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Corporate Monitors in Dynegy Settlement

Dynegy Inc., a power producer, agreed to pay $468 million to settle accusations by lead plaintiff University of California that the company violated U.S. securities laws with misleading accounting and fake natural-gas trades that inflated revenue. Dynegy also agreed to elect two new directors from a list of not less than five candidates submitted by the University of California. (Dynegy Agrees to Settlement of Suit by Its Shareholders, NYTimes, 4/16/05) Board members selected (at least in part) by shareholders, what a novel convept. Dynergy now joins Worldcom, Homestore, Broadcom, Ashland, Hanover Compressor, Micorotune and perhaps others whose settlements contained similar provisions. (Ashland Will Allow Investors to Nominate Directors, Broadcom Pledges Director Nomination and Other Reforms to Settle Suit, ISS)

Caterpillar and Gannett Votes; Majority Rules...Almost

Meeting results at Caterpillar found corporate governance resolutions generally getting much higher levels of support than those targeting social concerns. While the shareholder resolution on Sale of Equipment to Israel by Sisters of Loretto got most of the press because of protestors at the meeting, the measure only 3% of the vote. The resolution by the Church of the Brethren Benefit Trust did better getting 6%.

The United Brotherhood of Carpenters Pension Fund's proposal "switch from plurality to majority voting in electing directors" got 38% of the vote and John Cheveddan's resolution to Redeem or Vote Poison Pill got 51%. "If we are at 38% with Caterpillar, we're going to be looking at near-majority votes as we work through the season," said Ed Durkin, the union's director of corporate affairs. "It will gain some momentum, that's been our experience with other votes." (Caterpillar shareholders reject majority voting, MarketWatch, 4/13/05)

In fact, a similar proposal at Gannett got 48%. With CalPERS endorsing majority vote election procedures last month and the Council of Institutional Investors endorsing it this month, we can expect such resolutions to start getting majority votes this season. The ISS Friday Report quotes CalPERS president, Rob Feckner, "Majority vote will give shareowners the power to hold directors accountable for their actions and their performance, and elect the best person for the job."

Members the Council of Institutional Investors approved a new policy in favor of majority voting for director elections. The new policy reads:

Director Elections: When permissible under state law, companies' charters and by-laws should provide that directors are to be elected by a majority of the votes cast. If state law requires plurality voting (or prohibits majority voting) for directors, boards should adopt policies asking that directors tender their resignations if the number of votes withheld from the candidate exceeds the votes for the candidate, and providing that such directors will not be re-nominated after expiration of their current term in the event they fail to tender such resignation.

"The results at Caterpillar and Gannett exceed all expectations. It now appears that a significant number of the plurality-to-majority resolutions should receive majority support this season. I guess that quite a few boards are regretting their decisions to turn down invitations to join the group of issuers that will sit down to discuss this issue with the proponents. This also raises the chances that we'll see a binding bylaw offered on this topic before too long," Patrick McGurn, ISS Executive VP told The Friday Report. The 4/15 issue also contains an interesting interview with Ed Durkin, director of corporate affairs at the United Brotherhood of Carpenters & Joiners, and the man most responsible for initiating the majority-voting proposals filed by the building trades unions this year. (See also IRRC's All Eyes on Caterpillar and Majority-vote measure loses, Chicago Tribune, 4/14/05)

My personal opinion is that these are the most important initiatives of the season. We would prefer an open ballot but this appears to be the most productive road towards democratic corporate governance in these times. Way to go Ed!

PayWatch

The AFL-CIO significantly updated its Executive PayWatch site. "Every year, shareholders and America’s workers learn of new jaw-dropping executive compensation packages that seemingly defy rational explanation. In 2004, the average CEO of a major company received $9.84 million in total compensation, according to The New York Times." High on their list are Yahoo, Apple, Coach, TXU, Occidental petroleum, NVR, KB Homes, Toll Brothers, Allegheny Energy and Motorola.

Responsible Voting

I recent study by the Social Investment Forum Foundation found that SRI funds are "stronger Corporate Governance proponents than Conventional funds. SRI funds as a category support more shareholder-proposed corporate governance resolutions and “Vote No” campaigns than their conventional peers by a 2-to-1 margin. They also tend to support more controversial governance resolutions, like separating the CEO and Chair positions, or limiting nonaudit services by auditors. SRI funds are also more consistent in their support of popular 'plain vanilla' governance issues we examined (poison pills, expensing stock options, golden parachutes, and declassifying the board)— totaling 90% support for these four issues, opposed to72% support by Conventional funds."

As expected, SRI funds also supported social issues much more frequently 84.6% (and 3.9% abstaining) compared to Conventional funds’ support of 15.1% (and 18% abstaining). (SRI Funds Vote Proxies More Conscientiously Than Conventional Funds on Corporate Governance, CSRwire, 4/13/05)    

LSE More Efficient than NYSE

The London Stock Exchange (LSE) has kicked off an aggressive marketing campaign to lure emerging markets India, China and Russia by undertaking a broad range of interaction with companies across sectors so as to facilitate their listings in the exchange for tapping international finance to fuel their growth. LSE listed 423 new companies in 2004, in which 293 were IPOs (49 international companies), whereas NYSE had 131 IPOs out of which 11 were international listings in the last year. Comparing the US and UK approaches to regulation of companies listed in their exchanges, James Woodley, manager, Business Development, LSE said, "LSE is more flexible as it is based on sound principles and effective codes, whereas in the US it is prescriptive, costly and expensive." (London Exchange woos Indian firms, News Today, 4/9/05) The LSE appears to offer better corporate governance protections for minority shareholders at lower cost.

Financial Literacy Pays

Corporations whose audit committees were composed of board members who are financially literate had stocks that performed better in a study by Roman L. Weil, Douglas J. Coates and M. Laurentius Marais. The professors developed a classification scheme and researched corporate audit committees based on listing requirements of the NYSE, promulgated late in 1999, the ability of committee members to understand transactions by the company, the accounting issues involved in those transactions, the choices by management, and the implications of those choices for potential manipulation of financial reports.

