We are discussing In re Intech Investment Management, a recent administrative proceeding brought by the Commission against an adviser with pro-shareholder voting practices.

Intech put in place a system of voting that tracked an approach apparently developed by ISS in consultation with the AFL-CIO. 

One can imagine, therefore, that the standard more completely tracked the interests of shareholders rather than management.  The release indicated that this was done to attract more union pension business.  Perhaps, but it was an approach to voting that favored shareholders and, presumably, beneficiaries of pension plans.  It was apparently this motivation that caused Intech to be sanctioned.  See In re Intech Investment Management ("INTECH chose an AFL-CIO-based voting platform for all clients without addressing and describing its potential effect on INTECH’s ability to retain and obtain business from existing and prospective union-affiliated clients.")

Intech did disclose the actual voting results to its clients and a significant number (27%) were switched back to the more pro-management platform.  Ultimately, Intech opted to not use the AFL-CIO inspired platform as a default but instead to select as a default platform the approach that "best represent[ed] the client type."  In short, unions were voted in accordance with the union supported platform and company pension plans voted in accordance with the pro-management platform. 

There are several notable things about this case.

First, one suspects that advisers often vote in a manner that is designed to assuage clients and attract additional business.  Thus, having to say that a voting policy can have this effect is in some ways redundant.

Second, one further suspects that the majority of advisers who do this are voting in a pro-management fashion.  In other words, advisers know that in order to attract additional pension plan business from corporations they must vote in a management friendly fashion. Yet the Commission happened to sanction an adviser voting pro-shareholder, remaining silent on what is probably a far more common practice.

Third, the Commission did not in fact establish that the policy implemented by Intech was not in the best interests of the beneficiaries of the pension plans.  The approach clearly was not favored by some of Intech's clients.  These were presumably corporate pension plans, with management of the various companies unhappy with the pro-shareholder voting platform.  The Commission made no attempt to ascertain whether the clients insisting on a change in the voting platform were actually operating in the best interests of their beneficiaries.

This case in the end sanctioned an adviser for voting in a pro-shareholder fashion.  It essentially required advisers wishing to do so to disclose that they are doing so in order to attract additional business, something few are likely to do.  As a practical matter, therefore, advisers are less likely to opt for the pro-shareholder platform. 

On the other hand, the Commission did not impose a similar requirement on those voting in a pro-management fashion.  As a result, advisers can employ a pro-management platform without any revealing disclosure.  It is what most are likely to do.  In short, this case was designed to discourage pro-shareholder voting by advisers.  It is a legacy of the Cox Commission.

We are discussing In re Intech Investment Management, a recent administrative proceeding brought by the Commission against an adviser with pro-shareholder voting practices.

According to the release, Intech had responsibility for voting shares of an assortment of clients, some connected to public companies (pension plans and the like) and others connected to unions. In deciding how to vote the shares, Intech relied on the recommendations of the Institutional Investors Service (IIS), a practice specifically approved by the SEC in its adopting release.  See Investment Company Act Release No. 2106 (Jan. 31, 2003)("Similarly, an adviser could demonstrate that the vote was not a product of a conflict of interest if it voted client securities, in accordance with a pre-determined policy, based upon the recommendations of an independent third party.")

IIS had in place a variety of approaches, at least one of which was pro-management.  Another, developed with the apparent assistance of the AFL-CIO, was more pro-shareholder in the approach to voting.

Intech originally opted for the pro-management approach with respect to all votes.  According to the release, however, Intech switched from a pro-management to pro-shareholder approach to “please its union-affiliated clients” and potentially attract additional union business.  Apparently at the time of the change, Intech did not inform clients that the new policy tracked the voting recommendations of the AFL-CIO.

Intech did, however, send to clients on a quarterly basis a report showing how it voted a client’s shares, apparently causing some expressions of concern.  Ultimately, clients were given an option to choose between a pro-management (called "management friendly" in the SEC release) or pro-shareholder style of voting. Approximately 27% of the clients chose pro-management. Eventually, Intech disclosed to clients that the default system for voting shares was developed by ISS in conjunction with the AFL-CIO and that this could result in the Adviser retaining and obtaining union clients.

The Commission sanctioned Infotech for willfully violating Section 206 and Rule 206(4)-6, apparently for failing to have in place policies designed to vote shares in the best interest of their clients.  According to the release:

• This case involves a registered investment adviser, INTECH, which, from at least 2003 through 2006 (the “relevant time period”), exercised voting authority over client securities without having written policies and procedures that were reasonably designed to ensure it voted its clients’ securities in the best interests of its clients because those policies and procedures did not include how the adviser would address material potential conflicts of interests that may arise between its interests and those of its clients.

The Commission sanctioned the Adviser $300,000 and the responsible official inside the adviser $50,000 (for aiding and abetting). We will give some thoughts on this case in the next post.

We are discussing In re Intech Investment Management, a recent administrative proceeding brought by the Commission against an advser with pro-shareholder voting practices.

The case involved the first apparent enforcement action under Rule 206(4)-6 (adopted back in 2003).  The rule was a response to problems of voting by pension plans and mutual funds (at the same time the Commission imposed disclosure obligations on voting behavior of mutual funds; see Investment Company Act Release No. 25922 (Jan. 31, 2003). 

Pension plans own a large portion of equity shares in the United States.  According to the GAO:  "In 2001, pension plans, as a whole, owned about 20 percent of the total corporate equity issued by U.S. companies, with private pension funds owning about 59 percent of that amount."  This reflects, therefore, a substantial percentage of voting shares and can easily sway votes by shareholders in one director or another.

