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March 2007

Who Let the Dogs Out?

Broc Romanek's always delightful TheCorporateCounsel.net Blog, cites the excuses given in a late Form 10-Q filing by Neptune Industries. There was the six week delay "because the audit partner on the Company’s account had taken extended maternity leave, which was concealed from the Company despite repeated calls and e-mail." Then there was the "junior accountant with no experience in or knowledge of the Company account" and a series of non-material changes. "The Form 10-KSB was filed at 5:06 PM on October 13, 2006, but was reported on the SEC EDGAR web site as filed on Monday October 16, 2006." And there's more. (But At Least, My Dog Didn't Eat It!, 3/30/07)

Say On Pay Moves

As expected, the House Financial Services Committee passed Chairman Barney Frank's "say on pay" bill. The measure would give shareholders a nonbinding advisory vote on executive compensation plans. The bill would also give shareholders an advisory vote if a company gives a new but undisclosed "golden parachute" while negotiating to buy or sell a company. ("Say on Pay" Bill Passes House Committee, CFO.com, 3/30/07)

Hedge Funds Grow, While Earning Less

Although hedge funds didn’t deliver stellar returns in 2006, many of them trailing major stock indexes, their assets rose 30% to $2 trillion worldwide, Bloomberg reports, citing a report from HedgeFund Intelligence. Last year, the average hedge fund returned 13%, compared to the S&P 500 Index’s 16% return and the MSCI World Index’s 21% gain. (Hedge Funds Rise 30% to $2 Trillion Worldwide, Money Management Executive, 3/30/07)Last year, the average hedge fund returned 13%, compared to the S&P 500 Index’s 16% return and the MSCI World Index’s 21% gain. (Hedge Funds Rise 30% to $2 Trillion Worldwide, Money Management Executive, 3/30/07)

Victory for Shareholder's Advocacy Trust

A new model of shareholder advocacy that may be especially effective at small companies where individuals hold most of the shares, and where no one outside management holds a large enough block to make monitoring pay, won its first major victory. At AVI BioPharma Inc., Chairman and Chief Executive Officer Denis Burger resigned, and the company named an interim chief executive to serve during the search for a permanent replacement.

Richard Macary, a New York-based stock analyst and venture capitalist who started the grass-roots revolt at AVI BioPharma, claims victory for his AVI BioPharma Shareholder Advocacy Trust, which reportedly represents the holders of about 20% of outstanding shares. Read Joe Rojas-Burke's report in the Oregonian at AVI BioPharma's CEO resigns. AVI BioPharma officials gave no reason for Burger's resignation. (3/29/07). See blander coverage at AVI BioPharma Chairman and CEO Resigns, Genetic Engineering & Biotechnology News, 3/28/07)

In October, Macary formed a legal trust under Delaware law to represent AVI shareholders. Macary solicited donations by mail and via the web. The Oregonian reports that since its inception in 1980, AVI BioPharma has spent more than $200 million but has yet to bring any technology or drugs to market. AVI claims to have developed synthetic polymers that block the function of a targeted gene or virus by binding to a specific gene sequence. They have also advanced several potential treatments into human clinical trials, including drugs to prevent clogging of heart arteries and fight hepatitis C infection.

Macary faults management for the lack of institutional shareholders and lack of coverage by Wall Street analysts. He questions the company's repeated rounds of private placement financing that have diluted the value of publicly traded shares. K. Michael Forrest will serve as interim CEO. Jack L. Bowman, a current boardmember was named chairman.

It will be very interesting to see if the model takes off or if it has difficulty overcoming "free-rider" issues. For a related strategy, see the Corporate Monitoring Project.

1928 All Over Again

The New York Times reports a widening of Income inequality in 2005, with the top 1% of Americans — those with incomes that year of more than $348,000 — receiving their largest share of national income since 1928. The top 10%, roughly those earning more than $100,000, also reached a level of income share not seen since before the Depression.

Average incomes for those in the bottom 90% dipped by $172, or 0.6% from 2004, whereas those in the top 1% grew to an average of more than $1.1 million each, an increase of more than $139,000, or about 14%. The top tenth of a percent reported an average income of $5.6 million, up $908,000, while the top one-hundredth of a percent had an average income of $25.7 million, up nearly $4.4 million in one year. The top 300,000 Americans earned almost as much as the bottom 150 million.

Notably, "The Internal Revenue Service estimates that it is able to accurately tax 99 percent of wage income but that it captures only about 70 percent of business and investment income, most of which flows to upper-income individuals, because not everybody accurately reports such figures." The equation does not take into account cuts in fringe benefits, such as health care, child care and education spending, which don't impact the wealthy nearly as much. (Income Gap Is Widening, Data Shows, 3/29/07)

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Notable Anglo-American Differences

Following the success of the 'Beyond the myth of Anglo-American corporate governance' roundtable in Washington DC in December 2005, the Institute of Chartered Accountants (England and Wales) held a one-day roundtable to highlight conclusions from the year long 'Pressure Points' consultation exploring the opportunities and pressures arising from differences between US and UK corporate governance systems. Although I was unable to attend the event on January 10 in London, Robert Hodgkinson, the Institutes's Executive Director, was kind enough to forward a copy of their latest findings in this very informative series, entitled Emerging Issues, which summarizes findings, and a video of the conference. I can, without reservation, recommend the entire series.

A very few of the major points, which may be of special interest to US shareholders, are as follows:

• Reports of the death of US capital markets are exaggerated. Regulation is not the only driver of market attractiveness. Markets outside the US are now are now far better regulated, deeper and more liquid than in the past. Companies that might once have accessed the US markets to raise capital can now satisfy their requirements in their own domestic markets or in foreign markets that are closer to home and in a less litigious environment.
• The US system relies heavily on public rules of securities regulation. Consequently, one of the main roles of the SEC is to protect all shareholders by implementing and enforcing requirements to maintain good corporate governance. In the UK, shareholders have powers to protect their interests directly and support the role of the Financial Reporting Council in upholding the Combined Code on Corporate Governance.
• A key advantage of shareholder-led governance, such as practiced in the UK, is that it operates on a company-by-company basis. It is responsive to particular problems and can produce tailored solutions, which are preventative and not simply reactions to scandals of the past. However, it depends on a body of responsible shareholders willing and able to engage with boards, the power of shareholders to influence change, and a real obligation on companies to make corporate governance disclosures work on a comply-or-explain basis.
• The UK approach to takeovers is based on the premise that shareholders have definitive authority on whether or not to accept a bid. In the US ultimate authority rests with directors.
• The fact that UK shareholders have the authority to appoint or remove a director encourages an environment where the use of such power is rarely needed. In the US, shareholders who wish to propose alternative directors for election to the board must enter into a proxy fight and pay for the costs of communicating with other shareholders directly. The expense involved often dampens shareholders' appetite for battle. Therefore such action is rare.
• In the UK, directors' duties are owed to a company of members, not a corporation. In the US, a corporation is viewed as a public construct, rather than a creation of the members who own it. Directors' duties are owed to the corporation.
• The ability of shareholders to appoint and remove board members in the UK encourages a sense of collegiality and an appreciation of accountability to shareholders. CEO influence on board appointments in the US creates a perception that, although the board acts in the interests of shareholders, in practice it is accountable to management.
• Independence. The irony is that the greater the proportion of independent non-executive director on a board, the greater the reliance on executive management to supply them with information.
• Direct regulation of pay levels is considered politically impossible and is therefore limited to influencing behavior through disclosure. In fact, UK experience suggests that disclosure may have unforeseen consequences in creating an upward spiral in pay levels. Where regulation and shareholder action are limited in their effect, intervention by the media may provide a more effective constraint.
• US non-executive directors are generally perceived to be more active in their monitoring role, whilst their UK counterparts are involved in both monitoring and strategy. Despite this involvement in strategy, UK non-executive directors' remuneration is less closely linked to overall corporate success. In contrast, US non-executive directors are often rewarded in share options to reflect their contribution to corporate strategy. In this sense, UK non-executive directors can be seen to act more like executives but are paid more like compliance officers, whilst US non-executive directors act more like compliance officers and are paid like executives. Share-based incentives are generally seen as creating a self-interest threat to a UK non-executive director's independence and objectivity. In the US, share options are considered to align the interests of non-executive directors with those of the company.