Executives with clear accounting experience received the highest score of four; financial executives scored a three; nonfinancial executives scored a two; and nonbusiness executives, like university presidents or politicians, scored a one.

They scored the audit committees of 300 large companies in 2000 and 2004, and of a subsample in 1996 as well. Scores did not change significantly between 1996 and 2000, but improved companies began implementing financial literacy requirements. Companies who improved their financial literacy experienced superior stock market returns enjoying excess annual returns of 4.6% more than those which did not improve.

They also surveyed committees on how companies assess the financial literacy of audit members. They received 27 responses, 25 from audit committee chairs and 2 from CFOs. None of the respondents reported a formal process to assess the financial literacy of audit committee members. The majority report that the someone else screens candidates before nominating them. Two-thirds reviewed background experience. "Not one of the respondents indicated that their board had any formal process to increase financial literacy of the audit committee members." "We found neither evidence of formal training nor systematic steps taken by the firm to increase the literacy of the audit committee members."

They conclude, "Shareholders appear to benefit from the company’s having a more literate audit committee and the magnitude of the return dwarfs the costs of increasing that literacy." (The Better the Audit Panel, the Higher the Stock Price, New York Times, 4/9/05 and Audit Committee Financial Literacy: A Work in Progress, SSRN, March 11, 2005) Why not give them a test?

Bosses Still Unaccountable to Owners

The Economist discusses recent trails and tribulations of several American CEOs and says many will believe recent history points to the same, welcome conclusion: "that the imbalance in corporate power of the late 1990s, when many bosses were allowed to behave like absolute monarchs, has been corrected. Alas, appearances can be deceptive. While each of these recent tales of chief-executive woe is a sign of progress, none provides much evidence that the crisis in American corporate governance is yet over. In fact, each of these cases is an example of failed, not successful, governance."

Sarbanes-Oxley is imposing heavy costs but "whether these are exceeded by any benefits is the subject of fierce debate and may not be known for years." The 4/7/05 article, Bossing the Bosses, concludes with the following:

Give shareholder democracy a chance

How much better it would be, then, if the owners of corporate America were to play a more active role in policing the bosses who run their firms. Alas, the institutional shareholders which, on paper, are big enough to do this job are rarely inclined to do so. On the face of it, this looks like just the kind of failure of fiduciary responsibility that Mr. Spitzer likes to pursue. But there is one big problem with demanding more activism from shareholders: their votes in America are still largely worthless, as this season's proxy season, which has just begun, will show once again.

Despite all the talk in America about shareholder democracy and ownership, shareholder resolutions, even if backed by a majority, are rarely binding on management. In many cases, managers can even stop a resolution from being put to a vote. The Securities and Exchange Commission recently proposed a tiny rule change to make it slightly easier for shareholders to nominate candidates for election to boards of directors. Lobbyists representing America's top bosses easily and unceremoniously killed the proposal. Look no further to see where the real power still resides in corporate America.

Schwarzenegger Spares Public Pensions... For Now

With law enforcement officers and firefighters all around, it was clear an announcement would be forthcoming. Sure enough, at a surprise news conference on the morning of 4/7/05 California's Governor announced he is withdrawing his support of an initiative that would have outlawed defined benefit pension plans for all public employees in California.

Opinion polls had first shown overwhelming support for the plan. According to a poll by the Public Policy Institute of California, 61% favored his plan, while 25% opposed it. However, when voters began learning that the initiative would have eliminated death and disability benefits, images of disabled police and firefighters, as well as their widows, drew hundreds of protestors to Schwarzenegger's fund raisers and his polls dropped to below 50% approval.

Requiring two systems during a forty-year phase-out wouldn't have saved taxpayers money and would have resulted in lower retirement benefits for the vast majority of new public employees. According to the San Francisco Chronicle, the median defined contribution plan (DC) plan return from 1990 through 2002 was 6.86%. For the same time period, CalPERS' rate of return was 8.9%. So why the proposal?

One obvious reason is that some want to feed at taxpayer expense. It costs 0.37% to administer the CalPERS defined benefit (DB) plan, but will probably cost more than 1.5% per year as a defined contribution (DC) plan, with no death/disability benefits or inflation protection. If California funds have assets of approximately $500 billion (CalPERS and CalSTRS alone have over $300 billion), the yield to money managers will be an extra $5.65 billion every year while earning $10.2 billion less for public employee retirements every year.

Second, Schwarzenegger raised more than $23 million in political donations in 2004, using the money for initiative campaigns, travel, and fund raising. The DB to DC initiative would have helped him raise a fortune - at least $50 million to fund his 2005 initiatives and another $50 million for his reelection campaign. And the amount to be raised for initiatives may be understated, since these are not subject to the reelection campaign limits of $22,300 per donor. Schwarzenegger would have raised more money than all candidates but the President.

However, another huge reason for the initiative was the role CalPERS, CalSTRS, and other public funds have taken in corporate governance. Jon Coupal, of the Howard Jarvis Taxpayers Association that was collecting signatures to put the initiative on the ballot, said the proposal seeks to end "the social engineering and corporate governance agenda” of CalPERS. Why do powerful forces want to end traditional pension funds, especially public pension funds? Because pension funds are the primary check on the power and greed of corporate CEOs who don't want the pay linked to their performance and don't want to be evaluated by board members that can be held accountable by shareholders. CalPERS has been a leader in the effort to bring accountability to corporate boardrooms. In November 2004 they announced their next major target - CEO pay. Could that have something to do with the attack?

The withdrawal of the pension initiative marks the first major defeat for the Republican Schwarzenegger.

