US Special: Investors rally on say-on-pay and sub-prime votes

Compensation concerns in focus as US meeting season looms.

The 2008 US annual meeting season will find investors focused primarily on three key issues: executive compensation reform, director elections, and risks to portfolio companies stemming from mortgage-backed securities and other high-risk investments following regulatory and economic developments that took place late in 2007.
Investor calls for advisory votes on pay – similar to resolutions now voted on each year at UK companies – and other measures to reform executive compensation will resonate in 2008 as US markets slide toward recession. A network of investors, led by Boston-based Walden Asset Management and the American Federation of State, County and Municipal Employees, has so far filed more than 90 proposals calling for an advisory vote on pay, compared with 44 such resolutions at this time last year: “Companies receiving the proposal include those where shareholders believe there has been non-performance, options backdating, and other major issues that shareowners need to address,” said Timothy Smith, senior vice president at Walden Asset Management. The proposal, dubbed “say on pay,” will also be filed atcompanies such as General Electric that are viewed positively by shareholders with respect to executive compensation and other facets of governance, according to Smith: “We believe [such companies] should provide leadership in adopting an advisory vote.”
Three US companies: Par Pharmaceuticals, Verizon Communications, and Aflac, have so far taken steps to allow for advisory votes on pay following shareholder proposal filings in 2007 calling for the right. Aflac, the Georgia-based insurer, will be the first to give shareholders the vote when it holds its annual meeting on May 5. The company originally planned to allow for the vote in 2009. Reports of record Wall Street bonuses at financial firms that sustained considerable losses in 2007 as a result of exposures to mortgage-related investments are likely to stimulate broad support this year for proposals tied to executive pay. Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Stearns together awarded roughly $39bn (€27bn) in year-end bonuses, exceeding the $36bn distributed in 2006 when the industry reported all-time high profits, according to recent press reports. CEOs at Morgan

Stanley and Bear Stearns forfeited bonuses in light of losses on sub-prime mortgage-backed securities. That may mollify shareholders who are expected to vote on a range of proposals including those calling for strengthened links between pay and performance. Labor funds, led by the United Brotherhood of Carpenters and Joiners of America (Carpenters), have so far filed more than 50 such resolutions at spring annual meetings.
A longstanding board reform proposal will also receive fresh attention in light of the Securities and Exchange Commission’s (SEC) November decision keeping investors from voting on proxy access proposals. Shareholders have in recent years sought the right, which would allow certain investors to nominate corporate directors, though business interests and others have lobbied against the measure. The SEC has let proposed rules on the measure languish, or opposed them.
Consequently, majority threshold voting proposals, which typically ask boards to require directors to receive a majority of votes cast “for” and “against” to win election, will be filed at dozens of companies, thereby giving investors at those firms a greater say in board elections. Such practice is commonplace in the UK and many other global markets, though many US-based companies rely on a plurality vote standard whereby investors lack the option to vote “no” on a candidate.
Influential Delaware Chancery Court Judge Leo E. Strine Jr., writing in the October, 2007, edition of the Journal of Corporation Law, noted that “shareholder access has gone nowhere,” but that this “does not mean that management won.”Strine argued that majority voting represents a more “potent weapon” to change the composition of the board. The Carpenters’ fund, which pioneered majority voting proposals in the US in 2004, plans to submit up to 100 such resolutions in 2008, the vast majority of which will be at large-capital S&P 500 companies.
Meanwhile, a growing number of US companies find themselves in the crosshairs of investors troubled by their involvement in, or exposure to, the sub-prime mortgage crisis that has roiled global capital markets. A number of labor funds are targeting homebuilders with mortgage lending operations as well as financial firms whose investments in mortgage-backed securities have resulted in deep losses. Shareholder proposal filings at those firms include calls to report on mortgage business risks, as well as those to establish new policies on dealings with ratings agencies.
The CtW Investment Group, the investment arm of the Change to Win labor coalition, announced in January it would target directors of Citigroup, Morgan Stanley, Merrill Lynch and others following the release of fourth quarter 2007 results that included write-downs in the billions for subprime losses at those firms. Former UK Financial Services Authority head Sir Howard Davies, a member of Morgan Stanley’s audit committee, is among those targeted.
Credit rating agencies also have been targeted over the sub-prime mortgage crisis. Both Moody’s and McGraw-Hill, parent company of Standard & Poor’s, have received proposals that include calls for the board to adopt policies to bar the employment of any individual who worked for a client within the past year, as well as other
measures to limit potential conflicts of interest.
McGraw-Hill did not responded to requests for comment, while a Moody’s spokesman said the company would comment only if the proposal showed up in the proxy statement. Many firms receiving shareholderproposals related to sub-prime losses, advisory votes on compensation, and other issues have petitioned the SEC for “no-action” relief under the agency’s Rule 14a-8, which allows for omission of proposal filings that do not conform to federal proxy rules.
Subodh Mishra is Managing Editor at ISS Governance Services, a unit of RiskMetrics Group.