Before the start of the U.S. proxy season, investors were expected to give significantly greater support for governance reform proposals while withholding votes from directors who presided over record losses. As the credit crisis worsened early in 2008, the attitudes of many investors appeared to shift from anger to anxiety.

Early on, it seemed that 2008 would be marked by frequent displays of shareholder discontent. Activist institutional investors, angered by the Securities and Exchange Commission’s decision in November to bar proxy access proposals, appeared ready to rally behind shareholder proposals seeking independent board chairs and advisory votes on executive pay. The SEC also frustrated activists by allowing many firms affected by the credit crisis to exclude most of their new proposals that sought compliance committees, mortgage risk reports, and better CEO succession planning.

After the labor-affiliated Change to Win Investment Group (CW) threatened “vote no” campaigns against directors at six large financial companies in January and February, it appeared that many investors would vote against board members at other financial firms and homebuilders. Democratic lawmakers joined the fray, holding a hearing in early March to denounce the generous compensation received by outgoing executives at Countrywide Financial, Citigroup, and Merrill Lynch.

However, shareholder views appeared to shift after Bear Stearns, an 85-year-old Wall Street stalwart, suddenly collapsed in mid-March. The firm, which had traded at $170 per share a year earlier, initially agreed to be sold for $2 a share to JPMorgan Chase in a government-supported bailout (JPMorgan ultimately agreed to pay $10 per share).

“Simply put, the bear market mauled the 2008 proxy season,” said Pat McGurn, special counsel for RiskMetrics Group's ISS Governance Services unit. “The collapse of Bear Stearns on the eve of the season let most of the air out of the shareholder activism balloon.”

The fall of Bear--along with soaring oil prices and falling real estate values--helped drive consumer and retail investor confidence and optimism to new depths. The TIPP economic optimism index--conducted by TechnoMetrica Market Intelligence for Investor’s Business Daily and the Christian Science Monitor--hit an all-time low in April and has continued to fall. The Yale School of Management’s Stock Market Confidence Index (the one-year outlook) for individual investors also hit its low point for the decade in April.

The season’s vote results suggest that many shareholders were more inclined to back management and refrain from supporting shareholder proposals or initiatives to unseat directors. With a few notable exceptions where compensation concerns were raised or a heavily staked hedge fund led the charge, most directors at U.S. companies were elected with wide support. While investors expressed slightly more support for “say on pay” advisory vote proposals and independent board chair resolutions, the increases were less than what some governance observers had expected at the start of the year. At six financial firms, support for “say on pay” actually declined from 2007 levels.

“People are focusing on whether there is going to be a tomorrow in the market, and not on these traditional governance issues,” James Cox, a securities law professor at Duke University, told Risk & Governance Weekly. “Some institutions may believe--given the trauma of the marketplace--that management shouldn’t be distracted by these concerns.”

Activist investors also appeared to shift their tactics after Bear’s collapse. The American Federation of State, County, and Municipal Employees (AFSCME) and two state pension funds dropped plans to sue Bear and JPMorgan over the exclusion of proxy access proposals. CtW decided to wage “vote no” campaigns at just two of its targeted six financial firms, while the AFL-CIO dropped a campaign against C. Michael Armstrong, Citigroup’s audit and risk management committee chair, after the company announced that he would leave the panel. The California Public Employees’ Retirement System, the largest U.S. public pension fund, focused its attention this year on firms outside the troubled financial and homebuilding sectors (with the exception of a “vote no” campaign at Standard Pacific).

This muted investor response was apparent at the April 8 meeting of Morgan Stanley, the first of the major Wall Street firms to hold its annual meeting. Despite a “vote no” campaign by CtW against two directors and Chairman/CEO John Mack, all the directors won at least 90 percent support, which is consistent with historic voting patterns at the firm. Several other factors may have contributed to the results. Mack is well liked on Wall Street, so many investment managers were reluctant to vote against him, CtW officials said. Most of Morgan Stanley’s writedowns stemmed from a single failed trading strategy, rather than broad exposure to mortgage-backed securities; Mack responded by firing the head of trading and replacing the chief risk officer, which helped assuage investor concerns. Duke University’s Cox also noted that Mack’s decision not to accept a bonus in 2007 also dampened potential opposition.

At most financial firms, directors received overwhelming support this year. Wachovia’s board members all received more than 92 percent support at the annual meeting, which occurred before the company reported more problems in its loan portfolio and fired its CEO in June. At Lehman Brothers, the directors all won at least 95 percent support. Bank of America also avoided an opposition campaign this year, but it may face greater scrutiny from investors in 2009 over its purchase of Countrywide. Countrywide, which was the largest U.S. mortgage lender, was targeted by labor funds late last year, but it didn’t hold a regular 2008 meeting.

