The ChamberPost

A Trinity of Issues for the SEC

by Tom Quaadman

Do bad things happen in threes? Well, today, the SEC is expected to approve a measure eliminating the broker discretionary vote, while taking a vote to issue, in the near future, regulations for say on pay votes for executive compensation of TARP companies, as well as revamped disclosure rules for corporate governance and executive compensation. Let's look at what the SEC is going to do and see if the saying holds up.

The elimination of the broker vote is disappointing at best and a move to embolden activist investors at worst. Currently, brokers can cast shares that they hold, if they don't receive instructions from the owners, for routine items.  Traditionally, uncontested elections of public company directors were considered "routine" matters, which brokers can vote on, but today's action makes the vote a "non-routine" matter, which brokers can't vote on. Eliminating the ability of brokers to vote uninstructed shares in uncontested elections will diminish the retail voice. Smaller mom and pop shareholders will be disenfranchised and large institutional shareholders will wield disproportionate power. Simply put, large activist investors get to jump to the head of the line. Instead, the SEC should take a holistic view of all market participants in examining and improving broader proxy voting participation. Putting a set of special interests ahead of small retail investors is just not how the system should work.

Back in February, the Chamber wrote to Secretary Geithner asking that say on pay be advisory, periodic and provide an opt-out through a super-majority vote by shareholders. Non-binding allows shareholders to express their opinion, but allow directors to retain the ultimate decision making authority. By periodic, we meant three years which is the average life of a corporate compensation plan. Allowing these votes to happen on a three year cycle reduces the costs to the company (and ultimately the investor and consumer). An opt-out clause would allow a 2/3 vote of shareholders to forestall any further say on pay resolutions for 5 years. We believe that these are sensible principles that will allow shareholders, directors and management to craft the best system for a company.

In the same letter to Secretary Geithner, the Chamber stated that corporate governance and executive compensation policies should be rooted in long-term shareholder growth and profitability, while not constraining reasonable risk taking and innovation. The Chamber believes that strong corporate governance is a cornerstone of our economy. Additionally, any new proposed disclosures must provide meaningful disclosure and not subject businesses to unintended consequences that will place them at a competitive disadvantage.

So for those keeping score, the broker vote decision is bad, while the say on pay and new disclosure rules are incompletes until we see the fine print. Bad things may happen in three's, but if things work out we may be singing Meatloaf's favorite line—two out of three ain't bad.

Union Command and Control of the Economy

by Tom Quaadman

In commenting on the introduction of the Shareholder Bill of Rights by Senator Charles Schumer (D-NY), noted economist Larry Kudlow stated, "This is nothing more than union command and control of the economy."

How right he is.

For over 100 years, corporate governance in the United States has been regulated by the states. This has led to diverse corporate structures that have served the economy well and employed countless numbers of workers. Shareholders provide capital, boards of directors provide oversight and management runs the business.

Under this system, all of the parties involved must work together to increase the value of the company. If the relationship works well, everyone wins. If not, a shareholder can sell their shares, or where allowed by state law, replace management or board members. These laws vary by state thereby allowing corporate governance to be tailored fitting the stakeholder’s needs.

"Reform" efforts are not about improving the corporate governance of poorly run companies, rather, it is to liberalize rules so that activist investors can avoid costly proxy fights and elect their own directors instead. Activist special interest investors, including some unions, have sought to use the proxy voting system as leverage to advance other agendas under the guise of improving corporate performance. But, in fact, their efforts do not have that result. The recent Navigant Consulting study, released by the U.S. Chamber of Commerce, found no evidence that the 166 shareholder proposals key-voted by the AFL-CIO improved stock prices over the short or long-term. The last time I checked, the purpose of investing is to increase the value of your investment.

If directors and management have to spend their time fighting special interest agendas and complying with burdensome federally-mandated corporate structures, they cannot manage a company. Sales will be lost, profits disappear, and jobs destroyed. One has to wonder about a pension fund that wants to play politics rather than increase retirement benefits for its members.

Indeed, the existing system has been working well and reforms have occurred in a steady and diverse way. Our state-law based system has been a laboratory for experimenting with different approaches to corporate governance that have suited the challenges individual companies face. This system has evolved through a dialogue between management, directors, and shareholders, all without mandates from Washington.

Passage of measures such as the Schumer Shareholder Bill of Rights will create a body of federal corporate law that will eliminate the state driven model that has existed since the start of the modern public corporation. A Washington centric one-size-fits-all approach will destroy the variety that has allowed the American economy to thrive and be the most successful in world history.

