Governance Roundup

February 13, 2017

Significant Pension Shortfall Worldwide

     MSCI issued a report after examining the pension funding status of nearly 5,300 companies across North America, Western Europe, Asia-Pacific and Japan.1  The report identifies severe underfunding of pensions worldwide, finding:

BlackRock’s Fink Calls on CEOs for Adjusted Strategies, Pension Fix

     In his recent annual letter to CEOs, Larry Fink once again put corporate leadership on notice that BlackRock is watching and will act, particularly in these turbulent times.

     Fink, the head of BlackRock, the world’s largest asset manager, reminded CEOs that just because investors are thinking long term does not mean that they have infinite patience. Investors are looking for corporate leadership in the boardroom and the C-suite to deploy assets for sustainable value creation – including investments in people – not just to boost short-term stock prices:

     Companies have begun to devote greater attention to these issues of long-term sustainability, but despite increased rhetorical commitment, they have continued to engage in buybacks at a furious pace.  In fact, for the 12 months ending in the third quarter of 2016, the value of dividends and buybacks by S&P 500 companies exceeded those companies’ operating profit.  While we certainly support returning excess capital to shareholders, we believe companies must balance those practices with investment in future growth.  Companies should engage in buybacks only when they are confident that the return on those buybacks will ultimately exceed the cost of capital and the long-term returns of investing in future growth.

     In addition to investing in internal training, Fink called on companies to step forward and provide new solutions to our inadequate retirement system, which now increasingly places the burden of retirement savings on the employee rather than the employer:

[A]s major participants in retirement programs in the U.S. and around the world, companies must lend their voice to developing a more secure retirement system for all workers, including the millions of workers at smaller companies who are not covered by employer-provided plans.  The retirement crisis is not an intractable problem.  We have a wealth of tools at our disposal: auto-enrollment and auto-escalation, pooled plans for small businesses, and potentially even a mandatory contribution model like Canada’s or Australia’s.

. . . If we are going to solve the retirement crisis – and help workers adjust to a globalized world – businesses need to hold themselves to a high standard and act with the conviction that retirement security is a matter of shared economic security.

Center for Audit Quality 10-Year Look Back and Forward

     The Center for Audit Quality celebrated its 10th anniversary with a conference that included a discussion on upcoming developments and an assessment of the organization’s progress since it was first created as a response to the Enron-era series of accounting failures.2  Committed to the notion that accounting is “a force for good,” director Cindy Fornelli emphasized the profession’s commitment to “independence, objectivity, and skepticism.”  Many participants discussed the need for cybersecurity experts and greater sustainability (including non-GAAP reporting) disclosure, as well as the importance of maintaining international collaborations.

     Though the speakers generally agreed that the Sarbanes-Oxley Act of 2002, which created the Public Company Accounting Oversight Board, has been successful, it is not without fault.  Former SEC Chair Mary Schapiro said, “In terms of the outcomes of the law, it’s been highly successful, though that doesn’t mean there aren’t things you need to tweak.”  Former SEC Chair Harvey Pitt supported the legislation when it passed, but stated he would have preferred making it a part of the Securities Exchange Act of 1934.  Some speakers expressed concern about overloading the board, especially the audit committee, and the consensus was that with issues like cybersecurity, the committee should be responsible for ensuring a system is in place, not for performing the checks itself.

     Many participants voiced apprehension regarding the new administration’s more insular, protectionist approach to international affairs, which might lead to withdrawal from essential international coordination efforts, leaving a gap in leadership.  Pitt said, “If we do not participate, it will diminish our impact . . . and our ability to compete in a global marketplace.”

JPMorgan Chase to Pay $264 Million to Settle Foreign Bribery Case

     JPMorgan and its Hong Kong subsidiary agreed to pay $264 million to settle charges relating to a vast foreign bribery scheme.  The case involved JPMorgan’s hiring practices in China, where it gave jobs to the children of Chinese leaders to win business.  The government charged that some of those hired were not qualified and were paid in excess of their abilities and assignments.  Banks, including HSBC, Goldman Sachs and Deutsche Bank, have hinted that they face investigations into their hiring practices in China, but it is unclear whether or how the Trump administration will pursue further cases.

CEO Turnover Increases

     In The New Yorker, James Surowiecki explains why boards are increasingly willing to fire CEOs:3

     Business professors once talked about “the imperial C.E.O.,” but, increasingly, we’re in the era of what Marcel Kahan, a law professor at N.Y.U., calls “the embattled C.E.O.”  He told me, “Big shareholders and boards of directors have more power, and are more willing to use it.  And C.E.O.s have been the net losers.”  The breakdown of the old order began more than thirty years ago, but things have accelerated since the turn of the century.  The Sarbanes-Oxley Act, passed in 2002, required greater disclosure to investors, and increased the independence of corporate boards.  “In the old days, boards were often loyal to the C.E.O.,” Charles Elson, a corporate-governance expert at the University of Delaware, told me.  “Today, they’re more loyal to the company.”  The rise of activist investors – who campaign aggressively for change when they’re not satisfied with performance – has exacerbated the trend.  One study found that when activist investors succeed in winning seats on the board of directors the probability that the C.E.O. will be gone within a year doubles.

