The following summary was provided by:

Veritas Executive Compensation Consultants, (“Veritas”) is an executive compensation consulting firm. 
October 6, 2014
As part of its annual policy formulation process, each year ISS seeks feedback from institutional investors, public companies and consulting and legal communities on emerging corporate governance, executive compensation and other issues.
More than 370 total responses were received, including 105 individual institutional investors and 255 members of the corporate issuer community (including consultants/advisors).
The survey, conducted between July 17, 2014 and September 5, 2014, was structured around several high-level themes including:
  • Pay for performance;
  • Board accountability;
  • Boardroom diversity;
  • Equity plan evaluation;
  • Risk oversight and audit;
  • Cross-market listings; and
  • Environmental and social performance goals.
For more information about the survey and to view more detailed survey responses, please click here.
Pay for Performance
CEO pay limits relative to company performance resonate with investors
In response to whether there is a threshold at which the magnitude of CEO pay warrants concern even if the company’s performance is positive (e.g., outperforming peer group), 60% of investors indicated a concern. Support for alternative solutions varied as 27% favored relative proportional limits based on the degree of outperformance versus the company’s peer group; 19% favored absolute limits on CEO compensation regardless of performance; and 14% advocated for proportional limits on compensation in relation to absolute company performance.
In determining excessive pay magnitude, methods such as comparisons to median CEO pay at peer companies, CEO compensation to pay of other NEOs, and proportion of CEO pay to corporate earnings or revenue have all garnered support.
Positive changes in succeeding year may be a mitigating factor for pay-for-performance concerns for the year in review
When evaluating say-on-pay, 63% of investors (and 34% of issuers) indicate that positive changes to pay programs can somewhat mitigate pay-for-performance concerns. In contrast, 52% of issuers (versus just 14% of investors) indicate that they can substantially mitigate concerns.
Of those investors who indicate that positive changes to pay programs can somewhat or substantially mitigate pay-for-performance concerns, 90% expect disclosure of specific details of such positive changes (e.g., metrics, performance goals, award values, effective dates) in order for the changes to be considered.
European investors and issuers diverge on peer group comparisons in evaluating compensation practices
For European markets, 83% of investors indicate that a European pay for performance quantitative methodology, including the use of peer group comparisons, would be useful as a factor in such evaluations. A significant majority (87%) of investors would also like to see a comparison to cross-market industry sector peer groups. Regarding other factors of comparison, 74%, 83%, and 85% indicate that they would favor local market peer groups, regional peer groups (i.e., Europe-wide), and cross-market peer groups based on company size/capitalization, respectively.
However, 58% of issuers indicate peer group comparisons are not appropriate to gauge each individual company’s compensation practices.
Mixed views on the relationship between goal-setting and target award values
43% of investors (and only 3% of issuers) indicate that if performance goals are significantly reduced from one performance period to the next, target award levels should be commensurately modified to reflect the expected lower level of performance. By contrast, two-thirds of issuers (and 26% of investors) indicate that the compensation committee should have broad discretion to set both goals and target awards at levels deemed to be appropriate under the circumstances. In addition, 25% of issuers (and 19% of investors) indicate that performance goals should be set independently of target awards, which must be maintained at competitive levels in order to attract and retain top quality executives.
Unilateral Adoption of Bylaws
Investors indicate little tolerance for unilateral boardroom adoption of bylaw amendments that diminish shareholder rights
72% of investors indicate that a board should never adopt bylaw/charter amendments that negatively impact investors’ rights without shareholder approval. Other investor respondents say “it depends,” selecting from a list of factors (directors’ track record, level of board independence, other governance concerns, the type of bylaw/charter amendment, and the vote standard for amendments by shareholders) which appear to be relevant in evaluating board accountability. Specifically, more than 85% of investors view each of those factors as relevant.
Conversely, nearly one-half (44%) of issuers indicate that boards should be free to unilaterally adopt any bylaw/charter amendment(s) subject to applicable law, while 34% of issuers say “it depends.”
Investors and issuers diverge on pre-IPO adoption of shareholder unfriendly provisions
63% of investors indicate that directors should be held accountable if shareholder unfriendly provisions are adopted prior to a company’s IPO. When determining whether to hold directors accountable, 21% of investors indicate “it depends,” with common responses including the type of provisions and whether directors are willing to address the issues after the IPO. On the other hand, 62% of issuers do not believe directors should be held accountable for pre-IPO actions.
Boardroom Diversity
Investors and issuers take big picture approach on boardroom diversity
60% of investors and 75% of issuers indicate that they consider overall diversity (including but not limited to gender) on the board when evaluating boards. Meanwhile, 17% of investors and 7% of issuers indicate that they do not consider gender diversity at all when evaluating boards.
Equity Plans
Investors indicate that they would weigh a combination of plan features and grant practices as or more heavily than plan cost alone in a scorecard approach to evaluating U.S. equity-based compensation proposals
ISS plans to implement a “balanced scorecard” approach to evaluating plan proposals for U.S. companies that gives weight to various factors under three broad categories: (1) Cost, (2) Plan Features, and (3) company Grant Practices. With respect to how the plan Cost category should be considered in a scorecard, 70% of investors indicate weights ranging from 30% to 50%. 62% of investors suggest weightings from 25% to 35% for Plan Features; and 64% indicate weights ranging from 20% to 35% for Grant Practices. Weightings suggested by issuers were quite dispersed, but generally skewed somewhat higher with respect to Cost, and somewhat lower for Plan Features and Grant Practices, compared to investors.
Use of performance conditions is a very important factor for investors when voting on equity-based remuneration proposals in markets where levels of disclosure are generally poor
When assessing proposals to implement equity-based remuneration plans benefitting executives in markets where levels of disclosure are generally poor, all factors (pricing conditions, vesting periods, dilution, performance conditions, and plan administration features) are “very” or “somewhat” important to a majority of investors in their voting decision. Use of performance conditions is at the top of the list, deemed by 76% of investors as a factor to be “very important.”
Risk Oversight/Audit
Investors focus on boardroom oversight subsequent to incidents when evaluating the board’s role in risk oversight
Over the past few years, shareholders’ investments have been impacted by a number of well publicized failures of boardroom risk oversight. When evaluating the board’s risk oversight role, a majority of shareholders indicate that the role of the company’s relevant risk oversight committee(s), the board’s risk oversight policies and procedures, boardroom oversight actions prior to incident(s), boardroom oversight actions subsequent to incident(s), and changes in senior management are all either “very” or “somewhat” important to their voting decision on directors. Boardroom oversight action subsequent to an incident garners the highest percentage (85%) as a “very important” factor whereas only 46% indicate that changes in senior management are “very important.”
Investors consider disclosures concerning selection and tenure of audit firms to be very important when voting on auditor ratification and audit committee members
A slim majority of investors identify disclosures of the relevant factors the audit committee considers when selecting or reappointing an audit firm and the tenure of the current audit firm (53% and 51%, respectively) as “very” important factors in making informed voting decisions on auditor ratification and the reelection of audit committee members.
Cross-Market Companies
Investors and issuers provide mixed responses regarding policy selection treatment for cross-market companies
An increasing number of companies incorporate in one market but list in another (or multiple) geographic region. For example, some U.S.-based companies have inverted (reincorporated in non-U.S. markets with more favorable corporate tax regimes) and many non-U. S. companies have listed in the U.S. When asked how ISS should generally evaluate such companies, 47% of investors indicate that ISS should evaluate mainly under its policy guidelines for the main market of coverage, but for individual ballot items that arise from other regimes apply the policy of the market whose stock exchange rules or corporate statutes require the proposal to appear on the ballot. Other investor responses are split between evaluating entirely under ISS policy guidelines for main market of coverage (23%) and evaluating case-by-case depending on the nature of the proposal (24%).
Issuer responses are similar to those of investors with 41% indicating that ISS should evaluate mainly under its policy guidelines for main market of coverage, but for individual ballot items that arise from other regimes apply the policy of the market whose stock exchange rules or corporate statutes require the proposal being on the ballot; 29% indicate that ISS should evaluate entirely under its policy guidelines for the main market of coverage; and 26% indicate case-by-case, depending on the nature of the proposal.
Environmental & Social (E&S) Performance Goals
Investors and issuers differ on the appropriateness of quantitative E&S performance goals
When asked when it is appropriate for a company to utilize quantitative E&S performance goals, a majority of both investors and issuers, 57% and 75%, respectively, indicate a preference for case-by-case analysis (“it depends”). Of those investors, 89% consider if a company’s performance on a given environmental or social issue shows a negative trend or if the company has experienced significant controversies; 92% consider if the company has operations with significant exposure to potential regulatory or financial impacts; and 90% consider if the practice has become an industry norm. A slight majority (51%) indicate that it depends only if/when the quantitative goals are required by government regulations.
In contrast, with respect to issuers who select “it depends,” 65% indicate that only if/when the quantitative goals are required by government regulations and just under one-half (49%) indicate that it depends if a company’s performance on a given environmental or social issue shows a negative trend or if the company has experienced significant controversies.
Notably, 39% of investors indicate that it is appropriate for a company to always utilize quantitative E&S performance goals compared with only 7% of issuers. In the absence of quantitative goals, a significant majority of investors and issuers indicate that both company disclosure of a robust set of E&S policies, oversight mechanisms, and related initiatives, and/or company disclosure of E&S performance data for a multiyear period can be mitigating factors.
Posted in Corporate Governance | Tagged , , , | Comments Off

Corporate Governance Update: Important Proxy Advisor Developments

September 25, 2014

Corporate Governance Update: Important Proxy Advisor Developments

By David A. Katz and Laura A. McIntosh*

As 2014 winds down and 2015 approaches, proxy advisory firms—and the investment managers who hire them—are finding themselves under increased scrutiny. Staff guidance issued by the Securities and Exchange Commission at the end of June1
and a working paper published in August by SEC Commissioner Daniel M. Gallagher2 both indicate that oversight of proxy advisory services will be a significant focus for the SEC during next year’s proxy season. Under the rubric of corporate governance, annual proxy solicitations have become referenda on an ever-widening assortment of corporate, social, and political issues, and, as a result, the influence and power of proxy advisors— and their relative lack of accountability—have become increasingly problematic.3 The SEC’s recent actions and statements suggest that the tide may be turning. Proxy advisory firms appear to be entering a new era of increasing accountability and potentially decreasing influence, possibly with further, more significant, SEC action to come.

The proxy advisory industry currently is dominated by two firms, Institutional Shareholder Services (ISS) and Glass Lewis & Co. With nearly 100% market share between them,4 their widespread influence in shareholder activism and proxy voting has resulted in calls from the business community for greater SEC 5 supervision of their business practices, potential conflicts of interest, and transparency.

The SEC will monitor shareholder voting decisions and corporate board elections in 2015 to evaluate the effect of the SEC staff’s recent guidance.6 It is clear that the SEC expects investment advisers to take a more active role in overseeing proxy advisory firms and holding these firms accountable both for the quality of their recommendations and the business practices that produce them. By leveraging the influence of their clients, it appears that the SEC hopes to put pressure on proxy advisors to reform from within. However, as many shareholder activists are also clients of these firms, it may not be easy to promote change.

Need for Reform

Commentators have for years lamented the undue influence of proxy advisory firms in corporate elections. James R. Copland of the Manhattan Institute has observed that an ISS recommendation in favor of a given shareholder proposal increases the approval vote by, on average, fifteen percentage points.7 In other words, as Copland puts it, “At least when it comes to shareholder proposals, a small, thinly funded outfit with 600 employees in Rockville, Maryland, is acting like an owner of fifteen percent of the total stock market.”8 In some instances, ISS’s influence can be even greater. In 2014, for example, shareholder proposals related to social and political issues received9 average support of 29% with ISS’s support, and only 5% if ISS recommended against. That is, ISS directly influenced nearly a quarter of the votes cast on these matters. Because the SEC’s rules for resubmission of a failed proposal by a shareholder in the next year’s proxy statement require that the proposal have received up to 10% of the vote (depending on how many years it has been submitted),10 the significant voting impact of an ISS recommendation can empower a proponent to resubmit a proposal year after year, imposing costs on the company and creating waste and negative publicity to the detriment of the company and its shareholders.

The problem of waste is exacerbated by the fact that ISS’s voting recommendations, on topics from compensation to social issues, have been dramatically out of line with voting results. One example is cumulative voting: ISS has supported 96% of proposals to adopt cumulative voting; however, out of 107 such proposals at Fortune 200 companies between 2006-2012, only one received majority support.11 As Copland notes, “The significant influence of ISS on corporate proxy voting—along with the large, systemic gap between its preferences and those observed in shareholders’ actual votes—raises questions about whether shareholder voting is working effectively to improve share value.”12

Proxy advisors’ influence, elevated to great heights by two 2004 no-action letters noted below, received an additional boost in 2010 from the passage of the Dodd- Frank Act. The legislation’s enshrinement of say-on-pay votes in the annual shareholder meeting raised the stakes for the shareholder vote and provided an annual opportunity for activist shareholders to, with the help of ISS, put public pressure on corporate issuers.13 The Manhattan Institute’s Copland observes that a negative recommendation from ISS on an executive compensation proposal has the effect of reducing shareholder support for it by 17 percentage points.14

In the 2014 proxy season, ISS’s negative recommendations increased and voting results for directors were low, reflecting activist shareholders’ perception that directors were insufficiently responsive to their concerns. One possible cause is a change in ISS’s policies, which now call for withhold recommendations for directors who did not, after the prior annual meeting, implement a shareholder proposal that received a majority of votes cast (as opposed to votes outstanding).15 This policy change likely has had the effect of incentivizing companies to avoid a vote by agreeing to adopt reforms proposed by shareholders, particularly if a proposal is likely to meet ISS’s new, lower standard and thus—if not adopted before the next shareholder meeting—lead to a withhold-the-vote recommendation for directors in the following year. The influence of ISS therefore does not merely affect vote results themselves, but also boards’ decisions as to which proposals actually will come to a vote.16

Recent SEC Guidance

On June 30, 2014, the SEC’s Divisions of Corporate Finance and Investment Management released new guidance regarding investment advisers’ responsibilities relating to proxy voting and their reliance upon proxy advisory firms. Under the “Proxy Voting Rule,” investment advisers have a fiduciary duty to their clients to vote their proxies in the clients’ best interests. Staff Legal Bulletin 20 (SLB 20) prompts investment advisers to take an active role on behalf of their clients, particularly in evaluating and overseeing any proxy advisory firm they may engage to help them fulfill their voting responsibilities. Investment advisers are required to adopt and implement written policies and procedures designed to ensure that they comply with the Proxy Voting Rule. The guidance states that investment advisers should take steps to demonstrate compliance, including reviewing, at least annually, the adequacy of their proxy voting policies and procedures to ensure that they are reasonably designed and being effectively implemented. SLB 20 suggests using proxy vote sampling to ensure that votes have been properly cast.

A key point emphasized in SLB 20 is that the Proxy Voting Rule does not require that investment advisers vote every proxy or take on all of a client’s proxy voting responsibilities.17 Although the SEC had previously conveyed this message in other materials,18 many investment managers interpreted two 2004 no-action letters19 to indicate that they were required to vote on all matters. This interpretation led to heavy reliance on proxy advisory firms, as investment advisers largely outsourced their voting responsibilities.20 The recent guidance refutes this interpretation and suggests a variety of arrangements in which a client and an investment adviser may allocate the proxy voting responsibilities between them as dictated by the best interests of the client. Possible alternatives include focusing resources only on particular types of proposals or establishing default voting parameters for proposals made by management or certain shareholder proponents. At the extremes, the parties may agree that the adviser will vote all of the client’s proxies, or not vote any proxies at all, regardless of whether the client votes them itself. The adviser and client may use a cost-benefit analysis and the preferences of the client to determine the best arrangement for fulfilling proxy voting responsibilities.21

SLB 20 urges investment advisers to be demanding clients themselves when it comes to their proxy advisory firms. The guidance states that, when considering whether to retain or continue utilizing a proxy advisory firm, an investment adviser should make certain that the firm “has the capacity and competency to adequately analyze proxy issues.”22 In addition to the quality of the firm’s personnel, investment advisers are urged to consider the “robustness” of the proxy advisory firm’s policies and procedures designed (a) to ensure that proxy voting recommendations are based on current, accurate information and (b) to identify and address any conflicts of interest and other considerations affecting the nature and quality of the advice and services provided.23 Moreover, the Proxy Voting Rule requires that an investment adviser must oversee a proxy advisory firm on an ongoing basis to ensure that the firm continues to guide proxy voting in the best interests of the investment adviser’s clients. If an investment adviser determines that a proxy advisory firm’s recommendation was based on inaccurate information, the adviser should investigate the error and determine whether such errors are being addressed by the proxy advisory firm. Corporate issuers should take note of this guidance and be proactive in reviewing the information in proxy voting reports and submitting any necessary corrections. The guidance emphasizes the fact that a proxy advisory firm’s business or conflicts policies can change from time to time, requiring an investment adviser to reassess its use of the proxy advisor. Accordingly, investment advisers should monitor changes in a proxy advisory firm’s conflicts or conflicts policies by, for example, requiring updates from the proxy advisory firm as to these matters.

For their part, proxy advisory firms are instructed to be more forthcoming with respect to conflict-of-interest disclosures, which are required when a material conflict exists. SLB 20 states that where a proxy advisory firm provides consulting services to a company on a matter that is also the subject of a voting recommendation (or provides a voting recommendation to clients on a proposal sponsored by another client, or has any other interest in a matter), it must make a fact-specific determination as to whether its relationship with the company or proponent is significant or its interest material. Generally speaking, the SEC considers “significant” and “material” any element that would reasonably affect a client’s assessment of the reliability and objectivity of the proxy advisor’s advice. If necessary, the proxy adviser must then take affirmative steps to disclose the relationship to the client receiving the voting recommendation. The guidance states explicitly that disclosure of a conflict cannot be boilerplate; rather, it should provide the recipient of the disclosure with sufficient information to understand the nature and scope of the conflict, including any steps taken to mitigate it, in order that the client may be able to assess the recommendation. Interestingly, despite the SEC’s push for more robust disclosure, the conflicts disclosure need not be provided publicly so long as it is provided to the client in a timely and relevant manner designed to allow the client to assess both the advice and the conflict at once. Investment advisers, recognizing the increasing significance of conflicts in the proxy advisory industry, may wish to require proxy advisory firms to disclose potential conflicts more broadly than is legally required so that the investment adviser itself can decide what it considers material. In some cases, investment advisers may wish to independently investigate and verify the disclosures provided by proxy advisers to ensure that they do not inadvertently breach their fiduciary duties to their clients by relying on inaccurate information.

The SEC notes that “investment advisers and proxy advisory firms may want or need to make changes to their current systems and processes in light of this guidance” and expects such changes in advance of the 2015 proxy season. Investment advisers should be mindful that they, and not the proxy advisors, are the entity that must fulfill a fiduciary duty to a client. Because of this, investment advisors should promptly evaluate (and create a record of their evaluation of) one or more proxy advisory firms to support a decision to hire one of them or continue to retain such services. From there, investment advisers should, as advised by SLB 20, ensure that their policies and procedures relating to ongoing oversight of a proxy advisory firm are effective and up-to- date.

U.S., Canadian and European Reforms

Commissioner Gallagher, in a working paper published in August, indicated that he supports additional reforms relating to proxy advisors. He observed that “over the past decade, the investment adviser industry has become far too entrenched in its reliance on these firms, and there is therefore a risk that the firms will not take full advantage of the new guidance to reduce that reliance.”24 Promising to closely monitor whether SLB 20 will ameliorate current problems, Commissioner Gallagher noted that public companies may be disregarded by proxy advisory firms and institutional investors when they have concerns about inaccurate information being used to create voting recommendations. His interest and engagement in this issue is such that he has asked that these companies send copies of their shareholder communications directly to his office.

Commissioner Gallagher has suggested that the two 2004 no-action letters should be withdrawn and replaced with Commission-level guidance reminding institutional investors of their responsibility to fulfill their fiduciary duties by taking the lead on voting decisions rather than deferring automatically to proxy advisory firms. He is not alone in this view; former SEC Chairman Harvey Pitt as well as Congressman Patrick McHenry have made similar proposals.25 Though he stops short of calling for comprehensive regulation, Commissioner Gallagher supports the idea of a universal code of conduct for proxy advisory firms to increase transparency and promote accountability and best practices.26

A recent proposal by the European Commission (EC), cited with approval by Commissioner Gallagher, would come close to implementing a universal code of conduct. This spring, the EC released a proposal for legislation designed to improve the accuracy and reliability of advice from proxy advisory firms.27 The EC report calls for action at the European Union level and emphasizes the broad-based need for increased transparency from proxy advisory firms. Under the proposed law, proxy advisors would be required to disclose, on an annual basis, substantial information relating to how their voting recommendations are determined, including their methodologies, their information sources, whether they have taken into account market, legal, and regulatory conditions, and the extent and nature of any dialogues they may have with the companies that are the subject of their recommendations.28 Further, proxy advisory firms would be required to promptly disclose any actual or potential conflicts or business relationships that could influence their recommendations, along with any actions they have taken to reduce or eliminate such conflicts.29

Canada, too, is increasing pressure on proxy advisors to be more transparent and accountable. In April, the Canadian Securities Administration (CSA) published for comment proposed guidance for proxy advisory firms.30 The policy-based approach would provide recommendations for best practices and disclosures on the part of proxy advisors. The proposed guidance highlights conflicts of interest, stating that “[e]ffective identification, management and mitigation of actual or potential conflicts of interest are essential in ensuring the ability of the proxy advisory firm to offer independent and objective services to a client.”31 Additional guidance focuses on transparency, accuracy, tailored governance recommendations, and communications with clients, market participants, the media and the public.32

2015 Proxy Season

At best, proxy advisors play an important role in making investment managers more informed, efficient stewards of their clients’ proxy voting. However, their influence has become so significant that it is crucial that their recommendations be as worthwhile, transparent, and objective as possible. As the focus shifts to the 2015 proxy season, companies should be mindful of the SEC’s increased scrutiny of investment advisers’ voting and use of proxy advisory firms. Corporate issuers can and should be proactive in obtaining and reviewing proxy voting reports relating to the company and promptly requesting any needed corrections of incorrect information. In cases of material misstatements or confusion created by the proxy voting reports, companies may wish to add their own corrections to their proxy materials or other shareholder communications. Companies should, as always, continue to engage directly with their large shareholders and make the case for supporting the recommendations of the board. Healthy communication with issuers will help enable institutional investors to make their own independent, informed decisions about voting matters.

A separate issue that has not been widely discussed is whether the proxy advisory firms should be required to make their reports public, since they influence such a large segment of the voting population. Although the proxy advisory firms currently are not required to publicly file their reports, if the goal is increased transparency, perhaps this should change. As the SEC monitors the proxy advisory firms in the coming months, appropriate consideration should be given to modernizing the antiquated proxy voting system and determining what additional steps, if any, should be taken to regulate these firms and their influence on public companies.

Companies concerned about the undue influence of proxy advisors have an engaged advocate in Commissioner Gallagher, and momentum may be building, both in the United States and abroad, toward further reform in this area. The upcoming proxy season will be a key time for the SEC to observe any ramifications of SLB 20 and to consider next steps. Fundamentally, the SEC has, with SLB 20, reminded investment managers that their fiduciary duties are incompatible with inattentive overreliance on proxy advisors. It remains to be seen what effect the new guidance will have, but if it proves to be effective, it may herald a new era of decreasing relevance for proxy advisory firms.




∗ David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz. Laura A. McIntosh is a consulting attorney for the firm. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole.

1 Securities and Exchange Commission Staff Legal Bulletin No. 20, “Proxy Voting: Proxy Voting Responsibilities of Investment Advisers and Availability of Exemptions from the Proxy Rules for Proxy Advisory Firms,” June 30, 2014 (“SLB 20”), available at

2 Commissioner Daniel M. Gallagher, U.S. Securities and Exchange Commission, “Outsized Power and Influence: The Role of Proxy Advisers,” Washington Legal Foundation Critical Legal Issues Working Paper Series, No. 187, Aug. 2014 (“Gallagher Paper”), available at

3 See, e.g., U.S. Chamber of Commerce, Center for Capital Markets Competitiveness, “Best Practices and Core Principles for the Development, Dispensation, and Receipt of Proxy Advice,” March 2013, at 2, available at Principles-for-Proxy-Advisors.pdf.

4 See U.S. Chamber of Commerce, Center for Capital Markets Competitiveness, supra, at 3 (estimating that the two firms together have 97% market share).

5 See Gallagher Paper, supra, at 12; see also Holly Gregory, “SEC Guidance May Lessen Investment Adviser Demand for Proxy Advisory Services,” Sidley Austin LLP Update, July 29, 2014, available at proxy-advisory-services/; Yin Wilczek, “Congress Will Act If SEC Fails To Move on Proxy Advisors,” Bloomberg BNA, June 27, 2014, available at

6 See Thomson Reuters Tax & Accounting News, “Scrutiny of Proxy Advisers to Continue,” July 28, 2014 (citing statements by Keith Higgins, director of the SEC’s Division of Corporate Finance, on July 24, 2014) available at newsstand/scrutiny-proxy-advisers-continue/.

7 See James R. Copland, “SEC Needs To Rethink Its Rules on Proxy Advisory Firms,” Washington Examiner, July 24, 2014, available at!.

8 Id.

9 Sullivan & Cromwell LLP, “2014 Proxy Season Review,” June 25, 2014, at 16 (“S&C Proxy Review”), available at

10 Securities Exchange Act of 1934, Rule 14a-8(i)(12).

11 See James R. Copland, “Politicized Proxy Advisers vs. Individual Investors,” Wall St. J., Oct. 7, 2012 (“Copland 2012”), available at

12 See id.

13 See David F. Larcker et al., “The Influence of Proxy Advisory Firm Voting Recommendations on Say- on-Pay Votes and Executive Compensation Decisions,” The Conference Board Director Notes, April 2012, available at

14 See Copland 2012, supra.
15 See S&C Proxy Review at 1.

16 See id. at 6.

17 SLB 20, Answer to Question 2; see also Gallagher Paper, supra, at 3, 13.

18 See, e.g., Investment Advisers Act Rel. No. 2106 (“We do not suggest that an adviser that fails to vote every proxy would necessarily violate its fiduciary obligations. There may even be times when refraining from voting a proxy is in the client’s best interest, such as when the adviser determines that the cost of voting the proxy exceeds the expected benefit to the client.”), available at 2106.htm.

19 Institutional Shareholder Services, Inc., SEC Staff Letter (Sept. 15, 2004), available at, Egan Jones Proxy Services, SEC Staff Letter (May 27, 2004), available at

20 “Reforming the Proxy Advisory Racket,” WSJ Review & Outlook, July 22, 2014, available at

21 SLB 20 clarifies that a proxy advisory firm engages in a “solicitation” under the federal proxy rules when it furnishes proxy advice. SLB 20, Answer to Question 6; see also Securities and Exchange Act of 1934 Rule 14a-1(l ) and Release No. 34-31326 (Oct. 16, 1992). Proxy advisory firms are therefore subject to the antifraud and other provisions of the proxy rules unless an exemption applies; merely distributing reports containing recommendations would not qualify as a solicitation. SLB 20, Answer to Question 8; see also Securities and Exchange Act of 1934 Rule No. 14a(2(b)(1) and Rule No. 14 a(2(b)(3). However, an exemption would not apply to a proxy advisory firm that allowed a client to establish general guidelines or policies, in advance of receiving proxy materials, that the firm would use to vote on behalf of its client. SLB 20, Answer to Question 7.

22 SLB 20, Answer to Question 3.

23 The U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness has released a set of best practices and core principles for proxy advisory firms that is a useful reference for investment advisers and proxy advisors alike. See U.S. Chamber of Commerce, Center for Capital Markets Competitiveness, supra.

24 Gallagher Paper, supra, at 16.

25 See David Scileppi, “Congress to the Rescue?: Congressman Hints at Legislation To Rein in Proxy Advisory Firms,” The Securities Edge, June 27, 2014, available at proxy-advisory-firms/.

26 Gallagher Paper, supra, at 17.

27 European Commission, “Proposal for a Directive of the European Parliament and of the Council amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement and Directive 2013/34/EU as regards certain elements of the corporate governance statement (Apr. 9, 2014), available at

28 Id. at Article 3i, “Transparency of proxy advisors.”

29 Id.

30 Canadian Securities Administration Notice and Request for Comment, Proposed National Policy 25-201, “Guidance for Proxy Advisory Firms,” Apr. 24, 2014 (“CSA Proposal”), available at The comment period closed on June 23, 2014.

31 Id. at 2. 32 Id. at 7-8.


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Treasury Announces First Steps to Reduce Tax Benefits of Corporate Inversions

Treasury Announces First Steps to Reduce Tax Benefits of Corporate Inversions


Unfair Practice Erodes the U.S. Tax Base

WASHINGTON – Today, the U.S. Department of the Treasury and the Internal Revenue Service (IRS) issued a notice that takes targeted action to reduce the tax benefits of — and when possible, stop — corporate tax inversions. Companies are increasingly using the technique of inversion, whereby a U.S. based multinational restructures so that the U.S. parent is replaced by a foreign corporation, in order to avoid U.S. taxes. These transactions erode the U.S. tax base, unfairly placing a larger burden on all other taxpayers, including small businesses and hardworking Americans.

More than two years ago, President Obama laid out his framework for business tax reform. In addition, the Administration’s FY 2015 budget included a legislative plan to reduce the incentives to invert as well as make it more difficult to accomplish an inversion. Secretary Lew has been urging Congress to move forward with anti-inversion legislation, which is the only way to fully rein in these transactions.

“These first, targeted steps make substantial progress in constraining the creative techniques used to avoid U.S. taxes, both in terms of meaningfully reducing the economic benefits of inversions after the fact, and when possible, stopping them altogether,” said Treasury Secretary Jacob J. Lew. “While comprehensive business tax reform that includes specific anti-inversion provisions is the best way to address the recent surge of inversions, we cannot wait to address this problem. Treasury will continue to review a broad range of authorities for further anti-inversion measures as part of our continued work to close loopholes that allow some taxpayers to avoid paying their fair share.”

Genuine cross-border mergers make the U.S. economy stronger by enabling U.S. companies to invest overseas and encouraging foreign investment to flow into the United States. But these transactions should be driven by genuine business strategies and economic efficiencies, not a desire to shift the tax residence of the parent entity to a low-tax jurisdiction simply to avoid U.S. taxes.

Specifically, today’s action eliminates certain techniques inverted companies currently use to gain tax-free access to the deferred earnings of a foreign subsidiary, significantly diminishing the ability of inverted companies to escape U.S. taxation.  It also makes it more difficult for U.S. entities to invert by strengthening the requirement that the former owners of the U.S. company own less than 80 percent of the new combined entity. For some companies considering mergers, today’s action will mean that inversions no longer make economic sense.

Treasury will continue to examine ways to reduce the tax benefits of inversions, including through additional regulatory guidance as well as by reviewing our tax treaties and other international commitments. Today’s Notice requests comments on additional ways that Treasury can make inversion deals less economically appealing.  Today’s actions apply to deals closed today or after today.

Fact Sheet: Treasury Actions to Rein in Corporate Tax Inversions



Actions under sections 304(b)(5)(B), 367, 956(e), 7701(l), and 7874 of the Code 
What is a corporate inversion?
A corporate inversion is transaction in which a U.S. based multinational restructures so that the U.S. parent is replaced by a foreign parent, in order to avoid U.S. taxes. Current law subjects inversions that appear to be based primarily on tax considerations to certain potentially adverse tax consequences, but it has become clear by the growing pace of these transactions that for many corporations, these consequences are acceptable in light of the potential benefits.
An inverted company is subject to potential adverse tax consequences if, after the transaction: (1) less than 25 percent of the new multinational entity’s business activity is in the home country of the new foreign parent, and (2) the shareholders of the old U.S. parent end up owning at least 60 percent of the shares of the new foreign parent. If these criteria are met for an inverted company, the tax consequences depend on the continuing ownership stake of the shareholders from the former U.S. parent. If the continuing ownership stake is 80 percent or more, the new foreign parent is treated as a U.S. corporation (despite the new corporate address), thereby nullifying the inversion for tax purposes. If the continuing ownership stake is at least 60 but less than 80 percent, U.S. tax law respects the foreign status of the new foreign parent but other potentially adverse tax consequences may follow. The current wave of inversions involves transactions in this continuing ownership range of 60 to 80 percent.
Genuine cross-border mergers make the U.S. economy stronger by enabling U.S. companies to invest overseas and encouraging foreign investment to flow into the United States. But these transactions should be driven by genuine business strategies and economic efficiencies, not a desire to shift the tax residence of the parent entity to a low-tax jurisdiction simply to avoid U.S. taxes.
Today, Treasury is taking action to reduce the tax benefits of — and when possible, stop — corporate tax inversions. This action will significantly diminish the ability of inverted companies to escape U.S. taxation.  For some companies considering mergers, today’s action will mean that inversions no longer make economic sense.
Specifically, the Notice eliminates certain techniques inverted companies currently use to access the overseas earnings of foreign subsidiaries of the U.S. company that inverts without paying U.S. tax.  Today’s actions apply to deals closed today or after today.
This notice is an important initial step in addressing inversions.  Treasury will continue to examine ways to reduce the tax benefits of inversions, including through additional regulatory guidance as well as by reviewing our tax treaties and other international commitments. Today’s Notice requests comments on additional ways that Treasury can make inversion deals less economically appealing.
Specifically, today’s Notice will:
·         Prevent inverted companies from accessing a foreign subsidiary’s earnings while deferring U.S. tax through the use of creative loans, which are known as “hopscotch” loans(Action under section 956(e) of the code)
o   Under current law, U.S. multinationals owe U.S. tax on the profits of their controlled foreign corporations (CFCs) although they don’t usually have to pay this tax until those profits are repatriated (that is, paid to the U.S. parent firm as a dividend). Profits that have not yet been repatriated are known as deferred earnings.
o   Under current law, if a CFC, tries to avoid this dividend tax by investing in certain U.S. property—such as by making a loan to, or investing in stock of its U.S. parent or one of its domestic affiliates—the U.S. parent is treated as if it received a taxable dividend from the CFC.
o   However, some inverted companies get around this rule by having the CFC make the loan to the new foreign parent, instead of its U.S. parent. This “hopscotch” loan is not currently considered U.S. property and is therefore not taxed as a dividend.
o   Today’s notice removes benefits of these “hopscotch” loans by providing that such loans are considered “U.S. property” for purposes of applying the anti-avoidance rule. The same dividend rules will now apply as if the CFC had made a loan to the U.S. parent prior to the inversion.
·         Prevent inverted companies from restructuring a foreign subsidiary in order to access the subsidiary’s earnings tax-free(Action under section 7701(l) of the tax code)
o   After an inversion, some U.S. multinationals avoid ever paying U.S. tax on the deferred earnings of their CFC by having the new foreign parent buy enough stock to take control of the CFC away from the former U.S. parent. This “de-controlling” strategy is used to allow the new foreign parent to access the deferred earnings of the CFC without ever paying U.S. tax on them.
o   Under today’s notice, the new foreign parent would be treated as owning stock in the former U.S. parent, rather than the CFC, to remove the benefits of the “de-controlling” strategy. The CFC would remain a CFC and would continue to be subject to U.S. tax on its profits and deferred earnings.
·         Close a loophole to prevent an inverted companies from transferring cash or property from a CFC to the new parent to completely avoid U.S. tax (Action under section 304(b)(5)(B) of the code)
o   These transactions involve the new foreign parent selling its stock in the former U.S. parent to a CFC with deferred earnings in exchange for cash or property of the CFC, effectively resulting in a tax-free repatriation of cash or property bypassing the U.S. parent. Today’s action would eliminate the ability to use this strategy.
·         Make it more difficult for U.S. entities to invert by strengthening the requirement that the former owners of the U.S. entity own less than 80 percent of the new combined entity:
o   Limit the ability of companies to count passive assets that are not part of the entity’s daily business functions in order to inflate the new foreign parent’s size and therefore evade the 80 percent rule – known as using a “cash box. (Action under section 7874 of the code) Companies can successfully invert when the U.S. entity has, for example, a value of 79 percent, and the foreign “acquirer” has a value of 21 percent of the combined entity.  However in some inversion transactions, the foreign acquirer’s size is inflated by passive assets, also known as “cash boxes,” such as cash or marketable securities. These assets are not used by the entity for daily business functions. Today’s notice would disregard stock of the foreign parent that is attributable to passive assets in the context of this 80 percent requirement. This would apply if at least 50 percent of the foreign corporation’s assets are passive. Banks and other financial services companies would be exempted.
o   Prevent U.S. companies from reducing their size pre-inversion by making extraordinary dividends. (Action under section 7874 of the code) In some instances, a U.S. entity may pay out large dividends pre-inversion to reduce its size and meet the 80 percent threshold, also known as “skinny-down” dividends. Today’s notice would disregard these pre-inversion extraordinary dividends for purposes of the ownership requirement, thereby raising the U.S. entity’s ownership, possibly above the 80 percent threshold.
o   Prevent a U.S. entity from inverting a portion of its operations by transferring assets to a newly formed foreign corporation that it spins off to its shareholders, thereby avoiding the associated U.S. tax liabilities, a practice known as “spinversion.” (Action under section 7874 of the code)  In some cases a U.S. entity may invert a portion of its operations by transferring a portion of its assets to a newly formed foreign corporation and then spinning-off that corporation to its public shareholders. This transaction takes advantage of a rule that was intended to permit purely internal restructurings by multinationals.  Under today’s action, the spun-off foreign corporation would not benefit from these internal restructuring rules with the result that the spun off company would be treated as a domestic corporation, eliminating the use of this technique for these transactions.


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“Activist” hedge funds: creators of lasting wealth?

“Activist” hedge funds: creators of lasting wealth? What do the empirical studies really say?

Yvan Allaire, Ph.D. (MIT), FRSC François Dauphin, MBA, CPA, CMA

Executive Chair, IGOPP Project Director

(Opinions expressed herein are the sole responsibility of the authors)

Executive Summary

Hedge funds have found, in some academic circles, supporters and champions of their enduring contribution to shareholder wealth. Some recent empirical research has triggered an important debate in the American corporate/financial world about the role of board of directors, the rights of shareholders, and the very concept of the business corporation. The terms of the debate run as follows: Are boards of directors responsible for the long-term interest of the company? Or, are there lasting benefits from “activist funds” pushing and prodding reticent boards of directors to take actions these activists consider likely to create significant wealth for shareholders? What are the consequences of this “activism” for other stakeholders and for the very nature of board governance?

A wide range of observers with considerable financial experience and corporate expertise take a dim view of “activist hedge funds”, lambasting them for their greed-fuelled short-term stratagems and their prejudicial influence on the long-term health of companies. Professor Lucian Bebchuk of the Harvard Law School, argue that these wise people, with loads of practical experience, have no “scientific” basis for their collective judgment that activist interventions are detrimental to the long-term interests of shareholders and companies. Having assembled reams of data and statistics, Bebchuk and his colleagues claim they have “scientifically” demonstrated that hedge funds are not “myopic activists”, but on the contrary bring to corporations they target performance improvements which last long after they have exited the target company.

We carefully reviewed Bebchuk et al.’s paper and reached the following conclusions:

First, the authors have not demonstrated that activist hedge funds, per se, create lasting, long- term value and bring a long-term perspective to their “activism”. They have merely shown some statistical relationships to provide (weak) support to their thesis. The weight of experience still trumps the results presented in Bebchuk et al.

Secondly, the most generous conclusion one may reach from these empirical studies has to be that “activist” hedge funds create some short-term wealth for some shareholders as a result of investors who believe hedge fund propaganda (and some academic studies), jumping in the stock of targeted companies. In a minority of cases, activist hedge funds may bring some lasting value for shareholders but largely at the expense of workers and bond holders; thus, the impact of activist hedge funds seems to take the form of wealth transfer rather than wealth creation.

Thirdly, “activist” hedge funds operate in a world without any other stakeholder than shareholders. That is indeed a myopic concept of the corporation bound to create social and economic problems, were that to become the norm for publicly listed corporations.

Finally, the Bebchuk et al. paper illustrates the limits of the econometric tool kit, its weak ability to cope with complex phenomena; and when it does try to cope, it sinks quickly into opaque computations, remote from the observations on which these computations are supposedly based.page2image24960 page2image25120


For some time now activist hedge funds have cultivated a revamped reputation as creators of lasting economic value for shareholders. Hedge funds have now found in some academic circles supporters and champions of their enduring contribution to shareholder wealth.

Some recent empirical research has indeed triggered an important debate in the American corporate/financial world, about the role of board of directors, the rights of shareholders, and the very concept of the business corporation.

The terms of the debate run as follows: Are boards of directors responsible for the long-term interest of the company? Or, are there lasting benefits from “activist funds” pushing and prodding reticent boards of directors to take actions these activists consider likely to create significant wealth for shareholders? What are the consequences of this “activism” for other stakeholders and for the very nature of board governance?

Simply stated, would a form of “direct democracy” whereby shareholders have a say in all important decisions of the company lead to better long-term corporate performance? That is the implicit claim of “activist hedge funds”.

But, a wide range of observers with considerable financial experience and expertise take a dim view of “activist hedge funds”, lambasting them for their greed-fuelled short-term stratagems and their prejudicial influence on the long-term health of companies.

Among those sharing this view, one finds top corporate lawyers, public officials, at least one SEC chairman, judges of the Delaware Chancery Court, senior corporate executives, legal academics, influential economists and business school professors, prominent business columnists, business organizations, and so on.

For instance, famed lawyer Martin Lipton, founding partner of Wachtell, Lipton, Rosen & Katz, describes what he sees as the consequence of this new variant of “shareholder activism”:

“U.S. companies, including well-run, high-performing companies, increasingly face:

  • -  pressure to deliver short-term results at the expense of long-term value, whether through excessive risk-taking, avoiding investments that require long-term horizons or taking on substantial leverage to fund special payouts to shareholders;
  • -  challenges in trying to balance competing interests due to excessively empowered special interest and activist shareholders; and significant strain from the misallocation of corporate resources and energy into mandated activist or governance initiatives that provide no meaningful benefit to investors or other critical stakeholders.

These challenges are exacerbated by the ease with which activist hedge funds can, without consequence, advance their own goals and agendas by exploiting the current regulatory and institutional environment and credibly threatening to disrupt corporate functioning if their demands are not met.(Lipton, 2013a)

However, a group of academic researchers, most prominently, Professor Lucian Bebchuk of the Harvard Law School, argue that these wise people, with loads of practical experience, have no “scientific” basis for their collective judgment that activist interventions are detrimental to the long-term interests of shareholders and companies….Having assembled reams of data and statistics, Bebchuk and his colleagues claim they have “scientifically” demonstrated that hedge funds are not “myopic activists”, but on the contrary bring to corporations they target performance improvements which last long after they have exited the target company.

He and his fellow researchers have recently published the results of a large empirical study on the topic. Bebchuk even wrote an op-ed in the Wall Street Journal (August 8th 2013) to herald their findings1. Here’s how he summarizes their study’s findings:

“The Myth of Hedge Funds as ‘Myopic Activists’ ”

Our comprehensive analysis examines a universe of about 2,000 hedge fund interventions during the period of 1994-2007 and tracks companies for five years following an activist’s arrival. We find that:

  • -  During the five-year period following activist interventions, operating performance relative to peers improves consistently through the end of the period;
  • -  The initial stock price spike following the arrival of activists is not reversed in the long term, as opponents assert, and does not fail to reflect the long-term consequences of activism;
  • -  The long-term effects of hedge fund activism are positive even when one focuses on the types of activism that are most resisted and criticized – first, those that lower or constrain long-term investments by enhancing leverage, beefing up shareholder payouts, or reducing capital expenditures; and second, adversarial interventions employing hostile tactics;

    1 Before their paper was reviewed by any professional journal, a rather unusual move. The paper is slated to appear in the December 2014 issue of the Columbia Law Review.

  • -  The “pump-and-dump” claim that activists bail out before negative stock returns arrive is not supported by the data; and
  • -  Contrary to opponents’ beliefs, companies targeted by activists in the years preceding the financial crisis were not made more vulnerable to the subsequent downturn.”

    (Wall Street Journal, August 8th, 2013)

    The authors conclude their paper with the following recommendation:

    “Our findings that the considered claims and concerns are not supported by the data have significant implications for ongoing policy debates. Policymakers and institutional investors should not accept the validity of the frequent assertions that activist interventions are costly to firms and their long-term shareholders in the long term. They should reject the use of such claims as a basis for limiting the rights and involvement of shareholders.” (p.37)

    The paper of Bebchuk, Brav and Jiang (2013) is quoted urbi et orbi as providing compelling evidence in favour of hedge fund activism; but does it really?

    The Bebchuk et al. paper is heavily laden with statistics and econometric jargon. Those “wise” people who disagree with Bebchuk et al. are usually not versed in the arcane of statistical analysis and thus avoid a direct challenge of this “empirical evidence”. Then, as the statistical analysis carried out by Bebchuk, Brav and Jiang abides by the conventional norms and typical methods of econometric studies, no criticism will likely come from specialists of the trade.

    Thus, the paper’s data, analysis, empirical claims and conclusions have not been thoroughly vetted.


Is econometric analysis a better lens through which to understand complex social or economic phenomena than the collective judgment of people expertly engaged with these phenomena?

For instance, anyone with a modicum of experience with the operations of real-life business organizations would list as factors influencing their performance: quality of management and leadership, talented workforce, quality of the products, effective marketing, excellence of the distribution channels, differentiation, lean operations, savvy and timely investments, customer service, etc.

Yet, the common practice in econometrics is to attempt to capture the influence of these complex factors through proxy or dummy variables. The various factors influencing the economic performance of a company are supposedly captured by firm size and its age 2 and a multitude of dummy variables to approximate the dynamics of time, and the subtlety of industrial differences, etc.

At best, these proxy variables assembled together in a generalized linear model can “explain” a small part of the variations in observed performance but in no circumstances should one claim that these variables have “caused” the observed performance.

Econometrics provides a crude tool kit, a weak lens through which the researcher can, at best, view the blurred contours of complex phenomena.

Imagine that a researcher had collected a thousand judicial decisions in criminal cases and wanted to build a regression model to “explain” the decisions of several hundred judges. It would be edifying to have a professor of law, Professor Bebchuk for instance, build such a model; what variables would have to be included to capture the nuances of every situation; would “dummy” variables suffice for that purpose? What conclusions of a policy nature could one draw from such a study?

That is perhaps the reason why the Harvard law school (and its business school) tends to teach law (or business) through cases with their manifold complexity and nuances.

2 Measured by the natural logarithm of the market capitalization and the natural logarithm of the firm’s age.


The Bebchuk paper’s fundamental argument and main conclusion are derived from two tables based on 2,040 interventions3 by activist activist hedge funds which were carried out sometime during the period from 1994 to 2007.

To assess the performance of these firms, the authors use two metrics: ROA (return on assets) and Tobin’s Q (a common ratio calculated thus: the sum of the market value of equity and book value of debt, divided by the book value of equity and book value of debt).

Time “t” represents the year of the activist’s “intervention”, and subsequent years are identified as t+1, t+2, etc. up to the fifth year following the intervention.

The first table presents the descriptive data from the sampling of firms analyzed by the authors.

Table 1

Operating Performance Pre- and Post-Intervention

No Industry Adjustment

Average Median Observations

Average Median Observations


t+1 t+2

t: Event Year

t: Event Year






t+4 t+5

0.046 0.089 694

t+4 t+5

2.160 1.412 710































Source: Excerpt from Table 2 of Bebchuk, Brav and Jiang, 2013, p.8.

3 “Intervention” sounds almost like some psychological ministration but in fact merely means that a fund has filed a 13D report stating that it has accumulated 5% of a company’s outstanding shares.

So, the average return on assets (ROA) of 1,584 firms calculated at the time of the “intervention” (that is, some in 1994, some in 1995 and so on until 2007) came out at 2.2% and at t+5, the average ROA of 694 firms is now 4.6%.

But they are not quite comparing apples with apples! Where did the 890 missing firms go? What would be their ROA? Did they disappear because of bankruptcy, acquisitions, liquidation or other discomfitures, with the healthier firms from t=event year, presumably with higher ROA, still around five years later? Or, which companies have been acquired, merged or delisted for whatever reason and what is the impact on overall statistical comparisons? The authors mention “normal” attrition rate without supplying any information about the impact of this attrition on their results.

In Panel B, results for Tobin’s Q are reported, again with the sample shrinking from 1,611 observations to 710 by year 5. The median Q results indicate that the companies did not improve at all for four years and then show a small improvement in year 5 (Q=1.412), presumably (?) due to the “intervention” five years earlier of a hedge fund which has long exited the company. Whatever the case may be the authors report that none of the results in Table 1 are statistically significant.

They then proceed to compile the same statistics but in Table 2 adjusted to take into account the industrial sector. This standard procedure in econometrics serves presumably to eliminate the confounding effect of cross-industry variations. The adjusted metrics represent the average (or median) of the difference between the performance measure of a given firm and the average performance of firms in the same industrial sector (defined by 3-digits SIC code).

Table 2

Industry-Adjusted Operating Performance

Pre- and Post-Intervention

PANEL A : INDUSTRY-ADJUSTED ROA (benchmark = industry average)


page8image16984 page8image17144 page8image17304

t: Event Year t+1

t+2 t+3 t+4 t+5

-0.009 0.002 694
















Average Median Observations

PANEL B: : INDUSTRY-ADJUSTED Q (benchmark = industry average)
t: Event Year t+1 t+2 t+3 t+4 t+5
















Average Median Observations

-0.935 -0.420 710

Source: Excerpt from Table 3 of Bebchuk, Brav and Jiang, 2013, p.9.

Apart from the same observation about the varying sample size over the years, what is most striking about these results is the large number of negative signs. The Tobin’s Q improves but remains decidedly inferior to the mean Q of companies within the same industrial sector.

The median difference in the ROA of 1,584 companies at “intervention” time compared to the mean ROA of companies with the same SIC code came out as (-0.005); that is, these companies in need of the ministrations of hedge funds had a ROA performance minimally under the average performance of the companies in their industry overall. Five years later, the 694 companies remaining from the original sample now show a median ROA difference 0.002. So the positive impact of hedge funds, if that difference were really attributable to their intervention, would amount to going from a performance infinitesimally smaller than industry performance to a performance infinitesimally better than industry performance. These results are reported as “statistically significant” (which merely means that the difference is not zero) but are they significant from a managerial or investment perspective? Yet, that is the basis for the claim of Bebchuck quoted above:

During the five-year period following activist interventions, operating performance relative to peers improves consistently through the end of the period. (Wall Street Journal, August 8th, 2013)

The reduction in sample size between year 1 and year 5 raises significant issues; the authors of the paper should have been more transparent on what happened to the missing cases.

Part of the reason for the discrepancy may be found in another paper by two of the authors writing with Bebchuk. Using the same dataset4, but for the period between 2001 and 2007, Brav, Jiang and Kim (2010) listed the breakdown of various forms of hedge fund exit. Their table reproduced below shows that, on average, close to 13% of the targeted firms disappeared from the sample because they were sold, merged or liquidatedpage9image17384 page9image17544

Table 3

Breakdown of exit


1. Sold shares on the open market
2. Target company sold
3. Target company merged into another
4. Liquidated
5. Shares sold back to the target company 6. Still holding/no Information

Source: Brav, Jiang & Kim (2010), in Hedge Fund Activism: A Review



All Events

29.5% 6.8% 5.2% 0.9% 0.4% 57.1%














4 Curiously, the number of events varies between the two papers for the same period. There were, for the same time period, 1,172 events in the Brav, Jiang & Kim (2010) paper, compared to 1,283 in Table 2 of the Bebchuk, Brav & Jiang (2013) paper.

But there have to be other reasons as the sample in Bebchuk et al. shrinks by more than 50%!

Another reason might be linked to the rate of failed attempts at intervention by hedge funds. There is some evidence that failure rate hovers between 17% and 34% (See Brav, Jiang, Partnoy & Thomas, 2008; Klein & Zur, 2009). How these failed interventions were handled in the Bebchuk et al. paper is unclear. Of course, only “successful” interventions should be included in a study purporting to capture the impact of hedge fund intervention on company performance. Is it the case in the Bebchuk et al. paper? Not clear.

A close examination of their results raises additional questions:

- A higher Tobin’s Q is not a demonstration of a firm’s improved performance (Dybvig and Warachka, 2012). Write-downs of assets, of goodwill, reductions in capital investments and R&D that have no near-term impact on stock price also boost Tobin’s Q. So will selling assets/divisions with low ROA but perhaps high expected growth in profit. For instance, the following figure (Figure 1) shows how an activist hedge fund could pressure management to sell assets D and E, call on them to pay a special dividend or buy back shares with the proceeds. The result would be a large increase in ROA and given a probable increase in stock price as a result, also a large increase in Tobin’s Q. But even if stock price did not increase, Tobin’s Q would still increase substantially. In the longer run though, having been shorn of its growth assets, the company would stagnate.

