Waddell and Reed: Hyperbole as a Measure of Performance

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.

Corporations and Politics: Why Political Disclosure is Irrelevant

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?

Ernst & Young: Enron Redux?

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.

Black and Decker: Will Shareholders Take the Money and Run?

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.