Classes & Research

Code of Conduct: Windowdressing or Binding?

The International Labor Rights Fund (ILRF) filed a class action in Los Angeles Superior Court on behalf of the employees of Wal-Mart’s overseas suppliers to find out. The ILRF argues Wal-Mart’s “Standards for Suppliers,” which specify wages, hours of labor, and environmental conditions constitutes a binding contract. Wal-Mart is likely to claim it is simply a goal to work toward – an aspiration. An excerpt follows:

As a supplier, you are asked to sign the document for our records. Wal-Mart is required to keep all signed copies of the Supplier Standards for Direct Imports on file. Buyers working directly with suppliers forward all signed copies of the Supplier Standards to the Wal-Mart Vendor Master. Wal-Mart requires that a poster version of the Supplier Standards in the local language and English be placed in each production facility servicing Wal-Mart.

Companies might do well to review any of their own such codes to ensure mere hopes and dreams are clearly labeled as such and real standards are enforced. (Labor Group Holds Wal-Mart To Code Of Conduct, Corporate Legal Times, November 2005)

Majority Vote: Real Democracy or Illusion?

That’s essentially the question asked by Phyllis Plitch, writing for Dow Jones Newswires in an article entitled Critics Fault Changes to Board Votes (WSJ, 11/29/2005) The common element of the new majority vote policies is that directors will be asked to tender their resignations if they get more “withhold” votes than “yea” votes. This is to avoid the situation where even a vast majority of votes against (withheld) results in their election under plurality voting. The issue being raised is that in many cases these new voluntary guidelines are not legally binding.

Ed Durkin, director of corporate affairs for the United Brotherhood of Carpenters and Joiners of America and the driving force behind the majority vote movement, “thinks having a legally binding “no” vote is important, in part because it will force investors to give serious thought to how they cast a vote.” We would advise doing away with plurality voting. Shareholders should be able to place their nominees on the corporate proxy and elections should be decided by instant run-off voting.

SEC Proposes Proxy Option

The SEC voted in favor of an alternative model by which companies conducting proxy solicitations could satisfy Rule 14a-3 requirements to furnish proxy materials by posting them on an Internet website and providing shareholders with notice of their availability. Companies could potentially save about $500 million a year or more in printing and postage costs. According to the SEC, “other soliciting persons also would be permitted to follow the proposed alternative model.” For further information, contact Raymond Be, Special Counsel, Office of Rulemaking, Division of Corporation Finance, at (202) 551-3430. 

Cox said the SEC probably won’t eliminate paper copies. “Some investors will always prefer to avoid computers at any cost,” Cox said. “In a nation of 300 million people, we can’t have a one-size-fits-all approach. But even investors who continue to get their proxy statements mailed to them will benefit from electronic delivery because it’s their money we’ll be saving.” Companies are estimated to spend $5 on printing and mailing each package containing a proxy statement and annual report. The cost of postcards would be small by comparison. Supported by all five commissioners, the proposal, which is now subject to a 60-day public comment period, would not take effect until 2007.

Persons other than the company that are soliciting proxies would be able to rely on the proposed “notice and access” model in substantially the same manner as the company, with appropriate changes in the information required in the Notice. Potentially, that could make it somewhat easier for shareholder activists to reach out to other shareholders. However, activist still face legal challenges and many other expenses.

Similarly, the NYSE proposed to the SEC on Sept. 30 that they eliminate a requirement that listed companies physically distribute annual reports to shareholders if companies make their annual financial statements available on their Web sites. (SEC Considers Proxy Rule Changes To Allow Web Delivery, Compliance Week, 11/29/2005) (SEC may back online proxy posting, Chicago Tribune, 11/29/2005) (SEC press release, 11/29/2005)

Corporate Watchdog Radio

Tune into a new half hour radio show and audio/video podcast, Corporate Watchdog Radio. Hosted by attorney Sanford Lewis and journalist Bill Baue, it originates on the 1st and 3rd Wednesday of the month but you can listen to it anytime. The show seeks a national audience, with a frequent focus on SRI topics. On a recent show, they interviewed SRI investor and author John Harrington (The Challenge to Power: Money, Investing And Democracy). Upcoming shows include Robert Monks on the future of shareholder democracy. Check it out this great resource.

Webb Challenges HK “Reforms”

Under the Hong Kong government’s proposals, 100 of 800 new seats on the expanded Election Committee would go to the industrial, commercial and financial sectors which are dominated by corporate voting.

In almost any democracy, there are strong, well-financed corporate and special-interest lobbies, and depending on the quality of campaign finance laws, they can be very influential on government policy, but the difference is that they are nothing more than lobbyists without a vote of their own, and ultimately those democratically elected governments have to make policies that as a whole are acceptable to the public who elect them by universal suffrage, or they won’t win re-election. By contrast, the HK Government’s mandate, and its support in the Legislative Council, is dependent on just a tiny fraction of the population who control the corporate and special interest votes.

We encourage readers to subscribe to David Webb’s informative independent newsletter on corporate and economic governance, business, finance, investment and regulatory affairs in Hong Kong. (Corporate Voting in HK Elections, 11/28/2005)

Focus on Strategy Needed

According to a study by the consultancy Booz Allen Hamilton, of all the value destroyed by the largest US companies between 1999 and 2003 (including Enron, Tyco and friends), just 13 per cent was the result of failures of regulatory compliance or board oversight. Eighty-seven per cent was caused by strategic or operational error. The constant pressure on boards to spend more time on investor relations and meeting regulatory requirements was diverting attention from strategic and operational issues, thus perversely increasing the chances of corporate failure.There are now 273 governance codes in place around the world.

1. Prescriptions based on it don’t seem to work. ‘Good’ governance according to the codes may or may not prevent fraud (Enron ticked all the boxes at the time).
2. Share options that were intended to align director interests with shareholders generated perverse incentives for fund managers and executives first to collude in hoisting share prices above their underlying value and then to use any means to keep them there.
3. Where there is a reported 90% churn of FTSE stockholdings annually, the idea of ownership and the primacy of shareholder rights, the fountainhead of agency theory, simply dissolves. (Compliance, the corporate killer, Guardian Unlimited, 11/27/2005)

Greece Gets Poor Grade

Only 33% of the companies have complied with the Combined Code of corporate governance as compared to 60% in Great Britain, according to a survey by Grant Thornton and the University of Economics of Athens. In over half of the companies, the president of the board was formerly the CEO or currently holds that position too. The survey also found little transparency in announcing the hiring and assigning new BoD members. (Greece: 33% of Companies Adopt Corporate Governance Directive, Reporter.gr, 11/25/2005)

Sebi May De-list

The Securities and Exchange Board of India said listed entities could face stiff penalties, including de-listing, if they do not comply with corporate governance norms, such as having at least 50% independent by the year-end. (Sebi may de-list corporate governance defaulters, The Economic Times, 11/25/2005) A study by Business Line last week of the 50 companies that constitute the Nifty shows that just one of the nine PSU companies in the index — BHEL— complies with the requirement. Companies will also have to submit a Compliance Report to the stock exchanges every quarter on the composition of the board, Audit Committee and its functioning and disclosures on related party transactions, subsidiaries, etc. (A Clause that must be enforced, Business Line, 11/27/2005)

Pensions Hedge Bets

Pension plans and other large institutions are expected to invest as much as $300 billion in hedge funds by 2008, up from $5 billion a decade ago, according to a study by the Bank of New York and Casey, Quirk & Associates. Critics wonder whether it makes sense to rely on investments whose returns are hard to predict, managed by private partnerships that disclose little about their operations, and charge the highest fees on Wall Street. (Pension Officers Putting Billions Into Hedge Funds, NYTimes, 11/27/2005)

Lack of Trust in Asian Businesses

An Edelman survey of 131 fund managers in 10 countries found lack of trust as a prime issue.  Only 23% of Asian-based fund managers trust businesses to “do what is rigt.”  Trust was even lower for company executives; 1 in 5 trust businesses to “do what is rigt.”  Nongovernmental bodies were the most trusted organizations, perhaps reflecting the growing importance of socially responsible investing, the environment and worker rights. Governments were the next most trusted organizations, with the media coming in last. (FT, Funds sceptical over Asian businesses, 11/22/2005) At least we can still trust the Financial Times. 

China Loosens Up

China is going to exempt licensed overseas investors from a capital gains tax and make it easier for them to invest in a number of ways, according to Money Management Executive. Investors will be able to sell holdings after 3 months instead of a year. China is increasing the $4 billion limit it had imposed on foreign investors to $10 billion. China also plans to speed up the application process and lower the minimum asset threshold it now requires of foreign investors. Currently, that is $10 billion in assets and an investment commitment of $50 million.

The Shanghai Composite Index and the Shenzhen Index are down 9.7% and 12% respectively so far this year. (China Seeks to Entice Overseas Investors, 11/21/2005) Will these measures be enough to turn that around. I doubt it. Something is wrong when investors are losing money in one of the world’s fastest growing economies and making it easier to invest doesn’t address more fundamental issues of democratic corporate governance.

ESG Goes Mainstream

Compliance Week reports that Mercer Investment Consulting has begun rating investment managers on their environmental, social and corporate governance (ESG) voting, as well as their success at integrating ESG issues into mainstream investment analysis. No longer a fringe part of the investment community, “a growing number of clients were starting to ask how they can incorporate ESG issues into their investment decision making,” says Jane Ambachtsheer, a principal with Mercer Investment Consulting in Toronto.

A survey by Mercer Investment Consulting released earlier this year found that 73% of 190 regional investment management organizations polled predicted that incorporation of ESG performance indictors will become mainstream within 10 years, and 65% predicted that positive or negative screening will be mainstream within 10 years. Mercer apparently wants to be on the front of that wave. Mercer consults institutional investors, including pension plans, churches, and charities, in 35 countries. (Firm Begins Rating Investment Managers On ESG Issues, 11/22/2005)

Elson Seeks Investor Involvement in Board Nominations

The current issue Directors & Boards (4th Quarter 2005) includes an advice snippet from eleven board members and governance experts. The most responsive was from Charles Elson, Edgar S. Woolard Jr. Chair in corporate Governance and director of the John L. Weinberg Center for Corporate Governance at the University of Delaware.

…”Large investors need to take a more active role in the board nomination process – seeking either director of indirect representation. Directors representing large equity interests tend to be highly motivated and effective management monitors. Rules and norms, both legal and market-based, that restrict such involvement need to be re-examined and reformed to encourage this kind of activity. This is the biggest single change to our governance system that I believe is now necessary to ensure better board functioning.”

Elson is leagues ahead of the others who call for boards to “strengthen the focus on strategy,” “be better informed,” “know what and where all the risks are,” “get passionate about the company’s mission,” etc. Compared to Elson’s response, most sound like answers from Miss America contestants. Charles Elson, you’re at the top of the class.

Runner-up advice came from Greg Taxin, CEO of Glass, Lewis. We need to “encourage more ‘noisy exits.’” “Directors should resign when they detect incorrigible malfeasance on the part of management. This would serve to alert shareholders…it is curious we do not see more noisy exits by independent directors who come to realize they cannot change value-destructive behavior.” One reason just might be that they want to get appointed (there are really no “elections”) to another board. That isn’t likely if they make a noisy exit because boards want team players. Taxin, maybe you’re just too idealistic but its better than calling for a “pull back on the ‘separating roles’ movement.

Dennis A. Johnson

The Corporate Board (November/December 2005) includes a conversation with Dennis A. Johnson, Senior Portfolio Manager for Corporate Governance at CalPERS. Johnson has 24 years of industry experience in investment management and proxy voting policy.

Johnson indicates that executive compensation disclosure and transparency will be at the top of their list of priorities. They’ll be looking for paying continued attention to compensation “paid outside of the bounds of employment contracts, such as those surrounding transactions with accelerated vesting and option bonuses.”

Important secondary issues will include greater transparency and disclosure of corporate environmental liabilities. Johnson also said they would be pursing proxy access to the board ballot and that he is “fortunate to be surrounded with incredible people on our staff. See contents of current issue.

China Looks Past U.S.

