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From the Chairman & the President
Dear Members, It's a very real pleasure for us to announce the winner of this year's Bracebridge H. Young Distinguished Service Award: Earl Franklin, Vice President and Secretary, Eaton Corporation. The Society's Distinguished Service Award was established in 1988 and was created to recognize persons who have rendered unusual or exceptional service, or service rendered over a period of years, that directly furthers the Society's goals in a significant manner. The award, which is determined by the Chairman and President of the Society, is the Society's highest honor. The award was renamed the "Bracebridge H. Young Distinguished Service Award" in 1997 to honor Bracebridge Young, one of the five signers of the Certificate of Incorporation of the Society when it was formed in 1946. In 1954, Mr. Young became the Society's president, and served the organization for 16 years. Society membership doubled to almost 2,000 during his tenure. This year's winner, Earl Franklin, has served the Society with great distinction. He has been a panelist at National Conferences and Essentials courses from 1989 through this year. He has served as the Ohio chapter's treasurer, secretary, vice president and president. Mr. Franklin has been on the Corporate Practices Committee since 1990, was a member of the Executive Steering Committee in 1999-2000 and served on the National Conference Committee in 2003-2004. And, as if all of that weren't enough, he served on the Society's Board of Directors from 1995-2000 and was the Society's Secretary from 1995-1997. Thank you, Earl, for the tremendous work you've done for the Society for the last 16 years. We look forward to your continued service, support and wisdom. The award presentation will be made at this year's National Conference in Los Angeles. We hope many of you will have a chance to attend what is sure to be a great conference. As you've probably heard, we're doing something a bit new this year: There will be a 1-day version of our Essentials Course on Tuesday, June 21, at the same hotel as the Conference, the Westin Century Plaza Hotel and Spa. The Essentials is a great way to introduce someone to the basics of the corporate secretary's job or to refresh the memory of anyone who hasn't taken the seminar in a while. On Wednesday, June 22, we'll have our pre-Conference panels on "Supporting Ethical Behavior in Corporations" and "Coaching for Effective Leadership." And then it's off to the races as the full Conference, with all of its timely business and wonderful social programs, kicks into gear. One of the most important sessions at the Conference is our annual meeting. If you haven't already, please be sure to vote your proxy, which you can do online at the Society's website at: www.governanceprofessionals.org/annreport.shtml [The meeting having been held by the time of this posting, the proxy-voting mechanism has been closed. You may still read the annual report online if you wish.] From Kathy: I'd like to thank the members of the Society for the chance to serve as your chairman this past year. It was a privilege and an honor. I wish good luck to Susan Wolf, Bill Mostyn and our directors as they lead us toward our 60th Anniversary in 2006! -- Kathy Gibson & David W. Smith
Majority Voting: Karl Barnickol InterviewThe National Office's Geoff Loftus interviewed Karl Barnickol (via e-mail) on the topic of majority voting. Mr. Barnickol is a former chairman of the Society, and he worked at Solutia Inc. as Senior Vice President, Secretary and General Counsel. He is currently a partner at Blackwell Sanders Peper Martin in St. Louis. Loftus: Just to make sure everyone understands what we're talking about, could you define "majority voting" as it applies to corporate shareholders? And how is it different from the current voting system? Barnickol: Under a majority voting system, director-nominees who do not receive the affirmative votes of 50.1% percent of the shares voted would not be elected to the board. Under the current system, directors are elected by a plurality: The candidates receiving the largest number of votes for the open positions are deemed elected. With the plurality system, you could imagine an extreme case where all the shares were withheld from a particular director except the shares owned by that director, who voted for himself or herself. If the number of nominees equals the number of open positions -- the situation at most annual meetings -- then that director would be elected based only on his/her own votes. Loftus: Could you give us the background story on what's brought majority voting to the front burner, so to speak? Barnickol: In a speech to the Society's June 2004 National Conference, Vice Chancellor Leo E. Strine of the Delaware Court of Chancery raised the issue, favoring the majority-vote approach over the SEC's pending rule proposal to allow shareholder nominations in management's proxy statement if certain precursor events have occurred. The Chancellor suggested that the SEC's proposed rule was an indirect, cumbersome, and possibly ineffective method of addressing the concerns of some shareholders regarding the process of electing directors. At roughly the same time, and following on through 2004 into 2005, there has been much debate on the proposed rule and not much progress toward its adoption -- possibly having the effect of tabling the proposal indefinitely. Thus, some shareholder activist groups now see majority voting as a more promising route to achieving their objectives. Adoption could come in several ways:
The laws in some states -- notably California -- would require amendment to implement a majority voting system, since they currently mandate plurality voting. Importantly, several unions filed about 80 shareholder proposals during the 2005 proxy season, seeking votes on precatory proposals calling for by-law amendments to adopt majority voting. The SEC has decided that these proposals cannot be excluded, adding to the impetus for majority voting. Loftus: What are the pros and cons of majority voting? Barnickol: The primary appeal of majority voting is that it appears more democratic. It seems unfair for a director who has received what amounts to a vote of "no confidence" -- more than 50% of the shares withheld -- to nonetheless be elected because he/she received more votes than any other candidate. In the typical annual meeting there is no "other candidate" because the number of nominees equals the number of open seats. Many argue that a "withhold" vote on a proxy should have more impact than mere moral disapproval. They point to majority voting requirements in major European countries, including the United Kingdom. There are several disadvantages. Following the SEC's rule proposal for shareholder nomination of directors, the Society conducted a poll to evaluate the likely impact. One finding of that poll is that an ISS recommendation will generally swing 25-30% of the vote. ISS has some rules about voting against directors, e.g., if they fail the 75 percent board meeting attendance test, regardless of the reason. If you add the noise-level withheld votes -- often from unionized employees and unhappy retirees holding shares through the company's 401(k) plan -- you are getting much closer to 50.1 percent. On the other hand, it has been suggested by some commentators that, if the vote had real consequences, the proxy advisory services and the public and union-sponsored pension funds might be more restrained in their use of the "withhold" vote. There are also technical problems created by the proposal. In a majority voting system, how would abstentions and broker non-votes be counted? State laws vary, and the result would be different from state-to-state. If a nominee is rejected, what happens to the vacant seat? Typically, the board has the authority to fill vacancies, but in this situation, would that be acceptable to shareholders? Would another meeting need to be convened quickly? Additional concerns include the accuracy of vote counting under the current system and the difficulties for corporations in communicating with their shareholders under the NOBO/OBO rules, which have been pointed out to the SEC in the rule-making proposal of the Business Roundtable of April 12, 2004. Given the serious consequences of failure to elect a nominee to the board, the impact of these concerns warrants study. Loftus: If majority voting were adopted, what kind of changes would that cause in the lives of corporate secretaries and general counsels, especially with regard to the proxy? Barnickol: Obtaining a positive recommendation for your director-nominees from proxy advisory services would become much more critical. For example, it is often difficult to get ISS's attention to the situation of an individual company during proxy season. At least one of the services, Glass-Lewis, does not take input from the company. Nominating committees would need to be advised of any facts about a nominee that would tend to make him or her "unelectable," even those which the directors might regard as insignificant. Proxy statement text may need to be expanded to incorporate explanations of situations involving individual directors which might trigger automatic withhold votes from institutional investors. If the company has shareholders holding large blocks, their voting policies on directors will need to be reviewed and personal contacts may need to be added to the proxy solicitation process. Corporate secretaries and general counsel, who are already overwhelmed during proxy season, would have to make time for these additional tasks. Loftus: Could you comment on the March 13th memo of Martin Lipton (Wachtell, Lipton, Rosen & Katz) titled "Majority Vote to Elect Directors"? He seems to feel that majority voting would give activists a disproportionate leverage. Barnickol: Lipton raises several concerns about the majority voting proposal. He makes the point that, if the standard is that the withheld