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Recently in Corporate Governance Category

by Walter Olson
Senior fellow at the Cato Institute's Center for Constitutional Studies

Last month, over sharp dissents from two Republican commissioners, a three-member majority of the Securities and Exchange Commission proposed a new rule to implement a mandate under the Dodd-Frank law that U.S. corporations disclose the ratio between the pay of their chief executive officer and that of their workers. (For more background, and a harsh description of the bind in which Congress placed the Commission, see Michael Greve's take here. The rule is open for public comments through December 2.)

Labor advocates were pushing for a tough rule, and the one they got requires compliance methods that for international companies in particular are likely to prove quite burdensome, the cost often reaching into the six and even sometimes the seven figures. Notes Marc Hodak, "we are almost certain to see quite a few companies paying more than they actually pay their CEO to figure out how much more their CEO makes than their median worker. If this rule [were] really being implemented for the benefit of the shareholders, then Congress could have let each company's shareholders opt in or opt out of this disclosure regime. Clearly, the people pushing this ratio had no interest in giving actual shareholders a veto over this racket."

Wrote dissenting commissioner Daniel Gallagher: "There are no - count them, zero - benefits that our staff have been able to discern. As the proposal explains, '[T]he lack of a specific market failure identified as motivating the enactment of this provision poses significant challenges in quantifying potential economic benefits, if any, from the pay ratio disclosure[.]'" "Proponents have acknowledged the sole objective of the pay ratio is to shame CEOs, but the shame from this rule should not be put on CEOs - it should be put on the five of us," said dissenting commissioner Michael Piwowar. "Shame on us for putting special interests ahead of investors."

When I wrote up a version of the above in a post at Overlawyered, a commenter named Allan responded that cost-based opposition to the rule was "simply ludicrous":

Just take the amount paid to all employees and divide it by the number of employees. [Voila] - you have the average salary.

It is ridiculous to assert that it would cost more than a calculator to figure out the average employee's pay or the CEO's pay. If a company does not know how much it is paying its employees, it needs a new CFO and a new director of HR.

It is never a sound idea to lose one's patience with commenters but I fear I may have done so just a bit with my reply:

Before Allan opens up his promising "Here, let me work it out for you on the back of an envelope" business consultancy, he might want to check out some relevant sections of the proposed SEC rule. Here are excerpts (footnotes omitted) from the commission's explanation of its controversial decision to include overseas employees in the median wage pool:
According to [critical commenters], the international variation in compensation arrangements and benefits, in addition to cost-of-living differences and currency fluctuations, could distort the comparability of employee compensation to that of a PEO based in the United States. In addition, these commenters noted that the types of compensation that are recorded in payroll and benefits systems outside the United States may vary from those recorded as compensation in the United States due to local accounting standards and tax regulations. ...

We acknowledge the concerns of commenters that the inclusion of non-U.S. employees raises compliance costs for multinational companies, introduces cross-border compliance issues, and could raise concerns about the impact of non-U.S. pay structures on the comparability of the data to companies without off-shore operations. ...

In particular, we are cognizant that data privacy laws in various jurisdictions could have an impact on gathering and verifying the data needed to identify the median of the annual total compensation of all employees. Commenters have asserted that, in some cases, data privacy laws could prohibit a registrant's collection and transfer of personally identifiable compensation data that would be needed to identify the median. We also understand that in many cases, the collection or transfer of the underlying data is made burdensome by local data privacy laws, but is not prohibited.

"So remember" (I concluded), "the SEC might throw the book at you if you use a currency conversion formula it doesn't agree with, and foreign governments might throw the book at you if you export pay data on their citizens for purposes of doing the required calculation. Other than that, and maybe a few dozen other complications, Allan's advice is perfectly safe to follow."

Hodak further points out that even the benefits of the rule to unions are at best speculative:

...since the unintended consequences of this rule are difficult to fully predict. For instance, it might encourage further outsourcing of relatively low-wage work to foreign companies, depressing employment of union workers. In other words, we could very well see the average pay of the median worker go up in public companies falling under the rule, but only if you don't count the zero wages being earned by those who are laid off as a result of this law.

To gain short-term fuel for the stoking of demagogic envy, in short, this whole exercise undercuts the competitiveness of American employers overseas and even at home. If Congress had its eye on the ball, it would be revisiting this section of Dodd-Frank with a mind toward repeal.

