Mark Gilbert Has Forgotten the Meaning of Capitalism

On Bloomberg, Mark Gilbert asks:

Should the investment arm of one sovereign nation be using its financial muscle to influence salary policies in other sovereign nations, setting principles which then guide how it votes in particular examples?

It isn’t surprising that he gets the wrong answer, calling the sovereign wealth fund’s votes against excessive compensation “mission creep.” He’s asking the wrong question. It should be: “Should a major shareholders who is a sophisticated institutional investor have the right to exercise its independent judgement on matters legally required to be put to a shareholder vote?”

The answer is yes. That is what capitalism means. A provider of capital has certain rights granted to ensure confidence in the markets through transparency, accountability, and structural limits on conflicts of interest. To put it another way, who is in a better position to evaluate CEO pay, the board members selected by, paid by, and informed by the CEO him or herself or a fiduciary shareholder obligated to deploy its resources to maximize returns for its beneficial owners?

Gilbert presents no evidence that these actions are taken for any reason other than the creation of shareholder value, a case he cannot make for the design of most CEO pay plans. On the contrary, he quotes the fund’s policy approvingly, noting that

it would back remuneration policies that are “driven by long-term value creation and aligns CEO and shareholder interests.” Pay packages should be transparent, pension entitlements should be only “a minor part” of total packages, while a “substantial proportion” should be in the form of equity that’s locked in for “at least five and preferably 10 years.”

His objection is Norges’ conclusion that its efforts should “moderate pay levels in the longer term.” Of course, he has no basis for arguing that this goal, even if achieved, would be anything other than beneficial to shareholders.

Toshiba Listing Tests Ability of Tokyo Stock Exchange to Protect Investors

The Nikkei Asian Review writes that the recent decision to allow Toshiba to continue to be listed on the Tokyo Stock Exchange — by a single vote — raises questions about its ability to protect investors.

The TSE’s philosophy on how to handle corporate wrongdoing has changed considerably over the past 15 years. When Seibu Holdings unit Seibu Railway and cosmetics maker Kanebo were kicked out in 2004 and 2005, punishment was seen as the best way to protect the principles of the market, and delisting was often the first response to severe infractions. But shareholders did not take kindly to the strategy. On top of a sliding stock price, delistings robbed them of the opportunity to trade their shares at all, the argument went.

The exchange now does all it can to avoid giving companies the boot, instead supporting their rehabilitation. The “securities on alert” system was introduced in 2007 as a means of enforcing regulations without imposing undue harm on shareholders, giving companies a period of time to turn themselves around under the bourse’s supervision — 18 months, under the latest rules.

While the designation limits such activities as fundraising, shareholders can continue to trade. Major companies with the resources to make improvements “hardly ever end up delisting,” a former Financial Services Agency official said.

Toshiba pushed limits of TSE’s rehab regime

Improving Corporate Governance and a Strong Free Press are Essential for Emerging Economies

At the Dubai Global Financial Forum, Arif Naqvi, who heads the region’s largest private equity firm, Abraaj, said that the term “emerging markets” (EM) should be replaced by “global growth market.” But he emphasized that:

“The only sense in which they [emerging markets] are still emerging is in terms of governance and transparency,” he declared.

He explained that corruption, lack of transparency and a general refusal to “play the game” by EM corporates had affected the view of western and other investors, and resulted in lower valuations, higher risk assessments and a reluctance to commit capital on the part of big western investors used to their own, generally much higher, standards of governance.

Some experts now argue that governance, or rather the lack of it, is a far more important investment criterion than geography or industrial sector. A well-run, transparent company will always carry an investment premium for big western investors, regardless of where it happens to be in the world, or what business it is in.

Executives of EM companies regularly pay lip-service to the need for better governance, and in some cases actually implement policies — codes for financial reporting, remuneration and recruitment — that might facilitate it.
Corporate governance, or lack of it, may be a better guide in determining what constitutes an emerging market rather than geographical location in the modern investment world.

But the problem stubbornly remains, and the most significant factor that remains behind virtually all cases of the EM discount is simple: Government control and interference.

Emerging media necessary to help ensure global standards of corporate governance

Report: Conflicts of Interest on the FINRA Board

Ann Marsh of Financial Planning says that a new report documents conflicts of interest on the FINRA board, the self-regulatory body with jurisdiction over financial services.

A new report by a group of securities arbitration attorneys calls into question FINRA’s ability to protect investors given alleged conflicts of interests on its board.

The report was issued Wednesday morning by the Public Investors Arbitration Bar Association, whose members represent investors in legal disputes with FINRA member firms. The group raises concerns about five of FINRA’s 13 public governors and one recently departed governor who now sits on the Federal Reserve’s Board of Governors.

FINRA’s board is comprised of 24 members. Among them, 10 have open industry ties consistent with the nonprofit’s public-private status as a self-regulator of the financial industry. Another 13 seats are designated to public members, intended to represent investors. The remaining seat is for FINRA’s CEO.

VEA Vice Chair Nell Minow was quoted:

“It’s just a disgrace,” says corporate and nonprofit governance expert Nell Minow. “These conflicts of interest are a monstrous issue. It destroys any credibility that the organization has at all.”

Minow, who is vice chairman of ValueEdge Advisors in Portland, Maine, was not involved in PIABA’s report. “This is exactly the reason that we don’t like to see industries regulate themselves,” she says. “Normally it takes a government agency at least a generation to become completely captive to industry. But in a self regulatory system, it takes five minutes….”This is not the fox guarding the henhouse,” she says of FINRA’s governance issues. “This is the fox eating all the hens.”

