Friday, December 17, 2010

Proxy Advisory Services Regulation: What’s Good For the Goose…

As a commentator, one of the best things you can find to write about is when you come across someone being totally disingenuous; it’s almost as good as when companies do something really stupid (for which see “How Not to Run a Conference Call” December, 2007 and “What Was He Thinking, Whole Foods Version”, August 2007).

Which brings me to this week’s subject, the possibility of the Securities and Exchange Commission imposing regulations upon proxy advisory firms. Proxy advisory firms have grown in size and influence over the last twenty years. Their positions on corporate governance, compensation and proposed mergers and acquisitions have become important to both investors and corporations, creating in effect, de facto standards. Yet the manner in which the proxy advisory firms reach their recommendations and ratings, the formulas they use when looking at compensation and equity plans, and the process by which they make recommendations regarding merger and acquisition activity are considerably less than transparent. Further, the amount of research available to support their positions on corporate governance is less than overwhelming and far from conclusive. Finally, some firms, such as ISS, have actively worked both sides of the street, advising institutions how to vote and selling their consulting services to corporations to tell them how to structure things in order to get approval and high ratings from ISS.

So when the Securities and Exchange Commission asked for comments on the proxy process earlier this year it is not surprising that a number of comments came back suggesting that proxy advisory firms be subject to some regulation from the SEC, namely that proxy advisory firms should be subject to proxy rules and regulated as investment advisers, including mandated disclosure of specific conflicts of interest, transparency on how they develop their ratings and recommendations, and that they adopt procedures ensuring the accuracy of their reports and voting recommendations.

It seems as though the proxy advisory firms, which like more regulation for corporations, are not so happy when the shoe is on the other foot. Here’s Nell Minow, Chair of The Corporate Library and former general counsel and CEO of ISS in a comment letter to the SEC: “I would like to object in the strongest possible terms to the possible regulation of proxy advisory services.” Later in her comment letter, she goes on to explain how market forces will keep the proxy advisory services honest.

In other words, if we just let competition work without government getting in the way, everything should be fine. Of course this is exactly what they say doesn’t work for corporations when they want more regulation on say on pay, proxy access, compensation disclosure and a whole host of other corporate governance issues.

It does seem to make sense that these firms, which have a great deal of influence in how investment firms vote should at least be required to disclose the methodology by which they come to their ratings and recommendations, disclose any potential conflicts of interest (or better yet, be prohibited from conflicts of interest) and show they have stringent procedures in place to prevent inaccurate reports and recommendations.

After all, if increased disclosure and regulation is good for the goose (corporations), then it is certainly also good for the gander (proxy advisory firms).

Monday, December 6, 2010

Lawyers Gone Wild

To a certain degree, we are all governed by our experiences. In the case of Wal-Mart, that experience seems to include getting sued – a lot. While I was unable to get exact, recent numbers, a 2001 USA Today report had Wal-Mart stating that they were sued 4,851 times during the year 2000. Another source on the web reported that Wal-Mart was sued 845 times in federal court alone during 1999. The point here is not the preciseness of the numbers, but rather the magnitude, and the simple fact is that Wal-Mart finds itself on the receiving end of lawsuits with great regularity.

Having to deal with plaintiff’s lawyers on such a regular basis would warp the sensibilities of almost anyone and it appears that a bunker mentality regarding being prepared for lawsuits has crept into Wal-Mart’s investor relations pronouncements. How else can you explain the safe harbor language for forward-looking statements contained in their most recent earnings call?

A transcript of Wal-Mart’s third quarter earnings call shows that their safe harbor statement runs 1,316 words, or about 4 1/2 pages of dense, lawyer drafted prose. By my calculations using the transcript available on Seeking Alpha, this was slightly more than 10% of all the words spoken during the call. Interestingly, this was almost 300 words longer that their second quarter safe harbor statement, which came in at a mere 1,038 words. To get an idea of how things have escalated, their fourth quarter 2005 earnings call used a safe harbor statement containing 455 words. At this rate, pretty soon Wal-Mart’s entire earnings call will consist solely of a safe harbor statement.

I am fortunate enough that I don’t get sued with great regularity, so I may not be as sensitized to this issue as Wal-Mart is, but to me it seems like lawyerly overkill. Here’s an example:

“This call will contain statements that Wal-Mart believes are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended, and intended to enjoy the protection of the safe harbor for forward-looking statements provided by that Act. These forward-looking statements generally are identified by the use of the words or phrases anticipate, are anticipating, are expecting, assume, could be, expect, forecasting, goal, guidance, guided, is expected, is planning, may affect, plan, will accelerate, will add, will be, could save, will drive, will ring, will be growing, will come, will continue, will cost, will experience, will generate, will grow, will improve, will not continue, will remodel, will see, will spend, will take, would represent, or a variation of one of those words or phrases in those statements or by the use of words and phrases of similar import. Similarly, descriptions of our objectives, plans, goals, targets, or expectations are forward-looking statements.”

The lawyer seems to have parsed through every verb that was going to be used in the call and labeled anything that could possibly be construed as future tense as forward looking. Of course, then for good measure, they throw in the phrase “or a variation of one of those words or phrases in those statements or by the use of words and phrases of similar import” which is legalese for “I can’t think of anything else, but if you can that’s excluded too”. Similarly, it appears as though a lawyer was determined to parse through every statement that Wal-Mart proposed to make during its earnings call, call out anything that could be deemed even slightly a forward looking statement, and specifically disclaim liability for it if things didn’t turn out as represented. That goes on for almost four pages. This is deadly stuff, and I don’t mean that in a positive way. I can’t image what Wal-Mart’s lawyers would do if the company actually took questions from analysts during the call.

All of this points out one of the central tensions of investor relations; the desire of IR practitioners to point out the road the company intends to pursue in order to earn future profits, versus the desire of lawyers to insulate the company from liability in a dangerous world where securities class action attorneys wait to pounce on any slight misstep. I’m not sure where the proper balance exists between these two desires, but management needs to recognize when lawyers are getting in the way of the message and tell them to cut back on the excess verbiage.

Certainly, if the lawyers are taking up over 10% of the message, things have gone too far.