The Directors Letter

Corporate Governance News Since 2006


Written by Executives, Read by Executives

September 9, 2017
In This Issue                                 
Consumer Trends, Paradigm Shift
Managing the Media Story
Activists, Winning and Losing
Corporate Ethics Start at the Top
Get Off the Front Page   In politics, any front page story that does not include the word "indictment" is considered positive PR. This is not the case with business media coverage. 

The ideal business story is  "Quarterly profit beats analysts' expectations. Company stock climbs 10 %."

For a moment, it is worthwhile reflecting on the board's responsibility relative to the impact of major media stories. Uber recently has been mentioned consistently on the front page with the dismissal of the CEO, the alleged theft of intellectual property, accusations of sexism, a lawsuit from the lead investor, and extensive executive turnover. In July, it announces a national search for a new CEO. The headlines now shift to an ongoing discussion of GE's Jeff Immelt as the lead candidate with HP's Meg Whitman (despite her denials) waiting in the wings. This is positive PR.

Next, the company announces that it has hired Dara Khosrowshahi, the long-time CEO of Expedia. He is an experienced and well respected CEO. He comes from a non-proprietary, highly competitive consumer service company, specifically travel booking. Expedia has a sophisticated IT booking operation which is relevant. They are globally structuring deals with various partners and vendors on an ongoing basis. The challenges of storing personal data and local government intervention should not be a surprise to him.

Ed Note:   The board unanimously elects him. He announces that an IPO is under consideration sometime in in the next 12 to 24 months. In the short run, everyone is happy and Uber is off the front page. This is even more positive PR.

In contrast, Wells Fargo seems to have a lock on front page bad news. The stories include the expanding sales scandals, executive terminations, regulatory investigations and fines. There is public dissatisfaction from institutional investors and the price of the stock flat lines. Where is the good story? What is the subject? Who is responsible for driving the process?

Might there be a chapter in the Board of Directors Good Governance Handbook on how to "Get Off of the Front Page"?  If so, it is beyond the time to read it.

Trouble at Tenet Inc    In terms of background, Tenet is the nation's largest for-profit hospital chain. While you may not be involved in the healthcare industry, there are corporate governance lessons worthwhile reviewing. Glenview Capital Management is the largest institutional shareholder in Tenet with 18%. Glenview has two (since 2016)   board of director representatives. Based on the original agreement, Glenview had the option to appoint two more board members.   

In August, the two sitting Glenview directors publicly resigned citing "irreconcilable differences" over significant matters involving the company. During this time, Glenview was desirous of expanding its stake in Tenet and was involved in a "standstill" agreement. On the day before the standstill agreement was to expire; the company instituted a "poison pill" plan to prohibit Glenview's ownership expansion. Last week, the company announced that Chairman and CEO Trevor Fetter would be stepping down as Chairman immediately and will relinquish, the CEO role in March or sooner if a new CEO can be identified. Another director, Ronald Rittenmeyer will become executive chairman effective August 31, 2017.

Ed Note: Obviously, there are significant demands in 2017 on any operation involved in healthcare. In this case, the aggressive and very public push-back from a proactive institutional investor is relevant to everyone. This involves not just comments in the media, but public board resignations. Glenview clearly stated its desire to purchase more shares and make significant changes at Tenet. This is another example of the push-back from very large and pro-active investors in 2017.

Return of the Buzzword    "Blank Check Companies" are public entities also called Special-Purpose Acquisition Companies or SPACs. They are generally speculative and fall under the category of "penny stocks" by the SEC.  Currently, they are again being listed on both the NASDAQ and NYSE. The companies have no revenue and no more than several hundred original shareholders prior to the listing. The goal of the company is to raise cash for future acquisitions. Usually, there are one or two marquee names associated with the company giving validity to the business plan. Now you know.

Know Your Investors   Competent and well managed boards are always aware of these critical items. Who are their larger shareholders? What percentage do they hold?  When was it purchased? What is their investing history and who are their friends?  What are the changes in other shareholdings by your large investors?

There is an increasingly proactive nature to certain institutional investors, such as Vanguard, BlackRock, and State Street Global Advisors. Often, this is based on their ETF holdings. For example, both Vanguard and State Street were public regarding their negative votes for Wells Fargo directors.

