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The deal evaluators
by Matt Miller Posted 03:10 EST, 24, Feb 2004 In September, the board of New York-based financial services firm MONY Group Inc. embraced a $2.3 billion acquisition offer from Axa SA, France's largest insurer. The decision infuriated some MONY shareholders, who mounted a proxy campaign, blasting the low sales price, the lack of an auction process and a $94 million payout that MONY executives would receive. MONY responded that no other offers had emerged and that it needed a larger partner. The debate was strident. In the countdown to the Feb. 24 vote, many eyes were focused not on the two sides, but on a pair of investment advisory services that promised independent evaluation of the deal. First, dissident shareholders made their pitch in a conference call for institutional investors hosted by Institutional Shareholder Services, long established in corporate governance and proxy services. Two days later, Glass, Lewis & Co. LLC, a year-old rival, hosted a similar event. On Feb. 11, ISS, based in Rockville, Md., issued a thumbs-down ruling. San Francisco-based Glass Lewis weighed in six days later with a similar recommendation against the merger. MONY, which refused to participate in the calls, pooh-poohed the rejection. "ISS' position will sway few votes," said MONY in a press release. ISS, it noted, is "best known for its opinions ... relating to corporate governance matters." That reputation isn't in dispute. Since its founding in 1985 by governance authority Robert A.G. Monks, ISS has made a name providing direction on mostly routine, governance-related decisions for managers of trillions of dollars worth of pension assets and mutual funds. But the service, which is privately held, has also become a growing and sometimes controversial force in the M&A arena. Last year's entry of Glass Lewis — founded by investment bankers, lawyers and accountants as a proxy service but with a significant M&A orientation — has focused attention on the question of how ISS arrives at its recommendations. The very existence of a rival indicates that the world's biggest investors want help in assessing major corporate decisions — including deals. "They're influential," says Richard Koppes, of counsel at Jones Day and the former general counsel of the California Public Employees' Retirement System, or CalPERS. "Now you've got two of them and they're both well respected in the institutional community." They're certainly widely used. ISS, which turned down numerous requests to comment for this story, claims on its Web site to have 950 clients, pretty much a who's who of pensions and mutual funds. (A cursory look at Securities and Exchange Commission documents lists such funds as Franklin Templeton, ING, Gartmore and AIM.) Gregory Taxin, Glass Lewis' CEO, declined to put a number on his customer base. He would only say clients collectively manage $3.5 trillion in assets. CalPERS and Franklin Templeton, for example, subscribe to both services. While the people minding all this money don't automatically follow the services' advice, there's ample evidence that their recommendations matter. Philip Goldstein, an activist investor who runs hedge fund Opportunity Partners LP, recalls an unsuccessful attempt he mounted in 2001 to block the acquisition by Commercial Net Lease Realty Inc. of a smaller REIT called Captec Net Lease Realty Inc. The day after ISS backed the deal, several hundred thousand proxy votes registered in favor of the acquisition, Goldstein says. Institutional shareholders apply proxy service recommendations in different ways. According to one proxy solicitor, the more important the decision, the less likely institutions will rely wholly on the service. "Many institutions look to ISS and Glass Lewis for voting recommendations primarily on much more mundane matters like compensation," says the solicitor, who declines to be identified. "When it gets to mergers, there's a little more input by fund managers." Koppes describes three degrees of reliance on the services. At one extreme, certain index funds cede voting decisions to ISS. For more institutional clients, the recommendations serve as a research tool; they're informational. In between are clients "where staff or managers have to have really good reasons to vote against" what the services recommend, says Koppes. The recommendations resemble a seal of approval. And what happens when ISS and Glass Lewis issue conflicting recommendations? Koppes laughs. "Frankly, that's good for the field. It puts that middle group in a real bind, which makes them work harder."
