Businesses say corporate governance can go too far

By Edward Iwata, USA TODAY

Shaken by shareholders’ long-running revolt against overpaid CEOs, weak boards and poorly run businesses, the nation’s corporations are starting to strike back.

Business officials are challenging the new post-Enron rules, calling them harsh and costly. They’re blasting the two strongest forces in the governance movement: California Public Employees’ Retirement System (Calpers), the public pension fund giant, and Institutional Shareholder Services (ISS), the No. 1 proxy-advisory firm. And in a huge regulatory fight, they’re pressing the Securities and Exchange Commission to tone down a rule that would give shareholders more power to name board candidates.

Corporate-governance watchdogs the pension funds and proxy-advisory firms that monitor and invest trillions of dollars in publicly traded companies have won praise for making businesses more accountable to shareholders in recent years.

In a recent survey of 9,000 executives and directors by the Foley & Lardner law firm, 67% think the new governance rules are too strict. In another survey, 40% of 120 money managers questioned by Broadgate Consultants believe that pension funds hold too much power.

We need great corporate governance, but the pendulum is in danger of swinging too far, says Steve Odland, CEO of AutoZone and corporate-governance chairman of the Business Roundtable, an industry group of 150 CEOs.

The reformers’ critics say that activist pension funds continue to bombard companies with outrageous proposals on social issues.

During the current proxy season, for instance, shareholders have called on companies to disclose their policies on campaign contributions to political candidates. They’ve urged drug firms to fund research for AIDS and Parkinson’s disease. And they’ve asked corporations to ban workplace bias against gays and lesbians.

This year, institutional investors filed a record 1,110 proposals in corporate proxy statements, according to the Investor Responsibility Research Center. One-third involved social and political issues.

Some may be well-meaning issues, says John Castellani, president of the Business Roundtable, but they are indeed minority issues and don’t necessarily represent the interests of shareholders.

The backlash against corporate governance comes as businesses wrestle with the Sarbanes-Oxley Act and other tough laws and industry rules adopted after the financial scandals involving Enron, Tyco and other companies.

Governance advocates say the harsher requirements courtesy of Congress, the Securities and Exchange Commission, the New York Stock Exchange and Nasdaq will flush out rogue executives and deadwood directors.

Stronger rules, they say, will help rebuild investors’ faith in U.S. companies, which lost many billions of dollars in stock market value after the corporate scandals.

Corporate-governance supporters also defend their boardroom activism. Pressure from them has led companies to upgrade their governance practices, from naming more independent directors to limiting executives’ high pay. And businesses are meeting more often with shareholders to air issues and make changes.

It’s all about trying to create the best alignment of interests between shareholders and the managers of the corporations they own, says Sean Harrigan, board president of Calpers, which has investments in more than 1,800 companies. It’s about accountability.

Business officials applaud the crackdown, too. But they fear that lawful corporations are being tarnished by the crooked outfits.

We can always improve. Everybody can improve, says Cary Klafter, corporate secretary at Intel, an early business leader in corporate-governance issues. But we think there should be balance with respect to the good guys.

Pfizer corporate secretary Peggy Foran sees both sides. She’s chairman of the American Society of Corporate Secretaries and a director of the Council of Institutional Investors, which represents pension funds and other shareholders.

Foran praises most institutional investors as thoughtful, hardworking people who want the best for shareholders. But a few, she contends, game the system for publicity and political gain.

The backlash is surging on several fronts:

A flood of new requirements.

Business officials say the new requirements are swamping some businesses especially smaller firms shaky from the recession and stock market swoon.

The legal and administrative costs of adopting the new rules are $1 million a company, the Business Roundtable reports. Complying with Sarbanes-Oxley will cost $5.5 billion this year, according to a survey of CEOs by AMR Research.

In a recent speech, CEO John Thain of the New York Stock Exchange argued that the new requirements may scare U.S. and foreign firms from investing here. The Foley & Lardner survey of executives found that 20% are thinking of going private with their companies because of burdensome governance rules.

Shareholder activists scoff at complaints that corporate pocketbooks or even the economy will be hurt by stronger governance.

The price of compliance is a very small price to pay for the restoration of investors’ trust in our marketplace and our companies, says Ann Yerger, deputy executive director of the Council for Institutional Investors, which represents 130 funds with $3 trillion in assets.

Proxy-consulting leader ISS.

Business officials and some regulators say that ISS, the nation’s largest consultant to investment managers and companies on proxy issues, wields too much unchecked power.

They’re not truly accountable to anyone, says Craig Nordlund, corporate secretary at Agilent Technologies in Silicon Valley.

Based in Rockville, Md. ISS boasts 1,000 clients and bills itself as the world’s authority on proxy issues and corporate governance.

Its proxy-advisory arm analyzes thousands of corporate proxies for investors. ISS then recommends how large investors should vote on director elections, executive pay and other proposals made at companies’ annual meetings.

An ISS recommendation can swing large blocks of votes. Two years ago, its advice to shareholders to vote for the controversial merger of high-tech goliaths Hewlett-Packard and Compaq Computer helped to seal the deal, governance experts say.

But ISS’ corporate-consulting arm advises firms on how they can improve their governance practices and make Wall Street shareholders happy. That’s a blatant conflict of interest, critics say.

Dozens of companies have complained to their industry groups and the SEC that ISS pressures them to pay or play by buying its consulting services. If the companies don’t purchase the consulting products, they risk getting hit by ISS with low ratings, which could scare away institutional investors.