Wu Chen argues in “View From China” that the uproar over CNOOC’s failed bid to purchase Unocal and the fiasco in the wake of Hurricane Katrina have eroded Chinese admiration for American capitalism. (CFO.com, November 2005) Also from CFO.com, mark your calendar for a free webcast –Good Governance, Smart Performance: Turn Improvements in Your Financial Closing Process into Drivers for Excellent Performance – Sponsored by Cognos. January 17, 2006.

Board Evaluations Up

A survey by Corporate Board Member and PricewaterhouseCoopers found that 84% of respondents say their boards conduct formal evaluations; 37% evaluate individual board members. This compares to 33% and 19% respectively in 2002. Individual evaluations were rated “very effective” or “effective” in the 2005 survey, compared with 37% in 2002. Fully 58% of those surveyed got a raise during the year, 73% felt their risk had increased over the same period and the average number of hours per month on board activities has gone from 19 to 22 in the last year.

Although most governance experts believe a separate board chair, lead director or collaborative process should set the board agenda, 74% of survey respondents say primary responsibility should fall to the CEO. Only 53% of boards get information about employee values and job satisfaction. Growing topics of discussion may be their company’s competitive position, strategic planning, and majority vote director elections. CEO compensation will also be up as a topic since 70% of those surveyed admit to having trouble controlling it and shareholder a likely to submit more proposals on this topic than ever. (Research by Nixon Peabody found 42% of Forutne 100 companies increased disclosure of some exec perks in their 2005 proxy statements, according to CFO.com, 12/2005. Even the October Reader’s Digest carried an article, $54,000 Per Hour) Another topic that begs for attention is crisis planning, since 51% say their boards haven’t even discussed it.

Mutch Joins Governance Game

Peregrine Systems CEO John Mutch plans to launch a $250 million hedge fund to invest in tech firms that need a corporate governance overhaul. “Mutch has first-hand experience with what could happen with poor corporate governance. San Diego-based Peregrine, which makes software businesses use to manage their information-technology assets, got hit by an accounting scandal that resulted in multiple indictments of former executives on fraud charges.” (New hedge fund eyes governance, MarketWatch, 11/18/2005)

Shareholder Empowerment is Alive and Well

That, according to Sister Pat Wolf, executive director of the Interfaith Center on Corporate Responsibility (ICCR), a shareowner engagement network of more than 275 faith-based institutional investors with assets of about $110 billion. The evidence? William Baue cites the following:

• Sister Pat is in constant demand as a speaker.
• The United Brotherhood of Carpenters and Joiners and other unions are re-filing resolutions seeking director elections by majority vote–the resolution recently received 61.2 percent support at KLA-Tencor (ticker: KLAC).
• Growing number of companies adopting a policy that asks directors who get a majority withhold vote to resign.

Baue reminds us that Bob Monks pronounced the “death of shareholder democracy” after the SEC allowed ExxonMobil (XOM) to omit his third-year resolution requesting a separation of CEO and chair roles. (Shareowner Empowerment Is Alive and Well: a Preview of the 2006 Proxy Season, 11/16/2005)

But I’m sure Bob would readily admit, we’ve never had shareholder democracy, so it was never born to die. A coalition of CEOs, money market managers, and politicians keeps the machinery of laws and regulations working against us. For example, ADP, the large processor of proxy votes, reported that 23% of the votes in the 2002 proxy season were cast by brokerage firms that lacked instructions from shareholder, and every vote supported mangement.

Bob has tilled the soil and planted many seeds: requiring pension fund fiduciaries to vote soley in the interest of plan beneficiaries, founding ISS to provide advice on how to vote and LENS to show there is money to be made in creating more democratic corporate structures, writing numerous books and articles to awaken generations, convincing the SEC to require disclosure of mutual fund votes and policies…to name just a few. I just hope he lives long enough…I hope I live long enough, to see democratic corporate governance take hold.

Owners Have No Say Over Teflon Directors

Forbes and The Corporate Library found that many who were directors of Enron, WorldCom, Adelphia Communications, Global Crossing, Waste Management, Tyco International and others during periods of fraud and abuse are still overseeing companies.

Many companies don’t make it easy for shareholders to find out where their directors have been. Sprint Nextel’s biography for William E. Conway, for instance, mentions nothing of his stint at Enron. Nor will you find the Global Crossing (nasdaq: GLBC – news – people ) directorship of Eric Hippeau among the listed achievements in his Yahoo! bio. Director biographies on the Web sites of Lockheed, Viacom, Coca-Cola, Avon Products (nyse: AVP – news – people ) and Overstock.com (nasdaq: OSTK – news – people ) also fail to mention service at Enron, Global Crossing or WorldCom. Viacom and Coca-Cola point out that their practice is to mention only current affiliations.

Forbes.com notes “This is possible under the current system, in which shareholders only get to withhold votes for, and not vote against, a director. Since boards usually propose only as many nominees as there are available seats, even a single vote could give someone another term.” The fight for more democratic corporate governance still has a long way to go but appears stalled under the Bush administration. (Teflon Directors, Forbes.com, 11/17/2005)

Stausboll Interim CalPERS CIO

Attorney Anne Stausboll has been named as Interim Chief Investment Officer (CIO) at CalPERS, following the recent resignation of the pension fund’s current CIO Mark Anson who will step down in January to become Chief Executive Officer of Hermes.

Stausboll is currently the Assistant Executive Officer of CalPERS Investment Operations. She formerly served in the CalPERS legal office for six years, including two years as Deputy General Counsel. She left in 1999 to become General Counsel for California State Treasurer Phil Angelides, and was later appointed Chief Deputy Treasurer in July 2000. She returned to CalPERS in 2004 to help lead CalPERS investment operations.

CalPERS expects to name a new CIO in the next six to eight months after a global search. (Press Release, 11/16/2005)

KSU Corporate Governance Center Honored

The National Association of Corporate Directors, Atlanta chapter, recently recognized the Kennesaw State University’s Corporate Governance Center, which is celebrating its 10th anniversary this year.

Center Director and professor of management and entrepreneurship Paul Lapides, accounting professor Dr. Dana Hermanson and forensic accountant Bobby Vick, of Vick & Co., were each presented with a plaque recognizing their “pioneering vision and ongoing leadership in the field of corporate governance.”

Founded in 1995, the center is composed of more than 20 professors from 10 universities, and is nationally recognized as one of the leading providers of corporate governance information to directors, CEOs and other senior executives, researchers, professors, advisers and the public. That same year, KSU became the fifth school to offer director-education programs, joining Harvard, Wharton, Stanford and Northwestern. The center’s programs and services promote effective corporate governance for public, private and nonprofit enterprises.

“The vision we had was to become a leading source of information on corporate governance for anyone who might be interested in the field,” Lapides said. “There was, and still is, a tremendous opportunity for directors to improve what they do, and to increase their understanding of what their duties and responsibilities are as directors.” And, true to that vision, over the last 10 years the center has consulted with practitioners, authored relevant research, and provided expert and unbiased analysis to the news media.

“The Kennesaw Governance Center is a jewel in the realm of director education and research institutes,” James Kristie, editor and associate publisher of Directors & Boards, said. We congratulate the Center, especially Paul Lapides, on their 10th anniversary …the same age as CorpGov.Net.

Frank CEO Pay

The Protection Against Executive Compensation Abuse Act, sponsored by Rep. Barney Frank (D-Mass.), takes aim at CEO pay. Frank cited a study showing that in 2003 the top five executives at each US public company received compensation that on average amounted to 10.3% of their employer’s profit, up from 4.8% in 1993.

The Business Roundtable said it would oppose the measure — although spokeswoman Tita Freeman couldn’t say why until they read the proposal. The bill would require publicly traded companies to:

• Provide all details about how much executives earn in cash, incentives and perks each year, and submit the packages for shareholder approval.
• Disclose the full market value of company-paid perks, such as an executive’s personal use of a company jet.
• Publicly report the specific criteria by which executives earn incentive pay and return any bonuses or incentive pay if their company restates its earnings downward within 18 months of when the award was granted.
• Tell shareholders “in a clear and simple form” how much the executive officers stand to make on a proposed takeover or acquisition that requires shareholder consent.

The average CEO took home a 91% raise in 2004, according to Corporate Library, even as workers got raises amounting to less than 4% on average. (Bill Targets Executive Compensation, LATimes, 11/11/2005)

Hidden Financial Risk

Hidden Financial Risk: Understanding Off Balance Sheet Accounting by J. Edward Ketz examines the methods that companies use to hide the failings of managers, directors and auditors who allow questionable accounting methods. Here are a few snippets to give you a flavor of the book.

“When a corporation controls the operations of another company, it should consolidate the operations of both. When the parent applies the equity method instead, we can be sure that it is hiding debt.” (p. 70)

“Use of operating lease accounting ‘gains’ the managers an understatement of their firm’s financial structure by 10 to 15 percentage points.” (p. 101)

“Pension expense includes the service cost plus the interest on the projected benefit obligation minus the expected return on plan assets plus the amortization of various unrecognized items, such as the unrecognized prior service cost. The only item found on the balance sheet is the prepaid asset or the accrued pension cost, which in turn equals the pension assets minus the projected benefit obligation minus various unrecognized items.” (p. 123)

Regarding special purpose entities, “consider investing only in those companies that consolidate their SPE debts…Do not invest in those that play games…or those that refuse to recognize the liabilities.” (p. 143)

Boardroom Tea Leaves

Ralph Ward’s Boardroom Insider warns us to look beyond good governance checkboxes. “Half of the current GM board members have ‘retired,’ ‘former,’ or ‘emeritus’ in their titles. Further review of this board’s other members (including Karen Katen, president of Pfizer and Ex-Compaq chief Eckard Pfeiffer) raises another concern — none seem to have any experience actually making or marketing cars. In short, the board of General Motors seems shaped not to oversee a growing, dynamic enterprise, but to equitably manage the affairs of a dying one — seemly, workmanlike executors of a corporate estate.”

CCO Errors

Bob Mueller, a contributing editor with the IT Compliance Institute, discusses 7 common errors firms make in their frenzy to hire chief compliance officers or corporate compliance officers (CCOs) or chief governance officers. (Seven Mistakes Companies Make in Hiring a Chief Compliance Officer)

1. Thinking of compliance as an IT issue. “While CCOs should have the technical savvy to understand IT’s role in the compliance picture, they should generally have a broader business background and knowledge base.”
2. Hiring someone without industry-specific expertise. “The food and drug industry, for example, functions in an entirely different regulatory environment than, say, banking.”
3. Failing to set job goals before hiring. “Most companies have never hired a chief compliance officer before, and they haven’t thought through what they expect from a CCO or even what the full scope of compliance is.”
4. Failing to involve departmental stakeholders in the decision. “Compliance occurs within the major business units.”
5. Undermining the position’s authority. “Just assigning a compliance officer means nothing if that compliance officer doesn’t have what it takes to get the job done.”
6. Omitting background checks. “CCOs should be untainted by the sorts of abuses regulations are meant to discourage.”
7. Low-balling compensation. Pay enough to keep them. “When it comes to compliance leadership, instability introduces risk.”

Effective Board Engagement in Strategy

That’s the subject of a talk by Beverly Behan of Mercer Delta Consulting scheduled for Thursday, December 8, 2005 in Sacramento.

The management and the board need to define a process that draws from and leverages the knowledge and insight around the board table. Those organizations that succeed to effectively engage their boards on strategy will effectively drive the mission. In the absence of effective board engagement, the management runs the risk of moving forward with a strategy neither buys into nor really understands. This is a dangerous combination as it can lead to a lack of support and knee-jerk decision making that may not be in the best interest of the organization or its shareholders. Such a combination can ultimately lead to board action that affects the very involvement of the leaders in the organization.

Join us if you’re in Sacramento. Event sponsored by the Sacramento Subchapter of the Northern California Chapter of the National Association of Corporate Directors. CorpGov.Net’s publisher, James McRitchie, will be there.

Bribes Not at Issue for SEC

According to a 11/8/05 press release by Harrington Investments Inc (HII), the SEC has okayed Monsanto’s right to keep an HII resolution on bribes off the corporate proxy. The resolution requested the Board of Directors to establish an oversight committee of independent directors to insure compliance with the Monsanto Code of Conduct, the Monsanto Pledge, and all federal, state and local government laws, including the Foreign Corrupt Practices Act. Monsanto has apparently admitted bribing Indonesian government officials, violating federal law, and the company code of conduct.

