The 2010 proxy season is shaping up to be one of the most active in
memory. ‘The 2009 year was sheer chaos with shareholders unclear which
companies were truly underperforming their peer group,’ observes Richard
Grubaugh, senior vice president at DF King. ‘We have now seen a rebound in
many companies’ stock prices so it’s a little clearer which companies are
underperforming – and shareholders will likely act with more ammunition.’
Companies face a truly daunting list of challenges, with regulatory and
cultural shifts taking place seemingly every week. ‘Our first test for
companies is whether or not they’re creating long-term returns for
investors; if the company is a laggard, we take a closer look,’ comments
Richard Ferlauto, director of corporate governance and pension investment
for the American Federation of State County and Municipal Employees (AFSCME)
pension fund, which has more than $850 million in assets under management.
According
to Ferlauto, his team is looking for a greater level of engagement and
cooperation from companies in the run-up to proxy season 2010.
The hot-button issues this year center on board elections and executive pay.
Interestingly, shareholders’ rights on both these topics are changing
dramatically, but not in time for the majority of 2010 annual meetings. The
US House of Representatives approved a say-on-pay bill giving shareholders
at some companies a non-binding vote on executive compensation last April
but the bill is not expected to become law for this season. To date, 27
companies – including Microsoft, Intel and Prudential – have adopted
voluntary say-on-pay votes ahead of the legislation but others are waiting
to see what comes out of Washington.
Experts are expecting investors to continue to push for say on pay during
2010. ‘They will want to signal their support for early congressional action
so we think say on pay will remain a strong category among shareholder
proposals,’ predicts Patrick McGurn, special counsel
at RiskMetrics.
Perhaps the most contentious – and certainly one of the most time-consuming
– issues facing companies is the SEC’s proxy access proposal. To the relief
of the majority of listed companies, the rules will not be in place for the
2010 season, but they are already changing the name of the game for board
elections. Companies are well advised to pay attention to director withhold
votes this season and new SEC disclosure rules for director nominations,
says McGurn.
Another area of increasing interest is reimbursement of expenses for
shareholders conducting ‘successful’ proxy campaigns for the election of
directors. Alabama-based HealthSouth recently became the first company to
reimburse activist shareholders for expenses incurred to unseat
management-backed directors. The company is authorizing a Delaware bylaw
stating companies must repay ‘reasonable’ expenses for successful dissident
board candidates. It has also agreed to partial reimbursement for those
gaining at least 40 percent of votes. Reimbursement is an underestimated but
rapidly emerging challenge and is on AFSCME’s agenda; the fund plans at
least six proposals for bylaw changes this year, and proxy experts predict
more proposals on this topic in 2010.
An election year
The entire director election process continues to undergo upheaval. In
addition to the aforementioned areas, the SEC is asking companies to provide
more information on the skills and experience of qualifying directors and
nominees for board seats. One question for corporate secretaries is which
format to use for these disclosures. ‘A table oversimplifies the categories,
so narrative is really the way to go,’ says Chris Pereira, senior corporate
securities and finance counsel at General Electric.
He also suggests contacting the board early to give directors time to chime
in on what will be added to their bio. ‘Depending on when you file, you
might want to use your committee meetings to discuss this,’ he says.
The other change affecting board elections is, of course, Rule 452, which
abolishes the broker discretionary vote. This will lead to a heightened
focus on director elections with beleaguered boards facing possible
shake-ups. ‘In 2010, we could see directors lose their seats, especially at
companies that are troubled and have already moved to majority voting,’
points out Stephen Davis, executive director at Yale University’s Millstein
Center for Corporate Governance and Performance.
Ken Altman, president of the Altman Group, says Rule 452 will have a
disproportionately negative impact on smaller-cap companies with
comparatively larger retail shareholder bases. In late October he submitted
a 20-page proposal to the SEC outlining changes to the proxy voting system
and advocating greater shareholder transparency in light of the new proxy
rules. ‘One of the things companies can do this spring is communicate to the
SEC that, given Rule 452 and proxy access, they would like better access to
their owners,’ he suggests.
