Current News and Commentary. 2007: January, February, March, April, May, June, July, August, September, October, November, December. News Archives. Corporate governance defined. Disclaimers, Copyright and publisher James McRitchie's potential Conflicts of Interest as of 8/9/07. Book bites. Contact Presidential Candidates on Proxy Access: End the Electile Dysfunction of Choice-Free Elections. Final results of our poll are in. 40% of respondents thoght access resolutions should have the same thresholds as other resolutions. 18% thought proponents should have held their stock for 2 years. 16% wanted a threshold of 1% of owners, 12% said 1% for two years. Only 14% thought it should be 5% held for a year, as in the SEC's now dead limited access proposal. In a similar poll of ICGN members, "82% stated that shareholders should have the right to propose directors for the board of the company. 76% thought the rules and requirements for proposing directors should be no different to that for introducing other resolutions to the agenda." The SEC received 34,000 letters and emails on their proxy access proposals by the close of public comment on October 2. Short "no access" release S7-17-07 (comments). Long limited proxy access proposal, S7-16-07 Shareholder Proposals (comments). The SEC voted to strip shareowners of their rights. Thanks to everyone who opposed repealing proxy access. Cox will bring the issue back in 2008 but who will trust him? What are the next roadblocks?

January 2008

Pay Continues as Hot Issue

“We’re tired of waiting 10 years for the minimum wage to go up while chief executive pay is soaring,” said Barack Obama. Last May he authored a bill that would give shareowners a vote on company directors’ pay packages. Dow Jones reports that Hillary Clinton has signed up as well. President Bush has threatened a veto. (Let's keep the pressure on: Contact all leading Presidential candidates and tell them we also need Proxy Access to end the electile dysfunction of choice-free elections)

US candidates sign up for corporate governance (1/30/08) goes on to note "say on pay" is enjoyed by shareowners in the UK, Australia, the Netherlands and some Scandinavian countries. Resolutions increased from 7 in 2006 to more than 40 last year when the average vote in favor was 42%.

The Risk and Governance Blog says this year a network of nearly 75 funds led by Walden Asset Management and AFSCME have filed more than 90 proposals so far on the subject. Proposals have been filed with both problematic and leadership companies. Par Pharmaceuticals, Verizon Communications, and Aflac will allow for advisory votes this year, based on proposals filed last year.

"Concerns over compensation in 2008 will not be limited to calls for advisory votes on pay, though. Novel proposals will include demands for companies to adopt a policy on the use of so-called 10b5-1 stock-selling plans, and those seeking to limit or bar tax gross-ups for senior executives. Another resolution seeks to place limits on executive employment agreements."

Labor funds, led by the United Brotherhood of Carpenters’ and Joiners of America, have filed more than 50 resolutions aimed at the subprime mess, with some focused on strengthening the links between pay and performance. (see also Pension Funds Fired Up About Subprime Mortgage Write-Downs, CRO, 1/30/08) AFSCME plans to submit proposals at Safeway and SanDisk calling on them to plug a loophole for executive stock sales under “Rule 10b5-1” plans that appears to allow cancellation of trades based on insider information. "AFSCME also is submitting a new compensation-related proposal that seeks to limit the use of tax gross-ups, whereby companies cover the tax liability of executives, often following a change in control." Additional new pay related proposals are also mentioned. (2008 Preview: Pay Proposals, 1/30/08)

What We Say, Not What We Do

SocialFunds.com reports that a survey released by the Boston College Center for Corporate Citizenship and The Hitachi Foundation shows a gap between what companies say and do. "Although 73% of the 751 top executives surveyed said that corporate citizenship needs to be a priority for businesses, only 39% of the businesses include corporate citizenship as part of their business planning. An even smaller percentage of these businesses (28%) actually have written corporate citizenship policies or statements."

Additionally, while 4 out of 5 top-level executives "see the importance of valuing employees and treating them well," only 54% offer health insurance and less than a third offer training and career development for low-wage employees.

"Sixty-five percent of business leaders replied that the public has “a right to expect good corporate citizenship" yet only 29% report that they to discuss corporate citizenship with stakeholders and only 21% report to the public on these issues." (New Survey Uncovers Discrepancies on Corporate Citizenship Issues, 1/29/08)

Board & CEOs Should Hold for 3 Years After Leaving

Panelists at the World Economic Forum noted that CEOs are five times more likely to be fired than they were in 1980 for the same performance, and the average CEO tenure declined from nine to seven years between 1990 and 2005. Stock is held for an average of 11 months despite investor claims that they are in the market for the long term. Among the key highlights:

• It is important to meet investors face-to-face. In addition to being concerned by financial aspects, they are motivated by the purpose shown by the CEO and how comfortable they feel with the person at the top. In selling off non-core businesses, the fact is that shareholders will want cash. Companies can win confidence and support for new investment by clearly defining actions and reporting on progress regularly.
• Participants debated stock ownership by boards. They were generally in favour of the proposal that board members as well as the CEO should be required to keep company stock for three years after the end of their tenures. Performance-based remuneration, based on metrics such as customer satisfaction, for both management and employees, was also suggested. (Long-term Value in a Short-term World, 1/25/08)

Will Populists Drive the Fed?

I'm not an Investor's Business Daily fan but Robert J. Samuelson raises an important point in Have Populists Stampeded Fed Into A Mistake? (1/29/08) "What [Jim] Cramer and many talking heads offer are selective and sensationalized views that favor short-term conditions and immediate gratification: higher stock prices tomorrow; better trading profits."

Trying to make matters better now may make them much worse in a few years if higher inflation emerges to temporarily boost stock prices. While the 3/4 point reduction was reasonable, I don't think Cramer will be satisfied until the rate is zereo... but that leaves no flexibility for the future. Let's hope Bernanke's logic doesn't get sweeped away.

Subprime Tip of Iceberg

The Nobel Peace Prize-winning Intergovernmental Panel on Climate Change report is already out of date. The IPCC projected that only between eight inches and two feet of sea level rise would occur by the end of this century. Yet, Greenland and West Antarctica already are depositing enough freshwater into the ocean to drain the equivalent of Lake Ontario every 18 months — sea level rise in the 21st century may well end up being measured in several meters rather than in feet and inches.

Amidst the enormity of the current sub-prime lending crisis, it’s easy to see how an issue like this might get lost in the wash. Yet these two problems bear some eerie similarities—namely that the financial community is failing to properly account for underlying risks to a huge class of assets, with tremendous repercussions for the global economy as these risks play out.

Trillions of dollars of coastal infrastructure could be laid to waste—airports, highways, power plants and water treatment systems, not to mention millions of homes and commercial properties. Are investors and bankers paying attention to this important news? (Investors Face Big, Emerging Risks from Sea Level Rise, Risk & Governance Blog, 1/29/08)

Ironically, as Arctic ice vanishes at about 8% per decade, international skirmishing over oil and gas increases. The Arctic contains an estimated 25% of the world’s untapped reserves. While that could serve an energy hungry planet, it could also accelerate global warming. (The Arctic: Less Ice, More Oil, World Economic Forum, 1/24/08)

Chamber Misleads

I've written before on the recent DoL letter in response to the US Chamber of Commerce (see "Anti-Labor Rant in WSJ" below). Basically, the Chamber wrote to DoL hoping it would allow them to block discussion of social or environmental issues raised by unions that have increasingly been shown to be clearly related to the destruction and preservation of investment value. DoL responded by reiterating that pension funds regulated by ERISA cannot use the proxy process to further causes that have no clear economic benefit to the pension plan. The Chamber promptly heralded the response as "a clear message that union pension trustees need to put workers' retirement security first, instead of any political agenda."

Several articles appeared touting the letter, including one in the WSJ (The New Labor Activism, 1/23/08) by Eugene Scalia (son of Supreme Court Justice Antonin Scalia) calling on DoL to investigate activism by unions and specifically to look into their efforts to "monitor or influence management." I was happy to see the WSJ print a letter by J. Robert Brown, Jr. on 1/28/08 (Shouldn't Owners Control?) arguing that all pensions have a duty to monitor. "There is a role for the Labor Department here, but it is the examination of pension plans that still take a largely passive approach to managerial oversight."

Also of note is an article in the 1/29/08 Compliance Week (Pushing the Limits of Pension Fund Activism). In the article, Daniel Pedrotty, director of the AFL-CIO Office of Investment, says, "The Chamber is being intentionally misleading." "They are intentionally propping up this mistake because they can't get the DOL to say [proposals calling on companies to disclose political contributions] is a bad use of assets."

The AFL-CIO submitted proposals to Bristol-Myers Squibb, Eli Lilly, Johnson & Johnson, JP Morgan and others asking for twice-yearly reports disclosing company policies and procedures for political contributions and expenditures made with corporate funds. The proposals also called for identifying the person or persons in the company who participated in the decision to make the contribution. More than 50 similar measures are being submitted by a variety of sponsors this year's proxy season.