“Shareholders can’t nominate Monsanto directors and can’t vote against corporate self-nominated directors. Corporate directors can be elected by one “yes” vote. Moreover, this shareholder resolution that the SEC is allowing Monsanto to keep off the ballot is advisory only. Even if the shareholders voted to support independent director oversight, it would not require the company to comply. Stalin would love this system,” said John Harrington, President and CEO of HII. “Clearly, the SEC leadership under Christopher Cox, who was on the corporate dole while in Congress, cannot be relied upon to protect the interest of shareholders, the legal owners of publicly-traded corporations.”

The press release goes on with a list of complaints, crimes, and fines. Corporate democracy at work. Are we disgusted yet?

Nappier Vows End to “Scavenger” Hunts on CEO Pay

Connecticut’s State Treasurer Denise Nappier is focusing on six companies and may introduce resolutions next year to bring CEO pay under control. Patrick McGurn, of Institutional Shareholder Services thinks “this is going to be the breakout year” as shareholder express their growing frustration.

According to The Corporate Library, CEO pay growth doubled last year, with a median increase of 30% compared with 15% the year before and 9.5% in 2002. Median total compensation at the largest companies is nearly $6 million. Companies, such as Merck, have failed to tie pay to perfomance. They awarded then-CEO Raymond Gilmartin a $1.38 million bonus after the earnings collapse brought on by the failure of Vioxx. And that was on top of $34.8 million from exercising stock options and a new grant of 250,000 options.

Total compensation for James Bagley, CEO of Lam Research Corporation, increased by 7,440%, triggered by over $31 million in stock option profits. According to the survey, six of the ten companies whose CEOs received the highest increases in Total Compensation underperformed their peers in stock price appreciation over the previous five years. (press release)

Even the usually guarded Charles Elson, of the Weinberg Center for Corporate Governance, says “I think the excesses have just gotten to the point opposition has reached critical mass.” Nappier will urge companies to clearly disclose their executive compensation in one place on the proxy statement. “As investors, we should not have to engage in a scavenger hunt.” (Executive pay sparks ire of institutional investors, Newsday, 11/8/05)

UN Fails to Follow Own Guidance

Bloomberg reports, the United Nations often ignores its own “Global Compact” when investing its own fund. Apparently, fighting anti-pollution, labor rights and other standards of corporate responsibility, isn’t so important that it stops the UN from business as usual. (UN Ignores Own Standards in Investing $29 Billion Pension Fund, 10/31/2005)

Fiduciaries Should Include ESG Factors

According to Bill Baue’s article, Fiduciary Duty Redefined to Allow (and Sometimes Require) Environmental, Social and Governance Considerations, “The longstanding conventional wisdom that fiduciary duty precludes environmental, social, or governance (ESG) considerations in institutional investment decisions was overturned by a report released at the United Nations Environment Programme Finance Initiative (UNEP FI) Global Roundtable.” While I doubt all objections to ESG considerations will immediately be dropped, the worldwide scope of the report and the reputational strength of its authors, London-based Freshfields Bruckhaus Deringer, should add increased credibility to inclusion of such factors.

Here is a short excerpt from the portion of the report dealing with the United States:

While there continues to be a debate about the exact parameters of the duty, there appears to be a consensus that, so long as ESG considerations are assessed within the context of a prudent investment plan, ESG considerations can (and, where they affect estimates of value, risk and return, should) form part of the investment decision-making process. Some state laws go further. For instance, Connecticut state law expressly permits the state pension fund industry (the Treasurer) to consider the social, economic, and environmental implications of its investments.

There appears to be no bar to integrating ESG considerations into the day-to-day process of fund management. Indeed, this would seem to follow inexorably from the acceptance of modern portfolio theory and the discretion that gives trustees to fashion diverse investment strategies – provided the focus is always on the purposes or beneficiaries of the trust and not on securing unrelated objectives. Although the Department of Labor has on occasion appeared to support an investment-by-investment approach to decision-making, case law and the weight of commentary indicates that US courts would almost certainly apply the modern portfolio approach in evaluating challenges to investment decisions. That is, while not entirely free from doubt, it appears that the bare profit maximisation of individual investments has not survived the modern prudent investor rule.

Ratings May Vary

In Spotting the next Tyco, Marc Gunther highlights the differences among rating firms the Corporate Library, Institutional Shareholder Services (ISS), and Governance Metrics International. While the Corporate Library gives Home Depot, Lucent, Wells Fargo, and Viacom grades of F, only Viacom get low grades from each of the services.

Gunther notes “The Corporate Library gives subpar grades of D or F to 162 of the FORTUNE 500, including such blue chips as Wal-Mart Stores, Exxon Mobil, GE, Chevron, Citigroup and Time Warner. With that many companies tagged, the odds of picking up one or two cases to brag about are pretty good.”

The proof may be in how well funds do that use the ratings as an investment strategy. According to Gunther, “Monk and Minow have seeded two small funds (assets: about $100,000 each) that buy shares of firms with better ratings and short low-rated ones.” That doesn’t sound like much of a gamble. “ISS, meanwhile, has formed a partnership with the FTSE Group to create six investable indexes, each of which eliminates companies with the lowest governance scores.” For more information on the FTSE Group/ISS effort, see FTSE ISS Corporate Governance Index Series. So far, no mutual fund families have implemented such an approach, but that time is coming.

$10,000 Award Offered for Testing Turbo Democracy

The Problem, according to TurboDemocracy.org, is that uninformed voters elect poor leaders in governments and corporations, resulting in waste, pollution, war, and numerous other problems that many of us are all too familiar with. The Solution is TurboDemocracy, which empowers voters by letting them pay news media with public (or corporate) funds. This allows the news media to provide better coverage. Their reimbursement can fluctuate based on the usefulness of the information they provide, as determined directly by voters. More informed voters will elect better leaders. To test that theory, TurboDemocracy.org is offering $10,000 to a university student council willing to implement the idea on an experimental basis. Contact: Mark Latham.

TurboDemocracy is an outgrowth of Latham’s proposal that shareholders join together to hire a corporate monitoring firm to provide unbiased advice on corporate election issues. We hope a demonstration of TurboDemocracy will reinforce and reinvigorate the efforts of the Corporate Monitoring Project as well.

New Valley

The Special Committee of the Board of Directors of New Valley Corporation (NASDAQ: NVAL) has recommended New Valley stockholders reject Vector Group Ltd.’s (NYSE: VGR) exchange offer to purchase the outstanding shares of common stock of New Valley that it does not already own.  As set forth in the Committee’s press release (abbreviated by GorpGov.Net), below, the Committee found Vector’s offer of 0.461 Vector shares per share of New Valley to be “inadequate and not in the best interests of the holders of the shares of Common Stock, other than Vector and its affiliates”.

This recommendation concurs with the views already expressed by New Valley’s largest independent shareholder, Lawndale Capital Management,  in its October 18, 2005 13-D filing with the SEC. The Special Committee has authorized its financial advisor, The Blackstone Group, L.P., to continue discussions with Vector’s financial advisors. At a fair and appropriate valuation for NVAL, Lawndale supports a combination of the two companies, which would reduce or eliminate both the inherent conflicts of interest and operational inefficiencies that have existed between New Valley and Vector.

A full account of Vector’s offer and subsequent proceedings may be found in New Valley’s form 14D-9 Recommendation Statement filed with the SEC on November 2, 2005.

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

NEW YORK–(BUSINESS WIRE)–Nov. 2, 2005
The Special Committee of the Board of Directors of New Valley Corporation  (NASDAQ: NVAL) today announced that it has recommended to stockholders of New Valley that they reject the previously announced exchange offer made by Vector Group Ltd. (NYSE: VGR) to purchase all of the outstanding shares of common stock of New Valley that it does not already own. Vector commenced its offer on October 20, 2005 and the offer is currently expected to expire at 5:00 P.M. on December 1, 2005. In response to the offer, after careful consideration, including a thorough review of the offer with the Special Committee’s independent financial advisor and independent legal counsel, the Special Committee has determined on behalf of the board of directors of New Valley that the offer is inadequate and not in the best interests of the holders of the shares of common stock of New Valley, other than Vector and its affiliates. Accordingly, the Special Committee recommends that holders of shares of common stock of New Valley reject the offer and not tender their shares of common stock of New Valley pursuant to the offer. In accordance with the federal securities laws, the Special Committee filed with the Securities and Exchange Commission on behalf of New Valley a Solicitation/Recommendation Statement on Schedule 14D-9 stating this recommendation.

CONTACT:
Kirkland & Ellis LLP
Stephen Fraidin, 212-446-4840

Consultant Wanted

The Russia Banking Sector Corporate Governance project, an initiative launched by IFC with support from the Swiss State Secretariat for Economic Affairs, aims to improve the corporate governance practices of Russian banks. Project activities include training and consultations on corporate governance for banks as well as work on legislative reform. For two separate legislative reform initiatives in Russia, one in the area of corporate registrars and another in the area of corporate reorganizations, the project is looking for proposals from: Consultants (firm or individual) specialized in either

• legal issues related to corporate registrars, or
• legal issues related to corporate reorganization

The Consultant is required to:

1. Deliver a written position paper on corporate registrars (or corporate reorganizations), drawing on experiences from international best practices;
2. Submit amendments and/or a draft law on corporate registrars (or corporate reorganization); and
3. Attend working group meetings in Russia to present the position paper and to discuss further reform initiatives.

Liability Issues Abound

From an article in 10/31/05 issue of Pensions & Investments, it appears that liability issues may abound at both DB and DC plans. An article entitled “Fiduciary lapses more harmful that scandals, consultant says” reports on two studies by Mercer Human Resources Consulting. One looked at 200 plans and found “as many as 90%” of the DB plans had errors in calculating vesting, while “70% had miscalculations in benefits.” At DC plans, “85% filed to correctly determine eligibility and contributions.” While most errors involved calculations, they also found problems such as “failure to deposit employee contributions in a timely fashion.”

The other study looked at a subsample of 30 governance reviews. It found that 28 of the 30 “had no up-to-date governance committee charter and 27 of them suffered from deficiencies in committee processes. These findings regarding governance raise a question. How can the fiduciaries demonstrate their decisions are “in the best interest of plan participants,” when the vast majority have inconsistencies (25 out of 30) and neither charters or processes are up-to-date? How are they avoiding personal liability? It looks like trouble on the horizon.

To help plans address these issues, Mercer developed what they pitch as Mercer Fiduciary Management Diagnostic, or Mercer Fiduciary MD.

Stong Companies, Weak Countries

The OECD is inviting public comment on a draft risk management tool for investors in weak governance zones, designed to help companies manage their operations with integrity.

A weak governance zone is a place where government is not working – public officials are unable or unwilling to assume their roles in protecting rights, enforcing the law and providing basic social services. About 14 per cent of the world’s people live in such areas, notably in sub-Saharan Africa. For international business, they represent some of the most difficult investment environments in the world. Challenges include endemic crime and violence, extortion, solicitation and human rights abuses.

We encourage not only businesses to comment but also investment funds. CalPERS, for example, has essentially black-listed investments in such zones. Can they use the OECD guidelines to help them make investments in strong companies in weak zones? Draft text for public consultation. Comments may be sent to Kathryn Gordon, Senior Economist, OECD Investment Division:Kathryn.gordon@oecd.org by 10/23/2005. 

ISS Increases M&A Service

Institutional Shareholder Services (ISS) has expanded its research offerings to include in-depth and independent reports on high-profile mergers and acquisitions as well as proxy contests. The new offering, called M&A Insight, is designed specifically for investment professionals who want to evaluate the merits of a transaction through a combined financial and corporate governance lens.

Global Boards

The Wall Street Journal carried an article recently entitled “Globalizing the Boardroom” (10/31/2005). The essential message was that companies world-wide are adding foreign directors, but boards in the US have been slow to follow.

“A 2005 survey by recruiters Spencer Stuart found that only 35% of 149 large U.S. businesses have at least one non-American director, a modest rise from 31% in 1999. By contrast, about 90% of Europe’s largest concerns by market capitalization boast one or more directors from outside their home country. At about 49% of those 99 companies, there is at least one American on the board, up from about 35% in 1999.”

