Give Shareholders an Easy Way to Vote Their Minds

First Published in the Atlanta Journal-Constitution May 8, 2009

by Rob Hassett

As part of the federal stimulus package, more than 400 financial institutions will be required to hold non-binding shareholder votes this year approving or disapproving executive compensation.

Shareholders at many public companies will also be voting whether to permit shareholders to vote on non-binding resolutions on executive pay.

None of this will have much impact unless each shareholder is given the right to be notified by e-mail when a proposal is to be voted on. The e-mail should link to a clear description of the proposal and link the shareholder to a proxy or other method to vote. Most companies will only offer this convenience if required by the Securities and Exchange Commission.

Under new SEC rules, public companies are required to post information about proposals to be voted on by the shareholders on their Web sites. But the SEC does not require companies to allow shareholders to grant proxies or otherwise vote via the Internet. Most shareholders who obtain information over the Internet would probably not go to the trouble of then mailing a proxy grant. Probably for these reasons, fewer individual shareholders are voting now than in the past.

In most cases shareholders can learn what methods of receiving materials and voting are available by checking the company’s investor relations page.

Failure of shareholders to cast votes is a primary reason that challenges to managements’ positions are almost always defeated. As a result, outrageous executive pay and conflicts resulting from executives serving on the board of directors have not been curbed.

Under Delaware and Georgia corporate law, the percentage of shares needed to constitute a quorum can be set as low as one-third of the shares outstanding. In companies that set a quorum at the minimum, when most shareholders do not vote, as few as one-sixth of the shares (plus one) can block any reform. Additionally, in some corporate bylaws, a failure to cast a vote by proxy or other means results in that shareholder’s shares being deemed cast in favor of management’s position. Finally, management is often supported by managers of mutual and hedge funds who genuinely believe that executives, like themselves, are entitled to exorbitant pay for mediocre performance.

Coca-Cola recently held a shareholder vote on whether to have a shareholder advisory vote on executive compensation. Certainly most individuals holding shares would want a chance to review and give an opinion on executive pay. That said, only 36 percent of the shares were voted in favor of the proposal.

An increasing number of companies are permitting individual shareholders to grant proxies over the Internet. On May 20, Intel is set to become the first public corporation to allow shareholders to participate in the annual shareholders meeting over the Web, which will include the ability to ask questions and cast votes during the meeting.

Most executives and board members will not want shareholder input on executive pay and other sensitive issues. Many shareholders will say that they do not have the time to adequately review the materials to make an informed decision on these matters. Ten years ago these attitudes may not have made much difference. But not today. In light of recent abuses and the dismal records of executives and directors, these kinds of decisions should not be left up solely to management.

Rob Hassett is a corporate and technology lawyer with the Atlanta law firm of Casey Gilson P.C.

Copyright 2009, The Atlanta Journal-Constitution.

 

Curbing Excessive Pay, Board Clout of Executives Would Help Business


First Published in the Atlanta Journal-Constitution 2-4-2009

by Rob Hassett

Now that we taxpayers are bailing out banks and other companies that were grossly mismanaged, we should put corporations on a sounder footing and curb excessive compensation for executives of public companies.

First, no executive of a public company should be allowed to sit on the board of directors of that company. The CEO of a public company is often on the board and sometimes the chairman. Being on the board gives the CEO undue influence on the other board members regarding his or her compensation.

Second, each public company should be required to display the last three years of revenue, earnings, stock prices and executive pay in a prominent and clear format on the investor-relations page of the company’s website. Investors can obtain this information from the Security and Exchange Commission’s Website, but putting it on the investor-relations page would make it more accessible to the average investor.

Third, if despite all of the above the directors of a company still decide to provide executive compensation that is above an amount that would be set liberally by the SEC based on the size of the company and other factors, the company should be required to obtain shareholder approval.

Unfortunately, many executives have shown they are not capable of reining in excessive pay and bonuses on their own.

Merrill Lynch, a company that lost $27 billion last year, paid out billions of dollars in bonuses to many of its executives just before Bank of America’s taxpayer-backed takeover. In 2006, the highest paid executive of any public company was Stanley O’Neal, the chief executive officer of Merrill Lynch at the time, who received total compensation of $91 million.

