The Globalization of Corporate Governance
Submitted by: Stephen Deane, Vice President of ISS' Center for Corporate Governance
The following are excerpts from Chapter 2 of the 2006 ISS Global Institutional Investor Study. ISS will present the findings from its Global Investor Study the week of June 5 in a series of webcasts. To attend the online forums, please register here.
With the globalization of the world's capital markets, corporate governance has followed swiftly onto the world stage. We find universal views on the importance of corporate governance in every market we studied. Furthermore, global forces are shaping the continuing development of corporate governance, and institutional investors, with their expanding cross-market holdings, have become agents for change.
The importance of corporate governance is hardly limited to Anglo-American markets. Our study finds that investors share strong views on the value of corporate governance regardless of their region. A majority of investors in every market consider corporate governance to be "very important" or "important" to their firms. Answers range from a high of 90 percent of Chinese investors, who consider corporate governance a necessary building block for successful capital markets, to a low of 61 percent in Continental Europe. Conversely, the percentage of investors saying that governance is not important is limited to single digits in every market we studied.
Momentum is also global. In almost every market studied, a majority of investors say that corporate governance is more important today than it was three years ago and will become even more important in the next three years. Again, Chinese investors lead the responses, with 93 percent anticipating that corporate governance will become significantly or somewhat more important over the next three years, followed by investors in Continental Europe. "There is momentum," observed a study participant from a Dutch investment management firm. "Things are going fast."
Investor perceptions of the value of corporate governance are also consistent across the world. A majority of investors in all markets studied say that corporate governance in their institutional investing "offers value but is hard to quantify," ranging from a high of 84 percent in Canada to a low of 52 percent in Japan. In addition, a range of 18 percent to 38 percent of investors believe that focusing on corporate governance offers competitive advantage in their equity investments. In addition, a majority of investors in every market studied believe that their relationships with portfolio companies have become more constructive, ranging from 61 percent in the U.S. to a high of 92 percent among Chinese investors.
Global Forces Shaping Governance Practices
Globalizing forces exert a pull that shapes and accelerates the development of corporate governance in markets throughout the world. The introduction of corporate governance regulations and best practices in one country or region (such as the European Union) increasingly affects practices in markets far beyond those borders.
"You haven't discussed the speed of globalization of corporate governance," a British investment manager remarked when prompted for thoughts on issues we hadn't already covered. "There's a lot of 'copy-cat' tactics," he continued, referring to the spread of best practices from one market to another.
For example, in 2002 the U.K. became the first country to require companies to submit remuneration reports to a shareholder vote. Though non-binding, the votes enable shareholders to voice their concerns on corporate compensation packages. A year later, the Netherlands took the same practice one step further by requiring companies to submit remuneration reports to a binding vote by shareholders. In 2005, Sweden and Australia both adopted requirements for non-binding shareholder votes on remuneration reports.
This year, remuneration reports have become a topic of debate in the U.S. The American Federation of State, County, and Municipal Employees filed five shareholder resolutions this season seeking an advisory vote on compensation committee reports.
The U.S. Sarbanes-Oxley Act (SOX), along with the implementing requirements that followed, represents another example of a standard with an impact that extends well beyond national borders. Investors from Canada, the U.K., Europe, and Australia all commented on SOX. In Canada, for instance, study participants from pension and mutual funds praised the legislation for improving financial reporting. In the U.K., however, an investment management interviewee derided the legislation as overly burdensome and urged, "Ditch Sarbanes-Oxley." Likewise, a German investment banker pointed to SOX as a regulation that Europe should avoid.
These comments indicate that investors throughout the world are taking notice of SOX, and their responses, positive or negative, are shaping the development of regulations and standards in their own countries.
In Australia, an investment management interviewee described the ripple effect that the legislation has had: "Members of our boards are also members of other boards. Some of those other companies are listed in the U.S. SOX has an impact on those companies that operate in the U.S. And it [influences] Australian regulations. So we must be interested. It filters through to our shareholders, too."
Investors also highlighted the impact of other regional and global standards. In France, for example, an asset manager pointed to the pull of pan-European standards in raising those in his own country. "Regarding corporate governance, the Netherlands, Belgium, and Luxembourg are much more advanced. Consequently, France should follow these countries," he explained.
In the U.K., an investment manager predicted that the standards embodied in the country's Combined Code on Corporate Governance would be implemented on a more global basis. And in his own country, he said that the International Financial Reporting Standards are "driving this need to take more action on financial goals and quality of audit."
And in Japan, investors emphasize the impact of global corporate governance standards and the role of international investors. "Our priority is improvement in Japan, but we are concerned that any deterioration of global standards could slow progress here in Japan," remarked an investment manager in Tokyo. Another Japanese asset manager commented, "We are interested in learning… how overseas investors' view of Japanese issuers might be changing."
Increase in Cross-Border Voting
Investors also are using the power of the ballot box to raise corporate governance standards overseas. The ISS study shows that investors in the U.S., Canada, and the U.K. are the most likely to cast proxy votes outside their home markets, with 73 percent of U.S., 67 percent of Canadian, and 60 percent of U.K. investors voting at least 50 percent of the shares they hold outside of their home market.
We also find anecdotal evidence that investors in other markets are increasing their cross-border voting as well. In Australia and New Zealand, fund officials told us that they were upgrading their global voting practices or were planning to do so in the future. Likewise, a Dutch asset manager observed: "Before, we had a proxy committee but did little voting. Starting in January 2005, we have had a global committee."
To review the full study, please visit here.
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May 26, 2006 |
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Option backdating . . . what next?
Submitted by: Rosanna Weaver, Governance Research Service Analyst
Activists and academics have speculated for years that executives sometimes timed their option grants to occur before the release of good news that would spur market gains. But now, it seems, a number of them may have taken that questionable practice a step further by backdating their grants: After all, why bother to time your option award when you can simply ink in an optimal grant date? Specifically, a date coinciding with a low point in your company's stock price, which then becomes the price at which you can purchase the option shares during, typically, the next 10 years. Multiply each extra dollar of gain in the stock price over the exercise price of an option covering, say, 500,000 shares, and you are talking big money.
Enough money, it seems, to tempt at least some executives into manipulating the official date of their option grants. Accounting and tax rules stipulate that an option with an exercise price below the market value of the stock on the (actual) option grant date constitutes a discount-priced option, with negative consequences for both. And most stock incentive plans provide that the option price will be set at the stock's fair market value on the grant date, so determining a grant and then setting the exercise price at an earlier date would violate the terms of the plan. Not to mention stirring the wrath of investors if the practice is detected, as apparently has been the case recently with a number of mostly tech-sector companies. Every few days over the past weeks it seems another tech company has issued a vague statement about subpoenas received, requests from federal investigators for data, or internal reviews being conducted by boards regarding potentially back-dated options. A total of more than 20 companies have made such announcements recently.
ISS' Governance Research Service took a look to see if any companies who've made such announcements this month have had shareholder proposals in the past on related issues. Of 15 companies examined, two have had shareholder proposals related to options. In 2005, 58.2 percent of shareholders of Altera voted in favor of a shareholder proposal seeking option expensing. The company had urged shareholders to vote against the proposal, arguing that, "At a time when the public seems to be demanding consistency in financial reporting and more ease in comparing companies' financial statements, we believe that adopting the . . . .proposal could have the opposite effect." The proponent of the proposal, a fund affiliated with the United Brotherhood of Carpenters and Joiners, contended that Altera had been active in attempting to modify FASB ruling requiring the expensing of options. The vote for this proposal at Altera was slightly below average of 59.9 percent for the 11 similar proposals that came to a vote last year; two proposals garnered more than 70 percent support. On May 8, 2006, Altera announced that its board had established a special committee of independent directors, assisted by independent legal counsel and outside accounting experts, to review the company's historical stock option practices and related accounting.
The vote on a 2002 proposal at Juniper Networks on a repricing proposal, on the other hand, was the highest in recent years. On May 22, Juniper, of Sunnyvale, California, announced that the company had received a request for information from the office of the U.S. Attorney for the Eastern District of New York relating to the company's stock option grants. A company press release said Juniper is "actively involved" in responding to the request and that the board's audit committee, assisted by independent counsel and advisers, is reviewing the company's historical stock option granting practices.