This puts US firms at a disadvantage in the global market. Many problematic examples are cited, from Disney and Hewlett-Packard to Wal-Mart. Yet, too often we here the same tired refrain. H-P’s Robert Sherbin is quoted saying that big U.S. companies are all competing for the same “small pool” of foreign candidates. Other excuse American firms because of the cost and inconvenience of travel. But Board members don’t all have to be CEOs and with teleconferencing, travel impediments are no excuse. Plasma screens and computerized agendas can facilitate participation that is as close to being there in person as is practical. We’ve run out of excuses.

ICI Releases Report on Ownership

The Investment Company Institute released a report on fundamentals of ownership. An estimated 53.7 million households and 91.3 million individual investors own mutual funds in 2005, according to an ICI press release.  Almost 36 million households own mutual funds inside an employer-sponsored retirement plan, while 39 million own funds outside of employer-sponsored plans. Household ownership peaked in 2001 at 52% and gradually slipped to 47.5% in 2005. 

ICI notes that “mutual funds continue to be largely a middle-class investment product: More than half of U.S. households that own mutual funds in 2005 have incomes between $25,000 and $74,999.” Yet, looking at their published tables, it is obvious that mutual fund ownership is disproportionate in favor of households earning more than $50,000.

Chevedden Report: Anti-Poison Pill votes

The redeem or vote poison pill topic won 84% at Sun Microsystems and 66% at Sara Lee on October 27 based on yes and no votes. The 84% vote at Sun even exceeded the vote for at least one of the directors who received a paltry 76% vote. William Steiner was the proponent at both companies.

FundAlarm

The November Highlights and Commentary at FundAlarm opens with a discussion of a disturbing practice among some mutual funds that build histories as “incubator funds.” Delaware Small Cap Core is cited as using “one of the industry’s most cynical, most deceptive, entirely legal, and still largely unregulated practices…..For the first six-and-a-half years of its existence, Small Cap Core was in ‘limited distribution.’” The limited distribution funds that do poorly are dumped; those that perform well are offered to the public.

“During most of the incubation period, the fund had a different name, different managers, a different style of investing, a more concentrated portfolio, a small and stable asset base, a lower expense ratio, and it didn’t extract a 12b-1 fee…..In other words, the current fund is essentially new, yet it’s being marketed with a track record that was carefully cultivated under totally artificial conditions.”

“Delaware isn’t alone in this practice. Since 1999, Putnam’s board acknowledges that the firm has incubated 16 funds, only one of which made it to market. Yes, Putnam’s board is in on it, the entity that’s supposed to represent investor interests.” I’m wondering how widespread this practice is and why it hasn’t been made illegal?  It sounds like something the industry should deal with before the practice gives the industry a bad name.

Chevedden Proposal to Boeing

Shareholder proposal (under Rule 14a-8) submitted to Boeing today in response to Boeing announcing that Mr. James McNerney will be Boeing’s new everything – chief executive, chairman and president.

[June 30, 2005]
3 –Chairman of Our Board to Have Oversight Responsibilities Only

Stockholders request that our Board of Directors change our governing documents to require that the Chairman of our Board serve in that capacity only and have no management duties, titles, or responsibilities.

When a person acts both as a corporation’s Chairman and its CEO, a vital separation of power and responsibility is eliminated – and we as the owners of the corporation are deprived not only of a crucial protection against conflicts of interest, but also of a clear and direct channel of communication to the corporation through our Chairman.

What stockholder-damaging conflicts of interest can be more serious than those that so often occur when overseers are allowed to oversee themselves? When a corporation’s Chairman is also its CEO, such conflicts can and do happen.

It is well to remember that at Enron, WorldCom, Tyco, and other legends of mis-management and/or corruption, the Chairman also served as CEO. And these dual roles helped those individuals to achieve virtually total control of the companies.

Clearly, when a Chairman runs a company as Chairman and CEO, the information received by directors and others may or may not be accurate. If a CEO wants to cover up corporate improprieties, how difficult is it to convince subordinates to go along? If they disagree, with whom do they lodge complaints? The Chairman?

Thus this proposal is consistent with our company’s prodigious effort to improve company ethics.

Stockholders must continue to expect the unexpected unless and until they help cause company boards to be composed of substantial majorities of independent and objective outside directors – and until those directors select a chairman those who is similarly independent of management.

Chairman of Our Board to Have Oversight Responsibilities Only
Yes on 3

Submitted by shareholder John Chevedden of Redondo Beach, Calif.

SEC Affirms Independent Chair Rule

As expected, the SEC voted to affirm a controversial rule that requires mutual fund companies to appoint independent chairmen for their funds. Reconsideration was required after the U.S. Court of Appeals for the District of Columbia questioned the high costs that would be incurred by fund companies and also ordered the SEC to consider alternatives to rule. A new study that concludes the financial burden would be minimal was presented at the hearing.

The U.S. Chamber of Commerce, which brought the suit against the SEC that put the mutual fund rule before the U.S. Court of Appeals for the District of Columbia Circuit, threatened to sue the agency again. (SEC requires independent mutual fund chairmen, USA Today, 6/29/05)

A Wall Street Journal editorial said Donaldson was flouting the law. The editorial questioned an SEC investigation of Fidelity Chairman and CEO Edward Johnson “for the oh-so-grave sin of possibly having accepted free tickets to an Olympic event from a Wall Street firm. Mr. Johnson — who has run Fidelity scandal-free for some 30 years — happens to be among the most vocal critics of the mutual fund rule. Could the leak have been an act of SEC vindictiveness?” (A Lawless SEC, 6/29/05)

Scrushy Wants Back

Acquitted on all counts of directing the HealthSouth accounting fraud, Richard Scrushy is seeking a return to his former job. His name won’t be among nominees to the board, said HealthSouth spokesman Andy Brimmer in an e-mailed statement.

Scrushy may find it difficult to mount a challenge to management’s slate of directors, said Ben Nahum, portfolio manager at David J. Greene & Co., which owned about 844,000 shares of HealthSouth. ”No one will vote for him,” Nahum said in a telephone interview. “Trust me, he has no support outside of those 12 idiots they found to sit on the jury. The man’s a criminal.” (Scrushy seeks a return to glory, Miami Herald, 6/30/05)

On Scrushy’s acquittal, “I think it’s a huge disappointment for everyone who was counting on Sarbanes-Oxley to rein in excesses in the corporate suite,” said Thomas Donaldson, professor of business ethics at the Wharton School of the University of Pennsylvania. “It proves once again how easy it is for people at the very top to isolate themselves from both knowledge and responsibility,” said Donaldson, who testified before Congress during deliberations on the Sarbanes-Oxley law and pressed for tougher criminal penalties.

Prosecutors may have made a tactical error by bringing the case on Scrushy’s home turf in Alabama, where the former executive was a popular figure for his outspoken religious views and generous philanthropy. (Scrushy acquittal a setback for US corporate crimes clampdown, 6/29/05)

Cure for CEO Psychopaths

Alan Deutschman has an interesting article in July’s Fast Company. “Is Your Boss a Psychopath?” starts out discussing Robert Hare’s “Pschopathy Checklist” and his contention that many recent corporate scandals could have been prevented if CEOs were screened for psychopathic behavior. “We screen police officers, teachers. Why not people who are going to handle billions of dollars,” says Hare. This summer, Hare and Paul Babiak began marketing B-Scan, a personality test that companies can use to spot job candidates who may have an MBA but no conscience. I’ll be interested to learn if it catches on.

Babiak says organizational shake-ups create a welcoming environment. “The psychopath has no difficulty dealing with the consequences of rapid change; in fact, he or she thrives on it. Organizational chaos provides both the necessary stimulation for psychopathic thrill seeking and sufficient cover for psychopathic manipulation and abusive behavior.”

Corporate psychopaths score high on factor 1, the “selfish, callous, and remorseless use of others” category, which includes eight traits:

• Glibness and superficial charm
• Grandiose sense of self-worth;
• Pathological lying
• Conning and manipulative;
• Lack of remorse or guilt;
• Shallow affect;
• Callous lack of empathy;
• Failure to accept responsibility for one’s own actions.

On factor 2, which pinpoints “chronically unstable, antisocial, and socially deviant lifestyle,” corporate psychopaths score only low to moderate. It appears that business executives are more likely to be “successful psychopaths,” in contrast to criminals who are too impulsive and physically aggressive, making them more likely to wind up in jail.

Bosses from hell listed in the article’s margins include John D. Rockefeller, the most corrupt mogul of the most corrupt era; Henry Ford, with his secret police; Walt Disney, a suspicious control freak; and Ivan Boesky, who routinely screamed at his staffers and never said he was sorry.

Deutschman then compares corporate psychopaths to “productive narcissists,” who include people like Steve Jobs, Jack Welsh, and Bill Gates. Narcissists also see people as a means toward their ends, are poor listeners, and can be touchy about criticism but in their eyes they are improving the world. In contrast, psychopaths, we are informed, are only interested in themselves and enjoy hurting others.

Europe and Asia are far ahead of the US, according to Deutschman. Europe has a growing “antibullying” movement and new laws in France and Sweden. Asian countries have long emphasized community bonds rather than individual glory. Deutschman concludes, “Unless business makes a dramatic shift, we’ll get more Enrons – and deserve them.”

But are such issues likely to be resolved by administering B-Scan or any other test to prospective CEOs? I think not. The solution isn’t picking a benign dictator.

T T Rammohan’s editorial in The Economic Times of India, Only first among equals, addresses the core issues. Rammohan discusses Morgan Stanley and their recent decision to ask its CEO, Philip Purcell, to leave. There are more detailed accounts in the Wall Street Journal but Rammohan makes the important point that “Mr Purcell’s departure was forced by a systematic campaign carried out by former executives of the firm.”

The board, “mostly handpicked by Mr Purcell, initially did what most boards tend to do. They reflexively sided with the CEO.” Then, under the threat of a proxy battle, “both the board and Mr Purcell threw in the towel.” Rammohan argues, “the Morgan Stanley board may have unwittingly underlined a hitherto neglected principle, namely, that the CEO is not everything in a firm, he is merely the most important face of the firm.”

Rammohan credits Rakesh Khurana popular book, Searching for a Corporate Savior, as highlighting the idea that the cult of the charismatic CEO is a recipe for corporate disaster. “This is because charismatic authority tends to discourage criticism, concentrate authority and pursue grandiose visions in disregard of legal or ethical norms. Such leadership thus carries within itself the seeds of future disaster.”

The remedy, according to Rammohan, is to ensure there is a “chain of succession and that power is widely dispersed.” “Boards must recognise that they cannot be guided by the CEO alone in matters relating to the corporation.” He praises the corporate governance reform that has led boards at more companies to have regular meetings without the CEO.

The success of the democratic ideal rests on the belief that the pooled wisdom of many is superior to that of any one individual. If this applies to nations, it applies to corporations as well. Ensuring that the CEO is only first among equals, not an absolute monarch, is crucial to the health of corporations.

We need more mechanisms that push corporate structures toward democracy such as:

• Independent boards who are accountable to shareholders,
• Audits that provide information necessary for shareholders to hold management accountable, instead of focusing on hypothetical future owners,
• Split chairs and CEOs,
• Majority voting requirements for electing directors, and
• Shareholder access to the corporate proxy for nominating directors.

We can’t afford to pay an Elliot Spitzer clone to watch every corporation and we can’t depend on a rare pool of former employees being ready to fund a proxy fight. Give shareholders the proper tools and corporations are less likely to be dominated by psychopaths. Power, if widely dispersed, will facilitate the important contributions of all employees, shareholders, and other stakeholders. Pooling our wisdom is a more effective long-term strategy than blindly following a leader, even if we are able to screen out the psychopaths with B-Scan.

DB Plans Down

The rate at which large companies froze or terminated their defined benefit pension plans accelerated sharply last year even as the average funding level for plans continued to increase, according to a new analysis by Watson Wyatt Worldwide, a leading human capital consulting firm.

Watson Wyatt found that 11% of companies in the Fortune 1000 that sponsor defined benefit plans had a frozen or terminated plan in 2004. The 11% represents 71 companies and is an increase from 7% (45 companies) in 2003 and 6% (39 companies) in 2002. Additionally, 4% of employers (25 companies) had pension plans that were closed to new hires in 2004. Still, two-thirds of the Fortune 1000 companies (63%) currently sponsor a defined benefit plan.