More telling is this statement: "In a telephone interview, a Chamber spokesman conceded that the Labor Department letter 'is not ground breaking.' Rather, he said, 'it puts boundaries around the activities that unions can engage in.'" -- Boundaries that were already there.

See Facts about the AFL-CIO’s Proxy Votes: The AFL-CIO’s Policies and Procedures for Proxy Voting in Corporate Director Elections.

Class Actions Up, Predicts Marshall

2008 will be a robust year for securities class action filings in 2008, according The Corporate Library. In contrast to Joseph Grundfest, who founded the Stanford Securities Class Action Clearinghouse and sees the current uptick as an aberration  due to the subprime implosion, Ric Marshall says the two-year lull that ended in mid-2007 was the anomaly. Small-caps will be more frequent targets for disgruntled investors this year.

According to Marshall, we've only seen the tip of the iceberg re financial institutions. Suits at high tech companies will be up and those at pharmaceutical companies will continue at about the same high levels. 27.1% of the companies face a high risk of being sued this year, compared with 17.5% last year. Similarly, 47.1% are rated moderate risks this year, compared with 35.1% last year. And the number of companies classified as low risk this year fell by nearly half to 21.2% from 41% in 2007.

He bases his predictions based on 35 factors, including:

• Excessive CEO compensation.
• The ages, tenures, over-commitments and lack of independence of company directors.
• 60% or greater ownership of traded stock by institutional investors.
• Conducting business within the high-tech, pharmaceutical, health care and financial services industries.
• A market cap of at least $400 million, though small-cap companies' risk is growing.
• An annual trading volume of between 2 billion and 25 billion shares.

See "Predicting Securities Litigation—2007 Year-End Report." (Securities class action risk expected to rise, study finds, Business Insurance, 1/28/08)

RMG

RiskMetrics Group (RMG), which owns ISS and offers an out-sourced proxy research, voting and vote reporting service to assist companies with their proxy voting responsibilities. . The company raised $245 million by offering 14 million shares near the bottom of its estimated price range of $17-$19 a share on January 25. The stock closed that day at $23.75. (RiskMetrics IPO Analysis, SeekingAlpha, 1/27/08) Disclosure: The publisher of CorpGov.net, James McRitchie, is now an RMG shareowner.

Another Reason to Fight Global Warming

High temperatures can reverse the sex of dragon lizards before they hatch, turning males into females. "High temperature during the development of the embryos prevented the male DNA triggering testis development," Quinn told LiveScience. "By default, they developed instead as females with ovaries."

Their study opens up the possibility that many other reptiles might face the same risk. Although reptiles have persisted through many climatic fluctuations, scientists are now concerned the current rate of climate warming might be too fast for these animals to adapt to it. (Warming Climate Reverses Sex of Lizards, Live Science, 4/19/07)

How "Independent" are Directors?

A study by AT Kearney, AZB & Partners and Hunt Partners found 90% of Indian companies in 2005-2006 appointed "independent directors" using referrals from the chief executive officer or chairman or through his personal network. Moody’s found that 75% of companies didn't even have a nomination committee. Nominations are apparently left to the controlling shareholders. (Corporate governance: Sustained growth needs better company practices, FT, 1/24/08)

Gatekeepers: The Professions and Corporate Governance
by John C. Coffee Jr.

Although the book was written in the wake of Enron and WorldCom, it is equally applicable to the subprime debacle in its analysis of “gatekeeper failure.” In a personal note to me, Professor Coffee laments, “perhaps I should have waited a year longer to write this book.” Better he should have written it a couple of years earlier, with copies to Allen Greenspan and others charged with regulating and rating the mortgage industry.

However, the book's timing could hardly be better, since substantive reform only seems to occur with a crisis. Implosion of the savings and Loan Industry brought us the Federal Institutions Reform, Recovery and Enforcement Act of 1989. Accounting scandals at Enron, WorldCom, etc. brought us the Public Company Accounting Reform and Investor Protection Act of 2002 (Sarbanes Oxley). The subprime debacle is likely to bring significant reform as well.

It would be great if those advising Presidential candidates would consult Gatekeepers in preparing such proposals. Coffee focuses on auditors, attorneys, securities analysts and credit-rating agencies who inform and advise corporate managers, boards and shareholders. After a brief introduction explaining the failure of gatekeepers and a comparative overview of their roles internationally, Coffee devotes a chapter to each of the four groups. He typically provides an informative history, a review of current issues such as conflicts of interests, and an evaluation. He wraps up the book with a thematic discussion of what's gone wrong and how it might be fixed.

In general, gatekeepers act as “reputational intermediaries” by verifying corporate statements to investors. When trusted and successful, this lowers the cost of capital. However, as Coffee notes, “Watchdogs hired by those they are to watch typically turn into pets, not guardians,” especially in the euphoric environment typified by stock or housing bubbles, when the public is typically lulled into complacency.

As management incentives were aligned with shareholders through options, income smoothing gave way to robbing the future for earnings that could be recognized immediately. Coffee explains how Enron's audit committee was blinded by professional advisers who fed it only the information senior management wanted them to have. Auditors were retrained and incentivized to sell consulting services. He explains why fund managers and gatekeepers tend to herd and why, until four days before Enron declared bankruptcy, its debt was rated “investment grade.' Only those with a financial self-interest, the short-sellers, searched beyond the surface and predicted Enron's accounting restatements. At WorldCom, “the limited due diligence that was conducted appears to have been constrained by the need not to offend the client” and the actual fraud was detected by the firm's internal auditors.

Coffee helps the reader see from a different perspective. For example, while some studies have found that audit firms with high consulting revenues were more likely to acquiesce to questionable earnings management, others found no such correlation. Coffee points out that instead of looking what is already in hand, we should look to possibilities. “The real conflict lies not in the actual receipt of high fees, but in their expected receipt.” That explains why audits became a “loss leader” to obtain consulting services.

Similarly, disclosure of conflicts of interests often does not lead to expected results. Social psychologists find those on the receiving end often let down their guard, thinking because conflicts were disclosed they are being dealt with fairly. However, the conflicted party often feels that, having made the disclosure, they are now free to pursue their own interests aggressively. Gatekeepers is filled with such insights.

The major problem is that gatekeepers have come to view corporate managers, not shareowners, as their principals. Their livelihood depends on being viewed as flexible, problem-solving and cooperative, rather than rigorous or principled. “If left to their own devices and subjected to a significant threat of private litigation, professionals will respond by defining GAAP and auditing standards in their own interest, rather than that of investors.” “Absent a litigation threat, professionals acquiesce in dubious and risky practices that their 'client' wants; but once subjected to an adequate litigation threat, professionals insist upon narrow duties, hopelessly specific safe harbors and a rule-base system that often seems devoid of meaningful principles.”

According to Coffee, “The challenge for the regulator is not to take discretion out of the system, but to preserve and expand it. But discretion must be accorded to the gatekeeper, not the client (whereas present-day GAAP does the reverse).” The gatekeeper must assess not simply whether GAAP contains a rule authorizing a given treatment, but whether discretion so exercised is reasonable. Pressure to reform must come from regulators, investors and the young that the profession hopes to recruit who would find that greater discretion enhances the professions' image in their own eyes and those of the public.

Some of Coffee's more interesting recommendations, at least as I read them:

• Break-up the major accounting firms to provide more competition.
• Establish an intermediary that receives payment from the issuer but then selects the analyst based on objective criteria, such as their record of predictions.
• Restore “aiding and abetting” liability for professionals instead of de facto immunity for knowingly or recklessly participating in fraud.
• Formalize the role of “disclosure counsel” by requiring audit committees to retain them to investigate and test corporate disclosures on an on-going basis.

Yes, you can download Gatekeepers onto your Kindle.

Glass-Steagall and Chinese Walls

Financial Week is rerunning an opinion piece, Glass-Steagall wasn't such a bad idea after all, 1/23/08. I hope it gets more attention this time around. "It’s time to rethink the Gramm-Leach-Bliley Act, otherwise known as “Sandy’s Law” (after then-Citigroup chief executive Sanford “Sandy” Weill), which nailed shut the coffin of the Glass-Steagall Act of 1933...The Depression-era law separated commercial lending from investment banking to help avoid problems arising from conflicts of interest, including shell games and Ponzi schemes involving bank-created investment funds that collapsed during the October 1929 market crash. Sound familiar?"

In the subprime mortgage variation, "securitization" helped stir credit risk are render it unrecognizable — not just within the mortgage lending process but throughout the worldwide banking system — "the same conflict-ridden sausage-making that rendered banks’ Chinese walls meaningless in the cases of Enron and WorldCom... After getting borrowers to pile on more and more debt and then masking it by taking it off their balance sheets through devices known as collateralized debt obligations and asset-backed commercial paper conduits, the banks are gearing up to pitch their restructuring talents to those borrowers."

Of course, the Great Wall of China was only a one-way barrier. It was built to keep outsiders out; not to restrict the free movement of the officials who directed its building. Today's variant seems to be working the same. Artificial "Chinese walls," or real laws to protect against conflicts of interest? We should demand the later.

