Proxy Battles Serve as a Vehicle for Change

By Vittorio Lara and Patricia Tiller

While it's difficult to name a sure winner or loser in a proxy contest, there is one certainty: A proxy fight causes the world to sit up and take notice. By the end of the 2002 proxy season, the proxy contest had once again proven its effectiveness as a vehicle for change, with dissidents making their voices heard at 30 companies and announcing new campaign initiatives at a steady pace.

Of the 18 proxy contests on which ISS issued a recommendation and that went to a shareholder vote, management prevailed in 11. Though board contests have become a common practice at underperforming companies over the past several years, it remains a difficult task to oust incumbent directors. However, contests are a time-tested vehicle for investors to explain, loudly and publicly, their views on just how management is failing shareholders. And while this often did not result in enough votes to oust the incumbents in 2002, the opinions of dissidents did not go unheard.

Table 1: Proxy Contests (January-July 2002)

The 2002 proxy campaigns have reflected varying trends. In several cases, management prevailed in highly publicized proxy fights, most notably at recognized corporations like Hewlett-Packard Co., Aetna, Inc., and TRW, Inc. In other instances, where dissident directors were successful in achieving requisite proxy votes and the balance of power shifted in their favor, board members were quick to clean house in hopes of increasing investor confidence. In other cases, dissidents were successful in achieving minority board representation through negotiation, rather than a vote of shareholders, as evidenced by settlements or dropped proxy contests.

Increasingly, when companies begin to perform poorly, shareholders are not necessarily selling out and eating a loss. Instead, they are using the opportunity to address problems with management and general governance issues. And while this year’s dissidents were not always successful in their efforts to rid the board of members they considered problematic, dissidents were successful in causing a stir and placing directors under the microscope.

Investors have the ability, the right, and, many would agree, the obligation, to make their concerns known, particularly in the post-Enron world. Antitakeover devices, entrenched management, falsely-inflated revenues, decreased shareholder value: These are all governance issues that active dissidents can play a productive role in resolving, even if the result is not the election of new nominees to the board.

Management Prevails in Contested Mergers…

The highest-profile proxy contest for the 2002 proxy season undoubtedly was Hewlett-Packard Co. shareholder and director Walter Hewlett’s battle with CEO Carly Fiorina over the company’s proposed $20 billion acquisition of Compaq, Inc. The two parties battled out the hotly-contested deal for about half a year, even after shareholders voted at the company’s March 19 annual meeting.

Hewlett, son of one of the HP co-founders, launched a bitter proxy campaign to block the HP-Compaq merger and issued heated remarks against HP directors and Fiorina. Hewlett argued that HP was paying too much for Compaq, would get "bogged" down in selling low-margin personal computers and services, and would assume a high amount of risk in the complex integration process. Likewise, the campaign of Fiorina—whose reputation and job were staked on the success of the merger—included verbal attacks on dissident director Hewlett and his ideas, calling them "quick-cooked" and accusing him of offering "nothing meaningful." HP and Compaq each asserted that the merger of the two entities would allow the combined company to realize operational efficiencies, cost savings, and other potential synergies, and argued that the merger was essential to their survival in a consolidating computing industry.

Notwithstanding, Hewlett staged a relentless proxy fight until the bitter end. Despite HP’s claims of victory by a "slim but sufficient" margin on the eve of the company’s meeting, Hewlett continued his battle in the courtroom. Shortly after the company’s meeting, Hewlett filed a lawsuit against HP, alleging that the company bought proxy votes—specifically from investor Deutsche Bank, which reportedly switched 17 million votes to favor the deal at the last minute—and lied to HP shareholders about the status of its integration plans. On April 20, 2002, Delaware Chancery Court Judge William Chandler III ruled that the votes were legal, paving the way for the HP-Compaq merger to be finalized.

TRW Corp. offered more fireworks in another 2002 proxy contest that ended with a victory for management. TRW, the manufacturer of advanced technology products, became a hostile takeover target after its board unanimously rejected defense contractor Northrop Grumman, Inc.’s (NG’s) unsolicited $5.9-billion bid on April 3, 2002. NG initially offered $47 in common stock for each TRW share, or $5.9 billion, and then sweetened its bid to $53 per TRW share, or $6.8 billion. Failing to receive a positive response to its sweetened bid from the TRW board, NG launched an aggressive proxy campaign urging TRW shareholders at the company’s annual and special meetings to vote in favor of its control share acquisition proposal and related proposals, which would allow NG to increase its ownership of TRW shares beyond a current 20-percent limit.

