Connecting Human Rights, Politics and Capital

Recently, a number of web sites I have developed came under a severe hacker attack. Starting last October, several sites were “vandalized” with the site’s home pages replaced with new ones proclaiming that the site had been hacked. A little research into the servers and I thought the problems had been solved.

I was mistaken.

The attacks continued for some months, escalating into a full-blown battle for control of my sites. DDoS, SQL injetion viruses, brute force attacks and god knows what else was thrown at my sites. Eventually, Google forced the site offline by proclaiming that my sites had become predator sites and that anyone visiting the sites should go elsewhere. Several months later, things are returning to normal. Considerable expense and hundreds of man hours were spent fixing the problems and, quite frankly, I am not entirely certain that it won’t happen again.

Questions remain. How did my sites get hacked, who did it and why was it done?

After considerable research into the subject, I discovered that these are the great unknown questions. Answers to these questions can at best be inferred. An acquaintance in the cyber-policy community  heard my story and said “Iran and China. Look there for answers.” After further prodding, he referred me to a recent report issued by a Canadian organization, SecDev Group, which recently issued its report,”Tracking Ghostnet: Investigating a Cyber-espionage network.” This is a frightening exposé of a world around us that most of us, certainly myself, are totally unaware of but should pay close attention to. What I learned from this report was troubling given the risk that we all face from cyber-criminals, cyber-terrorists and nation states bent on asserting themselves on the world stage.

The report details hackers from China (PRC) who waged an attack on the Indian government and the offices of the Dalai Lama. These hackers were able to successfully intrude with impunity into the computers of these organizations, stealing secret information, identities and use those computers to wreck havoc elsewhere.

The pattern was a familiar one to me based on my experience. However, what happened next was even more striking.

As I was putting new security precautions in place on my servers, I found that I could track visitors to my sites. What I found was alarming to say the least. In the time I installed the intrusion tracking software (I am speaking about a couple of minutes), a single intruder had tried to enter the site 288 times.

I now know a new technology term: “IP address blocker.”

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Last week, Freedom House, the independent watchdog organization supporting and assessing freedom around the world, issued it’s annual “Freedom of the Press 2010″ report. It found that globally, freedom of the press declined in 2009, noting that only one in six people live in countries with a free press.

The report notes several key reasons for this decline:

• Most governments appear unwilling to reform laws used to punish journalists.
• In countries experiencing political upheaval, journalists have become targets.
• Continuing impunity for attacks on journalists is encouraging new attacks.
• The Internet is facilitating means for governments to identify and control citizen communication.

The report goes on to identify the 10 worst countries for press freedom and the names should be no surprise to readers: Belarus, Burma (Myanmar), Cuba, Equatorial Guinea, Eritrea, Iran, Libya, North Korea, Turkmenistan and Uzbekistan.

This report can be found at the Freedom House website.

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Among the many proposals up for consideration at this year’s annual meeting at Morgan Stanley is one that deserves your attention and your vote. Proposal #7 calls for the separation of the positions or chairman and CEO and also requires that the chairman be “independent.” For those of you that pay attention to these sorts of things, an independent chair proposal is not new. What makes this proposal unusual is the corporate chutzpah that suggests that this proposal is not in the interest of shareholders. Remember that “financial crisis” from a few weeks back? The boys at Morgan Stanley were some of the dealers at that crack house fiasco.

Morgan Stanley, along with a number of other financial services companies on Wall Street were engaged in a range of financial transactions that contributed to the global financial meltdown. The company, along with its compadres on the Street, traded on a range of securities that bet on the failure of the mortgage market. This gamble based on a failed bet that the unsustainable mortgage market would last (i.e. millions of bad mortgages would not somehow fail all at once) blew up, leaving ordinary people in financial disarray, economies around the world in crisis and the financial companies at risk of collapse. So far so good?

In 2008 and 2009 the company was in crisis. The Company’s then CEO John Mack (now the Chairman) was under pressure from the Fed and the Treasury to merge the company with JP Morgan Chase. Eventually, the Company was forced to take TARP funds, which it has since paid back. While all of this was going on, shareholders were taking quite the hit. MS share price went from a high of $67 and change in 2007 to less than half of that amount in 2010. Of course then CEO and now Chairman Mack saw a $41 million payday in 2007, which has since diminished to a paltry $1.5 million and change in 2009.

Yeah, pay for performance is working here.

Anyway, late in 2009 the Company announced the change in duties of Mr. Mack and the co-President James Gorman but from a shareholder perspective has anything changed on the board?

Well, no.

