Are You on Calper's Hit List?
from
September/October 2003
by Bonnie Azab Powell
With its $130.7 billion portfolio, the California Public Employees’ Retirement System (Calpers) is the big bad wolf of institutional investors. And its tradition of unrelenting shareholder activism has been further fired up by the $40 billion hit it has taken since mid-2000, mostly from the overall market slide but also from companies whose stock has been battered by fraud and malfeasance. Calpers lost $105.2 million on its Enron investments alone. A longtime proponent of independent audit committees and of putting limits on the additional services auditors may provide, Calpers is pushing hard for other reforms, including the separation of the CEO and chairman jobs.
The fund likes to name names of companies that don’t meet its standards. It is pressuring five offshore corporations, among them Tyco International and Ingersoll-Rand, to become U.S. citizens once again. In March it issued its 11th annual “focus list,” calling for specific board and other governance changes at Gemstar-TV Guide International, JDS Uniphase, Manugistics, Midway Games, Parametric Technology, and Xerox. All six companies will be top Calpers targets this coming proxy season. Then there are the lawsuits. In 2000 Calpers and two New York pension funds won the largest securities class-action recovery in history, collaring more than $2.8 billion for shareholders of Cendant Corp. in a lawsuit that claimed the company had issued false and misleading financial statements.
Pending suits include a $250 million action against AOL Time Warner and some of its top executives, past and present. Among other allegations, Calpers says that AOL inflated earnings before merging with Time Warner and that insiders indulged in a “flurry of stock sales” soon after the merger. “Fraud of this magnitude won’t be tolerated,” says Sean Harrigan, 56, who was elected president of Calpers in February. “We intend to take swift action, today and in the future, to obtain recovery of the assets we lost.” Harrigan, a longtime leader of the Union of Food and Commercial Workers, talked with Corporate Board Member’s Bonnie Azab Powell about what else Calpers is up to and what directors should watch out for. Excerpts:
Calpers’s annual focus list gets quite a lot of coverage. Is your goal just to publicly shame the companies and their boards?
I think the media look at the list as a negative—these are the bad actors. It’s maybe somewhat embarrassing to officers and directors. But at the same time, it’s been very, very successful in encouraging them to address the concerns of at least one large institutional investor.
We really look at it as a positive, proactive process. It gives us the opportunity to have discussions with CEOs and top officers in a lot of corporations about where we think their inadequacies are in terms of corporate governance. Most of them address those issues. We think that’s extremely positive.
The list you published earlier this year included the media company Gemstar and cited the fact that former CEO Henry Yuen and former CFO Elsie Leung together received $29 million in severance packages and yet remained on the board. A month later Gemstar terminated those directorships. Score one for Calpers?
Well, the timing was interesting. We’d voiced our concerns over the severance package multiple times, along with the fact that those individuals were staying on the board to the detriment of the company. Whether or not there was any cause and effect, who knows? The list certainly didn’t have a negative impact.
Xerox is on your list. Among other things, you alleged that since the board comprises “the same members that oversaw Xerox during a significant accounting scandal and strategic missteps,” the company should at least add three more independent directors. Xerox has added only one. It has also refused to take away the chairperson role from CEO Anne Mulcahy, which you pushed for as well. Will Xerox be back on the list next year?
We’ll have to wait until next year and find out. Again, the purpose of the list is to align shareholder interests with the interests of the managers of those corporations. In our opinion, there weren’t enough independents on the Xerox board. We had some dialogue with the company. Xerox believed that they responded in an adequate way. We think it was inadequate. I had a brief conversation at the Council of Institutional Investors conference with Mulcahy the day Xerox went on the list. She was not real pleased. We’re going to try to convince Xerox that they should do the right thing.
So companies aren’t blindsided by the list.
No, we contact them. The focus-list process spans three, four, five months. It involves meetings, lots of correspondence. The companies are deeply involved; they have every opportunity to address what needs to be corrected before they go on the list. There are always companies that don’t want to participate. You know what? That’s a finding. If a company doesn’t want to meet with shareholders and doesn’t care what they have to say, that tells us an awful lot.