Anti-Labor Rant in WSJ

Several readers drew my attention to an anti-labor rant in the WSJ (The New Labor Activism, 1/23/08) by Eugene Scalia (son of Supreme Court Justice Antonin Scalia and a partner at Gibson, Dunn & Crutcher), whose firm represents a long list of companies with serious corporate governance flaws, including Tyco, Qwest, Halliburton, HP, Wal-Mart, and Exxon -- all of which I understand share a "D" grade from The Corporate Library's Board Analyst. 

Scalia joins with the Chamber of Commerce in an attempt to mislead readers concerning a recent response from the Department of Labor’s Employee Benefit Security Administration (EBSA) that "the use of pension plan assets by plan fiduciaries to further policy or political issues through proxy resolutions that have no connection to enhancing the value of the plan’s investment in a corporation would violate the Employee Retirement Income Security Act (ERISA)." (Use of Plan Assets for Non-Plan Related Political Issues Violates ERISA) As I reported earlier this month, EBSA Advisory Opinion 2007-07A simply reiterates a previously stated position prohibiting the use of ERISA-plan funds for administrative expenses related to conveying opinions on Social Security policy and reform -- and manager selection based on those issues. 

The Chamber of Commerce had written to DoL hoping it would allow them to block discussion of social or environmental issues that have increasingly been shown to be clearly related to the destruction and preservation of investment value. They didn't get it. Yet, they and their surrogates, like Eugene Scalia, continue to use the DoL letter, and a flawed student paper out of the University of Chicago, in a veiled attempt to discredit union activism in pushing corporate governance reforms, such as proxy access.

Scalia calls on DoL to investigate "misuse" of pension fund assets. As law professor J. Robert Brown (Of Hedge Funds, Unions and Shareholder Access, theRacetotheBottom.org, 1/23/08) observes:

First, he is wrong to conclude that access is unrelated to the value of the company.  The entire debate in this area is about electing directors more focused on the best interests of shareholders.  Directors who know that they might be removed from office by shareholders have a greater incentive to do what shareholders want.  Right now the only meaningful way a director can be removed is when the nominating committee of the board decides not to renominate.  This means that renomination depends not upon promoting the interests of shareholders but upon maintaining good relations with management. 

Second, he picks on union retirement plans.  But of course other pensions plans are very involved in the governance process and using shareholder proposals to alter the behavior of management.  He doesn't explain why he reserves his ire for unions.  Of course, he no doubt has a particular dislike for unions (they did, after all, contribute to his failure to get Senate confirmation to be solicitor in the DoL).  But his analysis is transferable to all pension plans.  He is essentially taking the position that pension plans should not be actively involved in monitoring management.  Pension plans, in other words, should be seen and not heard.

Pension plans have fiduciary obligations under ERISA on behalf of their plan beneficiaries.  It is not hard to understand why this duty would compel pension plans "to monitor and to influence" management.  Brown points out that "What Scalia ought to be asking, if he is truly concerned about fiduciary obligations, is why more  pension plans do not following the path of unions and fight even harder for shareholder access.   In other words, there is a role for the DoL here but it is the examination of pension plans that still take a largely passive approach to managerial oversight." 

In 1995 I wrote DoL concerned that many pension funds weren't treating their proxy voting rights as plan assets and was told "no enforcement actions have been taken by PWBA against a plan fiduciary for voting a proxy contrary to the best interests of plan participants and beneficiaries." The DoL letter went on, "You also asked whether PWBA has ever taken action against a plan sponsor for failure to monitor the voting decisions of outside managers tainted by conflict of interest. Although such potential issues have been reviewed by PWBA in some situations, to date no enforcement action has been brought by the Department."

A subsequent 1996 DoL report found that only 25% of the investment managers automatically report votes to their pension fund clients. "The managers who did not send their reports indicated that few clients ever requested a written report." Only 35% of the plans could provide sufficient evidence that they performed substantive monitoring of their delegated authority. Although guidance 94-1 indicates prudent shareholder activism is consistent with a fiduciary's obligations under ERISA, only one investment manager reviewed for the 1996 report appears to have been so engaged. My conclusion at the time was that "the incentive of earning higher returns does not appear to outweigh the fear many pension fund trustees probably have that such involvement will alienate the members of the corporate and political communities to which they often owe their positions." (see Fiduciary Responsibilities for Proxy Voting)

Little appears to have changed. Scalia is right in one respect, DoL should investigate pension funds, but not for activism. DOL should revive its long dormant "Proxy Project" and should take enforcement action against pensions that have failed in their duty to vote proxies and use their voice to advocate on behalf of plan beneficiaries to earn higher returns.

Shareowners Rebuffed Again

The Supreme Court refused to hear a $40 billion case brought by investors against banks they say colluded with Enron. The decision was expected by many, since in Stoneridge v. Scientific-Atlanta the Court already ruled against investors who had accused suppliers of Charter Communications of colluding to deceive shareowners. (Supremes Rebuff Enron Investors, 1/22/08) The Court continues to throw obstacles in the way of those who sue secondary actors. Let's hope the next President makes more shareowner friendly appointments. For background on Stoneridge, see Supreme Court Rules on Naming Secondary Actors in Fraud Cases, SocialFunds.com, 1/22/08.

Who’s to Blame?

After investigating, the NYTimes says "someone else." "Homeowners are suing mortgage lenders. Mortgage lenders are suing Wall Street banks. Wall Street banks are suing loan specialists. And investors are suing everyone." Questions surround how much lenders and investment bankers were required to disclose to consumers, credit rating agencies, and investors.

“What strikes me here is that this a tainted system from A to Z,” said Tamar Frankel, a law professor at Boston University. The article goes on with a litany of examples and who is suing who. Apparently, securitization of mortgages involves a whole set of rules, or lack of rules, that will create a learning process for the bar and judiciary. (If Everyone’s Finger-Pointing, Who’s to Blame?, 1/22/08)

Labor coalition Change to Win's investment group will target Citigroup’s audit committee and the chair of Merrill Lynch’s nominating and governance committee, according to CtW Investment Group Executive Director William Patterson. They also sent letters Wachovia’s Risk Committee members Dona Davis Young, Donald M. James, Van L. Richey, and William H. Goodwin. Unless Risk Committee members can provide a "convincing account of their oversight activities" CtW will urge shareholders to reject their bids for reelection.

The Laborers’ International Union of North America, or LIUNA, has filed resolutions calling for enhanced disclosure of lending practices at a half dozen companies including the Ryland Group and Beazer Homes. The SEC denied Beazer's request for a “no action” petition was denied. LIUNA is asking Lehman Brothers, Washington Mutual, and Bear Stearns to report on mortgage originations and mortgage securitizations.

A proposal by Amalgamated Bank at half a dozen firms calls for the establishment of mortgage lending compliance committees, composed of independent directors to report findings and recommendations, as well as progress made, within six months of the 2008 annual meeting. However, at least one company, Toll Brothers, has obtained a no action letter.

Moody’s and McGraw-Hill, parent company of Standard & Poor’s, have also been targeted with conflict of interest proposals. Both failed to downgrade ratings until markets began to collapse. (2008 Preview: Subprime Proposals, Risk & Governance Blog, 1/22/08 and CtW challenges Wachovia directors, Investment News, 1/22/08)

Back to the top

Electile Dysfunction

AFSCME filed proxy access proposals at Countrywide Financial, E*TRADE Financial, JP Morgan Chase, and Bear Stearns, hoping they would not seek no action letters, under threat of litigation. However, Bear Stearns and JP Morgan Chase have already submitted requests. The Countrywide proposal may be nixed by Bank of America’s pending acquisition. AFSCME also submitted a proposal would require Apache to reimburse solicitation expenses for a shareholder-nominated short slate in the event that at least one of those nominees wins. This is where shareowners are likely to go without access and, as I've noted previously, it is likely to be a more expensive route for companies, since they could be paying both sides in costly battles. According to SEC's John Nester, the agency won't move forward on another access proposal until all Commission seats are filled. (Union revives proxy issue, Financial Week, 1/21/08)

The subprime recession and the SEC's rule to bar proxy access are likely to lead to more activity from Richard Breeden's Capital Management and other activists. The former SEC chair says having large shareowners on corporate boards is beneficial because they have more resources than part-time board members. "I can put eight MBAs on studying a company's problems," Breeden said. He also noted, the SEC has "fallen short" in protecting shareowners.

Herb Denton of Providence Capital also sees a banner year ahead for shareowner activists, with the economy hamstrung by higher energy costs and a credit crisis. (Firms keep blocking activist investor's goal, LATimes, 1/22/08) There will be no lack of potential targets suffering from choice free electile dysfunction brought on by the SEC's decision to close off proxy access.

Are Indian Companies Just Going Through the Motions?