James R. Copland
March 27, 2012

In 2012, we'll again be tracking annual meetings among America's largest public companies at the Manhattan Institute's Our 2012 Proxy Scorecard contains relevant proxy-ballot information on the largest 200 public companies, as ranked by Fortune magazine, including links to all shareholder proposals and executive compensation advisory votes. Our publicly available, easy-to-use database is sortable by meeting date, company name, type of proposal, proponent, and voting results. We will be adding companies' information to the scorecard throughout the year, as soon as ballots have been distributed to shareholders, and we will update the database with voting results after meetings occur and results have been reported to the Securities and Exchange Commission's Edgar website.

Although the corporate annual meeting season begins in earnest in mid-April, twelve Fortune 200 companies have already held their annual meetings, and 51 had mailed proxy ballots as of March 15. From this partial sample, we can already discern some trends of interest.

Of the 12 companies to hold meetings to date, three companies have seen shareholder proposals receive majority support:

• Johnson Controls, which at its January 25 annual meeting saw over 85 percent of its shareholders vote for a proposal by Gerald Armstrong calling on the company to declassify its board;

• Emerson Electric, which at its February 7 annual meeting saw over 76 percent of its shareholders vote for a proposal by the pension fund of the American Federation of State, County, and Municipal Employees (AFSCME) to declassify its board; and

• Apple, which at its February 23 annual meeting saw over 80 percent of its shareholders vote for a proposal by the California Public Employees' Retirement System to adopt a majority-voting standard for director elections.

That 2012's successful shareholder proposals have involved procedural rules such as board declassification and majority voting is in keeping with recent trends.

Such corporate-governance related proposals, not involving executive compensation or social or public-policy issues, thusfar constitute a majority of all shareholder proposals in 2012, a higher share than that seen recently. Proposals relating to executive compensation remain far less frequent relative to their levels before 2011, when executive compensation advisory votes became mandatory for all public companies under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

2012's early returns involving such say-on-pay votes demonstrate the substantial role being played by the nation's largest shareholder advisory firm, Institutional Shareholder Services (ISS), in such voting. While no Fortune 200 company has seen shareholders reject executive pay packages in 2012, the four companies to have received the lowest percentage support--Johnson Controls, Navistar, Qualcomm, and Walt Disney--each received "no" vote recommendations from ISS on their executive pay plans. On average, these companies received 64 percent support from shareholders in say-on-pay votes, as compared to an average 94 percent support for other companies meeting by mid-March.

Since ISS's position almost certainly helped to influence the markedly different shareholder votes on pay packages, it would seem that an unintended side effect of Dodd-Frank-mandated say-on-pay votes is to give the proxy advisory firm a major "gatekeeper" role over executive pay. ISS's strengthened position might be enhanced further if institutional investors heed its newly promulgated advice to challenge management to respond whenever fewer than 70 percent of shareholders approve of board-proposed compensation packages--a position that would seem to be rather self-fulfilling given ISS's influence over the votes in the first place. Given that many of ISS's clients are labor-union pension funds and social-investing funds that may be motivated by issues other than maximizing shareholder value--and have respectively sponsored one-third and one-fifth of all shareholder proposals to date in 2012--I'll be watching the proxy advisory firm's role closely.

What else will I be watching in the upcoming annual meeting season? I'll be paying particular attention to certain classes of shareholder proposals in which union and social funds have taken a special interest:

• Proposals related to corporate spending on politics and lobbying (looming for Citigroup on April 17, Honeywell on April 23, BB&T and IBM on April 24, Johnson & Johnson on April 26, AT&T on April 27, and UPS on May 3), which have been increasing in number--though not getting majority support--in the wake of the Supreme Court's 2010 Citizens United decision affirming First Amendment protection for corporate political speech;

• Proposals calling on the company to separate the positions of chairman and CEO (looming for Bank of New York Mellon on April 10, Honeywell on April 23, General Electric on April 25, Johnson & Johnson and Lockheed Martin on April 26, and AT&T on April 27), which have been pushed hard by union funds and certain shareholder activists; and

• Proposals calling on the company to grant proxy access to shareholders nominating directors (looming for Wells Fargo on April 24), which are reappearing on this year's proxy ballots after the D.C. Circuit last summer rejected the mandatory proxy access rule proposed by the SEC.