And this from Robert Bruce in London: "Diehards in America argue that their system of corporate governance is fine. But at the top of the process the first moves are being made to prepare for change. The chairman of the SEC, Christopher Cox, has commissioned a study of how Europe and much of the rest of the world deals with such issues as shareholder powers. The gulf between the cosy American world where shareholders have hardly any power to bring about change and where the idea of the chairman and the CEO being one and the same all-powerful, buccaneering tyrant is seen as fine, has now opened up to such an extent that it is embarrassing." (Corporate governance: Ripple effect, WhatPC?, 3/29)

Lawsuit Targeting Sarbanes-Oxley and PCAOB Dismissed

Last week, the lawsuit filed by Free Enterprise Fund seeking to abolish the PCAOB was dismissed. The lawsuit claimed that Congress acted unconstitutionally by creating the regulator because it operates independent of government supervision. In his decision, U.S. District Court Judge James Robinson disagreed by noting that the PCAOB is accountable to federal officials because the SEC Commission can remove its members. The Judge also said that the plaintiff raised "nothing but a hypothetical scenario of an overzealous or rogue PCAOB investigator.'' The Free Enterprise Fund plans to appeal. (lifted straight from Broc Romanek's TheCorporateCounsel.net Blog, 3/28/07)

Fund Democracy

Noteworthy letter from Mercer Bullard of Fund Democracy. "We encourage the Commission to adopt its fund governance proposals and not to abandon ship in the face of chimerical, cost-based arguments that have repeatedly, and now definitively, collapsed before rigorous, empirical study."

If the SEC abandons its push for an independent chair at mutual funds, Bullard advocates that at least two key responsibilities be assigned to a director who is independent of the fund manager to protect against self-dealing by the fund manager.

1. The foremost of these is the exclusive authority to oversee the boardís relationship with the fundís Chief Compliance Officer (CCO). The Commissionís adoption of the CCO rule would be an empty gesture if the CCO were to report to and communicate with the board through an executive of the entity most likely to engage in self-dealing at the fundís expense. The CCO should report directly to an independent fund director who should be primarily responsible for coordinating all fund compliance matters or other matters that involve a potential conflict of interest with the fund manager, principal underwriter or significant service provider.
2. The authority to set the agendas and conduct the meetings must reside with an independent director. Such plenary authority is necessary because the overwhelming majority of matters addressed at board meetings involve compliance and fund manager conflicts. Affiliates of the fund manager should not be relied upon to ensure that compliance issues and other matters that involve fund manager conflicts of interest are adequately addressed by the board.

Education Needed

A poll from job placement and human resources consultant Adeco found that 56% feared the US is globally uncompetitive and 76% agreed more investments in training and development are needed to allow the workforce to keep up with workers from other nations. 64% agreed the US educational system is not properly training workers for the jobs of the future. 92%) agree strengthening the education system should be a top priority in the next decade. (Survey: U.S. Workers Behind in Global Marketplace, PlanSponsor.com, 3/26/07)

US Gains Competitive Edge

An article in Financial News, BGC Partners faces listing setbacks (3/27/07) makes us wonder about US competitiveness. It seems BGC Partners had announced its intent to list in the UK, but is now pursuing a US float after a cool reception with London-based interdealer broker analysts who "were less than enthusiastic about the company’s prospects."

Cantor Fitzgerald, BGC's parent company, reportedly intends to issue dual class stocks, as it did with electronic brokerage eSpeed, which now faces an attack led by hedge fund Chapman Capital. Chapman is calling for a change into a single class with equivalent voting rights, instead of the current structure where B shares have one vote each, while its Cantor-controlled A shares have 10 votes each.

The BGC filing showed directors Lee Amaitis and Sean Lynn were paid bonuses of $2.5m and $1.9m respectively last year, on top of salaries of $1.5m and $1.2m, despite the company producing a net loss. Chapman alleged that Howard Lutnick’s dual role as CEO of Cantor and eSpeed give rise to conflicts of interest concerns. The BGC document showed Lutnick will serve as co-chief executive of BGC and Cantor will have no duty to refrain from competing with BGC, doing business with its customers or pursuing any corporate opportunities for itself.

The floated sale isn't expected to be popular with institutional investors, such as TIAA-CREF, CalPERS, or Vanguard which favor one share one vote or at least voting rights proportionate to economic investments.

According to Financial News, "looking at the BGC initial public offering document, there are surprising risk factors. The document showed the company made repeated mistakes in its UK tax computations, that competitive conditions had forced it to pay generous advances to attract staff in the form of “forgivable loans”, and the company had admitted to 'material weakness' in its internal financial controls. It also revealed the onerous conditions imposed on employee share participation, and that at least four lawsuits against BGC and its affiliates are outstanding."

We want competitive markets in the US, but is this the type of company that is going to give us back our competitive edge? We think not.

100 Companies With Integrity

Audit Integrity, an independent Los Angeles firm that does research on corporate governance best practice, has drawn up its first list of 100 American companies that, in its judgment, "showed the highest degree of accounting transparency and fair dealing to stake-holders during 2006."

The top six, which all appear to have the same score are as follows:

• AllianceBernstein Holding LP, an asset management company, provides diversified investment management and related services globally to a broad range of clients. Also provides distribution, shareholder servicing and administrative services to its sponsored mutual funds.
• Bemis Company, manufacturer of flexible packaging products and pressure-sensitive materials selling to customers throughout the U.S., Canada and Europe. The company's markets include food, chemical, agribusiness, medical, pharmaceutical and printing industries.
• CDI, provides engineering and information technology outsourcing and professional services, specialized staffing and permanent placement services, and franchise services.
• Dollar Financial, provides financial services to under-banked consumers, primarily of check cashing, short-term consumer and longer-term installment loans and money orders.
• Fred's, based operator of discount general merchandise stores in 14 states primarily in the southeastern U.S. Its stores generally serve low-, middle- and fixed-income families located in small- to medium-sized towns.
• OPNET Technologies, provider of management software for networks and applications, such as application performance management, network configuration management, capacity planning, and network research and development.

The firm's proprietary model seeks to identify risks by comparing company financial and governance metrics against those of known fraudulent companies and identifying statistical outliers. The flagged metrics form the basis for an assigned AGR® score. The firm computes over 600 of these metrics, which support benchmarking and analysis. According to posted notes regarding methodology, the subject areas include:

• Corporate Accounting: Financial statement data and other derived data to compute metrics measuring the accuracy of a company’s accounting.
• Corporate Governance: Source and derived data items are used to compute metrics measuring the quality of a company’s governance. These metrics cover not only traditional governance topics – such as Board independence, executive qualifications, and compensation practices – but also related topics such as corporate reporting, corporate actions, and oversight issue.
• In addition to accounting and governance ratings, Audit Integrity calculates ratings using financial ratios to measure a more traditional fundamental evaluation of corporate strength: Financial Condition, Earnings Quality and Sustainability.

Additional information concerning methodology and "white papers" at auditintegrity.com. (America's Most Trustworthy Companies, Forbes.com, 3/27/07)

US Competitiveness

Has the United States lost its competitive edge among the world’s capital markets because of overly burdensome regulation and litigation? Yes, says Professor Hal Scott, director of Harvard Law School’s Program on International Financial Systems.

In 2005, only 5% of the money raised through global initial public offerings of stock was raised in the US, compared to 50% in 2000. The US share of equity capital raised in the world’s top 10 economies was an anemic 27.9% in 2006, down from 41% in 1995. According an article in the Harvard Law Bulletin (Endgame?, Spring 2007), a Harvard-led team wants to get US competitiveness back, and some powerful people are paying attention to the Committee on Capital Markets Regulation.

Barney Frank and Senator, Christopher Dodd both expressed a desire to hold hearings on US capital market competitiveness, in part based on the Committee's report. “If we reform our system and make it more like Europe’s, in the long term it will benefit everyone,” said Scott. “Then we can sit down and deal with the rules globally, instead of competing on the legal rules. To get to that, our rules have to be closer to theirs. If we’re successful in this effort, that will happen.”

While the chamber deserves a cheer for trying to make the lofty ambitions of the Scott report more practical, they have left behind a critical balancing feature captured by the "grand bargain" the Scott report posed. That bargain was to lift the burden of regulation, where it could be shown to be onerous and not useful, and in return, shareholders would be given a tool kit to look after themselves, just as they are in most developed markets around the world. (U.S. Capital Markets Need Regulatory Relief, WSJ, 3/24/07, Ira M. Millstein, Senior Associate Dean for Corporate Governance, Yale School of Management and Anne Simpson, Executive Director, International Corporate Governance Network)

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Harvard Law

In the past five years, Harvard Law School’s corporate law scholars have accounted for nearly a third of the top 10 articles on corporate law and securities published nationwide, as ranked by an annual poll of corporate law professors around the country. See a roundup of recent research efforts at Corporate Governance in a Global Economy: Diversified portfolio.

Clawback Provisions Grow

Gretchen Morgenson's Fair Game (NYTimes, 3/25/07) cites Michael Melbinger, a partner at the law firm Winston & Strawn in Chicago who says, he has seen 10 recent cases of companies actually recovering money from executives. ''Boards are getting deadly serious about this,'' Mr. Melbinger said. ''The old agreements were extremely executive-friendly, and we are moving to a less executive-friendly environment. But not everybody's there yet.''

