On Nov. 28, the Securities and Exchange Commission missed an opportunity to find a middle ground on proxy access.

That day, Chairman Christopher Cox joined with the SEC’s two other Republicans in a 3-1 vote to approve an amendment to Rule 14a-8(i)(8) to allow companies to resume omitting proxy access proposals from shareholders. The Republican majority approved this “non-access” rule even though it was opposed by more than 95 percent of the nearly 9,000 comment letters submitted to the SEC. While Cox said the rule was needed to prevent legal uncertainty and possible fraud, the rule change has angered many public pension funds and labor investors and likely will generate more litigation.

Although Cox said he hopes the agency will revisit the issue in 2008, investors and Commissioner Annette Nazareth, the SEC’s lone Democrat, are skeptical that the agency will want to again debate the question of whether shareholders should have the ability to nominate board candidates to appear on management proxy statements.

Regardless of one’s views on the merits of proxy access, both investors and companies would have been better served had the SEC found some way to allow shareholders and issuers to continue to express their views on the issue.

Investors already have shown that they are willing to vote for well-crafted access proposals. During the 2007 proxy season, access proposals won 53.4 percent of votes cast at small-cap Cryo-Cell International and received at least 43 percent support at UnitedHealth and Hewlett-Packard. In the RiskMetrics Group’s 2007 Policy Survey, which was conducted prior to the commission’s Nov. 28 vote, two-thirds of institutional investor respondents said they support proxy access at all U.S. companies.

Until recently, Cox, a former lawmaker, had been widely praised by both Democrats and Republicans for his ability to achieve consensus on thorny issues. In contrast to his immediate predecessor, William Donaldson, who presided over several high-profile 3-2 votes, Cox has obtained unanimous commission support for new rules on executive compensation disclosure, electronic shareholder forums, and other issues.

Given his reputation, it’s unfortunate that Cox didn’t broker a compromise on proxy access or take other steps to promote board accountability. With some creativity, the commission might have obtained a compromise that would have allowed investors and companies to continue to express their views on proxy access, while addressing the Republican majority’s concerns about avoiding legal uncertainty or potential fraud.

For instance, the SEC could have adopted a rule of limited duration (e.g., that would apply to corporate meetings until Dec. 31, 2008, or Dec. 31, 2009) that would permit investors to file only non-binding access proposals. Since these proposals would be non-binding, companies could not be forced to adopt a potentially problematic access bylaw and accept shareholder nominees in 2009 without sufficient safeguards. While some investors prefer to file binding bylaw proposals, most of them presumably would prefer to get a non-binding resolution on the ballot than nothing at all.

While some companies, judges, and law professors have criticized non-binding proposals, many investors believe that they are an effective, less-prescriptive way to let shareowners and companies debate issues and to customize an approach that works best for the firm’s particular circumstances. This happened during the debate over majority voting in director elections. After non-binding proposals won widespread shareholder support in 2005, companies responded by adopting director resignation policies, and later, many firms approved majority voting bylaws. This company-by-company approach would be especially appropriate for proxy access, given the widespread corporate opposition to the SEC’s 2003 draft rule on proxy access that would have applied to all public companies.

Of course, a company can still decide on its own to put the issue on its proxy statement. CEO Warren Buffett took this enlightened approach during the 2007 season when he allowed Berkshire Hathaway investors to vote on a Sudan-related resolution even after the company obtained SEC permission to exclude it.

Allowing non-binding proposals on corporate ballots in 2008 would enable investors and issuers to continue to debate the issue--without the risk of fraud or wasteful litigation. If the proposals received wide support, companies would know that proxy access is an issue that is important to mainstream investors. Boards could then sit down with the proponents to craft a balanced access bylaw that would require a meaningful minimum (e.g., 3 to 5 percent) ownership stake, a sufficient holding period (e.g., two to three years) to deter short-term investors, and sufficient disclosure about the nominator’s ownership and intentions.

If the access proposals fared poorly, the American Federation of State, County, and Municipal Employees, the California Public Employees’ Retirement System, and other access proponents presumably would stop filing those resolutions and move onto other governance issues that have broader support.

Alternatively, the SEC could have adopted a rule to address its disclosure concerns without barring access proposals completely. The agency could have amended Rule 14a-12(c) to clarify that investors who make director nominations pursuant to an access bylaw must also file a Schedule 14A detailing their ownership, background, and solicitation efforts. While some investors have objected to placing new disclosure obligations on anyone who simply files an access proposal, it’s in the best interests of both investors and issuers to require disclosure from shareholders who take the additional step of proposing board candidates.