In voting shares, advisors may have a conflict of interest.  Most noticeably, corporate run pension plans might expect advisors to take a pro-management stance when voting shares.  As a GAO Study noted:

• Business associations between a proxy voter and any entity that may influence their vote presents a conflict of interest. Some experts we interviewed explained that these associations may form whether proxies are internally or externally managed because company management has direct access to the proxy voter who is either an employee, in the case of internally voted proxies, or is a service provider, in the case of externally voted proxies.

The Commission intervened in the area when it adopted Rule 206(4)-6.  The rule required that advisors:

1. Adopt and implement written policies and procedures that are reasonably designed to ensure that you vote client securities in the best interest of clients, which procedures must include how you address material conflicts that may arise between your interests and those of your clients;
2. Disclose to clients how they may obtain information from you about how you voted with respect to their securities; and
3. Describe to clients your proxy voting policies and procedures and, upon request, furnish a copy of the policies and procedures to the requesting client

In short, the approach was limited to disclosure.  There needed to be policies designed to ensure that policies are voted "in the best interests of clients" and provide information to clients on how they voted.  It contained no substantive obligations.  Nonetheless, exposure of the voting process was likely to lead to substantive changes in behavior (see Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure).

In adopting the rule, the Commission recognized the concern over conflicts of interest.  In noting the conflict, the Commission specifically mentioned the problems associated with the management of private pension plans operated by companies.  In other words, the concern was over management's ability to influence the adviser.  As the adopting release noted:

• An adviser may have a number of conflicts that can affect how it votes proxies. For example, an adviser (or its affiliate) may manage a pension plan, administer employee benefit plans, or provide brokerage, underwriting, insurance, or banking services to a company whose management is soliciting proxies. Failure to vote in favor of management may harm the adviser's relationship with the company. The adviser may also have business or personal relationships with participants in proxy contests, corporate directors or candidates for directorships. For example, an executive of the adviser may have a spouse or other close relative who serves as a director or executive of a company.

Given these views and obvious concerns, one would expect the early enforcement efforts to center around attempts to address conflicts between advisers and management.  In fact, this was not the case, as In re Intech Investment Management demonstrated.

By now it is clear that the Commission under the prior Chairman tied the hands of enforcement, interfering with the Division's ability to perform its function.  Certainly this was the point of an article in the Washington Post (In Cox Years at the SEC, Policies Undercut Action).

But perhaps the most damaging legacy was the prior Commission's record when it came to corporate governance.  The Agency sat on reforms of NYSE Rule 452 (broker votes in director elections) and affirmatively denied shareholders access to the company's proxy statement for their nominees (the short sightedness of which will become increasingly clear as the Commission moves forward on that issue). 

A residual of that approach could be seen in a recent case brought by the Commission against an investment advisor.  Although finished under Schapiro, the case was almost certainly initiatied under Cox. In In re Intech, Investment Advisers Act Release No. 2872 (admin proc May 7, 2009), the Commission opted to penalize an investment adviser that maintained a pro-shareholder voting record. 

The voting patterns for advisors are a problem.  Many simply back management irrespective of the merits.  This is particularly true where the pension plan is controlled by management, irrespective of whether the voting pattern is in the best interests of the plan beneficiaries.  Despite these concerns, the Commission under Cox managed to single out an advisor who happened to vote in a pro-shareholder manner.  As with the former Chairman's demonization of "off shore hedge funds," the case reflects an anti-shareholder approach of the prior Commission.  With that in mind we turn to the case over the next several posts.

We will spend a couple of posts examining the case.

Imagine a shareholder who owns 80% of a company but can't get effective control of the board of directors.  That would describe the situation in place now with respect to the government and AIG.  How so? 

The federal government owns almost 80% of AIG's voting power.  The authority to vote the shares has been placed in the hands of three trustees.  Nonetheless, this does not ensure that defeated directors will actually leave office.  AIG, as a Delaware corporation, requires that directors who do not receive a majority submit an irrevocable letter of resignation.  The board, however, has the authority to reject these resignations. As AIG provides in its corporate governance guidelines:

• Voting for Directors. The Board shall nominate for election as directors only incumbent candidates who have tendered, prior to the mailing of the proxy statement for the annual meeting at which they are to be re-elected as directors, irrevocable resignations authorized by Section 141(b) of the Delaware General Corporation Law that will be effective upon (i) the failure to receive the required vote at any annual meeting at which they are nominated for re-election and (ii) Board acceptance of such resignation. . . . The Board shall accept such resignation unless it determines that the best interests of the Corporation and its shareholders would not be served by doing so.

This is in contrast to the somewhat inconsistent reference in the bylaws which cross references the guidelines but merely notes that directors "shall be elected by the vote of the majority of the votes cast."  Even if the government votes against some of the directors, they will remain on the board if the other directors do not accept their letter of resignation.

Of course, if the board does accept their resignation it doesn't get shareholders (including the government) much.  Their resignation creates a vacancy.  Who gets to fill it?  The remaining directors on the board.  See The Corporate Governance Guidelines ("In the event that a vacancy on the Board is created for any reason, and it is determined by the Nominating and Corporate Governance Committee that the vacancy is to be filled, the Nominating and Corporate Governance Committee will consider the views of interested shareholders, as it is deemed appropriate.").

Perhaps given this, the government (as the 80% shareholder) might run a competing slate of directors.  In that case, the process operates not under a majority but a plurality vote system.  Those directors who get the highest number of votes will win which would mean the government nominated directors.  Unfortunately for the government, AIG has an advance notice bylaw (see section 1.12 of the bylaws) that more or less requires a shareholder to submit nominees to the board at least 90 days before the meeting.  As a result, the government is out of luck.  Any attempt to nominate directors would be out of order.