Less than half of the companies surveyed believe corporate governance, especially Clause 49 (of the listing agreement) dealing with appointment of independent directors, is of some benefits to their organizations, according to a report by The Times of India. Grant Thornton found that only 45% of the companies in India feel that Clause 49 has actually benefited their organizations. Additionally, people are questioning what the penalty is for noncompliance. One has to ask if companies are just going through the motions to tick off what they thing is another useless regulatory requirement. In turbulent times, investors may seek other markets where independence and shareowner rights are more valued.

Nazareth to Leave SEC at Month's End

Annettte L. Nazareth, the last remaining Democrat on the SEC will step down at the end of the month, leaving only Republicans on the Commission at a time of market volatility when SEC enforcement officials have opened three dozen investigations into banks losses and insider trading. Nazareth joined the SEC as an adviser to SEC Chairman Arthur Levitt and later served as a division chief.

I'll remember Nazareth was the sole defender of sharowner rights voice of dissent last winter when the Commission took up "proxy access" in late November 2007. At the meeting, she said the GOP majority had worked "explicitly and unreservedly to deny shareholder rights" and raised several issues. For example, she pointed out that Long Island Care, which Cox relied upon as rationale for the need to adopt a rule, was decided six weeks before the Commission's July open meeting. It wasn't mentioned at the meeting nor in any of the 34,000 comments received on the Commission's two proposals. If the non-access rule was a temporary fix until the Commission can agree on access language, why was no sunset language included? She favored leaving access decisions up to the shareowners of each individual company. "Responsible management need not fear its shareholders," she said. Corporate governance is not well served by unaccountable directors. (see her Statement of November 28, 2007)

Replacements for Campos, who left earlier, and Nazareth are expected to be Elisse B. Walter, a longtime Washington regulator now at the Financial Industry Regulatory Authority, and Luis A. Aguilar, a corporate lawyer in Atlanta. Both are undergoing background checks, require approval from the White House and a vote in the full Senate. (Lone SEC Democrat To Leave Jan. 31, Washington Post, 1/22/08)

Number of Pension Plans Down

The total number of pension plans fell for the fifth consecutive year, by 0.6% in 2005 to 679,000 plans, according to the Private Pension Plan Bulletin: Abstract of 2005 Form 5500 Annual Reports recently released by the Department of Labor’s Employee Benefits Security Administration (EBSA). CCH, citing Spencer's Benefits Reports, said the EBSA found the number of defined benefit plans actually increased by 0.2%, while the number of defined contribution plans fell by 0.6%. The decline in defined contribution plans was led by a 20% decrease in the number of money purchase plans, after a 30% decrease in 2004, the news report said. (Dropped DC Plans Drive Decrease in Retirement Offerings in 2005, Plansponsor, 1/18/08)

If We Are Deceived but Don't Hear It Directly? (updated)

A tree falling in the forest apparently doesn't make a sound, unless someone not only hears it but relies on it. Deception alone isn't enough to establish securities fraud. Falsifying documents and other acts of deception are okay, as long as they are not communicated to the public. That's what the 5-3 US Supreme Court vote appears to be affirming in Stoneridge, reinforcing a1994 decision in Central Bank of Denver v. First Interstate Bank that there is no private right of action in federal courts against parties for "aiding and abetting" securities law violations. See coverage at theRacetotheBottom, HedgeWorld, and scotusblog.

While not as bad as one might have expected from this court, Stoneridge simply furthers the current trend of professions acting as zealous champions of their clients. Reputation is now based less on rigor and principle than ability to manipulate the rules; public interest be damned.

From Weil, Gotshal & Manges LLP: In its long-anticipated opinion, the Court, ruling 5-3,2 concluded that the implied private right of action under § 10(b) of the Securities Exchange Act of 1934 does not reach those whose acts or statements are not relied upon by investors. In so holding, the Court rejected the concept of “scheme liability” through which plaintiffs have sought to impose liability on defendants who neither made a public misstatement nor violated a duty to disclose but, rather, allegedly participated in a scheme to violate the securities laws.

From J. Robert Brown: These cases will no longer turn on whether the deceptive behavior had to involve disclosure.  Falsifying documents and other actions can be deceptive.  Future issues will instead turn on whether the deceptive act was somehow communicated to the public. 

From John C. Coffee: Of course I agree with the dissent in Stoneridge, but I think you are clutching at straws if you expect the Court to distinguish the Enron class from Stoneridge. They may remand in light of Stoneridge, but more likely they will deny cert; either way, the Fifth Circuit will hold to its position.. Stoneridge requires that there be investor reliance  and this is virtually equivalent to requiring that there be a statement. There will similarly have been no reliance on Merrill Lynch's conduct in connection with the Nigerian barge transaction. I emphasize this harsh truth because I think the issue now moves into the legislative sphere. Given Congress's dissatisfaction with the subprime mortgage debacle and the presence of many secondary actors in that mess who should not escape private liability, I think there is a real chance that Congress will seriously consider restoring aiding and abetting liability in 2009 (assuming a Democratic President).

Swap Agreements

Although swap agreements have been around for over a decade (see Swaps are Nothing But Contracts... Right Now), they appear to be getting more attention and its is about time. The NYTimes notes, A Loophole Lets a Foot in the Door. In the case reported, hedge funds suddenly owned 21% of CNet without ever having to file under the13D rule, which requires investors to disclose stakes of more than 5%.

By entering into “swap” agreements with investment banks to buy on the investors’ behalf, the funds enter into "a pseudo-off-balance-sheet deal." They don’t own the shares at all, just the “economics” of them. "The banks that put together these swaps are likely to take direction from their clients on how to vote, seeing as how those clients pay them millions a year in fees and commissions." The SEC is still looking into it, perhaps waiting for the next scandal.

Year of Boardroom Leadership

Ralph Ward notes that 2007 was the year of proxy access but hopes 2008 will be the year of "boardroom leadership." "A boardroom leader who is not a manager, retired manager, founder or majority shareholder, yet who holds real governance power, is very much a novelty in the U.S." Ward hopes to compile best practices in that area during the coming year. I wish him luck. Please send him your observations, so that he builds on as much feedback as is practical. One helpful article would be What Makes an Outstanding Chairman? Findings from the UK Non-Executive Director of the Year Awards, 2006 in CG: An Internation Review.

The January issue Ralph Ward's Boardroom Insider contains valuable tips on Shaping Your 2008 Compensation Discussion & Analysis; Making Audit Partner Rotation Work; Improving Compliance Efforts; Six Questions to Ask Before Joining a NonProfit Board, and How Not to Quit a Board. Quick insights for the busy board member.

International Review Rolls On

The latest edition of Corporate Governance: An International Review sent me to my bookshelf so I could compare it with the first edition from January 1993. Most obviously, the latest edition (November 2007 is just getting to me) is almost 500 pages, compared to less than 60. Yet the cost of a indidual subscription has plumetted from $145 to $92.

While the 1993 volume dealt with relatively broad themes like the Cadbury Report, what a is company for, and the globalization of regulation, the 2007 volume demonstrates far greater segmentation and more specifics such as, "Is There a Relationsip between Firm Performance, Corporate Governance, and a Firm's Decision to Form a Technology Committee."

In 1993 authors were setting up a corporate governance research agenda. In 2007 we had reports on the link bewteen corporate governance and performance in Bangladesh, Tunisia, Spain, Korea, and Sweden. A couple of punds of information for practitioners and academics alike. One that drew my attention was Nicholas Apostolides' "Directors versus Shareholders: evaluating corporate governance in the UK using the AGM scorecard." While one can quibble with the importance of some of the indicators, such as the quality or lack of food offered, Nicholas Apostolides is on to a good idea that I hope gets picked up around the world. Intersting, of the small initial survey, football clubs as a group placed last in that they were less inclined to hear the views of members, were more controlling of proceedings and lower standards of governance and suffarage.

Also of note is Call for proposals for Research Symposium on Corporate Governance in China and India. When:10/24/2008 - 10/25/2008. Organized by: Wiley-Blackwell Publishers and Old Dominion University. Where: Virginia Beach, USA. Contact: Shaomin Li. Proposals due March 30th. More information.

Constituency Directors

The Constituency Director, a post to the Harvard Law School Corporate Governance Blog, argues that “constituency directors,” whose board membership is traceable to a recognizable voting constituency or “sponsor,” should be entitled to advocate their sponsors’ parochial interests during boardroom deliberations as long as they make full disclosure. Joseph Hinsey goes on,

However, that concession should not extend to voting. If a sponsor’s parochial interests translate into transactional conflict, then the CD should invoke the common law procedures for director conflict (i.e., disclosure/recusal) or a corporate statute’s provisions re directors’ conflicting interest transactions.

While conventional wisdom is that a directors’ fiduciary duties entail service in the best interests of the corporation and all of its shareholders, how these obligations may conflict with that of constituents is too little discussed. We should welcome Hinsey's contribution, especially as it may apply to corporations with cumulative voting, family or venture capital representatives as well as to organizations, such as CalPERS, where the board is composed of representatives from various interest groups.

