In the latest instance of proxy advisors establishing a governance standard without offering evidence that it will improve corporate governance or corporate performance, ISS has adopted a new policy position that appears designed to chill board efforts to protect against “golden leash” incentive bonus schemes. These bonus schemes have been used by some activist hedge funds to recruit director candidates to stand for election in support of whatever business strategy the fund seeks to impose on a company.
Posts Tagged ‘Steven Rosenblum’
In many respects, the relentless drive to adopt corporate governance mandates seems to have reached a plateau: essentially all of the prescribed “best practices”—including say-on-pay, the dismantling of takeover defenses, majority voting in the election of directors and the declassification of board structures—have been codified in rules and regulations or voluntarily adopted by a majority of S&P 500 companies. Only 11 percent of S&P 500 companies have a classified board, 8 percent have a poison pill and 6 percent have not adopted a majority vote or plurality-vote-plus-resignation standard to elect directors. The activists’ “best practices” of yesterday have become the standard practices of today. While proxy advisors and other stakeholders in the corporate governance industry will undoubtedly continue to propose new mandates, we are currently in a period of relative stasis as compared to the sea change that began with the Sarbanes-Oxley Act and unfolded over the last decade.
In other respects, however, the corporate governance landscape continues to evolve in meaningful ways. We may be entering an era of more nuanced corporate governance debates, where the focus has shifted from check-the-box policies to more complex questions such as how to strike the right balance in recruiting directors with complementary skill sets and diverse perspectives, and how to tailor the board’s role in overseeing risk management to the specific needs of the company. Shareholder engagement has been an area of particular focus, as both companies and institutional investors have sought to engage in more regular dialogue on corporate governance matters. The evolving trend here is not only the frequency and depth of engagement, but also a more fundamental re-thinking of the nature of relationships with shareholders and the role that these relationships play in facilitating long-term value creation. Importantly, this trend is about more than just expanding shareholder influence in corporate governance matters; instead, there is an emphasis on the roles and responsibilities of both companies and shareholders in facilitating thoughtful conversations instead of reflexive, off-the-shelf mandates on corporate governance issues, and cultivating long-term relationships that have the potential to curb short-termist pressures in the market.
ISS Proxy Advisory Services recently recommended that shareholders of a small cap bank holding company, Provident Financial Holdings, Inc., withhold their votes from the three director candidates standing for reelection to the company’s staggered board (all of whom serve on its nominating and governance committee) because the board adopted a bylaw designed to discourage special dissident compensation schemes. These special compensation arrangements featured prominently in a number of recent high profile proxy contests and have been roundly criticized by leading commentators. Columbia Law Professor John C. Coffee, Jr. succinctly noted “third-party bonuses create the wrong incentives, fragment the board and imply a shift toward both the short-term and higher risk.” In our memorandum on the topic, we catalogued the dangers posed by such schemes to the integrity of the boardroom and board decision-making processes. We also noted that companies could proactively address these risks by adopting a bylaw that would disqualify director candidates who are party to any such extraordinary arrangements.
Empirical studies show that attacks on companies by activist hedge funds benefit, and do not have an adverse effect on, the targets over the five-year period following the attack.
Only anecdotal evidence and claimed real-world experience show that attacks on companies by activist hedge funds have an adverse effect on the targets and other companies that adjust management strategy to avoid attacks.
Empirical studies are better than anecdotal evidence and real-world experience.
Therefore, attacks by activist hedge funds should not be restrained but should be encouraged.
Harvard Law School Professor Lucian A. Bebchuk is now touting this syllogism and his obsession with shareholder-centric corporate governance in an article entitled, “The Long-Term Effects of Hedge Fund Activism” (previously discussed here). In evaluating Professor Bebchuk’s article, it should be noted that:
A long-term oriented, well-functioning and responsible private sector is the country’s core engine for economic growth, national competitiveness, real innovation and sustained employment. Prudent reinvestment of corporate profits into research and development, capital projects and value-creating initiatives furthers these goals. Yet U.S. companies, including well-run, high-performing companies, increasingly face:
- pressure to deliver short-term results at the expense of long-term value, whether through excessive risk-taking, avoiding investments that require long-term horizons or taking on substantial leverage to fund special payouts to shareholders;
- challenges in trying to balance competing interests due to excessively empowered special interest and activist shareholders; and
- significant strain from the misallocation of corporate resources and energy into mandated activist or governance initiatives that provide no meaningful benefit to investors or other critical stakeholders.
