Interlocking Directorates: Looking for signs of collusion, conflict of interest and overboarding

Conflicts of interest, collusion and the overboarding of directors have been known to grab the attention of the biggest media outlets. As many companies are unfortunately aware. How can this be avoided right from the start?

Conflicts of interest, collusion and the overboarding of directors on publicly listed companies have been known to grab the attention of the biggest media outlets. As many companies are unfortunately aware, this unwanted attention raises questions, creates risk to a company’s reputation, gains attention from activist investors, and can ultimately affect the value of company shares. However, there is a way that all of this can be avoided right from the start.

Interlocking directorates are nothing new. It occurs when two firms share a common director, and the tie or connections that he/she creates is also referred to as a board interlock.

Although lawful and not illegal, it does raise questions about the independence of decisions made in the boardroom and can be seen by the U.S. Federal Trade Commission (FTC) as an anti-competitive practice prompting an investigation.

As stated by the FTC it is their responsibility to, “take(s) action to stop and prevent unfair business practices that are likely to reduce competition and lead to higher prices, reduced quality or levels of service, or less innovation”.

WHEN INTERLOCKS BECOME A CONCERN

An example of where interlocks became a concern for the FTC was during 2009. During this year Apple’s director Arthur Levinson abruptly resigned his seat on Google board following pressure from regulators. Following the announcement FTC’s chairman praised Google and Levinson “for their willingness to resolve our concerns without the need for litigation”.

That same year also saw Google’s Eric Schmidt resign from Apple’s board, three years after accepting a seat.

Eric Schmidt
Eric Schmidt resigns from Apple’s board in 2009

It’s important to mention that prior to these resignations, the FTC had been looking into whether interlocking directorates between Google and Apple raised competitive issues. These competitive issues may have violated U.S. antitrust laws.

The only safe way for companies to avoid situations of interlocking directorates that prompt investigation is by having oversight of every board members’ seats on other companies. By gaining this oversight companies can instantly see any risks or red flags, which are likely already on the radar of investors with governance issues coming under greater scrutiny of late.

This is also hugely important when a company makes new appointments to their board, or an existing director takes on additional responsibilities. Without oversight, companies might be opening themselves up to governance risk and wider liability.

 

CGLytics online solution provides instant information about a company’s board composition, director skills and expertise, as well as interlocking directorates for corporations, investors and advisors.

 

Interlocking directorates are common. It is not new. Most directors will have other board positions across one or more industry, however with highly confidential information that they are privy to, it is vital to identify potential conflicts of interest.

That being said, interlocking directorates can be indicators of the following:

– Collusion: Two or more members of the board holding appointments on another board and using this connection to influence the decision-making away from the best interests of either company.

– Conflict of interest: Directors with specific industry experience will often sit on boards that could be in competition. This can lead to questions from investors on if these board members are performing their duties in the best interests of the company.

– Overboarding: Directors must have the adequate time to devote to their duties of providing oversight for a company. US Proxy Advisory standards state that a director is considered to be overboarded when he/she is a non-executive director and sits on more than five boards, or he/she is an executive director and sits on more than three boards.

– Chairmen of the board are expected to spend double the amount of time as a NED and are considered overboarded with one chair and three other NED roles.

By identifying whether a board member is also on the board of a potential competitor (sometimes inevitably in niche markets where experience is necessary), or if two or more members of the board sit on the same board of another company, is vital for the nomination and governance committees to be aware and ensure that they have the correct policies and procedures in place, as regulators, investors and activists are constantly monitoring.

THINK LIKE AN ACTIVIST

Activist investor campaigns are continuing to show a year-on-year increase with more focus being placed on the composition of the board and the board members existing commitments. Leading investors are voting against the re-appointment of directors who are perceived to be overboarded. In addition, never before has there been as much scrutiny on the skills that a director brings to the board.

Activist investors are using CGLytics’ data and analytics for assessing the board effectiveness of listed companies worldwide.

 

With deep insights into how boards are composed in the CGLytics platform, and a skills matrix applied consistently across all companies in its universe, activist investors easily benchmark a board and assess if its compliant with regulatory and stewardship codes, hence see if there is any reputational risk.