Figure 1

A company with five assets/divisions

Average ROA of the Firm
Expected Average Growth Rate in Profit

page10image16416 page10image16576 page10image16736 page10image16896 page10image17056 page10image17216 page10image17376 page10image17536

Asset B

Asset C

Asset A

Asset E
Asset D

Expected Growth in Profit


  • -  The adjustment for “industry peers”, a common practice in econometric studies, brings up a host of problems rarely, if ever, mentioned in these econometric studies: in many instances, the “peers” are not really comparable companies; companies often operate in several 3-digit SIC classification; newer types of companies are difficult to classify in this old classification (e.g. Google, Facebook, etc.). Indeed, since 1997, a new system, the North American industrial classification system (NAICS), has been developed to replace SIC codes; “NAICS codes provide a greater level of detail about a firm’s activity than SIC codes… There are 358 new industries recognized in NAICS, 250 of which are services producing industries. Additionally, NAICS codes are based on a consistent, economic concept, while SIC codes are not”. Canada has shifted totally to the NAICS while the U.S. is doing so gradually.
  • -  Bebchuck et al.’s research spans the period 1994 to 2012 during which economic conditions fluctuated wildly, the industrial make-up of the American economy shifted dramatically; yet, as is the standard practice in econometric research, all these influences are deemed captured by “dummy variables”. That may be good enough to publish papers in professional journals but not good enough to get at causality and capture complex relationships; that statistical device is a crude, approximate attempt at taking into account subtle, interactive, non-linear phenomena. The introduction of “firm fixed effect” is particularly questionable; the authors write: In regression (2) we include a dummy for each firm, running a firm fixed effect regression, to account for time-invariant factors unique to each firm. Under such a specification, the coefficients on the key variables, t, t+1,…, t+5, should be interpreted as the excess performance of a target firm, during years t to t+5, over its own all-time average and adjusted for market-wide conditions (due to the year fixed effects). Firm fixed effects automatically subsume industry fixed effects. (Emphasis added). In “Hedge Fund Activism, Corporate Governance, and Firm Performance”, Brav, Jiang, Partnoy & Thomas mention that “for the period 2001 to 2006 [...], the target companies span 183 three-digit SIC code industries.” That means there are at least 182 dummy variables in the regressions for industry fixed effects. The authors never explain how the original sample of 2,040 interventions observed for 8 years (thus leading to some 16,320 observations) turns into some 120,000 observations (!) for the purpose of regression analysis. The paper utterly lacks transparency about the many unobserved decisions made by the authors in the course of their analysis.
  • -  In their regression analysis, the authors use the natural logarithm of the age of the firm as control variable. In the literature, this variable is frequently used; the well-known relationship is that as firms grow older, the ROA tends to decrease. What is interesting to observe is that the coefficient of Ln(Age) is positive and statistically significant on all the regressions using ROA as dependent variable, a result completely at the opposite of what previous studies have established. The authors give no explanation for this surprising result, which may be an indication of a common, but serious, econometric problem called “multicollinearity”, making the interpretation of all coefficients subject to great caution.

- The methodology used by Bebchuk et al. does not provide proof or causal relationships of the benefits of hedge fund “intervention”. [Actually, no econometric study ever does.] For instance, the pattern of changes in ROA and Tobin’s Q reproduced here as Tables 1 and 2 is consistent with typical historical or cyclical patterns of company performance.

The graphs in Figure 2 illustrate this point. By mapping the return on invested capital (ROIC, a close equivalent of ROA) and enterprise value over invested capital (EV/IC, a close equivalent to Tobin’s Q) for 743 firms from 2001 to 2009, McKinsey and Co. found a clear pattern of convergence towards the mean. Firms which showed performances better than average at the beginning of the period tended to do less well eight years later. Firms at the bottom in terms of performance moved closer to the average performance.

The bottom line in these two graphs is virtually identical to the results presented above as Tables 1 and 2 drawn from Bebchuck et al. Yet, there were no generalized hedge fund “intervention” in the data collected by McKinsey; only the dynamic interplay of competition as the advantage of the best-performing firms is eroded by imitation by other firms and best industry practices gradually become the norm and standard for all players (Bradley, Hurt and Smit, 2011).

Figure 2

Market and economic forces drive convergence of performance towards the mean

Markets drive a reversion to mean performance

Performance cohorts based on position in 2001 relative to mean, n = 743*

Return on invested capital (ROIC), %

Ratio of enterprise value to invested capital (EV/IC)

3.5 3.0 2.5 2.0 1.5 1.0 0.5

0 –0.5 –1.0 –1.5

2001 2003 2005 2007 2009

Bottom quintile

20 15 10


0 –5 –10 –15





Middle quintile


page13image13648 page13image13968 page13image14128 page13image14448 page13image14608 page13image15192 page13image15352 page13image15512 page13image15672 page13image15832 page13image15992 page13image16152 page13image16312 page13image16472 page13image16632 page13image16792 page13image16952 page13image17112 page13image17272 page13image17432 page13image17592 page13image17752

Top quintile

page13image18400 page13image18560 page13image18720

*Sample of largest 1,200 nonfinancial US-listed companies in 2009 was narrowed to 743 that were also listed in 2001. Source: Standard & Poor’s Compustat; McKinsey analysis


The authors of the paper claim that, not only does the stock price of targeted companies increases in the short term, but that this price increase persists for 36 months or 60 months after the “intervention”.

They never show actual stock prices but proceed by statistical estimations of “alpha” in the well- known capital asset pricing models (CAPM) and the Fama-French four-factor model. This “alpha” is supposed to capture the value added over and above the market risk and other factors that may influence stock price.

Again, the number of treatments5, estimations and assumptions going into producing their results are mind-numbing. Here’s an example:

Specifically, for each event, we compute the buy-and-hold return over a predetermined holding period after the intervention net of a benchmark return that is meant to capture the event firm’s expected return. In particular, for each event firm, we use information on its pre-event market capitalization and book-to-market to match it to one of the Fama and French 25 size and book-to- market value-weight portfolios. [Question: why is a company’s future stock performance supposed to behave in the same way as companies that have similar market capitalization and book-to-market valuation, but may come from different industries?]

Since the target firm’s market capitalization and book to market ratio change over the subsequent holding period we allow the benchmark portfolio to change by using the new firm attributes in every subsequent year. [So, every year the stock market performance of the target firm is compared to that of a new set of companies!] In those cases in which a target firm is missing a book to market ratio in a given year we impute the value from the previous year and if, missing, two years earlier. [What is the impact of this treatment?] Finally, if a target firm delists prior to the chosen investment horizon we reinvest the proceeds in the market portfolio (the Fama and French value weight portfolio, “RM”) and similarly reinvest the benchmark return to that point in the market as well. [How many target firms were delisted? What is the “proceeds”? How many were delisted because of acquisitions? How does the study take into consideration the fact that these acquired companies would have benefited from a control premium? What were the consequences of this treatment on results?] (Bebchuk et al., 2013)

After an examination of these statistical treatments, assumptions and approximations, the “scientific” character of these empirical studies appears dubious. Perhaps, Bebchuk should not be so dismissive of actual real-world experience.

5 It is curious that for their estimation of stock price performance, the authors manage to retain some 1397 firms after five years but for the ROA/Q computations reported in Tables 1 and 2, the number of cases dropped to 694 and 710 after five years. Can it be that more than 600 companies were “delisted” and the authors “reinvest the proceeds in the market portfolio and similarly reinvest the benchmark return to that point in the market as well”? The net effect of these treatments cannot be assessed without more information. Some explanation and detailed divulgation would have been welcome here.


The Bebchuk et al. paper is discreet about the length of time that hedge funds remain engaged with target companies. But, in another study based on the same data set, the authors, Brav, Jiang and Kim (2010) provide this useful information: the duration (in days) of hedge fund activists’ investment in target companies.

The results reproduced in the Table 4 below show that half of the interventions, from the first Schedule 13D filing to divestment, had duration of 266 days or less (not even 9 months). Claiming that these are long-term “investors” seems a bit of a stretch. It is even more of a stretch to credit these activist funds for a favourable, enduring effect on the performance of a firm 3 to 4 years after their departure.

page15image8296 page15image8456

Table 4

Length of Holding Period (Days) for Completed Spells


5% 25% 50% 75% 95%

Hostile (Initial)

Non-hostile (Initial)

All Events

22 126 266 487 1,235











Source: Brav, Jiang & Kim (2010), in Hedge Fund Activism: A Review


Assuming for a moment that “interventions” by activist hedge funds produce positive (or “abnormal”) returns at least in the short term6 and possibly in the longer term, the question becomes: where did this added value come from? Certainly the data reported above on the ROA improvement do not explain stock price improvement.

Several studies actually show that there is no “creation” of value, but rather a “transfer” of value in favour of the shareholders from employees (Brav, Jiang and Kim, 2010, 2013) and bondholders (Klein and Zur, 2009).

Brav, Jiang and Kim (2013), two of them co-authors of the Bebchuk paper and thus strong supporters of the benefits of activist hedge funds, must nevertheless acknowledge that:

Overall, results in this section suggest that target firm workers do not share in the improvements associated with hedge fund activism. They experience a decrease in work hours and stagnation in wages, while their productivity improves significantly. Moreover, the relative decrease in productivity-adjusted wages from above-par levels suggests that hedge fund activism facilitates a transfer of “labor rents” to shareholders which may account for part of the positive abnormal return at the announcement of hedge fund interventions. (Brav et al, 2013, p.22, emphasis added)

This “admission” provides a counterpoint to the fawning description of the whole undertaking:

create value for shareholders by taking it from workers!

Other studies show that the value created for shareholders comes in part at the expense of bond holders.

“For our sample, on average, bondholders lose an average excess return of -3.9% around the initial 13D filing, and an additional -4.5% over the remaining year after the filing date…We also find evidence suggesting an expropriation of wealth from the bondholder to the shareholder”. (Klein and Zur, 2009)

Aslan and Maraachlian (2009) also claim that existing bonds of companies that were targeted by the activist investors performed more poorly than a portfolio of comparable bonds by a difference of 5% per year on average for the two years following the announcement of the intervention, in addition to being more likely to undergo a ratings downgrade.

“Collectively, our results indicate that activism is viewed negatively by bondholders in the long-run and that part of the overall gain to stockholders is the result of a wealth transfer from bondholders”. (Aslan and Maraachlian, 2009)

These empirical results reveal a more sombre reality than that painted by the new admirers of these activist “benefactors”.

6 The more academic researchers claim to have proven the benefits to shareholders from “activist interventions”, the more likely and the stronger will markets react to the news that a hedge fund has taken a position in a target company!


What conclusions can one draw from these various considerations?

First, Bebchuk et al. have not demonstrated that activist hedge funds, per se, create lasting, long- term value and bring a long-term perspective to their “activism”. They have merely shown some contorted statistical relationships to provide some (weak) support to their thesis.

Their paper provides little “scientific” support for their categorical final recommendation:

“Policymakers and institutional investors should not accept the validity of the frequent assertions that activist interventions are costly to firms and their long-term shareholders in the long term. They should reject the use of such claims as a basis for limiting the rights and involvement of shareholders.”

Policy makers should weigh the experience and expertise of knowledgeable people rather more than tortured statistics.

Secondly, the most generous conclusion one may reach from these empirical studies has to be that “activist” hedge funds create some short-term wealth for some shareholders (and immense riches for themselves) as a result of investors, who believe hedge fund propaganda (and some academic studies), jumping in the stock of targeted companies. In a minority of cases, activist hedge funds may bring some lasting value for shareholders but largely at the expense of workers and bond holders; thus, the impact of activist hedge funds seems to take the form of wealth transfer rather than wealth creation.

Thirdly, “activist” hedge funds operate in a world without any other stakeholder than shareholders. That is indeed a myopic concept of the corporation bound to create social and economic problems, were that to become the norm for publicly listed corporations.

Finally, the Bebchuk et al. paper illustrates the limits of the econometric tool kit, its weak ability to cope with complex phenomena; and when it does try to cope, it sinks quickly into opaque computations, remote from the observations on which these computations are supposedly based.


  • -  Aslan, H. & H. Maraachlian. (2009) “Wealth Effects of Hedge Fund Activism”. SSRN Working Paper Series.
  • -  Bebchuk, L. A., A. Brav & W. Jiang. (2013) “The long-term effects of hedge fund activismColumbia Business School, July, 40p.
  • -  Becht, M., J. Franks, J. Grant & H. Wagner. “The Returns to Hedge Fund Activism:
    An International Study
    ”. European Corporate Governance Institute Working Paper Series in Finance, No 402/2014.
  • -  Borstadt, L. & T. Zwirlein. (1992) “The Efficient Monitoring Role of Proxy Contests: An Empirical Analysis of Post-Contest Control Changes and Firm Performance”. Financial Management, Vol. 21, No. 3.
  • -  Bradley, C, M. Hirt & S. Smit. (2011) “Have you tested your strategy lately?”. McKinsey Quarterly, January.
  • -  Bratton, William W. “Hedge Funds and Governance Targets”. Georgetown Law Journal, Vol. 95, p. 1375; SSRN No 928689, August 11, 2010
  • -  Brav, A. W. Jiang & H. Kim. (2013) “The Real Effects of Hedge Fund Activism: Productivity, Asset Allocation, and Industry Concentration”.
    SSRN Working Paper Series.
  • -  Brav, A., W. Jiang, F. Partnoy & R. Thomas (2008) “Hedge Fund Activism, Corporate Governance and Firm Performance”. The Journal of Finance, Vol. 63, no. 4, 1729-1775.
  • -  Brav, A., W. Jiang & H. Kim. (2010). “Hedge Fund Activism: A Review”. SSRN Working Paper Series.
  • -  Brav, Alon, Michael Bradley, Itay Goldstein and Wei Jiang, “Shareholder Activism and Price Dynamics: Evidence from Closed-End Funds”, Duke University, University of Pennsylvania, and Columbia University, Working paper 2007
  • -  Dos Santos, J. & C. Song. (2009). Analysis of the Wealth Effects of Shareholder Proposals – Volume II. U.S. Chamber of Commerce, May, 25p.
  • -  Dybvig, P. H. & M. Warachka (2012). “Tobin’s q Does Not Measure Firm Performance: Theory, Empirics, and Alternative Measures”. SSRN Working Paper Series.
  • -  Fleming, M. J. (1995) “New Evidence on the Effectiveness of the Proxy MechanismFederal Reserve Bank of New York, Research Paper No. 9503.


page18image18704 page18image18864 page18image19024 page18image19184 page18image19344 page18image19504 page18image19664 page18image19824 page18image19984 page18image20144 page18image20304 -  Greenwood, R. & M. Schor. (2007) “Hedge fund investor activism and takeoversHarvard Business School, July, 08-004.

  • -  Ikenberry, D. & J. Lakonishok. (1993) “Corporate Governance through the Proxy Contest. Evidence and Implications.” Journal of Business, vol 66, no 3, 405-435.
  • -  Ingraham, A. T. & A. Koyfman. (2013) Analysis of the Wealth Effects of Shareholder Proposals – Volume III. U.S. Chamber of Commerce, May, 25p.
  • -  Karpoff, J. M., P. H. Malatesta & R. A. Walkling. (1996) “Corporate Governance and Shareholder Initiatives: Empirical Evidence”. Journal of Financial Economics,
    Vol. 42, 365-395.
  • -  Klein, A. & E. Zur (2009). The Impact of Hedge Fund Activism on the Target Firm’s Existing Bondholders. SSRN Working Paper Series.
  • -  Lipton, M. (2007) “Shareholder Activism And The ‘Eclipse of The Public Corporation’The Corporate Board, May/June.
  • -  Lipton, M. (2013a). “Empiricism and Experience; Activism and Short-Termism; the Real World of Business”. The Harvard Law School Forum on Corporate Governance and Financial Regulation, October 28.
  • -  Lipton, M. (2013b). “The Bebchuk Syllogism”. The Harvard Law School Forum on Corporate Governance and Financial Regulation, August 26.
  • -  Macey, J. & E. Buckberg (2009). Report on Effects of Proposed SEC Rule 14a-11 on Efficiency, Competitiveness and Capital Formation. NERA Economic Consulting, August 17, 29p.
  • -  Prevost, A. K. & R. P Rao. (2000). “Of What Value Are Shareholder Proposals Sponsored by Public Pension Funds”. The Journal of Business, Vol. 73, No. 2.
  • -  Romano, R. (2001). “Less is More: Making Institutional Shareholder Activism a Valuable Mechanism of Corporate Governance”. Yale Law School, Faculty Scholarship Series. Paper 1916.
  • -  Strine, Jr., L. E. (2010). “One Fundamental Corporate Governance Question We Face: Can Corporations Be Managed for the Long Term Unless Their Powerful Electorates Also Act and Think Long Term?” 66 Business Lawyer 1, November, 32p.
  • -  Strine, Jr., L. E. (2014). “Can we do better by ordinary investors? A pragmatic reaction to the dueling ideological mythologists of corporate law”. Columbia Law Review, Vol. 114, 449-502.
  • -  Wahal, S. (1996). “Pension Fund Activism and Firm Performance”. Journal of Financial Quantitative Analysis, Vol. 31, No. 1, 1-23.


Created in 2005 by two academic institutions (HEC Montréal and Concordia University – The John Molson School of Business) and the Stephen Jarislowsky Foundation, the Institute for governance (IGOPP) has become a centre for excellence about governance of public and private organizations. Through research, training programs, policy papers and participation in public debates, IGOPP has become a key reference on all issues of governance in the private and public sectors.

  • This article is available online in PDF format at © 2014, IGOPP. All Right Reserved.


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SEC Issues Proxy Voting Responsibilities of Investment Advisers

Division of Investment Management
Division of Corporation Finance
Securities and Exchange Commission

Proxy Voting:  Proxy Voting Responsibilities of Investment Advisers and Availability of Exemptions from the Proxy Rules for Proxy Advisory Firms

Staff Legal Bulletin No. 20 (IM/CF)

Action: Publication of IM/CF Staff Legal Bulletin

Date: June 30, 2014

Summary: The Division of Investment Management is providing guidance about investment advisers’ responsibilities in voting client proxies and retaining proxy advisory firms.  The Division of Corporation Finance is providing guidance on the availability and requirements of two exemptions to the federal proxy rules that are often relied upon by proxy advisory firms.

Supplementary Information: The statements in this bulletin represent the views of the Division of Investment Management and the Division of Corporation Finance.  This bulletin is not a rule, regulation or statement of the Commission.  Further, the Commission has neither approved nor disapproved its content.

Contacts: For further information relating to investment advisers, please contact the Division of Investment Management’s Office of Chief Counsel by calling (202) 551-6825 or by e-mailing  For further information relating to the proxy rules, please contact the Division of Corporation Finance’s Office of Chief Counsel by calling (202) 551-3500 or by submitting a web-based request form at

Question 1.  As a fiduciary, an investment adviser owes each of its clients a duty of care and loyalty with respect to services undertaken on the client’s behalf, including proxy voting.1  Further, the Commission’s rules provide that it is a fraudulent, deceptive, or manipulative act, practice, or course of business for an investment adviser registered or required to be registered with the Commission to exercise voting authority with respect to client securities unless the adviser, among other things, adopts and implements written policies and procedures that are reasonably designed to ensure that the investment adviser votes proxies in the best interest of its clients (“Proxy Voting Rule”).2  What steps could an investment adviser take to seek to demonstrate that proxy votes are cast in accordance with clients’ best interests and the adviser’s proxy voting procedures?

Answer.  Compliance could be demonstrated by, for example, periodically sampling proxy votes to review whether they complied with the investment adviser’s proxy voting policy and procedures.  The investment adviser also could specifically review a sample of proxy votes that relate to certain proposals that may require more analysis.  In addition, as part of an investment adviser’s ongoing compliance program, it should review, no less frequently than annually, the adequacy of its proxy voting policies and procedures to make sure they have been implemented effectively, including whether these policies and procedures continue to be reasonably designed to ensure that proxies are voted in the best interests of its clients.3

Question 2.  Is an investment adviser required to vote every proxy?

Answer.  The Proxy Voting Rule does not require that investment advisers and clients agree that the investment adviser will undertake all of the proxy voting responsibilities.  We understand that in most cases, clients delegate to their investment advisers the authority to vote proxies relating to equity securities.4  We further understand that, in general, clients usually delegate this authority completely, without retaining authority to vote any of the proxies.  The staff notes that investment advisers and their clients also may agree to this type of delegation, as well as other proxy voting arrangements in which the adviser would not assume all of the proxy voting authority.    Some agreements between investment advisers and their clients may include the following arrangements:

  • An investment adviser and its client may agree that the time and costs associated with the mechanics of voting proxies with respect to certain types of proposals or issuers may not be in the client’s best interest.
  • An investment adviser and its client may agree that the investment adviser should exercise voting authority as recommended by management of the company or in favor of all proposals made by a particular shareholder proponent, as applicable, absent a contrary instruction from the client or a determination by the investment adviser that a particular proposal should be voted in a different way if, for example, it would further the investment strategy being pursued by the investment adviser on behalf of the client.
  • An investment adviser and its client may agree that the investment adviser will abstain from voting any proxies at all, regardless of whether the client undertakes to vote the proxies itself.
  • An investment adviser and its client may agree that the investment adviser will focus resources on only particular types of proposals based on the client’s preferences.

As these non-exclusive examples demonstrate, an investment adviser and its client have flexibility in determining the scope of the investment adviser’s obligation to exercise proxy voting authority. 5  We reiterate, however, that an investment adviser that assumes proxy voting authority must do so in compliance with the Proxy Voting Rule.

Question 3.  What are some of the considerations that an investment adviser may wish to take into account if it retains a proxy advisory firm to assist it in its proxy voting duties?

Answer.  When considering whether to retain or continue retaining any particular proxy advisory firm to provide proxy voting recommendations, the staff believes that an investment adviser should ascertain, among other things, whether the proxy advisory firm has the capacity and competency to adequately analyze proxy issues.6  In this regard, investment advisers could consider, among other things: the adequacy and quality of the proxy advisory firm’s staffing and personnel; the robustness of its policies and procedures regarding its ability to (i) ensure that its proxy voting recommendations are based on current and accurate information and (ii) identify and address any conflicts of interest and any other considerations that the investment adviser believes would be appropriate in considering the nature and quality of the services provided by the proxy advisory firm.

Question 4.  Does an investment adviser have an ongoing duty to oversee a proxy advisory firm that it retains?

Answer.  The staff believes that an investment adviser that has retained a third party (such as a proxy advisory firm) to assist with its proxy voting responsibilities should, in order to comply with the Proxy Voting Rule, adopt and implement policies and procedures that are reasonably designed to provide sufficient ongoing oversight of the third party in order to ensure that the investment adviser, acting through the third party, continues to vote proxies in the best interests of its clients. 7  In addition, the staff notes that a proxy advisory firm’s business and/or policies and procedures regarding conflicts of interest could change after an investment adviser’s initial assessment, and some changes could alter the effectiveness of the policies and procedures and require the investment adviser to make a subsequent assessment.  Consequently, the staff has stated that investment advisers should establish and implement measures reasonably designed to identify and address the proxy advisory firm’s conflicts that can arise on an ongoing basis,8 such as by requiring the proxy advisory firm to update the investment adviser of business changes the investment adviser considers relevant  (i.e., with respect to the proxy advisory firm’s capacity and competency to provide proxy voting advice) or conflict policies and procedures.

Question 5.  What are an investment adviser’s duties when it retains a proxy advisory firm with respect to the material accuracy of the facts upon which the proxy advisory firm’s voting recommendations are based?

Answer.  As stated above, it is the staff’s position that an investment adviser that receives voting recommendations from a proxy advisory firm should ascertain that the proxy advisory firm has the capacity and competency to adequately analyze proxy issues, which includes the ability to make voting recommendations based on materially accurate information.9  For example, an investment adviser may determine that a proxy advisory firm’s recommendation was based on a material factual error that causes the adviser to question the process by which the proxy advisory firm develops its recommendations.   In such a case, the staff believes that the investment adviser should take reasonable steps to investigate the error, taking into account, among other things, the nature of the error and the related recommendation, and seek to determine whether the proxy advisory firm is taking reasonable steps to seek to reduce similar errors in the future.

Question 6.  When is a proxy advisory firm subject to the federal proxy rules?

Answer.  A proxy advisory firm would be subject to the federal proxy rules when it engages in a “solicitation,” which is defined under Exchange Act Rule 14a-1(l) to include “the furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.”  As a general matter, the Commission has stated that the furnishing of proxy voting advice constitutes a “solicitation” subject to the information and filing requirements of the federal proxy rules.10  Providing recommendations that are reasonably calculated to result in the procurement, withholding, or revocation of a proxy would subject a proxy advisory firm to the proxy rules.  Exchange Act Rule 14a-2(b) provides exemptions from the information and filing requirements of the federal proxy rules that a proxy advisory firm may rely upon if it meets the requirements of the exemptions.

Question 7.  Where a shareholder (such as an institutional investor) retains a proxy advisory firm to assist in the establishment of general proxy voting guidelines and policies and authorizes the proxy advisory firm to execute a proxy or submit voting instructions on its behalf, and permits the proxy advisory firm to use its discretion to apply the guidelines to determine how to vote on particular proposals, may the proxy advisory firm providing such services rely on the exemption from the proxy rules in Exchange Act Rule 14a-2(b)(1)?

Answer.  No.  Rule 14a-2(b)(1) provides an exemption from most provisions of the federal proxy rules for “any solicitation by or on behalf of any person who does not, at any time during such solicitation, seek directly or indirectly, either on its own or another’s behalf, the power to act as a proxy for a security holder and does not furnish or otherwise request, or act on behalf of a person who furnishes or requests, a form of revocation, abstention, consent or authorization.”  The exemption would not be available for a proxy advisory firm offering a service that allows the client to establish, in advance of receiving proxy materials for a particular shareholder meeting, general guidelines or policies that the proxy advisory firm will apply to vote on behalf of the client.

In this instance, the proxy advisory firm would be viewed as having solicited the “power to act as a proxy” for its client.  This would be the case even if the authority was revocable by the client.

Question 8.  If a proxy advisory firm only distributes reports containing recommendations, would it be able to rely on the exemption in Rule 14a-2(b)(1)?

Answer.  Yes.  To the extent that a proxy advisory firm limits its activities to distributing reports containing recommendations and does not solicit the power to act as proxy for the client(s) receiving the recommendations, the proxy advisory firm would be able to rely on the exemption, so long as the other requirements of the exemption are met.

Question 9.  To the extent that Rule 14a-2(b)(1) is not available to a proxy advisory firm, either for the reason specified in the answer to Question 7 or otherwise, is there any other exemption from the proxy rules that might apply?

Answer.  Yes.  Exchange Act Rule 14a-2(b)(3) exempts the furnishing of proxy voting advice by any person to another person with whom a business relationship exists, subject to certain conditions. 11  The exemption is available if the person gives financial advice in the ordinary course of business; discloses to the recipient of the advice any significant relationship with the company or any of its affiliates, or a security holder proponent of the matter on which advice is given, as well as any material interests of the person in such matter; receives no special commission or remuneration for furnishing the advice from any person other than the recipient of the advice and others who receive similar advice; and does not furnish the advice on behalf of any person soliciting proxies or on behalf of a participant in a contested election.

Question 10.  If a proxy advisory firm provides consulting services to a company on a matter that is the subject of a voting recommendation or provides a voting recommendation to its clients on a proposal sponsored by another client, would the proxy advisory firm be precluded from relying on Rule 14a-2(b)(3)?

Answer.  In order to rely on Rule 14a-2(b)(3), a proxy advisory firm would need to first assess whether its relationship with the company or security holder proponent12 is significant or whether it otherwise has any material interest in the matter that is the subject of the voting recommendation and disclose to the recipient of the voting recommendation any such relationship or material interest.  Whether a relationship would be “significant” or what constitutes a “material interest” will depend on the facts and circumstances.  In making such a determination, a proxy advisory firm would likely consider the type of service being offered to the company or security holder proponent, the amount of compensation that the proxy advisory firm receives for such service, and the extent to which the advice given to its advisory client relates to the same subject matter as the transaction giving rise to the relationship with the company or security holder proponent.  A similar inquiry would be made for any interest that might be material.  A relationship generally would be considered “significant” or a “material interest” would exist if knowledge of the relationship or interest would reasonably be expected to affect the recipient’s assessment of the reliability and objectivity of the advisor and the advice.

Question 11.  If a proxy advisory firm determines that it has a significant relationship or a material interest that requires disclosure for purposes of relying on Rule 14a-2(b)(3), what must it disclose?

Answer.  The proxy advisory firm must provide the recipient of the advice with disclosure that provides notice of the presence of a significant relationship or a material interest.  We do not believe that boilerplate language that such a relationship or interest may or may not exist provides such notice.  In addition, we believe the disclosure should enable the recipient to understand the nature and scope of the relationship or interest, including the steps taken, if any, to mitigate the conflict, and provide sufficient information to allow the recipient to make an assessment about the reliability or objectivity of the recommendation.

Question 12.  Does the disclosure requirement in Rule 14a-2(b)(3) permit a proxy advisory firm to state only that information about significant relationships or material interests will be provided upon request?

Answer.  No.  Rule 14a-2(b)(3) imposes an affirmative duty to disclose significant relationships or material interests to the recipient of the advice.  We do not believe that providing the information upon request would satisfy the requirement in the rule.

Question 13.  Does disclosure of a significant relationship or material interest have to be provided in a document that conveys a voting recommendation or advice, such as the proxy advisory firm’s report about a company, and must it be publicly available?

Answer.  Rule 14a-2(b)(3) does not specify where the required disclosure should be provided.  A proxy advisory firm should provide the disclosure in such a way as to allow the client to assess both the advice provided and the nature and scope of the disclosed relationship or interest at or about the same time that the client receives the advice.  This disclosure may be made publicly or between only the proxy advisory firm and the client.

*    *    *    *    *

The staff recognizes that investment advisers and proxy advisory firms may want or need to make changes to their current systems and processes in light of this guidance.  The staff expects any necessary changes will be made promptly, but in any event in advance of next year’s proxy season.

1 Proxy Voting by Investment Advisers, Release No. IA-2106, at n. 2 and accompanying text (Jan. 31, 2003) (“Proxy Voting Release”), citing SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963) (interpreting Section 206 of the Investment Advisers Act of 1940 (“Advisers Act”)).

2 Rule 206(4)-6 under the Advisers Act.

3 See Rule 206(4)-7 under the Advisers Act (e.g., requiring investment advisers to adopt and implement written policies and procedures reasonably designed to prevent violation, by the adviser and its supervised person, of the Advisers Act).  See also Rule 38a-1 under the Investment Company Act of 1940 (“1940 Act”) (e.g., requiring each registered investment company to adopt and implement written policies and procedures reasonably designed to prevent violation of the federal securities laws by the fund, including policies and procedures that provide for the oversight of compliance by the registered investment company’s investment adviser, among others).

4 See Proxy Voting Release.

5 See id. at n. 19 (“The scope of an adviser’s responsibilities with respect to voting proxies would ordinarily be determined by the adviser’s contracts with its clients, the disclosures it has made to its clients, and the investment policies and objectives of its clients.”)

6 See Egan-Jones Proxy Services, SEC Staff Letter (May 27, 2004) (“Egan-Jones”) and Institutional Shareholder Services, Inc., SEC Staff Letter (Sept. 15, 2004) (“ISS”).

7 See Rule 206(4)-7 under the Advisers Act and Rule 38a-1 under the 1940 Act.

8 See Egan-Jones and ISS.

9 Id.

10 See Shareholder Communications, Shareholder Participation in the Corporate Electoral Process and Corporate Governance Generally, Release No. 34-16104 (Aug. 13, 1979).

11 In 1992, the Commission noted that “advice given with respect to matters subject to a shareholder vote by . . . proxy advisory services in the ordinary course of business is covered by the exemption provided by [Rule 14a-2(b)(3)], so long as the other requirements of that exemption are met.”  SeeRegulation of Communications Among Shareholders, Release No. 34-31326 (Oct. 16, 1992).

12 Rule 14a-8 does not require that the identity of the shareholder proponent be disclosed in the proxy statement.  Therefore, there may be instances in which the proxy advisory firm has no knowledge that the proponent is a client.  In such a case, we do not believe that there would be a duty to investigate who the proponent is.  To the extent that the identity of the proponent is unknown, there is little concern that the relationship would affect the proxy advisory firm’s recommendation regarding that proposal.

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Veritas Executive Compensation Consultants
June 23, 2014
So far this proxy season, 2,602 companies have held Say on Pay votes. Of the 2,602 companies, 49 companies failed their Say on Pay with an average 60% “Against” vote, 73% of companies received greater than 90% “For” vote, and the average “For”, “Against” and “Abstain” votes among all companies was 90.5%, 8.0% and 1.5% respectively. The results, broken down by Revenue, Market Cap and Industry are summarized below. 
Of the 49 companies that failed their Say on Pay vote this year, 14 failed votes in previous years, 35 had 1 year total shareholder returns of over 10%, and 15 companies received 90% “For” votes in 2013. A full list of companies that failed Say on Pay in 2014 thus far can be viewed below. 
Since 2011 (when Say on Pay became mandatory), the reasons for companies failing Say on Pay have remained much the same, with Problematic Pay Practices, Pay and Performance, and Rigor of Performance Goals being the most problematic issues.
Veritas Executive Compensation Consultants, (“Veritas”) is a truly independent executive compensation consulting firm. 
We are independently owned, and have no entangling relationships that may create potentialconflict of interest scenarios, or may attract the unwanted scrutiny of regulators, shareholders, the media, or create public outcry.  
Veritas goes above and beyond to provide unbiased executive compensation counsel. Since we are independently owned, we do our job with utmost objectivity – without any entangling business relationships. 
Following stringent best practice guidelines, Veritas works directly with boards and compensation committees, while maintaining outstanding levels of appropriate communication with senior management. 
Veritas promises no compromises in presenting the innovative solutions at your command in the complicated arena of executive compensation. 
We deliver the advice that you need to hear, with unprecedented levels of responsive client service and attention. 

Visit us online at, or contact our CEO Frank Glassner personally via phone at (415) 618-6060, or via email at He’ll gladly answer any questions you might have. For your convenience, please click here for Mr. Glassner’s contact data, and click here for his bio.

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Renewed Focus on Corporate Director Tenure

By David A. Katz and Laura A. McIntosh

United States and abroad. U.S. public companies generally do not have spe-cific term limits on director service, though some indicate in their bylaws a “mandatory” retirement age for directors—typically between 72 and 75—which can generally be waived by the board of directors. Importantly, there are no regulations or laws in the United States under which a long tenure would, by itself, prevent a director from qualify-ing as independent.

Institutional Shareholder Services (ISS) and other shareholder activist groups are beginning to include director tenure in their checklists as an element of direc-tor independence and board composition. Yet even these groups acknowledge that there is no ideal term limit applicable to all directors, given the highly fact-specific context in which an individual director’s tenure must be evaluated. In our view, director tenure is an issue that is best left to boards to address individually, both as to board policy, if any, and as to specific directors, should the need arise. Boards should and do engage in annu-al director evaluations and self-assessment, and shareholders are best served when they do not attempt to artificially constrain the board’s ability to exercise its judgment and dis-cretion in the best interests of the company. In addition, much the same way boards con-sider CEO succession issues, boards are beginning to address director succession issues as well.

Director Tenure in the United States

According to executive recruiting firm SpencerStuart, the average tenure of directors at S&P 500 companies in 2013 and 2012 was 8.6 years.1 The average tenure of CEOs was close, at 7.2 years, in both 2013 and 2012.2 ISS reports that the average tenure of S&P 1500 directors was 10.8 years in 2013, an increase from 10.3 years in 2012.3

Very few U.S. companies—only 3 percent of the S&P 500—have term limits for directors, none of which is less than 10 years.4

There appears to be a recent trend toward raising retirement ages and ex-tending board service as valuable directors grow older. In the S&P 500, over the last 10 years, the percentage of boards with a mandatory retirement age of 70 has decreased from 51 percent to 11 percent, while the percentage of boards with a mandatory retirement age of 75 or greater has increased from 3 percent to 24 percent.5 Meanwhile, the average age of independent directors in this group has increased from 60 to 63.6 Board turnover was reported last year to be at a 10-year low; one source reports that 291 board seats turned over at S&P 500 companies in 2012, as compared to 401 in 2002.7

Despite these trends, boards are steadily becoming more diverse.8 Long tenure is often cited as an obstacle to achieving board diversity,9 yet current patterns of tenure and retirement have not prevented increases in gender and racial diversity on U.S. boards. The number of women directors continues to rise; at S&P 500 companies, the percentage with at least one woman director has grown in the last decade from 85 percent to 93 percent, and the total percentage of women directors has increased from 13 percent to 18 percent.10 Minority representation has also increased in this timeframe, as has the percentage of independent directors of non-U.S. origin.11

In the United States and Canada, regulators have wisely refrained from adopting guidelines regarding director tenure. Long tenure on a corporate board histori-cally has been understood—and demonstrated—to be an asset to board effectiveness and a feature that goes hand-in-hand with solid corporate performance and good management. Having a core group of long-term directors has been seen as beneficial to board dynamics as well as to the relationship between the board and management.

12 According to some estimates, new directors require between three and five years to acquire sufficient com-pany-specific knowledge,13 with more time required for directors of companies with complex operations and more intangible assets.14 Long-serving outside directors thus are highly valued for their experience and organizational memory. Often, they have made important and useful industry connections over the course of their careers. Such directors frequently have gained a deep understanding of the relevant industry, and in board dis-cussions they can offer historical context for consideration in corporate strategic deci-sionmaking. These resources are particularly valuable to a company whose business is highly complex or whose significant projects have unusually long-term horizons for completion.15

In recent years activists’ attempts to micromanage the boardroom have begun to complicate the traditional view. Boards with many long-serving directors are now described as “entrenched” and deaf to shareholder concerns.16 Critics posit that old-er directors—who are typically the longer-tenured directors—can no longer keep current with respect to industrial or technological developments and are unable to offer new in-sights into corporate issues; they fear that these directors may hold fossilized positions that are no longer relevant in the changing economic and business environment.17 Some argue that extended board service can create a culture of undue deference to management, particularly in cases where the chief executive also has held the position for many years. While these may be valid concerns in isolated situations, it is often the case that older directors are among the savviest and most skilled board members, and that long-tenured directors may be in the best position to manage a powerful chief executive by virtue of their shared history and many years of building trust and collegiality together. Whether the advantages outweigh the disadvantages of long tenure for any given director on any particular board ultimately can only be evaluated by considering the specific circum-stances. As with many other important elements of corporate governance, in matters of director tenure, one size does not fit all.

Director Tenure Abroad

A growing number of countries have adopted tenure-related guidelines or restrictions for independent directors.18 With very few exceptions, the “comply and ex-plain” model prevails, and the recommended maximum tenure for a corporate director is between nine and 12 years. The European Commission recommends that independent directors serve a maximum of three terms or twelve years.19 In the United Kingdom, the UK Corporate Governance Code (formerly known as the Combined Code) provides that a board should explain, in its annual disclosures, its reasons for determining that a director who has served more than nine years qualifies as independent.20 The average tenure of a UK director is less than five years.21 In Hong Kong, an independent director is limited to a three-term, nine-year maximum tenure unless shareholders separately vote on a resolu-tion permitting re-appointment, which should include the board’s justification for deter-mining his or her independence.22 Singapore recommends “rigorous review” of the in-dependence of a director who has served more than nine years, and the board is expected to explain any determination of independence in such case.23 In France, the only country with a mandatory regime, directors may not be deemed independent after the end of a

term in which they reach 12 years of service on the board.

24 The French rule creates an effective term limit, as longer-serving directors are not eligible for audit committee membership or other board roles left to independent directors.

In Australia, a recent move toward a recommended term limit was quashed by significant opposition. The Australia Stock Exchange Governance Council, an advisory committee that includes business, shareholder, and industry groups, last year proposed a “comply or explain” guideline that ASX-listed companies’ independent direc-tors be limited to nine years of service. Reportedly, pressure from several of the coun-try’s largest companies resulted in the Council’s dropping the tenure restriction in its fi-nal guidelines.25 The final report incorporates references to tenure limits, recommending that one factor to be considered in assessing director independence is whether the indi-vidual “has been a director of the entity for such a period that his or her independence may have been compromised.”26 The commentary expands on this point: “The mere fact that a director has served on a board for a substantial period does not mean that he or she has become too close to management to be considered independent. However, the board should regularly assess whether that might be the case for any director who has served in that position for more than ten years.”27 According to one source, 21 percent of nonex-ecutive directors at the top 50 listed companies in Australia have directors who had served at least nine years.28 The Australian episode demonstrates that strong opposition to director tenure limits still exists abroad despite the increasing international popularity of such policies.

Academic Studies

Academic researchers have examined the question of whether there is an optimal length of tenure for outside directors, with varying results. Studies from the 1980s through the 2000s have shown, for example, that longer tenure tends to increase director independence because it fosters camaraderie and improves the ability of directors to evaluate management without risking social isolation.29 A 2010 study confirmed that companies with high average board tenure (roughly eight or more years) performed better

than those companies with lower average board tenure, and that companies with diverse board tenure performed better than those with homogeneity in tenure.

30 A 2011 study, by contrast, examined a sample of S&P 1500 boards and found that long-serving directors (roughly six or more years)—as well as directors who served on many boards, older di-rectors, and outside directors—were more likely to be associated with corporate govern-ance problems at the companies they served.31 One 2012 study found that boards with a higher proportion of long-serving outside directors were more effective in fulfilling their monitoring and advising responsibilities,32 while another 2012 study found that having inside directors increased a board’s effectiveness in monitoring real earnings manage-ment and financial reporting behavior, presumably due to their superior firm-specific knowledge and operational sophistication.33 On the related topic of board turnover, a recent study of S&P 500 companies from 2003 to 2013 found that companies that re-placed three or four directors over the three-year period outperformed their peers.34 The study found further that two-thirds of companies did not experience this optimal turnover and that the worst-performing companies had either no director changes at all or five or more changes during the three-year period.35

A 2013 study on director tenure by a professor from the INSEAD Busi-ness School has received significant attention. The study hypothesizes that there is a tradeoff between independence and expertise for outside directors—a prejudgment that is widely disputed36—and examines the effect of tenure on the monitoring and advising ca-pacities of the board.37 After review of over 2,000 companies, the author finds that the optimal average tenure for an outside director is between seven and 11 years, though in-dustry- and company-specific factors create substantial variability.38 He concludes that nine years is generally the optimal point at which a director has accumulated the benefits

of firm-specific knowledge but has not yet accumulated the costs of entrenchment.

39 As a policy matter, however, he suggests that in light of the significant variations across in-dustries and company characteristics, regulating director tenure with a single mandatory term limit would not be appropriate.40

Taken together, the academic studies show that conclusions about optimal director tenure are elusive. Common sense indicates that a board should use tenure benchmarks not as limits but as opportunities to evaluate the current mix of board com-position, diversity, and experience.

Activists and Term Limits

Shareholder groups have begun to highlight the issue of director tenure. The Council of Institutional Investors (CII) last year announced a new policy calling for boards to evaluate director tenure when assessing director independence.41 The statement accompanying the policy change suggested that long tenure can affect a director’s “unbi-ased judgment” and asserted that “[e]xtended tenure can lead an outside director to start to think more like an insider.”42 Nonetheless, CII stopped short of endorsing a tenure limit, noting that “[r]equiring all directors to step down after a certain number of years could rob the board of critical expertise.”43

Beginning in the 2014 proxy season, ISS offered a new product called Governance QuickScore 2.0, which uses specific governance factors and technical speci-fications to rate public company governance.44 Company ratings (based on data that companies may review and correct) were released in February, and the scores are includ-ed in proxy research reports issued to institutional shareholders. ISS has stated that it will use corporate public disclosures to update ratings on a continuous basis throughout the year. Director tenure will now factor into a company’s rating: ISS views tenure of more than nine years as “excessive” by virtue of “potentially compromis[ing] a director’s inde-pendence.”45 Having long-tenured directors thus may negatively affect a company’s score.

While the factors ISS uses to produce a company’s rating are public, the specific calculation methodology is not. There is no reason to believe that a rating gener-ated by this new product will bear any relation to the actual quality of governance or fi-nancial performance of a particular company. The very name of the QuickScore metric alludes to the superficiality of its mechanically derived results, generated without regard to the fact-specific circumstances of a board of directors and the real-world needs of the company it supervises.

Governance QuickScore 2.0 is an outlier with respect to director tenure—not in terms of the nine-year limit, which may well have been determined by reference to the policies of some foreign countries and perhaps even to the 2013 study mentioned above—but in considering any longer service to be automatically detrimental. We are not aware of any country whose governance guidelines create a mandatory maximum of nine years for a corporate director. While various countries use the three-term, nine-year time frame as a benchmark, they recognize that boards may indeed have excellent reasons to extend a director’s term well beyond that limit. Hence the flexibility of the “comply-or-explain” model, which requires a board to consider director tenure and communicate with its shareholders, yet still preserves the board’s ability to make informed decisions for the company using its business judgment.

Outside of the QuickScore product, ISS itself recognizes the wisdom of a more reasonable approach. The ISS 2014 Proxy Voting Manual discusses the pros and cons of limiting director tenure and contains the following, eminently reasonable, lan-guage on director retirement age and term limits:

Rather than impose a narrow rule on director tenure, shareholders gain much more by retaining the ability to evaluate and cast their vote on all di-rector nominees once a year and by encouraging companies to perform pe-riodic director evaluations.46

Accordingly, ISS offers the following proxy voting policy for U.S. companies in 2014: “Vote against management and shareholder proposals to limit the tenure of outside direc-tors through mandatory retirement ages. Vote against management proposals to limit the tenure of outside directors through term limits. However, scrutinize boards where the average tenure of all directors exceeds fifteen years for independence from management and for sufficient turnover to ensure that new perspectives are being added to the board.”47 ISS endorses—rightly, in our view—a robust director evaluation process, con-ducted annually by the corporate governance or nominating committee of the board.

Board Judgment

It is unfortunate that the tenure of outside directors may become yet an-other point of controversy in shareholder activists’ ongoing efforts to dictate ever more elaborate standards for director independence and board composition. There is no reason to believe that extended director service does, in and of itself, compromise director inde-pendence. Indeed, as the studies mentioned above suggest, factors ranging from indus-try-wide characteristics all the way to company-, board- and candidate-specific elements can be meaningful in assessing appropriate director tenure. Term limits, like any bright-line rule, may offer superficial appeal, but the potential downside is that valuable direc-tors may be forced off the board in circumstances that would be detrimental to the board, the company, and the shareholders.48 Moreover, term limits can interfere with the devel-opment of effective collaboration among board members, a crucial element of a success-ful board and one than can be built only over a period of time. “In the end, creating a stellar Board of Directors is part science, part art.”49


Many arguments both for and against long tenure are valid. The debate can best be resolved in individual cases by reference to the facts on the ground, and no arbiter is better positioned to determine the appropriate length of service of a director than the board as a whole. Companies and their shareholders should resist any pressure to establish term limits, a mandatory retirement age, or another mechanism that would constrain board discretion in evaluating the effectiveness and performance of individual directors. With annual evaluations and self-assessments, most boards monitor and man-age their own performance quite effectively, and they should continue to have the latitude to determine the tenure of their directors in light of their conclusions regarding the needs of the company. As a general matter, this country is well served by directors’ using their business judgment to act in an informed manner in furtherance of the best interests of the company and its shareholders, and the area of director tenure is no exception.



1 SpencerStuart Board Index 2013 at 17.

2 See id.

3 ISS 2014 U.S. Proxy Voting Manual at 37. See also Vipal Monga, “Board Directors Are Extending Their Tenures,” CFO Journal, WSJonline, April 1, 2014. An investigation by the Wall Street Journal found that 28 outside directors in the Russell 3000 had served on a single board for at least 40 years. See Joanne S. Lublin, “The 40-Year Club: America’s Longest-Serving Directors,” Wall St. J., July 16, 2013.

4 See SpencerStuart Board Index 2013 at 15. One oft-cited example of a U.S. company with term limits is Target Corporation, which recently raised its directors’ term limit from 15 to 20 years. See Target Corpo-rate Governance Guidelines, § 24, November 2013, available at

5 See SpencerStuart Board Index 2013 at 6.

6 See id. 

7 See Carol Hymowitz and Jeff Green, “Corporate Directors Get Older, Hold Their Seats Longer,” Bloom-berg Businessweek, May 23, 2013.

8 As we have previously discussed, while diversity on U.S. boards of directors has improved in recent years, significant additional improvement is both desirable and necessary. See David A. Katz and Laura A. McIntosh, “Developments Regarding Gender Diversity on Public Boards,” N.Y.L.J., Oct. 31, 2013, availa-ble at

9 See, e.g., Kimberly Gladman & Michelle Lamb, “Director Tenure and Gender Diversity in the United States: A Scenario Analysis,” GMI Ratings, June 2013, available at

10 See SpencerStuart Board Index 2013 at 6.

11 See id. at 19-20.

12 See, e.g., Judy Canavan et al., “Board tenure: How long is too long?” Directors & Boards, Board Guide-lines 2004, at 39 available at

13 See Raymond K. Van Ness et al., “Board of Director Composition and Financial Performance in a Sar-banes-Oxley World,” Academy of Business & Economics Journal10 (5), 56-74 (2010), at 8 available at

14 See Sterling Huang, “Zombie Boards: Board Tenure and Firm Performance,” July 2013 Draft, at 30, available at

15 See, e.g., BHP Billiton, Submission to the ASX Corporate Governance Council, Nov. 15, 2013 (“[W]e believe that particularly in a long-cycle business such as ours, governance is enhanced by having a balance of longer serving Directors…. Formulaic considerations of tenure should not override the other considera-tions of independence and the proven ability of Directors to be able to exercise independent judgement and act in the best interests of the Group and shareholders.”), available at

16 See, e.g., Hymowitz & Green, supra note 7

17 See, e.g., Canavan et al., supra note 12.

18 See, e.g., Janet McFarland, “Countries Set out Rules on Directors’ Tenure,”, Nov. 24, 2013 available at

19 See Official Journal of the European Union, Commission Recommendation of 15 February 2005, Annex II, “Profile of Independent Non-Executive or Supervisory Directors,” Section 1(h), available at

20 The UK Corporate Governance Code B.1.1 (September 2012), available at .

21 “Investors Focus More Attention on Director Tenure,” Society of Corp. Secretaries & Governance Pro-fessionals, July 30, 2013 (citing a Grant Thornton survey of 2012 data).

22 HKEx Corporate Governance Code and Corporate Governance Report A.4.3, available at (updated per HKEx Consul-tation Conclusions on Review of the Corporate Governance Code and Associated Listing Rules, Oct. 28, 2011).

23 Singapore Code of Corporate Governance 2.4 (May 2, 2012), available at

24 Afep-Medef Code, Corporate Governance Code of Listed Corporations Section 9.4 (June 2013), availa-ble at

25 See Ross Kelly, “Australia Backs Away from Proposed Director-Tenure Cap,” Asian Business News, March 25, 2014.

26 ASX Governance Council, Corporate Governance Principles and Recommendations (Third Edition), March 27, 2014, at 16, available at

27 Id. at 17.

28 See Kelly, supra note 25

29 See Van Ness, supra note 13, at 8-9 (citing various studies) .

30 See id. at 18.

31 See Greg Berberich and Flora Niu, “Director Busyness, Director Tenure and the Likelihood of Encoun-tering Corporate Governance Problems,” January 2011, at 5, available at

32 See ISS Benchmark Policy Consultation, “Director Tenure (US and Canada),” 2014, available at

33 See Jeff Zeyun Chen et al., “Can Inside Directors Be Effective Monitors?—Evidence from Real Activi-ties Manipulation,” Aug. 24, 2012 Draft, available at percent20gunny.pdf.

34 See George M. Anderson & David Chun, “How Much Board Turnover Is Best?” Harvard Business Re-view, April 2014, available at

35 See id. 

36 See, e.g., Van Ness et al., supra note 13.

37 See Huang, supra note 14. The study examined 2009 data.

38 See id. at 30-32.

39 See id. at 4-5.

40 See id. at 7.

41 See Amy Borus, “More on CII’s New Policies on Universal Proxy and Board Tenure,” Council of Insti-tutional Investors, Oct. 1, 2013, available at

42 Id. 

43 Id. 

44 For more information on Governance QuickScore 2.0, see David A. Katz et al., “ISS QuickScore 2.0,” Wachtell, Lipton, & Katz Client Memorandum, Jan. 28, 2014, available at; see also ISS’s website:

45 See ISS’s website:

46 ISS 2014 U.S. Proxy Voting Manual at 39.

47 Id. at 37.

48 See, e.g., Carnavan et al., supra, at 41.

49 Amy Errett, “The Dream Team: What it Takes to Build an Effective Board of Directors,” Maveron Fea-tures (2011), available at


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Are CEO’s Paid Too Much?

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Steve Odland discusses the state of CEO pay on Fox Business Opening Bell program with Maria Bartiromo on May 16, 2014.


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Odland: The Consumer Is Not Back

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Steve Odland discusses the state of the consumer on Fox Business Opening Bell program with Maria Bartiromo on May 16, 2014.

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Fink: Deliver Sustainable, Long-term Results

Text of letter sent by Larry Fink, BlackRock’s Chairman and CEO, encouraging a focus on long-term growth strategies.

March 21, 2014

Dear Chairman or CEO,

As a fiduciary investor, one of BlackRock’s primary objectives is to secure better financial futures for our clients and the people they serve. This responsibility requires that we be good stewards of their capital, addressing short-term challenges but always with a focus on the longer term.

To meet our clients’ needs, we believe the companies we invest in should similarly be focused on achieving sustainable returns over the longer term. Good corporate governance is critical to that goal. That is why, two years ago, I wrote to the CEOs of the companies in which BlackRock held significant investments on behalf of our clients urging them to engage with us on issues of corporate governance. While important work remains to be done, good progress has been made on company-shareholder engagement. I write today re-iterating our call for engagement with a particular focus on companies’ strategies to drive longer term growth.