The analysis also found that about half of the companies that terminate their plans drop off the Fortune 1000 list the following year, indicating that the decision may often be driven by weak financial performance. About one- half of the companies that froze or terminated their plans in 2004 had credit ratings below investment grade, compared with 25 percent of firms with active pension plans.

Improved returns in equity markets and sizable cash contributions by employers helped boost the average pension plan funding ratio to 83 percent in 2004. The average funding ratio was 81 percent in 2003 and 76 percent in 2002. (Press Release, 6/22/05)

Milberg Weiss Under Investigation

Milberg, Weiss, Bershad, and Schulman, the class-action law firm, is being investigated for alleged fraud, conspiracy, and kickbacks in dozens of securities lawsuits, according to The Wall Street Journal. A grand jury in Los Angeles that was convened last October has been hearing evidence of alleged illegal payments to plaintiffs who appeared on dozens of securities class-action lawsuits brought by the firm during the past 20 years.

Michael Hausfeld, a prominent Washington plaintiffs’ lawyer, is quoted saying such a case “could taint private civil enforcement of securities law” and deflect attention from “the egregious corporate misconduct at issue in these suits.” For names, kickback amounts and the gory details, see “U.S. Pushes Broad Investigation Into Milberg Weiss Law Firm,” 6/27/05)

Cooperative Leads the Way

Co-operative Insurance Society became the first insurer to launch an ethical engagement policy based on the views of its members. The policy is the result of an extensive consultation with its five million policyholders and will govern the way the firm interacts with the companies it invests in. The new policy, which is backed by 98% of customers, will guide the group on such issues as human rights, the arms trade, environmental impact, labour standards, animal welfare and corporate governance.

The group said it would use its power as a major shareholder to make its views known at annual general meetings and to put pressure on companies. Its stance is similar to one already adopted by the Co-operative Bank, which refuses to do business with companies it deems to be unethical. (Ethics priority at insurance giant, icCoventry, 6/27/05)

Barron’s Review

In an article titled “The Governing Class” Theresa W. Carey and Kathy Yakalwith offer a “refresher course in corporate governance.” Lead mention went to Corporate Governance, “a straightforward, informative site that tracks the important developments in the field.” OfEncycogov.com, “the serious student of the field will find plenty of theory and examples here.”

Among the others, ShareholderProposals.com is a “plain, just-the-facts site that helps investors take advantage of a decades-old Securities and Exchange Commission rule that allows shareholders to include proposals in a company’s proxy materials. It takes you step-by-step through the process and provides concrete examples of good corporate governance policy statements.”

GuruFocus.com ”isolated 21 investment gurus who have racked up an average annual total return of more than 15% in at least the last 15 years…Tables highlight buy and sell recommendations or actual actions over the last year or so, and recent commentaries written by each are printed or linked.” NetSteering is a terrific resource for keen watchers of insider trading.

India Inc Will Need 3,000 Directors

The government estimates corporate India will need 3,000-4,000 “independent directors” within the next six months to comply with the Securities and Exchange Board of India’s (Sebi) listing requirements.

To ensure that corporates are able to find qualified people, the company affairs ministry is facilitating the formation of databases of potential “independent directors” through professional bodies and industry chambers. (Business Standard, 6/23/2005)

AFP Calls for Greater Disclosure of Governance Rating Methods

Companies with poor governance practices may see an increase in their cost of funds and access to credit.

Association for Financial Professionals (AFP) president Jim Kaitz urged the SEC and the nationally recognized statistical rating organizations to bring more sunshine into the scoring process when he testified before the US House Financial Services Committee Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises last September.

Moody’s, Standard & Poor’s and Fitch Ratings have publicly outlined their governance rating methods. Moody’s wraps corporate governance into its risk management overview, according to Ken Bertsch, senior vice president and director, corporate governance. “We’re not scoring on corporate governance at this time. We’re doing a very in-depth risk management review,” Bertsch said.

Moody’s corporate governance assessment emphasizes board independence and management accountability to the board, board and executive compensation arrangements, management succession plans, public disclosures, legal and regulatory structures, ownership structures, governance transparency, and shareholder voting rights.

S&P assigns scores from 10 (very strong practices) to one (very weak practices) to the four individual components that contribute to overall sound governance. According to 2002 and 2004 reports, these elements include: ownership structure and influence of external stakeholders, investor rights and relations, financial transparency and information disclosure, and board structure and process.

Fitch uses a rating tool that ranks companies based on criteria such as board independence and quality, presence of related-party transactions, integrity of the audit process, executive compensation, and different ownership structures (in particular majority-controlled and family-owned companies).

Dominion has no written policy, but the company has included corporate governance factors in its rating process for nearly 30 years. As the newest nationally recognized statistical rating organization approved by the SEC, Dominion has been rating US companies for less than one year. (Looking Beyond the Numbers – Governance Concerns in Scoring Process, AFP, 6/20/2005)

ABA Seeks Comment on Majority Elections

The American Bar Association (ABA) Committee of Corporate Laws has issued a 32-page discussion paper on majority elections for corporate directors and invites public comment. Resolutions have been voted at more than 50 companies so far this year. The average level of support has been around 45% of votes cast, according to the The ISS Friday Report.

The ABA paper outlines four options and discusses their potential benefits and problems:

• Retain the current plurality vote default rule.
• Change to a majority vote default rule.
• Adopt a default plurality rule requiring that a director must be elected by at least a “minimum” plurality vote, such as one-third.
• Leave the plurality vote default rule in place but specifically authorize against votes with consequences where a director achieves a plurality vote but more against than for votes. These consequences could include, for example, shortening the term of that director, unless the board acted within a specified time frame to confirm the director’s election, or giving the board the authority to remove that director.

Comments should be sent by Aug. 15 to: E. Norman Veasey, Chair, ABA Committee on Corporate Laws, or by snail mail to 1201 N. Market Street, Suite 1402, Wilmington, Delaware 19801. We urge readers to cc the publisher of Corpgov.net: James McRitchie.

Pfizer announced that it would require any director who receives a majority of “withheld” votes at the annual election of company directors to offer to resign. The company’s shareholders can vote “yes” or “withhold” when they vote on a director. The company has said that investors were concerned that some directors could be elected with only a few positive votes from a handful of shareholders.

Pfizer officials said the company has been a leader in corporate governance issues, such as the election of directors and anti-takeover provisions. Pfizer was one of the first companies to dump its “poison pill” takeover defense, which would have made a takeover unattractive because of special “poison” provisions that would have greatly added to the cost of such a takeover. In addition, Pfizer now requires that all directors be elected to one-year terms.

The selection of a replacement Director would still be within the power of those who selected the Director found to be unacceptable to Shareholders.  “Under the amendment to Pfizer’s corporate governance principles, any director who receives a majority of withheld votes must submit his or her resignation to the board. The board will in turn consider the resignation and make a recommendation.”

Governance Premium in Hong Kong

Researchers studying the corporate governance of 168 of Hong Kong’s largest listed companies have found a positive and significant correlation between corporate governance scores and price-to-book ratio. (seeWebb-site.com for details and links) Here is a highlight:

A significant and positive relationship is found between CGI and MTBV after taking account of a comprehensive set of control variables. Results show that a worst-to-best change in CGI, from 32.86 to 76.34, implies a 147% increase in MTBV. The transparency-related performance is significant in explaining variations in firm value as well. After comparing the regression results between China-related firms and Hong Kong firms, we find that corporate governance practice matters more for China-related firms.

Chevedden Report

Caterpillar finally pastures its poison pill on June 30, about 17 months ahead of its scheduled termination date of Dec. 11, 2006. This topic won an impressive level of shareholder support at Caterpillar – a 59% yes-vote at the 2005 annual meeting. Additionally the Caterpillar shareholder level of support ranged from 48% to 55% in each year from 2000 to 2004 based on yes and no votes. Each of these proposals was sponsored by John Chevedden.

Corpgov Bits

Managing ERISA Risk; Denali FM offers an online fiduciary training course re Risk Management in 401k Plans. Minority owners acquire more rights in Hong Kong.

Corporate governance costs climb 33%. The cost of being a public company in 2004 was a third higher than it had been a year earlier, shows a study by a national law firm. Average audit fees for companies with fewer than $1 billion in annual revenue climbed 96 percent to $1 million in 2004. Costs of corporate governance have gone up 223 percent since the government enacted Sarbanes-Oxley in 2002.

Conference Board Issues a “Definitive” Report on Corporate Governance Practices. It calls on corporate directors to redefine their roles with management, strengthen their independence, and improve practices and processes in their companies’ key audit, compensation, and governance committees. The report focuses on best practices covering legal, regulatory, and stock exchange requirements and precedents established by the influential Delaware courts.

Russian state companies are not transparent, according The Standard & Poor’s international rating agency survey. Their average level of information provision is 47%. This means that they fail to disclose information as readily as Russia’s private companies of the same level do (52%) and considerably worse than their overseas counterparts (63%). However, this is not a bad result for a country where norms of corporate governance were only introduced recently and the Code of Corporate Conduct appeared only a couple of years ago.

Oregon to Go DC?

Kevin Mannix, the GOP candidate for governor of Oregon, has proposed moving new public employees to a 401(k) plan style retirement program. The 2003 Legislature enacted a hybrid pension plan for newly hired public employees that offered a scaled-down guaranteed pension plus a 401(k)-style plan.

Mannix said he wouldn’t take away current employees’ guaranteed pensions under the Public Employees Retirement System. Instead, he would encourage them to switch to the 401(k)-style plan through incentives. Mannix’s comments came after chief GOP rival Ron Saxton co-wrote an article suggesting that all Oregon public employees could be temporarily fired to terminate their contractual right to PERS benefits, then rehired under a less-costly retirement plan. (Mannix endorses 401(k)-style plan, Statesman Journal, 6/17/2005)

Undermining the Statutory Audit

In “Undermining the Statutory Audit: The Damaging Effects of Adopting IFAC-IAASB Standards on Auditing (ISAs), June 2005, UK’s Morley Fund Management argues the move to create international standards should not be pursued by means of US derived ISA since the approach will undermine the “true and fair view” basis of audits established under the Companies Act. The shift away from public interest/shareholder audits to a process driven by a technical compliance assurance more limited in scope will have the principal effect of reducing the scope of the auditor’s role and exposure to risk. The Morley paper argues strongly against making the directors/management the “client” instead of shareholders.

It appears the Audit Practices Board is moving forward with this ill-advised shift in without proper consultation or regulatory impact assessment. Again, the impact of US standards is being obfuscated by denying words their normal meaning. While the words “true and fair view” are retained, they now simply mean compliance with IFAC-IAASB. Enron would have been a clear audit failure under the current regime but not under the US standards. The paper contains an excellent appendix, which highlights the differences between the frameworks. One of the most important, from our standpoint, is that fundamental notion that UK audits are conducted for current shareholders and in the “interest and protection of the public,” instead of with the board or appropriate representatives of senior management, with whom the auditors agrees on the terms of engagement and any variation.

CalPERS Sets Standards for Consultants

On May 16th the SEC’s released its Staff Report Concerning Examinations of Select Pension Consultants. Effective June 13th, CalPERS established a new protocol to:

(1) assure that the information and advice CalPERS receives from its Consultants is impartial;
(2) to outline a system whereby Consultants disclose to CalPERS those circumstances that may create actual, potential or perceived Conflicts of Interest; and
(3) to set forth a process for CalPERS to evaluate the disclosures to determine whether assignments should be precluded.

To read more about the policy, see their June 13 press release and a pdf version of the policy.

Chevedden Report

Pep Boys (PBY), redeem or vote poison pill, 75% yes-vote, proponent John Chevedden. This is the 3rd consecutive year that this proposal topic has won more than 60% support.

General Motors, cumulative voting shareholder proposal, at least 48.8% yes-vote, proponent John Chevedden. GM continues to refuse to state the no-vote which may be less than 48%. In any event the GM Chairman, Richard Wagoner said at the annual meeting that this was an all-time record high voting percentage for a GM shareholder proposal.

