Sovereign Wealth Funds and Emerging Governance Issues
Submitted by: Subodh Mishra, Governance Institute
Although they have been in existence for decades, sovereign wealth funds have found themselves in the spotlight in recent months. While much of the recent attention given to these funds has focused on the political implications of their investment, sovereign funds’ impact on fellow shareholders has received scant coverage. Indeed, their growing presence has sparked discussion within the global institutional investor community on how best to define, understand, interact, and potentially influence these funds.
As such, RiskMetrics Group's new report, Sovereign Wealth Funds & Emerging Governance Issues, is intended to: (1) provide an overview of sovereign wealth funds; (2) identify key and emerging issues of interest to institutional investors; and (3) explore potential solutions to concerns related to the transparency practices of sovereign investors.
Key takeaways from the paper include the following:
* Sovereign wealth funds are firmly established. There are now roughly 40 such funds—half of which came into being since 2000—collectively managing assets in the range of $1.9 to $2.9 trillion. Macroeconomic trends, including a weak U.S. dollar, tightening of credit, growth in commodity prices, and market volatility suggest that sovereign investment, and its influence, will only grow.
* Traditional institutional shareholders are seeking to understand the investment objectives and strategies of these potential power brokers. The International Monetary Fund is now involved in consultations with more than two dozen sovereign wealth funds in an effort to develop a code of conduct for their transparency, and market regulators across the globe are considering guidelines for disclosure and related issues. Mainstream investors will wish to monitor and potentially influence these efforts.
* There are concerns that sovereign funds will primarily be “disengaged” investors in equities. Some traditional investors have suggested that they will ride the coattails of other shareholders who press underperforming management for change through governance activism; or that their proclivity for non-voting stakes could help to entrench or otherwise insulate underperforming management.
* Substantial investment from sovereign funds could lessen pressure on governments and corporations in developing economies to raise corporate governance standards in such markets.
* Sovereign wealth investors with long-term investment horizons may serve as a stabilizing force in the market, however. Most are not bound by the constraints of many traditional investors who may have to withdraw capital on short notice for income or liquidity needs. Moreover, sovereign investors have demonstrated their willingness and ability to expeditiously shore up the capital base of distressed companies.
* There is no standard disclosure model for sovereign wealth investors. But some sovereigns may be more comfortable with disclosure models other than that of Norway’s fund—widely viewed as the gold standard for transparency—and traditional institutional investors may wish to promote alternatives such as Temasek’s approach to transparency. Temasek, a Singapore-based fund, is an active investor disclosing key investment objectives and strategies though does not disclose its full portfolio or voting record.
* Pressure from lawmakers and regulators for sovereign investors to meet elevated standards of disclosure could have unintended consequences. Such pressure might lead to the funds avoiding direct investment in corporate issuers and allocating more of their capital to private equity and hedge funds, potentially leading to greater acquisition activity and proxy fights.
To access RiskMetrics new paper, Sovereign Wealth Funds and Emerging Governance Issues, please visit here.
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June 13, 2008 |
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CSX Proxy Fight Preview
Submitted by: L. Reed Walton, Publications
Questions of shareholder value, board competency, and transparency continue to drive the high-profile proxy contest between rail company CSX and two hedge funds.
The Children’s Investment Fund (TCI), a London-based equity group, and Cayman Islands-based 3G Capital Partners say they’re seeking board seats because CSX has refused to engage in dialogue about the firm’s business model. Together, TCI and 3G own 8.7 percent of the Jacksonville, Fla.-based company, and have an additional 12.3 percent stake through stock swaps.
The June 25 proxy contest will be the 30th challenge to go to a vote at a U.S. company this year. The fight for CSX has received the most media attention after Carl Icahn’s proxy bid at Internet firm Yahoo!, which is slated for an Aug. 1 vote. TCI’s decision in December to seek five seats on CSX’s 12-member board has led to a war of words in the press, legal actions on both sides, and even Congressional hearings.
