Reading Proxies for Fun and Profit
Normally, the annual meeting of Morgan Stanley follows the company script: Everybody congratulates one another on the wonderfulness of the venerable Wall Street firm, the few shareholders who bother to attend re-elect the directors, the meeting is adjourned, and it's time for lunch. But this spring's meeting was different. An upstart investor advice company with the forgettable name of Glass Lewis & Co. had lambasted Morgan Stanley for excessive executive pay and told its clients, including the powerhouse New York State Common Retirement Fund, to support a proposal limiting future golden parachutes. To Morgan Stanley's shock, it passed with 55 percent of the vote.
From snazzy 33rd-floor headquarters with panoramas of San Francisco, one of the most influential companies you've never heard of provides advice to 155 of the nation's biggest money managers--including eight of the 10 biggest pension funds--who control $11 trillion worth of shares. And it will soon sell advice to individual investors as well.
That growing clout is already generating controversy as some investors and executives complain that Glass Lewis is trying to make its name by unfairly criticizing corporate honchos. And some investor advocates worry that the company may not be living up to its pro-investor tough talk.
Such controversy seemed impossible in January 2003, when attorneys Kevin Cameron, then 34, and Greg Taxin, 33, stood staring at 75 abandoned desks in a converted warehouse they'd just rented on San Francisco's Pier 1. They had to stand. The new office had no chairs.
The two had become friends in 1999. Taxin, a gregarious Californian, was the Goldman Sachs staffer helping San Francisco-based NorthPoint Communications, a money-losing but hot DSL provider, go public. Cameron, a tall, thin, and cerebral-looking Canadian, was NorthPoint's in-house counsel. Within two years, the company, which had reached an analyst-hyped market value of $5.3 billion, had to restate its earnings and then collapsed in bankruptcy.
Taxin and Cameron moved on to other jobs, but as they watched companies like Enron and WorldCom implode, they started brainstorming about starting a business. Perhaps investors would pay for analysis of companies' proxies. After all, most investors threw away those mind-numbingly legalistic annual meeting agendas even though they provide important hints about executive pay and board members' conflicts of interest. Their dream, Taxin said, was that "we could provide help to investors. The world would be better. And we'd be richer for it."
In 2002, the time seemed ripe. The Securities and Exchange Commission was about to require mutual funds to reveal how and why they voted their shares. And some large investors had become unhappy with the only existing provider of proxy advice, Institutional Shareholder Services. By selling advice on corporate governance to companies, ISS risked a potential conflict of interest. (ISS insists that its consulting arm is kept separate.)
Champion. So the duo met with a local venture capitalist. "This was the best business idea I'd seen" in six years of funding start-ups, says Larry Howell. But how would two obscure attorneys get noticed by money managers? Howell said they needed a well-known champion of investors, someone like Lynn Turner. Who? The name of the outspoken former SEC chief accountant meant nothing to Taxin and Cameron.
Nevertheless, when they reached Turner at Colorado State University and described their plan, he was intrigued. After checking their bona fides and extracting guarantees that, as director of research, he'd be free to call 'em as he saw 'em, he quit his safe teaching job and joined the start-up. "Sometimes I question my own sanity. So does my wife," Turner says with a laugh. "There were other opportunities that would have allowed me to make a lot more money. But they did not involve a public interest on behalf of investors. When you look at Enron and see the damage that did: People lost their jobs. People who worked hard all their life and thought they had retirement taken care of all of a sudden have to flip burgers. ... I despise that with a passion."
Next, they needed a company name. Since the founders were unknown, they took parts of the names of two of their heroes, the influential SEC Chairman William O. Douglas (hence, Glass), and Justice Louis D. Brandeis, famous for the quip "Sunlight is said to be the best of disinfectants" (Lewis, their preferred spelling).
As soon as they'd written a few sample analyses of proxies, they made their first sales call: to the nation's biggest activist investor, the California Public Employees Retirement System, or CalPERS. When Ted White, then CalPERS's chief of governance, saw examples of Glass Lewis's proxy reports, he was sold. "They were really good," says White.
Dissing Disney. With stamps of approval from Turner and CalPERS, Glass Lewis's business took off. It didn't hurt that the company soon earned free publicity when Taxin and Turner made harsh comments about some famous executives and directors. In 2004, for example, Glass Lewis called for the ouster of both Disney CEO Michael Eisner and Disney board member George Mitchell. The former Maine senator was "an ill-advised choice" because both he and his law firm had done business with Disney, Taxin charged. While Eisner eventually resigned, Mitchell remains chairman. A company spokesperson dismissed Taxin's comments as publicity-seeking.
To meet booming demand for advice on all sorts of companies, Glass Lewis went on a hiring spree. Now, Glass Lewis has 100 employees, including enough international lawyers, accountants, and investment bankers that the company can provide analysis and voting recommendations on the proxies of 12,000 companies from 65 countries.
And it has branched into investment advice. Turner's forensic accountants mine financial reports, merger documents, and insider-trading filings to find warning signs. In January, for example, Turner's crew noticed subtle accounting maneuvers at SafeNet, a Belcamp, Md., computer encryption firm. Some of SafeNet's recent profits seemed to stem from little more than changes in accounting assumptions. Glass Lewis issued an alert to clients. A few weeks later, SafeNet's stock started to plunge from the low 30s, and the company restated its earnings. In April, the chief financial officer resigned. The company's stock now trades for about $21 a share. The company didn't respond to requests for comment.
In collaboration with executive compensation expert and Harvard law Prof. Lucian Bebchuk, Glass Lewis has also created an index that overweights companies with good corporate governance. The board accountability index generally outperforms the S&P 500 by about a third of a percentage point, Glass Lewis says. Taxin expects the index to be available for investments from large money managers within six months.
Glass Lewis also hopes to sell its advice to small investors. The firm is pushing to create an exchange-traded fund or mutual fund that would allow individuals to bet on the index. In addition, staff members are brainstorming ways to help small investors--who typically throw away proxies--vote their shares.
Some in the investment world worry that getting so big so fast has forced Glass Lewis to become more conservative. Glass Lewis recently backed the election of John Pepper to Disney's board, even though Pepper served on Xerox's auditing committee during the period that the company goosed its earnings using techniques the SEC said were improper. (Xerox settled the charges.)
But Taxin, noting that his company is now being criticized for both being too tough and not tough enough, figures they've struck just the right balance. "If you are seen as too extreme in either direction, you can marginalize yourself." For now, that fate seems unlikely for the budding adviser to the world's investors.
This story appears in the May 22, 2006 print edition of U.S. News & World Report.