SEC CHAIRMAN DONALDSON RESIGNS

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1 QUARTERLY SUMMARY D uring this reporting period, Securities and Exchange Commission (SEC) Chairman Donaldson resigned and Mr. Christopher Cox was nominated as his replacement, shareholder efforts requesting corporations to adopt a majority vote standard for electing boards of directors escalated, and compliance with Section 404 of the Sarbanes-Oxley Act of 2002 became too costly according to corporate America. This issue of the VOLUME 1, ISSUE #6 MARCH 1, 2005 JUNE 30, 2005 SEC CHAIRMAN DONALDSON RESIGNS Corporate Governance Quarterly Review discusses these topics and also contains a report that lists all companies in LACERA s equity portfolio that did not implement majority-approved shareholder proposals after one year. JOn une 1, 2005 William H. Donaldson, Chairman of the SEC, announced that he would step down as Chairman (effective June 30, 2005). On that day he said: Roughly two and one-half years ago, public confidence was severely undermined, reflecting the corporate and financial scandals that had shaken the nation. Thanks to the dedicated efforts of the many professionals who serve at the SEC, this period has represented an extraordinarily active and effective time for the agency. MAJORITY VOTE STANDARD It may well be remembered as the most consequential and productive period in the commission's history since its founding in During his 2 1/2 years as Chairman, institutional investors lauded his accomplishments, continued on pg.2 R eform efforts to use majority voting in U.S. director elections became one of the most significant corporate governance issues of the year. This year, a majority of shareholders at twelve companies (including Altera-59%, Advanced Micro Devices-58% and Raytheon-57%) voted in favor of shareholder resolutions requesting companies to switch from plurality to majority vote as the standard for electing corporate directors. According to most state corporate laws, including Delaware s statutes, a plurality vote is the standard used in the election of the board of directors. Under this system, a board-backed nominee in an uncontested election needs to receive only a single affirmative vote to claim his or her seat in the boardroom. Even if holders of a substantial majority of the votes cast withhold 1 support, the director nominee still wins the seat. 1 The only way (in the current system) to cast your vote against a director nominee is to withhold your vote. Under the majority vote standard, a director nominee must receive support from holders of a majority of the votes cast in order to be elected (or re-elected) to the board. A majority vote standard transforms the director election process from a symbolic gesture to a meaningful voice for shareholders. continued on pg.3 Corporate Governance Committee Lisa Mazzocco, Chair Marsha Richter David Muir Stuart Mesnik, Staff

2 SECTION 404 OF THE SARBANES-OXLEY ACT I ntended to help prevent fraud at public companies, Section 404 of the Sarbanes-Oxley Act requires companies to assess their internal controls over financial reporting. Chief executives and financial officers are required to attest (in writing) that they have in place appropriate internal controls to ensure accurate and reliable financial reporting. Additionally, accounting firms must vouch for those controls and companies must disclose any material weaknesses to investors. Many corporate executives have complained that auditors have driven up the costs of Section 404 compliance by performing massive reviews that aren t necessarily tailored to a company s size or specific risks and by looking at things that have no bearing on the accuracy of a company s financial statements. Studies have estimated the cost to companies at about $3 million a year. 2 As a result of the corporate complaints, the SEC and PCAOB released additional guidance on the implementation of Section 404. Importantly, this guidance was released without suggesting any rollback of its provisions. Both regulatory agencies emphasized the same points: First, certification and auditing of companies internal controls under section 404 have improved confidence in the reliability of financial reporting. Second, 404 audits have cost too much, although both agencies said compliance costs were expected to decline Section 404 audits should be less costly and more useful if auditor and company managers used more judgment and focused more on high-risk items with a high probability of having material effects on financial reports. Appropriately tailored, integrated audits of high-risk activities should lower costs and make the process run more smoothly. 3 SEC CHAIRMAN DONALDSON RESIGNS continued from pg.1 which included the implementation and enforcement of the Sarbanes- Oxley Act, and the creation of the Public Company Accounting Oversight Board (PCAOB). The SEC also adopted rules that required mutual funds to have independent chairpersons, required hedge fund registration, and the trade through rule which required that investor orders to buy or sell stock be filled at the best price, as long as the order can be executed immediately. One major goal that Mr. Donaldson did not accomplish, was the adoption of the proxy access rule allowing shareholders to nominate corporate directors. This was the result of intense opposition from corporations, business groups and lobbyists. Chairman Donaldson s departure has raised some concern that the SEC s corporate governance reforms may stall, or even be rolled back. SEC observers predict that Mr. Christopher Cox, Mr. Donaldson s nominated successor, will take a less regulatory approach to corporate governance. This likely portends a very dramatic shift in the direction of the SEC. You re more likely to see an SEC that the Chamber of Commerce and the Business Roundtable are more comfortable with said Joel Seligman, Dean of the Washington University Law School in St. Louis. In addition, Columbia University Law School Professor, John Coffee said He ll (Mr. Cox) be a formidable chairman, but it will be a major change in direction. 2 Source: Auditors Get Sarbanes-Oxley Rebuke, Wall Street Journal, May 17, Source: Volume 10, Issue No. 16, Council of Institutional Investors Alert, May 19,