The dissident slate includes TCI Managing Partner and founder Chris Hohn; Gilbert Lamphere, a former director at Canadian National; Timothy O’Toole, managing director of the London Underground subway system; Gary Wilson, former board chair at Northwest Airlines; and Alexandre Behring, managing director at 3G and former CEO of Latin American rail company America Latina Logistica. TCI aims to replace the four longest-tenured directors: Elizabeth Bailey (18 years); Robert Kunisch (17 years); William Richardson (15 years); and Frank Royal (14 years). The fifth targeted director, Jacksonville-based contractor Steven Halverson, has only one year of board service; TCI contends that he lacks experience with both CSX and with railroad management.
Hohn said his fund, which is CSX’s second-largest shareholder with a 4.4 percent stake, has tried unsuccessfully for over a year to engage the firm in a productive dialogue about the company’s future. The proxy contest was a last resort, but “it is impossible for us to effect the change we see as possible if we don’t change the board,” Hohn told Risk & Governance Weekly.
Though Hohn has said repeatedly that his dissident slate does not want to take over the company or oust management, CSX Chairman and CEO Michael Ward told Financial Week on May 21 that the proxy contest is specifically aimed at removing him. CSX maintains that it repeatedly agreed to meet with TCI representatives and offered board seats, lead director Ned Kelly said at a June 9 forum hosted by RiskMetrics Group.
Since its founding in 2003, TCI has sought to find “great companies with underperforming shares,” and attempt to engage with directors to turn performance around, Hohn said at the June 9 forum. TCI has a history of prompting action at its portfolio companies, recently catalyzing board and management change at German stock exchange holding company Deutsche Börse and bringing about the sale of Dutch financial firm ABN Amro to a consortium of European banks.
CSX, the third-largest U.S. railroad, argues that it does not need a turnaround. The company’s share price has risen more than 270 percent since January 2004. TCI counters that most of the stock gains stem from rising prices and productivity in the rail industry as a whole, rather than just at CSX. North America’s largest railroad companies have all posted stock price growth during the same period--Union Pacific (131 percent), Norfolk Southern (185 percent), Burlington Northern Santa Fe (257 percent), and Canadian National (154 percent)--though none as pronounced as CSX’s share gain.
Two Union Funds Support Management
Two transportation-affiliated unions, the Brotherhood of Locomotive Engineers and Trainmen (BLET) and the Brotherhood of Railroad Signalmen (BRS), have come out against the dissident slate.
In a May 30 bulletin, the BLET warned that TCI would increase investor returns by “disinvestment in capital improvements.” CSX likewise has criticized TCI’s call for freezing capital expansion; the company voiced its objection to such a strategy in a November letter to TCI. During the June 9 forum, however, Hohn sought to clarify, saying that TCI did suggest a capital freeze, but only in the case of Congressional re-regulation of the rail industry in order to avoid damaging shareholder value.
The BLET also contends that hedge funds like TCI often seek to break up companies and sell the pieces to benefit shareholders, while company workers suffer. The union cites an article in the Jacksonville-based Florida Times-Union that linked TCI’s role in the sale of ABN Amro to the layoff of 550 Jacksonville-area Amro employees. TCI founding partner Snehal Amin dismisses this claim as “totally untrue,” telling R&GW that Amro sold that branch of its business to Citigroup--in which TCI held no shares at the time--and had no connection to the Florida layoffs.
The BRS has questioned the experience of the dissident nominees. However, one of the foundations of TCI’s proxy challenge is that none of the incumbent board members, aside from CEO Michael Ward, have railroad management experience. One new director on the management ballot this year, John McPherson, is a former president of Florida East Coast Railway.
The union echoes CSX’s claim that dissident nominee Behring, of 3G, presided over a railroad with an “abysmal” safety record. Behring noted, however, that the safety record of the Latin American railway he managed experienced an overall dip in safety when it acquired a smaller and poorly maintained track network, which he said the company brought up to excellent safety standards within a year.