The SEC also could have lessened the outcry over proxy access by taking another meaningful step to enhance board accountability. Most notably, the commissioners could have agreed to seek public comment on the New York Stock Exchange’s proposal to bar the counting of uninstructed broker votes in uncontested board elections, a practice that the Council of Institutional Investors has described as “legalized ballot-box stuffing.”

The rule change, first proposed by the NYSE in October 2006, would make “vote no” campaigns more effective. This reform is increasingly critical as more companies adopt bylaws and policies to require director candidates to receive a majority of votes cast. Progress by the SEC on this issue would have helped diminish some of the bitterness among access advocates over the new rule, which the AFL-CIO described as a “partisan” attack on investor rights.

With such a step or a compromise on proxy access, the SEC could have reassured investors that the agency still is willing to take meaningful steps to promote board accountability.

This commentary expresses the views of the author alone and does not purport to represent the views of RiskMetrics Group or its clients.

December 18, 2007

Looking Beyond the Bali Climate Change Talks
Submitted by: Doug Cogan, Head of Climate Change Research

Many of you probably saw the headlines over the weekend that the United States has agreed to formally participate in a successor treaty to the Kyoto Protocol, which is set to expire in 2012.

This is being heralded as big news, because the Bush administration had opted out of this climate treaty in 2001. But the reality is that tough negotiations on a new agreement are not going to take place until 2009, after President Bush leaves the White House. And virtually all of the candidates to succeed him have acknowledged the need to re-enter the post-Kyoto negotiating process.

So, in effect, the Bush administration is running out the clock on its term in office, while sparing the U.S. further ignominy of being the last industrialized nation to embrace the need for greenhouse gas controls. (Australia had been the other holdout, but it endorsed Kyoto last month after holding federal elections.)

The other thing that happened at Bali—or actually didn’t happen, I should say—is that no agreement was reached on the how much to cut future greenhouse gas emissions. The European Union had been calling for industrialized countries to achieve a 25 to 40 percent cut below 1990 levels by 2020. But the U.S., Canada and Japan insisted that this figure should be worked out in the next two years of negotiations, not decided at Bali. These are among the industrialized nations whose emissions have grown the most since 1990, so they’ll have the hardest time achieving such cuts.

Nevertheless, the U.S. delegation at Bali did agree to language that calls for “deep cuts in global emissions,” as called for in the latest report from the Intergovernmental Panel on Climate Change (IPCC), whose authors share the 2007 Nobel Peace Prize with former Vice President Al Gore. And by deep cuts, the IPCC means really deep cuts!

If the goal becomes to hold the global temperature increase below 5.5 degrees F (or 3 degrees Celcius), the IPCC says industrial nations will need to achieve emissions cuts in a range of 40 to 90 percent below 1990 levels by 2050. And if the goal is to hold the increase below 3.6 degrees—which the IPCC believes would be much better for the climate and global environment—then industrialized nations would need to achieve cuts of 25 to 40 percent below 1990 levels by 2020, as the E.U. is recommending, and cuts of 80 to 95 percent by 2050. For all practical purposes, this would mean a virtual “de-carbonization” of industrial economies over the next half-century.

One final thing that came out the Bali climate negotiations—and a sticking point that almost derailed these talks—is that industrialized nations agreed to provide technical and financial assistance to developing nations so that their greenhouse gas emissions also are reduced from baseline forecasts as their economies grow. The U.S. delegation objected to this language, but finally relented after other delegates accused it of abrogating its leadership role in these talks.

So why does all of this matter to investors? First, it means that global warming is no longer a debate about science, but rather one about politics and economics. Second, it means that carbon emissions are going to become a big factor in global trade, with industrial countries earning credits for clean technologies that they help finance and deploy in emerging markets. And third, and most important, it means that carbon will come with a market price on emissions, which will have a profound effect on future investment decisions.

One investment banking analysis released just yesterday projects that carbon dioxide emissions now being traded in Europe will rise to 35 euros ($50) per tonne for allowances traded in 2008 and beyond. In the power sector, that would have the effect of making new gas-fired power plants competitive with new coal-fired ones, even though coal fuel costs are 50 percent cheaper than natural gas. The ripple effects would be felt throughout many industries that are heavy electricity or fossil energy consumers.

