’s experience with Directors Desk, a Web-based service that allows corporate secretaries to create and distribute boardroom information over the Internet. “It now takes me about 10 minutes to post online what would normally take me a day to do,” says Cherry, a paralegal at Kodak.

Kathy Surace-Smith, vice president, general counsel and corporate secretary of Bothell, Wash.-based SonoSite Inc., a manufacturer of portable ultrasound systems, has her directors approve minutes from previous meetings and vote on resolutions online. She also no longer makes hardcopies for teleconferenced committee meetings.

“We had a pilot program so that some people could become familiar with it and be the cheerleaders for it as well,” Cherry says. Experts say the most effective way to acclimate directors to new technology is to take baby steps. (Digital Director, InsideCounsel, 2/07) See also BoardVantageBoardWorks, andDiligent Boardbooks.

Batchelder Joins Home Depot Board

Home Depot has agreed to let David H. Batchelder, of Relational Investors, on their board. Relational Investors has agreed to drop a previously announced proxy contest.

Ralph Whitworth, previously indicated Home Depot should sell its industrial distribution division, a cyclical business that added roughly $12 billion in revenue over the past year. However, the new CEO, Frank Blake, in his previous role over business development and corporate operations, was heavily involved in acquiring the companies that comprise Home Depot’s wholesale supply business. It isn’t clear if Whitworth’s recommendations will move forward. (Shareholder activist to join Home Depot board, The Atlanta Journal-Constitution, 2/6/07)

UK Pensions Target Audit Function

LAPFF funds will initiate a major shareholder engagement campaign during 2007 aimed at improving company audit practices.The UK’s Local Authority Pension Fund Forum (LAPFF) is a voluntary association of 39 public sector pension funds with combined assets of over £70 billion. Their purpose is to maximize their influence as shareholders and to promote corporate social responsibility and high standards of corporate governance amongst the companies in which they invest.

The Forum’s primary engagement targets will be the small number of All-Share companies without an audit committee. It will also engage with companies in the All-Share where the Forum believes the structure of the audit committee poses significant risks to the defence of shareholders interests.

The campaign will exert pressure on companies which refuse to disclose the terms of the auditor’s engagement through targeted voting at AGMs. Forum members will oppose all resolutions seeking to limit auditor liability as well as the re-appointment of firms at companies where they earn more fees for non-audit work than for the audit itself.

Cllr Darrell Pulk, chair of the Forum, said: “Credible financial reporting is the lifeblood of efficient capital markets, which is why we as shareholders attach so much importance to audit quality and auditor independence. There are some laggards in the market who simply need pulling up to minimum acceptable standards. But the broader aim of this investor campaign is to give companies a clear message of shareholder expectations on audit, and to begin embedding best practice on issues such as terms of engagement and auditor liability.”

China Falling Short

Accepting that corporate governance has improved immensely in China in the past few years, the country still ranked almost last in Asia. Only Indonesia scored lower.

Boards now have more control but most are “board-virgins, are unsure of their roles and responsibilities, according to the annual “CG Watch” survey by CLSA Asia-Pacific Markets, an investment bank, produced in association with the Asian Corporate Governance Association.

Companies are feeling swamped by new legislation and are doing the bare minimum rather than embracing a culture of accountability, according to a report issued by the International Finance Corporation, the private sector arm of the World Bank. (Asia-Pacific: Chinese corporate governance – Getting better, but still at the bottom, Ethical Corporation, 2/7/07)

Atkins Expresses Reservations on Access

In an interview with InvestmentNews (An SEC member’s take on a range of issues, 2/5/07) SEC member Paul Atkins, indicated a need for stock lending to be addressed before proxy access can be blessed.

Q. Is there a concern at the SEC that hedge funds control an increasing number of proxy votes?
A. I gave a speech last week where I called attention to this empty-voting phenomenon or practice, where a hedge fund or shareholder can vote shares for which he doesn’t have an economic interest. It’s not illegal, of course, but it does show that if we’re going to do anything in the area of direct nomination of directors by shareholders, we have to proceed cautiously, because there are a lot of unintended consequences [potentially resulting from the disconnect between who owns shares and who votes shares].

