Richard S. Levick

• Activists have used social media to compel CEOs to resign, as we saw a few years ago when Eric Jackson—a blogger with 96 shares and about eight readers a day—struck a chord with a high-authority blog he created to air grievances about Yahoo’s business performance. Small investors, representing around 2.6 million shares, responded warmly. Six days after a contentious board meeting, Chief Executive Terry Semel stepped down.
• Activists are using social media to influence mergers and acquisitions, as we saw when shareholders in On2 Technologies used a venue called Moxy Vote to consolidate their ranks and expedite voting, ultimately forcing Google to increase its bid for the company by 25 percent.
• Carl Icahn used Web-based resources to attempt to overthrow the board of Lionsgate in an acquisition bid. The bid failed, but Icahn proved that social media isn’t just for the little guy, and that a proxy fight once requiring months of preparation and shareholder outreach could be waged in a matter of days and at minimal expense.
• Facebook and Twitter are reliably potent rallying tools, but other sites now provide sundry investors with effective forums. Seeking Alpha, StockTwits and Wikinvest allow investors to discuss valuation and investment potential. Family Bhive calls itself the “Facebook for the Fortunate” and provides proprietary social networks catering only to the wealthiest investors.

Not surprisingly, activist shareholders with social and political agendas take quite comfortably to social media. Here too, new sites offer tailored venues for such agendas. For example, the aforementioned Moxy Vote provides investors with proxy recommendations from a variety of interested groups, including the Humane Society of the United States and the International Brotherhood of Teamsters.

The additionally compelling significance of such campaigns is that they don’t just organize activist shareholders; they create activist shareholders on multiple fronts.

Directors of public companies must ensure that a response strategy is in place or risk ceding control of their destinies. Social media must be comprehensively monitored. Appropriate responses and possibly proactive communications must occur in the same space where their potential adversaries now live.

Yet, as recently as 2009, studies found that only three percent of U.S. large companies use social media as part of their IR communications. To be sure, corporations tread a minefield here that the activists don’t. Mistakes in the social media can damage brands. They can generate lawsuits. The wrong message on Twitter can reverberate throughout the world—an expensive if not fateful 140 characters. And disclosure issues loom large over all facets of outreach. That said, corporations are doing enough positive things in social media to encourage similarly innovative thinking.

For example, Alcoa’s Facebook page has nearly 14,000 followers and a Twitter account linked to earnings releases and investor webcasts. eBay tweets updates on earnings calls and analyst meetings. Amgen uses the Web to survey shareholders about executive pay. Intel has interactive Q&As that allow shareholders to vote online during its annual meeting.

Officers and directors have an opportunity to do more than simply think up creative, catchy social media deliverables. More than such one-offs are needed. Their companies must attack this field with vision and strategy. They must recruit and deploy teams of digital communicators. They must develop formal policies and procedures that define what can and cannot be done in every social media venue. They must think of financial communications, with all its requirements and regulations, as brand communications and engage the web appropriately.

In the final analysis, it will only reassure shareholders when they see the directors of the companies they own living in the same world they do.

Richard S. Levick, Esq., is the president and chief executive officer of Levick Strategic Communications. Reach him at rlevick@levick.com.

Stephen L. Brown

What do you like most about the changing boardroom landscape?
The passage of the corporate governance reforms included within Dodd-Frank was a watershed event that affects boards, management and shareholders alike. Boards and management will now have to take more interest in investors’ viewpoints. And shareholders must take on greater responsibility in monitoring boards with the tools provided to them by Congress.

Are the new requirements being embraced or resisted?
Both. The best practitioners—issuers who have always addressed governance into their road shows, for example—are continuing to do the right thing, and I don’t think Dodd-Frank has raised their blood pressure much. You have another category of issuers who are new to engaging with shareholders and they’ve embraced the challenge and are sincerely attempting to understand how to be more responsive to shareholders. And then there is this third category of what I like to call “the governance cavemen and cavewomen.” These are folks who are still in the Stone Age about the need for regular dialogue with their key shareholders.