Back to the top

Global Corporate Governance Standards: Wharton Roundtable

Michael Useem argues that companies that globalize know that adoption of internationally accepted governance standards help them compete against other firms in the market for less expensive capital, converging toward a common model. Mauro Guillen, however, is not sure worldwide convergence on one model is inevitable. This may be especially true in countries with less dispersed shareholders. Additionally, appropriate structures may vary by industry or phase. He thinks the auto industry, which depends on heavy capitalization and a long-term horizon, might benefit from the Japanese system, which traditionally has featured large boards of management directors.

Marshall Meyer argues the Chinese model, which where the parent company doesn't have a board and children and grandchildren companies have board dominated by the parent company, "isn't going to change to the U.S. model." There, "independent directors" "help with technical issues, but are not expected to provide strong strategic or management direction."

Peter Cappelli agrees that global capital will play a role in convergence, but at least some local character may persist in corporate board structures and in governance practices. "Companies that want that money will have to play by their rules." However, "Different national practices can still exist if they provide acceptable levels of transparency." (Is One Global Model of Corporate Governance Likely, or Even Desirable?, Knowledge@Wharton, 1/9/08) Money will chase returns. When burned, corporate governance standards and transparency take on greater importance.

Nominating Talent

Susan Shultz, a recruiter for OakBridge Executive Search International, is quoted in the WSJ saying that nominating committees are "where directors who don't have particular expertise typically end up." Yet, the same article says, "Nominating committees are now headed for the hot seat. The pressure on them is building as new board candidates and incumbents up for re-election increasingly are subject to rejection if they don't win a majority of shareholder votes cast, and as shareholders push for the right to nominate their own board candidates." Then it quotes Richard Koppes, governance consultant "it is the next committee in the spotlight." (Where the Action Is, 1/14/08)

If the nominating committee is "where the action is," why would it be the dumping ground for those with few skills? WSJ reports more boards are reaching out to shareholders and nonCEOs for potential directors, but If nominating committees remain a dumping ground, boards won't be able to deliver and shareholders will be driven to demand more oversight. See the whole series of Corporate Governance articles in the same issue of WSJ, including The Change Agent, which profiles the activities of CalPERS advocate Dennis Johnson.

Ambitious Shanghai

Shanghai is working to put the infrastructure in place by 2010 to become a global financial center to rival New York and London by 2020. The Shanghai Stock Exchange (SSE) now ranks sixth in the world and third in Asia in terms of market capitalization and recently launched a new Governance Index to evaluate the corporate governance of listed firms. (Shanghai makes big strides in its bid to be a global financial centre, 1/14/08) One of the major problems with adopting corporate governance standards is ineffective enforcement. The new index seeks to side-step this issue through third-party review and disclosure. Time will tell if the strategy works. At this point, it still isn't clear to me just what the standards are.

Further Reforms Needed in India

Vikas Dhoot argues that Pension funds from across world flock to Dalal Street while India still waits (indianexpress.com, 1/13/08). The Sensex was at 5,000 when the government proposed switching to a new pension scheme for government employees that would allow investment of 10% in equities. Three years and 16,000 points later, the government continues to dither. Meanwhile, CalPERS and 151 other global pension funds from 18 countries have joined in the action. Jayanth R Varma, finance professor at the Indian Institute of Management argues India should go further and "open up the new pension scheme for civil servants to everybody. The option of allowing workers to invest 10 per cent in index stocks instead of individual stocks is also good as in the long run, they won’t lose their capital as feared.”

Interesting conversation at moneycontrol.com (Corporate Governance: Has it caught up in India?, 1/11/08) between Sunil Mittal and KV Kamath, the President and VP respectively of the Confederation of Indian Industry, as well as JJ Irani of Tata. Mittal noted the conversion of many to good corporate governance may not have been true belief but extra valuation and easier access to capital. Asked about benchmark standards, Mittal said Bharti Airtel has been having independent directors meeting outside the board meeting for over three years and has a Lead Director to better challenge management.

Kamath agreed and noted they had been doing the same at ICICI Bank. The independent Board meets one hour ahead and then has a very clearly thought out agenda is to what is it that they would like to talk with the executive board. He advised starting from within, "then the need for external ratings is only by the way."

Mittal advised thinking big even when small, including foreign partners and sustainable strategies. Kamath made a comparison with the quality movement. Just as companies began building quality control into the processes without it being mandated by the government, most changes towards good corporate governance will take the same route.

Irani noted that at Tata "there are more unlisted companies than listed ones. But we have made an absolute rule that even the unlisted companies have to follow exactly the same norms because one day, they may get listed and its happening as well. So whether it is the Independent Chairman and the Chief Executive or the number of Independent Directors, whatever applies under Sebi guidelines to listed companies, we make it almost mandatory to our unlisted companies. He also stressed the need to ensure the wealth created is properly distributed, not to a few individuals but to educational, medical, and cultural trusts ...definitely a long-term strategy.

The consensus seemed to be that even smaller family firms are beginning to move toward good corporate governance practices because they see it pays. In fact some restrictions, such as the limits on fees for directors attending meetings, should be lifted, according to Irani.

Caution Advised on Flame Posts

Nigel Smith, a shareholder activist, is suing four retail investors and threatening to sue 42 others for allegedly publishing defamatory remarks about him on ADVFN's bulletin boards. He has already received £20,000 in damages and costs from three other individuals. (Bulletin board posters sued for defamation, telegraph.co.uk, 1/12/08)

Gillan to RiskMetrics

Kayla Gillan will join RiskMetrics Group next month as Chief Administrative Officer. Gillan has been with the Public Company Accounting Oversight Board since its inception. I first met her when she was General Counsel at CalPERS. Gillan also serves on the Independent Advisory Board to the NACD Corporate Directors Institute, and on the Board of Governors of the International Corporate Governance Network. (Kayla Gillan to Join RiskMetrics Group as Chief Administrative Officer, press release, 1/11/08) Congratulations.

Proxy Access

According to RiskMetrics, AFSCME has now filed or co-filed binding proposals seeking shareholder access at four companies:

1. Countrywide Financial with Connecticut Retirement Plans and Trust Funds.
2. E*TRADE.
3.&4. Bear Stearns and JP Morgan Chase with state pension systems for North Carolina and New Jersey. 

Additionally, CalPERS filed at Kellwood.

Resolutions seeking reimbursement for short-slate solicitation expenses are set to appear at a handful of companies this coming proxy season. (2008 Preview: Director Elections, Risk & Governance Blog, 1/11/08)

It was bound to happen, with access denied. However, such resolutions are likely to lead to more expensive contests than would access, since proponents will spend more if they think they are likely to have expenses reimbursed. Denying access may have backfired.

SEC Protections: More Worries for Investors

The Sarbanes-Oxley Act of 2002, Section 404(a) requires smaller public companies (non-accelerated filers) with fiscal years ending after December 15, 2007 to document a Management Assessment of their Internal Controls over Financial Reporting (ICFR). Their outside auditors however, are not required to opine or test internal controls until after December 15, 2008. Of course, there have been many complaints about costs and SEC Chairman Christopher Cox indicated in a hearing to the House Committee on Small Business that he was considering extending the delay that requires auditor attestation until December 15, 2009 in order to gather cost estimates associated with the new standards.

Lord & Benoit, LLC, a SOX Research and Compliance firm has now done the research and estimates the total average cost for compliance was $53,724, about $13,000 less than the SEC estimated it would be. Costs ranged from as low as $15,000 to as high as $162,0007. The total average cost of complying with both SOX Section 404(a) and Section 404(b) amounted to $78,474. The initial prediction by the SEC was a cost of $91,000 for all public companies. Companies with multiple in-scope locations with complex purchasing, inventory and IT systems in industries such as manufacturing and distribution incurred the highest compliance costs.

The study also points to what it calls "a potential paradox." It appears that AICPA Auditing Standards for non public companies "may require even greater attention to internal control attestation on an audit of the financial statement of a NON PUBLIC company than for an audit of a smaller PUBLIC company," due to the delays in implementing Section 404(b) requirements. Apparently, companies could save money on such audits by going public. When the SEC make investors in public companies safer? (The Lord & Benoit Report:The Sarbanes-Oxley Investment A Section 404 Cost Study for Smaller Public Companies)

Even more interesting is The Lord & Benoit Report: Bridging the Sarbanes-Oxley Disclosure Control Gap. As noted in the report, the SEC Subcommittee on Smaller Public Companies recently released a draft report containing recommendations it believes will reducing the cost of compliance to SmallCap and MicroCap public companies based on investor reliance that such companies will self report material weaknesses in internal controls.

Unfortunately, the Lord & Benoit Report that only 1 in 12 companies with ineffective Section 404 controls self reported ineffective 302 controls in the prior year. Financial restatements for both accelerated filers and non-accelerated filers have increased to record levels over each of the past three years, reaching 14% of 2005 filers in each group. For those companies with ineffective internal controls, the expected rate of full and accurate disclosure under Section 302 will range between 8 and 15 percent. The highest rates of material weaknesses in Section 404 internal controls over financial reporting will be SmallCap and MicroCap companies with revenue below $250 million. It is precisely this size company, MicroCap, which produces the greatest number of errors.

