Shareholder activists come in several varieties, but Richard Ferlauto is a little more unconventional than most. For a start, the tiny pension fund he oversees for staffers at the American Federation of State, County and Municipal Employees doesn’t own enough shares of anything to exert much sway. With $700 million in assets, it is dwarfed by the tens of billions in capital that allow such behemoths as the California Public Employees’ Retirement System and TIAA-CREF to throw their weight around in executive suites.
What’s more, despite his senior position at AFSCME, a big union with a strong liberal-Democratic bent, Ferlauto makes an improbable labor movement agitator. He grew up in a solidly Republican household in suburban New Jersey, even volunteering back in seventh grade to play Republican candidate Richard Nixon in a mock presidential debate. But the 48-year-old hasn’t let that keep him from emerging as one of the most outspoken and influential critics of corporate America amid the raging battle over how companies should be governed in this era of seemingly endless financial frauds. Longtime AFSCME International president Gerald McEntee hired Ferlauto as director of pension investment policy in 2002, when scandals at Enron Corp. and WorldCom were still front-page news, to agitate for change in the corporate world. Since then Ferlauto has transformed the federation into one of the most activist institutions in the country -- and one that gets results despite its paltry assets.
In the past 18 months, Ferlauto, formerly an executive with proxy-advisory firm Institutional Shareholder Services, has been a driving force behind major governance concessions by Circuit City Stores, Marsh & McLennan Cos. and Ryder Systems. And he and AFSCME almost single-handedly pressured the Securities and Exchange Commission into proposing to allow shareholders to nominate candidates for corporate boards directly, a dramatic departure from historical practice. Business groups, including the U.S. Chamber of Commerce and the Business Roundtable, have vehemently opposed it.
How has Ferlauto done it? By using AFSCME’s tiny in-house fund as a platform for proposing shareholder resolutions at annual meetings, while relying on the secondary clout of the union’s nearly 1.4 million members, whose pension assets are invested in a number of non-AFSCME plans. The union’s own fund typically holds only a few thousand shares of the companies it targets, hardly enough to gain credibility at widely held concerns with hundreds of millions of shares outstanding. But AFSCME’s members participate in other pension schemes, mostly state-run plans, that total $1.4 trillion in assets. Although these funds include a big chunk of money invested on behalf of non-AFSCME members (the union says it’s impossible to determine exactly how much because the various defined benefit plans don’t allocate assets to individual beneficiaries), Ferlauto ultimately can hold himself up as a protector of the retirement security of a wide swath of the labor force. And he’s exploiting that influence for all it’s worth.
“Enron didn’t occur in isolation,” Ferlauto says, noting that the pension systems in which AFSCME members are enrolled lost $1.3 billion from the Houston company’s 2001 collapse. He says the toll rises to a whopping $300 billion -- 15 percent of these plans’ equity assets -- when figuring in the overall damage of the scandal-tinged market downturn of 2001 and 2002. “Many boards are dominated by imperial CEOs, with no checks and balances and no voice for shareholders,” says Ferlauto. “I
am trying to make the markets as effective as they should be by creating that voice for owners.”
Ferlauto’s efforts have won him the respect of other activists. “Rich and AFSCME have taken the lead on a number of issues,” says Cornish Hitchcock, an attorney who provides counsel on governance issues to institutional investors such as New Yorkbased Amalgamated Bank, a longtime union bank that has $10 billion in workers’ retirement savings in its LongView family of mutual funds. “He deserves a lot of credit.”
“He is one of the leaders among labor activists in institutional corporate activism,” notes Jay Eisenhofer, a principal and founding partner of Wilmington, Delawarebased law firm Grant & Eisenhofer who has represented a number of institutional investors in corporate and securities litigation.
But Ferlauto’s foray into governance reform is also earning the federation its fair share of enemies. AFSCME’s signature issue of investor access to corporate proxies -- and thus to board of director nominations -- has been a lightning rod. The SEC’s October 2003 proposal on proxy access would require companies to include certain shareholders’ nominees for board seats on proxy ballots distributed to investors in advance of annual meetings. Corporations fear that giving investors -- particularly left-leaning union pension funds -- access to the proxy would allow activists to nominate inexperienced, hostile directors who would push a social justice agenda rather than focus on creating value for stock owners.