As he said in the movie, "The Terminator," "I'll be back." The Governor said "misconceptions" among firefighters and police officers that privatization would strip them of death and disability benefits had come to dominate the issue. "I have decided to work together with leaders in local government and public safety to craft new initiative language that makes it absolutely clear that the families of every cop, firefighter and public safety professional lost in the line of duty are protected in our pension reform plan," said Schwarzenegger. Then he can put the revised language to the voters in June 2006. "Let's pull it back and do it better," said Schwarzenegger. (see Full Text of Governor Schwarzenegger's Pension Reform Announcement - April 7, 2005)

Sempra Energy's London Meeting

Sempra held its annual meeting in London because it wanted to raise its profile with its European investors. However, reports are that Sempra's large London-based shareholders, Barclays Global Investors and UBS Asset Management, didn't attend. Only 50 people attended and half were Sempra officers.

Shareholder won the following proposals: annual election of Sempra directors passed with 67% vote, expensing of stock options won with 62%, repeal a poison pill passed with 72%. A proposal to link the award of stock options with corporate performance targets was defeated, winning only 23% of the vote.

John Chevedden's spokeperson at the meeting, Neil Millar-Robinson of the Manifest Voting Agency, noted that firms based in the United Kingdom aren't allowed to hold annual meetings abroad without making them available for Internet broadcast. Good advice for companies like Sempra, seeking to hide from their shareholders. (Sempra's half-hour in London, 4/6/05, San Diego Union Tribune)

Investments Don't Govern Themselves; Active Ownership is the Answer

That's what we've been writing for ten years and it is also the subtitle of an article reporting on the work of Joachim Heel and Conor Kehoe. They looked at a sample of five or six deals at eleven leading private equity firms, factoring out market or sector increases, and found that active ownership pays. Add to the growing pile of evidence. That's great but Heel and Kehoe go an important step further. They report their "research reveals a strong correlation between five steps that private equity firms can take" to outperform.

1. Secure privileged knowledge before committing.
2. Institute focused performance incentives for top management and require their substantial investment.
3. Craft and execute better value creation plans. The key may be an independently researched plan to critically review management's plan and then to subject the new plan to continual review and revision.
4. Front-loading by spending almost each of the first 100 days with top execs.
5. Changing management? Do it early.

The author's end with "A standard active-ownership process that applies and develops best practices is the next step for the private equity industry." See Why some private equity firms do better than others in The McKinsey Quarterly, 2005 Number 1.

Why Don't More Shareholders E-Mail Boards?

The Wall Street Journal ran an article by Marcelo Prince on 3/24/05 entitled "Companies Let Anyone E-Mail The Board, But Few Write In." Since Sarbanes-Oxley requires the audit committees of all public companies to establish confidential systems for receiving employee complaints regarding accounting or auditing matters and the NYSE requires listed companies to provide the public with a method to contact nonmanagement directors, most have opened e-mail channels to directors. Mr. Prince goes on to quote Nell Minow, of the Corporate Library, "It's a very good step, despite the risk they will get overwhelmed with a lot of junk. Even though in theory the directors work for the shareholders it's easy for them to forget that."

You can say that again. I happened to be reading through one of my proxy statements on the same day the article appeared and decided to give it try. My e-mail to John Mackey, CEO of Whole Foods Market was about a shareholder proposal by John Chevedden to require redemption of any poison pills and voting on any such future pills:

I pointed out that Chevedden's proposal says "during 2004" three directors each owned zero stock. The rebuttal says "all but one of our directors owns common stock." But that is now. What about then? So I asked, did three not own stock at some point in 2004? Which director owns no stock now? ... I hope Ms. Greene now owns considerably more than the 32 shares she bought on 8/5/04. What about Mr. Siegel? Why should I vote for a director who holds only 32 shares or holds no stock in the company?

I also pointed out that Mr. Chevedden's proposal says that in 2004 directors were allowed to remain on the board up to 24 years. The rebuttal, under the heading "inaccurate assumptions," says that WFMI has a 12 year term limit policy. True, but that doesn't squarely negate Mr. Chevedden's point. For one thing, hadn't you (Mackey) already served on the board 24 years in 2004? For another, doesn't the policy WFMI adopted allow a director to serve 12 years, sit out 2 and serve another 12, for a total of 24?

Do you see a pattern here? The rebuttals sound as evasive as a presidential press conference. It makes shareholders question how accurate other WFMI statements are.

The following was the heart of the response I received from IR/Shareholder Services the next day: "Because of SEC regulations, we are required to limit our substantive comments regarding shareholder proposals to documents that we file with the SEC.  While we would like to do so, we are precluded from separately addressing the points raised in your letter at this time.  You should note, however, that the beneficial ownership of our stock by each of our directors is set forth in the table on page 23 of our proxy statement."

And Mr. Prince wonders why "few write In." If this is typical, maybe we need to change the rules to allow some system of continuous filing during proxy season so that shareholders can get substantive answers to the questions they have. Or, maybe we need to elect corporate monitoring firms at each corporation to analyze proxy issues. The Corporate Monitoring Project has been filing such proposals for a few years, this year at Metro One Telecommunications. The time has come to start voting in favor. Let's get monitors to expose deceptive statements in proxies and answer the substantive concerns of shareholders.

E-mail examples of deceptive proxy statements and the types of responses you've been getting back from boards to MonitorTheProxy.

Samsung Best

Over 200 fund managers and equity analysts voted and FinanceAsia has named Samsung Electronics non-Japan Asia's best corporation, in terms of overall management, corporate governance, investor relations and commitment to paying dividends. (Samsung Electronics is Asia's best company, FinanceAsia.com, 3/24/05)

Court Affirms Right of SEC to Hold Pay

A federal appeals court strengthened the SEC's hand in curbing payments to executives during fraud investigations. The ruling affirms a major provision of Sarbanes-Oxley and gives the agency a powerful weapon that both increases the likelihood shareholder will be able to recover a small portion of their losses and reduces the assets that a defendant can use to fight an SEC suit.

In a 10-1 ruling, the Ninth US Circuit Court of Appeals in San Francisco upheld a freeze on $37.6 million in termination pay and bonuses to former Gemstar TV Guide International Chief Executive Officer Henry Yuen and former Chief Financial Officer Elsie Leung who are suspected of overstating company revenue by $223 million.