At the same time, carbon pricing is also going to have a profound effect on commodities trading, investment and lending decisions, asset liabilities and credit ratings. Just last week, four major banks teamed up with the New York Mercantile Exchange to announce the formation of the Green Exchange, a new commodities exchange that will offer a range of environmental futures, options and swap contracts for climate change-focused markets, starting in early 2008.

Also stay tuned for a RiskMetrics report to be released next month—commissioned by Ceres and the Investor Network on Climate Risk, an investor coalition with $4 trillion in assets under management—that analyzes how climate change will affect all facets of the banking industry. We’ll be holding a webcast with Ceres in early January to discuss the report.

*This commentary expresses the views of the author alone and does not purport to represent the views of RiskMetrics Group or its clients.

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December 17, 2007

Laborers Ask Firms for Better CEO Succession Plans
Submitted by: L. Reed Walton, Publications

The Laborers' International Union of North America has filed a new proposal that urges Toll Brothers and three other firms to adopt a detailed CEO succession policy and disclose it to shareholders.

The proposal asks that the board collaborate with the current CEO on succession planning to develop criteria for the job, identify internal candidates, and institute a formal process to evaluate candidates. The Laborers also filed the resolution at Merrill Lynch, Bank of America, and Verizon Communications, and plan to submit it at a few more firms for the 2008 proxy season, said Jennifer O'Dell, assistant director of the Laborers' office of corporate affairs.

In the Toll Brothers proposal, the union pension fund writes that "our [c]ompany's CEO, Robert Toll … has been CEO of the [c]ompany since its inception in 1986. His long tenure indicates a need for a clear succession plan." According to the company's corporate governance guidelines, the board should be "sensitive" to succession planning issues, but the document does not spell out specific policies in case of a CEO's retirement or emergency departure.

The Moody's ratings firm has recommended that boards should have an emergency succession plan in place in case the CEO is abruptly unable to continue the job.

"If the board appears to make the plan up in the heat of firing a CEO, this highlights the board did not focus on emergency CEO planning," the Moody's report stated. Having a succession plan in place can limit the possibility of overly large severance packages and prevent additional expenses such as "make whole" payments or other premiums for hiring a CEO from outside the company, the report stated.

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December 14, 2007

Agency Rejects Beazer's Request to Omit Mortgage Report Proposal
Submitted by: L. Reed Walton, Publications

The Securities and Exchange Commission has rejected a "no action" request by Beazer Homes to exclude a new proposal by the Indiana Laborers' Pension Fund that seeks a report on the company's mortgage operations and loan-default risks.

The SEC staff ruling presumably will clear the way for similar shareholder resolutions to appear on the ballot at other builders, mortgage companies, and financial firms. The Laborers' International Union of North America, of which the Indiana union is a part, has filed mortgage report proposals at Washington Mutual, Ryland Group, and Bear Stearns, all of which have seen financial losses because of the subprime credit crisis.

"It's great that this is going to set a precedent at those other firms," said Jennifer O'Dell, assistant director of the Laborers' office of corporate affairs. "We couldn't be happier for a first-time proposal."

The Beazer proposal asks the board to make a report to shareholders within 90 days of the annual meeting detailing how many of the company's mortgages are subprime, as well as the regions most reliant on subprime mortgages and the firm's expectations of mortgage defaults. The proposal also asks for the identity of the purchasers buying mortgage loans on the secondary market.

Representatives of Atlanta-based Beazer did not respond to phone calls by press time.

The homebuilder asked the SEC for permission to exclude the Laborers proposal from its proxy statement on the grounds that it violates Rule 14a-8(i)(7), which allows firms to omit resolutions that relate to "ordinary business" operations. Lawyers for Beazer also invoked a less-often used exclusion, Rule 14a-8(i)(5), which lets companies exclude proposals that "relate to operations which account for less than 5 percent of the company's total assets … and for less than 5 percent of its net earnings and gross sales."

In late November, the SEC concluded that it was "unable to concur" with Beazer's arguments to "exclude the proposal under Rule 14a-8(i)(5) ... [and] 14a-8 (i)(7)."

Though Beazer's exclusion request was denied, a vote on the Laborers' proposal is not entirely certain, O'Dell said.

