July 2006

ISS Blog Clarifies Position on Voting

Rajeev Kumar, Director of U.S. Research, and Robert Kellogg, Managing Director, Taft-Hartley Advisory Services at ISS responded to Keith Bishop's recent post on TheCorporateCounsel.net Blog (The "Skinny" on the California Bill Amendments). "Majority vote standard and cumulative voting compliment each other. Without majority vote standard, cumulative voting in an uncontested election has no teeth because then a director could still be elected if he/she receives one single vote."

"Regarding ISS' policy on cumulative voting with respect to majority vote standard, we would not support a cumulative voting shareholder proposal if the company has majority vote standard in place. This is not because the two are incompatible, as many companies have been arguing. Rather, the rationale behind this policy is to provide an incentive mechanism (the carrot) for companies to move toward a majority voting standard for electing its directors." (Does Cumulative Voting Compliment Majority Voting?, 7/31/06)

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Shock and Awe

The SEC voted to force companies to reveal more information about how top executives are compensated, including salaries and perks. CEO pensions are likely to result in a lot of 'holy cow' moments, according to leading experts. As standard pension programs for rank-and-file workers are terminated to cut corporate expenses, hefty executive pensions have become a hot-button issues, especially with union sponsored funds.

Under the new requirements, companies must provide a second set of charts that will reveal precisely how much each of their five most highly compensated officers have accumulated in their individual pension and deferred-compensation accounts.

In many cases, those numbers will run into the tens of millions of dollars, predicted Patrick McGurn, executive vice president of Institutional Shareholder Services, a firm that provides guidance on corporate governance issues to big investors. "That's going to be the area that produces the stunned-silence moments," he said. "Those numbers could be eye-popping." (Executive Pensions Could Raise Ire, LATimes, 7/29)

More Restatements Ahead

PCAOB alert regarding stock options grants, entitled Matters Relating to Timing and Accounting for Options Grants, could unleash a wave of restatements. (more at TheCorporateCounsel.net Blog)

Mace: Preventing or Facilitating Crime?

I feel safer walking down the street with a can of Mace because I know it can help protect me against crime, but it now appears shareholders may need protection from the company's own compensation committee.

In a filing with the SEC on July 27, 2006, Mill Valley, CA-based Lawndale Capital Management and its affiliates filed an initial form 13D for its 6.7% position in Mace Security International Inc. ("MACE"). MACE designs, manufactures and sells a wide range of personal defense sprays and security products and sells professional electronic surveillance products for corporate, industrial and governmental uses. In addition, Mace owns or operates 53 car and truck washes that it plans to divest. Lawndale believes the public market value of MACE is undervalued by not adequately reflecting the value of MACE’s personal defense, car/truck wash (and underlying real estate) and corporate security assets.

Lawndale’s President, Andrew Shapiro, has communicated a summary of his concerns with MACE Compensation Committee (the “Committee”) members regarding certain aspects of MACE’s compensation agreement with its Chairman & CEO, Louis D. Paolino, Jr., as well as criteria used by the Committee in determining performance bonus payments. Shapiro has requested a meeting to share his concerns more fully with the Committee prior to its deliberation on any renewal or extension of Mr. Paolino’s employment agreement that, according to MACE’s 10-K, is set to expire in a few weeks, on August 12, 2006.

One item, likely to be discussed, is an extraordinarily excessive $2.5MM termination payment provided for in section 7, on pages 7 and 8, of the employment agreement .  It appears Mr. Paolino is to be paid $2.5MM payout even if he is terminated pursuant to:

7b(iv) gross negligence or willful misconduct with respect to the Company or any of its affiliates or subsidiaries, including, without limitation proven dishonesty in the course of employment, or a conviction of a felony or a misdemeanor involving moral turpitude, or a finding of adjudication withheld, with imposition of a sentence, to either a felony or a misdemeanor involving moral turpitude, or the entering of a plea of guilty or nolo contendere to a felony. (my emphasis)

The Chairman of the Compensation Committee is Dr. Constantine Papadakis, President of Drexel University. His bio highlights his board service at many companies including Mace. Maybe readers should research compensation agreements at Dr. Papadakis' other companies before investing.

Disclosure: James McRitchie, the publisher of CorpGov.Net has an investment in a fund managed by Lawndale Capital Management, LLC.

The Cost of Backdating

Gretchen Morgenson gives us a glimpse of the cost of backdating, providing several examples. One is Altera, a semiconductor maker. Altera's most recent annual report stated that between 1996 and the end of 2005, it had repurchased 86.6 million shares at a cost of $1.8 billion, averaging $20.78 a share. For example, last year Altera paid an average of $18.58/share to buy back 20 million shares. As employees exercised options in 2005, Altera received roughly half that amount -- $9.32 a share on average. "In other words, Altera and its shareholders swallowed a 50 percent hit on shares the company purchased to maintain its lush options program -- while Altera employees and executives who sold stock after exercising options pocketed that lucrative difference." Morgenson also makes similar calculations for prior years.

Of course Altera is not alone and Morgensons provides two more examples. Since 2003, Affiliated Computer Services, an information technology company in Dallas, has purchased 22 million shares at an average price of $50.27 each. Morgenson calculates that Affiliated's shareholders paid almost $130 million to buy high and sell low, 13.5% of the company's net income. Broadcom, a semiconductor company, paid $77 million to buy high and sell low in 2005 and will have to restate earnings. (Options Fiesta, and Investors Paid the Bill, NYTimes, 7/30/06)

I assume the list could go on and on, although perhaps a bit dramatically. Where is the accountability to shareholders? Unfortunately, our legal system does little to enable shareholders to throw out directors who participated on the compensation committees of such companies. It certainly points to the need for majority voting requirements and open access to the proxy.

Don't Ask; Don't Tell

A study by Glass Lewis & Company finds that 1,430 public companies in the United States changed auditors in 2005, a turnover rate of 11.3%. In 72% of the cases, the companies didn't provide a reason when they notified the SEC of the change, up from 58% percent in 2004.

In 1999, when Computer Associates, now known as CA, dismissed Ernst & Young, it told investors there was no disagreement on accounting, and no ''reportable event.'' A few years later, investigators from the SEC and the Justice Department found that Ernst was fired in retaliation for requiring disclosures regarding compensation of top executives.

Glass Lewis now recommends that the SEC add ''significant difficulties'' faced by the audit firm in doing its job to its list of reportable events. As Floyd Norris writes, don't ask; don't tell "may or may not be a good policy for the Army when dealing with gay soldiers, but it is a bad policy when an audit firm resigns an engagement." (Deep Secret: Why Auditors Are Replaced, NYTimes, 7/30/06)

To me, it simply looks like one more reason to allow shareholder select the auditors, as Mark Latham proposed in a resolution to USG Corporation in 2003.

Webb Seeks Broker Reforms

With the demise of Tiffit Securities, David Webb proposes changes to the Stock Segregated Account with Statement Service (SSA) system, whereby each client's shares are held by the broker in a separate, named account, and a printed statement is sent to the client each time stock is added or removed from the account, as well as a monthly statement. To update the system, Webb proposes:

1. HKEx should revamp the SSA system to allow all communications, including transaction statements and links to on-line issuer documents, to be sent to account holders by e-mail. This will give them instant notice when stock is moved in or out of their accounts by their broker, or when a shareholder meeting is being called.
2. HKEx should also allow SSA holders to log in and view their stock balances on the web and by phone.
3. HKEx should allow SSA holders to give voting instructions through the same web and phone system. To avoid conflicting instructions, brokers should not be permitted to vote shares in SSA accounts. By connecting CCASS directly with investors, this will greatly increase retail investor voting, improving the real effect of corporate governance rules designed to protect investors, which are ineffective if they don't vote, for example, on connected transactions.
4. Due to lower costs, the electronic SSA system should be made available by HKEx for free, but the existing charge of HK$10 per month (or perhaps more) should be levied for those who want the printed, mailed service. This will incentivise use of low-cost electronic communications. HKEx will recover the cost through increased retail participation in the market, which generates fees itself.
5. Brokers would continue to control the SSA accounts and handle anything involving cash, including transaction settlement and rights issue and warrant subscriptions. The SSA system should allow authorised re-pledging, by indicating a "P" on the statements. This will make it clear to investors whether or not their stock has been pledged by a broker to finance its business. If no such flag is attached, then in the event of a brokerage failure, no re-pledging of that stock will be recognised by HKSCC.
6. Finally, and most importantly, the SFC should require that all client assets of retail banks and brokerages be held in SSA accounts. That is, every retail investor who wishes to leave stock in the custody of a bank or broker shall be required to have an SSA account and give either an e-mail address or, if they want printed statements, a postal address. Investors may instead take direct custody through the existing IP account service which will remain available. (Trust, but Verify)