History has proven the command and control economies do not work. The use of appropriate management and judgment by individual companies has more collective beneficial impact than mandates from Washington ever will. Let’s not have to re-learn bad lessons from history.

Corporate Governance - Review and Preview

by Tom Quaadman

As has been expected, the issue of corporate governance came to the forefront last week, with an SEC proposal on Shareholder Access and Senator Schumer’s introduction of a Shareholder Bill of Rights. We will discuss these issues in great detail over the coming weeks, but I just wanted to recap where the Chamber has been on these issues.

On February 6, 2009, the Chamber sent a letter to Treasury Secretary Timothy Geithner (with copies going to every member of Congress) outlining a set of principles for effective Corporate Governance, Investor Responsibility and Executive Compensation. These principles include:

• Corporate governance policies must promote long-term shareholder value and profitability but should not constrain reasonable risk-taking and innovation.

• Long-term strategic planning should be the foundation of managerial decision-making.

• Corporate executives’ compensation should be premised on a balance of individual accomplishment, corporate performance, adherence to risk management and compliance with laws and regulations, with a focus on shareholder value.

• Management needs to be robust and transparent in communicating with shareholders.

The letter also included principles for advisory Say on Pay votes on executive compensation. These principles stated that Say on Pay resolutions should be advisory, periodic (once every three years) and provide ability for shareholders to approve an opt-out of Say on Pay.

Last month, the Chamber sent a letter to SEC Chair Mary Schapiro in advance of the Commission’s proposal on shareholder access. The Chamber letter reiterated that these were matters under the jurisdiction of state law and that the SEC lacked the legal authority to act.
However, the Chamber did request the SEC to take action in areas where they have the authority, such as increasing disclosure and increasing proxy voting participation.

Last week, the Chamber issued a Navigant study of 166 shareholder proposals key-voted by the AFL-CIO. This study showed that these proposals did not increase shareholder value in the short-term or long-term. A fundamental truism of investing is to make a return on your money. Clearly, activist agenda proposals miss the mark on that truism as well as the principles developed by the Chamber.

We took these steps knowing that Corporate Governance would be a battle ground. Public corporations have been the backbone of the American economy for the past 150 years. Recently, in the heat of debate we have seen a willingness to throw the baby out with the bath water. That is a price that businesses and workers can ill afford to pay.

The SEC proposal and the Schumer bill are misguided. But if we are going to have a debate, let’s have one that is thoughtful and rational. The stakes are too high and we have to get it right. The alternatives are too grim to contemplate.

The SEC and State Corporate Law

by Tom Quaadman

The SEC yesterday held an open meeting to discuss their plans to provide shareholder access to the proxy. By a 3-2 vote, the SEC will release its proposal for public comment and review.  Seeing this train coming down the tracks, the Chamber didn’t wait for the SEC to act.

On April 28th the Chamber sent a letter to SEC Mary Schapiro expressing its opposition to the creation of a federal right to shareholder access. The letter highlights four points in opposing such an effort:

1. Regulation of shareholder rights and director elections falls within the purview of state corporation law and preempts federal action;
2. The SEC does not have the legal authority to act in this area;
3. Numerous reforms have been taking place without federal mandates; and
4. The integrity of the proxy voting system deserves urgent attention by the SEC.

In opposing the new SEC proposal, Commissioners Casey and Paredes echoed many of these same themes. Facts are stubborn things and they can’t (and we will make sure that they won’t) be overlooked in this debate.

State corporate law works well for over 15,000 public companies and has provided a diverse base for the world’s most productive economy. Over the past several years, we have seen management; directors and shareholders adjust governance systems to best fit their companies. Most S&P 500 companies now have majority voting, while others have eliminated staggered boards and some have separated the CEO and Chairman duties.

As it has for almost 200 centuries, the system has worked. To throw out state corporate law expertise, during the worst economic crisis in 75 years, is just folly.  The lines are drawn and the battle joined. This isn’t just about the board room, but if we want to keep the foundation of the greatest economy in world history intact. That is a fight we are only too willing to take on.

If It Isn’t Broke, Don’t Fix It

by Tom Quaadman

Today, Senator Schumer is introducing the "Shareholder Bill of Rights". The title is in quotes for a reason; the Bill should called by its true name—The Haranguing Activists Right to Abuse Shareholders Statute (HARASS).

For the past two centuries Corporate Governance has been regulated by states. This has led to diverse corporate structures that have served the economy well and employed countless numbers of workers. Shareholders provide capital and trust the Board of Directors and management to make the right calls.