In remarks to the Corporate Directors Forum 2007, Atkins expressed additional reservations:

  • First, what authority does the SEC have to mandate the inclusion of shareholder nominated director candidates on the company proxy statement? (The SEC shouldn’t mandate proxy access, they should simply acknowledge the findings of AFSCME v AIG and refrain from issuing no action letters when companies keep shareholder proposals off the proxy.)
  • Second, are we indirectly preempting state law, which traditionally governs the selection of directors? (Again, there would be no preemption issue if the SEC simply stayed out of it.)

He ends his discussion indicating, “I would be happy to support the introduction of any proposal that Chairman Cox sets forth to get this discussion going and to bring certainty to the marketplace. The commentary and discussion would be highly productive and informative, as it was in 2003.”

42% of Resolutions From Unions in 2006

Corporations have faced almost 200 shareholder proposals from major union-sponsored pension funds so far this proxy season, targeting largely executive pay and board accountability. In 2006, 295 of 699 shareholder proposals were introduced by union pension funds. By contrast, for 2006, public pension funds sponsored 31 proposals; mutual funds and other types of equity funds, 23; social or religious funds, 39; and individuals, 280. (Union funds champs of proxy season, P&I, 2/5/07)

Plan Sponsors Not Liable Once Advisor Chosen

While plan sponsors and other fiduciaries must exercise prudence in choosing a fiduciary investment adviser and periodically monitor the adviser’s abilities and qualifications, they do not have to oversee the providing of specific advice.

“[I]t is the view of the Department that a plan sponsor or other fiduciary that prudently selects and monitors an investment advice provider will not be liable for the advice furnished by such provider to the plan’s participants and beneficiaries, whether or not that advice is provided pursuant to the (prohibited transaction) statutory exemption under (Employee Retirement Income Security Act) section 408(b)(14).” (Field Assistance Bulletin (FAB) 2007-01)

During an advice provider search, DoL says, “[A] fiduciary should engage in an objective process that is designed to elicit information necessary to assess the provider’s qualifications, quality of services offered and reasonableness of fees charged for the service. The process also must avoid self dealing, conflicts of interest or other improper influence.” The process should take into account:

  • the experience and qualifications of the investment adviser, including the adviser’s registration in accordance with applicable federal and/or state securities law;
  • the willingness of the adviser to assume fiduciary status and responsibility under ERISA with respect to the advice provided to participants; and
  • the extent to which advice to be furnished to participants and beneficiaries will be based upon generally accepted investment theories.

DoL expects advice providers “will maintain, and be able to demonstrate compliance with, policies and procedures designed to ensure that fees and compensation paid to fiduciary advisers, at both the entity and individual level, do not vary on the basis of any investment option selected. Moreover, it is anticipated that compliance with such policies and procedures will be reviewed as part of the annual audit.” (DoL Sets Out Fiduciary Adviser Selection/Monitoring Guidelines, PlanSponsor.com, 2/2/07)

International Investors Seek Same Rights in US

An coalition of 13 international institutional investors endorsed the right of US shareholders to an annual advisory vote on executive compensation. According to a report by ISS, the 1/25/07 letter to the SEC was orchestrated by the Universities Superannuation Scheme of the United Kingdom, was signed by eight other U.K. institutions, two from the Netherlands, one from Australia, and the Connecticut Retirement Plans and Trust Funds. Such advisory votes are required in the United Kingdom, Australia, and Sweden, while Dutch firms must submit pay policies to a binding shareholder vote. (International Investors Endorse Pay Votes)

CII & NACD Agree on Majority Voting

The Council of Institutional Investors (CII) and the National Association of Corporate Directors (NACD) have jointly issued a series of governance recommendations based on their report entitled Looking Back, Looking Forward: Recommendations on Majority Voting, Section 404, and Executive Compensation. Findings include the following:

  • The task force agreed that directors should be elected by a majority of votes cast. But a postelection process should be in place to ensure that the board can function after the election, whatever the outcome.
  • Management and external auditors should work to make the process more cost efficient. Despite that challenge, task force members believe Section 404 must not be weakened.
  • CEO compensation should be clearly linked to performance and not excessive. The board should understand and fully disclose the potential payout of all elements of the compensation program.