Judging by this season's executive pay filings, provisions that would require so-called clawbacks of pay are becoming much more prevalent at major corporations. They are becoming broader as well, extending to the recovery of gains from stock options that may have been exercised while dubious practices were taking place.

Equilar, an executive compensation research firm reviewed pay recovery provisions last November at the 100 largest US companies and found about 18% had disclosed clawback policies for the previous year. Among the 50 that have this year, Equilar found 44% with clawback provisions. Six of the 50 put their policies in place last year.

''Some of these companies are so serious about these provisions that they are putting them into the compensation committee charter,'' compensation consultant James F. Reda said. ''They are hard-wiring it to be more than just a policy; it is a requirement, and plainly stated for everyone to see.''

Morgenson concludes with "after years of shareholders shouting themselves hoarse over pay, they are finally being heard -- in some boardrooms, at least."

Fund Holders Lose

Chuck Jaffe, a columnist for MarketWatch writes "there's no official word from the SEC yet, but it's pretty clear from agency insiders that the issue is dead." The issue is requiring all funds to have chairmen and three-quarters of directors be independent.

Benefits to be lost, according to Jaffe (Independent director rule for funds appears likely to vanish, Minneapolis Star Tribune, 3/24/07), include the following:

• Negotiating fees. The board sets a fund's fee structure on behalf of investors; lower fees are good for shareholders, while high fees enrich the management firm. While there are independent boards that have allowed fee increases, studies have shown that the higher the percentage of directors that are independent, the lower the fees.
• Eliminating other conflicts. Many fund companies have sister businesses that handle back-room operations. Independent directors will be more likely to look for the lowest-cost services.
• Protection. Hiring an independent chairman improves the odds of having someone in charge who is earning their keep, rather than considering this one more chore in a busy day.

Low Readibility of Compensation Disclosures

SEC chairman Christopher Cox today blasted the "readability" of disclosures made in recent proxy filings. The filings “aren't anywhere near to Plain English,” he said. The new disclosure format for compensation was intended to be a “candid conversation” about compensation, Cox said.

He promised that the SEC would “wage an all out war on complexity” of financial disclosures. (Cox knocks unreadable proxies, InvestmentNews, 3/25/07)

ProxyTrak

According to a report by PlanSponsor.com (Cogent Releases Automated Stock Recall Tool, 3/22/07), Cogent Consulting LLC developed a tool to automate tracking and recall of shares on loan by institutional investors and monitoring material corporate events. ProxyTrak was designed in response to the growing problem on Wall Street created when mutual funds, pension funds, hedge funds, and trust companies need to quickly recall shares of stock they own but have lent out, so they can uphold their fiduciary duty to vote proxies on material issues.

Each day, a firm's money managers can log into ProxyTrak via a secure, password-protected Web interface and see, on a stock-by-stock basis, the number of shares owned, the amount that has been loaned out, upcoming material corporate actions related to their portfolio, and the record and event dates. Users can sort and filter the data any way they like and they can receive PDF reports based on any parameters requested.   

Definition of a Fiduciary Broadened

PlanSponsor.com reports that a U.S. District Court has ruled that a brokerage firm which provided investment advice to a profit sharing plan for a fee is considered a fiduciary under the Employee Retirement Income Security Act (ERISA), even though it did not have discretionary authority over the plan.
 
Judge Joseph Scoville wrote, "Although it is certainly true that the possession of discretionary authority and control is generally the benchmark for fiduciary status under ERISA, it is also true that, in the special case of those providing investment advice, the existence of discretionary authority is not necessary to a finding of fiduciary status." (Court Finds Adviser to Retirement Plan is a Fiduciary, 3/21/07)

SOX Impact Measured

According to a recent study, SOX induced small firms to exit the public capital market during the year following its enactment.  In contrast, SOX appears to have little effect on the going-private propensities of larger firms. (Ehud Kamar’s Study on the Consequences of SOX, Harvard Law School Corporate Governance Blog, 3/21/07)

Kinder to Speak in SF

Peter Kinder, president of KLD Research & Analytics, has been a thought leader in responsible investing for nearly 25 years. He co-founded the first social index, the DSI 400, the first social index fund and the first social i-Shares ETFs the KLD 400 and Select Social. His books, articles and white-papers have shaped the course of SRI.

Peter will talk on: "Here Come the Institutions! The Rapidly Changing Nature of SRI & What it Means for You." Five years ago, a handful of institutional investors acknowledged any to SRI. Today, institutions representing $6 trillion have signed the UN's Principles for Responsible Investment and the Gates Foundation has had to defend inconsistencies between investment and charity due to a lack of SRI policy. What do these changes mean for SRI, your clients and you? And what do all these new terms, such as ESG, mean?

Wednesday, March 28th, 5:30pm - 7pm
433 California Street, 11th Floor
(Between Sansome & Montgomery in San Francisco)
Hosted by Sierra Club Mutual Funds. Please let them know in advance if you plan to attend by calling (510) 549-8780. Don't miss this opportunity to interact with a real thought leader.

Drury Reports "Startling" Decline in CEOs on Boards

JamesDruryPartners, a leading executive search and board recruitment firm, reports a "startling" 53% decline in board seats filled by Fortune 500 CEOs on outside corporate boards over the last 16 years. They found "active CEOs are not only abandoning board service at an alarming rate, but those who continue to serve on outside boards have reduced their commitments from an average of 2.2 boards to 1.4 boards, representing a decline of 36%."

There is something unexpected and potentially damaging happening in America's boardrooms and executive suites," Drury observed about the study's findings. "Over the last decade and a half, the composition of boards has changed as the number of active CEOs sitting on the boards of other companies has declined dramatically. It's a stealth revolution that has important consequences, as this development is robbing American companies of some of the most experienced and influential board members who bring a particularly vital point of view and relevant experience to board deliberations.

The firm, which makes most of its money requiting executives for public firms, is worried that governance activists, increased regulation, and heightened scrutiny may be pushing American industry toward a business system that takes companies private where small investors won't be able to afford to acquire a stake. (press release, 3/20/07)

For some reason, I don't see Drury as a strong spokesman for the small investor. There is no shortage of board talent. Let CEOs stick to their own companies. I don't know how a CEO can find the time to serve on more than one additional board. There will be fewer potential conflicts of interest with fewer CEOs on boards. Boards that aren't dominated by CEOs may even get a better handle on executive pay.

As for the flow of money into private equity, private ventures should always be more efficient than public ones because they involve fewer owners and they have great incentive to be more intimately involved in decisions. Since the managers typically are the investors, they have no incentive to issue misleading information to themselves.

If too much is going into private equity, the market will correct itself. As a recent article in The Economist notes (Barbarians in the dock, 3/3/07), "private equity firms have begun to pay absurdly high prices; investors pay them too much...The habit of charging huge fees for arranging deals does not align with the interest of investors and managers. It was investors who suffered in the 1980s from the last round of private-equity excess." The same is likely to hold in this round. As more money flows into private equity, the prospect for higher returns will decline. If it hasn't happened already, it inevitably will.

P&I Endorses Say on Pay

Influential trade publication Pensions & Investments has come out in favor of say on pay legislation. Their endorsement is reluctant, preferring a free market solution. Delay, they fear, might result in worse measures aimed at limiting total compensation. The following are excerpts from their editorial A necessary ‘say on pay’ (3/19/07):

‘‘Say-on-pay” legislation requiring companies to have an annual, non-binding vote on executive compensation is unfortunate, but necessary. Shareholders should have a non-binding vote on executive compensation...

But that vote should be secured through discussions between management and shareholder groups.

Unfortunately, given the outrage aroused by sky-high compensation packages awarded to a few apparently non-performing CEOs, it apparently is too late for that.

Passage of Rep. Frank’s proposal might be necessary to head off even more drastic and damaging legislation.

Elsewhere in the same issue, P&I reports DB plans keep up inexorable march toward retirement. Thirty-eight percent of total household assets of $42 trillion were in retirement accounts in 2006, the same as in 2005, according to the Fed.