The shareholder proposal against repricing followed an opportunity given to employees, including executives, in October and November 2001, to exchange their 1999 and 2000 stock options with exercise prices exceeding $10/share, for options issued six months and one day after the date of cancellation. (These six month-plus-one-day repricings were not unusual at the time, with the timing designed to avoid unfavorable accounting consequences that had at that time been put in place for option repricing.) Chairman and CEO Scott Kriens, for example, elected to exchange a total of 2.2 million options granted in 1999 and 2000 for an equal number of option shares issued on or after May 28, 2002, with the exercise price of the new options to be set at the fair market value of the company's stock on the date of grant. Kriens received his replacement grant on May 28, with the exercise price set at that day's closing price, $10.31 -- which in this case turned out to be the highest price the company's stock would see for quite some time. A few months later in July 2002, Kriens received another option covering 550,000 shares, exercisable at $5.69 per share.
Meanwhile, the New York State Retirement Fund filed a shareholder proposal voted on at the company's 2002 annual meeting, urging the adoption of a policy that Juniper wouldn't reprice (or terminate and later re-grant) any options to lower the exercise price without shareholder approval. The fund argued that since shareholders had suffered from a steep loss in the stock price, "the incentive should be for management to increase the long-term performance of Juniper rather than increase their opportunity to gain personally from a decline in market value." Nearly half the shares voted at the 2002 meeting supported the proposal: that 45.6 percent is the highest level of support any anti-repricing proposal has earned since that date.
Although Kriens participated in the repricing and has received several large stock option grants over the ensuing years as well, he does not appear to have reaped much benefit from these grants to date. The company's proxy statements over the past five years indicate that he has not exercised any stock options during that time, although the stock moved close to $30 per share during 2004. It recently closed at $15.03, however. The executive who exercised the most options during that period was James Dolce, Jr., who became a vice president of the company in July 2002, when Juniper acquired Unisphere Networks. Since then, Dolce has exercised 2.6 million option shares, realizing net gains of over $43 million dollars. In January 2006, the company announced that Dolce would be leaving the company, "to pursue personal interests outside of Juniper."
With analysts now scrambling to identify potential "backdaters" who may come under SEC scrutiny -- so they can exit the stock before it tumbles -- companies would do well to beef up their option controls and reassure shareholders that their grant practices are sound.
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May 25, 2006 |
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Is the Enron Verdict Justice for Shareholders?
Submitted by: Cheryl Gustitus, Senior Vice President of Marketing and Communications
The 2001 collapse of Enron defined an era where corporate malfeasance ran rampant and, as a result, wide corporate governance reforms were implemented to protect shareholders. So, nearly five years from the start of the Enron investigation Ken Lay and Jeffrey Skilling were both found guilty on multiple counts of conspiracy and fraud today.
Will shareholders finally feel vindicated? Use our blog to post a point of view.
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Ken Lay and Jeff Skilling Found Guilty in Enron Trial
Submitted by: Sarah Cohn, Director of Communications
According to a Reuters article today by Matt Daily and Dan Whitcomb, Ken Lay and Jeff Skilling have both been found guilty today on fraud and conspiracy charges. Lay was convicted of six counts of conspiracy and fraud and faces up to 45 years in prison, while Skilling was found guilty of 19 counts of conspiracy, fraud, insider trading and making false statements which, combined, carry a maximum sentence of 185 years. To read the full article, click here.
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May 24, 2006 |
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Judge Gives Final Approval to $6.6 Billion in Enron Settlements
Submitted by: Bruce Carton, Vice President of Securities Class Action Services
According to an Associated Press article today by Kristen Hays, a federal judge in the Enron securities class action case gave final approval to the $6.6 billion in settlements reached with defendants Citigroup Inc., J.P. Morgan Chase & Co. and the Canadian Imperial Bank of Commerce. In addition to the $7 billion (and counting) in Enron settlements, the SCAS database shows another U.S. $7 billion in pending securities class action settlements from shareholder actions at Sears, Nortel, AIG, HealthSouth, FreddieMac, the IPO Securities Litigation, Time Warner and dozens of other cases.
With over $14 billion in the settlement pipeline, there is now a huge amount of money waiting to be claimed by eligible shareholders. The "fun" part now for institutions is tracking these settlements, identifying the claim deadlines, and filing the proof of claims with the claims administrators.
Notably, however, a recent study by Professors Cox and Thomas entitled "Letting Billions Slip Through Your Fingers: Empirical Evidence and Legal Implication of the Failure of Financial Institutions to Participate in Securities Class Action Settlements" concluded, based on data from 118 settlements, that on average, roughly just 28% of eligible institutional investors filed claims in these securities class action settlements! 28%! Download file here to read the study.
The study further found that the institutions' mean loss was a very substantial $850,000, and the average median loss was roughly $275,000. Perhaps most importantly, the study showed that had these institutions filed claims, the average mean recovery would have been approximately $280,000 and the average median recovery would have been more than $90,000.
By almost any standard, those are big bucks to be leaving on the table time after time.
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May 23, 2006 |
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Japanese Public Pension Fund Targets Board-Adopted Pills
Submitted by: John Taylor, Principal Researcher Japan Governance Research Services
Japan's Pension Fund Association for Local Government Officials (PAL) has joined its corporate counterpart, the Pension Fund Association (PFA), in opposing "poison pill" defenses adopted without a shareholder vote.
Without targeting specific companies, PAL is publicly urging its external equity managers to vote against the election of directors at firms where boards have formally adopted poison pill defenses. The PFA adopted a similar policy while detailing plans to vote against specific incumbent directors at firms where pills were adopted.
PAL's Web site includes an outline of its recently revised voting guidelines, with a statement that the pension group will in principle oppose any takeover defense that it believes was not adopted with "maximum priority given to shareholder interests," or that does not “contribute to the firm's long-term profitability." PAL further warns that it will "express opposition through our votes on the election of directors to hostile takeover defense plans that boards have adopted without placing them to a shareholder vote."
PAL is the major plan sponsor for public employee pensions in Japan, responsible for 14 trillion yen in assets, or about $125 billion, ranking second only to the Government Pension Investment Fund (the umbrella group covering the local equivalent of U.S. Social Security) as Japan's largest public pension system.
Unlike the PFA, PAL so far has not developed a detailed voting policy or sought to recruit other investors to adopt its voting policies. Still, PAL made waves last year when it opposed some 16.5 percent of management proposals at June 2005 annual meetings. Much of the opposition focused on bonuses for retiring board members.
PAL's efforts last year are widely credited with encouraging a recent trend among Japanese issuers to abolish such retirement bonuses. Such bonuses, widely seen as inherently seniority-based, are giving way to annual compensation that may be more reflective of individual or corporation-wide performance in the preceding year.
With the combined influence of the PAL and the PFA, managements seeking to authorize poison pills without shareholder approval will likely be on the defensive when Japan's 2006 annual meeting season gets under way next month.
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May 22, 2006 |
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Did anyone hear a "pop?" Executive compensation and shareholder proposals at real estate companies
Submitted by: Rosanna Weaver, ISS Governance Research Service Analyst
Some shareholders advocate performance-based options as a potential tool to link pay to performance. But -- since no one disputes that a company's market price may be influenced by many factors beyond management control --the trick is how to make sure the performance being rewarded is the performance of the executives being rewarded. Funds affiliated with the Laborers Union decided last year that the residential homebuilding industry provided "a good vehicle" to consider some of the questions around pay for performance, according to Richard Metcalfe, the Laborer's director of corporate affairs. "Is management adding value or riding up a bubble?" asks Metcalfe, noting that the fund was interested in having discussions with companies on executive compensation. The fund filed proposals at a number of residential construction companies, including two proposals on performance-based options. Proponents report that this year 5.7 percent of shareholder at Lennar and 51.7 percent of shareholders at Pulte voted in favor of performance-based options.
Not surprisingly shareholder return performance graphs of these companies closely track graphs of home prices over the same period, a line moving sharply higher. Investors who had the foresight to see the looming decline of the NASDAQ in November 2000 and invest $100 in the Dow Jones Homes Construction Index would have been rewarded with $454 five years later. Executives, of course, reaped extraordinary rewards as well.
For 2005, Lennar President and CEO Stuart A. Miller received a bonus of $21.5 million, and a restricted stock award valued at $6.3 million in addition to his $1 million salary. The size of the bonus was directly linked to the company's performance: because the company met prescribed earnings per share, return on capital and customer satisfaction ratings, Miller was entitled to the pre-set maximum of one percent of pre-tax earnings. This is the same percentage that was achieved in fiscal 2004. Since the company's pre-tax earnings grew from $1.5 billion in fiscal 2004 to $2.2 billion in fiscal 2005, Miller's bonus eligibility increased from $15.2 million in 2004 to $21.8 million in 2005. (Several company employees agreed with the company to reduce their bonus payments in order to increase amounts available under the bonus pool; Miller agreed to reduce his bonus by $250,000.)