Gross-ups Another Symptom of Powerless Shareholders

According to Gretchen Morgenson, 75% of CEOs have “tax gross-ups,” which push the cost of excise taxes from golden parachutes onto shareholders. A tax of 20% on the executive’s entire pay applies when their exit package exceeds 2.99 times their average annual pay over the last five years. Think Robert L. Nardelli’s $211 million from Home Depot.

Gross-ups weren’t disclosed to shareholders in the past, but new proxy requirements will force them into public view. Michael Kesner, principal at Deloitte Consulting in Chicago says, ”boards are now just getting a sense of how big that number is.” Directors may have been aware of the costs when they were instituted years ago, but few have kept up with their growth. Kesner has seen gross-up payments reach 8% of the total cost of a merger. Since executives are generally in a 60% combined tax bracket, such benefits are very expensive.

Morgenson reports that Sara Lee Corporation eliminated all gross-up provisions on its books. (The C.E.O.’s Parachute Cost What?, NYTimes, 2/4/07) Although she concludes it will be “fun to watch” directors try to justify gross-ups to shareholders this year, most appear unlikely to make the attempt.

The recent survey of 1,300 US directors by PricewaterhouseCoopers and the Corporate Board Member magazine found that 50% of directors say board leadership flows from the CEO who is also board chairman. Only 8% of directors would like more control and 59% don’t want the chair to be an independent director. A third believe that stockholders are the group most likely to get pay pared down. (Corporate directors are out of the loop, Asbury Park Press, 02/4/07) Directors seem to have no shame when it comes to CEO pay.

Tom Sullivan gets it: “Congress and the Securities and Exchange Commission have created a massive web of regulations to look out for the little guy, but somehow along the road, they’ve dismissed the idea that if given a vote, the little guy might just do a darned good job of taking care of himself…You can bet that the private equity firms taking so many companies private are going to administer CEO pay in a much more direct way. They are not going to reward greed, incompetence or unethical behavior by a CEO. They will, however, handsomely reward the CEO who delivers great results. It is time to give the stockholders more say in what the big guys make and time for everybody else to remember your last name isn’t Kravitz.” (Tom Sullivan: Complaints misguided on CEO pay, 2/4/07)

When will millions of shareholders have more political power than the 160 CEOs who comprise the Business Roundtable?

Insiders Know When to Buy and Sell

In a study of data from 40 companies over two years, Thomson Financial has confirmed that insider transactions really are a ‘harbinger’ of future stock performance. Moreover, insiders at tightly held companies, where management owns a large percentage of stock, are better at predicting the future than executives at more widely held companies. The researchers also found that executives have a better feel for future performance than directors. (Insiders really can predict the future, IR Magazine, 2/2/07)

Velvet Gadflies

Writing for Fortune, Katie Benner, contrasts the style of Carl Icahn and Ralph Whitworth. Icahn buys a 1.9% stake in Motorola and begins “a war of words designed to shake things up at the troubled cell phone maker.” Ralph Whitworth, with less than 1.2% of Home Depot, ‘presented a plan that made sense to shareholders and spurred changes at a company with an executive suite that, rightly or wrongly, had become the public face of corporate arrogance and greed.”

According to Benner, Whitworth is a “velvet gadfly – who treads more softly, works well with management and can be all bite without the bark because he or she has the most powerful tool of all: the right idea.” Another example, she writes is Clifton Robbins, a 20-year private equity veteran whose hedge fund, Blue Harbour, looks for “undervalued companies that will budge if presented with a plan that makes sense.” Blue Harbour won’t work with companies unless they’re open to his ideas.