At some companies, there may have been a limited response because investors didn’t learn of the full extent of their firm’s problems until after the annual meeting. Lender IndyMac and mortgage financiers Freddie Mac and Fannie Mae--whose troubles made headlines in July--faced no organized investor opposition at their meetings in May and early June and received just one shareholder proposal.

Greater Engagement
Another explanation for this season’s votes is that companies are doing a better job of reaching out to investors. “Boards have gotten a lot better at opening a dialogue with investors, and that may be having an effect,” Cox said.

For instance, all six financial firms targeted by CtW agreed to meet with the labor investment group. The United Brotherhood of Carpenters and Joiners of America withdrew more than half of its pay-for-performance proposals after negotiations with companies. A record number of issuers have sponsored board declassification proposals this year. And at ExxonMobil, independent chair proponents say their proposal would have done better but for the oil company’s “unprecedented outreach effort . . . to solicit votes from institutional and retail investors.”

“What shareholders were looking for was responsiveness from directors, and in those cases, they gave them a break,” recalled Richard Ferlauto, director of pension and benefit policy at AFSCME.

Notable Withhold Votes
The most notable display of investor discontent occurred at Washington Mutual’s April 15 meeting. CtW urged investors to vote against Mary Pugh, chair of the finance committee, and James Stever, chair of the human resources committee, which oversees compensation. AFSCME waged its own campaign against Stever and four of his fellow panel members at the Seattle-based lender. The labor investors assailed the human resources committee’s decision to shield 2008 executive bonuses from the firm’s subprime losses, while CtW argued that Pugh should be held accountable for the company’s risk management failures. Investors also complained about equity dilution after WaMu negotiated a $7 billion cash infusion from TPG Capital.

Overall, nine WaMu directors received at least 26 percent opposition. A year earlier, all the directors received at least 92 percent support. Pugh stepped down after receiving 49.9 percent opposition, while Stever and director Charles Lillis received more than 40 percent negative votes. In early June, WaMu responded by appointing an independent chairman, adopting majority voting in board elections, and naming new chairs to its finance and human resources committees.

Michael Garland, CtW’s director of value strategies, said the WaMu results show that an increasing number of money managers and mutual funds will consider voting against directors if “there is a compelling fact pattern.” “At Washington Mutual, it all came together,” he said, noting the firm’s “strategic failures” and poor compensation practices.

There also were notably high withhold votes at several firms where there were no concerted opposition campaigns. At Citigroup, three pay committee members received more than 25 percent opposition--all the firm’s directors had at least 93.7 percent support in 2007. The dissent this year appeared to be a reaction to former CEO Charles Prince’s exit package. He received a $10.4 million bonus for 2007, even though the company’s shares fell 43 percent that year. Citigroup also agreed to give him an office, an administrative assistant, and a car and driver for five years (or until he commences full-time employment with another employer), and pay certain taxes on these post-termination benefits.

While Capital One Financial was not targeted by investors, three pay panel members received almost 21 percent opposition. In 2007, the three directors running for reelection to the firm’s classified board all won more than 93 percent support. This year’s vote appears to stem from the compensation committee’s decision to grant stock options worth $23.5 million to CEO Richard Fairbank in 2007, while the company’s stock price fell. The shares at the McLean, Va.-based credit-card firm posted a 38.4 percent one-year decline, and a 17.4 percent decrease over three years.

The director votes at Citigroup and Capital One suggest that compensation concerns still resonated among many shareholders, even in the absence of “vote no” campaigns. At Washington Mutual, the executive bonus policy was a significant factor in fueling opposition, whereas investors did not raise compensation concerns at Morgan Stanley. “Compensation seemed to be key,” recalled Ferlauto of AFSCME. “When investors seemed to be incensed by pay, there was a reaction.”

In the homebuilding industry, there were greater than 23 percent withhold votes against directors at Toll Brothers, KB Home, and Hovnanian Enterprises that also appeared to be a reaction to compensation practices. Most of the homebuilders have yet to report their official board election results, so there may have been significant opposition at other firms, such as Ryland Group, which faced a CtW “vote no” campaign.

Mixed Results for “Say on Pay”
While compensation concerns led to significant withhold votes against some directors, that discontent did not translate into greater support for “say on pay” proposals. At six financial companies where the issue also was on the ballot in 2007--Merrill Lynch, Wachovia, Citigroup, Morgan Stanley, Capital One, and Wells Fargo--there was lower support this year. At Merrill Lynch, support fell from 45.6 percent to 37.5 percent, while the vote at Citigroup declined from 46.2 percent to 41.9 percent this year. Ferlauto of AFSCME, which filed numerous pay vote resolutions, attributes the lower results at Merrill Lynch and Citigroup in part to CEO changes. “There’s a honeymoon period,” he said. “At Merrill and Citi, there was new management, so shareholders gave them the benefit of the doubt.”