Morningstar’s Innovation

The Wall Street Journal reports the investment-research firm says it will hold monthly “forums” to answer questions about its business from any investor or prospective investor. Investors submit written questions by email, fax or mail. Morningstar’s director of investor relations digs up the answers and reports to shareholders and the SEC. The first forum, released June 3, featured 21 questions about Morningstar’s estimates for long-term growth, hiring plans, potential for acquisitions, stock-option expensing, corporate governance and other matters.

Joseph Carcello, University of Tennessee’s Corporate Governance Center, praised Morningstar’s first effort, saying its responses were candid and specific, including providing a breakdown of its revenue by new and renewal business, information that many companies prefer not to disclose for competitive reasons. Alyssa Machold Ellsworth, Council of Institutional Investors, agreed, “this a really good example of proactive shareholder communications.”

WSJ terms the move “Democracy in Action.” It certainly is something of an innovation in reporting but if it wanted to be a true leader in democracy, Morningstar would take measures which actually allow shareholder to act like owners. For example, they could allow potential auditors to place their proposals in the proxy and allow selection by shareholders. They could allow shareholders to place the names on director nominees on the proxy. Steps such as those would truly be democracy in action. (Morningstar Shines Light on Itself, 6/15/05)

Are You in the TIAA-CREF Retirement System?

If not, you can still help. Do you want our money to help build housing and businesses in low-income communities? To support socially and environmentally responsible products and services?

Spend five minutes to support Social Choice for Social Change. In the 1980s, Campaign for a New TIAA-CREF lobbied the pension giant TIAA-CREF (TC) for five years to set up a socially responsible fund, the Social Choice Account. Now Campaign for a New TIAA-CREF is pushing for an improved fund with practices that are becoming standard in socially responsible investing. Their effort has been endorsed by many academic and activist groups, and individuals like Noam Chomsky and Howard Zinn. Here’s how you can help:

• Contact TC and ask them to modify the Social Choice Account by investing in low-income area community development and in social venture capital for companies pioneering socially responsible products/services. Thank them for agreeing to vote their shares in corporate stock in a socially responsible manner, and ask them to otherwise lobby those companies to be socially responsible. If you are a participant, let them know that. Call CEO Herbert Allison at 800-842-2733; 212-490-9000 (monthly, if you can) or email him atHAllison@tiaa-cref.org (but calls are preferable. You will be asked to leave a message with an assistant.)
• Receive Campaign Updates (every two to four weeks). Contactnjwollman@manchester.edu to be added to the list.
• Forward this message with a short personal endorsement to listserves, organizations, and your colleagues and friends nationally.

Campaign for a New TIAA-CREF is also part of a national coalition of activist groups, Make TIAA-CREF Ethical, that is pushing for TC to be more socially and environmentally responsible in its various investments. For further information, contact Neil Wollman, Ph.D.; Senior Fellow, Peace Studies Institute; Professor of Psychology; Manchester College, North Manchester, IN 46962.

Audit Independence

Robert Monks graciously sent me a copy of Tim Bush’s recent paper,Divided by Common Language, which I found very helpful in explaining the origins and differences between financial reporting in the UK and the US. For years I’ve been told the UK approach is more principles-based and ours is more rules or check-box based. However, after reading this paper I am finally beginning to grasp what this means and how the differences shape corporate governance in each country. Fundamentally, the problem may be that the duty of care for auditors in the US is not to shareholders but is to buyers and sellers in the market. Our audits are better designed for day-traders than long-term owners.

Bush points out the UK Companies Act “requires that auditors are appointed by and report to shareholders as a obligation of the privilege of incorporation,” although it appears that in actual practice they are selected by the board. However, at least the accounting goal is to ensure that financial statements are relevant and as free of self-serving bias as possible for shareholders. In contrast, under the US 1933 Securities Act, US audits are primarily concerned with market-pricing. The objectives are to ensure an efficient secondary market and an efficient primary issue market.

Bush points out, a company that is incurring expenditure beyond the economic needs of the business may not be defrauding the secondary market by strict federal legal definition. If earnings are depressed due to operational inefficiency the market price may reflect this but the interests of shareholders are not well served, nor are they given access to information needed to remedy the problem. “Efficient markets and efficient companies are not the same thing.”

He provides an example of an insurance company disclosing the company is exposed to asbestos-related liabilities. In the US, they could leave it at that. In the UK the auditor would have to include other relevant facts, such as that liabilities arose as a result of a relatively recent acquisition by the current board. The UK model does not insulate investors from risk, but it does appear to give owners better information to allow them to hold directors accountable. The US model encourages owners to sell or sue when audits find problems.

Bush notes, “shareholder value is created from serving the prime objective of earning a surplus in excess of the cost of capital, not setting one’s prime objective as ensuring accurate reporting for market regulators.” The US scheme is particularly ineffective when companies generate most of their capital from profits, rather than from new issues, which may have been the presumption in the early 1930s when the legal framework was set.

Anyone who truly wants to address the issues surrounding audit independence would do well to read Bush’s paper, along with How US and UK Auditing Practices Became Muddled to Muddle Corporate Governance Principles by Shann Turnbull. Turnbull argues that establishment of an audit committee with “independent directors” cannot remove the conflicts of interest which are only exacerbated by the US Sarbanes-Oxley (SOX) and the UK Combined Code. Along with Roberta Romano, he believes SOX has enshrined in its statute the cause of the problem it was supposed to eliminate, since “audit committees provide a more intimate and frequent basis for bonding the external auditor to the directors rather than to the shareholders who use the information.” Some European countries avoid these conflicts by having the auditor controlled by a shareholder committee or “watchdog board.”

Turnbull’s paper provides a history of how we got here, as well as a compilation of several alternatives. Like him, I am “overwhelmed with the plethora of codes of conduct, ethics, and professional behavior and so called “best practices.’” “They represent intrusive prescriptive complex band-aids that do not address the fundamental flaws of the dominant governance systems.” What is required are self-governing mechanisms of the type found in natural systems and simple thermostats.

That is where I believe Mark Latham’s work comes into play. Although he doesn’t address the fundamental purpose of audits, such as informing shareholders rather than protecting secondary markets by calling for a change in statutes, his proposals would address even those fundamental questions in practice. If shareholders could select the auditor, as he proposes, it is likely they would choose one which places a high priority on informing shareholders about corporate inefficiencies.

Latham introduced his “Auditor Independence” proposal for inclusion in the proxy at several US firms. However, the SEC has consistently allowed management to omit them from the proxy. One of the primary arguments is that selection of the auditor is part of “ordinary business” operations. How this can be held out year after year in light of Enron and the demise of Authur Andersen is beyond me. I can only conclude that Latham needs the help of an attorney familiar with all the recent case law and we need SEC commission members who believe in guarding the interests of shareholders. Arguments on both sides of the proxy inclusion debate are linked at corpmon.com/ProposalSubmissions.htm for the companies Fleetwood Enterprises and SONICblue.

Bush, Turnbull, and Latham present the problem, as well as offering reasonable solutions. Meanwhile, as Turnbull notes, “every effort should be taken by countries around the world to resist the hegemony of the fundamentally flawed US auditing practices.” Don’t let the contagion spread!

Pension Plan Advisors Conflicted

With the resignation of Donaldson, and Cox being named to head the SEC, many seem to have missed the SEC’s May 16th Staff Report Concerning Examinations of Select Pension Consultants. Investment advisers owe their advisory clients a fiduciary duty and are required to “eliminate, or at least expose, all conflicts of interest.” Investment advisers registered with the SEC typically make such disclosures to advisory clients in their Form ADVs. Additionally, advisors registered with the SEC are required to designate a Chief Compliance Officer and to maintain written procedures designed to assure compliance with the Advisers Act.

The SEC conducted focused examinations of a representative sample of 24 pension consultants who are registered investment advisers to determine their level of compliance. Conflicts of interest among pension consultant are worse than even cynics assumed. Here are a few highlights of those they reviewed:

• Many pension consultants do not consider themselves to be fiduciaries to their clients.
• More than half the pension consultants provided products and services to both pension plan advisory clients and money managers on an ongoing basis. For some of these consulting firms, the compensation received from money managers comprised a significant part of their annual revenue.
• More than half have affiliated broker-dealers or relationships with unaffiliated broker-dealers, allows the pension consultant to obtain payment for its services with brokerage “commission recapture” programs. Two failed to disclose these compensating relationships, although the SEC was unable to “fully analyze whether pension consultants ‘skewed’ their recommendations to favor certain money managers.
• Many have affiliates that also provide services to pension plan clients. These relationships create disclosure and conflict of interest issues that have not been addressed by pension consultants.
• More than a third employ advisory representatives that are also registered representatives of a broker-dealer.
• Based on the recommendation of their pension consultant, many pension plan clients choose to utilize an affiliate of the consultant to provide various services, including investment management, brokerage execution, and transition management. Of the 19 consultants or their affiliates that provided products/services to money managers, three (or 16%) provided no disclosure of these other services, and 16 (or 84%) provided limited disclosure.

Here is the closest the SEC comes to enforcement. “We conclude that consultants should enhance their compliance policies and procedures to include those policies and procedures that will ensure that the adviser is fulfilling its fiduciary obligations to its advisory clients.” What would Elliot Spitzer have done? What the SEC does is provide a list of good tips for plan sponsors.

Alternative Structures

PricewaterhouseCoopers is running a series on corporate governance. Part 1 is entitled Emerging Companies and Boards of Directors: What Works Best? and it includes a good discussion of alternative structures, including an advisory board and a two board structure.

So Yesterday

Corporate governance reforms are “soooo yesterday, dude,” according to a report in the Toronto Globe and Mail. First, the U.S. Supreme Court overturned the 2002 conviction of Arthur Andersen on obstruction of justice. Second, President George W. Bush nominated pro-business congressman Christopher Cox as new chairman of the SEC. (U.S. corporate governance is yesterday’s news, 6/4/05)

In other words, the official charged with cracking down on corporate shenanigans will be the same guy who has repeatedly opposed tougher enforcement of boardroom antics, including abuse of stock options, and vigorously pushed for a law making it harder for shareholders to sue companies.

One has to admit, there is a certain logic to Mr. Bush’s recent nominations: Iraq-war champion Paul Wolfowitz as boss of the nice-roads-for-poor-people institution, the World Bank; sabre-rattling unilateralist John Bolton as U.S. ambassador to the United Nations; and now the poacher Mr. Cox to be Wall Street gatekeeper.

Duffy is Back

The Turnaround Tactician is Maureen Nevin Duffy’s new vehicle to report on activist or relational investors.  These are typically “value” investors who don’t buy and wait. They buy and use their governance know-how to turn companies around by unlocking that value, sometimes working with management, sometimes pushing back.  Want to know what Relational Investors, Providence Capital, and others are up to?  Duffy is the closest we have to a journalist on the front lines of corporate governance investing.  She gives you the straight scoop and we can’t wait to see her latest venture take off. Click here to see a sample issue. Then click on Buy Now; you won’t be dissapointed.

Donaldson Steps Down: 
Expecte Rollbacks Under Cox

SEC Chair William H. Donaldson, who took office in the wake of massive corporate scandals and the resignation of securities lawyer Harvey Pitt and aggressively stepped up the agency’s focus on fraud and good governance, announced he’s resigning at the end of the month. Pitt initiated serious reforms, including requiring that mutual funds report on the voting policies and votes. Donaldson went a step further but failed on the most important reform to open up the corporate proxy, if even in a token way, to shareholder nominees.

He was a much more strident reformer than many expected. US Chamber of Commerce President and CEO Thomas Donohue is suing the SEC over a rule pushed by Donaldson that requires 75% of mutual fund board directors to be independent. He noted that the chairman “came to the SEC at a critical time — his job was to restore trust and confidence in our capital markets. “His successor will need to focus on ensuring the future competitiveness of our markets.”

President Bush named Rep. Christopher Cox, R-Calif., a conservative veteran of 16 years in Congress, to succeed Donaldson. Cox has long been an ally of business groups and who helped rewrite securities laws to make investor lawsuits more difficult to file. He supported efforts to repeal the estate tax, the capital gains tax on savings and investment, and taxes on dividends.

