Exec. Comp, Majority Voting to Rule 2006 Meeting Season

Spring is in the air, and so the 2006 annual meeting season gets underway—with executive compensation and majority voting for directors expected to dominate this year’s shareholder confabs.

Both issues come as little surprise. Executive pay looms large because the Securities and Exchange Commission is proposing a far-reaching overhaul of compensation disclosure, long a sore point with pension funds and governance watchdogs. Majority voting, meanwhile, has been pushed onto the annual meeting agenda by shareholder activists at dozens of companies.

Brian Lane, a partner at Gibson Dunn & Crutcher, says executive compensation “is the most important issue this year by far.” The SEC’s guidance around perks, included in its proposing release, is catching some companies by surprise, he says, because while the proposed rules aren’t expected to take effect until next proxy season, the guidance on perks is in effect for this proxy season.

“Companies need to pay extra attention to how they calculate perks to be consistent with the guidance,” Lane says. Depending on how companies interpret the SEC guidance, their definition of what’s considered a perk may be broader, he says. For example, a luxury box seat at a sporting arena is not a perk if used to entertain clients. But if an executive takes his daughter to an game, disclosure is less clear and shareholders start to get fussy. “What’s the incremental cost to the company of one seat at one game? It’s hard to determine,” says Lane.

Nathan

Chuck Nathan, a corporate lawyer at the firm Latham & Watkins, expects the disclosure of perks “to be substantially beefed up over prior years,” as a result of the guidance. “That’s an area that will be sensitive for all of the obvious reasons,” he says. “If a CEO has a golf membership the company pays for, or management uses the company plane for private purposes, it’s grist for the activist investor and financial press mill and almost anything can be painted as excessive.”

And while companies may think they don’t need to worry yet about all the proposed new compensation disclosure tables until final rules are adopted, Lane says that’s not the case. “Companies need to adjust their practices now because all of the decisions that were made this year regarding compensation will be displayed in next year’s proxy,” he warns.

The other issue sharing the spotlight at this year’s meetings is majority voting. Shareholders filed about 140 proposals on the issue for 2006, according to research done by law firm Neal, Gerber & Eisenberg. The measures are mostly in response to investor dissatisfaction with the current plurality standard in place at most U.S. companies, where a board member who runs uncontested only needs one vote to be elected.

“A limited number of companies had majority voting bylaws before this movement,” says Claudia Allen, partner and chair of corporate governance practice group at Neal, Gerber & Eisenberg. “It’s hard to imagine a campaign that’s moved so quickly with so much success.”

Numerous companies have tried to head off a fight at their annual meeting on the issue, by adopting some sort of majority voting plan pre-emptively—and often one that only calls for directors to resign after receiving large numbers of “withheld” votes, rather than outright majority voting. Hewlett-Packard, Analog Devices and Ciena Corp. all employed such a strategy this spring, and all three defeated shareholder resolutions for majority voting at annual meetings just three weeks ago.

Allen

Allen says most companies have put in place majority voting policies, rather than bylaws, although she says there’s been a “marked up-tick” in bylaw adoptions since Intel adopted a majority vote bylaw in January. “The question for companies that have [already] adopted majority vote policies where there's also a bylaw proposal up for a vote is, will stockholders think a policy is enough?” she says.

“The jury is still out on how shareholders are voting on different formulations [of majority vote proposals] and what lines are being drawn,” says Nathan. “Majority voting is in a state of tremendous flux.”

Another issue facing companies is shareholder concern over the so-called “holdover rule,” under which an incumbent director who doesn’t get a majority of votes remains in office until his successor is elected. Allen notes that some companies, such as Intel, have dealt with the rule by adding a policy to their bylaws or a separate document providing for “holdover directors” to offer their resignations to the board for consideration.

“The issue of director resignation policies and the holdover rule is still evolving,” Nathan says. “A lot of companies that haven’t done anything to date may wait to see if things clarify themselves before the next proxy season.”