Another labor investor, the United Transportation Union (UTU), is remaining neutral in the proxy fight as part of a wage agreement with CSX. The union originally backed TCI’s reform requests, though. “The hired hands who manage CSX railroad should be given their walking papers,” UTU International President Paul Thompson said in an October statement on the union’s Web site. The statement also goes on to criticize CSX’s treatment of workers and its safety record.
“If CSX had devoted more attention to running its railroad as efficiently as other railroads do, they wouldn’t be in the position they’re in,” UTU spokesman Frank Wilner told R&GW.
Large public pension funds have also said they will weigh in on the contest. The California Public Employees’ Retirement System plans to release its vote recommendation the week before the June 25 meeting, fund spokesman Clark McKinley told R&GW. The public pension funds of New York City also have holdings in CSX, but reported that the city comptroller’s office, which controls the funds, has not yet taken a position.
Meanwhile, hedge fund TPG Axon Capital, which owns 2 percent of CSX, plans to support the dissident slate, according to the Reuters news service.
Lawmakers Scrutinize TCI
Lawmakers in Washington have also joined the debate. The House of Representatives Committee on Transportation and Infrastructure called a hearing in March to discuss foreign investment in the railroad industry. Michael Ward and Snehal Amin both testified at the March 5 proceeding. CSX is well-connected in Washington; according to the Associated Press, the company spent approximately $3.2 million in 2007 lobbying for issues such as legislation that would require hedge fund managers to register with U.S. securities regulators.
Rep. Corrine Brown, a Democrat who represents the district in Florida where CSX is based and chairs the House subcommittee dealing with railroads, accused TCI of trying to execute a “short-term money grab” in the case of CSX, the New York Post reported. Both Brown and fellow Democrat Rep. Nick Rahall of West Virginia repeatedly questioned Amin about TCI’s attempted “hostile takeover” of the rail firm, according to the Post.
Just prior to the hearing, CSX donated $20,000 to the Nick J. Rahall Appalachian Transportation Institute at West Virginia-based Marshall University, and an additional $25,000 to Edward Waters College, a Jacksonville-based historically black university with ties to Rep. Brown, news reports indicate. Just after the hearing, Michael Ward donated an additional $1 million to Waters College. The CSX chief executive told R&GW that he has been a patron of the college for 17 years, and that the million-dollar donation was a personal one, unaffiliated with the company.
More recently, six U.S. senators sent a letter to Treasury Secretary Henry Paulson Jr., asking for a review of TCI’s acquisition of CSX stock by the Committee on Foreign Investment in the United States (CFIUS). In the June 3 letter, Democratic Senators Evan Bayh (Indiana), Sherrod Brown (Ohio), Thomas Carper (Delaware), and Robert Menendez (New Jersey), along with Republicans Jim Bunning (Kentucky) and Mel Martinez (Florida), said the agenda of TCI’s investors is invisible to government regulators. “They could be charities and university endowments, but they could also be foreign governments’ sovereign wealth funds,” the lawmakers write. They call on Paulson and CFIUS to determine who TCI’s investors are and whether they threaten national security or the “vital asset” that is CSX.
Corporate Governance Concerns
TCI also is targeting what it sees as lax corporate governance at CSX. Before the proxy contest was launched, TCI sent a letter to the board, urging the company to separate the roles of chairman and CEO (both of which are held by Ward), refresh the board with independent directors, and align management pay with investor interests.
Early in the negotiations, the company said it offered TCI three board seats and a fourth mutually agreed-upon director. TCI wrote in its white paper, “CSX: The Case for Change,” that it accepted the board seats, but asked that the issue of chairman/CEO separation be put to a shareholder vote. The company wanted a commitment to an ongoing joint chairman/CEO position, TCI said, and when the dissidents objected, the company abruptly broke off negotiations. “Not saying ‘thank you very much,’ when we [offered the board seats] was unreasonable,” CSX lead director Kelly said at the June 9 forum.
