Proxy season shake-up 2009

With the 2009 proxy season drawing to a close, we asked a few experts for their key takeaways on shareholder activism and proxy proposals. The results, as expected, included more than a few surprises, as well as a few major trends that simply vindicated predictions from 2008. And, of course, nearly all of the commentary was colored by the financial meltdown. 

The hedge fund factor
Hedge funds were down, but by no means out. Yet while they remained active, the profile of activist hedge funds, as well as the outcome in some of their battles, was different from the recent past. 

David Drake, president, Georgeson: ‘Prior to the beginning of the season we asked whether the difficulty in the markets and the struggles that were challenging hedge funds would result in them having less effect than in past years in terms of seeking board representation. It was a relatively busy proxy season, but we did see a number of situations where hedge funds failed to gain the support of the larger institutional community when they targeted companies for a change in a board of directors. 

‘In a couple of fights, including Target and Orthofix International, where there were recommendations from RiskMetrics that appeared to support the dissident hedge funds, the companies received fairly strong support from their non-activist investors. So while there were some hedge funds that gained representation in some smaller fights, to some extent the market conditions and perhaps even the bad PR hedge funds suffered over the past year made it difficult for them to receive widespread support from other institutional investors.’ 

Paul Schulman, executive managing director, the Altman Group: ‘Hedge funds were quieter this year to some degree. Some of those hedge funds that have used activism as one of their primary objectives in the past were less visible. However, in their place were new funds the investment community was largely unfamiliar with in terms of activism. These were funds that went activist because they had to. They’d been decimated by the market and they had positions that, out of necessity, forced them to take action against the board. 

‘For example, one comment we heard was, We’re not activists, but this is a situation where management has not responded well to the economic climate, and we felt we had to step in to protect our investment. Most of the focus of this activism was around director nominations. The hedge funds rarely look for control, but they clearly want board seats to influence the direction of the company. Of course, as was the case before, a lot of these fights were settled without the need for an actual proxy campaign.’ 

Increased accountability
Be it withhold or ‘vote against’ campaigns, shareholders seemed intent on holding directors’ feet to the fire, and had more tools at their disposal to do so.

Mark Harnett, president, MacKenzie Partners: ‘We saw an incredibly large number of contested meetings where the proxy contests were over the election of directors, both withhold votes and competing slates. I think investors and advisers like RiskMetrics were more cautious in rocking the vote this year. They’ve been trending in the past with a bias toward dissidents, but I think they’ve pulled back a little, given the economic times. There were instances where the shareholder mix or the company situation created success for dissidents. Overall, however, the sheer number was daunting. 

‘That said, I think it’s important enough to restate that with the combination of majority voting being increasingly implemented, the open access rules that the SEC will probably adopt and the likely elimination of discretionary broker voting, you’re looking at a perfect storm for allowing shareholders to put pressure annually on directors. 

‘Those three issues have put directors under the gun to answer for their actions each year. That could be good or bad, based on your perspective. Managements will say investors lack long-term perspective; institutions say you can’t operate behind closed doors and present afait accompli in terms of what you want to do.’ 

John Siemann, managing director and partner, Laurel Hill Advisory Group: ‘This was a year when institutional shareholders pushed forward the notion of director accountability. They did that through an increasing use of the withhold vote or an actual vote against nominees. This was triggered by a slew of actions by corporations, many of them in relation to compensation, which in the past simply elicited comments from investors that such actions were frowned upon but didn’t prompt a real reaction. 

‘Institutions made it clear that, in future, they not only want greater input on director elections but also, once directors are elected, institutions are committed to reviewing their actions and holding them accountable for any actions that aren’t in shareholders’ interests.’

Tax gross-ups
One pretty universal surprise this year was RiskMetrics’ attack on tax gross-ups. That caught everyone off guard, which in turn caught RiskMetrics off guard.

Rick Grubaugh, senior vice president, DF King: ‘The most significant event of this season is that 2009 became the year RiskMetrics took on excise and perquisite-related tax gross-ups. Early in the season RiskMetrics took a shock-and-awe approach against compensation committee members who provided for tax gross-ups. RiskMetrics basically attacked what it deemed to be stealth compensation practices. The big stick it has is the withhold or against vote on directors. 