"We don't know whether Beazer will be able to hold an annual meeting" in 2008, she said, citing concerns that the company's mortgage troubles may lead to a financial restatement. Under SEC rules, companies that are restating past results cannot hold regular annual shareholder meetings because they do not have current financial information to include in proxy materials.

Beazer is now under formal investigation by the SEC and by federal prosecutors in North Carolina in connection with past mortgage lending and financial practices. Several employees of the company's mortgage finance division were found during an internal investigation to have broken Department of Housing and Urban Development laws relating to down-payment assistance programs, charges which the firm said it hopes to settle out of court for $15 to $18 million, Beazer said in an October press release.

The SEC has also begun calling on banks and insurance companies to provide greater disclosure of subprime risks. According to a Dec. 11 Associated Press report, the agency plans to send letters to more than 20 firms that previously disclosed off-the-books purchases in collateralized debt obligations and other investment vehicles.

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December 13, 2007

New RiskMetrics Group Study: Employee Incentive Plans in Sweden
Submitted by: Christel Dumas, Marketing

Incentive plans of listed companies have become increasingly important and certainly more controversial. In a new study published by our Nordic research analysts titled "Employee Incentive Plans in Sweden," we will shed light on some of the specifics of incentive plans encountered in the Swedish market.

There are generally two categories of equity-based incentive plans in Sweden: option plans and share plans. Among the options plans, we distinguish four instruments – call options, convertible bonds, subscription rights, and stock appreciation rights. Among the share plans are restricted share plans and matching share plans.

In Sweden, market practice indicates that the conversion price of stock options is at least equal to market value on, or close to, the date of grant. What makes Swedish stock option plans interesting are not so much the conversion price or instruments used, but how the taxation of stock options in Sweden has compelled companies to come up with inventive solutions.

To access the report, please visit the "What's New" section of RiskMetrics Group's Knowledge Center.

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December 12, 2007

Investors Voice Concern Over International Accounting Standards
Submitted by: L. Reed Walton, Publications

International regulators should make sure that companies, auditors, and the European Union do not have undue influence on international financial reporting standards before the U.S. considers adopting them, the Council of Institutional Investors (CII) wrote in a Nov. 9 letter to the U.S. Securities and Exchange Commission.

"[A]t least three related … issues should be resolved as soon as possible and certainly before the [SEC] considers allowing U.S. issuers to prepare financial statements in accordance with [International Financial Reporting Standards]," CII General Counsel Jeff Mahoney wrote in the letter. These issues include the funding sources for the International Accounting Standards Board (IASB), the European Union's influence over the approval of standards, and the lack of sufficient investor representation on the IASB's 14-member board.

The SEC is considering allowing U.S. companies to use International Financial Reporting Standards (IFRS), the accounting rules set by the IASB, in addition to, or instead of, the Generally Accepted Accounting Principles (GAAP) that are used in the United States. On Nov. 15, the SEC voted to drop rules requiring foreign firms listed in the U.S. to reconcile their financial reports with GAAP.

Meanwhile, the European Union, Japan, and other nations have been urging the agency to allow U.S. companies to use the international reporting standards. The SEC received almost 100 letters on the topic between Aug. 9 and the Nov. 13 comment deadline. The commission has announced plans to hold roundtables on the issue on Dec. 13 and Dec. 17.

Most of the funding for the London-based IASB comes from voluntary contributions by fewer than 200 international companies and auditing firms. By contrast, the IASB's U.S. counterpart, the Financial Accounting Standards Board (FASB), is funded by mandatory accounting-support fees from U.S. issuers.

In the CII letter, Mahoney cited a concern raised by the FASB in its comment letter to the SEC: "We believe the current funding levels and staffing mechanisms of the IASB are not adequate for the tasks it will face if the … IFRS becomes the single set of global accounting standards."

In response to these concerns, the IASB has announced a "broad-based funding regime" that would give the organization an additional £12 to £16 million per year, beginning in 2008. Money would come from national funding schemes based on gross domestic product in countries such as Australia, the United Kingdom, and the Netherlands, while voluntary giving programs would continue in countries like China, France, India, and South Africa, the IASB said in a Nov. 6 press release.

Notwithstanding the IASB's new funding approach, the California Public Employees' Retirement System, the largest U.S. state pension fund, wrote in its own comment letter to the SEC on Nov. 14 that it is "not confident at this point that these steps will ensure an independent, well-governed IASB that is free of potential influence."

