Pushing that button….. — The bigger picture of the 2013 ClickSoftware proxyPosted: June 12, 2013 | |
As it is the case for all postings in this blog, my standard disclaimers apply for this posting. However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice. Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.
In a previous posting (here,) I wrote about what it, in my opinion, means to be an excellent investor, arguing that being an excellent investors is about being engaged in your investment:
… [B]eing an excellent investor includes more than just allocating money. In its simplest and most direct form it includes voting on proxy matters, including, yes, the firing of members of the Board of Directors (much the same way you would fire your attorney or an employee if you found that he or she did not adequately represent your interest,) …
I touched upon the issue of proxy voting in another posting where I dealt with the subject of how to be a bad investor. In the posting I wrote:
Most investors, by far, including investors with sizable portfolios and institutional investors, are completely passive with their investment, taking no action whatsoever to ensure that their investment in a company is protected except perhaps to pray at night before they turn out the lights.
Yes, institutional investors are, indeed, for the most part passive (I paint with a broad stroke brush here and, of course, exclude the so-called investor activist,) and, yes, in most cases they don’t have a firm idea of what a company that they have invested in is actually doing.
This passivity, which, for reasons that should be obvious, is silly to the extreme, manifests itself consistently throughout the retail shareholder community with even the simplest action of all, to vote in annual proxy events, not being exercised or being exercised haphazzardly. This is puzzling to me since the proxy is the sole vehicle available to shareholders for directly and forcefully impacting upon the company’s decision through voting on issues and determining who gets to manage the company that they have invested in.
I encounter many reasons or excuses for this passivity, but most of them are not valid, and I believe that the real reason why most shareholders are passive with their investments is that they have adopted a view that investments are like lotteries where the most important decision is when to buy in.
Needless to say, investments should not be treated like the lottery. Perhaps trading and speculation, two sides of the same coin, should be, but investment should not be.
Shareholders are owners, but they are a special class of owners in that, ceteris paribus, they can only exercise their ownership through an elected proxy, the Board of Directors, and through a voting process that is infrequent and largely does not involve any real operational issues (for the purposes of this posting, I ignore preemptive rights and other exotic rights that shareholders might have, including the rights to sue under the securities laws.)
Unfortunately, the Board of Directors, which is elected through an infrequent voting process, frequently for a period of service of three years, is in reality often simply a proxy for — or a puppet of — the company’s management team in general and the company’s CEO in particular, and does not truly represent the individual shareholders. Moreover, the process for nominating or recalling a member of the Board of Directors, which, in the interest of corporate governance, should be straightforward and transparent — and certainly should not be controlled by the the Board of Directors, the management team, or the CEO — is effectively constructed in such a way as to secure status quo.
Likewise, the voting process in general, which is mostly available only as part of an annual meeting, is constructed in such a way as to make it difficult for shareholders to influence the company’s management or operations, including, for instance, elaborate processes making it hard for shareholders to raise issues for voting by the shareholders and the effective enabling a company’s Board of Directors, management team, and CEO to exercise far more influence than can the shareholder raising an issue for voting.
As described in a recent study (here) by Lee Harris, an Associate Professor of Law at the University of Memphis Law School. and a J.D. from Yale Law School (with slight reformatting by me) the deck is stacked:
… [S]hareholder-initiated proposals are subject to exclusionary rules that give the board of directors the ability to leave many proposals out of the firm’s proxy statement.
Among other reasons, the board of directors can exclude proposals from the proxy statement if the proposal sponsor fails to strictly adhere to securities regulations, if the proposal violates state law, or, importantly, if the proposal concerns a director election.
Because of this last exclusion, shareholders who want to nominate a candidate for the board of directors cannot use a shareholder proposal as a method of nominating their preferred candidate. Second, binding proposals can be excluded, so the vast majority of proposals are merely recommendations to the incumbent board. If shareholder proposals make it through the thicket of exclusionary rules and into the proxy statement, shareholders have only 500 words to convince other shareholders to vote for each proposal.
