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February 2004 News

Volume 12, Number 1

Corporate Governance: An International Review remains the world’s premiere academic journal on the subject under Christine Mallin’s capable editorial hands. The January 2004 edition includes a review of corporate governance rating services by Howard Sherman of GovernanceMetrics International and Nick Bradley of Standard & Poor’s Governance Services group, as well as reviews of tools and rating ideas in Germany and Greece.

An empirical study, “The Stock Market Reaction to the Introduction of Best Practices Codes by Spanish Firms,” finds the market reacts positively to announcements of compliance with the code of best practice that imply a major restructuring of the board of directors, whereas no wealth effects are observed for announcements that relate to isolated reforms recommended by the code. Another empirical study, “The Link Between Earnings Timeliness, Earnings Conservatism and Board Composition: evidence from the UK,” finds firs with a higher proportion of outside board members are more likely to recognize bad news in earnings on a timely basis, yet they don’t display greater reporting conservatism with respect to good news.

Along with several other feature articles, the Review also includes book reviews, including one by Marc Goergen on Mark J. Roe’s excellent Political Determinants of Corporate Governance, as well as a section entitled “Corporate Governance Update,” which attempts to highlight news around the world. No quarterly publication can keep readers up-to-date on world news. However, I always see items that I have failed to notice and it is always interesting to see what the editor includes.

California May Trump SEC's Move Toward Democracy

• Shareholder eligibility: Corporate election procedures would allow shareholders or groups with more than 2% of the company’s stock held for 2 years to nominate directors. This compares with the SEC's proposed requirement of a 5% threshold and without the "triggering" event to stall action.
• Soliciting support: Companies would be required to make information available to shareholders no less than once per year regarding all individuals or groups interested in soliciting support to nominate candidates for the board. The notifications required by the corporation will better enable shareholder coalitions to form.
• Deadlines and candidate information: Proxy statements shall include 250 word statements provided by director candidates. The proposed SEC rules require far fewer words and contemplates use of shareholder internet sites to convey information.
• Candidate limits: Not less than 40% of the total number of directors on the board must be eligible for nomination by shareholders. The SEC proposal limits most companies to 1 or 2 shareholder nominated directors.
• Nomination process: In order to have a nominee included in a company's proxy statement and proxy card, the nominating shareholder or group must provide specified notice to the company, no later than 80 days before the company mails its proxy material.
• Allowable restrictions: The procedures may include restrictions to restrict nominees who are not independent or are convicted criminals. "Independent" may need to be further defined but the law would not appear to preclude shareholder from nominating professional "relational investors" or turnaround specialists, unlike the SEC proposal.
• A company's proxy card shall identify shareholder nominees, and shall present the nominees in an impartial manner. Each candidate must be voted on separately. This provision helps to level the playing field.
• If a company includes statements in its proxy statement supporting company nominees or opposing shareholder nominee(s), the nominating shareholder or nominating group shall be given the opportunity to include a statement not to exceed 500 words per nominee.
• Companies would be required to make information regarding the process and deadlines to nominate and elect an individual to the board available on their website and in their annual report.
• The Secretary of State shall, not later than December 31, 2005, provide access to the corporate election procedures by means of an online database. This provision would seem to require a substantial amount of work the Secretary of State. How would the possible need for an appropriation during California's budget crisis impact the bill's chances of passage?

Fiduciary College - Save the Date

Fiduciary College at Stanford Law School explores "best practices" for fiduciaries interested in discharging their responsibilities prudently and effectively. Learn from and work with experts from academia, government, and investment management, as well as seasoned pension, endowment, and foundation function practitioners.

Comcast and Disney

Communications Workers of America President Morton Bahr issued the following statement recemtly:

We're pleased that the Securities and Exchange Commission will allow Comcast shareholders to address the issue of disproportionate voting power and to call for reforms, as outlined in the shareholder proposal submitted by the CWA Members' Relief Fund.

Comcast's capital structure defies the most fundamental aspect of shareholder democracy – the principal of one vote per share. It gives CEO Brian Roberts and his family a 33-1/3 percent undilutable voting control even though they own less than one percent of the market value of the company.

This archaic structure, in which the family's Class B stock holdings are given undue weight over Class A holdings, is more commonly seen at small companies – not Fortune 100 giants like Comcast. It gives CEO Roberts an effective veto power over shareholder initiatives and stifles accountability.

This issue is especially important in light of Comcast's ongoing effort to take over the Walt Disney Co. Under terms of Comcast's proposal to Disney, Roberts would continue to control one-third of the voting power of what would be one of the world's most powerful media conglomerates.

Kitchen-Table Vigilance

John Wasik, Author of The Kitchen-Table Investor and Retire Early and Live the Life You Want Now, argues that vigilant investors might have detected the troubles that besieged Parmalat, Enron and other companies whose accounting practices turned them into corporate pariahs if there had been greater transparency. "The momentum for enhanced corporate democracy is stronger than ever."