Many commentators lament the short-term demands of the capital markets. We share those concerns, and believe it is part of our collective role as actors in the global capital markets to challenge that trend. Corporate leaders can play their part by persuasively communicating their company’s long-term strategy for growth. They must set the stage to attract the patient capital they seek: explaining to investors what drives real value, how and when far-sighted investments will deliver returns, and, perhaps most importantly, what metrics shareholders should use to assess their management team’s success over time.

It concerns us that, in the wake of the financial crisis, many companies have shied away from investing in the future growth of their companies. Too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks. We certainly believe that returning cash to shareholders should be part of a balanced capital strategy; however, when done for the wrong reasons and at the expense of capital investment, it can jeopardize a company’s ability to generate sustainable long-term returns.

We do recognize the balance that must be achieved to drive near-term performance while simultaneously making those investments – in innovation and product enhancements, capital and plant equipment, employee development, and internal controls and technology – that will sustain growth.

BlackRock’s mission is to earn the trust of our clients by helping them meet their long-term investment goals. We see this mission as indistinguishable from also aiming to be a trusted, responsible shareholder with a longer term horizon. Much progress has been made on company-shareholder engagement and we will continue to play our part as a provider of patient capital in ensuring robust dialogue. We ask that you help us, and other shareholders, to understand the investments you are making to deliver the sustainable, long-term returns on which our clients depend and in which we seek to support you.

Yours sincerely,

Laurence D. Fink

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Remarks at the 26th Annual Corporate Law Institute, Tulane University Law School: Federal Preemption of State Corporate Governance

Commissioner Daniel M. Gallagher

New Orleans, LA

March 27, 2014

In April 2010, when my friend and former colleague Troy Paredes spoke at this conference, he expressed his misgivings about the draft legislation moving through Congress that ultimately became the Dodd-Frank Act.[i]  Today, nearly four years after its enactment, the fundamentally flawed nature of the Act has become clear—or, to those of us who recognized its many faults from the start, clearer.

Title I of Dodd-Frank, for example, created the apparently unaccountable and inherently politicized Financial Stability Oversight Council, or FSOC.  The FSOC is dominated by bank regulators, and Title I authorizes it to designate non-bank financial services companies as systemically important financial institutions, thereby making them subject to prudential regulation.  This can happen without regard for whether that regulatory paradigm is appropriate for non-bank entities operating in the capital markets—or, as I like to call them, the “non-centrally controlled” markets.

I believe it is important for the SEC and other capital markets regulators to openly debate and resist where necessary the encroachment of the bank regulatory paradigm into the capital markets.  I hope that market participants and lawmakers will join the debate about the proper regulatory framework for non-bank markets.  To be clear, this is not a partisan issue.  The structure of FSOC vests tremendous authority to appointees from the President’s party.  Those who enthusiastically support FSOC today may well be singing a different tune upon a change in administration.

I should also make clear that I’m not motivated by turf wars or empire building.  In fact, I believe the SEC should be willing to recognize areas where we should be the ones to stand down in favor of an alternative legal regime that is a better fit.

And so today I’d like to focus on an area where the SEC should be taking less of a role:  the regulation of corporate governance.

I.          Federalization of Corporate Governance

Unfortunately, the trend towards increased federalization of corporate governance law seems well-entrenched.[ii]  The Sarbanes-Oxley Act included significant incursions into state corporate governance regulation, but Title IX of Dodd-Frank may cause some of you to long for the simpler days of SOX § 404.

Title IX mandates an array of new federal regulations relating to matters traditionally left to state corporate governance law, the most infamous being a requirement to hold a shareholder vote on executive compensation, or “say on pay.”  Concerns that a negative vote may harm a company’s reputation or encourage litigation can lead companies to expend significant resources to guarantee passage of the vote.  Even more concerning, boards of directors could substitute proxy advisors’ views on pay for their own judgment as a means of minimizing potential conflict.

And that’s just one of the new Dodd-Frank requirements encroaching on corporate governance.  Others include the politically-motivated pay ratio disclosure requirement, proposed by a majority of the Commission in September 2013,[iii] as well as mandated rules micromanaging certain incentive-based compensation structures, which were proposed jointly with other regulators, again by a majority of the Commission, in March 2011.[iv]  In addition, Dodd-Frank calls for rules regarding compensation clawbacks in the event of an accounting restatement, pay for performance, and employee and director hedging of company stock.

Some of these requirements unashamedly interfere in corporate governance matters traditionally and appropriately left to the states.  Others masquerade as disclosure, but are in reality attempts to affect substantive behavior through disclosure regulation.  This mandated intrusion into corporate governance will impose substantial compliance costs on companies, along with a one-size-fits-all approach that will likely result in a one-size-fits-none model instead.  This stands in stark contrast with the flexibility traditionally achieved through private ordering under more open-ended state legal regimes.

II.        Shareholder Proposals

One area where the SEC’s incursions into corporate governance have had a particularly negative effect is shareholder proposals.

1.         The Problem

While the conduct of the annual shareholder meeting is generally governed by state law, the process of communicating with shareholders to solicit proxies for voting at that meeting is regulated by the Commission.  The Commission’s rules have for decades permitted qualifying shareholders to require the company to publish certain proposals in the company’s proxy statement, which are then voted upon at the annual meeting.

Unfortunately, the Commission has never adequately assessed the costs and benefits of this process.  Currently, a proponent can bring a shareholder proposal if he or she has owned $2,000 or 1% of the company’s stock for one year, so long as the proposal complies with a handful of substantive—but in some cases discretionary—requirements.  Activist investors and corporate gadflies have used these loose rules to hijack the shareholder proposal system.

The data and statistics are striking.  In 2013, the number of shareholder proposals rose,[v] with an amazing 41% of those proposals addressing social and environmental issues.[vi]  And while proposals calling for disclosure of political contributions or lobbying activities continued to predominate,[vii] these proposals received particularly poor support from shareholders.[viii] Overall, only 7% of shareholder proposals received majority support in 2013.[ix]

These proposals are not coming from ordinary shareholders concerned with promoting shareholder value for all investors.  Rather, they are predominantly from organized labor, including union pension funds, which brought approximately 34% of last year’s shareholder proposals, as well as social or policy investors and religious institutions, which accounted for about 25% of 2013’s proposals.  Approximately 40% were brought by an array of corporate gadflies, with a staggering 24% of those proposals brought by just two individuals.[x]

In other words, the vast majority of proposals are brought by individuals or institutions with idiosyncratic and often political agendas that are often unrelated to, or in conflict with, the interests of other shareholders.  I find it particularly notable that corporations that donated more funds to Republicans than to Democrats were more than twice as likely to be targeted with political spending disclosure proposals sponsored by labor-affiliated funds.[xi]

Astonishingly, only 1% of proposals are brought by ordinary institutional investors—including hedge funds.  As you all know, hedge funds are not shy about elbowing their way into the boardroom when they believe a shake-up is overdue.  The low level of hedge fund activism here implies that their concerns with corporate management are being addressed using avenues other than shareholder proposals—as most legitimate concerns can be.[xii]

Given all of this, it’s time we asked whether the shareholder proposal system as currently designed is a net negative for the average investor.[xiii]

2.         Needed Reforms

a.         Who should be able to bring a proposal?

All of this isn’t to condemn shareholder activism per se.  I’ll leave that debate to Marty Lipton and Lucian Bebchuk.  But existing shareholders who are unhappy with management have a range of well-accepted responses other than proposals.  Given the depth and liquidity of today’s markets, passive investors can simply sell their position—taking the s0-called “Wall Street Walk.”  Activist investors can threaten to take this Walk as a means of influencing management.  Investors can also vote against directors who are not sufficiently overseeing management—this strategy doesn’t have a clever name, but perhaps “vote the bums out” will do.

And, of course, where management is breaching its fiduciary duties, investors can have recourse to the courts.  This “see you in court” strategy is particularly viable given the outstanding job the Delaware courts do, day in and day out, in refereeing disputes between shareholders and management.  Given these and other strategies, I’m not sure we need shareholder proposals at all.

But if we must have shareholder proposals, the SEC’s rules can and should do a better job ensuring that activist investors don’t crowd out everyday and long-term investors—and that their causes aren’t inconsistent with the promotion of shareholder value.

One thing is clear:  we can’t continue to take the approach of our current regulatory program, especially the all too liberal program of the last five years, and simply err on the side of over-inclusion.  It is enormously expensive for companies to manage shareholder proposals.  They must negotiate with proponents, seek SEC no-action to exclude improper ones, form and articulate views in support or opposition in the proxy, include the proposal and the statement in the proxy itself, then take the vote on it at the annual meeting.  Conversely, companies can simply fold and acquiesce to the activists’ demands.  Both approaches are costly, and these costs are borne by all shareholders.  Taking money out of the pocket of someone investing for retirement or their child’s education and using it instead to subsidize activist agendas is simply inexcusable.  It is incumbent on the Commission to create a regulatory environment that promotes shareholder value over special interest agendas.  I have a few suggestions.

First, the holding requirement to submit proxies should be updated.  $2,000 is absurdly low, and was not subject to meaningful economic analysis when adopted.[xiv]  The threshold should be substantially more, by orders of magnitude:  perhaps $200,000 or even better, $2 million.  But I don’t believe that this is actually the right fix:  a flat number is inherently over- or under-inclusive, depending on the company’s size.  A percentage threshold by contrast is scalable, varies less over time, better aligns with the way that many companies manage their shareholder relations, and is more consistent with the Commission’s existing requirements.  Therefore, I believe the flat dollar test should be dropped, leaving only a percentage test.

Of course, we’d have to make sure we get the percentage holding requirement right.  Requiring a sufficient economic stake in the company could lead to proposals that focus on promoting shareholder value rather than those championed by gadflies with only a nominal stake in the company.  We would need to apply rigorous economic analysis to determine what percentage would be an appropriate default, as well as what factors should be taken into account when deviating from that default.  This could be an opportunity to address the practice of “proposal by proxy,” where the proponent of a resolution—typically one of the corporate gadflies—has no skin in the game, but rather receives permission to act “on behalf” of a shareholder that meets the threshold.  While I would support banning proposal by proxy, we could also consider alternatives such as requiring a proponent acting on behalf of one or more shareholders to meet a higher percentage threshold of outstanding shares than would be the case for a proponent who owns the shares directly.

I also think we need to take another look at the length of the holding requirement.  A one-year holding period is hardly a serious impediment to some activists, who can easily buy into a company solely for the purpose of bringing a proposal.  All that’s needed is a bit of patience, and perhaps a hedge.  A longer investment period could help curtail some of this gamesmanship.

Making adjustments along these lines will go a long way towards ensuring that the proposals that make it onto the proxy are brought by shareholders concerned first and foremost about the company—and the value of their investments in that company—not their pet projects.

b.         What issues should proponents be able to raise?

I also believe that we need to do a better job setting requirements as to the substance of proposals.  While I don’t think a complete reevaluation of the existing categories for exclusion is necessary, we do need to re-think their application.

For example, the “ordinary business” criterion for exclusion in our rules has been perennially problematic.[xv]  This provision permits exclusion of a proposal that deals with the company’s “ordinary business operations,” unless it raises “significant policy issues.”  However, these terms are not defined and the Commission has given no guidance, leaving the Staff to fend for itself in determining whether to issue no-action relief pursuant to the provision.

As a result, we have seen a number of dubious “significant policy issue” proposals.  For example, in 2013 the Staff denied no-action relief to PNC Bank with respect to a proposal requesting a report on greenhouse gas emissions resulting from its lending portfolio, on the grounds that climate change is a significant policy issue—arguably a reversal of a prior Staff position.[xvi]  And, in 2012, Staff denials of no-action relief forced AT&T, Verizon, and Sprint to include a net neutrality proposal, even though proposals on that same topic were excludable in prior years as ordinary business.  That year, 94% of AT&T shareholders voted “no” on the net neutrality proposal despite the best efforts of Michael Diamond, who some of you will know as Mike D. of the Beastie Boys—who, by helping to bring the proposal to a vote, at least succeeded in his fight for the right to proxy.[xvii]

It is a disservice to the Staff—and, more importantly to investors—when the Commission promulgates a discretion-based rule for the Staff to administer without providing guidance as to how to exercise that discretion.  In addition to providing better guidance, the Commission needs to become more involved in the administration of this rule.  In particular, I believe that the Commission should be the final arbiter on the types of proposals for which the Staff proposes to deny no-action relief on “significant policy issue” grounds.  The Presidential appointees should vote on these often-thorny policy issues and not hide behind the Staff.

We also need to take another look at the rule which permits the exclusion of proposals that are contrary to the Commission’s proxy rules—including proposals that are materially false and misleading or that are overly vague.[xviii]  In Staff Legal Bulletin 14B, issued in 2004,[xix] the Staff curtailed the use of this ground for exclusion in light of the extensive Staff resources that were being consumed in their line-by-line review of shareholder proposals, instead forcing issuers to use their statement in opposition to take issue with factual inaccuracies or vagueness.[xx]  I believe issuers have raised some legitimate concerns with this approach.  For example, while issuers are not legally responsible for the proposals or statements in support, they are still being forced to publish, in their proxy, statements they believe are false or misleading.  Moreover, use of the statement in opposition is sometimes an incomplete remedy.  Taking valuable space to correct misstatements distracts from a substantive discussion about the proposal itself, and proposals that are overly vague make it difficult to draft a sensible rebuttal.

In light of these competing concerns, I believe the pendulum has swung too far in the direction of non-intervention.  And I’m not alone in this belief.  Recently, a district court in Missouri granted summary judgment to Express Scripts, permitting it to exclude a proposal that contained four separate misstatements.[xxi]  While I support companies exercising their right to take matters to the court system,[xxii] which can serve as a useful external check on the SEC’s no-action process, companies shouldn’t have to go through the time and expense of litigation to vindicate their substantive rights under our rules.  The burden to ensure that a submission is clear and factually accurate should be placed on the proponent, not the company.  I believe that the Staff should take a more aggressive posture toward proponents that fail to meet that burden.  And I hope issuers would refrain from using our rule to quibble over minutiae.  If this happy medium is not achievable, I believe the SEC needs to revisit our rules:  we as a Commission either need to give the Staff the capacity to enforce the rule as it is currently written, or craft a rule that is enforceable.

c.         How many times may a proposal be repeated?

The final issue I want to raise today with respect to the shareholder proposal process is the frequency of reproposals.  Currently, once a proposal is required to be included in the proxy, it can be resubmitted for years to come, even if it never comes close to commanding majority support.  Proposals need only 3, 6, or 10% of votes in support to stay alive, depending on whether the proposal has been brought once, twice, or three times or more in the past five years.[xxiii]  So a proposal that gets a bare 10% of the votes, year after year, is not excludable on that basis under our current rules.  Such proposals are an enormous waste of time and shareholder money.

We need to substantially strengthen the resubmission thresholds, perhaps by taking a “three strikes and you’re out” policy.  That is, if a proposal fails in its third year to garner majority support, the proposal should be excludable for the following 5 years.  The thresholds for the prior 2 years should be high enough to demonstrate that the proposal is realistically on the path toward 50%, for example, 5% and 20%.

3.         Conclusion

Implementing these kinds of reforms can, I believe, help provide some much-needed improvement to the shareholder proposal system.  I hope the Commission can consider such common-sense issues in the near future.  These are real and substantial issues, and the Commission has the authority to effectuate needed change.  We should not dare Congress to intervene due to our inaction, as it had to with the JOBS Act.

III.       Remaining the Right Regulator

Finally, I want to return to my original theme:  good government requires that, when we must regulate, we should do so in the most efficient manner possible.  This means assigning the right regulator to the issue and minimizing unnecessary regulatory overlap.  And of course, the Commission must continue to ensure that its regulatory approach advances its core goals of investor protection and the promotion of efficiency, competition, and capital formation.

That means, for example, pressing ahead with much-needed reforms to our corporate disclosure requirements to ensure that our filings provide investors with the information they need to make informed investment decisions and are not overwhelmed by extraneous information—like conflict minerals reports.

We must also take exception to efforts by third parties that attempt to prescribe what should be in corporate filings.  It is the Commission’s responsibility to set the parameters of required disclosure.

The somewhat confusingly-named Sustainability Accounting Standards Board provides a good example of an outside party attempting to prescribe disclosure standards.  I say “confusingly-named” because the SASB does not actually promulgate accounting standards, nor does it limit itself to sustainability topics, although I suppose it is in fact a Board.  The SASB argues that its disclosure standards elicit material information that management should assess for inclusion in companies’ periodic filings with the Commission.[xxiv]

I don’t mean to single out the SASB, but it’s important to stress that, with the sole exception of financial accounting—where the Commission, as authorized by Congress, has recognized the standards of the Financial Accounting Standards Board as generally accepted, and therefore required under Regulation S‑X—the Commission does not and should not delegate to outside, non-governmental bodies the responsibility for setting disclosure requirements.  So while companies are free to make whatever disclosures they choose on their own time, so to speak, it is important to remember that groups like SASB have no role in the establishment of mandated disclosure requirements.

With respect to information that the Commission requires to be included in filings, we need to be sure that our requirements are eliciting decision-useful and up-to-date information.  We should be willing to reexamine all of our disclosure requirements.  Indeed, the Commission should be engaged in a comprehensive program of periodic re-assessment of its disclosure rules to ensure that the benefits of disclosure continue to justify its often-substantial costs.

This is of course a tall order, but I know the fine men and women who serve the public at the Commission are up for the challenge.

* * *

Thank you all for your time and attention today, and I hope you enjoy the rest of the conference.

  [i]       See Troy A. Paredes, Speech by SEC Commissioner:  Remarks at the 22nd Annual Tulane Corporate Law Institute (Apr. 15, 2010), available at

  [ii]       See Daniel M. Gallagher, Speech, Remarks before the Corporate Directors Forum(Jan. 29, 2013), available at; see also, e.g., J. Robert Brown, Jr., The Politicization of Corporate Governance:  Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors, 2 Harv. Bus. L. Rev. 61, 62 (2012).

  [iii]      Rel. 33-9452, Pay Ratio Disclosure (Sept. 18, 2013).

  [iv]      Rel. 34-64140, Incentive-based Compensation Arrangements (Mar. 29, 2011).

  [v]       James R. Copeland & Margaret M. O’Keefe, Proxy Monitor 2013:  A Report on Corporate Governance and Shareholder Activism (Manhattan Institute, Fall 2013) at 2 (average Fortune 250 company faced 1.26 proposals in 2013 versus 1.22 in 2012); Gibson, Dunn & Crutcher LLP, Shareholder Proposal Developments During the 2013 Proxy Season(July 9, 2013) at 1 (noting more proposals in 2013 (~820) than 2012 (~739)).

  [vi]      Proxy Monitor 2013 at 7.

  [vii]     Proxy Monitor 2013 at 12 (“[P]roposals related to corporate political spending or lobbying have been more numerous than any other class of proposal in each of the last two years.”).

  [viii]     ISS reports political contribution/lobbying activity approval percentage at 29%, an increase of 7.3% over 2012.  See Gibson Dunn at 6.  However, Proxy Monitor finds the opposite trend, at least with respect to the Fortune 250 companies.  See Proxy Monitor 2013 at 2.  Specifically, disaggregating lobbying and political spending proposals shows adecline in y-o-y support for both proposal classes:  22% in 2012 to 20% in 2013 for lobbying, and 17% to 16% for political spending.  Id.  But a change in the mix of proposals—there were more lobbying-related proposals, which typically garner higher support, given that 2013 is a non-election year—creates the impression of an increasing overall rate.

  [ix]      Proxy Monitor 2013 at 2 (contrasting with 9% in 2012).

  [x]       Proxy Monitor 2013 at 6–7.

  [xi]      Proxy Monitor 2013 at 8 (“Those companies [giving at least $1.5 million to candidates or PACs], as a group, were much more likely to be targeted by shareholder proposals introduced by labor-affiliated pension funds in 2013: 44 percent of these politically most active companies faced a labor-sponsored proposal, as opposed to only 18 percent of all other companies.  What’s more, those corporations that gave at least half of their donations to support Republicans were more than twice as likely to be targeted by shareholder proposals sponsored by labor-affiliated funds as those companies that gave a majority of their politics-related contributions on behalf of Democrats.”).

  [xii]     James R. Copeland, Proxy Monitor 2011: A Report on Corporate Governance and Shareholder Activism (Manhattan Institute, Sept. 2011) at 4.

  [xiii]     Allan T. Ingraham & Anna Koyfman, Analysis of the Wealth Effects of Shareholder Proposals–Vol. III (U.S. Chamber of Commerce, May 2, 2013).

  [xiv]     See Rel. 34-40018, Amendments to Rules on Shareholder Proposals (May 21, 1998) (describing the change from $1,000 to $2,000 as an adjustment for inflation).

  [xv]     Exchange Act Rule 14a‑8(i)(7).

  [xvi]     See, e.g., Hunton & Williams, Client Alert, SEC Refused to Allow Bank to Omit Climate Change Proposal from Proxy Materials (Mar. 2013).  It has been argued, however, that PNC was not a reversal, but rather was driven by some substantive differences with PNC’s lending portfolio.  See Gibson Dunn at 9–10 (citing a “SEC spokesman” commenting to that effect).  This may indicate a need for the Staff to provide fuller statements of their reasoning in no-action letters, so as to avoid confusion among practitioners and the public.

  [xvii]    See Larry Downes, AT&T, Verizon, and Sprint Net Neutrality Proposals: Simply Awful, (Apr. 12, 2012, updated Apr. 27, 2012), at

  [xviii]   Exchange Act Rule 14a‑8(i)(3).

  [xix]     See SLB 14B (2004).

  [xx]     Of 90 denials of exclusion during the 2013 proxy season, 63% of them had raised (i)(3) arguments.  Gibson Dunn at 2.  While there could be several reasons for this trend, it calls for further examination.

  [xxi]     Express Scripts Holding Co. v. Chevedden, No. 4:13-CV-2520-JAR (E.D. Mo., Feb. 18, 2014).

  [xxii]    See Waste Connections v. Chevedden, No. 13-20336, slip op. (5th Cir., Feb. 13, 2014) (affirming court’s subject matter jurisdiction over company’s declaratory judgment action despite Chevedden’s promise not to sue if company excluded the proposal).

  [xxiii]   See Exchange Act Rule 14a‑8(i)(12).

  [xxiv]   See, e.g., SASB, Commercial Banks Sustainability Accounting Standard, Provisional Version (Feb. 2014) (“SASB Standards are comprised of (1) disclosure guidance and (2) accounting standards on sustainability topics for use by U.S. and foreign public companies in their annual filings (Form 10-K or 20-F) with the U.S. Securities and Exchange Commission (SEC).  To the extent relevant, SASB Standards may also be applicable to other periodic mandatory fillings with the SEC, such as the Form 10-Q, Form S-1, and Form 8-K.  SASB’s disclosure guidance identifies sustainability topics at an industry level, which may be material—depending on a company’s specific operating context—to a company within that industry.  Each company is ultimately responsible for determining which information is material and is therefore required to be included in its Form 10-K or 20-F and other periodic SEC filings.”).



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March 24, 2014
On March 19, 2014, SEC Chair Mary Jo White stated that the Securities and Exchange Commission will soon review recommendations for possible regulatory action targeting proxy advisory firms. 
White did not offer any details regarding new rules or changes that could be in store for proxy advisory firms like Glass Lewis and Institutional Shareholder Services, which help large institutional investors weigh how to vote on critical company issues such as board elections and compensation.
The SEC previously held a roundtable about the sector, where stakeholders discussed a variety of concerns such as whether the firms properly disclose potential conflicts of interest and whether investment advisers rely too heavily on their advice when they vote on behalf of clients.
Without signaling what the SEC might do, White, speaking to an audience at the U.S. Chamber of Commerce, said that she was “particularly” interested during the roundtable in hearing the discussions about improving disclosure of possible conflicts and about how much investment advisers rely upon proxy advisory firms and what this means for their fiduciary obligations.
The U.S. Chamber of Commerce has been among the most vocal in pressing the SEC to reform the proxy advisory sector.
“The staff now will be making recommendations to me in the very near term about what additional action might be taken on these issues,” White told the audience.
Some of White’s colleagues on the commission, including Dan Gallagher, a Republican, have said the SEC has enabled investment advisers to rely too heavily on proxy advisory firms for advice after the SEC staff issued letters that permit advisers to rely on the advice without the fear of possible enforcement action.
This is problematic because investment advisers have a fiduciary obligation to put their customers’ interests first, Gallagher has said.
Most recently, in a March 18 letter, 10 members of Congress, including New Jersey Republican Scott Garrett and North Carolina Republican Patrick McHenry, called on the SEC to require more disclosures of conflicts.
In the letter, lawmakers expressed concern that the SEC does not require proxy advisory firms to disclose whether a proponent of a shareholder proposal or a competing director slate is a client.
“In our view, this lack of disclosure calls into question the legitimacy and veracity of the advice dispensed by proxy advisory firms and undercuts the ability of their clients to meet their fiduciary duty to individual investors,” they wrote.
Published by Veritas Executive Compensation Consultants, (“Veritas”), an  independent executive compensation consulting firm. 
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Court of Chancery Stresses Need for Board Monitoring of Advisors and Potential Conflicts

By Paul K. RoweDavid A. KatzWilliam SavittRyan A. McLeod

Last week, the Delaware Court of Chancery reached the rare conclusion that an independent, disinterested board breached its fiduciary duties in connection with an arm’s-length, third-party, premium merger transaction.  In re Rural Metro Corp. Stockholders Litig., C.A. No. 6350-VCL (Del. Ch. Mar. 7, 2014).  The decision, which relies heavily on findings that the board’s financial advisor had undisclosed conflicts of interest, holds the advisor liable for aiding and abetting the breaches, but does not reach the question of whether the directors themselves could have been liable, as they settled before trial.  The decision sends a strong message that boards should actively oversee their financial advisors in any sale process.

The opinion arose out of the 2011 sale of Rural Metro to a private equity buyer.  In late 2010, Rural’s board formed a special committee to evaluate the potential acquisition of a competitor then being auctioned.  The Court found that the committee’s financial advisor believed that if Rural were involved in a sale process at the same time as its competitor, the possibility of combining all or part of the two companies would present financing opportunities to the advisor that would dwarf the advisory fees it stood to receive from the special committee assignment alone.  Without disclosing its desire to provide such buy-side financing, the advisor counseled the special committee to commence a limited auction for Rural, and the committee proceeded to do so.  The Court found that this decision was a breach of duty, because the committee did not give appropriate weight to the fact that there were restrictive confidentiality agreements that many potential bidders for Rural had entered into in connection with the process being run by its competitor, thus making it an inopportune time to sell Rural.  The Court also found fault in the fact that the board never authorized the special committee to explore the sale of the company.  In its ruling, the Court was influenced by evidence that the members of the special committee had personal reasons to favor a near-term sale of the company unrelated to shareholder interests generally.

Even after it became clear that Rural would not be a buyer for its competitor, the special committee continued with the sale process and the financial advisor continued to desire a role in buy-side financing for any potential sale of Rural itself.  Although the special committee negotiated for a sale price representing a 37% premium to market, the Court found that the committee’s process was insufficient and ill-informed, as the committee held “only two formal meetings” and “had not received any valuation information until three hours before the meeting to approve the deal.”  And that valuation information, the Court found, was revised downward by the financial advisor at the same time the advisor was “secret[ly] lobbying” the buyer to supply buy-side financing.

On this record, the Court ruled that the Rural directors failed to discharge their responsibility to provide “active and direct oversight” of both the process and the activities of their financial advisor.  The Court explained that this required the directors to be “reasonably informed about the alternatives available to the company” and to “act reasonably to identify and consider the implications of the investment banker’s compensation structure, relationships, and potential conflicts.”  The Court noted that the actions taken here may have been reasonable had they been made by a “well-informed board.”  But because here the financial advisor “misled the Board,” and because the board failed to provide appropriate oversight, it was “not a case where a Board’s independent sense of the value of the company is sufficient to carry the day.”  Because the directors settled before trial, the Court did not address the question of whether the kinds of breaches found on this record could result in personal liability.

          Rural Metro does not disturb the well-established principle that Delaware courts will respect the decisions of well-informed boards that engage in a careful sale strategy.  It does emphasize the importance of the board’s role in identifying and addressing potential conflicts—be they of management, other directors, or financial advisors.  To ensure that directors are protected in a sale process, boards should be sensitive to conflicts and should satisfy themselves that any sale process is thoughtfully structured, supported by an appropriate contemporaneous record, and at all times executed under the supervision of the board itself.

Paul K. Rowe
David A. Katz
William Savitt
Ryan A. McLeod

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Governance QuickScore 2.0

By David A. Katz , Sabastian V. Niles, Francis J. Stapleton

ISS QuickScore 2.0 

Institutional Shareholder Services Inc. (ISS) has announced the governance factors and other technical specifications underlying its new Governance QuickScore 2.0 product, which ISS will apply to publicly traded companies for the 2014 proxy season. Companies have until 8pm ET on Friday, February 7th to verify the underlying raw data and can submit updates and corrections through ISS’s data review and verification site. ISS will release company ratings on Tuesday, February 18th, and the scores will be included in proxy research reports issued to institutional shareholders. While previous QuickScore ratings remained static between annual meeting periods, ISS has now committed to update ratings on an on-going basis based on a company’s public disclosures throughout the calendar year.

We have listed the individual factors used by QuickScore 2.0 in Annex A. However, the specific weightings and balancing between quantitative and qualitative factors remain undisclosed, and companies will not be able to calculate scores on their own. As we have previously noted, the relationship between ISS’s governance metrics and company financial performance has been dubious at best, and we continue to urge companies and boards to see QuickScore for what it is—a data point generated by an artfully marketed product, rather than a target or an ideal—and to consider their individual circumstances in establishing and evaluating appropriate corporate governance practices and compensation policies for their companies. No single metric or bundle of metrics can substitute for the informed business judgment of a well-advised board as to what is necessary to promote corporate and shareholder interests in dynamic, real-world circumstances.

Scoring under QuickScore 2.0 will continue to use the familiar “four pillar” approach that analyzes governance across Audit, Board Structure, Compensation/Remuneration and Shareholder Rights categories, and company-level and underlying pillar scores will continue to be presented on a 1 to 10 scale, relying upon “decile” comparisons of a company’s raw scores against the scores of other companies within the applicable index and region. Accordingly, ISS’s QuickScore 2.0 unfortunately continues to deploy an unproven and opaque methodology that reduces the complex realities of corporate governance into an easily digestible, but inherently misleading, decile system. Given the success to date of governance activists in driving companies towards one-size-fits-all governance structures, it is likely that only minor differences will separate the deciles, resulting in companies with no serious governance concerns receiving an unjustified “taint” by virtue of a lower score.

Although the new specification builds mostly upon the methodology used in previous years (which began as the CGQ Corporate Governance Quotient and then evolved into the GRId Governance Risk Indicators in 2010, which was then supplanted by QuickScore 1.0 in 2013), several new factors will be incorporated into the overall scoring model and a few additional “zero-impact” factors will be disclosed in the QuickScore report for informational purposes but will not, at this point, impact ratings.

New Factors that Impact Scoring 

“Excessive” Director Tenure. Tenure of more than nine years will be considered “excessive” by QuickScore 2.0 on account of “potentially compromis[ing] a director’s independence” and negatively factor into weightings depending on the proportion of directors with such tenure. Given that ISS had recently announced a longer-term review of this issue for possible application to the 2015 proxy season and beyond, its inclusion in QuickScore for the 2014 proxy season may signal that ISS has already prejudged the issue. As we have previously stated, we do not believe that there is a sufficient basis to consider an extended tenure of board service in and of itself as indicative of a lack of director 2

independence. Given the significant differences in companies’ needs and directors’ attributes and experiences, this is a clear instance where a company-specific approach is superior to a rigid rule.

Director Approval Rates. In addition to continuing to consider whether one or more directors received 50% or greater “against” or “withhold” votes, QuickScore 2.0 will now consider the percentage of directors who receive “less than average” levels (as measured against the company’s industry index) of shareholder support for their election.

Compensation of Outside Directors. How a company’s outside director compensation compares to median levels of the ISS-determined peer group will now be considered. Specifically, QuickScore 2.0 will measure the prior year’s average outside director’s pay (based on total compensation reported for each director in the company’s proxy statement) as a multiple of the median pay of its ISS-determined comparison group for the same period.

Alignment between Pay and TSR. Consistent with ISS’s 2014 voting policy updates, QuickScore 2.0 will now incorporate the relative degree of alignment (RDA) between compensation and TSR based on a single, annualized RDA measure for a three-year measurement period, instead of the previous 40/60 weighted average of one- and three-year RDA. The previous QuickScore factors of three- and one-year RDA will still be included for informational purposes only and will be zero-weight factors on the scoring model.

Say-on-Pay Support. The level of shareholder support on the company’s most recent say-on-pay proposal and how such support compares to industry-index levels will also affect ratings.

New Informational Factors with No Impact on Scoring 

Three new board composition-related factors will be included in the QuickScore report for informational purposes. According to ISS, these factors, however, will not currently impact overall scoring for the issuer.

Board-Level Gender Diversity. According to ISS, some academic and other studies have shown that increasing the number of women on the board correlates with better financial performance. As a result, QuickScore will now begin analyzing the number of female directors as well as the relative proportion of male to female directors on the board.

Number of Financial Experts on Audit Committee. QuickScore will provide information on the number of financial experts that serve on the board’s audit committee. This is a zero-weight issue for U.S. companies, most of which are required to have at least one financial expert serving on the audit committee due to stock exchange listing requirements.

Board Size. QuickScore will begin providing information on the number of directors on the board. According to ISS, boards should generally have no fewer than six directors and no more than 15. A board composed of nine to 12 directors is considered by ISS to be optimal.



ISS QuickScore 2.0 Factors for U.S. Companies

1. Non-Audit fees represent what percentage of total fees?

2. Did the auditor issue an adverse opinion in the past year?

3. Has the company restated financials for any period within the past two years?

4. Has the company made non-timely financial disclosure filings in the past two years?

5. Has a securities regulator taken enforcement action against the company in the past two years?

6. Has a securities regulator taken enforcement action against a director or officer of the company in the past two years?

7. Is the company, or any of its directors and officers, currently under investigation by a regulatory body?

8. Has the company disclosed any material weaknesses in its internal controls in the past two years?

9. How many financial experts serve on the audit committee?

10. How many directors serve on the board?

11. What is the number / proportion of women on the board?

12. What is the independent director composition of the board?

13. What proportion of directors sit on the board for an excessive length of time?

14. What is the classification of the chairman of the board?

15. Has the company an identified senior independent director?

16. What percentage of the board consists of immediate family members of majority shareholders, executives, and former executives (within the past five years)?

17. What percentage of the board are former or current employees of the company?

18. What percentage of nominating committee members are independent based on ISS standards?

19. What is the independent status of the compensation committee members?

20. What is the independent status of the audit committee members?

21. Does the CEO serve on an excessive number of outside boards? / How many boards does the CEO sit on? (U.S. only)?

22. How many non-executives serve on an excessive number of outside boards?

23. Did any directors attend less than 75% of aggregate board & committee meetings without a valid excuse?

24. How many directors received withhold/ against votes of 50% or greater at the last annual meeting?

25. What percentage of directors received shareholder approval rates below the industry-index level?

26. Has the board failed to implement a shareholder resolution supported by a majority vote?

27. What is the average size of outside directors’ compensation as a multiple of the median of company peers?

28. What is the aggregate level of stock ownership of the officers and directors, as a percentage of shares outstanding?

29. Are directors subject to stock ownership guidelines?

30. Do all directors with more than one year of service own stock?

31. Did any executive or director pledge company shares?

32. Does the company have a robust policy prohibiting hedging of company shares by employees?

33. Does the company disclose board/governance guidelines?

34. What percent of the directors were involved in material RPTs [related party transactions]?

35. Do the directors with RPTs sit on key board committees?

36. Are there material related-party transactions involving the CEO?

37. Does the company have classes of stock with different voting rights?

38. Are there any directors on the board who are not up for election by all classes of common shareholders?

39. Are all directors elected annually?

40. Is the board authorized to issue blank check preferred stock?

41. Does the company have a poison pill (shareholder rights plan) in effect?

42. What is the trigger threshold for the poison pill?

43. Does the poison pill have a sunset provision?

44. Does the poison pill have a TIDE provision?

45. Does the poison pill have a qualified offer clause?

46. What is the expiration date of the poison pill?

47. Is the poison pill designed to preserve tax assets (NOL pill)?

48. When was the poison pill implemented or renewed?

49. Does the company’s poison pill include a modified slow-hand or dead-hand provision?

50. If the company has a majority voting standard, is there a plurality carve-out in contested elections?

51. Does the company require a super-majority vote to approve amendments to the charter and bylaws?

52. Does the company require a super-majority vote to approve mergers/business combinations?

53. What is the percentage of share capital needed to convene a special meeting?

54. Can shareholders act by written consent?

55. Does the company have a majority vote standard in uncontested elections?

56. Are there material restrictions as to timing or topics to be discussed, or ownership levels required to call the meeting?

57. What is the degree of alignment between the company’s cumulative 3-year pay percentile rank, relative to peers, and its 3-year cumulative TSR rank, relative to peers?

58. What is the degree of alignment between the company’s cumulative 1-year pay percentile rank, relative to peers, and its 1-year cumulative TSR rank, relative to peers?

59. What is the size of the CEO’s 1-year cumulative pay, as a multiple of the median pay for company peers?

60. What is the degree of alignment between the company’s TSR and change in CEO pay over the past five years?

61. What is the ratio of the CEO’s total compensation to the next highest paid executive?

62. What is the degree of alignment between the company’s annualized 3-year pay percentile rank, relative to peers, and its 3-year annualized TSR rank, relative to peers?

63. Are any of the NEOs eligible for multiyear guaranteed bonuses?

64. What is the ratio of the CEO’s non-performance-based compensation (All Other Compensation) to Base Salary?

65. Do the company’s active equity plans prohibit share recycling for options/SARS?

66. Do the company’s active equity plans prohibit option/ SAR repricing?

67. Does the company’s active equity plans prohibit option/ SAR cash buyouts?

68. Do the company’s active equity plans have an evergreen provision?

69. Do the company’s active equity plans have a liberal CIC definition?

70. Has the company repriced options or exchanged them for shares, options or cash without shareholder approval in the last three years?

71. Does the company grant equity awards at an excessive rate, according to ISS policy?

72. Did the company disclose a claw back or malus provision?

73. What are the minimum vesting periods mandated in the plan documents for executives’ stock options or SARS in the equity plans adopted/amended in the last 3 years?

74. What are the minimum vesting periods mandated in the plan documents, adopted/amended in the last three years, for executives’ restricted stock / stock awards?

75. What is the holding/retention period for stock options (for executives)?

76. What is the holding/retention period for restricted shares / stock awards (for executives)?

77. What proportion of the salary is subject to stock ownership requirements/guidelines for the CEO?

78. Does the company disclose a performance measure for the short-term incentive plan (for executives)?

79. What is the level of disclosure on performance measures for the latest active or proposed long-term incentive plan?

80. Did the most recent say-on-pay proposal receive shareholders’ support below the industry-index level?

81. What’s the trigger under the change-in-control agreements?

82. Do equity based plans or other long-term plans vest completely upon a change-in-control?

83. What is the multiple of the change-in-control/severance payment for the CEO (upon a change-in-control)?

84. What is the basis for the change-in-control or severance payment for the CEO?

85. Does the company provide excise tax gross-ups for change-in-control payments?

86. What is the length of employment agreement with the CEO?

87. Has ISS’ qualitative review identified a pay-for-performance misalignment?

88. Has ISS identified a problematic pay practice or policy that raises concerns?


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Corporate Governance Update: Boardroom Confidentiality Under Focus

January 23, 2014

David A. Katz and Laura A. McIntosh

In our Age of Communication,1 confidential information is more easily exposed than ever before. Real-time communication tools and social media give everyone with Internet access the ability to publicize information widely, and confidential information is always at risk of inadvertent or intentional exposure. The current cultural emphasis on transparency and disclosure—punctuated by headline news of high-profile leakers and whistleblowers, and exacerbated in the corporate context by aggressive activist shareholders and their director nominees—has contributed to an atmosphere in which sensitive corporate information is increasingly difficult to protect. There is limited statutory or case law to guide boards and directors in this area, and there exists a range of opinions among market participants and media commentators as to whether leaking information (other than illegal insider tipping) is problematic at all.2

3 Directors’ legal obligations with respect to confidentiality are not well articulated, and confidential board information is unique in the corporate context. It includes material, non-public information, the disclosure of which is regulated by federal securities laws and by company-wide policies and procedures, but it also includes sensitive boardroom discussions that have both personal and business elements and implications. In order for boards

to function effectively, directors must feel comfortable expressing their views in the boardroom on corporate matters honestly and freely, without concern that their conversations will be made public.

Concerns about leaks often increase with the election of “constituent” directors. These directors, placed on public company boards through proxy access or a proxy fight, are typically perceived—rightly or wrongly—as representatives of those shareholders that nominated them and are considered likely to share details of board deliberations with their sponsors. When sensitive board information is deliberately exposed by a director, boards may struggle to respond effectively, as the remedies available to the board and the company are limited, particularly since directors cannot require another director to resign. In order to protect confidential and sensitive information, boards should, at a minimum, have robust director confidentiality policies and, in appropriate circumstances, should consider adopting bylaws regarding preserving confidentiality. Companies may also want to review their crisis management plans to ensure that they cover breaches of confidentiality by directors in addition to employees.

Confidential Board Information

Confidential, non-public corporate information falls generally into three categories: proprietary information that is of competitive, commercial value to the company; inside information about the company’s finances, operations, and strategy; and sensitive information regarding board proceedings and deliberations. Unauthorized disclosures of proprietary information could imperil a company’s competitive advantage or commercial success while unauthorized disclosures of inside information can lead to illegal insider trading and manipulation of the company’s stock price. Information in any category that is material and non- public may be disclosed by company insiders only in specific ways prescribed by the federal securities laws, including Regulation FD. For these reasons, all companies should have comprehensive corporate confidentiality policies that apply to employees as well as directors. The authorized processes and channels for disclosure of confidential corporate information should be well defined and understood within the company, as improper disclosures can lead to criminal and civil liability in certain circumstances.

The third category, sensitive board information, includes information to which a director is privy by virtue of his or her membership on the board of directors. In the course of fulfilling their fiduciary duties and director responsibilities, directors are entrusted with significant amounts of material, non-public information of all types; however, they also become aware of the inside story: how this confidential corporate information is discussed, used, and understood within the board itself. Directors generally know how their fellow board members view corporate executives, strategic initiatives, potential acquisitions, competitive and legal threats, and even each other. They also understand how board deliberations have developed over time. Any element of this “meta-information” may be of particular importance, may be potentially disruptive or embarrassing if disclosed, or may simply have been shared within the boardroom with the expectation of privacy. Leaks of sensitive board information—as opposed to proprietary or valuable corporate information—also can be highly damaging to a company. Such

leaks can be made publicly, to the media and the investor community at large, or privately, to a director’s sponsor or other influential shareholders.

Public and Private Disclosures

The most sensational type of leak happens when a disgruntled or dissatisfied director provides confidential information to the media in order to put pressure on the rest of the board. One recent headline-making situation involved J.C. Penney director, and activist investor, William Ackman. Ackman was a major stockholder of J.C. Penney, owning nearly 18 percent of the company’s shares through his hedge fund Pershing Square Capital Management. In August 2013, Ackman provided to a major news outlet two letters from himself to the J.C. Penney Board.4 The letters detailed boardroom discussions and expressed frustration with the leadership of the company and the J.C. Penney board, particularly with respect to the ongoing chief executive search process. The public firestorm that ensued benefited no one; the outcome included high-profile criticism of Ackman’s behavior from prominent members of the corporate community, Ackman’s resigning from the J.C. Penney board, Pershing Square’s sale of its holdings in the company, and a dramatic (and ongoing) decline in the value of J.C. Penney stock.

A less dramatic but likely more prevalent type of boardroom leak is the private communication of confidential information by constituent directors to their sponsoring shareholders. Activist shareholders and the investment community are increasingly pushing for shareholder-sponsored directors on public company boards, and indeed their numbers are growing.5 Dissident success in proxy fights put more constituent directors on boards in 2013 than in any year since 2009. In 2013, there were 90 proxy fights, 30 of which went to a shareholder vote. Of those 30, 17—over half—were won by the dissident. By contrast, 2012 6 saw only 77 proxy fights, of which 28 went to a vote, and nine of those were won by dissidents.

The possibility of mandatory proxy access still lingers, though fortunately it is no longer on the near-term horizon. Proxy access had been a top Securities and Exchange Commission (SEC) priority but suffered a setback in 2011 when the U.S. Court of Appeals for the D.C. Circuit overturned the rule on the basis that the SEC had not conducted an adequate analysis of the rule’s economic impact.7 In 2012, SEC Chairman Mary Schapiro told a

Congressional panel that the SEC had no immediate plans to revisit its proxy access rule.8 Nonetheless, shareholder proposals on proxy access slightly increased in number and shareholder support in 2013, and two did receive shareholder approval.9

Constituent directors may be chosen for board seats by their sponsoring entities on the explicit understanding that they will share inside information for investment evaluation purposes. Indeed, the Delaware Chancery Court recently expressed the view that “[w]hen a director serves as the designee of a stockholder on the board, and when it is understood that the director acts as the stockholder’s representative, then the stockholder is generally entitled to the same information as the director.”10 Absent contractual or bylaw provisions to the contrary, Delaware law permits constituent directors to disclose information to their sponsors so long as they do so in a manner that is consistent with their fiduciary duties. If the corporation were harmed by the disclosures, or if the director knew that the sponsor would use the information disclosed to usurp corporate opportunities belonging to the company, the director likely would be found to have breached his or her duty of loyalty.11 Regardless of the director’s intention, however, once information has been passed outside of the board, as a practical matter it is impossible to control the flow of information from the sponsoring shareholder’s employees to others in the investment community, absent specific confidentiality obligations being in place. Other directors may not be aware of the extent or type of information that a constituent director is providing to the sponsoring shareholder, nor how widely the information is being disseminated. Certain activists routinely enter into confidentiality agreements with companies on whose boards they participate, and these agreements, when properly drafted, protect both the company and the activist.

Some activist hedge funds have begun the unfortunate practice of providing their constituent directors with special compensation arrangements, some of which are contingent on certain events or on the implementation of the shareholding entity’s plans for the company. These arrangements are deeply problematic, as directors—regardless of who nominates them— owe fiduciary duties to all shareholders of the company and should not be prioritizing any particular agenda for personal benefit. As one commentator has observed, “If this nonsense is not illegal, it ought to be.”12 Boards should give consideration to adopting a bylaw that would

disqualify candidates from serving as directors if they are party to such arrangements,13 although a position recently taken by ISS makes this decision more difficult.14

Confidentiality Policies

There is a risk of harm to the company itself when any confidential information is leaked, but there is certain harm to the functioning of the board of directors when its sensitive deliberations are publicly disclosed. An effective group of directors trusts and relies on each other, encourages discussion and debate, and can tolerate even strongly-held dissenting views. When trust has been undermined, board effectiveness will be seriously compromised. A major breach of confidentiality, or an ongoing flow of sensitive information outside the board, can have a chilling effect on board deliberations, thereby depriving shareholders of the full benefit of the directors’ expertise and judgment. Meetings are likely to become contentious, and the board may become incapable of consensus or timely decision-making. All of this is particularly true when a leak exacerbates existing board dysfunction. Showing a lack of understanding of board dynamics, activist director William Ackman opined—in one of his letters to the J.C. Penney board that he provided to the media—that “[e]xtreme candor among directors is critical.”15

Public company boards should consider implementing a confidentiality policy specific to directors. The policy should define “confidential information” broadly, listing examples of the types of information covered, and emphasize that the category includes all non- public information entrusted to or obtained by directors due to their position on the board. The policy should remind directors of their fiduciary duties and state that directors may only use confidential information for the benefit of the company, and not for personal benefit or the benefit of any other entities. The policy should specifically address the issue of disclosure by constituent directors to their sponsors and should note that directors are bound by their confidentiality obligations even after their tenure on the board concludes. The policy should

expressly state that, while directors may disclose confidential information when required by law, in such cases a director should provide advance notice of the upcoming disclosure to the board, its chairman, and the chief executive officer. The policy could also require the director is to attempt, in cooperation with the company and at the company’s expense, to avoid or minimize any required disclosures through legally available steps.

Having a detailed and robust board confidentiality policy will serve both to advise directors (and their sponsors, if any) as to their obligations with respect to sensitive board information and to create a board culture that views leaking as unacceptable and dishonorable behavior. The chairman of the board should provide the policy to director candidates before they are nominated (or, in the case of constituent directors, directors-elect before they begin service) and may wish to obtain written or oral assurances that they understand and can abide by the terms of the policy. Another available mechanism is a board-approved bylaw requiring director nominees to confirm their acceptance of the board’s confidentiality policy and to agree that they will not act as representatives of particular constituencies while on the board. Advance notice bylaws for director nominations may also contain confidentiality requirements. To the extent information will be shared with sponsors by their directors, the board should require the execution of a confidentiality agreement with the sponsor.

The board should review its confidentiality policy during its annual review of the company’s corporate governance policies. The board chairman or board counsel may wish to specifically remind directors of their confidentiality obligations when contentious or sensitive situations are at the forefront of board affairs. As a general matter, the board chairman should ensure to the best of his or her ability that directors never lose sight of their shared obligation to fulfill the fiduciary duties they owe to all shareholders.

If legal disputes do arise, a well-drafted confidentiality policy can be a factor in a court’s determination of whether information should be deemed confidential. In a 2005 Delaware Chancery Court case involving the Walt Disney Company, the court determined that certain documents relating to “‘private communications among or deliberations of the Company’s board of directors’” should remain confidential. Vice Chancellor Lamb based his decision on the company’s written confidentiality policy, which covered documents of this type, as well as on the expectation of privacy of the individuals who participated in the communications described therein.16 The court observed that “By adopting this [confidentiality] policy, the board has recognized the necessity of keeping the thoughts, opinions, and 17 deliberations of its members confidential. This board policy deserves significant weight.”

Breaching Confidentiality

There are legal ramifications for some breaches of confidentiality. Disclosure of material, non-public information can result in civil or criminal charges. A damaging leak of

confidential material could in certain circumstances amount to a breach of the duty of loyalty, which could result in personal liability for damages and limit the director’s legal and contractual protections against such liability. At the board level, however, breaches of confidentiality by directors are notoriously difficult to handle. The first principle should be for the board not to exacerbate the situation by taking actions that would create negative publicity for the company. Removing a director, for example, can only be done by the shareholders and is a very difficult and time-consuming process, and attempting to do so likely would result in protracted public controversy.

Typically, when a serious breach of confidentiality occurs, the board asks for the offending director’s resignation. A board cannot demand it, however, unless the director has signed an advance resignation letter, which commits a director to resign under certain specified circumstances. The effectiveness of advance resignation letters is likely to depend largely on the fairness of the process to determine whether the triggering event has in fact occurred. If the director or sponsoring shareholder resists, enforcement could result in a damaging public controversy regardless of the validity of the process used. Moreover, if the trigger is a finding by a court that the director breached his obligations, the issue is unlikely to be resolved in a timely fashion. Thus, boards commonly wait until the director’s term has expired and decline to renominate him or her when faced with trust issues of this type. A board may wish to adopt a bylaw stating that no director who is determined by the board to have violated the board confidentiality policy may be eligible to serve on the board.

When a request for a director’s resignation fails, a board usually creates special committees for sensitive topics. A director cannot be completely isolated, however, as all directors must have the information needed to fulfill their fiduciary duties. In the 2013 case Kalisman v. Friedman, which involved a constituent director who sought access to board information that had been kept from him, Vice Chancellor J. Travis Laster of the Delaware Chancery Court reiterated a director’s broad right to information, stating, “A director’s right to information is ‘essentially unfettered in nature.’”18 The letter opinion observed that a special committee is entitled to have protected communications with its separate legal counsel to the extent necessary for its work but cautioned that “[t]he degree to which such a committee would need to provide some form of update periodically or upon request to other directors or the board has not been fully determined and is likely fact-dependent….”19 One exception in extreme cases is that “a board or a committee can withhold [attorney-client] privileged information once sufficient adversity exists between the director and the corporation such that the director could no longer have a reasonable expectation that he was a client of the board’s counsel.”20

Finally, the board’s crisis management plan should include provisions regarding director leaks of sensitive board information, whether private or public and whether intentional or inadvertent. Advance preparation can help to ensure procedural fairness and to prevent emotional responses to what can be perceived as a personal betrayal from clouding the board’s judgment.

Culture of Trust

The obligation of confidentiality fundamentally derives from the fiduciary duties of loyalty and care, and questions of disclosure are, when not covered by existing agreements or company policy, matters of business judgment. Ultimately, there is no substitute for genuine trust, collegiality, and a proper amount of respect among board members. The creation of a culture of confidence is probably a board’s best protection against damaging leaks, and the chairman or lead director should proactively build trust and cohesiveness among directors whenever possible. As a matter of best practices, boards also should establish and maintain clear policies about the handling of confidential board information and the process to be followed in the event of a leak and should require confidentiality agreements in situations where directors may be sharing confidential information with their sponsors.



1 See, e.g., Zion Lights, “Is This the Age of Communication,” HuffPost Tech (United Kingdom), Dec. 29, 2012 (“One person can send a short message via a tweet that might be read by a million people within a minute. Or spam three million people with the click of a button.”), available at of-communication_b_2372785.html.