Ironically, however, the most importance corporate governance inhibitor is not the hindrances arguably built into the corporate bylaws and applicable corporation laws in order to prevent free and open election of Board of Directors members and free and open voting on issues important to the shareholders. Rather it is the near complete lack of voting or the unintelligent voting by the shareholders that are not insiders, not large institutional holders, and not investor activists.
It has never been clear to me why shareholders, who have very few ways to directly impact upon the management of the company that they own, would not exercise their right to vote or would do so in a haphazard manner. Given that there normally is only one opportunity to vote per year and that votes have what is effectively near perpetual effect (typically Board of Directors members are elected for three years,) it would appear obvious that (1) shareholders should vote and (2) that shareholders should vote with exceptional forethought. And yet most shareholders don’t…..
I was reminded of this fact recently, when ClickSoftware issued its yearly proxy, containing five items that should be voted upon:
- The approval of the appointment of Brightman Almagor Zohar & Co., a member of Deloitte Touche Tohmatsu, as the company’s independent registered public accounting firm.
- The approval of a compensation policy for the company’s directors and officers.
- The re-election of Mr. Menahem Shalgi, as a member of the Board of Directors to hold office for three years.
- The approval of the appointment of Dr. BenBassat as both Chairperson of the Board of Directors and CEO for a period of three years.
- The approval of the grant of options to Dr. BenBassat for the purchase of 90,000 shares of the company.
As I have written about before (here,) ClickSoftware is an Israeli based software company traded on Nasdaq under the ticker symbol CKSW. It has annual revenues is excess of $100 million and strong competitive advantages and is an interesting and intrinsically very valuable company with the potential to greatly grow over the next years, and, generally, I approve greatly of how the company’s management team and Board of Directors moves forward with a long term outlook, rather than a quarter-by-quarter outlook — even when the market disagrees and quarter-after-quarter assigns CKSW a low per share price.
That being said, I do have issues with the approach of ClickSoftware’s management team and Board of Directors on certain issues, primarily when it comes to the company’s issuance of excessive amount of incentive equity to the company employees and the the continued issuance of incentive equity to the company’s CEO. As I wrote in a previous posting:
Year after year, the company has experienced an aggressive dilution rate because of its regular grant of incentive equity to its staff. This dilution is particularly problematic because of the fact that the per share price of CKSW effectively has moved very little since the company’s IPO in June of 2000 — where the company’s equity was priced at $7 per share — in spite of an enormous growth in annual revenues and one of the strongest balance sheets around ….
The sting of this dilution, which I consider almost completely unnecessary given the company’s current revenue level, projections for growth, stability, and excellent compensation (at this stage, the company is hardly extending options as sweat equity or to compensate for any risk,) is aggravated by the company’s consistent issuance of incentive equity to Dr. BenBassat, at a level that effectively has kept him immune from the dilution that he, as the company’s CEO, is the prime mover behind.
My disagreement with the company’s management team and the Board of Directors on these points, however, pales next to the expressions of discontent voiced by shareholders on the Yahoo Finance message board for ClickSoftware (I assume they are shareholders, but, for the record, I don’t really know this to be factually correct and I am open to the possibility that they are simply agitators of some sort.)
Many of these expressions of discontent are based on pure ignorance, many are silly, and some border on defamation of character, but nevertheless it is clear that there is widespread discontent with the share price (and, accordingly, with the performance of the company’s management, Board of Directors, and CEO,) the regular option grants to Dr. BenBassat, and the entrenched nature of the management team, and — oddly — with the age of Dr. BenBassat who is in his mid-sixties.
In light of this discontent — whether or not one agrees with it — it is interesting to note that this year’s proxy offers the discontenting shareholders a strong opportunity to impact upon their company and address at least some of their issues, being provided with (1) the opportunity to terminate a member of the Board of Directors, thereby sending a clear signal to the company’s remaining members of the Board of Directors; (2) the opportunity to deny Dr. BenBassat the options and to reject the company’s compensation plan, thereby sending a clear signal that pay for performance is the name of the game; and (3) the opportunity to split the CEO and Chairperson of the Board of Directors role, thereby reducing Dr. BenBassat’s influence and reducing the company’s dependency on him.