Within the financial sector, the best showings for “say on pay” were 44.9 percent support at Bank of America and 45.6 percent at Goldman Sachs. Neither firm faced that proposal in 2007. Ferlauto said he believes the issue also would have done well at Washington Mutual, but proponents did not file that resolution there because they were focusing their attention on Countrywide and the Wall Street firms.

At the same time, the overall support for advisory vote proposals increased marginally at U.S. companies. According to preliminary and final results available as of July 15, those proposals have averaged 42.7 percent support over 52 meetings this year, up slightly from 42.5 percent support over the same number of meetings in 2007. Shareholders at nine companies, including Lexmark International and Apple, gave greater than 50 percent support (based on the votes cast for and against) to “say on pay” proposals through July 15, compared with eight majority results during all of 2007. Notably, all of this year’s proposals earned at least 30 percent support, except at Wal-Mart Stores where officers and directors control a 43.4 percent stake.

A total of 75 “say on pay” resolutions are slated for a vote this year, up from 50 in 2007, according to RiskMetrics data. Most of the remaining vote results will become available when companies file their second-quarter 10-Q reports in early to mid-August. Investors withdrew two proposals, at Johnson & Johnson and Verizon Communications, the latter of which has committed to holding an investor pay vote in 2009. The SEC allowed companies to omit an additional nine resolutions.

This is the third year that shareholder pay vote proposals have been on the ballot at U.S. firms. They appear unlikely to match the third-year success posted in 2006 by investor proposals seeking a majority voting threshold in director elections. In that year, majority vote proposals averaged about 50 percent support at 84 companies and won majority support at 36 firms, according to RiskMetrics data.

James Cox, the Duke University law professor, expects that investor support for advisory votes will increase in the future, and said this year’s showing may be “a product of the times.” “It’s hard to imagine not having ‘say on pay’ in some form, given that it exists in England,” Cox noted. Both major U.S. presidential candidates have endorsed the concept of advisory pay votes.

Other Compensation Proposals
Pay-for-performance proposals have averaged 27.4 percent support over nine meetings where results are known, as opposed to 29.5 percent support over 38 meetings last year. This average does not include a 91 percent result at Credence Systems, where management supported the measure, however. Twenty-five proposals have gone to a vote this year, according to RiskMetrics data.

The most notable development this season was the increase in investor-issuer engagement on this issue. The Carpenters and other investors withdrew more than 30 performance-based pay resolutions after discussions with companies, as compared with 17 withdrawals last year. (For more on those proposals, please see this week’s “In Brief” section.)

Early results suggest that investors were more receptive to limits on supplemental executive retirement plans (SERPs). Just eight SERP-related proposals were filed this year, and half of those were withdrawn. Resolutions asking for greater disclosure of, limits on, or shareholder approval of SERPs have won 35.8 percent support at AT&T and 44.7 percent at Black & Decker so far this year. SERP proposals averaged 32.9 percent support at 14 meetings last year.

One compensation proposal topic has fared considerably less well this year--shareholder requests to “claw back” management bonuses in case of a restatement or malfeasance. Five proposals this year won an average of 10.7 percent support, as opposed to 31.9 percent support at 10 meetings in 2007.

A new AFL-CIO proposal that seeks “responsible” executive employment agreements garnered 33.9 percent support over two meetings. Only three were filed this year, but Daniel Pedrotty, director of the labor federation’s office of investment, told Risk & Governance Weekly that the proposals will be re-filed next year, though he said it was too early to determine which firms will receive the proposals.

A new AFSCME proposal to prohibit tax payments, or “gross ups,” to executives, won 44.5 percent support, on average, over four meetings. Resolutions asking for stock options to be performance-based received 15.9 percent support at General Motors and 32 percent at Boeing, proponents say.

Board Reform Proposals
Independent board chair proposals received record support this year--31.3 percent support over 20 meetings, 4.6 percentage points higher than last year, when they averaged 26.7 percent support over 43 meetings. Twenty-seven proposals have gone to a vote this year, though, with seven meeting results still outstanding. While an independent chair is the prevailing practice in the United Kingdom and many international markets, many U.S. firms have been reluctant to embrace this reform. Forty-five percent of S&P 1,500 companies have separate chairman/CEO positions, but just 17 percent of those firms have independent chairs, according to RiskMetrics data.

