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I was about to sit down this morning and write another scathing post on Kinetic Concepts when I learned of their press release announcing they will gradually declassify their board. They gave no reason as to why they took this action just ahead of their annual meeting. Perhaps they looked again at their guiding principles,

We act with integrity and honesty above all, in all that we do.

I e-mailed them to ask why but they have not answered. A more probable cause was the likelihood that shareowners would oust board members currently up for election. The whole episode shows that persistant shareowners can hold board members accountable.

As readers of CorpGov.net may recall, shareowner John Chevedden submitted a proposal to Kinetic Concepts to declassify their board and have all members up for annual election. Kinetic Concepts filed for a no-action letter from the SEC on the grounds that Chevedden had provided insufficient evidence that he owned Kinetic stock. The SEC’s March 21 denial was in line with previous denials at Hain Celestial, Union Pacific, Devon Energy, Prudential, and News Corp where companies had  not met the burden of 14a-8(g). They had not demonstrated they are entitled to exclude these proposals.

Despite denial of their no-action request, Kinetic Concepts sent an April 5 letter to the SEC putting them on notice they would mail their proxy without Mr. Chevedden’s proposal, despite the SEC’s refusal to grant their no-action request.

As justification, Kinetic pointed to a flawed court decision from a suit brought against Mr. Chevedden by KBR. Even a quick glance at page 6 (2011-04-04 KBR Chevedden Docket 24 – Memorandum and Order https://www.corpgov.net/wp-content/uploads/2011/04/2011-04-04-KBR-Chevedden-Docket-24-Memorandum-and-Order.pdf) reveals the judge didn’t base her decision on what is required in order to show evidence of ownership for a 14a-8 proposal. Instead, she based her decision on evidence of ownership requirements adopted in 14a-11, the provisions for placing shareowner director nominees on the proxy. Aside from being on a completely different subject, these rules are not even in effect, but have been stayed because of the lawsuit on the SEC’s proxy access rules.

They made no attempt to exhaust legal remedies. Kinetic simply pointed to the flawed court decision and essentially said, our case is like that case, so we’re not including the proposal from Chevedden.

I wrote several articles warning of dire consequences if Kinetic Concepts was allowed to get away with simply ignoring the law. (SEC: Time to Remove the Gag; Texas Secession Led by Apache, KRB and Kinetic Concepts; Take Action: Sixty Years of ShareOwner Rights at Risk; and Go Directly to Court, Do Not Pass SEC, Prepare to Spend Thousands). Some of these posts also appeared at Shareowners.org and Accountability Central. I also contacted several large funds, unions, proxy advisors and, of course, the SEC.

My experience with the SEC was frustrating. Although I got a sympathetic ear at Corporation Finance, they claimed the case was out of their jurisdiction. I needed to contact Enforcement. Enforcement has no public phone number and the internet forms are not set up to handle complaints on shareowner rights.

It was like writing into a black hole. In my direct experience, nothing seems to come out of Enforcement. As a brief aside, note Broc Romanek’s recent posts at theCorporateCounsel.net: The SEC’s Whistleblower Office Does Not Want To Talk To You and The Bigger Picture: Why Doesn’t the SEC’s Enforcement Division Provide a Phone Number? It turns out that due to a lack of funding the whistleblower office doesn’t exist and the Enforcement Division doesn’t want to talke to anyone.

I don’t know if the SEC took any action at all. However, I do know funds that investigated the issues and spoke to people at Kinetics. The big break for shareowners probably came when ISS and Glass Lewis both recommended voting against board members. The following are extensive quotes from ISS’ advisory:

In this case, while the company cites precedent cases as a reason for excluding the proposal, the company has not received correspondence from the SEC or a ruling from the US District Court stating that the company may exclude Mr. Chevedden’s proposal. Furthermore, the company has not filed a case to the court with regarding this proposal and as such has not fully exhausted its legal remedies in seeking a no action ruling from the SEC. In this instance the company has taken upon itself the role that is reserved for the SEC and the courts and in doing so, has denied shareholders an opportunity to vote on an important issue without the force of law…

ISS also notes that the company is ignoring a proposal to declassify the board, which is a well-accepted governance reform that regularly receives high levels of shareholder support. For instance, in 2010, such shareholder proposals filed at U.S. public companies received an average of 61.1-percent support from votes cast for and against. Furthermore, studies have shown a negative correlation between the existence of a classified board and a company’s value. ISS believes that all directors should be accountable on an annual basis and that a staggered board can entrench management and effectively preclude takeover bids or proxy contests…

By omitting this item despite the SEC’s correspondence stating that it should be included, the company has disenfranchised its shareholders from one of their key entitlements. As owners of the company, shareholders should have the right to judge a shareholder proposal which could affect the governance structure of the company. In this case, by directly disregarding the SEC’s statement confirming that the shareholder proposal should appear on the ballot, the company has intentionally disenfranchised its shareholders and as such, ISS recommends that shareholders WITHHOLD votes from the entire class of directors standing for election at this annual meeting.

Soon after Kinetic Concepts issued their press release indicating they would move to declassify their board, both ISS and Glass Lewis revised their voting recommendations to include voting in favor of all incumbents.

Lesson: Vigilance pays. Had we done nothing, shareowner rights would have been trampled. Thanks to our many readers who took action.