Why did it come to the necessity of enacting a law?
Many would have preferred private ordering to achieve reform. However, when market participants can’t find consensus, regulation follows. With respect to say on pay, a few years ago we approached some of our largest portfolio holdings and asked them to voluntarily adopt an advisory vote with hopes that the rest of the market would follow. Many responded that they preferred to wait for legislation; not wanting to be a first mover. The lack of widespread voluntary adoption mixed with public angst over executive compensation, and the onset of a financial crisis, yielded an inevitable response by public policymakers. So, here we are.

Click here to view the full Director’s Guide to Compensation

More stories in the Director’s Guide to Compensation:
New Risks and Rewards
Executive Pay and the Boardroom After Dodd-Frank
New Rules Give Power To The Compensation Committee

Do governance practices differ among companies according to market capitalization?
The fact is that over the last decade the larger-cap companies have been the focus of large institutional investor activism; so those companies have responded to the various viewpoints of shareholders with respect to governance best practices. However, most of the mid- and small-cap companies have had the cover of the large caps. It’s likely to be different now. No more cover. The mid and small caps will have to raise their governance IQs and address governance more proactively.

How often do problems in corporate governance relate to CEO compensation?
It’s often a red flag rather than a cause. We define problems not by the absolute amount of compensation, but focus on whether or not the compensation program is aligned with our interest in creating long-term sustainable shareholder value. Compensation issues can be indicative of misaligned risk/reward incentives, lack of long-term focus, or simply show that there’s not enough counter balance in the boardroom.

Directors could take the outcome of a say-on-pay vote and bring it in with them to a meeting with the CEO saying, “Listen, this is what shareholders are thinking.”

You might have read that Rob Feckner [president of the California Public Employees Retirement System] said CalPERS would no longer publish its watch list and that they would approach companies privately because they thought it would be more effective. Do you agree with this kinder, gentler activism?
We absolutely agree that it’s more effective. Quiet diplomacy has always been TIAA-CREF’s style of issuer engagement. In our experience, you can achieve optimal outcomes when you can get a company to focus solely on key governance issues and avoid public embarrassment over being targeted. A sense of partnership and respect are elements that should exist when engaging with issuers to bring about changes aimed at long-term value creation. More aggressive approaches may be warranted at times, but it is certainly not the starting point for long-term focused institutional shareholders.

What are the means or methods that you’ve seen in which directors are effectively communicating with TIAA-CREF?
We appreciate clear and meaningful proxy disclosures. Disclosure should not simply be viewed as regulatory mandates, but rather as an opportunity for directors and management to make their case to shareholders. TIAA-CREF takes care to intelligently execute our proxy-voting duties and we can do so effectively and efficiently when we are able to understand with confidence how directors exercised their duties on our behalf. Providing clear, concise and meaningful disclosure in the [Compensation Disclosure & Analysis] section of the proxy is one such opportunity with respect to compensation. The newly required enhanced disclosure related to board leadership, director qualifications, risk oversight and other related corporate governance issues is another opportunity to tell your story. The arrival of mandatory say-on-pay votes this proxy season heightens the importance of providing good disclosure.

Direct dialogues should complement good disclosure. While we do speak with companies during proxy season, the most constructive dialogues occur at governance “road shows” outside of proxy season when there is more time.

How can a company prepare for a governance road show?
It’s common for issuers to create an agenda with us prior to the meeting. That way both sides can manage expectations and ensure that the issuer has the right people in the room. The right people include those senior executives who can speak knowledgeably about issues on the agenda—we are starting to see more heads of executive compensation in these meetings in order to address detailed compensation questions. Although we know it is not always feasible all the time, having independent directors as part of these meetings is an invaluable emerging best practice. Finally, prior to embarking on a road show, it can be helpful for issuers to host their own mock dialogue with their outside advisors such as compensation consultants.

That’s an excellent idea. Tell me, what do you think of say on pay?
We think a shareholder vote on executive compensation policies empowers both investors and boards. It allows board members to use investor sentiment as expressed through its advisory votes in their conversations with the C-suite. It arms the compensation committee chairs with real feedback. Directors could take the outcome of a say-on-pay vote and bring it in with them to a meeting with the CEO saying, “Listen, this is what shareholders are thinking.” And by the way, these shareholders have the power to vote directors off the compensation committee and out of office, particularly if directors are elected by a majority of votes in uncontested elections.