The dissidents are still pushing for Ward to give up his chairmanship. Kelly noted that the board went against Ward’s wishes when offering the seats to TCI, proving that the directors had the autonomy to oppose management.
The company adopted a bylaw in February that allows shareholders owning 15 percent or more of the company’s outstanding stock to call special meetings. An investor proposal on this topic, submitted by the Rossi family, won 69.6 percent support at CSX’s 2007 annual meeting. “This is very much cutting-edge best practice [in corporate governance],” Ward told R&GW.
However, TCI says the new bylaw is flawed. Under the provision, shareholders cannot call special meetings to elect or remove directors, or call meetings to discuss issues on the agenda at an annual meeting within the 12 months of the special meeting date. CSX representatives said that the bylaw seeks to prevent “continuous recall elections” that would disrupt the board. TCI dismisses this rationale. “Management doesn’t want its actions to be scrutinized by … a better informed board,” Hohn said at the June 9 forum.
CSX’s proxy statement asks shareholders to approve the special meeting bylaw. TCI, which opposes that resolution, is asking investors to vote for its own special meeting proposal that would allow a 15 percent shareowner to request a meeting to address any issue, including director elections. In addition, the fund is seeking to repeal all bylaw amendments made by the board since Jan. 1. TCI is also urging shareholders to abstain from ratifying the company’s auditors.
Court Fight Over Swaps Disclosure
CSX and the dissidents also have engaged in litigation over the disclosure of “total return equity swaps,” which are cash-settled swaps that allow hedge funds and other investors to gain economic exposure to a stock (and tax advantages) without actually owning it. Under such an arrangement, a counterparty (such as a brokerage firm) holds and vote the underlying shares. However, some companies complain that hedge funds use these “stealth swaps” to avoid filing Schedule 13D reports to disclose equity stakes over 5 percent.
In a federal lawsuit in New York, CSX argued that the dissidents should have disclosed sooner the 12.3 percent stake that they maintain through equity swaps. The rail company asked U.S. Judge Lewis Kaplan to bar the dissidents’ slate and force them to sell part of their holdings. According to court documents, TCI began entering into swap arrangements in October 2006 and had amassed swaps that related to 10.5 percent of CSX's stock by January 2007. The dissidents ultimately negotiated swaps with eight investment banks.
Kaplan asked the Securities and Executive Commission for its opinion on the issue. In a June 4 letter, Brian Breheny, deputy director of the Division of Corporation Finance, concluded that a swap arrangement between a hedge fund and a counterparty is not sufficient to trigger Schedule 13D obligations. “In our view, the conclusion is not changed by the presence of economic or business incentives that the counterparty may have to vote the shares as the other party wishes,” Breheny wrote. He also noted that SEC is considering whether to propose a rule to address swaps.
The Securities Industry and Financial Markets Association and the International Swaps and Derivatives Association weighed in for the dissidents, arguing in a court brief that subjecting swaps to 13D rules would “chill” the market for those instruments. Two University of Texas law professors who have jointly written articles on securities lending and “empty voting” issues reached opposite conclusions on the issue. Professor Bernard Black asserted in a court filing that no disclosure was required, while Professor Henry T.C. Hu concluded that disclosure should be mandated in those cases where there is a clear intent to influence the company, The New York Times reported.
On June 11, Judge Kaplan ruled that the dissidents had violated federal disclosure rules, but he said he was barred by U.S. appeals court precedent from blocking the funds from voting at CSX’s annual meeting. The judge criticized the dissidents for trying “to justify their actions on the basis of formalistic legal arguments even when it is apparent that they have defeated the purpose of the law.”
CSX responded to the court’s decision with a June 12 letter urging shareholders to “consider … these violations and the patterns of deceptive conduct from the TCI Group--including false testimony under oath--as you evaluate whether the TCI Group nominees are fit to serve on the board of a U.S. public company.”