Parmalat, for example, scored 2.5 out of 10 (6.5 was the median score) on a measure of board accountability. Only three of 13 Parmalat directors were classified as independent by GMI. A traditional response to the "unchecked power'' of shuttered boardrooms has been increased government regulation.

Wasik notes that "unfortunately, that approach has limits and has never been totally effective against fraudulent activities. Corporate malfeasance, though, can be more effectively policed by more than 100 million global investors than by a handful of government agencies. Such vigilance often starts with a simple question: Is management operating in the best interests of shareholders?" (Could Investors Have Detected Parmalat, Enron Woes?: John Wasik, Bloomberg, 2/16/04)

Editor: We couldn't agree more. In the U.S. what's needed is not more regulations requiring that companies tick off boxes. Instead, shareholders should be empowered to actively monitor. What better way for that to happen than to allow shareholders to play a much more significant role in nominating and electing directors?

Women Add Value

A study of 353 of the 500 largest US companies from 1996 to 2000, by BMO Financial Group and Catalyst, shows that companies in the top quartile in terms of having the most women executives showed a return on equity of 17.7% and a total return to shareholders of 127.7% compared to 13.1% and 95.3% for the bottom quartile, those with the lowest percentage of women among their top officers. (BusinessWeek 1/26,  Corporate Governance Alliance Digest, 02/17/04)

Avoiding Shareholder Battles

Rob Norton's "The SEC Opens the Boardroom to Unhappy Investors," in the March/April edition of Corporate Board Member magazine, offers sound advice on what directors should do now to prepare for possible changes in nominating procedures that will give shareholders a little more power.

• Move quickly to restructure the nominating process along the lines of the SEC requirements. Many boards have already instituted some of the required reorganization and disclosures, but many have done too little. In a survey of 150 members of the Business Roundtable conducted last June, for instance, a third of the companies said their nominating or governance committees had no process for communicating or responding to shareholder nominations of board candidates.

• If your company has not already done so, take steps to demonstrate a readiness and willingness to add truly independent, tough-minded outside directors—the kind whose nominations assure shareholders that the company is genuinely interested in having a board that represents their interests as well as management’s. And make sure to communicate the company’s seriousness to the public and to institutional investors. Says Kerry Moynihan, a managing partner at the executive search firm Christian & Timbers: “Companies can inoculate themselves against unwanted nominations if they are seen as having a rigorous process in place to nominate directors who aren’t just the CEO’s golf buddies.”

• Consider taking steps to avoid the triggering events that would enable shareholders to make the board open the proxy to outside nominees.

• Reach out to shareholders. A less combative and ultimately more effective way to avoid having institutional shareholders propose their own candidates would be to make sure that lines of communication are open and effective. “Board members should make an effort to know who their shareholders are—which can be difficult,” says John Wilcox, vice chairman of Georgeson Shareholder Communications in New York. “Directors should then analyze what kinds of issues might be of concern to them, either through surveys or other kinds of research.” Says Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, “My advice to board members is: Communicate with your institutional holders, listen to them, and be sensitive to their needs. It’s as simple as that.”

Norton concludes with the following admonition, "if companies dig in their heels and fight the trend—and especially if corporate scandals continue—what the SEC has done so far with proxy access may turn out to be merely the beginning of a longer march toward making the nomination and election of directors less like the discreet boardroom protocols of the past and more like the rough-and-tumble battles of political contests."

Real Reform of Nominations

Phillip Goldstein, President of Kimball & Winthrop, Inc., wrote one of the more interesting supplementary comment letters to the SEC regarding Security Holder Director Nominations, S7-19-03(comments. Through his usual wit, Goldstein asks the Commission to scrap its "proxy access" proposal and restart with a new objective. "All shareholders have a fair opportunity to vote for the nominees of their choice. The only way they can do that is if they are provided with a proxy card that includes all bona fide nominees."

Goldstein recommends that new rules be modeled after Section 481 of the Labor-Management Reporting and Disclosure Act of 1959. Granting shareholders of publicly traded corporations the same level of voting rights as union members would "ensure the free exercise of the voting rights of stockholders and almost certainly would be upheld by a court as a valid exercise of the Commission's rulemaking authority."

Victory for Shareholder Democracy

Judge Richard J. Holwell denied a preliminary injunction sought by the MONY Group claiming that Highfields Capital Management's inclusion of a duplicate proxy card in a campaign to defeat a corporate merger violated rules passed pursuant to section 14(a) of the Securities Exchange Act of 1934.

Holwell said that a bar could be seen as "frustrating the animating spirit that lies at the core" of the rule in question, which is intended to make it easier for shareholders to communicate without having to mount expensive battles. (Dissident's Use of Proxy Card Exempt From Rules, Law.com, 2/14/04. Judge Rules in Favor of Opponents of MONY Takeover, NYTimes, 2/12/04)

Lawsuit Threatens Speech at Shareholder Meetings

Cintas Corporation brought a defamation lawsuit against Timothy Smith and Walden Asset Management for alleged statements he made at their annual shareholders meeting accusing Cintas of supporting sweatshops.