The only hope for the government would be the cumbersome process of calling a special meeting and electing a new board.  For this, AIG was unprepared, at least with respect to an 80% shareholder.  Delaware provides that shareholders may call a special meeting and that the percentage may be included in the bylaws or the articles.  See Del. C. Section 211(d) ("Special meetings of the stockholders may be called by the board of directors or by such person or persons as may be authorized by the certificate of incorporation or by the bylaws.").  AIG has set the bar at 25%, a percentage more or less impossible for shareholders to meet in ordinary times, effectively eliminating the right.  But these are not ordinary times and the government in fact owns enough shares to call a special meeting.

Were this an MBCA jurisdiction, the ability to call a special meeting might hardly matter.  The MBCA allows companies to restrict the shareholder right to remove directors so long as the provision is in the articles of incorporations.  See § 8.08(a) REMOVAL OF DIRECTORS BY SHAREHOLDERS ("The shareholders may remove one or more directors with or without cause unless the articles of incorporation provide that directors may be removed only for cause.").

Under Delaware law, however, directors may be removed by shareholders with or without cause.  See Del. C. Section 141(k).  Of course, there are exceptions and one of them is a staggered board.  In that case, directors can only be removed for cause.  Id.  Moreover, some companies have attempted to limit this removal authority by raising the percentage of votes necessary to replace the board.  See Beal Bank v. Westpoint, 2007 Del. Ch. LEXIS 77 (Ch. Ct. May 30, 2007)(noting that company adopted requirement "requiring a two-thirds supermajority stockholder vote to remove any director—even for cause; a corporation has the right to restrict the ability to remove directors.").  

AIG does not have a supermajority provision, nor does it have a staggered board.  See AIG Articles (this is the only version that we could find online).   The bylaws specify that the shareholders have this authority.  See AIG Bylaws, Section 2.2 ("Any director or the entire Board of Directors may be removed, with or without cause, by the affirmative vote of holders of a majority of the shares then entitled to vote at an election of directors; and any vacancy so created may be filled by the affirmative vote of holders of a majority of the shares then entitled to vote at an election of directors."). 

Thus, the 80% shareholder, in this case, the Government, could replace the board if it went through the cumbersome process of nominating a slate, meeting the requirements of the advance notice bylaw, and requesting that a special meeting be convened.  Moreover, had AIG been better prepared (having a staggered board in place, for example), it could have nullified even this avenue, effectively denying an 80% shareholder any significant say in the management of the company.

As the Obama administration finds itself owning large blocks of stock in public companies, the issue of governance becomes something of more immediate importance.  Nowhere is it more important than with respect to AIG.  Moreover, shareholders, particularly the unions, are seeking to test the Administration's mettle.  We take a look at two posts on the AIG matter.  This one examines the role of the Trustees appointed by the Department of Treasury to handle the 80% of the voting power held by the Government.  The second post examines the utter ineffectiveness of shareholder rights under Delaware law, suggesting that the Government, as an 80% shareholder, may have little say in the management of the company.

AIG has been the largest recipient of federal bailout funds so far.  In return, the government has received, among other things, voting control over the company. The government holds approximately 80% of the voting rights of AIG (see AIG Annual Report on Form 10-K, March 2009 (noting that series C preferred stock is entitled to: "to the extent permitted by law, vote with AIG’s common stock on all matters submitted to AIG’s shareholders and hold approximately 77.9 percent of the aggregate voting power of common stock, treating the Series Preferred Stock as converted.").

The shares are in a trust and three trustees have been appointed.  Who are they?

• One of them is Jill M. Considine, a former chief executive of the Depository Trust and Clearing Corporation and a former banking regulator, now chairwoman of the Butterfield Fulcrum Group in Bermuda, a firm that provides administrative support to hedge funds.

• The two other trustees are Chester B. Feldberg, a former senior official at the New York Fed and a former chairman of Barclays Americas; and Douglas L. Foshee, the chief executive of the El Paso Corporation, a natural gas producer and pipeline operator.

Despite the presence of voting control, the trustees have been quiet.  The NYTimes described them as having "no office, no staff and almost no mission" although they apparently have a lawyer and a part time spokesperson to field media inquiries.  Quiet does not, however, mean inactive.  In fact, they are likely acting in a manner that is the most appropriate for AIG and its shareholders.

The impact of these trustees will become more overtly apparent at the company's annual meeting, now scheduled for May 13 (no proxy statement has yet been filed and AIG has indicated that it will be setting a new meeting date).  As we will discuss in the next post, the Trustees, despite controlling 80% of the vote, have no ability to displace the incumbent directors.  The incumbent board will all be management nominees.  There will be no shareholder nominated directors on the AIG Board.

This does not mean that the Trustees will not have influence over the nomination process.  A number of directors have already indicated that they will not stand for reelection.  Moreover, the delay in filing the proxy statement occurred in connection with a reshuffling of the board, suggesting that more changes at the top are likely.  This suggests that behind the scenes, the Trustees are negotiating over a more independent board.  Indeed, as the NYTimes reports, meetings between the Trustees and management are taking place.

• “The trustees meet once a month in person and have a standing weekly conference call,” the spokesman, Peter Bakstansky, wrote in response to an inquiry. The group is also meeting with A.I.G. executives and government officials, he continued. “And yes, there have been more meetings recently, many in the context of the upcoming A.I.G. shareholders meeting.“

In other words, this is an example of management listening to shareholders and shareholders (actually shareholder) behind the scenes providing input.  Thus, while the directors will all be nominated by management, the nominees will reflect shareholder input.  The SEC tried to do something like this back in the 1990s when it put in place disclosure requirements designed to encourage shareholders to submit nominees to the board.  (This is discussed at length in The SEC, Corporate Governance, and Shareholder Access to the Board Room).  It didn't work. 