2 See, e.g., Nell Minow, “Coverage of H-P ‘Pretexting’ Scandal Misses Point,” MarketWatch, Sept. 11, 2006 (lamenting “journalists’ automatic bias in favor of leaks”), available at; Justin Fox, “When Leaking Is the Right Thing To Do,”, Sept. 21, 2006 (“From the perspective of a shareholder in a public corporation, there are times when you want the board members to be blabbermouths, and times when you don’t.”), available at

3 See, e.g., Cyril Moscow, “Director Confidentiality,” 74 Law and Contemporary Problems 197, 198, 200 (Winter 2011) (“A [board] confidentiality requirement does not arise directly from statutory formulations…. There is little case authority dealing directly with a director’s duty to maintain the confidentiality of corporate information.”), available at

4 “JC Penney Board Erupts into Fight over next CEO,” Aug. 8, 2013,, available at; “Bill Ackman’s Aug. 9 Letter to J.C. Penney’s Board,” Aug. 9, 2013,, available at

5 See, e.g., “Rethinking Director Nomination Requirements and Conduct in an Era of Shareholder Activism,” Skadden, Arps, Slate, Meagher & Flom LLP Memorandum, available at director-nomination-requirements-and-conduct-era-shareholder-activism.

6, Proxy Fight Trend Analysis, available at

7 Business Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011) available at v-sec/.

8 Securities and Exchange Commission Chairman Mary L. Schapiro, “Testimony on SEC Oversight,” Testimony Before the Capital Markets and Government Sponsored Enterprises Subcommittee and Financial Institutions and Consumer Credit Subcommittee of the U.S. House of Representatives Committee on Financial Services, April 25, 2012, available at

9 Sullivan & Cromwell LLP, 2013 Proxy Season Review, July 2, 2013, available at 10 Kalisman v. Friedman, C.A. No. 8447-VCL, letter op. (Del. Ch. April 17, 2013), at 6, available at 11 See, e.g., Agranoff v. Miller, No. Civ. A 16795 (Del. Ch. April 12, 1999), 1999 WL 219650.

12 Stephen Bainbridge, “Can Corporate Directors Take Third Party Pay from Hedge Funds?” April 8, 2013, available at pay-from-hedge-funds.html.

13 See “Bylaw Protection Against Dissident Director Conflict/Enrichment Schemes,” Wachtell, Lipton, Rosen & Katz Memorandum, May 9, 2013, available at

14 See “Director Qualification/Compensation Bylaws FAQs,” ISS (Jan. 13, 2014) (“The adoption of restrictive director qualification bylaws without shareholder approval may be considered a material failure of governance because the ability to elect directors is a fundamental shareholder right. Bylaws that preclude shareholders from voting on otherwise qualified candidates unnecessarily infringe on this core franchise right. Consistent with ISS’ “Governance Failures” policy, we may, in such circumstances, recommend a vote against or withhold from director nominees for material failures of governance, stewardship, risk oversight, or fiduciary responsibilities.”), available at; see also “ISS Publishes Guidance on Director Compensation (and Other Qualification) Bylaws,” Wachtell, Lipton, Rosen & Katz Memorandum, Jan. 16, 2014 (“In light of ISS’ threat that it may issue withhold vote recommendations against boards that adopt director compensation bylaws, it can be expected that many companies will decide that discretion is the better part of valor and avoid a confrontation with ISS, despite the risks posed by “golden leash” schemes. This would be a rational response given the hopefully low probability for any company of actually having to deal with this issue, the fact that “golden leash” arrangements taint dissident candidates and can be used against them in proxy contests, and the prospect that the courts may step in to address the conflicts of interest and duty of loyalty problems created by such schemes.”), available at

15 Ackman Aug. 9 Letter, supra.

16 Disney v. The Walt Disney Co., 2005 Del. Ch. LEXIS 94 (Del. Ch. June 20, 2005), at *10-*11. 17 Disney, at *11.

18 Kalisman, at 5 (citations omitted). 19 Kalisman, at 6.

20 Kalisman, at 7 (citing SBC Interactive, Inc. v. Corporate Media P’rs, 1997 WL 770715, at *6 (Del. Ch. Dec. 9, 1997)).


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Increased Shareholder Governance Reduces Firm Value

A Corporate Culture Channel: How Increased Shareholder Governance Reduces Firm Value

Jillian A. Popadak

University of Pennsylvania – The Wharton School

October 25, 2013

I show corporate culture is an important channel through which shareholder governance affects firm value. I develop a novel data set to measure aspects of corporate culture and use a regression discontinuity strategy to demonstrate stronger shareholder governance significantly increases results-orientation but decreases customer-orientation, integrity, and collaboration. Consistent with a positive link between governance and value, shareholders initially realize financial gains from the results-oriented corporate culture: increases in sales, profitability, and payout occur. However, by concentrating on tangible benchmarks, managers hurt the intangibles, which is not in the best long-term interest of the firm. Over time, the value of the firm’s intangible assets significantly deteriorates. This longer-term negative link between governance and value appears to act via the governance-induced changes in corporate culture. Estimates suggest firm value declines 1.4% via the corporate culture channel. I use an instrumental variable design and interventions by activist hedge funds to test the external validity of these inferences. Across these complementary research designs, I consistently find strong support for the importance of a corporate culture channel.


Number of Pages in PDF File: 82

Keywords: Corporate Governance, Intangible Assets, Corporate Culture, Hedge Fund Activism, Managerial Myopia, Multitasking

JEL Classification: D23, G23, G30, K22, M14, O16

working papers series 

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Firms That Adopt A Staggered Board Increase In Firm Value

Staggered Boards and Firm Value, Revisited

Martijn Cremers

University of Notre Dame

Lubomir P. Litov

University of Arizona – Department of Finance; University of Pennsylvania – Wharton Financial Institutions Center

Simone M. Sepe

University of Arizona – James E. Rogers College of Law

December 5, 2013

This paper revisits the association between firm value (as proxied by Tobin’s Q) and whether the firm has a staggered board. As is well known, in the cross-section firms with a staggered board tend to have a lower value. Using a comprehensive sample for 1978-2011, we show an opposite result in the time series: firms that adopt a staggered board increase in firm value, while de-staggering is associated with a decrease in firm value. We further show that the decision to adopt a staggered board seems endogenous, and related to an ex ante lower firm value, which helps reconciling the existing cross-sectional results to our novel time series results. To explain our new results, we explore potential incentive problems in the shareholder-manager relationship. Short-term oriented shareholders may generate myopic incentives for the firm to underinvest in risky long-term projects. In this case, a staggered board may helpfully insulate the board from opportunistic shareholder pressure. Consistent with this, we find that the adoption of a staggered board has a stronger positive association with firm value for firms where such incentive problems are likely more severe: firms with more R&D, more intangible assets, more innovative and larger and thus likely more complex firms.


Number of Pages in PDF File: 81

Keywords: Staggered Boards, Classified Boards, Firm Value, Incentive Problems, Entrenchment

JEL Classification: G34, K22

working papers series 

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ISS Releases 2014 Voting Policies and Announces New Longer-Term Consultations

ISS Releases 2014 Voting Policies and
Announces New Longer-Term Consultations

By David A.  Katz
Trevor S.  Norwitz
David E.  Kahan
Sabastian V.  Niles
S.  Iliana Ongun

          Institutional Shareholder Services Inc.  (ISS) recently published its 2014 Corporate Governance Policy Updates, which would apply to annual meetings beginning in February 2014.  ISS updated relatively few of its policies this year, but the changes largely represent a more measured, company-specific approach to corporate governance practices, which reflects a move by ISS to avoid “one-size-fits-all” policies and recommendations.  ISS also announced a new consultation and comment period concerning potential policy changes applicable to the 2015 proxy season or beyond with respect to director tenure, director independence, independent chair shareholder proposals, equity-based compensation plans and auditor ratification.

2014 Policy Updates

          Board Response to Majority Supported Shareholder Proposals.  As announced last year, ISS evaluates a company’s response to shareholder proposals that receive a majority of shares cast in considering “withhold” recommendations against the full board, committee members or individual directors.  With respect to such majority supported shareholder proposals, ISS will now make vote recommendations on director elections on a case-by-case basis and will no longer require boards to fully implement majority supported shareholder proposals in all cases.  Instead, ISS will consider mitigating factors in cases involving less than full implementation, including the board’s articulated rationale for its response and level of implementation (with consideration of such rationales being a new factor not previously considered by ISS), disclosed shareholder outreach efforts by the board in the wake of the vote, the level of support and opposition for the proposal, actions taken,  and the continuation of the underlying issue as a voting item on the ballot (as either shareholder or management proposals).

Beginning in 2014, ISS will also address case-by-case whether “withhold” recommendations are warranted in the following circumstances: where the board failed to act on a takeover offer into which a majority of shares tendered and where a director received more than 50% withhold/against votes of the shares cast at the last election and the company has not addressed the issue that caused the high withhold/against vote.  Implementing an advisory vote on executive compensation on a less frequent basis than the frequency that received a plurality, but not a majority, of the votes cast at the most recent shareholder meeting at which shareholders voted on say-on-pay frequency will also result in a case-by-case review.

Pay-for-Performance Quantitative Screen.  ISS has modified the methodology for calculating its Relative Degree of Alignment (RDA) pay-for-performance screen, a core component of its say-on-pay recommendation analysis.  Currently, RDA is calculated by reference to the difference between a company’s TSR rank and the CEO’s total pay rank within an ISS-selected peer group, as measured over one-year and three-year periods (weighted 40% and 60%, respectively).  Beginning with the 2014 proxy season, ISS will eliminate the one-year measurement period and calculate RDA solely by reference to relative TSR rank and CEO total pay rank over the three-year period.

Lobbying.  ISS has revised the factors it considers in evaluating shareholder proposals requesting details on a company’s lobbying activities (direct, indirect and grassroots).  Beginning in 2014, ISS will consider the company’s current disclosure of relevant lobbying policies and oversight by the board as well as management, the company’s disclosure regarding trade associations (a new ISS focus) or other groups that it supports (or is a member of) that engage in lobbying activities, and recent significant controversies, fines or litigation regarding the company’s lobbying activities.  ISS will no longer consider the impact that the public policy issues may have on the company’s business operations, if specific issues are addressed in the proposal.

Human Rights Risk Assessment.  Beginning in 2014, ISS will consider on a case-by-case basis proposals requesting that a company conduct an assessment of the human rights risks in its supply chain or operations or publish a report on its risk assessment process.  In evaluating such proposals, ISS will consider the degree to which existing relevant policies and practices are disclosed (including as to actual implementation and oversight), the company’s industry and whether the company or its suppliers operate in areas where there is a history of human rights concerns, the presence of recent, significant controversies, fines or litigation regarding human rights involving the company or its suppliers, and whether the proposal is unduly burdensome or overly prescriptive.

Consultation on Possible Longer-Term Voting Policy Changes for 2015 and Beyond

          Director Tenure.  ISS is considering whether director tenure should be a factor in classifying directors as independent or determining vote recommendations on director elections, such as potential “withhold” votes against members of the nominating and governance committee.  As ISS notes in its explanation for the new consultation, academic studies on this topic offer conflicting conclusions.  We do not believe that there is a sufficient basis to consider an extended tenure of board service to be in and of itself indicative of a lack of director independence.  Indeed, given the significant differences in companies’ needs and directors’ attributes and experiences, this is a clear instance where a company-specific approach is superior to a rigid rule.

Director Independence.  ISS is considering whether to replace its bright-line distinctions for classifying a director as an inside director, an affiliated outside director or an independent outsider with a case-by-case analysis.  Certain of the standards that ISS currently uses to classify directors are more stringent than those used by the Securities and Exchange Commission and national stock exchanges.  In particular, ISS is considering taking into account facts and circumstances in assessing whether former CEO status, familial relationships, and professional services provided to the company should impact independence.  We encourage ISS to adopt a case-by-case approach to classifying individual directors, rather than relying on inflexible standards.

Independent Chair Shareholder Proposals.  Currently, ISS recommends a vote “for” independent chair shareholder proposals unless the company has a robust lead director position and has no other material governance or performance concerns.  ISS is considering moving away from accommodating a strong lead director structure and instead always recommending a vote “for” independent chair proposals or, alternatively, generally recommending a vote “for” independent chair proposals but considering certain company-specific circumstances, such as company size, the company’s length of time as a public entity, and CEO transition, that may warrant a combined CEO/chair position.  We believe that the current ISS policy, which permits a thorough review of a company’s governance practices and recognizes that a robust lead director structure can provide effective leadership at boards with an executive chairperson, is superior to the proposed alternatives.

Equity-Based Compensation Plans.  ISS’s current policy can result in a recommendation against an equity compensation plan based on a failure of the plan to satisfy one of six tests enumerated by ISS.  ISS is considering replacing this policy, which it describes as not taking into account mitigating factors, with a “balanced scorecard approach that allows the weighting of multiple factors in a holistic evaluation of the equity plan.”  We agree that all plan evaluations should be holistic, although any “scorecard” approach should avoid recommendations based solely on mechanical generic formulae and allow for appropriate exercise of judgment and flexibility to consider the situation of the particular company.

Auditor Ratification.  ISS is considering whether to take into account the length of auditor tenure in determining the vote recommendation to ratify independent auditors.  Currently, ISS recommends that shareholders vote to ratify auditors unless certain rare circumstances exist, such as if the auditor has a financial interest in the company or if fees for non-audit services are excessive.  The interaction between an independent auditor and a company is an area of focus for regulators, national stock exchanges and industry participants, which are well-suited to evaluate appropriate requirements for sufficient auditor independence, and that audit committees can exercise appropriate discretion as to whether to require rotation based on company-specific circumstances.  We believe that current regulations, in particular the legally mandated rotation of the lead audit partner every five years, and audit committee practices are appropriate.

*          *          *

          In contrast to policy changes in recent years, ISS’ 2014 policy updates generally avoid a “one-size-fits-all” approach to corporate governance.  However, the alternatives presented for consultation present a potential shift away from this more nuanced approach in certain important areas.  We encourage companies to express their views of these potential changes to ISS.  As always, we recommend that companies facing anticipated negative recommendations consider engaging with their shareholders and, if appropriate, with ISS in advance of the 2014 proxy season to ensure that all parties understand each company’s unique business and governance situation.

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Developments Regarding Gender Diversity on Public Boards

October 31, 2013

Corporate Governance Update: Developments Regarding Gender Diversity on Public Boards

David A. Katz and Laura A. McIntosh

While the number of women directors on U.S. public company boards has not risen dramatically since 2012, the issue of gender diversity on boards continued to gain momentum and global prominence over the last 12 months. Since we last discussed1 this issue, new legislative and non-governmental initiatives around the world have resulted in growing numbers of women directors and greater shareholder focus on board diversity and related disclosures. This issue is likely to become increasingly significant in 2014 and beyond, both in the United States and abroad.

EU Developments

Earlier this month, the European Commission moved a step closer to imposing a form of gender quota on major public companies in the European Union. Two committees of the European Parliament voted in favor of a proposal by the European Commission to require certain public companies to increase the representation of women on their boards.2 The proposed law applies only to large public companies, with no exceptions even for companies in which women compose less than 10 percent of the workforce, and, if adopted, provides for obligatory sanctions for failure to follow the proposed requirements.


The proposed law requires covered companies that do not have women composing 40 percent of their non-executive directors to introduce a new selection procedure for board members, thereby giving priority to qualified female candidates. It authorizes individual member states to determine sanctions for noncompliance. It is intended to be a temporary measure, expiring automatically in 2028. Though the proposed quota does not apply to companies with fewer than 250 employees and revenue below €50 million, the law includes a requirement that all exchange-listed companies set their own targets for gender board diversity to be met by 2020 (2018 for publicly owned enterprises), with annual reporting requirements as to their progress toward those targets. The proposal has received positive opinions from several Parliament committees and is expected to be voted upon by the European Parliament’s plenary session in November 2013,3 although its passage is by no means certain.

This month, the European Commission also released a new report on women in positions of authority in major European public companies.4 As compared to October 2012, data from April 2013 shows that the percentage of women on boards has increased to 16.6 percent from 15.8 percent. The report highlighted the fact that, predictably, mandatory quotas have produced the most significant changes; in France, for example, women now represent over 26 percent of public company directors, as compared to 12.3 percent in 2010, due to a mandatory 40 percent quota that must be achieved in large companies by 2017. In Iceland, companies with more than 50 employees are required, as of September, to have at least 40 percent of each gender on the board; by April 2013 the percentage of women directors was 48.9 percent, so it appears that mandate has been successfully implemented.5

Britain has resisted quotas thus far, preferring to rely on corporate initiatives to promote board diversity. The past two years have produced a significant increase in the number of women directors as the issue gained prominence and nominating committees made efforts to achieve gender diversity. A BoardWatch report issued earlier this month with data as of October 1 showed that the percentage of women on FTSE-100 company boards has risen to 19 percent from 12.5 percent in 2011.6 The number of all-male boards on the FTSE-100 correspondingly has fallen from 21 in 2010 to only 5 currently. Meanwhile, the percentage of women board members in the FTSE-250 has risen to 14.9 percent from 7.8 percent in 2010. Overall, 25 percent of board appointments in the FTSE-100 and 36 percent in the FTSE-250 that have been made since March 1, 2013, have been women.7 The initial 2011 Women on Boards report by Lord Davies, the former British Trade Minister, stopped short of endorsing quotas but recommended that FTSE-100 companies aim for a minimum of 25 percent of their directors positions to be filled by women by 2015, with other companies in the FTSE-350 setting their own goals.8 He recommended that companies report annually on their diversity policies, including measurable objectives for implementation and the progress made in achieving these goals. Lord Davies noted in that report that government “must reserve the right to introduce more prescriptive alternatives if the recommended business-led approach does not achieve significant change.”9 In his April 2013 update, he exhorted chairmen and chief executives to “demonstrate real progress” in this area in order to stave off European-level legislative measures that would limit flexibility and impose diversity requirements.10 Britain has opposed the legislative initiative that is now progressing through the European Parliament, gathering a group of eight other countries to co-sign a letter in September 2012 to the leadership of the European Commission expressing their position that gender diversity should be addressed through national efforts.11 It remains to be seen how the controversy generated by the recent committee votes will play out among the member states of the European Union, but it is clear that this issue will continue to be prominent.

Other International Developments

In Canada, the Ontario Securities Commission (OSC) this summer commenced a consultation process regarding disclosure requirements for gender diversity on listed company boards and in senior management.12 The consultation paper cited surveys showing that as of March 2013, 13.1 percent of public company directorships were held by women,13 and that in 2012, women represented only 15 percent of senior officer positions in the Financial Post 500 companies.14 The consultation paper indicated that Canada’s progress in increasing those numbers has been slow relative to that of other countries. There is currently no requirement for Canadian public companies to have a gender diversity policy or to disclose the percentages of women on their boards or in senior management, and OSC put forth a “comply-or-explain” disclosure model as a possible regime to increase gender diversity. The policy considered in the paper would not establish any quotas, nor does it contemplate sanctions for failure to achieve gender diversity at any level.

During the comment period, which ended earlier this month, the OSC received a wide range of responses.15 The Ontario Teachers’ Pension Plan expressed the view that gender diversity in Canada has been too slow to improve and that the OSC therefore should establish a mandatory minimum of three women directors per company (scaled for board size) with delisting as a potential sanction for noncompliance.16 Royal Bank of Canada wrote in support of the proposed disclosure model rather than regulator-imposed quotas and noted its own diversity guideline for directors, which includes the objective that women should represent at least 25 percent of the board.17 BlackRock, the largest asset management corporation in the world, submitted a thoughtful response supporting the proposed comply-and-explain model. BlackRock’s letter suggested that each company be required to include in its disclosures a discussion of its diversity objectives and any obstacles that may have thwarted the fulfillment of those objectives. This, in BlackRock’s view, “should help both identify any industry-specific, structural or fundamental impediments to achieving diverse corporate leadership which may need to be dealt with by policy makers and otherwise inform the broader societal discussion regarding gender diversity in the corporate context.”18 The Institute of Corporate Directors, the Canadian association of directors and boards, also wrote in support of the OSC’s approach and reiterated its opposition to quotas in directorships or management positions.19

Elsewhere in the world, gender diversity on boards is emerging slowly but surely as a legislative and social objective. In India, for example, the August 2013 Companies Act now requires every listed company to have at least one female director within one to three years of its listing, depending on the size of the company.20 In 2012, women represented only 7 percent of directors on Bombay Stock Exchange 100 companies, with almost half of the BSE-100 companies having no women directors at all.21 A drafter of the new law estimates that 6,000 women will be needed to fill the positions on Indian listed company boards.22

Australia and New Zealand also have adopted disclosure requirements regarding diversity. In Australia, the Workplace Gender Equality Act 2012 requires private companies with 100 or more employees to report annually on certain gender diversity indicators, including pay equality, family-friendly working arrangements, and consultations with employees regarding gender equality. The rules include sanctions for noncompliance.23 The Australian Securities Exchange requires listed companies to disclose their diversity policies, including measurable objectives and progress, or to explain why they do not disclose this information.24 The New Zealand stock exchange (“NZX”) also enacted, effective as of year-end 2012, new rules requiring listed companies to provide data on the gender breakdown of their boards and executive officers.25 At the end of last year, the NZX published a guidance note for issuers regarding gender diversity policies and disclosures.26 Even the Hong Kong stock exchange has proposed a listing policy on board diversity.27

Other Efforts to Promote Diversity

Throughout the world, efforts to increase gender diversity on boards continue to gain momentum both in legislatures and in non-governmental organizations.28 In the United States, there have been no legislative initiatives at the federal level other than the 2010 efforts by the SEC; however, the California state senate recently approved a resolution formally encouraging gender diversity.29 The resolution—the first of its kind among the states—urges every California public company to have, by the end of 2016, one to three women on its board, depending on the size of the board. The resolution cites various studies showing that the presence of women on a board can improve corporate performance and board processes in many ways.30 This last detail is perhaps telling; in the United States, there is still a sense that an emphasis on gender diversity needs to be justified rather than pursued as a matter of course. In Europe and elsewhere, the discussion surrounding legislative initiatives tends to be focused on the best way to achieve greater gender diversity rather than whether or not it is a worthwhile goal.31

Numerous non-governmental organizations are promoting gender diversity, with some degree of success. Catalyst, a global organization dedicated to expanding opportunities for women in business, issued the “Catalyst Accord” in 2012 to encourage Canadian Financial Post 500 corporations to achieve 25 percent gender diversity by 2017.32 At the one-year mark, 13 companies had signed the accord, including RBC, HSBC Bank of Canada, Ernst & Young LLP Canada, and KPMG LLP Canada.33 Catalyst publishes regular census and research reports tracking the progress of gender diversity in boardrooms and executive suites, and the Catalyst Canada Advisory Board provides participating companies with a roster of qualified women director candidates.

The Thirty Percent Coalition, founded in 2011, is composed of leading women’s organizations, institutional investors, senior executives, elected officials and other market participants. Its goal is 30 percent representation of women on U.S. public company board seats by 2015.34 Beginning in 2012, the Coalition sent letters to 168 companies in the S&P 500 and the Russell 1000 that have no female directors, urging them to commit to gender diversity on their boards. The Coalition also initiated the filing of 25 shareholder resolutions in 2013 to bring greater attention to the issue at these companies.35 Three of these resolutions went to a vote (one of which received over 50 percent support), while 18 were withdrawn as companies agreed to include diversity considerations in their corporate governance guidelines on the nominating process.36 In light of its success this past proxy season, it seems likely that the Thirty Percent Coalition will promote the filing of shareholder resolutions on gender diversity in the 2014 proxy season.

A similar organization, 2020 Women on Boards, was founded in 2010 and has the goal of increasing the percentage of women on U.S. corporate boards to 20 percent by 2020. This organization annually publishes a Gender Diversity Index of Fortune 1000 Companies and hosts an annual “National Conversation on Board Diversity,” with simultaneous events in many cities on the same date.37

Advocacy groups such as these do not generally support mandatory quotas as a means of achieving their objective. The Thirty Percent Coalition champions “collaborative effort,”38 while 2020 Women on Boards focuses on national discussions rather than legislative initiatives. Helena Morrissey, the founder of the 30 percent Club—a British organization of company chairmen who are working toward 30 percent representation of women on boards—has opposed the EU quota initiative.39 Two other organizations of chairmen and chief executives, New Zealand’s 25 Percent Group40 and Australia’s Male Champions of Change,41 support the self-regulatory approach favored by the United Kingdom and the United States over the mandatory quota system that is gathering momentum in Europe.

Gender Diversity Going Forward

A continuing debate is whether the relatively low numbers of women directors are attributable to a shortage of supply or of demand. Lord Davies noted in his initial 2011 Women on Boards report: “Part of the challenge is around supply–the corporate pipeline…. Part of the challenge is around demand.”He expanded on this concern in his April 2013 update, noting: “The executive pipeline is not an easy nut to crack.”43 The inadequate representation of women at all levels of corporate leadership is a recurrent theme, with BusinessEurope,44 BlackRock,45 and other organizations citing similar concerns. Indeed, despite significant increases in the representation of women on European public company boards, the European Commission report found very few women chief executives or board chairs. Of the 587 companies covered by the European Commission’s database, only 26 (4.4 percent) are chaired by women and only 16 (2.7 percent) have a woman as the chief executive officer.46 A breakdown of FTSE-100 data shows that the total of 19 percent women directors includes 23.8 percent non-executive directors and only 6.1 percent executive directors.47 In the United States, the numbers of women executives also are low; as of September 2013, only 4.5 percent, or 21, women served as CEOs of Fortune 500 companies.48 By comparison, the number of women directors as of March 1, 2013 at U.S. public companies ranges from 16.9 percent in the S&P 500 to 11.9 percent in the Russell 3000 and has not changed significantly since 2012.49

However, many corporate observers and participants believe that supply is not the main obstacle in achieving greater gender diversity. Patricia Lenkov, an advisory board member of 2020 Women on Boards, has spoken for this cohort in opining that “board diversity isn’t a supply problem, but rather it’s a demand problem.”50 One academic commentator has pointed

out that men tend to cite supply issues while women—rightly, in his view—argue that the real issue is lack of demand.51

52 SEC Commissioner Luis Aguilar spoke on the topic of gender diversity this past He expressed frustration with the fact that board nominating committees often attribute

the dearth of women on their boards to the small number of qualified women in the pipeline, arguing that with the vast resources available to public companies—including the activities of numerous organizations devoted to the identification and training of potential candidates—any board that is truly dedicated to gender diversity should be able to find plenty of qualified candidates. He emphasized the benefits of obtaining the full participation of women in a corporate boardroom, citing statistics showing that, as of 2013, women earn the majority of bachelor’s, master’s, and doctorate degrees in the United States and over one-third of MBA degrees. He also mentioned some of the same studies cited in the California senate resolution to support the argument that gender diversity on boards is correlated with improved governance and financial performance.53 A recent study by Thomson Reuters reached similar
conclusions. 54Commissioner Aguilar endorsed the existing SEC disclosure requirements as an important first step towards prioritizing diversity, although he indicated that enhanced disclosures beyond the scope of the rules may be important to satisfy investors and bring greater transparency to the nominating process. He commended the companies, such as Wells Fargo, Coca Cola and Citigroup that have provided more fulsome disclosure in their recent proxy statements regarding the diversity of their boards and how their boards considered diversity in the nominating process.55

As noted by Commissioner Aguilar, if gender diversity on boards is to improve, it is critical for nominating committees to spend time and effort identifying potential female candidates as well as working to expand the potential pool. It hardly matters how many women are in the pipeline of NGOs and corporations, after all, if they are not nominated to serve as directors. While demand has increased dramatically as chairmen and chief executives have begun to prioritize gender diversity, both on their own initiative and at the urging of shareholders and outside groups, there is room for significant improvement in this area.

Yet, as Harvard Professor Boris Groysberg has noted, “There is a big difference between diversity and inclusiveness. Diversity is about counting the numbers; inclusiveness is about making the numbers count.”56 Groysberg appropriately notes that the key to making gender diversity a meaningful element of corporate governance is to create “the conditions under which you’d expect diversity to have a positive effect on performance.”

At the OSC roundtable discussion held on October 16, 2013, Kathleen Taylor, the recently appointed Non-Executive Chair of the Royal Bank of Canada spoke eloquently about these issues:

I do think it is also important to say you can’t get too fixated on percentages. The most important thing for boards is to have the right people at the table at the right time constantly focused on renewal and diverse expertise, and so as you go through that, percentages will fluctuate, but within a range. There is nothing wrong with focusing on that and coming to some company-specific determination of what constitutes critical mass.

I think that one of the things we see in business and boards is that when women are there in sufficient numbers there is a catalyst for change in th[e] thought process, and so it is important to think about what the size and shape of that is for your organization and get to the right point on that.57

We remain convinced that in the United States, a mandatory quota system is not desirable, and we are optimistic that gender diversity will continue to increase at all levels of corporate organizations through the informal, situation-specific, yet results-oriented process of the market system as influenced by American society and culture. Effective change should, and in our view, will come from within the boardroom; it should not be imposed by regulatory means.




∗ David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz. Laura A. McIntosh is a consulting attorney for the firm. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole.



1 See David A. Katz and Laura A. McIntosh. “Corporate Governance Update: Gender Diversity on Public Company Boards” N.Y.L.J. (Sept. 27, 2012) available at (subscription required).

2 The two committees are the Committee on Legal Affairs (JURI) and Women’s Rights and Gender Equality (FEMM). These committees are jointly responsible for shepherding the proposal through the legislative process to the Parliament’s vote in November. See European Commission Press Release, “Women on Boards: Share of Women up to 16.6 percent as European Parliament Committees Back Commission Proposal,” Oct. 14, 2013, available at

3 See id.

4 European Commission, Memo, “Report on Women and Men in Leadership Positions and Gender Equality Strategy Mid-Term Review,” Oct. 14, 2013 (“EC Gender Equality Memo”) available at release_MEMO-13-882_en.htm.

5 See id.

6 Professional Boards Forum BoardWatch, “UK: Women on Boards – Statistics Update,” Oct. 7, 2013 (data from

BoardEx, Oct. 1, 2013), available at (“BoardWatch Report”).

7 Id.

8 United Kingdom Department for Business, Innovation & Skills, “Women on Boards: Review,” Feb. 24, 2011, at 4 (“Women on Boards 2011”), available at

9 See id. at 2.

10 United Kingdom Department for Business, Innovation & Skills, “Women on Boards: Second Annual Review,” April 10, 2013, at 5 (“Women on Boards 2013”), available at boards-2013-second-annual-review.

11 Letter to Jose Manuel Barroso and Vice President Viviane Reding, European Commission, from Totyu Mladenov, Bulgarian Minister of Labour and Social Policy, et al., Sept. 14, 2012 (letter was also signed by officials from the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, the Netherlands, and the United Kingdom, with Germany writing separately to express its support for the views ).

12 Ontario Securities Commission Staff Consultation Paper 58-401, “Disclosure Requirements Regarding Women on Boards and in Senior Management,” July 30, 2013 (“OSC Consultation Paper”) available at

13 OSC Consultation Paper at 5 (citing GMI Ratings, “GMI Ratings’ 2013 Women on Boards Survey,” May 1, 2013 (“GMI 2013 Survey”)). The GMI 2013 Survey is available at 2013-women-on-boards-survey/.

14 OSC Consultation Paper at 5 (citing Catalyst, “2012 Catalyst Census: Financial Post 500 Women Senior Officers and Top Earners,” Feb. 19, 2013).

15 See OSC Staff Notice 58-702, “Extension of Consultation Period,” Sept. 20, 2013 (extending the comment period closing date from Sept. 27, 2013, to Oct. 4, 2013). The complete set of comments is available at

16 Letter to Secretary, Ontario Securities Comm’n, from Wayne Kozun, Ontario Teachers’ Pension Plan, Oct. 4, 2013, available at 401_ontario-teachers-pension-plan.pdf. See also Letter to Secretary, Ontario Securities Comm’n, from Eileen A. Mercier, Ontario Teachers’ Pension Plan Board, Sept. 26, 2013, available at pension-plan-board.pdf.

17 Letter to John Stevenson, Secretary, Ontario Securities Comm’n, from Carol McNamara and Zabeen Hirji, Royal Bank of Canada, Oct. 4, 2013, available at Comments/com_20131004_58-401_rbofcan.pdf.

18 Letter to Secretary, Ontario Securities Comm’n, from Michelle Edkins, BlackRock, Oct. 3, 2013 “BlackRock Letter to OSC”), available at Comments/com_20131001_58-401_blackrockinc.pdf.

19 Letter to Secretary, Ontario Securities Comm’n, from Stan Magidson, Institute of Corporate Directors, Sept. 23, 2013, available at 401_icdeng.pdf.

20 See Companies Act 2013 (India), Aug 29, 2013 (repealing and modernizing the predecessor Companies Act 1956), available at

21 See Bhuma Shrivastava, “Women Sought on Boards as Stiletto Groups Grow: Corporate India,”, Oct. 22, 2013 (citing data from the Spencer Stuart 2012 India Board Index and Bloomberg), available at

22 See id.

23 Workplace Gender Equality Act 2012 (Australia), available at

24 ASX Corporate Governance Council, “Corporate Governance Principles and Recommendations with 2010 Amendments,” 2d Ed. Principle 3 (2010). The 2013 draft revisions, which will be effective as of 2014, note that disclosures in compliance with the Workplace Gender Equality Act 2012 suffice for ASX purposes. ASX Corporate Governance Council, “Corporate Governance Principles and Recommendations,” Draft of 3d Ed., Principle 1, Aug. 16, 2013. In 2012, women held 12.3 percent of ASX 200 directorships, up from 8.4 percent in 2010, and in 2012, women held 9.2 percent of ASX 500 directorships. Catalyst, “Women in the Labour Force in Australia,” Aug. 8, 2013, available at

25 NZX Limited, NZSX/NZDX Listing Rules, Rule 10.5.5(j), Oct. 5, 2012, available at documents/NZSX:NZDX%20Listing%20Rules%205%20October%202012.pdf.

26 NZX Markets Supervision, “Guidance Note—Diversity Policies and Disclosure,” Dec. 17, 2012, available at

27 “HKEx Proposes Companies Have Board Diversity Policies,”, available at 0-hkex-proposes-companies-have-board-diversity-policies.html.

28 See GMI 2013 Survey, supra; Paul Hastings, Breaking the Glass Ceiling: Women in the Boardroom, Third Edition, 2013, available at

29 California Senate Concurrent Resolution 62 (introduced July 11, 2013 and passed August 26, 2013 (“Legislature . . . urges that, within a three-year period from January 2014 to December 2016, inclusive, every publicly held corporation in California with nine or more director seats have a minimum of three women on its board, every publicly held corporation in California with five to eight director seats have a minimum of two women on its board, and every publicly held corporation in California with fewer than five director seats have a minimum of one woman on its board”), available at 0100/scr_62_bill_20130711_introduced.pdf.

30 See id (citing, inter alia, Credit Suisse’s global research study of 2,400 companies from 2005-2011).

31 See Karyn L. Twaronite, “Women on Boards: Moving From ‘Why’ to ‘How,’”, Jan. 8, 2013,

available at

32 Catalyst, “Catalyst Accord: Women on Corporate Boards in Canada,” Mar. 8, 2012, available at

33 Catalyst, “At One Year Mark, Thirteen Leading FP500 Companies Pledge to Catalyst Accord,” May 8, 2013, available at

34 Thirty Percent Coalition, “Coalition Contacts 127 Russell 1000 Companies,” Feb. 5, 2013, available at

35 Thirty Percent Coalition, “Institutional Investors Note Progress as Eight Companies Appoint Women to their Boards,” Sept. 18, 2013, available at eight-companies-appoint-women-to-their-boards.

36 See id.

37 2020 Women on Boards Website,

38 Thirty Percent Coalition Website,, “About,” last viewed Oct. 29, 2013.

39 See James Quinn, “EU Quota for 40 percent of Women on Boards Moves Step Closer,” Telegraph, Oct. 14, 2013, available at

40 25 Percent Group Website,, “The Group,” last viewed Oct. 29, 2013.

41 Australian Human Rights Commission, “Male Champions of Change,” May 9, 2013, available at -7-

42 Women on Boards 2011, supra, at 3. 43 Id. at 6.

44 BusinessEurope Position Paper, “Gender Balance in Boards of Directors,” May 25, 2012 (encouraging promotion of female participation at all corporate organizational layers), available at equality/opinion/files/120528/all/63_en.pdf.

45 BlackRock Letter to OSC, supra (“While the debate on female representation in corporations has primarily concentrated on boardrooms in recent years, we believe the more important priority is the development of a sustainable pipeline of female candidates for executive positions”).

46 See EC Gender Equality Memo, supra.

47 See BoardWatch Report, supra.

48 See Catalyst, “Women CEOs of the Fortune 1000,” Sept. 18, 2013, available at

49 See GMI 2013Survey, supra.

50 See Mike Myatt, “Boards Remain Pale, Male and Stale–Old Boys’ Club Alive and Well,”, Sept. 19, 2013 (quoting Patricia Lenkov), available at male-and-stale-old-boys-club-alive-and-well/.

51 See Marjorie Censer, “Women Influencing Corporate Boards, Despite Shortage of Numbers,” Washington Post, Sept. 22, 2013 (citing Harvard Business School Professor Boris Groysberg), available at women.

52 Speech by Luis A. Aguilar, Commissioner, U.S. Securities and Exchange Commission, at the Women’s Executive Circle of New York, “Merely Cracking the Glass Ceiling Is Not Enough,” May 23, 2013 (“Aguilar Speech”), available at

53 See id.

54 André Chanavat and Katherine Ramsden, “Mining the Metrics of Board Diversity, Thomson Reuters, June 2013 (“Findings show how the progression of women on boards has increased gradually over the past five years but that, on average, companies with mixed-gender boards have marginally better, or similar, performance to a benchmark index, such as the MSCI World, particularly over the past 18 months. Whereas, on average, companies with no women on their boards underperformed relative to gender-diverse boards and had slightly higher tracking errors, indicating potentially more volatility.”), available at This study complements an earlier Thomson Reuters analysis which indicated that corporations were doing more to track the number of women they employ and that those corporations that had more women at managerial levels appeared to benefit from higher share prices in times of market turmoil. André Chanavat, “Women in the Workplace” Thomson Reuters, February 2012, available at

55 See Aguilar Speech, supra.

56 See Carmen Nobel, “Few Women on Boards: Is There a Fix?” Harvard Business School Working Knowledge, Jan. 14, 2013, available at

57 OSC Roundtable Discussion re Women on Boards and Senior Management, Oct. 16 2013, at 20-21 (unedited transcript), available at 401_transcript.pdf.


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Activism and Short-Termism; the Real World of Business

This article was written by Martin Lipton, Wachtell, Lipton, Rosen & Katz

October 25, 2013

Empiricism and Experience; Activism and Short-Termism; the Real World of Business 

Harvard Law School Professor Lucian Bebchuk believes that shareholders should be able to control the material decisions of the companies they invest in. Over the years, he has written numerous articles expressing this view, including a 2005 article urging that shareholders should have the power to initiate a shareholder referendum on material corporate business decisions. In addition to his writings and speeches, Prof. Bebchuk has established and directs the Shareholder Rights Project at Harvard Law School for the purpose of managing efforts to dismantle classified boards and do away with other charter or bylaw provisions that restrain or moderate shareholder control of corporations (see “Harvard’s Shareholder Rights Project is Wrong” and “Harvard’s Shareholder Rights Project is Still Wrong”). In addition, Prof. Bebchuk has been at the forefront in arguing to the SEC that, despite the specific action of Congress in 2010 to empower the SEC to adopt a rule to require fair and prompt public disclosure of accumulations of shares by activist hedge funds and other blockholders, the SEC should not do so because it would limit the ability of activist hedge funds to attack corporations. In short, Prof. Bebchuk believes that shareholders should have the power to control the fundamental decisions of corporations – even those shareholders who bought their shares only a few days or weeks before they sought to assert their power, and regardless of whether their investment objective is short-term trading gains instead of long-term value creation.

While there is no question that almost every attack, or even rumor of an attack, by an activist hedge fund will result in an immediate increase in the stock market price of the target, such gains are not necessarily indicative of real value creation. To the contrary, the attacks and the efforts by companies to adopt short-term strategies to avoid becoming a target have had very serious adverse effects on the companies, their long-term shareholders, and the American economy. To avoid becoming a target, companies seek to maximize current earnings at the expense of sound balance sheets, capital investment, research and development and job growth. Indicative of the impact of shareholder pressure for short-term performance is the often cited comment by then-Citigroup CEO Chuck Prince in the July 9, 2007 Financial Times: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance.” Many commentators have cited pressure to boost short-term performance metrics as one of the causes of the 2008 fiscal crisis, such as Lynne Dallas in her 2012 article in the Journal of -2-

Corporation Law (“[t]he financial crisis of 2007-2009 was preceded by a period of financial firms seeking short-term profit regardless of long-term consequences”) and Sheila Bair in her last speech as FDIC chairman in 2011 (“the overarching lesson of the crisis is the pervasive short-term thinking that helped to bring it about”). Virtually all of the academic and government studies of the fiscal crisis have concluded that shareholder pressure was a contributing cause.

In August of this year, Prof. Bebchuk released an article describing what he characterized as empirical evidence that attacks by activist hedge funds do not harm companies and their long-term shareholders (see “The Long-Term Effects of Hedge Fund Activism”). I released a paper pointing out serious deficiencies in the methodology, analysis and conclusions that Prof. Bebchuk used and I cited an academic study questioning his statistics, an empirical study to the contrary and real-world experience and anecdotal evidence that activism and its concomitant short-termism destroy long-term value and damage the American economy (see “The Bebchuk Syllogism”; see also “Current Thoughts About Activism” and “Bite the Apple; Poison the Apple; Paralyze the Company; Wreck the Economy”). Apparently, my paper touched a raw nerve. In an attempt to resuscitate his promotion and justification of attacks by activist hedge funds, Prof. Bebchuk has published a new paper (“Don’t Run Away from the Evidence: A Reply to Wachtell Lipton”) accusing me of running away from the evidence; a serious accusation, but demonstrably untrue. Let’s take a look at some of the evidence (empirical, experiential, and overwhelming) that supports my views.

Empirical Evidence 

It should be noted that Prof. Bebchuk’s claim that “supporters of the myopic activists view have failed to back their view with empirical evidence or even to test empirically the validity of their view” is patently false. In fact, numerous empirical studies over the years have produced results that conflict with those Prof. Bebchuk espouses. These other studies generally find that activism has a negative effect or no effect on long-term value, particularly when controlling for the skewing impact of a takeover of the target (which generally occurs at a premium regardless of whether the target is the subject of activism). This fact compels a careful assessment and critical review of his study to determine why his results differ from many prior studies – something I attempted to provide in my previous paper. I have provided below a brief, and admittedly incomplete, sampling of such studies. -3-

Director Contests and Firm Performance 

● According to Jonathan Macey and Elaine Buckberg in their 2009 “Report on Effects of Proposed SEC Rule 14a-11 on Efficiency, Competitiveness and Capital Formation,” there are “[s]everal studies [that] establish that when dissident directors win board seats, those firms underperform peers by 19% to 40% over the two years following the proxy contest.”

● One of those studies is David Ikenberry and Josef Lakonishok’s “Corporate Governance Through the Proxy Contest” (published in the Journal of Business in 1993), which reviewed 97 director election contests during a 20-year period in order to examine the long-term performance of targeted firms subsequent to a proxy contest. Their findings were striking: “When the incumbent board members successfully retain all board seats, cumulative abnormal returns are not significantly different from zero over the next 5 years. Yet, in proxy contests where dissidents obtain one or more seats, abnormal returns following resolution of the contest are significantly negative. Two years following the contest, the cumulative abnormal return has declined by more than 20%. The operating performance of these same firms during the postcontest period is also generally consistent with the pattern observed using stock returns.”

● Michael Fleming obtained similar results when looking at instances where a dissident obtains board representation in “New Evidence on the Effectiveness of the Proxy Mechanism,” a 1995 Federal Reserve Bank of New York research paper. Reviewing a sample of 106 threatened proxy contests between 1977 and 1988, Fleming found statistically significant negative returns of -19.4% in the 24 months following the announcement of a contested election for the 65 firms in his sample where dissidents won board seats – either as a result of a shareholder vote or a settlement. Fleming found that the majority of gains resulting from threatened proxy contests were “attributable to firms which [we]re acquired within one year of the outcome of the proxy contest,” suggesting that the gains were due to payment of a takeover premium (consistent with Greenwood and Schor’s findings described below), not from operating improvements or governance changes.

● Lisa Borstadt and Thomas Zwirlein found very similar results in “The Efficient Monitoring Role of Proxy Contests: An Empirical Analysis of Post-Contest Control Changes and Firm Performance,” published in Financial Management in 1992. These authors examined 142 exchange-traded firms involved in proxy contests for board representation over a 24-year period. They found the following: “A dissident victory in the proxy contest does not necessarily translate -4-

into superior corporate performance. Positive abnormal returns over the proxy contest period are realized by firms in which the dissidents win the proxy contest and the firm is subsequently taken over. In contrast, no abnormal performance over the contest period is observed for the firms in which the dissidents win but the firm is not subsequently taken over. For these firms, large negative (although insignificant) cumulative returns are observed in the postcontest period.”

Shareholder Proposals and Firm Performance 

● In “Investor Activism and Takeovers,” published in the Journal of Financial Economics in 2009, Robin M. Greenwood and Michael Schor examined Schedule 13D filings by portfolio investors between 1993 and 2006 to investigate the effect of activist interventions on stock returns. They found the following: “[A]ctivism targets earn high returns primarily when they are eventually taken over. However, the majority of activism targets are not acquired and these firms earn average abnormal returns that are not statistically distinguishable from zero. . . . Thus, the returns associated with activism are largely explained by the ability of activists to force target firms into a takeover, thereby collecting a takeover premium.”

● In “Pension Fund Activism and Firm Performance,” published in the Journal of Financial and Quantitative Analysis in 1996, Sunil Wahal reviewed 356 “targetings” by the nine most active funds between 1987 and 1993. “Targetings” included both proxy proposals and nonproxy targeting, and were typically initiated by sending a letter to the target firm (either publicly or privately) followed by a telephone call from the activist fund. Wahal found that, while pension funds “are reasonably successful in changing the governance structure of targeted firms,” these changes have no impact on stock performance. According to Wahal, “targeting announcement abnormal returns are not reliably different from zero,” and “[t]he long-term abnormal stock price performance of targeted firms is negative prior to targeting and still is negative after targeting.” Wahal also found that “accounting measures of performance do not suggest improvements in operating or net income either; accounting measures of performance also are negative prior to and after targeting.”

● Two studies released by the U.S. Chamber of Commerce in partnership with Navigant Consulting reviewed shareholder proxy proposals between 2002-2008 and 2009-2012, respectively, for impact on firm performance. The studies, published in May 2009 and May 2013, both focused on shareholder proposals that were identified as “Key Votes” by the AFL-CIO in annual surveys during the respective time periods, including proposals reflecting board declassifications, proxy -5-

access and director removal policies. In the first study, “Analysis of the Wealth Effects of Shareholder Proposals – Volume II,” Joao Dos Santos and Chen Song reviewed 166 shareholder proposals between 2002-2008 and found “no evidence of a statistically significant overall short-run or long-run improvement and some indication of a long-run decrease in market value for the firms in our sample.” In the second study, “Analysis of the Wealth Effects of Shareholder Proposals – Volume III,” which reviewed 97 shareholder proposals between 2009-2012, Allan T. Ingraham and Anna Koyfman came to similar conclusions: “We . . . find no conclusive or pervasive evidence that the shareholder proposals assessed in this study improve firm value or result in an economic benefit to pension plans and plan participants. Given that the proxy process imposes costs on both firms and shareholders, and given that there are no proven benefits in terms of corporate performance, the overall net benefit of these initiatives is likely negative.”

● Andrew K. Prevost and Ramesh P. Rao studied the impact of shareholder activism by public pension funds in their paper “Of What Value Are Shareholder Proposals Sponsored by Public Pension Funds?” (published in the Journal of Business in 2000), examining a total of 73 firms that received shareholder proposals during the period of 1988-1994. They came to the following conclusions: “Firms that are subject to shareholder proposals only once during the sample period experience transitory declines in returns, but firms that are subject to repeat shareholder proposals experience permanent declines in market returns. . . . Long-term changes in operating performance corroborate the event study results: firms targeted only once exhibit positive but insignificant long-term results, while those targeted repeatedly show strong declining performance.”

● Jonathan M. Karpoff, Paul H. Malatesta and Ralph A. Walkling reviewed 522 shareholder proposals at 269 companies between 1986 and 1990 to determine the impact of shareholder proposals on firm performance in “Corporate Governance and Shareholder Initiatives: Empirical Evidence,” published in the Journal of Financial Economics in 1996. After finding that “proposals are targeted at poorly performing firms,” they concluded that, notwithstanding this fact, the “average effect of shareholder corporate governance proposals on stock values is close to, and not significantly different from, zero.” In fact, “[s]ales growth declines for firms that receive proposals in relation to sales growth for control firms,” “[c]hanges in operating return on sales are not significantly larger for proposal firms than their controls, and are not significantly related to the persistence or intensity of proposal pressure, or to the sponsors’ identity,” and “[c]hange in operating ROA are not related to the pressure’s intensity or sponsors’ identity.” -6-

● In “Less is More: Making Institutional Shareholder Activism a Valuable Mechanism of Corporate Governance,” published in the Yale Journal on Regulation in 2001, Yale Law School professor Roberta Romano conducted a review of the corporate finance literature on institutional investors’ corporate governance activities, involving seven different empirical studies and a total of over 4,500 individual shareholder proposals. She found that the shareholder proposals had “little or no effect on targeted firms’ performance” over the time periods considered in the studies and proposed that improvements might be achieved if the rules were revised “to require proposal sponsors either to incur the full cost of a losing proposal or a substantial part of the cost.”

● It is particularly noteworthy that CalSTRS, one of the major public employee pension funds and one of the leaders in proxy voting and investing in activist hedge funds, has recently reported that its aggregate investments in activist funds as of October 2012 trailed the United States public equity market, as shown by this chart from its annual report.

If activist funds fail to achieve attractive returns for their own investors, it raises the question whether pension funds and other fiduciary investors are actually promoting the best interests of the beneficiaries of the funds they manage when they invest in activist funds, given the fact that activist funds promote short-termism with its attendant costs to the rest of the market and to the economy as -7-

a whole (see Leo E. Strine’s “One Fundamental Corporate Governance Question We Face: Can Corporations Be Managed for the Long Term Unless Their Powerful Electorates Also Act and Think Long Term,” published in The Business Lawyer in November 2010). This month the UK Law Commission published a consultation paper responding to a government request, based on the Kay Review discussed below, “To evaluate whether fiduciary duties (as established in law or as applied in practice) [of investment intermediaries] are conducive to investment strategies in the best interests of the ultimate beneficiaries. We are asked to carry out this evaluation against a list of factors, balancing different objectives, including encouraging long-term investment strategies [emphasis supplied] and requiring a balance of risk and benefit.”

Takeover Defenses and Firm Value 

● Approaching the question from another perspective, William C. Johnson, Jonathan M. Karpoff and Sangho Yi investigated the impact of takeover defenses on firm value in “The Bonding Hypothesis of Takeover Defenses: Evidence from IPO Firms” (April 29, 2013 working paper, available at Looking at a sample of 1,219 firms that went public between 1997 and 2005, the authors tested the “bonding hypothesis of takeover defenses” – that is, the theory that “takeover defenses increase the value of managers’ commitments to maintain their promised operating strategy and not to opportunistically exploit their counterparties’ investments in the IPO firm,” which, “in turn, encourages the firm’s counterparties to invest in the business relationship, yielding benefits for the IPO firm.” The authors reported the following findings:

(1) IPO firms deploy more takeover defenses when they have large customers, dependent suppliers, or strategic partners;

(2) The IPO firm’s value is positively related to its use of takeover defenses, particularly when it has large customers, dependent suppliers, and/or strategic partners;

(3) The IPO firm’s subsequent operating performance is positively related to its use of takeover defenses, particularly when it has large customers, dependent suppliers, and/or strategic partners; -8-

(4) When the IPO firm announces its intention to go public, its large customers experience a change in share values that is positively related to the IPO firm’s use of takeover defenses; and

(5) After the IPO, the longevity of the IPO firm’s business relationship with its large customer is positively related to its use of takeover defenses.

According to the authors, these results are explained by the fact that “takeover defenses … help to economize on the cost of building and maintaining value-increasing trading relationships between the IPO firm and its counterparties.” As a result, “at IPO firms whose values depend heavily on their relationships with customers, suppliers, and strategic partners, takeover defenses appear to increase value by bonding the IPO firm’s commitment to these relationships.”

● In “The Impact of Antitakeover Amendments on Corporate Financial Performance” (published in The Financial Review in 2001), Mark S. Johnson and Ramesh P. Rao examined a sample of 649 antitakeover amendments adopted between 1979 and 1985 to determine the impact of the passage of antitakeover amendments on firm share price. Contrary to the management entrenchment hypothesis, the authors found that “antitakeover amendments are relatively benign events that do not significantly impact managerial behavior,” and that “antitakeover amendments are not associated with deleterious effects to shareholders in terms of their impact on various fundamental firm performance measures.”

