ISS' SEC Comment Letter on Compensation Disclosure

March 28, 2006

Ms. Nancy M. Morris
Secretary
U.S. Securities and Exchange Commission
100 F Street, NE
Washington DC 20549-9303

Re: File Number S7-03-06


Dear Ms. Morris:

Thank you for the opportunity to provide feedback on the proposed amendments to the SEC's disclosure rules for executive and director compensation. The comments and suggestions in this letter reflect the views of ISS and do not necessarily reflect the views of our clients.

ISS Supports the SEC's Efforts to Improve Compensation Disclosure

ISS supports improvements in executive compensation disclosure. Current requirements, which have been static during the past decade, are out of step with the growing complexities in executive pay packages. Shareholders' frustrations with the lack of disclosure on retirement plans, change-in-control arrangements, and many forms of stealth compensation have led to a growing compensation lexicon, such as "tally sheets" and "holy cow" meetings. The proliferation of multiple pay vehicles and the increase in shareholder concerns over compensation arrangements necessitate change to the current disclosure system. Overall, the SEC's proposed rules are a positive step to mandate improved disclosure, create clarity for shareholders, and underscore the accountability of directors to ensure that shareholders' assets are used wisely.

The spirit of the proposed rules is consistent with the philosophy embodied in ISS' proxy voting policies -- to enhance shareholder value, promote shareholder rights, and ensure director accountability. We commend the SEC staff for their efforts to ensure that shareholders obtain a clearer picture of executive compensation. Specifically, ISS supports the following proposed revisions to the SEC's disclosure rules:

- inclusion of a Compensation Discussion and Analysis (CD&A) section patterned after the Management's Discussion & Analysis (MD&A) disclosure;
- revision to the Summary Compensation Table to provide Total Compensation figures;
- inclusion of supplemental equity tables that disclose prior year awards as well as potential sources of future gains;
- disclosure of retirement and post-employment benefits; and
- tabular disclosure of director compensation.

ISS Recommends Several Enhancements to the Proposed Rules

While we generally support the Commission's proposed rules on executive compensation, we respectfully suggest that the SEC consider the following modifications:

Require the CD&A report over signatures of the compensation committee

Requiring the Compensation Discussion and Analysis to be "filed" and hence covered by the certification requirements of the Sarbanes-Oxley Act, is an excellent way to send a strong message of accountability to those approving compensation packages. The concept regarding the report being "furnished" rather than "filed" to allow for more robust discussion has not borne out. Rather than being robust, too much of the current disclosure is boilerplate, and the SEC has made clear in its current proposal that boilerplate disclosure is unacceptable. To increase accountability, we believe that the CD&A report should also be over the names and signatures of the compensation committee. Because the CD&A is intended as a principles-based document, the compensation committee would be signing off on the principles and practices that they utilize in creating pay packages. Their signatures reinforce the compensation committee's obligation and accountability to shareholders.

Require all companies, including small firms, to include the CD&A

The Commission indicates that the CD&A should focus on material principles underlying executive compensation policies and decisions. As such, the CD&A is key to ensuring that investors have a firm understanding of compensation decisions. Small companies should not be exempt from disclosing material information about compensation objectives and policies. Compensation arrangements in small businesses can be even more complex as a result of their limited cash flow situations, and we recommend that small businesses file CD&A disclosures.

Disclose performance targets or actual performance upon payouts

Companies should publicly disclose target levels for specific quantitative or qualitative performance-related factors considered by the compensation committee or the board of directors. Without disclosing the specifics of performance targets, shareholders cannot assess the rigor of the program or the difficulty of meeting those targets. Performance targets could be disclosed either at the beginning of the performance cycle or after the completion of the performance period. The disclosure of performance targets does not create adverse competitive effect, as evidenced by the growing number of companies that have voluntarily disclosed specific hurdles that the named executive officers must clear to profit from performance-based equity awards.

Remove the $10,000 minimum threshold for perquisites

We concur with the Commission's comments that the current perquisite exclusion of the lesser of $50,000 or 10 percent of the total of an executive's annual salary and bonus has resulted in material omissions. However, having a $10,000 minimum threshold would allow companies to continue to avoid disclosure of many executive perquisites. Often, the small monetary value of perquisites belies their significance. Inappropriate perquisites, even in small dollar amounts, may portend larger compensation problems. Therefore, we believe that having no minimum threshold would shed light on all types of perquisites provided to executives and would minimize any abuse in this area.

Remove the compensation disclosure of up to three non-officer employees

The disclosure of up to three employees who are not executive officers but earn more in total compensation than any of the named executive officers will provide little value to shareholders without the appropriate narrative disclosure and the supplemental figures to support the total compensation figure. Unlike the named executive officers, the three non-officer employees are generally not individuals who have the ultimate authority over the company's strategic imperatives or broad business activities. Furthermore, these three individuals may change each year depending on their total compensation figures. The lack of continuous and consistent disclosure further dilutes the need for such information.

Require disclosure of all related-person transactions

The Commission's proposal to increase the minimum threshold for reporting related- person transactions from $60,000 to $120,000 will exclude many smaller transactions that in aggregate may be material enough to warrant shareholder concern. Therefore, we urge the SEC to require disclosure of all related-person transactions and not set a minimum threshold. This approach would allow shareholders to view and evaluate all related-person transactions and make their own determinations about the materiality of specific transactions or in aggregate. Also, any related-person transaction could potentially be problematic, and therefore it is important for shareholders to know of such potential conflicts. To make it easy for investors to review this data, the transactions should be listed in tabular form and in descending order from highest to lowest.

Mandate certain standard assumptions on FAS 123R for executive pay

ISS supports FAS 123R as the appropriate approach for valuing equity-based awards. Stock-based and option-based awards should be valued in total on the grant date and should not be adjusted on the vesting date. We agree with the SEC's proposed method that subscribes to the measurement method of FAS 123R, but also provides for immediate disclosure of compensation, separate from the compensation expense for accounting purposes. To make the total compensation figure comparable across companies, the SEC should mandate some standard assumptions for stock-based compensation. Specifically, we advocate for the full term assumption rather than expected term assumption for calculations for named executive officers. Expected term assumption can vary widely from company to company due to such factors as age, tenure, and income bracket. The full term assumption is objective and consistent, and will ensure that investors have apples-to-apples comparisons across companies.

