Player in the Proxy Wars
HP-Compaq Merger Has Brought a Shareholder-Services Firm Out of Obscurity

By Martha McNeil Hamilton
Washington Post Staff Writer
Monday, April 1, 2002; Page E01

This is the high season at Institutional Shareholder Services in Rockville, where tons of proxy statements and annual reports pour into its mailroom each day. In the corporate offices, the heightened activity manifests itself as a hush, as researchers pore over lists of proposed boards of directors and other issues that stockholders will put to a vote at their annual meetings.

"Go away -- It's the season, and I'm working" reads the sign outside one analyst's cubicle.

A few weeks ago, it was anything but quiet as proponents on both sides of the merger fight between Hewlett-Packard Co. and Compaq Computer Corp. made their way to ISS to argue their cases, each believing that ISS's recommendation to pension funds and mutual funds on how to vote could determine the outcome.

Although the final tally of votes on the bitterly contested merger is not in yet, the vote is believed to be close enough that ISS may well have made the difference, validating its emergence as a player from the normally low-profile world of shareholder activism.

"This, in my experience, was unprecedented," said Ramanathan Kumar, who wrote the merger analysis. "At a certain point, you want people to stop calling you and to stop knocking on the door, so you can write your analysis."

For most of the last decade, ISS has toiled in relative obscurity, but its role has grown along with shareholder activism. Once insulated from all but a few cranky challengers, corporate managements now face a growing number of fund managers who control huge numbers of shares and ask pointed questions about executive decisions, including whether they benefit management at the expense of shareholders.

Once a tiny group of researchers and activists, ISS has grown to employ 290 workers -- and more at the height of shareholder proxy season. Recently relocated into two floors of offices just outside Gaithersburg, the company keeps tabs on more than 20,000 companies here and abroad for about 1,000 clients. And it is expanding globally with offices in London, Tokyo, Manila and Toronto.

Beth Young, a consultant to the AFL-CIO on corporate governance issues, said that the ISS recommendations probably deliver about 20 percent of institutional investor votes in any given contest. "I find their process to be extremely valid," said Young, who has found herself both opposed and supported by ISS on different shareholder solicitations.

"Because of the level of analysis they bring to the process, it improves what everybody is doing," she said. "As a shareholder, it forces me to think more thoroughly through what I am doing, and I think it does the same for management."

ISS, with clients that include large pension and mutual funds, gave Hewlett-Packard's management a major boost March 5 when it recommended a yes vote for the merger. After the vote, Hewlett-Packard Chairman Carly Fiorina declared victory, although the official count is still underway and dissident director Walter B. Hewlett has said he believes the election will be decided by less than 1 percent.

The shareholder-activism movement that led to the creation of ISS can be traced back to the late 1980s and early 1990s, when the Labor Department's Employment Retirement Income Security Act administration, which oversees pension funds, began pressuring pension-fund managers to be more careful how they voted proxies in corporate contests to protect their investors.

ISS was created in 1985 by Robert A.G. Monks, a former ERISA administrator, to inform institutional investors about proxy issues and recommend how to vote. Suddenly called upon to pay attention to proxy issues they had formerly ignored and to vote ballots they might have thrown away in the past, fund managers were looking for help. Monks was joined at ISS in 1986 by Nell Minow, before the two elected to shift their focus to shareholder activism by founding Lens Investment Management.

ISS's services include actually casting votes for clients, but not necessarily dictating how those votes are cast. In some cases the clients elect to follow ISS guidelines about how to vote on issues, but in others, clients supply their own guidelines and the ISS casts votes in accordance.

"We have 157 guidelines established by the mutual fund board," said Valerie Loegering,senior business analyst for American Express Financial Advisors, which has used ISS for about 12 years.

"If something falls outside the guidelines or involves a vote against management, we involve the research analyst who covers the company to guide us on the vote," she said. That was the case in the proposed merger between Hewlett-Packard and Compaq. American Express Financial Advisors voted yes, she said, but more as a function of its own research than of ISS's recommendation.

ISS operates as something close to a monopoly. Although another Washington area organization, the Investor Responsibility Research Center, provides research and analysis, it does not make recommendations on how to vote.

Proxy Monitor Inc., which formerly provided the same services as ISS, was part of an investor group that acquired ISS last year from Thomson Corp. While it is a monopoly for now, there are no barriers to entry to anyone else who wants to compete as a source of proxy recommendations, said Proxy Monitor's chief executive officer, James E. Heard.

This summer ISS is adding a product, the corporate governance quotient. The CGQ will rate how companies are governed by comparing them with their peers -- both by industry and size, said Patrick S. McGurn, vice president and director of corporate programs.

Kumar, now director of U.S. research for ISS, said that the policymaking team at ISS spent hours talking to Fiorina and Compaq chief Michael Capellas and to Hewlett, as well as to investment bankers, analysts and others about the proposed merger. Both sides were impressive, he said.

"While Mr. Hewlett makes a credible case that the risks associated with the transaction are real and material, we believe that management's upside scenario is achievable," the nearly 16 pages of analysis concluded.

Some of ISS's clients followed that recommendation, and others did not, Heard said. Many clients say they use the firm's analysis as just one tool to make up their minds on proxy issues, even in cases where companies pay ISS to cast their votes on most issues.

In major proxy contests, shareholders have backed ISS's recommendation about half the time. The firm has supported both dissidents and management; just before weighing in on Hewlett-Packard and Compaq, it sided with Weyerhaeuser Co. in its longstanding hostile-takeover bid for forest-products rival Willamette Industries Inc.

Minow, who still owns what she calls a "teensy-weensy, like one or two shares of stock," interest in ISS, confessed to feeling a thrill when she woke up one morning a few weeks ago to hear National Public Radio leading its news with a story about ISS's recommendation in the merger between Hewlett-Packard and Compaq. Minow, who has been opposed by ISS on shareholder issues, said she did not agree with ISS on this one, either. But she still felt proud.

So did Monks, whose son Bobby is now chairman of ISS. "I was really proud to death," he said, adding that he was impressed that the top executives of the organization stayed out of the way and let the attention focus on Kumar.

"We had a culture there, and the culture has stayed intact," said founder Monks. "The culture is that there needs to be an expert, honorable proxy advisory firm in which people can have confidence. I have repeated that mantra to myself a couple of times as I was losing the proxy fight" in situations where ISS recommended against his position.

"HP is hardly typical of what we do here," ISS's Heard said. And now the business is settling back to the unglamorous business of wading through proxy statements where nothing more may be at stake than re-electing an unopposed board of directors. (Although, even there, ISS will sometimes recommend a no vote for a director it believes unfit, Heard said.)

In the long run, the public attention will go away, and the work will go on.

"They're only as powerful as their advice," Monks said.