Lord Myner's Corporate Governance bash - Everyone's  invited, but who will turn up? 

Lord Myners, the Financial Services Secretary to the Treasury, has been demanding improved corporate governance.  With the Royal Bank of Scotland's (RBS) 2008 Annual General Meeting being held on 3 April 2009, we believe Lord Myners should hold a "Get on the Good Corporate Governance Bandwagon" bash.

Shareholders will be asked to vote on the Remuneration Report. The Report includes details of Sir Fred Goodwin's pension. Equally important, the Report includes details of bonus arrangements for the new Chairman and new Chief Executive. Both arrangements are firmly against best practice guidelines.

The Government. Lord  Myners has been critical of just about everyone in relation to effective corporate governance at RBS. In his oral evidence to the House of Commons Treasury Committee, he stated that institutions needed to wake up to responsibilities of ownership and engagement with investee companies. He highlighted his recent proposal to place legal obligations around the responsibilities of fiduciaries, fund managers and assurance companies to pursue good governance. In relation to RBS, he criticized Legal & General for “running into the sand” and “giving up” on their request for the removal of Sir Fred Goodwin. He criticized the Association of British Insurers (ABI) and Research, Recommendation and Electronic Voting (RREV) for supporting the RBS 2007 Remuneration Report. He criticized the Board and Remuneration Committee over the approval of Sir Fred’s pension. He criticized the Board and executive management for being in denial of the seriousness of RBS’ situation in October of 2008.

Is the Government/Treasury coming to "Lord Myners' Corporate Governance bash"? No, but it may send a representative. Having allocated all of its holdings in RBS to a dedicated fund management company, the Government cannot vote its shares. However, as the ultimate owner of the holding in RBS and in line with best practice guidelines, it should instruct its agents on how it wants its shares voted. 

Corporate Governance Firms. In the next group, we have the corporate governance advisory firms and trade associations which include, the ABI, RREV and Pirc.  These firms have already expressed their views on the Remuneration Report to be voted on at the 2008 AGM.

The ABI has issued an "amber-top" alert on the report. They state that Sir Fred Goodwin's pension would normally require the issuance of a "red-top" alert. Instead they have issued an "amber-top" because most of the directors who made the decision have left the board. Although this is correct, all of the eight current directors, not the current chairman, were board directors at the time of the final pension approval (11/12/13 October). This includes Stephen Hester, Art Ryan and John McFarlane, who took up their non-executive director roles on 1 October 2008.  

The ABI also raises concern over the share awards to the new Chairman and new Chief Executive. The Chairman has been granted performance related share awards. The Chief Executive has been granted non-performance related share awards. In normal circumstances, the awards would be the other way around.  Granting performance based awards to a non-executive chairman ties the individual too closely to the executive directors.  It also believes that granting non-performance based awards to a Chief Executive is unconventional, even if they are granted to compensate for loss of incentive benefits from previous employment. (Interestingly, based on the declines in earnings per share, total shareholder return and net asset value per share for the nine months to 31 December 2009 and then the recent rights issue at his previous company, British Land, it is very unlikely that he would have received the incentives had he remained.) 

The ABI has issued an "amber-top" alert on both issues, suggesting considered judgement is required by shareholders when voting on the Remuneration Report. 

Pirc, the one corporate governance firm recently "praised" by Lord Myners, takes a more aggressive stance. Pirc states that the granting of the full pension of £ 693,000 per annum to Sir Fred Goodwin was at the discretion of the Remuneration Committee and the full Board. Pirc believes the pension to be contrary to best practice in that it should have been discounted. It also strongly objects to the performance and non-performance based share awards to the new Chairman and Chief Executive respectively. Pirc recommends voting against the Remuneration Report. 

RREV, jointly owned by RiskMetrics Group and the National Association of Pension Funds, believes that the award of performance based shares means that the Chairman can no longer be deemed "independent".  It recommends abstention (Withholding of Vote), where the shares are not counted as either "For" nor "Against" the Remuneration Report. 

Are the corporate governance firms and trade associations coming to "Lord Myners' Corporate Governance bash"?  Yes, but one or two are leaving early. 

The UK Financial Investments Ltd (UKFI). The UKFI currently manages, on behalf of the Government, 57.4% of the common equity of RBS, which will rise to 70% following the conversion of the preference shares. The company has stated, ".. we will operate like any other active, engaged shareholder to protect and create value, operating on a  commercial basis and at arm's length from Government. In order to ensure we  meet this standard we will follow in full the Institutional Shareholders' Committee's statement of Principles. This includes:

·       Monitoring performance. We will maintainan active and regular dialogue with our investee companies’ boards and senior management. We will seek to satisfy ourselves that the boards are operating effectively, and that the companies’ strategies protect and enhance shareholder value.