That concern was also raised during a Nov. 12 roundtable discussion on accounting convergence at New York University. Participants agreed that the IASB should have a more reliable source of funding as well as board stability.

The CFA Institute Centre for Financial Market Integrity, a worldwide organization of investment professionals, also told the SEC--in a comment letter on a related rule release--that the financial independence of the IASB is an important concern.

The CFA Institute also noted that there are "major gaps" in the IFRS that must be addressed before the U.S. could consider adopting those standards. The gaps, the group stated, include accounting for insurance contracts and extraction activities involving minerals, oil, and gas, as well as deficiencies in standards for pension plans and leasing.

The European Union's close involvement in setting international accounting standards is also cause for concern, the CII letter stated.

In July 2003, the European Commission, the administrative branch of the EU, voted to begin endorsing the standing IFRS, and any modifications to the standards in the future. The endorsement process is a long one that involves three independent financial standards committees and the European Parliament in vetting each new principle.

"The EU endorsement process has resulted in several incidents that raise serious questions about whether the process impairs the independence of the IASB," Mahoney wrote in the CII letter. He cites two instances--in 2005 and again in April of this year--when one of the independent committees recommended against a proposed change to IFRS, causing the measure to be delayed indefinitely or withdrawn.

Auditing firm PricewaterhouseCoopers has acknowledged that the endorsement process is a key factor in influencing international standards, but the firm stated in a July report that "EU adoption is a delay but otherwise not a concern."

Among the U.S. companies that submitted comments to the SEC, none specifically mentioned the EU role in endorsing IFRS. The tone amid companies commenting on the idea of using IFRS in the U.S. was almost entirely positive and welcoming of a single global standard.

Some issuers--like Cisco Systems and United Technologies--wrote that they were eager to see the FASB play a significant role in setting a global financial reporting standard. The two companies also questioned the financial independence of the IASB in their comment letters.

In an effort to include input from other governments, Charlie McCreevy, European Commission internal markets commissioner, met with SEC Chairman Christopher Cox, Japan's Financial Services Agency Commissioner Takafumi Sato, and Executive Committee Chair Jane Diplock of the International Organization of Securities Commissions. According to a Nov. 6 press release, the officials intend to create an international monitoring body that helps choose board members for the IASB.

Mahoney of the CII warns that this move would only ensure more influence from political appointees who may not have investment or auditing experience.

"We believe that, at minimum, four members of the IASB should be drawn from the ranks of pension fund investment advisors, equity security financial analysts … or other users of financial reports," Mahoney wrote.

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December 11, 2007

RiskMetrics Group to Hold December 14 “What You Need to Know” Forum on Credit Market Impacts and 2008 Perspectives
Submitted by: Marc Siegel, Head of Accounting Research,

Please join us for a panel discussion among RiskMetrics Group’s experts in the fields of accounting, corporate governance and risk management on the impact of the credit market and what investors can expect in the year ahead. To register for this webcast, click here.

What lessons have we learned from the turmoil of the credit markets – from accounting, corporate governance and risk management perspectives – and what can investors expect in 2008? The debate of the credit market’s impact on the days and months ahead is all the more meaningful with company writedowns, high-profile CEO departures, and failed hedge funds not entirely behind us. Just today, UBS announced a $10 billion writedown and Washington Mutual unveiled a plan to cut dividends, slash jobs and sell preferred stock to raise capital. It would only seem prudent to expect other imminent losses and reorganization plans from already liquidity-challenged banks and brokerages.

On top of the wave of bad news coming out of the subprime fallout, renewed volatility in the financial markets has put the future of the U.S. economy hanging in the balance, and as volatility persists, fears of a recession. While the Fed’s efforts of cutting rates has helped to relieve some of the stress in the money markets in the near-term, do conditions have to get worse before they get better?

Looking back on the trail of missteps of credit quality assignment, it is little wonder the market had very little liquidity in trading, even when times were good, thanks to the complexity of the subprime securities and the varying ratings that agencies assigned to them. If there was no trading in a security, no rating change, and no change in its indicative price, it would be easy to slip into the misconception that the security carries little risk. During the credit forum, Chris Finger, Head of Risk Management Research, will discuss insight into trading into illiquid securities and how a risk manager can do more than compute poor volatility estimates, such as mark-to-model approaches that seek to value and forecast risk given the specifics of individual securities.