“I am concerned about proxy access,” asserts Michael Eskew, chief executive officer of United Parcel Service and a member of the Business Roundtable, a Washington-based group of CEOs that advocates business-friendly public policy. “It’s important for companies to manage their affairs with boards that are independent and transparent but that truly represent all shareholders. Selection boards still need to find their own nominees.”
Thanks to an intense corporate lobbying effort, part of a broader backlash against the SEC’s aggressive regulatory stance under chairman William Donaldson, the agency’s proxy proposal now appears all but dead. Donaldson, who has pushed through controversial new rules affecting hedge funds and mutual funds by joining with the five-person commission’s two Democrats against his two fellow Republicans, wants to avoid another 3-2 vote on a contested issue, say people close to the process. The SEC also has permitted several companies, including giant insurer American International Group, to ignore AFSCME shareholder proposals that sought to achieve proxy access on a company-by-company basis after the SEC process stalled. The union responded last month by taking AIG to court to force it to include the access proposal on the proxy for its May annual meeting.
But running into a roadblock on that issue isn’t preventing Ferlauto and AFSCME from going after corporate America even harder during the current proxy season, which will reach its height when the bulk of publicly traded U.S. companies hold their annual meetings in April and May. Among the large, widely held companies the union is targeting with a variety of governance proposals are Amgen, Bank of New York, Bed Bath & Beyond, Bristol-Myers Squibb, Home Depot, Ingersoll-Rand Co., Maytag Corp. and Siebel Systems. Ferlauto’s agenda focuses in particular on more closely tying executive pay to company performance, removing antitakeover measures such as poison pills and ensuring that companies heed majority shareholder votes on annual meeting resolutions.
FERLAUTO’S ACTIVISM ON BEHALF OF UNION
members might surprise those who knew him when he was growing up in the upper-middle-class New Jersey suburb of East Brunswick. The son of a management-level chemist for oil giant Mobil Corp. who presided over what Ferlauto remembers as a “moderate Republican” household, he eagerly accepted his seventh-grade teacher’s call for a volunteer to play Nixon to the Democrats’ Hubert Humphrey in a 1968 classroom debate. “I believed he would get the U.S. out of Vietnam in an honorable way,” he recalls.
But in 1978, while studying philosophy and economics during his senior year at Georgetown University, Ferlauto read a book that would change his life. The North Will Rise Again: Pensions, Politics, and Power in the 1980s, by liberal intellectuals Jeremy Rifkin and Randy Barber, exhorted everyday workers to use their power as corporate shareholders -- through their pension funds -- to oppose layoffs, factory relocations and other putatively antiunion policies.
After graduation Ferlauto abandoned his plan to become a philosophy teacher and began working to help nonprofit groups and trade associations improve the lot of working people. But he has taken care to pursue market-based solutions to social inequities. “My whole life I have been looking for creative ways that markets can be used to generate jobs and economic opportunity and return economic benefits to the community,” he explains. “It’s a social orientation and an economic orientation.”
After college Ferlauto joined Volunteers in Service to America, known as the domestic Peace Corps, where he worked with a nonprofit group to help dispossessed low-income tenants in tony Fairfield County, Connecticut. “We were looking for alternative sources of capital to invest in housing,” he recalls. Some pension funds got involved. The experience stoked Ferlauto’s interest in how pensions could influence public policy.
In 1982 he cut short graduate studies in public policy at New York’s Hunter College to join girlfriend Hillary Horn, an activist for the Farm Labor Organizing Committee, on a three-week protest march. Ferlauto had met Horn when she was working for the United Farm Workers in Connecticut. The FLOC march took them from Toledo, Ohio, to the annual meeting of Campbell Soup Co. in Camden, New Jersey, where the group, through its pension fund, pushed to win better pay for seasonal tomato pickers. The union’s resolution failed, but the group subsequently negotiated a deal with management that established a pay floor and access to health care benefits for the farmworkers.
“It was my first annual meeting,” remembers Ferlauto, “and it opened my eyes to how investors could shape corporate decision making.”
Ferlauto wound up marrying Horn and worked mostly on housing issues for much of the 1980s and early 1990s. From 1985 through 1987 he was chief of staff for New Jersey State Assemblyman David Schwartz, a Democrat who chaired the committee on housing and urban affairs. In 1988 he and Schwartz co-founded the American Affordable Housing Institute at Rutgers, the State University of New Jersey. While at the AAHI, Ferlauto advised the staff of the U.S. Department of Housing and Urban Development on ways that employers and pension funds could help workers afford homes. He also co-authored two books with Schwartz, A New Housing Policy for America (with a foreword by thenU.S. Senator Bill Bradley) and Employer-Assisted Housing: A Benefit for the 1990s. In late 1992, Ferlauto left the AAHI for the Center for Policy Alternatives, a nonpartisan think tank that worked with states and public pension funds to attract capital for housing and economic development.