Require full disclosure on deferred compensation plans

Quantification and disclosure of the costs of deferred compensation, including forgone tax deductions and the costs of investments, present a full and complete picture to shareholders. Therefore, ISS recommends disclosure of cumulative contributions and earnings accrued on deferred compensation plans. We also recommend disclosing the cumulative dollar amount of contributions, the aggregate interest or other earnings accrued from inception of the executive's participation in the plan through the end of the company's last fiscal year, and the specific interest rate applied to cash-denominated deferral accounts for the last fiscal year's accruals.

Require quantitative and tabular disclosure on potential post-employment payments

To be consistent with the additional tabular disclosure in supplemental equity tables and post-retirement tables, ISS recommends tabular disclosure regarding payments upon termination or change in control. The tabular disclosure should include each potential termination event, severance upon termination, and severance upon change in control.

Require aggregate actuarial value of pensions

The estimated annual retirement payment does not present the magnitude and potential pension cost to shareholders. ISS recommends the quantification of the aggregate actuarial value of pension for all companies without regard to whether the plan permits a lump sum distribution. We believe that the present value of a pension paid for the life of an executive provides the complete picture of the potential cost implications.

Retain key information available to shareholders under current rules

The Commission indicates that the proposed disclosure rules will build on current requirements rather than replace them. As such, several useful disclosure items should remain to provide clarity and completeness to investors. Information that is helpful to shareholders and should remain as disclosed items include: the five-year performance graph, the ten-year option repricing table, and the percent of total options granted column in the Grants of All Other Equity Awards table.

Rule Changes Will Lead to a Positive Impact for Shareholders

The proposed rules on executive and director compensation will address the major deficiencies in the current disclosure system. ISS supports the Commission's work, and we suggest further enhancements to ensure that shareholders have complete quantitative and qualitative information to assess executive pay. The revisions to compensation disclosure will serve shareholders well, provided that they, in turn, do their part as advocates in this process. In conjunction with the SEC's proposal, we urge continued engagement and constructive dialogue between issuers and investors to promote better disclosure of executive compensation, as well as more consensus on other corporate governance matters.

Sincerely,


Martha L. Carter, Ph.D.
Senior Vice President and Managing Director, Corporate Governance

March 28, 2006

More Firms Adopt Majority Vote
Submitted by: Thaddeus C. Kopinski, Staff Writer

More U.S. companies are trying to head off shareholder proposals seeking majority board elections by changing their bylaws to require a majority of votes cast to elect a director.

The latest firms to embrace a full majority vote standard include Alaska Air Group, Altera, and Safeway. These changes bring to at least 18 the number of companies that have adopted a majority vote bylaw plus a resignation policy for incumbents who fail to gain the requisite vote, an approach commonly referred to as the "Intel model." Another seven companies have confirmed that they are in the process of doing so.

Last year, Alaska Air faced eight investor resolutions seeking annual elections, a vote on "poison pill" plans, and other governance reforms, half of which got more than 70 percent of votes cast. Five shareholder proposals received a majority of votes cast in both 2004 and 2003. In response to these votes and another round of shareholder proposals this season, Alaska Air adopted a majority vote bylaw and is seeking shareholder approval to declassify the board and rescind supermajority requirements at the company's May 16 meeting.

At Altera, a majority vote resolution filed last year by the Sheet Metal Workers Union got 59.5 percent of votes cast. A similar proposal by the United Brotherhood of Carpenters and Joiners received 46.1 percent at Safeway.

In 2004, Safeway was the subject of a "vote no" campaign by four public pension funds, which generated withhold votes of 15 to 17 percent against CEO Steve Burd and two directors. In the face of the campaign, Safeway introduced a number of governance changes, including naming an independent lead director.

At Marriott International, management is supporting a majority vote proposal by the Carpenters at the company's April 28 annual meeting. Last year, a similar proposal by the union fund received 39.1 percent of votes cast.

"The company now believes that the clear trend in corporate governance is toward greater and greater adoption of the majority vote standard for uncontested elections," the company said in its proxy statement. "Corporate governance experts agree that the majority vote standard will likely become the norm over the next few years."

While Pfizer and some 80 other firms have adopted resignation guidelines while retaining plurality voting, the Carpenters and other proponents argue that only an explicit majority standard would provide shareholders with a meaningful vote in uncontested elections.

"The growing list of major companies whose boards have adopted a true majority standard combined with post-election resignation policies has set a new standard," Ed Durkin, the Carpenters union's corporate affairs director, told Governance Weekly. "I think we have turned the corner on the issue and the burden is now on those companies that do not have majority vote standard bylaws to justify their continued use of a plurality vote standard."

Of the 65 majority-vote proposals filed by the Carpenters' pension fund this year, three came to a vote earlier this month at Analog Devices, Ciena, and Hewlett-Packard. (For details, see the March 17, 2006, issue of Governance Weekly.) Fifty-one resolutions are still slated for a vote, while 11 have been withdrawn. Many of those firms have agreed to implement a majority standard.

A "Very Strong Vote"
Durkin said that the 45 percent support received at Hewlett-Packard, which adopted a resignation policy modeled after Pfizer's, was "a very strong vote." Pfizer was the first to introduce a director resignation policy last June.

"Despite action by the H-P board to adopt a director resignation policy and the company's strong advocacy against the proposal, nearly half the shareholders said that its director resignation policy combined with a continuation of the plurality vote standard do not go far enough," Durkin noted.

Richard Ferlauto, director of pension investment policy at the American Federation of State, County & Municipal Employees--which has a majority elections proposal at Morgan Stanley's April 4 annual meeting--has a similar view.

"I don't believe [the Pfizer model] is good policy. I think the momentum is there and most investors do understand the critical differences between a resignation policy and changing the voting standard itself," Ferlauto told Governance Weekly. "I expect that there will be strong and growing support for majority voting throughout the season."