shares need only be a majority of the votes cast, then the director election process is, as a practical matter, subject to undue influence from blocks of activist shareholders, such as union pension funds. He argues that rejection of a director nominated by an independent nominating committee and the board is a decision of such importance that it should require a majority of the outstanding shares, as do other fundamental corporate matters subject to a shareholder vote. His proposal would reduce the leverage of the activist holders and alleviate somewhat the impact of an adverse recommendation from ISS and the other proxy advisory services. It also solves some of the technical problems with a majority vote rule, such as the ambiguities about abstentions and broker non-votes. Loftus: Do you think that majority voting, if implemented, might make it even more difficult to find people willing to serve as directors? Barnickol: I imagine there will be some diminution of the pool of director candidates. Some individuals who would now be considered will be found to have "disabilities" known to trigger negative recommendations from the proxy advisory services or negative votes from key institutional holders. Few companies will want to nominate (or re-nominate) a candidate that they know is at risk of being voted down and few individuals will want to take the reputational risk that might flow from a negative result. Combined with the current trend for companies to restrict the number of outside boards on which their CEO and/or other senior officers can sit, this will be another factor making the already difficult job of finding suitable outside directors even more problematic. The rule changes adopted in the wake of the Sarbanes-Oxley Act have already started a trend toward older mandatory retirement ages. If majority voting is adopted and you have directors who do not have problems getting a comfortable majority of "for" votes, why throw them out?
Relying On Corporate Documentation In The New Hostile Corporate EnvironmentBy Robert J.A. Zito Robert J.A. Zito is a partner at Schiff Hardin LLP, resident in the New York office. He recently spoke about crafting corporate minutes at a Society NY Chapter meeting. Lessons learned in the courtroom are invaluable in the boardroom. Three years ago, I defended the first class action under Section 14 of the Securities Exchange Act of 1934 to be tried before a jury. The plaintiffs' case comprised two causes of action. The first was for alleged disclosure violations under the Section 14, and the second was for breach of fiduciary duty. The proponent of the proxy, the general partner of the public limited partnerships being solicited, had sought permission to sell various assets of the partnerships to an entity related to the general partner, in a self-dealing transaction. Although the proxies were voluminous and disclosed extensive information regarding the transaction, the jury returned a verdict in favor of the plaintiffs on both counts. Curiously, the damages awarded on the fiduciary duty count were significantly more than the damages awarded on the securities count, even though the theory of damages should have been identical for both counts. This suggested that the jury was focused more on fiduciary duties than on the actual disclosure employed in the proxy materials. Indeed, the jury's findings on the breach of fiduciary duty count probably influenced the additional finding of a securities violation. The juror interviews produced startling revelations for me. When I asked jurors to identify the most compelling evidence against the defendants, they identified the proxy statements themselves. However, when asked whether the proxy statements were false or misleading, as required for a finding of liability under Section 14, the jurors responded "no." Instead, they pointed out that in their view "admissions" were made in the proxy statements. The so-called "admissions" were certain hard disclosure portions of the proxy statements. The jurors said that the general partner admitted to a litany of diligence failures in the proxy statements, such as not performing appraisals of the assets being sold, and not shopping the assets to third parties. While there may have been some very good business reasons for not completing such tasks, there were few corporate records documenting the reasons. The lawyers representing the company no doubt believed that disclosure would suffice. Those who have spent time in the boardroom are familiar with discussions about the intricate diligence issues associated with a transaction. When the diligence process begins to appear burdensome, complicated, expensive or impractical, directors and other executives look to lawyers for a way out. Lawyers often will offer disclosure as a practical alternative. From a jury's perspective, however, disclosure is no substitute for good old-fashioned diligence. Diligence is something that is understood, especially in today's hostile corporate environment. Disclosure, on the