The Corporate Library Blog

Shareholder Activism at Denny's: No Grand Slam

UPDATE

About two months ago, I blogged on how Denny’s had become a target of certain activist investors looking to right a fledging American franchise.  A proxy fight was mounted by The “Committee to Enhance Denny’s”, a group of investors who collectively account for about 6.5% of Denny’s common stock.  Fed up with Denny’s losing 20 percent of its market share to I-HOP and other breakfast chains over the last five years, dejected over more than $300 million spent in remodeling capital expenditures which have yet to yield quantifiable dividends to shareholders, and annoyed with inadequate marketing messages, the group had sought to replace three current Denny’s directors with candidates of their own.  One of these investors, Jonathan Dash was a guest on CNBC’s “Squawk On The Street” Tuesday. He discussed the need to hold management’s feet to the fire regarding poor financial results over the last seven to eight years as well as issues such as overpricing an inferior food product and promoting to a clientele unlikely to repeatedly patronize the establishment.

The committee was seeking not to just replace any three directors, but the CEO, chairwoman, and former chairman of the board. Following Denny’s annual meeting on Wednesday, the “Committee to Enhance Denny’s” does not believe any of their three nominees were successfully elected to the board based on the information they received, though details may not be made official for another week or so. What’s more, the group appears to be facing litigation from Denny’s for distributing confidential Denny’s Franchisee Association (“DFA”) documents in its effort to persuade shareholders to shake-up the board. The chairman of the DFA questioned the group’s ethics and judgment and accused the committee of obtaining, distributing and misrepresenting materials to further its personal agenda. None of this news has been good for Denny’s shareholders either it seems with shares down more than eleven percent since last Friday.

Greg Ruel - Advisory Services Manager

Jack Bogle on "The Silence of the Funds"

At the CFA Institute conference in Boston this morning, Jack Bogle spoke passionately of the need for institutional money mangers--most of whom, he says, now manage both mutual fund and pension assets--to increase their attention to corporate governance.  Decrying "the silence of the funds," he noted that no mutual fund company has ever filed a shareholder proposal opposed by management. "Never," he stressed. "That's not very often." The Vanguard mutual fund founder also said proxies also need to be more actively voted, especially with regard to "excessive executive compensation." Part of the problem, he said, is that mutual funds have moved from the "own-a-stock" mentality of his youth (typical fund turnover was about 20 percent in 1950) to a "rent-a-stock" model (average turnover today is 100 percent).

He urges a return to a longer-term view. He also recommends the return of Glass-Stegall--although he knows it's an uphill battle--and supports many of the aims of proposed financial regulation. At the same time, he criticizes the lack of specificity of many of the bill's provisions, and the fact that Congress intends to act in June although the Angelides commission won't report back on crisis causes till December.

Finally, he urged funds to take governance into account in security analysis, and says he'd favor a federal statute to clarify fiduciary responsibility (this would cover conflicts of interest and the need to attend to governance issues).

Kimberly Gladman - Director of Research and Risk Analytics

Small Print

Here is this week's edition of Small Print, featuring weird, funny and disturbing information clipped from SEC filings by our indefatigable data team.

A Mole in Molex...?

Thanks to Marjorie Schwietering – Events Analyst – for finding this in an April 9 8-K for Molex.

Molex Incorporated (NASDAQ: MOLX and MOLXA), a global electronic components company, has learned that an individual working in Molex Japan’s finance group obtained unauthorized loans from third party lenders in Molex Japan’s name which we believe to be in the range of $175 million and to have been used to trade on margin in unauthorized accounts in Molex Japan’s name. We also believe that the individual has misappropriated cash from Molex Japan which resulted in a loss in the range of $15 million. The individual has admitted to forging documentation in arranging the transactions. We have retained outside legal counsel, and they are retaining forensic accountants, to investigate the matter and the extent of our liability, if any, for the unauthorized loans.

KERP PERK

KERP, PERK, SERP, how is it spelled? It’s acronymitis. Compensation Analyst Ashley Kotzur spotted this in Cenveo’s 2010 proxy statement.

Key Employee Retention Program (KERP):  In 2008, the Company put in place a KERP to ensure that it retains the services of managers who the Board has determined are critical to the long-term performance of the Company.  Under the KERP, a participant is awarded a specified dollar award that is paid out in equal monthly installments over a minimum of two years.  KERP awards are not vested and any participant who leaves the Company forfeits the unpaid portion of the award, except for retirement or death.

