Building a better mouse trap

This is an old saying in both journalism and politics: ‘It’s not what you know and it’s not who you know. It’s what you know about who you know that really matters.’ This saying applies equally well to corporations during annual meeting and proxy season. Fifteen years ago no one really talked about shareholder relations as much as we do now and the proxy voting business was a very different beast indeed. But several years of significant regulatory changes have dramatically changed the governance landscape and greatly emboldened the activist shareholder community. Not even the most ardent activist could have realistically envisaged the level of shareholder rights and access that exist today.

As a result of this brand new era of shareholder activism and increasingly intense focus on the roles and responsibilities of corporate directors it has become more important than ever to gain an in-depth understanding of your shareholders and their attitude toward proxy voting.

The rise in governance awareness and the implementation of majority voting practices at many larger publicly listed companies have led to several changes in the proxy solicitation business. With more companies coming under the spotlight of activist shareholders and experiencing contested votes for board of director positions, the importance of reliable and creative proxy voting solicitation services has increased.

This greater awareness led to the formation of two new solicitation firms, just in time for the 2008 proxy season. Joining well-established players such as Georgeson, DF King, MacKenzie, Innisfree and Altman, the new firms, Laurel Hill and Okapi Partners, strive to improve corporations’ understanding of shareowners and how they are likely to vote.

With so many proxy solicitation firms already in the space, it is natural to question if there is capacity in the market for new entrants. The consensus, at least among the proxy solicitation service providers, is a definite yes, there is room for new entrants.

New kids on the block
Mark Harnett, president and co-founder of MacKenzie Partners, explains, ‘There is clearly capacity in the solicitation market for new players because there are a lot of companies engaging services of this type for the first time.’

As the smaller players receive more attention from activist shareholders, they are going to need experienced and dedicated solicitors who can properly assist them with their needs.

Bruce Goldfarb, president and CEO of Okapi Partners, agrees: ‘There [are] going to be a lot of companies in the small to mid-cap space that will be employing the services of a proxy adviser or solicitor for the first time. This is due to activist attention shifting down the market cap spectrum and a changing regulatory environment for smaller players.’

This increase in demand will be partially absorbed by the larger firms but it is a natural progression that new players will enter the space. With two new players on the scene, corporate secretaries and the companies they work for are going to have greater choice when selecting a solicitor. This will present benefits, as competition usually does, but it also makes the choice of the right firm more complicated.

David Drake, president of Georgeson, says, ‘Competition is healthy.’ And Goldfarb concurs: ‘Choice is typically a good thing. Companies want to feel they are getting the attention they deserve all the time. With more players in the market this is more likely to be achievable.’

Filling a niche
But what role will the new players take and what segment of the market are they targeting? ‘My sense,’ says Drake, ‘is that the new firms will be competing for basic annual meeting services. At least that is what we have seen so far based on proxy disclosures.’

Paul Schulman, executive managing director at Altman Group, says, ‘I think the addition of new vendors into the solicitation space is a clear sign that the field is doing well. They are entering at a good time and will fall into some clients to begin with. The two new firms have made a big splash in the media, which is to be expected. They have picked up a few clients but because they got up and running with the proxy season almost under way, many corporations already had their proxy relationships in place.’

Harnett explains that the new firms clearly have people who bring existing relationships and will bring some clients with them. ‘But having said that, and having been involved in starting a proxy solicitation business in the early 1990s, I can say that clients are surprisingly loyal to companies rather than individuals.’

The emergence of new firms in the solicitation space is a part of the natural cycle for the industry. Every few years companies either enter or leave the market. In the past few years there have been some small consolidations and most recently two new firms have taken the opportunity to fill in the space that has opened up as a result. ‘It is nothing new,’ says Harnett, explaining, ‘As a new firm there is a transition. Some clients will come from existing relationships but it takes a number of years to develop a track record and build a reputation.’

Rather than just looking to take up some excess capacity in basic annual meeting services, Laurel Hill is adopting a different approach. Tom Kies, partner at Laurel Hill, adds, ‘Our model is to be an ongoing, year-round adviser to companies. We believe that in the current environment the best results are achieved through educating clients on governance and shareholder issues throughout the year, not just for the 60 to 90 days period around the annual meeting and proxy season.’

Another partner at Laurel Hill, John Siemann, further explains the new firm’s strategy: ‘We are looking at many of the large-cap firms who we believe are looking for a different type of service but we are also working with the small to mid-cap companies that are witnessing more shareholder activism and taking their first steps into the proxy solicitation area.’

Overall it appears as though added vendors and a little competition is a good thing. For the corporate clients, competition provides greater choice and the opportunity to match services to their specific needs. For the vendors, it helps to clarify their mission and refine services.

Drake explains that ‘Georgeson’s strategy has not been affected by the newcomers. We are experiencing a record year for proxy fights and hostile M&A assignments. Even prior to the current industry expansion we began focusing on strengthening our ability to advise clients in an increasingly activist environment with the hiring of Rachel Posner, who advised clients on M&A and proxy contests at Fried Frank, and Rajeev Kumar, who was formerly director of US Research at RiskMetrics [which purchased Institutional Shareholder Services (ISS)]. We are developing a governance consulting practice that simply doesn’t exist elsewhere in the industry.’

‘We are seeing a growing interest in a well-thought out, strategic approach to solicitation and, for that matter, shareholder communication as a whole,’ says Goldfarb.