Also on the call, Financials Analyst Zach Gast, will explain what loan and asset classes are most at risk, and if we will see loan loss reserves begin to build, as the credit cycle continues to deteriorate. On the governance front, in the brave new world of trading illiquid securities, few boards had standing committees charged with even tracking such risk. With several CEOs having lost their jobs as a result of the risky behavior in the sub-prime mess, will shareholders hold board members accountable at their annual meetings this spring? Special Counsel Pat McGurn will explore these and other questions on board accountability, such as pay programs.

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December 10, 2007

Laborers Ask Companies for Greater Monitoring of Credit Agencies
Submitted by: L. Reed Walton, Publications

In a new proposal for 2008, the Laborers' International Union of North America is asking for greater board monitoring of companies' relationships with Moody's and other credit rating agencies.

So far, the Laborers have filed the proposal at two firms, Citigroup and Indymac Bancorp, both of whose stock was hit hard by rating downgrades after the subprime mortgage crisis.

The proposal asks the boards to delegate new duties to the audit committee, including selecting and monitoring all credit rating agencies the company uses, and disclosing to shareholders all services provided by rating firms and any fees paid.

The resolution also stipulates that the company should not employ anyone who worked at a credit rating firm in the past year. Internal audits should be conducted every year to see that these policies are being followed, the Laborers state in the proposal.

A separate Laborers proposal--also new this year--asks rating agencies themselves to examine their relationships with client companies to minimize conflicts of interest.

The union quotes a Wall Street Journal article from August in its supporting statement, saying that "[t]he scope of [the subprime] crisis is not the only similarity to the Enron-era scandals. They also share root causes that include conflicts of interest, a lack of accountability … Then, these symptoms were found among a key group of gatekeepers--auditors. Now, they are found in an equally critical gatekeeper--the credit ratings agencies."

The resolution, filed so far at Moody's and Standard & Poor's, asks ratings firms to rotate lead analysts every five years, and to conduct internal reviews to ensure that the audit committee is managing potential conflicts of interest. The proposal also asks the credit rating firms not to hire anyone who worked for a client company in the past year.

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December 7, 2007

Pay Consultant Concerns Debated
Submitted by: L. Reed Walton, Publications

U.S. lawmakers this week heard testimony from investor representatives who called for more disclosure from companies about other work done by consulting firms that advise boards on executive pay.

The hearing of the House Committee on Oversight and Government Reform was called by panel Chairman Henry Waxman, a Democrat from California, to determine whether compensation consultants are likely to recommend excessive executive pay in exchange for lucrative contracts on other services for companies. The Dec. 5 hearing coincided with the release of a report by Democratic lawmakers drawing a link between egregious pay practices and the competition by pay consultants for other contracts.

Labor and state pension funds previously have expressed concern that work done by compensation consulting firms outside of advising boards on executive pay may compromise a consultant's independence. The AFL-CIO and other labor funds filed nine proposals on this topic this year--three of which went to a vote--and plan to file similar resolutions for 2008.

In testimony to lawmakers, shareholder advocates blamed rising executive pay on the Securities and Exchange Commission's failure to require U.S. companies to tell their investors what services outside of pay advice these consulting firms provide. The SEC's 2006 compensation disclosure rules do not require issuers to list the outside services provided by pay consulting firms or how much money was paid for these services.

"The SEC betrayed investors by not going far enough in their disclosure rules," said Daniel Pedrotty, director of the AFL-CIO's office of investment. "The board is relying on advice that could be conflicted," he added, "and shareholders should know about that."

Meredith Miller, assistant treasurer for policy in the Connecticut State Treasurer's Office, which oversees the state's pension funds, said corporate disclosure on pay consultants has been "woefully inadequate."

Competing for contracts that can pay much more than compensation consulting alone, Miller said, puts consultants "on the exact same path" toward being totally beholden to top management as auditors were before the accounting scandals at Enron and WorldCom.

"One of the lessons of Enron is that when an auditor has a business relationship with companies, their independence is questionable," said Rep. Elijah Cummings, a Democrat from Maryland.

Republican lawmakers criticized the comparison between audit firms that fraudulently signed off on company accounts and compensation consultants who do other projects for the company, and questioned the need for disclosure to shareholders.

"Shareholders rely on audit reports, but not on compensation consultant reports. Only directors rely on that," said Rep. Tom Davis of Virginia, ranking minority member of the committee.

Houman Shadab, a research fellow at George Mason University and a witness at the hearing, agreed. "Having companies disclose information that is not material to deciding whether to purchase securities … would flood the market with confusing information," Shadab said.