Skin in Game Pays

A study by researchers at the Georgia Institute of Technology  and the London Business School, looked at 1,300 mutual funds. They separated the funds where the manager owned at least some shares in 2004, and found that they delivered 8.7% in 2005, compared to 6.2% by the funds where managers held no shares. For every 0.01% increase in manager ownership, fund performance improved 0.03%, it found. Still, fewer than half of U.S. mutual funds included investments by managers. (Another Way to Assess a Mutual Fund, WSJ, 7/26/06)

SEC Adopts Executive Compensation Disclosure Rules

See TheCorporateCounsel.net Blog for a very informative summary. (7/27/06)

Chevedden Reports

McKesson Corporation (MCK) shareholders voted 86% in favor of annual election of each director at the July 26 annual meeting. The proposal (No. 3 on the ballot) was sponsored by William Steiner of Piermont, NY. The early-bird meeting (8:30 a.m.) at Giannini Auditorium, San Francisco was attended by several rank-and-file shareholders in addition to 40 employees.

The Board declared a regular dividend of six cents per share on the Common Stock, payable October 2, 2006, to stockholders of record on September 1, 2006.

Support California's SB 1207

When I have a question, one of the first places I often turn is to the extensive practice areas on TheCorporateCounsel.net, edited by Broc Romanek. I'm also an avid reader of Romanek's blog, one of the most respected sources of “practical corporate and securities law” on the internet. His postings are always informative and usually objective. However, a recent posting provided by Keith Bishop (The "Skinny" on the California Bill Amendments, 7/25/2006) appears to be the rare exception of misinformation.

SB 1207, which facilitates the use of majority vote requirements for directors of publicly-traded companies in uncontested elections, is blasted in Bishop's contorted analysis. He claims it would “gut” California's long-standing support of cumulative voting. “Given the negative impacts of SB 1207 on cumulative voting, I find it ironic that this bill is being sponsored by CalPERS. By statute - Government Code Section 6900 - CalPERS is required to vote its shares to permit or authorize cumulative voting," he concludes.

Mr. Bishop is a member of the Executive Committee of the Business Law Section of the California State Bar. The State Bar has expressed its opinion that majority voting could lead to several negative impacts. Their alarmist analysis finds:

• Boards will lack individuals with the necessary qualifications, which may lead to the delisting of California Corporations.
• Majority voting will deter qualified individuals from agreeing to stand as directors.
• There could be potential contractual breaches if CEO or other officer employment contracts requires that they remain a member of the board.
• It may increase the cost of shareholder votes in order to garner the required majority.
  

But how many directors really fear getting less than 50% of the vote when no one is running against them? This latest argument by Bishop appears to be a red herring, thrown up to distract readers from recent amendments that simply permit, rather than require, publicly-traded California companies to use majority vote requirements in uncontested elections.

I checked with staff of both the cosponsors of SB 1207, CalPERS and CalSTRS. From CalPERS:

We agree that California has a longstanding policy of affording shareholders the protection of cumulative voting. We think it doesn't make sense to mix cumulative voting and majority voting in the same election. Cumulative voting is only meaningful for contested elections and majority voting only will apply for uncontested election... CalPERS is not aware that shareowners have ever been to utilize cumulative voting even symbolically in uncontested elections.

Some critics of majority voting, namely the Chamber and the Corporations Committee of the State Bar, would require a corporation to make an "either or" choice between majority voting and cumulative voting. In other words, they would permit California corporations to adopt majority voting in uncontested elections only if they were willing to eliminate cumulative voting in all elections, whether contested or uncontested. We think that choice is best left to each corporation and its shareholders. Corporations already have the ability under Section 301.5 to opt-out of cumulative voting if they wish to do so. There is no reason to force a choice.

Put another way, is there a reasonable justification as to why the corporations code should, as a matter of law, prevent a corporation from electing to implement cumulative voting in contested elections and majority voting in uncontested elections? We think the answer is no. They serve different purposes and can co-exist quite well. The policy goal of majority voting is to provide a means for shareholders to vote against incumbent directors. It takes a majority of votes to reject a director. The purpose of cumulative voting is to ensure minority representation on a board. While the policy purposes may overlap, they don't conflict.

And the following from CalPERS:

We don't believe that SB 1207 guts cumulative voting. We believe that the two can co-exist since majority voting is not going to be used in contested elections… Logistically and I think, legally, it is impossible to use cumulative voting in uncontested elections… CalSTRS has gone on record as supportive of the Delaware approach. We believe that the progress of majority voting is the most important right for shareholders.

SB 1207 is far from the Holy Grail that Les Greenberg and I hoped for when we petitioned the SEC for an “equal access” rule in the summer of 2002, but it does provide at least some mechanism for shareholders to be able to hold directors accountable. The bill is currently on the floor of the Assembly. I urge readers, especially those in California, to write letters of support for SB 1207 to its author, Senator Richard Alarcón. His address is: State Capitol, Room 4035, Sacramento, CA 95814. His phone number is (916) 651-4020. You can also send an e-mail to him using the "Your Feedback" link on Senator Alarcón's website. Those who live in California should also write to their Assembly member, urging that they vote in favor of this important measure.

McRitchie Files to Protect Assets of CalPERS Members

James McRitchie, publisher of Corpgov.Net and a candidate for the CalPERS Board of Administration, filed a petition with the Office of Administrative Law, seeking a determination by that agency that several regulations enforced by CalPERS concerning the conduct of elections have not been formally adopted, as required by law. These "underground regulations" expose CalPERS members to increased risk from identity theft and provide opportunities for incumbent board members to gain unfair advantages in elections.

Hedge Fund Activism

Chris Young, Director of M&A Research at ISS, blogs on the convergence of trends. High-profile M&A disasters like the AOL-Time Warner (TWX ) merger and numerous academic studies together have established a new conventional wisdom among investors that a significant percentage of deals destroy shareholder value.

Second, high-profile scandals like Enron, WorldCom, and Tyco International, (TYC ), have made shareholders more cynical about the decision-making process of boards of directors. Lastly, investors and regulators began to pay more attention to how fiduciaries were voting shares. Today, institutional shareholders who consistently defer to management (the modus operandi of the past) may be accused of abdicating their fiduciary duties.

lately, "vanilla" managers have taken the first tentative steps toward activism. In the Chiron buyout, dissidents were joined by Citibank's (C ) asset management arm, proving an imprimatur of legitimacy to the activists' cause. To the extent that other traditionally passive investors follow that lead, the power of the M&A vote to rock management's world will only increase. (Hedge Funds to the Rescue, 7/25/06)

Voting Problems at Heinz

H.J. Heinz Company (NYSE:HNZ) said retail shareholders with "street name" holdings (shares held through brokers or intermediaries) of approximately 75 million shares (30% of outstanding shares) have been prevented by a combination of actions by the Trian fund and ADP Proxy Services from casting votes via the Internet or by telephone since July 17.

Street name shareholders trying to use the Internet or phone system receive an "error" message from the ADP system that their control number on their proxy card is wrong, when the real issue is that the Internet and phone system at ADP is not working. Until this problem is remedied, the only way for these shareholders to vote is by mail. (Heinz Retail Shareholders Prevented from Voting via Internet or Telephone, Pittsburgh Daily Business News, 7/24/06)

At an employee meeting this past week, the company distributed bottles of its signature product with labels urging them to re-elect the firm's slate of directors and reject those nominated by Peltz and his partners. Peltz and his New York-based Trian Group, an investment firm that owns 5.5 percent of Heinz's shares, are seeking to add his board nominees to implement an aggressive plan designed to boost shareholder returns. (Heinz Enlists Ketchup Ally, theday.com, 7/23/06) For a discussion of the issues, see Heinz Proxy Fight Heats Up, ISS Corporate Governance Blog, 7/24/06

Enterprise Risk Management

The Conference Board has released an important new report, The Role of U.S. Corporate Boards in Enterprise Risk Management. Among its major findings - less than half of the directors surveyed can point to robust techniques to help them oversee risk and the majority of boards are not yet using a ranking system as part of their risk management practices. Financial/insurance and energy/utility industries appear to be leading the way in ERM development.

