Spring 2011 has sprung—and so has Spring 2016! At annual meetings around the nation, proxy votes are deciding the future of Corporate America, for both now and at least the next half decade: Are pay plans acceptable to shareholders? How often should pay plans be voted on? What social issues do shareholders care about and how strongly do they care? These votes reflect regulatory requirements, but they also project them; proxy-voting trends can be like tea leaves for Washington’s future regulations.
Proxy Access MIA
First, let’s read the gaps. Conspicuous by its absence is proxy access, not available for spring season. The Securities and Exchange Commission had passed rules last year but the U.S. Chamber of Commerce and the Business Roundtable got them stayed legally, arguing that by preempting state law and shareholder rights the rule violates the first amendment to the United States Constitution: “Congress shall make no law respecting or… abridging the freedom of speech.”
Proxy ballots are distributed to shareholders at the H. J. Heinz Co. annual meeting in Pittsburgh. AP photo/Keith Srakocic
The SEC will argue that its proposed rule does not restrict free speech but rather can “enable the federally regulated proxy process to more closely approximate the conditions of the shareholders’ meeting.” An amicus curiae letter from 36 law professors adds that the proposed proxy access rule “neither compels a company to carry speech by third parties nor restricts a company from engaging in speech.” Oral arguments were scheduled to begin April 7, 2011.
Even without direct access, shareholders are making their views on director candidates known. As proxy advisor Patrick McGurn reported in the last issue of NACD Directorship [“Proxy Season Preview: Seven for Yo-Leven,”] the Connecticut Retirement Plans and Trust Funds plan to propose a board diversity resolution and The United Brotherhood of Carpenters and Joiners has launched a letter campaign to get nominating committees to meet with 1 percent holders. McGurn, an executive director at Institutional Shareholder Services (ISS), also predicts that New York City pension funds will be pushing for greater expertise on boards. Companies that listen to such concerns early on will ease their transition into proxy access, should it return from legal exile.
Hot Social Issues
In 2011, one-quarter of the first 359 shareholder resolutions address environmental issues. Forty-one proposals address climate change, most of which request that companies set green house gas reduction goals or adopt public policy principles on climate change issues, including deforestation and renewable energy. Meanwhile, in Congress, 15 current bills address greenhouse gases—including the Defending America’s Affordable Energy and Jobs Act, which has versions in both the House and Senate.
A re-emerging issue has been controversy over the influence and independence of proxy advisors. Almost one year ago, the SEC included this issue in its concept release on the proxy system. NACD joined corporations and shareholders to ask for a closer look at proxy advisor conflicts of interest. Since then, consolidation has increased the clout of the two leaders Glass Lewis (now serving the customers of Proxy Governance) and ISS. Meanwhile, Governance Metrics International (GMI) merged with The Corporate Library, a research organization, increasing its influence in the sphere of governance ratings.
Even without direct proxy access, shareholders are making their views on director candidates known. Companies that listen will ease their transition into proxy access, should it return from legal exile.
Washington will be paying more attention to this issue. The Obama Administration has been relatively active in antitrust (per Global Competition Review, February 2011). Lawmakers in both parties listen to corporate leaders—who continue to be unhappy that some institutional voters follow recommendations from the advisors rather than listening to what companies have to say. Another related and important issue raised by the SEC’s concept release is the fact that many companies cannot reach their shareholders due to the rules that, by default, make brokerage customers objecting beneficial owners (OBO) rather than non-objecting beneficial owners (NOBO). Watch for a revival of this issue.
Say on Pay at Last
Now let’s see what’s right in front of us: say on pay. That’s the big issue this season, thanks to Dodd-Frank. Section 951 of the 2010 law requires public companies holding an annual meeting on or after January 21, 2011, to give shareholders an advisory vote approving the compensation of the company’s top executive officers (including parachutes). The SEC approved final rules January 25 and they are effective now—60 days after publication in the Federal Register. There’s a two-year exemption for “smaller reporting companies” (with revenues and public float of less than $25 million) but the free pass to procrastinate goes only so far. The definition of “smaller reporting companies” under relevant law does not apply to investment companies, asset-backed issuers or corporate subsidiaries (unless the parent is also “small”). According to a new free website, proxymonitor.org, 2010 saw winning votes for say on pay at 14 of the 100 largest public companies in the three proxy seasons leading up to Dodd- Frank (2008-2010)—no doubt encouraging the law and subsequent rules in this regard. Behind the scenes and below the Top 100 ice cap, ISS has identified 220 companies that have revised their pay plans in preparation for this voting season.
