Shareholder activism in 2010

‘It’s quiet. Too quiet,’ says Pat McGurn, special counsel at proxy advisory firm RiskMetrics Group, recalling the old movie line. ‘It’s almost the middle of April and we haven’t seen a single high-profile activism campaign emerge. No major proxy fight hovers on the horizon.’

With the stock market rebound, has financially driven shareholder activism gone underground? With all eyes focused on say on pay and ballot access, are we in an era of governance-dominated activism? Can companies breathe more easily?

Don’t bank on it. Traditional balance sheet-driven activism has not gone away. As Corporate Secretary went to press, the 2010 proxy season was in full swing but a few things had already become clear: several new requirements have changed the proxy landscape, with more changes to come. A couple of players that have been sitting on the sidelines in recent years are also getting into the game and are well worth watching: the SEC and Congress.

Midstream in 2010, what should issuers be thinking about, both this year and in anticipation of the changes to come? Firstly, the field of investor relations (IR) will find itself placed front and center with the board like never before, as so many of the changes affect board members themselves.

Here’s a rundown of major changes already in place: elimination of broker voting in uncontested elections, real-time reporting of vote results, enhanced discussion of risk surrounding compensation practices and climate change, discussion of board diversity, enhanced disclosure of board members’ past affiliations and litigation involvement and, finally, greater transparency about board members’ experience, qualifications, attributes and skills (EQAS).

All change, please
And that’s not all. Several developments are expected after this proxy season is over. A presumed centerpiece of the financial reform package working its way through Congress will likely include a say-on-pay mandate that cuts across all companies. A long-awaited pronouncement from the SEC on opening up proxy access to shareholder nominees is also pending. In addition, the regulator has indicated it will dive deep into the entire proxy voting process, with likely positive implications for non-objecting beneficial owners’ and objecting beneficial owners’ access and empty voting.

‘Vote no’ is the major action this proxy season, according to McGurn. He describes the synergy brewing between the elimination of broker voting and the ‘vote no’ movement as one that may deliver some surprising and unwelcome election results, both this year and down the road. You do the math: after several years of shareholder agitation, many large-cap companies have adopted rules requiring directors to achieve a majority, not just a plurality, of ‘yes’ votes. Last year nearly 100 directors failed that test, but none of them lost his/her job. At majority-vote companies, losing directors submitted their resignation, which the board rejected in every case. Firms with a plurality rule simply ignored the negative vote.

In addition, nearly 800 directors chalked up at least 30 percent of ‘no’ votes last year. With the broker vote at some public companies reaching as high as 30 percent, and the dismal track record of individual investors actually casting proxy ballots, many of these directors would be at risk if majority voting were in place at their companies, McGurn observes. Governance activists are also pushing majority voting downstream as they press smaller firms to adopt it, he adds.

Rise in governance activism
Phil Garon, senior partner at Minneapolis law firm Faegre & Benson and a veteran of corporate proxy contests, looks to the stock market gains from last year’s dismal levels to explain the absence of high-drama activist contests. ‘When stocks are depressed, you’re going to see activists getting a better audience for their issues,’ he notes. While he is watching contests at Genzyme, Denny’s and Kona Grill, Garon points to the settlement made earlier this year by USA Technologies – in which the classified board was eliminated and two seats were surrendered to dissidents – as a more typical response by companies under siege.

McGurn sees several reasons why no high-profile proxy fights have emerged this year. In an email exchange, he says activists ‘hope to see broad mandates [from Congress and the SEC] on core issues: say on pay, majority voting and proxy access’. Investors are also ‘trying to digest the smorgasbord of new disclosures that has their heads spinning. Additionally, activism is hidden from public view because it now focuses on firms below the S&P 500.’

McGurn predicts high-profile campaigns against boards at some former Troubled Asset Relief Program fund holders this season. RiskMetrics recommended a ‘no’ vote a year ago for the Citigroup slate, but this year McGurn praises the ‘full-court press’ Citigroup mounted to defuse ongoing criticism, including state-of-the-art proxy disclosures and outreach to the Council of Institutional Investors.