Not only does such a move threaten to silence critics who will now fear expensive lawsuits, it also could put a serious damper on fun. Shareowners have one opportunity each year to confront managers with tough questions. Will frequent filers, such as Evelyn Y. Davis and John Chevedden, be forced into silence. Walden, which advocates "socially responsible'' investing sponsored a resolution at the October 14, 2003 Cintas meeting asking the company to evaluate its vendor code of conduct and the compliance of off-shore factories and suppliers. The lawsuit seeks damages of at least $75,000, plus unspecified punitive damages and an injunction preventing Walden from making statements linking Cintas to Haitian sweatshops.

Shareowners who believe such a lawsuit is counterproductive might want to contact William C. Gale, Senior Vice President-Finance and Chief Financial Officer of Cintas Corporation at 513-573-4211. (Citizens Advisers Urges Cintas Corp. to Withdraw Defamation Lawsuit Against Shareholder Advocate, Shareholder Action Network, 2/12/04. Cintas sues for defamation, The Cincinnati Enquirer, 2/6/04) You might also want to post to the Yahoo! message board, eRaider, or elsewhere.

SEC RoundTable March 10th

The Securities and Exchange Commission will host a roundtable on March 10, 2004, from 9 a.m. – 5:15 p.m., to discuss the rules proposed by the Commission on Oct. 14, 2003, relating to Security Holder Director Nominations, S7-19-03. The proposals would, under very limited certain circumstances, require companies to include shareholder nominees for directors on their proxy ballot.

The roundtable will take place in the William O. Douglas Room of the Commission’s headquarters at 450 Fifth Street, N.W., Washington, D.C. on March 10, 2004. The public is invited to observe the discussion, and seating will be available on a first-come, first-served basis. It appears there will be many small panels with about a 10 minute time allocation to each person on the panel. The roundtable discussion also will be available via webcast on the Commission’s Web site. A final agenda and list of participants will be published in a press release prior to the roundtable discussion.

The Commission will accept comments regarding issues addressed in the roundtable discussion and otherwise regarding the proposed rule amendments from March 10, 2004 until March 31, 2004. Submit your comments to rule-comments@sec.gov. Be sure to refer to File No. S7-19-03 in the subject line. Comment letters will be posted on the Commission’s Web site. Only include information that you wish to make available publicly.

For additional information, contact Lillian C. Brown or Andrew Brady, Division of Corporation Finance, at (202) 824-5250, or, with regard to investment companies, John M. Faust, Division of Investment Management, at (202) 942-0721, U.S. Securities and Exchange Commission, 450 Fifth Street, N.W., Washington D.C. 20549.

Compliance Webcast

Companies that focus on complying ONLY with the letter of the law may find themselves with bloated controls, burgeoning expenses, and enduring headaches. But corporate leaders who embrace the spirit of the law should see a re-energized company, reassured investors, and maybe even reduced costs. Research conducted by McKinsey Co. found that 57% of institutional investors said that good governance determined whether they increased their holdings in a company. Sign-up now for 2/5/04 2 PM ET broadcast. (Bridge to Excellence: Comply, Sustain and Improve)

Investing in Firms With Good Corporate Governance Pays

Mutual funds that invest in companies with superior governance practices, such as the Sequoia Fund and Northern Large Cap Value Fund, tend to have better long-term returns, according to a study by Lipper Inc.

The 10 large-company value, core and growth funds with the best records of investing in good-governance companies had better one-, three- and five-year returns than their average competitor, said fund research company Lipper and GovernanceMetrics International, which rate corporate governance practices. However, funds with worse corporate-governance investments actually did better over one year, probably due to the technology stock rally in 2003. (Mutual funds benefit from strict governance, Contra Cost Times, 2/2/04)

CBS.MarketWatch.com's Gadfly Gets It

After reading comments submitted on the SEC's Security Holder Director Nominations, S7-19-03 rulemaking, self-described "gadfly" Michael Collins writes that "free elections are more likely in Iraq than at U.S. corporations." See Fair Elections? Not for U.S. Companies (1/31/04, you'll have to search for it). Collins sees through the Business Roundtable's argument that CEOs should continue to play a larger role in choosing directors than "special interest groups," such as pension funds and shareholders. Let's hope others read his commentary and become enlightened. The movement seems to be growing. California Secretary of State Kevin Shelley, who oversees elections for public office, recently indicated that he wants a law forcing companies doing business in California to allow shareholders to nominate candidates for corporate boards of directors. (Fundamental change in corporate governance proposed, San Jose Business Journal, 1/19/04) See also Should Corporations Try Democracy?

GE, Striving for Average

General Electric was named the "world's most respected company" for the six straight year in a survey of 903 CEOs conducted by PriceWaterhouseCoopers for the "Financial Times." However, shareholder activist John Chevedden is battling for them to just reach average with regard to director independence. He beat back GE's challenge to the SEC, so his proxy proposal will be in the 2004 GE proxy with minor changes.

RESOLVED: Shareholders request that our Board initially strive for and then at least maintain an average independence level for our Board. This proposal includes that, once adopted, if our company reverts back to the current practice, this will be subject to a shareholder vote.

