Proxy vote a conflict of interest

By BRUCE SHEPPARD*

At Fletcher Forests' extraordinary meeting last month to consider the Central North Island Forest deal, the chairman, Michael Walls, voted ADRs - American Depository Receipts - under an undirected proxy.

This undirected proxy totalled about 4 per cent of the issued stock of Fletcher Forests. The remaining ADRs (3 per cent) were voted by their holders. This critical 4 per cent could have been the difference between a major transaction being passed by shareholders or not.

In the end the transaction failed, and the fact that Walls voted the stock made no difference to the outcome. So why all the fuss? The issue of ADRs under arrangements such as those elected by Fletcher Forests strikes to the very heart of the debate on corporate governance, and that is why Walls' actions remain an issue for both him and shareholders.

A company creates ADRs as a vehicle to issue stock in the US market and to have that stock quoted and traded on a US exchange. New Zealand companies do this to attract US investment and improve the liquidity of the company's stock, and by implication the share price.

All this, of course, comes at a cost - between US$100,000 and US$500,000 a year in direct and indirect costs, a high price for relatively small New Zealand companies.

The company's shares are held by a depository, which issues the ADRs to the underlying holders. In effect the depository acts as a trustee, and a number of US banks offer this service. Each bank offers different terms, so it is possible to shop around for the terms best fitting management requirements.

Herein lies the first problem. Fletcher Forests' management selected a depository that allowed management to call on the depository to give the company's nominee an undirected proxy in respect of any ADRs not voted by the ultimate holder.

When challenged on this point before the meeting, Fletcher alleged that the depository terms were standard, which is true of that particular bank. However, all banks are different, so this is a rather hollow excuse as Fletcher picked the bank in the first place.

It is clearly the board's role to develop corporate strategy. It is also the board's role, where shareholders are required to vote on that strategy, to present that strategy to shareholders.

Obviously, if the board is backing a particular course of action, it is also appropriate for the board to wholeheartedly advocate the strategy to shareholders, and to attempt to convince them to support the board.

It then becomes the shareholders' responsibility to adopt or reject the strategy presented. This is fundamental to corporate governance.

So when Walls voted "yes" without a specific mandate from the owners of the ADRs, he effectively put himself in a position of advocate and judge, which should have been an obvious conflict to him - after all, he is a lawyer.

So why did he do it?

Walls' argument goes like this: the ADR holders knew or should have known when they bought the instrument that the depository agreement included a power for the company to vote the stock if the owner did not. Given the lengths to which the company went to get the holders to vote, any who chose not to vote would have known that their lack of action would result in a "yes" vote by the company.

In essence, the contract between the depository and company was such that if holders did not vote "no" they were voting "yes", and they should have known that.

This is an example of a neat legal argument to justify less-than-appropriate conduct.

The reality is that most shareholders of public companies do not know the terms of a company's constitution even though it is the basis of their contract with the company.

Clearly the existence of ADRs represents a considerable governance risk to shareholders in companies that issue such instruments. Fortunately not many New Zealand companies are affected.

Below is a summary of those companies that are:

ADRs represent 8.1 per cent of the total Telecom stock on issue. The depository agreement requires that the stock be voted. The company's policy is to vote the ADRs that have not been voted by the owners pro rata with the votes cast at the meeting. The effect is to neutralise the governance issue. Telecom shareholders are therefore not at risk from the effects of the ADRs.

Evergreen and Fisher & Paykel Healthcare also have ADRs on issue, but in both cases they represent less than 1 per cent of the stock. Also, representatives from both companies have stated that they would either not vote ADRs that are not specifically mandated or would vote them pro rata with the votes cast at the meeting. Again, no risks.

Tranz Rail, Fletcher Building and Sky Television have also had ADR programmes, but they are now terminated.

So this is an issue for the shareholders of four New Zealand companies to consider. Three of those companies have a policy that is consistent with appropriate governance practices.

Against this background it makes Fletcher Forests' and Walls' conduct less than convincing.

* Bruce Sheppard is chairman of the Shareholders' Association.

* bruce@gilshep.co.nz

* Brian Gaynor is on holiday