While a number of new faces have appeared on the MS board over the last couple of years, much remains the same. Several directors are seriously overboarded, holding 4 or more board positions (James Hance (5), Donald Nicolaisen (4), Charles Noski (4), Laura Tyson (4)), several directors have held their posts for excessive terms (Robert Kidder (17 yrs), Laura Tyson (13 yrs)) and of course, the chairmanship is held by an insider, Mr. Mack. Perhaps these problems could be ignored if the company hadn’t, well, screwed the pooch. Unfortunately for the rest of the world, that was not the case.

For MS shareholders interested in sorting out the pros and cons of this shareholder proposal, the Company proxy statement is of little help. Regrettably, the proponent talks in platitudes about the merits of independent chairmen. (Yawn). But somehow, corporate hubris seemed to get the best of executives at the Company who offer that “[t]he Board should not be constrained by an inflexible, formal requirement that the Chairman be an independent director who has not previously served as an executive officer.” The proxy statement goes on for several more interminable paragraphs suggesting that its independent board and committees all somehow validated its decision to let Mr. Mack continue on as CEO-Emeritus/Chairman.

Okay, so let’s recap: Stock price in the toilet, entrenched Chairman, entrenched board, executive pay rewarding short term performance, shareholders left holding the bag. This is a no brainer folks.

Vote for requiring that the chairman be I N D E P E N D E N T!

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In the never-ending grab for higher levels of excessive pay at shareholder expense, CEOs have shown a remarkable set of qualities: hubris, greed and brazenness. This list runs on but today, I am reminded by CorpGov.net that another talent has been overlooked, at least at the financial services company Waddell and Reed. That quality is hyperbole. It seems that the company’s CEO, Henry J. Herrmann has quite a talent in that department.

In a March 5, 2010 letter to shareholders, Mr. Herrmann suggests that a shareholder proposal coming to a vote on April 7th “could put Waddell & Reed Financial, Inc. at a serious competitive disadvantage and could erode the value of your investment.”

Really?

This apocalyptic event Mr. Hermann refers to is a shareholder proposal calling for an advisory vote on executive compensation. As Mr. Herrmann notes in a quieter moment in his letter, the proposal “recommends that the Board of Directors adopt a policy requiring an advisory vote of our stockholders to approve the Compensation Committee Report and the executive compensation policies and practices set forth in the company’s Compensation Discussion & Analysis in our proxy statement.” Somehow, this doesn’t strike me as a doomsday event so it prompted me to see what’s going here at WDR. (See ProxyAnalyst’s recommendation on this vote here)

A quick glance at the company’s proxy statement clarified things. Indeed, somebody would be at a disadvantage should shareholders be allowed some say on executive pay. However, it wouldn’t be the company’s investors.

Mr. Herrmann received approximately $4.9 million in total compensation in 2009, up roughly 20% from 2008. The market was up, company performance as measured by stock price for 2009 was up. One could argue that pay linked to performance was as it should be. Unfortunately for shareholders, the process could use a bit of tweaking considering how pay was set at the company.

As noted in the company’s proxy statement, four factors were used in determining Mr. Herrmann’s pay:

• The Company’s financial and operational performance for the year;

• Market survey information for comparable public and private asset managers prepared by the Committee’s independent compensation consultant;

• Recommendations of the Company’s Chief Executive Officer, based on individual responsibilities and performance;

• The previous year’s compensation levels for each named executive officer; and

• Overall effectiveness of the executive compensation program.

Yes, it seems that at Waddell and Reed, the CEO calls the shots when it comes to setting his own pay package. This arrangement is threatened should investors have some sort of input into this process. Undoubtedly, Mr. Herrmann is disturbed at the prospect that shareholders might take exception to his pay package, which includes the free personal use of the corporate jet, tickets to sporting and cultural events as well as this nifty pay package. Mr. Herrmann has undoubtedly worked hard to cultivate a solid relationship with his board of directors and doesn’t need that apple cart upended by the company’s owners.

However, it seems unlikely that this hullabaloo will come to much should shareholders approve this proposal. After all, the same proposal submitted by the same shareholder received majority support from shareholders last year. What did the company do in response?

Nothing.

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As investors and other react to the U.S. Supreme Court’s decision in Citizens United to allow unlimited corporate political spending, it is more apparent than ever that shareholder proposals calling for corporate political disclosure are a waste of time.

The Capital Eye, the blog for the Center for Responsive Politics has mentioned a recent agreement between Bank of America and New York City Comptroller John C. Liu who is all agog over the fact that the company has agreed to disclose its political contributions. In these sorts of matters, the devil is in the details, to wit:

• The information Bank of America will publish is already publicly available,
• Bank of America will not publish donations made individually by its employees, including top executives who routinely contribute to political causes with their employer in mind.
• Bank of America is refusing to disclose money it donates to not-for-profit political organizations, such as the U.S. Chamber of Commerce, that now, thanks to the recent Supreme Court decision Citizens United v. Federal Election Commission, have the ability to spend unlimited amounts of money on advertisements advocating for or against specific political candidates.