During the hearing, many Republicans questioned the need for additional disclosure when the compensation committee is already required in many instances to be free of ties to executives. Since 2003, the New York Stock Exchange has required companies to have a pay committee that is composed entirely of independent directors.

In 2004, the National Association of Corporate Directors released a report stating that firms providing pay advice to board compensation committees "should not be retained by the company in any other capacity."

Rep. Virginia Foxx, a Republican from North Carolina, said that if shareholders were truly upset about compensation consultant disclosure, they would have contacted lawmakers prior to the hearing. Democratic Rep. Peter Welch of Vermont acknowledged that he had not heard from shareholders about the issue, either.

However, Miller and Pedrotty said they have approached the SEC and individual companies. The Connecticut State Treasurer and the AFL-CIO joined 11 other institutional investors in October 2006 in writing letters to the 25 largest U.S. companies, urging them to exceed the SEC's reporting requirements on compensation consultant independence.

Miller said that 11 companies out of the 25 that received letters now have an outright ban on compensation consultants doing other services for the same company. In December 2006, General Electric agreed to provide additional disclosure in response to a proposal by the AFL-CIO.

Compensation Consultants Respond
During the second half of the Dec. 5 hearing, pay consultant representatives criticized boards and other consulting firms for practices that shareholders might see as problematic.

Representatives of two of the consultancies, Towers Perrin and Hewitt Associates, testified that they have clear internal divisions separating employees who deal with compensation committees from those who work with executives and management. The two firms are "diversified" companies, offering both executive pay advisement and other services such as human resources management.

"There is an underlying assumption that having a so-called 'independent' adviser will result in better pay, lower pay," said Donald Lowman, a managing partner with Towers Perrin. Lowman cited a Corporate Library study that showed the highest numbers of stock options granted to CEOs were at companies advised by firms like Frederick W. Cook that do nothing but executive pay consulting.

Most large companies recognize that best practices include having an independent consultant, countered George Paulin, CEO of Frederick W. Cook.

"Diversified human resources consulting firms have great incentive for lucrative [outside contracts]," said James Reda, managing director of James F. Reda & Associates, another firm that only provides executive pay consulting to corporate boards. Reda said that his firm estimates that 0.2 to 5 percent of revenue in diversified consultancies comes from executive compensation advisement, and the rest from outside contracts or consulting for management.

Charles Scott, president of human capital consulting at diversified firm Mercer Human Resources Consulting, told lawmakers that the firm recently adopted a policy of disclosing to boards the exact amount of money earned from other services, "whether they like it or not."

It is the board's responsibility to decide whether or not they will disclose this information to shareholders, Scott said.

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December 6, 2007

A Change in Federal Enforcement Tactics
Submitted by: Ted Allen, Publications

Five years after the passage of the Sarbanes-Oxley Act, the Securities and Exchange Commission has increased its civil enforcement efforts, but the agency is collecting less in penalties from companies, and federal prosecutors are bringing fewer criminal cases.

During the 2007 fiscal year that ended Sept. 30, the SEC brought 656 enforcement cases, a 14 percent increase from the 574 cases in 2006, according to Bloomberg News. The increase--the first in four years--stems in part from the 24 cases the agency brought over the alleged backdating of stock options.

“There are still more to come,” Linda Thomsen, the SEC’s enforcement director, said at a Nov. 10 law conference in New York, according to Bloomberg News. “My hope is we will get a lot more done” over the next year, she said.

Overall, more than 200 companies have disclosed internal or federal probes into past option grants. However, the SEC has concluded probes at more than 31 firms without recommending any enforcement action--which should be good news for companies and directors who are facing investor lawsuits. Peter Stone, a defense lawyer with Paul Hastings Janofsky & Walker, told The Recorder legal newspaper that “the existence of an ongoing formal SEC investigation is a significant factor in settlement discussions with plaintiffs.”

Among the recently cleared firms are: Electronic Arts, Interwoven, Linear Technology, Zoran, Computer Sciences, PMC Sierra, VeriSign, Sunrise Telecom, and Sunrise Senior Living, according to Bloomberg News.

During fiscal 2007, the SEC also filed 47 insider-trading cases over suspicious trading before the release of buyout news; those actions included cases against former employees at UBS, Morgan Stanley, and Bear Stearns, Thomsen said.