KERP payments are paid through regular payroll and are to be paid over a 33 month period.

In 2009 CEO Robert G. Burton, Sr. received $ 1,474,338 as part of KERP. In 2008 he received $450,000.

Sounds like salary to me too, Ashley.

An Inconvenient Truth

As if AIG needed anything else… Dovid Muyderman,  Events Analyst, found this in its April 12 8-K.

On April 7, 2010, the Board of Directors (the “Board”) of American International Group, Inc. (“AIG”) determined to provide its former Chairman and Chief Executive Officer, Edward M. Liddy, with an annual stipend of $120,000 in respect of 2009. This stipend represents the overall higher cost of living and inconvenience that Mr. Liddy was required to incur as a result of his service in New York notwithstanding that he and his family resided in Chicago. Since Mr. Liddy retired from AIG in August 2009, he was only eligible for $80,000 of the stipend. AIG was permitted to pay this amount under the TARP Standards for Compensation and Corporate Governance after providing the proposal for the stipend to the satisfaction of the Special Master for TARP Executive Compensation.

So, like he was in New York City, but living in Chicago. How does he do that? Never mind Special Master for TARP Executive Compensation, doesn’t that make Liddy a Jedi Master? A Timelord? Something special.

Sister No Action or Sister Act

OK. This has to be the longest list of proponents (religious or otherwise) ever to be attached to a proxy proposal, albeit that it was found in a No Action Reply letter of April 1 by Heidi Packard – Events Analyst. And, no, it wasn’t an April Fool’s day gag.

This is in regard to your letter dated March 31, 2010 concerning the shareholder proposal submitted by the Wisconsin Province of the Society of Jesus; the Benedictine Sisters of Boerne, Texas; the Benedictine Sisters of Virginia; the California Province of the Society of Jesus; Catholic Healthcare West; Catholic Health East; the Chicago Province of the Society of Jesus; Creighton University; CHRISTUS Health; Convent Academy of the Incarnate Word; the Detroit Province of the Society of Jesus; the Dominican Sisters of Hope; the Dominican Sisters of Mission San Jose; the Jesuit Fathers of Upper Canada; the Jesuits of the Missouri Province; Loyola University Chicago; Marquette University High School; the Maryland Province of the Society of Jesus; the Benedictine Sisters of Mount St. Scholastica; the Milwaukee Province of the School Sisters of Notre Dame; the Chinese Province of the Society of Jesus; Missionary Oblates of Mar Immaculate; the New England Province of the Society of Jesus; the New Orleans Province of the Society of Jesus; Providence Trust; the New York Province of the Society of Jesus; Rockhurst University; the School Sisters of Notre Dame Cooperative Investment Fund; the School Sisters of Notre Dame of St. Louis; the Congregation of the Sisters of Charity of the Incarnate Word, Houston, Texas; the Sisters of Mercy, Regional Community of Detroit Charitable Trust; the Sisters of St. Dominic, Congregation of the Most Holy Name; the Sisters of St. Francis of Philadelphia; the Sisters of St. Joseph in California; the Congregation of the Sisters of Saint Joseph of Chestnut Hill, Philadelphia; the Sisters of the Holy Cross of Notre Dame, Indiana; the Sisters of the Holy Names of Jesus and Mar U.S.-Ontario Province; the Sisters of the Humility of Mar of Vila Maria, Pennsylvania; the Unitarian Universalist Service Committee; the University of Detroit Mercy; the University of San Francisco; and the University of Scranton.

The result? They withdrew the proposal because they got what they wanted – Chevron’s disclosure of an existing human rights policy.

That’s what happens when you’ve got God on your side.

Odd One Out

One of these things is not like the others, comments Heidi again of this April 12 website press release for Alliant.

Alliant Techsystems (NYSE: ATK) has acquired Blackhawk Industries Products Group Unlimited, LLC, one of the most recognizable brands in the rapidly expanding security market.  The acquisition of Blackhawk, combined with the recent acquisition of Eagle Industries, strengthens ATK's position in tactical accessories and equipment for domestic and international military, law enforcement, security, and sport enthusiast markets.  Terms of the agreement were not disclosed.