This is the type of back and forth discussion that ought to be a regular part of the governance process.  In Great Britain, where the governance code recommends a separation of chairman and CEO, the chairman's role is essentially designed to be a liaison with large shareholders.  Unfortunately, it is not.  Instead, it takes the overwhelming presence of an 80% shareholder to induce this type of dynamic.

It is a pleasure to watch some of the changes taking place at the Securities and Exchange Commission.  With regime change at the top, a corporate governance agenda is quickly taking place.  We expect to see an access proposal shortly (for a history of access, from the 1940s through the present, take a look at The SEC, Corporate Governance, and Shareholder Access to the Board Room).  Rule 452 of the NYSE is about to be amended, preventing broker-dealers from voting uninstructed street name shares for unopposed directors (thereby making it easier for the directors to succeed under a majority vote standard).  Other proposals will be coming. 

With the SEC stepping up to the plate, where is Congress?  Congress has at time expressed grave concern over executive compensation but has done little except to restrict bonuses in financial institutions taking TARP funds. There has been no serious attempt yet to permanently change the way executive compensation is determined. 

One small exception is S 386.  The Act in part extended federal laws to mortgage companies.  In addition, however, it provided funding to beef up enforcement, with funds slated to go to the FBI (to beef up the white collar unit) and the US Attorneys' Office (among other prosecutors).  In the original draft, the bill made no mention of the Securities and Exchange Commission.  Senators Schumer and Shelby are trying to get the bill amended to add in $20 million of additional funding for the Securities and Exchange Commission.

The Agency can use the resources.  In addition, it would be a tremendous moral booster to have the SEC be on the receiving end of good news rather than the butt of relentless criticism.  Hopefully the Schumer/Shelby amendment will make it into the final bill.

One of the most anti-shareholder actions taken by the Commission under the prior regime was to refer a shareholder proposal to the Delaware Supreme Court for an advisory opinion.  This occurred in connection with CA v. AFSCME.  The staff confronted a shareholder proposal that required mandatory reimbursement of proxy expenses for shareholders who nominated a short slate of directors and succeeded in electing at least one to the board. 

The Commission submitted the matter to the Delaware Supreme Court, with the Court taking the matter despite a likely violation of its own rules.  The Court issued a poorly reasoned, predictably anti-shareholder opinion.  (The Court ignored meritorious arguments that were raised and discussed at oral argument). 

In doing so, the case provided a legal basis for companies to argue that a wider set of shareholder proposals should be excluded under Rule 14a-8 of the proxy rules as a violation of state law.  It was, on the part of the Commission, a step entirely inconsistent with the Agency's shareholder protection mandate.  We on this Blog have called on the Commission to disavow the authority and commit to leaving it dormant. 

In addition to the philosophical problem of an ostensibly pro-shareholder agency submitting a matter to an anti-shareholder court, the more salient issue was that it was entirley unnecessary.  And that point brings us to Kistefos AS v. Trico Marine Services. 

Plaintiff submitted a shareholder proposal to management to be voted on at the upcoming shareholder meeting (the proposal was a tougher majority vote proposal than what the company had in place).  The board opted to exclude the proposal as inconsistent with the company's articles and under state law.  Plaintiff sought an expedited hearing in order to address the issue before the shareholder vote. 

What did Chancellor Chandler do?  He refused to rule on the merits, allowing the vote to take place.  If the proposal failed, it would moot the issue.  If it passed, the company could implement it.  In other words, the merits might become irrelevant.  As a result, he refused to give an advisory opinion and instructed the parties to return only if there was still a dispute following the vote.  As he wrote:

• The stockholders will vote on Proposal 8 at the annual meeting, and if the proposal receives the required number of votes, then the issue will be preserved and ripe for judicial review. Additionally, pending the stockholder vote on Proposal 8 at Trico’s 2009 annual meeting, the issue of the legal validity of Proposal 8 is not ripe because the relevant events that must occur before the issue requires adjudication—namely, the approval of Proposal 8 by Trico’s stockholders—may never occur. Absent some compelling reason to do otherwise, this Court should refrain from rendering an advisory opinion where adjudication of the issue is not needed for there to be an informed stockholder vote on the proposal.

This is exactly what the SEC should have done in CA v. AFSCME.  The Agency should have allowed the proposal to be included in the proxy statement and voted on by shareholders.  It might have failed or mangement might have agreed to implement it.  There was no need to submit the matter to the Delaware Supreme Court for an advisory opinion, particularly one likely to be anti-shareholder in its result. 

Should the Commission consider this approach again, it should take advise from Chancellor Chandler and eschew advisory opinions.

I went to the eulogy for Diane Sanger, my former boss from the SEC who passed away last December at the age of 55.  It was held at the SEC's office in Washington at 100 F St. 

Back in the 1980s, I was a staff attorney in the counseling section of the General Counsel's Office.  Diane was, at the time, the Assistant General Counsel over the group that reviewed anything corporate finance related.   This meant takeovers (which, back in the 1980s, was a hot area), insider trading (remember the whole Drexel/Milikin era?), and corporate disclosure (recall Carnation, the case that discussed the materiality of ongoing merger negotiations, even before Basic).  We reported to Elisse Walter (now Commissioner Walter) who was the associate general counsel and then to Dan Goelzer, the General Counsel (who is now on the PCAOB).

Elisse was there and spoke, carrying her own words and those from Dan Goelzer.  Former Commissioner Steven Wallman spoke, as did Ralph Ferarra, a former General Counsel who hired Diane back in 1979.  An assortment of friends and family members also shared some thoughts and observations.  In the audience were a host of other illuminaries (Mary Schapiro attended at least part of the eulogy) and staff of the Commission

The comments were thoughtful and accurate.  Diane spent her career at the SEC, joining almost thirty years ago.  She was razor smart and, as one speaker described, "relentless in her pursuit of the the right answer."  During those three decades, she was singularly devoted to the mission of the SEC and its investor protection goal.  Others described her courage (Diane was injured in college and consigned to a wheel chair) and strength, her sense of humor, her bluntness, and her inability to suffer fools.  It was also clear that for many people (myself included) she was a mentor and/or friend.

