April 2012

The Occupy Wall Street Movement has turned its focus on annual meetings, which one media outlet is calling "a rare public forum in U.S. business." News reports indicate that a coalition of unions and other organizations calling itself the "99% Power" intends to target more than 200 meetings, although only a few dozen companies were listed on its website. Some of these organizations sponsored trainings for those interested shareholder protests. Reportedly, over 1,000 demonstrators descended upon the Wells Fargo meeting site, where activists bought single shares of stock to gain entrance and over a dozen were ejected for disrupting the meeting. The press today reported that GE's annual meeting was delayed in order to remove two dozen people chanting at the beginning. GE confronted about 100 protestors in Detroit. Videos of the demonstrations outside the meetings, as well as the protestors' efforts during the meetings, have been posted online.

The focus of these particular agitators are not the items on the proxy ballots. At Wells Fargo, demonstrators targeted the bank's foreclosure and lending practices and mortgage operations.  The anger directed at GE stems from reports about its tax rate. The protests also did not seem to affect the voting results. Wells Fargo saw over 96% support for its advisory vote on executive compensation and GE received over 92% in favor. It appears that the first proxy access shareholder proposal to be voted on this season at Wells Fargo did not pass. According to various articles, the shareholder proposal that received the highest support at that meeting, at 38%, was one to split the chairman and CEO roles. The same proposal won 22% of the vote at GE. As Ted Allen discussed recently in his blog, shareholders of 44 companies will vote on independent chair proposals this season. 

Glass Lewis released a brief overview that it calls a "Primer for Issuers." Glass Lewis reiterates that it does not engage in discussions with companies during the proxy solicitation period because of concerns about the possibility of receiving material, nonpublic information. However, it will sometimes host a Proxy Talk conference call during which a company's management or board can speak directly to Glass Lewis' clients.

Board Matters. It is not always clear when a director will run afoul of Glass Lewis' voting recommendations. The Issuer FAQ provides some information about related person transactions, noting that a director who controls more than 20% of voting stock would be deemed an affiliate. Different types of relationships receive varying levels of scrutiny assessed against different financial thresholds. The condensed proxy voting guidelines are truly "abridged" and only provide the most general of discussions on different voting matters.

Pay-for-Performance Analysis. Some information in this section also raises more questions than provides answers. The Glass Lewis model examines six indicators (stock price change, change in book value per share, EPS growth, total return, return on equity and return on assets) and the total compensation of executives against four different peer groups (industry peers, sector peers of similar size, companies of similar market capitalization and companies in the same geographic regions). Each peer group is assigned a weight based principally on the market capitalization of the company. In the Issuer FAQs, Glass Lewis notes that it uses market-based data to calculate shareholder returns from FactSet and, like ISS, finds peers from the Global Industrial Classification System (GICS).

In the end, the model calculates an executive compensation percentile and a performance percentile against peers. A final numeric score is then calculated for each company based on these weighted-average percentile scores, which are then placed on a forced curve, producing the infamous Glass Lewis letter-grade on compensation.  20% of companies receive As and 10% receive Fs.  The remaining distribution is not disclosed. 

Say-on-Pay Analysis.  The above pay-for-performance discussion makes up only the quantitative aspect of the Glass Lewis say-on-pay analysis.  Here issuers will find more lists and charts and general descriptions of items examined to come up with the say-on-pay recommendations.  With more negative recommendations on say-on-pay when compared to ISS, one thing to note that makes Glass Lewis quite different is its focus on proxy disclosure, particularly with respect to performance metrics.

In a recent study trying to determine whether and how any of this matters, The Conference Board, NASDAQ, and the Rock Center for Corporate Governance at Stanford University surveyed 110 companies.  More than 70% reported that their compensation programs were influenced by the guidance received from proxy advisory firms or by the policies of these firms.  The study found that a negative recommendation from ISS, on average, influences between 13.6% to 20.6% percent of say-on-pay votes.

The impact is further detailed in a different study that examined the reports issued for the S&P 1500, concluding that a negative recommendation from ISS is associated with 24.7% (12.9% for Glass Lewis) more votes against say-on-pay. When both advisors make negative recommendations, voting dissent is higher by 37.9%.  According to this study, not all "Against" recommendations have the same impact.  The impact is greater when ISS identifies a problem in pay-for-performance and change-in-control agreements, and when it identifies a problem in more than one category.  In the case of Glass Lewis, the impact is higher for companies with the worst letter-grade ratings. 

Yesterday, the SEC sued two former executives of Arthrocare Corporation, a manufacturer of medical devices, to recover bonuses and stock profits they had received after the company had filed false financial statements. In doing so, the SEC continued its policy of seeking to apply Section 304 of Sarbanes-Oxley to executives who have not been personally charged with the fraudulent financial statements.

Under Section 304, if “an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct,” then its CEO and CFO is required to reimburse the issuer for certain compensation received or profits made from the sale of the issuer’s stock during the 12-month period after the fraudulent financial statement was filed. While the SEC had previously settled charges against two other Arthrocare executives who were charged with fraudulently overstating the company’s revenues and earnings, it did not charge the CEO or CFO with any personal misconduct in its current complaint.

In a previously litigated case, SEC v. Jenkins, the District Court of Arizona held that disgorgement of compensation and profit pursuant to Section 304 of Sarbanes-Oxley does not require personal misconduct.

In its press release, Robert Khuzami, the Director of the SEC’s Division of Enforcement, stated that clawbacks under Sarbanes-Oxley are “yet another reason for CEOs and CFOs to be vigilant in preventing misconduct and requiring that companies comply with financial reporting obligations.”