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Sub-prime Suddenly a Focus for Investor Activists

Taub Stephen | January 2, 2008

It’s that time of year when shareholder activists plot their strategies to needle, cajole, and confront Corporate America later this spring in the proxy season.

As has been the case for several years, executive compensation is a major concern. Buoyed by Verizon’s decision to adopt shareholder advisory votes over executive pay and Aflac’s plan to move up its advisory vote on the issue to this year—marking the first time such a vote has ever happened in the United States—activists plan to file a sizable number of similar measures.

Another issue sure to dominate discussion this year was hardly a thought in most investors’ minds 12 months ago: the sub-prime mortgage collapse. Several investor groups plan to submit proposals designed to prevent, or at least lessen the chance of, a similar crisis in the future.

Here is what’s in store from a number of union pension funds, always in the vanguard of shareholder activism.

Preventing the Next Mortgage Crisis

The Laborers’ International Union of North America is making early moves to target companies caught in the sub-prime mortgage meltdown. Already LIUNA has scored a critical victory with the Securities and Exchange Commission, which ruled that Beazer Homes must include a LIUNA resolution in the proxy statement that proposes greater disclosure of the homebuilders’ mortgage investments

The scandal-plagued Beazer (it fired its chief accounting officer this year for destroying financial records, plans to restate financials, and is under investigation by the SEC) is one of more than 25 companies LIUNA has in its sights this year. The union is submitting similar resolutions to Lehman Brothers, the Ryland Group, Washington Mutual, Bear Stearns, Standard Pacific, and others; all have suffered from dabbling in the sub-prime mortgage market.

The union is also calling on directors to instruct audit committees to enhance disclosure policies and limit conflicts of interest between financial services companies and credit rating agencies. Measures have been filed with financial services firms Citigroup, IndyMac Bancorp, and Wells Fargo, as well as rating firms Moody’s and McGraw-Hill, which owns Standard & Poor’s.

“We are the only ones using this process to get at this issue,” asserts Richard Metcalf, LIUNA’s corporate affairs director.

LIUNA also plans to submit proposals that would hold directors accountable for development and disclosure of detailed succession plans for executive management and executive pay policies that reward performance. Those issues are not new, but several banks badly stung by the sub-prime crisis tossed their CEOs over the side with no obvious successor, and gave them handsome exit payouts as well.

Succession proposals have been filed at corporations including Merrill Lynch (which replaced its CEO last fall) and at Toll Brothers; executive pay proposals have been filed with Goldman Sachs and Morgan Stanley. “Executive comp will continue to be a focus for the next few years,” Metcalf says.

LIUNA also plans to initiate “withhold” campaigns against certain directors up for re-election at companies reeling from the mortgage crisis. At Toll Brothers, the union plans to target founders Robert and Bruce Toll, who in 2008 are up for re-election at the classified board. Other potential targets include directors at Countrywide Financial and Beazer Homes. (Since Beazer is not current with its filings, however, its annual meeting is on hold.)

AFSCME Targets Pay and Accountability

The American Federation of State, County, and Municipal Employees has led the push for the so-called say-on-pay advisory votes on executive compensation for several years; 2008 will be no different. The union alone plans to submit another dozen proposals this proxy season, and activists altogether could submit as many as 80, according to Richard Ferlauto, AFSCME’s director of pension and benefit policy.


Ferlauto says AFSCME will file more specific proposals this year as well. For example, he expects proposals at about 10 companies calling for a ban on tax gross-ups, where companies pay the taxes on certain forms of executive compensation. “It is an obnoxious practice and we want to see it ended,” he says. “It is an inefficient use of shareholder money.”

AFSCME will also file six to eight proposals this spring to ban executives from selling stock under Rule 10b-5 (which allows regular, automatic sales to avoid allegations of insider trading) while their companies are in the midst of a stock buyback program. ”It doesn’t send a good message that the CEO is selling and the company is buying,” Ferlauto says.

Finally, AFSCME plans to submit measures with a few companies that ask for reimbursement of shareowner expenses for running a short slate of directors—a perennial issue with activists that never gains much traction when votes are held.

AFL-CIO Targets Conflicts of Interest

Health care will be one issue the AFL-CIO tries to address this year. For example, the union has filed a resolution with McGraw-Hill requesting that its board adopt a policy addressing conflicts of interest involving board members with health industry affiliations.

Specifically, the union notes that McGraw-Hill Director Sidney Taurel is CEO of drug company Eli Lilly & Co. and a director of the powerful Pharmaceutical Research and Manufacturers of America trade association; he also chairs McGraw-Hill's compensation committee and serves on the corporate governance committee. Another director, Winfried Bischoff, also serves as a director at Eli Lilly. “The company’s health care costs could be cut by as much as $1,160 per employee if Congress enacted universal health insurance and required Medicare to negotiate prescription drug prices directly with pharmaceutical companies,” the AFL-CIO's measure states. Lilly, and the two directors’ stock holdings in the drug maker, could be hurt by such a policy, the union contends.

The union also plans to file measures that urge boards to adopt principles for health care reform based upon those developed by the Institute of Medicine: that health care coverage should be universal, continuous, and affordable. About 12 to 15 companies will get the proposal, including Boeing, United Technologies, and IBM. “We're looking for partners,” says Daniel Pedrotty, director of the AFL-CIO Office of Investment. “It is an engagement device.”

Beyond health care, the AFL-CIO has submitted a proposal to Merrill Lynch calling on the board to adopt a set of principles that curb automatic extension of a CEOs’ tenure. The principles include having a specified termination date, not to exceed three years and not to contain an “evergreen” clause that provides for automatic renewal without shareholder approval. Companies also should not permit accelerated vesting of stock options, restricted stock, and other equity-based awards and should not provide tax gross-ups or similar make-whole arrangements.

Pedrotty says the principles aim to undercut the excuse that companies have no legal choice when they hand out huge severance packages to executives who leave after doing lousy jobs.

Amalgamated Bank Targets Homebuilders

Another relatively new resolution that will surface this year comes from Amalgamated Bank. The “union bank” will call on several homebuilders that have subsidiary mortgage units to adopt a compliance committee comprised of independent directors. These committees would exercise oversight for all legal, regulatory, and legislative initiatives, explains Scott Zdrazil, the bank’s director of corporate governance.

Zdrazil says audit committees—which at first blush would seem to be the likely group to handle these tasks—are mostly focused on financial compliance. Among the likely targets for the measure: KB Home, Lennar, Ryland Group, Pulte Homes, NVR, and Toll Brothers.

Otherwise, the bank will continue its push in more familiar areas. It plans to ask at least four companies to declassify their boards, including Arkansas Best, where a similar measure last year generated majority support. (Arkansas Best is also a target of the Council for Institutional Investors.)

Zdrazil also anticipates filing eight or nine resolutions seeking majority vote policies to elect board directors. His group is targeting small-cap and mid-cap companies, which have been less of a focus among the activists in general. Two likely targets: Valassis Communications and Invacare. Amalgamated also will call on Lexmark and Tenet Healthcare to hold advisory votes on their executive compensation.