Issue: April/May 2007


Acts Together

Laws on their own cannot create a culture of shareholder activism. They can, and have begun to, create the environment that enables them to take root. South Africa can, and should be, at the start of a new era in empowerment of ordinary investors.

It happens in stops and starts. From time to time, there’s a flutter of challenge over a governance issue or an offer price in this company or that. In isolated instances, shareholder activism flares. As a movement gathering momentum and establishing direction, it fails.

Not the sort of shareholder activism where odd-bods pitch up at meetings on their own to whinge or score points off directors, and be spurned because the merit of their argument is unmatched by the muscle of their votes. Neither the sort envisaged by the King Code because, in the five years since its high-minded recommendations, the shareholder activism it propagated as a means to enhance corporate governance has witnessed some indefensible extravagances of single-minded greed.

The limpness of King is a function of voluntary implementation, allowing form to substitute for substance and practice to become window-dressing. Under its skirt of ostensible compliance, triple-bottom line reporting (of economic, social and environmental impacts) can degenerate into spin, and wrongs against shareholders can be perpetrated with respectability. These needn’t necessarily be criminal wrongs of the Kebble variety, wilfully perpetrated with accounting and disclosure manipulation, but also the more mundane and everyday wrongs such as boards holding excess capital that can better be distributed or squandering cash on empire-building acquisitions that serve primarily to inflate the value of executives’ share options.

So long as shareholders are prepared to behave like sheep, it’s been said, they must expect to be shorn. On display is shareholder impotence derived from apathy, not least on the part of institutional investors to whom South Africans entrust their savings.

Why should any of this change? Because there’s emerged a convergence of laws and commitments with a golden thread: the new Companies Bill, National Treasury’s proposals on retirement-fund reform, the Financial Sector Charter, the Pension Funds Act and the Broad-Based Black Economic Empowerment Act. Then, too, there is the Government Employees Pension Fund (GEPF) becoming a signatory to the United Nations Principles for Responsible Investment (PRI), presaging execution through the Public Investment Corporation as its agent.

What they have in common, explicitly or implicitly, is the advent of shareholder activism. Yet none define the term. Generally understood, it’s these days taken to mean recognition of shareholdersas owners beyond merely attending company meetings and receiving dividends. Integral is engagement with company management on strategy, performance, market value and governance. Success is gauged by changes that targeted companies adopt. The power of investors is not simply to hold directors “accountable”, but also to vote them down where what’s “accountable” is unacceptable.

Moreover, retirement funds are invariably significant holders of shares in the major corporates. Their claim for accountability and activism is accentuated by the wholesale switch from defined-benefit to defined-contribution funds. For it’s individual members of the latter

  • several millions of them
  • who now directly bear the investment risk.

By their nature, these funds invest for the longer term. Their representatives have an interest, even a responsibility, to support company managements in subordinating short-term gain for promoting long-term sustainability; in other words, “sustainability” is consistently to increase shareholder value and simultaneously to advance good corporate citizenship. These objectives are inseparable if gains on the swings aren’t lost on the roundabouts.

That’s why the GEPF’s signing of the PRI (see box) is significant; the intent of South Africa’s largest pension fund is on its sleeve. That’s also why signatories to the Financial Sector Charter must drive through conflict: fund managers, for practical purposes at the activism coalface, represent the long-term interests of private-sector funds but at the same time face competitive pressures for short-term performance.

The California Public Employees’ Retirement System (CalPERS), one of the largest funds in the world and from which many activists take their cue, looks at it thus: “The twin duties of loyalty and care prohibit CalPERS fiduciaries from placing non-financial considerations over risk/return considerations . . . However, actions taken by CalPERS as a shareowner can be instrumental in encouraging action as a responsible corporate citizen by the companies in which the Fund invests.”

In South Africa, the road ahead might be bumpy and uphill. The destination, however, is neither obscure nor distant:

The new Companies Bill

To replace the 1973 Companies Act, it was published in February for comment. The law, it says upfront, should “protect shareholder rights, advance shareholder activism, and provide enhanced protections for minority shareholders”.