QUICK TIPS

Kenneth Goldmann, a partner at J.H. Cohn, an accounting and consulting firm in Roseland, N.J., says companies should prepare to address shareholder questions on a number of issues at this year’s annual meetings. Among the most prominent:

Conflict of interest issues. Chief executives should be prepared to answer questions about related party transactions. Shareholders of middle-market companies are likely to ask questions and demand to know more about them.

CEO compensation. Along with questions on compensation issues under existing rules, CEOs should expect queries on the SEC’s proposed rules and how they will affect compensation reporting. Executives ought to be cognizant of the proposals, and in particular, those related to stock options and perks. They also ought to be prepared to discuss how FAS No. 123R, which requires the reporting of the fair value of employee stock options granted, will affect the company’s 2006 earnings. However, Goldmann cautions companies to be careful about providing forward-looking guidance.

Sarbanes-Oxley compliance. In addressing questions about compliance with SOX, Goldmann says companies should stress the positive aspects rather than focusing on the cost of compliance. He also notes that while it’s always been the case at larger companies, there’s a trend now among smaller companies of hiring internal auditors to monitor SOX compliance on an ongoing basis.

Board oversight. Board members should expect questions about their role and function. “Shareholders want to know, is the board really challenging the CEO, or is the CEO running the company and the board?” Goldmann says. “Someone other than the CEO ought to be prepared to speak to how active the board is in fulfilling its oversight role.”

Follow up. Goldmann cautions that companies should be certain that any issues or complaints that have been reported though their whistleblower hotlines are followed up prior to the annual meeting. “The outcome could be horrible for the company if a former employee shareholder shows up at the meeting and says they called the hotline and didn’t get a response,” he warns.

For a list of typical questions that boards may be asked to address, see the J.H. Cohn Guide, “">Annual Meeting: What Shareholders of Middle Market Companies Want to Know.”

Compiled by Melissa Klein Aguilar

The convergence of majority voting with other trends, such as board de-classification proposals, which are still on many ballots, creates “an interesting dynamic,” according to Allen. “There’s a potential shift in the balance of power from the board more toward stockholders.”

That’s because if companies adopt both majority voting and declassified boards, their full board must stand for election each year and must obtain a majority vote to be elected—at which point, she says, “shareholders can hold them accountable at the ballot box on matters like executive compensation.”

Nathan puts it more starkly: “In a couple of years, we’ll see activist investors trying to use their power under a majority vote regime to enforce shareholder views on executive compensation.”

“Compensation committees could easily become the target of legally effective ‘against’ vote campaigns for ignoring shareholder views on excessive compensation,” Nathan continues. The question, he says, is “whether investors will push people off of boards rather than send a message with a ‘withhold’ vote.”

And executive compensation is one issue that could easily galvanize people to vote against directors, says Nathan. “That’s huge leverage for investors,” he says. “The lesson I draw from that is, if I were a board member, I wouldn’t go on the compensation committee for love or money.”

Allen also notes that a case currently in Delaware Chancery Court, Unisuper v. News Corp., has raised the question of whether company policies are binding. In that case, News Corp. adopted a policy to grant shareholder approval of poison pills and then extended its poison pill without obtaining the stockholder vote called for by the policy. Institutional investors sued the board, which argued that it had the right to change governance policies without shareholder approval. A Delaware court refused to dismiss the case. A trial is set for later this month.

“The case is causing some companies to look at their policies and think about whether shareholders are going to view them as some type of enforceable contract,” Allen says.

Lane

Lane says companies should also think about the SEC’s proposal to move to the electronic delivery of proxies. “I expect e-proxies to be widely embraced,” he says. “Taking proxies to the Internet is the natural next step.” If the e-proxy proposal is adopted, Lane speculates it could be the next step to virtual annual meetings.

Still, he says people shouldn’t view the e-proxy proposal as “an indication that virtual meetings are around the corner.” Annual meetings—messy floor fights, boring PowerPoint presentations, proxy battles and all—will still be around this year and many more.