On a side-note, it is interesting that there appears to be very little debate about the election of an auditor (arguably, as we learned from the WorldCom and Enron debacle (and as I saw lately with Unitek Global Services (read about it here), one of the most important decisions in a corporation’s life-cycle, and, so, I would expect the choice of an auditor to be a highly controversial issue) or the proposed compensation plan (which, for reasons that I will not get into here, is a document that is byzantine and obscure-by-design and that sends all the wrong signals to all stakeholders in the company and ought to be struck down before it seriously harms the company.)
If the commentary on the Yahoo Finance message board is indicative of anything, this opportunity is not fully understood by the shareholders of ClickSoftware. Here are two comments from the last weeks that should give the reader a sense of what we are dealing with:
“I will vote against all three proposals. Unfortunately so many investors, especially institutional investors, simply “rubber-stamp” proxies [sic] the chance of derailing these three corrosive ideas is slim.”
“If institutional owners do not get want to get rid of him, we will be stuck with him until he wants to leave.”
Let’s look at the proxy resolutions up for vote and see what could really be done….
The voting process
Although, for sure, the true proxy power lies with the Board of Directors, common shareholders are not without proxy influence and voting validation power. As the company writes in its proxy:
To the extent you would like to state your position with respect to any of proposals described in this proxy statement, in addition to any right you may have under applicable law, pursuant to regulations under the Israeli Companies Law 5759 – 1999 (the “Companies Law”), you may do so by delivery of a notice to the Company’s offices located at 94 Em-Hamoshavot Road, Petach Tikva 49527 Israel, not later than June 10, 2013. Our Board of Directors may respond to your notice.
Following the Meeting, one or more shareholders holding, at the Record Date, at least five percent (5%) of the total voting rights of the Company, which are not held by Controlling Shareholders (as defined hereunder) of the Company, may review the Proxy Cards submitted to the Company at the Company’s offices during business hours.
The first right is essential and allows the shareholders to, among other things, bring any discontent to the attention of the institutional shareholders, with a significant potential for impacting upon the voting results.
The second right is critical, not just as a validation of the legality of the voting process, but also because it provides an insight into what way the company’s common shareholders are truly leaning on the issues at hand.
If, for instance, we look at the proxy voting conducted in 2012, we note that there were several important measures on the ballot, including the re-election of Dr. BenBassat to the Board of Directors and the approval of a grant of 150,000 options to Dr. BenBassat — two measures that would allow the shareholders to directly deny Dr. BenBassat the disputed options and to dramatically reduce Dr. BenBassat’s influence over the Board of Directors of the company and to significantly reduce the company’s dependency on him. However, in a case of unacceptable corporate governance, all we know about the outcome of this voting voting is what the company said in its filing on July 25, 2012, where the following two lines were “crammed” into a quarterly earnings announcement:
ClickSoftware also reported that at its Annual Shareholders Meeting held on June 28, 2012, all items on the agenda as set forth in the proxy statement furnished on Form 6-K with the U.S. Securities and Exchange Commission on May 16, 2012, were approved.
This is as oblique as it is probably possible to be and leaves us with no real understanding of the shareholders sentiment. Was the option grant, for instance, approved by an overwhelming majority or by the thinnest of margins? Did the institutional holders vote?
Personally, I am mystified by something like this. Why, pray tell, would the common shareholders not automatically receive, on each and every voting item, a detailed breakdown of the number of shares cast, abstained, in favor, and against? Is there something to hide?
With respect to the mechanics of the voting, the company clearly lays out the voting rules in the proxy:
…[A] “broker non-vote” occurs on an item when a broker identified as the record holder of shares is not permitted by applicable rules, to vote on that item without instruction from the beneficial owner of the shares and no instruction has been received. For instance, the election of directors is not a “routine” matter for purposes of broker voting. If a shareholder does not instruct the broker how to vote with respect to such item, the broker may not vote with respect to this proposal and those votes will be counted as “broker non-votes.”
The matters described in Proposals 3 to 6 [items 2 through 5 in the list above] are not “routine” matters, and therefore, if a beneficial shareholder does not instruct the broker how to vote with respect to these items, the broker may not vote with respect to these proposals and those votes will be counted as “broker non-votes.”