So long as shareholders are prepared to behave like sheep, it’s been said, they must expect to be shorn.

For the activism to happen, consider this:

  • It does not introduce narrative financial reporting, which enables users of financial statements to actually understand the performance and development of a business, along the lines recently adopted in the UK and even more stringently in the European Union (TT June-July 2006). Instead, it provides only for financial reporting to “be consistent with” standards of the International Accounting Standards Board and generally accepted accounting practice. The technical nature of such reporting, intelligible only to specialists, upholds the highly formalistic communication that lends itself to consumer abuse. It undermines the requirement of the Global Reporting Initiative (which guided King and which the JSE is supposed to endorse) for easy comprehension. Without narrative reporting, at least as a complement, shareholders cannot be properly informed of the opportunities and risks of the businesses in which they’re invested. Let alone be stirred to activism.
  • Although it provides for shareholders to elect directors, it is silent on the right of shareholders to nominate them. In South Africa, boards incline to self-perpetuation under the convention that outweighs control over ownership. This convention is obsolete in limiting the right of shareowners only to elect directors nominated by other directors. In the US, the subject is equally vexed. As the International Corporate Governance Network put it to the Securities & Exchange Commission last October: “One of the basic assumptions of corporate governance is that shareholders should have the right to exercise a meaningful role in the election of directors and that the election process should thereby function as a means to ensure board accountability . . . The US system clearly lags behind other major global markets where the rights of shareholders to participate in and influence director elections are already well established.”
  • It provides for shareowners only to receive reports of directors’ remuneration, not to approve them. Clearly, there’s a disconnect. There’s no obvious purpose in pushing out reports for their own sake. Remuneration disclosures were supposed to have acted as a brake for containment by showing reasonableness and wise discretion by independent directors. But this has not prevented some of the most egregious awards known to man. When share options bear closer relationship to the luck of timing in the market stratosphere than to the individual’s contribution in company performance, it’s at the expense of shareowners. Yet their say is limited to an ‘advisory’ vote.

Positively, the Bill proposes proxy voting by electronic communication at shareholder meetings. If anything can take the hassle out of exercising votes, and thereby cause shareowners to actually vote, this will. But it is significant for another reason, too. It’s that the proxy process has the potential to trigger shareholder activism. The more voting is facilitated, the more votes will be cast; the more votes that are cast, the more power will be redistributed to owners; the more scope for power redistribution, the greater the obligation on fund managers to obtain mandates from indirect shareowners on how to vote, and the more fund trustees will have to apply their minds in formulating those mandates.

A glimmer of the potential in proxy voting has been witnessed in the Actis bid for Alexander Forbes. Pressure by international investors for a higher offer has been inspired by Institutional Shareholder Services, a leading provider of advice on how to vote proxies, founded by renowned US activist Robert Monks. At present, South Africa has no similar service.

National Treasury’s second discussion paper on social security and retirement reform

Also published in February, it’s forthright on governance of retirement funds. It emphasises the importance of trustees playing a “rigorous role” in safeguarding the interests of members, which involves “trustee knowledge of investment principles”. Then it mentions the need for focus on:

  • An appropriate definition of socially responsible investment (SRI) in the South African context and its “interaction with existing initiatives” such as the Financial Sector Charter;
  • How SRI should be “actively encouraged”;
  • The scope for shareholder activism and the duties this entails specifically for “relevant stakeholders”.

These are areas that invite broad consultation, it says. “Pension fund trustees and retirement fund participants themselves should be encouraged to develop tailored solutions to these challenges.”

Financial Sector Charter

The latest report of the Charter Council is deafeningly silent on progress in implementing the commitments on shareholder activism, although “the financial sector” recognises it as a “critical component of continued confidence and long-term growth of the sector”.