Miller's 2005 option award of 200,000 shares (representing 12.6 percent of all options granted for the year), would be worth approximately $3 million with 5% annual appreciation over a 10-year term. The value of his outstanding options, however, is much higher: at the end of FY05, Miller held 353,290 exercisable options and 846,000 unvested options in class A common stock that were then worth $12.3 million and $13.9 million, respectively.
Lennar performed well over the last several years: an investment of $100 into Lennar stock on 11/30/2000 would have grown to $410 five years later, while a similar investment in the Dow Jones Total Market Index would have only grown to $108. If the company had granted indexed based options, however, the executives would not have had the same success. The company slightly lagged behind its peers. Yet all the named executives other than Miller exercised stock options in fiscal 2005, realizing between $1.9 and $4.6 million in gains.
Pulte Homes, which also faced a performance-based options proposal from a Laborers fund, also underperformed its peers over the last five-year period. So indexed-priced options at Pulte might well have provided incentive awards tied more closely to the performance of Pulte's management rather than the industry trend. On the other hand, going forward, if Pulte's shareholder return outperformed its peers, executives holding indexed options could benefit even if the stock does not risen significantly.
In 2005 Pulte Homes granted CEO Richard J. Dugas Jr. 400,000 options with a potential value of $10 million if company stock appreciates 5 percent per year. Dugas' option award represented 9.22 percent of options granted by the company in 2005.
For 2005, Dugas received a bonus of $11 million including $6.4 million as cash and a restricted stock award valued at $4.6 million. Dugas also received $1.32 million in long-term incentive payouts in addition to his $850,000 salary. None of the company's named executives exercised stock options in fiscal 2005. In addition to substantial restricted stock holdings, at the end of 2005 Dugas held 550,000 exercisable options and 1.1 million unvested options that were worth $13.4 million and $10.4 million, respectively, at that time.
Dugas' ownership stake, however, pales when compared to that of company founder and chairman, William Pulte, who owns 42 million shares, representing a 16 percent stake in the company. Pulte has not received options from the company in the last three years, though as employee chairman he received a $5 million cash bonus and a restricted stock award valued at $4.6 million for 2005. The company reports that Pulte's holdings include 41.6 million shares that are owned by various trusts of which Pulte is a trustee, and over 300,000 shares of restricted stock that are scheduled to vest over the next three years.
The shareholder proposal -- which suggests that options with an exercise price tied to the market index ensure that executives are rewarded for out-performing the competition -- raises a number of interesting questions. Should top executives realize wealth on what was clearly not solely the result of executive talent? On the other hand, would it be reasonable to expect an executive to receive no gain in a situation where shareholders have benefited so spectacularly?
And, perhaps of most interest, what happens next? Several home construction companies have warned of high inventory, cancelled orders and disappointing sales, and the Home Construction index has fallen. Should -- as some have speculated -- the housing bubble "burst," these executives might benefit from having their options linked to how competitors are faring. Under such a model, executives could conceivable profit even if the stock price falls as long as they perform better than competitors.
Lennar noted in its statement of opposition to the proposal that under the company's 2004 stock incentive plan the company may grant performance-based options, though it wanted to maintain the flexibility to determine whether to do so. It will be interesting to see if performance-based options become more appealing should the company stock price fall.
What do shareholders think? Well, the vote at Pulte was significantly above that average vote on this proposal last year (35.6 percent). Lennar's weak 5.7 percent support is likely due in part to significant inside ownerships: directors and officers control 48.4 percent of the voting power at that company.
Meanwhile, Metcalf reports that the Laborers are involved in "on-going discussions" with a number of companies.
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May 19, 2006 |
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Union's Pill Proposal Could Set Precedent
Submitted by: Marc Saltzburg, Associate Counsel
A labor union proposal regarding takeover defenses at Hilton Hotels has the potential to establish a legal precedent that could help clarify issues surrounding "binding bylaw" proposals.
The proposal by Unite Here'ss pension fund would amend Hilton's bylaws to state the "corporation shall not maintain a shareholder rights plan, rights agreement or any other form of 'poison pill' making it more difficult or expensive to acquire large holdings of the corporation's stock, unless such plan is first approved by a majority shareholder vote."
The bylaw proposal also states that a "majority of shares voted shall suffice to approve such a plan." The proposal calls on Hilton to "redeem any such rights now in effect," and states, "notwithstanding any other bylaw, the Board may not amend the above without shareholder ratification."
If the binding proposal is approved, Delaware-incorporated Hilton has said that it would refuse to recognize the bylaw change, arguing that the proposal is contrary to basic principles of Delaware law giving boards of directors the power to manage the business and affairs of a corporation.
Hilton has obtained a legal opinion from Richards Layton & Finger, a Delaware law firm, in support of this position. The company did not ask the U.S. Securities and Exchange Commission (SEC) for permission to exclude the proposal from its proxy statement.
A paucity of legal decisions on the issue of binding bylaw proposals cloud the issues related to the Unite Here proposal, but the resolution could lead to new precedent clarifying some of these issues. While Delaware courts have not addressed the issue, two other courts have done so.
In Int'l Brotherhood of Teamsters Gen. Fund v. Fleming Cos. (1999), the Oklahoma Supreme Court upheld a binding bylaw on poison pills, interpreting an Oklahoma statute that closely resembles Delaware's. However, in Invacare Corp. v. Healthdyne Technologies Inc. (1997), a federal judge in Georgia declared invalid a binding bylaw amendment to require a company to remove "dead-hand" pill features, which typically permit a pill to be redeemed only by "continuing directors." The court in that case relied heavily on the existence of "continuing director" provisions in Georgia corporate law that are not found in Delaware corporate law.
Unsettled Law
In addition, the lack of settled law on binding bylaw proposals has led the SEC to adopt a "hands off" approach on no-action requests by companies seeking to exclude binding poison-pill proposals from their proxy statements. (Under federal proxy rules, a company may omit a shareholder proposal that would violate state law.)
The SEC has held this position since its 1997 no-action ruling at PLM International. After PLM sought to exclude a binding bylaw proposal setting a time limit on the company's use of a poison pill without shareholder approval, the SEC held that, "whether the proposal is an appropriate matter for shareholder action appears to be an unsettled point of Delaware law…[and thus there is not a] basis for excluding the proposal from the company's proxy materials." Since this ruling, the SEC generally has made it a practice not to take positions on unsettled questions of state corporation law relating to poison pill bylaws.
In their opinion, Hilton's Delaware lawyers argue that "Absent an express provision in a corporation's certificate of incorporation to the contrary, [Delaware General Corporation Law (DGCL) Section 141(a)] vests in the board of directors the authority to manage the corporate enterprise. Among the powers conferred upon directors under Section 141(a) is the power to adopt and maintain defensive measures prior to or in response to a takeover proposal."
The lawyers also argue that, "adopting a stockholder rights plan is a function specifically assigned" to the board by Section 157 of the DGCL. "Absent a provision in the corporation's certificate of incorporation to the contrary, a board . . . cannot be directed by a stockholder-adopted bylaw to exercise such authority in a particular way or delegate to stockholders or others the authority to exercise such power," the Hilton lawyers argue.
However, many companies, including Hilton, provide concurrent power to both directors and shareholders to amend bylaws. Hilton's view of Delaware law carries the risk that any shareholder-promulgated bylaw amendment could be seen as infringing on a board's authority. This, however, would lead to a result--that all shareholder adopted bylaw amendments are invalid--that is contrary to the express authority set forth in Delaware law for shareholders to amend bylaws.
Also, it is not clear that Hilton has the legal authority to deny that its bylaws have been amended. Alternatively, the company could ask a judge to rule that the proposal is invalid. If the bylaw proposal is approved, Unite Here may have to go to court to ensure that the company complies with the bylaw change and to confirm that it does not violate Delaware law.
There is a definite possibility that Unite Here may be able to obtain shareholder approval of its proposal, as Hilton does not have any supermajority voting rules for bylaw amendments that would make shareholder approval of the proposal unrealistic to obtain. The Unite Here proposal would require approval by a majority of the company's outstanding shares.
Investors generally vote in favor of shareholder proposals regarding poison pills. In 2005, the average level of support for those proposals was 60.1 percent of votes cast. Given that many shareholders fail to vote at annual meetings, the labor pension fund likely will have to obtain significantly more than a majority of votes cast to constitute a majority of Hilton's outstanding stock. If that happens and Unite Here and Hilton end up in court, investors and companies should watch closely.
