Proxy Access Heats Up for 2012

Francis H. Byrd is Senior Vice President, Corporate Governance & Risk Practice Leader at Laurel Hill Advisory Group. This post is based on a Laurel Hill newsletter by Mr. Byrd. Work from the Program on Corporate Governance about proxy access includes Private Ordering and the Proxy Access Debate by Bebchuk and Hirst; more posts about proxy access can be found here.

As we prepare to bring down the curtain on 2011 and look ahead to a new year and proxy voting season, the fallout from the governance scandals, risk control and business failures continue to rain down upon executives, boards and shareholders providing lessons for each.

Although the final word on the individual problems spotlighted at the above mentioned companies has yet to be stated, the lessons and the actions they will result in are fairly clear. Without casting judgments on the companies and individuals involved we’ll comment, in this week’s and our final Byrd Watch for 2011, on what we believe the key lessons are and how market participants (investors, senior executives and corporate directors among them) may react going forward.

Lesson 1 – Sino Forest: The Importance of Internal Controls

Sino Forest, a Chinese lumber company, faced serious allegations, from a research analyst/short seller, Carson Block of Muddy Waters that the company had misled investors about earnings and the scope of its timber assets. .The resulting furor has led to resignations of the Chairman/CEO and members of the board. A recently released report by a special committee of the board has identified the lack of internal control and audit systems. Sino Forest has come to exemplify investor concerns with accounting, audit and controls at Chinese reverse merger companies trading on western stock exchanges.

Regulators and the exchanges are seeking to close the barn door before future livestock runs away with investors’ money. Many shareholders have voted with their feet and several of those who remain are hoping to recapture losses and hit breakeven. Sino Forest has had its credit rating withdrawn by Moody’s, has missed an interest payment and is struggling to work out a deal and continue as a going concern.

The scandal highlights investor concerns with the quality of the full boards, the audit committee members, auditors and management of Chinese companies. Shareholders are likely to be much more rigorous in their examination of both foreign and domestic portfolio companies’ control regimes. The concept release by the Public Company Accounting Oversight Board calling for auditor rotation echoes the worry by investors about whether there is too much comfort in the auditor/issuer relationship. Shareholder proposals on this issue may not arrive in force for 2012, but depending on the responses to the PCAOB’s concept release and the outcomes from the other 2011 notable governance/control scandals, we may start to see the number click upward.

Lesson 2 – News Corporation: What Are Our Key Risks and How Much Risk Can We Tolerate?

Even as continued investigations yield information on what was known, by whom and when regarding the incidents of phone hacking in the United Kingdom, perhaps the most disturbing aspect is that the practice in question did not appear to be deemed a “risk” to be protected against or that would destroy the credibility of either News of the World or its corporate parent News Corp. If senior managements and the boards cannot identify or agree on what constitutes risks – and which one absolutely need to be taken – then there will be little hope of stopping or controlling practices that lead or create “firm killing risk” for the firm. This issue has been obscured by discussions of media ethics, Murdoch family control of News Corp and concerns about the CEO succession process.

Defining, identifying and mitigating risk is the work of management, determining the tolerance for the amount of risk the company must take is the role of the board. The financial crisis has led some to believe that assessment of risk is much more critical to the banking and investment sectors than to corporations. The phone hacking scandal at News Corp demonstrates that risk oversight is also of critical importance outside of the financial services sector.

This also points out an issue gaining more attention in the past year Dual-class share ownership is becoming an acceptable capital structure for new companies as many recent IPOs – especially among internet and social media companies – provide for dual classes and therefore limit the ability of shareholder to effectively voice concerns on governance and other issues. This is an issue both proxy advisor firms have discussed in their 2012 policy reviews and updates.

Lesson 3 – Nabors: Ignore Your Shareholders At Your Own Peril

The filing of a proxy access resolution at Nabors this week was not at all unexpected and did not come as a surprise to the company or its advisors. The company had exhibited a number of the issues that would attract attention from the governance advocate community – a list of governance concerns, failure to act on a majority vote and the hat-trick actions taken on executive compensation and CEO succession planning are certain to generate negative media attention and place the company at the top of the advocates’ focus list. It will be interesting and no doubt instructive to watch what happens next in the shareholder proposal dance between the company and the public funds.