The report reviews the August 2005 Disney decision, the prior Caremark case, listing standards, SOX and the 1992 COSO Internal Control - Integrated Framework. The authors conclude “the market demand for periodic updates on risk may increase the pressure on the company to establish a comprehensive ERM infrastructure.” Yes, highly likely, especially since both Moody's and Standard and Poor's have begun to incorporate risk management assessments into their credit rating decisions.

So far, at most companies, non-financial risks receive only “anecdotal treatment” in the boardroom. Top-down risk management is viewed more as a strategic effort than a compliance practice. Many boards are missing the point of ERM, which is to improve company performance by providing decision-makers with insights into how risks are linked to value. “The data contribute to the impression that there is a gap between the perception and the reality of ERM implementation in U.S. businesses.”

The report includes practical recommendations on how to develop a systematic ERM to ensure directors are fulfilling their fiduciary responsibilities. Board reports should prioritize key risk issues and include management's assessment of risks, including a display of trade-offs and their rationale.

We've been pushing a greater focus on ERM for years at Corpgov.net, especially attempting to increase awareness of environmental liability risks. For more on that subject from an investor's viewpoint, see the Environmental Fiduciary Project of the Rose Foundation for Communities and the Environment.

Option Mirage

Writing for the New York Times, Gretchen Morgenson reflects on the executives at Brocade Communications who face criminal charges related to possible backdating of option grants. Stock options, "one of the biggest wealth redistributions ever fobbed off on American investors -- was apparently a mirage." Morgenson lists three mirages:

1. Stock options aligned executives' interests with those of shareholders. But Investors don't get to look back and choose the lowest prices for their stock.
2. Options should not be considered an employee cost because the value of the options could not be measured. Proponents predicted job creation would dry up. Morgenson thinks they may have been more concerned with their own accounts dwindling.
3. The bulk of options were given to rank-and-file employees. Executives got the biggest grants. She goes on to cite Jack T. Ciesielski, who found that of the 53 companies under investigation for stock option grants as of June 30, 57% granted considerably more options to their top executives during the past five years than their peers did.

"Options do not cause crookedness," Morgenson concludes, "But the easy money that they represented for companies and executives, especially when the awards were not accounted for as a cost or monitored by investors, seems to have encouraged some corporate chiselers to take advantage of their shareholders, whom they never had to face." (At the Options Buffet, Some Got a Bigger Helping, 7/23/06)

Shareholder Intervention

On the morning of Nell Minow's recent appearance at the Corporate Director's Forum, the San Diego Union Tribune ran a nice little article, Shareholder rights activist stands up to corporations, 7/21/06. Although Minow never acquired a sizable stake in the companies she criticized, so is no Kirk Kerkorian or Carl Icahn, "she has spurred changes at many companies – and helped to oust their chief executives – by simply speaking out."

Of course, the article also points out that Minow derived much of her influence by joining Monks as a co-founder of Institutional Shareholder Services, again at the Lens fund, and now at The Corporate Library. “I'd rather have one-tenth of one percent, a good case to make, and a record of taking nothing for myself that is not offered to all shareholders equally than have 15 percent and a record of taking greenmail or going for short-term gains,” Minnow said.

Several intresting anecdotes are included, such as Monks recalling that the late J. Peter Grace, once spit on Minow outside of a Stone & Webster shareholder meeting and Minow telling Monks that what they were born for was bringing news above the 72nd floor of the Sears tower (or anywhere CEOs are in seclusion). "What we do is like a Betty Ford intervention!”

Mutual Funds, Next Target?

Eight years after the Northwest Corporate Accountability Project first filed an environmental shareowner resolution, it will finally go to vote at the Merrill Lynch Global Allocation Fund.

"Now that mutual funds have to publish their proxy voting policies and votes, shareholders could advocate for the creation of thoughtful proxy voting policies that address environmental and social issues," Ms. Chan-Fishel of Friends of the Earth points out.

Mercer Bullard, founding president of Fund Democracy, a nonprofit that advocates for mutual fund shareholder rights, sees resolution-filing at mutual funds as a potentially effective strategy to enhance corporate democracy. (Filing Resolutions at Mutual Funds: The Next Frontier for Shareowner Activism?, by Bill Baue, SocialFunds.com, 7/21/06)

"So Little Support," Such a Short Memory

In A Sarbox Legacy: Alan Beller - A Q&A with the former director of the SEC's Division of Corporate Finance, Stephen Taub, writing for CFO.com asked Beller what his biggest disappointment was while a director at the SEC? Beller responded that it was their "inability to find a solution for the Commission to adopt [its] shareholder access [proposal].

Anyone reading Corpgov.net for the last several years knows its publisher, James McRitchie (photo) and Les Greenberg petitioned to allow shareholder proposals to elect directors: Petition File No. 4-461, which the Council of Institutional Investors said "re-energized" the "debate over shareholder access to management proxy cards to nominate directors." Therefore, readers will know Beller's statement got my attention. However, Taub then went on to ask "Why do you think it received so little support?"

It was widely reported that the rule received more comments than any in the SEC's history and almost all of them favored opening access to the corporate proxy to allow shareholders to nominate directors. Taub's phrasing is very disappointing. Yes, the proposal received little support from CEOs of the Business Roundtable but support from shareholders was nearly unanimous. Sure, most of us would have liked to see it go further, but enactment would have been a step in the right direction.

At least the proposal's failure spawned the majority vote movement. Beller indicated, "I also support mandatory shareholder proposals for by-law changes. If enough [stockholders] feel strongly it is the right approach, that's what they should get."

Pitt on Backdating

In an article he wrote for Forbes.com on the day of the Enron verdict (The Next Big Scandal), Harvey Pitt said backdated stock grants would be the first big post-Enron scandal, but not the last. More regulation, however, isn't always the best solution to corporate wrongdoing. Join the conversation: Go to Forbes.com/CEOchat at 3 p.m. EST, Monday, July 24.

Federal prosecutors and regulators filed criminal and civil fraud charges against three Brocade Communications Systems executives on Thursday for participating in an alleged stock options backdating scheme that concealed "millions of dollars in expenses from investors" and significantly overstated the company's income. (DOJ, SEC Charge Brocade Execs, CFO.com, 7/21/06)

Cover for Insider Trades

Compliance Week reports that a study by Equilar found the number of executives participating in "10b5-1 plans," where corporate insiders spread stock trades over time automatically, jumped 22% last year. The plans provide a legal defense against allegations of insider trading. Paul Hodgson, of the Corporate Library, is quoted saying "it's a good governance thing to do." Everyone knows in advance when stock will be off-loaded, so what's not to like?

"We generally believe if you enter into a written plan in advance and you are not in the possession of material, non-public information, it is safer for the executive, says John Coburn, corporate secretary of Nike, with 17 executives participating. (Interest in Stock Trading Plans Surges; Safer for Executives, July, 2006)

Changing Retirement Needs - Call for Papers

This call for papers by the Society of Actuaries is organized around three themes related to retirement spending and needs.  The first theme is understanding the difference between spending on essential, discretionary and unpredictable needs.  Essential spending would be for the most basic day-to-day needs: food, clothing, shelter and medical care.  Discretionary spending would cover all predictable, non-essential spending, including gifts, travel and dining out.  Unpredictable needs would include high cost, unpredictable items such as catastrophic medical costs, long-term care and living to an extreme old age. 

The second theme is how sources of retirement income change consumption patterns.  Does retirement consumption change depending on whether the income is derived from an annuitized stream of payments, a single self-managed lump sum, or from work? 

The third theme considers what strategies retirees use to plan for and adjust their consumption.  How does consumption adjust over time, and how much are retirees able to and how often do they adjust their consumption patterns? Abstract or outline of proposed papers due August 15, 2006. See Retirement Spending and Changing Needs During the Retirement Period - Call for Papers.

Investor Engagement on the Rise in Europe

ISS tracked a total of 299 shareholder proposals filed at continental European firms through June 30, a 25% increase over the number of proposals tracked during the same period last year. For the entire year, ISS is projecting that the total number of shareholder resolutions will significantly exceed the 384 investor resolutions filed in calendar year 2005.