Are there areas of frustration for you that were not addressed in Dodd-Frank?
I think many people are unhappy that majority voting was taken out of the corporate governance provisions of Dodd-Frank. But the vast majority of your large-cap companies have already adopted this best practice. And the rest of the issuers who have yet to adopt will likely see significant shareholder pressure to do so this year.

Click here to view the embedded video.

Click here to view the embedded video.

But will boards own up to their true responsibility and take on the considerable work required to bring true oversight to management? Recent regulatory action has endorsed shareholder legitimacy for holding boards accountable. With the annual meeting season in full swing, corporate boards need to assert their independence and autonomy in carrying out their role of governance while providing true oversight of corporations. Interestingly, the loudest critics of corporate boards do not advocate their elimination. Rather, they want boards to provide greater oversight by asserting their independence and doing the job for which they have been hired.

It will take substantive changes for boards to regain the trust needed to re-establish their governance authority. A board must thoughtfully reorganize itself, examine the competencies of its members as well as board processes and committee roles.Boards need to transform themselves into strong, highly functioning work groups whose members trust and challenge one another. Directors also need to recognize the role shareholders play: They are the owners of the company and board/shareholder engagement is an important element in keeping them invested. Most importantly, boards need to demonstrate leadership with a transparent, results orientation in the conduct of their work.

No other entity can provide the oversight that an independent, engaged and committed board can deliver. We all have an enormous stake in reforming boards to carry out the responsibility for providing true oversight of management in a complex global business environment. Directors need to rethink and reconfigure their committee structure and committee work for greater effectiveness—which will likely involve a combination of some new responsibilities in existing committees, the creation of new committees and new skills and qualifications for directors.

In the future, boards must also include greater committee work on leadership development and succession planning, operations, growth, risk management and shareholder communication if they hope to provide meaningful and credible oversight for the companies they represent.

As in all blueprints for change, the devil is in the details. The following ideas represent a fundamental shift in the breadth and focus of board work required, which will bring about other needed changes. As boards get back tothe proper oversight of management and focus on leadership development, corporate strategy, corporate performance and risk management, the enterprise itself will be strengthened.

The following is an outline of the responsibilities, roles and skills which need to be addressed in new or existing committees more effectively:

Leadership development/succession planning:
Boards need to spend far more time in this area, including overseeing the human resource alignment with the business strategy. The issue of leadership development and succession is without a doubt the area of highest risk if not pursued in a proactive mode by the board of directors.

Operations to include the establishment of performance targets by implementing best practices in productivity, quality and service. In addition, boards should audit the application of technology, shared services and outsourcing to achieve performance improvement. Such audits provide a vital forward-looking area of key indicators impacting risk and future financial performance.

Corporate growth and resources to include reviewing organic growth targets and trends. This should include products and services, markets and channels, geography and relevant resource requirements to achieve and sustain growth. This committee should oversee the due diligence related to acquisitions as well as post-merger audits. They would also be responsible for understanding and overseeing the targeted and actual growth in revenues from new products in the last three to five years.

A risk management committee should be configured to oversee issues which can affect the business, including macroeconomic conditions, regulatory trends, demographic changes, technology, competition, environment, consumer behavior, energy, leadership depth and breadth, financial resources and balancing change and continuity. In addition, this committee should periodically review a strength, weakness, opportunity and threat analysis(SWOT).

Shareholder communications requires a more proactive approach to transparency across multiple audiences—including investors, brokers, and owner research groups—as well as through traditional outlets such as proxies, annual reports and on investor
website portals.

Compensation committees should adopt a clear statement of compensation philosophy, which provides a transparent understanding of the factors that drive compensation decisions. Incentive compensation awards for executives should be tied to the long-term business performance and not share price. While goals may include both short- and long-term targets, longer-term performance and goals should
be weighted more heavily.