There is a plan to create a Diane Sanger speaker series.  When the information is made available, we will put up a post.

Chairman Schapiro gave a speech to the Council of Institutional Investors and outlined some of the SEC's corporate governance agenda.  Some are important but relatively uncontroversial.  She mentioned the possibility of stepped up disclosure about director nominees, something long overdue.  More importantly, however, the Chairman noted the possibility that the SEC would begin to delve into the problem of board structure.  As she noted:

• We'll also be considering whether boards should disclose to shareholders their reasons for choosing their particular leadership structure — whether that structure includes an independent chair, a non-independent chair, or a combined CEO/chair.

This Blog listed as an agenda item for the SEC the use of disclosure to try to encourage the separation of chairman of the board and CEO, a separation common overseas but not in the United States.  By combining the two positions, public companies in the United States more or less give to the CEO a monopoly over the information funneled to the board.  This by definition makes it harder for the board to monitor the activities of the CEO, a primary function of the body.  Those serious about corporate governance reform know that these positions need to be separated.

The proposals represent a first, albeit very small, step in that direction.  They entail an attempt by the SEC to influence corporate governance through the only means available:  disclosure.  As discussed at length in Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure, the Commission has attempted to use disclosure to affect substantive board behavior in a number of instances, ranging from an effort to improve disclosure of beneficial ownership to exerting downward pressure on executive compensation. In most instances, however, the approach has proved ineffective.

The same will likely be true in this case.  CEOs want to remain chairman because of the control that it provides.  With most large companies having a super-majority of "independent" directors (89 of the 100 largest companies in one survey), these directors have few sources of information about the company except what they get through their position on the board.  As a result, the position of chair, with its control over information and agendas, becomes even more critical.

To the extent that the SEC moves forward with these disclosure provisions, it will force boards to justify why they have in place a system that puts the fox in charge of the hen house.  But they will do it (most likely with boilerplate) rather than actually separate the two positions.  Why?  Because the costs of any bad publicity are outweighed by the desire of the CEO to retain control over the body that can fire him or her.

The Wall Street Journal reported the Obama administration has forced the resignation of General Motors CEO Rick Wagoner. Wagoner served as CEO since 2000, but has been with the company for 31 years. Although he has overseen GM during some of the company’s most turbulent times, GM’s stock price has fallen from $70 per share at his appointment in 2000 to $2.88 earlier today. Below is a table detailing the compensation Wagoner has received over his time as CEO. GM has yet to file its proxy statement for 2008.

The big news on Sunday was that the Obama Administration insisted on the removal of Rick Wagoner, the CEO at General Motors as a precondition for any additional bailout money.  As the article summarized:

• Mr. Wagoner has been CEO since 2000 and has managed the company through some of its most difficult moments. The company has not logged a profit since 2004, reporting losses since then of $82 billion, and it nearly ran out of money at the end of 2008 before the Treasury Department provided emergency loans. GM's stock was trading above $70 when Mr. Wagoner took over as CEO in June of 2000. Shares closed last week trading at $3.62, placing the company's market capitalization at $2.21 billion.

The degree to which these circumstances can be blamed on Wagoner is not clear (turning a huge barge like General Motors is not a simple matter).  But it seemed clear that as General Motors tottered on the edge of bankruptcy and the Company asked for additional government money, a change in management was in order.  As usual, the salient question is where was the board of directors? 

As the announcement was being made that the US government had to step in and do the board's job by insisting on regime change, the board of Peugeot Citroën did its job and removed its CEO.

In addition to demonstrating continued weakness in the system of corporate governance in the United States, the act demonstrates the unfortunate ad hoc practice still taking place in the federal government with respect to these corporate governance problems.  Congress wants to take away the bonuses paid by AIG, the Obama Administration wants to replace management.  These are tasks that rest with the board.  It is not useful to interfere with board duties on a case by case basis.  This entire problem screams for systemic solutions, none of which are apparently under serious consideration.

Later in the week we will propose a legislative solution, at least with respect to the executive compensation problem.  It is time to move beyond an ad hoc approach and beyond temporary reform that is limited only to companies taking public funds.

In re Parmalat Sec. Litig. , 2009 WL 179920 (S.D.N.Y. Jan., 2009).

Paramalat SpA collapsed in 2003 after the discovery of immense understatements of debt and overstatements of assets. The international extent of the fraud has garnered a lot of attention from accounting firms worldwide, with the latest U.S. ruling causing particular concern.

Plaintiffs filed a derivative suit under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 against Deloitte Touche Tohmatsu (DTT) alleging vicarious liability for fraud committed by member firm Deloitte Italy. The District Court for the Southern District of New York denied plaintiff’s motion for summary judgment under both the respondeat superior claim and the joint and several liability claim.

The court first rejected defendant’s contention that Stoneridge foreclosed secondary liability for Exchange Act claims under common law. The court related that Stoneridge did not foreclose the principle of respondeat superior, and principals may be held expressly liable for violations of Section 10(b) by their agents.

The court then addressed whether DTT was in fact a principal of Deloitte Italy by analyzing the elements of control. The court found several factors that mitigated in favor of substantial control. Those factors included but are not limited to DTT requiring 1) adherence to policies, and protocol regarding professional standards and methodology; 2) specific methods and procedures for conducting audits; 3) member firms to sign a license agreement mandating compliance with quality standards; 4) use of the DTT name; and 5) authority to transfer employees from one member firm to another, without the transferring firm’s permission. Finally, there was evidence that DTT exercised authority specifically in the Paramalat engagement.