A majority--57%--were board related, such as proposing shareholder nominees to the board (46% of all shareholder resolutions), attempting to remove an existing director (3%), requiring a majority of independent directors on the board (1%) or introducing an age limit for board members (1%).

Shorter Reporting Leads to Longer View

According to CFO.com, a 2005 survey of more than 400 financial executives revealed that 55% would delay starting a project with a positive net present value in order to avoid falling short of quarterly consensus earnings. Apparently, the Business Roundtable Institute for Corporate Ethics at the University of Virginia and the CFA Centre for Financial Market Integrity came up with several ideas, like moving away from a focus on quarterly earnings. (The Longer View, 7/12/06) But how should that be done?

In the same issue of CFO.com comes one overlooked approach. Joseph McCafferty reports that Progressive Insurance doesn't provide earnings guidance. Instead, the provide complete financial statements to the public every month. The unaudited statements are released about two weeks after the end of each month.

"We don't have the craziness of trying to get the quarterly financials out the door, says corporate treasurer Thomas King. They just add in the last month and the statements are ready to go. Progressive has been taking this approach since 2001. "Investors get good insight into where we are each month, so there are no surprises." (Reporting: Frequent Flier, July 2006)

Dey Changes With Experience

Peter Dey no longer believes Canada needs some of the key standards he helped to create in the mid-1990s. He advocates scrapping a recommendation that boards contain mostly independent directors, as well as the rule that audit committees be completely independent of management. "My experience in boardrooms is that definitional independence doesn't guarantee independent-mindedness.

Instead, he now advocates companies have a non-executive board chairman; be required to provide more detailed disclosure of directors' conflicts and connections to the company and major shareholders; provide a detailed explanation of how each new director was selected; and would make it mandatory for boards to do rigorous annual performance reviews of their directors. (Mr. Dey's About Face, Globe and Mail, The Globe and Mail, 7/17/06)

Retirement Assets Hit $14.5 Trillion

The nation's retirement assets reached a record $14.5 trillion in 2005, a 7% increase over the prior year and a 40% jump since 2002, according to the Investment Company Institute. Retirement assets now account for more than one-third of household financial assets, up from about 23% in 1985.

The majority of retirement savings, 51%, is now invested in defined contribution (DC) plans and Individual Retirement Accounts (IRAs), in which the investor makes the investment choices. Mutual funds now manage 48 percent of assets in DC plans and 45% of IRA assets. Nearly two-thirds of retirement assets are held in employer-sponsored plans, including both defined contribution and defined benefit plans. (The U.S. Retirement Market, 2005)

Backdating Spread by Overlapping Directors

Outside directors may have spread the idea of backdating options through more than 50 companies under federal investigation for the potentially illegal pay practice, according to a corporate governance research group. The Corporate Library LLC found that the 51 companies had common board members to a greater extent than a randomly chosen control group. TCL's Paul Hodgson said his research suggested that directors at one company alleged to have backdated stock options relayed the concept to other boards on which they served. (Study finds board ties in option probe, AZcentral.com, 7/17/06)

SB 1207 Majority Vote Bill Amended

California SB 1207 (Alarcon) was amended on June 28 to facilitate the ability of California listed companies to amend their bylaws to provide for the election of directors by a majority vote. Up until June 28, the bill had required use of majority (rather than plurality) voting to elect a member of the board of directors of a publicly-traded, California corporation, in an uncontested election, and would have required a seated member of the board who failed to receive a majority vote in an uncontested election to resign within 90 days of the election.

The bill supporters include CalPERS, CalSTRS, AFSCME and SEIU. In opposition to the mandatory requirements were American Electronics Association (AEA), California Bankers Association, California Business Roundtable, California Chamber of Commerce, California Hospital Association. The State Bar of California Corporations Committee of the Business Law Section, and the United Hospital Association. (Learn more and track the bill at leginfo.ca.gov)

Hole Foods Digs Out

Whole Foods Markets irked many and got some bad press when they refused to let shareholders present resolutions at their annual meeting in March. (Whole Foods Market Gags Shareowners at Annual Meeting, 3/10/06, SocialFunds.com) Some of us wrote to see if they were receptive to change. Months later, they appear to have started digging out and repairing their reputation with a response.

"After researching common practices with regard to the presentation of shareholder proposals at annual meetings, we have decided to allow some form of presentation during the formal portion of next years(sic) annual meeting from shareholders who have properly submitted a proposal which has been included in out proxy statement," they wrote. Additionally the company will "work with our voting agent to improve the timing of the release of the final voting outcome for all proposals."

While the company will not be hiring a CSR/ Sustainability Director, as many had suggested, the company reports it has updated the corporate governance section of its website to make information readily available regarding policies and procedures.

Despite the delay in response and lack of apology, most appear to consider the response a success, hoping for much improved behavior in coming years. (Disclosure: Corpgov.net publisher, James McRitchie, holds a substantial portion of his assets in WFMI stock.)

TIAA-CREF Surveys Participants

TIAA-CREF, the huge provider of retirement plans in the academic, medical and cultural fields, released results of a comprehensive survey of participants on issues related to socially responsible investing.

"This survey affirms that our participants want a secure retirement and investment decision making that is driven by financial returns," said Scott C. Evans, Executive Vice President and Head of Asset Management.  "It also illustrates that many participants think about the environmental and social impact of their investments."

The survey sought to examine participants' attitudes around Socially Responsible Investing (SRI), to gauge their knowledge of and commitment to TIAA-CREF's SRI strategies, and to inform the company's SRI strategies moving forward. 

"There is an opportunity to educate participants about socially responsible investing generally and about opportunities that TIAA-CREF offers," said Amy O'Brien, TIAA-CREF's Director of Social Investing. "We now have a baseline of information of how our participants view socially responsible investing and the issues and strategies they currently find most appealing." (press release, 7/13/06: report) Congratulations to Amy Muska O'Brien, who I understand deserves disproportionate credit for bringing this survey to reality.

Why don't CalPERS, CalSTRS, and others take similar surveys of their members and taxpayers? The results could provide critical support when they are frequently accused of pursuing a "social agenda" or when they are under attack to change from defined benefit to defined contribution plans. They should determine the baseline and not stray too far without educating and/or carrying out a dialogue with members and taxpayers.

Corporate Defenses

Hannah Clark, a reporter at Forbes.com, offers 5 ways to treat your shareholders in How To Fight Off Shareholder Activsts (7/13/06):

1. Shmooze Shareholders. From Chris Young, mergers and acquisitions research director at Institutional Shareholder Services, "Companies that fall back on name-calling, labeling the investors as raiders or short-term investors--that tends not to work." "From a public relations perspective, look like you're open to new ideas." Even better if you actually are open, I would say.
2. Invite Activists In. A little communication goes a long way. During a proxy fight with Reader's Digest in the late 1990s, the CEO gave Nell Minow a private meeting without his entourage. "That was so disarming and so candid that it bought a lot of credibility with me," Minow says. Again, I say it has to be genuine; tokenism only lasts so long.
3. Build A Stake. If the CEO holds a large stake in the company, other shareholders can be thoroughly marginalized. I say, you can always go private too. Then you won't have to worry about pesky shareholders.
4. Compromise. Clark cites Herb Denton's experience with Hollinger International last year where he won a reduction in CEO Gordon Paris' pay and got three directors to step down. Clark's advice begins to sound like learning to avoid fights in the playground.
5. Skip The Annual Meeting. It worked for Home Depot when all but one board member skipped out. "We tried a new approach, and clearly our shareholders preferred our prior format," says spokesman David Sandor. Like they didn't know that already. Minow isn't mollified. "I give them no credit whatsoever," she says. "They managed to escape this year, and that's what they cared about." Most shareholders are fools.

There's a lot of room to negotiate between stonewalling and handing over the keys. As the owners of corporations, shareholders deserves some respect.