Sarbanes-Oxley gave the SEC the power to ask a court to order a company to temporarily put into escrow "extraordinary" payments made to executives under investigation for possible violations of federal securities laws.

"One after another, many persons, companies and pension plans have been left holding an empty bag after corporate insiders committed fraud and other corporate crimes and misdeeds,'' Judge Stephen Trott said in the majority opinion. Allowing the SEC to freeze the funds during its investigation adds "necessary teeth'' to the law, he said, because traditional after-the-fact remedies like fines and restitution might otherwise be futile.

The central issue in the case was whether the law's reference to extraordinary payments was clearly defined to include bonuses like the amounts negotiated by Yuen and Leung before their termination in 2002. All "substantial non-routine" payments to top corporate officials of a company under investigation should be considered extraordinary, Judge Stephen Reinhardt wrote, joined by Judge Susan Graber. Judge Carlos Bea dissented, writing that the SEC should be required to present evidence that payment was "extraordinary relative to payments made to other comparable companies" under circumstances that didn't involve an SEC investigation.

The company first reported overstating revenues in April 2002, sending its stock into a 37 percent plunge -- five days after Yuen had sold Gemstar stock for $59 million, the court said. Seven months later, the company announced termination agreements under which Yuen was to receive $29.5 million in cash and $27.2 million in stock, and Leung was to get $8.1 million in cash and $6.2 million in stock. (Court: SEC can hold pay Fraud probes warrant putting bonuses in escrow, 3/23/05, SFGate.com & 9th Circuit Defines 'Extraordinary' Executive Pay, 3/24/05, Law.com) (Disclosure: the publisher of CorpGov.Net holds Gemstar stock)

CEO Knockdown

A Fortune magazine article with the above title points to the sacking of Michael Eisner from Disney, Nobuyuki Idei from Sony, Harry Stonecipher from Boeing, Hank Greenberg from AIG, Carly Fiorina from Hewlett-Packard, Franklin Raines from Fannie Mae, Christopher Milliken from OfficeMax, and Scott Livengood from Krispy Kreme. "There hasn’t been this much sacking since the Goths dropped in on Rome."

Geoffrey Colvin argues recent lawsuit settlements at Enron and WorldCom were boardroom earthquakes, even though the WorldCom settlement was later overturned, because the court did not reject the idea of personal liability. "Result: For the first time in memory, directors can lose everything because they serve on the board of a company that goes wrong."

He fails to note that at Enron ten former directors will pay $13 million out of their pockets, forfeiting 10% of the pre-tax profits they made trading Enron stock. That's like taxing bank robbers on their take, and at a low rate. Not much of a deterrent. In contrast, the Worldcom settlement represented 20% the ex-director's net worth (excluding, house, retirement and some other joint marital property). At least that might have hurt.

Colvin says watch the lawsuit against Disney’s directors over Michael Ovitz’s severance pay. "No one has alleged fraud, just utter cluelessness and laxity. If the judge’s decision goes against the directors, Disney’s D&O insurance might not cover any damages awarded." The first great eruption of board assertiveness was in 1992, when directors, pressured by institutional investors such as CalPERS, fired the CEOs at IBM, General Motors, and American Express, to name a few. Colvin attributes those firings to embarrassment. Today, he says it is fear. He's probably right.

However, we need to refine our tools and not use such a broad brush, in order to not scare away good directors. As Stephen Davis and Jon Lukomnik argue, investors should put "at the top of our agendas the creation of a Goldilocks 'just right' level of individual director accountability. The list of potential mitigations is long, from changing the way boards are elected, to releasing board minutes and/or formal votes" so that we can know which directors acted appropriately and which did not.

In "Looking For A Goldilocks Accountability Standard," Davis and Lukmnik cite an assessment of Bill Paterson's (Bill is director of the Office of Investment at the AFL-CIO) that we could start by getting each director report individually at the annual meeting, such as they do at Intel. Noting Intel's resistance on expensing stock options, Bill is quoted, "So, we have a completely different sense about how that board works (compared to boards where only the CEO speaks). It does by god will. We disagree on the issue, but at least we talk." (Compliance Week, 3/2005)

International and Natural Resource Funds Climb

According to a 3/21/05 report from Plansponsor.com, total US stock mutual fund value topped $5 trillion for the first time in February, with an inflow of $29.5 billion that month.

Over 50% of total stock inflows went into international equity funds, spurred by concerns over a falling dollar and $2.2 billion flowed into natural resource funds, which, when compared to assets in the category, tops the rate of flow into technology just before the tech bust of 2000.

Majority Voting Gains Support

As previously reported, Institutional Shareholders Services, gave a qualified endorsement to shareholder proposals calling for majority vote election procedures for corporate directors. Now CalPERS has adopted a three-pronged plan to ensure that directors cannot be elected by the vote of a single share unless they are opposed by a dissident candidate. CalPERS will:

1. seek to implement majority policies at individual companies through company bylaw and charter amendments;
2. pursue changes to state laws to implement majority vote where feasible; seek to implement the majority vote concept at the Securities and Exchange Commission and major stock exchanges; and
3. amend their own orporate governance core principles and guidelines to advocate majority votes for corporate directors.

Plurality votes led to several situations in the 2004 proxy season where directors received significantly less than 50 percent of the shares voting yet remained on a company's Board. The examples include 16 directors at nine corporations. The UK and Australia already, in essence have majority vote requirements, since a majority can remove a director by resolution. Time for the US to play catch up.

6th International Conference on Corporate Governance

One of the hottest issues being debated in corporate governance since the introduction of Sarbanes Oxley Act (SOX) in the USA, relates to the extent to which corporate governance should be regulated. This year's conference theme, therefore, is "Making Corporate Governance Decisions That Work" and we invite you to take part so that together we can move corporate governance thinking and practice a major step forward.