The number of SEC actions also was boosted by the 39 orders that the agency issued in September against accounting firms and individuals who allegedly audited public companies without registering with the Public Company Accounting Oversight Board.

At the same time, the agency is collecting less in fines and penalties from companies and corporate officers. During the 2007 fiscal year, the SEC collected $1.6 billion in penalties and illegal profits, down from more than $3 billion in each of the previous three years, Bloomberg News reported, citing an agency report released Nov. 15.

“The cases they're bringing these days are much smaller,” James Cox, a securities law professor at Duke University, told Bloomberg News. “The commission has adopted “a new ethos about penalties,” based on the concern that “savaging” companies with fines amounts to punishing their investors.

The SEC adopted a new corporate penalty policy in early 2006 after corporate advocates and Republican Commissioner Paul Atkins complained that the penalties were disproportionately high and ultimately were hurting shareholders. Earlier this year, Chairman Christopher Cox directed the agency’s enforcement division to obtain commission approval before negotiating corporate fines.

When asked by Bloomberg News about the decline in total fines, Chairman Cox noted that there wasn’t a major corporate fraud settlement this year. In 2006, the agency collected an $800 million penalty from American International Group and obtained a $400 million settlement from Fannie Mae.

The decrease in corporate penalties ultimately is a significant issue for investors, because much of this money is eventually distributed to investors through the SEC’s Fair Fund program, which was created by the Sarbanes-Oxley Act. The SEC has returned more than $3.2 billion to investors since 2002.

A continued decline in corporate penalties may undermine the arguments of class-action litigation critics, who contend that only the government should be permitted to recover damages for investors. Investor lawyers, including Fred T. Isquith of Wolf Haldenstein Adler Freeman & Herz and Jay Eisenhofer of Grant & Eisenhofer, have countered by pointing out that the SEC doesn’t have the resources to fully protect shareholders and that private lawsuits typically generate greater recoveries. (For more on these arguments, please see the March and April 2007 editions of the SCAS Alert.)

Fewer Criminal Cases
Meanwhile, the number of major criminal cases has declined significantly in the past two years after a wave of corporate fraud indictments between 2002 and 2005. According to an article in the November issue of The American Lawyer magazine, there were 357 indictments in major criminal cases during that period. Last year, there were 14 major corporate fraud cases; there have been just 12 cases so far in 2007, the magazine reported.

The decline in criminal cases may stem from the limited resources available to federal prosecutors around the country. While the SEC has added more than 1,000 attorneys, accountants, and economists since 2002, the number of lawyers in U.S. attorneys’ offices has grown more slowly, increasing by 56 to 529 in 2006, according to The American Lawyer, which cited data compiled by Syracuse University researchers.

Joan Meyer, an official with the U.S. Justice Department, said the decline in criminal cases actually is evidence of the success of the department’s Corporate Fraud Task Force. “You’re getting a lot more focus on compliance and on ethics internally in corporate structures,” Meyer told The American Lawyer. “We do believe that the success of the Corporate Fraud Task Force, in conjunction with the Sarbanes-Oxley Act, is making it more likely that fraud is being detected by corporations themselves.”

While prosecutors won the convictions of former Hollinger International CEO Conrad Black and ex-Brocade Communications CEO Gregory Reyes in the past year, the government also suffered setbacks as senior executives at AOL and Duke Energy were acquitted. In July, a federal judge dismissed charges against 13 former KPMG executives in a case that prosecutors once described as the largest tax fraud case in history.

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December 4, 2007

RiskMetrics Group’s 2008 Board Practices Study
Submitted by: Sarah Cohn, Marketing and Communications

RiskMetrics Group is pleased to present its 2008 Board Practices Study. Some of the key findings from the study revealed:

1) Board independence levels rose to 74 percent in 2007 after having leveled off at 72 percent in 2006 (the first year no increase at all was found from the prior year’s levels).

2) 45 percent of major U.S. companies had separated the posts of chairman and CEO at the time of their most recent shareholder meeting—an increase of 20 percentage points since 2000, and four percentage points over the previous year.

3) The number of companies with staggered boards continued to decline in 2007, to 52 percent overall, down from 55 percent in 2006.

To learn more about the findings from the study, please tune into the "State of the Board" interview with Carol Bowie of RiskMetrics Group’s Governance Institute, and Patrick McGurn, special counsel at RiskMetrics Group. To access the study, please visit here.

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