Militaristic sports enthusiasts would that be? Tactical accessories for sports enthusiasts? It’s not cricket is it?

Paul Hodgson - Senior Research Associate

Financial Executive Magazine: The Year of the Shareholder

Paul Sweeney has an excellent article in Financial Executive Magazineas a part of its special issue on what's ahead for 2010.  Provocatively entitled "Will 2010 Be the Year of the Shareholder," it opens:

A constellation of forces is coalescing to give investors more clout over such thorny issues as executive pay, the composition and election of corporate boards, board transparency and responsiveness to shareholder concerns....In addition, continued shareholder outrage at overly generous pay packages to top executives — often at poorly performing companies — is further tilting the balance of power.

While Sweeney predicts some pushback from corporate executives, who argue that these pay packages are necessary for retention and to provide incentives,

even a respected source such as the executive search firm Spencer Stuart urges boards of directors to recognize that much governmental and shareholder scrutiny is deserved. “The perceived — or, in some cases, real — disconnect between company performance and executive compensation is fanning the flames of shareholder discontent,” Spencer Stuart notes in its comprehensive 2009 survey on the state of corporate boards. “In light of these pressures,” the report adds, “boards need to be sure they are operating as effectively as possible and have good governance practices in place.”

Sweeney quotes Hye-Won Choi, the head of corporate governance at TIAA-CREF, on the impact of the rule change that eliminates automatic votes in favor of board candidates.  “The end of discretionary broker voting means that management can no longer expect elections to be routine. It will level the playing field. Now the vote will be a clearer expression of shareholder sentiment.”  And he notes that even before this rule change went into effect, the percentage of votes against directors has been rising. 

Through August 2009, 9.8 percent of unopposed director nominees had at least 20 percent of shares voted against them or withheld, a 78-per- cent increase above the 5.5 percent figure in 2008.  The percentage of directors with a majority of shareholders registering opposition to their candidacy tripled, to 0.6 percent in 2009 compared with 0.2 percent in 2008. It may seem a tiny number, but amounts to 84 director nominees at 49 companies.

Sweeney predicts a rise in shareholder resolutions on compensation, governance, and climate change. 

The proxy season, in combination with significant congressional legis- lation and additional SEC rule making, could make the year 2010 among the most historic in the annals of corporate governance. The consultancy Spencer Stuart puts it this way: Events this year “could potentially reshape the corporate governance landscape as dramatically as Sarbanes-Oxley. And just as with SOX, it may take several years before the full impact of the changes becomes apparent.”

Nell Minow - Editor

Warren Buffett Says No to Kraft's Blank Check

Warren Buffett had to give Kraft a lesson today.  Buffett's Berkshire Hathaway is the largest shareholder in Kraft, which is attempting to acquire Cadbury.  Kraft has asked its shareholders for permission to issue 370 million new shares to use as a part of the $16 billion it proposes to spend for this transaction.  The problem with this proposal was that it would have given Kraft executives unlimited authority to change the terms of the deal without coming back to the shareholders for approval.  Berkshire announced that it would vote no.  They don't have a majority stake, but Kraft would not be foolish enough to try to override Buffett, even if they could get the support of the other shareholders.

Berkshire said, “The share-issuance proposal, if enacted, will give Kraft a blank check allowing it to change its offer to Cadbury – in any way it wishes – from the transaction presented to shareholders in the proxy statement. And we worry very much that, indeed, there will be an additional change from the revision announced this morning.”

This seems probable, as there is at least one other possible bidder.  

Berkshire's response is an important lesson for Kraft and for any other corporate executives who think they can get the shareholders to grant them unlimited authority.  It is a lesson in economics about the moral hazard in a deal that allows executives to impose all downside expense on the shareholders.  It is a lesson in fiduciary obligation -- Kraft management was attempting to evade their obligation to their shareholders and Berkshire was upholding their obligation to theirs.  It is a lesson in fairness and logic and judgment and credibility.  We have seen this over and over.  Everyone wants to externalize their risk, and in the past we have made it too easy too often. 

Berkshire's statement concludes that if by the deadline of January 19 it finds the terms of the deal beneficial to Kraft shareholders, it will change its vote to yes.  Will Kraft be able to put together a deal with terms that meet Berkshire's standards of transparency and accountability?  Well, one thing we know is if they don't, the answer from Omaha will still be "no."