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May 18, 2006 |
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CalPERS Makes Sudan Divestment Decision
Submitted by: Jan Fetter-Degges, Senior Research Analyst
Yesterday, the California Public Employees Retirement System (CalPERS) board announced that it would not permit its fund managers to buy shares in nine companies that do business in Sudan. (CalPERS does not currently own stock in any of the companies.) The list of prohibited companies (Bharat Heavy Electrical Ltd., China Petroleum and Chemical Corp., Nam Fatt Co., Oil & Natural Gas Co., PECD Bhd., PetroChina Co., Sudan Telecom Co., Tatneft OAO; and Videocon Industries Ltd.) is identical to that released by the University of California Regents in March. These companies, a CalPERS position statement said, "were clearly shown to be providing monetary or military support to the Sudan government, while showing little or no interest in the violence in Darfur or in helping to improve the welfare of the Sudanese people."
Companies associated with atrocities in Sudan pose "a serious risk to creating sustainable and responsible long-term value," a CalPERS Investment Committee staff memo dated May 15 reads. These risks include "federal and international sanctions, substantial fines and penalties imposed by authorities, an impairment of [companies'] ability to raise capital in public markets as well as long term reputational damage," the memo continued. "There is no place in for these companies in our portfolio until the atrocities and human rights violations end," CalPERS Board president Rob Feckner said in a press release.
CalPERS will continue its current policy of "constructive engagement" with companies in its portfolio that have ties to Sudan, CalPERS Investment Committee Chair Charles P. Valdes said in a CalPERS press release. Such engagement "means identifying companies that have a presence in Sudan, determining the impact of their business on human rights, and demanding that they respond to our concerns." Last month, CalPERS sent letters to 11 companies in its portfolio that it had recently identified as active in Sudan. The letters asked the companies to clarify their involvement in Sudan, including information on whether the companies are doing "anything to promote and/or protect human rights" in light of ongoing atrocities. CalPERS sent similar letters to five companies last summer and met with representatives of those companies this winter.
The divestment decision is part of CalPERS' continuing compliance with a resolution passed by the state legislature last year, asking CalPERS and the California State Teachers Retirement System (CalSTRS) to examine their holdings in companies doing business in Sudan in order to ensure that their investments are not furthering human rights abuses. In April, the CalSTRS board adopted a motion stating that the system would "move forward to divest its holdings from companies identified as doing business with the government of Sudan," using "the same general criteria utilized by the UC Regents."
A bill that would mandate CalPERS and CalSTRS divestment from Sudan is pending in California's legislature.
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May 17, 2006 |
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Resolution: French Government Cleared in Tampering Charges for Suez and Gaz De France Merger
Submitted by: Michael Gray, International Content Manager
The European Commission found that the French government did not overstep its bounds in its actions related to the planned merger between two French energy firms Suez and Gaz de France. The hastily arranged merger was used as a preemptive strike against a potential takeover bid from Italy's Enel energy company. The decision serves to highlight the difficulties involved in cross-border transactions in the EU and as a reminder that shareholders in European companies continue to be subject to the desires of governments over the desires of the marketplace. According to a report in the Financial Times the deal still must clear the regular competition commission, so there is still some chance that the market might still prevail.
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May 16, 2006 |
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Investors File Fewer Pill Proposals
Submitted by: Marc Saltzburg, Associae Counsel
While more large U.S. companies are dropping "poison pills" and investor support for mandating a shareholder vote on such takeover defenses remains strong, the number of shareholder proposals on this topic has declined significantly, according to a recent ISS report.
However, that trend may change next year. A recent Securities and Exchange Commission (SEC) ruling may prompt more shareholders next year to seek bylaw amendments to require an investor vote on pills. In addition, a Delaware court ruling may inspire some investors to press again to encourage companies to seek shareholder approval before adopting a poison pill.
Among S&P 500 companies, 46 percent had a poison pill defense at the end of 2005, down from 53.8 percent in 2004, according to the 2006 Background Report on Poison Pills at U.S. Companies by ISS' Governance Research Service. Among the prominent firms that abandoned their pills last year were the Bank of New York, Caterpillar, McGraw-Hill, and Sempra Energy. The percentage of S&P 500 companies with such plans has declined steadily since 2002, when 60 percent had pills.
In 2005, voting support remained high for shareholder proposals concerning poison pills. (Typically, such proposals request that a company's poison pill be redeemed or submitted for shareholder approval.) Seventeen of the 25 pill proposals that appeared on company ballots received majority support. Those 25 proposals received an average of 59.4 percent support, a slight decrease from the 61.1 percent average in 2004.
Despite this strong support, there has been a significant drop-off in the number of proposals filed. In 2004, 101 shareholder proposals were submitted (of which 52 came to a vote). Last year, 51 proposals were submitted (of which 25 came to a vote). ISS is currently tracking 29 proposal filings for 2006, of which 17 have either come to a vote or are expected to come to a vote.
SEC No-Action Rulings
The trend toward fewer proposals on poison pill issues may stem from SEC staff rulings in 2004 on "no-action" requests to omit proposals by companies that already have poison pill policies in place. Typically, such policies state that the company will obtain shareholder approval prior to the adoption of a poison pill or, in the event the company adopts a pill without shareholder approval, that the company will seek such approval within 12 months or at the next annual meeting. Nevertheless, investor opponents of poison pills argue that such policies allow companies the same discretion to adopt a pill without prior shareholder approval that the company had before the adoption of the policy.
In 2004, the SEC's Division of Corporation Finance granted no-action relief to a number of companies that did not have a poison pill in place but that did have a policy on poison pills. The SEC typically concluded that the company had "substantially implemented" the shareholder proposal because of the existence of the company's policy on poison pills. As a result, the SEC in 2004 allowed companies to exclude 24 of the 101 poison pill proposals filed by investors. The combination of these SEC rulings in 2004 and the decline in pill proposals in 2005 and 2006 suggests that shareholders may have viewed proposals at certain companies as futile efforts.
In early 2006, however, the SEC staff denied no-action relief to Electronic Data Systems (EDS) and a number of companies that have poison pill policies. At several of these companies, the SEC had permitted exclusion of pill proposals in 2005. The 2006 proposals differed from earlier proposals in that they included a request that the company amend its charter or bylaws to incorporate the proposal "if practicable."
In early March, the SEC reportedly reversed its position after several companies requested reconsideration. In the case of EDS, it was reported that the SEC ruled, "We note that there is a substantive distinction between a proposal that seeks a policy and a proposal that seeks a bylaw or charter amendment. In this regard, however, we further note that the action contemplated by the subject proposal is qualified by the phrase 'if practicable' and that the company has otherwise substantially implemented the proposal."
Thus, while such proposals were excluded this year, the SEC staff rulings suggest that a future poison pill proposal that requests a charter or bylaw amendment likely would not be excluded, as long as the proponent does not use the objectionable phrase "if practicable."
Cornish Hitchcock, a lawyer who represents shareholder proponents including union pension funds and other institutional investors, said he was "surprised the SEC took that position on the 'if practicable' language but that this is something that should be addressed by proponents next year."
Significant Delaware Court Ruling
Another important development regarding poison pills was the December 2005 ruling by Chancellor William Chandler of the Delaware Court of Chancery in the Unisuper Ltd. v. News Corp. litigation. The court ruled that Delaware law does not require that a poison pill policy contain a "fiduciary out."
The central issue in the case, whether a company policy on poison pills may be changed at will by directors, was held over for a trial. The plaintiffs argued that News Corp. made an enforceable promise in the form of its pill policy to persuade shareholders in 2004 to approve the company's reincorporation from Australia to Delaware. (On April 6, investors announced that they had reached a settlement to the litigation, in which the company agreed to put its pill to a shareholder vote. For more details, see the April 7, 2006, issue of Governance Weekly.)
Prior to the court's December 2005 decision, many companies had claimed that, under state law, they are prohibited from adopting a policy requiring prior shareholder approval for the adoption of a poison pill. Companies argued that their fiduciary duties required them to retain the option of adopting a pill without shareholder approval. Companies making such arguments relied on earlier case law holding that a current board may not take action that disables a future board from managing the company.
Chancellor Chandler rejected this reasoning in the context of poison pill policies. The court noted that these earlier cases had dealt with "defensive measures that took power out of the hands of shareholders." Such defensive measures are different from poison pill policies where "shareholders will make the decision for themselves whether to adopt a defensive measure or leave the corporation susceptible to takeover," the chancellor noted.
Chandler held that, "It makes no sense to argue that the News Corp. board somehow disabled its fiduciary duties to shareholders by agreeing to let the shareholders vote on whether to keep a poison pill in place." The court further held that, "Fiduciary duties cannot be used to silence shareholders and prevent them from specifying what the corporate contract is to say. Shareholders should be permitted to fill a particular gap in the corporate contract if they wish to fill it."
