Editor: Each year, a few key issues command the attention of shareholders, regulators and the media as corporations host their annual meetings. What issues do you see getting attention during this year's annual meeting season?
McCarthy: This season promises to be interesting. A federal appellate decision this past September (AFSCME v. AIG) has emboldened activist shareholders - it could open the door to revolutionary changes in governance for some companies. We have a wild card with the SEC's new executive compensation disclosure rules - some companies may have "Dick Grasso" problems. Many companies were pressed to adopt majority voting last year, so that this year we may see some incumbent directors forced off boards.
Editor: Can you explain what majority voting is about?
McCarthy: At most companies, directors seeking re-election run unopposed. Under the minimal "plurality vote" standard required by most state statutes, even if a majority of shareholders vote "no," the director still gets re-elected. A majority voting requirement changes this. If a director doesn't get a majority vote, he or she is required to step down.
Last season, activist shareholders pressed companies to adopt a majority voting standard. Something like 200 companies (including many large companies) adopted either a by-law or a formal policy to require majority voting. Importantly, institutional shareholders supported this movement. Majority voting is no longer an oddity - it's become an accepted part of good corporate governance.
With majority voting, shareholders have a new means to voice their displeasure: a "no"vote isn't just a protest vote. Shareholders can take rifle shots at targeted directors to send a message - without having to run a full-blown proxy contest. Shareholders can vote the chair of the compensation committee out of office, for example, if they don't like the way the company is paying management. They can even vote the CEO off the board, if they don't like the strategic direction of the company. We may see a few rifle shots this year.
Editor: What's AFSCME v. AIG about?
McCarthy: It's about shareholders getting access to the company's proxy statement to nominate competing candidates to the board. This issue has been kicking around for decades. While management gets to use the company proxy statement - at company expense - to nominate its candidates, shareholders don't get access. If shareholders want to contest a director election, they have to use their own proxy statement at their own expense, which is almost always prohibitive.
In 2003, the SEC proposed changes, which weren't adopted. Shareholders would have been able to use the company proxy statement for their nominees in some circumstances. The SEC proposed elaborate triggers for this, including using shareholder approval of a specific Rule 14a-8 proposal as a trigger to require shareholder access.
As the SEC proposal languished, activist shareholders pressed on. A union (AFSCME) targeted AIG. AFSCME used Rule 14a-8 to submit a proposal to amend AIG's by-laws to allow shareholder nominees to be included on the company's ballot. The SEC sided with AIG against this end-run around SEC authority: it allowed AIG to use Rule 14a-8(i)(8) to exclude the proposal so that it never made it to a vote. AFSCME sued. In September 2006, the Second Circuit ruled for AFSCME and against the SEC's reading of the SEC's own rule. The SEC said it would consider rule changes to address this (presumably to vitiate the Second Circuit's decision), but has twice postponed acting.
Into this vacuum, activist shareholders are now introducing AIG-like proposals at scores of companies. Hewlett-Packard will be an early test case. Given H-P's lack of nexus to the Second Circuit, H-P may assert a jurisdictional defense.
It's not clear at this stage whether these proposals will gather the support of institutional investors necessary to adoption. If institutional investors support these proposals the way they supported majority voting last year, the result will be a kind of ad hoc company-by-company adoption of the changes proposed by the SEC in 2003. It could mark a significant change in corporate governance for some companies. We'll see.
Editor: What's the "Dick Grasso" problem?
McCarthy: Last year's executive compensation hullabaloo was over perks: what you had to put in the proxy statement about your jet-setting CEO - these disclosures were mostly a rounding error in the overall compensation picture. This year could be very different. With the new SEC executive compensation disclosure rules in place, we may see a slew of "revelatory" disclosures.
As you'll recall, Dick Grasso was the CEO of the New York Stock Exchange for many years. There was shock and outrage in many quarters when it came to light to that Mr. Grasso was to get a payment of $140 million when he left the NYSE. Eliot Spitzer sued. It's still being litigated. One of the issues was that Grasso's payout got so big because of a "multiplier effect." Increases in Grasso's annual pay triggered increases in his retirement plans. There were questions about whether the board fully understood the total payout to Mr. Grasso as they approved his pay increases over the years.
The new SEC executive compensation disclosure rules will require tables to show the full-amount of these sorts of payouts. Until now, SEC rules haven't required clear disclosure of these amounts. If a company had a "Dick Grasso" problem, shareholders wouldn't necessarily know it. M&A deals have sometimes triggered disclosure of previously undisclosed CEO pay packages - North Fork Bank recently had to reveal a nine-figure payment to its CEO when it was sold to Capital One. The size of North Fork's payment to its CEO made the cover of the Wall Street Journal . Shareholders would never have known that from the annual proxy statements.
The wild card is how many of these nine-figure totals are out there. These totals build over a career; they can get big fast if there's a "multiplier effect" at work. There could be a lot of these nine-figure totals that come to light this year for the first time, not always deserved. It's notable that ISS (the very influential proxy advisory firm) has recently said it will recommend that its institutional investor clients vote against compensation committee members at companies that have poor compensation practices. If a lot of companies have a "Dick Grasso" problem, it may even get the interest of a new Congress in control of the Demo-crats.
Editor: What resources does LawyerLinks offer to help corporate counsel tackle the challenges of this year's annual meeting season?
McCarthy: We're a comprehensive integrated information service for corporate lawyers. There's nothing else out there like us. We integrate rules and current market developments in an easily accessible way. Our service is a very effective tool to keep on top of corporate law developments as they happen.
Published January 1, 2007.