In 2006, the CEO of Countrywide Financial Corporation, Anthony Mozilo, received total compensation of $48 million. Countrywide was teetering on the edge of bankruptcy when it was recently sold to Bank of America in a fire sale brought on by poor management.

Mel Karmazin, the founder and chief executive officer of Sirius Satellite Radio, received compensation of $32 million in 2007 even though Sirius never made a profit before merging with XM Satellite Radio in 2008.

These are not isolated instances. The problem is not just that a few rogue executives are extraordinarily greedy and have indifferent or intimidated boards. The problem is that too many executives of public companies have insatiable appetites for money and choose to use their considerable skills to increase their compensation instead of doing what’s best for their shareholders.

Some will argue that part of the compensation referred to above was in the form of incentive compensation. In other words the executives were paid a large portion of their compensation for “outstanding” performance. The problem with incentive pay is that it encourages executives to accept unreasonable long-term risks for immediate income that increases incentive pay for that year. Agreements regarding incentive pay should be monitored as tightly as any other form of compensation.

The adverse consequences of unjustifiable executive compensation add up to more than what compensation gets paid out. It puts the company at a disadvantage when negotiating with unions, it creates cynicism among the other employees of the company and it understandably causes a lack of willingness by the public to provide taxpayer-funded bailouts when the economy turns sour.

Rob Hassett is a corporate and technology lawyer with the Atlanta law firm of Casey Gilson P.C.

Entity Comparison Chart

By Rob Hassett

CAUTION – THIS CHECKLIST HAS BEEN PREPARED FOR GENERAL EDUCATION PURPOSES ONLY AND DOES NOT CONSTITUTE SPECIFIC LEGAL ADVICE. THERE ARE MANY EXCEPTIONS TO THE INFORMATION SET FORTH IN THIS CHART AND THEREFORE ANY READER SHOULD RELY ONLY ON THE ADVICE OF A PROFESSIONAL TAX ADVISER WITH RESPECT TO TAX RELATED MATTERS.

(1)  Applies to All Three:

CONSIDERATION

C CORP

S CORP

LIMITED LIABILITY COMPANY*

Limited Liability

Yes

Yes

Yes

(2)  Reasons to Use C:

CONSIDERATION

C CORP

S CORP

LIMITED LIABILITY COMPANY*

Number of Owners

No restrictions

1-75

No restrictions unless publicly traded

Tax Year

May be fiscal

Usually calendar

Usually calendar

Deductions for health insurance

Yes

Yes

Yes

Fed tax on income left in business

Essentially 34%

Up to 35%

Up to 35%

Qualified small business stock (10% on capital gain)

Yes

No

No

(3)  Reasons to Use C or S:

CONSIDERATION

C CORP

S CORP

LIMITED LIABILITY COMPANY*

Expenses of setup

Inexpensive w/out shareholder agreements, incentive stock options, etc.

Inexpensive w/out shareholder agreements

Usually more expensive where advantageous (to deal with allocations, capital accounts, etc.)

1244 Stock (ordinary loss on sale or liquidation)

Yes

Yes

No

Tax deferred reorganization

Yes

Yes

No

ISO’s allowed

Yes

Yes

No

Gain on redemption taxed at ordinary income rates to extent of receivables

No

No

Yes

(4)  Reasons to Use C or LLC:

CONSIDERATION

C CORP

S CORP

LIMITED LIABILITY COMPANY*

Allowed Owners

No restrictions

Individuals and Certain Trusts, or 100% by S

No restrictions

Classes of Ownership

Yes

Voting v. non-voting only

Equivalent to C available

(5)  Reasons to Use S:

CONSIDERATION

C CORP

S CORP

LIMITED LIABILITY COMPANY*

FICA including Medicare reductions

No

Yes

No

(6) Reasons to Use S or LLC:

CONSIDERATION

C CORP

S CORP

LIMITED LIABILITY COMPANY*

Levels of Federal Taxation

2

1

1

Levels of State Taxation

2

1

1 in most states

Long-Term Capital Gain

Federal Income Tax at full rate on corporation’s gains

Federal Income Tax at 15% to shareholders

Federal Income Tax at 15% to Members

Accumulated Earnings Tax

Yes

No

No

Cash method of accounting

Generally allowed if under $5 million in sales (Restrictions apply when primary business is sale of inventory)