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May 12, 2006 |
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Why Companies Must Act on Climate Risks
Submitted by: Doug Cogan, Deputy Director of ISS' Social Issues Service
With the launch of the Kyoto Protocol and the E.U. Emissions Trading Scheme, managing greenhouse gas emissions is now a part of doing business in global trading markets. As the United States catches up to this international effort to combat global warming, climate governance practices will assume an increasingly central role in corporate and investment planning.
A new report commissioned by CERES and written by Doug Cogan of ISS' Social Issues Service employs a "Climate Change Governance Checklist" to evaluate how companies are addressing climate change through board oversight, management execution, public disclosure, emissions accounting and strategic planning.
Join Doug Cogan and representatives of the pension and investment community for a one-hour ISS webcast beginning at noon EDT on Tuesday, May 16 for a discussion of this new report and how it can be used by company executives, board members, investors and Wall Street analysts to employ effective climate governance strategies. To register for the webcast, click here.
Ultimately, effective climate governance requires boards and managers working together on strategies to control greenhouse gas emissions, with stakeholder disclosure and investor accountability. Given the sweeping global nature of climate change, climate risk has become embedded, to a greater or lesser extent, in every business and investment portfolio. Companies face not only new risks from regulations, but also direct physical risks that are becoming increasingly apparent. Climate change deserves discussion in securities filings in the many instances in which direct financial risks or opportunities can be identified.
*Physical Risk: Businesses are at risk from the physical impacts of climate change, including the increased intensity and frequency of severe weather events, droughts, floods, storms and sea level rise.
*Regulatory Risk: State, national, and international regulations are putting increasing pressure on companies with emissions from operations or products to invest in emissions controls, purchase carbon credits, or alter their energy use patterns.
*Competitive Risk: Tightly linked to regulatory risk, climate risk preparedness is emerging as a key driver in a company's reputation, growth prospects and ability to compete.
*Technological Opportunities: Companies in many sectors can increase profitability by implementing energy efficiency strategies and developing emission-reducing technologies that meet changing corporate and consumer demands in a carbon-constrained world.
In short, the stakes could not be higher for U.S. companies and investors. The greatest investment opportunities as this new era takes hold will lie with companies that capitalize on this emerging shift in global energy use and production methods. The greatest risks will be with those that choose to ignore those trends and try to carry on with business as usual.
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Majority Vote Trends Continue
Submitted by: Ted Allen, Director of Publications
Shareholder proposals seeking majority voting in director elections continue to do well at U.S. companies that have not announced board election reforms.
So far this season, those resolutions are averaging 56.8 percent of votes cast at 13 firms that had not adopted a director resignation policy or other majority election alternative before issuing their proxy statements, according to ISS data. As of May 10, those proposals had won majority support at 11 of those firms, including a 53 percent showing at Union Pacific and 61 percent support at Verizon on May 4.
The two exceptions were the 27 percent vote at PepsiAmericas and a 32 percent vote for at Paccar. One explanation may be the significant insider shareholdings at those companies. PepsiAmericas has a 53 percent insider voting block, which includes a 43.4 percent stake owned by PepsiCo. At Paccar, directors and officers control 7 percent of the company's shares. This year's vote is slightly better than the 30 percent received by a similar proposal at Paccar in 2005.
By contrast, the strongest showing was a pair of 67 percent votes at Marathon Oil and Sprint Nextel in April. (For more details on other vote results, Download file here to see the table. This table includes 33 meetings where specific vote results were released and then collected by ISS. This data doesn't include the 95 percent vote on April 28 at Marriott International, where management supported the proposal by the Sheet Metal Workers.)
Meanwhile, majority vote proposals continue to lag at companies that have resignation policies like those adopted by Pfizer and more than 80 other firms. Those resolutions have averaged 37.3 percent of votes cast at 22 meetings this season.
However, majority vote proposals won 54 percent support at EMC and 51.8 percent at Chubb, which both have resignation policies. A binding proposal won a surprising 49 percent support at Honeywell International, which also has a resignation policy. (In addition, the United Brotherhood of Carpenters and Joiners report that their proposals won 60 percent support at PerkinElmer and 56 percent support at Raytheon. These two results were not received in time to be included in the table.)
The poorest showing was 19 percent at General Electric, which has adopted one of the strictest director resignation policies. (ISS' recommendation research staff did not support the proposal at GE.) If the GE vote is excluded, then majority voting is averaging 39.3 percent at companies with resignation policies.
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May 10, 2006 |
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Establishing Responsible Executive Compensation Practices
Submitted by: Broc Romanek, CompensationStandards.com Editor,
CEO pay levels have been set for over a decade using a process that clearly is malfunctioning. This broken process has led to skewed results, for both performing and underperforming companies. And, while good CEOs can make a difference, it still can't hide the fact that some CEOs received their windfalls due to side affects caused by this broken process.
For example, CEOs were provided megagrants of options on an annual basis throughout the 1990s, primarily because boards began to think of option grants as part of the annual routine of reviewing a CEO's pay package - rather than the original purpose of them as one-time grants to proper incentive (we have now called on boards to use "wealth accumulation charts" so they can keep better track of outstanding equity grants and not "overly incentivize" a CEO).
Another example - now widely recognized - is that the commonly used peer benchmark has led to an incredible racheting up of CEO pay as each CEO wants to be paid in the top quartile; thus, creating inflation each year in the benchmark as everyone scrambles to be in the top 25%. Over 15 years, that inflation has gotten quite high. There are many other process elements that are askew, as we have laid out in three issues of The Corporate Counsel, freely available on the right side of www.CompensationStandards.com.
CEO pay is not set like your pay or mine. The process often lacks any real negotiation with the board of directors and CEOs can quite easily get what they ask for. Just because a company has performed well for the past 20 years (as has the entire stock market) doesn't necessarily entitle a CEO to name his or her price. Comparison of CEO pay to big-name entertainment stars has been widely discredited; their pay levels are set by the market - CEO pay levels are not.
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May 9, 2006 |
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ISS 2006 Global Investor Study: Is Corporate Social Responsibility the Next Frontier?
Submitted by: Stephen Deane, Vice President of ISS' Corporate Governance Center
Another interesting trend which emerged ISS' 2006 Global Investor Study is how investors are integrating corporate social responsibility (CSR) measures into their investment decision-making. The topic of corporate social responsibility produced diverse investor views, drawing passionate responses and splitting investors along geographic fault lines as well as investor groups. ISS found the strongest support among pension funds and in Europe, Canada, and Australia. While investors are far from consensus on CSR, its advocates contend that it represents the next frontier in corporate governance.
Our study finds investors struggling to not only properly define the corporate social responsibility debate but also the precise name for this issue. Proponents we spoke with used such terms as CSR, socially responsible investing (SRI), sustainability, and extra-financial considerations. Perhaps the proper name for this topic is so elusive because proponents see not a single issue, but a nexus of issues involving social, environmental, and other factors. "Corporate governance is just one part of the all governance risks--social, environmental, and corporate governance risks. We favor a holistic response," the CEO of an Australian superannuation (or pension) fund commented.
We found pension funds in Australia-New Zealand to be among the strongest supports of sustainability and SRI. Ironically, though, it was a pension fund leader in that market who delivered this critique: "SRI is impractical warring between people competing for the same space: investment managers versus the 'conscience of the world' with no skin in the game. Everyone (in SRI) has gotten so pious." This pension fund executive found corporate governance satisfactory in presenting a set of best practice standards and practical solutions that his fund could act upon. But he expressed "great frustration" over the lack of any comparable standards or solutions when it came to SRI.
One person's frustration, however, is another's chance to show leadership by changing the terms of the debate. "It's been delegated to special interests and to moral issues," a U.S. pension fund leader acknowledged. "But there is increasing evidence that it has economic impact. We have a new, long-term project to look at the issues and try to bring it to the mainstream." Likewise, other advocates argue that CSR should be integrated alongside corporate governance factors into financial and risk analysis so as better to inform investment decision-making. Some investors are already taking action. A Danish pension fund professional reported: "If we first take corporate governance, it is very much a case-by-case exercise where the portfolio manager decides how to integrate corporate governance in the investment decision-making. For SRI, we have our own in-house department and a SRI committee that screens companies on the basis of our SRI criteria."
But investors aren't just looking inward. From Switzerland to Australia, they pointed us to the Enhanced Analytics Initiative (EAI), which an international group of major pension funds and fund managers launched in October 2004 with the declared goal of "changing the way the broker community analyses extra-financial issues and intangibles." EAI members--whose total assets under management exceed EUR 681 billion (U.S. $830 billion)--commit to allocate 5 percent of their brokerage commissions on the basis of how well brokers integrate analysis of extra financial issues and intangibles.