Managerial Behavior and Pressures to Achieve Short-Term Performance 

● Jie He and Xuan Tian’s “The Dark Side of Analyst Coverage: The Case of Innovation” (forthcoming in the Journal of Financial Economics) examined the effect of analyst coverage on firm innovation to investigate how the pressure to achieve short-term performance impacts managerial behavior. The short-term pressures exerted by activist investors are often no different than those generated by stock analysts, and in many instances activist investors merely piggyback on stock analyst commentary when they launch attacks. Examining a sample of 25,860 firm-year observations relating to U.S. listed firms during the period of 1993-2005, He and Tian explored the “innovation output” of firms (as measured in terms of the number of (i) patent applications filed in a given year that are eventually granted and (ii) non-self citations each patent receives in subsequent years) in relation to the intensity of analyst coverage (as measured by the average number of -9-

earnings forecasts issued for the firm each month). The authors found that “an exogenous average loss of one analyst following a firm causes it to generate 18.2% more patents over a three-year window than a similar firm without any decrease in analyst coverage” and that “an exogenous average loss of one analyst following a firm leads it to generate patents receiving 29.4% more non-self citations than a similar firm without any decrease in analyst coverage.” He and Tian determined that this evidence “is consistent with the hypothesis that analysts exert too much pressure on managers to meet short-term goals, impeding firms’ investment in long-term innovative projects.”

● Natalie Mizik published similar findings in “The Theory and Practice of Myopic Management,” featured in the Journal of Marketing Research in 2010. In this study, Mizik reviewed the operating performance, marketing spending, R&D spending and stock price performance of 6,642 firms between 1986 and 2005 to assess the financial consequences of the practice of cutting marketing and R&D spending to inflate short-term earnings. In order to isolate firms that were potentially engaging in “myopic management,” Mizik filtered for firms that simultaneously reported greater-than-normal profits, lower-than-normal marketing expenses and lower-than-normal R&D spending. Mizik then compared the stock performance of these “potentially myopic” firms against the performance of “nonmyopic” firms. Potentially myopic firms initially experienced much better stock performance than the firms that failed to meet performance expectations. However, after four years, “the portfolio of potentially myopic firms ha[d] a negative return of -15.7%, far below the return to the two nonmyopic benchmark portfolios (29.2% and 13.3%) and the S&P 500 return of 21.6%.” Mizik concludes that “[m]yopic management might have some short-lived benefits – it leads to higher current-term earnings and stock price – but it damages the long-term financial performance of the firm because the initial gains are followed by greater negative abnormal returns.”

● Aleksandra Kacperczyk’s “With Greater Power Comes Greater Responsibility?” (published in the Strategic Management Journal in 2009) tested the effect of takeover protection on the amount of corporate attention paid to shareholders and non-shareholding stakeholders, respectively. Looking at a sample of 878 firms between 1991 and 2002, Kacperczyk found that “an exogenous increase in takeover protection leads to higher corporate attention to community and the natural environment, but has no impact on corporate attention to employees, minorities and customers,” and that “firms that increase their attention to stakeholders experience an increase in long-term -10-

shareholder value,” measured over the two-year and three-year periods following the increase in takeover protection.

● Other empirical studies have shown that pressure from investors with short investment horizons can influence management to engage in financial misreporting. In “Institutional Ownership and Monitoring: Evidence from Financial Misreporting” (published in the Journal of Corporate Finance in 2010), Natasha Burns, Simi Kedia and Marc Lipson examined a sample of firms that restated their earnings between 1997 and 2002, finding that ownership by “transient institutions” (those with short investment horizons) are positively related with an increase in the likelihood and severity of an accounting restatement. The authors concluded that “[i]t is precisely these institutions, which trade frequently and therefore are likely to focus management attention on short-term reported performance, that provide incentives to manipulate earnings.”

● Another relevant study coming out of the financial crisis examined whether the corporate governance characteristics of banks impacted the likelihood of banks requiring government “bailout” support during the financial crisis. In “Shareholder Empowerment and Bank Bailouts” (a 2012 working paper), Daniel Ferreira, David Kershaw, Tom Kirchmaier and Edmund Schuster created a “management insulation” index ranking the degree of banks’ management insulation based on their charter and by-law provisions and on the provisions of the applicable state corporate law that make it difficult for shareholders to oust management. They found that, in a sample of U.S. commercial banks, banks in which managers are “fully insulated” from shareholders were roughly 19 to 26 percentage points less likely to receive state bailouts than banks whose managers were subject to stronger shareholder rights. The authors explained that “[b]ank shareholders may have incentives to increase risk taking beyond the socially-optimal level” and that, “in search for higher returns, bank shareholders had incentives to push their banks towards less traditional banking activities.”

● In his article “Do Institutional Investors Prefer Near-Term Earnings Over Long-Run Value?” (published in Contemporary Accounting Research in 2001), Brian Bushee examined a sample of 10,380 firm-years between 1980 and 1992 to determine whether institutional investors exhibit preferences for near-term earnings over long-run value. Bushee found that “the level of ownership by institutions with short investment horizons (transient institutions) and by institutions held to stringent fiduciary standards (banks) is positively (negatively) associated with the amount of value -11-

in near-term (long-term) earnings.” Bushee found no evidence that banks “myopically price” firms by overweighting short-term earnings potential and underweighting long-term earnings potential. However, in transient institutions “high levels of transient ownership are associated with an over- (under-) weighting of near-term (long-term) expected earnings and a trading strategy based on this finding generates significant abnormal returns. This finding supports the concerns that many corporate managers have about the adverse effects of an ownership base dominated by short-term-focused institutional investors.”

● The above result is consistent with an earlier empirical study by Bushee that examined the influence of shareholder demographics on earnings management by managers. In “The Influence of Institutional Investors on Myopic R&D Investment Behavior,” published in the Accounting Review in 1998, Bushee investigated whether institutional investors create or reduce incentives for corporate managers to reduce investment in research and development to meet short-term earnings goals. Examining a sample of all firm-years between 1983 and 1994 with available data, Bushee found that “a high proportion of ownership by institutions exhibiting transient ownership characteristics (i.e., high portfolio turnover, diversification, and momentum trading) significantly increases the probability that managers reduce R&D to boost earnings.” Bushee believed that “[t]his result supports the widely-argued view that short-term-oriented behavior by institutions creates pressures for managers to sacrifice R&D for the sake of higher current earnings” among those firms with high levels of transient ownership.

● William Pugh, Daniel Page and John Jahera, Jr.’s “Antitakeover Charter Amendments: Effects on Corporate Decisions” (published in the Journal of Financial Research in 1992) tested whether managers adopt a longer-term investment strategy after their firm passes antitakeover charter amendments. Examining a sample of firms that adopted antitakeover charter amendments between 1978 and 1985, the authors found that “firms increase spending on fixed capital as a percentage of both sales and assets the year of passage and for several years thereafter,” and that overall results with respect to R&D expenditures “appear to support the managerial myopia hypothesis.”

● A recent survey of 1,038 board members and executives by McKinsey & Company and the Canada Pension Plan Investment Board found startling levels of short-term orientation among corporate executives. As reported in the Wall Street Journal on May 22, 2013, this study found the following:-12-

– Sixty-three percent of business leaders indicated the pressure on their senior executives to demonstrate strong short-term financial performance has increased in the past five years.

– Seventy-nine percent of directors and senior executives said they felt the most pressure to demonstrate strong financial performance over a time period of less than 2 years. Only 7% said they felt pressure to deliver strong financial performance over a horizon of 5 or more years.

– However, respondents identified innovation and strong financial returns as the top two benefits their company would realize if their senior executives took a longer-term view to business decisions.

– Yet, almost half of respondents (44%) said that their company’s management team currently uses a primary time horizon of less than 3 years when they conduct a formal review of corporate strategy. Seventy-three percent said this primary time horizon should be more than 3 years and 11% said the horizon should be more than 10 years.

● The McKinsey findings are consistent with an earlier study published in the Financial Analysts Journal in 2006. In “Value Destruction and Financial Reporting Decisions,” John Graham, Campbell Harvey and Shiva Rajgopal described the results of a survey of 401 senior financial executives. Going a step further than the McKinsey study, the authors asked executives if they would be willing to sacrifice long-term value in order to smooth earnings. An “astonishing 78% admit[ted] they would sacrifice a small, moderate or large amount of value to achieve a smoother earnings path.”

Short-Termism and Macroeconomic Productivity 

● The problems discussed above have larger implications than simply the performance of individual firms. In his 2012 book, Corporate Law and Economic Stagnation: How Shareholder Value and Short-Termism Contribute to the Decline of the Western Economies, Pavlos Masouros used macroeconomic data to show that the shift in corporate governance toward shareholder interests and increasing short-termism in France, Germany, the Netherlands, the UK and the US have contributed to low GDP growth rates in those countries since the early 1970s. Masouros -13-

outlined the unfolding of a “Great Reversal in Corporate Governance” whereby the primacy of shareholder value in the corporate governance pecking order was established, as well as a “Great Reversal in Shareholdership” where the average holding period of shares rapidly decreased, both of which contributed to a dramatic increase in the average equity-payout ratio of firms and a decrease in the average capital retention and reinvestment of profits by firms. Masouros’ prescription for ameliorating this trend away from capital reinvestment is what he calls “Long Governance” – moving toward a system where shareholders are infused with incentives that would allow them to develop long-term horizons that would align their interests with other constituencies and increase companies’ incentives to invest in future productivity.

● In “The Kay Review of UK Equity Markets and Long-Term Decision Making,” published by the UK Department for Business Innovation and Skills in July 2012 (the “Kay Review”), John Kay examined how the structure of the UK equity markets encourages short-termism and discussed the impact on UK businesses and investors. Kay started with the observation that “[a]s a percentage of GDP, research and development expenditure by British business has been in steady decline” and proceeded to explore why this was the case. He then identified a fundamental misalignment of the interests of the UK asset management industry and the ultimate principals, the companies which use equity markets and the individual UK “savers” who provide funds to them: “Returns to beneficial owners, taken as a whole, can be enhanced only by improving the performance of the corporate sector as a whole. Returns to any subset of beneficial owners can be enhanced, at the expense of other investors, by the superior relative performance of their own asset managers. Asset managers search for alpha, risk adjusted outperformance relative to a benchmark. But savers collectively will earn beta, the average return on the asset class.” This misalignment exists because “the time horizons used for decisions to hire or review investment managers are generally significantly shorter than the time horizon over which the saver, or the corporate sponsor of a pension scheme, is looking to maximize a return.” Kay pointed out that “[c]ompetition between asset managers to outperform each other by anticipating the changing whims of market sentiment … can add nothing, in aggregate, to the value of companies … and hence nothing to the overall returns to savers.” Predictably, the short-term incentives of asset managers flow down to corporate managers, many of whom are incentivized “to make decisions whose immediate effects are positive even if the long run impact is not” and “whose consequences are likely to be apparent within a short time scale.” After describing the problem in great detail, Kay presented a series of recommendations that he believed “will help to deliver the improvements to equity markets necessary to support sustainable long-term -14-

value creation by British companies,” including the recommendation that “regulation must be directed towards the interests of market users – companies and savers – rather than the concerns of market intermediaries.” The applicability of Kay’s analysis to American equity markets is obvious.

The Evidence of Experience 

No matter how much Professor Bebchuk attempts to denigrate what he calls “anecdotal” evidence, the experiences of those with “boots on the ground” must be taken into consideration in combination with the empirical evidence sampled above. Take, for example, some of the statements below from leaders who have firsthand experience with the short-term pressures faced by public company managers and directors.

● Bill George, a professor at Harvard Business School, former chief executive of the medical device company Medtronic, and currently a director of Goldman Sachs and Exxon Mobil, recently said in his August 2013 New York Times article, Activists Seek Short-Term Gain, Not Long-Term Value: “While activists often cloak their demands in the language of long-term actions, their real goal is a short-term bump in the stock price. They lobby publicly for significant structural changes, hoping to drive up the share price and book quick profits. Then they bail out, leaving corporate management to clean up the mess. Far from shaping up these companies, the activists’ pressure for financial engineering only distracts management from focusing on long-term global competitiveness.”

● Warren Buffet and 27 other highly regarded businesspeople, academics, investment bankers and union leaders expressed concerns about short-termism in “Overcoming Short-Termism: A Call for a More Responsible Approach to Investment and Business Management,” a 2009 Aspen Institute policy statement. In this paper, these leaders voiced concern that “boards, managers, shareholders with varying agendas, and regulators, all, to one degree or another, have allowed short-term considerations to overwhelm the desirable long-term growth and sustainable profit objectives of the corporation,” and that this trend toward short-term objectives has “eroded faith in corporations continuing to be the foundation of the American free enterprise system.” In particular, they noted that “the focus of some short-term investors on quarterly earnings and other short-term metrics can harm the interests of shareholders seeking long-term growth and sustainable earnings, if managements and boards pursue strategies simply to satisfy those short-term investors,” which “may put a corporation’s future at risk.” -15-

● Dominic Barton, global managing director of McKinsey & Company, described the problem in “Capitalism for the Long-Term,” a 2012 McKinsey publication: “[E]xecutives must do a better job of filtering input and should give more weight to the views of investors with a longer-term, buy-and-hold orientation. . . . If they don’t, short-term capital will beget short-term management through a natural chain of incentives and influence. If CEOs miss their quarterly earnings targets, some big investors agitate for their removal. As a result, CEOs and their top teams work overtime to meet those targets. The unintended upshot is that they manage for only a small portion of their firm’s value. When McKinsey’s finance experts deconstruct the value expectations embedded in share prices, we typically find that 70 to 90 percent of a company’s value is related to cash flows expected three or more years out. If the vast majority of most firms’ value depends on results more than three years from now, but management is preoccupied with what’s reportable three months from now, then capitalism has a problem.”

● Daniel Vasella, former chairman and CEO of Novartis AG, spoke firsthand about the pernicious effects of the pressure created by such short-term expectations in a 2002 Fortune article: “Once you get under the domination of making the quarter – even unwittingly – you start to compromise in the gray areas of your business, that wide swath of terrain between the top and bottom lines. Perhaps you’ll begin to sacrifice things (such as funding a promising research-and-development project, incremental improvements to your products, customer service, employee training, expansion into new markets, and yes, community outreach) that are important and that may be vital for your company over the long term.”

A Proposal for Effective Shareholder Engagement 

In laying out the evidence above, I do not mean to say that all forms of investor engagement are bad. To the contrary, I believe that collaborative interaction between boards and long-term shareholders can help increase the effectiveness of boards. Consider the observations of John Kay in the Kay Review. Kay encouraged “effective engagement” between asset managers and the companies they invest in. However, he did not hold all forms of engagement equal, arguing instead that all participants in the equity investment chain should act according to the principles of what he calls “stewardship”: “Our approach, which emphasizes relationships based on trust and respect, rooted in analysis and engagement, develops and extends the existing concept of stewardship in equity investment. This extended concept of stewardship requires that the skills and knowledge of -16-

the asset manager be integrated with the supervisory role of those employed in corporate governance: it looks forward to an engagement which is most commonly positive and supportive, and not merely critical.” Kay recommends that company directors “facilitate engagement with shareholders, and in particular institutional shareholders such as asset managers and asset holders, based on open and ongoing dialogue about their long-term concerns and investment objectives.” But, importantly, he also emphasizes that directors should “not allow expectations of market reaction to particular short-term performance metrics to significantly influence company strategy.”

I support Kay’s views on what constitutes “effective engagement” and believe shareholder collaboration with management and directors along these lines could be a value-enhancing development for many companies both in the short-run and long-run.

Standing Firm, Not Running Away 

As to Professor Bebchuk’s allegation, I think it is clear that, far from “running away” from the evidence, my views and my colleagues’ views are supported by many highly respected academics, policymakers, investors and business leaders whose empirical analyses and real-world experiences show that most activist interventions contribute to managerial short-termism and harm the innovation and growth potential of American companies. It is also clear that empirical evidence must be considered in context with other forms of evidence, including macroeconomic analysis, real-world experience and common sense, to determine if it tells a story that makes sense in the real world.

Martin Lipton

With thanks to: 

Steven A. Rosenblum

Eric S. Robinson

Karessa L. Cain

Sabastian V. Niles

William T. Clayton

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Canadian Securities Administrators Intend to Regulate Proxy Advisory Firms

September 25, 2013

Canadian Securities Administrators Intend to Regulate Proxy Advisory Firms

          The Canadian Securities Administrators (CSA), an umbrella organization of Canada’s provincial and territorial securities regulators, recently issued an update on their ongoing, consultative process concerning possible regulation of proxy advisory firms. CAS Notice 25-301, Update on CSA Consultation Paper 25-401, Potential Regulation of Proxy Advisory Firms (Sept. 19, 2013). Following feedback from market participants on the impact proxy advisors are having on the integrity of Canadian capital markets, the CSA has concluded that a response from Canadian securities regulators is warranted, with a proposed approach intended to be announced in the first quarter of 2014.

The CSA expects to develop a “policy-based” regulatory approach that would “promote transparency and understanding” and provide guidance on recommended practices and disclosure.  While the ultimate scope and nature of the regulatory response will be thoroughly debated, the CSA response is expected to address, at least in some fashion, the following concerns, many of which were raised by the CSA in their June 2012 consultation paper:

  • Risks to Canadian capital markets arising from supply and demand market forces failing to provide sufficient “checks and balances” on the quality of proxy advisory voting recommendations due to limited competition in the proxy advisory industry;
  • Potential conflicts of interest, such as those arising from proxy advisory firm business models and ownership structures, among other sources of conflict;
  • Perceived lack of transparency into voting guidelines, methodologies and analyses;
  • Inaccurate reports and limited opportunities for issuers to dialogue with proxy advisors;
  • The extent to which proxy advisory firms have become de facto corporate governance standard setters, with the effect of compelling issuers to adopt “one-size-fits-all” standards that may be unsuitable for their specific circumstances; and
  • Over-reliance by institutional investors on proxy advisory firm recommendations and the potential for proxy advisory firms to significantly influence voting outcomes.

An effective regulatory response by Canadian securities regulators addressing the issues raised by the CSA Consultation would put Canada on a different page than the U.S., where no decision has been made as to whether to subject the proxy advisory firms to additional regulatory oversight.  With respect to the U.S., the SEC’s wide-ranging July 2010 concept release on the U.S. proxy system also addressed proxy advisory firms, their ability to influence a significant percentage of the vote (despite having no direct economic interest themselves), potential conflicts that these firms may have in formulating their voting recommendations, and concerns about factual inaccuracies in their reports.  In July 2013, SEC Commissioner Daniel M. Gallagher proposed various regulatory reforms to discourage “rote reliance” on the recommendations of proxy advisors, voicing doubts over whether institutional investors properly fulfill their fiduciary duties by relying on and following recommendations from proxy advisory firms.

It remains to be seen if the SEC will follow the Canadian securities regulators’ example and subject the proxy advisory firms to additional regulatory scrutiny or whether the SEC will maintain the status quo of minimal regulatory oversight.  Regardless of the SEC’s decision, institutional investors should be encouraged to exercise their own independent, informed judgments on voting matters and resolve governance and other issues constructively with issuers through direct, case-by-case engagement on the merits.


David A. Katz
Sabastian V. Niles

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Shareholder Activism Gone Mainstream

Corporate Governance Update: The Mainstream Shareholder Activism in 2013

David A. Katz and Laura A. McIntosh

David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz. Laura A. McIntosh is a consulting attorney for the firm. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole.

The 2013 proxy season was in many ways unremarkable, yet in important respects it illustrates the developing nature of Shareholder activism in our era of corporate governance. The issues in dispute, the voting results, and the overall trends were not significantly different from those in recent years. Nonetheless, there is an important takeaway from the 2013 season: shareholder activism has gone from fringe to mainstream. While individual gadflies and labor union pension funds are still the most prolific sponsors of shareholder proposals,1 some elements of their agendas have begun to find support among traditional investors.

Not too long ago, large, profitable corporations were considered immune from economically-motivated activist attacks, and activism was not central to the agendas of establishment players in the corporate arena. In 2013, it became clear that even household-name companies with best-in-class corporate governance and rising share prices are liable to find themselves under siege from shareholder activists, often represented by well-regarded investment banks, law firms, public relations firms and other advisors. Even some academics praise shareholder activists’ latest exploits. Shareholder activism, in its latest incarnation, is no longer a series of isolated approaches and attacks; instead, it is an environment of constant scrutiny and appraisal requiring ongoing monitoring, awareness and engagement by public companies. Proxy statement disclosures are an important tool in shareholder engagement and have been a focal point for companies in the 2013 season. In particular, companies successfully enhanced their proxy disclosures regarding executive compensation, shareholder outreach efforts, the qualifications, expertise and diversity of their board members, and audit committee reports.2 Companies also have been successful at communicating with investors

throughout the year to minimize conflict during the proxy season. Some major institutional investors have established in-house proxy departments to engage directly with corporations and make voting decisions without relying on the recommendations of proxy advisory firms.

There are two primary types of shareholder activism. The first is corporate governance-related activism that centers on issues such as board structure, takeover defenses, compensation, and political, social and environmental concerns.3 The second might be called strategy-related or economically-motivated activism, frequently associated with hedge funds—sometimes viewed as the modern-day corporate raiders— and it aims to fundamentally alter the destiny of a corporation by, for example, replacing one or more directors or ousting senior management, with the intent to create short-term gains by returning capital to shareholders, causing the disposition of major assets through a sale or spin-off or instigating the sale of the entire corporation. Shareholder activism in both of these forms has been growing over the last decade, and both were prominent in the 2013 proxy season.

2013 Proxy Season Results

In 2013, shareholder proposals increased slightly overall for the second year in a row, and proposals made by hedge funds also increased slightly after a decline in 2012.4 The number of corporate governance-related proposals represented a smaller share of the total this year, due in part to the fact that so many companies have, in recent years, taken steps such as instituting majority voting, declassifying their boards of directors, eliminating takeover defenses and splitting the roles of chairman and chief executive officer.5 According to recent statistics, only 7 percent of S&P 500 companies

have a poison pill in place, 15 percent have a classified board, and 8 percent have not adopted a majority or plurality-plus vote standard to elect directors.6

Board leadership structure remains a hot topic, however; more proposals were submitted to separate the chairman/CEO roles this year than ever before, though the levels of support for the proposals that went to a vote were lower than in recent years.7
It is possible that the successful model of independent lead or presiding directors has taken some of the steam out of proposals to separate the two roles.8 Board declassification proposals represented over 11 percent of the total number of corporate governance proposals submitted at Russell 3000 companies this year, as opposed to over 14 percent in 2012.9 The primary driver of board declassification proposals was the Shareholder Rights Project, operated by Harvard Law School. Now in its second year, the Shareholder Rights Project reportedly works with seven large pension funds and a foundation to sponsor governance proposals at companies whose shares are owned by the funds and the foundation.10 These proposals received, on average, nearly 80 percent support, slightly lower than last year’s level but still the most widely endorsed proposal across ownership types.11 In light of the proposals’ popularity and the potential negative consequences of the failure to declassify a board following a majority vote, at least 35 companies agreed to declassify after being approached by the Shareholder Rights Project this year. Overall, management at more than 70 companies sponsored declassification proposals on their own initiative in 2013, presumably to forestall critical attention from shareholders.12 It also appears that governance activists are starting to target smaller companies, which tend to have fewer resources available to resist the pressure from activists than their larger brethren.

There was a noticeable increase in the number of proposals relating to executive compensation, as proponents focused on specific pay practices such as tax

gross-ups, death benefit payments, and severance agreements, and support for 13 compensation-related proposals on these three topics averaged above 35 percent.
was also an increase in proposals on social and environmental policy issues, as well as in proposals on political spending and lobbying. Support in each of these categories hovered around 20 percent, though in recent years many of these proposals have seen a steady, albeit small, increase in favorable votes.14

Companies sought more no-action requests this year from the Securities and Exchange Commission (SEC) to exclude shareholder proposals, yet the percentage of exclusions granted was lower as shareholders carefully crafted their proposals in accordance with prior SEC responses and comments.15 On the other hand, the percentage of proposals that were withdrawn rose significantly, perhaps due to increased engagement and accommodation on the part of both companies and activists.16 Increased outreach and communication were also crucial for companies attempting to turn around failed say- on-pay votes from last season. Sixty companies experienced failed management say-on- pay votes in 2012; of the 48 that had held their votes by July 31, 39 had obtained shareholder approval.17 Nearly all of the 39 successful companies specifically mentioned shareholder outreach in their proxy statements, and many gave detailed descriptions of the extent of their communications efforts.18

The number of proxy contests rose significantly this year, from 24 in 2012 to 35 in 2013 for the Russell 3000 companies.19 Notably, large companies were among the targets. Fourteen of the 35 companies had market capitalizations of over $1 billion at the time the proxy contests were announced.20 Overall, large companies received a disproportionately high percentage of shareholder proposals this year, particularly regarding executive compensation and social and environmental policy issues.21 Institutional investors such as mutual funds that in the past typically did not participate in

activism and proxy fights now are taking a more active role, which has emboldened activists to launch campaigns directed at large and prosperous corporations.22

One target was Walt Disney, which reported high profits and completed a successful major acquisition in the past financial year. The company’s success was rewarded not with deference but with an activist-led attempt to separate chief executive Bob Iger from his role as chairman of the board. Though the initiative was defeated, it was a sign of the times that such a vigorous campaign would be waged against the governance structure of a company that, by all metrics, had a terrific year.23 No company is immune in the current environment, though it is still true that weak performance makes companies more likely to capitulate to activist demands.

Declining Reliance on Proxy Advisors

Two recent developments illustrating the changing nature of shareholder activism are the declining influence of proxy advisory firms and the establishment of in- house proxy departments at large investment funds.

There are two significant proxy advisory firms, Glass Lewis and Institutional Shareholder Services (ISS), and their recommendations have been powerful forces in influencing corporate behavior and voting results. Companies try very hard to avoid a negative recommendation from these two advisors, both for the sake of their upcoming vote and because of the unpleasant publicity it would generate. In the last decade, the influence of proxy advisory firms has increased. One factor has been the steadily growing emphasis on corporate governance ever since the fall of Enron and the adoption of the Sarbanes-Oxley Act of 2002. Another factor is the SEC’s 2003 rule, designed to minimize potential conflicts of interest, that—along with no-action letters that followed—effectively created a safe harbor for fund managers who, in accordance with pre-determined policy, relied upon the proxy voting recommendations of a third party.24 This past July, SEC Commissioner Daniel Gallagher expressed concern about

the influence wielded by proxy advisory firms and lamented the SEC’s role as “a significant enabler” of the tendency of institutional investment advisers to “view their responsibility to vote on proxy matters with more of a compliance mindset than a fiduciary mindset.”25 He indicated that the SEC should issue Commission-level guidance (as opposed to staff no-action letters) “clarifying to institutional investors that they need to take responsibility for their voting decisions rather than engaging in rote reliance on proxy advisory firm recommendations[.]”26 The Commissioner’s view is a sensible one, and the release of Commission guidance as he describes would, in our view, be a modest yet highly beneficial reform.

Similarly, the Canadian Securities Administrators (CSA), an umbrella organization of Canada’s provincial and territorial securities regulators, recently issued an update on their ongoing, consultative process concerning possible regulation of proxy advisory firms.27 The CSA has been concerned—like SEC Commissioner Gallagher— that proxy advisory firms have, to an alarming extent, effectively imposed uniform and somewhat arbitrary corporate governance standards on companies through investors’ over-reliance on proxy advisors’ voting recommendations.28 Following feedback from market participants on the impact proxy advisors are having on the integrity of Canadian capital markets and whether a response from the CSA was even necessary, the CSA has concluded that a response from Canadian securities regulators is indeed warranted. The CSA expects to develop a policy-based regulatory approach that would “promote transparency and understanding” and provide guidance on recommended practices and disclosure. The CSA’s proposed approach is expected to be published for comment in the first quarter of 2014.

Yet even as the SEC takes note of proxy advisory firms’ heretofore outsize influence, the power of Glass Lewis and ISS seems to be waning, at least slightly. With respect to say on pay votes, for example, 261 companies received negative ISS29 recommendations in 2013, yet only 18 percent failed to win majority approval.
Moreover, in a highly anticipated and hotly contested battle, JPMorgan Chase succeeded in defeating an activist proposal for an independent board chair, for the second year in a

row. Despite the recommendations of both major proxy advisory firms, the proposal received only slightly more than 30 percent of votes at the 2013 annual meeting, prompting a Glass Lewis executive to comment: “Our power is probably shrinking a bit.”30 While in 2012 100 companies reacted to negative vote recommendations from proxy advisors by filing supplemental materials, in 2013 only 59 companies did so.31 Supplemental filings can be useful in certain circumstances, but the significant drop may be one more indication that proxy advisors’ vote recommendations are viewed by companies as less influential than they have been in recent years.

More significant than the results of any individual vote campaign, however, is the fact that major investors are internalizing the function of proxy analysis and vote determinations. In 2012, BlackRock—which manages nearly $4 trillion and is the world’s largest asset manager—sent a letter to the leadership of 600 U.S. public companies encouraging them to engage directly with the asset manager.32 BlackRock had been frustrated that companies typically did not reach out to communicate regarding upcoming votes, perhaps because of an assumption that BlackRock would simply follow the recommendations of the major proxy advisors. Not so, BlackRock’s chief executive wrote in the letter: “We reach our voting decisions independently of proxy advisory firms on the basis of guidelines that reflect our perspective as a fiduciary investor with responsibilities to protect the economic interests of our clients.”33 BlackRock has, through its voting decisions, demonstrated that its policies on certain governance issues differ from those of Glass Lewis and ISS. While BlackRock has never sponsored a shareholder proposal, it engages actively with companies to work through contentious issues. According to the top corporate governance executive at BlackRock, “the firm generally votes against a director or a company proposal only when a behind-the-scenes ‘engagement’ has failed.”34

The actions by investment funds to voluntarily assume more of the responsibility that had been outsourced to proxy advisory funds is exactly what Commissioner Gallagher hopes to promote through the prospective guidance he outlined in his July speech. He stated that institutional investors should be “actively researching the proposals before them and ensuring that their votes further their clients’ interests” and

implied that indeed, their fiduciary duties require them to undertake these tasks.35
Though many institutional investors have been performing this function internally for years, merely supplementing their own policies and research with those of proxy advisory firms, the highly public communication from BlackRock is meaningful.36 It is a step toward returning proxy advisory firms to their proper role—as advisors, not dictators— and it is a step toward increasing the engagement between investors and companies and making dialogue the first step in any “activist” agenda. At a certain point, some forms of shareholder engagement may start looking less like a nuisance and more like a beneficial, dynamic relationship between investors and corporations.

Shareholder Activism’s Future

One communications expert noted recently that “Funds engaged in activism have matured, and they are less combative and more responsible in how they approach being activists…. That makes it a lot easier for mainstream, blue-chip companies to be associated with activism.”37 As activism goes mainstream, it is to be hoped that some of its more objectionable features—such as naked short-termism and one-size-fits-all corporate governance dogma—may be minimized as activist shareholders attempt to make their agendas more palatable to traditional investors.

As a general matter, companies should be wary of implementing changes at the behest of activist shareholders that cannot easily be reversed, such as eliminating a classified board structure. Not only is a classified board a valuable takeover defense, but it also may help companies resist some of the more aggressive activist tactics on the governance side as well. ISS has announced that, beginning in 2014, it will recommend voting against the election of directors at companies that have not fully implemented majority-approved shareholder proposals. (The prior policy, only slightly less aggressive, was that a shareholder proposal had to receive majority approval for two years to trigger a negative vote recommendation against directors.)38 This sort of extortive policy—a blanket response to a situation with any number of important variables—represents the least thoughtful variety of activism. The policy is not specific enough to further the interests of shareholders of any given company and yet attempts to substitute the judgment of not only shareholders but also proxy advisors for that of the board. Eliminating a classified board structure simply makes directors and public companies more vulnerable to activist campaigns, especially those of the economically motivated variety.

The big question remains: Does shareholder activism help or hurt companies? While this question is still relevant, and by no means settled,39 for many companies it is becoming a practical question of how companies can engage with major shareholders in order to respond to shareholders’ concerns, make the case for the corporate strategy, and avoid capitulation to harmful demands from shareholder activists. Indeed, the value of shareholder engagement has been endorsed in the past year by entities as diverse as the SEC,40 BlackRock,41 and ISS,42 as well as by a host of corporate executives, lawyers and commentators. At the end of the day, this is the practical approach companies are utilizing to attempt to handle a difficult issue in a flawed system.

But in our view, the bottom-line is very clear: If activist pressure—or the threat of activist pressure—causes companies to focus on short term results, it is bad for companies, shareholders and the American economy as a whole. As Chancellor Strine eloquently noted:

As a whole, institutional investors have pushed for corporate managers to be highly responsive to the immediate pressures and incentives of the capital markets. The upside of this is that the boards of public corporations have never been more sensitive to what the corporate electorate wants at any given moment. The downside of this, however, is that if the electorate itself does not have the correct incentives and does not push an agenda that appropriately focuses on the long term, the responsiveness of managers to the incentives they face can result in business strategies that involve excessive risk and, perhaps most worrying, underinvestment in future growth.43



1 See Jackie Cook, “Proxy Season Roundup: Shareholder Resolutions,” CookESG Research, July 2013, at 2 available at G.pdf.

2 See, e.g., Ernst & Young LLP, “Key Developments of the 2013 Proxy Season,” June 2013 (“E&Y Report”), at 11 available at$FILE/Key-developments-of-the-2013-proxy-season.pdf; see also James D.C. Barrall et al., “Disclosure Lessons from the 2013 Proxy Season,” Director Notes, The Conference Board, Aug. 2013 (examines the key disclosure issues and challenges facing companies during the 2013 proxy season and provides examples of company responses to these issues taken from proxy statements filed during the first half of 2013), available at

3 Thomas Singer, Social Issues in the 2013 Proxy Season, Director Notes, The Conference Board (Sept. 2013) (more than half of the shareholder proposals on social issues submitted at Russell 3000 companies that held meetings during the first half of 2013 went to a vote, constituting 21.1 percent of voted shareholder proposals during the Jan.—June 2013 period, with the vast majority related to political issues, specifically those urging companies to disclose details of their lobbying policies and their total spend on lobbying activities) available at 131.pdf&type=subsite.

4 The Conference Board/FactSet, Proxy Voting Analytics (2009-2013) Executive Summary (“PVA 2013 Summary”) at 3. The report is based on shareholder meetings held at Russell 3000 and S&P 500 companies and is available at

5 See PVA 2013 Summary at 3, 4.

6 See Ning Chiu, “Poison Pill & Declassification Proposals: Bucking the Trend of S&P 500 Companies,” (Sept. 24, 2013) (statistics from SharkRepellent) available at companies.html.

7 See “2013 Proxy Season Review: United States,” ISS, Aug. 22, 2013 (“ISS 2013 Review”) at 26. The ISS report includes data from all U.S. public companies with meeting dates from Jan. 1, 2013 through June 30, 2013. See also PVA 2013 Summary at 6.

8 See E&Y Report at 4.

9 See PVA 2013 Summary at 5.

10 See Gretchen Morgenson, “New Momentum for Change in Corporate Board Elections,”, July 6, 2013, available at corporate-board-elections.html?pagewanted=all.

11 See PVA 2013 Summary at 5.

12 See ISS 2013 Report at 28; PVA 2013 Summary at 5.

13 See PVA 2013 Summary at 5-6.

14 See ISS 2013 Review at 22; PVA 2013Summary at 3-4, 6-7.

15 See PVA 2013 Summary at 4-5.

16 See E&Y Report at 4; see also PVA 2013 Summary at 4.

17 See Georgeson Report, “Facts Behind 2013 ‘Turnaround’ Success for Say on Pay Votes,” Aug. 28, 2013, at 1, available at

18 See id. at 4.

19 See PVA 2013 Summary at 8. The PVA 2013 report notes that in the S&P 500, where proxy fights are less common, the number increased from 2 in 2012 to 5 in 2013.

20 See PVA 2013 Summary at 8.

21 See PVA 2013 Summary at 4.

22 See Brittaney Kiefer, “Shareholder Activism Rising, Big Companies in Crosshairs,”, Sept. 1, 2013, available at crosshairs/article/308954/.

23 See “Corporate Governance: Shareholders at the Gates,” The Economist, March 9, 2013, available at owners-never-shareholders.

24 Investment Advisers Act of 1940, Rule 206(4)-6. See also Leo E. Strine, Jr., “One Fundamental Corporate Governance Question We Face: Can Corporations Be Managed for the Long Term Unless Their Powerful Electorates Also Act and Think Long Term?” Business Lawyer (Nov. 2010) (“The problem of short-termism is also illustrated by the policies of proxy advisory firms whose growth was fueled by the Labor Department’s informed voting requirements for regulated investment funds.”), available at L.pdf.

25 SEC Commissioner Daniel Gallagher, Remarks at Society of Corporate Secretaries and Governance Professionals, July 11, 2013 (“Gallagher Speech”), available at

26 Id.

27 CSA Notice 25-301, Update on CSA Consultation Paper 25-401, “Potential Regulation of Proxy Advisory Firms,” Sept. 19, 2013, available at 301_update-25-401.htm.

28 See CSA Consultation Paper 25-401, “Potential Regulation of Proxy Advisory Firms,” June 21, 2012, available at

29 See Ted Allen, “A Review of the 2013 U.S. Proxy Season,” IR Update, Sept. 2013, at 17.

30 See Robert A. Profusek, “2013 Proxy Season: A Turning Tide in Corporate Governance?” Harvard Law School Forum on Corporate Governance and Financial Regulation, Aug. 23, 2013, available at

31 See Allen, supra.

32 See Suzanne Craig, “The Giant of Shareholders, Quietly Stirring,”, May 18, 2013, available at stirring.html?pagewanted=all.

33 Id. 34 Id.

35 See Gallagher Speech, supra. 36 See Profusek, supra.

37 See Kiefer, supra.

38 See Allen, supra, at 20-21.

39 See, e.g., Martin Lipton, “The Bebchuk Syllogism,” Harvard Law School Forum on Corporate Governance and Financial Regulation, Aug. 26, 2013, available at

40 See Gallagher Speech, supra.

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Hedge Fund Activism

The following is commentary written by Wachtell Lipton Rosen & Kratz regarding Harvard professor Lucian Bebchuk’s article on shareholder-centric corporate governance.    Essentially Bebchuk loves all shareholder activism and believes empirical evidence proves his point.  WLRK argue this is not the case.

– Steve Odland

August 26, 2013

The Bebchuk Syllogism

Empirical studies show that attacks on companies by activist hedge funds benefit, and do not have an adverse effect on, the targets over the five-year period following the attack.

Only anecdotal evidence and claimed real-world experience show that attacks on companies by activist hedge funds have an adverse effect on the targets and other companies that adjust management strategy to avoid attacks.

Empirical studies are better than anecdotal evidence and real-world experience. 

Therefore, attacks by activist hedge funds should not be restrained but should be encouraged.

            Harvard Law School Professor Lucian A. Bebchuk is now touting this syllogism and his obsession with shareholder-centric corporate governance in an article entitled, “The Long-Term Effects of Hedge Fund Activism.”  In evaluating Professor Bebchuk’s article, it should be noted that:

There is heavy reliance in the article on Tobin’s Q (i.e., a ratio of market value to book value, with book value intended to serve as a proxy for replacement value) to measure the performance of the targets of activist attacks, and the article presents the data in a way that makes the statistical analysis appear favorable to Professor Bebchuk’s argument.  The article highlights the average Q ratio for companies subject to activist attack in the following five years.  Since averages can be skewed by extreme results (as the article acknowledges), focusing on the median outcome would be more appropriate.  Indeed, the article presents median results, but does not reference in the text that the median Q ratio for each of the first four years following the attack year is lower than the median Q ratio in the year of the activist attack.  Only in year five does the median Q ratio exceed the Q ratio in the attack year.  While the article fails to disclose the average holding period of the activists in the study, it is undoubtedly less than five years.  So it seems quite speculative, at best, to credit activists with improvements in Q ratios that first occur for the median company only in the fifth year after the attack.

Beyond the highly questionable conclusions Professor Bebchuk draws from his Tobin’s Q statistics, there is also the fundamental question of whether Tobin’s Q is a valid measure of a company’s performance.  A 2012 paper by Olin School of Business Professor Philip H. Dybvig, “Tobin’s q Does Not Measure Firm Performance: Theory, Empirics, and Alternative Measures,” points out that Tobin’s Q is inflated by underinvestment, so a high Q is not evidence of better company performance.  Companies that forego profitable investment opportunities—including as a result of pressure from activists to return capital to investors or defer investments in R&D and CapEx—can actually have higher Q ratios while reducing shareholder value that would have been generated by those investments.  In addition, the use of book value as a proxy for replacement value introduces complications from different accounting decisions, including the timing of write-downs, depreciation methods, valuation of intangibles and similar decisions that can significantly distort a company’s Q ratio.  The other metric that Professor Bebchuk relies on in his article—return on assets (ROA)—is highly correlated with Tobin’s Q (indeed, both ratios use the same denominator, and the numerators are substantially related), and thus his ROA statistics suffer from these same shortcomings and add little to the analysis.

Further undermining the validity of the empirical analysis, the article acknowledges but fails to control for the fact that 47% of the activist targets in the dataset cease to survive as independent companies throughout the measurement period.  The study sheds no light on whether the shareholders of those companies would have realized greater value from other strategic alternatives that had a longer-term investment horizon, whether those companies were pressured to sell on account of the activist attack (as other empirical work has argued), or whether shareholder gains from activism are largely driven by the cases that result in sales of control.

Lastly, Professor Bebchuk concedes that his analytical methodology provides no evidence of causation, and thus simply misses the crux of the debate:  whether activists can impair long-term value creation.  Favorable results would arise under his approach whenever managements of the target companies pursue value-enhancing strategies, even those that run counter to the activists’ pressures or were being initiated even before the activist appeared.  In addition, improving economic, market, industry and company-specific conditions would also contribute to favorable results independent of activist pressure.  Professor Bebchuk also states that the targets in his dataset “tend to be companies whose operating performance was below industry peers or their own historical levels at the time of [activist] intervention”; if true, it is plausible that many companies improved from a historical or cyclical trough position in spite of—rather than as a result of—activist pressures.

These defects, among others, are sufficient in and of themselves to raise serious doubts about the conclusions that Professor Bebchuk draws from his empiricism.  But there is a more fundamental flaw in Professor Bebchuk’s syllogism:  it rejects and denies the evidence, including anecdotal evidence and depth of real-world experience, that he acknowledges in the article comes from a “wide range of prominent writers . . . significant legal academics, noted economists and business school professors, prominent business columnists, important business organizations, and top corporate lawyers.”

No empirical study, with imperfect proxies for value creation and flawed attempts to isolate the effects of activism over a long-term horizon influenced by varying economic, market and firm-specific conditions, is capable of measuring the damage done to American companies and the American economy by the short-term focus that dominates both investment strategy and business-management strategy today.  There is no way to study the parallel universe that would exist, and the value that could be created for shareholders and other constituents, if these pressures and constraints were lifted and companies and their boards and managements were free to invest for the long term.  The individuals who are directly responsible for the stewardship and management of our major public companies—while committed to serious engagement with their responsible, long-term shareholders—are nearly uniform in their desire to get out from under the short-term constraints imposed by hedge-fund activists and agree, as do many of their long-term shareholders, that doing so would improve the long-term performance of their companies and, ultimately, the country’s economy.

Reflecting on Professor Bebchuk’s article and failed syllogism, one is reminded of Mark Twain’s saying, “There are three kinds of lies: lies, damned lies and statistics.”

Martin Lipton
Steven A. Rosenblum
Eric S. Robinson
Karessa L. Cain
Sabastian V. Niles

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Current Thoughts About Activism

by Martin Lipton, Steven A. Rosenblum, Sabastian V. Niles

A long-term oriented, well-functioning and responsible private sector is the country’s core engine for economic growth, national competitiveness, real innovation and sustained employment.  Prudent reinvestment of corporate profits into research and development, capital projects and value-creating initiatives furthers these goals.  Yet U.S. companies, including well-run, high-performing companies, increasingly face:

  • pressure to deliver short-term results at the expense of long-term value, whether through  excessive risk-taking, avoiding investments that require long-term horizons or taking on substantial leverage to fund special payouts to shareholders;
  • challenges in trying to balance competing interests due to excessively empowered special interest and activist shareholders; and
  • significant strain from the misallocation of corporate resources and energy into mandated activist or governance initiatives that provide no meaningful benefit to investors or other critical stakeholders.

These challenges are exacerbated by the ease with which activist hedge funds can, without consequence, advance their own goals and agendas by exploiting the current regulatory and institutional environment and credibly threatening to disrupt corporate functioning if their demands are not met.  Activist hedge funds typically focus on immediate steps, such as a leveraged recapitalization, a split-up of the company or sales or spinoffs of assets or businesses that may create an increase in the company’s near term stock price, allowing the activist to sell out at a profit, but leave the company to cope with the increased risk and decreased flexibility that these steps may produce.

The power of the activist hedge funds is enhanced by their frequent success in proxy fights and election contests when companies resist the short-term steps the hedge fund is advocating.  These proxy contest successes, in turn, are enabled by the outsized power of proxy advisory firms and governance reforms that weaken the ability of corporate boards to resist short-term pressures.  The proxy advisory firms are essentially unregulated and often demonstrate a bias in favor of activist shareholders.  They also tend to take a one-size-fits-all approach to policy and voting recommendations without regard for or consideration of a company’s unique circumstances.  This approach includes the potential for across-the-board “withhold votes” from directors if the directors fail to implement any shareholder proposal receiving a majority vote, even if directors believe that the proposal would be inconsistent with their fiduciary duties and the best interests of the company and its shareholders.  Further complicating the situation is the fact that an increasing number of institutional investors now invest money with the activist hedge funds or have portfolio managers whose own compensation is based on short-term metrics, and increasingly align themselves with the proposals advanced by hedge fund activists.  In this environment, companies can face significant difficulty in effectively managing for the long-term, considering the interests of employees and other constituencies, and recruiting top director and executive talent.

Although there is no single solution to these problems, the following perspectives and actions may help to restore a more reasonable balance:

  • Recognize that the proper goal of good governance is creating sustainable value for the benefit of all stakeholders, rather than reflexively placing more power in the hands of activist hedge funds or often-transient institutional shareholders who are themselves measured by short-term, quarterly portfolio performance;
  • Resist the push to enact legislation, regulations or agency staff interpretations that place more power in the hands of activist hedge funds and other investors with short-term perspectives, and that thereby weaken the ability of corporate boards to resist such short-term pressures; and
  • In any new legislation or regulation that is enacted, provide appropriate protections to companies, as opposed to focusing only on new rights for shareholders who already have significant leverage to pressure companies.

Some specific examples of possible steps to implement these general principles may include the following:

  • SEC Commissioner Daniel Gallagher recently questioned whether “investment advisors are indeed truly fulfilling their fiduciary duties when they rely on and follow recommendations from proxy advisory firms” and expressed “grave concerns” about institutional investors engaging in “rote reliance” on proxy advisory firms’ advice.  He attributed this in part to the unintended consequences of two SEC staff no-action letters from 2004, which he noted were not approved by the Commission and did not necessarily represent the views of the Commission or the Commissioners, that had “unduly increased the role of proxy advisory firms in corporate governance” by “essentially mandating the use of third party opinions.”  New Commission-level guidance could replace these staff interpretations and, instead, encourage proxy voting based on individual evaluation of each company and its long-term best interests.  Other agencies may also wish to keep in mind this illustration of unintended and undesired outcomes as appropriate.
  • Activist shareholders take advantage of Securities Exchange Act Rule 14a-8 to force the inclusion, year-after-year and notwithstanding prior failures, of corporate governance and business-related shareholder proposals in public company proxy statements that have little connection to effective governance or the creation of long term shareholder value.    These proposals can be misused to exert leverage over companies, and dealing with the deluge distracts from the business and requires significant time and resources.  Rule 14a-8 should be revisited to raise the bar on inclusion of shareholder proposals.  This could include more substantial and longer-term ownership requirements to be eligible under Rule 14a-8, and exclusion of proposals in subsequent years that did not obtain a truly meaningful level of support (current rules prohibit a company from excluding a repeat proposal the following year unless 97% of the shares reject it the first time or 90% of the shares reject it at least three times, standards that are far too low).
  • Proxy advisory firms, such as Institutional Shareholder Services (ISS) and Glass, Lewis & Co., have disproportionate influence over voting decisions made by every public company’s institutional shareholder base and regularly support activist shareholders and hedge funds.  Their recommendations and analyses may also contain material inaccuracies, and companies have little visibility into the preparation of these reports and the proxy advisory firms’ methodologies.  We believe that the proxy advisory firms should be held to reasonable standards to ensure transparency, accuracy and the absence of conflicts and that the special regulatory treatment given to these firms should end.
  • Activist hedge funds have recently exploited loopholes in existing SEC rules under Section 13(d) of the Securities Exchange Act to accumulate significant, control-influencing stakes in public companies rapidly without timely notice to the market.  These techniques are facilitated by the widespread use of derivatives, advanced electronic trading technology and increased trading volumes.  Many non-U.S. securities markets have already taken action to address the risks of such rapid, undisclosed accumulations.  A rulemaking petition, pending before the SEC since March 2011, would close the derivatives loophole and require acquirers of 5% stakes to disclose such positions to the public within one day, instead of the current ten-day window established forty years ago. We believe approval of this rulemaking petition will help curb abuses and bring the rules current with contemporary practices and technologies.
  • Companies face significant difficulty engaging with their institutional shareholder base because the current reporting regime does not provide timely information to companies as to who their shareholders are.   A second rulemaking petition pending before the SEC, submitted in February 2013, requests that the SEC shorten the deadline for institutional investors to report their positions on Forms 13F from 45 days to two business days after quarter-end and increase the frequency with which shareholders report their position.  The petition also supports reform of the Section 13(d) stock accumulation rules.  We believe approval of this rulemaking petition will promote market transparency and facilitate engagement between companies and shareholders.
  • Harvard Law School Professor Lucian Bebchuk has established the Harvard Law School Shareholder Rights Project to promote corporate governance that facilitates activist hedge fund attacks on companies. He has also published several articles and editorials arguing that activist attacks are beneficial to the targeted companies and should be encouraged.  His articles and editorials are widely used by activist hedge funds and institutional shareholders to justify their actions.  We believe that the statistics Professor Bebchuk uses do not establish the validity of his claims that activist attacks are beneficial nor justify his uncritical embrace of activists.  We believe that attacks, and the threat of attacks, by activist hedge funds and pervasive activism have significant implications for the broader economy and our nation’s competitiveness and are major contributors to unemployment and slow growth of GDP.  We believe that the recent studies by:

Professor Pavlos E. Masouros, Corporate Law and Economic Stagnation:  How Shareholder Value and Short-Termism Contribute to the Decline of the Western Economies

Professor Lynn Stout, The Shareholder Value Myth:  How Putting Shareholders First Harms Investors, Corporations, and the Public

Professor Colin Mayer, Firm Commitment:  Why the corporation is failing us and how to restore trust in it

Professor David Larcker and Brian Tavan, A Real Look at Real World Corporate Governance

reflect the true effects of activism and that it is in the national interest to reverse the legislation and regulation that promotes activism. 

Martin Lipton
Steven A. Rosenblum
Sabastian V. Niles


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Role of the Board of Directors And Management

The following summary was developed by the Business Roundtable.

Board of Directors

The board of directors is responsible for oversight of management’s strategy and performance. Its role is to make decisions in the best interests of the corporation’s shareholders, taking into account the interests of other stakeholders. The board considers the advice, reports and opinions of management, counsel and auditors and also seeks independent advice when appropriate.

“Some 10 percent of CEOs currently heading the top S&P 500 companies received undergraduate degrees from Ivy League colleges, according to a survey by executive recruiter Spencer Stuart. But more received their undergraduate degrees from the University of Wisconsin than from Harvard, the most represented Ivy school.” — The Wall Street Journal, Sept. 18, 2006

Primary Duties

Primary duties of the board include:

  • Selecting and overseeing the CEO, who runs the corporation with senior management on a daily basis.
  • Monitoring management’s performance and adherence to corporate and ethical standards on behalf of shareholders.


Members of the board bring a wide range of knowledge and experience but do not represent any particular constituencies. Board members include:

  • The chairman, who leads the board and is elected to the position by the other members of the board. w Independent directors, who are not affiliated with the corporation in any material capacity.

Board Committees

Board members also participate on committees with more specific duties, such as the:

  • Governance and Nominating committees, which oversee effective corporate governance and identify and evaluate candidates for board positions. Nominated candidates are then voted on by the shareholders.
  • Audit Committee, which supervises the corporational relationship with its auditor and oversees the corporation’s financial reporting process.
  • Compensation Committee, which determines the corporation’s overall compensation structure, policies and programs.

Members of these committees are required by the New York Stock Exchange, Nasdaq and American Stock Exchange to be independent directors


The CEO and senior executives are responsible for running the day-to-day operations of the corporation and keeping the board informed of the status of these operations.

Primary Duties

Primary duties of the CEO and senior management include:

  • Performing strategic planning, including developing and implementing annual operating plans and budgets.
  • Selecting qualified management and establishing an effective organizational structure.
  • Identifying and managing corporate risks.
  • Reporting corporate finances accurately and transparently and making timely disclosures.

Key Positions

  • Chief executive officer (CEO). The CEO is the highest-ranking executive in the corporation. The CEO’s main responsibilities include developing and implementing high-level strategies, making major corporate decisions, managing the overall operations and resources of the corporation, and acting as the main point of communication between the board of directors and corporate operations.
  • Chief financial officer (CFO). The CFO is responsible for overseeing the financial activities of the entire corporation, including certifying financial statements, monitoring cash flow and performing financial planning.
  • Chief legal officer (CLO) or general counsel. The CLO is responsible for providing legal advice to senior executives and the board on issues including compliance and litigation.
  • Chief operations officer (COO). The COO is responsible for managing the corporation’s day-to-day operations.

