From the April 2008 issue of Treasury & Risk magazine

Sub Rosa Subprime

Not surprisingly, the next proxy season threatens to be more tumultuous than usual--but not entirely for the reason one might assume. While the subprime credit crunch dominates headlines, it is unlikely to be the cause c?(C)l??bre in 2008 proxy votes--except at high-profile losers in financial services and homebuilding. The exclusion of the topic from proxies is mostly thanks to the Securities and Exchange Commission's no-action process, which allows companies to bar issues outside the company's ordinary areas of business. As a result, a slew of corporations outside of mortgage lending have nixed proposals related to subprime-related exposures and investing practices. "As bizarre as it sounds, the issue that is top of mind for investors right now won't be on many ballots," says Patrick McGurn, special counsel to the ISS governance unit of RiskMetrics Group in New York. "Next year may be a different matter."

Even so, the subprime crisis will be in the room, so to speak, at annual meetings in the tenor of fed-up investors unlikely to be as willing as usual to wait for reform or follow management's recommendations on proxy votes. Leading the charge, in many cases, will still be activist hedge funds, despite the pummeling a few high profile firms have taken.

Although experts had predicted that tightened access to credit would cause activism to wane, "The lion's share of proxy contests are being driven by activists trying to get board seats," says ISS's McGurn. Already this year, there have been more than half a dozen instances where boards have settled privately, agreeing to give a seat to dissident shareholders.

What should boards of directors and senior management prepare for this year? The leading candidates are:

Majority vote. Here's one place where investor pain from subprime and declining trust in boards of directors could translate into decisive proxy victories for activist shareholders. Majority vote proposals would stop the current practice of allowing board members who receive only one vote to be elected. Under majority rule, directors would all be required as the name suggests to garner votes from a majority of shareholders or force board action to stay. This has been a contentious issue for the last two years in particular as powerful institutional shareholders became frustrated by SEC foot-dragging on rules that would give them the ability to nominate directors. Majority voting is still only the rule at 27% of the 1,754 companies tracked by RiskMetrics, so there's plenty of room for growth. Most governance experts, like Nell Minnow, editor and co-founder of the Corporate Library, a Portland, Maine-based research group focusing on corporate governance, expect the practice to have been adopted at every major public company within the next five years--if only because not having it could begin to jeopardize the board's ability to attain liability coverage against shareholder suits. "This issue is where the rubber meets the road," she says. "It's a real opportunity to boot out those board members who don't deliver what they're supposed to." Giving majority vote a further boost may be its recent adoption by Pfizer Inc., always considered a leader in governance best practices. The pharmaceutical company's so-called director resignation policy in 2005 inspired other firms to take that route. Now, its embrace of majority vote in 2007 could encourage similar me-too actions.

Say on Pay. As always, executive compensation remains a lightning rod for shareholder displeasure, and when the market is in turmoil and the economy flagging it is a good guess they aren't happy. So far, there are more than 90 proposals giving shareholders an advisory vote on exec pay packages, compared to 44 this time last year, according to RiskMetrics. Some companies include Abbott Laboratories, Capital One, Lexmark and Wells Fargo. "This will be an area of high interest this year," says John Jarrett, research director of GovernanceMetrics International (GMI), a corporate governance ratings firm in New York. But whether or not shareholders show their defiance, ISS's McGurn and other shareholder advocates believe that Congress is ready to pass a law to that effect anyway--particularly if the Democrats win big in November. "This year's proposals could become regulatory dictates for public companies in the future," he says.

Pay for Performance. Proposals typically call for compensation committees to set up compensation plans with specific criteria and metrics for achieving targets that trigger payouts. That could include such steps as measuring performance of the company against performance of peer companies either within an industry or stock index or adopting performance-vested equity awards, rather than time-vested awards. According to GMI's Jarrett, less than 10% of companies "do this in any meaningful way."

Reimbursement for proxy fights. The American Federation of State County and Municipal Employees plans to submit at least a handful of proposals calling for reimbursement for participants in proxy fights, according to RiskMetrics. Specifically, they want candidates in contested election of directors to be reimbursed for printing, mailing, legal and other related expenses. Of course, for many directors, it's a moot point. "When dissident board members are elected, one of the first steps they take is to reimburse themselves," says Minnow.

Climate change. As you'd expect, there also are a number of proposals related to global warming risks. "They're calling for better and more robust reporting and monitoring," says Jarrett. At Apple Computer Inc., for example, there's a call to create a board committee on sustainability to watch issues like energy use and waste disposal.

The credit crisis. Shareholders at financial services companies stung by exposure to mortgage-backed securities have started "Vote No" campaigns, aimed at unseating directors. The Change to Win labor coalition recently targeted five members of Citigroup's audit committee, as well as directors at Merrill Lynch, Wachovia, Washington Mutual, Morgan Stanley and Bank of America. The other investor issue: better disclosure on lending practices.


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