Friday Humor

Straight talk from an investment analyst. Of course, the SEC's regulation AC, which requires analysts to certify that they truly agree with their own stock recommendations, now protects investors from such deceit. Sleeping any better yet? Even with that issue "dealt with," how do we protect analysts from pressures and retaliation? How do we collectively pay for research without distorting their research?

Not Just the Negative

I read so many negative items on corporate governance, it was nice to see this recent quote at footnoted.org (Put Your Money Where Your Desk Is, 1/10/08) re Steve Dussek's employment agreement as the new CEO of NII:

Additionally, we would like you to consider making a commitment to NII through an investment in our shares of at least $1,000,000 when the first trading window opens and at the latest 3 months after your start date. Then we would expect you to gradually increase your holdings up to our policy of 5 times base salary after 5 years.

Although somewhat permissive, it still seems like a good step in aligning Dussek's interests with that of NII’s shareholders.

Divestment

Cody Ferguson, a former trustee of the Los Angeles County Employees Retirement Association, offers good observations and advice in Fallacies on divestment, Pensions & Investements, 1/7/08.

Change: Not Only Presidential Candidates

FactSet's SharkWatch reports a 17% jump in the number of campaigns launched for corporate change, from 429 to 501 in 2007. Campaigns pushed for control at companies, sale or a return of cash to shareowners. 135 new activist campaigns were announced in the fourth quarter of 2007. (U.S. shareholder activism up in 2007-research firm, Reuters, 1/8/08)

Corporate Board Member Magazine

Several interesting articles in the Jan/Feb 20008 Corporate Board Member magazine. How Directors Handle (Shareholder) Rejection reminds us how little shareowners really know about what goes on in those board and committee meetings. Of course, given the undemocratic system we have, we must use the only tools we have.

Short and sweet article on what XBRL will mean for culling through data filed with the SEC entitled Coming Soon (With Your Help): The Interactive SEC. Foundations Join the Ranks of Shareholder Activists confirms in my mind that Bob Monks has been pushing in the right direction lately (see Corpocracy). As the article says, "They may be latecomers to the game, but these groups have over $550 billion at their disposal—more than enough to tip the scale in tight proxy votes." New to me was this note on the Noyes Foundation. "If shareholder activism is or will be part of your organizing strategy, the foundation is open to a funding request to enable your organization to own the minimum shares necessary to participate.” Wow, now that a commitment to activism.

I also liked Rob Norton's well balanced Let's Reform Those Draconian Sentencing Guidelines. He's right, the public wants severe punishment for white-collar criminals and high-profile cases provide fast-track career advancement to prosecutors. However, I was glad to see his acknowledgement the whole system needs reform. "More than two million Americans are behind bars (about the same as the number enrolled in universities). The country’s incarceration rate, according to Brown University economics professor Glenn Loury, is 6.2 times that of Canada, 7.8 times that of France, and 12.3 times that of Japan."

People shouldn't be able to profit from illegal activities but do we really have so many more bad people in the USA than other countries? And if Dennis Kozlowski really is reading an average of 3 business books a week in at the Mid-State Corrections Facility near Syracuse, why isn't he sending me reviews to post on Book Bites? I'm sure he has insights others could benefit from reading. Still, however, it is clear that too many white-collar criminals are getting away with no punishment at all, see Commentary / Wall Street: Always an insider's game (Pittsburgh Post-Gazette, 1/6/08). The problem is largely due to the SEC, which eliminated the short-swing rule and allowed executives with stock options to immediately sell the stock and keep the profit. SEC Enforcement Director, Linda Thomsen, admitted to "seeing deliberate, calculated misconduct" -- "rampant" insider trading. Don't put them in jail forever, but the SEC should change the rules to require discouragement of all profits and the imposition of substantial penalties, including some time in jail.

Back to the top

Top Five Defenses of Delaware

Francis G.X. Pileggi counters J. Robert Brown's "top 5 list" of cases that showed why Delaware was "anti-shareholder and anti-plaintiff" by offering a "counter-list" of 5 cases in 2007 that demonstrate that the Delaware courts take shareholder rights and the duties of directors very seriously (In Defense of Delaware Corporate Law Opinions, Delaware Corporate and Commercial Litigation Blog, 1/4/08).

• Sample v. Morgan, 2007 WL 177856 (Del. Ch., Jan. 23, 2007), where the court chided directors for being mere “unwitting and uninformed accomplices” in a plan to enrich other directors.
• In Melzer v. CNET Networks Inc., 2007 WL 4146237 (Del. Ch., Nov. 21, 2007), the Chancery Court determined that a shareholder was entitled to books and records for a period of time prior to the date of stock ownership in order to allow for the detail necessary to plead a sustained and systemic failure of oversight by the Board as described in the Caremark case.
• infoUSA, Inc. Shareholders Litigation, 2007 WL 2332543 (Del. Ch., Aug. 13, 2007) (revised on Aug. 20, 2007) serves as a litigator’s guide on how to successfully plead a derivative case to challenge allegedly excessive executive compensation.
• Netsmart Technologies, Inc. Shareholders’ Litigation, (Del. Ch., March 14, 2007), involving a private equity deal that certain shareholders sought to enjoin, the Chancery Court ruled: (i) the board did not have a reasonable basis for failing to undertake any exploration of interest by strategic buyers; (ii) the plaintiffs established a probability that the proxy is materially incomplete because it failed to disclose projections used to perform a discounted cash flow valuation that supported the fairness opinion.
• Valeant Pharmaceuticals International v. Jerney, 2007 WL 704935 (Del. Ch., March 1, 2007), the Chancery Court ordered the return of an excessive bonus based on a failure of the former director and president to prove the entire fairness of the decision resulting in a payment being paid to him in the amount of $3 million.

Brown rebutts Pileggi rebuttal with another positive result out of Delaware (The Five Worst Delaware Cases: A Comment, TheRacetotheBottom.org, 1/10/08)

• Ryan v. Gifford, 918 A.2d 341   (Del. Ch. 2007), the first of the backdating cases issued by the Delaware Chancery Court, is a thoughtful and well done piece of legal reasoning by Chancellor Chandler, written in a dispassionate legal tone.

Top 5 SRI News Items of 2007

New alternative energy and green funds fuel expansion of socially responsible investing; climate change is pushed to the forefront; community development organizations flourish despite the subprime mortgage debacle; consumers demand healthy products and work environments; and SEC limits shareholder rights. Those were the Top Five Socially Responsible Investing News Stories of 2007, according to Anne Moore Odell writing for SocialFunds.com, 1/8/08.

SIF Leadership Transition and Jobs Board

Cheryl Smith, executive vice president and senior portfolio manager at Trillium Asset Management Corporation, is the new chair of the board of the Social Investment Forum, the national membership association for the social investment industry. She replaces outgoing Board Chair Tim Smith (no relation), the senior vice president of Walden Asset Management, who served in that position from 2002-2007, who remains active as immediate past chair.

The  other 2008 SIF officers are: vice chair George Gay, CEO, First Affirmative Financial Network; vice chair Reggie Stanley, senior vice president and chief marketing officer, Calvert; and treasurer Meg Voorhes, director, Social Issues Services, Risk Metrics.

The Social Investment Forum has also created a jobs board to help those working in the SRI industry find jobs in their field, and to help its members find top industry professionals. Already, they have three exciting jobs listed.

Essential for Understanding Corporate Governance in the Global Economy

Most corporate governance research has been on large mature businesses. Many have claimed, "One size doesn't fit all."

The Life Cycle of Corporate Governance (Corporate Governance in the New Global Economy) makes an important contribution to the idea that a firm's strategic dynamics and appropriate corporate governance practices are interlinked. It examines both life-cycle stages and how these are shaped by different contexts. The book is helpful in understanding transitions such as how governance changes from start-up to maturity as well as the consequences of ownership dispersion to family firms.

This volume compiles some of the best empirical research to date on the subject and is essential reading for understanding the new global economy.