The Controller is obviously giddy about his success but he has clearly missed the point. Some time ago, corporations figured out that contributing directly to political causes exposed companies to too much scrutiny. With organizations like the U.S. Chamber of Commerce willing and able to do the dirty work for them, why not give them piles  of cash, launder it so that no trail could be found by the public and really affect change that matters to corporate executives. With unlimited political spending now available to corporations thanks to the U.S. Supreme Court, why bother with direct political giving?  If the NY City Controller wants disclosure, no problem.

Coincidentally. our friends at MoxyVote noted on their blog recently that John Bogle, the founder of Vanguard and a leading advocate for investors argues that corporations are not people and don’t deserve the free speech treatment afforded them by a recent Supreme Court decision infamously known as Citizens United.

[p]ublic companies aren’t people. As Justice John Paul Stevens, writing for the minority, observed, the court committed a grave error in treating corporate speech the same as that of human beings. The notion that the same freedoms should apply when a public company, often with tens of thousands of owners, speaks in matters beyond the scope of its business affairs offends common sense.

Bogle then suggested an incredibly simple idea that will have executives screaming. He proposes a shareholder proposal calling for shareholder pre-approval of political contributions.

RESOLVED: that the corporation shall make no political contributions without the approval of the holders of at least 75% of its shares outstanding.

Simple and straightforward I say. Whether the SEC in its infinite wisdom would vet this remains to be seen but let’s test this out shall we?

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What have we learned from the collapse of Lehman Brothers Holdings?

The report issued by a bankruptcy court examiner into the collapse of Lehman Brothers was released last week, sending shock waves through the business world. Aide from many details about high-risk business deals undertaken by the company, what has been most revealing to me is the blame laid on Ernst & Young, Lehman’s outside auditors. One would think that post-Enron, where the once venerable Arthur Anderson was extinguished in the blink of an eye, the remaining Big Four would be a bit more rigorous about their audit engagements. Apparently not.

What came out of the Enron disaster was the Sarbanes Oxley Act (SOX), which among other things imposed increased responsibilities on companies and their auditors to conduct and verify their internal controls. In addition, Congress and the SEC severely limited outside accountants from engaging in non-audit work with the firms they were auditing.

Say hello to the “rule of unintended consequences.”

An interesting thing happened in 2001. That was the year that auditors were prohibited from doing other consulting work for their corporate audit clients. In the case of Lehman Brothers and Ernst & Young, that event seemed to have just the opposite effect in that the auditor’s fees skyrocketed. From 1999 to 2007, the last year auditor fee data was reported to Lehman’s shareholders, Ernst & Young’s fees increased 7 fold from $5.3 million to more than $31 million. While some of the increased revenues can be attributed to the additional work created by Sarbanes Oxley compliance, it remains interesting from a shareholder perspective that the numbers accelerated in such rapid fashion.

The following chart reveals the dramatic climb in E&Y’s fees for the 9-year period. It suggests that, in terms of fees collected from it’s client, the risk of “not biting the hand that feeds you” increased dramatically.

What we see is that, in the case of Lehman Brothers and Ernst & Young, the auditor was able to recoup their non-audit fees in spades. While the apparent conflict of interest that was eliminated by SOX was eliminated, the motivation to rigorously assess the financial dealings of Lehman Brothers may have taken a back seat to the revenues generated from the long-term engagement with Lehman Brothers.

I have no doubt that Ernst & Young officials would rigorously argue that no such conflicts existed. However, when “credible evidence” suggests that “accounting gimmicks” were not uncovered by Ernst & Young to shareholders, investors can only wonder.

So what have we learned here?

Despite SOX reforms, there are still risks to investors from shoddy audit oversight. Auditors are still subject to enormous pressure from unscrupulous clients who try to hide risk from their investors. Long-term engagements by companies of their outside auditors pose real risk to investors.

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Today shareholders at Black & Decker will consider a merger with the company’s rival Stanley Works. At a 22% premium, such an offer will be hard to pass on. So it seems like the perfect opportunity for the board of directors to grant BDK CEO Nolan Archibald a tidy pay package of $89 million. Included in the payout is a “cost synergy bonus” of more than $45 million if the company meets certain cost reductions (can you say “LAYOFFS”?). Mr. Archibald, a 1% owner of the company’s stock will do quite nicely without the out-sized pay package.