2000 was the last year Calpers honored companies that had once been on the focus list but had addressed your concerns. Are there none since then that deserve gold stars?
It’s probably time that we do another “good company” list. The market-reform issues have taken emphasis away from other areas. We’ve overlooked what I think is something important, and that’s to recognize the companies that do a great job, such as Pfizer and Waste Management. Pfizer has a very forward-thinking board, and it’s been very involved with the shareholders. They’re very, very proactive: They declassified their board before we ever even suggested that they do so, and made sure their audit committee was qualified and independent. Pfizer’s been a real example of a reformer whose lead we’d like others to follow.
And Waste Management would win “most improved”?
Yeah, they really would. Waste Management went through some really troubled times. Their board was radically changed, and you can see the difference. Another one that deserves credit for addressing crises is Computer Associates, which obviously went through some turmoil in some ways similar to Xerox’s situation. But the difference is that Computer Associates went out and found truly independent board members with great backgrounds and educations. For instance, the former chief accountant of the Securities and Exchange Commission [Walter P. Schuetze] is on there. There’s a stark difference between Computer Associates’ response to crisis and Xerox’s.
The Sarbanes-Oxley Act has banned audit firms from providing some additional consulting work, including bookkeeping, financial-information systems design and implementation, and investment-banking services. But then it says some activities, like tax services, will be allowed under certain conditions. Are you satisfied?
We’ve just sent out a letter to about 1,800 companies stating that we don’t think the act goes far enough in this respect, because it leaves open the possibility that external auditors may perform tax-related consulting and information systems design and implementation. We continue to feel that these types of services are inappropriate. We’re asking these companies to take steps to ensure that their auditors remain truly independent, and we plan to withhold our vote from audit committee members if they do not.
At Tyco’s annual meeting in March, 89.7% of its shareholders disagreed with Calpers, essentially saying it was okay by them if Tyco’s accountants did more than just the audit. How do you explain that vote?
A lot of times, the first year a shareholder proposal comes forward it doesn’t get anywhere close to a majority vote. In terms of Tyco and other companies where that issue will arise, Calpers will continue to play its role in encouraging shareholders to support those kinds of proposals. I think over time they will gain traction, and I believe ultimately Tyco will address the concerns that we have in that specific area.
Calpers is also nipping at Tyco’s heels about your wish that the company repatriate itself back to the U.S. from Bermuda. That too was voted down, by nearly 74%. Yet in a statement, you called this a victory. How do you figure?
Well, we thought we were going to end up in the teens. When we broke the 20% barrier, we were actually pretty pleased. The company was willing to look seriously at the issues, which was our goal. They didn’t know all the answers, and they openly admitted that. And the fact that they formed a special committee that looked through all those complex issues around repatriation was very satisfying. It was a good response.
Repatriation is a very controversial issue; there are strong arguments for and against. When companies move offshore, they aren’t held to the same standards as U.S.-based corporations, and the accountability of those officers is diminished. And we are very, very concerned about that. At the same time, we recognize the tax consequences of repatriation and that it could have adverse impacts on us as shareholders. There is an issue of the level playing field, so we also support tax reform that addresses the incentives these companies have to move offshore. But when we balance the two, the shareholder-rights issue is so important to us in terms of our legal rights that we do and will continue to support repatriation.
Will you actually divest from Tyco and other companies that have moved offshore if they don’t come back?
We’re very reluctant to do that. Since I’ve been on the Calpers board, the only time we’ve divested holdings was with tobacco. We’ll continue to be activists in terms of shareholder resolutions; we’ll talk to them; we’ll talk to other institutional investors. We’ll do everything we can to try to encourage these companies to reincorporate in the U.S. But I would not want to suggest that we would, at least at this point in time, even consider divestiture.
But Calpers did divest from companies doing business in South Africa during apartheid, and more recently from four developing countries where it has human-rights concerns. In April Calpers was credited with successfully pressuring GlaxoSmithKline to lower prices on its AIDS drugs for developing countries. Critics have said that such moves mean you sometimes rank social concerns above the bottom line. Is this true?