Check Proxy Monitor during the annual meeting season for my ongoing analyses of these and other issues, as well as our up-to-date scorecard of scheduled meetings and voting results.

Rick Esenberg

[Originally published in the Milwaukee Journal-Sentinel, 1-30-10.]

In Citizens United vs. FEC, the United States Supreme Court held that corporations (and - probably - unions) have a constitutional right to make independent expenditures advocating the election or defeat of political candidates. Much criticism of the decision turns on two assertions. "Money," the critics say, "is not speech," and "corporations are not people."

These are just sound bites. They are legally irrelevant and have been for a long time.

Money may not be speech, but a right to speak without the corresponding right to make one's voice heard would be an empty liberty. A genuine freedom to speak cannot be limited to the right to stand on the corner and holler at passersby. It takes money to use the Internet, print pamphlets, publish books or broadcast ads. Citizens United is an important case, but its recognition that prohibiting someone from spending money to disseminate a message can be the equivalent of suppressing that message is not novel. It's been settled constitutional law for almost 40 years.

Corporations are not people, but they are associations of people whose common endeavor is affected by government policy and election results. Like natural persons, some are wealthy and others are not. Some are formed to seek profit by providing goods and services, while others are nonprofit. Like natural persons, these associations have an interest in being heard on matters that affect them. Not surprisingly, courts have recognized that a corporation may have constitutional rights for well over 100 years.

What is new about Citizens United is its recognition that corporate free speech rights include not only the right to speak about issues but to engage in "express advocacy" for or against a particular candidate. Rather than limit themselves to gravely narrated ads asking you to call Sen. Foghorn and tell him to stop destroying the republic, corporations (and unions) can now simply ask you to vote for his opponent.

Corporations still may not contribute to candidates. Corporate speakers will have to identify themselves, and companies may be reluctant to become involved in public debate for fear of consumer or shareholder backlash. Contrary to the claims of President Barack Obama, foreign corporations are still prohibited from attempting to influence federal elections.

But, as a law professor who teaches election law, I do think that the ramifications of Citizens United are huge.

One of the motivations for campaign finance reform has been to reduce the amount of money spent on politics and to "equalize" political resources. This is not as noble as it sounds.

To restrict what can be spent on speech is to restrict speech itself. Restricting speech tends to favor incumbents - who generally hold an advantage in name recognition and fund raising. Allowing legislators to set the rules that govern the elections in which they seek to retain their jobs is a bit like asking a chronic gambler to manage your money.

For centuries, political thinkers ranging from James Madison to Alexis de Tocqueville have recognized that democracy - with its potential for unchecked majority rule - may lead to certain excesses. Madison, in particular, thought that one solution to this problem was to allow society's various "factions" - today we call them "special interests" - to offset one another.

That best happens when all are permitted to fully participate in the public debate.

"Corporations" and even "the wealthy" are not a monolithic interest. As we have seen in recent years, both Democrats and Republicans and both conservatives and liberals have successfully raised large sums of money. In addition, the Internet has increased the significance of small donors. No one faction is likely to dominate the political debate. No significant voice is unlikely to be heard.

As Justice Samuel Alito recently observed, candidates and factions all have different advantages. These might include wealth, incumbency, celebrity, intensity of interest and populist appeal. It is for voters - not the state - to decide which are and are not "legitimate."

In a recent article in an academic journal, I argued that campaign finance reform had turned into a never-ending game of Whack-A-Mole in which the moles always win. Efforts to stop spending "here" inevitably lead to more spending "there." Every "reform" is swamped by unintended consequences.

In the end, the only way to truly level the playing field is censorship managed by one side in the game. During oral argument in Citizens United, the government argued that - in the interests of "reform" - Congress could prohibit corporations from publishing books critical of candidates for federal office.

That scared me. That scared the court.

Citizens United is the result.

Rick Esenberg is professor of law at Marquette University Law School and blogs at Shark and Shepherd. He is a community columnist for the Milwaukee Journal-Sentinel, where this essay first appeared.

Corporate management decisions should be left to business leaders, not prosecutors.

James R. Copland

[Originally published in the, 8-26-09.]