3 MAJORITY VOTE STANDARD continued from pg.1 As a result of the reform efforts to switch to a plurality voting system, other companies are now considering the proposed change, while some have formed a working group comprised of 13 major corporations, including Time Warner, Texaco, Chevron, and Intel to consider the issue. In addition, the American Bar Association has established a panel to study state law issues regarding the majority vote for directors. After reviewing the proposed change to the director election process, James E. Heard, the Vice Chairman of Institutional Shareholder Services, wrote the following comments: Requiring directors to win a majority of votes cast would bring a limited measure of accountability to the process of selecting directors. But the attention this issue has attracted also underscores just how little say shareholders in the United States have in deciding who serves on public company boards. The nomination, election and replacement of directors is arguably the single most important power that shareholders have in the governance of public companies. But with nominations controlled by management and the incumbent board, and with the alternative of a proxy contest prohibitively expensive, shareholders have virtually no influence over the selection of their representatives. The inability of shareholders to affect the selection of directors remains a fundamental weakness of the U.S. corporate governance system--a weakness often noted by governance experts in other markets around the world. MAJORITY APPROVED SHAREHOLDER PROPOSALS On August 13, 2003, the Board of Investments adopted a policy to withhold votes from all director nominees of companies that fail to implement majority-approved shareholder proposals (SPs) after one year of inaction. Since that time, companies have implemented a record number of SPs, while investor interest in which companies have not adopted SPs has increased. Staff has continued to monitor this type of activity and has reported the results to your Board after the end of each fiscal year. During Fiscal Year , staff withheld votes from board nominees of 49 companies as result of this policy. The following list is a summary of all 49 companies in LACERA equity portfolio (as of June 30, 2005) that did not implement majority-approved SP s after one year: continued on pg.4 3

4 Shareholder Shareholder Proposals Proposals Receiving a Majority Vote Vote Not Not Implemented After One Year LACERA withheld votes votes from from Board Board nominees of of the following companies: Name of Company Shareholder Proposal Annual Meeting Date Adobe Systems Option Expensing April 28 Allegheny Energy Classified Board May 12 Amgen Option Expensing May 11 Boeing Classified Board May 2 Caterpillar Poison Pill April 13 Citizens Communications Golden Parachutes May 26 Citrix Systems Option Expensing May 5 Corning Golden Parachute April 28 Fortune Brands Poison Pill April 26 General Dynamics Poison Pill May 4 Adobe Systems Option Expensing April 28 Allegheny Energy Classified Board May 12 Amgen Option Expensing May 11 Boeing Classified Board May 2 Caterpillar Poison Pill April 13 Citizens Communications Golden Parachutes May 26 Citrix Systems Option Expensing May 5 Corning Golden Parachute April 28 Fortune Brands Poison Pill April 26 General Dynamics Poison Pill May 4 Gillette Classified Board May 12 Greater Bay Bancorp Classified Board May 31 Hewlett Packard Option Expensing Mar 16 Hilton Hotels Independent Directors May 26 Home Depot Poison Pill May 26 Honeywell International Supermajority Voting April 25 IMS Health Classified Board April 29 Ingersoll-Rand Classified Board June 1 Intel Option Expensing May 18 continued on pg.5 4

5 Shareholder Shareholder Proposals Proposals Receiving a Majority Vote Vote Not Not Implemented After One Year LACERA withheld votes votes from from Board Board nominees of of the following companies: Name of Company Shareholder Proposal Annual Meeting Date International Business Machines Option Expensing April 26 Keyspan Poison Pill May 20 Kimberly-Clark Poison Pill April 28 Kroger Classified Board June 23 Liberty Media Poison Pill June 8 Lucent Technologies Golden Parachute Feb 16 Marathon Oil Golden Parachute April 27 Massey Energy Golden Parachute May 24 MBNA Corp Option Expensing May 2 McGraw-Hill Poison Pill April 27 Mens Wearhouse Independent Directors June 29 Mesa Air Group Poison Pill Feb 8 Morgan Stanley Classified Board Mar 15 Northrop Grumman Classified Board May 17 PerkinElmer Option Expensing April 26 PG&E Poison Pill April 20 Prudential Financial Classified Board June 7 Raytheon Poison Pill May 4 Sempra Energy Classified Board April 5 Siebel Systems Option Expensing June 8 Stanley Works Classified Board April 27 Staples Poison Pill June 13 Texas Instruments Option Expensing April 21 UnitedHealth Group Option Expensing May 3 United Technologies Option Expensing April 13 VF Corp Classified Board April 26 Wells Fargo Option Expensing April 26 Weyerhaeuser Option Expensing April 21 Whole Foods Market Poison Pill April 4 Zimmer Holdings Auditor Ratification May 2 5