In keeping with this strongly solution-oriented focus, this year's conference follows a radically different format to allow, indeed to encourage, participants to contribute in a choice of different ways. As you see from the attached draft programme, working groups are being established to address key questions such as:

• What frameworks are most useful for corporate decision making?
• How best to improve the quality of decision processes?
• Can the role of the regulator further good governance?
• How far can social & environmental responsibility be exercised in today's market economy?
• How best to balance the interests of all stakeholders when making decisions?

The findings of each group will be presented and distilled into a volume of conference proceedings to be distributed among relevant institutions and marketed as the definitive text - with recommendations and guidelines - at the leading edge of global corporate governance thinking. All contributors will receive due acknowledgement in this prestigious volume which goes alongside the published papers. In this way participants will take away from the conference new perspectives and practical guidelines on their proposed issues, as well as being able to share their own valuable work with a global audience.

The World Council for Corporate Governance (WCFCG) international conference on corporate governance is not just a superb opportunity for sharing knowledge and networking, it is also an occasion for bringing together diverse minds, perspectives and practices from every continent - including business leaders, government ministers, senior policy makers, eminent jurists, accountants, auditors, top academics and consultants - in order to cross-fertilise and enrich governance thinking and practice at the highest levels. This year's conference, with its revised format, aims to tap this rich vein of expertise, wisdom and experience to put forward real, workable guidelines for others to follow.

Conference brochure containing registration details and registration form is available on the WCFCG internet site. Mention that you are a "subscriber" to CorpGov.Net and get a10% discount. We hope to see you there - 12-13 May 2005, Nuffield Hall, Regents Park, London.

Sempra Hides Meeting in London

According to ISS, Sempra, the San Diego based energy provider is one of the "meetings to watch." Sempra, which is defending itself against a $24 billion antitrust class-action lawsuit relating to charges of conspiracy and market manipulation, faces four different shareholder resolutions. The proposals seek to force the company to expense stock options, put each director up for re-election annually and tie all future stock-option grants to performance. Another proposal implores the company to refrain from adopting any poison pill plan without the approval of a majority of shareholders. Sempra's board has recommended a "no" vote against all the proposals. Activist John Chevedden, who represents shareholders on two of the proposals (Annual Election of Directors and Vote on Poison Pill) questions why the San Diego-based company is holding its April 5th annual meeting at the Mandarin Oriental Hyde Park Hotel in London, England. Nothing available in California? (ISS predicts 'hot meetings' for 2005 proxy season, Investor's Business Daily, 3/11/05)

ISS, also outlined a new policy of supporting proposals that could dramatically change the way company directors are elected -- and rejected -- by shareholders. The new policy would favor so-called "majority vote" bylaws that would require nominees for board seats to win a positive vote from a majority of shareholders.Under the current system in place at most companies, board members can retain their positions even if a majority of shareholders withhold support for the nominee. The SEC has taken the position that companies may not exclude these proxy proposals. CorpGov.Net encourages such resolutions and a small step towards democracy.

AFL-CIO v Schwab

Under pressure from the AFL-CIO, investment groups Edward Jones, Waddell & Reed and Financial Services Forum have pulled out of lobbying outfits pushing Social Security privatization. The AFL-CIO has now turned its focus on Charles Schwab, a leading member of the Alliance for Worker Retirement Security to privatize Social Security. Apparently, thousands of e-mails from union members does make a difference. (see Tell Charles Schwab: Take your hands off our Social Security)

Evangelicals Join Environmentalists

Although the White House has expressed doubt that global warming exists, despite overwhelming scientific evidence, a group of influential evangelical leaders has warned that global warming is an urgent threat that warrants government action. Leaders emphasize the Bible mandate for good stewardship of the earth and disproportionate affect of hurricanes and droughts on impoverished regions. Does this signal a new alliance between evangelicals and environmentalists? (A crack in coalition of faith and profits, The Courier-Journal, 3/14/05).

Ebbers Found Guilty

In another chapter in the nation's largest accounting fraud, former WorldCom CEO Bernard Ebbers was found guilty on all counts. The verdicts were a major victory for prosecutors who spend nearly three years investigating the $11 billion fraud that decimated shareholder value once valued at $100 billion. "Thank God for common sense," said Broc Romanek, editor of TheCorporateCounsel.net. "It is a huge boost for corporate governance and hopefully similarly situated executives will be facing the same types of juries soon. "See AccountingWeb.com and Ebbers "Aw Shucks" defense fails, boosting "404," Reuters.com, 3/15/05)

UK Ranks First

Corporate governance in the U.K. scored highest among 23 nations in the latest survey by GovernanceMetrics International, while 34 of the 3,220 companies rated a perfect 10. Japan and Greece ranked at the bottom; Canada was second and the United States third, followed by Australia and Ireland. In GMI's last ranking, the U.S. had the highest ranking, but slipped in the latest release due in part to the inclusion of lower-ranked small capitalization companies.

GMI found that more companies are separating the positions of chairman and chief executive. In July 2003, 47% of the companies then covered by GMI had a single executive serving as both chairman and CEO, but now 39% of the companies surveyed had split the posts. (UK Highest in Corporate Governance Rating, MSN, 3/6/05)

Extravagant CEO Pay is Back

In an article with the above title, Michael Brush notes that George David, the chairman and chief executive of United Technologies pulled down a cool $88.7 million in 2004. To provide perspective, "David pocketed just a little less than the $89.1 million we pay all the top executives running the three branches of our federal government. In other words, for around the same amount United Technologies shareholders paid for their CEO last year, taxpayers got: One president, a vice president, 535 lawmakers on Capitol Hill, and nine Supreme Court justices."