It should be noted that it is the intention of the persons appointed as proxies in the accompanying proxy to vote “FOR” the other items on the agenda unless specifically instructed to the contrary, or unless they may be determined not to be “routine” matters, in which case, a broker may not vote on such matters without instructions from the shareholder.
Abstentions and broker non-votes will be counted for purposes of determining the presence or absence of a quorum for the transaction of business, but such abstentions and broker non-votes will not be counted for purposes of determining the number of votes cast with respect to the particular proposal.
The affirmative vote of at least a majority of the votes of shareholders present and voting at the Meeting in person or by proxy is required to constitute approval of Proposal 2 [item 1 in the list above.] Proposals 3, 4, 5 and 6 [items 2 through 5 in the list above] are special resolutions which require the affirmative vote of a majority of the shares present, in person or by proxy, and voting on the matter, provided that either (i) at least a majority (and in respect of Proposal 5 [item 4 in the list above,] two thirds) of the voted shares of shareholders who are not Controlling Shareholders and who do not have a personal interest in the resolution are voted in favor of the resolution; or (ii) the total number of shares of shareholders, who are not Controlling Shareholders and who do not have a personal interest in the resolution, voted against the resolution does not exceed two percent (2%) of the outstanding voting power in the Company.
Here is a table with the number of shares held by shareholders holding more than 5% of the company’s outstanding shares and held by its Board of Directors members and executive officers.
Firing a member of the Board of Directors
As mentioned above, some shareholders appear to be concerned about whether the Dr. BenBassat is the right man to lead the company over the coming years, arguing in most cases that running a technology company requires attributes that are rare in an older person.
If the argument that youth beats experience is valid (see here for an example of this -not being true,) then surely a similar argument could be made about Mr. Shalgi, the member of Board of Directors who is up for re-election and who is 62 years old.
Moreover, if the performance of the Board of Directors has been unacceptable, then, surely, firing the members of the Board of Directors is an appropriate thing to do — particularly someone like Mr. Shalgi who appear to not have had an operating job since 2003 (that’s before mobile applications, development of which is a key part of ClickSoftware’s growth strategy, were even thought of,) and since he is part of the Compensation Committee, which recommended — and, I guess, recommend — the award of options to Dr. BenBassat.
To fire Mr. Shalgi is not difficult, it would seem. As the company writes in its proxy:
Under the Israeli Companies Law, the election of the nominee for external director requires the affirmative vote of a majority of ordinary shares present and voting at the Meeting, in person or by proxy, entitled to vote and voting on the matter, provided that either: (i) at least a majority of the shares of shareholders who are not Controlling Shareholders and who do not have a personal interest in the resolution are voted in favor of the election of the external director; or (ii) the total number of the shares of shareholders who are not Controlling Shareholders and who do not have a personal interest in the resolution voted against the election of the external director does not exceed two percent (2%) of the outstanding voting power in the Company.
Given that this is not a routine matter, a simple majority of the voted shares — exclusive of broker votes — are needed to re-elect Mr. Shalgi, and Mr. Shalgi’s own shares cannot be counted as he, arguably, has a personal interest.
Assuming that Mr. Shalgi can get the support and votes of the entire management team, the Board of Directors, and Mr. BenBassat and his wife, he will still be 30%, or so, short of the required 50% if all shareholders vote. In fact, even if he can secure the support and votes of the three largest institutional holders, he will still be 5%, or so, short, if, and only if, all shareholders vote.
And, therein lies the rub. The issue is not the institutional shareholders can be enlisted by the Board of Directors (they can, of course — thinking that they cannot and will not is just plain silly,) but, rather, whether all the common shareholders vote.
Moreover, if just one of the largest institutional holders decides that they don’t like Mr. Shalgi, the situation can quickly turn ugly, which, of course, should make any smaller shareholder wonder what kind of incentives might — hypothetically, of course — be provided to ensure that such a situation does not arise.