Upcoming Proxy Contests
While the traditional U.S. proxy season is winding down, there still are several notable proxy fights on the horizon. Billionaire investor Carl Icahn is seeking board seats at pharmaceutical firm Biogen Idec, trying to replace three of the four directors up for re-election to the classified board at the company’s June 19 meeting. Icahn argues that current leadership at Cambridge, Mass.-based Biogen deliberately failed to find an acquirer for the company despite saying it was in search of a buyer.
Shareholders at Yahoo are scheduled to vote on Icahn’s 10-nominee slate on Aug. 1. He is seeking to unseat the entire board, including CEO Jerry Yang. The diverse dissident slate includes Harvard Law School professor and shareholder activist Lucian Bebchuk, and Internet billionaire Mark Cuban, owner of the Dallas Mavericks basketball team. The proxy challenge is aimed at forcing Yahoo to resume negotiations with Microsoft, which withdrew a $44.6 billion takeover offer in May.
Several contests will go to a vote at smaller firms in the coming weeks. Investors Ronald Gutstein and Scott Frisoli are seeking two seats at the June 16 meeting of Keweenaw Land Association, an Ironwood, Mich.-based hardwood logging firm. The following day, shareholders in Mahwah, N.J.-based footwear manufacturer Footstar will vote on a two-seat challenge by hedge fund Outpoint Group. Former Team Financial board member Keith Edquist is seeking three seats at the Overland Park, Kan.-based banking firm’s June 17 meeting. On June 20, former TVI directors will challenge management for two board seats. TVI, based in Glenn Dale, Md., manufactures emergency first-responder equipment and collapsible shelters for industry and the military.
Ted Allen contributed to this article.
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June 6, 2008 |
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RiskMetrics Group to Hold Governance Forum Webcast on the Proxy Contest at CSX Corporation
On Monday, June 9 at 11 a.m. EDT, RiskMetrics Group will host a special Governance Forum on the proxy contest being waged at CSX Corporation. On this webcast, executives from both CSX Corporation and the dissident shareholders, The Children’s Investment Fund (TCI) and 3G Capital Partners, will make their cases for their respective slates. The Jacksonville, Florida-based railroad operator’s annual meeting is June 25, 2008.
Christopher Young, head of M&A Research for RiskMetrics Group, will moderate the forum, which will run two hours in order to provide both sides with ample time to speak and field questions from the audience. To register for this governance forum, please visit here.
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June 3, 2008 |
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Proxy Season Preview: Japan
Submitted by: Marc Goldstein, Director of Governance Research-Japan
“Poison pills” and other takeover defenses will once again dominate the agenda at Japan’s corporate meetings this year.
The vast majority of Japanese companies hold their shareholder meetings over a two-week period in late June. This year, the largest number of annual meetings will take place on June 27--when companies such as beauty products firm Kao, electronic manufacturer TDK, and Mitsubishi UFJ Financial Group will hold meetings--although many will be held on June 18-20, and June 24-26. A few meetings, such as those at electronics firm Idec and construction toolmaker Trusco Nakayama, will be held as early as the week of June 9.
The most controversial issue this year will again be the introduction and renewal of various types of anti-takeover measures. In the wake of takeover attempts at Hokuetsu Paper, Bull-Dog Sauce, and Sapporo Holdings, and the belated legalization in May 2007 of stock-swap acquisitions by foreign firms (called “triangular mergers”), many Japanese firms are in a state of near-panic over the possibility of being acquired.
Their fears may be overblown, however. Triangular mergers are used overwhelmingly for friendly acquisitions, not hostile takeovers; and the difficulties of successfully managing a company after a hostile acquisition will help to ensure that the number of such cases will be limited. Also, some of the firms implementing pills are not especially vulnerable, because founding families, business partners, or other insiders own more than a third of outstanding shares. This is enough to veto any special resolution, such as an article amendment or a merger, severely limiting what a hostile bidder could hope to accomplish.