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ISS Bits

ISS reports opposition to employee stock option plans is waning as dilution levels drop. Average opposition for 2006 stood at 22.1%, compared with 25.5% in 2005. Over the same period, dilution levels at S&P 1,500 firms dropped from 17.2% in 2005 to 14.5% in 2006. Dilution of 10% appears to be the voting threshold. Plans under that threshold were opposed by 24%, whereas opposition rises to more than 29% over that limit. (Opposition to Stock Plans Wanes, ISS Study Finds, 3/22/07)

CalPERS targeted 11 companies due to "dismal stock performance" and "poor governance practices." Firms on CalPERS' 2007 "focus list" include Sara Lee, Eli Lilly, Tribune Company, Marsh & McLennan, International Paper, Tenet Healthcare, EMC, Dollar Tree Stores, Corinthian Colleges, Kellwood, and Sanmina-SCI. The fund targeted just six companies last year, and five in 2005. (CalPERS Releases Focus List, 3/19/07)

ISS reports final tally in favor of proxy access proposal at Hewlett-Packard was 43%, higher than the 39% preliminary figures I quoted just after the meeting. (This figure does not include abstentions, which the company and some news organizations included in their tallies when reporting that the proposal received 39 percent support.)    “We are looking at filing at other companies that may be deserving of proxy access, focusing on option backdaters and springloaders with meetings late in the year,” Ferlauto told Governance Weekly. (Proxy Access Gets 43% at HP) We welcome your recommendation for next year's target firms for proxy access. Please e-mail CorpGov.net publisher James McRitchie.

Senate to Examine Access Issue

Reuters reports, US Senate panel eyes proxy access, targets hearing, 3/20/07. Senator Jack Reed's subcommittee on securities, insurance and investment is examining proxy access and will probably hold a hearing at some point this summer, according to Reed aide, Chip Unruh.

Barney Frank, who chairs the House Financial Services Committee, said that if his "say on pay" bill becomes law, but is widely ignored by board compensation committees, he would expect Congress to look into proxy access as the next step in addressing shareholder rights.

Fine, but knowing wether the "say on pay" will be ignored is several years down the road. I would hope they would immediately work to codify something close to the 2nd Circuit Court's decision in the case of AFSCME v AIG. Contrary to the Reuters report, the court decision has not "stirred confusion in the corporate governance world." Instead, that decision clearly allows shareholder to move forward with bylaws amendments tailored to each company, instead of using a "one size" fits all approach, as proposed by the SEC in 2003 after Greenberg and I filed our petition that is credited with re-energizing the access debate. See CII's Equal Access, What is It?

The Bigger They Are...

From a Motley Fool interview with Santa Monica Partners founder Lawrence J. Goldstein: "My dad inculcated in me that the bigger they are, the harder they fall. I want everything that I as a shareholder am entitled to -- nothing more, but nothing less. Companies say, "If you don't like the stock, sell it." I don't buy that. If I did all the work and research/analysis and I own it, I'm not going to sell it out because of the next-quarter result or next-year result. I want to be in it for the long haul, ideally for life."

Since 1982, their flagship fund (open only to accredited investors) has trounced the S&P 500 with a 20% gross return and, after fees, a 15% annualized return. Very interesting interview with more to come. Check out "Santa Monica Partners founder Lawrence J. Goldstein," 3/30/07

In Class B, The NYTimes Trusts

Relative to advice offered recently by Kevin Cameron, President of Glass Lewis at the Northern California NACD meeting, WSJ ran an article on the efforts of London-based portfolio manager at Morgan Stanley, Hassan Elmasry, and his efforts as a shareholder activist at the NYTimes. Too many letters and not enough meetings. I think Cameron would have advised Times CEO Arthur O. Sulzberger Jr. to meet with Elmasry right from the start.

In this case, at bottom is the problem of a dual class structure, or as WSJ puts it, "In Class B, We Trust." Class A stock can vote use of company shares for stock options, the selection of an accountant and, in some cases, buying stock or assets of other companies. Class B shareholders can vote on all matters. Any alteration to the dual-class structure must be ratified by six of eight directors who sit on the board of the Ochs-Sulzberger family trust, which controls roughly 88% of the company's class B shares.

WSJ outlines an interesting campaign by Elmasry, who does appear to have made inroads. However, it appears unlikely that directors of the Ochs-Sulzberger family trust will ever yield on Elmasry's primary demand to end the dual class structure. Who yields power willingly? There are few men or women of the caliber of George Washington; greed all too often carries the day. (PAPER CHASE: How a Money Manager Battled New York Times, WSJ, 3/21/07)

Mutual Fund Voting Improves Slightly

Citing data from The Corporate Library, Social Funds reports the three biggest mutual fund families--American Funds, Fidelity, and Vanguard--have been the biggest rubber stamps for corporate management. Fidelity voted against 126 CSR resolutions and for not a single one in 2005. This past proxy season, Fidelity supported one single CSR resolution while opposing 124, raising its support rate from 0 to 0.8%. Vanguard abstains on almost all CSR votes, which effectively creates the same impact.

"TIAA-CREF's voting record also illustrates another significant trend in 2006--a shift to voting for political influence resolutions asking companies to disclose and provide board oversight for their political donations. After voting against all 24 such resolutions in 2004 and 2005, TIAA-CREF voted for 27 of 34 such resolutions in 2006, radically upping its record from zero to 79 percent support." (Mutual Funds Inch Toward More Conscientious Proxy Voting on Social and Environmental Resolutions, 3/14/07) Bill Baue, the author of the article, also co-produces Corporate Watchdog Media, which last week addressed the issues of Asian Volatility and Toxic Products; Citizen Investors Democratizing Capitalism.

NACD in Sacramento

The day after the HP vote I had the pleasure of attending an program on board entrenchment in Sacramento put on by the Northern California Chapter on the NACD. They usually meet in the Bay Area and I live just south of Sacramento, so it was a pleasure not to have to drive for several hours to listen to Kevin Cameron, President of Glass Lewis, with a few comments from Richard Koppes and Dennis Johnson.

The come on to the meeting was a longer version of the following: "President Bush has assailed boards for condoning excessive executive compensation; activist shareholders like Carl Icahn are assailing boards for putting their own interests before shareholders; and Marty Lipton is warning that our system of capitalism is endangered. Which is right?"

I'm not sure Cameron answered that question directly. With regard to Lipton, he didn't seem to think the sky was falling because of corporate governance reforms. However, he did offer some useful advice to boards. He recommended boards tie executive compensation to easily understood metrics, believing that shareholders are fine with CEOs getting rich as long as they can easily understand the relationship between preset targets and CEO performance. It probably doesn't hurt is those targets can be seen as likely to lead to shareholder value too.

Another message was to communicate with your large shareholders. He related a story of an activist investor who acquired a 5% stake, eventually building to 15% because he though a company had too much access cash. After years of never meeting him and fighting him at great expense, certainly with regard to time, the shareholder was finally granted a seat on the board. After a few meetings, he came to realize the company needed the pot of cash to demonstrate to its customers that it would be around for many years and had the resources to continue to compete with bigger competitors. He soon began selling off his stake. How much time and money could have been saved on both sides if the company had just agreed to meet?

When faced with activist shareholders who are likely to push the company into a proxy contest, you can either take the company private or be more interactive with shareholders.

During the question and answer period, I ask what he thought of DSM's proposal to pay an extra 10% dividend to shareholders that have held their stock for 3 years or more. Citing the fact that most mutual funds hold their positions for less than a year, Cameron opined that he is not sure the scheme would be effective because it "introduced economic irrationality into the process." I'm not so sure what is economically irrational about a firm providing an incentive to retain shareholders on a long-term basis. If shareholders are getting more control over corporations, which shareholders would a company rather have, permanent shareholders or shareholders that hold for less than a year? Several in the SRI community think an increased dividend or greater voting rights for long-term shareholders may make a lot of sense, even if changes in law are required.

One thing I learned at the meeting (perhaps I'm a little naive), according to Cameron, Glass Lewis doesn't set its voting policies by trying to align them with the latest academic findings. Instead, they survey their clients and apparently go with the majority opinion. He later indicated clients often ignore their voting advice. That's certainly understandable, considering how their fundamental policies are set. As Les Greenberg notes, "is leadership learning which way the herd is running and running fast to get to the head?" I can't help thinking improvements should be on the way.

I guess I'd better pay more attention to the IRRC Institute for Corporate Responsibility and the Arthur and Toni Rembe Rock Center for Corporate Governance. So far, their published research is slim but I have great hopes progress will be made to correlate voting policies with shareholder value. Meanwhile, the next event of the Northern California Chapter of the NACD will be at the St. Francis Yacht Club in San Francisco on May 10, 2007. The write-up says "It’s a 'Flight Simulator' for boardroom training."

You’ll be an independent director on the board of an actual, disguised high-tech company. Thorny issues are guaranteed to come up. You and your fellow board members may grapple with conflict of interest, fiduciary duty, challenging global operations, and potentially risky M&A transactions. To succeed, you must identify the critical issues, understand your alternatives, and come to a consensus, while handling tricky boardroom dynamics.

"Presenters, Deborah Ludewig, Jean Fuller, and Ann Peckenpaugh, have pioneered the use of case studies in Director education." Sounds like more audience participation.

Where's the Theory in Corporate Governance?

