The Corporate Library Blog

Martin Lipton on Boards and "Aspirational Best Practices"

Legendary counsel to corporate insiders Martin Lipton spoke to the NYSE and CEO Peer Forum about "The Future of the Board of Directors" and his remarks are now available on Harvard's Corporate Forum on Corporate Governance and Finance website. 

Lipton continues to show his deftness at redefining the questions to fit his answers.  He says that boards worked better in the days before we put so much emphasis on independent directors.

At the same time as we have set these stringent expectations for performance and personal qualifications, we have allowed the playing field on which the board of directors performs to tilt in favor of shareholders who seek short-term profits rather than long-term growth.  To quote the title of a brilliant speech Vice Chancellor Leo Strine of the Delaware Court of Chancery gave at Stanford University last month, One Fundamental Corporate Governance Question We Face:  Can Corporations Be Managed For The Long Term Unless Their Powerful Electorates Also Act And Think Long Term?

...

The combined effect of the agency theory, Sarbanes-Oxley, the stock exchange governance rules, SEC regulations, the Institutional Shareholder Services Company (ISS) and the Council of Institutional Investors (CII) pressure and the corporate governance provisions of the pending financial industry regulation bill is to exalt short-term shareholder interests over that of all the other stakeholders—and of the American economy and the American public.  The assumption that empowering shareholders and promoting their interests will lead to better performance and more efficient management of corporations, and that shareholder interests are therefore aligned with those of other stakeholders, is contradicted by the short-term trading objectives of many of the major institutional investors and hedge funds.  It was the taking of undue risks in an effort to meet the short-term profits demands of shareholders that was a root cause of the financial crisis.

It is disingenuous at best for the creator of the poison pill to suggest that shareholders who seek short-term profits are the ones with the power.  And it is preposterous to blame the victims by making shareholders the cause of the financial crisis. 

Who is he talking about?  The largest shareholders in the world are the corporations themselves, through their pension funds.  The CEOs, as fiduciaries of those funds, are entirely responsible for their investment strategy and pension funds are the ultimate long-term investor.  As Pogo said, "We have met the enemy and he is us."  If CEOs want long-term shareholders, they should start with themselves.  And then there were those other shareholders, the Wall Street firms themselves, who preside over the largest pools of investment capital. They subordinated their interests as shareholders to their interests as executives, perpetuating and benefiting from perverse incentive compensation.  Because their boards let them get away with it.

The shareholders' responsibility in the financial meltdown was not a short-sighted and self-destructive focus on short-term returns.  It was negligent oversight of the perverse incentives in the compensation schemes that led to the over-investment in sub-prime mortgages and its derivatives and of the boards that approved them. 

Lipton asks us to

recognize that the purpose of corporate governance must be to encourage management and directors to develop policies and procedures that enable them to best perform their duties (and meet our expectations), while not putting them in a straight jacket that dampens risk-taking and discourages investing for long-term growth and true value creation.

No argument there.  But the best way to reach that goal is not to entrench management but to make sure that those who deploy capital are accountable to those who provide it. 

Nell Minow -Editor

Six directors received support from less than one-third of shareholders

This proxy season has proven to be an interesting one, as there are many more directors who are failing to receive support from a majority of shareholders. Increased scrutiny of directors combined with the elimination of broker voting in uncontested elections means that the proportion of "for" votes is likely to be smaller at most companies.  Our data team is processing the form 8-Ks, on which this information is now provided, and notifying us whenever a director has a no or withhold vote percent that is over 50%.  We have been surprised to see that more than a few directors have received support from LESS THAN ONE-THIRD of their shareholders.  So far, we have identified the following six directors who have failed to receive support from at least 70% of the company’s shareholders.  That means fewer than three in ten shareholders want that director to continue serving on the board.  And, in most cases the directors are still on the boards, despite this clear message from the very people the directors are supposed to serving.