Ed Note: The board needs a regular update on the composition of their company's significant investors. This composition is not stagnant and can change very quickly based on a media story, a change in investment philosophy or simply herd instinct.  No surprises are acceptable.

You Should Know  

Several HR items .    1. Now that same-sex marriage has become the law of the land some significant companies including Delta, IBM and Verizon are moving away from insurance coverage for domestic partners, covering only spouses. 2. Federal law doesn't bar terminating employees for political actions and views. These people do not constitute a "protected class," and these activities are not seen as civil rights issues. Source: Kiplinger

Brazil Ranked 123 out of 190 countries in the World's Bank's 2017 survey relative to ease of doing business in that country. This is not likely to change in the near future due to political challenges.

The dollar is down 12% this year against the Euro and 6.2% against the Yen.  If you bring back those offshore earnings, this could be a plus. Plan accordingly.

Warren Buffett and Berkshire Hathaway received no breakup fee when Texas based Energy Future Holdings Corp. took a pass on their $9 billion dollar buyout offer and went with a higher bid from Sempra Energy. No mistakes, no miscalculations, the deal was simply not far enough along to justify the breakup fee. Mr. Buffett and Berkshire will survive.

The Proxy Season
What's Being Discussed

Steve Van Putten, the Boston Managing Partner for Pearl Meyer (Executive Compensation) shares with us the discussions and topics that were covered in numerous boardroom and committee meetings this past proxy season. 

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KPMG logo        Goodwin Procter Logo
A Rolls-Royce SUV, Perhaps    Top end auto manufacturers are following the rush to SUV's. This would include Jaguar, Maserati, Bentley and the very successful Porsche SUV models.  However, the image of any model Rolls-Royce with "Winged Victory" perched atop the radiator, but now adorned with a trailer hitch behind, pulling a 20 foot Boston Whaler is most disturbing.

That Sacred 2% Inflation Rate    The media stories abound about   the Federal Reserve's never-ending pursuit of that 2%. It seems that if that number is not attained we will never maintain 3% growth in GDP, and our economic survival is at risk. Meanwhile, the stock market either over reacts or under reacts, relative to the Fed's interest rate discussions.

Ed Note:   We can remember when 5% unemployment was considered full employment and things ran relatively smoothly. Now that number is no longer valid, and there are dozens of definitions of employment, let alone full employment. Perhaps these numbers and the discussion thereof is part of the Economists' Full Employment Act.

Paradigm Shift in Big Food Brands    Your company may not be selling directly to the consumer, but in the short run and maybe the long run, you cannot afford to ignore the following trends: Big companies with well-known products, along with big retailers, are seeing a definite drop in demand for traditional packaged food products. Icons such as Campbell's SpaghettiO's and Kraft's Mac & Cheese are seeing a falloff in demand. The media has the millennials driving the move to fresh and healthy in the food area. Perhaps, but there are plenty of millennials who drink beer all weekend and order fast food delivered by Uber.

Numbers don't lie and there is a trend toward healthier eating which would be perilous to ignore. At the same time, consumer food manufacturers have other challenges to respond to.  Amazon is now in the food distribution business with its acquisition of Whole Foods. They immediately laid down the gauntlet to their competitors announcing significant price reductions. Large grocery chains which include Walmart and Costco have little choice but to respond. This results in increased pressure to reduce costs that are passed back to the food manufacturers.

Ed Note: In review, consumer food preferences are changing, perhaps permanently. Does your company have the products available, or in the pipeline to meet that changing demand? Distribution is changing as a behemoth distributor, Amazon, decides to move into brick and mortar, beginning with groceries from Whole Foods.  Next, they dramatically lower prices to pull more customers into the store that was previously seen as a yuppie destination. Amazon has a history, as do its investors, of tolerating losses based on lower prices to gain market share. Does your company have the financial staying power to compete and follow suit directly or through its retailers?

Reflect for a moment whether these macro trends or a similar scenario could impact your company and its marketplace. When you see consumer trends that significantly impact companies such as P&G, Campbell Soup, Kellogg, Kraft, and General Mills serious and strategic discussion is required. "We are not a consumer company, it couldn't happen to us", is not risk management.