Under this system, all of the parties involved must work together to increase the value of the company. If the relationship works well, everyone wins. If not, a shareholder can sell their shares, or under extraordinary circumstances, if allowed by state law, replace management or Board members. The laws vary by state and this has allowed for broad diversity in corporate structures. After all, variety is the spice of life.

The Schumer bill will junk that system which has worked so well; it would mandate:

• Say on Pay votes;
• Shareholder Access to the Proxy;
• Majority Voting for Board members;
• Separate the duties of CEO and Board Chairman; and
• Create separate risk management committees.

Some of these reforms are not controversial and in fact companies have been implementing some of them as they deem appropriate. If that’s the case, what’s wrong with the Schumer bill? Plenty.

The Bill isn’t about establishing better corporate governance, it is about liberalize the rules so that Activist investors can more easily engage in proxy fights and elect their own directors. Activist special interest investors, including some unions, have sought to use the proxy voting system as leverage to advance other agendas. The recent Navigant Consulting study released by the Chamber found no evidence of improvement of stock performance resulting from activist shareholder proposals.

If Directors and management have to spend their time fighting special interest agendas, they can’t manage a company. Sales will be lost, profits disappear and jobs destroyed. One has to wonder about a pension fund that wants to play politics, rather than increase retirement benefits for its members.

The Chamber supports good ideas for governance reform, if those proposals are proven to produce better outcomes for shareholders. We will fight to stop proposals that advance special interest agendas and do nothing to improve effective corporate governance.  Abusing shareholders during the worst economic crisis in 75 years isn’t a path to recovery.

If you think this is bad, let’s check in and see what the SEC does tomorrow.

Large or Small the Credit Crunch Hits Us All

by Tom Quaadman

Cross-posted at GrowSmartBusiness.com.

The fact of the matter is that the freeze-up of the credit markets also impacts small businesses in a hard way. Small businesses very often are start-ups, or are uniquely affected by the business cycles of a locality. As such, lines of credit and loans are necessary for small businesses to expand, or be able to survive the tough times. This is important, because small businesses are the engine that drives the economy and creates jobs.

While the financial crisis may have hit some large businesses early in the cycle, some small businesses will be impacted later as the effects work their way through the system. Also, the freeze-up of the credit markets that began in September, cut off the lifeline that some businesses needed to survive. This combination has led to a growing number of business closings and ever increasing job losses.

We have seen many efforts to restart the credit markets—TARP I, TARP II, TALF, the PPIP, the acronyms keep growing and growing. But often, in reporting these developments, the media misses the point and reports about the companies that are too big to fail.

The fact of the matter is that these efforts to shock the credit markets back to life are as much to restart lending for small businesses as for the large ones. In fact, the Chamber supported the efforts of the Obama Administration to increase lending to small businesses through the Small Business Administration. These efforts are vital for economic recovery to take hold.

The genius of the American economy has been the freedom of a person to start a business and give them the opportunity to grow it into a larger one. Sure there is too big to fail, but we have to remember that you need to think big and start small. With the right idea, work ethic, and sufficient capital, a small business can thrive and we can all benefit.

Just ask Bill Gates.

The Accounting Wars

by Tom Quaadman

Those who don’t want to see Mark to Market accounting rules change, or those who want to see them done away with all together, have been on the offensive trying to convince FASB from making much needed fixes. The Wall Street Journal and other publications have carried a wide-range of stories from how these proposals will harm the Geithner plan to resolve the toxic asset crisis, to the need for FASB to reassert its independence.

The truth of the matter is that when the system is broken, it needs to be fixed. Let's take a look at the rules:

1. Asset prices must be based on market values.
2. If a market no longer exists, use judgment in valuing assets.
3. If using judgment to value assets, go back to rule one.
4. If the asset has significant cash flows, but has lost value, you can’t recoup the loss.

Does this system work? Investors and businesses have been using sell orders over the past 18 months to say no.

The Chamber has been steadfast in advocating solutions to accurately value assets. No more, no less. The truth of the matter is, if FASB does nothing, or close to nothing tomorrow, we will remain in the quagmire. If an honest effort is made to change the broken system, we may be on the road to recovery.

We need a little more Patton and a little less Nero. The process may not be pretty, but we need results, and we need them now.

Corporations and Regulation

by Brad Peck

After breaking down mark to market accounting this morning Tom Quaadman went on CNBC to talk capital markets with Carlos Gutierrez, Andrew Metrick, and Rebecca Jarvis.