Companies can access these very same insights in the CGLytics platform.

Corporate issuers, their boards and stakeholders can see exactly how they are perceived by activist investors. CGLytics is helping to promote good governance through transparency to the market. View director interlocks, see how board composition compares to competitors and raise concerns of any red flags. Identify any potential skills gaps and be proactive in succession planning, with access to a database of 125,000+ executive profiles draw from 5,500+ publicly listed companies across 40 indexes and 24 countries.

Curious to see how companies are viewed through the eyes of an activist investors? Click here

 

RESOURCES

https://www.ftc.gov/enforcement/anticompetitive-practices

https://www.reuters.com/article/us-google/arthur-levinson-quits-google-board-appeasing-ftc-idUSTRE59B2R120091012

https://techcrunch.com/2009/08/03/google-ceo-eric-schmidt-resigns-from-apple-board-surprised/

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FirstGroup Take Another Ride on the Activist Train

Over the past nine months, FirstGroup plc has been the target of an activist campaign from New York-based hedge fund, Coast Capital. One of the main critiques by the activist investor was regarding the governance structure, specifically the composition of the board. Utilizing CGLytics’ analytics and tools in its platform, we show how FirstGroup could have spotted governance red flags to possibly avoid this situation.

As the dust settles from FirstGroup plc’s latest engagement from activist investor Coast Capital, CGlytics looks at the timeline and the reasons why the company was a target of shareholder activism. This was not FirstGroup’s first experience as a target of activism. In 2013, Sandell, which owned a little over three percent of FirstGroup, wrote to the directors urging them to spin off and list the U.S. business unit separately on the stock market. Sandell, at the time said the break-up would enable the company to fund a much-needed investment program in its British bus business. FirstGroup fended off the proposal, with the notion that it contained structural flaws and inaccuracies.

Where this activist ride began

Over the past nine months, FirstGroup has been the target of activism from New York-based hedge fund, Coast Capital. The back and forth between the issuer and the investor date back to November 2018 when the Non-Executive Chairman of FirstGroup’s board, Dr. Wolfhart Hauser, responded in a letter written to the latter. The letter from Coast Capital included demands for management change and included criticism over the company’s failure to pay a dividend.

On May 17, 2019, FirstGroup received a letter from Coast Capital requesting an EGM to remove six of the current directors, increase the size of the board by one seat, and elect Coast Capital’s seven nominees. Coast Capital criticized the board saying that its directors lacked sector and industry expertise with reference to the CEO, Matthew Gregory, and Chairman of the Board, Hauser. Again, the activist investor pushed for a separation of the US and UK businesses, having declared FirstGroup’s strategy – and particularly its UK rail investment – as “extraordinarily destructive of capital”.

In June 2019, FirstGroup seemed to be taking heed to the investor pressure and announced that it will be selling off its bus division and possibly withdrawing from UK rail operations. The company also announced that it will focus on the US, although stating that it plans to sell off the famous Greyhound coach line.

The board’s expertise

One of the main critiques by Coast Capital was regarding the governance structure, specifically the composition of the board. Utilizing the Board Expertise functionality in CGlytics’ platform, insights are revealed as to the current board’s skills and expertise makeup. In particular, the Skills Matrix functionality in CGLytics’ solution aids companies to identify any skills gaps within their current board.

For FirstGroup, of the 11 directors currently sitting on the board, the graph shows that the strongest levels of expertise present on the board are International, Leadership and Executive. According to the Skills Matrix, it appears that the company lacks directors with expertise in the areas of Finance and Technology.

FirstGroup plc's Board Expertise and Skills Matrix
FirstGroup's Board Expertise and Skills Matrix
Source: CGLytics Executive Compensation Models

Pay for Performance

According to the pay policy of FirstGroup, the company aims to align its pay with performance and also with best corporate governance global practice. The company currently uses three performance criteria in the determination of its long-term incentive plans:

– Total Shareholder Return (TSR),
– Earnings Per Share (EPS), and
– ROCE.