Chevedden uses the standard from the Council of Institutional Investors that "A director is deemed independent if his or her only non-trivial professional, familial or financial connection to the corporation or its CEO is his or her directorship."

By the Council’s definition, Chevedden believes the average Board at major U.S. companies is 70% to 80% independent. "This proposal requests that our board at first strive to be average and then maintain or exceed average. In 2003 our board was 59% independent" – considerably below average.

January 2004 News

Corporate Monitoring Project

The Corporate Monitoring Project has moved its headquarters from San Francisco to Vancouver, Canada. While broadening its focus to include Canadian companies, CorpMon.com promises to continue their primary emphasis on improving corporate governance in the USA. Their latest newsletter outlines the following developments:

• Three innovative shareowner proposals that have so far been submitted to six companies
• Stock voting leverage website development underway
• ProxyMatters.com voting discussion website launched
• New movie “The Corporation”

If you're not on the Corporate Monitoring Project's mailing list, you're missing some of the most world's most innovative thinking about developments to better enable shareowners to hold management accountable. The Project hasn't been on the cover of BusinessWeek but its influences are everywhere. To subscribe, send an e-mail request to Mark Latham.

ProxyMatters.com Launched

ProxyMatters.com's open forum for shareholders is billed as being a "first-of-its-kind Web site" allowing individual investors to voice opinions and research proxy votes related to publicly-traded equities. Yet, how is it significanly different than the bulletin board I posted in 1995 and later removed, the typical Yahoo! board, or eRaider? Yes, many of us have tried to set up resources for investors to exchange views and discuss proxy voting matters ranging from the election of boards of directors to issues such as the approval of executive compensation. They say the site "will help transition today's passive investor into an active stakeholder." We hope so. Take a look. Tell us what you think. Is there finally a forum for intelligent discourse.

Evelyn Y. Davis Establishes Scholarship

PRNewswire via COMTEX carried an item indicating that shareholder activist Evelyn Y. Davis and the Evelyn Y. Davis Foundation have contributed $100,000 to the University of Pennsylvania to endow a scholarship for students pursuing careers in business or political journalism. It appears identical to an earlier scholarship she established at the University of Miami School of Communication.

Davis publishes the influential corporate newsletter "Highlights and Lowlights" and has made a career of defending the interests of shareholders. She attended her first shareholder meeting years ago at IBM and today travels to more than 40 meetings annually, often commanding attention through her probing and challenging questions.

As editor of "Highlights and Lowlights," Davis has been attending White House press conferences since 1978 and has been recognized by presidents. Her publication offers political analysis and timely business coverage in corporate governance matters for corporate chief executives. Let's hope these scholarships help push some students to look critically at democracy as practiced in corporate governance.

Democratic Reforms Sought at SK in Korea

Sovereign Asset Management (Sovereign) announced its support of five new independent, non-executive board nominees to the board of SK Corporation (SK) at the forthcoming Annual General Meeting, to be held in March 2004. The candidates have been officially submitted to SK and are as follows:

1. Dr. Dong-sung Cho, Professor of Business Administration, Seoul National University, President-Elect of the Korean Academic Society of Business Administration.
2. Dr. Seung-soo Han, former Cabinet Minister, diplomat and President of the 56th Session of the United Nations General Assembly.
3. Mr. Jin-man Kim, former CEO of KorAm Bank and Hanvit Bank.
4. Dr. Joon-gi Kim, Associate Professor of Law and Executive Director, Hills Governance Center, Yonsei University.
5. Mr. Dae-woo Nam, former outside director of Korea Gas Corporation.

Sovereign also proposed a number of amendments to SK’s current Articles of Incorporation, designed to further enhance corporate governance at the company. James Fitter, CEO of Sovereign, said: “SK Corp is a potentially great company that deserves a fresh start. It is time to break from the past and revitalise the board of directors to ensure sound stewardship for a healthy future.” He added: “These candidates are independent Koreans who demonstrate the highest standards of integrity, transparency, and accountability. Their successful election will be dependent upon receiving the votes of Korean and foreign minority investors alike. We are confident that they will work constructively with the other members of the board to collectively make informed, independent decisions that are in the best interests of the company and are of benefit to all shareholders equally.”

Proposed Amendments to the Articles of Incorporation include:

1. Approval of Related Party Transactions
   Unanimous approval by a newly created Related Party Transactions Committee should be required for all major related party transactions.
   
   
2. Term of Office of Directors
   Directors’ terms should be reduced from 3 years to 1 year. There should be provisions for automatic termination of office in the event of criminal conviction carrying a prison sentence.
   
   
3. Method of Electing Directors
   The current prohibition of cumulative voting should be removed.
   
   
4. Election of Directors
   The total number of directors should be at least five, but no more than 10, with at least half being outside directors. The authority of the board to determine the number of outside directors is removed.
   
   
5. Compensation of Directors
   The compensation of directors should be determined by a newly created Director Compensation Committee and approved at the General Shareholders Meeting.
   
   
6. Written Voting and Electronic Voting
   Shareholders should be permitted to exercise their voting rights by submitting votes either in writing or electronically.
   