In contrast, Martin Lipton, a founding partner of the law firm of Wachtell, Lipton, Rosen & Katz, which represents corporate clients, sees the vote results at H-P, Ciena (31 percent support), and Analog Devices (35 percent) as a vindication of the Pfizer approach. "We continue to believe that the corporate governance guideline is sufficient and should satisfy the desire of governance advocates for majority voting," Lipton said in a memorandum to clients.

The issue is also on the ballot April 6 at Novell. Majority vote proposals are being voted on April 18 at Sprint Nextel, Wachovia, Kaman, and Electronic Data Systems. Similar proposals are slated to go to a vote at Burlington Northern Santa Fe on April 19 and at Weyerhaeuser on April 20. Majority election proposals are on the agenda at more than 100 meetings this proxy season.

Research Editor Rosanna Landis Weaver contributed to this article.

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March 27, 2006

Shareholders to Vote on Takeover Defenses in Japan
Submitted by: Marc Goldstein, Director of Research Services-Japan

As Japan's proxy season gets underway, "poison pill" plans and other takeover defenses are shaping up to be one of the major issues of 2006. Three companies have placed such measures on the ballot at their annual meetings next week, but a host of others have announced defenses that do not require a shareholder vote.

The three companies that are submitting their takeover defenses to a shareholder vote later this month are Lion, a manufacturer of home and pharmaceutical products; Torigoe, a flour milling company; and CAC, a computer systems developer.

Lion's plan is a so-called "trust-type" shareholder rights plan, of the kind adopted by a number of Japanese companies in 2005. Assuming the plan is approved by shareholders at the March 30 meeting, Lion plans to issue stock acquisition rights (warrants) for more than 600 million shares to Mitsubishi UFJ Trust and Banking, as the trustee of a new trust. The number of warrants represents 191 percent of the number of outstanding Lion shares as of the fiscal year-end. In the event the plan is triggered, Lion shareholders (other than the would-be acquirer) would be designated as beneficiaries of the trust, and the warrants would be transferred from Mitsubishi UFJ Trust to the beneficiaries. The warrants would be exchangeable for shares of Lion common stock at a one-for-one ratio.

The poison pill plan is designed to be triggered when a "specified large shareholder"-- defined as a party who holds or is attempting to acquire more than 20 percent of Lion shares--emerges, and the company deems the acquisition or attempted acquisition to be coercive or otherwise detrimental to shareholders. In making such a determination, the board would "assign maximum value to the recommendation" of a committee drawn from among the company's non-executive directors and statutory auditors. If the plan is triggered, Lion shareholders will have the right to exercise the warrants for JY 1 per share, thereby diluting the holdings of the potential acquirer. The exercise period for the warrants is set to expire on March 31, 2009, and if Lion decides to renew the plan, shareholder approval will again be required.

Lion's plan has positive features, including the absence of "dead-hand" provisions, an effective three-year sunset provision, and the fact that the independent committee will be able to hire legal and financial experts at the company's expense. Nonetheless, the ISS recommendation-research staff is advising shareholders to oppose the plan. First, Lion's 11-member board will have only two non-executives following this annual meeting. To ensure that the board remains responsive to shareholders after the introduction of a poison pill, ISS believes that independent directors should make up at least 20 percent of the board. Second, the poison pill is accompanied by another defense, namely an article amendment to eliminate all vacant seats on the board. This change will make it more difficult to elect shareholder candidates, as it will require management nominees to be defeated to make room for the shareholder nominees.

The takeover defenses proposed by Torigoe and CAC, both of which are holding their meetings on March 30, are what are known in Japan as "advance warning-type" defenses. These do not require a shareholder vote in Japan, and may be implemented with a board resolution; for this reason, those measures likely will far outnumber trust-type poison pills in 2006. However, Torigoe and CAC have chosen to present their plans to shareholders for a vote.

In both cases, any suitor that acquires 20 percent or more of the target company's issued share capital will be asked to explain the purpose of the bid, the method used to value the target's shares, the method used to raise funds, the identity of parties who offer those funds, and the bidder's strategic plan for the company if successful.

Once this information is obtained, the board would then ask the bidder to delay launching a tender offer until the board (or in the case of Torigoe, an independent committee) could study the information presented, and present an alternative plan where appropriate. The waiting period at Torigoe will be set at 60 days; at CAC, it will be 60 to 90 days, depending on whether the deal is an all-cash acquisition or involves a share exchange. However, if Torigoe's independent committee decides that it needs more time to make a recommendation, the committee can extend the waiting period.

If the would-be acquirer fails to comply with these rules, then the independent committee (at Torigoe), or the board acting on the advice of a special committee (at CAC) may act to dilute the holdings of the bidder by issuing warrants to all other shareholders. However, even if the bidder does comply with the rules, the companies may take such action if the board or the committee decides that the bid would clearly damage shareholder value (e.g., an attempt at "greenmail' or asset stripping). Should these plans be triggered, warrants would be issued to all shareholders other than the hostile bidder, and thus ordinary shareholders would not find their stakes diluted. However, those shareholders could potentially be denied the opportunity to receive a takeover premium for their shares.

Among the other companies which have announced "advance warning" takeover defenses in recent weeks are brewery and beverage holding company Sapporo Holdings, pharmaceutical maker Eisai, railway operators Hankyu Holdings and Keihan Electric Railway, biotechnology venture firm AnGes MG, and chemical manufacturer Tosoh. Many other companies are considering such measures, urged by law firms and investment banks, which see a huge business opportunity in designing such defenses and helping companies to implement them. In most of these cases, shareholders will not be able to vote on the adoption of the defense itself. If they decide that a plan is sufficiently objectionable, they may choose to vote against the re-election of directors. As shareholders evaluate these defenses, key issues will include the composition of the committee that will evaluate any bid, and the respective authorities of the committee and the full board.

Japanese companies that implement takeover defenses via a board resolution are required to note this fact in their proxy circulars. However, the quality as well as the timing of such disclosure varies considerably from company to company. Shareholders can expect to see takeover defenses announced--often at the last minute--by many of the companies that have problematic governance practices, such as insider-dominated boards, opaque capital strategies, or poor disclosure practices. Investors may conclude that it is precisely these companies whose shareholders have the most to lose from a takeover defense that insulates management from the threat of a hostile bid.