• Edward C. Nafus, director and former CEO of CSG Systems International, Inc., is the winner – or loser in this case – with the highest percent of withhold votes spotted so far this season: 80%. Amazingly, four out of five shareholders of CSG Systems do not want Mr. Nafus representing their interests as a director of the company. But he continues to serve.
• Peter B. Davis is a member of the Audit Committee at Nabi Biopharmaceuticals. More than three-quarters (76%) of the Nabi shareholders withheld their support from Mr. Davis’s reelection to the board. The Nabi board has adopted a resignation policy for those directors who do not receive support from a majority of shareholders (i.e., Plurality and Resignation Policy) – however, despite Mr. Davis’s poor showing, the board rejected the resignation he tendered after the election and so he will continue to serve on the board.
• Two directors who were up for election at the classified board of United Online, Inc. - Kenneth L. Coleman and Robert Berglass - both received 71% votes withheld at the company’s annual meeting in May 2010. Another director, Dennis F. Holt, who was up for election last year at the company’s 2009 annual meeting saw 65% of votes withheld from his re-election. All three of these directors are members of the board’s compensation committee.
• Shareholders of Helix Energy Solutions Group, Inc. were apparently upset at the attendance record of director Bernard J. Duroc-Danner, because only 29% supported his re-election to the board after he attended only four of eleven board meetings during 2009.
• Skywest Inc. director J. Ralph Atkin, who founded the company and now chairs the board’s Audit Committee, received support from less than 25% of shareholders at this year’s election. J. Ralph Atkin’s nephew, Jerry C. Atkin, is currently the company’s Chair and CEO.

Annalisa Barrett - Senior Research Associate

Director Elections: Majority Withhold Vote at Sterling Bancshares

Over the last few weeks, our wonderful  TCL data analysts have been sending the research team an email every time they process an 8-K with annual meeting voting results which show that a director has failed to receive support from a majority of shareholders.  We have been surprised at how many there are – and we’re keeping track for a comprehensive report to be published this summer.  In the meantime, we will be blogging about those that stand out.

For example, shareholders at Sterling Bancshares have voiced their continued dissatisfaction with director R. Bruce LaBoon.  At the company’s annual shareholder meeting held on April 26th, 58% of the votes were withheld from Mr. LaBoon’s re-election as director.  The last time he was up for election, in 2007 -- the company has a classified board -- 48% of the votes were withheld.

Mr. LaBoon serves “of counsel”  at Locke Lord Bissell & Liddell LLP, a law firm that provides services to the company.  In its proxy statement,  the company claims that  the “attorney fee arrangement with Locke Lord is negotiated on the same basis as arrangements with other outside legal counsel and is subject to the same terms and conditions.” However, shareholders seem to be concerned -- as we are -- that the relationship has the potential to undermine Mr. LaBoon’s independence and ability to effectively monitor management.  We noticed that the Sterling Bancshares annual meeting was held at the Locke Lord offices and that Mr. LaBoon reports the law firm’s address as his address on his Form 4, further supporting at least a strong perception of a conflict of interest.  We see situations like this often – presumably,  the board feels that they have sufficiently considered the potential for a conflict and have  decided that, in this case with this individual person, it is not a concern.  However, since shareholders are not involved in these deliberations and do not know the personalities involved to be assured that no conflict will arise, the best course of action is to avoid the potential for conflict and not have lawyers who are affiliated with firms which provide services to the company serve on the company’s board.

Annalisa Barrett - Senior Research Associate

Free Webinar: Director Elections 2010 - A Shareowner's Guide

Join us on April 28 for a free webinar with The Corporate Library's Chief Analyst and co-founder, Ric Marshall.

New SEC proxy disclosure rules and changing director election standards have greatly expanded the ability of shareholders to influence election outcomes for individual corporate directors, but for many investors they have also increased the complexity and uncertainty of the voting process. The Corporate Library's Chief Analyst and co-founder Ric Marshall will help cut through the complexity and confusion with a free webinar on a wide range of topics related to director election standards and decision-making.