   
7. Notice of Meetings
   The notice period for convening a General Shareholders Meeting should be increased to at least three weeks from the current two-week period.

A toll-free telephone information helpline, with Korean and English language services, has been set up so SK shareholders can call for assistance with the voting process. For those calling within Korea, the number is: 00798-612-1093. For those calling outside Korea, the number is: +61-2-9240-7469.

Director Trends

We have added Corporate Board Member magazine to our growing list of "stakeholders," leading authorities in explaining movements and motives in the field of corporate governance. The most recent issue, "What Directors Think," discusses the fact that reforms are increasing pressures and workload in the boardroom, with noticeable changes in directors' opinions during 2003.

Greater scrutiny and reporting requirements have significantly increased board members' workloads. Three-quarters of survey respondents are devoting more time to their director duties in 2003 than in 2002 - an average of 19.2 hours a month, up from 14%. The percentage of directors who reported board meetings lasting more than five hours increased sevenfold from 7% in 2002 to 50% in 2003.

With increased pressures, workload and time commitment, most directors believe an increase in pay should follow, especially for committee chairs. Of survey respondents, 81% said audit committee chairs deserve better pay, compared to 54% in 2002. Fully 80% of respondents said they are not paid enough for their board duties.

However, reforms have had a positive impact - 73% of directors now think they are less likely to be sued in a securities case thanks to better governance compared to 66% in 2002. In addition, more than 60% of survey respondents said good governance practices mean lower premiums and better coverage by directors' and officers' insurance, compared to 51% in 2002. Moreover, 86% of the 2003 survey participants believe good governance practices improve a company's image, and 46.7% believe it benefits a company's stock price. Clearly, the message is getting through.

UCLA Corporate Governance Conference

The Seventh Annual Corporate Governance and Equity Offerings Conference will be presented by the UCLA Anderson School of Management in cooperation with the Nasdaq and the National Venture Capital Association. This event opens with the Directors Networking Dinner on February 26th and continues on February 27th with a one-day conference and the Sixth Annual NVCA Los Angeles Networking Luncheon. The conferenced will feature top-level speakers addressing various board-level issues focusing on the best practices and emerging trends in corporate governance and the issuance of equity. They include Ralph V. Whitworth, Jamie Heard, Jay W. Lorsch and others. This conference will be held at the UCLA Anderson School at 110 Westwood Plaza, Los Angeles, CA. For questions about the conference, e-mail Simone B. Heald at sheald@anderson.ucla.edu or call (310) 825-1795.

Davos Leaders and OECD Contrast on Tougher Regulation

According to a 1/25/04 report by Reuters, business leaders at the World Economic Forum in Davos Switzerland "shunned calls for tougher regulation in the wake of a raft of corporate scandals, saying more rules would prove ineffective and cumbersome." Despite the billions of dollars gone missing from the accounts of Italian food group Parmalat in Europe, from U.S. energy trader Enron, and numerous others, the Davos attendees said a higher sense of moral responsibility at the boardroom level would be more effective than a rules clampdown.

The US introduced stiffer corporate governance rules under the Sarbanes-Oxley Act and in Europe, the Parmalat scandal has intensified calls for regulators to follow suit. "Checking boxes and signing things won't solve integrity problems," said Daniel Vasella, Chief Executive Officer of Swiss drugs firm Novartis. James Schiro, chief executive officer of insurer Zurich Financial Services, said "ethical behaviour cannot be regulated, it cannot be imposed by legislation."

"There have been huge failures in corporate governance," said, Nina Mitz, chief executive of public relations firm Financial Dynamics. "Companies have to be managed better and then the level of transparency has to be improved, and then afterward, this message has to be taken out to the public," she said.

In contrast, the Organization for Economic Cooperation and Development (OECD), made up of 30 member countries, including the US, UK and working relationships with more than 70 other countries, unveiled a draft revision of its "Principles of Corporate Governance" that was adopted by member governments in 1999. Although they are non-binding, the principles provide guidance for national legislation and regulation, as well as guidance for stock exchanges. Among the proposals:

• Granting investors the right to nominate company directors, as well as a more forceful role in electing them.
• Providing shareholders with a voice in the compensation policy for board members and executives, and giving them the ability to submit questions to auditors.
• Mandating that institutional investors disclose their overall voting policies and how they manage material conflicts of interest that may affect the way they exercise key ownership functions, such as voting.
• Identifying the need for effective protection of creditor rights and an efficient system for dealing with corporate insolvency.
• Directing rating agencies, brokers and other providers of information that could influence investor decisions to disclose conflicts of interest, and how the conflicts are being managed.
• Mandating board members to be more rigorous in disclosing related party transactions and protecting so-called "whistle blowers" by providing employees with confidential access to a board level contact.

Officials expect to submit a final revised version of the "Principles" to OECD governments for approval at the annual meeting of the group's Council at Ministerial Level on 5/13-14/2004. OECD Invites Comment on Draft Revision of its Corporate Governance Principles.