Mark to Market - Responsibility Breeds Independence

by Tom Quaadman

In today’s Washington Post, former Securities and Exchange Commissioner Arthur Levitt raises some interesting points about the independence of accounting standard setters. However, the larger picture needs to be framed to understand the issues at hand.

The cause célèbre in the world of accounting and finance is Mark to Market accounting. While Mark to Market accounting standards did not cause the worst financial crisis in 75 years, their procyclicality has exacerbated the impacts. Mark to Market is just one symptom that our financial reporting policy apparatus is broken.

Mark to Market accounting represents a significant shift in accounting philosophy. Many felt that the S&L crisis and the lost decade in Japan were caused by unrealistic asset values based on historic cost accounting. This in turn allowed entities to borrow more than their ability to pay. To correct these problems, it was decided that an accounting system was needed to value assets in each reporting period as if it was being sold. Thus the market would dictate asset values.

In developing this system the Financial Accounting Standards Board (FASB) did not test the new standards, implement pilot programs, review the new standards to determine their effectiveness post implementation, or work with financial regulators to determine how these new accounting standards would work in conjunction with capital requirements. Furthermore, the new standards were very hazy on how to value assets when an active market disappears.

Therefore, a procyclical accounting system was created that played off of procyclical capital requirements. Furthermore, there was not clear answer on how to value assets in the absence of a market.  Not a problem in an up-market, but a tremendous problem in a down-market and an absolute disaster when markets shut down. The result? Hundreds of billions of dollars in capital destroyed.

FASB ignored calls for reform and only brought about small changes in October as a result of political pressure during the debate of the Emergency Economic Stabilization Act. During the past several months, FASB ignored the facts that the system was not working and compounding the impacts of an unrelenting financial crisis. When the SEC called for Mark to Market accounting changes in December, FASB responded that they would get to the issue at the end of this year.

Arthur Levitt is right, FASB only issued proposed changes to Mark to Market accounting as a result of Congressional action. But that is also the point. FASB, in developing a new accounting regime did not properly vet the standards, try to develop an understanding of how it would work, nor go back to look at the standard when the financial system came to a grinding halt. Rather, they were content to rest on the laurels of intellectual purity. For the business that fails, the worker who loses their job, or the investor whose portfolio becomes worthless intellectual purity doesn’t mean much.

Senator Dodd hit it right on the head during the CCMC Capital Markets Summit earlier this month—you don’t want a 51-49 Senate vote on an accounting standard. We need an independent accounting standard setting and governance structure. But with independence comes responsibility and that has been sorely lacking. For our capital markets to recover and grow, we need accounting standard setting and governance reform. We can’t afford to wait.  

On the Slippery Slope

by Tom Quaadman

Its winter, which means it is also ski season. Any skier worth their salt will tell you that ice can turn a good downhill run into a treacherous obstacle course.

Following up on last weeks castigation of Wall Street bonuses, the Obama Administration is set to unveil tough executive compensation rules for companies receiving TARP funding. Today’s Wall Street Journal states that these rules may include a $500,000 cap on salaries for executives, with additional compensation tied to restricted stock or payments tied to the long-term health of a company. It was reported last week that the Administration was considering applying these rules to the top 50 most highly compensated employees of a company.

First, let’s be clear—the expenditure of tax payer dollars demand accountability. Outrageous behavior deserves criticism. However, Financial Week, yesterday, stated that House Financial Services Committee Chairman Barney Frank may seek to expand these TARP executive compensation rules to all U.S. companies.

Secondly, when the taxpayer gives money to a business, we as a Nation are making a statement that we want that business to survive and thrive. The cash infusion cannot include rules that may kill a company.

Companies should be allowed to attract the talent they need to survive, grow and be successful. Government restrictions on pay and disclosure will force executives to work elsewhere and deprive companies of the talent when it is needed most. Turnarounds only work if smart people are allowed to do there job, just ask Lee Iacocca. Last fall, in reaction to the financial crisis, Germany proposed tough executive compensation rules and withdrew them so fast it would make your head snap. Why? The Germans realized that their best business minds would leave Germany and work elsewhere. Can we afford to have our best business executives?

Also, do we really want government mandating how much people are being paid? If we are going to regulate the pay of the top  5, 25 or 50 executives, what is to stop the government from mandating how much all employees are to be paid? The government came pretty close in the early 1970’s when they imposed strict wage and price controls on the entire economy. That failed experiment helped to touch off the debilitating round of stag-flation that wasn’t broken until then Fed Reserve Chairman Paul Volker dramatically raised interest rates to almost 20%.

The new Administration is putting the United States on the slippery slope; hopefully our fragile economy can survive the fall.