The court then denied the motion for summary judgment under both the theory of respondeat superior and the issue of control. The court stated that DTT’s “general structure”—encompassing its authority over member firms—accompanied by its specific use of authority in this particular engagement, presented genuine issues of material fact as to whether Deloitte Italy was an agent of DTT leaving the issue of respondeat superior for the fact-finder. Turning again to the issue of control, the court rejected the contention that DTT did not control Deloitte Italy under the language of the statute. The court rejected this argument stating that the Section 20(a) does not require control of a particular violating transaction, but only control of a person or entity liable under the chapter.

DTT then proffered good faith as an affirmative defense. The court recognized that while there may not be evidence that DTT had reason to know of the fraud, or recklessly disregarded it, this did not demonstrate good faith. The court noted that this assertion neglects to encompass the possibility that DTT was willfully blind to the violations. Additionally, while DTT argued that appropriate compliance review systems were in place, the court stated that this is only a factor in evaluating good faith, but is not dispositive. The court further held without evidence of how systems were implemented during the time in question, the court could not find good faith.

The defendants next contended that DT-US did not control DTT and is therefore entitled to summary judgment. To this, plaintiffs argued that 1) many DT-US partners occupy important management positions at DTT; 2) that member firms, including DTT depend of DT-US for funding; and 3) there are specific instances where DT-US played a key role in DTT’s decision-making. The court held that each of these factors alone is not dispositive, but cumulatively show a genuine issue of fact as to DT-US’ control of DTT. The court also rejected DT-US’ assertion of good faith because the evidence does not sufficiently address willful blindness. Arguments that Copeland, CEO of DT-US and DTT were not in control or acted in good faith where quickly rejected based on his status in the company and a lack of evidence for the affirmative defense.

Finally, the defendants contend that they were not joint and severally liable because Section 21D(f)(2)(A) of the PSLRA limits joint and several liability to knowing violations of the securities laws, not merely reckless violations. The court rejected this argument based on legislative history.

The implication that accounting firms may be held liable for actions by their foreign affiliate may be welcome news to investors, but is sending shockwaves through the accounting world.

The primary materials for this post are available on the DU Corporate Governance Website.

The Center for Capital Markets of the Chamber of Commerce issued a report recently titled "Examining the Efficiency and Effectiveness of the US Securities and Exchange Commission."  Among the proposed reforms were changes to the system of issuing no action letters.

We have listed the recommendations from the report below.  We make this general observation, however.  While we have no doubt there can be problems with the current system (particularly delay), it represents an informal way to obtain the written views of the staff.  The suggested reforms (adoption of guidelines, the discontinuance of no action letters of general applicability, responses within 90 days, and the annual adoption by the Commission of "significant staff positions") would rigidify the no action letter process.

Ultimately, it would make it harder to get answers and would probably cause the staff to insist on far more supporting analysis, dramatically increasing the costs associated with the process.  What would be gained in certainty would be lost in flexibility.  It is always a temptation to want rigid rules for every process, something that essentially ties the hands of the bureaucracy by reducing its procedural discretion.  But at the same time, the system provides a mechanism for informal written advice, with the advice available to others with the same issue.  The proposed reforms take into account the need for certainty and consistency but do not take into account the impact on cost and flexibility.

Recommendation 1—The Commission should rationalize the current system of informal guidance by reducing the number of vehicles it uses to provide guidance. Each operating division should develop a web-based system of Compliance and Disclosure Interpretations (CDI), which should replace Staff Legal Bulletins, FAQs, summaries of staff comment letters, small entity compliance guides, and interpretive letters.

Recommendation 2—The Commission should publish guidelines distinguishing the use of no-action letters and exemptive orders.

Recommendation 3—The practice of issuing no-action letters of general applicability should be discontinued in favor of exemptive orders or emergency orders, as appropriate.

Recommendation 4—Each division should post on the SEC Website a list of the staff members, with e-mail addresses and phone numbers, who are authorized to provide informal assistance on specified topics, with all substantive responses promptly posted on the web-based CDI system, following supervisory review.

Recommendation 5—Each division should attempt to provide a final response to a no-action request within 90 days of receipt. To promote compliance, each division should be required to send a quarterly advice memorandum to the Commission identifying all requests pending for 90 days or longer. The memo would identify the issues presented that must be resolved and provide a target date for resolution. The division should also indicate if it is unlikely that a no-action letter will be issued.

Recommendation 6—A no-action letter should be viewed as informal guidance rather than a method of setting regulatory policy. Because it is often difficult to distinguish interpretation from policy on a prospective basis, the Commission should annually issue interpretive statements that review, adopt, and codify significant staff positions contained in no-action letters. These releases could also be used to withdraw or revise a no-action position previously taken, based upon new facts or an analysis of how it has been interpreted. The Commission should issue these interpretive statements following an opportunity for public notice and comment. The original recipient of a no-action letter could continue to rely upon the assurances provided in the letter. Any revisions or changes reflected in the Commission interpretative release would apply prospectively to third parties.

The Center for Capital Markets of the Chamber of Commerce issued a report recently titled "Examining the Efficiency and Effectiveness of the US Securities and Exchange Commission."  Of the 23 recommendations, seven of them call for an assortment of structural reforms.   We have listed them below.

A handful are hard to argue with.  They included a call for the creation of a Chief Operating Officer (the idea that the Chairman could benefit from additional professionals with specific oversight tasks is hard to argue with), greater coordination among the different divisions, increased staff expertise with respect to the operations of business and the capital markets, and the development of management program to transfer information.