Share Lending Practices Surveyed

The ISS Friday Report of 1/23/04 included an article on the International Corporate Governance Network's survey to learn more about the practice of institutional share lending and its impact on proxy voting. The confidential survey is intended for pension funds, mutual funds, investment trusts, insurance companies, and other asset managers. If your institution is involved in lending shares or has ever been frustrated in its attempt to recall shares to vote them, I highly recommend that you fill out the survey so that ICGN can aggregate data and recommend action. They are seeking responses by the end of February. The article said, "those interested in completing the form are advised first to read the accompanying cover letter," but I didn't see a letter. I'll ask them to post it.

Shareholder Nominated Directors

First, Hanover Compressor settled a shareholder lawsuit, agreeing to allow shareholders to nominate two independent directors. More recently, Pensions&Investments (1/12/04) reported that HealthSouth agreed to a settlement with the Louisiana Teachers' Retirement System. The fund will name eight nominees to the HealthSouth board including the following luminaries:

• Richard H. Koppes, formerly with CalPERS, currently Jones Day Reavis & Pogue, with projects too numerous to list;
• Charles M. Elson, law professor at the University of Delaware, Newark, and director of its Weinberg Center for Corporate Governance;
• John C. Coffee Jr., professor and director of Center on Corporate Governance at Columbia University Law School, New York; and
• Margaret M. Foran, vice president-corporate governance and secretary at Pfizer Inc., New York.

In addition, the Louisiana fund created a mechanism to gather more nominees from other institutional investors.

The SEC is currently in the process of developing a relatively toothless plan that would give shareholders the right to nominate board candidates under extremely limited circumstances. If the regulations are enacted as proposed, we may see more changes through shareholder lawsuits than through the new rules.

Now HealthSouth is back in the news after identifying $2.5 billion in fraudulent accounting entries and millions more in aggressive maneuvers, adding up to between $3.8 billion and $4.6 billion in bookkeeping irregularities. They hope to hire a new management team by June 2004 and to release restated financial statements by the first quarter of 2005. The company's former chief executive, Richard M. Scrushy, is scheduled to go to trial on 85 counts of fraud and money laundering this summer. How much shareholder value has been lost that could have been avoided if any significant shareholder could have placed director nominees on the corporate proxy?

CBS.MarketWatch.com (1/21/04) reports the SEC is planning a forum on the proposal for late February or early March. It's unclear when the commission will formally consider the proposal. Staff is reportedly still going through more than 12,000 comments, the vast majority of which called for shareholder access to the corporate proxy for their director nominees. Let’s keep the pressure on.

SEC Proposes Mutual Fund Governance Requirements

The Commission proposed amendments to its rules to enhance fund boards' independence and effectiveness and to improve their ability to protect the interests of the funds and fund shareholders they serve. The amendments are designed to strengthen the hand of independent directors when dealing with fund management.

• Independent Composition of the Board. Independent directors would be required to constitute at least 75% of each fund's board. This requirement is designed to strengthen the presence of independent directors and improve their ability to negotiate lower advisory fees and other important matters on behalf of the fund.

• Independent Chairman. The board would be required to appoint a chairman who is an independent director. The board's chairman typically controls the board's agenda and can have a strong influence on the board's deliberations.

• Annual Self-Assessment. The board would be required to assess its own effectiveness at least once a year. Its assessment would have to include consideration of the board's committee structure and the number of funds on whose boards the directors serve.

• Separate Meetings of Independent Directors. The independent directors would be required to meet in separate sessions at least once a quarter. This requirement could provide independent directors the opportunity for candid discussions about management's performance, and could help improve collegiality.

• Independent Director Staff. The fund would be required to authorize the independent directors to hire their own staff. This requirement is designed to help independent directors deal with matters on which they need outside assistance.

Comments on the proposed rule amendments should be received by the Commission within 45 days of publication in the Federal Register. New York Comptroller Alan Hevesi, California Treasurer Phil Angelides and North Carolina Treasurer Richard Moore outlined additional measures they want funds to adopt:

• Provide shareholders with an at least annual, customized statement of the charges, expressed in dollars, for management and other expenses they've paid to a fund. The industry has opposed personalized breakdowns as too difficult to develop, and the SEC has not pursued them.

• Reveal the rationale behind a fund's fee structure, and they want to make sure that if funds disclose their portfolio holdings to a third-party, that the same information be made public.

The nation's two largest mutual fund groups, Fidelity Investments and Vanguard Group, have already come out in opposition to the requirement that chairmen of mutual fund boards be independent.

Ending the Recurrent Crisis

The Recurrent Crisis in Corporate Governance pushes the edge of mainstream thought in this growing discipline. Authors Paul W. MacAvoy and Ira M. Millstein, giants in the field, have well deserved reputations as practitioners and scholars. This thin volume will quickly guide the course for progressive board members concerned with building solid companies, rather than future Enrons.

Although MacAvoy and Millstein stop short of urging direct nomination of directors by shareholders, the author’s do recognize the real benefit of boards being truly independent from the CEO. “The independent and professional board is the ‘grain in the balance’ of survival in the long run.”

