Pushing Back on Proxy Firms

How one CFO was surprised by a negative recommendation for his company's proxy ballot.

When the votes started coming in, Lakeland Industries CFO Gary Pokrassa was taken aback. After all, the ballot for his company’s annual meeting was tiny and routine. It didn’t contain any questions about executive compensation, since Lakeland is a smaller company, not yet subject to the say-on-pay mandate. Pokrassa had not been expecting any controversy.

But the initial votes for the reelection of one of the garment maker’s directors, and for the ratification of Lakeland’s accounting firm, were skewing negative in the weeks leading up to the meeting, which was held in June. In the end, the director, John Kreft, who has sat on Lakeland’s board since 2004, squeaked by with 56% of the vote in his favor. The accounting firm, Warren, Averett, Kimbrough & Marino, fared better, receiving 73% of the vote. Pokrassa calls the results “very upsetting,” saying Kreft “did absolutely nothing to deserve” any negative votes.

The reason for the poor showing? Pokrassa says it’s because proxy-advisory firm Institutional Shareholder Services (ISS) had recommended that shareholders vote against the director and audit firm based on a misinterpretation. More troubling, he says, was that Lakeland had no opportunity to clarify the matter because it didn’t know about the negative recommendations until the votes came in. In a letter to the ISS, Pokrassa, Lakeland CEO Christopher Ryan, and Kreft, who chairs the company’s audit committee, decried the lack of a heads-up. “You made no attempt to contact the company to verify the facts and made recommendations, based on erroneous assumptions, which have damaged the company and its auditors,” they wrote.

For its part, the ISS tells CFO that it stands by its recommendation and plans to follow up with Lakeland. The firm “directly engages with corporate issuers during the research process to ensure that we understand the issues, are interpreting the company’s practices accurately, and are ultimately applying our voting guidelines properly,” says Cheryl Gustitus, an ISS spokeswoman.

This past proxy season, disagreements between proxy-advisory firms, an industry dominated by the ISS and Glass Lewis, and the companies they evaluate seemed to grow in anticipation of the first year of mandated say-on-pay and say-on-frequency votes. Moreover, hanging in the wings is the possibility that the Securities and Exchange Commission may be changing some of the ways these firms operate.

Some companies that found out about negative suggestions before the annual meeting have pushed back. “We saw an uptick in the number of companies filing supplemental proxy materials after ISS made its recommendations,” says Claudia Allen, a partner at law firm Neal, Gerber & Eisenberg and chairman of its corporate-governance group. With the say-on-pay votes this past season, the ISS “has gotten more power,” she adds.

Pokrassa thinks the ISS was bothered by the fact that Lakeland paid its accounting firm higher nonaudit fees than last year, and consequently the firm may have seemed at first glance to be less than independent. For its fiscal year ended January 31, 2011, Lakeland paid the accounting firm $174,619 for “all other fees,” a little less than half of its total audit bill for the year and 55% more than the previous year. Pokrassa says this amount covered international tax planning and foreign tax issues, mainly in Brazil and India, which he believes falls under the allowable activities that an independent auditor can provide to its client.

Standing by the ISS’s evaluation, Gustitus says the firm’s factual error rate is less than 1%. As for the idea that pay issues may have caused problems this year between companies and the ISS, she offers statistics aimed at squelching any misconception about the firm tending to go negative on comp packages. The firm recommended against pay resolutions at 12.6% of the Russell 3000 companies and 14% of the S&P 500. “We believe that we are very careful and balanced in our analysis of executive compensation,” says Gustitus.

It may not feel that way to CFOs who see more negative votes coming in on their company’s ballots than expected. Smaller companies tend not to “encounter ISS or Glass Lewis unless they have had a stock-compensation plan or some other compensation plan recommended against them, and all of a sudden people are voting against it,” says Nancy Lieberman, a partner at law firm Farrell Fritz. (The chances of smaller companies encountering ISS recommendations may increase when those companies have to comply with the say-on-pay rules, starting in 2013.)

Lieberman recommends that her small-company clients consider hiring a proxy-solicitation firm, such as MacKenzie Partners, that specializes in knowing the proxy firms’ guidelines and likely recommendations.

In the meantime, executives are hoping the SEC will require the proxy firms to be more forthcoming in how they come up with their recommendations. SEC chairman Mary Schapiro has said the regulator would come out with a proposal this fall that could address questions about their transparency.

 

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