There are two in particular that deserve a bit more comment.  One proposal calls for a division that regulates both brokers and advisors, at least those providing services at the retail level.  Moreover, the Report indicates that the inspection process should be part of this Division.  No more OCIE in short.  Whether market oversight and retail financial services can be so readily divided is not at all clear.  Nonetheless, the notion that advisors and brokers are regulated in separate silos within the SEC is something that ought to be reexamined.  Madoff had both a broker and served as an advisor. 

Each service came under a separate division, with the inspections conducted by a third.  In truth, where retail investors used to access the markets through their neighborhood broker, it is probably the case that this happens more and more often through investment advisors. 

Whether OCIE should be rolled into the combined division is another interesting question.  The Inspection Office was made independent of the operating divisions in part to provide greater independence (and avoid capture).  At the same time, independence probably resulted in a loss of expertise.  Recombining OCIE with the operating divisions will provide heightened expertise but create potential problems of capture.  The true reforms necessary in OCIE go less to location and more to the nature and quality of inspections.

As for the proposal to weaken the Sunshine Act, the report seems to view the Act as an impediment to staff meetings.  It is true that when the commissioners meet collectively it can trigger an obligation under the Act to hold an open meeting.  When I was in the General Counsel's Office, there were a number of occasions when I would walk a matter to one commissioner, get his/her views, then  walk to another until all five had considered the matter.  By meeting with each individually rather than collectively, we avoided triggering the meeting requirement.

Having said that, there is nothing in the Act that prohibits one or two commissioners from meeting with the staff and going over concerns.  Before the Act is weakened (it is after all an important mechanism for ensuring that the public is allowed to witness the decision making process of the Commission), further study needs to be conducted as to whether in fact it really interferes with Commission/staff interaction.

Recommendation 1—The Division of Trading and Markets and the Division of Investment Management should be realigned into a Division of Investor Protection and Retail Financial Services Regulation and a Division of Market Oversight and Operations. The Examination Programs of the Office of Compliance, Inspections, and Examinations (OCIE) should be assigned to these new divisions.

Recommendation 2—The SEC should create an accelerated conditional approval process for new investment products or services.

Recommendation 3—The five-member Commission should play a greater ongoing role in the interpretation and application of regulatory policy. This may require Congressional action to amend the Government in the Sunshine Act (Sunshine Act) that was passed in 1976 that, among other requirements, mandates that every portion of every meeting of an agency shall be open to public observation. Although the Act was developed to create greater openness in government, it has had the unintended consequence of restricting valuable communications between Commissioners and SEC Staff.

Recommendation 4—The SEC should create a Chief Operating Officer (COO) position with sufficient authority to oversee daily operations throughout the SEC.

Recommendation 5 —The SEC should establish a coordinating council, chaired by the COO, to resolve issues or disagreements involving more than one division or office.

Recommendation 6—The SEC should expand the breadth of its staff expertise. Legal and accounting expertise should be complemented with staff experts in capital markets operations and the business operations of regulated entities as well as financial economics.

Recommendation 7—The SEC should develop a knowledge management program to transfer information and expertise between divisions, preserve the knowledge and experience of departing staff, and provide future staff with ready access to materials explaining and documenting the analysis and reasons for actions taken or not taken.

Back in the 1980s, I worked in the counseling side of the General Counsel's Office at the SEC.  My boss was Diane Sanger, then an Assistant General Counsel.  She was one of, if not the smartest person I knew at the Commission and tough as nails, not something that earned her kudos with everyone in the Agency.  When we talked about pretty much every legal issue (and the 1980s was the era of takeovers, insider trading and the disclosure of merger negotiations), she would profess to wonder why corporate disclosure was such a tough issue.  She would sum it up by saying "Just tell the truth."

It was with great sadness that I only learned that Diane passed away in December, apparently unexpectedly, at the terribly young age of 55.  There will be a memorial at the SEC in April.  She was a good mentor and someone that embodied the goals and philosophy of the SEC at its best.

When we did a series of posts on corporate governance agenda items for the new Commission, we strongly urged the Commission to consider action in the area of shareholder communications and voting.  Clearly, the Commission needs to simplify direct communications between shareholders and companies.  This means reform of the shareholder communication rules, rules that are currently a mess. 

In addition, however, we also recommended that the Commission move on the rule proposal submitted by the NYSE that would prevent brokers from voting uninstructed shares for directors.  Under NYSE Rule 452, brokers may not cast uninstructed shares on controversial matters.  This prevents these shares from having any significant influence on most matters of importance to shareholders.  There is, however, one significant exception. The provision applies to any matter that is "the subject of a counter-solicitation, or is part of a proposal made by a stockholder which is being opposed by management (i.e., a contest)" but does not apply to the unopposed election of directors.  In an era where unopposed directors must increasingly be elected by a majority of the votes cast, the broker votes can be outcome determinative. 

Back in 2006, after a study of the issue, the NYSE sent a proposed rule to the SEC to do away with discretionary voting in director elections by brokers.  The SEC sat on the proposal, inactivity the rule of the day.  We have learned from the Shareholder Communications Coalition that the NYSE has resubmitted the proposal and the SEC intends to take it up. 

It is an important albeit long overdue step in the governance area. 

For more on the problems of the shareholder communication rules, take a look at The Shareholder Communication Rules and the Securities and Exchange Commission: An Exercise in Regulatory Utility or Futility?

Section 111 of the Stimulus Bill requires the SEC to implement the say on pay provisions.  Senator Dodd wrote to the SEC setting out his views on the implementation of Section 111.  Specifically, he indicated a view that the Section did not require the implementation of say on pay for any TARP companies that had already filed a proxy statement (preliminary or final) with the SEC.  The SEC staff has provided guidance on the issue and responded to Senator Dodd.  We print the SEC response below.

 The Division staff is following the views expressed in Chairman Dodd's letter to Chairman Schapiro.