Where Was the Board ?   Arizona-based Insys Therapeutics is being sued by the state of Arizona alleging that the company improperly marketed a powerful opioid painkiller. In 2012, the FDA approved its Subsys product as a prescription mouth spray formulation of fentanyl. It was approved to be used for severe cancer pain where other opioids could not be tolerated.
The company is now accused of misleading insurers and healthcare providers about the proper use of the drug. The state of Arizona alleges that the opioid was advertised as appropriate for mild pain. This description is inconsistent with the original FDA approval.

Several company executives are being charged in the suit while others face criminal   multi-million dollar federal settlements with pharmaceutical companies for the "off label marketing" of FDA approved drugs. The trend towards paying physicians for anything related to drug promotion has slowed to a trickle or is in fact outlawed. We all agree, company ethics starts at the top. Criminality does not begin with the junior sales rep. in the field. Need we say more?

Wells Fargo, the Saga   Last week, the bank announced that the number of fake customer accounts from the bank's sales scandal was probably 3.5 million customers rather than the 2.1 million count that was released last fall.

Ed Note: A related inventory of events at the board level would include, congressional hearings, the departure of the CEO and other senior executives, compensation clawbacks, customer refunds, and regulator settlements. A United States senator calls for the Federal Reserve to remove all the board members. A recent filing by Vanguard shows that they cast ballots against the non-executive chair and two other directors. Wells Fargo's stock has remained flat over the past year, while its direct competitors have seen their stock gain on average 40%.

Perhaps the appropriate call from a fiduciary standpoint should be a resounding, "Time Out". The question is who is going to make that call? Given the board's glacial pace of change, it isn't going to be them. Looking at it another way, Wells Fargo will be a great business school case about ineffectual corporate governance.

Another Lawsuit Concern   Lawyers  for shareholder plaintiffs, who have incurred market losses, are becoming more aggressive in their filing of lawsuits against large and small firms. In the past, the basis for this type of action was usually a financial restatement. Now, the basis for a suit could include business disruptions or disasters. Inadequate warnings to shareholders about potential competitors will also be included. In the first six months of the year, 131 class - action securities suits were filed in federal court. This was a historic high according to Cornerstone Research and Stanford Law. In cases filed from 1997 to 2016, 48% have been settled, 42% have been dismissed, and 10% are continuing. Less than 1% reached a trial verdict. These numbers do not include law suits related to mergers and acquisitions.

Ed Note: The US has always been a leader in terms of the size and creativity of the plaintiff's bar. This appears to be the latest iteration. From a corporate governance standpoint, your company should have a public communications policy covering:  what you say, when you say it, and how you say it (via social media etc.) Certainly, settlement guidelines should be part of that policy discussion. All this is part of the glamorous role of being a senior executive or member of the board.

All Is Not Roses   The board at Automatic Data Processing ADP, recently rejected the three board members who were proposed by 8% shareholder Pershing Square Capital. The nominees included the boss, William Ackman. Now, he must take his battle for board seats directly to the shareholders.

There is another battle, this time  with Herbalife. In this situation, Mr. Ackman and Pershing Square hold essentially a $1 billion short position. The Company, no friend of Mr. Ackman, recently announced that it was buying back as much as $600 million of its stock from shareholders. This announcement sent the subtle message that possibly the company was going private. The stock market responded positively, and at the time the shares of Herbalife jumped 9.8%. Certainly, this was not good news to someone in a short position. Herbalife added another sweetener to the stock repurchase deal saying that any seller would be given an insurance policy so that they would not miss out on any gains if the company was sold in the next two years.

Ed Note: Shareholder activists, whether they be private equity, hedge funds, or whatever can wreak havoc in the executive suite and boardroom. These two scenarios, in the short run, demonstrate that caving in or acquiescing is not the only board response. In the ADP case the board held its ground and forced Pershing to take its case to the shareholders.

Herbalife, in the second case, was just plain creative. Both demonstrate the need to plan ahead, consider alternatives, and be willing to implement your plan in a rapid yet orderly and often public fashion. Senior-level, knee-jerk reactions usually are costly, often ineffective and not good governance. 

The Directors Letter

by Daly & Company Inc.

184 High Street, Boston, MA 02110
Dan Daly, Publisher

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