That has happened twice in the past half-year. ISS, which had rarely nixed a merger proposal before Glass Lewis entered the field, surprised Wall Street late last year by recommending against Boise Cascade Corp.'s acquisition of OfficeMax Inc. Glass Lewis supported the merger. Some of those within the proxy and institutional investor communities believe Glass Lewis' entry has prompted ISS to assess merger proposals more critically. ISS "was pretty soft," says the proxy solicitor. "Glass Lewis is actually much more aggressive." The merger bid of Hewlett-Packard Co. and Compaq Computer Corp. first highlighted the importance of a proxy service assessment to the investor community. Because its CEO was on the Hewlett-Packard board, Barclays Global Investors ceded the voting of its 3% stake in Hewlett-Packard to ISS. ISS clients represented as much as 20% of the voting shares. After heavy lobbying by Hewlett-Packard, which included a visit to ISS offices by Hewlett-Packard CEO Carly Fiorina, ISS recommended the merger. By some estimates, that call was crucial to its approval. The point is debatable, but critics of the ISS decision howled. They questioned the ability of ISS to run a sophisticated merger assessment, especially when its stated focus is rating a company in terms of corporate governance, not whether it's a competent acquirer. "Where ISS went wrong is making judgments as to business rationale. That's a far cry from governance issues," says a governance specialist who generally supports ISS' work. "It may have been different if [ISS] had a team of people qualified to pass judgments, but a lot of folks had their eyebrows raised because the [ISS] analysts didn't have know-how to do assessments." Indeed, an ISS proxy analysis is heavily weighted on governance-related factors such as whether independent directors have a voice and support a merger. Even its supporters note ISS has a tough task when it comes to M&A. ISS may not have the built-in conflicts of investment banks or brokerage houses. Neither, however, does it have trained Wall Street analysts, who spend their time assessing individual companies. Because ISS monitors thousands of companies, its research staff must be the ultimate generalists. A profile in SmartMoney magazine after the Hewlett-Packard-Compaq merger revealed many of its analysts started as temporary staff, some right out of college. ISS also took some heat after its chief analyst on the Hewlett-Packard-Compaq merger was forced to resign after a magazine revealed he had never finished law school, as he had claimed to his employers. "The knock on ISS is that their analysts have to become 90-day wonders, that they have to make sense out of highly complex matters. This is a very difficult role for any outside service provider," says Bert Denton, activist shareholder and head of New York-based Providence Capital Inc. Denton, however, calls ISS' corporate governance recommendations "a very useful tool" for both investors and boards. Two other factors further complicate ISS' position. One is its ownership of Proxy Voter Services, a subsidiary that advises Taft-Hartley pension fund managers on how to vote. That has caused at least one bizarre outcome. During Berkshire Hathaway's acquisition of Clayton Homes Inc. last year, ISS voted for the merger, PVS voted against, but their analyses were virtually identical. Critics have also slammed ISS for offering governance consulting to some of the same companies it reviews on proxy matters. (ISS has said in the past it has controls that ensure separation of the two functions. It does disclose its consulting clients.) Enter Glass Lewis — pulling no punches. "It's terrifying to us and some of our clients that an organization would have so much sway over something like the HP and Compaq merger, and yet they don't have the expertise to evaluate that transaction on a financial or economic basis," says Taxin, a former Banc of America Securities LLC managing director. "We strongly believe there is room for another set of opinions." Taxin and co-founder Kevin Cameron, a lawyer, put together a research team led by Lynn Turner, the high-profile former chief accountant for the SEC. The company, with offices in San Francisco and Denver, now has more than 40 employees. ISS has about 300 employees in New York, Chicago, London, Manila and Tokyo as well as its Maryland headquarters. Like ISS, Glass Lewis tracks thousands of companies. "We are obliged to cover any M&A activity in these 4,000 companies," says Taxin. "We write on every deal." Transactions where the board runs a good process with good advisers require less scrutiny, he says. Always, the focus is on shareholder value. "Our single overarching principle is whether this vote will make shareholders richer or poorer over the medium term," he says. "These companies are investments at the end of the day. And you've got to look at their financial performance and understand their accounting and the intricacies of their business models in order to have any opinion on what they should do or whether a deal should be done." ISS has been criticized for accepting fairness opinions issued by investment banks to boards, a kind of innocent-until-proven-guilty approach. Glass Lewis has seized on this in its pitch for another proxy service. "It may work to help a board defend itself from liability, but it doesn't go far enough to instruct or assist an institution in determining whether a deal is in the investor's best interest," says Taxin, who adds he once wrote fairness opinions for a living. "You'll never find one that questions the strategic sense of a deal or its value." Taxin says Glass Lewis' evaluations are "pretty much identical to the process I followed when I was an investment banker, with the small exception that we don't have any preconceived notions about the deal." This much is clear. Many institutions, notably mutual funds, will face more scrutiny on how they vote controversial shareholder issues than in the past. Some will rely on proxy services. Others will use them for cover as they try to appease customers and companies in which they invest. "The conflicts are just going to get greater and greater," says the proxy solicitor. "The easiest way to decide how to vote is putting the responsibility on ISS or Glass Lewis." ©Copyright 2004, The Deal, LLC. All rights reserved.
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