I found a very interesting podcast by Jonathan R. Macey delivering his inaugural lecture as the Sam Harris Professor of Corporate Law, Corporate Finance and Securities Law at Yale Law School. Professor Macey's lecture includes a brief examination of four of the most important institutions of corporate governance: the market for corporate control, the jurisdictional competition for corporate charters, shareholder voting, and corporate boards of directors.

Most fundamentally, Macey argues that corporate boards are conflicted if they attempt to act as both advisor to and monitor of management. Yes, Congress in some respects acts in this capacity with regard to the executive branch. However, unlike corporate board members, members of Congress don't generally owe their positions to the executive. Additionally, Congress has its own sources of information through its staff, hearings, etc., whereas boards are largely dependent on management for their information. Finally, Congress has at least two competing parties; boards don't.

Although the lecture was given on 10/9/06, it apparently wasn't published as a podcast until 2/15/07. Am I missing out on a whole world of equally interesting podcasts in the field of corporate governance? I hope so. Let's mine them together. I shared my latest find. How about you? E-mail the URL and I'll share it.

ISS Webcast on Share Lending

ISS will hold a webcast, Share Lending Practices and Share Recall Challenges, on March 21 at 1 p.m. Eastern Daylight Time. Securities lending "bends one of the basic assumptions behind the one-share, one-vote principle, and places investors who retain the economic interest in a challenging position. Yet, share lending has become a lucrative practice for many institutions."

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Both Sides Declare Victory at HP

Hewlett-Packard investors voted down a proposal that would have allowed shareholders who have owned at least 3% of HP's outstanding stock for at least two years proxy access to nominate two board candidates. About 1.61 billion shares, or 52% of the total shares voted, were against the proposal. More than 800 million shares, or 39% of the total shares voted, were in favor. The percentages were enough for both sides to declare victory.

"HP is pleased that this proposal was not approved by the super majority vote required... The board believes that this proposal was not in the best interests of HP stockholders," HP said in a statement.

Russell Read, the Chief Investment Officer at CalPERS issued the following: “This landmark vote will have a material impact well beyond HP, and will likely establish a new core principle in American business – that shareowners need the basic right to nominate directors particularly in extreme circumstances such as those we sadly experienced at HP. Two out of every five shareowners took a stand in favor of democracy. We urge HP to not ignore the guidance of those thousands who voted and who own over $32 billion worth of HP stock."

It was a vote heard around the world. As noted in the China Post, "corporate governance advocates say getting the proposal on the HP ballot was half the battle. A strong showing Wednesday could open the door to similar proposals at other companies. It could also spur federal regulators or Congress to require that companies let shareholders nominate their own candidates, and include those candidates on official company ballots." (Shareholders pass measure in landmark vote for HP, 3/15/07)

"There is no such thing as an independent director under the current system'' at Hewlett-Packard, said Nell Minow, editor of the Corporate Library, a corporate-governance research firm in Portland, Maine. "Their connections to management are not revealed in the proxy, and most of them are closely tied to the CEO.'' (Hewlett-Packard's Hurd Faces Investor Ire Over Spying, Bloomberg, 3/14/07)

I don't think there is much doubt that 39% was a strong showing, considering it was the first time out for such a measure...at least for many many years. Yes there was the spy scandal that introduced "the word 'pretexting' into the American lexicon," as AFSCME representative Scott Adams noted. However, just before the meeting state charges were dismissed against former HP chairwoman Patricia Dunn and three other defendants who faced four felony counts of conspiracy and identity theft offered no contest pleas to a misdemeanor charge.

Although several federal probes of the investigation continue, HP's shares have nearly doubled in value since Mark Hurd took over as CEO in 2004. That fact alone made a majority vote, let alone a super-majority vote unlikely. There will be more troubled targets for the measure in the future with scandals and lower earnings. The issue certainly hasn't gone away and I believe the vote at HP added fuel to the fire.

Of lessor note, two measures opposed by HP did carry. One, a proposal sponsor by Nick Rossi, of Boonville, CA to submit any future poison pill anti-takeover measure to a vote of shareholders, was approved by 72% of stock cast. An initiative sponsored by William Steiner, Piermont, NY, to more tightly link executive pay to company performance passed by a vote of 53% in favor to 45% against. According to the Financial Times, "reflecting investor frustration at the large pay packages awarded to Mr. Hurd when he joined HP, as well as the multi-million dollar severance package handed to his predecessor, Carly Fiorina, when she left the company two years ago." (HP shareholders deal blow to proxy campaign, 3/14/07) See also, HP investors vote down proposal for shareholder nomination, San Jose Mercury News, 3/14/07.

DSM Update

In an update to an item we covered earlier, it was reported that US investment company Franklin Mutual Advisors was considering legal action against the innovative loyalty dividend to be proposed by Royal DSM, claiming it discriminates between shareholders of equal stakes. (DSM loyalty div scheme wins backing from European corporate governance watchdog, Forbes.com, 3/14/07) Of course, it also encourages long-term investing...and that would be a very good thing.

Corporate Governance Institute Names Renowned Experts

San Diego State University College of Business Administration announced the formation of a board of advisors for its Corporate Governance Institute consisting of internationally recognized leaders.  “We are extremely fortunate to have Nell Minow, Cynthia Richson, Garry Ridge, Hugh Friedman, and Gail Naughton as inaugural members of our new board,” said Corporate Governance Institute Director Lori Ryan. “They will help to guide the institute’s development and application of responsible corporate governance practices.”

Nell Minow, editor and co-founder of The Corporate Library, based in Portland, Maine, was named one of the 30 most influential investors of 2002 by Smart Money magazine and, in 2003, was dubbed “the queen of good corporate governance” by Business Week online. Prior to co-founding The Corporate Library, Minow was a principal of Lens Investment Management, a $100 million investment firm that took positions in underperforming companies and used shareholder activism to increase their value. Her other professional experience includes serving as president of Institutional Shareholder Services and as an attorney at the U.S. Environmental Protection Agency, the Office of Management and Budget, and the Department of Justice. She has authored more than 200 articles and co-authored three books on corporate governance.

Cynthia L. Richson is president of the Investor Responsibility Research Center (IRRC), a provider of independent governance research for investors headquartered in Washington, D.C.  Prior to joining IRRC, Richson was the Corporate Governance Officer for the Ohio Public Employees Retirement System (OPERS).  In 2004, she was appointed to the Public Company Accounting Oversight Board Standing Advisory Group, and she was elected to the Council of Institutional Investors Board of Directors in 2005.  Richson previously served as the director of corporate governance for the State of Wisconsin Investment Board (SWIB), and created the nationally recognized Directors’ Summit in 2001. 

Garry Ridge is president and chief executive officer of the WD-40 Company headquartered in San Diego.  Mr. Ridge has been with WD-40 since 1987 in various management positions, including executive vice president and chief operating officer and vice president of international business.  He has worked directly with WD-40 in 50 countries. In 2003, Ridge was awarded Director of the Year for Enhancement of Economic Value by the San Diego Corporate Directors Forum, and, in 2004, received the Arthur E. Hughes Career Achievement Award from the University of San Diego. 

C. Hugh Friedman is a professor of law at the University of San Diego. After beginning his legal career as a California Deputy Attorney General, he became in-house corporate counsel for a San Diego-based corporate conglomerate and joined the faculty of the then-fledgling USD School of Law. Dr. Friedman is a long-time member of San Diego’s Corporate Directors’ Forum, serving on its Board of Directors and its program and corporate governance committees. 

Gail K. Naughton, dean of the College of Business Administration at San Diego State University, was co-founder of Advanced Tissue Sciences and co-inventor of its core technology. She serves as a director for several not-for-profit foundations, including the City of Hope, and sits on the scientific and industry advisory boards of leading universities, including the Georgia Institute of Technology. 

I'm impressed. See press release, 3/13/07.

Eyes on HP

Today focus is on Shareholder Proposition 3 at the HP meeting, which represents a real test on shareholder access. Sponsored by AFSCME, the New York State Common Retirement Fund, the Connecticut Retirement Plans and Trust Funds and the North Carolina Equity Investment Fund Pooled Trust, it has also been endorsed by CalPERS and CalSTRS. ISS and Glass Lewis, have endorsed as well.

The proposal would require HP to include on its proxy ballot the nominees of shareholders who've owned at least 3% of total shares for at least two years. Each party can nominate up to two candidates.

CalPERS, and others, are also supporting additional proposal to be presented by friend and long-time advocate John Chevedden:

4. Shareholder Proposal: Separate Chairman and CEO
Sponsor: Harold Mathis, Richmond, TX
For – CalPERS believes that if the Chair is not the CEO the board may be able to exercise stronger oversight of management.

5. Shareholder Proposal: Subject Future Poison Pills to Shareowner Vote
Sponsor: Nick Rossi, Boonville, CA
For – CalPERS believes no board should enact nor amend a poison pill except with shareowner approval.

