Florida SBA Seeks to Use Proxy Voting to Promote Good Governance Practices

Michael McCauley is Senior Officer, Investment Programs & Governance, of the Florida State Board of Administration (the “SBA”). This post is based on an excerpt from the SBA’s 2011 Corporate Governance Report by Mr. McCauley, Jacob Williams and Lucy Reams. Mr. Williams and Ms. Reams are Corporate Governance Manager and Senior Corporate Governance Analyst, respectively, at the SBA. The complete report is available here; further information regarding the SBA’s governance activities, including proxy voting data, is available here.

The State Board of Administration (SBA) supports the adoption of internationally recognized governance practices for well-managed corporations including independent boards, transparent board procedures, performance-based executive compensation, accurate accounting and audit practices, and policies covering issues such as succession planning and meaningful shareowner participation. The SBA also expects companies to adopt rigorous stock ownership and retention guidelines, annually seek shareowner ratification of external auditors, and implement well designed incentive plans. As noted in a recent Fitch Ratings research piece, “Assessing an issuer’s governance practice begins with its board of directors. An independent, active, knowledgeable, and committed board of directors signals a robust governance framework. A board that is not committed to fulfilling its fiduciary responsibilities can open the door for ineffective, incompetent, and in some cases, unscrupulous management behavior.”

The proxy vote is a fundamental right tied to owning stock. Pursuant to guidance from the U.S. Department of Labor, the SBA fiduciary responsibility requires proxies to be voted in the best interest of fund participants and beneficiaries. The SBA routinely votes proxies on all publicly-traded equity securities held within domestic and many international stock portfolios. These portfolios may be managed within either the defined benefit or defined contribution plans of the Florida Retirement System (FRS) or other non-pension trust funds. For omnibus accounts, including open-end mutual funds utilized within the FRS Investment Plan, the SBA votes proxies on all shares for funds that conduct annual shareowner meetings.

For fiscal year 2010, the SBA retained four of the leading proxy advisory and governance research firms: MSCI-Institutional Shareholder Services (ISS), Glass, Lewis & Co., ProxyGovernance, and The Corporate Library. These firms assist the SBA in its analysis of individual voting items and the monitoring of boards of directors, executive compensation levels, and other significant governance topics. In December 2010, ProxyGovernance discontinued its operations and will not be used for proxy research during 2011.

During the 2010 fiscal year, the SBA continued to use Institutional Shareholder Services (ISS) as external voting agent. The SBA’s voting agent executes, reconciles, and records all applicable proxy votes via a web-based database. The SBA utilizes governance research services, in conjunction with our proxy voting guidelines, in order to execute voting decisions. ISS provides specific analysis of proxy issues and meeting agendas. ISS research coverage includes the Russell 3000 Index, which represents approximately 98 percent of the U.S. public equity market, as well as foreign equity proxies. Glass, Lewis & Company (GLC) research also covers the entire U.S. stock universe of Russell 3000 companies and select non-U.S. equities.

In addition, the SBA subscribes to various specialized services. During the fiscal year, the SBA continued to utilize corporate governance research services offered by GovernanceMetrics International (GMI), The Corporate Library (TCL), KLD Research, IW Financial, Jantzi Sustainalystics, MSCI ESG Research, and Equilar. ISS provides the SBA analyses of corporate employment activities within Northern Ireland, as well as research tied to the Protecting Florida’s Investments Act (PFIA). For additional discussion of compliance with Florida statutes, please refer to the appendices. For more information on the current roster of research providers that the SBA uses, as well as other information, please see the corporate governance section of the SBA website.

SBA Voting Summary

In the 2010 fiscal year, the SBA executed votes on 3,566 public company proxies covering 28,282 individual voting items, including director elections, audit firm ratifications, executive compensation plans, merger approval, and other management and shareowner proposals. The SBA voted for, against, or abstained on 73.3 percent, 26.4 percent, and 0.1 percent of all ballot items, respectively. Of all votes cast, 26.1 percent were against the management-recommended vote, down five percent from the previous year.

While the SBA is not pre-disposed to disagree with management recommendations, some management recommendations may not be in the best interests of all shareowners. On behalf of participants and beneficiaries, the SBA emphasizes the fiduciary responsibility to analyze and evaluate all management recommendations very closely. Particular attention is paid to decisions related to: director elections, executive compensation structures, various anti-takeover measures, and proposed mergers or other corporate restructuring.