‘Many companies were caught off guard and were forced to rapidly decide whether or not they’d agree to capitulate and not enter into any additional tax gross-up payments, or face a withhold vote. I don’t think anyone at RiskMetrics realized how big the impact of this was going to be. It started with a hard line, but softened a bit. It caught on with institutional investors, however, including Fidelity, arguably one of the leaders on this cause, and it created a snowball effect.’ 

Mark Harnett: ‘The increasing focus or use of director withholds as a bludgeon against companies to change compensation practices was very noticeable. The main leverage was that RiskMetrics picked up on the focus of some large investors in previous years that have been looking to scale back tax and perquisite-related gross-ups. We saw a number of companies addressing that issue by agreeing with RiskMetrics and resolving not to enter into such agreements in the future.’ 

Say on pay
Perhaps one of the biggest headline grabbers going into this year’s proxy season, say on pay also coincided with the calamitous economic conditions – a fact some attributed to less explosive voting results, not only for say on pay, but also for other compensation-related issues. Of course, Congress and regulators may have the final word on say on pay.

Rick Grubaugh: ‘The number-one issue everyone thought would be leading the proxy debate for 2009 was say on pay. As a shareholder proposal, I would say proponents have to be less than enthusiastic with the voting results. It is getting significant support in some corners, but it is just not a proposal that is gaining traction with the larger institutional shareholders. 

‘It is, on the other hand, gaining tremendous traction with state pension funds and smaller shareholders. There are just too many institutional investors that dominate the shareholder base, which means the 
proposals are not passing in significant numbers. But the issue is getting traction in Washington.’

Mark Harnett: ‘Getting shareholder approval for equity plans wasn’t much more difficult than it has been over the past couple of years. Of course, it has been difficult for a few years now, but that hasn’t really changed. I think there was something of an expectation that shareholders would express greater unhappiness on stock performance this year by taking it out on companies when they were seeking to pass compensation plans. That didn’t happen, however.’ 

David Drake: ‘One surprising point was that we saw a fairly significant number of companies asking for support for option exchanges. It was interesting that most passed, whether or not they got proxy advisory support. One might have predicted, given the way shareholders have suffered, there wouldn’t be widespread support. 

‘What we found, however, was that when these proposals were designed appropriately, shareholders seemed to agree that some sort of reworking of these incentive plans was justified. I would have thought, given how much money investors lost, that anything with the whiff of potential repricing or resetting of options might have been strongly opposed.’ 

Other key takeaways
Rick Grubaugh: ‘What I believe have been the most significant proposals in terms of results are those we’re seeing for the right for shareholders to call a special meeting. This idea is gaining traction, and it has been passing at major companies. What I find interesting is that most of the proposals have shifted away from anti-takeover to governance or compensation-related shareholder proposals over the last couple of years. 

‘The right to call a special meeting establishes the opportunity for hostile bidders to replace board members at any time. This is just continuing the trend of making companies more vulnerable to an unsolicited attack. Some companies that allow for it at 25 percent are being attacked to lower it to 10 percent.’ 

Paul Schulman: ‘The proposals to have companies reincorporate to North Dakota, where Carl Icahn got the legislature to adopt some shareholder-friendly laws, received very little support. What’s interesting is that Delaware, maybe in response to North Dakota, changed its state charter with regard to proxy access.

‘I also think there was a much greater acceptance among vanilla institutions on some of the environmental issues. These used to be seen as a nuisance proposal from environmental activists, but they’re getting increasingly substantial support.’

John Siemann: ‘The Bank of America ‘vote no’ campaign was significant. It was a campaign that set the stage in terms of using a website that was particularly well organized. It did more than simply voice the opinions of investors – it went down to the level of detailed voting instructions for shareholders. Depending on your shareholder profile, it took you to the proxy card specific to you and showed you how to vote.’ 

RiskMetrics’ response to tax gross-ups 

‘We crafted the policy to focus only on new or materially amended agreements, versus those amended for technical reasons. We also looked at the outcome of those amendments to obviate a negative recommendation in cases that warranted it. But it’s true, there were a lot more companies that had entered into new agreements or otherwise materially modified their agreements than we anticipated. 

‘That said, we were comfortable with implementing the policy. We felt we were being reasonable by saying that if companies agreed not to do more of these agreements in the future, that was fine, and the response was positive. I would also point out that tax gross-ups in general have been poor pay practices for some time. We were more serious about enforcing the policy, in part because of feedback from clients who encountered these problematic practices.’