Experts view 2010 as a testing ground for NYSE Rule 452 and incoming proxy
access rules with board elections taking center stage for shareholder
concerns. ‘Director elections are now the main playing field for
shareholders,’ observes McGurn. ‘They view this as anything but routine –
and boards will have to do a better job at monitoring areas where their
company may be vulnerable.’
Let’s talk about money
One area of particular vulnerability for many companies and directors is
executive pay. The economic crisis spurred a new intensity around executive
compensation, with investors outraged by some of the big bonuses handed to
executives at bailout firms. ‘A number of compensation issues came up during
the meltdown and there is still a lot of concern around pay,’ notes Arthur
Crozier, co-chairman of Innisfree.
‘Board and compensation committees are going to have to evaluate their
compensation policies in light of the current environment where executive
pay continues to face heightened shareholder scrutiny and public anger,’
points out Rachel Posner, senior managing director and general counsel at
Georgeson.
‘We are perennially interested in executive pay and executive pay
structure,’ comments Ferlauto. AFSCME is advocating the pay model Kenneth
Feinberg, pay czar to Troubled Asset Relief Program companies, has
developed. Among its wish list for pay, AFSCME wants to see far less cash
paid to executives upfront with more given in the form of stock that has to
be held for a long period of time. Ideally, it would like to see executives
retain a significant portion of equity shares until two years past their
retirement.
‘This is a new proposal designed to foster a long-term focus on executive
compensation by asking companies not to pay out short-term bonuses until
performance has been maintained over a period,’ Ferlauto summarizes.
Pay was also a big concern last proxy season: there were more shareholder
proposals in 2009 on say on pay than anything else, with an average support
of 47 percent and resolutions receiving majority support at 22 firms. That’s
twice as many as in 2008, according to RiskMetrics. Last year also saw
double the number of withhold votes for directors, with around 90 failing to
get a majority of votes cast. ‘And if you look at the grounds for these
withholds, a high number had to do with compensation,’ highlights Crozier.
Other pay issues
Along with more say-on-pay proposals, proxy experts predict a flurry of
proposals on other compensation issues including tax gross-ups, bonus
banking and golden coffins. These pay issues are not new on shareholders’
agenda but the force surrounding them is, notes Timothy Smith, senior vice
president of Walden Asset Management. ‘Compensation is going to be on
everybody’s plate and we are going to see many board members withheld or
voted against,’ adds Grubaugh.
Approval of equity compensation plans is another challenge companies will
face this year. Issuers asking shareholders to support changes to equity
compensation plans or approve new plans will likely face more resistance,
predicts Mark Harnett, president of MacKenzie Partners. ‘Two thirds of the
companies that come through our door have equity compensation plans for
which they have to determine the level of grant options acceptable to
shareholders and proxy advisers,’ he says.
The attention surrounding compensation is further heightened by enhanced SEC
disclosure rules requiring companies to provide more information on pay and
its relation to risk in the compensation discussion and analysis (CD&A)
section of the proxy. The rules also ask companies to lay out the board’s
role in risk management. McGurn predicts that these additional disclosures
could lead investors to focus more on the board’s risk oversight role in
future shareholder proposals.
Corporate secretaries and corporate advisers are working hard to analyze
what works best for these new disclosures but the answers won’t be clear in
time for most proxies. ‘Companies will have to weigh in on their own as
there are no real examples to follow,’ comments John Siemann, managing
director and partner at Laurel Hill Advisory Group. ‘You’re better off
spending time now putting together a well-crafted response rather than
slapping together boilerplate.’