Well, Calpers does have a conscience. To deny that would be totally inappropriate. However, we understand very, very clearly that our first responsibility is fiduciary, to maximize our risk-adjusted rate of return. In light of that, are there other things we can do that have collateral benefit? A strong case was made that we should divest from tobacco companies because their potential liability could adversely impact our returns. We didn’t put any pressure on Glaxo; we just met with them and wrote a letter. But every action that Calpers takes has been based on what we have believed the impact would be on our overall performance.
There are things Calpers can do that we do believe produce some good. In 2001, for example, we committed $475 million in investments in underserved areas of California, both urban and rural, where there are high levels of unemployment, underutilized infrastructure, fairly cheap real estate. We believe that we will get better-than-market rates of return on our investment, and at the same time provide new opportunities in those communities. There’s obviously a social side to that, but our primary focus was on return on investment. I can give you example after example of things Calpers has done over the last 20 years that have proven to be very, very good investments in terms of the risk-adjusted rate of return, and that also have had collateral benefit.
More shareholder proposals dealing with executive compensation were filed in the first two months of this year than in all of 2002. Do you think we’ll start seeing major changes?
I certainly hope so. People are just livid over compensation. We represent a lot of individual shareholders, the pensioners of the system. Everyplace I go, people are talking about executive compensation, what’s happened over the last two decades. It’s just crazy. It’s totally gone amok, and I think it’s reprehensible.
We also believe that at least a significant component of executives’ pay—salary or options or both—ought to be tied to their performance relative to their peers. For the most part it isn’t. So, along with a lot of other institutional investors, Calpers will be trying to work on the whole issue of executive compensation. We’ll continue to pursue a requirement by the SEC that executive compensation plans be submitted to the shareholders for approval.
Does Calpers plan to increase its pressure on boards that ignore majority shareholder votes?
There’s quite a bit of pressure now. We do have a dialogue with companies after we put a shareholder proposal through. But yes, we believe that majority votes ought to be binding. We’ll continue to work with the SEC and other regulatory agencies to try to make sure that they are.
It’s probably the single most important issue to me. We are the owners. The officers are, in fact, the managers. For a majority of owners’ votes to be nothing more than advisory, for management to ignore that majority, is totally insane. We’ll keep banging away and banging away and banging away until ultimately we get a positive response.
Calpers has said for years that a board cannot truly be independent as long as the CEO and the chair are the same person. Most companies you’ve approached, including Xerox, have disagreed. Are you ever going to give up on this issue?
No. We feel very, very strongly about that, and we’ll continue to pursue it aggressively. I just talked to the CEO of a big company, who said, “If there’s one thing you can do that’ll really change the culture in the boardroom, it’s to have either an independent lead director or an independent chairman.” In my opinion, it’s all about power. If you’ve got it, you don’t want to give it up.
Do you and other pension funds intend to keep suing executives or directors individually, as you have with WorldCom?
In cases similar to WorldCom, where there really was malfeasance or misstatement or fraud, absolutely. That’s one of the things we’re concerned about with offshore companies—that it puts them beyond the reach of derivative lawsuits. If we see the level of malfeasance and fraud that we’ve seen over the last several years continue, then yes, there’s going to be more and more action against individual officers and directors.
What do you think it’s going to take for us to see a sustained recovery in the markets?
First and foremost, a recovery of investor confidence. There’s just been this huge, huge breach of trust between small investors and corporate America, and to some degree even our regulatory agencies. That’s one of the reasons that what Calpers is trying to do in terms of corporate governance is so important. Sarbanes-Oxley is so important because it helps to restore investor confidence. Obviously, the whole settlement with the large brokerage firms [over analysts’ conflicts of interest] hurts. There really must be more significant action by the regulatory agencies, by the exchanges, and by institutional investors like Calpers to give investors the feeling that they once again can have confidence in the individuals and groups of individuals that manage America’s corporations.