True, George David did help UTX shareholder earn stock gains three times the returns of the S&P 500. "That’s commendable, no doubt. But his $88.7 million in compensation last year was 19 times the median CEO pay package of $4.43 million at S&P 500 companies in 2003." The article goes on to identify several more extravagant pay packages and reviews the arguments for and against. (MSN Money, 3/16/05)

Retiring Later

Americans will be spending a lot less time in retirement than they do now, according to Jeremy Siegel, Wharton professor and author of The Future for Investors. According to Siegel, the average retirement age of Americans will rise from age 62 to age 73, because they won't have enough savings to maintain their lifestyle.defined benefit plans. Who gains? Providers of defined benefit plans. Apparently, Siegel isn't alone. In the March 2003 Financial Analysts Journal, Robert Arnott, of Research Affiliates, LLC, Pasadena, concluded that people born after 1945 will be unable to retire before approximately age 70.

The shortage of workers, Siegel explains, will mean that wages will be very high, since there will be a surplus of capital relative to workers. So, although demand for goods will be high, costs for the firms supplying these goods will go up faster than revenue, pinching corporate profits and reducing stock values. (Retirement Ain’t Gonna Be What It Used To Be, PlansSponsor.com, March)

Best Book of 2004

Pay without Performance: The Unfulfilled Promise of Executive Compensation was the best book published in 2004 in the field of corporate governance. Lucian Bebchuk and Jesse Fried focus on one aspect of corporate governance, executive pay, and clearly demonstrate that many features of executive pay are better explained as a result of shear managerial power, rather than arm's-length bargaining by boards of directors.

After thoughtful analysis, they find “systematic use of compensation practices that obscure the amount and performance insensitivity of pay, and the showering of gratuitous benefits on departing executives.” The cost of current corporate governance systems is weak incentives to reduce managerial slack or increase shareholder value and “perverse incentives” for managers to “misreport results, suppress bad news, and choose projects and strategies that are less transparent.”

Their recommendations on improving executive compensation are clearly aimed at eliminating or reducing some of the most egregious of the practices of those they document. Interestingly, the recommendations are written to shareholders, apparently because there is little likelihood such reforms will be raised by even “independent” directors without further corporate governance reforms. A few examples are as follows:

• To reduce windfalls in equity-based plans, shareholder should encourage that at least some of the gains in stock price due to general market or industry movements be filtered out. “At a minimum, option exercise prices should be adjusted so that managers are rewarded for stock price gains only to the extent that they exceed those gains (if any) enjoyed by the most poorly performing firms.”
• Executives should be prohibited from hedging or derivative transactions to reduce their exposure to fluctuations in the company's stock and should be required to disclose proposed sale of shares in advance to reduce perverse incentives to benefit from short-term gains that don't reflect long-term prospects.
• Do not provide large payments to executives who depart because of poor performance.
• The compensation table should include and should place a dollar value on all forms of “stealth” compensation, such as pensions, deferred compensation, postretirement perks and consulting requirements.
• Allow shareholders to propose and vote on binding rules for executive compensation arrangements.

Although many directors now own shares, their related financial incentives are still too weak to induce them to take on the unpleasant task of firmly negotiating with their CEOs. Recent reforms requiring a majority of independent directors, and their exclusive use on compensation and nominating committees, may be beneficial but “cannot be relied on” to produce the kind of arm's length relationship between directors and executives needed. CEOs retain influence over director compensation and rewards, as well as social and psychological rewards. “The key to reelection is remaining on the company's slate.” Remaining on good terms with the CEO and their director allies continues to be the best strategy for renominatation.

Executive compensation “requires case-specific knowledge and thus is best designed by informed decision makers.” They conclude, “While we should lessen directors' dependence on shareholder, we should also seek to increase directors' dependence on shareholders.” After discussing the now failed “open access” SEC proposal to grant shareholders the right to place a token number of candidates on the ballot after specified “triggering events,” the authors propose the following significant corporate governance reforms:

• Access to the ballot should be granted to any group of shareholders that satisfies certain ownership thresholds. Their example is 5%, held for at least a year.
• Such slates should be able to replace all or most incumbent directors in any given year.
• Companies should be required to distribute the proxy statements of shareholder nominated candidates and should be required to reimburse reasonable costs if they garner “sufficient support.”
• Legal reforms should require or encourage firms to have all directors stand for election together.
• Shareholders should be given the power to initiate and approved proposals to reincorporate and/or adopt charter amendments.

In their conclusion, the authors recognize the “political obstacles to the necessary legal reforms are substantial” and that “corporate management has long been a powerful interest group.” The demand for reforms must be greater than management's power to block them. “This can happen only if investors and policy makers recognize the substantial costs that current arrangement impose.” Pay without Performance will certainly contribute to such recognition. It should be required reading for every fund fiduciary, SEC board and staff, as well as all members of Congress. Shareholders should read while sitting down.

Mood Swing

In "A New Mood in Congress to Relax Corporate Scrutiny," Stepen Labton reports on the defeat of modest attempts by Democrats to curb bankruptcy abuses by corrupt or troubled corporations and their senior executives illustrates "a new reality and a sharp swing of the pendulum in the Senate."

The Senate rejected a proposal to prohibit corrupt companies from issuing huge payouts to senior executives shortly before entering bankruptcy, blocked curtailing the ability of companies like Enron and WorldCom to shop for the most favorable bankruptcy courts, defeated a proposal to protect employees and retired workers when their companies go bankrupt, refused to close the "millionaire's loophole" that permits wealthy individuals to shelter their assets from lenders by creating special asset-protection trusts, and rejected a proposal to put a nationwide limit on the homestead exemption, a provision that has enabled corporate executives to buy expensive homes in states like Florida and Texas to shelter their assets from creditors.