other hand, is a concept that is alien to anyone other than lawyers, judges and chancellors. That a director might be able to disclose away his or her fiduciary obligations, even if serving the interests of time and money, is something that the average juror will find counterintuitive. Boards and their counsel must establish that a fair process was employed in reaching a particular business decision. The more successful they are in doing this, the more likely it is that the decision will be able to withstand scrutiny. Being able to prove that a fair process was implemented is crucial in any transaction challenge. In an acquisition, for example, there can be a myriad of reasons for not obtaining every possible form of valuation, fairness opinion or other kind of professional advice. But the rationale for this process needs to be articulated, vetted and documented. Here is where carefully crafted minutes can be invaluable. In the past, conventional wisdom has suggested keeping corporate minutes brief and general. The litigation strategy was that the less class action lawyers knew, the less they could use in a complaint, with an uninformed complaint being more vulnerable to dismissal. This pas de deux, however, is becoming increasingly obsolete and ineffective. In the age of the Internet and EDGAR, it is naïve to think that sparse corporate minutes keep information away from stockholder lawyers. Rather, carefully crafted minutescan provide a board with an effective tool for demonstrating that the directors were diligent, and that they discharged their duties. Board minutes are increasingly becoming the central evidence in stockholder disputes. What exactly these minutes provide can mean the difference between victory and defeat in the courtroom. In re the Walt Disney Company Derivative Litigation, 825 A.2d 275, (De. Ch. 2003), which involves an attack on the company's board in connection with the compensation of Michael Ovitz, is instructive in this regard. There, on a motion to dismiss, the Chancellor scrupulously reviewed the minutes of the board. By comparing the amount of ink spent on each individual agenda item, the Chancellor was able to make a determination about how much time was spent on each such item. In employing such an approach, the Chancellor was able to conclude what was important to the board during the relevant time period and what was not. Under the Walt Disney Company analysis, brief and general board minutes run the risk of the conclusion that the issues described in such minutes were unimportant to the directors, or that they received short shrift. In the final analysis, every director must assume that his or her action is potentially the subject of scrutiny by a jury, judge, chancellor or regulator, and must prepare accordingly. Any analysis that uses disclosure as a substitute for process risks failure under scrutiny. Likewise, any process that is not documented by carefully crafted minutes, that accurately reflect the amount of time spent on the issues in the boardroom, risks failure in the courtroom.
Committee NewsSecurities Law Committee All three committees met in Washington, DC, on May 25, in connection with the Securities Law Committee's annual spring meeting with the Securities and Exchange Commission.
Corporate Practices Committee
Public Company Affairs
Membership UpdateThis year's membership campaign ended with a successful March as the net monthly increase of 26 brought total membership to 3,924 at March 31, 2005. Although this represents twenty fewer members than one year ago, the number of companies is higher. A significant part of this year's success was the high number of current Society members recommending new members – 194 members recommended 216 new members during the campaign. The top recruiter among members from non-vendors was Linda Kolodny, Senior Legal Analyst with Kraft Foods, Inc. in Northfield, Illinois, who recommended three new members. The top recruiter among vendor members was Carolyn Coffey, Corporate Compliance Consultant with Corporation Service Company in Denver, who recommended six new members. Congratulations to Linda who won registration, hotel and travel to a regional fall conference of her choice, and to Carolyn who won $1,000! The campaign prize drawing was held recently at the National Office; a recruiting member's name was entered for each new member recommended. The winner was Barbara Van Horn, Secretary of T. Rowe Price Group, Inc. in Baltimore, and the prize is registration, airfare and room at the 59th National Conference in Los Angeles. Finally the two campaign prizes for chapters have been determined. The $1,000 Chapter Recruitment Prize goes to the Houston Chapter. The $1,000 Chapter Retention Prize goes to the Ohio Chapter. Thank you all for your part in this year's campaign!
Key Facts from the Annual Meeting Survey
Survey respondents: 247. For questions about this survey, contact Blanca Rosbach (brosbach@governanceprofessionals.org) or Sara Sprague (ssprague@governanceprofessionals.org).