A negative recommendation from a proxy advisor can sway up to one in five shareholders, according to the Center for Executive Compensation (CEC) in Washington, D.C., as cited in a February 7 Wall Street Journal article. Since sayon- pay votes became mandatory, ISS has recommended a no vote on 10 percent of the proposals it has reviewed (13 out of 129); Glass Lewis recommended a no vote on 11 percent (18 of 171). In most cases, plans pass despite no votes.
Other Comp Rules on the Way
But say on pay is not the only new issue for 2011. Later this year, the SEC will be issuing final rules on compensation committee and advisor independence (already out in proposed form) and will propose new rules on clawbacks. These parts of Dodd-Frank are considered to be inevitable. Last season’s votes on clawbacks were not lost on legislators. A Master Trust’s clawback resolution at Morgan Stanley last year got 29.84 percent and at Bank of America a clawback proposal got 43.85 percent of the vote. Interestingly, the 2011 policy for ISS says they will proceed “case-by-case” on clawbacks. This may be in part because 73 percent of Fortune 100 companies already have clawback policies—up from 18 percent in 2006, according to the CEC.
Pending Indefinitely
Still up in the air are two other parts of Dodd-Frank: pay for performance and pay ratio. In a recent write-up of regulatory trends, the CEC predicts that House Republicans will push back on both issues, particularly pay ratios. The CEC anticipates that lawmakers may reword these provisions—or possibly ban funding for them. Congress could “prohibit the SEC from using funds to implement the provisions,” notes the CEC in a recent letter to its members.
Pay disparity appears to be a low-priority issue among larger shareholders and therefore could become moot legally. The 2011 ISS Voting Guidelines say: “Generally vote AGAINST proposals calling for an analysis of the pay disparity between corporate executives and other non-executive employees.” But this is a popular issue with members of the Interfaith Center on Corporate Responsibility. According to the Center’s 2011 proxy report, members have filed pay disparity measures at AOL-TimeWarner and General Electric.
Success would be a stretch. Last year, according to proxymonitor.org., the Sisters of Charity of the Blessed Virgin Mary received a 9.82 percent vote on a pay disparity measure at General Electric and The Franciscan Sisters of Perpetual Adoration received a 7.7 percent vote at Allstate—not as low as some have received but hardly a majority.
Policymakers Jaded
If regulators give companies a break from burdensome regulations or go after proxy advisors it will probably be based more on their pro-shareholder sentiment than any compassion for boards or corporate executives. Despite NACD’s many comment letters and meaningful dialogue with key staff on both sides of the aisle, the regulatory mood does not accord boards much importance. Policymakers surveyed in early 2011 for the second annual What Society Thinks? survey, show a jaded view of directors. Recent allegations of illegal insider trading by a prominent director do not help.
The cautious attitude of policymakers may be a hangover from the recent financial crisis. Some policymakers and their staffs are no doubt still reading The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, an unsparing 600-plus pages naming culprits for the financial crisis, including financial company boards.
Interestingly, the 2011 policy for ISS says they will proceed “case-by-case” on clawbacks. This may be in part because 73 percent of Fortune 100 companies already have clawback policies.
Why the tome? Recall that two years ago, with passage of the Fraud Recovery and Enforcement Act of 2009, Congress vowed to study the causes of the financial crisis; this report released in late January, is the result. The Commission was composed of 10 “prominent United States citizens with national recognition and significant depth of experience in such fields as banking, regulation of markets, taxation, finance, economics, consumer protection and housing”—six appointed by the majority leaders of the House and Senate (then Democrats) and four appointed by Republican leaders.
The 2011 report sets the stage by recounting early reforms at Freddie Mac and Fannie Mae and AIG, but similar to the reports surrounding the collapse of Enron, this one goes on to tell of apparently imprudent decisions at a number of financial institutions, including AIG, Bank of America, Bear Stearns, Citigroup, Countrywide, Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch, Moody’s and Wachovia. (The dissenting report written by the four Republican appointees also mentions board decisions but focuses only on failures at the quasi-governmental institutions Fannie Mae and Freddie Mac.)
The main report finds that in institutions extending credit, “lending standards collapsed, and there was a significant failure of accountability and responsibility throughout each level of the lending system. This included borrowers, mortgage brokers, appraisers, originators, securitizers, credit rating agencies and investors, and ranged from corporate boardrooms to individuals.”
With respect to the crisis, it does levy some general blame in the areas of compensation and lending: “Compensation systems—designed in an environment of cheap money, intense competition and light regulation—too often rewarded the quick deal, the short-term gain—without proper consideration of long-term consequences… Often, those systems encouraged the big bet. This was the case up and down the line—from the corporate boardroom to the mortgage broker on the street.”
Dynamic Interplay
The interplay between proxy season and proxy regulation is truly dynamic. Right now, proxy votes are leading and regulations are lagging, but that could switch. All it will take is another crisis. That is why all wise directors and shareholders are looking ahead to prevent one.