Banking & Capital Markets

Investors Getting Cranky

Shareholders harder to convince, easier to set off.
Joseph McCafferty and Tim ReasonAugust 26, 2002

CFO Bud Robertson got a rude shock in April when investors at the company’s annual meeting voted down his plan to replenish Progress Software Corp.’s stock-option pool. He now faces a dilemma about how to compensate his employees, many of whom normally receive options. “We have enough options to do most of this year’s grant,” he says, “but next year it could be a big problem.”

Robertson knew before the meeting that Institutional Shareholder Services (ISS), a proxy advisory group, had counseled large investors to vote against the options. Progress’s overhang — the percentage of total shares represented by outstanding options — already exceeded the level ISS considers acceptable. “We knew going in that the vote was going to be close,” he says. “One or two big shareholders can swing it the wrong way.”

But he also thought he could convince enough large investors to disregard ISS’s position on the options overhang, as he had two years earlier. He argues that the overhang is largely caused by stock buybacks, a five-year vesting period, and his employees’ tendency to hold their options — all of which investors applauded.

And Progress is no dot-com start-up. The Bedford, Mass.-based company is profitable, has $191 million in cash (conservatively invested), and last year produced a 32 percent return, while its peer group lost 29 percent.

But times — and proxy committees — have changed. “People who would listen to reason before won’t now,” says Robertson. He believes proxy committees are now rigidly adhering to ISS guidance to protect themselves in the event of a shareholder lawsuit.

“What’s changed is not that investors are slavishly following our recommendations this year,” counters Patrick McGurn, an ISS vice president. “They’re just not buying the arguments being made by issuers.”

Institutional investors may have waived their guidelines in the past, he adds, but now they have hardened their stance. “I think we have seen a permanent change in the difficulty some companies will have getting shareholders to approve additional (option) allocations.”

Progress’s experience, he contends, is a common one. “Votes against (option) plans have been rising on a regular basis,” says McGurn. “Blame it on Enron, not ISS.”

Selling investors on a company’s specific merits is a matter of trust, he says, “and the trust level is quite low right now.”

The Sue Nation?

In fact, investors’ lack of faith in corporate accounting — and accountability — is also triggering a whole slew of lawsuits. And those suits are being filed against some unlikely candidates, too.

On July 2, for example, pharmaceuticals giant Merck & Co. was hit with a class-action securities lawsuit filed by Milberg Weiss Bershad Hynes & Lerach LLP, one of the most notorious class-action securities law firms. The suit marks a huge departure from the typical targets of securities suits: technology firms.

And Merck is not the only new target.

A recent study by PricewaterhouseCoopers LLP shows that a lower portion of securities litigation cases filed so far this year involve high-tech companies. Instead, suits involve an array of industries, including energy, pharmaceuticals, and retail. “No publicly traded company is immune,” says Charles Laurence, a partner at PwC.

Roughly two-thirds of securities suits in the first half of 2002 have been brought against nontech companies, Laurence notes.

That trend does not surprise Kimberly Pinter, director of corporate finance and tax at the National Association of Manufacturers. “It has to do with a general decline in the stock market,” she says. “The biggest driver is still stock prices going down.”

Not so, argues Melvyn Weiss, senior partner at Milberg Weiss. “The reality is that many non-high-tech companies are fooling around with their financials,” he contends.

He adds that the popularity of using stock options outside the tech sector has put pressure on more companies to artificially inflate results.

Through June, 114 securities suits have been, according to a Web site maintained by Stanford University ( A record 483 securities suits were filed last year.

Of that number, 308 involved disputes over the allocation of initial public offering shares — so-called laddering cases. As for the remaining suits: a record 57 percent included allegations of accounting improprieties. As recent headlines suggest, that trend has continued.

The securities suit against Merck, for example, alleges that the company’s Medco unit boosted revenue by billions of dollars by improperly including copayments made to pharmacies that it never received. In the past Merck has defended the practice, which does not affect earnings, and claims that two independent auditors reviewed the procedure without objections.

The PwC study also finds that more New York Stock Exchange companies and foreign companies are being named in suits. “What is stunning is the number of cases against Fortune 500 companies,” adds Weiss. In the past year, Kmart, Halliburton, Merrill Lynch, Ford, and several others have been hit with shareholder lawsuits.

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