Current subscribers of The Corporate Library's Board Analyst database will benefit by learning more about the individual director screens employed by our top analysts in evaluating individual director and board effectiveness, while non-subscribers will have an opportunity to better inform their own analysis and decision-making by learning more from these same insights.

Title: Director Elections 2010: A Shareowner's Guide

Date: Wednesday, April 28, 2010

Time: 1:00 - 2:00 PM EDT

Register for the webinar now.

Director leaves Herley Industries board after receiving majority withhold vote

The faster reporting of the results of director elections is proving to be very interesting – we no longer have to wait until the summer to watch the drama of majority withhold and against votes unfold.  The elimination of broker voting in uncontested elections means that the proportion of "for" votes is likely to be smaller at most companies.   And, now that more director elections are subject to a Majority standard or a “Plurality and Resignation Policy”, the likelihood of directors stepping down as a result of these votes is much higher this year than ever before.
 
One of the first companies to report that holders of a majority of shares have withheld votes from a director is Herley Industries, which had its annual meeting on March 23rd. As required under the new disclosure rules, the company filed an 8-K on March 29th reporting the voting results from the meeting.  One of the two directors up for re-election, 77-year-old Rear Adm. Edward K. Walker, Jr. (Ret.), received a very high withhold vote – nearly 66%.  Of course, I can’t be sure of all of the reasons behind this lack of shareholder support, but one thing that caught my eye was this statement from the company’s proxy:  “Adm.  Walker has a consulting arrangement with us for services relating to corporate governance and ethics at an annual fee of $75,000.”  While this is a relatively small amount of money, any consulting arrangement between a director and the company is cause for concern because it has the potential to compromise the director’s independence.   But, when the consulting is for corporate governance and ethics it makes one wonder . . .  isn’t that what directors are supposed to be doing anyway? 
 
What makes this even more interesting is the fact the Herley Industries has a “Plurality and Resignation Policy”.  And, unlike other companies in prior years where directors’ resignations have been declined after being considered by boards facing this dilemma – allowing directors who have received a majority withhold vote to continue serving on the board -- this director’s resignation was accepted and he is no longer serving on the board.  The company filed an 8-K on April 6th stating the following: 

“In accordance with Registrant’s By-Laws, since Rear Admiral Edward K. Walker, Jr. (Ret.) received more “withheld” votes than “for” votes, Admiral Walker submitted a resignation letter to the Board of Directors.  The remaining Board of Directors, excluding Admiral Walker, met on March 31, 2010, to determine whether to accept his resignation.  In light of the results of the shareholders vote at the Annual Meeting, the Board, following the deliberation process provided for in the By-Laws, determined unanimously to accept Admiral Walker’s resignation and to terminate the consulting arrangement between the Company and Admiral Walker.  In making its determination, the Board noted Admiral Walker’s service as a director of the Company since October 1997 and thanked him for his contributions to the Company during his directorship.”

Hopefully, this is the beginning of a trend of boards reacting to majority withhold votes in a more responsive manner than in the past. Purchase Herley's governance risk profile here.

Annalisa Barrett - Senior Research Associate

Unfortunately, the Herley Industries board made an unusual decision in combination with this positive one:  the board now has only four directors.  This makes it one of only 24 companies in the Russell 3000 which currently has fewer than five directors.  Boards this small may pose a risk to shareholders because they do not provide for enough independent directors to staff the board’s key committees and conduct the other work required to fulfill the board’s fiduciary duties.