Former SEC chairman Richard Breeden founded hedge fund Breeden Partners, with “hopes that his insider ties, reputation and willingness to stick with a company as it works to right itself will make him a velvet fist to be reckoned with.” “Our goal is not to have to run in a proxy contest, but rather to work constructively with the board to address performance issues and identify ways to make the situation better. Good companies are open to that kind of input,” says Breeden. (The new breed of corporate raider, 2/2/07)

Open Access Could Address Pay Issues

In a survey of 55 large institutional investors, managing $800 billion in assets, by Watson Wyatt Worldwide 90% said the current system overpays executives and that pay practices are hurting corporate America’s image.

In a survey of 1,300 board members by PricewaterhouseCoopers and the Corporate Board Member magazine, 50% of directors said board leadership flows from management – from a CEO who is also board chairman, despite the fact that it’s the board’s job to hire, set pay, and if needed fire the CEO.

AFSCME has about 50 “say on pay” resolutions that will be voted on at annual meetings. The CSMonitor reports:

  • As part of a minimum-wage hike under consideration in the US Senate, new taxes would be imposed on one important form of executive pay.
  • Rep. Barney Frank (D) of Massachusetts, who chairs the House Financial Services Committee, plans to introduce a bill to require public companies to put their executive compensation plans before shareholders for an annual vote.
  • President Bush used a podium on Wall Street to admonish corporate boards. “You need to pay attention,” to see that top-level pay is tied to good performance, he said. (Washington takes aim at CEO pay, CSMonitor, 2/2/07)

While an advisory vote on pay by shareholders would be a positive step, open access to the proxy for the purpose of nominating and electing directors would be a much more powerful tool. With the SEC on the fence, shareholders should move forward with bylaw amendments at more companies where directors are not ensuring a reasonable relation between pay and performance.

Public Comments Sought on CalSTRS Rules Prohibiting Certain Campaign Contributions

CalSTRS seeks public comments on its rulemaking through March 12, 2007 at 5:00 p.m. The rules would prohibit any party who does business with CalSTRS, or seeks such business, expected to generate at least $100,000 annually in income, fees, or other revenue from making any campaign contributions in excess of $1,000 to:

  • CalSTRS officers and employees,
  • any existing Teachers’ Retirement Board member,
  • the sitting Governor, Controller,
  • Treasurer,
  • Superintendent of Public Instruction
  • candidates for Teachers’ Retirement Board member, and
  • candidates for the offices of the Governor, Controller, Treasurer, and Superintendent of Public Instruction

The prohibition also applies any third party solicitor who assists any of the above parties.

Any party found in violation would be disqualified from engaging in business with CalSTRS for two years. If they already have an existing business relationship with CalSTRS and are found in violation the penalty then would be one or both of the following:

  1. Disqualification from doing future or additional business with CalSTRS for a period of two years, and/or termination of existing business with CalSTRS.
  2. A fine payable to CalSTRS equal to the value of the amount of the impermissible campaign contribution or $10,000, whichever is greater.

I encourage everyone to read and comment on this very important rulemaking. If CalSTRS adopts the rule, or a modified version, others will be sure to follow.


Qwest Communications and its former CEO agreed to a $46.5 million settlement over an accounting fraud lawsuit brought by CalSTRS. By opting out of a $400 million federal class-action settlement between Qwest and shareholders and pressing ahead in California courts, CalSTRS received roughly 30 times more than those in the federal class settlement. Qwest and several banks and accounting firms will pay CalSTRS $45 million. Former CEO Joseph Nacchio agreed to a $1.5 million payment. (CalSTRS’ go-it-alone lawsuit pays off big, SacBee, 2/1/07)

Nacchio faces 42 counts of insider trading in US District Court over allegations that he sold $101 million of Qwest stock knowing the company would not reach its revenue targets. A jury trial is set to begin March 19.

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