Shareholder rights

Founder-controlled companies: A few cautionary tales

May 4, 2012: 10:24 AM ET

Some of the nation's greatest corporations started with a few people. But when trouble hits, they need to be held accountable to their many shareholders.

FORTUNE -- I don't know about you, but my head is spinning. Google, Wal-Mart, News Corp, Chesapeake Energy. We all know absolute power corrupts, but the apparent level of ethical challenge at these public, founder-controlled companies is mind-boggling.

Worse, these companies not only do damage to themselves and those that work there, they lower the level of trust in corporations overall.

Wal-Mart, No. 24 on Fortune's list of World's Most Admired Companies, is knee-deep in a scandal over alleged bribery and a cover-up that implicates both the current and former CEO, and calls into question board and audit committee oversight, following investigative reporting by the New York Times last week. The Walton family founders control approximately 1.7 billion Wal-Mart (WMT) shares and nearly 50% of the voting rights according to the company's latest proxy. Nevertheless, the New York City Pension Fund, which has been concerned with Wal-Mart's board independence and oversight for years, is recommending a no vote on five of the board's members. Wal-Mart did not return a call seeking comments.

At Google (GOOG), its founders control approximately two-thirds of the voting rights in a dual class share arrangement, according to the company's preliminary proxy, and they have plans to ensure that hold.

Over the weekend the Los Angeles Times reported that Google's drive-by capture of personal nformation was not as inadvertent as Fortune's second-most admired company, originally made out. "We had mistakenly included code in our software that collected samples of payload data," a 2010 Google blog entry stated.

But according to the FCC report that Google released late Friday, the work was a result of a "deliberate software design decision." The report shows that the engineer who devised the software submitted draft code and a draft design document to his project leaders, who shared his document with all members of the company's Street View team. Google assigned an engineer to "review and 'debug'" his code, five engineers tested it, and a Google senior manager asked for information from the captured data.

A Google spokesperson wrote in an email to me that the report shows Google did not break the law. But the report states that Google deliberately impeded the FCC's investigation and that "several countries, including Canada, France and the Netherlands have determined that Google's collection of payload data violated their … laws and regulations."

"We hope that we can now put this matter behind us," the Google spokesperson wrote me. And perhaps they'll be able to. U.S. regulators appear to be weak-willed, and shareholders chasing issues at Wal-Mart, News Corp., and Chesapeake Energy, among others, have their hands full and haven't focused on Google's news. We have only so much bandwidth, they've told me.

A 125-page British Parliament report released this week, says News Corp. CEO Rupert Murdoch "exhibited willful blindness and … this culture ... permeated from the top throughout the organisation and speaks volumes about the lack of effective corporate governance at News Corporation … Rupert Murdoch and James Murdoch -- should ultimately be prepared to take responsibility." As of its last proxy filing, Rupert Murdoch controlled nearly 40% of the votes in the dual class share company. News Corp., (NWS) which doesn't appear on Fortune's most admired list, did not respond to a call and email seeking comments.

Since the U.K. phone hacking scandal broke, "we haven't seen the sweeping changes Rupert Murdoch references, and News Corp. has done nothing about the board in the wake of high no votes against the members last year," Julie Tanner, assistant director of socially responsible investing at Christian Brothers Investments told me. "Shareholders need to see sweeping changes on the board." Christian Brothers and the Local Authority Pension Fund Forum have filed a shareholder proposal calling for an independent chair.

Laura Campos, director of shareholder activities at the Nathan Cummings Foundation, wrote in an email to me that after the scandal broke, "we gave the company roughly six months to respond to the serious level of shareholder discontent … and saw only token changes … Thus we decided to submit a proposal calling for dual class unification."

Last month, News Corp. announced it was stripping non-U.S. shareholders of their voting rights to meet FCC requirements on foreign control but would not use the move to increase Murdoch's voting position. Campos wrote "if ALL shares -- both class A and class B -- carried voting rights, the company would most likely not have been in violation of U.S. law and would not have been forced to suspend some of the voting rights of its foreign investors to remain in compliance with it."

Our final founder-run company of note is Chesapeake Energy (CHK), which also doesn't make the Most Admired list. An investigation by Reuters last month into loans arrangements related to a well ownership scheme uncovered poor oversight of Chesapeake Energy co-founder and CEO Aubrey McClendon who was stripped of the Chair title this week. A new report from Reuters on Wednesday says that for four years as CEO, McClendon had been running a $200 million hedge fund on the side with his Chesapeake co-founder Tom Ward. According to last year's proxy, Ward was also allowed to participate in the well ownership program.

Mike Garland, executive director for corporate governance at the New York City Office of the Comptroller, says while he "welcomes the belated move to separate the CEO and chair roles, the issues go beyond [just] the leadership of the board. The issue is the board." New York City pension funds have a proxy access proposal at Chesapeake, which would allow shareholders to nominate directors on the official proxy in future years. Based on last year's proxy disclosures, Chesapeake's founders don't control the share votes, so the proposal may have a shot. There was a fairly high vote in favor of proxy access at Wells Fargo (WFCthis year, and the New York City pension fund is introducing a similar proposal at Nabors Industries (NBR). Chesapeake did not respond to an email seeking comment.

While shareholders may be able to effect changes at Chesapeake, the ability to make change is severely limited if not impossible at firms like Wal-Mart, News Corp., and Google. Carlyle (CG) and Facebook investors will also face investment risks with practically no means to hold the founders accountable.

In 2006, when concerns arose over Wal-Mart's "legal troubles" and "systematic violations," Norway's global pension fund and a Sweden-based pension fund sold their shares, according to Bloomberg. In so doing, they were acting as fiduciaries, concerned with the soundness and prudence of investing other people's money in the stock.

It would certainly make the job of pension funds and investment managers in the U.S. easier if exchanges refused to list dual class shares or shares with no effective voting privileges. But the exchanges have no incentive to do so -- other than concern for the capital markets system. So too with indices that include the stocks and investment banks that underwrite them. But no matter the actions of other parties in the system, as a matter of prudence, fiduciaries that invest other people's money should not be investing in companies where they cannot effectively exercise their rights of control. Fiduciaries are under an obligation not to invest in stocks like these, and they are paid well for ensuring they do not.

It isn't as though pension funds, mutual funds, and investment managers don't have prohibited stock lists (i.e. stocks that they never invest in). They do. Now it's time fiduciaries stepped up to put shares without rights on their lists. It's easy to be patient if it's someone else's money. But, as many funds admit, they don't have the bandwidth to oversee all the stocks they own now anyway.

Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance (http://thevaluealliance.com), a board advisory firm.

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