Last year, Agilent paid ISS’ proxy service $20,000 for advice on a big stock-option proposal that Agilent had put before shareholders for a vote, Nordlund says. But Nordlund was startled when ISS’ consulting arm then asked for an additional $16,000 in fees to help the tech firm improve its score on overall governance issues.

The price of admission of even talking to them was to pay for their services, Nordlund says.

Patrick McGurn, ISS senior vice president, says ISS has strong safeguards against conflicts of interest. A firewall divides ISS’ researchers from its corporate consultants, who work in different offices. Clients also study ISS’ policies before buying its services, to establish a comfort level with ISS, he says.

If clients think we’re not doing the right thing, they’re not going to subscribe to our services, McGurn says.

ISS and Calpers drew criticism in late spring after they recommended that Coca-Cola shareholders boot legendary investor and director Warren Buffett from the company’s audit committee.

Calpers urged shareholders at Coca-Cola and other companies to withhold their votes from directors who allow accounting firms to audit corporate books while also performing consulting and tax services. That’s a conflict of interest, Calpers believes.

ISS had warned investors that Buffett, the CEO of Berkshire Hathaway and Coke’s largest shareholder, could not be independent as a Coke director because five Berkshire Hathaway subsidiaries have deals with the soft-drink king.

Berkshire Hathaway Vice Chairman Charles Munger accused ISS of loony-bin behavior that has made the firm a laughing stock. Coca-Cola director Herb Allen, writing in The Wall Street Journal. compared ISS’ criticism of Buffett to the Salem witch trials.

ISS’ McGurn replies that, under the new governance rules, Buffett does not qualify as an independent director on an audit committee.

We’re not questioning Warren Buffett’s character, McGurn says. But there’s a higher standard for audit committees. Most companies have adopted zero tolerance (of directors with potential conflicts).

Corporate leaders are pressuring the SEC to more closely regulate ISS and other proxy-advisory firms as aggressively as it oversees Wall Street analysts.

In a public letter to the SEC in December, Intel corporate secretary Klafter wrote: (Firms) such as Institutional Shareholder Services have become major forces in the proxy-voting process, and yet they are basically unregulated.

McGurn says the SEC conducts periodic reviews of ISS, a registered investment adviser. Regulators have reviewed ISS’ firewall, its employees’ code of conduct and its conflict-of-interest policies.

Pension-fund king Calpers.

Business critics of Calpers, a corporate-governance leader for many years that oversees $170 billion in assets, say it has become a politically driven machine that is straying from its duty to shareholders.

Critics say Calpers uses a cookie-cutter approach that blindly targets all companies, good or bad. This proxy season, for instance, Calpers recommended that shareholders withhold votes for directors at 2,700 companies, or 90% of the firms that Calpers invests in.

Corporate leaders also accuse Calpers of pursuing a pro-labor agenda. Last month, the pension fund unsuccessfully tried to oust Safeway CEO Steve Burd as the supermarket chain wrestled with union woes.

Eleven of Calpers’ 13 board members are union officials or members, and Harrigan is executive director of the United Food and Commercial Workers union, which spearheaded the Safeway campaign.

Calpers’ Harrigan calls Safeway’s board one of the worst in the country.

Calpers spokeswoman Pat Macht says the fund has not abandoned its investment responsibilities. Its directors are required by law to act in the financial best interests of our membership. They take that very seriously.

California Controller Steve Westly, who sits on the Calpers board, publicly scolded the pension fund and called on Calpers to review its proxy-voting policies. The fund has agreed to review its proxy-voting strategies during a meeting in July.

Corporate governance is a good thing, Westly says, but we’re trying to do it in a responsible way, with a rifle not a shotgun.

The battle over shareholder power.

In the fiercest governance debate of the year, businesses have stepped up their fight against a controversial SEC rule proposed last fall that would give shareholders more power to nominate directors to corporate boards.

Businesses claim the rule would lead to special-interest groups hijacking the election process and dividing boardrooms over nasty political spats and elections.

We believe it will weaken boards, weaken governance and hurt shareholders, says David Hirschmann, senior vice president at the U.S. Chamber of Commerce.

If the SEC approves the rule, the chamber has threatened to sue the agency, claiming that state securities laws supersede federal authority on the issue.

Martin Lipton, a corporate attorney at Wachtell Lipton Rosen & Katz, argues that shareholders have no legal duties to companies they invest in. If they dislike a company’s performance, shareholders can simply sell their stock.

Shareholder activists reply that many boards are run like country clubs, with managers and directors still cozying up to each other in backroom dealmaking. And, shareholders say, they rarely have a real voice in corporate issues.

When a corporation is in weak hands, says SEC Commissioner Harvey Goldschmid, it’s in the shareholders’ interests and the nation’s interests to make managements and boards more effective.

Under pressure to strike a balance in the rule, the SEC is expected to unveil a final version soon.

Corporations say their boards already are more independent. A Business Roundtable survey found that 70% of the directors on its members’ boards are independent, with no business or family ties to management.

You’d have to be very foolish today to run amok and think the board is your private turf, says Robert Todd Lang, an attorney at Weil Gotshal & Manges.

As the governance debate roars on, the regulatory future is unclear.

Some hope a balance will be struck between the aggressive rulemaking sought by shareholders and the more cautious approach sought by corporate leaders.

Governance is expensive, time-consuming and sometimes burdensome, but it’s serving a good end, Lang says.

Hopefully, things will calm down a bit.