Relationship of the CEO and Board

Corporate scandals such as Enron and WorldCom, which caused devastating financial losses for shareholders, have resulted in today’s boards demanding more accountability from CEOs. As a result, annual CEO turnover has grown, rising 59 percent from 1995 to 2006, according to the CEO Succession White Paper 2006 by Booz Allen Hamilton. The average tenure of a Business Roundtable CEO is four years.

In principle and practice, many boards support pay for performance for senior executives. Forty percent of Business Roundtable companies reported adjusting the pay-forperformance element of senior executive compensation in 2007.

Board Independence

The presence of independent representatives on the board, who are capable of challenging the decisions of management, is one way to protect the interests of shareholders and other stakeholders.

To comply with the Sarbanes-Oxley Act and enhance accountability, S&P 500 corporations have increased the percentages of independent directors on their boards.

U.S. corporations continue to increase the percentage of their independent board members and independent board leadership positions.

  • Ninety percent of Business Roundtable corporations reported that 80 percent of their board members were outside directors.
  • Nine out of 10 companies had an independent chairman, lead director or presiding director.
  • The percentage of corporations with an independent chairman has continued to increase, growing by 120 percent between 2006 and 2008.
  • The percentage of companies that have adopted majority voting for directors leapt to 82 percent between 2006 and 2007.

In addition, fewer CEOs are serving on other boards, given the enhanced time commitment of serving on a board of directors. Three-quarters of Business Roundtable CEOs serve on no more than one other public company board.

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Gender Diversity on Public Company Boards

September 27, 2012

By David A. Katz and Laura A. McIntosh

The issue of gender diversity in the corporate boardroom has risen to new prominence in the wake of recent efforts to impose quotas for women directors for companies in the European Union. The EU’s recent initiative has provoked controversy not only as to the optimal gender balance of boardrooms but also as to whether a quota system is a fair or effective way to achieve the underlying objective of women’s full and equal participation in corporate affairs. In the United States, the relative dearth of women directors on public company boards, and the potential effect on company performance of increased gender diversity, has been a topic of interest in the corporate governance sphere for many years.Unknown

The meaningful participation of women at all levels of the corporate hierarchy is an important goal. From a practical perspective, however, we believe that aspects of the European experience demonstrate the downsides of using a quota system to obligate this result. Individual public companies, and the U.S. corporate culture generally, would, in our view, be best served by corporate boards’ taking a dedicated, thoughtful and individualized approach to the nomination, election and full integration of women directors. This approach seems likely to yield the most successful substantive result in the short and long term, producing benefits both for corporate performance and the common wealth.

EU Quota Initiative

The most recent effort to increase the number of women directors in Europe has been spearheaded by Viviane Reding, the European Union Justice Commissioner and Vice-President of the European Commission. Reding strongly supported a law imposing sanctions on companies that do not have boards composed of at least 40 percent women. The proposed law reportedly would have required Europe’s listed companies to meet the quota by 2020; companies with more than 250 employees or 50 million euros in revenue that did not comply would have faced administrative fines or be barred from state aid and contracts.

However, the proposal appears to have generated fatal resistance from EU member states. On September 14, officials of nine countries including the United Kingdom, which led the effort signed a letter addressed to Reding and Jose Manuel Barroso, President of the European Commission, indicating their strong opposition to any European-level adoption of binding provisions regarding the number of women on company boards.

The signatories have sufficient power to block the proposal under the voting process of the European Union, and other countries, including Sweden and Germany, have also indicated their opposition to such a law.

The opposition letter affirmed the signatories’ support for women in executive positions and as public company directors, stating that “[t]he myriad barriers women encounter throughout their career are unacceptable from a gender equality point of view [and]…are among the factors preventing the optimal use of the skilled workforce potential.”

The signatories noted that “[m]any of us are considering or have implemented various and differing national measures…to facilitate raising the proportion of women in boardrooms” but contended that “[t]hese efforts must be granted more time in order to establish whether they can achieve fair female participation in economic decision-making on Europe’s company boards.”

Therefore, the signatories concluded: “[A]ny targeted measures in this area should be devised and implemented at [the] national level. Therefore, we do not support the adoption of legally binding provisions for women on company boards at the European level.”

The proposed law is due to be published in draft form next month. A European diplomat reportedly said that many of the countries opposing the proposed law do not necessarily want to scuttle it completely but do want to ensure that national governments retain influence or control over enforcement of quotas.

In any event, the proposed legislation has a long road before it would be approved and have the effect of law: All 27 EU commissioners must agree on the proposed law before a draft is published, and the law then must be approved by national governments as well as the European Parliament.

Impact of Quota Legislation

Several European countries have implemented quotas at the national level for women directors on public company boards, including Norway, France, Italy, Spain, and the Netherlands.9 In 2003, Norway passed a law requiring that at least 40 percent of public company board seats be allocated to women. Covered companies were given five years to comply with the law, and the proportion of women directors rose from 9 percent at the time of implementation to the current average of just over 40 percent.

It is important to separate the effect of quota legislation from the effect of gender diversity on company boards. While the latter has been shown to be beneficial to corporate performance, there are indications that the former is a suboptimal way to achieve those benefits. A study of the aftermath of the Norwegian law showed that not only did the quota requirement cause a significant drop in stock price at the announcement of the law, but the quota then “led to younger and less experienced boards, increases in leverage and acquisitions, and deterioration in operating performance.”

This may be due in part to the fact that the quota requirement contained a relatively short timeframe in which Norwegian companies had to find and elect female directors, resulting in a drop in the average quality of board members.

By contrast to the results of the Norway study, a 2012 worldwide study of the nearly 2,400 companies in the MSCI ACWI by the Credit Suisse Research Institute showed that from December 2005 to December 2011, large-cap companies with women directors outperformed peers with no women directors by 26 percent and small- to mid-cap companies with women on the board outperformed their peers with all-male boards by 17 percent in that period.

The study also found that companies with one or more female board members experienced higher returns on equity, lower leverage, better growth, and higher price/book value multiples.

Some directors have opined that the significant increase in participation by women “professionalized” boards by contributing to a more pleasant, formal atmosphere at meetings, and some commentators view the policy as having “paved the way for women to influence corporate decision making.”

While other studies have reached mixed conclusions regarding the role of women in the boardroom, there are many possible reasons why the full participation of women on company boards could contribute to stronger performance. The Credit Suisse report identifies seven of these, described in detail in the report itself.

First, the appointment of women directors may be an indication that a company is already fundamentally sound and looking to improve from a position of strength. Second, there is evidence that greater diversity on a team can enhance the performance of both the majority and minority groups, improving average outcomes overall. Third, gender diversity can improve the overall level of leadership skills, as studies have shown that women excel in defining responsibilities clearly and mentoring and coaching employees.

Fourth, deliberately expanding director candidate searches to include women provides access to a significantly wider pool of available talent. Fifth, a gender-mixed board may have a better understanding of the consumer preferences of households, particularly in sectors where women make many of the spending decisions. Sixth, academic research has demonstrated that having women on a corporate board improves performance on corporate and social governance metrics for companies with weak governance. Seventh, women have been shown to be generally more risk-averse than men, which may explain in part why companies with women directors in the Credit Suisse study were less leveraged on average than their peers; the study notes further that “lower relative debt levels have been a useful determinant of equity market outperformance over the last four years.” Strikingly, the Credit Suisse study showed that almost all of the share price outperformance of companies with women directors came after 2008, during the financial crisis period and its aftermath.

These companies exhibited less volatility in a falling market and delivered higher returns during this period, suggesting that women directors contribute to a stronger defensive profile, including better risk management and downside control.

One recent study of Israeli companies concluded that boards with three or more women directors were roughly twice as likely to request further information and to take an initiative, leading to higher return on equity and net profit margins compared to peer companies.

Moreover, both men and women directors were more active when at least three women directors were in board meetings, and women were more likely than their male counterparts to take actions on supervisory issues.

In addition to enhanced corporate performance, there are other reasons to favor the full participation of women in boardrooms: the values of societal fairness, gender equality, and corporate meritocracy, for example, or the desire to create a positive culture of valuing the contributions of each individual. While quotas provide a relatively quick fix to the problem of gender imbalance in the boardroom—and some politicians and commentators have expressed frustration with the rate of voluntary action absent legal requirements-they do so in an artificial manner that could create resentment and board dysfunction. Moreover, forcing quotas of women directors prioritizes gender diversity over all else, potentially at the expense not only of director quality but also of other types of diversity that may be valuable to corporate performance.

Business Community View

The European business community, while expressing support for increasing the number of women directors, generally opposes European-level quotas as means of doing so. BusinessEurope, the largest organization of employers in the European Union, issued a position paper this past May outlining views similar to those expressed in the UK-led opposition letter described above.

The paper supports a voluntary approach to increasing diversity, both in terms of gender and in terms of talent, skills and experience. BusinessEurope opposes mandatory European-level initiatives and, in particular, one-size-fits-all quotas “which disregard the highly diverse conditions in different sectors/companies and do not take into account the way corporate boards function and are renewed.”

It appears that companies are willing to take voluntary measures to increase the number of women directors on their boards. They are aided in their efforts by organizations such as the Professional Boards Forum, which helps chairmen in Norway and the United Kingdom find qualified women to fill independent director positions,26 and the 30 Percent Club, a group of chairmen of U.K. companies who are working toward a goal of 30 percent female representation on U.K. boards.27 The 30 Percent Club’s mission statement highlights the view that meaningful participation by women cannot be mandated by top-down quotas but instead must be the result of concerted, long-term efforts to encourage women to succeed in corporate careers. The organization issued the following statement last month, as controversy over the potential EU quota legislation was brewing:

“[T]he only way to achieve better gender balance at all levels in the UK’s leading companies is to ensure the pipeline of female talent is developed from an early stage. In light of recent commentary on the lack of progress at the Executive Board level, the group argues that a concerted effort to develop the pipeline of female talent…will help achieve better gender diversity in senior roles at UK companies.”

The 30 Percent Club is no doubt correct that improvement in the number and quality of corporate positions held by women will “trickle up” into the boardroom; the full integration of women into the boardroom and executive suites of major public companies is a goal with both long- and short-term components.

U.S. Boards’ Gender Diversity

According to GMI Ratings’ 2012 Women on Boards Survey, the United States currently ranks 11th out of 45 countries in terms of gender diversity on public company boards, with an average of 12.6 percent women on S&P 1500 boards.29 Because there are fewer women on the boards of smaller companies, only 11.6 percent of Russell 3000 directors are women.30 In addition to these data points, a GMI study from July 2012 also found significant differences among states and regions, largely driven by the concentration of specific industries in certain areas.31 The percentage of women on U.S. boards increased by only 0.5 percent in the period 2009 to 2011.

The United States has not yet seen a strong movement toward quotas or other legal requirements in terms of gender diversity on boards. U.S. Securities and Exchange Commissioner Elisse B. Walter, speaking last week at the Third SAIS Global Conference on Women in the Boardroom, argued in favor of action at the shareholder level. She pointed out that strong disclosure standards help provide investors the information they need in order to exercise their “voice” to encourage companies to increase the diversity of their boards. Commissioner Walter cited evidence that the SEC’s rule on disclosure of director qualifications that first applied in 2010 is leading to more detailed discussions regarding the composition of boards, and as a result, investors are more engaged in the issue.

As in Europe, the United States has organizations that are committed to increasing the number of women on corporate boards. DirectWomen, for example, is a program designed specifically “to identify, develop, and support…accomplished women attorneys to provide qualified directors needed by the boards of U.S. companies, while promoting the independence and diversity required for good corporate governance.”33 Through strategies designed to help women advance in their careers and come to the attention of executive search firms and other corporate leaders, DirectWomen and groups like it are effecting meaningful change at the individual company level.

Many positions on U.S. public company boards are filled by search firms and companies can provide these firms with specific requests as they seek additional diversity on their boards.34 These firms are working hard to develop a larger group of qualified women candidates who are actively seeking board positions. In our experience, these search firms are very successful at helping public companies increase gender diversity on public company boards. The Credit Suisse Research Institute report indicates that increasing the number of women board members can result in an improvement in the quality of directors and many other positive effects for companies. Doing so through voluntary action, which takes into account the individual circumstances of each company, should be the best way to achieve these benefits without the downsides of mandated quotas and artificial timeframes. As the issue of gender diversity in the boardroom gains prominence, as the benefits to having women directors become better understood, and as resources such as director databases increase in utility, it seems likely that U.S.  companies will pursue the goal of greater gender diversity with increasingly successful results in the boardroom and for investors.


[David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz. Laura A. McIntosh is a consulting attorney for the firm. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole.]



1 See Aoife White, “EU Said to Seek 40 Percent Quota for Women on Supervisory Boards,”Bloomberg, September 4, 2012.

2 Letter to President Jose Manuel Barroso and Vice President Viviane Reding, European Commission, from Totyu Mladenov, Bulgarian Minister of Labour and Social Policy, et al., September 14, 2012. The letter was also signed by officials from the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, the Netherlands, and the United Kingdom (“Opposition Letter”). Germany indicated its support for the views contained therein in a subsequent letter to U.K. officials. See “Germany joins EU group against women’s quota,” The Local, Sept 15, 2012.

3 See James Fontanella-Khan, “UK musters support to block EU women quota,” Financial Times, September 16, 2012.

4 Opposition Letter, supra note 2.

5 Id.

6 Id.

7 See Stephen Castle, “European Plan to Put More Women on Boards Runs into Opposition,” The New York Times, September 17, 2012, available at

8 Id.

9 See Brian Groom and Ines Burckhardt, “Business opposes quota of women directors,” Financial Times, September 4, 2012.

10 Kenneth R. Ahearn and Amy K. Dittmar, “The Changing of the Boards: The Impact on Firm Valuation of Mandated Female Board Representation,” Quarterly J. of Economics, 2012, vol. 127(1): 137-197, May 20, 2011 (First Draft March 18, 2009, Current Version August 18, 2011), available at

11 The MSCI ACWI Index is defined as follows: “The MSCI ACWI Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The MSCI ACWI consists of 45 country indices comprising 24 developed and 21 emerging market country indices. The developed market country indices included are: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom and the United States. The emerging market country indices included are: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey (as of May 30, 2011).” MSCI,

12 Credit Suisse Research Institute, “Gender Diversity and Corporate Performance,” August 2012, at 12, available at

13 Id. at 3.

14 Agnes Bolso, “Ignore the doubters. Norway’s quota on women in the boardroom is working,” The Guardian, July18, 2011; see also Global Corporate Governance Forum Focus 9, “Women on Boards: A Conversation with Male Directors” (“Women on Boards”), 2011 available at MOD=AJPERES.

15 See Steven M. Davidoff, “Seeking Critical Mass of Gender Equality in the Boardroom,” The New York Times Dealbook, September 11, 2012 ( “Critical Mass”), available at

16 “Gender Diversity and Corporate Performance,” supra note 12, at 17-19.

17 Id. at 19.

18 Id. at 6.

19 Id.

20 See Miriam Schwartz-Ziv, “Does the Gender of Directors Matter?” Working Paper, June 23, 2011 (last revised September 7, 2012), available at

21 Id.

22 See, e.g., Stanley Pignal, “Commission to push quota for women directors,” Financial Times, March 4, 2012 (quoting Viviane Reding as saying, “I am not a fanatic about quotas…but I like the results quotas bring about.”); Christine Murray, “Quotas for women directors are the way forward,” BreakingViews, September 5, 2012 (opining that without mandatory quotas and tough sanctions, companies are too slow to add female directors to boards).

23 BusinessEurope claims to represent, through its 41 member federations, more than 20 million companies from 35 countries. The organization describes its mission as “to ensure that companies’ interests are represented and defended vis-à-vis the European institutions with theprincipal aim of preserving and strengthening corporate competitiveness.” See BusinessEurope,

24 BusinessEurope Position Paper, “Gender Balance in Boards of Directors,” May 25, 2012, available at

25 Id. at 1.

26 See Professional Boards Forum,

27 See 30 Percent Club,

28 30 Percent Club, “Development of senior female talent is a key longer term goal and a growing priority for companies,” August 29, 2012, available at

29 GMI Ratings 2012 Women on Boards Survey, March 2012, at 11, available at Citing Catalyst (a nonprofit organization devoted to furthering women in business), Steven Davidoff notes that American companies have the fourth-highest average of women directors in the world, noting that women make up 16 percent of the average board of a Fortune 500 company in the United States. “Critical Mass”, supra 15; see Catalyst, “Women on Boards,” August 2012, available at

30 GMI Ratings, “Variation in Female Board Representation Within the United States,” July 2012, at 2, available at

31 Id.

32 U.S. Securities and Exchange Commissioner Elisse B. Walter, “Remarks at Third SAIS Global

Conference on Women in the Boardroom,” September 20, 2012, available at See also Securities and Exchange Commissioner Luis. A. Aguilar, “Diversity in the Boardroom is Important and, Unfortunately, Still Rare,” September 16, 2010 (speech at SAIS Center for Transatlantic Relations: Closing the Gender Gap: Global Perspectives on Women in the Boardroom) available at (“While the SEC’s new rule focuses only on disclosure, an indirect effect of putting a focus on a board’s diversity is that boards may decide to add, or add more, minorities and women as directors. It is reasonable to expect that the process of focusing on their diversity policy and its effectiveness could likely result in greater diversity. I personally believe that companies that expand their search for new directors to include more women and minorities will find a breadth and depth of talent that will serve to improve their performance and increase the wealth of their investors.”).

33 See DirectWomen,

34 See “Women on Boards”, supra note 14, at 35 (comments by Peter Browning); see also Aguilar, “Diversity in the Boardroom is Important and, Unfortunately, Still Rare,” supra note.

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Important Questions About Activist Hedge Funds

The following was written by WLRK and  is re-posted here with permission.

March 8, 2013

Important Questions About Activist Hedge Funds

          In what can only be considered a form of extortion, activist hedge funds are preying on American corporations to create short-term increases in the market price of their stock at the expense of long-term value.  Prominent academics are serving the narrow interests of activist hedge funds by arguing that the activists perform an important service by uncovering “under-valued” or “under-managed” corporations and marshaling the voting power of institutional investors to force sale, liquidation or restructuring transactions to gain a pop in the price of their stock.  The activist hedge fund leads the attack, and most institutional investors make little or no effort to determine long-term value (and how much of it is being destroyed).  Nor do the activist hedge funds and institutional investors (much less, their academic cheerleaders) make any effort to take into account the consequences to employees and communities of the corporations that are attacked.  Nor do they pay any attention to the impact of the short-termism that their raids impose and enforce on all corporations, and the concomitant adverse impact on capital investment, research and development, innovation and the economy and society as a whole.

The consequences of radical stockholder-centric governance and short-termism prompt a series of questions that cry out for re-examination of basic premises by the academics who exalt simplistic principal/agent theories and neo-classical economic models on only select principal/agent relationships while ignoring not only all social cost and all of behavioral economics but even the application of these same agency theories to other key actors in the current financial landscape.  So too do they cry out for re-examination of the regulations that facilitate corporate raiding and short-termism and the failure to put in place a system that would allow managements to achieve the optimal long-term value of public corporations, for the benefit of long-term investors and the whole American economy.  The boot-strap, bust-up, junk-bond takeovers of the 70’s and early 80’s proceeded unchecked and laid waste to the future of many great companies, all cheered on by the academics and aided by do-nothing regulators.  The new incarnation of sacrificing the future for a quick buck is at least as dangerous.  It requires new thinking to address the new threat.

Among the questions that must be addressed are:

  1. Purpose of the American Business Corporation.  Is the fundamental purpose of the American business corporation, and the proper goal of sound corporate governance, optimal long-term value creation?  Or is the purpose to maximize short-term stockholder value at any time any particular stockholder—with its own goals and agenda, which are unlikely to be congruent with the interests of other stockholders—happens to demand it?
  2. How Are “Excess” Returns Actually Obtained?  Activist hedge funds are reportedly outperforming many other asset classes as their raids seem to “unlock” value through pressured transactions.  Is this value actually created, or merely appropriated from fellow stockholders with longer-term investment horizons, and from other stakeholders such as employees, including by sacrificing capital spending and investment in long-term research and development?
  3. Are There Really Best Practices?  Is there sufficient (or any genuine) evidence that “best practices” corporate governance of the type promoted by the academics and advisory services results in enhanced long-term performance of the corporation — especially given the fact that American corporations have historically enjoyed the best long-run performance in the world?  Is “best practices” corporate governance a major factor in short-termism?
  4. Structural Conflict.  Is there a structural conflict in a system in which stockholders exercising power over a corporation owe no legal duty to anyone and are an ever-changing group that is free to enter a stock in size without advance disclosure and exit at any time of their choosing, act in concert, or even mask their interests using derivatives and engage in empty voting?  And in which the decision-makers at these stockholder bodies are themselves agents, compensated, in many cases, on the basis of the short-term performance of the investment portfolios they supervise on behalf of savers and investors?
  5. The “Principal/Agent” Premise.  Is the essential premise of the stockholder-centric proponents – the principal-owner/agent view of the corporate firm – accurate or reasonable, given that the legal system gives legal immunity to the “owners” (stockholders) and imposes fiduciary duties and liabilities on the “agents” (directors)?
  6. The Missing Principal.  Is the principal/agent structure of institutional investors imposing an unacceptable cost on corporations when the underlying beneficial holders of the managed portfolios– retirees, long-term investors and savers – play little if any role in checking the power of those running the investment intermediaries?  Regulation, litigation, and public scrutiny perform powerful roles in addressing agency costs that may exist at the corporate board and management level.  But given the massive intermediated ownership of public corporations today by a variety of different types of institutional investors with varied compensation and governance arrangements of their own, do we fully understand the agency costs of these investment intermediaries, who is bearing those costs and whether they are being sufficiently monitored and mitigated? And why has the academy not fixed its gaze on these powerful actors, including advisors such as ISS and Glass Lewis?
  7. Trust the Directors.  Is the assumption by academics that directors on corporate boards cannot be trusted based on any actual evidence, on observed anecdotal information, or just the skepticism of a group that has never (or rarely) been in the boardroom or been charged with overseeing a for-profit enterprise?  And does the constant assumption and allegation of untrustworthiness in fact create both a disincentive to serve and a disinclination to act, all to the detriment of the corporate enterprise and its beneficiaries?
  8. Directors’ and CEOs’ Time.  Is it desirable that directors and CEOs spend a third of their time on governance?  Has the governance-rather-than-performance-centric debate resulted in a new breed of lawyer-type-CEOs and box-checking “monitoring” boards rather than sophisticated and experienced “advising” boards?
  9. Escaping Governance.  What part of the private equity activity wave is fairly attributable to increased costs imposed by corporate governance in the public markets that makes management for long-term value appreciation difficult or impossible in those public markets?  Is that good or bad?
  10. Why Do Venture Capitalists and Entrepreneurs NOT Choose the Academics’ Governance Model? Why do highly successful technology corporations go public with capital structures that preserve management control? To avoid the pressure for short-term performance? To avoid shareholder pressure on management? Do these companies underperform or are they our most innovative companies?
  11. Economic and Business Theory. Is there any evidence that the ideas and suggestions of short-term money managers, who oversee diverse portfolios, promote long-term (or even medium-term) value creation? What happens to investment, strategic thinking and risk management in a world in which the ideas have time horizons measured in months or quarters? How do the advocates of stockholder-centric governance take account of the fact that stockholders do not have information and expertise about the corporation on a par with its directors and officers? Similarly are long-term stockholder interests and wealth creation served by intermediaries in the proxy advisory services, operating without regulation or fiduciary duty, either to the corporation or its stockholders or to investors and beneficiaries? And what to make of the elephant-in-the-room fact that activist hedge funds don’t have to eat what they cook?
  12. Political Theory. At bottom, doesn’t the stockholder-centric theory hark back to the crudest 19th century aspects of laissez-faire capitalism—pressing for the legal system to recognize a single social good (maximizing rentiers’ portfolio returns) while ignoring or slighting the interests of employees, communities and societal welfare? Is stockholder-centric governance as currently promoted and practiced by the academic and governance communities, and the short-termism it imposes, responsible for a very significant part of American unemployment and a failure to achieve a GDP growth rate sufficient to pay for reasonable entitlements without a significant increase in taxes?

Martin Lipton
Theodore N. Mirvis
Adam O. Emmerich
David C. Karp
Mark Gordon
Sabastian V. Niles

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Board Challenge: Preparing for Crisis

By Weil, Gotshal and Manges, LLP

An integrity lapse by a key executive, an environmental disaster, a compromise of confidential information, a product taint: companies expend significant resources on risk management and internal procedures to avoid such failures. But as important as crisis prevention is, companies must also be prepared to contain and manage crisis situations when they do occur. The board plays an essential role in this preparation. The board needs not only to assure that senior executives are well positioned for crisis management, but must also consider the board’s own preparedness and capacity for addressing crisis. A board should develop a plan that ensures both (1) the strength of its own culture to withstand the stresses that crisis brings, and (2) its ability to effectively manage both the corporation’s business interests and possible litigation consequences when making decisions in crisis-mode.

UnknownCrisis Readiness

By its very nature, crisis involves the unexpected, but a board can and must anticipate the occurrence of crisis. Times of crisis frequently create the risk of significant impairment of a company’s operational, financial, or reputational integrity, as well as the risk of related litigation. By the time a particular risk materializes, the board should already have adopted general procedures and policies that prepare it to coordinate with management to address the problem and minimize negative effects. The board should identify a crisis-management team and assign defined roles and create processes for problem analysis, decision-making and communication. In formulating this team and these procedures, the board should keep in mind the effect its action may have in future litigation, which is often brewing in the background during times of crisis. The board must be particularly tuned into issues related to attorney-client privilege. Adopting a comprehensive crisis-readiness plan will enable the board to decide issues with dispatch and in a manner that conveys appropriate concern resolve and credibility, while minimizing future-litigation risks.

Recognizing Crisis

The board and management need to be attuned to the most common and likely causes of corporate crisis. While crisis comes in many forms and the likelihood varies based on industry and other company specific factors, common causes of crisis include:

• Concerns regarding management credibility or integrity

• Loss of a key executive

• SEC or other government investigation or regulatory action

• Significant litigation

• Financial reporting issues, financial restatement

• Allegations of fraud

• Poor operating results (over multiple periods)

• Product failure

• Information security or confidentiality breach

• Environmental disaster

• Liquidity issues

• Default on covenants

• Failing labor relations

• Failing shareholder relations

• Systemic ethical issues

• Contest for corporate control

Boards should consider coordination with management to conduct crisis response simulations from time to time. This can be in the form of a discussion of several hypothetical scenarios involving issues that the board and management believe could arise and create significant problems for the company. Where appropriate, the board should consider involving legal counsel, either internal or external, in this exercise, to help the board to identify litigation-control measures that should be adopted in particular types of crises.

Internal Controls, Risk Management & Corporate Governance

The foundation of effective crisis management is a well-developed system of internal controls, risk management processes and corporate governance practices. Periodically, the board and management team should assess the strength of that foundation by, for example:

• Reviewing corporate policies and controls such as specific prohibitions on unethical and illegal conduct, confidentiality requirements and communication policies to ensure that they:

a. address appropriately and thereby decrease the likelihood of the types of behaviors that could raise significant risks, and

b. are aligned with ethical (and regulatory) expectations so as to foster the support and understanding of the public and regulators should a crisis occur;

• Identifying and periodically reviewing significant risks to business operations, financial condition and reputation and considering how crisis might materialize and be addressed in relation to such risks;

• Evaluating the governance culture and considering ways to continuously improve upon it; and

• Monitoring ongoing litigation and considering patterns of litigation risk.

Crisis Team

Effective crisis management also requires that the board identify a crisis-response team in advance. This is the team that will activate as soon as the potential crisis has been identified. The function of this team is to provide early assessment, response and litigation-risk management. One misstep companies frequently make during times of crisis is underestimating the seriousness of the problem, including the potential impact for negative public reaction and regulatory action or litigation. A frequent and related mistake is overestimating the company’s capacity to address the problem at the departmental level and without outside expertise. The crisis team should be designed to include a variety of expertise to help quickly determine what else may be needed. The company should identify:

• An internal crisis team: This should include senior executive officers (the CEO, CFO, COO, General Counsel), representatives of key operational departments and the heads of compliance, internal audit, human resources, corporate communications/PR, and sales/marketing. It should also include the appropriate board-level contact point, which may vary depending on the situation but likely will include the independent board leader and/or the audit committee chair. When a specific situation arises, the identity of the crisis team may need to be adjusted based on needs and on recusal of anyone whose integrity or behavior may be at issue. At times the full board may need to become involved.

• A team of external advisors: This should include external legal advisors and communications experts. Having established relations with professionals who get to know the company and the key members of the board and management before crisis occurs can pay dividends when the company must react quickly. The board should also understand under what circumstances the board may need to rely on independent advisors—primarily when the integrity or performance of the CEO or other executive officer is at issue or when management is otherwise conflicted. When coordinating with legal advisors, the board should be particularly aware of issues related to attorney-client privilege and develop procedures to avoid waving it.

Unknown-1Communications Plan

Well before any bad news materializes, the board needs to communicate its expectation to the CEO and key members of the management team (at minimum, the CFO, the general counsel, and the internal auditor) that bad news should be delivered promptly and directly. Everyone should understand that the board wants early warning and does not want to be “surprised” by hearing bad news from another source—especially a public source—because management thought it could manage its way out of a problem and failed to inform the board early.

The board and management should develop an agreed, workable and well understood crisis communications plan. A crisis communications plan should be thought of as a protocol for both internal and external communications in a crisis situation. Since actual communications must relate to the particular circumstances, the crisis communications plan should focus primarily on ensuring that the right people can be called together quickly to determine how to move forward and communicate, together with guidance for ensuring that the company speaks with one voice and confidentiality is maintained until the company has decided to speak. Key elements include the following:

• The plan should call for early communication of the known facts to the identified crisis team and the board for early analysis and response planning.

• Once the right people and expertise are involved, they can decide the time frame and message for communications with regulators, employees, shareholders, customers, suppliers, creditors, insurers, and the media.

• In most situations, the CEO or other members of the management team will be tasked as the spokesperson for both internal and external communications. However, any issues that involve concerns about the actions or integrity of the CEO will require board involvement in communications. In certain circumstances this may extend to situations involving other executive officers.

• Special attention should be given to monitoring social media given the speed with which information and misinformation can be transmitted and to having capacity to come up with strategies for using social media effectively in a crisis.

Note that sensitivity to how information flows in crisis response efforts is important in determining who to get involved and at what point. Even when at first blush an emerging crisis may not appear to have a legal issue at its heart, consideration should be given to whether and at what point there is benefit to having an attorney involved in coordinating the efforts of other advisors to help preserve the ability to assert the attorney-client privilege of certain communications.

Companies with operations and markets in non-U.S. jurisdictions should make sure that there crisis management efforts are sensitive to how different cultures react, so that they can manage accordingly, including by involving relevant experts who can assist not only with tailoring communications to different cultures but who also understand the political, regulatory, and legal environment.

Special Considerations Regarding Social Media and Preparedness for Crisis

Given the speed with which news, rumor, and innuendo can be disseminated through social media and the tendency for social media to be treated as an informal means of communication, it is particularly important that the company has in place and has educated its employees about policies related to the use of social media. When formulating social media policies and thinking about the risks of social media, it is important to differentiate between its uses since the type and degree of risks are distinct depending on how social media is being used:

• Social media can be a significant tool for listening to what customers, shareholders and others have to say about the company and in this respect can serve as an early indicator of issues that may be arising. Much of the risk related to observation or “listening” may be controlled through clear policies about mining public information in legitimate and transparent ways. Companies also need to prepare in advance for a negative message that is broadly repeated. Since the context will drive the appropriate response, and the response will need to be determined in real time, the company should have an understanding about who the crisis communication team is

• Social media can also be a powerful means of spreading a message—but it is in the effort to influence viewpoints where much of the risk lies. Corporations need to have very clear policies about who can speak on behalf of the corporation through social media (and any other media). These policies need to be accompanied by education for those who are restricted from speaking on the company’s behalf as well as for those who are empowered to speak.

In addition, policies should address expectations about how employees refer to the company in their personal use of social media. Clearly, there needs to be a system for vetting official company messages as well, just as for other media. However, since much of the value in social media is its real time and targeted nature, consideration needs to be given to the balance between these benefits and the degree of prudent internal control. Directors should use the same rules for social media that they use for contacts with shareholders and potential investors.

Directors should avoid at all costs any ad hoc communication about the company. Only official and coordinated communication is appropriate.

Because of the complicated and constantly developing legal issues surrounding online communications, a company’s social media policy should be carefully reviewed by legal counsel and updated as necessary.

Crisis Assessment, Investigation, and Mitigation

When a crisis hits, the crisis team—internal and external as appropriate—will have to quickly assess the situation to define the scope of the further investigation and analysis that will need to be undertaken and to fine-tune the team:

  1. How serious might the problem be and how widespread?
  2. How much is known and what is known now and what needs to be determined?
  3. What is the likely impact on liquidity, on customers, key employees, suppliers, and relations with regulators?
  4. What is the risk of related litigation or other potential for interrelated problems?

The crisis team and the board and management generally should assume that things are worse (or may get worse) than they appear, and bring a healthy skepticism to bear without overreacting. Based on its initial assessment of the situation, the crisis team will need to determine who the appropriate team is to lead the investigation and the response. This should include conferring with both inside and outside counsel about the plan, paying particular attention to attorney-client privilege issues at this stage.

The level of board involvement will depend on the nature and scope of the problem, including the extent to which members of the senior executive team are implicated. In most crises, the current CEO and key members of her team will be best positioned to provide the crisis management required. In such circumstances, the board should be fully and regularly advised and should provide guidance with sensitivity to the need for management to focus on the issue at hand. However, if the issue relates to, or could potentially implicate, senior management’s credibility or integrity, the outside and independent directors may need to oversee the crisis response including potential investigation with assistance from independent counsel. Is a special board committee needed to look to investigate allegations of wrongful conduct? Is independent outside counsel required? Is forensic expertise required? The board will also need to assess whether there are specific additional resources and expertise needed to help guide the company through the problem.

When company management has lost credibility with external constituents, the board may need to assess who is best positioned to give regulators, investors, creditors, customers, employees, and the public comfort that the board and management are engaged and focused on protecting the corporation’s assets.

The board also must be mindful its own public perception. In some instances, for example, where the issues raise concerns about whether the board was appropriately engaged, governance reforms or even changes in board composition may be helpful or necessary to send the right message to key constituents and investors.

Effective Board Culture

An effective board culture is essential to effective crisis management. A strong board culture will prevent the board from wasting time getting its own house in order when it should instead be taking decisive action.

The board culture to strive for is one in which confidentiality is protected and independent viewpoints are respected and valued, but consensus can be readily achieved after opportunity for full and informed discussion. Well-functioning boards usually are able to achieve a consensus that all directors can support, with only rare resort to a majority position that a minority of directors oppose. A corporation should embrace governance structures that support this type of culture.

A board’s ability to achieve consensus in an efficient manner is a function of its success in developing trust and mutual respect among members, creating shared expectations of how individual members should behave and contribute, and adopting a common understanding of the what is in the company’s best interest. A healthy board culture is one in which directors understand one another’s styles and strengths. Effective boards agree on the rules of engagement and accepted behaviors while valuing distinct opinions. Directors trust and rely on one another and at times defer to one another’s judgment. Well-performing boards reach consensus without significant conflict or tension. Dissent and disagreement are expressed and resolved.

A particular challenge for the board as a team is that it is charged with overseeing management but must at the same time rely on management for information and to otherwise support the work of the board. The board must be mindful of its relationship with management and should seek a “constructive tension” that balances attentive oversight and a critical review of management’s strategy and performance with support and guidance for management.

• Discuss and agree on the role of the board and management, clarifying as necessary the extent of delegated authority and expectations about board information needs and board involvement in decision- making.

• Emphasize the value and the limits of “constructive tension” in board/management relationship.

• Discuss and agree on valued behaviors—behaviors that are consistent with an environment in which “constructive tension” can thrive:

–      Respect for fellow directors’ and managements’ expertise and viewpoints – Constructive skepticism in questions directed to management

—      Opportunity for, and ease of, open discussion and debate

–       Commitment to achieving consensus after engaging in an informed and deliberative process

–       Commitment by all participants to listen and to self-control (not everyone needs to be heard on every issue)

–        Trust among directors and between directors and management

–        Protection of confidences

–        Attention to schedule, but in a manner that ensures time for important discussions

• Periodically evaluate board culture along the lines outlined immediately above

• Remind directors of confidentiality requirements and privilege issues.

Board Strategies for Avoiding/Addressing Potential Problem Behaviors

Note that boardroom confidentiality is critical if a board is to create and maintain an atmosphere in which full and frank discussion can thrive, and consensus can ultimately be reached. A failure of board confidentiality can undermine the ability of a board to make timely and deliberated decisions. It also may signal more significant difficulties within a board. And it may exacerbate or even lead to crisis situations.

A director must keep confidential all matters involving the corporation that have not been disclosed to the public. Directors must be aware of the corporation’s confidentiality, insider trading, and disclosure policies and comply with them.

Although a public company director may receive inquiries from major shareholders, media, analysts, or friends to comment on sensitive issues, individual directors should avoid responding to such inquiries, particularly when confidential or market-sensitive information is involved. Instead, they should refer requests for information to the CEO or other designated spokesperson.A director who improperly discloses non-public information to persons outside the corporation can, for example, harm the corporation’s competitive position or damage investor relations and, if the information is material, incur personal liability as a tipper of inside information or cause the corporation to violate federal securities laws. Equally important, unauthorized director disclosure of non-public information can damage the bond of trust between and among directors and management, discourage candid discussions, and jeopardize boardroom effectiveness and director collaboration.

Confidentiality: Excerpts From ABA Directors Guidebook, 6th Edition (2011)

Every company is susceptible to a crisis—whether from a single event or from a confluence of circumstances. The board plays a key role in positioning the company to weather crisis by acting to prevent the crisis from spiraling out of control and by establishing credibility with key constituents. The board also plays a critical role in positioning the company to deal with any litigation that may arise out of a crisis situation. To do so effectively requires both crisis preparedness and the development of a board culture of cohesion, respect and confidentiality.

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Compensation: Back to Basics

By Pearl Meyer & Partners

Compensation committees continue to find themselves at the center of the executive compensation firestorm, subject to intense public scrutiny and skepticism. Despite a fledgling economic recovery, unemployment remains stubbornly high, fueling resentment over the compensation levels of the 1 percent. Added to that, the regulatory environment grows ever more complex, threatening to overwhelm committees in a sea of expanding compliance requirements.

UnknownNotwithstanding the crowded agenda facing members in the months ahead, we think compensation committees are best served by taking a step back and asking three fundamental questions around executive pay programs.

How does your company define pay for performance? 

The focus on pay for performance by investors and boards alike is not new. There is virtually no public company that does not espouse the concept of aligning executive pay with sustained shareholder value in the CompensationDiscussion & Analysis (CD&A) section of their proxy. However, Institutional Shareholder Services (ISS) upped the pay-for-performance ante late in 2011 by rolling out a new methodology for evaluating CEO pay as disclosed in 2012 proxy statements. While we believe there are methodological flaws to the new review20, it is nevertheless critical that companies understand how their programs will hold up under the analyses and how their investors are likely to react to ISS’s ratings.

Beyond simply reacting to ISS’s analyses, companies should proactively communicate their pay-for-performance structure and alignment to their internal and external stakeholders. Communication begins with providing a clear and detailed rationale for choosing performance metrics other than total shareholder return (TSR), given that ISS has deemed TSR to be the best measure of performance from the perspective of shareholders.

In practice, however, TSR often fails to capture the motivational objectives of incentive plan design. To be sure, ultimately pay outcomes should create a reasonable alignment between the financial well-being of executives and shareholders. But incentive plans are not designed to serve as a “reward” for good results. Rather, they are intended as a tool for prioritizing executives’ attention and driving good decision-making that will promote the organization’s most important strategic needs. Put another way, TSR is an outcome—i.e., the market’s referendum on the company’s performance. The job of management is to generate performance levels (i.e., the input) that warrant a favorable TSR outcome. As such, management should be held accountable and be paid on the basis of performance that leads to positive TSR outcomes, as well as for the positive TSR outcome itself. The committee’s task is therefore to ensure programs are based on incentive metrics that are right for its needs and, over the long term, will be demonstrably tied to shareholder value creation.

Historically, incentive measure selection/calibration affected only short-term incentive design for most companies, since long-term performance plans were fairly rare. And, for most senior executives, the annual bonus target award value was dwarfed by the opportunities represented by long-term time-vested equity awards. However, a recent PM&P study21 indicates that long-term performance plans have quickly increased in both prevalence and target value. Committees therefore need to ensure they are devoting adequate time and attention to considering the selection and validation of plan metrics.

Ideally, incentive performance measures should be:

• Central to the company’s business strategy and market differentiation;

• Strongly and demonstrably correlated to shareholder value creation;

• Influenced by management actions in an appropriate timeframe (i.e., short-cycle metrics for annual incentive plans, longer-developing metrics for long-term incentives);

• Complementary to one another; and

• Able to be accurately measured and monitored.

Selecting the appropriate short- and long-term incentive metrics is only the first step—equally important is the process of goal-setting. The determination of target performance should incorporate multiple factors, including the company’s annual budget, historical performance, peer performance, and analyst expectations. The range of performance between threshold and maximum should be wide enough to justify the pay differential. At the same time, the threshold level of performance should not be so low that it will be perceived as a “give away” by shareholders, nor should the maximum be so high so as to be viewed as unachievable by participants without taking undue risks.

Finally, the committee should review actual pay relative to actual performance as part of its annual executive compensation analysis. The analysis should be more robust than the standards relied upon by ISS, using other performance measures in addition to TSR and including other named executive officers. Further, the calculation of actual pay should use the period-ending market value of equity grants, rather than the grant date value—this is particularly critical for option valuation. Importantly, the committee should then use the results of the actual pay-for-performance review to help refine the goal-setting process in the coming year.

Unknown-1How are you rewarding and retaining your stars? 

The lackluster economy took retention concerns off the radar screen for many companies in recent years. That said, many committees22 continue to see succession planning as one of their most important tasks and biggest concerns.

Corporate reality suggests that the retention of key next-generation talent cannot be left to chance—merit budget increases are firmly stuck at 2 percent – 4 percent for the foreseeable future and a slow economic recovery will limit the promotional opportunities for high performers at many companies. Furthermore, widespread attention to lists of defined governance “best practices” has pushed some companies too far in the direction of formulaic, “numbers driven” incentive structures.

Committees can play an important role by making sure their senior management has the tools and retains the flexibility to adequately differentiate high performers. They can ask the following questions:

• Does the annual incentive plan include individual objectives and/or the ability to exercise both positive and negative discretion?

• Do annual equity grant guidelines have ranges or flexibility to differentiate grants among individuals at the same level?

• Does the company have other long-term retention-oriented compensation and benefits programs (e.g., non-qualified deferred compensation plans)?

• Are there sufficient non-compensatory rewards for high performers (e.g., a positive culture, mentor programs, career development/training, etc.)?

With all the focus on pay for performance it is important that Committees not lose sight of the importance and the value of a stable executive team. Unwanted turnover can cause disruption on a number of fronts; and the organizational costs associated with external hiring of key executives can be substantial. Notwithstanding the importance of having a strongly performance-based compensation structure, companies must also make sure there are adequate retention elements to the compensation and benefits programs to ensure that key next-generation leaders are motivated to stay and perform.

When was the last time you really looked at your compensation philosophy and structure? 

While this “to do” may not seem very interesting or “new,” the timing here is important. Many companies reacted to the economic volatility of the past two years by making temporary changes to their compensation programs such as adjusting bonus payout curves and modifying equity grant levels. As companies and the economy settle into a “new normal,” committees should take the opportunity to step back and reassess their compensation philosophy and structure, rather than simply reverting to their old ways.

Start with a review of how changes to the company’s business expectations might drive changes to pay structure. For example, more modest future growth expectations might suggest a need to revisit the mix of options and full-value shares. Likewise, a change to the company’s cash position or debt structure may highlight the need to rethink incentive measures and weightings.

Next, consider changes to competitive practices. Have peers made changes to their pay programs that affect your company’s competitive positioning? Most notably, changes in pay mix (fixed vs. variable pay/cash vs. equity) or changes in incentive leverage (increase or decrease in thresholds and maximums) can change the competitive pay-for-performance landscape and may require changes to company programs to keep pace.

Finally, consider your approach to accepted “best practices” in compensation and benefits design. Public scrutiny and the influence of shareholder activists and governance watchdogs have made certain historical practices “unacceptable” by current standards (e.g., tax gross-ups), while other practices have become majority practice (e.g., stock ownership guidelines).

We do not advocate taking a purely “prevalence-based” approach to compensation philosophy and structure, nor do we believe companies should blindly adopt so-called “best practices” simply to satisfy ISS. Rather, we think companies should conduct a comprehensive, holistic review of their own current philosophy and structure. The objectives are to make sure, first and foremost, that they continue to support the company’s current business goals and objectives; that they provide competitive opportunity for competitive performance; and they are consistent with a culture of good governance and shareholder value creation.

In summary, we recognize that compensation committees need to spend a certain amount of time and attention on “current” compensation issues (regulatory compliance, responding to rating agency findings, etc.) But the urgent should not displace the important on committee agendas. Effective compensation committees should be making time in their annual calendar for strategic review and discussion of the design and structure of their executive compensation programs. Specifically, the three areas of review we’ve outlined above are focused on creating programs that stand the test of time, and deliver on the objectives of creating a strong, stable management team to deliver long-term value to shareholders.



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Governance Challenges Today and Tomorrow


This report highlights several pressing issues that NASDAQ OMX views as urgent for consideration during 2012 and beyond.

Job Creation and Access to Capital images

• Capital formation and job creation are in NASDAQ OMX’s DNA. Forty years ago NASDAQ introduced the world to electronic markets, which are now the standard for markets worldwide. The creation of NASDAQ grew an ecosystem of analysts, brokers, investors, and entrepreneurs, allowing growth companies to raise capital that was not previously available to them. Companies like Apple, Microsoft, Oracle, Google, and Intel, all of which are listed on the NASDAQ Stock Market, use the capital they raised to make the cutting edge products that are now integral to our daily lives. As they’ve grown, these companies have created millions of jobs along the way.

• The business community, U.S. government, and individuals around the country are still struggling to understand how to make job creation a reality. At NASDAQ OMX, we believe certain regulatory reforms will significantly facilitate permanent jobs and benefit the U.S. economy, like re-evaluating Sarbanes-Oxley. Additionally, we need to do more to fix structural problems that hamper the development of small- and medium-sized companies, which have historically done the most to create jobs. Increasing the number of H-1B visas and creating venues for small companies to receive resources and capital, like NASDAQ OMX proposed BX Venture Market, are a start to encouraging job growth.

• NASDAQ OMX has blazed a trail for entrepreneurs to achieve the pinnacle of business when they take their companies public. Venture-backed and other growth phase companies face numerous challenges as they attempt to access capital. Sarbanes-Oxley, other regulations, and the U.S. litigation system represent palpable costs. But with meaningful regulatory and structural changes, as well as innovative platforms like the BX Market, we will make our companies and economy stronger and spur job creation.

Sarbanes-Oxley 404

• NASDAQ OMX fully recognizes and supports increased financial transparency. Section 404 of Sarbanes-Oxley requires costly external audits in addition to the traditional audits of a company’s financial statements. At NASDAQ OMX, we believe it is the most visible sign of overregulation in this country, and the primary excuse for foreign companies and smaller domestic companies to forgo a U.S. public listing.

• Working with the Biotechnology Industry Association (BIO), the technology industry and others that were members of a broad coalition of businesses, NASDAQ OMX supported provisions to provide a complete exemption from SOX 404(b) for smaller companies. NASDAQ OMX was the first exchange to support an amendment authored by Reps. Scott Garrett (R-NJ) and John Adler (D-NJ) during House Financial Services Committee consideration of the bill. The final version of the legislation provides the exemption for companies under $75 million in market capitalization from SOX 404(b).

• At NASDAQ OMX, we believe that expanding this exemption to include companies with a $700 million market cap will significantly reduce the cost of going public for many firms. We also believe that companies who receive a clean bill of health should only receive a biennial 404 audit.

Legal Immigration Reform

• To be the best, companies need the ability to recruit the best workers. Global competition means global access to human capital. NASDAQ OMX supports comprehensive highly skilled immigration reform. We must increase the number of H-1B visas available and reform the employment-based green card process. These issues should not be tied, in policy or debate, to the illegal immigration issue.

• One-quarter of America’s technology startups led by foreign born individuals generate $52 billion and employ 450,000 workers. As of February 2012, university-level foreign-born students were receiving the highest number of engineering degrees in the United States and lead one-quarter of America’s science and technology start-ups: think Google, Intel, eBay, and Yahoo.

• It’s clear we can no longer ignore the immigration issue. Without increases in H-1B visas and reform of the employment-based green-card process we will continue to educate the world’s brightest individuals and then watch them spur job growth, gross domestic production and innovation abroad.

Venture Capital Markets

• In our markets, the number one source of job creation is entrepreneurship. Just as business incubators nurture small companies until they are ready to leave the security of that environment and operate independently, there should be a space for incubating small companies until they are ready to graduate to a national listing. The United States must create a space for these companies just as our foreign competitors have successfully done.

• Many innovative businesses around the world possess the innovation and fortitude needed to thrive in the public markets but lack the capital and resources to do so. NASDAQ OMX is addressing this need with its recently approved proposal to create the BX Venture Market.

• The BX Venture Market is an investment in the global economy. There are a lot of great ideas and well-thought out business models that simply lack the funding and resources necessary to get off the ground. Some of the most successful and game-changing start-ups of our time arose through venture capital backing—Microsoft, Google, Apple, Cisco.

• In addition to our proposal for the BX Venture Market, we remain proactive in our commitment to supporting programs that propel developing companies. Recently, we contributed a $730,000 grant to the Edward Lowe Foundation to fund the Institute for Exceptional Growth Companies, a new research and education institute focusing on job growth and capital access for developing companies in the United States

Executive Compensation Unknown

• In 2011, the expanded availability of say-on-pay proposals provided investors an alternative avenue to express their views on corporate pay programs, and we anticipate this to continue.

• NASDAQ OMX worked with a broad coalition to ensure that corporate governance provisions of the Dodd-Frank Act were workable and did not tip the balance between shareholder, management, and directors’ influence. A requirement that directors be elected by majority vote was eliminated from the final bill. The bill grants shareholders the right to a non-binding vote on executive pay and benefits. The bill does not mandate a proxy access regime but gives the SEC authority to engage in a rule-making, open to public comment, to determine any changes in this area. Because of U.S. Chamber and Business Roundtable legal threats, the SEC has postponed action on proxy access.

Corporate Political Spending

• For the protection of investors, NASDAQ OMX believes in setting stringent standards for a company’s employees, officers and directors. Implicit in this philosophy is the importance of sound corporate governance.

• As a listing venue for public companies, NASDAQ OMX is committed to helping board members of our listed companies understand their governance responsibilities. We are partnering with experts to provide opportunities for directors to receive relevant continuing education. One such initiative is an alliance with the National Association of Corporate Directors to provide corporate governance educational services to NASDAQ OMX companies.

• NASDAQ OMX actively works with policy makers and business associations to support corporate governance policies that encourage exceptional standards without hindering the legitimate management of a company, the process of capital formation and does not unduly open companies to frivolous lawsuits or special interests. The needs of both short-term and long-term shareholders should be balanced by all policy decisions in this area.

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A Board-Building View

By Marsh & McLennan Companies

Corporate boards are dynamic social systems. While each board is unique, there are similar challenges that boards face as a natural consequence of being teams, composed of individuals charged with doing important work in a very specific legal, economic, and social context. Effective boards, similar to effective teams, need to be built and maintained over time. In our work with boards, we have found that board effectiveness is shaped by a number of key factors including:images

• Clarity of the role of the board—the work it needs to perform and how it adds value.

• Backgrounds of the individual directors (their knowledge, experience, skills, and diverse perspectives), and their ability to work effectively with others.

• Content of the board’s agenda, driven by the potential value added of the board.

• Quality of the information the board receives about the company.

• Dynamics that develop among directors as they work together as a whole, with other directors separately, and with members of management.

• Leadership that enables and supports all of the above.

None of these elements is static. Effective boards are always assessing themselves and engaged in what we call “board building”—working on the factors that drive board effectiveness.

Board Challenges

With that perspective, some of the most critical issues that many boards will need to address in 2012 and beyond include the following:1293442437rs4fjc

1. The board’s role in strategy. Surveys continue to indicate that directors consider engagement with management around corporate strategy as one of the most valuable elements of their role. Yet directors repeatedly report that they are not satisfied with how that process occurs today. Boards and management need to design ways to effectively engage directors in the development of strategic direction and key strategic decision-making in a way that adds to, but does not interfere with, the role of management. This is critical to the core questions: What is the role of the board, what is the role of management, and how does the board add value? In our view, strategic work at the board level needs to move beyond the “concurrence” model, where management proposes a strategy and the board is simply left with a choice of concurring with or rejecting the proposal.

2. Understanding the drivers of the business. In our observations, boards frequently do not understand the drivers of the business—the core causal factors that drive profitable growth, create competitive advantage and can result in unexpected volatility in earnings. Without that understanding, it becomes difficult (if not impossible) for a board to engage on strategy and to understand key risks that must be managed for the business to succeed. Critical to the understanding and knowledge of the business is a steady stream of useful information. Ultimately, it requires  forward-looking (vs. backward-looking) information that helps the board to understand performance patterns and trends. Too often, boards are inundated with data about what the performance of the company has been. Not often enough are boards given information that can provide insight into the trajectory of the enterprise.