This year, the practice of activist hedge funds engaged in proxy contests offering special compensation schemes to their dissident director nominees has increased and become even more egregious. While the terms of these schemes vary, the general thrust is that, if elected, the dissident directors would receive large payments, in some cases in the millions of dollars, if the activist’s desired goals are met within the specified near-term deadlines.
These special compensation arrangements pose a number of threats, including:
As we enter 2013, a number of signs – including the strong finish to 2012, macroeconomic factors that appear to be reducing business uncertainty, and intensifying competition in many critical sectors – provide cause for optimism that the breadth and depth of M&A activity will be significantly greater in the coming year than in 2012. Global M&A activity dropped 17.4% in the first three quarters of 2012 compared to the comparable period of 2011, reflecting the European sovereign debt crisis, political uncertainty in the United States and slower economic growth in China and India. But M&A activity turned sharply upward in the fourth quarter: Global announced deal volume for the quarter was the highest in four years, and a number of transformative transactions were announced, including Freeport McMoRan Copper & Gold’s $9 billion acquisitions of Plains Exploration Company and McMoRan Exploration, and ICE’s $8.2 billion acquisition of NYSE Euronext.
The years since the onset of the financial crisis have served to further increase the demands on and scrutiny of public company boards of directors. The assault on the director-centric model of corporate governance continues in the shareholder activist and political arenas, and the challenges of planning for and investing in the long-term health of the corporation have become more daunting. As the power and organization of both governance and hedge fund activists have increased, the pressure to produce short-term results has only grown stronger, regardless of whether the steps necessary to produce those results may be harmful to the corporation in the long run.
In this environment, the challenge for directors is to continue to focus on doing what they believe is right for their corporations while maintaining a sufficient understanding of shareholder sensitivities to avoid a targeted attack that could undermine their ability to act in their company’s best interest. The primary focus of a director, of course, should be on promoting and helping to develop the long-term and sustainable success of their company. This encompasses a wide range of activities, including working with management on the company’s business and strategies, planning for the succession of the CEO and other key executives, overseeing risk management, monitoring compliance, setting the appropriate tone at the top and being prepared to step in to address any corporate crises that arise. At the same time, the board needs to be aware of and address shareholder demands in a constructive manner, consider how a hedge fund or other activist may view the company and its strategic alternatives and try to ensure that the company maintains a shareholder relations program that clearly articulates the reasons for the company’s strategies and engenders support from the company’s major shareholders. In some cases, this may include direct communication between board members and institutional shareholders.
Recently, the SEC adopted controversial new rules that create significant financial incentives for whistleblower employees to report suspected securities law violations directly to the SEC, potentially circumventing company compliance programs in the process. Under the new rules, which were adopted pursuant to Section 922 of the Dodd-Frank Act, the SEC will pay awards to whistleblowers who voluntarily provide the SEC with original information about a violation of securities laws that leads to a successful enforcement action brought by the SEC and that results in monetary sanctions exceeding $1 million.
The size of potential bounty payments may range from 10% to up to 30% of the total monetary sanctions collected in successful SEC and related actions. In some cases, this could result in multimillion dollar cash payments to whistleblowers. The final rules set forth the SEC’s methodology for determining awards, with specified factors weighing in favor of an increase in the reward size and others weighing in favor of a reduction in the reward size. In addition, the rules provide that various persons will not be eligible for whistleblower payments, including compliance and internal audit personnel, but an exception is provided for such personnel if they believe disclosure “may prevent substantial injury to the financial interest or property” of the company or investors, and at least 120 days have elapsed since the whistleblower reported the information internally at the company or became aware of information that was already known to the company.
The Delaware Court of Chancery last week provided fresh guidance on the standards of director conduct applicable to part-cash, part-stock mergers and reaffirmed the rules of the road for board process and deal protection provisions in strategic mergers. In re Smurfit-Stone Container Corp. S’holder Litig., C.A. 6164-VCP (May 20, 2011).
In a merger agreement announced on January 23, Smurfit-Stone, a leading containerboard manufacturer, agreed to merge with Rock-Tenn Corporation. The agreement provides that Smurfit-Stone stockholders will receive consideration valued at $35.00 per share as of the date of the merger agreement, representing a 27 percent premium over the stock’s pre-announcement trading price, with 50 percent of the consideration payable in cash and the other 50 percent payable in Rock-Tenn common stock. Shareholder plaintiffs sought to enjoin the deal, alleging that the Smurfit-Stone board had improperly failed to conduct an auction and that the deal protection provisions in the merger agreement were impermissible as a matter of Delaware law.