Of which, the first two are equally weighted at 40% and the latter accounts for the remaining 20%.  The CGlytics Absolute Positioning tool sheds light on the relationship between the EPS performance component and the CEO’s realized compensation from 2013 to 2018.

CGLytics’ data and analytics are trusted and used worldwide by Glass Lewis, the leading independent proxy advisor, as a basis for their research on companies

 

As indicated in the graph below, there exists significant volatility in the movements of EPS and CEO pay. From 2016 to 2018, although both indicators fell, there seems to suggest that EPS had a much steeper fall compared to that of the CEO pay.

Specifically, while CEO pay reduced by 20% over the period, EPS fell by 43%. The CGlytics Relative Positioning Pay for Performance Evaluation tool compares FirstGroup’s CEO Realized Compensation with that of the company’s own peer group disclosed in the 2019 annual report against the peer group’s one year TSR.

The Pay for Performance evaluation reveals that the CEO’s Total Realized Compensation appears aligned with its performance indicator relative to its peers. The company’s Total Realized Pay ranks at lower decile at 18th percentile while TSR ranks in the 32nd percentile. It is also worth noting that the low pay stems from the fact that the company failed to meet its performance measures, and so the LTI part of the Total Compensation vested at only 12.5%.

Source: CGLytics Executive Compensation Models

Before, During and After the EGM

With Coast Capital’s request for an EGM, FirstGroup published a notice for the shareholders’ meeting to vote on the removal of six directors of the current board (including the Chairman, CEO and four other independent Directors). Additionally, appoint seven directors who are nominees of Coast Capital. Expectedly, in the EGM notice of meeting, the board recommended to vote against all the resolutions, believing that they the right strategy to take the company forward.

They added that Coast Capital’s director nominees do not have current relevant experience and also put forward plans that will leave the group with higher debts.

Interestingly, the movement and arguments garnered support from other leading shareholders.

Columbia Threadneedle, with a 10% stake, said it will join in voting against the reappointment of Wolfhart Hauser, the FirstGroup chairman since 2015. Schroders, with a 9% holding, was also seen to have taken sides with Coast Capital.

In a rather unexpected turn of events, one of the director nominees by Coast Capital, David Martin, missed the nomination affirmation deadline and was withdrawn ahead of the general meeting. Speculations suggested that David Martin, who is the former boss of Arriva, a transport company rival and one of the fund’s key nominees, decided not to run for a board seat because he had other projects under consideration.

At the general meeting which was held on June 25, 2019, the shareholders (on average) voted more than 20% in favor of the resolutions. The resolution to remove the Chairman Wolfhalt Hauser was supported by 29.33%, the resolution to remove the CEO was also approved by 25.15%. The resolutions to remove independent directors Imelda Mary, Stephen William Lawrence Gunning, James Frank Winestock and Martha Cecilia Poulter received votes of 31%, 25%, 46% and 25% respectively.

Not one of the directors put forward by the activist investor received the requisite votes to be appointed to the board.

Aftermath: Searching for a New Chairman

Despite receiving enough support to stay on the board, Wolfhart Hauser announced that he will not be seeking re-election to the board during the AGM, which is expected to come off on July 25, 2019. According to the company, senior independent director David Robbie will take on the role of chairman on an interim basis with effect from July 25, overseeing the search for a new chair.

To learn how companies can become proactive and support modern governance decision-making, with access to the same insights as activist investors and proxy advisors, click here.

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The Billionaire Battle over Anadarko

Much noise has been made around the USD 38 billion hard-fought acquisition of Anadarko Petroleum by Occidental Petroleum and the hotbed of disagreement. An analysis of Occidental’s board, using CGLytics board insight tool, yields telling results.

Much noise has been made around the USD 38 billion hard-fought acquisition of Anadarko Petroleum by Occidental Petroleum (Oxy). Occidental’s CEO Vicki Hollub, in her race to beat Chevron for the acquisition, secured funding from Warren Buffett—USD 10 billion to be exact at 78% cash and 22% stock. This then allows Buffett to acquire 100,000 shares of cumulative perpetual preferred stock and an 8% dividend payout annually.

The deal was born out of Occidental’s board preferring to bypass an extraordinary shareholder meeting, wherein which the initial deal would have required a change of the Company Charter and a slim chance at a passing vote. Enter the second billionaire to the mix: Carl Icahn.

After getting wind of the deal, Icahn launched a lawsuit against Oxy on the grounds that the proposed acquisition was “fundamentally misguided and hugely overpriced.” There may be some truth to his assertion, with Oxy opening nearly 6% lower after the acquisition announcement.

Icahn accused Buffett of exploiting Oxy’s need for cash. Buffett is set to receive an 8% yield, far above Oxy’s pre-bidding 4.7%. This equates to a pre-tax cost of debt of around 10%, which is three times Oxy’s bond yield, and would put the company debt up to USD 40 billion.

In addition, Chevron decided against a counteroffer for Anandarko; thus, the company must now pay USD 1 billion in breakup fees to Chevron. It is also critical to note that this comes at a time when shareholders are calling for spending cuts and improved dividends.

As such, and perhaps the most glaring issue in the governance field, is the clear bypassing of shareholders’ voice by attempting to avoid an Extraordinary General Meeting of Shareholders (EGM).

Because of Buffett’s funding, Hollub and Oxy were able to exclude shareholder votes (as aforementioned). According to Icahn, this move was “disturbing” and “usurped the fundamental and critical role of the stockholders.”

Icahn, acting as the poster child for agitated shareholders, is calling for a restructuring of the board with seats of his own in order to ensure that Oxy acts in the best interest of shareholders. It seems apparent that the market and shareholders alike strongly disagree.

In current market conditions, Icahn has stated that the deal is a bet on the price of oil. Should oil prices fall below USD 45 per barrel, Occidental could be forced to cut dividends and once again defy shareholders. In turn, both Icahn and T. Rowe Price have agreed that the potential to put stockholder dividends at risk should first be cleared with the stockholders themselves.

An analysis of Occidental’s board, using CGLytics’ board effective and insights tool, yields telling results.

Occidental Petroleum Corporation’s Board Expertise

Source: CGLytics’ Board Effectiveness and Insights

Occidental’s board lacks significant expertise in two key areas extremely relevant to the recent deal; Financial and Industry/Sector. While there are a few financial experts, Audit and Capital Management skills particularly stand out as lacking in board discussions. Further, the lack of Financial expertise may certainly have ineffectively prepared the board to examine management’s agenda as well as properly evaluating the financial implications that come with the deal. Additionally, the Industry and Sector expertise appears inadequate; especially when considering the size of this acquisition.

The hotbed of disagreement over the deal is sure to play out in the coming weeks. It is possible that Hollub and Oxy avoided shareholder approval of such an acquisition of this scale because of the risk of disapproval at an EGM. Notwithstanding, Oxy resolved this issue by consulting Buffett.

Buffett saw opportunity arise out of the Company’s dilemma and divvied out premium funding. Now, Icahn demands a justification and correction of this supposed breach in shareholder rights. Following Icahn’s demand, Oxy will be holding a shareholder meeting on August 8th to determine the sentiment on this year’s biggest oil and gas deal. It is improbable that Icahn will win out on a lawsuit of this magnitude, especially when asking to gain seats on the board to prevent such deals in the future; but then again, it was equally unexpected that Occidental would attempt a merger with Anadarko.

Corporate boards and executive teams increasingly require insights and analytical tools to identify any potential areas of reputational risk. Without this oversight, companies may be targets of activist campaigns and cannot proactively prepare.

To learn more about how CGLytics’ deep, global data set and unparalleled analytical screening tools can potentially help you identify these areas of risk, click here.

SOURCES

THE MARKET REALIST
YAHOO FINANCE
CNBC

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Barclays, Bramson, and Lessons Learned

Barclays, one of the UK’s largest banks recently has recently come under attack by activist investor Edward Bramson. CGLytics takes a look at the drivers behind the attack and how Barclay’s responded.

