Proxy season survival kit

A season for the ages. A history making event. The busiest and most exciting period in the business. These are just some of the comments that were made at the beginning of the 2008 proxy season, only one short year ago. The experts had good reason to be bullish. We were in the early stages of a massive credit crunch, the stock market was showing signs of a continued downturn, we were coming off an extremely active 2007 and there were two presidential candidates promising a crackdown on corporate excess. Like the buildup to the Beijing Olympics and all the hype about Michael Phelps, the proxy business was expecting great things.

But unlike the great and inspiring swimmer from Baltimore, proxy season 2008 failed to deliver. The predicted boom in shareholder proposals never came to fruition, in spite of some strong signs early on. There were a number of strong displays of support for a range of proposals and some companies took groundbreaking steps in voluntarily implementing new ‘say on pay’ and shareholder access plans. But by and large, 2008 was not a banner year for activism. The simple reason: people were confused.

At no time in the past three decades have global financial markets been more uncertain than they are at this very moment. Predicting the future direction of markets and success of companies is particularly difficult, at least in the near term.

With investors across the country from small and very small retail buyers to the largest and most sophisticated investors struggling to understand the latest market movements and plan a strategy through it, issues of governance and activism are being viewed in a dramatically different light.

As Patrick McGurn, special counsel for RiskMetrics puts it: ‘2008 was a sideways season. A lot of the trends went sideways and levels of support for some proxy proposals were not at all what we expected. One of the most surprising things about 2008 in terms of proxy voting and shareholder proposals is that there were no surprises. We expected going into the season to see a lot of anger directed toward some of the actors who are seen as responsible for the market meltdown. But with the collapse of Bear Stearns and other companies suffering, many people lost focus on activist issues.’

Looking ahead to 2009, it is likely that this uncertainty will continue to be a dominant theme. In its recently released ‘Annual corporate governance review’ for 2008, Georgeson predicts the following: ‘The only bit of certainty about the 2009 proxy
season is that it will be filled with uncertainty. Activist shareholders will likely seek to address many of the concerns that have arisen from the volatile market.’

Uncertainly is the new normal
But what will the activist scene look like in 2009? Many large shareholders with a history of activism have suffered badly and it is likely that many hedge funds will soon cease to exist. Some experts are predicting that between 40 and 50 percent of all hedge funds will either shut their doors or be bought out.

With regard to the hedge funds that do manage to navigate through the sea of financial unpredictability, they are likely to take a different approach to activist investing. David Drake, president of Georgeson, highlights this point: ‘We may not know until late January or even February what the capital base of the hedge funds will be going forward. It is possible though that, come mid-year, they will be back with a vengeance.’

He continues, ‘Even if there are only 2,000 hedge funds left, there will still be enough activism to go around.’ But those that are left will likely take a different approach: ‘We might not see the same drive from hedge funds investing and then pushing to sell the company [or part of the assets]. What might happen is that they will undertake a more long-term strategy and engage in governance-driven proxy fights.’

McGurn has an alternate view: ‘We expect to see a bumper crop of proxy fights during 2009, mostly led by pension funds and other traditional investor groups.

‘It is likely that the hedge funds will be largely absent from the scene, at least during the first half of 2009,’ McGurn goes on. ‘They are not buying companies much at all right now and certainly not with the intention of shaking up governance structures. This could change in the long term, though. Right now, those that are buying are looking for bargains or genuine value opportunities. Few are willing or able to launch potentially expensive proxy campaigns.’

A new generation
With the likely absence of hedge funds and with some other groups evaluating their strategies, the door is open for new players to enter the governance activism space. New York attorney general Andrew Cuomo is stepping into the fray and demanding strict compensation restrictions for any company involved in the TARP bailout. He achieved success during 2008 against AIG when he influenced the company to reclaim compensation from former CEO Martin Sullivan and former president Joe Cassano. Emboldened by this success, Cuomo has demanded compensation and bonus details from nine banks: Bank of America, the Bank of New York Mellon, Citigroup, Goldman Sachs, JP Morgan, Merrill Lynch (since merged with Bank of America), Morgan Stanley, State Street and Wells Fargo.

In addition, a spokesman for New York City comptroller William Thompson Jr’s office explains that it is preparing governance and compensation related proposals against 14 companies and it ‘will continue to closely monitor other companies and take action where necessary, possibly in cooperation with other investors.’

Defining a path
With the activist landscape changing, what will be the hot topics for the 2009 proxy season? McGurn predicts that majority voting, requests for independent chairmen and say on pay will be the most common proposals, but TARP and risk management related issues will also be prevalent. The top nine proposals for this season are listed above in ‘Pat’s top nine for 2009’.

Executive compensation proposals, according to Georgeson’s report, ‘will surely be in the forefront.’ As Drake explains, ‘We expect to see a large number of proposals on limiting golden parachutes, linking pay to performance and anti-tax gross-up policies.’

Two significant trends that all issuers should keep a close eye on are the rise of ‘no’ and ‘withhold’ votes against corporate directors and increasing levels of action against smaller companies. According to Georgeson, the number of directors receiving a majority of no votes (votes against reelection) in 2008 was 30, exactly twice the number in 2007. This trend is likely to continue as investors shun say on pay in favor of direct campaigns against members of compensation committees that approve excessive pay arrangements.

There have also been a handful of proposals for companies to reincorporate in North Dakota, which, following laws passed in 2007, is among the most investor-friendly states. Three proposals have already been filed and others will follow; few experts believe they will pass.

Smaller companies are likely to become targets mostly because many larger firms have ‘fixed’ the issues activists are concerned about. So they have to start looking for new pastures. This is well demonstrated by looking at the top issues from 2003 compared to now. As reported by Georgeson, ‘In 2003 the top two governance related proposals were for the expensing of stock options and redeeming poison pills, accounting for 35 percent of proposals. In 2008 these were only 1 percent of proposals.’

Taking off the gloves
One trend that might see a reversal is the willingness companies have displayed to voluntarily implement changes to avoid having proposals go to a vote. While all issuers recognize the benefits of engagement, McGurn believes 2009 could see increased levels of resistance in some specific cases. ‘There is a greater likelihood that corporates will push back a lot more during 2009. This is a trend that started to emerge throughout 2008 and will be amplified this year. Any hedge fund looking to buy a company, or even in the event of [becoming engaged in] a contested takeover, the target management is likely to rally around the refrain of: This is no time for a fire sale. Values are depressed not through any fault of our own but more due to general market conditions. Some purchasers will look to take advantage of depressed values to pick up healthy companies cheaply and in some cases management will have a point in pushing for higher values,’ he explains.

The actions of the new government will also significantly impact the tone of activism during and beyond 2009. Many pension funds and investor groups are lobbying Congress for more shareholder rights. And some union funds might feel they have a once in a lifetime opportunity to promote their agendas. A lot of anti-corporate sentiment is circulating at all levels of society.

The Council of Institutional Investors is leading the way in this area and lobbying Congress for stronger legislation across a range of issues that it believes will ‘provide meaningful investor oversight of management and boards.’ While the group strongly supports regulatory action, its members feel legislation is only the base and that shareholders need to be responsible for driving constructive long-term change.’ (See ‘New laws to underpin progress’ )

Regardless of what happens, engagement will continue to be the name of the game and more companies will increase efforts to reach out to shareholders. This may include using board members for outreach, official governance roadshows and in-person investor days. While no records were set in 2008, this year could see a Phelpsian-like achievement in shareholder outreach and communication strategies.