     The information revolution has created other dangers for C.E.O.s.  In the social-media era, damaging stories travel fast, and boards take public relations very seriously.  P.R. disasters have sealed the fate of top executives at no fewer than five advertising companies this year.  (The most notorious example was at Saatchi & Saatchi: the chairman resigned after telling a reporter that he didn’t think gender inequality in the industry was a problem.)

Teamsters Pension Fund Asks the McKesson Board to Claw Back CEO Pay

     General Secretary-Treasurer Ken Hall of the International Brotherhood of Teamsters wrote to the board of McKesson asking them to get back millions of dollars of incentive compensation from chief executive John H. Hammergren, citing damage to the company’s reputation caused by its role in the opioid crisis.4  Hall said that under Hammergren, the company “repeatedly [fell] down on its number one priority,” the safety and integrity of its supply chain.  He called on the board to establish a special committee to investigate the claims made by West Virginia that the company’s actions were “illegal, reckless, and malicious” in “flooding” the state with 100 million illegal opiate doses over a five-year period.

British Prime Minister Theresa May Promises Corporate Governance Reform

     Prime Minister May is expected to release a proposal in the near future to implement some of her promised corporate governance reforms, including “advisory” employee representatives on board compensation/remuneration committees, binding votes on executive pay, and the mandatory publication of pay ratios.

Tata Governance Upheaval Raises Question About Independence of Boards in India

     Without following its own procedures, Tata Sons abruptly ousted independent Chairman Cyrus Mistry, who claims there was “a total lack of corporate governance” at the family-dominated company, with two of its independent directors “reduced to mere postmen,” acting as a rubber stamp for whatever the insiders wanted.  One of these directors is Harvard Business School Dean Nitin Nohria.  Tata Sons is now seeking the removal of another independent director at some of its separately listed operating companies who has backed Mistry.  As top proxy advisory firm IiAS notes, allowing large block shareholders to remove independent outside directors undermines the purpose of having independent directors and any benefit they provide to minority shareholders.  Lawyers Tejesh Chitlangi and Puneet Shah write:5

     The Tata-Mistry row unveils the sad state of corporate governance in the country.  The current scheme of things should give sleepless nights to a regulator such as the Securities and Exchange Board of India (Sebi) which, along with the stock exchanges, seemingly had no clue of the wrongs (if the concerns highlighted in Cyrus Mistry’s letter are even partially true) being perpetuated for the past many years.

*  *  *

A strong framework of listing regulations, disclosure requirements and securities laws alone cannot safeguard investor interest if implementation is missing. Sebi and the stock exchanges, as first-line regulators, should have been pro-active and stepped in to control the damage.  Even in the aftermath of the Tata-Mistry spat, no strong message has been conveyed by the regulator to restore investor confidence.  The regulator must chip in before the situation worsens.

Call for Update to U.K. Corporate Governance

     In a letter to the FT, Mazar Board Practice head Anthony Carey calls for an update to the now quarter-century-old Corporate Governance Commission best practices:6

     The research by academics at Lancaster University (“‘Negligible’ link between CEO pay and investor value boosts case for shake-up,” December 287) raises challenging questions, for instance on how to set the criteria for executive bonuses.  But it would be best for any review to look at corporate governance in its broader context.

     It will be a quarter of a century next year since the publication of the Cadbury report and the development of the UK’s first corporate governance code.  Progress has been made on a number of areas since then, but it would be timely for a corporate governance commission to be set up to look at reforms needed to enable companies to achieve long-term sustainable success that benefits all their direct stakeholders and wider society.  The commission would build on the work of the parliamentary inquiry under way and the recent green paper on corporate governance reform, and should be made up of representatives of all key stakeholders – independent and executive directors, other employees, investors, consumers and civil society.

     It would have a full agenda: the merits of companies having an inspiring purpose and clearly articulated values; board composition; setting the right “tone from the top”; engagement with, and the fair treatment of, stakeholders including setting remuneration across the business; ensuring investors have due regard to the interests of the ultimate beneficiaries of the shares they hold; the promotion of innovation and building the societal license to operate.

     Remuneration has dominated the dialogue in the UK between boards and investors for the past 20 years since the publication of the Greenbury report.  For the next two decades it will be in the interests of business and the society of which it is an integral part for the discussions to range more widely and more deeply.