Choosing the right solicitor
So, with shareholder activism unarguably on the increase and greater scrutiny across the board the need to understand your shareholder base is definitely more important. That means that choosing the right proxy solicitor also becomes more important and while more choice is a good thing it makes picking a partner that much more complicated.

When assessing what types of services you need and which solicitation firm best fits the bill, there are a number of key considerations.

‘More choice is a good thing,’ says Drake. ‘We think that companies looking for solicitation advice should carefully research the backgrounds of new firms and ask probing questions. Who are your key advisers and what direct experience do they have in the areas that concern my company, like the threat of a proxy fight or a controversial merger vote?

Companies should carefully check client references to ensure that a new entrant’s resume is valid.’ Kies echoes these sentiments: ‘When a corporate is looking to take on a solicitor they need to consider the background of the organization, the experience of the people involved, the size of the support base. You should question if they have the ability to run a full call center campaign.’

Harnett adds, ‘When choosing a proxy solicitor a company needs to ask a number of questions. These include: Am I comfortable with the people I am dealing with? Do they understand my needs and will they be able to give me the level of service I expect and be able to update me on a schedule I am happy with? Do the references check out? Did they forecast the vote correctly? Did they secure the vote? How proactive were they when changes and surprises occurred?’

Of course it is not possible to discuss proxy solicitation without mentioning the role of voting advisory firms. An important part of a solicitation is understanding the role of advisers and determining the impact they may or may not have on the vote.

With the prevalence of proxy advisory firms telling investors how to vote, explains Kies, ‘it is important to understand their role in the process. What happens, for example if an investor who was using ISS moves over to Glass Lewis or one of the other advisory firms or even takes proxy voting in-house?’

Siemann adds, ‘We follow proxy voting advisory firms like ISS and Glass Lewis very closely but it is important to remember that there are a lot of major institutional investors that do not use either of these firms and have their own, in-house voting policies. Without this understanding, and a good link to the institutions, it is not possible to really understand how the shareholder base at a given company is likely to vote on any issue.

‘Size of the solicitation firm,’ says Goldfarb, is not necessarily an indicator of performance. ‘Execution is often more important than the number of employees. Making a lot of calls to investors is one thing but you have to have the ability to get investors to take action and vote in a particular fashion.’

Readying for battle
In this hostile environment special skills and experience will also be required. There will likely be a lot more proxy fights, shareholder resolutions and tough M&A situations for 2008 and going forward. There have already been more contested situations this year than in all of 2004. Therefore, experience in a fight situation is extremely important.

‘There are a lot more players getting involved in proxy fights than in previous years. Companies that may not have gone through a fight before are retaining their usual solicitor, who may not have been through a fight either. I think it is important for companies going through a proxy fight, especially those that are doing it for the first time, to consider the solicitor they choose. It is an advantage to engage a firm that is experienced in a fight situation, and not all solicitors have been. But at the same time there is also a consideration about the level of service you will receive. Some smaller companies might feel that the larger players will not give them their A-team and they will fall somewhere down the priority list. I think this is a fair belief but you need to strike a balance,’ says Schulman.

Drake stresses that the newer players in the field have not yet garnered much experience in active management of proxy fights and M&A situations.

Harnett believes that the current market conditions are perfectly suited to MacKenzie: ‘Our focus has always been toward the non-routine situation – proxy fights, unsolicited takeover attempts and other contested situations, so we feel quite comfortable with the current situation of increased activism and more shareholder actions.’

Regulatory changes are likely to have a further impact on the solicitation business and expand the need for services. Schulman points out that ‘If and when the elimination of the broker discretionary vote for the election of directors happens it will have a profound impact on smaller companies. They are starting to realize this and are seriously moving to understand their investor base and the impact the new rules might have on quorum requirements.’

Many firms are also concerned about the potential impact of the new notice and access rules regarding distribution of proxy materials. For companies with a significant retail investor base there is a real risk that voter turnout will decline, making solicitation even more important.

There are also other factors at play. When deciding which proxy solicitor to use there are more than just performance and size issues to consider. As Harnett explains, ‘One of the hurdles in gaining business as a new solicitor is the conservative approach taken by corporate secretaries and others who engage proxy solicitors. They often don’t want to take the risk of engaging a new firm and then have them not get the job done. Because they will have to explain to their boss why they went with an unknown entity. For this reason people have a tendency to go with an established player. It is more defendable in the event of problems. It is perfectly understandable and it can take several years of proven performance to overcome this.’

New wave
Given the ever-changing world of solicitation what will the future bring? Drake predicts that, with respect to basic proxy services, ‘the recent expansion will likely be followed fairly quickly by consolidation.’

It’s wise to consider what is likely to happen at your solicitation firm. There are risks with any player. As Kies notes: ‘I think one important consideration is: What is the succession plan at some of the older or larger companies? There are a few people who have built these firms up and the relationships and expertise are centered around a handful of people. What happens if those people leave or retire? Will those companies be able to offer the same level of service?’

Schulman adds, ‘There are certainly a couple of firms where all the relationships and reputation are concentrated around one or two individuals. If these people were to leave then those firms may find it very hard to survive.’

All these factors highlight the need to carefully consider your company’s situation and its specific solicitation needs. No doubt the market will experience further changes so it is important to constantly reassess your relationships and ensure they fit with your strategy and current situation.