The resolution receiving the most media attention was an independent chair proposal at ExxonMobil. While a coalition of activist investors, state pension fund officials, and Rockefeller family members endorsed the measure, the proposal received 39.5 percent support, less than last year’s 40.7 percent showing at the oil giant. An independent chair proposal received 51.5 percent support at Washington Mutual, which since has appointed an independent chairman. Wachovia took that step in May, although it didn't have an independent chair resolution on the ballot this year. Other high votes include 43 percent support at Time Warner and 42.8 percent at Pfizer.

A new proposal this year that asks boards to establish an independent “lead director” has garnered an average of 36.3 percent support over four meetings. Only four proposals were voted this year, all filed by individual investors.

Fewer resolutions seeking majority voting in uncontested board elections went to a vote in 2008, as more companies agreed to adopt bylaws on that topic. So far this year, 47 of the 90 majority vote resolutions filed have been withdrawn by proponents. At the 16 meetings this season where results are known, majority voting proposals won 50.4 percent support--the same percentage as last year. This average does not include the 90 percent-plus votes at Analog Devices and RadioShack, where the shareholder resolutions were supported by management. Including those votes, the overall average support rises to 55.2 percent. The total number of proposals filed has declined from 134 last year and 143 in 2006.

Meanwhile, 31 firms have asked shareholders to approve a majority vote standard this year, while 32 did last year, according to RiskMetrics data. More than 72 percent of S&P 500 companies have adopted some form of a majority vote standard, according to Claudia Allen, a partner with the law firm Neal, Gerber & Eisenberg, who conducts an annual study on majority voting.

Investor calls for cumulative voting have also seen increased support so far, with 37.7 percent support over 12 meetings, compared with 33.7 percent over 24 meetings last year.

Takeover Defenses
Resolutions asking firms to end staggered boards received slightly less support so far this year, with 60.2 percent average support at 16 meetings where results are known. This compares to 63.9 percent support over 38 meetings in 2007. Support for shareholder declassification proposals has waned since 2006, when the topic averaged 66.8 percent. The highest vote so far this season came at Kilroy Realty’s May 20 meeting, proponents say, when 93 percent of investors supported annual director elections, despite management opposition. The average support for this year may change as more results become available, as 80 proposals have been or will be put to a vote in 2008. Investors withdrew six declassification proposals, while the SEC allowed companies to omit an additional 13.

What is notable this season is the number of board declassification proposals put forward by management. So far this year, 79 companies have placed declassification resolutions on the ballot. There were 54 company-sponsored proposals in 2007, and 72 management resolutions in 2006, according to RiskMetrics data.

Investor calls to eliminate supermajority requirements for bylaw changes and other matters also continue to garner significant support, although less than the 2007 peak average of 67.9 percent. The measure has won 60.5 percent support over 12 meetings this year.

The number of proposals asking for the right of shareholders to call special meetings increased dramatically this year--from 22 in 2007 to 51 proposals filed in 2008. Twenty-two companies this year were allowed to omit special meeting proposals, while 31 went to a vote. At the 26 companies where results are known, those proposals logged 45.9 percent average support, a drop from last year's 56.5 percent support over 18 meetings. Shareholder activist John Chevedden, whose network of retail investors filed most of the special meeting proposals, recalled that proponents revised their resolved clauses in the middle of the 2008 submittal period to remove a 10 percent shareholding requirement. Many of those resolutions were excluded at the SEC or received less support, he said, adding that investors later reverted to their original proposal language.

Investors are continuing to submit fewer proposals that target “poison pill” takeover defenses. Just 13 have been filed in 2008, down from 22 in 2007, 35 in 2006, and 51 in 2005. Of this year's resolutions, five have gone to a vote, while six were withdrawn, and two were omitted. So far, those proposals have averaged 50.3 percent support over four meetings this year, compared with 37.6 percent average support over 16 meetings last year.

Hedge Fund Activism
2008 is on pace to shatter the all-time record for proxy challenges, although few contests have gone to a vote. Given the market meltdown, many boards have been willing to provide board representation to dissidents. Hedge funds have brokered seat-ceding settlements at scores of boards, including those at Sprint, Dillard's, Charming Shoppes, the New York Times Co., Borders Group, Tiffany, and Zales.

“While many public and labor funds appeared reluctant to rock a sinking ship, hedge fund activists were only too happy to raise the Jolly Roger,” noted McGurn of RiskMetrics.

Editor’s Note: RiskMetrics reports vote percentages based on “for” and “against” votes cast, excluding abstentions or broker votes. This is the same approach the Securities and Exchange Commission uses under Rule 14a-8(i)(12) to evaluate the support received by proposals in previous years. Note that many results are preliminary and do not include all 2008 meetings as of July 15, because some companies have declined to release vote totals on shareholder resolutions until their next quarterly regulatory filings. The figures in the table below do not include management-sponsored or supported proposals.

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July 18, 2008