Harvey J. Goldschmid, is expected to leave in the coming weeks to return to a teaching position at Columbia University. Senate Democrats have proposed that his seat be filled by Annette L. Nazareth, a senior staff official. The term of another Democratic member, Roel C. Campos, expires this month, although he hopes to be nominated for a second term. (Bush Nominates Congressman to Replace Donaldson at S.E.C., NYTimes, 6/2/05)

“This likely portends a very dramatic shift in the direction of the SEC,” Joel Seligman, dean of the Washington University Law School in St. Louis, told Reuters. “You’re more likely to see an SEC that the Chamber of Commerce and the Business Roundtable are more comfortable with.” “He’ll be a formidable chairman, but it will be a major change in direction,” Columbia University Law School Professor John Coffee told Reuters. “If Cox had written our securities laws, the executives at WorldCom and Enron wouldn’t have any legal troubles,” Damon Silvers, general counsel of the AFL-CIO, told Bloomberg News.

The first rollback? Earlier this year, Cox co-sponsored a House bill, H.R. 913, that would delay implementation of the Financial Accounting Standards Board’s expensing rule by at least three years. Instead of expensing options, the bill calls on the companies to disclose additional information on their option plans and directs the SEC to study the issue for three years. (The ISS Friday Report, 6/3/05) We expect the period of reform at the SEC has come to an end for the duration of the Bush Administration.

Review: Governance and Ownership

Governance and Ownership, Robert Watson, editor (Edward Elgar, 2005). This is an excellent collection of 20 papers, most published in the late 1990s, enhances our understanding of the relationships between ownership corporate ownership governance. Issues investigated include:

• diversity of ownership forms and corporate control implications
• effectiveness of such forms in influencing executives to enhance corporate value
• role of owners in appointing and removing executives
• influence of ownership structures on corporate restructuring, mergers and acquisitions
• motivation of various classes of owners – their ability and willingness to influence corporate decisions

Many of the findings are interesting and run counter to common assumptions in the field. For example, the La Porta et al. (1999) study found that contrary to Berle and Means, companies in most countries (the US included) have “controlling” (10%) shareholders (generally the State or families). Families control about 35% of the largest firms in the richest economies, compared to 24% held by the State. Monitoring and protection of minority shareholder rights take on new meaning.

Wahal (1996) examines pension fund activism in the US and finds, contrary to other studies, no evidence of long term performance improvements. Wahal concludes pension fund activism is no substitute for an active market for corporate control.

Holland (1998) examined fund managers in the UK and finds that institutional voice is typically highly constrained by relative powerlessness and a general unwillingness to interfere, especially during times of good corporate performance. Quasi insider knowledge was typically held “in reserve” until performance took a downturn. Are the costs of monitoring justified if they are only going to be used to accelerate sacking the CEO in times of financial crisis?

David et al. (1998) views the struggle between CEOs and owners over pay. They find that institutional owners that have only an investment relationship with the firm are able to influence CEO compensation, whereas those that also depend on the firm for business are not. (No surprise there, but considers factors not always taken into account by other studies.)

In general, this book has much to recommend it, especially to complacent investors and over-confident executives. Governance and Ownership provides a ready reference to studies that will continue to influence scholarship and practice over the next decade.

Web posts blamed for firing, according to court documents filed on behalf of Dimitri Papadakos, formerly CEO of Gyrodyne Co. of America. Papadakos seeks $20 million in damages from Gyrodyne and various online posters, including his half brother, Peter Papadakos, a Gyrodyne director at the time. Also named were Peter Pitsiokos, Gyrodyne’s vice, president, corporate secretary and general counsel, who allegedly fed Peter Papadakos defamatory information for postings accusing Dimitri Papadakos of receiving illegal payoffs and diverting company assets for personal use. (WSJ, 1/27/00) No, this is not the kind of brave board activism we have been seeking.

Internet used to empower investors at Coho. See The Gadfly “Latest from the message board revolt: Coho investors swimming upstream,” by Michael Collins. Mr. Collins is one of the few in the mainstream press (if CBS MarketWatch can be called that) who routinely writes on shareholder activism.

Lens reported a preliminary vote tally showing 34% of shareholders supported their non-binding proposal which urged Ashland’s board to hire a nationally recognized investment banker to explore value enhancing alternatives for the company, including possible sale, spin-off, merger, or other transaction for any or all assets of the company. ISS had also recommended a favorable vote. (PR Newswire via Northern Light)

Deloitte & Touche guide says to expect shareholder questions on e-business, globalization, and M&A. “Questions at Stockholders’ Meetings 2000″ is available for free: contact Andrea O’Neil at (203) 761-3059.

The Corporate Library sent letters to the Corporate Secretaries of more than 500 leading companies last July, requesting a copy of each CEO’s compensation agreement and the name of a corporate governance contact person. Nell Minow says responses have ranged from “rude and evasive to genuinely concerned and helpful.” The cooperative response rate appears to be approximately 16%. The report is scheduled for release on February 25, 2000. For more information, contact Nell Minow.

Hostile takeovers come to Japan. The country’s first such all-domestic battle may signal a changes in corporate culture. (Business warfare rubs off on Japan, The Detroit News, 1/25/00)

Back in 1940, John C. Bogle’s Princeton thesis noted the SEC call at that time for mutual funds to serve “the useful role of representatives of the great number of inarticulate and ineffective individual investors in corporations in which investment companies are also interested.” With mutual funds now controlling 35% of stock and churning them at rate of 112%/year, Bogle still hasn’t given up on that 60 year old goal. He says mutual funds have become a marketing business, reluctant to offend potential clients. But an industrywide effort of 1/1000 of a basis point could raise $60 million for active corporate governance (6 times what TIAA-CREF spends).

Of course funds are unlikely to raise corporate governance issues, Bogle notes, because they “live-in-glass-houses” and are controlled by small outside firms whose principle business is providing the funds with “all the services required to conduct its affairs.” The yield is rising expenses, managed corporate earnings, the stock market as casino, and growing stock dilution from free riding management options. His hope on the horizon is index funds whose only way to add value is through shareholder activism. He offers prescriptions but more need to listen. (Governance: The Silence of the Funds, in The Corporate Board, 1-2/2000)

Do You Need a Dissident Director?, asks Steven A. Seiden, in the same issue of The Corporate Board. Seiden notes TIAA 1998 purge of Furr/Bishop’s board and the growth of limited partnerships who seek to turnaround underperforming companies. Prime among Seiden’s recommendations is that dissident directors need to be “unfettered by any financial, family or close personal ties to the activist” investor.

Sean Harrigan, Member of the California State Personnel Board, has been named as its representative to CalPERS. Harrigan serves as the Regional Director and International Vice President of the Food and Commercial Workers International Union (UFCW) Region 8 – Western United States. Harrigan was appointed to the State Personnel Board by Governor Gray Davis in June 1999 and replaces Ronald Alvarado as the Board’s representative to CalPERS. See alsoCalPERS bio.

CalPERS took a 10 interest in San Francisco-based Thomas Weisel Partners which invests in the growing internet, technology and communication industries centered in California. CalPERS will commit $500 million to act as lead investor in new alternative investment funds and may make another $500 million available.

Willie Brown Jr., the current mayor of San Francisco and former Speaker of the California Assembly, is rumored to be Governor Gray Davis’ choice for a seat on the CalPERS board reserved for a representative of local government. (Sacramento Bee, 1/22/2000) The profile of California’s $168 billion retirement fund is about to rise dramatically.

Back to the topDirectorship’s, 1/2000 issue, carried an interesting interview with Woody Small, co-portfolio manager of Undiscovered Managers All Cap Value Fund which picks portfolio companies, in part, based on the quality of directors. The fund has outperformed the Russell 1000 Value Index since 1997. We applaud Mr. Small for his action but wish he would take the next logical step. He indicates he has never taken an affirmative action to recommend that a board member resign or not stand for reelect ion. In addition he has never recommended director candidates to management.

Governance Institute expanded its biennial hospital survey of health system boards to include a ranking of the nation’s 20 top hospital systems based on governance practices. (Modern Healthcare, 1/17/2000)

Ira Millstein is reportedly resigning from his post as chair of the World Bank’s Private Sector Advisory Group. (see IRRC Corporate Governance Highlights, 1/20/2000)

Corporate Governance of State-Owned Enterprises in China was the subject of two-day meeting, which was co-sponsored by the Development Research Center (DRC) of the State Council, the Economic Cooperation and Development, and the Asian Development Bank. (see China Holds Corporate Governance Seminar)

Accoss the Board, the Conference Board Magazine, reports that “while the business pages are full of newly minted millionaires and billionaires, half of all Americans have less than $1,000 in financial assets.” (1/2000, p. 9)

Koppes, Richard H., Lyle G. Ganske, and Charles T. Haag, “Corporate Governance Out of Focus: The Debate Over Classified Boards,” The Business Lawyer, May 1999, Vol. 54, No. 3, pp. 1023-1055. The author’s argue that shareholder activists should reexamine their call for annual elections. Classifying a board greatly improves the ability of a corporation to defend against unsolicited takeovers bids and proxy fights. Classified boards can protect poison pills from being removed and promote continuity, stability and independence. Takeover premiums have been shown to be higher for companies with takeover defenses. Independence is best secured by serving multi-year terms. The danger of one-year terms is that truly independent board members may not be invited to run again after their first term and it often takes more than a year to make major changes.

The authors argue that focus should, instead, be on increasing board independence and activism, citing theMillstein/MacAvoy study which found a “significant correlation between an active, independent board and superior corporate performance.” However, the Millstein/MacAvoy study measured not only board independence, but responsiveness to shareholders. Any firm that didn’t return the CalPERS survey was graded F, whereas those who took the action CalPERS desired got an A+. Board independence is important but responsiveness and accountability to shareholders may also be key.

Early in the article, Koppes et al. quote from a recent statement by CalPERS in support of one of its proposals to eliminate a classified board. “We believe that the ability to elect directors is the single most important use of the shareholder franchise. Accordingly, directors should be accountable to shareholders on an annual basis.” The authors point to the fact that CalPERS itself has a classified board, where board members are elected or appointed for multi-year terms.

CalPERS is right in its first statement but their second statement does not follow. In fact the arguments of Koppes et al. would be convincing if certain steps were taken to reduce the likelihood of entrenchment by strengthening accountability to shareholders. First among these reforms would be the ability of shareholders to place nominees on the company proxy. One can argue about where the threshold should be set, but Bart Naylor’s recent proposal allowing those with 3% of shares to do so appears reasonable.

Secondly, to ensure those elected reflect the consensus of shareholders, any such proposal should be combined with the ability to use instant run-off voting (IRV). In 1993, for example, 96 candidates ran for two CalPERS Board positions. One of the winning candidates received less 5.5% of the vote. We certainly can’t say this was the candidate most voters wanted.

IRV facilitates expansion of voter choice by eliminating the “spoiler” impact of long-shot candidacies and avoids the expense of runoff elections. IRV works by allowing voters to rank candidates in order of preference, 1, 2, 3, and so on. The candidate who receives the fewest number of first choices from the voters would be eliminated in the first count and all his or her ballots would be redistributed to the voters’ second choice. Each successive count eliminates the next lowest polling candidate, transferring his or her ballots, until one candidate achieves a majority.

Other facilitating reforms would include confidential voting and a recognition that trust law requires that voting rights be subject to the same fiduciary standards as other plan assets. Although this rule has held since 1988 for pension funds, it has not yet been applied to other institutional investors, such as mutual funds and insurance companies.

Koppes et al. are right, but without mechanisms in place to allow shareholders better access to the nomination process, shareholders must continue to support annual elections as an important mechanism to avoid entrenchment.

Back to the topIRRC Corporate Governance Highlights discusses proposals for a one-time doubling of voting rights for shareholders who have continuously held shares for 5 years, establishing a right for shareholders with 2% of outstanding shares access to company’s proxy statement to nominate board members, electing the entire slate of board every 3 years, requiring an annual strategic report to shareholders, and implement exec compensation program that focuses management on the need to “maximize the company’s long-term wealth-generating capacity.” IRRC also summarizes some of the no-action relief letters from companies. (1/7/2000) IRRC indicates that CalPERS, NYCERS, and CII weighed in on the American Home Products sale. (1/14/2000) Still time to register for IRRC’s governance2000.com conference, to be held in New York City on Jan. 20-21.