Over three years ago, financial institutions undertook to

  • Promote increasing levels of influence of direct black owners at board level;
  • Encourage training and awareness programmes for all shareholders regarding the impact of indirect shareholding (eg, through retirement funds);
  • Encourage shareholder awareness through triple-bottom line reporting (presumably in language that shareholders can understand).

Fund managers and asset consultants also committed themselves “to improve their knowledge and that of union trustees regarding BEE transactions and targeted investment” (eg SRI). And pension fund trustees “are encouraged to play an increasingly active role . . . on their respective boards and in the entities in which they have taken significant investments”.

The institutions are the fulcrum because, more often than not, they are the registered shareholders (with legal rights accorded to them) on behalf of the beneficial shareowners (whose money they invest). As registered shareholders, they can vote shares in one way for one batch of beneficial shareowners and in a different way for another if so instructed. With the interests of beneficial shareholders paramount, they might well find themselves in a position of having to vote against resolutions proposed by companies that are clients of the same institution.

Over three years on, it’s high time that more visible activity on activism busted out.

Broad-Based Black Economic Empowerment Act

The final codes of good practice, gazetted earlier this year, measure ownership of enterprises as an entitlement to both voting rights and economic interest. Retirement funds, often the only vehicle through which black workers save, would meet both criteria as broad-based ownership schemes (see article elsewhere in this edition).

There are qualifications. Among them, at least 85 percent of the benefits allocated from the scheme (capital growth and dividends from investment in companies) must accrue to black people.

Logically, it’s for fund trustees to ensure voting rights are exercised. Practically, this would be through their fund’s managers. Otherwise, the right to vote without exercising it is purposeless.

Pension Funds Act

Members of retirement funds are entitled to elect half the trustees on their respective funds’ management boards. In a single sweep, members were given the capacity to influence the overall direction of investments in their funds and a legal basis was provided for workers to have a say equalling their employers.

This 1996 amendment introduced shop and office-floor democracy to the pension fund industry. That democracy allows for employee participation, through elected trustees, in formulating mandates to vote at shareholder meetings of companies where their funds are invested.

UN Principles for Responsible Investment (PRI)

A founding signatory, and the first South African signatory, is the Government Employees Pension Fund. With the sheer power of its share ownership, the persuasive influence it can bring to bear on corporate behaviour is formidable (TT Dec ‘06-Jan ‘07).

This is the influence that the Public Investment Corporation (PIC), as the fund’s manager, has the muscle to assert. But there’s a way to go. For all the headline-grabbing attention the PIC has attracted as an activist, to date its activism has been mainly on a narrow and noisy front.

PIC chief executive Brian Molefe has concentrated on punting the appointment of more black directors (as at Sasol and Barloworld). Well and good, but the higher pay levels he propounds for them is not usually a primary objective activist managers pursue in the interest of fund members. And when there’s been pressure for higher prices in private-equity offers (as at Shoprite), it’s been private-sector fund managers rather than the PIC that have led the charge.

For the recently corporatised PIC, having leapfrogged its own executive pay from public sector to “market-related” levels, these are early days. It’s now working on a policy document of corporate governance requirements (not recommendations) for companies where it invests. Once it’s done, there’ll be little excuse for private-sector fund managers not to do the same.

Such an initiative will need to be in conjunction with the GEPF as its major client. Asked by TT whether the GEPF would be prepared to disclose publicly its voting policies and practices at shareholder meetings – to show on its website how it or the PIC has actually voted on resolutions put to shareholders – GEPF chairman Martin Kuscus and chief executive Phenias Tjie responded: “We definitely must work towards it, particularly in light of our PRI commitments. But it must be recognised that this is a process. We’re just beginning to consider an appropriate proxy voting policy”.

Molefe, Tjie, Kuscus . . . active lead awaited

The GEPF and PIC take CalPERS as a role model, not least for the way that its proxy voting has led activism around the world. Once the GEPF and PIC get going, activism and the PRI will be in lights.

