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Sep 30, 2005

Disconnected

Fostering an environment of regular and meaningful communication between shareholders and boards is easier said than done.

In an informal show of hands at this summer's annual meet- ing of the Society of Corporate Secretaries and Governance Professionals, roughly 75 percent of corporate secretaries admitted that they don't encourage direct communication between shareholders and their company's directors.

Although such an admission may seem startling, corporate secretaries point out that they must manage shareholder com- munications to protect busy directors from a barrage of unwant- ed letters, phone calls and e-mail. Often, the corporate secretary acts as the first line of defense. 'We say that stockholders who want to send in a letter should send it to me as corporate secre- tary,' notes Cary Klafter, vice president of legal and government affairs at Intel. 'So I do serve as the gatekeeper in that regard.'

Many shareholders, however, prefer to communicate without a middleman. 'We would like as much access to the board of directors as possible,' says TerriJo Saarela, investor responsibility program manager for the State of Wisconsin Investment Board. Although Saarela typically contacts the corporate secretary, 'It would be nice to have a direct line to directors,' she notes.

John Wilcox, senior vice president and head of corporate governance at TIAA-CREF, is pleased that the recent attention to corporate governance is making the issue of shareholder-board communications so prominent, and bringing about some long overdue reforms. 'Back in the 1980s and well into the 1990s, many people argued that the board should never communicate with shareholders,' he says. 'We had a sit- uation where the elected representatives were unable to talk to their constituents.'

Wilcox credits Sarbanes-Oxley and NYSE listing standards with bringing about 'a radical change.' He continues, 'People now recognize that it's not only proper, but important and necessary for boards to be able to communicate with shareholders under appropriate circumstances.'

A complicated situation

The issues surrounding shareholder-board communications are no doubt complex. 'Public shareholders are owners with a strong interest who are capable of having thoughtful input into the operation of a business and ought to be consulted,' explains Greg Taxin, CEO of Glass Lewis & Co. 'That being said,' he continues, 'we recognize some of the practical difficulties in managing that communication flow.'

One problem is the wildly uneven quality of the communications. 'As you might expect,' says Klafter, 'a fair amount of what you get is in the nature of junk mail, or it relates to an individual request or grievance like Why don't you raise the divi- dend? ' Directors, he adds, don't need to be involved in these types of communication.

Robert Lamm, managing director, associate general counsel and corporate secretary for FGIC, suggests there are ways to discourage frivolous communica- tion. He points out that companies such as Pfizer and Computer Associates list a range of topics that are not appropriate for stockholder c o m m u- nications, for example, product solicitations and résumés.

That said, spam and other solicitations are just one hassle. Potentially more serious are legal concerns about the Regulation Fair Disclosure (FD) implications of board members communi- cating directly with shareholders. Should a director speak with an investor and reveal something material, that conversation could potentially run afoul of Reg FD, which dictates that material information must be available to all investors at the same time, says Taxin. 'You don't want to have board members telling an investor, We're looking at a couple of great acquisitions ,' he notes.

One thing is certain, though. Almost every time a sharehold- er talks with a board member, it sends the corporate secretary scrambling to prepare 8K filings within the 48-hour deadline. With the definition of what constitutes material disclosure far from clear, many secretaries would rather file unnecessarily than risk the consequences.

Not everyone considers FD a serious impediment, however. 'I don't think any of the conversations we have from the gover- nance area of TIAA-CREF are going to stray into those areas of concern with Reg FD's focus on avoiding selective disclosure,' says Wilcox. 'I think some companies may use Reg FD for not facing up to communications with shareholders.'

Apparently, the Business Roundtable agrees. In its May 2005 Guidelines for shareholder-director communications , it writes: 'Regulation FD should not stand in the way of shareholders sharing their concerns or meeting with directors. However, directors should be careful not to disclose material, nonpublic information to individual shareholders or groups of shareholders.'

Earl Franklin, vice president and corporate secretary at Eaton Corp, raises the flipside of the FD concern. 'When shareholders communicate directly, unconnected to management, there's a risk the directors may not be as knowledgeable as they should,' he says. Rather than risk spreading misinformation, Franklin or another management rep offers to draft a response to shareholder questions. 'We want to give directors the opportunity to talk with management, kick ideas around and compare notes,' he says.

