Rogue Missives Friday, August 15, 1997

For most of this century, the stereotypical image of the angry shareholder has been that of the crank who shows up at the annual meeting and takes over the microphone to berate management about sins real and imagined (most often imagined). Even as shareholder activism became more respectable in the 1980s, shareholders pushing for change at the corporations they own still exercised power primarily in a negative fashion, which is to say that they mainly told management where not to go by punishing those who erred.

In part, this stemmed from the fact that most shareholders -- whether institutional or individual -- care only about one thing, the short-term stock price, and don't spend much time worrying about how management can boost performance in the long term. But it also stemmed from the sheer difficulty of mounting a campaign to offer a meaningful alternative to the direction taken by a company's current management. Proxy fights for control of boards of directors are long and complex processes, in which the current board seems to hold most of the cards and in which challengers have to contend with the fundamental apathy that many shareholders bring to the voting process. As any number of columns in this space have suggested, protesting a company's direction by selling its shares is much easier than trying to change it from within.

In this respect, the vote taken two weeks ago by shareholders of SALLIE MAE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLM)") else Response.Write("(NYSE: SLM)") end if %>, may someday be looked back upon as a genuine milestone in the history of shareholder activism. For the first time in recent memory, shareholders were given the opportunity to vote on a dramatic change in a company's business model by voting on a dramatic -- which is to say wholesale -- change in a company's board of directors. And for the first time in recent memory, shareholders took that opportunity to throw out the old board and bring in the new. Democracy, rather surprisingly, worked.

At stake in this election was the direction Sallie Mae would take following its privatization. Previously, Sallie Mae was a federally-chartered corporation with one-third of its board made up of presidential appointees. The $47 billion company essentially bought and serviced student loans, and was backed by federal guarantees. Last year, though, at the urging of Sallie Mae itself, Congress passed a law requiring that Sallie Mae either privatize itself by March 1998 or be liquidated. Liquidation was never really an option, and the shareholder vote for privatization passed overwhelmingly. But as an earlier article on Sallie Mae explained, there was no real consensus on what the company should do after privatization.

Sallie Mae's management at the time, led by CEO Laurence Hough, believed the corporation should essentially keep doing what it had been doing, since the business almost guaranteed profits and the risks were very low. A dissident group of shareholders that called itself the Committee to Restore Value (CRV), though, advocated a more aggressive strategy, calling on the company to begin originating loans itself and to consider branching out into other areas, including consulting.

CRV, led by Albert Lord, had actually been able to install eight of its candidates -- including Lord -- on Sallie Mae's board in 1995, and they had been instrumental in implementing certain changes, including the securitizing of loans and a share buyback, that had sent Sallie Mae's share prices rocketing upward. But the presence of the federal appointees meant that CRV could not exercise real control over the company's direction. As a result, the group decided to offer an alternative slate of directors and wage a proxy fight over the company's future.

Alternative slates are remarkably difficult for dissident groups to produce, since most of the people who would make good candidates are not in the business of encouraging shareholder revolts. In addition, coming up with a convincing slate of candidates requires a clear sense of what direction one wants the company to follow, and that is something most protest groups don't really have. It's easy enough to recommend buybacks or other short-term devices, but producing a workable business model is something else entirely. The result is that alternative slates are often made up of less than credible candidates. But CRV's victory may go a long way toward changing that.

CRV was helped en route to victory by the Keystone Kops antics of Sallie Mae's management. When first confronted with the possibility of a proxy challenge, the company came up with a reorganization plan that gave CRV two seats on an 18-seat board, staggered the election of board members -- which makes it more difficult for challengers to gain control of a company -- and, most preposterously, set up a situation where shareholders would have to vote on privatization and the company's board together. In other words, if shareholders wanted to privatize -- as they did -- they would have to do so by installing a management-supported board. If they voted against the board, they would be voting to liquidate the company.

CRV's response was to come up with a plan that called for two votes to be taken, one on privatization and one on the new board, and for directors to be elected all at once, instead of in staggered elections. In May, each side held special meetings, but neither side won a majority of shares outstanding. As a result, the July 31 meeting was called, at which the CRV slate was voted into office.

CRV's proxy fight was expensive, but nowhere near as costly as one might have expected. As Lord told the New York Times, once the July 31 meeting was set, Sallie Mae paid for all of the proxy materials CRV produced. The curious thing about a proxy fight, after all, is that in essence it's a fight over who truly represents the company, and yet it's a fight in which only one side -- management -- has the company's financial backing. It would be as if in a presidential election taxpayers paid only for the incumbent. The further corporations go toward making proxy challenges easier, the better.

CRV benefited not merely from its credible slate of directors, but also from Lord's unrelenting focus and his remarkable ability to stay on message. It seems clear that Sallie Mae's management imagined that its acceptance of some of Lord's proposals -- like the share buybacks -- would mute his criticisms, but if anything it seems that they only emboldened him. Lord was unusual among shareholder activists in that he had an explicit idea about what the company could do to improve not merely its share price but also its bottom line. In that sense, CRV's victory is powerful testimony to the idea that shareholders have a role to play in shaping basic corporate agendas.

The particular machinations among Sallie Mae investors that catapulted CRV to its convincing victory -- CRV's slate received 25.5 million votes, to management's 18 million -- can, obviously enough, not be replicated elsewhere. Institutional Shareholder Services, a consulting firm that reports on proxy fights for hundreds of pension funds and institutional investors, had supported management's plan until a week before the vote, when it issued a report recommending that funds vote for the dissident slate. ISS' s change of heart may very well have been decisive.

It's also possible that had Hough, the company's CEO, not promised that he would step down if the current board was re-elected, management would have won. That seems counterintuitive, except that Hough's promise seemed to expose the nakedness of management's desire to win at all costs, and to suggest that the current board's hostility to Lord was more important to them than the company's future. Even more importantly, it meant that those who voted for the current board were voting for an unknown CEO.

Instead, they voted for Lord, who is Sallie Mae's new chief executive officer. That gives the whole situation something of the air of a palace coup, except that of course this was precisely the opposite of a coup. Indeed, the contrast between the changing of the guard at Sallie Mae and the recent wholesale housecleaning that Steve Jobs did at APPLE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AAPL)") else Response.Write("(Nasdaq: AAPL)") end if %> could not be more striking. Jobs essentially cajoled and strong-armed all but two of Apple's directors into resigning, and then installed a slate of big names, most of whom he was personally connected with.

It's possible, of course, that Jobs' hand-picked board will do great things for Apple. But the way power changed hands there is more reminiscent of the old days of managerialism than it is of anything resembling shareholder democracy. And while Lord's plan for Sallie Mae may backfire -- though it appears sound -- the implications of CRV's victory will not disappear. Given a real choice, shareholders can actually vote for change -- even in a situation when a company's stock has produced tremendous returns, as Sallie Mae's has. Instead of just being driven by short-term price concerns as the media portrays, it seems possible that shareholders may sometimes be driven by a vision for the company. The long term, it seems, is not completely out of sight.

-- Jim Surowiecki (Surowiecki)

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