Generally allowed (Restrictions apply when primary business is sale of inventory)

Generally allowed if not owned by particular types of C corporations (Restrictions apply when primary business is sale of inventory)

(7)  Reasons to Use LLC:

CONSIDERATION

C CORP

S CORP

LIMITED LIABILITY COMPANY*

Losses

Don’t pass through

Can’t be allocated

May be allocated

Later Conversion subject to tax on built in gains

C to S (yes ultimately)

C to LLC (yes)

S to C (no)

S to LLC (yes)

LLC to S (no)

LLC to C (no)

* The members of a limited liability company may elect that the limited liability company be treated for tax purposes as a C corporation, an S corporation or a partnership. For purposes of this checklist, it is assumed that the members have elected that the limited liability company be treated for tax purposes as a partnership.

Rob Hassett 3/15/2000 Revision.

 

Bear Stearns’ Collapse Was Inevitable

First Published in the Fulton County Daily Report in May of 2010

by Rob Hassett

Congress should enact legislation that discourages executives of financial firms and funds that are not regulated by the FDIC or other agencies from incurring unacceptable risk. Otherwise those unregulated financial firms are going to repeat the behavior that resulted in the collapse of Bear Stearns, Lehman Brothers and others.

During the week of May 3, 2010 James Cayne, the former chairman and chief executive officer of Bear Stearns, was quoted as saying in testimony before the congressionally chartered Financial Crisis Inquiry Commission:

[Bear Stearns’ collapse] was due to overwhelming market forces that Bear Stearns [could not survive].

Bear Stearns’ collapse was not only unavoidable but was inevitable. Bear Stearns’ business model, which is typical of financial firms and hedge funds, was to borrow many times the value of its equity mostly in overnight markets at low short term interest rates and place the money in long term investments at higher rates. I have seen reports that its ratio of assets to equity was over 35 to 1 before the collapse began. As a result of carrying so much leverage, its profits were immense. For example, with that ratio, if its investments paid 1% more than what it paid to borrow money, as a result of the high leverage, its profit on its equity investments, before compensation to employees, would equal about 35% per year. Each year the high level employees would receive very high compensation based on the huge profits.

Everything worked well so long as investments paid off at least marginally better than what was paid to the overnight lenders and the overnight lenders were comfortable renewing the loans. Of course even wise investments are not always successful and with such high leverage it was inevitable that at some point something would go wrong and the overnight lenders would refuse to renew their loans causing Bear Stearns to collapse.

Other Wall Street firms like Goldman Sachs also had outrageous asset to equity ratios, just not anywhere close to as high as Bear Stearns. Goldman Sachs survived because it was like two hunters being chased by a bear. Neither hunter has to run faster than the bear just faster than the other hunter. Likewise, Goldman Sachs just had to survive long enough for the government to be sufficiently shaken up by the failure of other firms to bail out the firms that remained.

The Wall Street firms and hedge funds that are not regulated are still operating under the same business model that resulted in the meltdown, although, for now, less aggressively. If things continue as they currently are, the incentive to increase leverage will inevitably result in another collapse, probably worst than the last one. To avoid another collapse, the incentives should be changed.

I suggest that Congress consider one or more of the following: (1) require any financial firm or hedge fund above a certain size, not already regulated, with an asset to equity ratio above a set number for more than thirty (30) consecutive days to pay a percentage of its annual profits, plus compensation above a set amount per employee, into an insurance fund to protect other parties in the event of a default, (2) provide that executives in any such firm or fund, which reaches an asset to equity ratio of greater than a set number for more than thirty (30) consecutive days to be personally liable to the extent of their compensation above a minimum amount for that year.

Taking steps like the ones suggested would create incentives for financial firms and funds to avoid taking on excessive debt as compared to their equity and thereby help avoid another financial crisis.

Rob Hassett is an attorney in technology, entertainment and corporate law with the Atlanta law firm of Casey Gilson P.C.