Nell Minow - Editor

Too Big to Save -- Bob Pozen's New Book

Robert Pozen, one of the most thoughtful and experienced analysts of financial services and the economy, has written an insightful new book, Too Big to Save? How to Fix the U.S. Financial System.

I have argued that some of the financial service companies requiring government bailouts were too big to succeed, that their very size made them ungovernable.  Pozen documents this with meticulous and devastating detail.  The book is worth buying just for the chapter on the role that GAAP accounting played in hiding the risks of derivative investments.  I especially like his crisp description of the criteria that should be applied in bailouts: one of the key functions of the banking system is to process payments through the Federal Reserve network or where the obligations are so large to so many other institutions that it would cause "widespread havoc throughout the financial sector.  

He shows that many of the recipients of TARP money failed to meet these criteria.  "Indeed, if we take the position that all large banks are too big to fail, we will create a self-fulfilling prophecy."  And he takes the provocative position that "(t)he adverse repercussions of Lehman's failure resulted primarily from the implicit expectations created by the federal bailout of all bond holders in Bear Stearns earlier in 2008.  If the federal government had let Bear fail, Lehman would have moved very quickly to bolster its financing sources and find an acquisition partner."  

Pozen correctly says that bailouts can "undermine the incentives of private investors to bring market discipline to bear on large banks" and give the recipient an unfair advantage over its peers.   He also calls on the Justice Department to prevent any further mergers that would increase the concentration at the top of the financial sector.  But he believes that it is "impractical to break up existing mega banks into small enough pieces to achieve a competitive financial sector," so that feels a bit like locking the barn door after the horse has been stolen.  

I would like to have seen Pozen spend more time on the failure of institutional shareholders like the bailed-out institutions themselves to do a better job of assessing and responding to the risks of CDOs and sub-prime mortgages.  While he does include an excellent set of guidelines for structuring executive compensation in the future, he does not urge investors to require these improvements in portfolio companies.  He does recommend a stronger board of directors, including "special master"-type experts and a better way to promote shareholder-nominated candidates and to remove unsatisfactory members of boards with majority votes against them.  But unless firms like Pozen's former employer, Fidelity, take the responsibility for exercising these rights, they cannot be meaningful.  

 Nell Minow - Editor

Francis Byrd Interviews Holly Gregory

Be sure to take a look at the Francis Byrd's interview of Holly Gregory for the Altman Group, published on the website of the Harvard Law School Forum on Corporate Governance and Financial Regulation.  Byrd, formerly at Moody's and the New York City Comptroller's office and Gregory, long-time colleague of Ira Millstein at Weil, Gotchal & Manges, are two of the most highly-respected and influential experts in this field, and this is an excellent opportunity to see the current thinking from the corporate perspective.

On proxy access:

According to proponents, this is necessary to make directors more accountable to shareholders. What we will have to see play out is whether more frequent contests for board seats results in positive gains from heightened accountability. Some believe that boards are already under an unhealthy degree of shareholder pressure for immediate and ever rising share price gains.

...

If the concerns that I’ve described are realized, proxy access will not be the panacea that the regulators intend, and shareholders as a whole will not be better off. In that scenario the primary beneficiaries will be shareholders who use proxy access to forward a specific objective or strategy that is not broadly shared by the entire shareholding body.

On the impact of say on pay:

This is the time for boards and management teams to be gearing up and thinking about shareholder relations in new, more creative and more engaged ways. Improved engagement with shareholders is the best hope companies have of avoiding or mitigating [the concerns raised above].

On the consequences of pay abuses and excesses:

Many of these issues are not new, but at times boards and managements have exhibited tone-deafness or an unwillingness to set forth in plain and rational terms the legitimate justifications for certain pay practices. It is no longer enough to simply cite competition and retention concerns to justify large packages and grants.

On proxy advisory services:

There are legitimate concerns about the power of certain of the proxy advisory firms and about their capacity to provide the kind of nuanced company-specific analysis that will only become more important to our economic system as shareholders gain power.