Directors who are unwilling to grow should look elsewhere. “Directors on the verge of quitting because of increasing responsibility and liability are not the ‘productive’ directors and, by leaving, imply an average increase in the quality of boards.” This book is for those who choose to stay and focus on what the author’s consider the real target, maximizing the generation of wealth and the return of profit to investors.

The recurrent crisis referenced in the title is primarily the “incapacity to deliver in practice on heightened expectations for governance. There is a void of capability (on corporate boards) which, if not filled will culminate again in misleading and inadequate reported financial results and large managerial extractions of wealth from failing companies.”

In a few brief chapters, the authors review recurrent themes during the last thirty years, from failure of the Penn Central Railroad to the decision by the General Motors board to publish governance guidelines after discharging its CEO, an act once widely acclaimed as a virtual Magna Carta for directors. They also discuss significant initiatives by public pension funds and court decisions that have affirmed the responsibility of directors to review and approve long-term goals and strategies. Yet, even with significant reforms, systemic flaws remain that will result in a continuing cycle of crisis and reform. However, the frequency and severity of such cycles can be significantly reduced through recommendation actions.

Their central theme is the need for independent directors, not just as defined by recent exchange reforms, but real independence, citing for example, studies like that of Shivdasani and Yermack who found that CEO involvement in the selection of directors negatively affected the quality and independence of nominees. P.33 Of course, one of the most significant studies in this area is one which MacAvoy and Millstein published in 1997. Examining data from 154 US companies, they found a positive correlation between active/independent boards and Economic Value Added.

Consistent with those findings, we cannot expect a CEO who is also chairman of the board to prepare the board to adequately evaluate their own lapses or those of senior staff. Therefore, the first and most important reform recommended by the authors is to end that dual role. “Ideally, the board’s chairman should be an independent director.”

The least painful time to make this transition is upon succession, which now often occurs every few years. Because a “lead” director is “still just another director subject to the influence if not dominance of the singular CEO/chairman, we have no confidence in that role as more than a temporary step on the road to separation.”

Other recommendations for boards from the book include the need to:

• Determine that management has appropriate processes in place to meet certification required by Sarbanes-Oxley
• Take responsibility for the company’s strategy, risk management and financial reporting
• Reward extraordinary, not market, performance
• Assure themselves of the integrity of management.

“The board cannot function without leadership separate from the management it is supposed to monitor.” It has the legal responsibility to do so. “Now it must be empowered with the opportunity to fulfill this responsibility.”

MacAvoy and Millstein end with the following: “Perhaps with these reforms, the recurring crises in governance will take place with less frequency and intensity.” Without these actions, shareholders, and maybe even the great unwashed masses, will be storming the corporate gates demanding much more in the way of a shift in power. The SEC’s latest proposal to allow up to three shareholder nominees could be just the beginning.

Directors should be shaking in their boots. From the January 19, 2004 BusinessWeek – “Lucent Technologies is asking shareholders to scrap its staggered board elections, a takeover defense despised by governance gurus. Allstate ditched its poison-pill takeover defense, citing ‘shareholder sentiment.’ And Alcoa is putting ‘golden parachute’ payments to a shareholder vote. In each case, the action followed a majority shareholder vote at the last annual meeting. Says Patrick McGurn, special counsel at proxy adviser Institutional Shareholder Services: ‘The only way you can explain the difference in behavior is the threat that proxy access may be available.’”

The board that MacAvoy and Millstein envision may be independent from the CEO, but it still is not directly accountable to shareholders. Although not my ideal, it would be a significant step in the right direction for most corporations and might just head off further reforms radical democrats like me have been calling for.

Mutual Fund Summit

The nation's leading experts from industry, government and academia will meet on January 24, 2003 in Oxford, Mississippi to discuss the fallout from the recent mutual fund scandals regarding fees and improper trading, as well as the future of the fund industry. The "mutual fund summit," hosted by Fund Democracy and the University of Mississippi School of Law, is open to the news media. The summit is being sponsored by the Zero Alpha Group (ZAG), the National Association of Personal Financial Advisors and the Financial Planning Association.

Separately, ZAG will hold on Wednesday, January 21, 2004 a phone-based telenews conference to release a major new study from Wake Forest University and the University of Florida on mutual fund industry brokerage commissions. For more information about the upcoming phone-based news conference, contact Stephanie Kendall, for the Zero Alpha Group, at (703) 276-3254.

Participants at the mutual fund summit will include: Mercer Bullard (moderator), founder and president of Fund Democracy and assistant professor of law, University of Mississippi School of Law; Barry Barbash, Shearman & Sterling; John Bogle, founder of The Vanguard Group; Harvey Goldschmidt, commissioner of the U.S. Securities and Exchange Commission; Paul Haaga, chairman of the Investment Company Institute and executive vice president and director of Capital Research and Management Company; Don Phillips, managing director of Morningstar; Linda Dallas Rich, senior counsel of the Financial Services Committee of the U.S. House of Representatives; John Rogers, chairman and chief executive officer of Ariel Capital Management; Barbara Roper, director of investor protection of the Consumer Federation of America; Paul Roye, director of the Division of Investment Management of the U.S. Securities and Exchange Commission; Erik Sirri, Walter H. Carpenter professor of finance at Babson College; and Craig Tyle, general counsel of the Investment Company Institute.