Five years later Ferlauto fully embraced shareholder activism. After becoming a full-time consultant to the AFL-CIO in early 1997, he helped establish its Office of Investment and its corporate governance program, often drafting and promoting proxy voting policies. Almost two years later, in December 1998, Institutional Shareholder Services hired Ferlauto as managing director of proxy voter services. In this role he advised pension plans on how to vote their proxies.
By the end of 2001, with Enron imploding beneath a cloud of scandal, AFSCME chief McEntee began to sense that corporate governance was a major issue affecting the financial security of union members. He sought out Ferlauto to bring the expertise he had developed at ISS to the federation. “We saw the need to defend the retirement assets of our members,” says McEntee, who has headed AFSCME for 24 years. “So we made a decision to launch an aggressive pension program.”
UNTIL THEN AFSCME HAD ONLY SPORADICALLY flexed its muscle as a shareholder. During the 1980s it pushed a handful of companies to divest holdings in South Africa as a protest against that country’s racial segregation. About five years ago it began to submit a few shareholder resolutions each year calling for corporate governance reforms.
Under Ferlauto’s influence, AFSCME emerged as an activist leader. He spearheaded shareholder proposals to 17 companies in 2003, the first full proxy season after his hiring, and followed with 22 more last year. Among the early victories were majority votes in favor of proposals to rescind poison pills at Circuit City, Pitney Bowes and Ryder in 2003; all three withdrew their pills -- antitakeover provisions that generally call for the issuance of massive amounts of shares in the event of a buyout bid -- after AFSCME made similar proposals last year. Another success came in 2003 when Great Lakes Chemical Corp. agreed to a proposal that all of its directors stand for annual election, a process known as declassifying the board, rather than have groups of directors serving staggered terms. That move came after a majority vote for an AFSCME resolution to declassify.
But Ferlauto’s signature issue has been the effort to win the right for investor-nominated director candidates to be included on proxy ballots. In analyzing the scandals that sent companies like Enron, WorldCom and Adelphia Communications into bankruptcy in 2001 and 2002, Ferlauto seized on a common thread: malleable boards of directors that were dominated by company insiders and friends of the CEO. If shareholders could nominate directors who they believed would better represent their interests, governance would improve, he and other activists reasoned. But under existing securities and corporate laws, investors can’t put candidates on proxy ballots. Instead they have to mount costly campaigns that require sending separate ballots to all owners of the company’s stock.
“It would be the most significant reform,” Ferlauto asserts. “It empowers owners to have a voice that they don’t have in the boardroom. This is all about creating wealth and shareholder value for the long term.”
Beginning in late 2002, Ferlauto set out to make that vision a reality. AFSCME proposed resolutions to be voted on at the 2003 annual meetings of six major corporations -- AOL Time Warner, Bank of New York, Citigroup, Eastman Kodak Co., ExxonMobil Corp. and Sears, Roebuck & Co. Each called for allowing shareholders to nominate director candidates who would be included on the official proxy ballot. Predictably, the companies cried foul. And the SEC issued so-called no-action letters that permitted them to omit the resolutions from their proxies without the threat of enforcement actions. The agency, however, also promised to create new rules that would facilitate shareholder nominations in the future.
By October 2003 the SEC had proposed those new rules, which would allow big, long-term shareholders to nominate directors under a fairly proscribed set of circumstances -- primarily when companies had ignored previous majority votes on shareholder proposals. The agency’s plan generated a record number of comment letters and spawned a rare SEC roundtable discussion last year. Despite the strict conditions set up for proxy access in the rules, groups like the Business Roundtable and the Chamber of Commerce objected strongly. The Roundtable even threatened to sue if the proposals were enacted.
“This is capitalism, not democracy,” says Morton Pierce, a partner at New York City law firm Dewey Ballantine who represents a number of large corporations. “If I don’t like how a company is run, it’s really easy -- I sell my stock.”
Amid the business lobby’s objections -- and a broader, election-year backlash against SEC chairman Donaldson’s surprisingly activist tenure -- the proxy-access proposal stalled late last year.