6. Shareholder Proposal: Link Pay to Performance
Sponsor: William Steiner, Piermont, NY
For – CalPERS is a firm supporter of performance based pay

WSJ Notes "New" Movement of Shareholders

WSJ names five as "part of an unusual new movement that has turned executive-pay activism into a potent mainstream force, and not just the redoubt of gadflies." Investors have submitted at least 266 shareholder proposals related to executive pay, almost double what they submitted last year.

Uniting them all is distaste for large exit packages given to ousted chief executives and recent revelations about rigged stock options. Executives who collect sky-high pay despite poor corporate performance are a particular target. Unlike the public grandstanding common to some activists in the past, this crowd prefers to work behind the scenes, often through persuasion rather than confrontation.

What is actually new are federal disclosure rules requiring companies to give investors more information about executive pay, perks and retirement benefits. Activists have been focused on executive pay for years; now they have eye-popping data supplied by the companies in their own proxies. According to the article, nearly half of the 500 biggest public companies will reveal CEO pay packages of around $100 million.

Named as representatives of the new, mainstream activism are five who have been key players, at least four of whom have been struggling on behalf of shareholders for years (How Five New Players Aid Movement to Limit CEO Pay, 3/13/07):

• Jesse Brill: He suggested directors include current and future compensation, and dubbed the result a "tally sheet." Then he aggressively promoted the notion to the 30,000 readers of his newsletters and Web sites, who include corporate lawyers, pay consultants and directors.
• Harvard Law School Professor Lucian Bebchuk is one of the intellectual engines of the pay-restraint movement, whose studies showing executives claiming a growing share of corporate profits have been cited by Rep. Barney Frank. See Pay Without Performance. Bebchuk, is playing a pivotal role in promoting a tactic for curbing compensation: revising corporate bylaws, the rules that govern companies' internal affairs.
• Meredith Miller is dubbed "the bureaucrat," since she is an assistant treasurer for the state of Connecticut. In October, she drafted a letter to 25 large companies seeking information about whether compensation consultants hired by the board had conflicts of interest. The new SEC disclosure rules don't address such conflicts.
• A mutual-fund trustee, John Hill, with Putnam, also makes the list. Last year, Putnam was among the firms that withheld their votes to re-elect directors at Pfizer and Home Depot. Mr. Hill followed up with personal letters to the CEOs.
• Unions are represented on the list by Edward Durkin, an official of the United Brotherhood of Carpenters and Joiners, who oversees governance issues for the union's pension fund and finds he's more effective when lobbying corporate executives in private.
  

European Corporate Governance Service backs DSM Loyalty Dividend

The European Corporate Governance Service (ECGS) is recommending that shareholders approve the introduction of a 10% per year "loyalty dividend," for shareholders that register their shares and subsequently hold the shares for a minimum period of three years, by the Dutch company DSM at its forthcoming annual meeting.

The company has stressed that the loyalty dividend will not be at the expense of the normal dividend whose policy remains unaltered. As such the proposal effectively offers a potential extra bonus to long-term shareholders without interfering with the one-share-one vote principle.

The resolution in question - 4.b - asks for a change in the Articles of Association of DSM to implement the loyalty dividend. ECGS favors the scheme as it provides a means for better communication between the company and its shareholders and an extra bonus for long-term holders of DSM shares. (DSM loyalty div scheme wins backing from European corporate governance watchdog, Forbes.com, 3/14/07)

ISS has apparently advised its 100s of clients which hold a stake in DSM to vote against the loyalty dividend.

Thanks to Tom Powdrill of PIRC Limited for alerting us to the issue. The concept is an interesting one and has the potential to encourage long-term shareholding if it spreads. I hope the issue get more attention.

CalFunds Up

CalPERS recorded another double-digit investment return, closing 2006 with a 15.4% gain and $230.3 billion in assets. CalSTRS fared even better, producing a 16.4% return for 2006 with $157.9 billion. During the same period, the S&P gained 15.8%, while the median public funds with more than $1 billion in assets gained 14.34%. (CalPERS reports 15.4% return for 2006, SacBee, 3/12/07)

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Cox to Keynote USC Corporate Governance Summit

SEC Chairman Christopher Cox will be keynote speaker at the Corporate Governance Summit, hosted by the USC Marshall School of Business in Los Angeles on March 22 and 23 in partnership with Resources Global Professionals, a multinational professional services firm.

Frontal Assault

Business interests are conducting a full-scale assault to ease the laws and rules laid down in response to the 2002 corporate scandals.

Last November the Committee on Capital Markets Regulation proposed to clip back corporate governance rules, class-action lawsuits against companies and auditors, and criminal prosecution of companies by the government. Then the Justice Department restricted its prosecutors‘ ability to crack down on companies that withhold confidential information during criminal fraud investigations.

The US Chamber of Commerce, which sued the SEC and won releases its recommendations this week, which calls for an end to quarterly earnings guidance from companies; proposes that auditing firms be allowed to seek private shareholders; and urges legislation allowing the SEC to ease the burden of Sarbanes-Oxley on foreign companies. Treasury Secretary Henry Paulson questioned whether the rules are hurting the competitiveness of US financial markets by driving companies away. Now the Treasury Department has convened a "Conference on U.S. Capital Markets Competitiveness" bringing together Warren Buffett, Jeffrey Immelt, Charles Schwab, Alan Greenspan and Michael Bloomberg. (Businesses decry corporate governance, Sky Valley Journal, 3/11/07)

All Eyes on Upcoming HP Annual Meeting

Hewlett-Packard's shareholders will vote on a proxy access proposal that management reluctantly included on the proxy statement.  The proposal is the first shareholder vote at a major corporation on a proxy access proposal in recent years and would allow a shareholder holding more than 3% of the stock for more than 2 years to use the management proxy statement to nominate candidates.  The measure requires a two-thirds vote of shares outstanding to pass. The vote at HP is the first on the issue since a federal appeals court ruling in September revived the ability of shareholders to pursue access resolutions.

Shareholders supporting the proposal include the nation's two largest public-pension funds, the California Public Employees' Retirement System and the California State Teachers' Retirement System, which together own about 1% of H-P's shares outstanding. The measure was sponsored by the American Federation of State, County & Municipal Employees and the retirement funds of the states of New York, Connecticut and North Carolina.

HP says the proposal will result in divisive elections; nominees could be in the pockets of special interest groups; and the forum for deciding on such issues as director elections lies with the Securities and Exchange Commission.

CalPERS says “simply seeking input is not a meaningful substitute for proxy access.” The ability to nominate directors would add value to the company by making them more accountable. Nominations would be limited to share owners that have long-term investments in the company and special interest candidates would probably be voted down if they were to get on a slate. “Open access to the proxy for director nominations is the most effective mechanism for ensuring accountability at H-P as well as at any company where share ownership exists.” (Battle Lines Are Drawn in Hewlett Proxy Issue, NYTimes, 3/9/07) “This reform is needed so investors have a meaningful way to hold accountable dysfunctional, entrenched boards that harm a company's ability to generate long-term value,” Russell Read, the chief investment officer of CalPERS, said in a March 2 statement.

In the past, the SEC's staff allowed companies to keep these proposals off their proxy statements, but a court decision late last year opened the door for them again.

Giving shareholders access to the company's proxy materials "would provide greater board accountability," San Francisco-based Glass Lewis & Co. said in a report to shareholders. "We do not agree with the company that this procedure will lead to divisive, costly proxy contests," Glass Lewis said in its report to shareholders. ISS, the nation's largest firm for advising shareholders on corporate voting issues is also supporting the closely watched proposal. Proxy Governance, the newest of the proxy advisory firms, recommended that shareholders oppose the proposal because it thinks the computer maker isn't the right target. (Advisory Firm, Glass Lewis, Supports Proxy Access At H-P, Dow Jones Newswires, 3/1/07) (Adviser Backs Holders' Bid To Gain Sway on H-P Board, WSJ, 3/2/07)

In late January, Chairman Christopher Cox said the agency would address proxy access before the 2008 proxy season. In preparation for these deliberations, Cox has commissioned a staff report on shareholder voting rights in Europe and other markets, according to the Financial Times.
Commissioner Roel Campos, who supported the 2003 draft rule, has suggested the SEC draft a rule that provides “some moderate measure of shareholder access to the proxy ballot.” He proposed that the agency allow a shareholder who owns at least a 5 percent stake for one year to propose a minority slate of nominees to appear on the company's ballot. Campos noted that the United Kingdom has a more permissive rule, allowing 5 percent investor groups to nominate a full slate, but he said that mechanism is never used because “good discussions with shareholders make it unnecessary.”