Question 1

Question: EESA Section 111(e)(1), as amended, is titled "Annual shareholder approval of executive compensation" and provides that any proxy or consent or authorization for "an annual or other meeting of the shareholders of any TARP recipient" shall permit a separate shareholder vote on executive compensation. Is a separate shareholder vote on executive compensation required for any meeting other than the annual meeting of shareholders for which proxies will be solicited for the election of directors or a special meeting in lieu of such annual meeting?

Answer: No. [Feb. 24, 2009]

Question 2

Question: EESA Section 111(e)(1), as amended, refers to the compensation of executives "as disclosed pursuant to the compensation disclosure rules of the Commission (which disclosure shall include the compensation discussion and analysis, the compensation tables, and any related material)." Smaller reporting companies are not required to provide compensation discussion and analysis under Item 402 of Regulation S-K. If a smaller reporting company is subject to the Act's say-on-pay provision, must the smaller reporting company provide compensation discussion and analysis disclosure?

Answer: No. [Feb. 24, 2009]

Question 3

Question: A company that determines to comply with EESA Section 111(e)(1), as amended, by including its own proposal to have shareholders approve executive compensation will be required to file a preliminary proxy statement pursuant to Exchange Act Rule 14a-6(a). If the company faces special circumstances and would like to request acceleration of Rule 14a-6(a)'s ten-day review period, how should it proceed?

Answer: The company should contact the Assistant Director of the office that reviews the company's filings to discuss the special circumstances the company faces and how the ten-day review period could be accelerated. [Feb. 24, 2009]

Question 4

Question: EESA Section 111(e)(1), as amended, states that the TARP recipient "shall permit a separate shareholder vote to approve the compensation of executives." Does this mean that the TARP recipient only needs to permit a shareholder vote if it receives a shareholder proposal on approving executive compensation?

Answer: No. The statute does not condition the requirement for a vote on the receipt of a shareholder proposal on approving executive compensation. Senator Dodd stated in his letter to Chairman Schapiro, "The law is intended to require a yearly vote by shareholders." [Feb. 26, 2009]

Question 5

Question: Can EESA Section 111(e)(1), as amended, be satisfied by a TARP recipient if it includes a shareholder proposal on "say on pay" in its proxy statement?

Answer: This provision calls for a shareholder vote on executive compensation as disclosed pursuant to the Commission's compensation disclosure rules. A shareholder proposal on "say on pay" that only asks the company to adopt a policy providing for annual shareholder votes on executive compensation in the future would not satisfy this requirement. The statute instead requires an actual, non-binding vote by the shareholders to approve executive compensation. [Feb. 26, 2009]

So, was President Obama correct in his State of the Union of the following:

• And I intend to hold these banks fully accountable for the assistance they receive, and this time, they will have to clearly demonstrate how taxpayer dollars result in more lending for the American taxpayer. (Applause.) This time — this time, CEOs won't be able to use taxpayer money to pad their paychecks, or buy fancy drapes, or disappear on a private jet. Those days are over.

The amendments to TARP in the Stimulus Bill edge in this direction but do not guarantee that this will occur.  The legislation hardly touches fancy drapes and private jets.  It merely requires the boards of TARP participants to have a policy in place with respect to excessive expenditures in this area.  Nonetheless, as a practical matter, things are not as usual.  While boards could put in place policies that still allow for corporate aircrafts or expensive remodelings by the CEO, it is unlikely to do so.  The policies will likely be more restrictive than what is legally required (which, under Delaware law, is almost nothing). 

In other words, the practices will decline.  But to ensure that this occurs, the SEC needs to require companies to make those policies public.

As a final post in this series, we note some additional provisions in the Stimulus Act that do not specifically expand the SEC's authority but are worthy of comment.

In addition to a compensation committee consisting of independent directors, TARP dips directly into the governance process.  The compensation committee must meet at least semi-annually and must "discuss and evaluate employee compensation plans in light of an assessment of any risk posed to the TARP recipient from such plans."  In other words, the legislation preempts state law by dictating the minimum number of meetings and by prescribing at least some of the tasks that must be undertaken by the committee.  This was done in SOX with respect to audit committees.  See Rule 10A-3, 17 CFR 240.10A-3. 

While these provisions are not as detailed as those required for audit committees, there is a profound difference in the regulatory approach of the two laws.  In SOX, the requirements were imposed as a listing standard.  Listing standards do not currently provide for a private right of action.  Moreover, the exchanges have historically had issues with enforcement of their own rules.  For a mix of posts on the subject, go here, here and here.  The topic is also discussed at length in Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure.  The provisions in TARP are not listing standards but substantive requirements imposed directly by the statute.  The relevant federal agencies can enforce them.

In addition, TARP now requires that boards put in place a "company wide policy regarding excessive or luxury expenditures, as identified by the Secretary." The provision lists topics that "may" be included. The list is predictable and includes: "(1) entertainment or events; (2) office and facility renovations; (3) aviation or other transportation services; or (4) other activities or events that are not reasonable expenditures for staff development, reasonable performance incentives, or other similar measures conducted in the normal course of the business operations of the TARP recipient." 

That federal law must dictate this demonstrates how little is required of boards under Delaware law.  If directors already had to do this under state law, there would be no need to have federal standards.  The provision, therefore, is a reflection of the utter lack of standards under state law.  The one irony of the requirement though, is that it might actually encourage remodeling and personal use of aircraft.  In identifying "excessive" expenditures, the board will, by definition, be defining a category of expenditures that are not excessive.  Thus, offices can be remodeled as long as they fall under the "excessive" standard.

With respect to these provisions, the SEC needs to improve disclosure.  The Commission should require all disclosure of the analysis employed by the compensation committee in connection with its review of the TARP requirements.  With respect to the excessive expenditures, the Commission should mandate disclosure of the policy.

For more on the subject, see Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure.