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We’re All Owned by Hedge Funds

Line up an institutional investor and a hedgie side by side and what do you see: A distinction without a difference?


While attending the conference on June 13 that launched the new Yale Center for Corporate Governance and Performance (see News below), where much of the discussion centered on the power and accountability of institutional investors, I came to a provocative conclusion: Corporate America is owned by hedge funds.

We all read the statistics of institutional investors’ growing clout. The Conference Board reported in an October 2005 study that institutional investors controlled 69 percent of the equity of the 1,000 largest U.S. corporations in 2004, up from 61 percent in 2000. For many corporations, that control position is much higher.

Now match that figure up with the various findings that the average institutional holding period is about 12 months – i.e., the average portfolio turnover in a year approaches 100 percent, as columnist Gary Sutton expands on below. For many funds, that turnover rate is much higher.

The third angle of this pyramid is the rise in number and activism of hedge funds. Our lead article in this e-Briefing addresses issues related to coping with that trend.

Now consider this. Line up one of your traditional institutional owners and a hedge fund side by side and what do you have: a distinction without a difference? Hedge funds, while notoriously able to sell short, are by some analyses net long in their holdings. So how do you tell them apart when their time frames are quite similar – short or shorter -- as is the range of their activism, from soft to louder to bullying? And institutional investors of course hedge their positions in various ways with various instruments, arbitrage strategies, and balancing of their holdings – which include, yes, placing a portion of their investments with hedge funds.

I may be off base on this, and if I am please tell me, but it sure seems to me that if a majority chunk of your equity is institutionally owned, you may as well consider yourself owned by hedge funds.

Question of the Month
Last month we asked, “How worried are you about the probe into the backdating of stock option grants?” Your response:
 
The practice is widespread and likely to erupt into a major scandal                 18.8%
Not widespread, but still a damaging example of board oversight                     62.5%
Limited cases, and not likely to broaden into a general indictment
of board oversight                                                                                        18.7%
So isolated that it’s a ‘tempest in a teapot’ and the issue will quickly subside   0%

The backdating of stock option grants is still much in the news, spreading a bit wider than when we teed up the question four weeks ago. The majority response seems about right, as do these individual replies:

 “Executives with the gall to ‘gold plate’ their already lucrative options packages via a backdating scheme which essentially guaranteed them unusually attractive gains should be ashamed! Every executive involved in such a scheme should be forced to resign and/or relinquish all the options so tainted -- and their boards should accept nothing less to make up for their own lapses in effective oversight.” 

“I trust the backdating issue is very limited. Most directors are informed and ethical. Any who have played or allowed these games should be loudly exited for cause along with their CEOs.” 

“Equity granting practices have been loosely monitored for some time. Adding to the complexity is that executive compensation surveys have only recently (and on a limited basis) broken out restricted stock and options into separate LTI components. Using only ‘peer’ (and that is also an elastic definition) data as comparison creates a domino-effect of bad practices.”
 
“Maybe I'm naive, but I believe the overwhelming majority of boards take their oversight and fiduciary responsibilities seriously. However, even a relatively small number of cases will probably be blown out of proportion by the press.” 

“Regardless of whether or not the practice is revealed as widespread, the underwriters of directors and officers liability insurance will undoubtedly use the possibility as an excuse to try to increase premiums.”
 
“It has been a practice for many, many years. The next question is when will they discover the other end: manipulating the exercise and sell dates?”

Now here is something that I invite your reaction to. At the aforementioned Yale conference, former SEC Chairman William Donaldson stated that, thanks to Sarbanes-Oxley, “It used to be said that it’s the CEO’s board; now it’s the board’s CEO.” Agree or disagree? Register your opinion here.

Jim Kristie is the editor and associate publisher of  Directors & Boards.

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Girding for a Media Battle with Activist Hedge Funds

By William G. McBride

Hardly a day passes without news of a fresh attack on a public company by activist investors, usually from the growing tribe known as hedge funds. And all too often, the article exposes the company’s lack of preparation for a pitched media battle.

Activist investors rely on negative media to keep the pressure on boards of directors. These antagonists rarely stop at criticizing the company’s business strategy. Boards routinely come in for public drubbings in the media over governance issues like cronyism, executive compensation and accounting practices.

These attacks can drive away more traditional, long-term investors, demoralize employees, distract management from operational responsibilities, invite regulatory scrutiny, increase litigation risk, and even raise questions among customers and business partners about the company’s future.

Even when a company seemingly survives an activist onslaught, reputations can take such a prolonged beating in the media that the board and its senior management lose a significant amount of control over the company’s destiny.
 
When approached initially by activists, boards sometimes hope they can forestall a public battle with measured steps and quiet contacts, avoiding developments that force regulatory filings and escalation of the debate into a public fight. But directors are often surprised when – in the midst of discreet discussions -- privately expressed criticism surfaces as a public issue in the media.
  
[Click Here to Read the Entire Article]

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Editor's note:  Each month, we ask a Directors & Boards reader to comment on critical issues facing directors today.  If you'd like to participate in this section in the future, please email Scott Chase. 

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July 5-7, 2006
The International Corporate Governance Network holds its 11th Annual Conference in Washington, D.C. The theme this year is "Creating Value - Building Trust: The New Agenda in Global Corporate Governance." Al Gore, Ira Millstein, and World Bank Group President Paul Wolfowitz will be among the keynote speakers, and sessions will address such topics as "Time for Glasnost in Governance: How Can Communication Between Investors and Companies Be Improved?" To register, visit http://www.icgn.org

July 16-19, 2006
Harvard Business School's Corporate Governance Series presents "Making Corporate Boards More Effective," a program that concentrates on cutting-edge techniques, strategies and action plans for improving board design, maximizing individual contributions to company boards, and improving corporate governance. Faculty chair is HBS Professor Jay Lorsch, and the program will be held on the HBS campus. For further information, visit http://www.exed.hbs.edu

July 26-28, 2006
The 15th Annual Corporate Community Involvement Conference, the premier conference for corporate grantmakers, will be held in Washington, D.C. Sessions will focus on sharing best practices and providing actionable strategies to maximize the impact of a grants program for the company and its community and key stakeholders. Visit http://www.pac.org/CCIC for more information.

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Boardroom Briefing:  The Wired Board
Directors & Boards' newest Boardroom Briefing takes an in-depth look at how technology is affecting the way boards communicate.  The Wired Board features new research on how directors use technology now, as well as a variety of articles and thought-leadership pieces.  The Wired Board is in the mail, and can be viewed electronically by clicking here.



Ira Millstein Heads New Governance Center
Ira M. Millstein, a senior partner at the international law firm Weil, Gotshal & Manges and senior associate dean for corporate governance at Yale School of Management, has been named director of the newly established Yale Center for Corporate Governance and Performance. The new center “will not follow traditional paths, but will break new ground as to the responsibilities of the corporation in society and how - and why - all the members of the governance paradigm - managers, boards, and shareholders - can better function to fulfill those responsibilities." The center has been funded with $20 million in gifts and commitments from individual and corporate donors, including a $10 million gift from David Nierenberg, a 1975 graduate of Yale College and a 1978 graduate of Yale Law School, and his wife Patricia, which represents the single largest gift in the history of the Yale School of Management (http://mba.yale.edu). Nierenberg, a former management consultant and venture capitalist, is president of Nierenberg Investment Management Co. Inc., which is the general partner of The D3 Family Funds, a group of private investment partnerships.


Multiple New Resources and Guides for Boards
Internal Audit Guide: The Open Compliance and Ethics Group (OCEG), a nonprofit organization with a mission to help organizations align their governance, risk, and compliance management activities to drive business performance and promote integrity, has released its Internal Audit Guide exposure draft. The guide, designed primarily for the internal auditor, will also help directors, executives, and other senior managers charged with governance responsibilities to better understand the issues and processes involved in an internal audit of a compliance and ethics program. The guide can be accessed at http://www.oceg.org. OCEG encourages interested parties to read and comment on the exposure draft and to direct their comments to iag@oceg.org. The comment period ends July 31, 2006, and final guidance is expected by the fourth quarter of 2006.

More on Internal Audit: PricewaterhouseCoopers has released its 2006 State of the Internal Audit Profession Study. The study shows that continuous auditing and monitoring is today's growing business trend, and that 'nontraditional' approaches to internal auditing are now employed to strengthen reporting and communication with senior management and the audit committee. To download a full copy of the report, entitled "PricewaterhouseCoopers 2006 State of the Internal Audit Profession Study: Continuous Auditing Gains Momentum,” visit http://www.pwc.com/internalaudit.

SOX Costs Study: June also saw the release of the fourth annual Foley & Lardner Sarbanes-Oxley Financial Impact Study, which measures the true cost and financial impact of governance reform among public companies. The results of the study contradict other such reports. For example, two studies released this year that said costs have come down by up to 40% in the second year after Section 404 requirements phased in for U.S. companies. The Foley study, which includes an analysis of a larger sampling of S&P data and more precise breakdown of the companies, found an increase in audit fees. Click here for a copy of the report.

Global Fraud Survey: Corporate controls to prevent fraud are well developed in the U.S., but board members will be concerned to learn that fraud prevention measures in emerging market operations seem lacking, according to a recent survey of the world’s largest companies by Ernst & Young. Released in the U.S. in June, E&Y’s “9th Global Fraud Survey: Fraud Risk in Emerging Markets” suggests that, while U.S. operations are increasingly secure, companies have real caution about entering emerging markets—and few are confident that their existing controls are as robust. For an overview of survey findings, click here. To see the complete report, visit http://www.ey.com/global/content.nsf/International/FIDS_-_9th_Global_Fraud_Survey.

Insurance Carriers Rated: Willis Group Holdings (http://www.willis.com), the global insurance broker, announced in June that it will be launching The Willis Quality Index, an initiative to benchmark insurance carriers from the perspective of servicing and supporting clients’ needs. The index will consider such areas as carrier performance, responsiveness, service, and ancillary capabilities.

Expert Witnesses: The TASA Group (http://www.tasanet.com), America’s leading resource for expert witnesses for litigation, on June 10 celebrated the 50th anniversary of its founding partnership. As a result of the increasing need for qualified, impartial experts who can clarify often complex issues, the TASA Group’s roster has grown to include specialists in more than 10,000 categories of expertise. Now headquartered in Blue Bell, Pa., and formerly known as Technical Advisory Service for Attorneys (TASA), the firm is widely regarded as the oldest and largest service of its kind. Annually, it fields more than 11,000 requests from law and insurance firms nationwide. TASA was founded by psychologists Edwin Sherman and Jay Rosen, graduates of Temple University, who started out in 1956 as partners in a vocational testing service. It continues today under the same ownership.

Executive Compensation Analyzed
DolmatConnell & Partners Inc. (http://www.dolmatconnell.com) released its Tech100 Study: Executive Compensation and Its Link to Financial Results. This is the firm’s 2nd annual survey of exec comp in the technology industry’s 100 largest firms. Click here for a PDF copy of the report.


New Leaders
The National Investor Relations Institute (NIRI) has elected Nancy C.
Humphries as CEO-elect and president effective July 7, 2006. Humphries, 56, will succeed Louis M. Thompson Jr., who announced his plans to retire earlier this year after 24 years of service.  Humphries served as the corporate officer responsible for investor relations and financial communications at BellSouth Corp. from 1991 to 2002, having started her career there in 1972. She was a member of NIRI's board of directors from 1999 to 2003 (http://www.niri.org).

Brian Burwell has been elected the new chief executive of Marakon Associates, the international management consultancy (http://www.marakon.com). Burwell, a managing partner in the firm’s San Francisco office, succeeds Ken Favaro, who has served as Marakon’s CEO since 2000. Favaro will continue to work as a managing partner and will pick up the additional title of co-chairman. Marakon Chairman and co-founder Jim McTaggart becomes the other co-chairman. Burwell joined Marakon in 1979 – a year after the firm’s founding – and has more than 25 years of experience working with senior executives at some of the world’s leading companies.

Tina S. Van Dam, recently retired corporate secretary of Dow Chemical Co. and current senior counsel for corporate governance and finance of the National Association of Manufacturers, joins The Conference Board in July as Associate Director of the Governance Center and Directors’ Institute in New York City (http://www.conference-board.org). Prior to joining The Conference Board, Van Dam implemented provisions of Sarbanes-Oxley and Securities and Exchange Commission and stock exchange regulations as part of her responsibilities for Dow Chemical. She has testified before and submitted written comments to various regulatory bodies in Washington, and has worked closely with directors of public corporations.

Author Notes
In the midst of the stock option backdating debate, WorldatWork has published a new book, Stock Options and the New Rules of Corporate Accountability, authored by Don Delves, an executive compensation authority and frequent Directors & Boards contibutor. The book examines many hot-button issues impacting executive compensation and proposes new methodologies and techniques for better aligning stock options, performance rewards, and accounting. First published by McGraw-Hill in 2003, this new edition has been revised and updated to make clear the implications of regulatory changes instituted by the Financial Accounting Standards Board (FASB). The book retails for $59.95 on the WorldatWork online bookstore at http://www.worldatwork.org/bookstore. WorldatWork, founded in 1955, is the association for human resources professionals focused on attracting, motivating, and retaining employees.

Donald Gallo has joined Watson Wyatt Worldwide (http://www.watsonwyatt.com). He has expertise in organizational design, human capital strategy, and change management. He had been a partner with Sibson Consulting, where he led the firm’s health care industry and governance practices and managed the firm’s Princeton office. He co-authored the Summer 2003 article, “Director Pay: Overhaul in Progress,” which has been frequently ordered from the Directors & Boards archive.