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March 23, 2006

Update on French Poison Pills
Submitted by: Fassil Michael, Director of Custom Research

Update on French Poison Pills

The French parliament today adopted the much-anticipated legislation that allows companies to adopt poison pills to thwart hostile takeovers. Going forward, French companies, upon receiving shareholder approval at their annual general meetings, will be allowed to issue warrants to existing shareholders at deeply discounted prices to block hostile takeovers. Some have commented on the "timeliness" of this legislation, in light of the ongoing debate over the GDF-Suez takeover deal, as well as the Arcelor deal. The Associated Press in Paris is covering the story.

We invite your comments on this legislation.

France authorizes 'poison pills' to thwart hostile takeovers
227 words
23 March 2006
13:03
Associated Press Newswires
English
(c) 2006. The Associated Press. All Rights Reserved.
PARIS (AP) - French lawmakers Thursday adopted measures allowing companies to use so-called "poison pill" defenses to thwart hostile takeovers.

Under the new takeover law, approved in a final reading by the Senate, French companies will be allowed to issue warrants to shareholders to fend off a hostile bid.

Warrants allow existing shareholders to acquire newly issued stock at an advantageous price, diluting the value of a company's shares -- which can force a hostile bidder to withdraw its offer.

The amendment allowing warrant issues was introduced after Mittal Steel Co. launched a hostile bid for Arcelor SA, a Luxembourg-based steelmaker that is also quoted on the Paris stock exchange.

A second amendment -- introduced in the wake of unconfirmed reports last year that U.S. soft drinks and snack maker PepsiCo Inc. was mulling a bid for French food group Danone SA -- allows French market authorities to force potential bidders to state their intentions if rumors begin to affect share prices.

Laurence Parisot, the head of French employers' organization Medef, said the new measures would place French companies on an equal footing with foreign firms. Poison pill defenses have been used by U.S. companies for about two decades.

"It's a sign of pragmatism and good sense, at an opportune moment," Parisot said in a statement.

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Poison Pills-Issues in 2006 and Statistical Trends
Submitted by: Mark Saltzburg, Associate Counsel

Issues in 2006

In 2006, it appears that poison pills will continue to be an issue of focus for shareholder proponents although to a lesser extent than in the past two years.

ISS' Governance Research Services (GRS) is currently tracking 24 poison pill shareholder proposals submitted to companies. This number of proposals is considerably lower than the 101 proposals submitted to companies in 2004.

As in 2005, most of the proposals for the 2006 proxy season were submitted by individual shareholders (including the Chevedden and Rossi families) rather than by institutional investors or large funds. In at least one case, a proposal was submitted by a labor union pension fund. Unlike in 2005, it does not appear that any of the 2006 proposals were submitted by investment funds.

Statistical Trends

Company Action:
Newly Adopted or Extended Pills: GRS tracked 41 companies in its core research universe that adopted or extended shareholder rights plans in 2005.

Shareholder Proposals:

Volume of Shareholder Proposals in Past Years: Last year in 2005, there were 51 shareholder proposals related to poison pills. In 2004, shareholders submitted 101 such shareholder proposals. In 2003, there were 107 such shareholder proposals; in 2002, there were 81; in 2001, there were 37 proposals.

Voting Support for Shareholder Proposals in 2005: GRS has voting results for 25 poison pill proposals that came to a vote at the company's meeting. Seventeen of the 25 proposals (or 68 percent) received majority votes. Sixteen of these 25 proposals (or 64 percent) passed according the companies' own voting requirements.

Average Level of Voting Support: In 2005, poison pill shareholder proposals won an average approval of 60.1 percent of shares voted. (This figure is slightly lower than the average of 61.1 percent in 2004. Other averages in recent years were: 60.0 percent in 2003; 60.2 percent in 2002; and 57 percent in 2001.)

Shareholder Proposals in 2006: Currently, GRS is tracking 24 precatory (nonbinding) shareholder proposals on poison pills for 2006.

For Companies Receiving Shareholder Proposals on Poison Pills in Successive Years, Change in Level of Voting Support: In 2005, shareholders voted on proposals regarding poison pills at 14 companies at which similar proposals were also submitted and voted on in 2004. Support for the proposal increased at 7 of these companies.

Number of Companies with Pills:
Number of Companies with Poison Pills: As of the end of 2005, GRS tracked approximately 1,821 U.S. companies with active poison pills. Of GRS's core research universe of 1,917 companies, 953 have active pills.

Percentages of Companies with Poison Pills: In 2005, the proportion of larger companies with shareholder rights plans fell below 50 percent. Among S&P 500 companies, 46 percent had a poison pill at the end of 2005. In previous recent years, this percentage had remained above 50 percent. In these prior years, the proportion of S&P 500 companies with poison pills was: 53.8 percent of companies at the end of 2004, 57.6 percent of companies at the end of 2003, 60.0 percent of companies at the end of 2002, and 59.6 percent of companies at the end of 2001.

Poison Pill Trigger Thresholds
Percentage Ownership of a Company's Equity that Triggers Its Pill: Of the approximately 1,776 companies for which GRS has trigger information, 437 companies (24.6 percent) have triggers of 20 percent, 1,201 companies (67.6 percent) have 15 percent triggers and 111 companies (6.3 percent) have 10 percent triggers.

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March 22, 2006

Regulators to Hold May 10 Forum on Internal Control Rules
Submitted by: Ted Allen, Director of Publications

The Securities and Exchange Commission and the Public Company Accounting Oversight Board plan to hold a May 10 roundtable to seek comments on the internal control reporting requirements of Section 404 of the Sarbanes-Oxley Act.

The forum will be held at the SEC's headquarters in Washington. The agencies held a similar forum in April 2005 on Section 404, which requires companies to disclose and fix internal control deficiencies, including "material weaknesses" that could lead to a restatement of financial results.

Company officials have complained about higher-than-expected compliance costs and the distraction of management from other strategic concerns. Institutional investors have praised the increased focus on internal controls prompted by Section 404 and cautioned against easing or delaying its requirements.