Risky business
In the wake of the global financial crisis, companies are already
reevaluating their risk management systems and oversight. The SEC’s
regulatory changes, combined with increased investor interest, offer further
incentive for issuers to formalize and update their risk processes
‘It’s important to use the good guidelines out there in terms of what
enterprise risk management means,’ comments Pereira. He advises talking to
the chief risk officer (or whoever manages internal controls) to get tips on
integrating governance disclosures with risk management. He also suggests
consulting the Federal Reserve’s recent guidance on how it’s analyzing
executive pay and risk at banks.
‘Industrial firms and other sectors obviously have a different risk spectrum
but there you at least have a game plan,’ Pereira says. ‘The struggle will
be for smaller companies that don’t have a risk function. For larger
companies it’s a matter of expanding their enterprise risk management system
to include compensation.’
‘This first year will be an exploratory process for everyone,’ observes
Crozier. In true SEC style, the disclosure requirements are very much
guidelines rather than rules and are not prescriptive in their advice.
‘There is a fairly wide debate about how you define excessive risk,’
observes Paul Hodgson, senior research associate at the Corporate Library.
‘Guidance for these disclosures is more likely to come from a company’s
peers.’
For his part, Pereira doesn’t think the SEC will come down hard on companies
in this introductory year. ‘The SEC will be fairly easy but you can expect
some comment letters,’ he says.
That’s not to say the commission won’t be tougher in future years, however.
‘There is also some legislation floating around mandating that companies
have risk committees in place and some discussion on Capitol Hill about a
requirement for companies to have chief risk officers,’ adds McGurn.
The full laundry list
The other issue companies need to watch is shareholders’ right to call a
special meeting. ‘The question is: what is the magical threshold that allows
shareholders the ability to hold a board accountable outside the AGM but
prevents activist shareholders from calling special meetings whenever they
want?’ says Grubaugh. The right to call a special meeting could create
significant problems in takeover situations, he warns. In short,
shareholders could basically push through the deal at a time when the stock
is trading at a discount by calling a special meeting to unseat the board.
Proxy advisers also expect proposals on a myriad of other topics including
the separation of chair and CEO, tying pay to pension funding, board
diversity and demand for companies to reincorporate in Delaware. Experts
advocate companies get an early start on shareholder engagement and consider
more board education. ‘Companies should devote a greater portion of their
board education to understanding business strategy and risk,’ advises
Posner.
‘As we enter an era with the broker discretionary vote disappearing and
proxy access around the corner, all companies are advised to have open and
honest communications with shareholders,’ summarizes Altman. ‘If the first
time the company calls an investor is when it is facing a challenge, it’s
much less likely to get that shareholder’s support.’
Looking ahead
Proxy experts predict a more stringent focus on social and environmental
risk disclosure, with pressure building for the SEC to take a firmer stance
on these issues. ‘We have heard the SEC is going to ask for risk-related
reporting on CSR-related issues,’ reports Patrick McGurn, special counsel
for RiskMetrics Group. The commission could in turn change its view on
shareholder resolutions related to CSR proposals and allow more through this
year.
Past CSR proposals have tackled several issues, including sustainability
reporting, carbon emissions disclosure and reduction, and workers’ rights.
The first majority vote on a climate change resolution came last year with
shareholders voting in a proposal calling on IdaCorp to establish a
greenhouse gas emissions reduction goal and report on it.
‘A lot of institutions are changing their views on this and showing more
support for these types of proposals,’ comments John Siemann, managing
director and partner at Laurel Hill Advisory Group.
There is a considerable cross-section of mainstream investors showing an
interest in these proposals, says Tim Smith, senior vice president at Walden
Asset Management. He points to the Carbon Disclosure Project, a group of
investors with $55 trillion in assets under management that requests carbon
emission and reduction targets from companies. ‘The do this because they
believe carbon risk affects the bottom line,’ Smith notes.
‘CSR is going to be a growing element of risk management and risk exposure,’
adds Paul Hodgson, senior research associate at the Corporate Library. With
big funds looking to build CSR risk into their investment strategies,
Hodgson anticipates that companies will have to move away from boilerplate
CSR disclosure pretty rapidly.