We will conclude the above column in our December 30th issue as we need to discuss, the status of the proxy access proposals filed in the last two weeks.

Click for larger PDF file

(Chart Source: ISS)

Proxy Access Chess Game Begins in Earnest – Three Proposal Types

As of Thursday, December 15th, 2011, 15 shareholder resolutions have been submitted asking for the introduction of proxy access regimes.

The proposals are as different as their proponents and this fact in itself may yield some clues as to the prospect of passage – if all the proposals reach or remain on the ballot – or settlement.

United States Proxy Exchange (USPX)

A clearing house and coordinator for retail shareholders seeking to file resolutions has developed a model proxy access resolution. The model proposal allows shareholders with a 1% ownership stake or for a group of 100 shareholders, each of whom would need to be qualified under Rule 14a-8 (the rule that allows shareholders to file resolutions at companies and calls for ownership of $2000 worth of stock for a year) and a 2 year holding period. The proposal is designed to provide retail shareholders an opportunity to participate, to propose directors, on a somewhat equal basis to the access sought by institutional investors. The USPX resolution has been filed by three proponents: John Chevedden, Kenneth Steiner and James McRichie with six companies (see chart below). The retail investors view access as a right that all shareholder should have and that retail owners have as much at stake in their investments as the pension giants and labor funds. This leads to the conclusion that these individuals would not be likely to settle for governance changes. Setting the precedent would be much more important.

The Governance Advocates: U.S. Labor and Public Pension Funds

The resolutions submitted by Amalgamated at H-P and the five public pension funds* at Nabors strictly follow the format of the vacated SEC 14a-11 Rule proposing a 3%, 3 year ownership and capping the percentage of director nominees at 25%.

These funds have been in the vanguard of the American corporate governance movement and can point to many successes both legislatively and in the realm of private ordering. The fact their proposals mirror the SEC rule is a confirmation that their goals are, of course the passage of the proposals, but further to convince the SEC to reintroduce proxy access. Settlements with H-P or Nabors that include the seating of directors (as well as governance changes) without a vote on the proposals could be seen as half a loaf, but it would be a huge victory.

Norges Bank Investment Management (NBIM)

Lastly, is the proposal filed by Norges Bank Investment Management (NBIM). manager of the Norwegian Government Pension Fund. NBIM’s model proposal calls for a minimum 1 percent ownership for one year and may propose to nominate no more than 25% of a board’s members.

NBIM and many foreign investors see the U.S. as a market where shareholder rights are fairly limited. Like the retail investors associated with USPX, they believe access is a right shareholder should possess. They may also view the 3:3:25 standard embodied in SEC Rule 14a-11 as flawed compromise, restricting shareholders. Thus they too may be more interested in setting precedents than in negotiating.

What Next?

While the number of total proposals is larger than many, including myself expected, the real issue is the difference in the resolutions and how investors and proxy advisory firms will react to them. One possible scenario (if all the proposals survive no-action requests) could have institutional investors and the proxy advisors:

  • rejecting the USPX model proposals out right;
  • providing majority support for some of the NBIM proposal (3 out of 6 for example)
  • providing majority support for the Amalgamated proposal at H-P
  • providing high 40s at Nabors for the public funds’ proposal

Of course it is impossible to handicap the prospects of each proposal at this stage. Also there is a chance that a proponent – more likely the public and labor funds – could settle with companies, for substantial governance changes and, perhaps even for a prospective director candidate. This raises the stakes for companies who have received the proposals. The focus will be on the SEC and on which grounds will they allow exclusion of proxy access resolutions. One tactic used in the past, on other governance and environmental report proposals, has been to file a management proposal making a similar, but not identical request to shareholders. That may not be as useful for the affected companies in that it would:

  • place proxy access on their ballot;
  • opens the door to negotiations with shareholders (the former proponents) over the type and workability of the access regime the company has put forward;
  • provide the proxy advisor firms with an opportunity via their vote recommendation to push back on the ownership and holding period percentages – if a company put forward a 5, 6 or 7 percent ownership and/or holding duration requirement – as being too onerous for shareholders;
  • the management proposal could lose – and advocates of proxy access could claim that it was rejected by shareholders because it was not seen as truly useable by shareholders

Over the next few months, we shall see where the chess game leads. And, of course there could be more proposals on the way.

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