Activist Investors Move to Oust Long-Term Corporate Board Members

During an insurgency campaign at Eastern (EML) last year, activist investor Jim Mitarotonda liked to point to the 27-year average board tenure for directors at the industrial and security products company.  

One director, David Robinson, had been on Eastern's board for 25 years. That came to an end after he was essentially ousted by one of the activist candidates introduced by Mitarotonda and his Barington Capital in a successful proxy fight for the fund that resulted in two new dissident director candidates coming onto the five-person board.

Research firm GMI noted in its analysis report prior to the Barington contest that while it recognizes the benefit of experience, "it becomes increasingly challenging to act independently with such extensive service." GMI added that "long-tenured directors can often form relationships that may compromise their independence and therefore hinder their ability to provide effective oversight."

Separately, insurgent fund Red Mountain Capital Partners made the average board tenure of four of iRobot's (IRBT) eight directors a linchpin for the fund's campaign and upcoming director-election proxy fight at the maker of the Roomba robotic vacuum cleaner.

Specifically, Red Mountain noted in its campaign to replace iRobot's board and management that four incumbent directors have been on the company's board between 12 and 23 years, predating its 2005 IPO. And while one of those directors is the company's founder, the others emerged from private equity backers that have essentially liquidated most of their ownership.

Andrea Geisser, 72, was a representative of Fenway Partners, one of the original private equity investors in iRobot and has been on the board for about 12 years. Two other directors, Ronald Chwang, president of ID Ventures America, and George McNamee, a former managing partner at FA Technology Ventures, have both been on the board for about 17 years.

Meanwhile, SpringOwl Asset Management managing director Eric Jackson is having some initial success with his campaign to have media giant Viacom (VIAB) replace its management and board. Part of his campaign focuses on Viacom's "absentee" chairman, founder Sumner Redstone, who controls the majority of voting power through a holding company. But it also concentrated on some of the company's overtenured directors, including William Schwartz, 82, who has been a member of Viacom or a predecessor media company since 1987 and is considered "independent" for stock exchange listing rule requirements, a red flag from a governance perspective.

A Viacom spokesman said its board pays great attention to its governance and responsibilities to shareholders, noting that every independent director meets Nasdaq's guidelines.

But, for Jackson, that's not good enough. (Full disclosure: Jackson is also a contributor to TheStreet's Real Money and Real Money Pro.)

"If you have been on there more than 12 years, you're a member of the club and you are friendly with Sumner," Jackson said. "There is obviously a lot of trust. I think an independent director should be standing up for minority shareholders especially at this kind of controlled company."

Activists, obviously, have a variety of other issues they like to raise as part of their share-price increasing campaigns. Barington, for example, urged Eastern's management to improve its strategic focus. And Red Mountain argues that iRobot has a poor capital allocation strategy despite having a great product and strong returns from its core vacuum cleaner business. Jackson wants Viacom to undertake a strategic review of assets and is pleased it's taking a look at finding a partner for its Paramount Pictures unit, largely in response to the media coverage around Jackson's campaign.

However, a common theme among these and a number of other campaigns has emerged -- a focus on over-tenured board of directors as a means to an end. Insurgent hedge funds and institutional investors argue that overtenured boards often have extremely cozy relations with what they often call "the imperial CEO," who they contend essentially controls the directors.

"Just because someone has served on a board for a long time doesn't necessarily represent a problem," said proxy solicitor Okapi Partners founder Bruce Goldfarb. "But tenure is one of the first things an activist considers when targeting directors."

Goldfarb said he frequently sees companies install brand new board members with investors who back them, saying they have more accountability than the long-serving ousted directors they replace.

Now, a key and influential public pension fund is putting its own pressure on companies with over-tenured directors. The California Public Employees' Retirement System, or CalPERS, the largest U.S. public pension fund, last month issued a proposal that would require any independent director who has held that position for 12 years or more to provide a detailed annual explanation of why that director can continue to be classified as independent. The public pension fund board will vote on whether to approve it later this month.

"We believe director independence can be compromised at 12 years of service," CalPERS said in the proposal. People familiar with CalPERS note that the influential institutional investor may vote its shares against overtenured incumbent directors in uncontested elections if they don't provide an adequate explanation.

In addition, Institutional Shareholder Services, a major proxy advisory firm that institutional investors consider the gold standard when it comes to governance, considers a tenure of more than nine years as one that "potentially compromises a director's independence."

ISS notes that a new director could sometimes back down from a powerful CEO, but one that has been with the company for a long time may "support that management team's decisions more willingly." ISS issues a red flag on its governance reports when there is a significant number of long-tenured directors.