CorpGov Bites

In 2007, 1,356 CEOs were shown the door, down 8.3% from 2006’s record 1,478 departures, according a report from Challenger Gray & Christmas. (Fewer CEOs shown the door in 2007, Investment News, 1/7/08) Also of interest in the same issue. The U.S. economy is in a recession, a Merrill Lynch & Co. Inc. economist wrote in a research note to clients this morning. (Recession has arrived, say analysts)

The Canadian Coalition for Good Governance will not be supporting any regulatory changes or recommend universal backing for resolutions that will introduce mandatory advisory shareholder votes on executive compensation this year. In its position paper on the issue of "Say on Pay", the Coalition stated that Canadian companies are already making strides to improve executive compensation practices, address disclosure issues and improve shareholder involvement, and that regulations of this kind are not the answer at this time. (press release, 1/7/08)

The Stock Exchange of Thailand has targeted increasing the Thai Institute of Directors corporate good governance score of Thailand's listed companies by 5% to 74 from 71 points within this year, according to a report in MCOT English News. (SET to raise corporate governance score of listed firms, 1/3/08)

Securities and Exchange Board of India Chairman, Mr M Damodaran, ruled out any change in corporate governance norm of 50% independent board members for listed public sector undertakings. (No exemption for listed PSUs on independent director norms, TheHinduBusinessLine, 1/2/08)

Private equity investments, which crossed $17 billion in calendar 2007 and are expected to grow by 50 per cent in the year 2008, are expected to play a more active role in ensuring corporate governance and undertaking management buyouts. (PE funds set to play bigger role in '08, Business Standard, 1/8/08)

New corporate governance rules for Sri Lankan banks would force long-standing directors to retire, prevent banks giving favoured treatment to related parties and ensure separation of power between the board and executive management. (Sri Lankan banks to retire directors under new governance rules, LankaBusinessOnline, 1/8/08) The headlines are more dramatic than the details... but still appears to be real reform.

The State Environmental Protection Administration (SEPA) is proposing to force publicly listed companies in China to regularly disclose environmental information through new rules that could be finalized in the next six months. The SEPA researched annual reports of 200 Chinese public companies in 2006, finding that only half mentioned the environment and none released specific data on emissions or investment in pollution controls. Companies will have to report their key emission indexes, such as on sulfur dioxide and chemical oxygen demand, along with records and goals in energy efficiency and cutting emissions. (Corporate ecology urged in China, China Daily, 12/31/07)

SEC Set to Continue Assult on Investors

Diahann W. Lassus, CFP, and Chairman of the NAPFA industry issues task force, make an impassioned plea in the 1/7/08 edition of InvestmentNews (SEC to continue assault on fiduciary protection in 2008).

It is time for the SEC to reverse course and apply broad fiduciary duties to all those holding themselves out as trusted advisers, to everyone who undertakes financial planning (whether "comprehensive" or "discrete") and to all other investment advisory activities.

The National Association of Personal Financial Advisors is rightly concerned that the new rule will blur the distinctions between fiduciary and non-fiduciary advisors and increase the confusion of consumers of investment advisory services. The Advisers Act definition of “Investment Advisor” imposes fiduciary status upon a “person,” not an account or transaction. Clearly, people need protection more fundamentally than atransactions. The proposed language is contrary to important anti-fraud consumer protections of the Act that apply fiduciary status to “persons” who “engage in the business of advising others.”

As in its recent decision to deny proxy access, the SEC appears ready to overturn the courts and deny reasonable protections to investors, favoring instead those with undisclosed conflicts of interest. See IA-2652.

SEC to Work Around Proxy Access

Reuters ran a news item, SEC to look outside ballot on proxy access (1/4/08), saying the SEC is hunting for options to empower shareowners as a substitute for proxy access. The SEC could encourage companies to make broader use of so-called e-proxies, press for the creation of electronic shareholder forums, or encourage companies to adopt majority shareholder voting requirements. However, none of these options would create boards that are dependent for their position and accountable to shareowners. Proxy access is the best and least expensive option to accomplish that goal. Lynn Stout, a securities law professor who has been critical of proxy access, is quoted at the end of the article saying, "You might as well say you're against apple pie." In a democratic country, it is difficult to see how anyone can continue to support a model of corporate governance that allows for either a CEO dominated board or a self-perpetuating board, accountable to no one.

Nothing for Education

PlanSponsor posted an item on 1/3/08 that alarmed many. "The Department of Labor’s Employee Benefit Security Administration (EBSA) has issued its view that the use of pension plan assets by plan fiduciaries to further policy or political issues through proxy resolutions that have no connection to enhancing the value of the plan’s investment in a corporation would violate the Employee Retirement Income Security Act (ERISA)." (Use of Plan Assets for Non-Plan Related Political Issues Violates ERISA) However, EBSA Advisory Opinion 2007-07A, appears to simply reiterate a previously stated position prohibiting the use of ERISA-plan funds for administrative expenses related to conveying opinions on Social Security policy and reform -- and manager selection based on those issues. 

I suspect the Chamber of Commerce sought guidance which would have allowed them to block discussion of social or environmental issues that have increasingly been shown to be clearly related to the destruction and preservation of investment value. It would be interesting to turn the tables. I'm sure there are many money managers and plan sponsors who have conveyed opinions in favor of social security privatization or defined contribution plans. Perhaps shareowners should be introducing resolutions to at least require disclosure of such expenditures.

Suits Up

Stanford Law School Securities Class Action Clearinghouse in cooperation with Cornerstone Research released their 2007 Securities Fraud Class Action Filing Report. “One hundred companies were sued in the second half of the year, a litigation rate that reversed a trend of four consecutive six-month periods with well below average litigation activity.”  Findings include the following:

• Stock Market Volatility and the Subprime Crisis Directly Correlate with Filing Activity—Stock market volatility and the number of filings are correlated. On average, a 10 point increase in the quarterly average S&P 500 Implied Volatility Index (VIX) is associated with 12 additional litigations per quarter. In 2007, for instance, the number of companies sued jumped from 66 in the first two quarters to 100 in the last two, just as stock market volatility rose
• Subprime Fallout Skyrockets Finance Filings—The Finance sector led the way in securities class action activity with 47 companies sued in 2007, more than quadrupling 2006’s 11 filings. The subprime fallout accounted for this spike, with 25 of the Finance sector filings associated with subprime market disclosure issues. The Consumer Non-Cyclical and Communications sectors had the second and third highest levels of litigation activity with 36 and 33 companies sued, respectively.Report found that a total of 166 companies were sued in all of 2007. (1/3/08 press release and full report)

TheRacetotheBottom in Delaware

Another of J. Robert Brown's excellent year end reviews is his Delaware's Top Five Worst Shareholder Decisions of 2007. You'll need to go to his blog at TheRacetotheBottom (1/3/08) to get the details but, according to Brown, they demonstrate the following:

• How difficult it is for shareowners to put someone on the board over the opposition of management.
• Barriers thrown up by the Delaware courts to the exercise of inspection rights by shareowners. 
• Providing directors almost carte blanche to reschedule a shareowners meeting whenever they are losing.
• Refusal to allow a backdating case to go forward despite statistical evidence indicating that the practice had occurred. 
• Inappropriate willingness to comment on multiple aspects of corporate governance that transforms the Delaware judiciary into another interest group.

Shareowner Power: A Mouse Click Away

Richard D. Foley, Stephen Nieman, Terry K. Dayton and Carl L. Olson have filed three resolutions this year at the Alaska Air Group (AAG). Spending very little money, using internet site votepal.com and email, the challengers have mustered several majority votes in their continuing battles at AAG.

One resolution they have proposed this year seeks cumulative voting, which they argue "allows a significant group of shareholders to elect a director of its choice - safeguarding minority shareholder interests and bringing independent perspectives to Board decisions." Another resolution seeks "say on pay" to "provide our board with useful information about shareholder views on our company's senior executive compensation, as reported each year."

However, a third resolution is the most interesting. If successful AAG's bylaws would be amended to require, barring other legal restrictions, the disclosure of "identification and contact information to the fullest extent possible by technology" of shareowner proponents, including functioning hyperlinks.

Foley believes implementation of the proposal would achieve "98% of what proxy 'access' seeks" and that "shareholders in this country would simply be 'a mouse click away from information freedom.'" That seems a little exaggerated. If you can't put the names of your director nominees on the proxy, management won't have to list the sponsor's site. Shareowners are still locked out.

However, for the continuing battle over resolutions, adoption of a requirement to provide an active link to the proponents site would represent substantial progress. AAG will be one shareowner's meeting worth watching for. (for historical background, see A 'Shareholder Tsunami,' SocialFunds.com, 5/31/05)

Deloitte to Pay for Improprieties

Deloitte & Touche LLP has agreed to pay more than $38 million to settle claims related to an accounting scandal at Delphi Corp., according to Grant & Eisenhofer, co-lead counsel for the lead plaintiffs, Teachers' Retirement System of Oklahoma, Public Employees' Retirement System of Mississippi, Raiffeisen Kapitalanlage Gesellschaft mbH, and Stichting Pensioenfonds ABP. (Deloitte to Pay $38 Million in Delphi Case, CFO.com, 1/2/08)

Back to the top

Sustainable Production

The Story of Stuff is a great little 20-minute look at the underside of our production and consumption patterns. If it only could have been mandatory viewing before the shopping season.

Edwards Pledges to Give Shareowners New Rights

"As president, I will immediately cap untaxed deferred compensation for executives. I will also give shareholders new rights and responsibilities so that they can call shareholder meetings, remove directors who aren't acting responsibly, and have a say on executive pay." (My Plan to Stop Corporate Abuses, WSJ, 1/2/08) Of course, I would have liked to see him explicitly include proxy access for shareowner director nominees, but he seems to be on the right track. It would be great to hear from the others.