Barclays, one of the UK’s largest banks recently has recently come under attack by activist investor Edward Bramson. Bramson threatened major changes in the boardroom after announcing plans for a shareholder vote on the company’s leadership and strategy. In order to push his agenda forward, Mr. Bramson spent approximately GBP 900m building a 5.5% stake in Barclays through his investment vehicle Sherborne Investors. After acquiring this stake, he told his own shareholders that such vote was necessary at Barclay’s, given that “consistent engagement” with the bank had failed to yield results. At the time, Bramson’s argument touched on the classic activist stance of reorganizing a company’s capital allocation and growth strategy in this instance by pushing the company to scale back its investment banking business, which he said has “strategic weaknesses”. Instead, he argued that resources should instead be funneled towards the bank’s “attractive” consumer retail operations.

Bramson’s attempt to ascend to the board

In a letter to shareholders, Edward Bramson, submitted a resolution to ask shareholders to appoint him to the board at the company’s annual general meeting, which was scheduled to be held May 2, 2019.

This move represented the first formal attempt by Bramson to win shareholder support for his campaign, after Barclays rejected his previous request to become a non-executive director in September 2018. In a letter to Sherbrooke investors in December, Bramson indicated that he would seek board changes at the meeting in May or call a special meeting of shareholders.

Barclays counters attack with improved financial results

In February 2019, Barclays announced its full year results for the financial year ended December 31, 2018. The financial year results disclosed the following key highlights:

  • Excluding litigation and conduct charges, Group profit before tax increased 20% to GBP 5.7bn despite the adverse effect of the 3% depreciation of average USD against GBP.
  • Barclays UK profit before tax increased to GBP 2.0bn (2017: GBP 1.7bn).
  • Barclays International profit before tax increased to GBP 3.8bn (2017: GBP 3.3bn).
  • Attributable profit was GBP 1.4bn (2017: loss of GBP 1.9bn)

When Barclays released the full year results for 2018, market watchers praised it as a victory for the company in its fight against Bramson. Aviva Investors, formerly a staunch supporter of Edward Bramson as a candidate, said it will support the Bank and vote against Edward’s election to the Board.  The announcement from Aviva came as Barclays’ markets division reported fourth-quarter results that were better than European peers. This strong performance punched a hole in Mr Bramson’s theory that the unit should be scaled back.

Barclays board composition and company performance, Classic Activist Red Flags?

A key feature in the consideration of the initial launch of Bramson’s campaign represents an almost formulaic approach for activists. Historically, lowered financial returns have motivated activist entities to seek a board seat or management change in order to influence the company’s capital allocation or business strategy. Initial research by CGLytics to be published in a forthcoming article on the red flags for investor activism indicates that lowered financial returns often allows a crack in the door for activists to enter into the debate over company strategy. Once a part of the argument, the activists push change at a higher corporate level. This is often compounded by a lack of technology expertise on the board, as technology is being incorporated into the vast majority of business operations. A cursory look at the board composition of Barclays indicates that it used to fit these two criteria, with at least two of the red flags present: initial lowered financial returns and a lack technology expertise on the board.

Day of Reckoning

At the Annual General Meeting on May 2, 2019, the resolution to elect Edward Bramson to the Board only received the support of 12.79% of shareholders. Although an anticlimactic end to a six-month campaign, many found the results unsurprising. The influence of proxy advisors could not also be overlooked. Ahead of the meeting, Bramson’s attempt was dealt a heavy blow when the two largest proxy advisors, ISS and Glass Lewis, came out in support of Barclays and recommended against the election of Bramson to the board.

As indicated above, corporate boards increasingly require a broader range of analytical tools to identify the red flags that may potential make them a target for activists such as Bramson.

Learn how CGLytics helps boards identify governance risks

For more information regarding how CGLytics’ deep, global data set and unparalleled analytical screening tools can potentially help you identify these areas of risk

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Glass Lewis’ assessment of executive remuneration reflects a balance of quantitative and qualitative considerations, with CGLytics’ suite of tools underpinning the quantitative component. In the following discussion, we review the quantitative assessment with respect to Deutsche Bank, using CGLytics’ analytical tools.

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