While there are strong supporters as well as skeptics in the CSR arena, exceptions notwithstanding, we found that pension funds were the most likely to emphasize environmental sustainability and corporate social responsibility. Among investors who integrate either corporate governance or socially responsible investing issues into their investment decision-making, pension funds were the most likely (at 41 percent) to screen for SRI. Pension funds argued that they took a very long-term view, which led them to understand the value of CSR. One pension fund executive observed that, if a company externalizes its costs onto society, those costs will come back to harm the members of the pension fund over time.
Despite the lack of consensus on CSR, our findings suggest that it is becoming an increasingly important issue for investors, corporations, and research houses. We welcome your thoughts on the CSR debate.
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May 8, 2006 |
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Canadian Banks Lead the Way on Board Elections
Submitted by: Michelle Tan, ISS Senior Analyst
As a group, Canada's banks are a market heavyweight, accounting for about 19 percent of the entire S&P Toronto Stock Exchange Composite Index. They also have been among the corporate governance leaders in Canada.
This season is no exception, as the banks have led the way in adopting director election reforms and improving their disclosure of executive compensation. Nine major banks held their annual meetings in March, and governance developments at these companies often are a sign of what will happen during the rest of the Canadian proxy season.
The Bank of Montreal (BMO) and Canadian Imperial Bank of Commerce (CIBC) held their annual meetings on March 2, followed by the Royal Bank of Canada (RBC) and Bank of Nova Scotia (BNS) on March 3. Laurentian Bank of Canada (LBC), National Bank of Canada (NBC), and Canadian Western Bank (CWB) followed with meetings on March 7, 8, and 9, respectively. The Toronto-Dominion Bank (TD) finished out the month on March 30.
It seems so long ago that shareholders were provided with an all or nothing choice when electing directors. In 2002, TD led the banks in moving from a single slate to individual elections, although LBC had individual elections to facilitate their cumulative voting process, and CWB still maintains a slate election. Canada's major banks, having accepted the idea of individual director elections, have paved the way this season as early adopters of majority voting policies--all except for LBC and CWB. The banks adopted policies, with a few modifications, based on the recommendations of the Canadian Coalition for Good Governance.
The banks are among the first issuers to start publishing disclosure on compensation consultants, as required by new regulations issued by Canada's securities administrators (Part 7 of Form 58-101F1). Meeting circulars must now include the identity and a summary of the mandate for any compensation consultants retained to assist in determining compensation for any of the directors and officers, and if the consultant was retained to perform any other work for the issuer.
While the banks' compensation committees each retained at least one consultant during 2005, their disclosure of mandates and fees varied considerably. Disclosed fees ranged from C$32,100 to C$323,000, while three banks did not provide dollar figures at all. Only one bank (TD) specifically noted that their consultant does not accept other retainers from the bank to maintain independence.
More significantly, disclosure of these consultant arrangements may bring about improvements in governance practices. This happened after Canadian issuers were required to start disclosing audit fees, including other (e.g., consulting) fees paid to their auditors. At six of the major banks, the percentage of other fees (as compared with the total fees paid to auditors) declined from 58.8 percent in 2001 to 5.5 percent in 2005.
Meanwhile, the average level of support for the 19 shareholder resolutions at the banks was 4.99 percent, up from 4.4 percent for the 45 resolutions in 2005. This year, a proposal by the Mouvement d'education et de defense des actionnaires (MEDAC) requesting shareholder approval for any increases in senior executive compensation won 6.9 to 8.7 percent support at four banks, indicating that some investors are frustrated with spiraling executive pay. Yet the single-digit support suggests that most investors are willing to leave compensation decisions in the hands of directors. Perhaps bank shareholders would have been more receptive to the MEDAC proposal if it had been drafted as a non-binding advisory shareholder vote as in the United Kingdom.
Eight proposals were withdrawn, including a request for a cost-of-management ratio that investor Robert Verdun withdrew from five banks after they agreed to work with each other to develop such disclosure.
An interesting Verdun proposal at NBC requested the elimination of the bank's executive severance policy, which was first adopted in 2000. Verdun argued that such policies were detrimental to shareholder interests, entrenched management, and contributed to complacency. NBC countered that the policy would ensure that executive officers would support any process leading to a change of control even if that process might go against their personal interests.
Meanwhile, the major banks are leading the Canadian market by voluntarily providing greater pay disclosure. Six banks provided total compensation data for their CEO, and all but one provided a three-year look back. Five banks went so far as to provide three-year look backs for all of their named executive officers (NEO). RBC and CIBC went one step farther, providing a comparison of aggregate NEO compensation with company performance factors. The tables provided by the banks are not easily comparable due to their lack of standardization and some unique pay policies. However, the figures do shed light on previously hidden pension service costs, including those associated with potentially generous supplemental executive retirement plans.
This increase in voluntary disclosure is occurring as Canadian regulators are considering whether to revise executive pay disclosure rules. This review was prompted in part by the U.S. Securities and Exchange Commission's recent proposal to overhaul compensation disclosure standards.
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May 5, 2006 |
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$4 Trillion of Investment Assets Back Principles for Responsible Investment
Submitted by: Doug Cogan, Deputy Director of Social Issues Services
Is it one small step for a group of progressive fund managers or a giant leap for the global investment community? That is the question raised by a new set of investment principles unveiled at ceremonies at the New York Stock Exchange on Apr. 27 and the Palais Brongniart in Paris on May 2.
At these launch ceremonies, 50 institutional investors with $4 trillion in assets signed on to the Principles for Responsible Investment. These principles contain six pledges and 35 action items that investors can take to integrate environmental, social and governance (ESG) issues into their portfolio management practices. (Download file here to read more about the six pledges.)
The Principles for Responsible Investment were more than a year in the making, with over 20 institutional investors and 70 experts involved in drafting this voluntary code. United Nations Secretary General Kofi Annan convened the process, with coordination by the U.N. Environment Programme Finance Initiative and the U.N. Global Compact. Mercer Investment Consulting was hired by the U.N. to help facilitate the development of the Principles, and the Ceres environmental coalition served as an advisor.
Skeptics may argue that the Principles for Responsible Investment have been launched with two strikes against them, because they are voluntary in nature and have been drafted under the auspices of the U.N. rather than an organization with more clout in the financial community. However, Mercer's role helps to diffuse this. Moreover, charter signatories include some of the world's largest and most influential pension funds. Money managers will have to take notice of these funds' desire for more consideration of ESG issues if they want to secure their business. (Download filehere to read more about charter signatories.)
"There's never been an international group of funds managing this much money coming together and publicly committing to a set of global guidelines" remarked Gavin Power of the U.N. Global Compact at the Apr. 27 launch of the principles. "The global roll-out will encompass many hundreds, perhaps thousands, of public and private pension funds around the world. This is a giant step for financial markets in terms of collective action and a big step for the U.N. system," he said.
Colin Melvin, director of corporate governance for Hermes Equity Ownership Service, and Chair of the PRI Investor Group, added that while there have been similar public-private initiatives in the past, there has been "nothing to this extent. This represents a shift in the mainstream of investment supported by the world's largest corporate owners."
Legal underpinning for the Principles for Responsible Investment came last year from an analysis written by Freshfields Bruckhaus Deringer, one of the world's largest law firms with a highly regarded environmental, planning and regulatory practice. The legal brief evaluated existing fiduciary guidelines for investment managers in seven countries in Europe, North America and Asia. The Freshfields analysis concluded, "the links between ESG factors and financial performance are increasingly being recognized. On that basis, integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions."
In effect, the Principles for Responsible Investment and this legal brief are turning conventional thinking about fiduciary prudence on its head. Rather than making exceptions for analyzing the shareholder value impacts of environmental, social and governance issues, they say, fund managers should make such analysis the rule. Conversely, fund managers that summarily dismiss ESG analysis because it does not conform with their traditional research methods or notions of corporate governance might be failing to conduct proper due diligence.
"The need for these principles is driven by a simple investment reality," observed Tim Gardener, Global Head of Mercer Investment Consulting, as his firm signed on to the principles on May 2. "While environmental, social and corporate governance factors are increasingly perceived as having an impact on corporate financial performance, they are rarely incorporated into investment decision-making. This leaves room for corporate scandal, environmental degradation and human rights abuses---all of which can affect both a company's bottom line and its share price."
In endorsing the principles, Chanchai Supasagee, director of corporate governance for the Thai government pension fund, framed the argument more bluntly. "We believe in the long-term returns to our beneficiaries," he told the Financial Times on Apr 27. "In the long run, if people are selfish or greedy, they are putting a bomb to their own land, and one day it is going to explode."