On Aug. 6, 2009, the Securities and Exchange Commission announced that it had reached a $15 million civil settlement with former AIG chief executive Maurice "Hank" Greenberg. This story has gotten far less attention than it deserves, given that it occurred against the backdrop of the collapse of AIG, which is now mostly owned by the federal government. Both the SEC-Greenberg settlement and AIG collapse help us to understand, in retrospect, the real costs of the war that former New York attorney general Eliot Spitzer waged against the insurance giant and its leader.

The SEC's action was not a roar but a whimper: The agency not only failed to make a criminal case against Greenberg but also failed to charge him with civil fraud. Instead, Greenberg was merely accused of being a "control person," ultimately responsible for his company's alleged accounting improprieties (allegations that Greenberg, in reaching the settlement, did not admit).

Still, the SEC's complaint, if credited, is serious enough. AIG was accused of inflating earnings and insurance loss reserves while obscuring actual underwriting losses. The allegations that appear front and center in the SEC's complaint—alleged sham transactions entered into between AIG and General Re, a reinsurer owned by Warren Buffett's Berkshire Hathaway—are those, which Spitzer focused on when going after Greenberg.

But even if Spitzer ultimately zeroed in on a corporate impropriety—he had previously looked into alleged bid-rigging and even Greenberg's 1970s-era charitable endeavors—his obsessive pursuit of AIG's captain, in hindsight, looks foolish indeed. The General Re transactions upon which Spitzer and the SEC focused may have been fraudulent, but their total alleged size—$500 million—pales in comparison to AIG's $99 billion in 2008 losses and the consequent $182.5 billion taxpayer-funded bailout of the company, designed to keep the financial system afloat. And while the transactions at the heart of the SEC's complaint may have resulted in material accounting misstatements, they are immaterial to the company's costly implosion: They occurred from 2000 to 2002 and are wholly unconnected to AIG's massive bet in the credit default markets that precipitated its ultimate collapse.

The chain of events that led to its collapse followed swiftly in Spitzer's wake. Shortly after Spitzer issued subpoenas against AIG in February 2005 related to the General Re transactions, the market began discounting the company's debt. The next month, AIG's board, under intense pressure from Spitzer, ousted Greenberg from the company; the very next day, the Fitch rating agency downgraded AIG's credit rating from AAA to AA, and Standard & Poor's followed suit later that month. The credit downgrades dramatically increased the potential collateral calls that AIG faced on its credit-derivative products.

More critically, as control of AIG shifted hands, vital risk-oversight practices waned. Greenberg's successor, Martin Sullivan, admits that he had "focused on other priorities including repairing AIG's standing with customers and regulators [and] cooperating with several government probes." AIG's financial products group, which sold credit-default derivatives and other financial instruments, wrote as many credit-default swaps over the nine-month period after Greenberg departed as it had in the previous seven years combined.

It is impossible to know whether the large derivative position amassed by AIG would have been accumulated under Greenberg's watch, though Greenberg did have a long track record of closely monitoring the financial products group's risk. David Havens, a credit analyst with UBS, insists, "Had Hank Greenberg still been running the company, I think it's pretty safe to say the situation wouldn't even be close to what is now."

Thus, AIG's downfall powerfully demonstrates the problem with turning over the regulation of corporate governance to criminal prosecutors with political agendas. The SEC's civil-enforcement powers, in addition to private civil actions at the state and federal levels, are more than sufficient to police accounting shenanigans such as those underlying the agency's settlement with Greenberg. (The power of private civil actions, themselves often abused, was exemplified one week after the SEC settlement, when Greenberg and other executives announced a $115 million settlement with class-action plaintiffs.)

Clearly, on occasion, individual business leaders' malfeasance warrants criminal prosecution. But corporate management decisions should be left to business leaders, not prosecutors who cannot understand the businesses they are investigating.

Unfortunately, the government's vast powers in the criminal arena enable prosecutors to coerce corporate boards to do their bidding, and far too often, prosecutors succumb to this temptation. Such abuses extend beyond Spitzer's crusades; federal prosecutors' criminal powers over accounting practices were expanded radically in the Sarbanes-Oxley Act of 2002, and U.S. attorneys regularly use "deferred prosecution agreements" to control corporations in the government's cross hairs. State and federal legislators should rein in such abuses, before we get another AIG.

James R. Copland is the director of the Center for Legal Policy at the Manhattan Institute.



Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.