Investor Concerns on Succession Planning

Integral Advisors, LLC and Board Advisor, LLC conducted qualitative research with a variety of players within the investment community to identify the key CEO “succession risks” that they were concerned about.  Investors understandably are concerned about both the process and the substance of CEO succession planning, especially in companies where the CEO does not maintain deep bench strength of executives old enough to be capable and young enough to be available.  Not much has changed since the publication of Jeffrey Sonnenfeld's ground-breaking book, The Hero's Farewell: What Happens When CEOs Retire, except that investors are more aware of the risks and consequences of board failure.  I like the way this study raises the core issues of board and executive involvement by pointing to specific indicators that go beyond disclosure.  For more information, contact Beverly Behan:  beverly.behan@boardadvisor.net

Nell Minow - Editor

Proxy Access: Our Comment Letter to the SEC

Via Email

Aug. 14, 2009

Elizabeth M. Murphy, Secretary

United States Securities and Exchange Commission

Re: Facilitating Director Nominations (File No. S7-10-09)

Dear Ms. Murphy:

On behalf of The Corporate Library, an independent corporate governance research firm, we are writing to express our support for the Securities and Exchange Commission’s (SEC) proposed rule, Facilitating Shareholder Director Nominations.  The current financial crisis underscores both the complacency within some boards to protect long-term shareholders’ interests and the need to strengthen accountability of boards and management.

We believe granting long-term shareholders the right to nominate directors, thereby ending the de facto monopoly the board and management has in picking director slates, is an important component of achieving the goals of effective oversight of U.S. publicly traded companies’ boards and of broad financial reform.  Therefore, we concur with the SEC that the reforms outlined in the SEC’s proposed Rule 14a-11 and revisions to Rule 14a-8(i)(8), following decades of debate over proxy access, are long overdue and should be adopted swiftly.  We support the application of Rule 14a-11 as proposed and welcome the opportunity to comment on points still under consideration.

We agree with the SEC’s position that the proposed rule should:

• Permit shareholders to aggregate their holdings to meet the minimum share ownership thresholds.
• Grant only long-term shareowners, those holding stock for at least one year, access to nominate directors.
• Employ safeguards to ensure that access is not used as a takeover mechanism by short-term profit seekers.
• Require strong independence standards for director nominees.
• Require full and accurate disclosure by nominating groups, including all pertinent information about nominated directors.
• Allow nominating shareholders to make statements of opposition against the election of other board members on the company’s slate in the proxy statement.
• Authorize shareholders to file resolutions related to the issue of board elections.
• Become effective immediately without a lengthy implementation period, associated triggering mechanism, or exemption or delay for smaller issuers.

We also would like to take this opportunity to comment in greater detail on several features of the proposed rule that are of particular interest to us:

• Priority access: We favor an approach whereby the largest beneficial owner or group of owners gain proxy access, as opposed to awarding access to the first shareholder or group of shareholders filing. We are concerned that a first come, first served approach might force shareholders to rush to file and result in a less thoughtful process than is otherwise possible. In the end, we also believe that the investor or group with the greatest stake in the director election and the company’s long-term financial performance should prevail in these situations.
• Failed nominations and resubmitting candidates: We believe that there should not be any waiting period for resubmitting candidates failing to win election to a board.
• Shareholder proposals: We oppose permitting companies subject to Rule 14a-11 to exclude shareholder proposals that they otherwise would be required to include. We believe the shareholder proposal rule 14a-8 is an important conduit for opening dialogue between management and shareholders on key ESG environmental, social, and governance policy issues that have significant consequences for long-term shareholder value as well as society.
• A uniform federal rule: We would also like to stress that we favor a uniform federal rule on proxy access. While some of those commenting on the rule have urged that the Commission instead allow access regimes to be adopted on a company-by-company basis (with, for example, different ownership thresholds, holding periods, or triggering requirements), we believe this would result in an unworkable administrative burden for broadly invested shareholders that need to track deadlines and requirements at many different companies. In addition, the very companies that would benefit most from a shareholder access regime are likely to put up the stiffest resistance to adopting access. Some companies may have or adopt supermajority voting requirements to amend the bylaws or, in states that permit it, eliminate shareholders’ right to amend the bylaws altogether. Similarly, although Delaware has recently adopted changes to its corporation code designed to clarify the validity of proxy access bylaw proposals, other states have not done so. As a result, a company incorporated outside Delaware could stymie shareholder efforts to press for access by litigating the validity of a shareholder proposal, which would entail substantial expense and delay. Even Delaware-incorporated companies could mount challenges to the statute or particular drafting choices made by a proposal’s sponsor, or their boards could repeal shareholder-adopted bylaws providing for access. (Unlike the Delaware statute on shareholder-adopted majority voting bylaws, the statute authorizing access and reimbursement bylaws does not state that such bylaws may not be repealed unilaterally by the board.)