Perhaps of greatest importance is the need to move to a principles-based system of compensation determination and reporting. Examples of key principles could include accountability, alignment, fairness, transparency and objectivity. Accountability should demonstrate that incentive pay is tied to business performance targets and metrics based on audited financial results and clawbacks for earnings restatements or fraud. The principle of alignment should address CEO incentive compensation in relation to shareholder rewards and incentives for other top level executives and tying it to longer-term business performance with incentive compensation to include a deferred component. Executives should be required to hold a targeted level of share investment in relationship to their compensation. There should be no tax gross-ups on executive compensation and perquisites. Objectivity should be demonstrated through verification of the independence of all compensation committee members and compensation consultants. Finally, transparency should be demonstrated by communicating clearly both internally and externally the company’s compensation principles, the application thereof and, if not, why not, and what has been done instead.

Lastly, boards need to carefully consider some of the new skills and qualifications required of directors to carry out the responsibilities outlined above. Boards will need to recruit beyond sitting CEOs to academicians, human resource executives, research leaders and experts in competitive assessment and shareholder communications.

In this new world, directors will need to engage with a broader group of stakeholders, convincing them of the board’s execution of their duty of loyalty and duty of care in overseeing the enterprise.

It will take substantive changes for boards to regain the trust needed to re-establish their governance authority.

Accountability should demonstrate that incentive pay is tied to business performance and metrics based on audited financial results.

Fred G. Steingraber is chairman and CEO emeritus of A.T. Kearney, a global strategy and operations consulting firm, and chairman of Board Advisors. He has served on 12 corporate boards and 17 notforprofit boards. Karen Kane, former board secretary for the Federal Reserve Bank of Chicago, heads a communication practice providing independent communication counsel to boards.

The Director’s Chair is a regular column featuring a viewpoint from inside the boardroom.

According to before the financial crisis, shareholders often had to pressure companies to “effect cash redistributions to owners or raise additional debt and use cash to boost stock performance,” said  Matteo Tonello, director of corporate governance research at TCB who co-authored the report with Damien Park, managing partner of Hedge Fund Solutions.

“Over the last two years, the capital squeeze has diminished the activist case for redistributing cash to shareholders, and activists have begun to focus primarily on strategic, operational and organizational adjustments that may be rewarded by the stock market through a share value increase,” Tonello said in a statement yesterday.

Fifty-five percent of activist demands in the first few months of the proxy season related to board declassification, removal of poison pills, “say-on-pay” or anti-gross up policies. Twenty-six percent of proposals were concerned with M&A transactions or pursuing alternative markets. Only 6 percent were aimed at cash distributions or related to other financial issues, down from 17 percent in 2009.

“With the economic crisis deflating corporate valuations and unprecedented regulatory interventions aimed at restoring public confidence, the balance of power has undeniably shifted toward investors seeking to engage with corporate boards to promote strategic, operational and governance-related improvements,” said Damien Park, managing partner of Hedge Fund Solutions.

The portal contains a directory of some 400 activist investors, detailed profiles of the top 50 and hundreds of sample documents. The intent  is to u0pdate the databas with voting policies by influential investment groups, proxy advisory firms and published documents. The tool intends to give directors a reliable and up-to-date resource on current corporate governance issues at the top of shareholders’ lists.

The TCB project is supported by funding and knowledge input from a variety of firms including Debevoise & Plimpton, Egon Zehnder International, Georgeson, Hedge Fund Solutions, Innisfree M&A, Joele Frank, Wilkinson Brimmer Katcher, MacKenzie Partners, Sard Verbinnen & Co, Sullivan & Cromwell and Wachtell, Lipton, Rosen & Katz.

David H. Webber, an academic fellow at New York University’s Center for Law & Business, will join Boston University Law School as an associate professor later this year. This is an excerpt from a newly published paper that studied pay-to-play litigation theory.

This paper provides a comprehensive analysis of the securities litigation activity of 111 such funds from the years 2003 through 2006. Three of the paper’s findings cast doubt on the pay-to-play theory, including that:

David H. Webber

(1) politicians and political control negatively correlate with lead plaintiff appointments;

(2) beneficiary board members—and outright beneficiary control of the board— positively correlate with such appointments; and

(3) the degree of a pension fund’s underfunding positively correlates with lead plaintiff appointments, particularly when the fund is controlled by beneficiaries.