Wilcox doesn't mind management's input in shareholder communication, provided it is clear that the directors considered the question and discussed it at the board or committee level.

Managing the process

Not surprisingly, most companies establish an official mechanism for shareholder-board communications. Generally, communica- tion is centralized within the company by designating a single 'go-to' person for all board correspondence and phone calls.

The Business Roundtable says that no matter who is designat- ed to collect, organize and review communications from share- holders, the procedure should be approved and overseen by the independent directors or a committee of independent directors.

Franklin, who is the point person for all communications with Eaton's board, makes it a practice to take all correspon-dence to the CEO. Meanwhile, Morgan Stanley has created an area on its corporate governance web site where shareholders can write directly to the board, according to assistant secretary William O'Shaughnessy. The board formally adopted policies for shareholder-board communications in early 2004, and these written policies are also posted on Morgan Stanley's web site.

Tempting as it may be, corporate secretaries shouldn't sim-ply disregard frivolous correspondence. The Business Roundtable suggests that even 'non-substantive communications' should be referenced in a communications report delivered to the board and made available to independent directors upon request.

A few exceptions

Wilcox estimates that 80 percent of the time, he has no trouble contacting a company's board of directors. He notes, however, that 'situations arise where we focus on a company with a serious problem, and that's when the doors start to close.'

The recent tussle at Morgan Stanley between shareholders and management is a case in point. In his company's proxy reports on Morgan Stanley, Taxin noted that shareholder groups had been attempting unsuccessfully to gain an audience with the board long before the movement against CEO Philip Purcell gained momentum. Taxin is critical of the fact that 'thoughtful and seri-ous investors who own a good piece of Morgan Stanley wanted to talk to the board and couldn't.' He continues, 'We're going to be watching this closely. We think the board would be better served by paying closer attention to the views of sophisticated investors.'

Yet corporate secretaries are quick to point out that the number of companies acting in bad faith is relatively small. 'It's easy enough in a worst-case situation to imagine a company that won't talk to its stockholders and the corporate secretary is just acting as a shield to fend everybody off,' says Klafter. 'We're not doing that, though.'

Finding a better way

Given that outright stonewalling is relatively rare, a larger prob-lem may be that the overwhelming majority of shareholders has no interest in exercising their right to participate in corporate democracy. Instead of flooding directors with correspondence, most investors never write or call.

Franklin estimates that he receives around one letter from Eaton shareholders a month. And Klafter says that while commu-nication ebbs and flows, he doesn't receive much board corre-spondence either. 'Frankly,' he says, 'shareholders have not been particularly interested in talking to directors, in our experience.'

Even Lamm, who served as corporate secretary at controversy- ridden Computer Associates, says, 'I could count on one hand the number of sub- stantive letters I received a month.' He adds, 'Every NYSE-listed company has to have a means for stockholders and others to communicate with directors. But as many have said, those procedures are not generating real communications.'

The question then becomes: Can cut- ting-edge companies establish a better, more user-friendly way for shareholders and the board to exchange ideas? An obvious answer – and one that many corporate secretaries have seized upon – is the annual meeting. 'All our board members attend our annual meeting,' says Klafter. 'They answer questions, and a couple of the committee chairmen give reports.'

Corporate governance professionals applaud this practice, but Taxin would like directors to go one step further and actively initiate conversations. He urges directors to 'go see the five or ten largest shareholders with some regularity to make sure the company is being respon- sive to the owners' views and emotions.'

The day may arrive when the value of shareholder-board communications is so widely accepted that companies actively foster these conversations. But for now, the issues remain practical. How do you protect directors' time by filtering out frivolous communications? Can we ensure that our directors respond to shareholder inquiries knowledgeably and consistently? Are we meeting all NYSE and other corporate governance stan- dards? Are we placing ourselves at risk to Reg FD challenges?

Most corporate secretaries agree that there are no easy answers as they strive to balance competing interests. Klafter con- cludes: 'Board members are not all that different from the CEO. Can any one of our four million stockholders just call up and get a meeting with our CEO? Probably not. You have to prioritize.'

Elizabeth Judd

Elizabeth Judd, a graduate of Yale and University of Michigan, regularly writes about investor relations, corporate governance and new fiction