Finally, we would like to express our view that the Commission has ample authority to adopt a uniform proxy access rule, contrary to the assertions of some who have commented on the proposed rule.  Section 14(a) of the Securities Exchange Act empowers the Commission to issue rules regarding the solicitation of proxies.  The Proposed Access Rule would not create a new substantive right for shareholders; indeed, it would operate only where state law gives shareholders the right to nominate directors.  Like Rule 14a-8, the Proposed Access Rule serves a disclosure function.  It would address the inclusion of an item in the company’s proxy statement used to inform shareholders of matters management knows will be brought to a vote at the upcoming meeting.  The Proposed Access Rule’s eligibility criteria and procedural requirements for using the proxy access process are similar to those found in Rule 14a-8 and reflect the Commission’s judgment regarding which items merit company-financed proxy disclosure.  Put another way, both the Proposed Access Rule and Rule 14a-8 allow shareholders to exercise in a particular venue—the company proxy statement—a right they already have.

In sum, we feel there is a strong case for proxy access based on the issues of equity, good governance, transparency and accountability.  Proxy access is a matter of fair corporate suffrage, necessary and appropriate for the protection of investors and the greater public good.  Therefore, we strongly favor the SEC’s approach to proxy access and appreciate the opportunity to express our views on this matter.

Sincerely,

Kimberly Gladman, CFA, Ph.D., Director of Research and Ratings

Beth Young, J.D., Senior Research Associate

Annalisa Barrett, MBA, Senior Research Associate

Mary Schapiro On Point

As we wind down our proxy season data collection and gear up to analyze the fruits of our labor, we would be aided by many of the proposed changes that SEC Chairman Mary Schapiro described in her testimony Tuesday (http://www.house.gov/apps/list/hearing/financialsvcs_dem/sec_testimony.pdf). Among the various improvements she described that the SEC has been working to propose and implement are proxy access (allowing alternative director candidates to be included on a proxy), expanded CD&A explanation of compensation policies (to include those regarding lower-echelons of employees beyond just the Named Executives), expanding disclosure of board information (to include qualifications of directors, among other details), requiring earlier disclosure of voting results after annual meetings, and elimination of broker votes on uncontested director elections.

All of these efforts would help shareholders, largely by improving the culture of accountability at their companies.  Needing to publish information often has an impact on the information itself – the proverbial “sunlight” on the issues at hand – and these proposals go far in this regard. Others improve the timing of information (there’s another proverb – time being money) which also aids shareholders and their efforts, giving closure to outstanding issues, and informing them of those still to be addressed. Yet others, like fighting “ballot-stuffing” and allowing for competition for a board seat, simply right past wrongs. Schapiro’s testimony was a refreshing view into an agency that is doing good in a tough time.

Michelle Lamb — Research Associate

SEC Votes to Change NYSE Broker Vote Rule: It's About Time

In an open meeting yesterday, the Securities and Exchange Commission voted to approve a change to the New York Stock Exchange’s rule that had permitted brokers holding shares in “street name” for their customers to vote those shares themselves in uncontested corporate director elections if the customers did not vote by 10 days before the annual meeting.  It’s about time. 

The NYSE had sought since 2006 to prohibit what the Council of Institutional Investors calls “stuffing the ballot box for management” but needed the SEC’s go-ahead to do so.  In recent years, shareholders have complained that the rule put a roadblock in the way of “vote-no” campaigns against directors, where a shareholder does not run a dissident candidate but instead urges other shareholders to register dissatisfaction by voting against one or more of the management nominees, because brokers voting customer shares always vote with management.