And if overtenure is a key consideration for activists, there are many potential directors and companies to target. According to a compilation of data by Deal affiliate BoardEx, there are 1,240 independent directors on S&P 500 (SPY) company boards who have held director positions at a particular corporation for more than 12 years. Of those, 15 have held their posts for more than 40 years, with many more keeping their positions for 20 or 30 years.

A Deal review of BoardEx data found that some of the longest-serving directors are related to top executives or other directors. Zions Bancorp (ZION) non-independent director L.E. Simmons has been on the bank's board for 38 years and is the brother of the bank's Chairman and CEO Harris Simmons.

Zions, which is on The Deal's activism watchlist and has seen its stock sag over the past year, sought to rectify concerns about independence by bringing in four independent directors since 2013. L.E. Simmons, the company notes, owns about 941,000 Zions shares, or 0.5% of its outstanding shares, so his interests are aligned with shareholders.

However, activist investor Richard Lashley, co-founder of PL Capital, takes issue with L.E. Simmons' "excessively long tenure" and "lack of independence," arguing that despite his significant accomplishments, he is conflicted.

"There is a reason judges recuse themselves in matters involving relatives. Zions board members should hold themselves to a similar standard," Lashley said.

The more intense focus on director length and CalPERS' recent proposal have driven at least two major crisis-management public relations firms to take a closer look at director tenures.

"We see directors who have been on boards for a long time who are critical to the success of the company," said Joele Frank, founder and managing partner of crisis management firm Joele Frank, Wilkinson Brimmer Katcher. "However, boards are at risk when the majority of their members have served for a very long time and are over the age limit."

Another managing director at a public relations firm said that he advises companies that tenure has to be tied to performance. "A poorly performing company can't have a number of overtenured directors," he said. "If an audit committee has too many overtenured directors, they need to be replaced."

And other institutional investors are also taking a closer look at opposing overtenured directors as part of their own private and public activist "just vote no" campaigns against long-serving directors.

The New York State Common Retirement Fund, which had roughly $185 billion in assets under management as of March 31, has a policy to "scrutinize" boards more closely when all their directors have held seats for 15 years or longer. In reality, said Gianna McCarthy, governance director at the Office of the State Comptroller in New York, the fund starts looking closely at a particular board when the average tenure is 10 years or more and the company has a variety of other troubling governance policies coupled with poor performance overall.

"Do they have a classified board and is the chairman independent?" McCarthy asked. "It has to be a number of issues along with an overtenured board for us to vote against directors."

McCarthy, however, does contend that a company with a large number of long-tenured directors often exhibits characteristics of entrenchment. "The management really starts to dominate and the firm value will suffer, but there are always exceptions to this thesis," she said.

She added that the New York state fund often finds that companies with long-tenured directors also often have boards that lack meaningful diversity. "Diversity means a lot of things: More women, more people of color and as companies become more international, non-domestic directors," she said.

The solution for many pension funds is to have companies hire a third-party consulting firm to evaluate stale, long-tenured boards and help with finding new directors.

A number of companies and organizations provide this kind of evaluation, including the National Association of Corporate Directors and even a number of law firms. The NACD has a board recruitment service that helps companies identify potential candidates for board service. It also helps boards evaluate their current board composition.

Beyond U.S.-based companies, corporations expanding globally may want to bring on some international board representation.

"We've had conversations with companies looking to expand their footprint abroad and it makes sense for them to find a director with an expertise in the area of the expansion," McCarthy said. "We want to know that the board membership is developing with the company's strategic plan."

However, not surprisingly, there is some pushback from corporations. A former general counsel at a major pharmaceutical company told The Deal that he believed that some directors who only joined the drug company's board in the past couple years were "deadwood" while other much longer-tenured directors were critical to the business, partly because they bring "valuable historical context" to the board.

"It has to be looked at case by case," he said.

Corporations under activist fund scrutiny have another option when faced with an overtenured independent director -- re-classify that board member as no longer independent.

Governance experts acknowledge that corporations employing such a reclassification would need to find a new independent director to take positions on now-vacated subcommittees, such as a corporation's pay and audit panels, to meet stock exchange listing rules.

"I am not aware of a company that has voluntarily classified a director as no longer independent for the purpose meeting the listing rules," McCarthy said.

For now, activists will continue to target long-tenured directors.

At Viacom, Jackson's campaign on its "overtenured, cozy" board is having an impact. The media company's 92-year-old founder, Redstone, stepped down from his chairman role -- he's now chairman emeritus -- last month, and the media giant's move to sell a minority stake in its Paramount Pictures unit is exactly what Jackson and another activist fund have been seeking.

Jackson says he will continue to look for overtenured directors as part of his insurgency campaigns. And he backs CalPERS' move to push companies to provide more information about overtenured directors.

"I'm sure you can find someone who has been on a board for 13 years and to artificially kick them off would be unfair," Jackson said. "But in general it is a good thing to have a requirement to take a closer look at long-tenured directors."

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