3. Enterprise risk management. More than a decade after the concept of risk-return management became popular with the rise of enterprise risk management, or ERM, few companies include risk management in their financial and strategic decision-making. Yet, most of the critical variables that companies consider in their strategic planning process have become more unpredictable. As outlined in the yearly report of the World Economic

Forum—the Global Risks Report—in which Marsh & McLennan Companies participates, the pace and scale of events introducing uncertainty into corporate earnings is increasing. Far too often, however, a firm’s underlying risk management process has little connection to the firm’s strategic or financial management. Risk management needs to be integrated into the strategic thinking of the company supported by a top-down, strategic examination addressing the drivers and core material risks of the organization. This approach enables management to examine the impact of different scenarios involving multiple risks on financial statements easily, quickly and accurately, and to keep the board informed of how critical emerging events, such as the recent Greece crisis  and associated effects on the European economy could affect the company’s financials. The NACD Blue Ribbon Commission Report on Risk Governance, published several years ago, provides a useful blueprint for effective engagement of the board in understanding risk and ensuring the effective management of risk.

4. Board succession. While management succession continues to be an evergreen challenge, there is another succession issue that many boards face. With the extension of age limits, many boards are aging. In the short term, this is mostly positive—boards have been able to benefit from the wisdom and perspective of experienced people. However, we see a bit of a demographic time bomb ahead as boards will need to replace and replenish their ranks with talent over the coming years. Given the evolving role of boards and the complexity of the problems that companies face today, thought needs to be given to the type of director that is needed. Clearly, diversity is critical— gender, racial ethnic, and geographic. But there is also a need for a diversity of skill sets and experiences. Planning for director succession needs to become more strategic.

5. Board leadership succession. A related but separate issue is how boards plan for the succession of their own leadership. The age of independent board leadership has arrived, whether in the form of independent non- executive chairmen or lead directors. These roles are very real and very critical. How the independent leader of the board fulfills his/her role, relates to fellow directors, and shapes the relationship with management can all have a tremendous impact on the functioning and effectiveness of a board. Given how critical the role is, boards can no longer just hope that an effective leader will emerge once the current leader retires or leaves the role. Boards will  need to understand the requirements for independent board leadership. Based on those requirements, recruitment and succession planning will be needed to ensure that the right candidates are available and being developed.

6. Surfacing and managing conflict. As social systems and teams, the dynamics of boards are as important as the mechanics, and perhaps more so. A recurring problem for boards is related to raising and resolving conflicts. Many boards have not created a culture, an environment, and a process for surfacing disagreements. When disagreements do arise (whether they be around strategic issues, quality of management, or how directors work together) boards do not have the processes in place to constructively work through and resolve conflicts. Issues frequently simmer beneath the surface and either never get raised or boil up to the point of a painful and destructive conflict. Board leaders, senior management, and individual directors need to become more comfortable with raising issues and working them through in a constructive manner.

Building Boards That Are Prepared for the Future

The underlying theme of our list of issues is board preparedness. The future is, by definition, uncertain, and increasingly more so. Boards need to prepare to face that future by having the right agenda, the right people, the right processes, and the right leadership to deal with what may come down the road. Good leadership underlies the obligation that boards have to their long-term shareholders and other stakeholders of the corporation.

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Comply and Explain: Should Directors Have a Duty to Inform?

Posted below is an article by John C. Wilcox, Chairman of Sodali Ltd. and posted here with permission.

“Can we end the long tradition of the boardroom as a sealed chamber from which we issue only unanimous endorsements of management’s actions and results? Can we move toward more transparency about the boardroom process, without undermining the ability of management teams to produce the results that shareholders want?”1


A new “Directors’ Duty to Inform” could be derived from the “Standards of Conduct for Directors” in section 8.30 of the Model Business Corporation Act (MBCA).2 To fulfill their duty to inform, directors of publicly held companies would be obligated to explain to shareholders how they are discharging their duties in a manner they “reasonably believe to be in the best interests of the corporation.”3

A duty to inform would have five main objectives:

1. Explain the relationship between the board’s governance decisions and the company’s business goals;

2. Enable shareholders to make an informed evaluation of A. the company’s governance, B. the directors’ competence and independence, and C. the board’s exercise of business judgment;

3. Enhance directors’ credibility through the articulation of  the processes by which board decisions are made, and B. the strategic rationale for their decisions;

4. Encourage customization, flexibility, and strategic focus in boards’ corporate governance practices comparable to the “comply or explain” approach used in principles-based governance systems; and

5. Promote dialogue and reduce confrontation between boards and shareholders.

The substantive information provided by directors pursuant to a duty to inform would be company-specific, qualitative, contextual, and forward- looking, thereby bringing it within the protection of the business judgment rule. The intent of the duty would not be to increase directors’ liability, but to increase their accountability to shareholders.4

The duty could be discharged by means of a written annual “Directors’ Discussion and Analysis” or by periodic communications from board committees or the board chair to the shareholders.

The expected long-term impact of a duty to inform would be to “operationalize” corporate governance policies and accustom boards to provide greater transparency about their deliberations and decisions on matters relating to governance, business oversight, and strategy.

Regardless of whether a directors’ duty to inform can be inferred from the MBCA or other provisions of state law, it could be implemented through the adoption of a charter or bylaw amendment initiated by the board or by shareholders.


Nell Minow, editor and co-founder of The Corporate Library, has famously said: “[B]oards [of directors] are like subatomic particles—they behave differently when they are being observed . . . .”5

The key words in Minow’s statement are “observed” and “behave.” From the perspective of long-term investors, corporate governance is primarily a means to observe and monitor the behavior of directors, who are the shareholders’ elected representatives, and to influence their behavior when necessary. The simple presumption behind most governance reforms is that directors will act with greater care and diligence when they are effectively monitored and accountable for their decisions. This presumption is a matter of human nature rather than law.

Given the goal of improved observation, a major governance dilemma arises because the boards of U.S. companies conduct their deliberations and make their decisions behind closed doors. Even though two decades of governance reforms have expanded companies’ disclosure requirements and amplified the duties and responsibilities of directors, boardroom windows at U.S. companies remain closed, with shades down and curtains drawn.

Corporate advocates in the United States vigorously defend boardroom privacy on grounds of collegiality, competitiveness, independence, and respect for directors’ expertise and business judgment. However, boardroom secrecy and constraints on communication create problems: they can polarize relations between directors and shareholders, forestall dialogue, undermine trust, reinforce adversarial forms of engagement, and impose substantial costs on both companies and shareholders. For companies, the primary costs of board secrecy involve the time and resources boards must devote to formal compliance with governance rules, disclosure requirements, and shareholder engagements—not to mention the legal, lobbying, and public-relations dimensions of these activities. Shareholders, particularly institutional investors, incur comparable costs in their governance advocacy, monitoring of portfolio companies, engagement campaigns, activism, and promotion of shareholder rights—not to mention the losses incurred when poor governance practices cause the value of portfolio companies to decline.

In addition to imposing these systemic costs, board secrecy and adversarial relations between companies and shareholders have contributed to the rise of a proliferating industry of corporate-governance experts, proxy-advisory firms, governance-rating entities, proxy solicitors, consultants, and intermediary service providers. The demand for the services of these firms has grown rapidly during the past two decades in parallel with increases in governance regulation and shareholder activism. At this point, there is every reason to think that the costs and resource demands associated with these activities will continue to grow in the aftermath of the financial crisis and the new Dodd-Frank regulatory regime.6

Even though shareholders have achieved a largely unbroken record of success in promoting governance reforms, it is becoming increasingly clear that there is a limit to the effectiveness of prescriptive rules and external metrics. The financial crisis demonstrated all too clearly that compliance with rules and best practices does not ensure good governance. In some high-profile cases, companies’ full compliance with governance norms did little more than provide cover for weak board oversight, incompetence, and fraud. In this skeptical post-crisis environment, new strategies are needed to ensure that boards are not just compliant, but are implementing governance effectively. These strategies must come from within the boardroom. Although   shareholders will continue to demand greater transparency and accountability, a window into the boardroom can be opened only by the directors. Boards must act on their own initiative, not just in response to more disclosure requirements and governance rules.


A. The Model Business Corporation Act

The MBCA is a logical place to focus the search for the fundamentals of a directors’ duty to inform. Section 8.30 of the MBCA sets forth the “Standards of Conduct for Directors.”7 The operative language in section 8.30(a) states: “Each member of the board of directors, when discharging the duties of a director, shall act: (1) in good faith, and (2) in a manner the director reasonably believes to be in the best interests of the corporation.”8

The comment to section 8.30(a) explains: “The phrase ‘best interests of the corporation’ is key to an explication of a director’s duties. The term ‘corporation’ is a surrogate for the business enterprise as well as a frame of reference encompassing the shareholder body.”9

In essence, the MBCA confirms the common understanding that directors have a duty to act in the best interests of the company and its shareholders. From both corporate and shareholder perspectives, the purpose of corporate governance should be to support this principle that aligns the interests of shareholders with the economic success of the business enterprise.

The generic MBCA Standards of Conduct for Directors are supplemented by the language in section 8.30(c), which requires a director to “disclose . . . to the other board or committee members information not already known by them but known by the director to be material to the discharge of their decision- making or oversight functions.”10 The comment describes this standard as “a duty of disclosure among directors.”11

Although section 8.30(c) defines a limited reciprocal duty among board members, it could be recast to serve as a template for a directors’ duty to inform. Substitution of the word “shareholders” for the words “other board members” in section 8.30(c) would transform and broaden the duty to “encompass the shareholder body.” With this textual revision, the new version of section 8.30(c) would read as follows: “In discharging board or committee duties a director shall disclose, or cause to be disclosed, to the shareholders information not already known by them but known by the director to be  material to the discharge of their decision-making or oversight functions . . . .” Under the revised language, the phrases “not already known by them” and “their decision-making or oversight functions” would refer to the shareholders rather than the directors. If Nell Minow’s observation is correct, this simple change of wording would effect a radical transformation in boardroom behavior by exposing directors’ decision-making to closer observation by shareholders.

Corporate directors have not traditionally been responsible for determining what information is material to their shareholders’ “decision-making or oversight functions.” Disclosure requirements under federal and state law have led companies to focus on materiality with respect to shareholders’ investment decisions, not their administrative functions. Nevertheless, from the perspective of corporate governance, there are compelling reasons for expanding the board’s standards of conduct under section 8.30 to address the duties and responsibilities of shareholders that are analogous to those of corporate directors.

Like corporate directors, many institutional investors, financial intermediaries, and other trustees are fiduciaries. Under the Employee Retirement Income Security Act of 1974, the Department of Labor has long regarded the exercise of proxy votes as a fiduciary duty of pension trustees and their designated investment managers.12 As fiduciaries acting on behalf of beneficial owners, the “decision-making and oversight functions” of investors include voting proxies and electing the directors of portfolio companies. A persuasive argument can be made that in order to discharge their fiduciary duty to vote shares and elect directors in an informed manner, investors should have access to “material . . . information not already known to them” about the conduct of portfolio companies’ directors and their discharge of the duties set forth in section 8.30.13 A directors’ duty to inform would provide this information to shareholders.

B. The Corporate Director’s Guidebook The Corporate Director’s Guidebook, developed by the American Bar Association Committee on Corporate Laws, is another logical source for understanding and interpreting board duties.14 Section 3 of the Corporate Director’s Guidebook sets forth the “Responsibilities, Rights and Duties of a  Corporate Director.”

Section 3.C.4 describes as one of the “legal obligations” of a corporate director a “duty of disclosure” that comes close to the concept of a duty to inform, but falls short in several ways.15

Section 3.C.4 states: “As fiduciaries, directors have an obligation to take reasonable steps to ensure that shareholders are furnished with all relevant material information known to the directors when they present shareholders with a voting or investment decision.”16 The emphasized language limits the duty by aligning it with disclosure requirements that exist under federal securities laws and narrowing the context to situations that involve specific action by shareholders. It does not establish a general continuing duty to inform shareholders about board processes and conduct. Section 3.C.4 also mentions that some courts have expanded the board’s duty of disclosure beyond circumstances involving shareholder action: “[E]ven where the directors are not recommending shareholder action, they have a duty (independent of disclosure obligations generally under the federal securities laws) not to mislead or misinform shareholders.”17

This interpretation is helpful in its acknowledgement that the state law duty of disclosure is independent and separate from federal disclosure requirements. However, it describes the duty in negative terms as an obligation “not to mislead or misinform shareholders,” rather than asserting an affirmative duty to provide shareholders with information that is material to their evaluation of directors’ conduct and business judgment.

Directors’ “disclosure” and “transparency” duties should be distinguished from the duty to inform in order to reinforce the qualitative differences in information communicated by a board at will rather than pursuant to a legal mandate. The duty to inform should not set limits, or dictate information that is deemed to be material, or mandate specific disclosures. Instead, the duty should encourage open communication in the form of a narrative that tells the story of a board’s decision-making processes and the strategic rationale for its choices in the context of the individual business enterprise. The substance of the narrative should be based on the judgment of the directors, not dictated by compliance requirements.

C. The U.K. Governance System: Comply-or-Explain

By definition, a duty to inform would confer broad discretion on directors to explain how they discharge their duties in a manner they “reasonably believe to be in the best interests of the corporation.” The duty would introduce a do-ityourself dimension to boards’ corporate governance programs that would be largely voluntary and self-administered. The duty would not be administered by a regulator (as the Securities and Exchange Commission (SEC) regulates shareholder proposals under Rule 14a-8).18 It would not be enforced by a self- regulatory organization (SRO) (as the New York Stock Exchange enforces listed company standards with the threat of delisting).19

It would generally involve decisions protected by the business judgment rule and would therefore not be subject to the “Standards of Liability” defined in section 8.31 of the MBCA (although it would certainly be subject to federal and state antifraud provisions). In lieu of these traditional methods of oversight and enforcement, the duty to inform would be based on directors’ accountability to shareholders.

The best-known model for accountability-based governance is the comply- or-explain program that has been in operation in the United Kingdom for nearly two decades.20 Although not without its critics, the United Kingdom’s voluntary comply-or-explain governance regime offers a number of advantages for companies. Comply-or-explain is specifically designed to promote flexible and customized governance practices rather than prescriptive rules and check- the-box compliance. It gives deference to the knowledge, expertise, and judgment of corporate directors. It assumes that boards are best positioned to determine what specific information is relevant to an explanation of noncompliance. It assumes that directors will be candid and avoid boilerplate. Most importantly (and perhaps aspirationally), it assumes that institutional investors will be diligent in committing time and resources to evaluate the quality of a company’s governance decisions in the context of business strategy and financial performance.

The U.K. Corporate Governance Code does not explicitly define a directors’ duty to inform, but it mandates an open relationship and constructive dialogue between directors and shareholders. Section E of the U.K. Code states the following “Main Principle”: “There should be a dialogue with shareholders based on the mutual understanding of objectives. The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place.”21

The important principle at the heart of the U.K. Code is that the board itself must assume responsibility for dialogue with shareholders, rather than vice versa. This approach is in contrast with U.S. practice, which discourages communication from boards to shareholders and encourages shareholders to initiate dialogue, usually through adversarial forms of engagement.

The U.K. Code’s provision E.1.2 further requires: “The board should state in the annual report the steps they have taken to ensure that the members of the board, and, in particular, the non-executive directors, develop an understanding of the views of major shareholders about the company . . . .”23

Again, the point is that with U.K. companies, the board has a direct role in outreach and dialogue with major shareholders in order to understand their views.


A directors’ duty to inform modeled on the United Kingdom’s principles- based, comply-or-explain system would pose challenges for U.S. companies. It is unclear whether state law could accommodate a board duty defined with such broad discretion and enforced primarily by means of shareholder accountability. Such a duty would occupy uncharted middle ground between the Standards of Conduct for Directors under section 8.30 of the MBCA and the Standards of Liability under section 8.31 of the MBCA. It is equally unclear whether the U.S. rules-based system of corporate governance could tolerate a principles-based, discretionary approach to directors’ duties and standards of conduct.

The success of a hybrid comply-and-explain governance system—grafting a new duty to inform onto the existing state and federal regulatory structure— would depend on two developments that are highly uncertain: (1) directors of U.S. companies would have to overcome their habitual antipathy to shareholders, assume a less-defensive posture, and accept primary responsibility for dealing with shareholder concerns related to governance and board conduct; and (2) institutional investors would have to give priority to their responsibilities as long-term owners, commit resources to the oversight of portfolio companies, and reduce their dependence on standardized third party governance analyses and proxy-voting recommendations.

In addition to these legal, structural, and cultural problems, the directors’ duty to inform would be likely to encounter resistance from U.S. companies and directors already overwhelmed by compliance requirements and facing additional controversial governance pressures including: the majority-vote standard in director elections, shareholder access, say-on-pay, risk oversight, takeover threats, conflicts of interest, short-termism, empty voting, proxy mechanics, environmental and social policies, and financial-system reform.

Ironically, the imposition of a directors’ duty to inform could actually help companies anticipate and avoid many of these contentious issues. A board-level narrative describing the decision-making process and explaining the context and business rationale for board decisions would help defuse shareholder concerns, reduce confrontation, and ultimately strengthen shareholder support even when there is a perception of non-compliance.

Executive compensation is a useful example that reveals the limits of disclosure rules and the need for better communication about board processes and policies. The say-on-pay movement grew out of shareholder frustration not only with perceived compensation excesses, but also with standardized disclosures that failed to address important strategic questions.24

The goal of an advisory vote is not to micromanage compensation but to increase board accountability and thereby compel directors to align pay with performance and explain how their compensation policies support business strategy and value creation. Through the exercise of a duty inform, directors would have greater discretion to provide a comprehensive Board Compensation Committee Report explaining their compensation philosophy, their decisions with respect to bonus and variable pay, and the economic goals that the incentives are designed to achieve.

This approach would be more effective than attempting to shoehorn the board’s views into the disclosure matrix of the management Compensation Disclosure and Analysis, or waiting to be targeted by shareholders and producing an explanation of directors’ policies and decisions after-the-fact.


Imposition of a directors’ duty to inform would not by itself result in “a dialogue with shareholders based on the mutual understanding of objectives.”25 Opening boardroom windows would help, but for interests to be fully aligned, institutional investors must also agree to comparable standards of candor and openness. Constructive dialogue between boards and shareholders must be a two-way street.

Debate over the Dodd-Frank bill launched a discussion of investor responsibility and fiduciary duty in the context of the abuses, conflicts of interest, and governance failures within the financial community that led to the crisis. As financial-system reform unfolds in the United States under the new law, many experts believe that institutional investors will replace companies and directors at the center of the governance-reform spotlight.26 Indeed, on October 21, 2010, the United States Department of Labor announced a proposed rule that would substantially strengthen the Employee Retirement Income Security Act (ERISA) definition of a “fiduciary.”27

More reforms are sure to follow. Discussion of investor responsibility is already well under way in the United Kingdom, where the Financial Reporting Council adopted a Stewardship Code for institutional investors in July 2010.28 It was preceded by an earlier Code on the Responsibilities of Institutional Investors, drafted in November 2009 by the Institutional Shareholders Committee, a forum representing major U.K. institutional investors.29

These efforts may prove useful as a precedent for a U.S. private-sector initiative bringing together both corporate and investor representatives to deal with the conjoined issues of board and investor conduct.


Well before the financial crisis, Leon Panetta suggested that companies should open the “sealed chamber” of the boardroom and provide greater transparency about board processes. Instead, boardroom windows remained closed and U.S. governance continued to pursue its traditional course of confrontation, legislation, and rule-making.30 Now, as companies stagger under the burden of compliance and face additional governance challenges in the Dodd-Frank Act, directors should seriously consider whether their sealed chamber is a privilege or a constraint and whether its growing costs outweigh its diminishing benefits.

The recent turmoil in the economy and financial markets underscores the importance of corporate governance and directors’ accountability to shareholders. However, in the United States, there is currently no basis for establishing a directors’ duty to inform shareholders about boardroom deliberations and governance decisions.

Section 8.30 of the MBCA requires directors to act in the best interest of the company and establishes a duty to inform other board members of information material to their decision-making function, yet it stops short of applying that standard to shareholders and investors. The Corporate Director’s Guidebook limits directors’ affirmative duty to inform shareholders in situations involving specific actions. The U.K. Code presents a more open model of communication under the voluntary comply-or-explain system, fostering flexibility and deference to business judgment. However, by requiring explanation primarily  when the board chooses not to comply, the U.K. Code still presents a level of communication short of the ideal.

A new duty to inform based on the principles of comply-and-explain would encourage directors of U.S. companies to articulate how decisions made in the boardroom advance strategic goals and align with shareholder interests. It would preserve directors’ discretion in the exercise of business judgment while providing shareholders with greater understanding of board conduct. In Panetta’s words, a directors’ duty to inform would “move toward more transparency about the boardroom process without undermining the ability of management teams to produce the results that shareholders want.”31

Under a comply-and-explain system, directors would have to overcome the inertia of a traditionally opaque and defensive posture, while investors would be under an obligation to embrace their oversight function and use their voice and votes to hold directors accountable. If directors and shareholders would both commit to such reciprocal duties, improvements in transparency, accountability, and corporate stability would surely result.

Copyright © 2011 by John C. Wilcox.This article is also available at * Chairman, Sodali Ltd. 1. Leon Panetta, It’s Not Just What You Do, It’s the Way You Do It, DIRECTORS & BOARDS, Winter 2003, at 17, 21.


For a general discussion of the problems of board–shareholder communication at U.S. companies, see generally Symposium, Who Speaks for the Board?, DIRECTORS & BOARDS, Second Quarter 2010, at 18; COMM. ON CORPORATE LAWS OF THE ABA SECTION OF BUS. LAW, REPORT ON THE ROLES OF BOARDS OF DIRECTORS AND SHAREHOLDERS OF PUBLICLY OWNED CORPORATIONS, available at; see also Stefan Stern, Investors Want You to Tell a Better Story, FINANCIAL TIMES.COM (May 31, 2010), 2. MODEL BUS. CORP. ACT § 8.30 (2008). 3. See id. § 8.30(c) (This section obliges directors to act in accordance with their reasonable beliefs about the best interests of the corporation, but it does not require that they communicate these beliefs to the shareholders). 4. The liability for selective disclosure prohibited by Regulation FD under the Securities Exchange Act could be avoided by limiting the topics covered by a duty to inform. See the discussion in COMM. ON CORPORATE LAWS, supra note 1, at 11 n. 24. 5. The Prime of Ms. Nell Minow (A CFO Interview), CFO MAGAZINE, Mar. 2003, at 56, 626. See generally Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111203, 124 Stat. 1376 (2010).8.307. MODEL BUS. CORP. ACT § 8.30 (2008). 8. Id. § 8.30(a) (emphasis added). 9. Id. §  cmt. 1 (emphasis added). 10. Id. § 8.30(c). 11. Id. § 8.30 cmt. 3. 12. Letter from Alan D. Lebowitz, Deputy Assistant Sec’y, Dep’t of Labor, to Helmut Fandl, Chairman of the Ret. Bd. of Avon Prods., Inc. (Feb. 23, 1988), reprinted in COUNCIL OF INSTITUTIONAL INVESTORS, EVERYTHING YOU ALWAYS WANTED TO KNOW ABOUT PROXY VOTING BUT WERE AFRAID TO ASK 14–16 (2007), available at resource%20center/publications/Proxy%20Voting%20Primer.pdf; see also Interpretive Bulletins Relating to the Employment Retirement Income Security Act of 1974, 29 C.F.R. § 2509.94-2 (1994); Interpretive Bulletin Relating to the Exercise of Shareholder Rights and Written Statements of Investment Policy, Including Proxy Voting Policies or Guidelines, 29 C.F.R. § 2509.08-2 (2008). 13. MODEL BUS. CORP. ACT § 8.30 (2008). 14. COMM. ON CORPORATE LAWS OF THE ABA SECTION OF BUS. LAW, CORPORATE DIRECTOR’S GUIDEBOOK (5th ed. 2007).  15. See id. at 26. 16. Id. (emphasis added). 17. Id.  18. Shareholder Proposals, 17 C.F.R. § 240.14a-8 (2010). 19. N.Y. STOCK EXCH., LISTED COMPANY MANUAL § 802.1D (2009), available at http:// 20. See FIN. REPORTING COUNCIL, THE U.K. CORPORATE GOVERNANCE CODE (2010), available at %20June%202010.pdf [hereinafter U.K. CODE]; see also James Hamilton, UK Reaffirms Comply or Explain Model for Corporate Governance as Financial Crisis Roils, CCH FINANCIAL REFORM NEWS CENTER (Aug. 28, 2009), model-for-corporate-governance-as-financial-crisis-roils.html (“The comply or explain approach has been in operation since the Code’s beginnings in 1992 . . . and the flexibility it offers is valued by company boards and by investors in pursuing better corporate governance.”). 21. U.K. CODE, supra note 20, § E.1, at 25. 22. See Symposium, Who Speaks for the Board?, supra note 1.  23. U.K. CODE, supra note 20, § E.1.2, at 25. 24. See, e.g., TIAA-CREF, 10 QUESTIONS FOR EVALUATING CD&A’S (July 2007), available at 25. U.K. CODE, supra note 20, § E.1, at 25. 26. For further discussion on the evolving role of investors, see generally the recent publications of BOGLE FIN. MKTS. RESEARCH CTR.,; see also John C. Bogle, Founder & Former Chairman, Vanguard Grp., Building a Fiduciary Society Remarks at the IA Compliance Summit (Mar. 13, 2009), available at sp20090313.html.  27. Definition of the Term “Fiduciary”, 75 Fed. Reg. 65,263 (proposed Oct. 21, 2010) (to be codified at 29 C.F.R. pt. 2510). 28. FIN. REPORTING COUNCIL, THE U.K. STEWARDSHIP CODE (2010), available at Stewardship Code July 20103.pdf. 29. INSTITUTIONAL S’HOLDERS COMM., CODE ON THE RESPONSIBILITIES OF INSTITUTIONAL INVESTORS (2009), available at sitebuilderfiles/ISCCode161109.pdf. 30. Panetta, supra note 1, at 21. 31. Id.

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Key Issues for Directors in 2013

[The following summary was written by Wachtell Lipton Rosen & Katz and is posted here by permission.]

November 16, 2012

The Spotlight on Boards

The ever evolving challenges facing corporate boards prompts an updated snapshot of what is expected from the board of directors of a major public company – not just the legal rules, but also the aspirational “best practices” that have come to have almost as much influence on board and company behavior – for consideration in conjunction with Key Issues for Directors in 2013.

Boards are expected to:

• Establish the appropriate “Tone at the Top” to actively cultivate a corporate culture that gives high priority to ethical standards, principles of fair dealing, professional- ism, integrity, full compliance with legal requirements and ethically sound strategic goals.

• Choose the CEO, monitor his or her performance and have a detailed succession plan in case the CEO becomes unavailable or fails to meet performance expectations.

• Work with management to navigate the dramatic changes in economic, social and po- litical conditions in order to remain competitive and successful.

• Plan for and deal with crises, especially crises where the tenure of the CEO is in ques- tion, where there has been a major disaster or a risk management crisis, or where hard-earned reputation is threatened by a product failure or a socio-political issue.

• Determine executive compensation to achieve the delicate balance of enabling the company to recruit, retain and incentivize the most talented executives, while also avoiding media and populist criticism of “excessive” compensation and taking into account the implications of the “say-on-pay” vote.

• Interview and nominate director candidates, maintain appropriate expertise, inde- pendence and diversity balance, monitor and evaluate the board’s performance and seek continuous improvement in board performance.

• Approve the company’s annual operating plan and long-term strategy, monitor per- formance and provide advice to management as a strategic partner.

• Determine the company’s reasonable risk appetite (financial, safety, reputation, etc.), set state-of-the-art standards for managing risk and monitor the management of those risks within the parameters of the company’s risk appetite.

• Set state-of-the-art standards for compliance with legal and regulatory requirements, monitor compliance and respond appropriately to “red flags.”

• Take center stage whenever there is a proposed transaction that creates a seeming conflict between the best interests of stockholders and those of management, including takeovers and attacks by activist hedge funds.

• Set high standards of social responsibility for the company, including human rights, and monitor performance and compliance with those standards.

• Oversee relations with government, community and other constituents.

• Pay close attention to investor relations to develop an understanding of shareholder perspectives on the company, interface with shareholders in appropriate situations and support the fostering of long-term relationships with shareholders.

• Work with management to encourage entrepreneurship, appropriate risk-taking and investment to promote the company’s long-term success, despite constant market pressures for short-term performance.

• Review corporate governance guidelines and committee charters and tailor them to promote effective board functioning.

To meet these expectations, it will be necessary for major public companies

(1) to have a sufficient number of directors to staff the requisite standing and special committees and to meet expectations for diversity;

(2) to have directors who have knowledge of, and ex- perience with, the company’s businesses, even though meeting this requirement may result in boards with a greater percentage of directors who are not “independent”;

(3) to have directors who are able to devote sufficient time to preparing for and attending board and committee meetings;

(4) to provide the directors with regular tutorials by internal and external experts as part of expanded director education; and

(5) to maintain a truly collegial relationship among and between the company’s senior executives and the members of the board.

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ISS Moderates Proposed Voting Policy Updates for the 2013 Proxy Season

[The following summary was written by David A. Katz, Trevor S. Norwitz, Jeremy L. Goldstein, and S. Iliana Ongun of Wachtell Lipton Rosen & Katz and is posted here by permission.]

Institutional Shareholder Services has released its 2013 Corporate Governance Policy Updates, which represent a more moderate approach than the proposals it released for comment in October. These changes, which will generally apply for the 2013 proxy season, continue the trend of narrowing director discretion in matters traditionally considered to be within directors’ authority. In addition, ISS’ expansion into social policy matters appears often to be at odds with shareholder and corporate interests and is far more likely to benefit special interest groups. It should be noted, though, that ISS took into account many of the comments it received and in some cases moved from a one-size-fits-all approach to a more appropriate case-by-case analysis. Although it is important that boards of directors be cognizant of ISS voting policies, it is essential that, in their decision-making, directors carefully consider the best interests of the corporations they serve and not merely defer to shareholder advocacy groups.

Board Responsiveness to Majority Supported Shareholder Proposals.

Although ISS will tighten its policy and recommend that shareholders vote “against” or “withhold” their votes for incumbent directors who fail to act on a shareholder proposal that received the support of a majority of votes cast in the previous year, it has – as we and others urged – implemented a transition rule, so that the tighter standard will only commence with shareholder proposals appearing in companies’ proxy statements in 2013, and will not apply retroactively. For shareholder proposals that won a majority of votes cast during the 2012 proxy season, board responsiveness will be assessed under the existing standard, which requires approval by a majority of outstanding shares the previous year or the support of a majority of votes cast in both the last year and one of the two prior years. While we continue to believe that the change to the current policy may impede board effectiveness by discouraging boards from considering long-term strategy when evaluating shareholder proposals, ISS has appropriately determined not to impose the harsher standard retroactively.

ISS has stated that it considers a board to have responded to a shareholder proposal if the board either fully implements the proposal or, if a shareholder vote is required, includes it as a management proposal on the next annual ballot. ISS will consider responses involving less than full implementation on a case-by-case basis, taking into account several factors, including the subject matter of the proposal and level of shareholder support shown, outreach efforts by the board to shareholders in the wake of the vote and actions taken by the board in response to its engagement with shareholders.

Voting on Director Nominees in Uncontested Elections.

ISS currently recommends that shareholders vote “against” or “withhold” their votes for incumbent directors, even in uncontested elections, when the company has experienced certain extraordinary circumstances including, among others, material failures of governance stewardship, risk oversight, or fiduciary responsibilities at the company. ISS has specified that, starting next year, failures of risk oversight will include bribery, large or serial fines or sanctions from regulatory bodies, significant adverse legal judgments or settlements, hedging of company stock or “significant” pledging of company stock. This policy update is a shift from ISS’ original proposal, which sought to categorize any pledging of company stock as a problematic pay practice that could lead to a negative say-on-pay recommendation, rather than a failure of risk oversight. In our view, categorizing only “significant” pledging of company stock as a failure of risk oversight provides for a more nuanced case-by-case consideration of pledging practices, rather than a one-size-fits-all approach.

Realizable Pay.

For large capitalization companies only, ISS will not only look to the value of compensation granted to executives generally as reported in the summary compensation table, but will add the concept of “realizable pay” to its analysis. Realizable pay will consist of the sum of relevant cash and equity-based grants and awards made during a specified performance period being measured, based on equity award values for awards actually earned and target values for ongoing awards, calculated using the stock price at the end of the performance measurement period. Stock options or stock appreciation rights will be re-valued based upon the remaining term and updated assumptions, using the Black-Scholes option pricing model.

Golden Parachute “Say-on-Pay” Vote.

ISS has modified its analysis of the golden parachute “say-on-pay” vote to include consideration of existing change of control arrangements and not merely newly-adopted agreements, as was the case under the current policy. While recent amendments that incorporate so-called problematic features (e.g., golden parachute excise tax gross-ups and single trigger payments) will carry more weight in the overall analysis, it appears that the presence of multiple legacy “problematic” features will also be closely scrutinized.

Pay for Performance Peer Group Selection Methodology.

In performing its pay for performance analysis, ISS previously focused on the subject company’s GICS industry peers, which frequently omitted competitors of the target company and/or included firms that were not competitors of the subject company for business or talent. ISS’ new methodology draws peers from the subject company’s GICS group as well as from GICS groups represented in the subject company’s self-selected peer group. The methodology additionally focuses initially at an 8-digit GICS code (a broad group) to identify peers that are more closely related in terms of industry. Finally, when selecting peers, the methodology prioritizes peers that maintain the company near the median of the peer group, are in the subject company’s peer group, and have chosen the subject company as a peer. In addition, ISS has slightly relaxed its size requirements, especially at very small and very large companies, and will use revenue instead of assets for certain financial companies.

Director Attendance; Overboarded Directors.

Starting next year, ISS will recommend that shareholders vote “against” or “withhold” their votes for: (1) individual directors who attend less than 75% of their board and committee meetings for the period for which they served, unless an acceptable reason is disclosed in an SEC filing; and (2) individual directors for whom proxy disclosure is insufficient to determine whether such directors met the 75% attendance threshold. In addition, ISS will no longer count publicly-traded subsidiaries owned 20% or more by the parent as one board with the parent company when determining the number of boards on which a director sits, and will continue to consider serving on more than six public company boards to be excessive. All subsidiaries with publicly-traded stock will be counted as boards in their own right, except such subsidiaries that only issue public debt. Mutual funds will continue to be rolled up to the mutual fund families, with one family counting as one board. Directors who sit on the boards of publicly-traded subsidiaries should re-evaluate their commitments to avoid inadvertently facing a negative recommendation from ISS.

Other Changes.

As ISS previously proposed, it has changed its recommendation for shareholder proposals to link executive compensation to environmental and social criteria from an automatic recommendation “against” to a “case-by-case” analysis. In adopting the change, ISS noted that incorporating sustainability-related non-financial performance metrics into executive compensation is becoming increasingly common in certain sectors, including the extractive industry sectors. ISS has also revised its policy position on proposals requesting information on a company’s lobbying activities to clarify that “lobbying activities” includes direct, indirect and grassroots lobbying, and not just direct lobbying. ISS’ expansion further into areas of social policy, however laudable it may appear to be, is in our view inappropriate and more likely to benefit special interest groups than businesses and the investors ISS purports to represent.

* * * * *

ISS’ 2013 policy updates generally continue the incremental shift towards a shareholder-centric model of corporate governance that may be at odds with the best interests of the companies that boards serve. As companies begin to prepare for the 2013 proxy season, they must be mindful of anticipated or actual negative recommendations and consider whether to proactively engage with shareholders to counteract any such recommendations. However, we continue to believe that in evaluating and responding to shareholder proposals, as in every decision they make, directors must carefully consider the best interests of the corporations they serve and not merely defer to shareholder advocacy groups.

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KPMG’s Ten To-Do’s for Audit Committees

By KPMG’s Audit Committee Institute

[This piece was written by KPMG, published by NACD, and is reposted here.]

Recognizing the sizeable challenges that audit committees and boards face, KPMG’s Audit Committee Institute (ACI) has issued its annual message to directors. “Ten To-Do’s for Audit Committees” highlights key issues that should be top of mind as audit committees think through their agendas for the future.

1. Stay focused on the audit committee’s top priority: financial reporting and related internal control risk. Ensuring that the audit committee’s agenda focuses on the issues that require its attention will be a significant undertaking. The challenges of ongoing economic uncertainty and volatility coupled with the impact of cost- reductions, major public policy initiatives, and an uncertain—yet clearly more-complex—regulatory environment will require the attention of every audit committee. Meeting this workload challenge will require focused (yet flexible) agendas, with an eye on the company’s key financial reporting and related internal control risks. As-needed updates from management between regular audit committee meetings can be invaluable.

2. Continue to monitor accounting judgments and estimates, and prepare for accounting changes. Monitor fair value estimates, impairments, and management’s assumptions underlying critical accounting estimates. Recognize that the company’s greatest financial reporting risks are often in areas where there is a range of possible outcomes, and management is called upon to make difficult judgments and estimates. Understand management’s framework for making accounting judgments and estimates (was the framework in the “Pozen report” considered?19), make sure management has appropriate controls in place, and ask for the external auditor’s views. Also, understand how major accounting changes on the horizon may impact the company, including implementation/resources and IT systems requirements. The SEC continues to explore what role IFRS will play in U.S. financial reporting, with a decision expected in 2012; and key FASB/IASB joint projects on revenue recognition, leases, financial instruments, and insurance are moving forward. Stay close to where these projects are headed and the timeline.

3. Consider whether the financial statements and disclosures tell the company’s story. Given the importance of transparency to the investor community, as well as the SEC’s ongoing focus on disclosures, consider how disclosures can be improved—perhaps going beyond what’s “required”— to better address expectations. Enlist management’s disclosure committee in this effort, and consider the findings of the recent FEI/KPMG study on disclosures, Disclosure Overload and Complexity: Hidden in Plain Sight. Understand the process management uses to calculate any non-GAAP measures that are used in SEC filings to ensure their relevance and reasonableness. At the end of the day, do the financial statements and disclosures tell the company’s story?

4. Focus on the company’s plans to grow and innovate. Growth, strategy, and innovation will be front-and-center as companies search for top-line growth and look forward, beyond the recessionary environment. A key challenge will be monitoring and calibrating growth plans to appropriately balance risk and reward. (Remember: good risk management enables innovation and growth.) Does lack of innovation pose a threat to the company? Make sure risk and strategy are discussed together—each hinges on the other. Given historically low valuations and high levels of corporate cash on hand, understand the company’s position in the M&A “ecosystem” (as a potential acquirer or target). Is there a robust M&A process in place in the event an offer or opportunity arises? What is the role of the audit committee versus the full board?

5. Reassess the company’s vulnerability to business interruption and its crisis readiness. As illustrated by the earthquake in Japan, the European debt crisis, and other systemic disruptions over the past 24 months, the global interconnectedness of businesses, markets, and risk poses challenges for virtually every company. Ensure that management is weighing a broad spectrum of “what-if” scenarios—from supply chain links and the financial health of vendors to geopolitical issues, natural disasters, and cyber threats. Is the company’s crisis response plan robust and ready to go? Is the plan actively tested or war-gamedz—and updated as needed?

6. Understand how technology change and innovation are transforming the business landscape—and impacting the company. IT risk discussions should be moving (rapidly) beyond “defensive” issues (compliance, data privacy, system implementations) to address the critical challenge today: understanding the transformational implications of IT and emerging technologies—cloud computing, social media, mobile technologies, and data—and the strategic issues they present. The audit committee can help the organization get its arms around IT by insisting on more frequent and robust communications with the CIO; elevating IT discussions to a senior management/full- board level (beyond the “IT shop”); helping to frame the big picture view of the company’s IT governance efforts (on data and social media); clarifying the oversight role(s) of the board, audit committee, and other committees; and strengthening the board’s understanding of IT (by bringing IT expertise onto the board and/or through education). A comprehensive IT risk assessment is essential, and support from internal audit can be invaluable. Review the SEC’s October 2011 guidance on cyber security disclosures, which may highlight IT issues requiring greater attention by the company and the board.

7. Focus on asymmetric information risk and seek out dissenting views. Is the audit committee hearing views from those below and beyond senior management—e.g., from middle management and business unit leaders, sell-side analysts and critics, and other third parties—about the risks and challenges facing the company? Does the information provided by management, internal audit, and external auditors tell a consistent story? What is being said about the company by customers, employees, and others on social media networks? Make time to visit company facilities and attend employee functions. Key goals here are to recognize when asymmetric information risk—the over-reliance on senior management’s information and perspective—is too high, and to promote a culture of candor and constructive skepticism, where raising red flags and challenging information are welcomed.

 8. Consider the impact of the regulatory environment on compliance programs and business plans. The increasing complexity of the global regulatory environment—including compliance challenges posed by the Foreign Corrupt Practices Act and the UK Bribery Act, the SEC’s whistleblower bounty program, and Dodd-Frank provisions on conflict minerals and compensation clawbacks—will require continued attention. The right tone at the top and throughout the organization is critical. From a broader business perspective, consider the potential impact of regulatory compliance developments on the business planning process, particularly when growth strategies include international expansion. Do the company’s regulatory compliance and monitoring programs align with its business plans?

9. Understand the company’s significant tax risks and how they are being managed and modeled. Prospects for business tax reform; ongoing assessment of uncertain tax positions; increased state, federal, and global enforcement activities; and the continued complexity of operating globally in different tax regimes all pose significant compliance and financial risks. To stay abreast of critical tax risks—including internal control, compliance, and disclosure issues—establish a clear communications protocol for management to update the audit committee on the status of its tax risk management activities. Ensure the tax function is monitoring the federal tax reform debate and “testing” the impact of various tax legislative scenarios (e.g., on R&D, capital investments, cash flow, hiring, etc.) and possible remedial steps as the proposals become more specific. Are leading risk management practices (such as scenario planning) being leveraged to manage significant tax risks?

10. Monitor the PCAOB’s initiatives on auditor independence and transparency, and consider the implications for the audit committee. PCAOB initiatives designed to promote auditor independence, objectivity, and professional skepticism have potentially significant implications for the audit process and the role of the audit committee. Set clear expectations with management and auditors for staying apprised of these projects and communicating their potential impact on the audit and the audit committee’s oversight (the PCAOB is seeking input from all stakeholders, including audit committee members). Consider how the audit committee currently reinforces auditor independence and skepticism. Would a more robust audit committee report be beneficial to investors?

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Corporate Governance: Five Mandates for a Complicated Era

By Heidrick & Struggles

[This piece was written by Heidrick & Struggles and published by NACD.  It is reprinted here.]

Directors can be forgiven for feeling bruised, even though the global economy shows slight signs of recovery. Consumer confidence appears to be picking up as jobless numbers ease, according to the latest figures from The Conference Board. And, chief executive officers seem less anxious about their organizations’ future prospects.

But directors themselves are far more guarded. NACD’s latest Board Confidence Index shows that directors’ confidence in continued growth in the U.S. economy has dropped. In fact, directors who last year characterized their outlook for general economic conditions as moderately positive now see little or no change for the future.

There is no way for directors to magically boost global demand or pull macroeconomic levers. But there are factors they certainly can control that will, over time, substantially improve the operations of the companies on whose boards they sit—not least because those factors will free the board and management team to focus on performance. Heidrick & Struggles identifies five issues that merit immediate and consistent attention.

1. Improving communications with shareholders. Do a quick Google search for “shareholder communication with directors” and up come all sorts of boilerplate assurances touting open lines of communication between boards and investors. But in many cases, the fine print betrays just how difficult it can be for shareholders to make themselves heard by directors.

Here’s one example that clearly demonstrates just how out of touch boards can often be in our Facebook and Twitter age: “Any shareholder who wishes to send communications to the Board of Directors should mail them addressed to the intended recipient by name or position in care of: Corporate Secretary [company name and address follows]. Upon receipt of any such communications, the Corporate Secretary will determine the identity of the intended recipient and whether the communication is an appropriate shareholder communication.” Translation: Please don’t bother—we are not open to input.

Increasingly, shareholders want—indeed, demand—more immediate access to the board. It’s not to circumvent proxy voting mechanisms or to subvert established whistleblower channels; it is simply to have more of a voice in issues that shareholders care about—and to know that directors are listening.

Given the well-publicized CEO succession snafus we have seen in recent years—and given the rise of shareholder activism in general—it is easy to see why shareholders are anxious for a real dialogue with the head of the nominating committee, for example. In an era in which corporate reputations can rise and fall with the ebb and flow of social media messages, it is necessary for directors to think anew about how their roles are perceived by investors.

We’re not saying every boardroom debate is up for public consumption or that every director should have a mandate to speak freely and candidly to anyone who asks—media, analyst, or shareholder. It is crucial that when directors speak, they speak with a unified voice.

But there are smart ways to be open. We believe that board openness starts with meetings with select institutional investors—and will soon become a hallmark of best-performing boards. As such, it will set the bar of expectation for shareholders everywhere. The Pfizer board is taking a more proactive approach to fostering open board and shareholder communications. It is sending out a press release announcing a board-shareholder meeting and later sending some of the materials distributed at the meeting between the board and 16 of its major shareholders. The reactions to this move are proving positive.

NACD has included “shareholder communications” as one of its 10 “Key Agreed Principles” to strengthen governance for public U.S. companies and made available a raft of materials for detailed discussion—from webinars to books to reports. Others eloquently support the case for improved communication with investors.

2. Mastering CEO succession planning. The old story about corner-office succession planning is that the CEO would keep an envelope tucked away in his or her desk drawer naming the future successor.

The story isn’t so far from the truth. The shock of it is that here, in 2012, CEO succession planning is still done so poorly—when it’s done at all. In recent years—naming no names—there have been some staggeringly awful succession gaffes by companies quite established enough to have known better.

The statistics are not encouraging. NACD’s 2009 research shows that 44 percent of corporations did not have a formal CEO succession plan in place. Although most had some basic process for replacing the CEO in an emergency, many had not planned for succession over a three-to-five year period. A 2010 study by Heidrick & Struggles and The Rock Center for Corporate Governance at Stanford University found that on average, boards spend only two hours a year on CEO succession planning, and only 50 percent have a written document detailing the skills required for the next CEO.9 Furthermore, in our 2011 Board of Directors survey, we found that only two-thirds of U.S. directors said their boards had vetted at least one viable candidate who could immediately step in as CEO if necessary.

The SEC is on the case. In October 2009, its Division of Corporate Finance issued new guidelines that support shareholders who want boards to provide more transparency about the process.11 The document pulls no punches: “We now recognize that CEO succession planning raises a significant policy issue regarding the governance of the corporation that transcends the day-to-day business matter of managing the workforce.”

Yet the benefits of thorough succession planning are not hard to find. Heidrick & Struggles’ research shows that merely announcing who your next CEO is can move the market value of your company by 5 percent or more.12 McDonald’s is the high-water mark for how to do succession planning right. When CEO Jim Cantalupo died unexpectedly in 2004, the board was quick to name veteran Charlie Bell—then president and chief operating officer—as Cantalupo’s successor. But shortly thereafter, Bell learned that he had cancer. The directors had a plan: Their continual preparation and development of a years-long leadership pipeline meant they did not have to go outside the company to replace Bell.

We have worked with a company that has pursued an exemplary board practice: It has run mock board meetings to identify a CEO successor in case of a sudden event like that which befell McDonald’s. The mock meeting was tasked to a specific committee, and individual directors had clear responsibilities for roles such as communicating to the executive team, to investment analysts, and others. That is the kind of initiative we have to see more often.

3. Aligning executive compensation with performance. This has long been a heated issue for boards, and it never seems to be resolved to the satisfaction of shareholders. Now, more than ever, it is the board’s responsibility to cool down the debate over executive pay.

The Occupy Wall Street movement is the least of directors’ concerns. Much more pressing are the increasingly shrill calls for fair play when CEOs are awarded epic sums for negative performance (and there were some jaw-dropping examples in 2011)13—or in quite a few cases, for no performance, in the form of “golden hello” handouts when a new CEO signs on. In some instances, the “hello” envelopes have been downright incendiary for some shareholders—and for the media—whether or not the sums have been inducements or “make whole” compensation for monies the executive may have left on the table at the previous employer.

Dodd-Frank, enacted in mid-2010, now gives shareholders some say on pay via non-binding votes on executive compensation and golden parachutes. But we contend that all too many directors—especially the members of compensation committees—are tone-deaf to the hard connection between performance and pay. We fully expect that institutional heavyweights such as CalPERS will, with Dodd-Frank behind them, wade more forcefully into compensation affairs. And we expect to hear a lot more from longtime activist investors such as Carl Icahn, Relational Investors, and others.

That said, we know plenty of directors who are frustrated by the compensation excesses they see all around them. They are more than happy to reward CEOs handsomely when those executives knock corporate performance out of the park, but they find themselves competing with decisions from directors at other companies who listen far too closely to what the compensation consultants have to say.

In their hearts, directors know that not all executives are somehow “above average.” Now they must confront this realization head-on.

4. Ensuring more diverse boards. Over the last three or four years, it is fair to say that diversity in boardrooms took something of a backseat. There is an excuse, of course: the economic downturn focused everyone’s attention on performance. But now it’s time to return to the admittedly hard job of building boards that represent the rich diversity found on any city street in the United States or in most offices and factory floors.

The pressure is on: There’s a striking example in the letter that CalSTRS earlier this year wrote to Facebook, urging that the company strengthen its corporate governance and increase the diversity of its board.14 The European Union is forging ahead with plans for quotas (always a controversial topic) to increase the percentage of women on boards.15 And we fully expect that organizations such as Catalyst—and increasingly influential efforts like Stanford University Graduate School of Business’s Stanford Women on Boards Initiative—will increase the drumbeat to appoint more female directors.

The calls for ethnic diversity may be less strident right now, but they are not likely to be mute for long. The rise of sovereign wealth funds, surging middle classes in emerging markets, and the growth of global markets are just some of the factors that are converging to pressure boards into mirroring the make-up of their shareholders worldwide.

Of course, it is one thing to be willing to build a more diverse board and quite another to do so. Heidrick & Struggles’ surveys show that nearly two-thirds of directors find it tough to hire well-qualified ethnic minorities, and more than half say it’s hard to hire qualified women directors. Nor is there widespread trust in the mechanisms for fostering diversity: Among men on boards, only 13 percent support quotas compared with 41 percent of women directors.

But those diverse hires have to happen. For a start, nominating committees have got to expand their director searches beyond their usual Rolodexes (86 percent of directors rely on their own contacts when looking for new directors, according to our research). Directors also have to proactively seek out and use the cornucopia of tools available to help accelerate diversity efforts—from the Diverse Director DataSource set up in April 2011 by CalPERS and CalSTRS to the wealth of board-succession planning tools offered by NACD.

Put simply: boards ignore the diversity issue at their peril.

5. Getting ahead of proxy access. Directors must begin taking this issue seriously. Even though a federal appeals court last year overturned the SEC’s interpretation of shareholders’ rights to nominate their own directors, most boards still have to get their arms around what the final rulings entail.

We agree with the experts that the SEC’s market-wide proxy access rule won’t much affect the 2012 proxy season. However, a wild card is now in play. Following the court’s ruling, what we are left with is the very real prospect of “private ordering” whereby irate shareholders can bring forward all manner of their own proposals to push proxy access in forms that they can determine, and whatever their intentions.

There is no telling how widespread such responses might be. But it is our bet that there will be a flurry of alarming though disparate assaults on individual companies. So it is incumbent on boards to get ahead of the proxy-access issue, possibly by developing their own rules and gauging the limits of those rules against likely shareholder advocacy.

As the Boy Scouts say, “It’s always better to be prepared.”

We don’t pretend that the five points made here represent the entirety of what should be on the board’s future agenda. But in our experience, the boards that adhere to the tenets we have outlined stand a far better chance of ensuring that their companies outrun and outlast their competitors.

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Government Role In Corporations

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is another in a series of articles that summarizes their principles.

Corporations, like all citizens, must act within the law. The penalties for serious violations of law can be extremely severe, even life-threatening, for corporations. Compliance is not only appropriate—it is essential. Management should take reasonable steps to develop, implement and maintain an effective legal compliance program, and the board should be knowledgeable about and oversee the program, including periodically reviewing the program to gain reasonable assurance that it is effective in deterring and preventing misconduct.

Corporations have an important perspective to contribute to the public policy dialogue and should be actively involved in discussions about the development, enactment and revision of the laws and regulations that affect their businesses and the communities in which they operate and their employees reside.

— Steve Odland

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The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is another in a series of articles that summarizes their principles.

Corporations have obligations to be good citizens of the local, national and international communities in which they do business. Failure to meet these obligations can result in damage to the corporation, both in immediate economic terms and in longer-term reputational value.

A corporation should be a good citizen and contribute to the communities in which it operates by making charitable contributions and encouraging its directors, managers and employees to form relationships with those communities.

A corporation also should be active in promoting awareness of health, safety and environmental issues, including any issues that relate to the specific types of business in which the corporation is engaged.

— Steve Odland

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The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is another in a series of articles that summarizes their principles.

It is in a corporation’s best interest to treat employees fairly and equitably.

Corporations should have in place policies and practices that provide employees with compensation, including benefits that are appropriate given the nature of the corporation’s business, the employees’ job responsibilities and geographic locations.

When corporations offer retirement, health care, insurance and other benefit plans, employees should be fully informed of the terms of those plans.

Corporations should have in place and publicize mechanisms for employees to seek guidance and to alert management and the board about potential or actual misconduct without fear of retribution.