The tone is set. The groundwork is laid. Be prepared.


Two years ago, then UN secretary-general Kofi Anan invited 20 representatives from the world’s largest institutional investors in 12 countries to develop a set of global best-practice principles for responsible investment. They were supported by a 70-person multi-stakeholder group of experts drawn from the investment industry, intergovernmental and governmental organisations, civil society and academia.

The purpose, Anan noted, was to establish “a clear set of common guidelines that individual and institutional investors can use to assess risks and opportunities fully”. The guidelines were adopted last year. These are for signatories to:

  • Incorporate environmental, social and corporate governance (ESG) issues into investment analysis and decision-making processes;
  • Be active owners, incorporating ESG issues into ownership policies and practices;
  • Seek appropriate disclosure on ESG issues by entities in which they invest;
  • Promote acceptance and implementation of the Principles within the investment industry;
  • Work together for enhancing effectiveness in implementing the Principles;
  • Report on activities towards implementation.

They specifically call for disclosure of active ownership activities on voting, engagement and policy dialogue.

“Almost inadvertently, the workforce has become the big owner of the world’s most significant companies. If we can work out how we can use our new powers responsibly, we have enormous opportunity to create sustainable development. This book is a roadmap. No-one who seeks to influence company behaviour should be without it.”

So says John Monks, general secretary of the European Union trade union confederation.“This book effectively spells out who the true beneficiaries of today’s capitalist world should be – us. It’s a call-to-action must-read for anyone and everyone with a stake in today’s investor-owned society.”

So says Ira Millstein, senior associate dean for corporate governance in the Yale school of management.

Their testimonials are among several cited in a book being reviewed extensively, usually with approbation, in serious business media abroad. The book is “The New Capitalists: How citizen investors are reshaping the corporate agenda” by Stephen Davis, Jon Lukomnik and David Pitt-Watson.

No leftie lightweights are they. Davis is an internationally recognised expert on corporate governance; Lukomnik is former deputy comptroller of New York City, where he managed assets of $80 billion, and Pitt-Watson was chief executive of Hermes Focus, which ranks as perhaps Europe’s leading activist fund manager.

Their thesis, richly argued, is to articulate and advance the power shift in corporate influence. Previously, corporate power was the preserve of the state and tycoons. Today, there’s rapidly emerging a “civil economy” where “new capitalists” can call the shots. Democracy comes to boardrooms as fresh air through windows.

Around the world, they point out, owners of large corporations are “the tens of millions of working people” whose pensions and other life savings are invested through funds in shares. The collective nest eggs of these people make them the ultimate owners, and the majority owners, of the corporations. There’s been a “historic transfer of ownership”.

Until now, the authors contend, citizens have hardly known it. Much less have they acted as owners. Ignorance or acquiescence has left power where it was. But the present “awakening of a consciousness of civil ownership” promises to make those traditional power brokers accountable, or be kicked out.

Why bother? Simply, shareholder activism is seen to enhance shareholder value. Companies attentive to shareholders tend to be better governed than those that aren’t, and their shares command higher prices. Costs of capital are lowered, with benefits for the companies and the economy. Realisation of the power that individual shareholders can assert – remember disinvestment from South Africa in the 1980s was driven by stakeholder pressure on American banks – encourages institutional investors to adopt “responsible portfolio and activist strategies”, the authors contend. In turn, company boards are encouraged to reform themselves – making them more accountable to shareholders and completing a “virtuous circle” when executives feel liberated to pursue strategies for sustainable growth.

Back home, to date, there’s a dearth of similar activity despite the bravado of the Financial Sector Charter and the King Code. So hooray for Allan Gray in having led the fight against the Shoprite private-equity proposals. Whatever the merits, at least a top fund manager has shown the balls of an activist – just as it did, a few years back, when it acted with Investec and RMB to expel the Comparex board.

More strength to the elbows of activist fund managers. Promulgation of a new Companies Act might yet be a serious factor in promoting it.