"We look forward to an update on compliance efforts after year two," SEC Chairman Christopher Cox said in an agency press release. "We will carefully consider the facts presented to help develop policies to effectively and efficiently improve the reliability of financial statements for the benefit of investors."

To offer comments on Section 404, one may use a submission form available here or send an e-mail to rule-comments@sec.gov. One may also send a letter (in triplicate) to: Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, N.E., Washington, D.C. 20549-1090. The deadline for comments is May 1, and all comments should refer to File Number 4-511.

We also invite your comments.

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March 20, 2006

Global Roundup
Submitted by: Subodh Mishra, Staff Writer

Swiss Firms in Shareholders' Crosshairs As Proxy Season Commences

Swiss governance watchers are focusing this proxy season on developments at consumer goods giant Nestle and packaging materials manufacturer SIG Holding, albeit for different reasons.

The debate over Nestle's governance practices will be renewed at the firm's April 6 annual meeting following investors' demands last year for improvements. In 2005, the Ethos Investment Foundation filed three shareholder proposals that included calls to separate the chairman and CEO positions, loosen shareholder proposal submission requirements, and reduce board terms from five to three years.

All three resolutions failed to carry. However, the strong showing (36 percent) of Ethos' proposal to split the top two posts prompted Nestle to take steps to shore up its governance. In August, the company sent shareholders a survey to gauge ways to improve governance practices. With responses in hand, management is now asking shareholders to vote on a proposal to amend the company's bylaws to potentially allow for governance improvements. The changes would likely take place in 2007 or thereafter.

One key improvement is expected to be the dismantling of a long-standing takeover defense that limits voting rights to just 3 percent, regardless of the size of an investor's holding, according to a March 12 report in London-based The Independent. The bylaws overhaul will allow the board to remove the defense, the article reported.

Prior to Nestle's meeting, Swiss governance observers will be focused on the efforts of dissident shareholder Special Solutions to shake up the board at SIG Holding's March 30 annual meeting. Sterling Investment Group, which controls Special Solutions and holds roughly 8.6 percent of SIG's equity, originally sought the removal of four directors, but it is now backing the removal of just one (although proposals calling for the removal of all four directors will remain on the ballot).

Sterling says it took this step in response to the company's failure to disclose the terms of potential takeover bids for the Schaffhausen-based firm. SIG management contends the company was under no obligation to detail the nature of the bids because they were non-binding. In addition, management says the bids provided no strategic rationale and failed to offer long-term benefits.

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March 17, 2006

Update: University of California Divests of Some Sudan-Related Investments
Submitted by: Jan Fetter-Degges,Senior Research Analyst, Social Issues Service

Yesterday, the University of California became the latest--and, as measured by the number of students in its system, the largest--educational institution to divest from companies doing business in Sudan. The university system's regents voted unanimously to divest of nine companies in various portfolios held by the university. These nine companies, all of which have equity invested in Sudan and two-thirds of which are involved in Sudan's oil industry, were "clearly shown to be providing monetary or military support to the government, while showing little or no interest in the situation in Darfur or in helping to improve the welfare of the Sudanese people," a statement by the Regents said.

Full divestment of these nine companies will take place over an 18-month period, beginning only after California's legislature has passed a bill that would free individual Regents and the university system as a whole for any liability resulting from divestment.

The Regents declined to divest of all companies in the system's portfolio with Sudan ties. Instead, they pledged to engage in continued dialogue with some companies whose presence in Sudan the Regents believe can benefit the Sudanese people as well as or instead of benefiting Sudan's government. A policy of limited divestment appears to be a trend in university divestments from Sudan: Harvard, Stanford and Yale have also adopted limited divestment strategies.

A new bill, mandating divestment by CalPERS and CalSTRS from Sudan, has been introduced in California's legislature. A similar bill was introduced last year, but was edited before passage, changing a divestment requirement to a recommendation.

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Majority Voting Gets Mixed Results
Submitted by: Thaddeus Kopinski, Staff Writer

Majority election proposals remain popular among investors, but the first vote results of the season suggest that those resolutions may not fare as well this year at U.S. companies that have adopted director resignation policies.

A proposal by the United Brotherhood of Carpenters and Joiners received 35 percent of votes cast at Analog Devices on March 14 and 31 percent at Ciena the next day. At Hewlett-Packard's March 15 meeting, the resolution received 45 percent support, close to the 44 percent averaged by 62 such proposals last year.

These were the first three annual meetings of 2006 where the issue of majority voting in board elections came to a vote; it was also the first time that majority vote proposals were on the ballot at these companies. Most significantly, the votes were the first test ever of whether investors are satisfied with the director resignation policies adopted by Pfizer and more than 80 other firms or would prefer that companies go further and adopt bylaws establishing a full majority standard, as Intel, Dell, and a dozen other firms have done.

Analog Devices, Ciena, and Hewlett-Packard, which opposed the proposal by the Carpenters' pension fund, all amended their corporate governance guidelines late last year to provide a director resignation policy while maintaining a plurality standard. H-P unsuccessfully tried to persuade the Securities and Exchange Commission to allow the company to omit the Carpenters' proposal, arguing that it had substantially implemented the resolution by adopting a resignation policy.

The three companies' policies call on director nominees who receive a majority of "withhold" votes to tender their resignation. Such votes are rare at U.S. companies; last year, just 14 out of more than 35,000 director nominees received a majority withhold vote. While the United Kingdom, Australia, and other nations have majority elections, most U.S. companies still have plurality voting. At those firms, management nominees are ensured of winning a board seat in uncontested elections, regardless of how many investors withhold their support. The Carpenters and other proponents argue that a full majority default standard is the only way to ensure that shareholders have a meaningful vote in uncontested elections.

With just three votes so far, it's too early to tell whether director resignation policies will suppress investor support for a full majority standard. Majority vote proposals will be on the ballot this season at two dozen other firms that have adopted resignation policies, including Morgan Stanley (April 4) and Novell (April 6). This issue may fare better later this season as more investors focus on it. Last year, a majority vote proposal did not receive majority support until the seventh meeting where it was on the ballot.