Corporations should communicate honestly with their employees about corporate operations and financial performance.

— Steve Odland

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Shareholders & Investors

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is another in a series of articles that summarizes their principles.

Over the past several years, some shareholders have expressed interest in having more input on matters affecting the corporations in which they invest. Corporations should productively engage with their long-term shareholders in a manner consistent with the respective roles of the board, management and shareholders. Corporations should be responsive to issues and concerns that are of widespread interest to their long-term shareholders.

Corporations also should take steps to educate shareholders and other stakeholders about the board’s role and its oversight responsibilities. Corporations should encourage shareholders to make voting decisions based on consideration of what is in the best interests of the individual corporation and its shareholders. Meaningful involvement of shareholders requires that shareholders make company-specific judgments and consider the interests of the specific corporation. In this regard, a corporation should consider additional outreach efforts as appropriate to explain the bases for the corporation’s recommendations on the matters it is asking shareholders to vote on.

Communication with shareholders is an important component of effective engagement. Corporations communicate with investors and other constituencies in proxy statements, annual and other reports, and shareholder meetings. Corporations also communicate through informal avenues of communication, such as earnings releases, conference calls and investor meetings.

» Corporations should consider whether, from time to time, it may be appropriate to use other mechanisms in order to solicit shareholder views. These may include periodic meetings with the corporation’s largest shareholders or surveys to obtain feedback from long-term shareholders about particular issues, such as executive compensation.

Corporations should take advantage of technology to enhance the dissemination of information. A corporation’s website should include copies of the corporation’s governance principles, the charters of its board committees and codes of conduct. Corporations also should consider posting biographies of directors and members of senior management, information about current committee memberships, copies of their articles of incorporation and bylaws, information about communicating with the board and information about the corporation’s annual meeting.

Corporations should have effective procedures for long-term shareholders to communicate with members of the board and for directors to respond in a timely manner to the concerns of long-term shareholders. Technology can facilitate these procedures. The board, or the corporate governance committee, should oversee and update these procedures as appropriate. Corporations should use the annual shareholder meeting as an opportunity to engage with shareholders.

Directors should attend the corporation’s annual meeting of shareholders, and the corporation should have a policy that directors attend the annual meeting each year, absent unusual circumstances. Time at the annual meeting should be set aside for shareholders to submit questions and for senior management or directors to respond to those questions. The board or its corporate governance committee should oversee the corporation’s response to shareholder proposals. The board should seriously consider issues raised by shareholder proposals that receive substantial support and should communicate its response to proposals to the shareholder-proponents and to all shareholders.

— Steve Odland

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Board and Committee Evaluation

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is another in a series of articles that summarizes their principles.

The board should have an effective mechanism for evaluating performance on a continuing basis. Meaningful board evaluation requires an assessment of the effectiveness of the full board, the operations of board committees and the contributions of individual directors. There are a variety of ways to conduct board and committee evaluations. These include written questionnaires, group discussions led by a designated director, employee or outside facilitator (often with the aid of written questions) and individual interviews. Each board, with the assistance of the corporate governance committee, should determine what method or combination of methods will result in a meaningful assessment of the functioning of the board and its committees. Boards and committees should consider periodically varying the methods they use to keep the evaluation process fresh.


» For some companies, securities market listing standards require that the board and its audit, compensation and corporate governance committees conduct annual evaluations. Regardless of whether an evaluation is required, the performance of the full board should be evaluated annually, as should the performance of its committees. The board should use the annual evaluation to assess whether it is following the procedures necessary to function effectively. Each committee should conduct an annual evaluation to assess its effectiveness, and to review the committee’s charter to determine whether any changes are appropriate. The results of this evaluation should be reported to the full board.

» Boards take a variety of approaches to assessing the contributions of individual directors. In this regard, board positions should not be regarded as permanent, and directors should serve only so long as they add value to the board. The corporate governance committee should examine a director’s ability to continue to contribute to the board each time it considers the director for renomination. In addition, the corporate governance committee also should consider the continued value that directors will bring to the corporation as part of the committee’s regular assessment of the skills and experience represented on the board as a whole and the board’s current and future needs. Some boards also conduct individual director evaluations through a more formalized process that involves self or peer evaluations.

— Steve Odland

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Senior Management Development and Succession

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the ninth in a series of articles that summarizes their principles.

Long-term planning for CEO and senior management development and succession is one of the board’s most important functions. The board, its corporate governance committee or another committee of independent directors should identify and regularly update the qualities and characteristics necessary for an effective CEO. With these principles in mind, the board or committee should periodically monitor and review the development and progression of potential internal candidates against these standards, and see that internal candidates receive the necessary preparation.

The board should review the corporation’s succession plan at least annually and periodically review the effectiveness of the succession planning process. Emergency succession planning also is critical. Working with the CEO, the board or committee should see that plans are in place for contingencies such as the departure, death or disability of the CEO or other members of senior management to facilitate the transition to both interim and longer-term leadership in the event of an untimely vacancy.

The corporation should disclose information about the board’s succession planning process, either in the corporate governance principles or proxy statement or both. This disclosure can help facilitate shareholder understanding of the process that the board follows in planning for succession to the position of CEO. Under the oversight of an independent committee or the lead director, the board should annually review the performance of the CEO and participate with the CEO in the evaluation of members of senior management.

All non-management members of the board should participate with the CEO in senior management evaluations. The results of the CEO’s evaluation should be promptly communicated to the CEO in executive session by representatives of the independent directors and used by the compensation committee or independent directors in determining the CEO’s compensation.

— Steve Odland

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Board Operations

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the eighth in a series of articles that summarizes their principles.

Serving on a board requires significant time and attention on the part of directors. Directors must participate in board meetings, review relevant materials, serve on board committees, and prepare for meetings and discussions with senior management. Certain roles, such as committee chair, chairman of the board and lead director, carry an additional time commitment beyond that attendant to board and committee service.

Directors must spend the time needed and meet as frequently as necessary to discharge their responsibilities properly. The board of directors, with the assistance of the corporate governance committee, should consider the appropriate frequency and length of board meetings. Longer meetings may permit directors to explore key issues in depth, whereas shorter but more frequent meetings may help directors stay up-to-date on emerging corporate trends, and business and regulatory developments. When arranging a meeting schedule for the board, each corporation should consider the nature and complexity of its operations and transactions, as well as its business and regulatory environment.

The board of directors, with the assistance of the committee responsible for overseeing director compensation, should periodically review the compensation of the board in light of developments in the marketplace and the board’s needs. This review should include consideration of differential compensation for specific roles that carry more responsibility, such as chairing committees, acting as lead director or acting as independent chairman. The board should approve changes in compensation based on the recommendation of the committee. In determining director compensation, the board should focus on creating total director compensation that is reasonable relative to directors’ responsibilities and compensation at comparable companies. The board also should be comfortable that compensation adequately rewards directors for the risks associated with board service, as well as their time and efforts. Director compensation should consist of a mix of cash and equity. The board should consider paying the cash portion of director compensation in the form of an annual retainer, rather than through meeting fees, to encourage directors to view board service as an ongoing commitment and to foster a long-term focus.

Equity helps align the interests of directors with those of the corporation’s shareholders, but equity compensation should be carefully designed to avoid unintended incentives such as an emphasis on short-term market value changes. Corporations increasingly are providing the long-term equity component of director compensation in the form of restricted stock, rather than stock options, to better align directors’ interests with those of shareholders. The board should establish a requirement that directors hold a meaningful amount of the corporation’s stock for as long as they remain on the board.

Service on too many boards can interfere with an individual’s ability to satisfy his or her responsibilities, either as a member of senior management or as a director. Before accepting an additional board position, a director should consider whether the acceptance of a new directorship will compromise the ability to devote adequate time and focus to present responsibilities. Directors should notify the chair of the corporate governance committee before accepting a seat on the board of another corporation or assuming a significant new role on an existing board (such as a committee chair or lead director position). Some boards require the prior approval of the corporate governance committee before a director accepts a seat on the board of another corporation. Similarly, the corporation should establish a process to review senior management service on other boards prior to acceptance in order to consider the time commitment and review any potential conflicts of interest and interlocks.

The board’s independent or non-management directors should have the opportunity to meet regularly in executive session, outside the presence of the CEO and any other management directors.

» Time for an executive session should be placed on the agenda for every regularly scheduled board meeting. The independent chairman or lead director, as applicable, should see that adequate time is reserved for these sessions, and should set the agenda for and chair these sessions.

» To maximize the effectiveness of executive sessions, the independent chairman or lead director, as applicable, should follow up with the CEO and other appropriate members of senior management on matters addressed in the executive sessions.

Many board responsibilities may be delegated to committees to permit directors to address key areas in more depth as discussed above. Regardless of whether the board grants plenary power to its committees with respect to particular issues or prefers to take recommendations from its committees, committees should keep the full board informed of their activities. Corporations benefit greatly from the collective wisdom of the entire board acting as a deliberative body, and the interaction between committees and the full board should reflect this principle.

The board’s agenda must be carefully planned yet flexible enough to accommodate emergencies and unexpected developments. The chairman of the board should work with the lead director (when the corporation has one) in setting the agenda, and should be responsive to individual directors’ requests to add items to the agenda and open to suggestions for improving the agenda. It is important that the agenda and meeting schedule permit adequate time for discussion and a healthy give-and-take between board members and management. The board should work to foster open, ongoing dialogue between management and members of the board. Board members should have full access to senior management outside of board meetings.

Board agendas should be structured to maximize the use of meeting time for open discussion and deliberation. Highlighting changes relevant to recurring agenda items and distributing copies of presentations sufficiently in advance of meetings can facilitate review of materials prior to meetings and increase the time that is available for discussion and constructive dialogue.

The board must have accurate, complete information to do its job; the quality of information that the board receives directly affects its ability to perform its oversight function effectively. Directors should receive and review information from a variety of sources, including senior management, board committees, outside experts and the outside auditor, as well as industry journals, and analyst and media reports. The board should receive information before board and committee meetings with sufficient time to review and reflect on key issues and to request supplemental information as necessary.

Corporations should consider ways in which they can use technology, such as board portals, to provide directors access to relevant information on a timely basis. Technology can provide a mechanism for providing meeting materials, delivering real-time information about developments that occur between meetings and creating resources with background information and educational tools for directors to access at their convenience.

Corporations should have a robust orientation process for new directors that is designed to familiarize them with the various aspects of the corporation, including its business, strategy, industry, management, compliance programs and corporate governance practices. Common components of board orientation programs include briefings from senior management, on-site visits to the corporation’s facilities, informal meetings with other directors and written materials.

Corporations should encourage directors to take advantage of educational opportunities on an ongoing basis. Continuing education can assist directors in keeping abreast of issues and developments relevant to the corporation and enable them to address specific subjects in greater depth. Continuing education can take the form of participation in outside programs or “in board” educational sessions, led by members of senior management or outside experts and customized for the corporation. Many boards rely on a combination of the two methods by informing their directors of outside programs and holding educational sessions for the full board or particular committees on a regular basis.

Where appropriate, boards and board committees should seek advice from outside advisers independent of management with respect to matters within their responsibility. For example, there may be technical aspects of the corporation’s business—such as risk assessment and risk management—for which the board or a committee determines that additional expert advice would be useful. Similarly, many compensation committees engage their own compensation consultants. Situations where the board or a committee may decide it is appropriate to seek independent legal advice include circumstances involving conflicts of interest, external or internal investigations, and mergers and acquisition activity. The board and its committees should have the authority to select and retain advisers and approve the terms of their retention and fees.

— Steve Odland

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Role of the Compensation Committee

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the seventh in a series of articles that summarizes their principles.

Every publicly owned corporation should have a committee composed solely of independent directors that addresses compensation issues. The compensation committee should have at least three members and should be composed solely of independent directors. All committee members should have and maintain sufficient knowledge of executive compensation and related issues to perform their duties effectively.

The compensation committee’s responsibilities include overseeing the corporation’s overall compensation structure, policies and programs, establishing or recommending to the board performance goals and objectives for the CEO and other members of senior management (or, in some companies, in conjunction with the corporate governance committee), and establishing or recommending to the independent directors compensation for the CEO and senior management.

The compensation committee should see that the corporation’s compensation policies reflect the core principle of pay for performance and should establish meaningful goals for performance-based compensation paid to senior management. The committee should see that the corporation’s compensation policies and performance goals are closely linked to its strategic plan and that they create incentives to produce long-term value for shareholders without encouraging excessive risk-taking.

The compensation committee should have the authority to retain compensation consultants, counsel and other advisers to provide the committee with independent advice. The compensation committee should understand all aspects of an executive’s compensation package, and should review and understand the maximum payout due under multiple scenarios (such as retirement, termination with or without cause, and severance in connection with business combinations or the sale of a business).

The compensation committee should require senior management to build and maintain significant continuing equity investment in the corporation. To align senior management interests with the interests of shareholders, the committee should establish requirements that senior management acquire and hold a meaningful amount of the corporation’s stock for at least the duration of their tenure with the corporation.

In addition to reviewing and setting compensation for senior management, the compensation committee should look more broadly at the overall compensation structure of the enterprise to determine that it establishes appropriate incentives for management and employees at all levels and that these incentives do not encourage inappropriate risk-taking. The committee should consider carefully and understand the incentives created by different forms of compensation. Incentives should further the corporation’s long-term strategic plans by looking beyond short-term market value changes to the overall goal of creating and enhancing enduring shareholder value, and they should be consistent with the corporation’s culture.

The committee should see that the corporation has in place appropriate practices to mitigate risks created by compensation programs. Executive compensation should directly link the interests of senior management, both individually and as a team, to the long-term interests of shareholders. It should include significant performance-based criteria related to long-term shareholder value and should reflect upside potential and downside risk.

The compensation committee should carefully examine the benefits and perquisites provided to senior management and determine whether they appropriately balance the interests of long-term shareholders and the ability of the corporation to recruit and retain top talent. The corporation should generally bear the cost of these items only if they are directly related to management’s job performance; the corporation should not bear the cost of personal expenses.

The compensation committee should oversee the corporation’s disclosures with respect to executive compensation. Disclosure about executive compensation should be transparent and written in plain English so that it is understandable to shareholders. In particular, the committee should use the compensation discussion & analysis (CD&A) disclosure to provide shareholders with meaningful and understandable information about the corporation’s executive compensation philosophy, policies and practices, the factors that the committee and the board consider in making compensation decisions, and the relationship between executive compensation and corporate performance.

— Steve Odland

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Role of the Corporate Governance Committee

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the sixth in a series of articles that summarizes their principles.

Every publicly owned corporation should have a committee composed solely of independent directors that addresses director nominations and corporate governance matters. The corporate governance committee (often combined with or referred to as a nominating committee) should have at least three members and should be composed solely of independent directors. The corporate governance committee recommends director nominees to the full board and the corporation’s shareholders, oversees the composition, structure, operation and evaluation of the board and its committees, and plays a leadership role in shaping the corporate governance of the corporation.

Depending on how the board has allocated responsibilities among its committees, the corporate governance committee also may oversee the compensation of the board if the compensation committee does not do so, or the two committees may share oversight responsibility for this area. The committee should remain informed about legal and regulatory developments in the area of corporate governance. As part of its responsibility to oversee the composition of the board, the corporate governance committee should engage in succession planning for the board. This process should include looking at the skills and experience currently represented on the board, identifying qualifications and attributes that the board may find valuable in the near-term and the future based on the corporation’s strategic direction, and planning ahead for the departure of directors and the designation of new board members.

The corporate governance committee should regularly conduct an assessment of the mix of skills represented on the board to evaluate whether the board, as a whole, contains the right balance of professional and personal backgrounds, and includes individuals that bring industry and other relevant knowledge, financial expertise, diversity and other desired characteristics to the board.

In performing the core function of identifying and recommending director candidates to the board, the corporate governance committee should establish criteria for board membership and recommend these criteria to the board for approval. There are certain criteria that every director should have, such as sound judgment, integrity and an objective mind.

The committee should periodically review the board’s membership criteria and recommend changes to the board as appropriate. Based on the board’s membership criteria and the qualifications and attributes identified through the assessment of the board’s composition, the committee should identify director candidates, review their qualifications and any potential conflicts with the corporation’s interests, and recommend new director candidates to the board.

In identifying director candidates, the corporate governance committee should take a proactive approach by soliciting ideas for potential candidates from a variety of sources. The committee should have the authority to retain search firms as appropriate to assist it in identifying candidates and should provide search firms with the criteria articulated by the committee. The committee also should develop a process for considering shareholder recommendations for board nominees. Although it is appropriate for the CEO to meet with board candidates, the final responsibility for selecting director nominees should rest with the corporate governance committee and the board.

In connection with the renomination of current directors, the corporate governance committee should review their skills and experience, assess their contributions to the board, and consider their continued value to the corporation in light of current and future needs. Some boards may undertake these steps, in part, through individual director evaluations, which may occur through a more formalized process or in connection with renominating directors.

The corporate governance committee should monitor and safeguard the independence of the board. An important function of a corporate governance committee, related to its core function of recommending nominees to the board, is to see that a substantial majority of the directors on the board meet appropriate standards of independence that are consistent with securities market listing standards and to see that these directors are independent both in fact and in appearance. It is also important that directors have the ability to question management, exercise constructive skepticism and express their views even when those views may differ from those of management or other directors.

The corporate governance committee should consider all relevant facts and circumstances in assessing independence and make recommendations to the board regarding determinations of director independence. If the board has developed a set of standards for assessing independence, the committee should evaluate directors’ relationships in light of these standards. In addition, the committee should receive prompt notification from directors of any change in a director’s circumstances that may affect the director’s independence (such as a family member’s job change).

The corporate governance committee should conduct a periodic evaluation of the board’s leadership structure to assess whether the current leadership structure remains appropriate. In addition, the committee should oversee the process of planning for succession to the position of chairman of the board, which should involve consideration of whether to combine or separate the positions of CEO and chairman of the board when the current chairman’s tenure ends and consideration of whether a new CEO might necessitate a change to the board leadership structure.

The corporate governance committee also recommends directors for appointment to committees of the board. The committee should periodically review the board’s committee structure and annually recommend candidates for membership on the board’s committees. The committee should see that the key board committees, including the audit, compensation and corporate governance committees, are composed of directors who meet applicable independence and qualification standards. In addition, the committee should consider whether periodic rotation of committee memberships and chairs would provide fresh perspectives and enhance directors’ understanding of various aspects of the corporation’s business.

The corporate governance committee should oversee the effective functioning of the board. The committee should review the board’s policies relating to meeting agendas and schedules and the corporation’s processes for providing information to the board, with input from the lead director or independent chairman.

The corporate governance committee should assess the reporting channels through which the board receives information and see that the board obtains appropriately detailed information in a timely fashion. This includes receiving information from a variety of sources, from inside and outside of the corporation, including both positive and negative materials such as analyst reports, industry publications and press articles. It also includes seeing that relevant information that the corporation receives from key stakeholders, such as long-term shareholders, is appropriately shared with the board.

The corporate governance committee should develop and recommend to the board a set of corporate governance principles, review them annually and recommend changes to the board as appropriate. The corporation’s corporate governance principles should be available on the corporation’s website and should address, at a minimum, board leadership, qualifications for directors, director independence, director responsibilities, the structure and functioning of board committees, board access to management and advisers, director compensation, director orientation and continuing education, board evaluations and management succession.

The corporate governance committee should oversee the corporation’s efforts in the area of shareholder engagement and coordinate with management any appropriate board-level involvement in that process. The corporate governance committee should oversee the evaluation of the board and its committees. Specifics concerning the evaluation process are discussed under “Board and Committee Evaluation.”

— Steve Odland

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Role Of The Audit Committee

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the fifth in a series of articles that summarizes their principles.

Every publicly owned corporation should have an audit committee of at least three members, who should all be independent directors. Audit committees typically consist of three to five members. The listing standards of the major securities markets require that all members of the audit committee qualify as independent directors under applicable listing standards, subject to limited exceptions, and that they meet additional, heightened independence criteria.

Audit committee members should meet minimum financial literacy standards, as required by the listing standards of the major securities markets, and at least one member of the audit committee should be an audit committee financial expert, as determined by the board in accordance with regulations of the Securities and Exchange Commission. Audit committee members, as with all directors, should understand the corporation’s business and risk profile and apply their business experience and judgment with an independent and critical eye to the issues for which the committee is responsible.

With the significant responsibilities imposed on audit committees under applicable law, regulations and listing standards, consideration should be given to whether it is appropriate to limit the number of public company audit committees on which a corporation’s audit committee members may serve.

Some boards have adopted policies that audit committee members may not serve on the audit committees of more than three public corporations, in accordance with applicable securities market listing standards. Policies may permit exceptions to this limit when the corporation’s board determines that the simultaneous service would not affect an individual’s ability to serve effectively on the corporation’s audit committee. The audit committee is responsible for supervising the corporation’s relationship with its outside auditor. In performing this responsibility, the primary functions of the audit committee include:

» Selecting and retaining the auditor and approving in advance the terms of the annual audit engagement. The selection of the outside auditor should involve an annual due diligence process in which the audit committee reviews the qualifications, work product, independence and reputation of the outside auditor, and the performance of key members of the audit team.

» Overseeing the independence of the outside auditor. The audit committee should maintain an ongoing, open dialogue with the outside auditor about independence issues. The committee should consider its overall approach to using the outside auditor as a service provider and identify those services, beyond the annual audit engagement, that the outside auditor can provide to the corporation consistent with applicable law and regulations and with maintaining independence. 

The audit committee also is responsible for overseeing the corporation’s financial reporting process. The audit committee should review and discuss the corporation’s annual financial statements with management and the outside auditor, and should review the corporation’s quarterly financial statements and related earnings press releases prior to issuance. As part of its reviews, the audit committee should review and discuss with management and the outside auditor the corporation’s critical accounting policies, the quality of accounting judgments and estimates made by management, any comments received from Securities and Exchange Commission staff, and any material written communications between the outside auditor and management.

The audit committee should oversee the corporation’s system of internal controls over financial reporting and its disclosure controls and procedures, including the processes for producing the certifications required of the CEO and principal financial officer. On a periodic basis, the committee should review with both the internal and outside auditors, as well as with management, the corporation’s procedures for maintaining and evaluating the effectiveness of these systems. The committee should be promptly notified of any significant deficiencies or material weaknesses in internal controls and should be kept informed about the steps and timetable for correcting them.

Unless the full board or one or more other committees does so, the audit committee should oversee the corporation’s program that addresses compliance with ethical and legal standards and important corporate policies, including the corporation’s code of conduct and the mechanisms it has in place for employees to report compliance issues. In accordance with applicable legal requirements, the audit committee should establish procedures for receiving and handling complaints and concerns related to accounting, internal accounting controls and auditing issues, and the committee should evaluate these procedures periodically and revise them as appropriate.

The audit committee should be briefed regularly by senior management on the status of outstanding compliance issues, including concerns submitted through the committee’s procedures for handling accounting and related concerns, and it should receive prompt notification of any significant compliance issues. The audit committee should report at least annually to the full board on its oversight of the compliance program.

Unless the full board or another committee does so, the audit committee should oversee the corporation’s risk assessment and risk management. Many corporations address risk through the audit committee, in part because securities market listing standards applicable to many corporations require audit committees to discuss policies with respect to risk assessment and risk management. However, the audit committee should not be the sole body responsible for risk oversight, and the board may decide that it is appropriate to allocate responsibility for some types of risk to other committees (for example, compensation risk to the compensation committee) or to the board as a whole.

No one risk oversight structure is right for every board, and different structures may be appropriate depending on a corporation’s industry and other factors. Committees with risk-related responsibilities should report regularly to the full board on the risks that they oversee and brief the audit committee as appropriate in cases where securities marked listing standards require the audit committee to retain some oversight responsibility for risk.

The audit committee should oversee the corporation’s internal audit function, including reviewing the scope of the internal audit plan, reports submitted by the internal audit staff and management’s response, and the appointment and replacement of the senior internal auditing executive. The senior internal auditing executive should have a direct communication line to the audit committee, so that the executive has the authority to report any issues or concerns directly to the committee.

Final decisions relating to the hiring and termination of the senior internal audit executive should be made following consultation with the audit committee. The audit committee should implement a policy covering the hiring of personnel who previously worked for the corporation’s outside auditor. At a minimum, this policy should incorporate the “cooling off” period and other auditor independence hiring requirements mandated by applicable law and regulations.

Audit committee meetings should be held at least quarterly, with additional meetings held frequently enough to allow the committee to monitor the corporation’s financial reporting appropriately. Meetings should be scheduled with enough time to permit and encourage active discussions with management and the internal and outside auditors. The audit committee should meet privately with each of the internal and outside auditors and management on a regular basis, and in any event at least quarterly, and communicate with them between meetings as necessary.

The audit committee also should hold private sessions on a regular basis with senior management responsible for the corporation’s legal function to facilitate the communication of concerns regarding legal compliance matters and significant legal contingencies. In addition, the audit committee should consider whether to hold private sessions from time to time with other parties, including senior management responsible for risk assessment and risk management, and those responsible for compliance.

— Steve Odland

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The Alternative to Shareholder Class Actions

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In this article by Hal Scott and Leslie Silverman of the Committee on Capital Markets Regulation (of which I was a member from 2006-2010), they argue that “despite arbitration’s endorsement by Congress and the Supreme Court, the SEC has rebuffed efforts to substitute arbitration for securities class actions.”  In the past months, the SEC has blocked attempts by the Carlyle Group and proposals by stockholders of Pfizer and Gannett, to mandate arbitration rather than litigation in disputes between investors and management.  The SEC gave no explanation for its actions.  Scott and Silverman argue that securities class actions undercut the competitiveness of the U.S. capital markets and are contributing to companies issuing IPO’s to go elsewhere versus the U.S.  The Committee has focused for years on how to make the U.S. capital markets more globally competitive by reducing regulation.  Here is one more example of how regulation is harming the markets.

— Steve Odland

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Board Organization

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the fourth in a series of articles that summarizes their principles.

Virtually all boards of directors of large, publicly owned corporations operate using committees to assist them. A committee structure permits the board to address key areas in more depth than may be possible in a full board meeting. Decisions about committee membership and chairs should be made by the full board based on recommendations from the corporate governance committee. Consideration should be given to whether periodic rotation of committee memberships and chairs would provide fresh perspectives and enhance directors’ understanding of different aspects of the corporation’s business, consistent with applicable listing standards.

In connection with joining a committee, directors should participate in orientation to familiarize themselves in greater depth with the subject matter areas that the committee is responsible for overseeing. In addition, all committee members should be encouraged to participate in continuing education relating to the committee’s areas of responsibility. For example, committees may benefit from periodic educational sessions, led by management or outside experts, which address recent developments and best practices relevant to the committees’ duties. In this regard, committee members should be cognizant of how recent developments impact the corporation’s own practices.

Committees should apprise the full board of their activities on a regular basis. Processes should be developed and monitored for keeping the board informed through oral or written reports. For example, some corporations provide minutes of committee meetings to all members of the board. Business Roundtable believes that the functions generally performed by the audit, compensation and corporate governance committees are central to effective corporate governance.

The listing standards of the major securities markets require corporations to have an audit committee that performs specific functions, and many corporations also are required to have committees that oversee executive compensation, director nominations and corporate governance matters. Business Roundtable does not believe that a particular committee structure is essential for all corporations. What is important is that the independent members of the board address key issues effectively. These issues include compliance, executive compensation, financial reporting, governance, risk oversight, director nominations and succession planning. Thus, the references below to the functions performed by particular committees are not intended to preclude corporations from allocating these functions differently, consistent with applicable listing standards.

Additional committees, such as finance, public responsibility or risk management, also may be used. Some corporations find it useful to establish committees to examine special problems or opportunities in greater depth than would otherwise be feasible. The responsibilities of each committee and the qualifications required for committee membership should be clearly defined and set out in a written charter that is approved by the board and publicly available. Each committee should review its charter annually and recommend changes to the board as appropriate.

— Steve Odland

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Harvard Law School Supports Declassified Board Challenges

The following statement was released today by the Harvard Law School Shareholder Rights Project:

“Below are links to joint press releases issued today by the Harvard Law School Shareholder Rights Project(SRP) and each of five institutional investors – the Illinois State Board of Investment, the Los Angeles County Employees Retirement Association, the Nathan Cummings Foundation, the North Carolina State Treasurer, and the Ohio Public Employees Retirement System.

During this proxy season, the SRP has been representing and advising these institutional investors in connection with the submission of shareholder proposals to a significant number of S&P 500 companies that have staggered boards. The proposals urge a move to annual elections, which are widely viewed as corporate governance best practice. As the press releases below indicate:

  • Proposals to declassify boards have been submitted to more than eighty S&P 500 companies, and
  • Forty-two S&P 500 companies receiving proposals – about one-third of the S&P 500 companies that had a staggered board at the beginning of this proxy season – have already entered into agreements committing them to bring management proposals to declassify their boards.

The companies that have entered into agreements to bring management proposals to declassify their boards should be commended for their responsiveness to shareholder concerns and for their willingness to move to annual elections. A list of twenty-one companies that have entered into such agreements, including only companies that have already made public filings that disclose the planned management proposal, is available here.

Joint press release by the Illinois State Board of Investments and the SRP

Joint press release by the Los Angeles County Employees Retirement Association and the SRP

Joint press release by the Nathan Cummings Foundation and the SRP

Joint press release by the North Carolina Department of State Treasurer and the SRP

Joint press release by the Ohio Public Employees Retirement System and the SRP

The Harvard Law School Shareholder Rights Project is a clinical program through which Harvard Law School faculty, staff and students assist public pension funds and charitable organizations to improve corporate governance at publicly traded companies in which they are shareowners. More information regarding the SRP can be found at”


— Steve Odland

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Board Leadership

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the fourth in a series of articles that summarizes their principles.

Boards of American corporations have taken a variety of approaches to board leadership, with some boards combining the positions of CEO and chairman and others appointing a separate chairman or designating a “lead” director. No one leadership structure is right for every corporation at all times, and boards of different corporations may reach different conclusions about the leadership structures that are most appropriate for their corporations at any particular point in time.

The board should decide whether to combine or separate the positions of CEO and chairman of the board based on its assessment of what is in the best interests of the corporation and its shareholders based on the corporation’s particular circumstances, and the board should evaluate its leadership structure periodically. In addition, in connection with the CEO succession planning process, the board should consider the appropriate board leadership structure.

Whatever leadership structure a board chooses, independent board leadership is critical to effective corporate governance. To provide independent leadership for the board, the board should consider appointing a lead director (or presiding director with comparable responsibilities) if it combines the positions of CEO and chairman or has a chairman who is not independent. The lead director should be appointed by the independent members of the board and should serve for a period of at least one year. At some corporations the lead director is appointed annually, while at others the lead director serves for a longer term or an indefinite period of time.

Lead directors perform a range of functions, depending on the needs of the board. One of the primary functions of the lead director is chairing executive sessions of a board’s independent or non-management directors. The lead director should have the authority to call executive sessions, and should coordinate and oversee appropriate follow-up on matters discussed in executive sessions to maximize the effectiveness of these sessions.

Other key functions of the lead director may include chairing board meetings in the absence of the chairman of the board, reviewing and/or approving agendas and schedules for board meetings and information sent to the board, and being available for engagement with long-term shareholders as appropriate. The lead director also may play a key role in overseeing performance evaluations of the CEO and the board, and leading the board in crisis situations. Depending on the responsibilities associated with the position of the lead director or independent chairman, the position may involve substantial responsibility and require a significant time commitment on the part of a director.

— Steve Odland

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Board Composition

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the third in a series of articles that summarizes their principles.

Boards of directors of large publicly owned corporations vary in size from industry to industry and from corporation to corporation. In determining board size, directors should consider the nature, size and complexity of the corporation as well as its stage of development. The experiences of many Business Roundtable members suggest that smaller boards often are more cohesive and work more effectively than larger boards. Directors should be elected by a majority vote.

In addition, boards should adopt a resignation policy that requires a director who does not receive a majority vote to tender his or her resignation to the board for its consideration. Although the ultimate decision whether to accept or reject the resignation will rest with the board, the board should think critically about the reasons why the director did not receive a majority vote and whether or not the director should continue to serve. Among other things, the board should consider whether the vote resulted from concerns about a policy issue affecting the board as a whole or concerns specific to the individual director. If the board decides not to accept a resignation, the corporation should disclose the reasons for this decision promptly.

In addition, when a director is elected but receives significant “withhold” or “against” votes, the board should consider the reasons for the vote. Having a variety of backgrounds and experience, consistent with the corporation’s needs, is important to the overall composition of the board. Because the corporation’s need for particular backgrounds and experience may change over time, the board should monitor the mix of skills and experience that directors bring to the board and assess whether the board, as a group, has the necessary tools to work together in a productive and collegial fashion and perform its oversight function effectively. The board should consider implementing a structured framework for this ongoing process, such as using a skills matrix detailing specific qualifications and identifying the skills that current directors, and director candidates, bring to the board.

Directors with relevant business and leadership experience are beneficial to the board as a whole and to the corporation. These directors can provide a useful perspective on business strategy and significant risks and an understanding of the challenges facing the business. Corporations should assist directors who do not have significant background in a corporation’s business or industry through orientation programs and otherwise. All directors should remain informed about issues and developments relevant to the corporation’s business and industry by reviewing pertinent information provided by management and the corporation, subscribing to industry journals, reviewing analyst and press reports, and participating in educational programs. As part of the ongoing assessment of board composition, the board should plan ahead for the nomination of new directors by engaging in succession planning. The board should conduct a forward-looking assessment to identify qualifications and attributes that the board may find valuable in the future based on the corporation’s strategic plans, anticipated director retirements and evolving best practices in the corporation’s industry. The board also should plan ahead for director departures, considering whether it is appropriate to establish or maintain procedures for the retirement or replacement of board members, such as a mandatory retirement age or term limits.

The board should assess whether other practices, such as the assessment of director candidates in connection with the renomination process, annual board evaluations and individual director evaluations, may make a retirement age or term limit unnecessary. Many boards also establish a requirement that directors who change their primary employment tender a board resignation, providing an opportunity for the board to consider the desirability of their continued service in light of their changed circumstances. Board independence is critical to effective corporate governance. Providing objective independent judgment is at the core of the board’s oversight function, and the board’s composition should reflect this principle. Accordingly, a substantial majority of the board’s directors should be independent, both in fact and appearance, as determined by the board.

Board independence depends not only on directors’ individual relationships and outlook but also on their ability to question management, exercise constructive skepticism and express their views even when those views may differ from those of management or other directors. The board should make an affirmative determination as to the independence of each director annually and should have a process in place for making these determinations.

» Definition of independence. An independent director should not have any relationships with the corporation or its management—whether business, employment, charitable or personal—that may impair, or appear to impair, the director’s ability to exercise independent judgment. The listing standards of the major securities markets define “independence” and enumerate specific relationships involving directors and their family members (such as employment with the corporation or its outside auditor) that preclude a director from being considered independent.

» Assessing independence. The board should consider all relevant facts and circumstances when assessing directors’ independence, taking into account the requirements of the federal securities laws, securities market listing standards, and the views of institutional investors and other relevant groups. When evaluating whether a director is independent, the board should consider whether the director has any relationships, either directly or indirectly, with the corporation, senior management or other board members that could affect the director’s actual or perceived independence. Corporations must disclose in their proxy statements relationships that the board considered in assessing independence in accordance with the requirements of the federal securities laws. Many boards have adopted standards to assist them in assessing independence. These standards should be included in a corporation’s corporate governance principles.

» Relationships with not-for-profit organizations. The board’s director independence assessment should include a review of relationships that directors, and their spouses, have with not-for-profit organizations that receive support from the corporation. In conducting this assessment, the board should take into account the size of the corporation’s contributions and the nature of the relevant director’s relationships to the recipient organizations. Independence issues are most likely to arise when a director, or the director’s spouse, is an employee of the not-for-profit organization and when a substantial portion of the organization’s funding comes from the corporation. It also may be appropriate to consider contributions from a corporation’s foundation to organizations with which a director or a director’s spouse is affiliated.

— Steve Odland

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WomenCorporateDirectors Takes Action during Women’s History Month to Move Women into Board Seats Globally

The Americas – Directors from throughout the Americas will convene in Palm Beach, FL on March 9 at WCD’s first-everAmericas Institute, with this year’s program focusing on Latin America and its growing priority for corporate boards. KPMG is lead sponsor of the event. Lars Thunell, CEO of the World Bank’s IFC, will deliver the keynote address at the event’s luncheon, and the slate of speakers and panelists includes: Sherry Barrat, Vice Chairman of Northern Trustand director of NextEra Energy, Inc.; Toti Graham, director of Interbank, Quimica Suiza, Grupo Salud del Peru, ENFOCA SAFI, Corferias del Pacifico, and Red i3; Janet Clarke, director of Cox Communications, eFunds Corporation, ExpressJet Airlines Inc., and Asbury Automotive Group Inc.; P. Michael McKinley, U.S. Ambassador to Bogota, Colombia, and former U.S. Ambassador to Peru; Lillian Garcia, EVP & AVP Argentina, Colombia, Venezuela & Ecuador, and Uruguay for Tupperware Brands Corporation; Madeleine L. Champion, director of Fresh Del Monte Produce, Inc., and Citizens Republic Bancorp Inc.; Julie Roberts, director of Calgon Carbon Corporation; Maria Sastre, director ofPublix Super Markets, Inc., and Darden Restaurants; and Steve Odland, director of General Mills.

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Role of the CEO and Management

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the second in a series of articles that summarizes their principles.

» It is the responsibility of the CEO and management, under the CEO’s direction, to operate the corporation in an effective and ethical manner. As part of its operational responsibility, management is charged with:

§ Operating the corporation. The CEO and management run the corporation’s day-to-day business operations. With a thorough understanding of how the corporation operates and earns its income, they carry out the corporation’s strategic objectives within the annual operating plans and budgets, which the board reviews. In making decisions about the corporation’s business operations, the CEO considers the long-term interests of the corporation and its shareholders and necessarily relies on the input and advice of others, including the board, senior management and outside advisers. The CEO keeps the board apprised of significant developments regarding the corporation’s business operations.

§ Strategic planning. The CEO and senior management generally take the lead in strategic planning. They identify and develop strategic plans designed to create long-term value for the corporation, present those plans to the board, implement the plans once board review is completed, and recommend and carry out changes to the plans as necessary. As part of the strategic planning process, the CEO and senior management identify, evaluate and manage risks associated with the plans.

§ Identifying, evaluating and managing risks. Management identifies, evaluates and manages the risks that the corporation undertakes in implementing its strategic plans and in the course of carrying out its business. It also manages the corporation’s overall risk profile, and senior management keeps the board informed on an ongoing basis about the corporation’s significant risks and its risk management processes.


§ Annual operating plans and budgets. With the corporation’s overall strategic plans in mind, senior management develops annual operating plans and budgets for the corporation and presents the plans and budgets to the board. Once the board has reviewed the annual operating plans and budgets, the management team implements them and monitors them, making changes as appropriate in light of changing conditions, assumptions or expectations. The management team also keeps the board apprised of significant developments and changes relating to the annual operating plans and budgets.

§ Selecting qualified management and establishing an effective organizational structure. Senior management is responsible for selecting qualified management and implementing an organizational structure that is efficient and appropriate for the corporation’s particular circumstances.

§ Accurate and transparent financial reporting and disclosures. Management is responsible for the integrity of the corporation’s financial reporting system, and the accurate and timely preparation of the corporation’s financial statements and related disclosures in accordance with Generally Accepted Accounting Principles and in compliance with applicable laws and regulations. It is management’s responsibility—under the direction of the CEO and the corporation’s principal financial officer—to establish, maintain and periodically evaluate the corporation’s internal controls over financial reporting and the corporation’s disclosure controls and procedures. In accordance with applicable law and regulations, the CEO and the corporation’s principal financial officer also are responsible for certifying the accuracy and completeness of the corporation’s financial statements and the effectiveness of the corporation’s internal and disclosure controls.

» The CEO and management are responsible for operating the corporation in an ethical manner. They should never put individual, personal interests before those of the corporation or its shareholders. Business Roundtable believes that when carrying out this function, corporations should have:

§ A CEO of integrity. The CEO should be a person of integrity who takes responsibility for the corporation adhering to the highest ethical standards.

§ A strong, ethical “tone at the top.” The CEO and senior management should set a “tone at the top” that establishes a culture of legal compliance and integrity communicated to personnel at all levels of the corporation.

§ An effective compliance program. Management should take responsibility for implementing and managing an effective compliance program and should report regularly to the board on compliance matters. As part of its compliance program, a corporation should have a code of conduct with effective reporting and enforcement mechanisms. Employees should have a means of seeking guidance and alerting management and the board about potential or actual misconduct without fear of retribution, and violations of the code should be addressed promptly and effectively.

— Steve Odland

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Role of the Board of Directors

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the first in a series of articles that summarizes their principles.

» The business of a corporation is managed under the oversight of the corporation’s board. The board delegates to the CEO—and through the CEO to other senior management—the authority and responsibility for managing the everyday affairs of the corporation. Directors monitor management on behalf of the corporation’s shareholders.

» Making decisions regarding the selection, compensation and evaluation of a well-qualified and ethical CEO is the single most important function of the board. The board also appoints or approves other members of the senior management team.

» Directors bring to the corporation a range of experience and knowledge, but there are certain characteristics that all directors should possess. Every director should have integrity, character and sound judgment. In addition, a director should represent the interests of all shareholders; directors should not represent the interests of particular constituencies.

» Effective directors maintain an attitude of constructive skepticism; they ask incisive, probing questions and require accurate, honest answers; they act with integrity and diligence; and they demonstrate a commitment to the corporation, its business plans and long-term shareholder value.

» The composition of the board, as a whole, should reflect a mix of skills and expertise that are appropriate for the corporation given its circumstances and that, collectively, enables the board to perform its oversight function effectively.

» Directors need to have a thorough understanding of the corporation, its business and the industry in which it operates. Directors should keep abreast of any relevant developments. Directors can gain and maintain this understanding through briefings from management, reviewing industry journals and press and analyst reports, participating in educational programs, etc.

» In performing its oversight function, the board is entitled to rely on the advice, reports and opinions of management, counsel, auditors and expert advisers. The board should use care in choosing advisers, be comfortable with the qualifications of those it relies on, and hold managers and advisers accountable. The board should ask questions and obtain answers about the processes used by managers and the corporation’s advisers to reach their decisions and recommendations, as well as about the substance of the advice and reports received by the board. When appropriate, the board and its committees should seek independent advice.

» Shareholders and other constituencies should reasonably expect that directors will exercise vigorous and diligent oversight of a corporation’s affairs. However, they should not expect the board to micromanage the corporation’s business by performing or duplicating the tasks of the CEO and senior management team. Directors should be informed about the operation of the corporation’s business, but they should not become involved with operational matters, which are the province of management.

» The board’s oversight function carries with it a number of specific responsibilities in addition to that of selecting and overseeing the CEO. These responsibilities include:

§ Planning for senior management development and succession. The board should oversee the corporation’s plans for developing senior management personnel and plan for CEO and senior management succession. When appropriate, the board should replace the CEO or other members of senior management. The board should review the corporation’s succession plans at least annually and periodically review the effectiveness of the senior management development and succession planning process.

§ Reviewing, understanding and monitoring the implementation of the corporation’s strategic plans. The board has responsibility for overseeing and understanding the corporation’s strategic plans from their inception through their development and execution by management. Once the board reviews a strategic plan, it should regularly monitor implementation of the plan to determine whether it is being implemented effectively and whether changes are needed. The board should understand the relationship between strategy and risk and review the risks inherent in the corporation’s strategic plans. The board also should be comfortable that the corporation’s incentive compensation program is appropriately aligned with the corporation’s strategic plan.

§ Reviewing and understanding the corporation’s risk assessment and overseeing the corporation’s risk management processes. The board has responsibility for overseeing the significant risks facing the corporation and the processes that management has implemented to identify and manage risk. The board, together with senior management, should agree on the appropriate risk profile for the corporation, and the board should be comfortable that the corporation’s strategic plans are consistent with that profile. The board should establish an appropriate structure for overseeing risk, involving assistance from committees as appropriate and the designation of senior management responsible for risk management. Whatever risk oversight structure the board adopts, that structure should enable the board to remain fully informed about, and understand, all of the corporation’s major risks and the steps that the corporation is taking to manage them.

§ Reviewing, understanding and overseeing annual operating plans and budgets. The board is responsible for reviewing, understanding and overseeing the corporation’s annual operating plans and for reviewing annual budgets presented by management. The board should monitor implementation of the annual plans to assess whether they are being implemented effectively and within the limits of approved budgets and whether the annual plans are appropriately responsive to changing conditions.

§ Focusing on the integrity and clarity of the corporation’s financial statements and financial reporting. The board, assisted by its audit committee, should be satisfied that the financial statements and other disclosures prepared by management accurately present the corporation’s financial condition and results of operations to shareholders and that they do so in an understandable manner. To achieve accuracy and clarity, the board, through its audit committee, should have an understanding of the corporation’s financial statements, including why the accounting principles critical to the corporation’s business were chosen, what key judgments and estimates management made, and how the choice of principles and the making of these judgments and estimates affect the reported financial results of the corporation.

§  Advising management on significant issues facing the corporation. Directors can offer management a wealth of experience and a wide range of perspectives. They provide advice and counsel to management in formal board and committee meetings, and they are available for informal consultation with the CEO and senior management

§ Reviewing and approving significant corporate actions. As required by state corporate law, the board reviews and approves specific corporate actions, such as the election of executive officers, the declaration of dividends and (as appropriate) the implementation of major transactions. The board and senior management should have a clear understanding of what level and types of decisions require specific board approval.

§ Reviewing management’s plans for business resiliency. As part of its risk oversight function, the board should oversee the designation of senior management who will be responsible for business resiliency. The board should periodically review management’s plans to address this issue. Business resiliency can include such items as business continuity, physical and cyber security, and emergency communications.

§ Nominating directors and committee members, and overseeing effective corporate governance. It is the responsibility of the board, through its corporate governance committee, to nominate directors and committee members, and to oversee the composition, independence, structure, practices and evaluation of the board and its committees. The committee should regularly evaluate the skills and experience represented on the board and oversee succession planning for the board.

§ Overseeing legal and ethical compliance. The board should set a “tone at the top” that establishes the corporation’s commitment to integrity and legal compliance. The board, acting through its committees as appropriate, should oversee the corporation’s compliance program and be comfortable that the corporation has implemented systems that enable the board to remain informed about the program and any significant compliance issues that may arise. In this regard, the board should be knowledgeable about the corporation’s compliance program and should be satisfied that the program is effective in preventing and deterring violations. The board, or an appropriate committee, should receive regular briefings about developments and significant changes relating to the program and about the corporation’s compliance trends. In addition, significant investigations of possible misconduct, investigations of misconduct involving senior management, the conclusions from any such investigations, and the investigative and remedial actions being taken should be presented to the board or appropriate committee. The board should pay particular attention to conflicts of interest, including related-person transactions.


— Steve Odland

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FTI Consulting Corporate Governance Survey

Capital Markets -Corp Gov Survey Feb 2012 FINAL

Here is the latest survey on Corporate Governance by FTI Consulting.  There were several interesting key findings:

  • Executive compensation is still a critical topic for investors and may be even more so than it was in 2011
  • Director independence and separation of chairman and CEO role are vital; investors are also focused on director qualifications and access to the Chairman
  • The trend toward greater shareholder involvement in corporate affairs continues
  • Proxy access is back
  • Other emerging issues in corporate governance have reasonably strong support
  • Ability to call a special meeting
  • Political contributions
  • Act by written consent
  • Decision-making on proxy matters is mostly independent and fairly balanced between PMs and Legal/Compliance

Of course, none of these issues is new but they continue to be top of mind.

— Steve Odland


Published with permission of FTI Consulting.

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CalSTRS To Vote Proxies Independently

CalSTRS introduced their report on executive pay last week.  It was notable for a couple reasons.  First, the large retirement fund acknowledges that questionable pay practices are on the decline although there still is room for improvement in their opinion.  From their press release:

“The California State Teachers’ Retirement System (CalSTRS) released, “Lessons Learned: The Inaugural Year of Say-on-Pay,” its analysis of shareholders’ ability to vote on executive compensation, known as say-on-pay, during the 2011 proxy season.  The analysis provides key findings from the first year with mandatory say-on-pay. The document notes that some questionable practices are on the decline, such as companies paying taxes on executives’ use of perquisites, and excessive perquisites themselves. However, the analysis also discusses CalSTRS’ primary reasons for voting against say-on-pay proposals and identifies areas where many companies can improve. Among these findings, are:

  • Persistent disconnect between executive pay and company performance was CalSTRS’ overwhelming reason for “against” votes.
  • Continued board use of broad discretion in developing compensation policies remains problematic.
  • Appropriate peer group selection continues to be a challenge.”

A second notable comment comes from the report itself:  “Given the unique nature of compensation, CalSTRS tried to evaluate pay holistically at every company.”  This is good news.  It is another example of a large investor looking at governance matters at public companies on an individual basis rather than relying on the black box models used at proxy advisory firms.  This judgment is welcome as no two situations are the same.  Good corporate governance demands that institutional investors make judgments about their investments’ corporate governance in context.  Hopefully more investors will follow this route in the future.

— Steve Odland

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Short-termism Creates Long Term Problems

If you asked most people what the goal of corporations should be they would rightly say the creation of long term shareholder value.  Unfortunately, today, most behaviors of public companies are focused on short term results, often quarter to quarter, resulting in long term issues.

The accounting requirements of quarterly earnings reporting has created a cadence for the planning and execution of business.  Each quarter companies are required to predict, execute, announce, and defend the variance of the results.  Each quarter’s results are expected to be higher than the previous quarter and the same quarter in the prior year.  Of course, like gravy, business is lumpy.  No business, even so-called non-cyclical businesses, operates on a straight line.  And yet that is what the analysts typically forecast and what investors expect.  Deviation from the line on the upside creates even higher expectations for the future and ultimately a let down, while deviation from the line on the downside often creates a call for management change.  In fact, “good management” is often defined as consistency in results.  Anyone who has ever worked inside a company knows that consistency is the rarest form of result and is more serendipitous than a symptom of good management.

The focus on short-termism can have negative consequences inside a company.  Once expectations for the coming quarters are shared internally, employees feel bound and determined to deliver.  But there are only so many buttons and levers that can be pushed in the short term to legitimately drive results.  As a result, short-term decision-making creeps in.  When results are not coming in as expected, costs must be cut and in the short-term this usually means marketing expenditures needed to grow the business are reduced or eliminated.  These cuts make more money in the short term but damage long-term results, sometimes irreparably.  Worst case, some employees may take things into their own hands and act or report financial results improperly.  Of course this is a terrible result that always ends up damaging the company for years to come.

Even the practice of issuing quarterly earnings guidance, once believed to be good management practice, creates short-termism.  In addition to defining the future focus as three months rather than three years or three decades, it creates the pressured referred to above.  Heaven help the management team that misses guidance as the analysts pummel them personally, shareholders are critical, and boards lose faith that their teams can deliver.  Hence the tendency to under forecast.  But even this practice can end poorly as it may diminish the goals and results

Boards and management teams must work together to resist short-term practices and focus on the long term.  They cannot allow pressure from short-term investors to take their eye off the ultimate goal of long-term shareholder value creation.

— Steve Odland

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WomenCorporateDirectors Announces Launch of First Annual “Americas Institute” for Boards

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BlackRock To Vote Proxies Directly

In a letter to 600 of its largest holdings, BlackRock chairman Laurence Fink urged companies to consult with BlackRock directly to address their proxy issues before they consult with proxy advisory firms.  This is a huge development.  BlackRock holds at least 5% of the stock of more than 2400 companies worldwide through actively managed funds as well as their iShares index funds.  They hold about $3.5 trillion in (yes, with a T) in client assets.  This move to weigh in on proxy matters with their own considerations is uniquely different than most institutional holders who rely on outside proxy advisory services to determine how to vote on proxy issues.

This development may be negative for a company if BlackRock decides to create their own “rules” of corporate governance.  But, alternatively, this could be a positive development since BlackRock says they will consider each company’s issues uniquely.

BlackRock reportedly has voted with the board’s recommendation 91% of the time historically.  Time will tell if this support continues or whether BlackRock decides to take a different course.

— Steve Odland

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Don’t Force Split CEO, Chairman Roles

Today’s Wall Street Journal article entitled “Drive to Split CEO, Chairman Roles Gains Steam” talks about a group of mostly past chairmen & CEOs called the “Chairmen’s Forum” that are proposing a policy endorsing an independent director as chairman after an incumbent CEO-chairman leaves.  Their view is that boards function more effectively with independent chairmen. 

Once again, this view endorses a “one-size-fits-all” approach to corporate governance.  Their point of view may be valid in some cases but it may also not be the best approach in other cases.  This is why boards are made up of mostly independent directors with usually the CEO as the only non-independent director.  Independent directors need to have the latitude to implement the best structure for the firm based on their judgment and knowledge about the needs of the firm.

It’s disappointing that a group of people almost all of whom had the ability to lead their company with combined chairmen and CEOs roles now have decided that it would be best to dictate to all companies to do the opposite.  It’s almost as if they are seeking to create roles for themselves as non-executive chairmen so they have something to do in retirement.  I’m sure that couldn’t be the reason but why push this for all firms?  Instead they should outline a principles-based approach that states when it makes sense to combine the roles, and when it doesn’t.  They should acknowledge that the huge shift in governance of the past decade has led to mostly independent boards and that these boards are best capable of defining the structure that is best for their companies.

Prescriptive, one-size-fits-all approaches to corporate governance are not the answer.

–Steve Odland

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