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ISS Conference Highlights Emerging Corporate Governance Issues

The post-Enron period led to a hallmark in shareholder activism, but last year saw less confrontation during the proxy season, according to Patrick McGurn, the executive vice president of Institutional Shareholder Services. The number of shareholder withhold votes has steadily dropped since 2003, partly due to the new listing standards and more constructive engagements with shareholders, he explained. McGurn, speaking at ISS's annual conference, said the top issues in the coming years will include changes in the election of directors from a plurality to a majority vote, determining whether boards should be led by independent chairs or lead directors, accountability on such issues as classified boards and poison pills, issues relating to executive compensation, the involvement of hedge funds as shareholder activists and corporate social responsibility.

McGurn noted that former SEC Chairman William Donaldson left the Commission with an unfinished agenda, including the proxy access proposal. The momentum from that stalled initiative has now jumped over to a majority voting bandwagon, he said. McGurn believes that majority voting proposals will dominate the 2006 proxy season. There is a sea change in support, he advised.

McGurn reported that the main issues that trigger votes against the reelection of directors are ignoring majority votes on shareholder proposals, excessive nonaudit fee payments, the adoption of poison pills without shareholder approval, affiliated outsiders on key committees, poor attendance and service on too many boards. Board independence has improved, he said, but related party transactions involving CEOs have actually gone up since Enron. McGurn believes that issue will be a priority this year.

Executive compensation is "the big wasteland" in corporate governance, according to McGurn. He said the process is broken. McGurn cited recent studies that link excessive executive pay to increased incidences of fraud, earnings restatements and shareholder litigation. One study found that once an executive is given personal use of company aircraft, corporate performance begins to slide. Surveys suggest that linking pay to performance is the most important reform, but there is no agreement on the best way to do so. McGurn predicted that there will be more "claw backs" in which companies take back some of the CEO's pay after an earnings restatement.

Hedge funds are playing a significant role in the markets, and their short term focus is an emerging issue, McGurn said. He cited Carl Icahn's reincarnation as an activist hedge fund manager in which he has won board seats, forced buybacks, scuttled deals and waged proxy fights.

Among the social issues in the forefront are global warming and environmental risks. McGurn noted that shareholders now couch their proposal in terms of market risk. Social issues continue to draw support and more companies are settling with shareholders. McGurn predicted that the hot topics in the coming proxy season will be Sudan , terrorism and soft dollars.

During a second panel discussion, Ira Millstein, a partner with Weil, Gotshal & Manges, debated ISS CEO John Connolly on what Millstein sees as a conflict of interest in ISS's consulting and standard setting functions. ISS is in a special position, Millstein said. It provides standards for corporate governance that are privately prepared through an unidentified process. ISS provides company ratings and companies also pay ISS for consultancy on how to improve their ratings, Millstein noted. He said that ISS is capable of rendering a major public service, but it would appear more credible if it were mutualized and if it opened up its process. If ISS continues to provide individual company ratings, Millstein said they should be based on demonstrable performance. He suggested that ISS divest its consulting business rather than hold seats on both sides of the table.

Connolly said that ISS obtains feedback from the marketplace in developing its policies. He added that the company's integrity is not for sale, and sees no conflicts between its consulting and standard setting. Connolly advised that 95% of ISS's clients renew every year.

A third panel discussion included Damon Silvers with the AFL-CIO, Mari-Anne Pisarri with Pickard & Djinis, and Edward Knight with the Nasdaq Stock Market, Inc. Knight reported that the markets and the listed community have adapted quickly to the Sarbanes-Oxley Act requirements with the exception of section 404 which is distinct from all other issues. The costs have fallen more heavily on smaller companies and are not going down, he reported. The U.S. markets are facing a lot of competition from the London Stock Exchange, he said, which is taking advantage of the fact that it does not have to comply with SOX. However, Knight believes that eventually there will be a convergence of requirements.

Pisarri said the major developments in the investment company and investment adviser areas are the enhanced focus on what it means to be a fiduciary, the aggressive enforcement climate, both at the SEC and by state attorneys general, and the push-back from regulated entities to regulators. She said she cannot recall a time when there were three pending lawsuits against the SEC for rules that it adopted.

Silvers predicted that the business community will lose its fight against greater shareholder involvement in the election of directors. SOX addressed a whole string of problems but hit a roadblock with the very issues that led to Enron and WorldCom, he said, which is the accountability of corporate executives. He believes the SEC will take up an executive compensation initiative and expects a big fight.