The most recent U.S. companies to adopt a resignation policy include General Dynamics, 3M, and Berkshire Hathaway. Of the almost 80 companies that have adopted director resignation policies, only two--Time Warner and Toro--have put these policies in their bylaws, as is being recommended in the latest proposal by the American Bar Association's Committee on Corporate Laws.

ABA Group Calls for Use of Bylaws
On March 13, the ABA committee released a series of proposed amendments to the Model Business Corporation Act to allow companies to adopt bylaws to provide for a modified plurality standard and more enforceable director resignation policies. The Model Act is used by most U.S. states to craft their corporate laws.

The ABA's proposed changes are consistent with a preliminary report issued in January by the lawyers' group, which disappointed the Carpenters and other investors by declining to support a majority default standard. In that preliminary report, the committee endorsed director resignation policies and other voluntary initiatives and pledged to work out language that would make these policies enforceable. Pfizer's corporate secretary, Margaret M. Foran, along with A. Gilchrist Sparks III of the Delaware law firm of Morris, Nichols, Arsht & Tunnell, co-chaired the task force that wrote the report.

In its latest report, the ABA committee seeks to address investor concerns about the enforceability of resignation policies by calling for the use of bylaw amendments, rather than corporate governance guidelines. Some investors have argued that adopting a resignation policy through a governance guideline is not sufficient, because those guidelines can be changed at any time by the board without shareholder approval.

These investors have cited the example of News Corp. to illustrate their concern. In 2004, the company stated that it would seek investor approval for future poison pills as it sought shareholder permission to reincorporate from Australia to Delaware. The company later adopted a pill and then extended it by another two years in August 2005 without seeking shareholder approval. Twelve U.S., Australian, and European institutional investors then sued the board. The company argued that it had the right to change governance policies without shareholder approval, but a Delaware court refused to dismiss the case in December. A trial in the case is set for April 28.

Meanwhile, state lawmakers in California are considering legislation to establish a default majority standard for uncontested director elections. On March 13, CalPERS, the country's largest public pension fund, publicly endorsed the bill introduced by Senator Richard Alarcon. If passed, the legislation would affect 23 public companies incorporated in the state. (For details, see the Feb. 10, 2006, issue of Governance Weekly.)

Holdover Directors
The ABA proposes to change the Model Act to allow either the board or shareholders to unilaterally adopt a director resignation policy for uncontested elections through a bylaw amendment (but only at companies that do not have cumulative voting).

The proposal also includes stronger language to force off nominees who receive majority opposition. The ABA calls on nominees who receive more votes cast against than for their election to serve an abbreviated term of either 90 days or until the date a replacement is selected, whichever comes first.

The Model Act now allows companies to opt out of the default plurality standard only by amending the articles of incorporation; this has to be done at the initiative of the board of directors and endorsed by shareholders. More than 30 states have adopted the plurality default provisions of the Model Act. In contrast, current corporation law in Delaware, where more than half of all public companies in the U.S. are incorporated, allows shareholders to opt out of the default standard by amending the bylaws. If the company's voting rules are in the certificate of incorporation, the change has to be made by the board of directors. Delaware is not a Model Act jurisdiction.

The current Model Act (as well as Delaware law) contains a provision known as the "holdover rule," which says that an incumbent director may stay in office until a successor is chosen and qualified. The report notes that the rule is prescriptive and does not expressly give the corporation the authority to change its provisions.

The ABA proposes to amend the Model Act to expressly allow changes in the articles of incorporation, initiated by the board and endorsed by shareholders to either eliminate the holdover rule altogether or adopt variations of it. "Such a change will permit corporations to strike an appropriate balance between the risks associated with failed elections and the goal of attaining greater director accountability," the report notes.

Investors Express Disappointment
Keith L. Johnson, who represents a group of 17 institutional investors from the Netherlands, the U.K., Australia, and the U.S. that have lobbied the ABA to support a majority default standard, expressed disappointment over the committee's proposals.

"Given the growing support that majority vote standard resolutions have received, the ABA committee's recommendation would create an inefficient process that forces companies and shareholders to deal with thousands of shareholder resolutions that will be eventually adopted," Johnson, a lawyer with the firm of Reinhart Boerner Van Deuren, told Governance Weekly. "However, it does challenge institutional investors to get their act together and seek self-help, which may be a good thing."

The proposal by the ABA committee is being published in late April in The Business Lawyer. Public comments can be sent until May 30 to E. Norman Veasey, Committee Chair, Weil Gotshal & Manges, 767 Fifth Ave., New York, N.Y. 10153, or by e-mail to e.normanveasey@weil.com. The document can be downloaded from the ABA Web site here.

Proposed amendments to the Model Act must be reviewed three times by the ABA committee before they are adopted. State legislatures then will decide whether to change their laws to reflect the Model Act amendments.

"We are a long way from that end in this matter," E. Norman Veasey, the former Delaware chief justice who heads the committee, told Governance Weekly.

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March 15, 2006

Commentary: Two for the Price of One
Submitted by: Bruce Carton, Vice President, Securities Class Action Services

Filing Claims in Securities Class Action Cases can Help Investors Also Get a Share of SEC Settlements

On Feb. 24, the Securities and Exchange Commission filed a motion with the court handling its case against Qwest Communications International requesting approval of a plan to distribute a $250 million settlement in a way that reflects an important and growing practice at the SEC.

The plan calls for the money to be distributed through the claims administration process that is underway in a completely separate securities class action settlement involving Qwest. Under this proposal, by filing a single proof of claim in the $400 million Qwest securities class action settlement (deadline: May 2, 2006), an institutional investor will also be able to recover its share of the $250 million SEC settlement. No part of the $250 million will be used to pay fees or expenses of counsel in the securities class action.

I realize that I am likely preaching to the choir here since SCAS clients reading this probably already understand the importance of filing claims in securities class action settlements. The SEC proposal in the Qwest case, however, is worth highlighting because it the latest reminder that the economic cost of failing to file claims in securities class actions can and does go beyond the amount at stake in the class action itself.