The Mutual Fund Summit will be held from 10am to noon on Saturday, January 24, 2004 in the Moot Court Room at the University of Mississippi Law School in Oxford, MS. Register. There will be a live Webcast of the Summit available at for those who are unable to attend. Zero Alpha Group (ZAG) will host a streaming audio replay starting Tuesday, January 27, 2004.

Mutual Funds and CalPERS

SEC chief William Donaldson didn't hold back in his recent speech to the Mutual Fund Directors Forum. "We (the SEC) cannot be in the boardroom when investors' interests may be compromised," Donaldson said. "Investors are depending on you to stand up for them." Investigators are "carefully looking at the role that independent directors played" in abuses. "We are asking whether the directors were aware of these abuses, and whether there were red flags that were ignored."

Donaldson said directors should serve as "independent watchdogs" for investors because almost all such funds are operated by money-management firms that want to maximize profits through fees but those fees also reduce investors' returns. That relationship creates inherent conflicts of interests and potential for abuse. He admonished directors to ask themselves whether "directors are too passive, sit on too many boards, lack the knowledge to keep apprised of a fund's activities, and are paid too much."

The SEC is reportedly considering the following:

• Requiring an independent chairman on all boards.
• Increasing the percentage of independent directors under SEC rules from 51% to 75%.
• Allowing independent directors to hire staff so they don't have to use fund advisers.
• Requiring directors to submit annual self-evaluations, including whether they sit on too many fund boards.
• Requiring directors to keep a paper trail of the information they used to determine that the fund managers were charging reasonable fees for management, advertising and administrative costs.

Most readers have seen the widespread reports of investigations by New York Attorney General Eliot Spitzer, the Securities and Exchange Commission and others.

Less reported have been investigations by CalPERS, which has already fired Putnam and placed Alliance Capital Management on its watch list. Now staff are investigating Franklin, parent of Franklin Templeton Investments, which has received subpoenas from New York Attorney General Eliot Spitzer, Massachusetts Secretary of State William Galvin and California Attorney General Bill Lockyer. Investigators are looking into the propriety of payments made to Morgan Stanley to promote its funds and the possibility that a Franklin salesman helped Prudential Securities evade market-timing restrictions.

CalPERS plans to discuss whether to terminate its contract with Franklin at its investment meeting next month. "Franklin will be subjected to the same scrutiny as Putnam and Alliance, " said Christy Wood, a senior investment officer for CalPERS. (see SEC Wants Mutual Fund Fees Explained, Washington Post, 1/8/04 and CalPERS money firms queried: Regulators have contacted 15 of 60 companies, SFGate, 1/7/04)

Given this turn of events, isn't it about time that Robert F. Carlson either resigned his seat on the CalPERS Board or his seats on 12 Investment trusts of the Franklin Fund? I'm certainly not alleging any impropriety on Mr. Carlson's part, but I am concerned about more than just appearances. How can a man, even one as brilliant as Carlson, serve adequately on so many boards? Additionally, CalPERS corporate governance principles define independent directors as "not affiliated with a significant customer or supplier of the Company." Can Mr. Carlson be considered an independent director at CalPERS when Franklin manages $780 million in U.S. stocks for the pension fund?

TIAA-CREF to Establish SRI Fund?

A coalition of groups and individuals have worked together for several years to help promote social responsibility and corporate governance reform within TIAA-CREF. They certainly got the attention of the press at the last annual meeting. Stories appeared in Barons, Dow Jones NS, Wall Street Journal, Corporate Social Responsibility New Service, Bloomberg NS, New York Daily News, NY Post, Investor Relations web, NY Times, Newsday, WFUV in NYC, Voice of America, and Investor Relations.

Representatives of TIAA-CREF have now agreed to meet with Social Choice for Social Change: Campaign for a New TIAA-CREF to discuss their proposal for a new socially responsible fund. To maintain our momentum and insure that the meeting is productive, the Campaign asks supporters to "make one call to TC in the next two weeks endorsing such a meeting, and requesting that at this meeting our ideas are fully explored." Call CEO Herbert Allison at 1-800- 842-2733; 212-490-9000.

Public Funds File More Suits

A new study by PricewaterhouseCoopers reveals that public pension funds are increasingly joining class action lawsuits - a trend the study tracks back to a record $2.8 billion settlement won by the California Public Employees' Retirement System and the New York State Retirement Fund in 1999. That year 18 cases had public pension funds as lead plaintiffs, while in 2000 there were 19 such cases. However, that jumped to 31 and 56 in 2001 and 2002, respectively, according to Dow Jones. In fact, two-thirds of all cases with public pension funds as lead plaintiffs have been filed in the past three years. (Suits With Pensions as Lead Plaintiff Rake In Bucks, PlanSponsor.com, 1/7/04)

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