Performance-Based Compensation May “Die” Under the Tax Cut Legislation

An amusing but telling “obituary” for performance-based compensation by Dan Walter outlines the consequences of doing away with the tax benefits for pay linked to stock price increases.

The proposed tax reform bill of 2017 would eliminate many of the time-tested and successful components of equity compensation, effectively removing one of the three legs of many companies’ three-legged stool of compensation philosophy.

Under the proposed rules:

Appreciation vehicles such as stock options and SARs would be taxed at vesting, instead of at the time of exercise. This would effectively shorten their useful lives from potentially 10 years to perhaps 4 or 5 years. It would also make the use of these tools for pre-IPO or other illiquid companies too risky to be a recommended practice.

Full value vehicles like RSUs, would be taxed much as they are today, but with far less flexibility in deferring income or linking vesting to performance conditions.

Performance vested awards would be taxed immediately, instead of at the time of performance achievement and associated vesting. While these are currently investors’ preferred tool for executive long-term incentives, the change in taxation would make them a punitive form of pay beginning in 2018.

It appears that all outstanding equity would be subject to these rules as of January 1, 2018. This would result in changes for both companies and employees that would include the death of long-term motivation and retention tools, immediate taxation for employees, acceleration of expense associated with all equity-based incentives and much, much more.

Presumably, cash bonuses tied to financial metrics or other performance goals would still be available.

Judge Allows Shareholder Suit Against Wells Fargo Directors to Go Forward

A shareholder suit against the directors of Wells Fargo for negligence and complicity in the creation of millions of fake accounts for the fees has survived an effort at dismissal, raising the possibility of a very rare ruling of liability for board members.

[Judge John Tigar] found the complaint properly laid out evidence showing executives and directors made false statements about the scheme in the bank’s filings to the U.S. Securities and Exchange Commission…Tigar found the bank’s board members and managers knew about the illicit account-creation scheme by 2014 and also knew they’d made false statements in securities filings about the program, designed to bump up bonuses for Wells Fargo employees.

“Just as it is implausible that the director defendants were unaware of the account-creation scheme given the extent of the alleged fraud and the number of red flags, it is implausible that Wells Fargo’s senior management, involved in the day-to-day operations of the bank” weren’t aware of the effort, the judge said.

See full article on Bloomberg

Cardinal Health Agrees to Shareholder Proposals

With Cardinal Health’s surprise announcement early Monday that it will separate the roles of chairman and CEO and fill the chairman position with an independent director, the Teamsters claimed victory in their push to get the company to do that.

“Cardinal Health’s announcement of leadership changes ahead of Wednesday’s shareholder meeting demonstrates the strength of a growing investor movement led by the Teamsters to hold America’s largest drug distributors accountable for their role in fueling the opioid epidemic,” said Ken Hall, general secretary-treasurer of the Teamsters, in a statement Monday.

“The bar has been set — no more business as usual. Cardinal’s decision to appoint a new CEO and transition to an independent board chair, as demanded by the Teamsters, signals that our message for strengthening corporate governance and setting a new tone at the top is getting through.”

Teamster-led Group Persuades Cardinal Health to Make Governance Changes

Multinational Organizations Best Address the Five Biggest Economic Challenges

Kalin Anev Janse, secretary general and a member of the management board of the European Stability Mechanism (the eurozone’s lender of last resort), considers five major challenges and why international organizations offer the best hope for managing them.

The Brexit vote and the U.S. presidential election outcome signal dramatic changes in cooperation globally and a push for more protectionism. In practice, these votes called into question the multilateral institutions and international collaboration among countries that embody that cooperation.

Janse says the five major challenges are: income inequality, protectionism, migration, technology replacing jobs, and social media and the “post-truth world.”

In my view, Europe can offer lessons in regional integration that are relevant for other parts of the world. Among others, my institution – the European Stability Mechanism (ESM) – is a product of European cooperation in response to the financial and economic crisis. As the largest and most active regional financing arrangement, the ESM works closely with its peers in other regions of the world.

Beyond Europe, the continued rise of Asian economies, as well as those in Latin America, present new opportunities for strengthening international cooperation in many of the areas I have mentioned, including finance, infrastructure, energy, education, climate change and others.

Investors Object to Virtual-Only Annual Meetings

Some companies are hoping to avoid in-person challenges at the annual meeting by scheduling virtual-only online session. The Council of Institutional Investors, whose members have $3 trillion in assets under management, has also spoken out strongly opposing virtual only meetings and the pension funds of New York City are voting against directors serving on board Governance Committees of companies moving to virtual-only meetings. Of course, in-person meetings enhanced by virtual participation for those who cannot otherwise attend is entirely different and should be encouraged.

The Sisters of Saint Francis of Philadelphia have taken the lead in challenging these decisions with shareholder resolutions at ConocoPhillips and Comcast. The Conoco resolution has already been cofiled by the Church of the Brethren Benefit Trust and the Needmor Fund, a Walden client. The Sisters have also filed a similar resolution with Comcast.

Walden’s Tim Smith stated, “The decision to move an annual meeting to cyberspace has moved far beyond a minor internal management decision and become an important governance matter for companies. Imagine if companies facing major controversies had decided to forgo physical meetings. If a company faces debate on their comp package or its climate change position or has votes on shareholder resolutions it is also a problem to have a disembodied discussion on line for a stockholder meeting.“