Campos said he would oppose any attempt to overrule the AIG ruling and bar shareholders from bringing access proposals. “If we can't agree on a specific course of action, then I think it would be wise not to do anything this proxy season and let the Second Circuit's interpretation stand. Then, after we see what really happens during proxy season, we can act or not act as we see fit, with the benefit of real-world information,” he said. (HP Investors to Vote on Proxy Access on March 14, ISS Governance Weekly, 3/14/07)

In other HP related news, a federal judge has dismissed a lawsuit by two institutional investors that claimed that Hewlett-Packard's board violated company policy by awarding a $21.4 million severance package to former CEO Carly Fiorina in 2005.

Don't Place Additional Limits on Class-Action Lawsuits

Arguing against a proposal to limit securities class-action lawsuits, Fred T. Isquith of Wolf Haldenstein Adler Freeman & Herz, writes that private litigation costs are paid by the investors who receive the money. "When the government acts, of course, the costs and inefficiencies are paid by taxpayers. Private attorneys' fees and expenses are disclosed and transparent. The government costs are never disclosed. What is more, the SEC is undermanned and underfunded, and, accordingly, lacks the resources to do all that should be done."

"There is no evidence whatsoever that the elimination of private litigation would result in a greater investor return of losses from stock fraud. Nor is there any evidence that the elimination of private litigation would do anything but embolden big business executives to enrich themselves further. Whether it is engaging in self enrichment through Wall Street manipulations, or the backdating of stock options, or otherwise enhancing already enormous compensation and benefit packages, or concealing their own embarrassment in making poor decisions that impact the business negatively, management will not be self-restrained. The money to be made is too big."

"The solution to America's economic problems does not lie in making it even less attractive to invest in America by increasing company-specific risk through less disclosure and enforcement. American business must forego obscene executive salaries and, instead, spend its money on education, repairing our infrastructure, and on serious research and development. American workers must not be forced by American business to compete with exploited non-American workers." (Guest Commentary: A SEC Monopoly Will Not Work, ISS Corporate Governance Blog, 3/7/07)

Why So Many Crooks?

"Why did so many intelligent, and sometimes brilliant, corporate executives commit white-collar crimes in the boardroom and executive suite?" asks Tom Walker of The Atlanta Journal-Constitution in What made execs do what they did? (3/7/07)

Walker cites the suggestion that corporate executives are akin to celebrities who "believe rules don't apply to them, or that they have the wealth to get themselves out of trouble, or that they're simply invincible."

Todd D. Kendall, who has studied celebrity behavior, found that misbehavior is clearly linked to money, or as he put it in a research report: "I find evidence that [personal] earnings are positively correlated with misbehavior."

Leonard R. Sayles and Cynthia J. Smith blame "weak oversight" by corporate directors, who supposedly run the company on behalf of the stockholders, who own it (The Rise of the Rogue Executive). A Duke University study, found 56% of the U.S. graduate students surveyed admitted to cheating.

Other theories cited included:

• The "beautiful mind" thesis holds that possibly a genetic factor that leads to brilliance also causes behavior outside social norms.
• Being rich, celebrities can hire good lawyers to get them out of trouble.
• Substitutability theory," someone who is especially talented or knowledgeable in some subject is able to get away with bad behavior because that person is difficult if not impossible to replace. There is no substitute — at lease for the moment.
• CEO's tend to be aggressive and hard-driven. Maybe their conduct should be compared with others in similar situations, rather than with the public at large.

"Business" as we know it is not a profession in the same way as medicine, the law or architecture. Those and other professions have controls and codes, require special training and licensing, and have recognized standards and enforcement procedures. "But business lacks this model," says Harvard University psychologist Howard Gardner. "You don't need a license to practice. The only requirements are to make money and not run afoul of the law." Should we license CEOs?

Chamber Members Fear Loss of Influence

The California Chamber of Commerce testified against proposed regulations at CalSTRS designed to rein in “pay-to-play” practices.

While the regulation is aimed at money managers, the chamber said it likely would ensnare far more businesses. “This blanket restriction could apply to businesses that provide information technology services, food products, insurance, building or maintenance supplies, legal services, copying services, office supplies and more,” said a representative form the Chamber.

The rulemaking would limit campaign contributions to $1,000 from companies engaged in or seeking business with CalSTRS worth more than $100,000 in income or fees to any existing CalSTRS board member or candidate, including state controller, state treasurer and the governor. Any party seeking a business relationship with CalSTRS found in violation, under the proposed rule, would be disqualified from contracts with CalSTRS for two years. Those in existing business relationship with CalSTRS would be subject to disqualification from future contracts for two years or be subject to a fine equal to the value of the amount of the impermissible campaign contribution or $10,000, whichever is greater.

The Chamber argued that enacting the regulation could prompt other agencies to pass similar ones, enacting in piecemeal fashion a stringent statewide campaign contribution limit. (Businesses Decry Pension Fund’s Proposed Campaign Giving Rule, Orange County Business Journal, 3/12/07)

Obviously, pay to play isn't restricted to money managers. I urge readers to support the rulemaking by commenting directly to CalSTRS. The Chamber is correct, if CalSTRS enacts such rules other agencies, such as CalPERS will soon follow. I once testified before a California Senate committee in favor of restricting contributions to CalPERS board members. The head of the committee indicated that if they enacted such a law, the public would soon be demanding such restrictions be placed on contributions to members of the Legislature. Yes, and I'd certainly favor taking pay to play out of that arena as well. Decisions should clearly be made on behalf of pension fund members and the public, not special interests.

I suggest CalSTRS amend the rules to further reduce such conflicts by prohibiting ALL contributions which exceed $1,000 to board members and board candidates. Those who attack public pension funds often do so, arguing that  "few politicians want to confront the powerful public employee unions," in the words of former Assembly member Keith Richman. Let's not give such give such critics any reason to doubt the basis of decisions by CalSTRS board members.

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Potential Conflicts Questioned

Two appointees tapped by Gov. Arnold Schwarzenegger to study ways to rein in public pension costs receive income from firms that invest $750 million annually for the California Public Employees' Retirement System, business ties that some say could call the panel's independence into doubt.

Among the other 10 commission members is Robert Walton, an assistant executive officer of CalPERS for the 17 years prior to his 2005 retirement. As a senior lobbyist for the California School Employees Association, Dave Low routinely is involved in issues before CalPERS and the state teachers' retirement system. The same holds for the representatives of the California Teachers Association and Service Employees International Union on the commission.

Representatives of unions -- four of the six legislative appointments -- are suspicious that the commission will be a replay of 2005 when Schwarzenegger earned their enmity by backing a plan to force new public employees to open 401(k)-style savings accounts rather than be part of retirement systems like CalPERS that pay a benefit to retirees based on salary and years of work, among other factors.

"I'm not sure the chairman of the commission should be someone who has business dealings to this extent, even though it's a minor part of CalPERS and his business," said Bob Stern, president of the Center for Governmental Studies in Los Angeles.

"Everyone around the table has one connection or another to public pension funds," said Parsky, who chaired President Bush's 2000 and 2004 California campaigns. "I think that's a good thing. You want to have people who understand the issue. (Pension reform panelists' ties to firms questioned
2 get income from companies that invest for CalPERS, SFGate.com, 3/8/07)

Get Human

Nothing to do with corporate governance but GetHuman.com provides directions for getting to a human on the phone at about 500 companies.

First Corporate Governance Billionaire?

Former SEC chairman turned hedge fund manager Richard Breeden is making headlines in the U.S. and Canada simultaneously. Negotiations with his activist hedge fund Breeden Capital have broken down after Breeden rejected the company’s offer of two board seats and he's making headlines in Canada for his role in the case of Conrad Black, whose criminal fraud trial is expected to begin next week in Chicago.

“The court-appointed “corporate monitor” at the collapsed WorldCom and an “adviser” to the special committee of Hollinger International, is on course to become the first corporate governance billionaire,” writes conservative Canadian columnist Mark Steyn in Macleans. (Rich List Billionaire - Is Richard Breeden The First Corporate Governance Billionaire?, LawFuel.com, 3/10/07)

Shareholders Need Information Act

William Ackman's Pershing Square Capital Management is suing Ceridian Corp. to compel the Bloomington company to release two letters that allegedly express concerns about the board's oversight duties and the former chief executive, according to a regulatory filing.

Pershing Square is pursuing a proxy fight against Ceridian and said the two letters are "directly relevant" to whether shareholders should support the hedge fund's nominees. Pershing Square, which has a 15.5 percent stake in Ceridian, intends to nominate eight directors at the information services company's annual meeting. (Shareholder sues Ceridian to release letters, Star Tribune, 3/8/07)

Shareholder activist Les Greenberg notes that Congress is dealing with legislation relating to shareholder rights.  Another big issue deals with amending the Freedom of Information Act to allow easier access to government agency information.  What about access to corporate information?  Now, we must make an informal request of a corporation and, when refused, file a legal action in Delaware or wherever the corporation is chartered. I agree, this is an area ripe for reform.