This evidence suggests that beneficiary board members (not politicians) drive these cases for reasons having to do with the financial soundness of the fund. The paper analyzes the substantial role played by these members in securities class actions in light of prior research comparing such board members to corporate managers with an equity stake in a corporation. The paper also finds no support for the theory that unions drive beneficiary board members to obtain lead plaintiff appointments, and offers evidence that resistance by politicians to lead plaintiff appointments correlates with the degree of business influence in the politicians’ home states.

Overall, while pay to play may be taking place in some instances, pay to play is not what is driving most public pension fund activism in securities litigation.

Download the entire report.

The search was stymied until I attended a conference where the previous evening’s social event had been bowling. As I mentally slipped on my rented shoes and imagined the large overhead electronic scorecard, the ten-frames format hit me like the thunderous crash of a bowling ball knocking down ten pins.

Beyond mere calendar-scorecard confluence, however, bowling may be the perfect vehicle to channel the 2010 proxy season’s likely ups and downs. Believe it or not, there are around six quintillion (that’s six billion billion for those directors who do not qualify as audit committee financial experts) possible outcomes in your typical ten-frame game of bowling. Considering all the moving parts in the current governance environment, the possible outcomes for the upcoming proxy season may be just as numerous.

Legislation/Regulation
To comprehend the complexity of the upcoming season, take a quick glance around the noisy Beltway Lanes venue. If the alley appears both familiar and crowded, it should. For the second straight season, all eyes will be on Washington, D.C., where members of Congress, staffers from the Securities and Exchange Commission (SEC) and Obama Administration appointees will be looking to make marks in every frame.

The legislative train has already left the station. On Dec. 11, 2009, the U.S. House of Representatives   voted 223-202 to approve the Wall Street Reform and Consumer Protection Act of 2009, sponsored by    U.S. Rep. Barney Frank (D-Mass.), chairman of the Financial Services Committee. The wide-ranging bill, which includes an annual say-on-pay mandate and authorization for the SEC to promulgate proxy- access rules, was pushed to passage solely by the Democrat’s House majority; 175 Republicans and 27 Democrats voted against the bill.

Chairman Frank’s bill will have to be reconciled with any financial-reform legislation that emerges from the U.S. Senate. There, Banking Committee Chairman Christopher Dodd (D-Conn.) backs a somewhat beefier banking reform initiative that includes most of the same governance goodies as Frank’s bill, plus an activist wish list that, among other things, would mandate majority voting in director elections and also force snap votes on retaining classified board structures.

Dodd’s bill has encountered stiff opposition and remains mired before his panel, but governance issues are the least of his concerns. While Frank and Dodd, who recently announced that he will skip a tough re-election campaign this year, will likely fuss over many aspects of the revamp of the regulatory oversight of the financial-services sector, there will be a love fest when it comes to governance. The resulting legislation—half-Frank/ half-Dodd or “FRA-DO”—could do to members of boardroom pay and nominating panels what Sarbanes-Oxley (SOX) did to their audit- panel brethren.

Just a few days after passage of Frank’s bill, the SEC voted 4-1 to finalize a set of new proxy-disclosure rules. “By adopting these rules, we will improve the disclosure around risk, compensation, and corporate governance, thereby increasing accountability and directly benefiting investors,” SEC Chair Mary Schapiro said during the Dec. 16, 2009 open meeting. The SEC made sure that its 129-page set of rules will take effect in time to apply to most issuers during the 2010 proxy season.

To be clear, Regulation FD requirement can create difficulties for companies in communicating with investors, but engagement with shareholders can be much different than the relationships companies maintain with equity and credit analysts. Whether you need to have your board members involved depends on the answer to four questions:

• Who is the shareholder making the request?
• What are the circumstances surrounding the engagement request (or need)?
• Will director involvement add value?
• Which director or directors need to be involved?

Answering the Questions
Your answers will dictate what level, if any, of director involvement is required in the engagement process. Yes, engagement process. A company’s decision to sit down with shareholders and enter into a constructive dialogue should be part of a process that takes into account the company’s management culture, by-laws and corporate governance guidelines. A review of board governance and general corporate governance for issues that might be flagged by shareholders can provide a much-needed road map for potential engagement. Your firm’s corporate secretary, general counsel and outside counsel and advisors should be involved in every step of the decision-making process because engagement should not be equated with abandonment of counsel. And it goes without saying that counsel should be involved in preparing executive management (CEO or CFO) and directors for any discussion or meetings with shareholders.