Frustrated, Ferlauto continued to try to bring about proxy access on a company-by-company basis, through resolutions targeted at Marsh & McLennan, Walt Disney Co., Halliburton Co., Eastman Kodak and AIG. His effort got an early boost last March, when Marsh agreed to appoint an outside director whom AFSCME and other shareholders deemed acceptable. Then things started going downhill. The Disney proposal, filed by AFSCME in October in conjunction with CalPERS, the New York State Common Retirement Fund and the Illinois State Board of Investment, would have allowed shareholder nominees to appear on Disney’s 2006 proxy. But in late December the SEC reversed an earlier decision and permitted Disney to exclude the proposal from consideration at its annual meeting, which took place last month. Then on February 7 the agency struck a crushing blow to the proxy-access effort by issuing a no-action letter to Halliburton, allowing the company to exclude from its proxy a proposal sponsored by AFSCME and the Connecticut state and New York City public pension funds. In the letter the SEC essentially reversed its stance, outlined in a footnote in its proxy-access rule proposal, that called for resolutions from individual shareholders seeking the same goal to be permitted on corporate proxies until the new regulation was approved. That gave the green light to AIG, Kodak and any other company that AFSCME might have targeted in the current proxy season to ignore the federation’s proposals.
Eighteen days later AFSCME filed suit against AIG in federal court, seeking to force the company to include the union’s proposal on its current proxy and submit it for a shareholder vote in May. If the SEC won’t follow through on its original plan, Ferlauto says, “the only other venue is through the courts.” AIG declines to comment. Securities lawyer Eisenhofer says the law governing the case is complex and murky but adds that the suit “definitely has a chance of succeeding.”
The SEC’s proposal is still pending, but given the political pressure on Donaldson, it’s not likely to see the light of day. And time may be running out. Democratic commissioner Harvey Goldschmid plans to step down this summer and return to his teaching job at Columbia University. It’s possible that the Bush administration will take its time naming a replacement, leaving the commission deadlocked. Still, Goldschmid remains cautiously optimistic that Donaldson will push the plan through. “I hope before I leave the commission, it will be enacted,” he says. “A fair number of people would say it would tarnish his chairmanship if he fails to act on this.” Donaldson declines to comment.
Others are more pessimistic -- or perhaps realistic. “I don’t think the SEC will adopt the proposal,” says John Coffee, director of the Center on Corporate Governance at Columbia Law School. “I think it is dead in the water.”
FERLAUTO, HOWEVER, WILL KEEP RAILING AGAINST corporate policies that he believes hurt AFSCME’s members. During the current proxy season, he’s focusing on enforcing the will of shareholders at companies that have made a habit of ignoring it. To this end, AFSCME has proposed that Maytag create a special board committee to deal with shareholder proposals that receive a majority vote yet are not implemented by the company. The committee would have to meet with the proponents of such measures to discuss them following their passage. Maytag has failed to act on several majority shareholder votes in favor of declassifying its board. AFSCME filed similar proposals at Gillette Co., Morgan Stanley and Raytheon Co., but withdrew them when the companies agreed to declassify.
Ferlauto also continues to oppose executive pay abuses. AFSCME wants the boards of Adobe Systems, Amgen and Bed Bath & Beyond to impose a two-year holding period on any shares acquired by management through the exercise of option grants. (Adobe says it will oppose the measure.) The union also proposes that AT&T Corp. and Bristol-Myers Squibb link the vesting of restricted stock awards to the attainment of specific performance milestones rather than just the passage of time, arguing that such awards can result in huge payouts to executives who perform poorly. (Both companies say they’ll respond to the proposals in their proxy statements this spring.)
And AFSCME continues to attack general governance abuses, such as poison pills and staggered boards. On February 28, Bank of New York said it would rescind its pill following an AFSCME proxy proposal that targeted it. A similar resolution gained a 65 percent vote at ADC Telecommunications’ annual meeting last month. The union is also taking aim at staggered boards at Siebel Systems and Ingersoll-Rand, which Ferlauto says has agreed in principle to voluntarily declassify its board. An Ingersoll spokesman says that the company is considering such a move in light of an AFSCME proposal last year that fetched 81 percent of shareholder votes, but, he adds, “we are not in a position to say that categorically.”
“Our trademark is identifying new approaches in corporate governance that get to the heart of the imbalance of power between shareholders and boards and getting that imbalance embraced by other institutional investors,” says Ferlauto. “Once we identify the company, we don’t let go until it makes the appropriate response.”