·       Intervening when necessary. Should we have concerns, for instance about strategy, operational performance or acquisitions/disposals, we will intervene with the board.

·       Voting. We will vote all our shares wherever practicable to do so; we will inform the company in advance of our intentions and rationale; and we will disclose how we have voted.

·       Evaluating and reporting. We will provide regular updates to our client – the treasury – on the performance of our investments and the effectiveness of our engagement with investee companies.“

The UKFI has not said how it will vote on the Remuneration Report.  What it has said is, "UKFI has made abundantly clear its profound opposition to the decision of the former board to enhance Sir Fred Goodwin's pension and has agreed with RBS that every legal  avenue for redress must be explored. The vote on remuneration runs much wider across a bank with 170,000 employees and UKFI will make its voting decision in due course." (The Herald, Scotland, 25 March 2009)

Is the UKFI coming to "Lord Myners' Corporate Governance bash"? Based on the wording of its statement to The Herald, the answer appears to be, "not yet and not likely to do so". It would appear that the UKFI is attempting to avoid a "No" or "Withhold" vote by blaming the approval of Sir Fred's pension on previous Board members. As we point out above, the eight executive and non-executives directors on the Board today, (excluding the Chairman), were directors when the pension decision was sanctioned.  

Also, the UKFI's concern about the "170,000 employees" is a red herring!  As stated in the Directors' Remuneration Report, "The Remuneration Committee makes recommendations to the Board on the remuneration arrangements for the executive directors and the Chairman."........"The Remuneration Committee also approves the remuneration arrangements of senior executives below Board level who are members of the Group Executive Management Committee, on the recommendation of the Group Chief Executive, and maintains high level oversight of the application of remuneration policy below this level. The Committee oversees annual incentive plans and reviews all long-term incentive arrangements operated by the Group." There is no mention in the report of specific individual nor aggregate remuneration payments to any employees other than the current and past executive and non-executive directors, to which the ten pages are wholly devoted. For the UKFI to use the 170,000 employees as a reason to vote "For" the Remuneration Report would be misleading and unacceptable in terms of the Treasury's desire for improved corporate governance. 

Private Shareholders. It is difficult to assess how many private shareholders own RBS common shares. The Annual Report and Accounts states that there were 195,000 individual shareholders at 31 December, 2008, holding 2.5%  (982 million) of the common shares. At the end of 2007, there were 174,438 individual shareholders, but they accounted for 6.9%  (693 million) of the common shares. This does not include shareholders who operate their holdings through nominee companies. It will include individuals, including past and current employees of the Group. Many have been vocal, especially at AGMs, with the press and in our polls. But as the figures highlight, individual investors continue to be further sidelined. 

The sidelining of private shareholders is one of the most unfortunate results of poor corporate governance. It is this group of investors that were most concerned about long term shareholder value. 

Are Private Shareholders coming to "Lord Myners' Corporate Governance bash?" We believe they would like to come but probably can't afford the bus fare. In the 12 months to 31 December 2008, the average value of private shareholder ownership in RBS has fallen from £ 3,400 to £ 493. Besides, similar parties in the past have been poorly attended by other groups and weren't much fun! 

Institutional Investors. This is the main group that Lord Myners has castigated for lack of engagement. In general, Lord Myners may be correct. Even if institutional investors have engaged, they have been very genteel in their approach, especially when compared to activist investors.  The activist investors have been prepared to do their research, engage with management, gather other institutional support, go to AGMs and, where necessary, write open letters to the press.  They have the luxury of a very narrow range of investments. However, the broader range of investments and the use of agents is no excuse for institutional investors to neglect their responsibilities to their investing clients. 

The other main criticism of institutional investors has been their apparent focus on short term profit growth rather than long term shareholder value. 

Are the institutional investors coming to "Lord Myners' Corporate Governance bash?"  We think they will, even if it's only to see if the UKFI shows up! 

Improving Corporate Governance

The UK Chancellor, Alistair Darling, is urging banks to act swiftly to regain public trust amid concern in government of an anti-banking backlash, similar to the one in the US, taking hold in the UK. Most financial institutions have promised improved financial transparency. We are not aware of any who have promised improved corporate governance and corporate governance transparency. Without improved corporate governance transparency from both the banks and the institutions, the trust of stakeholders, including the public, will not be regained. The government and the UKFI, along with institutional investors and corporate governance advisory groups will face their first test at the Royal Bank of Scotland's Annual General Meeting.

http://www.investorvoice.co.uk

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