Nevertheless, several hundred companies will introduce or renew pills this year. One in seven Japanese companies likely will have a pill in place by the end of June. Since 2006, the vast majority of poison pills have been so-called “advance warning-type” plans. With these pills, the board announces a set of disclosure requirements it expects any bidder to comply with, plus a waiting period between receipt of information and the bid, before any offers are made. Advance warning defenses do not require shareholder approval, but in most cases, companies are choosing to put them to a shareholder vote, believing that doing so will put the company in a stronger position in the event of a lawsuit. As long as the bidder complies with the rules, the company “in principle” will take no action to block the bid, but will allow shareholders to decide.
Exceptions are usually allowed when the bid is judged to be clearly detrimental to shareholder interests. These include cases involving “greenmail” (when the bidder buys enough shares to threaten a takeover and forces the company to buy the shares back at a premium to avoid a buyout), a possible stripping of company assets by the bidder, or coercive two-tier offers. Usually, judgments on shareholder harm are made by a “special committee” or “independent committee,” which may or may not include members of the board, but the committee’s decision is usually subject to being overruled by the board. At some companies, the decisions are made by the board with no committee input at all.
Many of the poison pills introduced in the past few years will be up for renewal in 2008. Shareholders at Shin-Etsu Chemical and Sharp, for example, will vote on takeover defense renewals this year. Some companies, while not putting a poison pill on the ballot, will seek to pave the way for the eventual introduction of a pill through measures such as increasing authorized capital. Investors also will be asked to approve other article amendments designed to ward off hostile takeovers, such as the elimination of vacant board seats that could be filled by shareholder nominees, and the tightening of procedures for removing a director from office.
Increased Shareholder Activism
There was a sudden spike in shareholder activism in Japan last year, with increases in unsolicited takeover attempts, investor proposals, and opposition to management proposals. This activism was in part a reaction to companies’ protectionist moves, and at the same time, the strengthening of corporate defenses was in part a reaction to the increase in activism. In 2007, all of the shareholder proposals were defeated, and none of the takeover attempts came close to fruition. In one of the most visible cases, U.S.-based Steel Partners unsuccessfully challenged a Japanese court ruling upholding a takeover defense that allowed condiment maker Bull-Dog Sauce to dilute Steel’s 10 percent stake. Steel Partners announced in April that it plans to sell off its remaining Bull-Dog shares, Business Week reported.
Steel Partners, The Children’s Investment Fund (TCI) of the United Kingdom, and other institutions also filed significantly more proposals in 2007 asking for greater dividends. Many Japanese companies have traditionally viewed large cash reserves as a sign of stability and a guarantee that they will be able to continue to pay a stable dividend in the event of a downturn. However, Japanese firms have begun to realize that these large reserves make them vulnerable to hostile takeovers. Shareholders also face a problem with dividend proposals. By Japanese law, proposals may only relate to the dividend for the fiscal year under review, and not future dividends; limiting proponents’ ability to structure the proposals in a way that would attract new investors looking for future income.
Though some companies are raising dividends on their own, frustrated shareholders have submitted proposals at firms such as Hibiya Engineering and Electric Power Development (“J-Power”). A proposal by TCI asking J-Power to double dividends is one of seven that the fund is asking investors to support this year. Others include a proposal to appoint at least three independent directors and one to oppose the re-appointment of current company President Yoshihiko Nakagaki, Bloomberg News reported. The company will decide by June 2 what items, if any, of the TCI proposal slate will be voted at the meeting, according to news reports.
Last year’s dividend proposals could be considered a partial success, as one forced Ono Pharmaceutical to promise to spend more on dividends and share buybacks--albeit on its own terms rather than those of the proponent. Annual proposals by the Japan-based investor group Kabunushi (Shareholders’) Ombudsman, asking electronics giant Sony for greater disclosure on executive compensation, regularly win the support of over 40 percent of shareholders.
In addition, shareholders have succeeded in blocking two merger proposals, at steel products company Tokyo Kohtetsu and supermarket chain CFS, in the past 15 months. These developments, as well as a market downturn that wiped out over a trillion dollars in value, ensure that activism will continue. Most of the investors who submitted shareholder proposals in 2007, including TCI and Brandes Investment Partners--which filed a dividend proposal last year--are doing so again this year.