Tidbits from Investor Relations, 1/2000. Less than 1/4 of ASX companies have internet sites with dedicated investor relations sections, according to a study by Computershare Analytics. Like the US SEC, the Australian Securities & Investments Commission is urging listed companies to dump briefings which are exclusive to analysts and institutions.International Accounting Standards Committee calls for the adoption of an international code of conduct to raise internet business reporting standards. Street-name investors of 5,000 publicly-traded US companies are enabled for internet proxy voting through ADP. Use of internet proxies is permitted in 20 states, up from 14 in 1998. States that do allow such voting are by far the leading states for registration. In 3rd quarter of 1999, over 1,500 publicly-traded companies webcaste their quarterly conference calls, according toStreetFusion. Investor Relations also profiles Yve Newbold who recently worked on raising voting levels in the UK. Her next project is chairing the Ethical Trading Initiative, to prod retail companies into applying proper labor standards in overseas factories.

Jason Zweig, mutual fund expert at Money Magazine, indicates that closed-end funds used to be a great corner of the market where you could find terrific stock pickers. “But I’m sad to say they have become a cesspool of lousy corporate governance, where the fund managers not only charge exorbitant fees but reject every single attempt at shareholder democracy.” He advises that he would not buy a closed-end fund without reading about “the latest attempts by shareholders to express their legitimate rights, and what the fund managers did to stomp on them.” (MoneyLive, 1/10/2000)

Sheryl Pressler, CalPERS investment manager, to step down on Feb. 28. A national search for her replacement has begun. Pressler is moving to Atlanta-based Lend Lease Real Estate Investments Inc. She earned just over $300,000 in fiscal year 1999 at CalPERS. William Crist, president of the CalPERS board, said “there’s no way, politically, we could have matched the (Lend Lease) pay.” (Sacramento Bee, 1/15/2000) Pressler dramatically raised the fund’s return, largely by increasing the proportion of investments in stocks.

BusinessWeek names General Electric as having best board, unseating Campbell Soup. For the third time in four years, Business Week surveyed Wall Street’s biggest investors and most prominent governance experts for their views of the best and worst boards in America. Boards of Campbell, IBM, Home Depot, Intel, Compaq, and Cisco Systems are near the top. Walt Disney Co. was named the worst in America. CEO Michael D. Eisner is coming under increasing fire for Disney’s recent lackluster performance. Institutional shareholders want Eisner to put more independent directors on a board that, despite improvement, remains packed with Eisner chums. Since May, 1998, Disney has lost nearly 18% of its market value, more than $15 billion. (BusinessWeek, 1/24/2000)

In an accompanying article entitled “Now, a Gadfly Can Bite 24 Hours a Day,” BusinessWeek calls eRaider ”the most ambitious effort to use the Web as a tool to champion change.”  [eRaider, which will be starting up shortly, will operate as a mutual fund which tries to influence the companies they buy. However, eRaider will be the first fund that actively organizes on the Internet for this purpose.] BusinessWeek ended the article with the sentence,  “It’s enough to make a CEO sentimental about the good old days when gadflies were little more than an annual annoyance.”

For old fashion boards, that may be.  However, boards that have been through something of a corporate governance revolution meet more frequently, savor their independence, and recognize that well informed owners can add value. Gone are the days when the voices of  owners are an annual annoyance; chat rooms run 24 hours a day.

Gladflies have helped bring about important changes in corporate governance over the years.  It was largely the Gilberts who persuaded the SEC to enact the rules governing shareholder proposals in 1942. Before them, companies weren’t required to put proposals to a shareholder vote or to let shareholders speak at annual meetings.  Gadflies made the  system of activist shareholders possible.

However, provocative criticism from individuals only goes so far.  By bringing individual investors together with an institutional investor committed to activism, eRaider forges a new constructive model orchestrating change by influencing the direction of underperforming portfolio companies.

Back to the topCalPERS is debating if it should use its influence to impact labor and human rights practices in emerging markets. Staff has been asked to make a recommendation in April. The board appears to be split between those who want to impose screens and those who seek “constructive engagement.” Treasurer Phil Angelides would like to screen out countries with excessive risk factors and look at democratization efforts, shareholder, human and workers rights. Chuck Valdes, who heads the investment committe, wants the fund to be “proactive” and believes divestment would be a “violation of fiduciary duty.” (Pensions&Investments, 1/10/2000)

I doubt divestment, in the face of excessive risk, would be a violation of fiduciary duty but in order for “constructive engagement” to work, there must be a viable movement for human/labor rights. I’d like to hear from readers regarding this issue and what action you think CalPERS should take. Please write jm@corpgov.net.

Ralph D. Ward, publisher of the Boardroom INSIDER online newsletter says the $142-billion buyout by America Online of Time-Warner announced is more than a triumph of New Media Over Old Media — it heralds “the triumph of the New Boardroom over the Old Boardroom.” “The AOL board of directors shows the strengths of the newer, high-tech model board with, with smaller membership (10 versus 13 at Time Warner), and a focused core of current leaders in the tech and venture industries,” including Nextel Chair Daniel Akerson, former Netscape CEO James Barksdale, and Frank Caulfield of Kleiner, Perkins Caulfield.

The Time-Warner board “is as blue-chip as the company itself, but older (average age 62), and less focused on up-to-the-minute media experience” with such directors as Beverly Sills, former Senator John Danforth, and retired Bank of New York Chair J. Carter Bacot. “Though the Time-Warner board has enormous talent, even a member like Ted Turner couldn’t turn them into a lean, nimble growth machine.”

Ward also predicts that it will be interesting to see how the final AOLTimeWarner board membership will shake out. “With names like those above, plus Colin Powell, Gerald Greenwald and [Fannie Mae Chair] Franklin Raines, how do you separate the sheep from the goats?”

Internet company board’s average 7 directors, much smaller than S&P 500 companies, which average 12 directors. While boards at most U.S. companies meet 8 times per year, Internet companies’ boards meet an average of 10 times per year. 53% of dot-com directors surveyed are considered independent, compared to 67.6% for the boards of S&P 500 companies. Only one in four of Internet companies surveyed has a nominating committee, compared with 90% at S&P 500 companies. Learn more about the findings of this recent IRRCstudy by attending their governance2000.com conference, to be held in New York City on Jan. 20-21.

Corporate Directors Forum, based in San Diego announced the six winners of its prestigious “Director of the Year,” award, which recognizes the leaders in the business community that represent superior corporate governance.

Those receiving awards include: Peter P. Savage, former president, CEO and chairman of the board of Applied Digital Access as Director of the Year for Corporate Citizenship; Gene Ray, chairman of the board of The Titan Corporation as Director of the Year for Companies in Transition; Irwin Jacobs, chairman and CEO of QUALCOMM, Inc., as Director of the Year for Enhancement of Economic Value; David R. Flowers, former chairman and CEO of Pulse Engineering, Inc., as Director of the Year for Corporate Governance; John C. Raymond, chairman and CEO of the Greystone Group, L.P, as Director of the Year for Not-for-Profit Organizations; and Jack Goodall, chairman of the board of Jack in the Box Inc., who will receive the Lifetime Achievement in Corporate Governance Award.

The winners will be recognized during the Corporate Directors Forum Annual Director of the Year Awards dinner on February 23, 2000 at the Hyatt Regency LaJolla. Thickets are still available by contacting Larry Stambaugh, Chairman of the Board of Corporate Directors Forum, 858-455-7930.

English version of “Corporate Governance Principles: A Japanese View” has been added to the ECGN codes page.

Back to the topShareholder activist John Chevedden raised an important issue in a recent letter to the SEC’s Jonathan G. Katz. Rule 14a-8(j)(1) requires that companies “simultaneously” provide proponents and the SEC with a copy of their no action requests. “Companies are evading the spirit of this rule by sending the Commission’s copy by courier or overnight delivery. Meanwhile, the proponent’s copy arrives by ordinary mail – 5 days later. Companies can further exacerbate this by using certified mail for more delay.” Chevedden notes further that while the company often has 40 days to respond to a short 500-word resolution, the proponent must often prepare a rebuttal of a 20 page company document – “with 5 days lost in transit.” Clearly, Chevedden is right. The SEC should clarify that Rule 14a-8(j)(1) requires companies to make a diligent effort to ensure letters delivered to the proponent and the SEC arrive on the same day. I urge readers to join Mr. Chevedden’s effort to seek clarity on this issue.

SEC released proposed rules on Fair Disclosure (File No. S7-31-99) moving to take advantage of the communication revolution. The rule would help to level the playing field when an issuer chooses to disclose material nonpublic information. A new item 10 would be added to Form 8-K but the rule would alternatively allow disclosure through qualified press releases or any other method reasonably designed to provide broad public access.

Although the rule does not consider an internet posting on the issuer’s site to be sufficient for public disclosure, I expect this will be one of the most popular mechanisms when used in conjunction with press releases and publicly accessible conference calls, especially with regard to playback. The internet is now the leading source for retail investment information. 75% of individual investors use corporate sites as important research tools and 90% choose companies without the help of an advisor.

As mentioned last month, Individual Investor Group Inc.(INDI) broke new ground by discussing corporate earnings on the company’s message board. The FD rule should facilitate such innovation. By removing some of the speculative advantage which a few investors enjoyed, the Fair Disclosure rule and other recent developments may convince stockholders to act as owners, taking a more active role in corporate governance rather than doing the Wall Street walk.

SEC also released final audit committee disclosure rules. Independent auditors must now review the companies’ financial information prior to the companies filing their Quarterly Reports on Form 10-Q or Form 10-QSB with the Commission. Company proxy statements must include additional disclosures and reports about and from their audit committees. The rules are designed to improve disclosure related to the functioning of corporate audit committees and to enhance the reliability and credibility of financial statements of public companies.

Boardroom INSIDER’s Ralph Ward reviews the new regs, noting that “Audit committees now have to put it on the line with a proxy report that they’ve reviewed financial issues with management, and that they stand behind the numbers. The committee also has to have a written charter, independent members with specific financial savvy, and be in charge of hiring and fire the outside audit firm.”

Ward notes that “most people are probably surprised to learn that these standards aren’t already required. If it raises a stir to say audit directors must be financially literate, independent, and responsible, what does that say about our current boardroom standards?” How should corporate boards cope with the new audit crackdown? Ward’s publication gives several tips

Wharton professors John E. Core and David F. Larcker studied 195 firms that adopted target ownership plans involving senior-level managers between the years 1992 and 1996. While target ownership plans aren’t a magic bullet, when CEOs with below-average stock ownership in their companies increase their holdings, company performance definitely improves. (CEOs and Their Companies Profit from Executive Stock Ownership, Knowledge@Wharton Newsletter)

NASD restructuring to streamline corporate governance. (seeNASDAQ/AMEX Newsroom)

Class action law suit alleges CalSTRS held retirement workshops and distributed information to members early in 1998 but never mentioned pending legislation which would boost their monthly retirement checks by $240 a month if they retired after 1/1/99. The suit alleges that employers contemplating changes in their pension program have a legal obligation to inform employees if that information might affect employees’ retirement decisions. (2 retired teachers sue pension fund, Sacramento Bee, 1/5/00.

Magellan trustees recommending shareholders approve allowing up to 25% of assets to be invested in a single company and to allow the fund to make investments that represent more than 10% ownership in a single company. This will allow Magellan to stop bumping up against its current 5% limit when investing in large companies and will facilitate investment in small firms. Although not mentioned in a recentWSJ article (“Fidelity Seeks More Freedom for Magellan,” C28, 1/1/00), it could also facilitate a move toward greater involvement in corporate governance activities.

Mark N. Clemente and David S. Greenspan have released their 1999 list of M&A “bloopers.” “This year, we are particularly amazed by the number of transactions that…are revealing serious accounting and financial irregularities.” Those making the list include America Online-Netscape, @Home-Excite, Disney-Infoseek, BNP-Bank Paribas, Tyco International Ltd-Binge/Purge, Deutsche Telekom, American Home Products-Warner Lambert, Aetna U.S. Healthcare, AutoNation, and Bank One. The Corporate Library LLC News Briefs, 12/15-28/1999.

CalPERS launches all-out campaign to rid Tyson Foods of dual-class structure. IRRC reports they have engaged Garland Associates (212) 866-0095 to assist in soliciting shareholder votes. (Corporate Governance Highlights, 12/30/99).