Board elections represent one of the most critical areas in voting since shareowners rely on the board to monitor management. The SBA supported 73.2 percent of individual nominees for boards of directors, voting against the remaining portion of directors primarily due to concerns about the candidate’s independence, attendance, workload, and overall board performance. The SBA also withholds votes from directors who fail to observe good corporate governance practices or demonstrate a clear disregard for the interests of shareowners.

The SBA voted to ratify the board of directors’ selection of external auditor in over 96 percent of such items. Votes against auditor ratification are cast in instances where the audit firm has demonstrated a failure to provide appropriate oversight, significant financial restatements have occurred, or when significant conflicts of interest exist, such as the provision of outsized non-audit services.

The SBA considers on a case-by-case basis whether a company’s board has implemented equity-based compensation plans that are excessive relative to other peer companies or those that may not have an adequate performance orientation. As part of this analysis, the SBA reviews the level and quality of a company’s compensation disclosure in the belief that shareowners are entitled to comprehensive disclosures of such practices in order to make efficient investment decisions. Quality disclosure is found to be severely lacking at many companies, raising critical questions about the transparency of their compensation practices.

Over the last fiscal year, the SBA supported 33 percent of all non-salary (equity) compensation items—while supporting 99 percent of shareowner resolutions asking companies to adopt an advisory vote on executive compensation (a.k.a., “Say-on-Pay”), 62 percent of executive incentive bonus plans, and 72 percent of management proposals to adopt or amend restricted stock plans in which company executives or directors would participate (33 percent for the amendment of such plans).

Increasingly, the SBA has supported sustainability reporting requirements and improved environmental disclosures issued by companies in its portfolio. The SBA supported 93 percent of shareowner resolutions asking companies to publish sustainability reports, 20 percent of shareowner proposals dealing with climate change and global warming, 72 percent of shareowner resolutions asking companies to produce reports assessing the impact on local communities, and 85 percent of shareowner resolutions regarding greenhouse gas emissions. Several annual shareowner meetings garnered public attention and represented high profile votes for their investors. Motorola was first company in U.S. history to receive less than a majority level of support for its compensation structure—its pay plan received the support of only 45 percent of its shareowners. Occidental Petroleum was the second U.S. company to have its compensation framework voted down, receiving only a 46 percent favorable support level. KeyCorp was the first company having received assistance from the Troubled Asset Relief Program (“TARP”) to receive less than a majority level of support.

Boards of directors were not immune from scrutiny, whereby MasseyEnergy directors received reelection only by a narrow margin. Three of its directors won by extremely slim margins—a company press release stated Richard Gabrys won with 55.36 percent approval, Dan Moore with 55.09 percent approval, and Baxter Phillips Jr. with 57.83 percent approval. All three directors served on Massey’s safety committee. Other ballot items on the MasseyEnergy proxy received higher levels of support. Investors gave 95.1 percent support to a shareowner proposal seeking board declassification. There was 63.9 percent approval for a shareowner proposal seeking majority voting in board elections.

FirstEnergy’s majority voting shareowner proposal won 77 percent of the votes cast. Incredibly, it was the sixth year in a row shareowners have voted in favor of this specific investor proposal. As a result, the SBA withheld support from FirstEnergy directors due to their failure to implement the proposal which has been supported by a majority of its shareowners. Director support at the meeting ranged from 58 percent to 65 percent of votes cast.

Within foreign equity markets, the SBA withheld support for two directors (Cynthia Carroll and George David) at BP plc’s annual general meeting due to their lack of stock ownership (despite serving on the board for more than one year). We voted in favor of BP’s “Executive Directors Incentive Plan,” although with some reservation given the compensation committee’s discretion to confer bonuses outside of the stated performance metrics. Another interesting feature of the plan is a three year bonus deferral element with a significant emphasis on achievement of high levels of safety and environmental performance. The SBA voted against a shareowner proposal to study the feasibility of the Sunrise oil sands project (feasibility in terms of oil price volatility, oil demand, anticipated GHG regulation, and legal and reputational risks due to possible ESG damage). The vote against the shareowner resolution was based on BP’s recent disclosure enhancements of its oil sands operations and oil price volatility assumptions. BP has also committed to producing a Canadian sustainability report during 2011.

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