Amendments to Articles of Incorporation
Many of the most significant voting items for Japanese shareholders take the form of amendments to corporate articles. Some of the most notable amendments in 2008 will cover areas such as shareholder rights, takeover defenses, and board structure.
Shareholder Rights. This year, a number of companies are proposing amendments to establish rules governing shareholders’ rights to submit proposals or call special meetings. Such rules may not negate any rights provided under Japan’s new Corporate Law, but could address issues not covered by the law. For example, the company might set a limit on the length of a shareholder proposal to be carried in the proxy circular. The old Commercial Code specified a limit of 400 characters (kanji characters), but that limit was not included in the Corporate Law. The new law allows a company to abbreviate or summarize long proposals, whereas under the old code, a company could simply reject a proposal that was over the 400-character limit. Some investors are concerned that companies, believing that a shareholder proposal could gain widespread support, could choose to impose restrictions on the length or format to limit the persuasiveness of investors’ arguments.
Poison Pills. Japanese companies believe that obtaining shareholder approval for a poison pill will put them in a stronger position in the event of a lawsuit by a bidder or another shareholder. However, pills are not traditional voting items, so many companies add language to their articles clarifying the basis on which they are seeking shareholder approval for the pill, or for the issuance of warrants pursuant to the defense. Unlike pills themselves, article amendments require a two-thirds majority vote, so if shareholders oppose the pill itself, they usually oppose the related article amendments to maximize the chance that the pill will be thwarted. Some companies may also add language to their articles specifically authorizing them to grant compensation to a hostile bidder, in exchange for denying the bidder the right to exercise the warrants granted to all shareholders. Bull-Dog Sauce used such a provision to compensate Steel Partners last year, subjecting itself to substantial criticism from Japanese investors.
Auditor Liability Limits. Japanese law allows two types of article amendments related to the liability of directors and statutory (corporate) auditors: one authorizes a company to impose limits on liability by way of board resolution, and the other lets a firm specify limits on liability in its contract with the outside director or outside statutory auditor. However, the new Corporate Law also allows companies to limit the liability of their audit firms. This provision may be particularly controversial in Japan, considering the recent instances of auditor malfeasance. Once the largest auditing firm in the country, Misuzu Audit was forced to cease operations last July after its auditors were implicated in the accounting fraud at consumer products company Kanebo. The firm also audited the books of Nikko Cordial, which was given Japan’s largest-ever fine for accounting irregularities--¥500 million ($4.8 million)--in June 2007.
New Share Classes. The new law gives companies the ability to issue new types of shares with differential voting rights, including so-called “golden shares,” provided they specify such authority in their articles.
Majority Vote Requirement to Remove a Director. A positive feature of the new Corporate Law is that the removal of a director, formerly categorized as a special resolution requiring a two-thirds vote, has been changed to an ordinary resolution requiring only a simple majority. However, companies are permitted to amend their articles to restore a supermajority requirement to remove a director from the board. Only a few companies have done so thus far, but other firms may consider this step.
Stock Option Plans
The rules governing stock option plans in Japan were overhauled in 2006. Under the old Commercial Code, options granted to directors and statutory auditors were not treated as compensation, but are classified as such under the new Corporate Law. The new rules allow companies to specify an annual monetary ceiling on option grants to directors and statutory auditors, with options valued according to models such as Black-Scholes. As long as each year’s option grants fall within this ceiling, the company does not need to seek shareholder approval for each year’s grants to directors and statutory auditors. (This is not true for grants to employees, however.) Although dilution from option grants in Japan has traditionally been quite low, dilution levels at some companies have been increasing, and in the case of “evergreen” plans for directors, shareholders need to be mindful of the potential impact of annual grants over many years.
Staff Writer L. Reed Walton contributed to this article.
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