There have been numerous other examples over the last 18 months of the SEC and even the U.S. prosecutors dumping settlement money from their own cases into the securities class settlement distribution process:

--September 2004: The SEC announced court approval of its plan to distribute the proceeds of its $150 million settlement with Bristol-Myers Squibb via the claims administrator appointed in a parallel securities class action against the company. This $150 million recovery was in addition to the $300 million recovered by the plaintiffs in the class action settlement.

--February 2005: The SEC filed a motion seeking to have its $25 million settlement with Lucent Technologies transferred to the account established by the claims administrator in the securities class action settlement involving Lucent. The SEC proposed that the claims administrator would distribute the funds to the class members who had already filed claims in that settlement (the claims deadline in the class action was March 2004).

--March 2005: A federal court overseeing the SEC's $1,450,000 settlement with a company called Measurement Specialties approved the SEC's plan to distribute all of this money on a pro rata basis to the class members who had already filed claims and qualified to receive funds under the allocation plan approved by the court in a securities class action against the company (the claim deadline in the class action was August 2004).

--July 2005: The U.S. Attorney's office handling the prosecution of former WorldCom CEO Bernie Ebbers announced that approximately $25 million to $33 million in restitution expected to be recovered from Ebbers would go to the victims of WorldCom via the securities class action settlement fund.

The past few years have seen an explosion in the dollar amounts of SEC civil penalties, to the point where settlements in the hundreds of millions of dollars are now almost routine. Following the enactment of the Fair Funds provision of Sarbanes-Oxley in 2002, these penalties are being distributed for the first time to investors (rather than to the U.S. Treasury). The SEC's distribution plan in the Qwest settlement, and all of the other cases above, demonstrate that in this new era, filing claims in securities class action settlements may be the only way for an investor to recover its rightful share of many significant SEC settlements.

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March 14, 2006

Update on French Poison Pills
Submitted by: Fassil Michael, Director of Custom Research

In response to recent high profile foreign hostile tender offers in France, the French National Assembly last week began debating the new takeover law that would give French companies the prerogative to use poison pills to thwart hostile tender offers.

A key point in the debates was whether the law should require a simple or a two-thirds majority vote of shareholders to adopt a poison pill. Finance Minister Thierry Breton reminded the Senate that, in the United States, shareholder approval of poison pills is not required and that the new takeover rule would simply give French companies the ability to defend themselves on equal terms.

However, many investors question whether such defense mechanisms would ultimately be in shareholders' best interests. Because poison pills alter the balance of power between shareholders and management, most believe that shareholders should at least be allowed to make independent evaluations of the provisions contained in poison pills.

Pills that do not contain shareholder friendly features, especially when coupled with other takeover defenses, insulate management from the threat of a change in control. They provide a target's board with veto power over takeover bids that may be in shareholders' best interests. As such, while many investors believe that the proposed law does not go far enough in protecting shareholder interests, most feel requiring an 'up or down' vote of shareholders is indeed a very important provision that should be preserved.

ISS, for its part, believes that features such as a three-year sunset provision (allowing shareholders to periodically affirm or redeem the pill) and a qualifying offer clause (which gives shareholders the ability to redeem the pill when faced with a bona fide tender offer) would make poison pills more palatable to shareholders. When evaluating the merits of a poison pill, shareholders should also take into account whether or not the company has brought acquisition offers to shareholders or has adopted other takeover defenses in the past.

The French National Assembly is scheduled to reconvene on March 16, 2006 to hammer out the final amendments before the new takeover rules come into law. But no matter what final form French poison pills take, the law should require companies to include in their annual reports to shareholders detailed descriptions of any takeover defenses they may institute. Such disclosures would surely allow shareholders to take action against underperforming boards who may use this newfound power to entrench themselves.

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March 13, 2006

Sudan Divestment Campaign Continues
Submitted by: Jan Fetter-Degges, Social Issues Service Senior Research Analyst

Pending Legislation
The Sudan divestment campaign, which included the consideration of divestment bills in one-fifth of U.S. state legislatures in 2005, shows no signs of tiring in 2006. Bills introduced in 2005 in New York, North Carolina and Vermont are still pending, and new bills could be introduced in Maryland (where a bill died in committee in 2005) and Massachusetts. In 2005, Illinois and New Jersey enacted laws mandating divestment of state funds from companies doing business in Sudan, while Arizona, Louisiana and Oregon passed laws encouraging divestment, and the California legislature passed a resolution encouraging the state's public pension systems to encourage companies doing business in Sudan to work to safeguard human rights. California's Public Employee Retirement System (CalPERS) has been studying the issue, meeting this winter with representatives from several companies with major investments in Sudan.

University Update
In the past four weeks alone, Yale and Brown have agreed to divest of some of their assets in Sudan, with Brown pledging total divestment and Yale divesting from seven oil companies and Sudanese government bonds (but retaining the possibility of holding stock in other companies with business in Sudan). Later this month, the University of California regents will meet to discuss Sudan divestment. Schools including Harvard, Stanford, Amherst and Dartmouth have already enacted divestment policies (in many cases choosing to divest of only a handful of companies that are major players in Sudan's oil industry), and students are pressuring the administrations of many other schools to consider divestment.

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March 10, 2006

E-Proxies Examined at This Year's SEC Speaks
Submitted by: Mark Saltzburg, Associate Counsel

Securities and Exchange Commission staff and commissioners gathered on March 3 and 4 for the Practicing Law Institute's annual "SEC Speaks" conference to detail a host of ongoing commission initiatives.

Speakers focused on topics including the commission's efforts to tackle accounting fraud, fairness opinions, enforcement actions, and its proposed Internet proxy rule. Staff members also provided some 2005 shareholder proposal statistics. Division of Corporation Finance Chief Counsel David Lynn noted that companies sought no-action on 337 companies, which is fewer than in past years, while the commission averaged roughly 42 days to respond to no-action requests.

SEC Focus on Accounting Fraud
This year's conference, held against the backdrop of the trial of former executives of failed energy giant Enron, included a panel examining the commission's work to identify accounting irregularities and how companies were "cooking the books."
SEC Division of Enforcement Chief Accountant Susan Markel described numerous instances of accounting violations the SEC found in 2005. She noted that frauds typically were committed at companies where management had financial incentives to do so, or was under pressure to produce results.
Markel also said it was common for management involved in frauds to rationalize the conduct. Typical reasons cited were the need to make projections; pressure from a superior; potential for a pending acquisition to fall through; and reliance that the company would make up next quarter fictitious revenue that had been booked.