Nine Democratic Senators Ask the Wells Fargo Board for More Information

     Members of the Senate Committee on Banking, Housing, and Urban Affairs have written to the Wells Fargo board of directors to ask for further information about the systemic fraud that led to the opening of millions of unauthorized accounts and a settlement that included a $185 million fine.8 Noting that former CEO John Stumpf failed to answer many questions when he appeared before the committee, the letter says that “continued failure to answer questions does nothing to restore the trust of Wells Fargo’s customers and shareholders.”  The requested information includes the members of the special board committee leading the independent investigation, the reasons for delay in launching the investigation, the scope of the investigation (including the time period and issues covered), the board’s involvement in the company’s responses to the questions and requests for information at the hearing, and the date on which Wells Fargo’s auditors raised the unacceptable sales practices with a board member.  It is significant that this letter is addressed to the board and not the new CEO, staff, or counsel.

President Trump’s First 100 Days

     With a new President and Republicans in the majority of both the House and Senate, we can expect to see several pieces of new legislation passed very quickly. We will be looking carefully at efforts to roll back the post-Enron and post-meltdown reforms, with many corporations preparing alterations to consumer and employee protections under the new administration and the Republican-controlled Congress. Look for them to be disguised as “reform,” as pointed out by Adam J. Levitin in American Banker:9

     The financial services industry is pushing hard for Congress to change the single director Consumer Financial Protection Bureau into a multimember commission under the guise of “good government.”  Let there be no mistake what this is really about: the proposal for a commission structure is a backdoor attack on the very existence of the CFPB as an agency.

     The financial services industry doesn’t have the courage to attack the CFPB, an immensely popular agency, directly.  So instead, the strategy is to try to render it ineffective by changing it from a single-director structure to a five-member commission.

What Will Exxon Do About Rex Tillerson?

     Now that Exxon CEO Rex Tillerson is the new Secretary of State, many important issues about conflicts of interest have been raised given Exxon’s extensive international operations – especially those in Russia.  It also raises questions about Tillerson’s holdings and departure package, similar to the concerns raised regarding Dick Cheney’s departure from Halliburton. In Cheney's case, his exodus was characterized as a retirement rather than a resignation so that his options would be vested immediately.  In December 2016, Jena McGregor reported in The Washington Post:10

     As CEO of one of the largest and most powerful public companies in the world, Tillerson received compensation valued at $24.3 million in 2015, and he ranked 29th on a list of the 200 highest paid CEOs compiled by the executive compensation research firm Equilar.  The pension benefits he will receive, accumulated over more than 40 years at the company, have been valued at $69.5 million.  And in a company document filed earlier this month, ExxonMobil said Tillerson has direct ownership of more than 2.6 million shares of ExxonMobil stock, which executive compensation experts say Tillerson will presumably have to divest if he is confirmed as the nation’s chief diplomat.

     Yet the majority of those shares – 2 million of them, valued at nearly $185 million based on ExxonMobil’s closing share price Friday [December 9] – are not yet vested.  That means that the shares have been granted to Tillerson but that he doesn’t yet have outright access to them.  ExxonMobil has an unusually long vesting schedule and clearly states in its filings that retirement does not speed up the vesting of those shares, meaning many of them aren’t currently due to be under Tillerson’s control for years.

     Now that the company has announced Tillerson will retire at year’s end and be succeeded Jan. 1 by Darren Woods as chairman and CEO, its board is faced with a nine-figure dilemma: Should it accelerate the vesting of those shares, rewarding Tillerson for his 41 years of service just before he could take a job that has enormous influence over the geopolitics that will affect his former employer?  Or should it stick to the terms in its filings, which have been cited for their good governance standards?

1    https://www.msci.com/documents/10199/904da30f-d851-4c48-bcfc-5e5f76d3335b
2    http://www.thecaq.org/
3    http://www.newyorker.com/magazine/2016/11/07/why-c-e-o-s-are-getting-fired-more
4    https://teamster.org/sites/teamster.org/files/gstmckessonletteropioid.pdf
5    http://www.livemint.com/Opinion/RFpq2bL7kvEYsgQKjVSVVM/Time-to-fortify-corporate-governance.html
6    https://www.ft.com/content/d703af88-c922-11e6-8f29-9445cac8966f
7    https://www.ft.com/content/abc7085e-c857-11e6-9043-7e34c07b46ef
8    https://www.warren.senate.gov/files/documents/2016-12-22Letter_to_Wells_Board.pdf
9    https://www.americanbanker.com/opinion/what-the-cfpb-commission-debate-is-really-about
10  https://www.washingtonpost.com/news/on-leadership/wp/2016/12/14/the-188-million-question-about-exxon-ceo-tillerson-joining-trumps-cabinet/?utm_term=.4f5461409c48

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