7 Days Not Enough for Sin

A federal appeals court, for a second time, threw out a prison sentence for Michael Martin, the former finance chief for HealthSouth, calling the sentence too lenient for his role in a $2.7 billion fraud at the company. “If any sentence is unreasonable, it is this one,” the appellate court said. “It is not remotely commensurate with the seriousness and extensive scale of the crimes and does not promote respect for the law.” (HealthSouth Sentence Rejected Again, 7/12/06, NYTimes) (D. C. Docket No. 03-00191-CR-UWC-HGD)

Stock Options Scandal

Worried that Silicon Valley executives may be committing fraud in doling out stock options, the top federal prosecutor in Northern California launched a task force to investigate suspicious grants that gave some workers a head start to profits. The announcement by U.S. Attorney for Northern California Kevin Ryan was the highest-profile federal action yet to deal with the widening stock options scandal that has tarnished the lucrative form of compensation that has been a hallmark of Silicon Valley and helped power the 1990s tech boom. (U.S. Attorney Launches Task Force On Backdating Federal Inquiry Hits Highest Level Yet, 7/14/06, San Jose Mercury News)

TIAA-CREF Challenges Continue

Earlier this year TIAA-CREF announced a major advancement in integrating social responsibility into its structure by creating a new Social and Community Investing Department. The move responded to a longstanding critique by the Make TIAA-CREF Ethical campaign, which has advocated for the incorporation of community investing into TIAA-CREF's socially responsible investing strategies. While this new department moves TIAA-CREF forward in defining what social responsibility looks like, the coalition still has a laundry list of concerns it intends to present at next week's CREF annual meeting in New York City. (CSRwire) Make TIAA-CREF Ethical calls on TIAA-CREF to live up to their commitment. Put reform pressure on six Industry Leaders that consistently display egregious behavior—or divest their stock. (Make TIAA-CREF Ethical)

Chevedden Report

John Chevedden and his associates are keeping the pressure on this year. What follows is a report on recent actions by boards to implement resolutions to repeal poison pills.

Shareholders won another victory when Amgen Inc.'s board of directors voted unanimously to eliminate its stockholder rights plan, commonly called a "poison pill," and approved a new policy that would seek an okay from shareholders before adopting a similar plan in the future. In May, although the board opposed it, 78% of shareholders supported Steiner's resolution to do away with its poison pill.

John Chevedden, who presented the stockholder proposal at the company's May meeting, said the vote to do away with the poison pill was a good move on the company's part. "It makes a strong argument when the vote goes that high the first time on the ballot," he said.

Chevedden said Amgen and several companies put a "loophole" in their poison pill policies that allow the company's board to adopt a poison pill plan without stockholder approval. The board's poison pill rule expires after a year if that plan is not put to a vote of the stockholders, and is then renewed. "They really never have to face up to the shareholders for a vote," he said, allowing them to "escape some responsibility for what they do."

"The whole advantage of this (doing away with a poison pill) is that it gives the management an incentive to keep the performance of the company up, because if the performance slips, the fact that they don't have any poison pill makes them more susceptible to being taken over," Chevedden said.

Last month, a court case determined that poison pill proposals from shareholders cannot be excluded from the ballot at company shareholder meetings as some companies have done in the past. (Lucian A. Bebchuk v. CA, Inc.) (Amgen kills its 'poison pill', 7/11/06, Ventura County Star)

Minow in San Diego on July 21

Have breakfast with Nell Minow, dubbed the “queen of good corporate governance” by Business Week online, and the "CEO killer" by Forbes magazine for her record in ousting non-performing CEOs. She is definitely the most quoted person in the US on corporate governance issues. Minnow turns complex ideas into memorable phrases that help people focus on the real issues. See the Corporate Governance Forum for details.

Public Pension Funding Gap

In the late 1990s public retirement plans were flush with cash thanks to a high-flying stock market, but lack-luster investment returns and "generous" government pensions left many plans with a funding gap.  Experts on this Insight radio program on KXJZ say how California's retirement systems should respond. However, none of the "experts" point out that converting California's defined benefit plans to defined contribution plans would funnel $5 billion/year extra to corporate money managers while reducing aggregate retirement earnings by $10 billion/year. (see Making Corporate Governance Decisions that Work for Whom?)

Sustainability Reporting

The Social Investment Research Analysts Network (SIRAN) issued its second annual analysis on the environmental and social reporting practices of companies in the S&P 100 Index. Among the new findings of how reporting practices have changed in the past year:

1. More than three-quarters of the S&P 100 Index (79 companies) now have special sections of their websites dedicated to sharing information about their social and environmental policies and performance. This represents a 34% increase from last year, when 59 companies in the S&P 100 included this information on their websites.
2. Overall, in the last year a dozen new companies issued corporate social responsibility reports for the first time, including Cisco Systems, General Electric, Time Warner, and Wells Fargo. Other members of the S&P 100, such as American International Group and Black & Decker, have pledged to issue their first reports later this year.
3. Over a third of the S&P 100 Index (34 companies) say they base their CSR reports on a widely recognized external standard for reporting called the Global Reporting Initiative's (GRI) Sustainability Reporting Guidelines. This was up sharply from 2005, when 25 companies in the S&P based their reports on the GRI guidelines. The uptick reflects a concerted outreach effort by SIRAN members to promote reporting based on the GRI to the S&P 100. In 2006, 27 S&P 100 companies included an index to GRI indicators in their reports, up from 23 in 2005. This year, six of the companies met the highest standard of reporting fully "in accordance" with the GRI guidelines.
4. Forty-three companies in the S&P Index now issue annual corporate social responsibility (CSR) reports (up from the 39 companies in the S&P 100 that issued such reports for the 2005 study). Note that this net figure reflects both the addition of 12 companies that joined the ranks of CSR reporters in 2005, and the deletion of eight companies that have moved to web-based CSR reporting rather than issuing stand-along reports, issued CSR reports in 2004 but not in 2005, or dropped out of the S&P 100.
   

Near Death Disclosure

“When you become the CEO, one of the luxuries you must relinquish is the luxury of privacy. “You are so important to the future of the company that they must know... if there are any health issues that may affect your ability to stay in that job for the long term,” Nell Minnow, of The Corporate Library, told MSNBC. Less than 50 percent of Fortune 500 companies have a succession plan ready to go.

However, “securities laws have no specific guidance or requirement for health,” said James Cox, a law professor at Duke University. “Or even a health condition that’s likely to impair continued performance of an executive – (there’s) no requirement that that be disclosed." (Should CEOs have to disclose health problems?, 7/10/06)

BRT's Word Games

Gretchen Morgenson took a revealing look at the Business Roundtable's study that claims CEO pay is up only 9.6% annually from 1995 to 2005, failing even to keep up with total stockholder returns of 9.9% at the companies they led during the same period.

Morgenson says the total pay figures cited by the BRT excluded:

• Dividends paid to executives on their restricted stockholdings.
• What executives made by cashing in stock options and restricted stock over the 11 years (only counting their value on the dates the awards were made.
• Pension benefits, deferred compensation and money received in severance packages.
• The difference between the targeted value of all other performance-based cash or stock awards granted executives, and what companies actually dispensed.

Her conclusion: "Despite its claims of setting the record straight on executive compensation, the roundtable's analysis does exactly what it has accused pay critics of doing: picking and choosing numbers to bolster their views." (Is 'Total Pay' That Tough To Grasp?, NYTimes, 7/9/06)

Petition to End Conflicts of Interest, Save Money, and Protect Members From ID Theft at CalPERS Rejected

CalPERS rejected a Petition for Reconsideration and Draft Petition for Underground Regulations Determination, submitted by CorpGov.Net publisher and CalPERS board candidate James McRitchie (letter). Regarding regulations which prohibit only CalPERS staff "directly involved" in elections from using their official position to influence the outcome, CalPERS responds that "the petition ignores the principle that administrative regulations may not override state legislation." Therefore, even though the regulation may conflict with statute and mislead staff into thinking they can use their official position to influence elections, as they have done in the past, the regulation will stand.

With regard to using "instant runoff" voting, which could have saved almost $1 million in the last CalPERS election, CalPERS responded that they had already rejected a similar request in 2001. Apparently, they see no need to revisit the issue.

The petition for reconsideration also pointed to several "underground regulations," adopted by CalPERS without benefit of full public notice and other protections afforded by the Administrative Procedure Act. These regulations require circulated candidate petitions to include the last six digits of their Social Security Numbers (exposing members to the risk of identity theft, since the first three numbers are regionally based), setting the number of signatures required and the dates of the election (allowing the Board to change requirements to their advantage without substantive public input). CalPERS chose not to address these allegations. (letter of rejection)

Although CalPERS rejected each of the petitioner's suggestions, the Benefits and Program Administration Committee agreed, months ago, to consider possible changes to the elections process through a yet to be named ad hoc committee, so there is still hope that someday these issues will be given more careful consideration. Additionally, McRitchie is likely to seek another determination from the Office of Administrative Law that CalPERS failed to follow legal requirements in adopting its "underground regulations."

For years, the CalPERS Board insisted they were exempt from laws, such as the Administrative Procedure Act, because of direct authority granted by California Constitution. However, OAL and the courts have determined the Board is not above the law. Continued use of "underground regulations," especially those which open members to financial risk from identity theft, arguably are a breach of fiduciary duty, undermine the credibility of efforts by CalPERS in the area of corporate governance, and make the entire system more open to attack.

Corporate Governance Key to Development

"Today, the private sector accounts for 90% of jobs in the developing world and ultimately, it will be these jobs that offer the most promising path out of poverty," World Bank president Paul Wolfowitz told the International Corporate Governance Network gathering. U.S. mutual funds are more likely to invest in emerging markets with strong shareholder rights, legal frameworks and accounting policies, he added. Foreign investment between developing countries is growing five times faster than developed-to-developing investments, and nearly tripled to $47 billion in 2003 from $14 billion in 1995. (Better governance is way out of poverty, Reuters, 7/7/06)

Heinz Fight

"The best-kept secret of shareholder activism is 'Lose the battle; Win the war,'" says shareholder activist Nell Minow, co-founder of the Corporate Library and editor of Board Analyst. The point is to exert pressure and gain concessions from management, so that winning or losing a proxy contest becomes a distinction without a difference. (Heinz could win battle, lose war in proxy fight, MarketWatch, 7/7/06)

Spring-loading Controversy

SEC commissioner Paul Atkins, told ICGN meeting attendees that the practice of "spring-loading" executive stock options (setting the grant date and exercise price of an option at a time shortly before the release of positive corporate news) should not be considered insider trading. Atkins questioned whether there was any "legitimate legal rationale" for pursuing any theory of insider trading in connection with option grants.

"An insider trading theory falls flat in this context where there is no counterparty who could be harmed. The counterparty here is the corporation – and thus the shareholders. They are intended to benefit from the decision," Mr. Atkins said. Even if a "nexus" could be established between a grant date and a news event it was still necessary to establish whether securities laws had been violated.

Bob Monks, founder of Institutional Shareholders Services and co-founder of The Corporate Library, said: "If it isn't insider trading, what is? I can't credit the notion that any possible impact on the market would compensate for the loss of trust. It will call the market into disrepute." In a snap electronic poll at the conference, more than 60% of ICGN delegates disagreed with Mr. Atkins. (Spring-loading of stock options stirs SEC controversy, MSNBC, 7/6/06) (S.E.C. Commissioner Sees Good in Options, NYTimes, 7/7/06) (Paul S. Atkins' remarks, 7/6/06)

Millstein to Shareholders: Elect Better Directors

Speaking at the annual meeting of the ICGN (whose international membership of institutional investors is estimated to hold assets exceeding $10 trillion) Ira M. Millstein, called on members to "complete the governance system demands that shareholders exercise informed judgment in selecting directors and communicating with them...Your major fiduciary duty, your foremost responsibility, is to pick the directors who you can count on to understand the scope of their discretion, and hopefully do their best to exercise that discretion to serve you, not just their management, or themselves." (The Board – Governing Beyond Where the Law Ends, 7/5/06)

Millstein recounted a study by Bebchuk and Grinstein that found aggregate compensation paid to the top five executives of U.S. public companies represented 10.3% of company profits in 2001-2003 – up from 4.8% of company profits in 1993-1995 – with the amount paid to executives totaling roughly $350 billion.

The conventional wisdom 50 years ago was that the appropriate differential between executive pay and the average worker should be 60 to 1; some now say the actual differential is 300 or 400 to 1. This income inequality is allegedly linked to adverse economic effects that go beyond social and political repercussions:

• Health problems linked to reduced efficiency and increased national spending on health, stemming from stress resulting from inequalities;
• Distortion, through ability to exchange money for political power in democracies, reduced efficient allocation of public and private resources and investment;
• Acquisition of greater political power by the wealthy, who can support policies that make themselves even wealthier at the expense of others. Tax cuts in the face of deficits mounting to the point where Standard & Poor’s has warned that Treasury bonds will be junk bonds by 2025 if the U.S. government doesn’t seriously alter fiscal policy;20 and
• Lower productivity and quality: “If a CEO’s salary is going through the roof and workers are getting pay cuts, what will happen?...Workers can’t outright reject the offer – they need to work – but they can reject it by working less hard and not caring about the quality of what they producing. Then the whole efficiency of the firm is affected.”

"The single most important thing you as shareholders can do is elect directors whose discretion you trust," Millstein said. He listed Jeff Sonnenfeld advice on director selection:

• Seek knowledge, rather than “brand” names;
• Pay more mind to character and “independent-mindedness” than to “independence;”
• Purge those with commercial or social agendas;
• Find people who are passionately interested in the business;
• Avoid joiners who collect boards like trophies; and
• Beware false recipes by governance consultants.

Millstein said we need to reexamine who is qualified, insisting that the principal of a grade school without an MBA, or a mid-level college or graduate school non-Dean academic, or a former judge, none of whom ever “ran a business,” may be better able, through questioning, to see the line that must not be crossed. "Have we tightened the noose of 'independence' so tight as to totally eliminate those who might 'know the business?'"

He ended with a call for action.

• Institutional investors should push for majority voting bylaws.
• Interact with Governance Committees on the issue of director selection. That may turn out to be essential “activism.” (I wish Mr. Millstein had mentioned the SEC rules that took effect on January 1, 2004. Disclosure Regarding Nominating Committee Functions and Communications Between Security Holders and Boards of Directors, requires corporations to disclose if their nominating committees have received a recommended nominee from a 5% shareholder or group and the disposition of that request.)
• Institutions should be required to disclose conflicts of interest that may distort their motivations and incentives. For example:
  • Corporate pension fund managers may find themselves balancing decisions in favor of corporations that retain them as plan sponsors (or potential sponsors), rather than the beneficiaries who have entrusted their retirement savings to the plan;
  • Union and public fund trustees may seek to use their position to further political interests at the expense of beneficiaries.
  • Institutional investors may be reluctant to sue to recover fraud-related losses where those lawsuits would be launched against other institutions which with they have (or want) a relationship; and
  • Banks that engage in proprietary trading may inappropriately support those activities using information they gather from clients in relation to trading intentions.
• Responsible voting requires judgment. Judgment cannot be outsourced. (Use proxy monitoring services but don't follow them blindly.)

Majority Vote: Beginnings of Director Dependence

Joseph Hinsey, the H. Douglas Weaver Professor of Business Law, Emeritus, at Harvard Business School, contends Corporate Governance Activists are Headed in the Wrong Direction in our push for majority voting. Hinsey set up the main problem as follows:

In light of public corporations' widespread shareholder diversity (and without taking into account the legitimate interests of employees, creditors, communities, and other non-shareholdes constituencies), which shareholder components are directors supposed to be representing and to which components are they supposed to be accountable: Institutional investors? Individual investors? Long-term investors? Short-term investors? Transient investors?

The law is that they have a fiduciary duty to all shareholders. Hinsey's underlying assumption is that duty differs by groups; it doesn't. Even if the director was elected by employee owners of an ESOP, their fiduciary duty would not be to employees but to shareholders. After expressing his confusion as to who directors serve, Hinsey then contends that dispersed shareholders have no basis for deciding who to vote for or against. He then points to the need for independence non-management directors and the conflict of interest that exists when board chair is in charge of heading the group that evaluates the CEO when, all too frequently the chair and CEO are one and the same.

It is true, many shareholders have too little knowledge concerning who to vote for. The solution to this issue is not to throw up our hands at the impossibility of the task. Rather it is to seek relevant information, in SEC filings, the press, and either by hiring proxy monitoring services directly or by banding together, as advised by the Corporate Monitoring Project. Of course, we also need choices, instead of a single slate picked either by management or a oligarchic board. Shareholders should continue to push for Equal Access to the proxy. Unfortunately, that isn't likely to happen until the composition of the SEC changes.

In the meantime funds should consider proposing replacement corporate directors under the SEC rules that took effect on January 1, 2004. Disclosure Regarding Nominating Committee Functions and Communications Between Security Holders and Boards of Directors, requires corporations to disclose if their nominating committees have received a recommended nominee from a 5% shareholder or group and the disposition of that request. My friends at The Corporate Library have been able to point to only two cases where the new rule has been invoked. In both cases, shareholders won. However, even if we don't win, invoking the rule helps build the future case for equal or open access.

Should we also be working on splitting board and chair positions, as advised by Hinsey? Yes, of course. However, the notion of "independent" directors has little meaning as currently defined by regulators. They can still be the CEO's best friends. What we need are board members who are dependent on the nomination by, and approval of, shareholders.

The movement for majority vote requirements clearly arose out of frustration with the SEC's refusal to enact equal or open access. However, even if it had not, it still makes a great deal of sense to ensure a majority of shareholders approve of each director. At least it provides shareholders with something akin to a veto. At least directors become dependent on the need to get more votes than (in most cases) a nonexistent opponent.

Sharetrader Control or Shareholder Control?

In a recent e-Briefing, Jim Kristie, editor and associate publisher of  Directors & Boards, came to a provocative conclusion: Corporate America is owned by hedge funds. Kristie notes the Conference Board's October 2005 study that institutional investors controlled 69% of the equity of the 1,000 largest U.S. corporations in 2004, up from 61% in 2000. Yet, the average institutional holding period is about 12 months – i.e., the average portfolio turnover in a year approaches 100 percent.

Gary Sutton, author of Corporate Canaries, says many institutional investors are “trading around the core.” When a stock hits a certain high number, they’ll dump a percentage of their shares. When it dips to another predetermined number, they buy some more. This, in effect, determines the firm's trading range. Barring some major announcement, this is how they make money. "So directors today don’t work for shareholders, since they no longer exist. What we do have are sharetraders." (There Are No Shareholders Anymore, July 2006)

Sutton's recommendation appears to be to ignore sharetraders and incentivise CEO, board and employees by spreading the use of stock options. In the same issue, William G. McBride. Managing Director of Gavin Anderson & Co. provides advice on Girding for a Media Battle with Activist Hedge Funds.

1. Make sure that management has actively and consistently communicated your company’s strategy.
2. Find out what your current shareholders are thinking.
3. Take a cold-eyed look at whether your communications team and advisers are up to a full-fledged media tussle of several months’ duration.
4. Educate yourself about your potential adversaries.

But Kristie seems more pessimistic: :Line up one of your traditional institutional owners and a hedge fund side by side and what do you have: a distinction without a difference? Hedge funds, while notoriously able to sell short, are by some analyses net long in their holdings. So how do you tell them apart when their time frames are quite similar – short or shorter -- as is the range of their activism, from soft to louder to bullying? And institutional investors of course hedge their positions in various ways with various instruments, arbitrage strategies, and balancing of their holdings – which include, yes, placing a portion of their investments with hedge funds." (We’re All Owned by Hedge Funds, 7/6/06)

Perhaps it is time we figured out how to reward long-term shareholders? Trades could be taxed or extra dividends could go to those holding long-term. Let me know of your ideas (e-mail publisher). How can we move from control (as minimal as it is, considering the dominant influence of management) by sharetraders to control by shareholders? Does it matter?

Retirees, Half Way There

The Congressional Budget Office recently reviewed 21 reports and concluded that half of Americans will be able to maintain their lifestyles in retirement, 25% will face hardship and the remaining 25% could go either way. The ability to live comfortably in retirement hinges on whether seniors will be able to maintain their health so that they can work and/or avoid expensive medical costs. Many will have to sell their homes and either move to less costly quarters or rent out a room in their home, he said. There's a huge amount of equity in our houses that can be tapped into, according to PBS commentator Jonathan Pond. (Outlook for Boomers' Retirement Not so Dire: Congress, Money Management Executive, 6/5/06 and Outlook for boomers' solvency in retirement isn't as bad as it seems, Arizona Republic, 6/25/06)

Hanging Together

Why does United-Health Group (UNH) CEO William W. McGuire remain in his job? It's a question that has baffled corporate governance experts since the Wall Street Journal reported that UnitedHealth might have backdated options grants for officers to boost compensation. Paul Hodgson, of The Corporate Library, blames a weak board that remains too deferential to its dynamic CEO.

Business Week says there's another important reason: "While boards at companies that have pushed out executives appear not to have known about the alleged backdating, UnitedHealth's board allowed McGuire to pick his options grant dates. To dump him would be to admit that some wrongdoing occurred -- a position that could increase the legal risks for directors themselves. Instead, they're hunkering down."

"...According to McGuire's 1999 employment contract, he could choose the grant dates and notify the compensation committee. Legal experts say board awareness would bolster his case that the grants were proper... Any concession of wrongdoing could increase their exposure to shareholder lawsuits. Already, directors have been named personally in a suit brought by the Ohio Attorney General. One high-ranking ex-SEC official says directors-and-officers insurance might not pay for people involved in securities violations. With their own wealth potentially at risk, 'my guess is that their legal counsel is advising them to be very cautious,' he says. 'You won't see that board do anything until it's forced to.'" (A Board With Its Back To The Wall, 7/10/06)

Director's College

82-year-old Charles Munger was one of the star attractions last week at the Director's College at Stanford Law School. Corporate America still has plenty of work to do to regain the public's trust in the wake of the Enron and WorldCom scandals -- and reining in exorbitant executive pay and perks would be a start. "I would argue that corporate compensation in America is offending a lot of people . . . There's a lot of wretched excess in the system,'' Munger said.

Also included on the agenda were Christopher Cox, chairman of the Securities and Exchange Commission, Meg Whitman, CEO of eBay, and the heads of the Nasdaq and New York Stock Exchange. About 390 people from a broad array of industries participated last week, up from 378 last year and 278 the year before. Companies paid up to $5,900 per person to cover tuition, lodging and meals.

Seminars covered auditing, mergers and acquisitions, ethics, executive retention and succession, D&O Insurance, managing intellectual property, and the manipulation of stock option grants. Munger focused on the role of directors as "stewards of corporate culture'' and criticized excessive executive pay and perks. Hank McKinnell, the chairman and CEO of Pfizer and chairman of the Business Roundtable, which helped kill the SEC's open access proposal took a different point of view.

McKinnell became the target of complaints about excessive executive compensation when Pfizer disclosed a retirement package under which he can he can choose from an annual pension of more than $6.5 million, or a lump sum payment of $83 million. He also earned nearly $16 million in 2005. At Director's College, McKinnell underscored the complexity of ensuring and measuring pay for performance and suggested that the people who claim the rise in executive pay has far outpaced that of average workers are lying, since the Business Roundtable's research says otherwise. (Corporate leaders go back to school, San Jose Mercury News, 7/2/06)

For a summary of BRT's findings, see WSJ's CEOs Get Off the Ropes On Executive Pay, 7/5/06. Researcher Frederic W. Cook finds that the median pay of CEOs -- which Mr. Cook argues is a better measure than average pay -- was $6.8 million last year, down slightly from its peak of $7 million in 2004. Those numbers include salary, bonus and the estimated value of options at the time they were issued, using the Black-Scholes method. It's "only" 179 times the pay of the average American worker -- not 475 times, a number of vague origins that has popped up in some media reports.

Of course, that's comparing apples to oranges. If median CEO pay is a more realistic measure, why not compare it with the pay of the median worker, not the average worker?

Who to believe, Munger or McKinnell? The Business Roundtable has denounced those who seek to enable the ability of shareholders to remove directors as wanting to “super-democratize” corporations. Let's see. After years of struggle, dozens of companies have adopted a requirement that directors must receive a majority vote. Shareholder still have no direct access to the proxy for the purpose of nominating their own directors. That does not sound like "super democracy" to me.

UK Shareholders Seek to Protect US Workers 

Investors in FirstGroup will have the opportunity to vote on a shareholder resolution at its AGM July 13th that would require directors to implement and monitor a company-wide workplace human rights policy. The filers of the resolution include 115 employee shareholders, the Cooperative Insurance Society, the TUC superannuation fund and the US transport employees union, Teamsters. The US-based SEIU, though not a filer of the resolution, was arguing the case for it among UK investors last month.
 
The shareholders proposing the resolution said the human rights policy would be designed to minimise the risks poor labor relations could pose to shareholder value, and ensure compliance with the International Labour Organisation’s (ILO’s) declaration on fundamental principles and rights at work.
 
The US operations of FirstGroup represent a significant part of its business. However, at least one of its subsidiaries, First Student, has been criticized for the anti-union stance of managers, while the UK’s Transport & General Workers Union says that industrial relations here are also poor. (FirstGroup shareholders propose human rights resolution, Manifest, 7/4/06)

Board Women

The number of women on the boards of companies based in Scandinavian countries has surged ahead of the rest of Europe thanks to those countries’ proactive policies to increase female representation, according to a study by the European Professional Women’s Network.
 
Norway maintained its leading position, having women in 28.8% of board seats – up from 22% last year – followed by Sweden (22.8%), Finland (20%) and Denmark (17.9%). The second EuropeanPWN survey found female representation stagnating across the rest of Europe. Women now hold 8.5% of boardroom seats across Europe – small progress on the 8% recorded in 2004.

In the US, Catalyst found women make up 14.7% of Fortune 500 boards.  (Scandinavia leads on female board representation, Manifest, 7/4/06)

A November 2001 US study shows that the Fortune 500 firms with the best record of promoting women to senior positions, including the board, are more profitable than their peers. The 25 firms with the best promotion record post returns on assets 18% higher, and returns on investment 69% higher, than the Fortune 500 median of their industry. (Women on Boards: Why would you do it?)

Third Point Victory

IVS Associates Inc., an independent election inspector has certified the election of two Third Point officials to the board of coal miner Massey Energy Co. Massey says it believes the hedge fund only won one seat. Third Point, which beneficially owns about 5.9% of Massey's outstanding shares, wants Massey to launch a bigger stock repurchase program. (Third Point Wins Massey Proxy Fight, chron.com, 6/28/06)

Tool Kit

Echelon Learning has developed a Board Development Tool Kit, available online. "This toolkit offers just-in-time performance support for directors and boards including those aspiring to be directors, directors new to their job, and experienced directors who may have gaps in their financial or corporate governance knowledge or those who want to check-out best practice - whether it be for public, corporate or charitable sector organisations."

A free diagnostic to check out your knowledge of corporate governance and thirteen additional tools – all licensed from the Institute of Chartered Secretaries & Administrators (ICSA) - focused on specific aspects of governance for which a board is responsible.

Principled-based Convergence

Former SEC chairman Harvey Pitt thinks more convergence between the US regulator and the UK's Financial Services Authority (FSA) will lead to better regulation. He lauds the 'many attractions' of the principles-based system run by the FSA while stating that 'the prescriptive-rules-based approach of the US system leaves much to be desired.' (Pitt calls for regulatory convergence, IRMagazine, 6/30/06)

Terror Screen

While many states are divesting from companies doing business with the genocidal regime in Sudan, others are adopting anti-terrorism screens that exclude companies doing business with Sudan and five other state sponsors of terrorism identified by the US State Department. For example, last week Missouri Treasurer Sarah Steelman announced that State Street Global Advisors (SSgA) will manage an enhanced index portfolio for the Missouri Investment Trust (MIT) with an anti-terrorism screen developed by Conflict Securities Advisory Group (CSAG). (Missouri Treasurer Implements Anti-Terrorism Screen on State Fund, SocialFunds.com, 6/28/06)

Mutual Fund Disclosure Isn't Enough

"Tons of large institutions vote routinely with management, regardless of what is on the ballot or what is in the ultimate interests of their clients," Stephen Davis, head of Davis Global Advisors, is quoted as saying in the Wall Street Journal. (Investor Activism Grows Globally, But Wins Are Rare, 6/3/06)

The WSJ article presents two recent cases. In one, enough institutional investors voted with management to rebuff a two-year campaign led by Sovereign Global Investment of Dubai to oust Chairman Chey Tae Won at SK, who had been convicted of accounting fraud. Capital Research & Management Co.'s mutual-fund group, American Funds, supported SK and an appellate-court judge suspended Chey's prison sentence and granted him probation so he could remain at the helm. What's a little fraud?

Nestlé investors rejected a proposal from several Swiss pension funds that called for dividing the chairman and chief-executive posts between two people to align the board more closely with shareholders than with management. Again, a number of institutional funds favored management. Institutional Shareholder Services urged shareholders to support activist efforts in both cases.

Three years ago the SEC adopted rules requiring mutual funds to disclose their voting policies and their votes in corporate elections three years ago out of concern that conflicts of interest could sway portfolio managers to vote against the interests of fund investors. Apparently, that doesn't provide enough incentive. In my opinion, what we need is a case where shareholder can clearly show that a mutual fund voted against there interests because they were afraid to lose a contract with corporate management to administer their pension plan. Until funds start getting big fat lawsuits, votes that are clearly against shareholder interests will continue.

Corporations to Pay for Revolutions

Delaware judge Leo Strine Jr., who serves as a vice chancellor of the state's Chancery Court, suggests subsidies be available for challenging each corporate director once every three years. To qualify for a subsidy covering "reasonable solicitation costs," a challenger would have to be nominated by shareholders owning at least 5% of the company, and win at least 35% of the votes cast. Reimbursement would give activists "a fair shot at getting board seats," Strine said during a recent panel at the University of Delaware's Alfred Lerner College of Business & Economics.

Strine suggests the proposal be enacted through state laws governing corporations. Strine would exclude from the subsidy shareholders seeking a hostile takeover by capturing a majority of board seats. His proposal is aimed at making corporate directors slightly more accountable to shareholders. Harvard Law School Prof. Lucian Bebchuk counted only 108 challenges for board seats, excluding hostile-takeover attempts, at U.S. companies between 1996 and 2004. Thirty-eight challengers won, but only two at companies with market capitalizations greater than $200 million. For medium-size and large companies, he says, "the risk of removal via the ballot box is practically negligible."

Reimbursement for activists "would make corporate democracy more real" and could "expand voices in the boardroom," contends Charles Elson, head of the John L. Weinberg Center for Corporate Governance at the University of Delaware. Richard Ferlauto, of ASCME, says the union will reintroduce the reimbursement proposal next year, targeting companies with entrenched boards and weak share prices. (Corporate Funding For Shareholder Activism?, WSJ, 4/3/06)

Les Greenberg and I petitioned the SEC to allow shareholder proposals to elect directors: Petition File No. 4-461, which the Council of Institutional Investors said "re-energized" the "debate over shareholder access to management proxy cards to nominate directors." See Equal Access - What Is It?. I still believe a similar uncomplicated and less costly measure should be the first step in democratizing corporate elections.

Unholy Investments

The Financial Services Commission of Ontario filed 15 charges against trustees of the Canadian Commercial Workers Industry Pension Plan for alleged breaches of the Pension Benefits Act relating to questionable investments made over a two-year period.

The Commission issued an 82-page report accusing the plan of investing $280 million in improper investments, some tied to business and property ventures of a convicted former priest. Plan trustees are accused of violating pension law by investing more than 10% of the plan's assets with one or two associated persons or affiliated companies when it provided sizable funds to the former priest's firms. (Trustees Charged in Canadian Pension Plan Investigation, PlanSponsor.com, 6/30/06)

FinancialWeek

Crain Communications has a new publication, FinancialWeek, and from the premier issue it looks like it will match the high quality of their other publications. "Our goal," it says, is alleviating the reading congestion' on your desk and in your briefcase." I'm not sure that goal will be met. What am I going to stop reading?

Still, they seem to be asking the right questions: Is it news? Is it accurate? Is it fair? The main opinion piece in the preview publication dated June 5th concludes the responsibilities of chief fiduciary officer be added to the job description of the chief financial officer. "It should be his or her duty to ensure that corporate management decisions are made primarily in the interests of shareholders, and to blow the whistle when they are not. No one else has both the management authority and the information sources needed for the job."

CFO would take on new meaning but the piece breezed by the real problem too quickly. "In theory, the chairman of the board should be the chief fiduciary officer, but the chairman too often is also the CEO" and CEO's, it notes, have "too often managed their companies, or the companies' earnings to produce short-term stock price increases for their own advantage (read stock options) rather than managing the company for long-term growth. That is a breach of fiduciary duty."

Wouldn't the simpler solution be to split the chair and CEO positions?

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