Markel noted the SEC took actions with respect to 185 cases of accounting violations in 2005. She said 44 of those action actions, or 24 percent, involved Fortune 300 companies. Typically, the SEC discovered the violations through news reports, self-reporting by the company, auditor reports, or from the Public Company Accounting Oversight Board, she noted.

Markel also indicated that there were several common methods used in such cases. One such method was improper revenue recognition, whereby a company books revenue in a chosen accounting period rather than in the period in which the revenue was actually earned. This, she noted, occurred at companies such as Peregrine Systems, SafeScript, eFunds, and Cutter & Buck. While revenue recognition issues may be hard to detect, Markel commented that a common problem for companies improperly recognizing revenue is that companies never collect the fictitious cash they claim to have earned. Thus, accountants may note items such as the companies' accounts receivable growing at a suspicious rate.

Frequently, the SEC found that, when companies engaged in accounting fraud, companies looked to use further improper accounting to cover up the initial deception, Markel said. Two strategies include the use of restructuring charges and merger accounting. When a company incurs restructuring charges, such as the cost of a plant closing or employee severance, such charges may be inflated to cover past overstatements of earnings.

In merger accounting, where the "purchase method" of accounting is used, the merged company adjusts the value of assets carried on its balance sheet. By deliberately adjusting the value of assets to a value other than true market value, companies may be able to cover up improper accounting from earlier periods.

Internet Posting of Proxy Statements to Improve Shareholder Access
Many panelists at this year's conference spoke about the commission's ongoing efforts to allow for Internet posting of proxy statements. SEC Commissioner Roel Campos argued that permitting shareholders to play a greater role in the governance of companies is one benefit of the ""Internet proxy" rule, the public comment period for which closed on Feb. 13. The proposed rule would permit companies to post their proxy statement on the Internet rather than to require companies to mail the proxy statement to shareholders.

Campos indicated that the proposal would reduce costs both for companies and for dissident shareholders seeking to wage a proxy contest. He noted that currently the combination of prohibitively expensive proxy fights and state law default rules providing for director election by a plurality of votes effectively give shareholders no alternative in most cases other than to vote for management nominees.

Currently, SEC interpretive guidance permits electronic delivery of proxy statements to shareholders consenting to such delivery. Thus, for shareholders who have already "opted-in," the process is already completely electronic and mailing costs are not incurred with respect to those shareholders. The number of shareholders opting-in, however, is estimated to be low at many companies.

The new proposal would require shareholders to "opt-out" in order to continue to receive paper proxy statements. When shareholders do not opt-out, mailing costs still would not be completely eliminated unless shareholders also opted to receive a post-card type meeting notice in electronic form.

Where shareholders do not opt-in to receive electronic notices, the cost savings produced by the proposed rule would be the difference between the mailing cost of the postcard type notice (potentially accompanied by the proxy card) and the mailing cost of weightier proxy statements. Also, the company may incur fees imposed by intermediaries, such as Automatic Data Processing (ADP), to whom brokers have contracted out responsibility to forward proxy materials to beneficial owners (who hold shares in "street name" rather than as record owners).

Betsy Murphy, chief of the Division of Corporation Finance's Office of Rulemaking, outlined key elements of the complex proposal.

Companies would post their proxy statement on an Internet site other than the SEC's EDGAR site and would send a meeting notice to shareholders 30 days before a shareholder meeting, she noted. The meeting notice could be used to satisfy state law shareholder meeting notice requirements, said Murphy, and the notice would state where the proxy materials are located on the Internet. She also noted that other soliciting materials could not accompany the notice and that the company's proxy card would be sent either with the notice or with the proxy statement.

According to Murphy, shareholders may request a paper proxy statement, and companies have two days to respond to requests received under the proposed rule. Delivery of proxy statements to beneficial owners of shares will occur by intermediaries forwarding the notice to beneficial owners. Proxy statements proposing that shareholders approve business combinations are excluded from the rule.

Commissioner Campos noted that, despite the cost-efficiencies the rule would create, he has concerns over two potential adverse consequences of the proposal. First, he indicated that separating the proxy card from the proxy statement might encourage retail shareholders to vote blindly without reading proxy materials. Second, Campos said the rule could disproportionately affect elderly people who may not have Internet access.

However, it is not clear whether the proposed rule would permit a shareholder to conduct a completely online proxy contest that is effective. Shareholders at Alaska Airlines in 2005 experienced frustration in their efforts to do this. In that contest, the Alaska Airlines dissidents relied on existing exceptions to the proxy rules that permit communication with other shareholders and conducted an Internet campaign.

But because the dissidents had not mailed materials to a sufficient number of shareholders, the New York Stock Exchange ruled that the matter did not constitute a contested election under its rules. Thus, brokers retained discretionary authority to vote the shares of beneficial owners holding in "street name" for management's slate, making success more difficult for the dissidents.

Nevertheless, the dissidents were successful in obtaining support for their proposals that the company had included on its proxy statement and card. They did this by gaining the support of the company's largest shareholders by contacting them directly.

The dissidents were frustrated, however, in their solicitation in favor of other proposals that did not appear on the company ballot. For these proposals, the dissidents did not mail their own proxy cards but posted their card on the Internet. Alternatively, they suggested shareholders scratch out the company's proxy card and write in votes in favor of the dissidents. Regarding the proposals not on the company proxy card, the dissidents ran into problems, however, because ADP (as voting agent) refused to vote the proxy card of the dissidents, and the dissidents balked at paying fees to ADP to forward the proxy card to street name holders.

It is not clear whether these issues of broker discretionary votes and acceptance of proxy cards by intermediaries such as ADP that arise when dissidents are required to do a mailing of any sort would be solved by the Internet proxy rule. The SEC may ultimately decide that, in the case of an annual meeting, dissidents are not required to mail a notice, because, presumably, the company would have mailed its own notice t