In the end, the Principles for Responsible Investment may not be a small step or a giant leap for the investment community, but rather the start of a chain reaction. As signatories increasingly look to incorporate ESG issues into their investment processes, the implementation of the principles will ripple through the investment supply chain---affecting investment managers, professional service providers and, ultimately, corporations. The principles will provide an overarching framework that enables investors around the world to address complex ESG issues in a coordinated fashion, and share their learning experiences as their investment management practices evolve.
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May 4, 2006 |
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Emerging Sudan Divestment Debate
Submitted by: Nancy Coelho, Senior Director of Marketing
Sudan divestment regulation continues to grow, having added Maine as the most recent state requiring divestment by 2008. Two additional states, Vermont and Ohio, have joined California by passing broad-based resolutions that suggest but do not require divestment. And, cities have gotten into divestment, as Providence, RI and New Haven, CT, have become the first two cities to mandate Sudan divestment.
Concurrently, a debate is beginning to develop. Both fund managers and business groups are starting to question the impact that the various laws are having on fund performance on the people of Sudan. Yesterday's Wall Street Journal article by Jane Spencer below (continue reading) raises the question about whether divestment actually helps or hurts. We'd like to invite opinions from all sides of the issue.
Sudan-Divestment Laws Draw Attacks From Fund Managers, Business Groups
By Jane Spencer
3 May 2006
The Wall Street Journal
C1
(Copyright (c) 2006, Dow Jones & Company, Inc.)
A CAMPAIGN to persuade universities and public pension funds to shed investments in companies doing business in Sudan is generating a backlash from fund managers and business groups.
To protest ethnic violence in the Darfur region, at least six states, including Illinois, New Jersey and Oregon, have passed legislation or policies in the past year requiring state-employee pension funds to sell or re-evaluate holdings in companies with links to Sudan. Texas, California, New York and about a dozen other states are considering such legislation.
In April, the California State Teachers' Retirement System pension fund said it would move forward with plans to divest itself of more than $11 million in holdings in three foreign energy companies operating in Sudan. The same month, Providence, R.I., became the first U.S. city to vote to divest itself from Sudan. Friday, Columbia University announced plans to prohibit future investments in 18 foreign companies with business in Sudan, joining Harvard, Yale, Stanford, the University of California system and other schools with such policies.
The campaign, the largest such divestment effort since similar tactics were used to protest South Africa's Apartheid government in the 1980s, is aimed at putting pressure on Sudan's Khartoum regime. The United Nations has accused the regime of supporting a brutal campaign against villagers in the Darfur region, where some 200,000 have died. The U.S. has labeled the civil violence genocide.
Pension-fund managers say the divestment laws could cause their funds to take a hit.
"Our ability to construct an effective, adequately diversified international equity portfolio is severely hampered by this law," wrote William G. Clark, director of the New Jersey Department of the Treasury's Division of Investment, in a March memo.
Mr. Clark said the New Jersey law doesn't adequately differentiate between companies with major operations in Sudan and those with indirect business links. About $2 billion of the state's $73 billion pension fund is invested in companies that the bill links to Sudan. Despite the concerns, the state plans to be fully divested two years ahead of the statutory deadline.
American companies have been barred from operating in Sudan since 1997. But some of the most stringent new divestment policies could affect dozens of major U.S. corporations.
Illinois's new law requires public pension funds to divest themselves of any company that is active in Sudan, including companies that work with Sudanese distributors. The state hasn't listed the companies affected, but the law could be read to include PepsiCo Inc. and Coca-Cola Co., which are allowed to sell ingredients to Sudan-based bottlers under U.S. Treasury licenses.
Both companies say they have no investments in the Sudan companies or employees there. (Coke was recently fined $136,500 for violating U.S. Sudan sanctions in 2002 to 2004; the company says it has improved its sanctions-compliance efforts.)
Foreign companies that aren't covered by the U.S. sanctions also could be affected by some such laws. Dozens of multinational corporations market products or services in Sudan, including Alcatel and Siemens AG.
Illinois fund managers worry the law could force them to pull money out of almost all private-equity funds, which hold about 5% of the state's $100 billion in pension assets. Under the law, private-equity firms that do business with the state must sign a sworn affidavit certifying that no company in their funds operates in Sudan.
Even divestiture-movement leaders say some divestment laws are too restrictive. "We have very large concerns about the Illinois bill," says Adam Sterling, national policy director of the Sudan Divestment Task Force, a student group spearheading the nationwide effort. "We're afraid that it targets too many firms and that many of these firms may in fact be helping the people of Sudan."
The new laws likely will face legal challenges. The National Foreign Trade Council, a business lobbying group that represents about 300 companies, says some of them may unconstitutionally trample on the federal government's exclusive right to handle foreign-policy matters.
Supporters of the Illinois law counter that public funds routinely adopt policies to avoid investments in companies or nations where human rights are violated. "We're not setting foreign policy," says Joseph Clary, an attorney for the Illinois State Senate. "We just don't want to be associated with genocide and terrorism."
The Sudan Divestment Task Force advocates "targeted divestment" that encourages cutting investments only in companies that provide revenue to Sudan's government, especially foreign oil companies.
Companies have heard from investors about Sudan, including Siemens, the German electronics and engineering company, which does business in Sudan. "Obviously it's a concern for us," says Siemens spokeswoman Paula Davis. But the company's work there, she added, is "helping the people of Sudan by providing critical infrastructure."
Sudan, for its part, opposes the campaign. Expressing "deep concern" last month, Sudan's ambassador to the U.S., Khidir Haroun Ahmed, said the campaign will "impede development [by] hampering foreign investment that is vital to rebuilding the country."
The campaign has itself spawned business ventures. Two private research firms, KLD Research & Analytics, of Boston, and Institutional Shareholder Services, of Rockville, Md., sell clients lists of companies with any Sudan links.
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Corporate Governance in Sweden
Submitted by: Brandon Meyer, International Ratings Manager
Swedish companies are governed by the Public Companies Act, the Stockholm Stock Exchange listing requirements, and the Swedish Act on Annual Accounts. Recently these rules have been adapted to come more in line with EU regulations and best practice recommendations.
This article examines Swedish companies' practices relating to: board and committee structures, takeover defenses, shareholder rights, and audit issues. CGQ currently rates 51 Swedish companies (out of 2,365 companies covered outside the U.S.) Swedish shareholding structures are very much in line with those of continental Europe and many Asian markets in that shareholdings are not as widely dispersed as the shareholdings in Anglo markets. Since the late 1990s, however, family control of relatively high percentages of the market value of Swedish companies has been declining.
Board Structures
Swedish companies have adopted a board structure that is close to the U.S. model. Most companies have a unitary (one-tier) board structure where all directors are elected annually by shareholders. In Sweden many companies have adopted the position that independence on the board makes for a stronger and well-governed company. This is evidenced by the majority of companies in Sweden having greater than 50% of their board classified as independent outsiders. Sweden is very progressive in this respect comparatively to other non-U.S. companies. The table below compares the average ratios of independent directors on Swedish boards and all other non-U.S. companies.
One rating discrepancy between markets should be noted---CGQ has a separate rating factor for U.S. boards with less than ten directors. This factor is not applicable in markets outside the U.S. In the U.S. ratings methodology, companies with less than ten directors on the board and having only one non-independent director receive the same credit as companies having over 90 percent independent outsider board composition.
The Swedish Code of Corporate Governance, while not legally binding, recommends that companies establish key board committees (nominating, compensation/remuneration/audit). Most Swedish companies have done so, however, they tend not to focus on independence within the committees as strictly as they have focused on the composition of their board. The code recommends, but does not require, that all committees include independent outsiders. Only the remuneration committee is recommended to be composed of fully independent members. It has been common practice in Sweden for the nominating committee to be composed of the chairman of the board and members from the largest shareholders and/or from the Swedish Pension Funds. Martha Carter, Senior Vice President and Managing Director of Corporate Governance at ISS, has long maintained, "Corporate governance begins in the nominating committee." The Swedish practice of having nominating committees which include insiders and affiliated outsiders might not provide the proper checks and balances to ensure minority shareholders fair representation on the board.
Takeover Defenses
The Swedish market generally does not have many of the familiar takeover defenses of the U.S. They frequently utilize multiple classes of common stock (Skanska AB, Electrolux AB) with unequal voting rights and fixed voting right ceilings (Svenska Handelsbanken). While on the surface both of these types of defenses seem insurmountable, the truth is that many companies have mitigated the "absoluteness" of the defenses. Many Swedish companies offer all classes of stock, regardless of their voting rights, to be sold on the open market. However, with such "strategic shareholders" as the Wallenberg family (estimated by Henrikson and Jakobsson in a 2003 study to retain a voting share exceeding 20 percent in just seven listed firms, down from 14 in 1998.) it is less likely that any one entity could purchase enough voting rights to take control over a company held by controlling shareholders. Some companies that have adopted fixed voting right ceilings have also adopted clauses that allow for shareholder votes to lift the ceilings.