Nell Minow - Editor

SEC Staff Reverses Two Controversial Interpretations of Rule 14a-8's Ordinary Business Exclusion

In Staff Legal Bulletin 14E released last week, the Staff of the Securities and Exchange Commission’s Division of Corporation Finance backed off of two troublesome interpretations of the SEC’s shareholder proposal rule, Rule 14a-8.  Rule 14a-8’s “ordinary business” exclusion allows companies to omit from their proxy statements proposals dealing with day-to-day matters that are more appropriately handled by management without shareholder input.

Although the SEC has provided some guidance in its releases regarding the application of the ordinary business exclusion, it has been left to the Staff to decide whether companies can exclude the many proposals challenged each year by companies.  In doing so, the Staff formulates decision rules, such as allowing exclusion of proposals dealing with legal compliance programs, choice of suppliers and a company’s code of ethics.

One such decision rule has allowed the omission of proposals dealing with an internal “evaluation of risk” or “risk assessment.”  This reasoning was developed for highly technical proposals asking companies to do detailed cost/benefit analyses of environmental liabilities.  In the past few years, however, the Staff had expanded the application of this rationale to allow exclusion of a wide variety of proposals, including proposals addressing topics the Staff had held to be “significant social policy issues” to which the ordinary business exclusion should not apply.  Companies began to cite this reasoning even when proposals didn’t mention or suggest risk evaluation or a cost/benefit analysis.

Unsurprisingly, companies were able to frame many kinds of proposals as touching on or somehow involving risk.  For example, a proponent might support a labor rights proposal by arguing that irresponsible practices could harm the company’s reputation or endanger a valuable contract; a company seeking exclusion would describe the proposal as requiring the company to assess the risks and benefits associated with its current labor practices, as compared with the practices urged in the proposal.  Governance proposals likewise often have a nexus with risk of some kind.

Sponsors began drafting to avoid this reasoning, which was difficult given its potential boundlessness and the existence of contradictory Staff determinations on the same proposal formulation.  Rather than squarely asking companies to disclose steps they were taking to respond to rising pressure to reduce greenhouse gas emissions—a formulation that was deemed excludable—proponents began filing proposals asking companies to set greenhouse gas emissions targets, one of the few climate-related proposals to survive the no-action process.

Sensibly, the SEC Staff has realized that the “evaluation of risk” decision rule resulted in the “unwarranted exclusion of proposals that relate to the evaluation of risk but that focus on significant policy issues.”  From now on the Staff will look to the underlying subject matter of the proposal in deciding whether it can be omitted on ordinary business grounds.  Although this approach does not eliminate all need for the Staff to exercise subjective judgment—a goal that is unachievable given the open-ended nature of the exclusion--it is an important step in the right direction.

A second change made by the Staff in SLB 14E relates to proposals on succession planning.  In the wake of the high-profile botched leadership transitions at Citigroup, Merrill Lynch and other financial companies, shareholders submitted proposals asking companies to adopt policies on CEO succession planning that included certain elements.

In a breathtaking example of missing the forest for the trees, the Staff allowed companies to exclude these proposals in reliance on the ordinary business exclusion, reasoning that they dealt with the “termination, hiring or promotion of employees.”  In other words, the Staff believed there was no meaningful difference between CEO succession planning by the board and the day-to-day managerial choice about whether John Doe gets promoted from grade 1 to grade 2.  SLB 14E reversed that interpretation and stated that proposals on CEO succession planning would not be excludable as ordinary business.

Activists will likely respond to SLB 14E by retooling proposals on key corporate accountability issues to ask for the precise changes they want to see, whether in disclosure or behavior.  Proposal formulations will likely vary more according to company-specific factors such as industry and current policies and practices.  Finally, sponsors will revive the CEO succession planning issue, which was in the spotlight again recently when Bank of America CEO Ken Lewis announced that he would retire at the end of 2009 and the board admitted that no successor had been identified.

Beth Young — Senior Research Associate

No More Exxon Annual Meetings For Bob Monks

The Corporate Library Co-Founder Bob Monks won't attend any more Exxon annual meetings, according to an essay posted on his blog Friday. He cites a disappointing lack of interaction between shareholders and management as a main reason.

Elizabeth Souder, a Dallas Morning News reporter writing for the Texas Energy and Environment Blog, writes about Bob's decision and her experience at Exxon's recent annual meeting here.

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