Stopping the issuance of options
To stop Dr. BenBassat from getting more options is actually easier than firing Mr. Shalgi. While the resolution to approve the grant of 90,000 options to the Dr. BenBassat is also not a routine matter, and therefore requires a simple majority of the voted shares, exclusive of broker votes, significantly, Dr. BenBassat and his wife’s shares can supposedly not be counted as votes since Dr. BenBassat has a personal interest.
The fact that, as far as I understand it, Dr. BenBassat’s voting shares and the voting shares of his wife — a total of 12.1%, or so, of all the outstanding shares — are eliminated from consideration, significantly increases the burden on Dr. BenBassat. Again, if all shareholders vote, it will be non-trivial for Dr. BenBassat to secure the needed majority to lock in the option grant.
Dismantling the power base
For his critics, the big opportunity to reduce Dr. BenBassats influence came about last year, when Dr. BenBassat ran for reelection as a members of the Board of Directors. Had he failed to achieve the simple majority of the voted shares, his role would, I guess, have been reduced to that of a CEO, reporting to the Board of Directors.
This year Dr. BenBassat’s critics gets a second chance, when they are afforded the opportunity to vote against Dr. BenBassat having a combined role of CEO and Chairperson of the Board of Directors. And believe it or not, achieving a split of these two roles is actually easier than preventing Dr. BenBassat from getting the 90,000 options.
As the company writes in the proxy:
Under the Israeli Companies Law, the approval of this resolution requires the affirmative vote of a majority of ordinary shares present and voting at the Meeting, in person or by proxy, entitled to vote and voting on the matter, provided that either: (i) at least two thirds (⅔) of the shares of shareholders who are not Controlling Shareholders and who do not have a Personal Interest in the resolution are voted in favor of the election of the resolution; or (ii) the total number of the shares of shareholders who are not Controlling Shareholders and who do not have a personal interest in the resolution voted against the resolution does not exceed two percent (2%) of the outstanding voting power in the Company.
So, in this case, not only can Dr. BenBassat and his wife’s shares supposedly not be counted as votes since Dr. BenBassat has a personal interest, but Dr. BenBassat is also faced with the prospect of having to achieve two thirds majority. This is a very high bar and even very shareholder friendly and popular CEOs can have difficulties achieving the required majority (for instance, Monica Iancu, the CEO of MIND CTI — a CEO quite popular among the company’s shareholders — recently failed to secure the required two thirds majority, and, accordingly, had to relinquish the role as Chairperson of the Board of Directors.)
Again, if all shareholders vote, it will be non-trivial for Dr. BenBassat to secure the needed majority to retain the combined role of CEO and Chairperson of the Board of Directors. With 32 million shares outstanding, of which four million shares controlled by Dr. BenBassat do not count, leaving 28 million shares, the resolution would require 21 million affirmative votes — a tall order by any measure.
So what does it mean?
I am not in agreement with the notion that Dr. BenBassat is not suited to be ClickSoftware’s CEO. However, I am in disagreement with the company’s management team’s and the Board of Directors apparently indiscriminate granting of options to Dr. BenBassat and to the company’s employees, and I am most certainly not in favor of the Escherian and unfair compensation plan that has been laid out for the shareholders approval. And, so, I will vote appropriately.
The issue at hand, however, is bigger than that of ClickSoftware and Dr. BenBassat. The general problem is one of corporate governance and inducement to fraud.
If the shareholders do not vote — and vote intelligently, that is — insiders will increasingly solidify their control of the operational and non-operational aspects of the company and will increasingly become entitled and detached from their true responsibility: the protection of the shareholders’ interests.
Moreover, by not voting, shareholders are continuously providing the insiders with increasing degrees of two of the three components of the the fraud triangle: Rationalization and Opportunity. And once you have achieved a critical mass of rationalization and opportunity, the laws of human nature dictates that it is only a question of time before sufficient mass of the last component of the fraud triangle, Pressure, kicks in, and a crime is committed.
Frankly, I find it hard to write about shareholder voting because not voting — or voting heteronomously should never really be an option.
Simply put, the common shareholders do have the power to enforce good corporate governance and to secure that their interests are protect, but only if they exercise their right to vote.
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