Book Review by Darla Stuckey: Conspiracy of FoolsBy Darla Stuckey Society Member Darla Stuckey has been Vice President and Senior Assistant Secretary of American Express Company since October 2004. Prior to holding this position, she was the Corporate Secretary of the New York Stock Exchange from January 2002 to September 2004. She is a member of the bar of New York and New Jersey. Conspiracy of Fools, by Kurt Eichenwald, a reporter for The New York Times, is a useful primer for corporate secretaries and governance officers. For this group -- us -- Eichenwald's reporting is more than a page-turning corporate cautionary tale. The book offers a well-crafted glimpse into the depths of the triple threat at Enron: its managers, its Board and its accounting firm. With this retelling of the Enron scandal, we can hopefully guard against any such future fiasco. The book reveals a totally mismanaged company run by executives who were inept, but obsessed with making their quarterly numbers; a Board that was too deferential; and an accounting firm that clearly valued its client's wishes over its own professional standards. This book is reminscent of Woody Allen's movie Melinda & Melinda -- telling the same story twice, once as comedy and once as a tragedy. Many scenes are pure comedy until you remember that because of these self-important fools and the fraud they perpetrated, all corporations are now living with sweeping and expensive regulatory consequences. There are many "show-stopping" scenes, but those below are particularly telling in the way they portray Lay, Fastow, and how the Board functioned at two crucial times. Ken Lay grew increasingly out of touch and ineffective as a leader. In 1999, he thought that perhaps his management team was "too big for their britches," so he brought in Michael Milken to speak to the group on the "value of humility." The irony is delicious. At the end, however, both Milken and Lay were nothing more than the butt of jokes.
Fastow comes across as greedy -- beyond the pale. For example, when Enron's treasurer proposed that the company buy out Chewco, a special purpose entity set up by Fastow and cohort Michael Kopper, to avoid the "headache" of valuing Chewco's assets to determine Enron's profits, Fastow asked for an 8,000 percent return.
Only months later however, with McMahon replaced, Fastow came back and got the deal done. Kopper and Fastow got their ten million dollar profit; Enron bought out Chewco for $35 million. Overseeing Lay and Fastow was the Enron Board. Where were the Board members and what were they doing while Enron was hiding the quality of its revenues from the Street? And how could the Enron Board have approved the special purpose entities Fastow created that let him serve as general partner when it was so clearly a conflict of interest? The description of the June 28, 1999 meeting at which Fastow seeks Board approval for the first LMJ partnership is illustrative.
The Board was not so passive, but nonetheless similarly misguided, when it approved a $2.25 billion purchase of UK based Wessex Water Service -- allowing Enron to enter the water business -- just days after overbidding by some $600 million to buy Elektro, Brazil's sixth-largest electricity distributor.
After 20 minutes in executive session, the Board reconvened for a vote.
These two events alone were probably enough to sink Enron, although at the end of the day, Enron had $15 billion invested in businesses that simply did not make financial sense. Why did the directors approve of the transactions? Did they ask enough questions, or the right questions? Were they afraid to show their own ignorance? Were they too accommodating of a Chairman, CEO, and CFO who were hyped by Wall Street and the financial press? These questions can be debated and doubtlessly will in the court of public opinion. But you won't be able to engage in the debate unless you have read this wonderful book. Having spent three years researching Enron, Eichenwald perhaps knows more about Enron than anyone else. And he has given us the poignant, frustrating and incredible story in a way that is very readable. To quote Eichenwald in a New York Times interview about the book's overarching lesson: "Whenever the crowd is bellowing that the old business rules no longer apply, sell your stock. They always apply. All that changes is mass delusion."
The Corporate Secretary & Governance Professional is published quarterly throughout the year as a service to members of the Society of Corporate Secretaries and Governance Professionals. Articles or statements appearing herein do not constitute legal opinion, advice or judgment and should not be relied upon as such. Inquiries regarding the content of this newsletter should be directed to Geoff Loftus: (212) 681-2000, gloftus@governanceprofessionals.org. Inquiries regarding membership or publication orders should be addressed to:
Society of Corporate Secretaries and Governance Professionals membership
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