The TRW-NG proxy fight became increasingly hostile as the two companies traded accusations in various press releases and in the courtroom. Following months of battling, however, and after TRW’s shareholders voted down NG’s proposals, the two parties announced on July 1, 2002, that a merger agreement had been reached, allowing NG to acquire TRW for $7.8 billion, or approximately $2 billion more than NG’s original offer. The new offer price of $60 per TRW share is about 27 percent more than NG initially offered in February 2002. Upon completion of the transaction, which is expected to close in the fourth quarter of 2002, NG will spin off TRW's automotive business, either through a sale or as a stand-alone company.

...But Dissidents Win Their Fair Share Elsewhere

For the second straight year, investors at ICN Pharmaceuticals, Inc., were able to effect change in the boardroom through some public finger-pointing. Last year, the dissidents succeeded in filling three seats at ICN, and a new dissident group was able to add another three directors this year, resulting in the replacement over the last two years of two-thirds of the nine-member board. The latest slate of dissident directors, proposed by Iridian Asset Management LLC and Franklin Mutual Advisers LLC, was elected by an overwhelming three-to-one margin at the company’s 2002 annual meeting.

Since the latest shareholder vote, ICN’s executive suite has seen significant changes. After two years of charging that the CEO and his team were mismanaging the company, dissidents have won power in the boardroom, leading to rapid changes in the ICN executive staff. In July 2002, ICN founder Milan Panic relinquished his titles as chairman and CEO of the company, though he remains a board member. The board subsequently appointed Robert O’Leary, a dissident director, as chairman and CEO of ICN. The board is also reviewing plans to spin off ICN’s international unit and the company’s 83-percent equity interest in Ribarphram, Inc., the unit that makes a hepatitis drug called Ribavirin. Management’s slow progress with the spin-off has long been a subject of shareholder ire.

Similarly, at SL Industries, Inc., shareholder Warren Lichtenstein launched a successful campaign that netted five seats on the board of the Mount Laurel, N.J.-based company that manufactures and markets power and data quality equipment and systems for industrial, medical, aerospace, and consumer applications. Lichtenstein and his dissident group were elected by a greater than two-to-one margin at the company’s annual meeting. Shortly after the election of his slate of directors, Lichtenstein—the well-known corporate raider from Steel Partners II LP—became chairman and CEO of SL Industries, while another dissident nominee, Glen Kassan, assumed the title of president. The proxy vote led to the immediate ouster of then chairman and CEO Owen Farren and the subsequent resignations of two of the three incumbent directors.

At Adair International Oil and Gas, Inc., a group of investors calling itself SCORE (Shareholders Committed to Restoring Equity) also sought immediate change in management after its defeat of the incumbent board. SCORE nominees received more than 45 million of the votes cast, while the incumbent board received more than 36 million. Similar to ICN and SL Industries, the newly-elected directors at Adair—Richard Boyce, John Brush, and Charles Close—sought to fulfill their watchdog capacities on the board. Mr. Boyce and Chris Dittmar were immediately named interim president and corporate secretary, respectively, and given the duties of interviewing and presenting for approval a new executive team.

Cybernet Internet Services’ management team suffered a similar fate in its proxy fight with a dissident group that included MFC Bancorp Ltd. and former Cybernet employees. The dissidents sought control of the board in order to restructure the German-based Internet communications company’s existing debt and to implement new plans and strategies designed to enhance shareholder value at the company. Perhaps anticipating defeat, management quickly entered into a settlement agreement with the dissidents prior to the company’s annual meeting. As part of the agreement, the incumbent directors called a board meeting on the day of the shareholders’ meeting and agreed to vote in favor of all of the dissident directors at the annual meeting. The four dissident directors—Michael Smith, Eduard Seligman, Greg Elderkin, and Roy Zanatta—were elected as directors at the meeting, and Smith took over as CEO of the company.