It is difficult to quantify the impact on director elections of broker voting because the proportion of shares affected varies from company to company.   Broadridge Financial Solutions, the dominant vendor handling distribution of proxy materials and tabulation of votes, disclosed that broker votes—which can be cast on a variety of “routine” items in addition to uncontested director election--accounted for 16.5% of votes at shareholder meetings in 2008.  Backers of vote-no campaigns have estimated that broker votes likely made the difference between election and defeat for directors at Citigroup, CVS/Caremark and Washington Mutual, among other companies. 

The SEC’s move is an important step toward making director elections more meaningful, and Chairman Schapiro should be lauded for ending the SEC’s inexplicable waffling on this issue.  The shift toward a majority vote standard in director elections-- which is in place at a large percentage of large-cap companies but less popular among their smaller brethren--has been touted by both shareholders and companies as a way to bring about greater accountability to shareholders. That hope can not be realized, however, if a significant proportion of votes cast do not represent the views of shareholders with a stake in the outcome.

Beth Young — Senior Research Associate, Shareholder Issues, M&A and Takeover Defenses

SEC Approves Proposed Proxy Access Rule

With a 3-2 vote split along party lines, the Securities and Exchange Commission voted to approve a proposed rule that would give shareholders the right to nominate up to 25 percent of the candidates for a board of directors and to have those nominees included in the proxy statement and card circulated by the company.  Interested parties will now have a chance to file comments with the Commission for 60 days, and then the staff will review the comments, revise the proposal, and put it to a final vote.  If approved, it could be one of the most fundamental and far-reaching changes in corporate governance since the creation of the SEC in the 1930's.

The issue of the role of shareholders in director elections has been under discussion at the Commission almost since that time, and both the Chair and one of the Commissioners commented on the long-term conflicts over this issue over many decades.  Currently, if permitted by state law and the company's governing documents, shareholders may nominate candidates for the board, but the complications and expense are all but prohibitive and proxy contests occur in only a fraction of a percentage of corporate elections.  In virtually all cases, management and the board select the nominees and no one runs against them.  They can serve even if they do not get majority support from the shareholders, as long as they run unopposed.  The proposal also gives shareholders the right to submit shareholder proposals relating to the board nomination and election processes.

The proposed rule would remove some of the most significant and costly impediments to shareholder nomination of directors.  If a significant number of shareholders (the amount is tiered, depending on the market capitalization of the issuer) who have held their stock for a year submit nominees, providing the same kind of information currently required for management-nominated candidates, plus an assurance that the slate is not seeking control, they will be included in the company's proxy and the shareholders will not have to obtain a separate shareholder list and print and circulate their own materials.  If more than one group submits a slate, the first in time after the nomination period is open will be included.  It is likely that these provisions in particular will provoke some lively debate.

Even the most enthusiastic advocates of this proposal do not intend for it to be widely used.  Its impact will be felt more pervasively in providing an incentive for management and support for boards to increase the transparency of their procedures and criteria for board nominations and encourage better communication with shareholders.

The Commissioners who oppose proxy access, Kathleen L.Casey and Troy Paredes, objected primarily on the issues of federalism, believing that this is a more substantive than procedural and disclosure-related rule and thus impinges on state authority, and on its mandatory application, instead of allowing shareholders to determine on a company by company basis whether proxy access is appropriate.

The business community has made it clear they intend to fight this proposal and the Chamber of Commerce has vowed to challenge the rule in court as soon as it becomes final.  Their most likely method of attack will be a lawsuit along the lines of the successful challenge to the SEC's jurisdiction in the "one share, one vote" case in the late 1980's.  Perhaps in anticipation of this vulnerability, Senator Schumer's bill, also introduced this week, would explicitly grant the Commission the requisite authority.  But since the rule is based on state law, we can also expect some lobbying at the state level to permit companies to opt out of giving shareholders the right to nominate candidates.

Nell Minow — Editor