Garon also predicts a continuing rise in governance-oriented activism from unions and pension funds, depending on the actual proxy access mandates from the SEC. ‘The lower the threshold for proxy access, the more proxy contests are likely,’ he says.

He also dismisses rumored boasting among some activists that they are acting on behalf of larger mainstream institutional investors that want to remain in the background. ‘I don’t believe it. Large institutional shareholders are not afraid to speak up,’ he says, pointing out that the vast majority of people in management and on boards ‘are very good listeners’ who welcome direct dialogue with shareholders.

Financial activism is alive
Beth Saunders, managing director at consultants FD, who counsels both activists and corporate clients, does not believe balance sheet activism has gone dormant. Saying she’s ‘never had a conversation about good corporate governance’ with activist clients, Saunders notes that for the most part they care about removing obstacles that prevent them from ‘doing what they want: getting a board member.’

Saunders is convinced that even the most skillful of companies, executing the best possible IR programs, can still be targeted by activists. In a survey of portfolio managers carried out last fall, FD found that nearly half of the survey respondents (48 percent) feel that ‘the presence of activist investors indicates a company is being mismanaged.’

It’s more missed potential than relative performance that activists zoom in on, Saunders says. ‘The very worst-performing companies are not necessarily the ones that have activist problems,’ she notes. ‘Even if a stock is at a 52-week high and the CEO is well regarded, if activists are saying they don’t like the strategy and management is perceived as ignoring the issue, they’ll take the activist route.’

Companies need to focus on the importance of transparency, communication and access to management and even possibly the board, Saunders says. ‘If management isn’t communicating, there’s always something negative an activist can find in a story,’ she adds. ‘The best investor relations officers have the ear and respect of their management team. Get in early, deflect all the venom and change the paradigm so we never hear about it – so it never hits the press.’

Saunders suggests that companies try to defuse tough messages with additional facts, and that they also maintain as diverse a shareholder base as possible. ‘If 30 percent of your shareholder base is outside the US, you probably won’t be its first target,’ she explains.

Getting to know you
Some observers have described the new board members’ EQAS disclosure as a potential heat map, guiding activists to craft appealing dissident slates that fill in any gaps. In response, Saunders says IR thought leaders among her clients are considering new ways to highlight board members’ bona fide EQAS scores.

‘What if, for example, once a month, you dig deeper on one board member on your website to make sure shareholders have all the background information they should?’ she suggests.

Greater transparency on compensation ‘is here to stay,’ Saunders adds, counseling clients to ‘look smart about it’ and lay out a defensible position. Most institutional investors view the issue as a check-the-box question. If a pay package appears extreme, they’ll send the proxy to compliance. ‘If not, they’ll ignore it and move on,’ Saunders observes.

She further notes that ‘the world has completely changed. Boards know it, but they don’t know the information they should be looking at.’ For example, she questions the value of the standard board report synopsizing what the sell side wrote and what the stock did, supplemented by an annual shareholder attitude survey. IR teams should make sure that ‘every time the board meets, it gets an update’ on what major holders are thinking, not just the sell side. In addition, it should know who is and isn’t in the stock, and why.

If 2010 is more a transition year than a brave new world, it still gives companies time to adjust to the new activist landscape. While some investors say the SEC is not forcing change fast enough, ‘others think this is year one in a 10-year process,’ Saunders concludes.


Top tips for increasing your company's activism IQ

• Showcase the experience, qualifications, attributes and skills of board members in venues beyond the proxy and annual report.
• Even if you determine that climate change or compensation risk disclosures are not required, describe the process the board went through to arrive at that conclusion.
• Be prepared to issue a press release announcing the results of your proxy vote – particularly if it’s a negative vote – on the day of the vote.
• Take the initiative on compensation. Know where you stand with proxy rating services and peers. Build a defensible position and lay it out there.
• Stay visible and proactive in communicating both results and strategy. If investors challenge the strategy, dive deep into the assumptions and rationale.
• Go beyond the typical board report. Keep both your board and senior management informed about the issues and concerns of shareholders.
• Assess your shareholder base to ensure it is as diverse as it should be, both geographically and by investment type and style. Go after shareholders where you have gaps.