Settlement Fever

In 2002, the majority of the potential proxy contests never made it to the ballot box, primarily because of the voluntary withdrawal of proxy campaigns by the dissidents or settlements between the opposing groups. Dissidents claimed victory, in most instances, as their campaigns to shake-up corporate boards and management teams proved effective. At some companies, management agreed to give dissident groups board representation (so far in 2001, settlements of threatened fights have netted board seats for dissidents at seven out of 12 companies). Meanwhile, other dissidents did away with their campaigns upon promises of change in corporate strategy (for example, V Investment Partners LLC ended its proxy campaign for board seats at Vestcom International, Inc., once management announced that Vestcom would be acquired by Cornerstone Equity Investors for $6.25 per share).

Table 2: Board Representation Resulting from Averted Proxy Contests (January-July 2002)

Successful negotiations between dissident shareholders and executive leaders led to dissidents claiming single board seats at Metromedia International Group, Inc., International Thunder Gaming Corp., FairMarket, Inc., and Dynex Capital, Inc. Meanwhile, Aquila, Inc., an electricity and natural gas wholesaler, successfully negotiated an agreement under which Aquila gained three seats on Quanta’s 10-member board. In exchange, Aquila agreed to end its hostile bid for Quanta, a power and telephone installer. The terms of the agreement prohibit Aquila from engaging in a contest for control of the Quanta board or purchasing Quanta shares on the open market, and effectively ends all litigation between the two parties.

While dissidents welcome the opportunity to gain board representation, such representation can sometimes be too little, too late to redress company ills. For example, Adelphia Communications Corp. shareholder Leonard Tow sought to replace directors at the company six weeks after the company disclosed $2.3 billion in off-balance-sheet loans. Tow, along with his family, owned about 13 percent of the company’s Class A common shares, and he campaigned vigorously for three board seats because of his concern over the loans that the company had provided to founder and Chairman John Riga and his family. Tow and his associate, Scott Schneider, became the collective voice of disappointed Adelphia shareholders once they were appointed to the board on May 24, 2002. However, their push for change at Adelphia proved to be too late as revelations of corporate greed and financial scandal escalated at the cash-strapped cable-TV provider. The directorships of Tow and Schneider at Adelphia were short-lived as the two resigned from the board approximately two weeks after their initial appointments, insisting that Adelphia’s "serial disclosure of wrongdoing" would have made it impossible for them to save the company. Subsequently, Adelphia filed for Chapter 11 bankruptcy protection on June 25 and federal authorities arrested Rigas, his sons Michael and Timothy, and other company executives, for accounting fraud and related charges.

Sam Wyly, who initiated a contest at Computer Associates (CA) for the second straight year, opted for a different sort of settlement than most dissident shareholders. His agreement with CA did not provide board seats. Instead, the agreement provided the Texas billionaire with a substantial payment—which critics deem a form of greenmail—to end future proxy campaigns for the next five years. In July, Wyly, who had accused CA Chairman Charles Wang and CEO Sanjay Kumar of mismanagement, withdrew his slate of nominees and agreed to support the company's nominees to the board pursuant to terms of the settlement agreement.

Under the terms of the agreement between CA and Wyly’s group, the company also agreed to add one independent director selected by the company's existing board subsequent to the 2002 annual meeting. The settlement also extended an existing noncompete agreement between Wyly and the company from 2004 through 2007 (the original noncompete was the product of Wyly’s sale to CA of Sterling Software, a company he had founded, in 2000). Furthermore, CA and Wyly also entered into a five-year standstill provision under which each party agreed, among other things, that Wyly would not be involved in a proxy contest with the company. While management argues that the agreement saved the company the trouble and expense of waging another contentious proxy contest, critics (including ISS) viewed it as far less shareholder-friendly than more traditional settlements that pay dissidents with board seats rather than dollars.

Conclusion

In the wake of numerous allegations of companies disguising executive perks and financial problems and engaging in other corporate misconduct, proxy contests have become one of the most effective vehicles for change. Investors want corporate boards to hold executives accountable for their wrongdoings. Proxy contests (real or threatened) have and will continue to drive change at companies with suffering stock prices as well as those that fail to obey generally accepted standards of good governance and corporate ethics. Given the events of the past few months, proxy contests appear to continue to have a bright future.