Unequal voting rights between classes of shares is the single most heavily penalized variable in the CGQ methodology. Only 4.3 percent of U.S. companies now have such dual-class structures which are used to maintain voting control of a company, compared to 27% of the Swedish companies rated by CGQ. This factor drags down the average CGQ score of Swedish companies, which have an average CGQ of 38.8, well below the average of 50.1 in the ex-U.S. universe of CGQ companies. Sweden's average Index CGQ ranks twenty-third out of the 32 ex-U.S. countries in the CGQ database.
Sweden previously relied heavily upon cross ownership between companies as a means to prevent takeovers. This practice was used until only a few years ago when it began to fall out of favor as the market put discounts on companies that engaged in such practices. While not as widespread as the above-mentioned defenses such practices are still in use by large companies such as Industrivaerden AB and SCA Pension.
As the Swedish market begins to feel greater pressure from the growing EU market, it may begin to move away from the takeover defenses it has utilized in the past. This could be especially true if their shares become more widely dispersed throughout the burgeoning capital market in continental Europe.
Shareholder Rights
On some issues, Swedish companies provide for stronger shareholder rights than those of U.S. companies. One example of this is the Swedish requirement that directors appointed to the board between annual/general meetings be approved by shareholders at the next general meeting. Only 55 percent of US companies follow this practice. Swedish shareholders holding ten percent of the share capital can convene an extraordinary general meeting (special meeting). Only 46% of US companies even permit shareholders to call special meetings. Conversely, 66.7 percent of shareholders in Swedish companies must approve changes to the articles of organization or bylaws, or approve mergers. These supermajority vote requirements are required by law and are intended to protect minority shareholder rights from large shareholders who could easily garner a majority vote to impose their will on the company. Conversely, in the U.S. market characterized by widely dispersed shareholdings, 65 percent of companies require only a simple majority vote to approve mergers; 46 percent of US companies require a majority vote to change the articles of incorporation or bylaws (these requirements vary between the 50 states).
On some key shareholder rights issues, Swedish companies have weaker than average practices than those of other European and Asian companies. A few examples illustrate this point:
--Of the CGQ-rated companies in Sweden, 72.5 percent of incentive plans have been adopted with shareholder approval compared to 90.1 percent of all other non-U.S. markets
--Only 27.5 percent of Swedish companies expressly prohibit repricing of options without shareholder approval compared to 44.8 percent of non-U.S. companies.
The only area where Sweden outperforms non-U.S. companies is in the annual election of directors: 98 percent of Swedish companies annually elect the entire board of directors compared with only 25.5 percent of all other non-U.S. companies. Shareholders in Swedish companies thus have the ability to hold directors accountable without having to file a special resolution.
Audit
The Swedish market has as set of well defined standards and rules governing the preparation of accounts and engagement of auditors. The rules have significant provisions requiring levels of disclosure for corporate governance issues/compliance. In Sweden, the rules are fairly strict with respect to the independence of the auditors, which are governed by the Swedish Companies Act. However, the rules generally do not govern the use of auditors for consulting or other non-audit services. In Sweden, the audit firms are elected for four year terms, but they can be removed by shareholders before the term ends. This type of auditor arrangement diminishes the accountability of the audit firm, as shareholders do not ratify them annually. Again, as Sweden continues to develop and adopt mainstream accounting standards, these extended appointments may be shortened to increase accountability.
Conclusions
The governance practices of Swedish companies will continue to change and be influenced by two trends: global convergence of governance best practices, and more dispersed shareholdings. The importance of shareholder rights and the independence of directors on board committees will grow as the need for checks and balances in the alignment of shareholder and management interests evolves in the Swedish market.
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May 3, 2006 |
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Securities Class Action Services (SCAS) Ranks the Top 50 Plaintiffs Law Firms for 2005
Submitted by: Bruce Carton, Vice President of Securities Class Action Services
ISS' Securities Class Action Services (SCAS) has released its annual list of the top 50 plaintiffs law firms ranked by the total dollar amount of final securities class action settlements occurring in 2005 in which the law firms served as lead or co-lead counsel.
Topping the 2005 list for the second year in a row was Bernstein Litowitz Berger & Grossman, which served as lead or co-lead counsel in final settlements totaling $3.74 billion--almost 50 percent of the record $7.6 billion in securities class action settlement dollars obtained in 2005. Rounding out the Top 5 in ISS' SCAS 50 were Barrack, Rodos & Bacine (#2 for the second year in a row at $3.67 billion); Lerach Coughlin Stoia Geller Rudman & Robbins ($1.8 billion); Milberg Weiss Bershad & Schulman ($637 million); and Grant & Eisenhofer ($322 million). Bernstein Litowitz and Barrack Rodos' top standing in 2005 was fueled in large part by their performance as co-lead counsel in the massive WorldCom securities class action.
Barrack, Rodos & Bacine led the way in 2005 in terms of average settlement amount for firms that served as lead or co-lead counsel in at least three settlements. With its five settlements in 2005 averaging more than $734 million per accord, Barrack, Rodos & Bacine beat out Bernstein Litowitz's average of $416 million (in nine settlements). Pomerantz Haudek Block Grossman & Gross was third, averaging $75 million over three settlements.
With respect to the total number of final settlements, Lerach Coughlin Stoia Geller Rudman & Robbins led all firms with 47 settlements. Finishing second in this category was Milberg Weiss with 34 settlements, followed by Schiffrin & Barroway, which was lead or co-lead counsel in 14 settlements. Other law firms with at least 10 settlements in 2005 included Berger & Montague (10) and Cauley Bowman Carney & Williams (10).
An interactive version of the SCAS 50 that can be sorted by its various columns is available here.
The SCAS 50 is published on an annual basis, and we welcome your feedback.
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May 2, 2006 |
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Amalgamated Bank Targets CA Again
Submitted by: Rob Kellogg, Managing Director of Global Research
The Amalgamated Bank's LongView Collective Investment Fund has filed a resolution at CA Inc. (formerly known as Computer Associates International) seeking to oust two directors at the company's annual meeting in August.
The targeted directors are former U.S. Senator Alfonse D'Amato and Lewis Ranieri, who both were on the board before 2002 when regulators started investigating the company's accounting. Ranieri, who served as vice chairman of Salomon Brothers in the 1980s, is chairman of CA's board.
The labor-affiliated fund has sought change at the company before. In 2004, LongView filed a novel proposal that urged Computer Associates to establish a policy to recoup unmerited compensation awards following financial restatements.
This year's proposal argues that all directors who served on the board prior to 2002 should be removed. According to the proponent, failing to make a full break with the past will continue to delay the company's financial recovery. The proponent points to reports in The New York Times as early as April 2001 that raised questions about Computer Associates' accounting practices, yet the board did not launch its own independent investigation until 2003. The Islandia, New York-based software maker agreed in 2004 to pay $225 million in restitution and make governance changes. And earlier this week, former CEO Sanjay Kumar pleaded guilty to securities fraud charges.
The LongView proposal is not the typical "vote-no" campaign that is often waged by activist investors, because it would appear as a separate ballot item apart from the director elections. Nevertheless, the underlying message is the same--someone on the board needs to be held accountable for the company's past accounting problems.
On April 21, the company petitioned the Securities and Exchange Commission for permission to omit the proposal. In a letter to the agency's Division of Corporation Finance, CA argued that the resolution relates to the election of directors and thus may be excluded under SEC Rule 14a-8(i)(8). The company cited a number of rulings where the SEC had permitted companies to exclude similar proposals.
The LongView fund asserts that shareholders have the right under Delaware law to remove directors at any time regardless of how much time is left on their terms or whether they intend to stand for re-election. As Cornish Hitchcock, an attorney representing LongView on this proposal, notes: "If state law gives shareholders this right, then why not utilize it? The fact pattern at CA is certainly compelling."
The SEC's rules governing shareholder proposals are not the typical means used by frustrated investors to remove directors. Shareholders should watch closely to see how the SEC evaluates the company's exclusion request. If the commission's staff deems that the resolution does not overlap with the company's election process and the proposal appears on the ballot, shareholders can expect to see similar resolutions in the future.
While Hitchcock acknowledges that the SEC has allowed the omission of similar proposals, he notes that the proponents in those cases did not raise the state law issues or make the arguments LongView will offer. "The beauty of the provision is that the SEC doesn't have to adopt any rules or issue any guidance. All it has to do is just stand back and let shareholders exercise their rights under state law," he says.
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