Who is making the request and why?
Has the request for a meeting with the company come from an individual shareholder “gadfly,” an activist institution such as the New York City Comptroller’s Office, Connecticut State Treasurer or AFSCME, or Nelson Peltz’s Trian Partners?  Your response to the request and concerns about FD will be different for each. A gadfly shareholder, with a few hundred shares, should not get the same level of management attention as a public pension, union fund or an activist investor. For prospective meetings with a public pension or union fund, the participation of a director may be merited by the subject matter to be discussed. These shareholders, while concerned with financial performance, usually are focused on governance or social responsibility issues they believe impact the corporate bottom line. Discussions with activist investors, such as hedge funds, are usually focused on current strategy, financial performance and operations; given the subject matter, engagement with these activists needs to be more closely monitored for potential FD breaches.

What are the circumstances surrounding the engagement request (or need)?
What issues are creating the need for engagement?  For example, a recent story in the Wall Street Journal discusses Goldman Sachs’ engagement with Connecticut State Treasurer Denise Nappier and social issue proponents regarding executive compensation and bonuses. In reviewing the story and accompanying links to the correspondence between Goldman and the funds, there is communication between the compensation committee chairman and the activist institutions. In this new governance paradigm, activist institutions with compensation concerns might seek to meet with the chair of the compensation committee to understand the process used by the board and the philosophy behind the rationale stated in the proxy statement. Some investors prefer to meet with board members rather than management–often viewing management’s defense of the company’s compensation processes as self-serving.

In the case of hedge funds, they are very often looking for dialogue with the board. This is especially true where the fund’s goal is to obtain board representation. Hedge fund activist may seek to be seriously considered by the nominating and governance committee. As stated above, much greater care around Regulation FD needs to be taken under these circumstances as the questions from hedge fund managers tend to focus more deeply on operations and execution of current strategy. These types of dialogue have the potential stray into areas that cross the lines set by Regulation FD.

Will director involvement add value to the shareholder engagement process?
In the instance where a company is seeking shareholder support for its compensation practices or providing clarity around board governance processes, director involvement may not only make sense, but has the potential to lead to the establishment of a better relationship with the shareholder. Keep in mind that engagement does necessarily mean there will be agreement between the company and the investor, but an open dialogue with a board member could create a greater sense of trust even when the parties agree to disagree.

Who from the board should be involved?
The “who” will be largely determined by the issue in question. Discussions of strategic planning, executive compensation, and succession planning are usually more about process than the details of operations, the profitability of specific divisions or the names of potential successors in an envelope. There may be questions from shareholders about past actions taken to provide color. Exceptions might include questions on global sourcing and use or review of foreign contractors in discussions of human and labor rights with social issue proponents. In these instances, the activists usually have detailed information to bring to the table and are seeking to understand what actions the company is willing to take to end and remediate the alleged poor behavior. The resulting dialogue may be so granular as to exclude director participation from the outset. However, the majority of these issues of concern could be discussed by the lead director (or non-executive chairman) or broken out by subject matter for the appropriate committee chairman. Directors who chose to participate in the engagement process should be fully briefed on the range of questions they may face from the shareholders, as the corporate secretary/general counsel in pre-meeting discussions with the activist have agreed upon an agenda. A pre-meeting discussion allows both the company and activist to know the boundaries and Regulation FD type questions about earnings expectations or projected inventory levels can easily be understood by both sides as out of bounds.

With the SEC having proposed more rigorous disclosure on compensation and risk, as well as on the role and skill sets of incumbent director nominees, board members will find themselves potential much more involved than ever more in shareholder engagement and outreach efforts of their companies. Given the trend, Regulation FD need not be an obstacle to director participation. Careful planning and pre-meeting negotiation with shareholders can provide for a director engagement process with shareholders that can foster trust, if not agreement.

Francis H. Byrd is managing director and co-leader of the corporate governance practice at The Altman Group, a proxy solicitation and advisory firm.