Looking Back at 2007 and Forward to 2008

The biggest stories of 2007 for Corpgov.net were the SEC roundtables, proposals, and withdrawal of access to the proxy for the purpose of electing shareowner director nominees.

The Supreme Court's decision in Long Island Care appears to have been used by Chairman Cox as a pretext for declaring a state of increased uncertainty, when reality was exactly the opposite. Cox also argued anti-fraud measures were needed to protect shareowners. However, the disclosures he proposed in the SEC's limited access proposal for submitting a resolution were far more burdensome than what is required in actual takeover contests. The disclosure issue appears to have been aimed more at discouraging access resolutions by requiring an overabundance of red tape, than actually providing protection to shareowners.

Expect more of the same in 2008, as Cox brings the issue back and attempts to link it with the NYSE's proposal to eliminate broker voting and more restrictions on shareowner resolutions. Roger Headrick's brief "win" at CVS/Caremark in 2007, based on a margin decided by broker votes, ensures that issue won't go away. Expect more such votes in 2008.

Although many shareowners have lost all faith in Cox's SEC as a protector of shareowners and look to the next administration for real reform, Cox can be expected to keep these issues on the table, perhaps hoping to reach a legacy “compromise.” Shareowners should take this opportunity to discuss not only proxy access but also broader associated topics, such as how to encourage long-term ownership and how to involve individual shareowners in corporate governance.

The attempt by the European Corporate Governance Service in 2007 to give long-term shareholders a 10% per year "loyalty dividend" represents the continuing struggle to find some way to encourage long-term holding, as stock churn continues to gain momentum. Future SEC roundtables should include discussions of this and other options. To address fading participation by individual shareowners, Stephen P. Norman's idea of client directed voting and Mark Latham's ideas around proxy voting brand competition might yield positive results.

While we at Corpgov.net have long looked to “universal owners” as the force that will bring better alignment between shareholder value and social responsibility, the SEC's actions and Robert Reich's book Supercapitalism highlighted the role of individual investors who actually have the power to vote in civil elections. We plan to be working on ideas to facilitate proxy assignment. Getting individual investors to think in terms of corporate governance brands may be one of the important keys in aligning the values and interests of corporations, their owners, and the larger society.

The struggle for direct access to the proxy hasn't lost a beat. AFSCME and several public pension funds will submit resolutions at companies that brought us the subprime mess and the next possible recession. Even if they meet with resistance in the court of law, they are sure to win in the court of public opinion.

Cox's one personal victory that arose out of the access rule, electronic shareholder forums, should increase the ability of shareowners to coalesce. Last year saw a continued increase in the use of such forums, even without the liability protections offered by the SEC's new rules. Continuing to build on earlier efforts by the Committee of Concerned Shareholders led by Les Greenberg, were the Association of BellTel Retirees' forum on Verizon, Eric Jackson's efforts at Yahoo and Motorola, and Richard Macary's AVI Shareholder Advocacy Trust.

The power of shareowners continued to increase as evidenced by the increased number of forums, such as “How Institutional Shareholders Are Gaining the Whip Hand …and What It Means for You as a Public Company Director,” sponsored by the Silicon Valley Chapter of the NACD.

Shareholders gave strong support to proposals that sought greater board accountability, such as those requesting annual investor votes on executive pay (beginning with Aflac), majority voting in director elections, board declassification, and the right to call special meetings. Companies are now implementing before resolutions even come to a vote. A few other signs worth noting in no particular order:

• Continued decline of the staggered board - 52% overall, down from 55% in 2006.
• Increased call for disclosure of corporate political spending may eventually reduce the influence of the Business Roundtable. (Now there's a long-term vision!)
• The strange experience of Whole Foods Markets, a late adopter governance reforms for such a large company. Medium and smaller companies should learn from their experience and avoid similar mistakes.
• Pfizer's invitation for dialogue with its largest institutional investors.
• Purchase of Glass Lewis by the Ontario Teachers Pension Plan. Will a proxy advisor "owned by investors for investors" make a difference? Clearly, they could if they opened their eyes to a new model by providing voting services for organizations of individual investors, such as AARP, AAII, Responsible Wealth, and others, creating competition by brand for retail votes.
• The $41.5 million settlement by five directors at Just for Feet. Directors who fail to do the homework necessary to make informed decisions will face increased liability of a type that seems unlikely where directors are actually nominated by shareowners.
• The shift of listings to London and elsewhere, where investors have more rights, and North Dakota's enactment of the most shareholder friendly incorporation provisions in the United States led many of us to wonder if the “race to the bottom” is finally turning around.
• Foundations and endowments are increasingly aligning their portfolios and voting with the values of their missions. If Robert Monks is correct, and I have little doubt he is, the actions of these thought leaders will influence others in the larger investing community.

As we move into 2008, Corpgov.net will continue to bring you news you aren't likely to find elsewhere and we will attempt to involve readers. For example, we recently brought your attention to Les Greenberg's request for a Congressional investigation of the SEC's abrogation of its authority. We ask that you join with us in writing to Congressman Frank in support of Greenberg's request. Congress should investigate the relationships between the SEC, SROs, and SICA to determine what reforms are needed to reduce conflicts of interests and ensure the best interests of the investing public will be served.

We will also continue efforts to reform public pension funds, which have been so crucial in obtaining corporate governance reform, to ensure that their own ethics and governance epitomize good governance. Our hope is that reforms at CalPERS and CalSTRS will carry over to corporations.

Landmark regulations to crack down on so-called pay-to-play practices, where money managers and firms attempt to parlay political gifts into lucrative investment deals, took effect on November 28 at CalSTRS. McRitchie's proposal for election reforms, including “instant runoff voting” (IRV) will get another hearing at CalPERS in 2008. How long will it take to institute IRV in corporate elections?

Shareowners are still trying to get the right to vote against the one candidate nominated for each position, instead of symbolically withholding votes. First we need to complete the reform to require majority elections. Then we need more than one candidate running for many board positions. Eventually, we may have three or more candidates for some positions. At that point, we'll be pushing for IRV. Yes, we're in it for the long haul.

J. Robert Brown's List of SEC's Most Anti-Investor Actions

1. Denying shareholders access for proposals that would sometimes require the inclusion of shareholder nominees in the company's proxy statement.  Chairman Cox' efforts to demonize hedge funds. 
2. The decision to approve the merger between the NYSE and Euronext (and the merger between the NYSE and NASD) without ensuring adequate enforcement of listing standards.
3. The Commission's inactivity in areas of critical importance to investors, particularly direct communication between street name owners and the company.
4. Chairman Cox' efforts to demonize hedge funds. 
5. The efforts to use the SEC to promote a political agenda by highlighting companies with operations in countries designated as "state sponsors of terrorism." (SEC's Five Most Anti-Investor Actions of 2007, TheRacetotheBottom, 1/2/08)

Proxy Solicitation Expense May Drive Accountability to Shareowners

According to RiskMetrics, "dozens of 'say on pay' proposals—calling for an advisory vote on compensation—have been filed, once again placing the issue front-and-center during the annual meeting season." However, those focused on the real shift in power will be watching AFSCME's binding proposal calling for the reimbursement of "reasonable expenses … incurred in connection with nominating one or more candidates in a contested election of directors to the corporation's board of directors, including, without limitation, printing, mailing, legal, solicitation, travel, advertising, and public relations expenses" at Apache.

AFSCME officials point to a footnote in the SEC's new rule on director elections that indicates agency officials will not approve the exclusion of certain proposals, including those that relate to the reimbursement of shareholder expenses in contested elections. (AFSCME Files Proxy Solicitation Expense Proposals, 12/27/07) With access cut off, shareowners have been forced to pursue this more expensive option.

Worst Footnote of 2007

Qwest’s (Q) decision to amend its employment contract with Ed Mueller, which gave Mueller’s family access to the corporate jet, won footnoted.org's contest for worst footnote of the year hands down. Just under 60% of those who voted selected that footnote as the worst in 2007. The stock is down nearly 30% since the contract was amended.

Fund Support

Fund Votes found the Berkshire family of funds voted 100% with management during the 2007 proxy season. At the other end of the spectrum was Citizens Funds, which voted with management 42% of the time and supported 75% of shareowner resolutions.

Board Meetings Are Formal Events

Directors often think that if they get together that is a real board of directors'  meeting. Not so. As this decision holds, a board meeting is a formal event that must be preceded by the appropriate notice, be conducted by voting on the issues and otherwise be properly called and conducted. Gatherings of even all the directors that do not meet these tests are void.

Moreover, the consequence of holding a meeting void is that actions taken cannot be ratified later. Thus, even when all but one of the company's directors wanted to fire the CEO, their attempt to do so at a haste gathering of all the directors was ineffective. (Court of Chancery Holds Board Meeting Is Void, Delaware Business Litigation Report, 12/13/07)

Protecting the Status Quo

J. Robert Brown's final comment of