New accounting treatment of stock options has been delayed, the "open access" rule that would have opened corporate elections to a modicum of democracy has been killed, and hearings Senator Shelby will hold hearings to determine if Sarbanes-Oxley went too far. Ann Yerger, executive director of the Council of Institutional Investors, is quoted, "We now spend much of our time trying to hold onto the reforms we had won." (New York Times, 3/10/05)

Nightmare Shift in the Making

In his essay, The Coming Transformation of Shareholder Value, which appears in the January 2005 edition of Corporate Governance: An International Review, Simon Deakin argues that corporate governance of the future will be centrally concerned with how "shareholders exercise their powers not as the representatives of the market, but as agents of society as a whole." However, that vision of the future may fundamentally depend on the continued influence of public pension funds that, as universal owners, have strong incentives to become actively involved in the affairs of individual corporations. We may be soon facing another paradigm shift if California, an opinion leading state, prohibits public agencies from offering defined benefit plan and, instead, requires defined contribution plans. Under that scenario, investors will be more likely to give management a free hand. The result will be increasing inefficiencies in the ability of corporations to create wealth and a greater shifting of corporate costs onto society and the environment.

Deaken makes the point that in most developed countries shareholders "take more out of publicly listed corporations than they put in. Their role is no longer simply to supply finance to companies. Most trades of shares in listed companies consist of movements from one shareholder to another with no new capital being supplied to the company. Rather, as agency theory prescribes, the function of shareholders is to discipline corporate management."

Under the "shareholder primacy" model, shareholders discipline management through market mechanisms. This is somewhat problematic to the larger society and the environment because "managers are encouraged to pursue strategies for share price maximization which depend upon the externalisation of costs on to other stakeholder groups." But Deakin sees the notion of corporate responsibility, especially as applied by large public pension funds as an important mediating factor.

He cites the work of Hawley and Williams who have argued that the rise of fiduciary capitalism, in particular public pension funds, has created an important class of universal owners who do not benefit from short-term gains in the market for corporate control or externalizing corporate costs. Since many public funds, such as CalPERS and CalSTRS, permanently own a broad cross section of all listed stocks, they are likely to hold equity stakes in both firms involved in any takeover. Substantial gains for target shareholder mean little to such funds if they don't also provide efficiencies to acquiring companies, which all too often is not the case.

Additionally, "the logic of universal ownership is that shareholders will, in the final analysis, bear the costs of externalities which cannot easily be absorbed by the parties or which produce dislocative effects upon society or the economy." For example, public fund beneficiaries and taxpayers, who may benefit from a portfolio company externalizing costs that contribute to global warming, will have to bear the cost of repairing the damage. Deakin concludes by holding out hope that laws requiring greater disclosure by companies of information related to social and environmental impacts will hasten the transformation to a kind of melding of shareholder and stakeholder paradigms where "shareholders exercise their powers not as the representatives of the market, but as agents of society as a whole." Since their investment time horizons are so long, their portfolio broad, and their holdings are almost permanent, such funds do tend to act on behalf of society as a whole. Additionally, they are at the forefront of setting standards of fiduciary duty that also apply to trustees of other private pension funds and mutual funds.

However, take away public pension funds and the vision falls apart. In theory, private pension funds and mutual funds could fill the void but that is unlikely because of the more direct conflict of interests trustees of such funds face. While the law is clear that fiduciaries cannot personally benefit from incentive payments and bonuses (with some exceptions), there is little protection from being fired for losing an account or for being too assertive in corporate monitoring.

As Robert AG Monks has pointed out frequently, "ERISA requires fiduciaries to consider only the interests of plan participants in their decision making. And this is their interest as pension plan participants, not their interest as employees or members of the community. But this provision has not been administratively enforced or judicially defined with sufficient conviction to mitigate the crippling conflict of interest problem that hobbles trustee behavior. Fiduciaries under ERISA are subject to strong industry pressures in the performance of their duties. It is clear to individual and institutional trustees that their continued employment is in the discretion of the plan sponsor. To the extent that they exercise their discretion in a manner that is perceived as inimical by plan sponsors, they can be sure of not being reappointed and of being "blacklisted" for new business by other employers." (Corporate Governance And Pension Plans: If One Cannot Sell, One Must Care, 1995)

A study entitled Would Mutual Funds Bite the Hand that Feeds Them? Business Ties and Proxy Voting, published on 2/15/05 by Gerald F. Davis and E. Han Kim, found that "the more business ties a fund company has, the less likely it is to vote in favor of shareholder proposals opposed by management." Although voting against management could provide a boost to the stock and therefore the funds, such an increase is not usually as financially attractive as the fees garnered from pension administration. As far as I know, this is the first study to use the data made available as a result of an SEC regulation passed in early 2003 that requires funds to disclose both their proxy voting policies and procedures as well as their voting records.

Summarizing the report's findings in a 3/07/05 article, Pension Business a Conflict for Fund Managers, in Ignites magazine, Alison Sahoo notes that Fidelity opposed client management in just 33% of the votes the researchers examined. Morgan Stanley voted against client wishes in 43% of the time, while Putnam opposed customer management in 47% of the votes examined. Vanguard fought client management in 51% of examined votes. In comparison, Franklin voted against management in 78% of the cases, while Janus opposed management 74% of the time and American Funds went against management in 70% of the votes. Fidelity, Morgan, Putnam and Vanguard each have big pension businesses with Fortune 1000 companies. According to the study, Fidelity makes more than $429,000, on average, from each of its largest Fortune 1000 pension accounts. Vanguard averages more than $581,000 and Putnam pulls in more than $362,000.

The firms also tend to invest more of their funds' assets in client securities than in non-client holdings. The study estimates that the mean value of Fidelity's holdings in a large pension client is $605,000 compared with an average of $375,000 in a non-client. Similarly, it says that Vanguard's client holdings average $220,000 versus $159,000 for non-client assets. (see also, subsequent article by William Baue at SocialFunds.com)

SEC rules could be amended to require that mutual funds disclose information about material relationships between themselves and securities issuers. The point is that public pension funds, such as CalPERS and CalSTRS have long been the leaders in corporate governance and mutual funds are unlikely to fill that role in any meaningful way.

A 1991 study found that over 80% of corporate board candidates were filled by CEO recommendations. Until 1992, when the SEC revised its proxy rules under pressure from CalPERS, shareholders could not even communicate with each other without going through elaborate and expensive filing procedures. What followed that rule change was a period of sweeping and highly visible change in boardrooms across America due to the activism of CalPERS and the Council of Institutional Investors. CEOs were ousted at American Express, Chrysler, General Motors, IBM, Kodak and Westinghouse.