In the Friday edition of the Wall St. Journal, it is reported that the New York Stock Exchange has raised questions about the independence of one of the directors on the company’s board – Anthony Burns. It seems that Mr. Burns as some significant personal business dealings with CEO Archibald that were somehow overlooked in the company filings with the SEC.

While it seems unlikely that the Big Board will do anything in response to this disclosure about this conflict, it speaks volumes to yet another example of boards failing to act in the best interests of company shareholders.

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As I often do when speaking before groups of people about proxy voting and corporate governance, I asked this question: “What do you do with your proxies?” The answer, which you can probably predict from your own experience is, “I throw them away.”

The follow on question I pose evokes a bit more complex response but a common thread usually emerges. “Why do you throw them away?” Almost to a person the reason is that people simply don’t understand how to vote on the issues. Fearing that they might do something stupid, most people opt for the trashcan.

To solve this information problem, I propose to offer a series of proxy voting strategies that are simple in form, don’t require much time to figure out and get the job of voting your proxy done with relatively little pain.

Here is my first strategy.

Now that’s not too complicated is it?

I realize that some readers might find this approach too simplistic. But given that most people don’t take the time to vote, I hope this approach will provide a means for investors to become more engaged in the governance process.

Let the debate begin . . .

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As noted on Wednesday, ProxyAnalyst recommends a vote against the Compensation Committee members of the board of directors at KB Homes. The Los Angeles-based homebuilder has continued to grant substantial stock awards, retirement benefits and bonuses to its CEO Jeffrey Mezger while the company has underperformed over the last five years.

In 2009, Mr. Mezger was awarded a base salary of $1M. However, after awards of stock options, stock grants, incentive awards and a slew of other compensation benefits, his salary rose to more than $9M.  While his total pay has fluctuated over the last five years, it has in no way tracked the overall performance of the company for that period.

The following graph reflects the company’s stock price performance for the period. It is not a pretty sight with the company losing almost 70% of its share value during that period.

What I find most troubling is the manner in which the Compensation Committee failed to adequately address shareholder concerns while shoveling executive pay out the door. The compensation problem at KB Homes hasn’t gone unnoticed by at least some shareholders.

Last year, the company was targeted with a proposal calling for an advisory vote on future compensation packages doled out by the board. The proposal received a majority of the motes cast on the issue. However, the company rejected implementing the proposal saying:

Although a majority of votes cast were in favor, the proposal failed to achieve the affirmative vote of the majority of shares of our common stock present and represented at the 2009 annual stockholders meeting, the applicable standard under our by-laws. Based on this outcome and given the significant legislative and regulatory momentum underway at the time of the 2009 meeting and through to the present time to establish a mandatory advisory vote for all U.S. public companies, your Board continues to believe that it is in the best interests of all stockholders to evaluate adopting an advisory vote mechanism when definitive rules are established.

So what the company said here is interesting for two reasons.

First, it points out a glaring flaw in the proxy voting system in which a company – in this case KB Homes – can count votes present or broker non-votes in calculating the total votes counted.

Let’s put this in the context of a presidential election. You and I vote for our candidate (he is running against the incumbent). Our guy receives a narrow majority (say 35 million) of the votes cast in the election out of a total of 60 million votes cast. However100 million voters were eligible to cast their votes. But 40 million of them stayed home. The incumbent says, “100 million voters are eligible to vote and if they didn’t, we will assume they voted for us, the incumbents.” So the incumbent counts an additional 40 million votes in his favor and walks away with the election.

Doesn’t sound fair but that is what KB Homes executives did in 2009 on the say-on-pay shareholder proposal.

Second, the company argues that because legislation is pending in Washington that might be a game changer on executive pay practices, it somehow shouldn’t have to pay attention to the wishes of a majority of its voting shareholders. What was that legislation anyway? While Congress has been debating financial reform for some time, nothing has materialized and the SEC has not taken any grand steps to obligate companies to obtain shareholder approval of pay awards. There is no real risk of legislative reform and I suspect that company executives knew that but obfuscation rather than reality seems to be the order of the day in that statement.

That brings us back to the situation at hand. The four directors, Stephen F. Bollenbach, Timothy W. Finchem, Michael G. McCaffery and Luis G. Nogales have not served the best interests of KB Homes shareholders in granting these pay packages to the company’s executives. Mr. Nogales is over-boarded (he serves on three other boards), Mr. Bollenbach is overpaid to the point that his independence is called into question and the Committee as a whole has not publicly demonstrated any sort of public leadership that could clarify its decision to pay executives outsized pay packages at shareholder expense.

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