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Disney Shareholders Favor Rights Amendment

Shareholder activist John Chevedden alerted me to the fact that Disney investors voted with a majority of 58% in favor of a shareholder-rights plan that the company's board and management had opposed. Shareholder Proposal 2 - Stockholder Rights Plan Bylaw Amendment, received votes of 879,028,289 FOR and 626,587,117 AGAINST, with 25,884,804 abstentions. To pass, the measure needed a two-thirds majority of shareholders. Company officials said they would give consideration to creating a similar initiative. The proposal was proposed by Harvard Law School professor and corporate-governance expert Lucian Bebchuk. (Disney Shareholders Elect All 11 Directors at 2007 Annual Meeting, press release, 3/8/07)

Say on Pay

The Business Roundtable, a lobbying group of 160 corporate CEOs, spoke out against proposed legislation that would let shareholders have an advisory vote on CEO pay packages. "Corporations were never designed to be democracies.... While shareholders own a corporation, they don't run it," said John Castellani, President of the Business Roundtable, at a hearing before the House Financial Services Committee. (Testimony for the Record Of John J. Castellani, President, Business Roundtable) See the prepared testimony of leading witnesses.

US investors have increasingly been demanding a "say on pay" vote, as currently exists in the UK, Australia and Sweden. Nell Minow, co-founder of the Corporate Library, said that "requiring an advisory vote on pay strikes exactly the right balance in providing a mechanism that is meaningful but not disruptive." Richard Ferlauto, the director of pension and benefit policy at AFSCME, said that an advisory vote "must be paired with a shareholder proxy access right to nominate directors." (Investors Back 'Say on Pay' Bill, WSJ, 3/8/07) (see also, Lawmakers Debate Pay Vote Bill, ISS, 3/9/07)

Let's Focus on Board Member Alignment, Not Individual Issues

Thanks to both Mark Thomsen, Research & News Director at SRI World Group, and Les Greenberg, Chairman Committee of Concerned Shareholders, for bringing my attention to Lynn Stout's very interesting commentary in the Wall Street Journal, "Democracy by Proxy" (3/8/07). Stout argues that if passed, proxy access "would dramatically accelerate an already dangerous trend: the flight of corporations away from public investors and into the arms of 'private equity.'" (my emphasis)

Stout goes on to argue, the difference in return between the average buyout fund (25% last year) and the S&P 500 Index (14%) "strongly suggests that public investors are being left holding only stocks in the companies the private equity firms don't want to buy, apparently for good reason, or that the burden of carrying public shareholders has become a serious drag on corporate performance."

He concludes, "public shareholders have more power and influence over corporate directors and executives today than at any time in American business history. They are using that power and influence to badger companies to do everything from paying a special dividend, to cutting carbon emissions, to even reducing the CEO's pay."

Stout seems worried that shareholders will be left with the dregs: "The ironic result seems to be lower returns for exactly the same average investor whom reformers calling for 'shareholder access' say they want to protect."

Contrast Stout's commentary with Private Equity Firms and Public Policy, 3/8/2007 by Bart Mongoven, affiliated with Stratfor, which provides issues management intelligence analysis to companies so they can manage risk by anticipating political, economic and security issues. (Thanks to Peter D. Kinder with KLD Research & Analytics for forwarding the article.)

Mongoven also notes the shift to private equity firms: "Credit Suisse has estimated that the buying power of private equity in 2007 will reach $2 trillion worth of corporate stocks...More than a dozen private equity funds now have more than $10 billion in assets, with the largest nearing $20 billion."

Mongoven's primary concern appears to be "market campaigns," which exert public pressure, ranging from "public relations campaigns against corporate brands, harassment of executives or pressure on major corporate customers."

These are all possible regardless of whether the company is publicly or privately held. "But practitioners know public companies are far more likely to quickly shift under this pressure than are privately held companies. Shareholder activism plays an important role in making public companies responsive, but it is not decisive. More important is the way in which top executives' job performance is being perceived in the wake of Enron, WorldCom and other public scandals."

He goes on to note, "the judges on the sidelines take their financial cues from influential Wall Street analysts and their social cues from the activists who create and define the issues with which CEOs must deal." "As private equity increases its role in corporate takeovers, the activists who recently have found power and effectiveness in marketplace campaigning will increasingly turn back to where they were 20 years ago -- namely, to laws and regulations." In other words he is warning his clients, as more companies go private, more laws will be enacted to circumscribe their behavior.

But why do private equity firms earn so much more money?

Friends in labor tell me it is because they cut jobs, increase hours and reduce benefits.  Shareholder friends tell me private equity firms simply rob owners by making the same cost-effective changes they could have made when the company was public.  When companies are taken private, managers typically make deals that dramatically increase their share of profits in order to get them to stay. Then, all of a sudden they are inspired to create new efficiencies.

Also possible is that private equity firms bring additional insights to bear as active monitors, introducing best practices, which result in those 20-25% returns. Much of the research that I've seen shows that companies with block-holders generally do better than those with no effective monitor.  For public companies, the largest block is often held by

1. Mutual funds, which generally take a very short-term approach and don't effectively monitor management, or
2. Pension funds which may take a longer view...but again, don't do much monitoring. 

CalPERS may be among those occasionally using a winning combination. Some of their best returns have been in the "corporate governance" area where they work in tandem with private equity firms who take on the role of monitoring and restructuring.  

Proxy access by shareholders above some threshold, say 3%, would result in many more public companies having an effective block-holder willing to take on the role of monitor without taking companies private. Shareholders wouldn't be stuck with the dregs, as Stout worries, if they are protected by an active blockholder. Additionally, Mongoven's clients might breath easier, since proxy access would put shareholder focus on electing the best board members, instead of focusing on market campaigns, which try to deal with each individual issue through proxy resolutions or new legal constraints. (see also, Making 'Great Deal of Progress' On Proxy Access, SEC's Cox Says, WSJ, 3/8/07)

Disclosure May Lead to Backbone

Which came first, boardroom backbones or the law requiring more detailed disclosure of executive pay? Even though "pay for performance" is the general rule for CEO compensation, too few boards exercise their power to reduce reimbursements, even bonuses, when performance is down. Will the exception soon prove the rule?

According to an article in the Dallas Morning News, when Blockbuster's profits tumbled by 28% the board cut CEO John Antioco's bonus to $2.28 million, which came with the condition that if he protests, he gets nothing. Antioco claims that he deserves $7.65 million based on performance targets set forth at the beginning of last year.

The article notes, "normally, boards and executives work out such issues behind closed doors. But since Antioco is fighting the directors' decision, the company had to include the information on the 'disagreement' in a Feb. 27 securities filing where it said it had set aside $4.5 million for this contingency, based on accounting rules.

Maybe this case is just the result of ongoing disputes between billionaire board member Carl Icahn and Antioco. Still, as the article concludes, if "Icahn ultimately gets what he wants, executives across corporate America should beware. Their performance pay could be next on the chopping block." (Blockbuster's bonus battle gives rare public glimpse, 3/6/07)

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Owners Should Hold Majority of Seats

Rather than foist outside directors on boardrooms, argue Eric Fogel and Andrew Geier in "Strangers in the House:  Rethinking Sarbanes-Oxley and the Independent Board of Directors," the SEC and other regulators should promote a model whereby shareholders comprise the majority of public company boards, and independent directors comprise the minority.

So-called independent directors," Eric says, "did not avert the staggering corporate scandals of recent memory. Consider Adelphia, Enron and Worldcom. It stands to reason that shareholder owners—not disinterested non-owners—would demonstrate greater zeal in monitoring management of the companies they own, and should therefore comprise a majority of a public company's directors. Owner-shareholders are the most efficient profit maximizers. They'll ask the tough questions and probe because it's in their interest to do so. All shareholders will benefit as a result."

Based on return on equity, their research denotes no correlation between the best and worst performing companies and the number of outside directors. "We found no hard evidence," says Andrew, "that outside board members increased financial returns to shareholders."

Sarbanes-Oxley was a quick fix in reaction to public scandals, Eric and Andrew agree, one that is proving cost prohibitive and ineffectual for American companies eager to compete in the global marketplace. The reforms they propose are designed to pave the way for greater participation by longer-standing "oversight shareholders"—allowing owners to serve on boards of directors and enjoy safe harbors against such liabilities as ERISA, tax, insider trading and controlling party liability.

Fogel and Geier recommend that governmental and regulatory governing bodies do three things:

1. amend the public company manuals for the NYSE and NASDAQ to encourage greater owner/shareholder participation on boards;