After a period of toned down involvement in corporate governance, the demise of Enron, Worldcom, and others in 2002 led CalPERS to begin another surge in corporate governance activism. Despite Sarbanes-Oxley, corporate governance concerns persist. Investors are now supposed to be protected from greedy CEOs by “independent” board members who will negotiate the terms of employment at arms length. But under current listing standards directors can still be considered independent even if they receive $60,000 to 100,000 a year in additional compensation. They can be the CEOs golfing buddies or former college roommates. Even if they start out as independent, most directors end up loyal to the CEO because they set the agenda and provide the perks.

There is growing recognition of the fact that, as Bacchus and Fried noted in Pay Without Performance), "Independence, even coupled with incentive schemes, cannot secure shareholder interests unless there is some mechanism at the end of the chain that makes the designers of incentive schemes designers [sic] accountable to shareholders. This basic point highlights the importance of making directors dependent on shareholders."

After being petitioned by the author and Les Greenberg, and later by the AFL-CIO, the SEC proposed a weak rule that would make it easier for shareholders to nominate a token number of directors, which they predicted might happen at 45, or 0.3%, of companies each year.

This “foot in the door” supported by CalPERS, CalSTRS, and public pension funds all over the nation so disturbed corporate managers that the U.S. Chamber of Commerce threatened to sue the SEC if the rule is enacted. The Business Roundtable, made up exclusively of top CEOs, placed ads in major newspapers signed by chief executives of 40 large corporations, warning the proposal would erode the independence of directors.

Poorly thought out proxy policies in 2004 led CalPERS to oppose the reelection of Warren Buffett to the Coca-Cola board of directors. "Like Donald Trump after a long day of watching tycoon wannabes struggle to gain his approval, CalPERS board members are trying to hand out pink slips to the directors at 90% of the companies in which the fund owns shares," began an article posted on the Republican Party's website entitled "CalPERS Puts Social Agenda Ahead of Profit."

In November 2004 CalPERS announced their next major target - CEO pay. Apparently, that was too much.

In January 2004, Governor Arnold Schwarzenegger remarked that the current pension system allows public employees to be "secure in the knowledge that a volatile investment market will not affect retirement benefits because they will continue to be covered by a defined benefit retirement plan; this is in stark contrast to the concerns of many private sector employees." However, now, Schwarzenegger has joined with the Howard Jarvis Taxpayers Association, which seeks to end "the social engineering and corporate governance agenda” of CalPERS (State workers balk at taking another hit, Sacramento Bee, 1/11/05) by terminating the ability of public employees to have a defined benefit plan, such as those currently administered by CalPERS and CalSTRS. Schwarzenegger is raising millions nationwide from business sources to back the Jarvis November ballot proposal.

Last year CalPERS earned 13.5% on its assets. The average large pension fund rose just 11.6%, according to Wilshire Associates, an investment consulting firm. Both funds are doing comparativly well, considering the losses experienced after Enron. Yet, according to a poll by the Public Policy Institute of California, 61% of California adults favor changing the pension systems for new public employees from defined benefit (DB) to defined contribution (DC) systems similar to a 401(k) plan, while 25% oppose such a change. (Pension crossroads, Sacramento Bee, 1/27/05) The public appears ready to accept the word of an action-hero governor who pitches the plan as a money saver, even though it is likely to cost taxpayers billions and will force future public sector retirees into poverty.

At CalSTRS, four of the governor's own appointees voted against his plan, which led Schwarzenegger to retaliate by firing them, a move his critics dubbed the "Thursday afternoon massacre." Mark Battey, Jim Gray, Gloria Hom, and Miguel Pulido were appointed last April by the governor. They were about to go before a state Senate committee for their confirmation hearings. But on 2/3/05 they voted with a 10-2 majority on the 12-member board that opposed conversion of a defined contribution plan, and an 11-1 majority that rejected the state’s canceling of its pension contribution. A fifth Schwarzenegger appointee supported the proposals.

After the four board members were dismissed, ex-board member Jim Gray said, "If you have to be in lock step, I guess I shouldn't be one of his appointees." Gray, a Republican from the southern California community of Indian Wells, had served as a trustee of the California state university system under Republican governors George Deukmejian and Pete Wilson. (Governor axes four CalSTRS directors, Sacramento Bee, 2/11/05)

The governor’s changes would place California among only two states and the District of Columbia that require new employees to use individual investment accounts. West Virginia requires them for teachers and Michigan for all new employees. Numerous other states, including Florida, Ohio, Colorado, Montana, North Dakota and South Carolina, offer the option voluntarily, according to the National Conference on State Legislatures. Yet, if the move is successful other states would be sure to follow.

CalPERS and other public pension funds have been instrumental players in almost every corporate governance reform since the late 1980s, from creating more independent boards to requiring better disclosure. They have also been aggressive in negotiating changes at individual companies, often resorting to the use public shaming to force changes at focus companies. Over the last several years, they have joined forces with unions, environmentalists, and small "socially responsible" mutual funds in addressing large issues such as global warming. Last, they have led in the use of lead plaintiff provisions of the Private Securities Litigation Act of 1995 by suing companies like ENRON and WorldCom to recover damages for securities violations and executive fraud.

If Schwarzenegger's latest move succeeds in doing away with most public retirement funds, we run the risk of more ENRONs and corporate management being accountable to no one. The thoughtful vision of Deaken, Hawley and Williams, Robert Monks and others who see such funds as shareholders who "exercise their powers not as the representatives of the market, but as agents of society as a whole" would be gone. I'm having nightmares already.

CSR: Mixed Messages

The Winter 2004 edition of Business Ethics and the February 2005 edition of the new publication, Ethical Corporation paint conflicting images of evidence supporting the idea tha