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Top Things To Watch At ISS

Interview With Pat Mcgurn, Special Counsel To ISS 

Pat; it seems to us like you have been a leading player in the Corporate Governance space forever, so we especially wanted to get your perspective on our theme this year.

What do you think of the current balance of power between management, boards and shareholders, and what, if anything, do you think needs “righting”?

McGurn: You’re right, I guess, about my history: This is my 19th Proxy Season, which is the way I measure time now - and I think there is a pretty fair balance of power today.

The top questions to ask, I think, are “Who does the board represent, and who has the ear of the board these days?” Our governance model has always been a basically board-centric, rather than a ‘public’ model. If we look back, it seems fair to say that a lot of CEOs thought of the board as “their board” – and many directors referred to “their board” too – which was pretty accurate back then, since they did all the picking and choosing.

But shareholders have much closer relationships with boards these days, and boards have become much more willing to listen to shareholders – especially their larger shareholders – and to be very responsive. Retail shareholders have moved very much to the sidelines following the financial meltdown, although John Chevedden – whom I call “Gad-Zilla” – is on track to file over 100 shareholder proposals in 2014. But for most companies these are pretty much back- burner issues.

What about Social and Environmental proposals? Do you see the same slow-down here that I see?

McGurn: Yes, I see a trend by proponents to link “E&S proposals” to long-term risk assessment programs, with boards being much more willing to negotiate, and agreeing to make greater disclosures. In 2013, 50% of the E&S proposals were withdrawn after negotiations.

Let me ask you about the ISS position to vote no on two directors at Provident National following their bylaw change to prohibit director candidates who would  receive  “incentive  fees”  for  running  for election. It strikes me that such arrangements violate two of our most important corporate governance pillars: That directors have a fiduciary duty to represent all shareholders – and that directors should not be stepping in as active “managers” in order to get the stock price up, and collect ‘incentive payments” if the price does go up.

McGurn: I think there will be a great debate here. Provident was a little different in that the bylaw provision was a very broad one – that precluded virtually any kind of potential payments to director candidates – that was not voted on by the shareholders – and where management was not willing to engage in discussions. At Agrium, and at Coke several years ago, and at Hess, directors did indeed surrender such payments before being seated. On the other hand, we need to recognize that agreeing to run on a separate slate represents a significant commitment of time and talent. So this will be an important debate to have.

I know that ISS is looking more closely at audit committees – and as an investor, I’m astounded at the number of defective audits that the PCAOB has cited – and by the percentage of repeat offenses by three of the big-four firms – and at how little blowback there has been from investors, and from audit committees, which, one would think, should be looking to raise the bar here.

McGurn: Shareholder ratification of the audit firm is one of the last “routine items” that remain on the ballot, and I think the SEC is reluctant to tackle this right now. One of these years I feel that it will emerge as a bigger issue – and Ed Durkin of the Carpenters Union, whose model proposal was kicked out by the SEC, has had some success in getting companies to agree to “enhanced audit disclosures.” So yes, I think there will be more to come here, down the road.

In early 2011, when the huge stashes of corporate cash first began to draw attention – but also in light of the truly horrible results produced by most share-buyback programs, and by most acquisitions – we predicted that “The Next Big Thing in Corporate Governance” would be “Holding Directors’ Feet to the Fire Over their Stewardship of Corporate Capital.” Do you think this has come to pass? And, more importantly, will ISS give a lot more weight to this when opining on how to vote on Director candidates?

McGurn: Could anyone have imagined five years ago that Apple would be the subject of today’s “Operational Activism” movement? And yes, many such investors are “second guessing” capital allocation decisions, as they should be. Most of our own institutional investor clients are giving very substantive attention to these issues – and feel very well qualified to do so. But they do want much more information on Directors than ever before, and, at their urging, we are building bigger data-bases about directors, and where they’ve served. Many investors have developed their own “no fly lists” of directors they will absolutely not vote for – and by 2020, I have been predicting that this will be the top issue with operational investors.

What do you think is the biggest threat facing companies on the governance scene these days?

McGurn: Boards need to pay a lot more attention to risk oversight: This is really a core responsibility of board members, and one where they need to be more active, more discerning, and to be a lot more specific in disclosure documents.

And what do you think are the biggest opportunities for Boards, these days?

McGurn: Boardroom succession planning: It’s the absolute Achilles heel of most boards today. Boards really need to improve their game. And while SEC guidelines for “skills matrices” helped considerably a few years ago, many companies have fallen back on boilerplate disclosures.

Anything else that’s high on your radar screen these days?

McGurn: Yes, and it also relates to director elections and to director qualifications and skill-sets: We need to be thinking about the Universal Ballot that the SEC Advisory Group has been calling for. With increasing focus on directors, and the likelihood of more competing slates, many investors want to be able to pick and choose among the management slate and a competing slate – to get the very best blend of skills they can.