It’s not unusual for investors to voice frustration after losing money in a poorly-performing stock. It is out of the ordinary when a board of directors ignores the way those investors vote their shares.
Consider the case of ServiceSource International, which last month failed to receive majority support at its annual meeting for two directors who ran unopposed: Bruce Dunlevie and Thomas Mendoza. As procedure required, the two directors tendered resignations. But rather than accept the resignations, the board prepared a rationalization for why it was keeping the directors.
The company, which announced the decision quietly in an SEC filing rather than a press release, essentially said it believed the two men were highly qualified, citing their experience, knowledge, and industry connections, among other factors.
Indeed Messrs. Dunlevie and Mendoza have some solid credentials. Mr. Dunlevie is a General Partner of Benchmark Capital, a prominent venture capital firm and one of the company’s largest shareholders. Mr. Mendoza, meanwhile, is Vice Chairman of NetApp, one of ServiceSource’s clients.
But the board of directors almost always needs to put shareholders’ will first. “The board is basically saying ‘we are ignoring a majority of shareholders who voted and we will listen to the silent minority,’” says Lawrence Elbaum, Partner at Vinson & Elkins and a corporate governance specialist. “Technically, the board has a fiduciary duty. It can’t think about its own interests. They had to believe the two directors were so valuable it would be a breach of their duty to accept their resignations.”
The company declined to comment through a spokesman while Mr. Dunlevie’s office at Benchmark didn’t respond to a voicemail and NetApp didn’t respond to an email seeking to reach Mr. Mendoza.
What drove so many shareholders to vote against Messrs. Dunlevie and Mendoza? The most likely reason is that both leading proxy advisors, ISS and Glass Lewis, recommended it – and many large investors took their advice.
In its voting recommendation report, ISS said its recommendations against the two directors, who comprise the compensation committee, were warranted given the near failure of last year’s so-called say-on-pay proposal, which lets shareholders weigh in on how much senior executives are paid. “Votes against the company’s say-on-pay and the company’s compensation committee are warranted, in light of the inadequate response to near-failing support for the 2018 say-on-pay proposal. Moreover, the shift from performance-conditioned long-term awards underscores the current pay-for- performance misalignment,” the ISS report said.
Glass Lewis recommended a vote against the two directors for similar reasons. “In our view, the members of the compensation committee have the responsibility of reviewing all aspects of the compensation program for the Company’s executive officers. It appears to us that members of this committee may not be effectively serving shareholders in this regard,” the Glass Lewis report said.
One could argue that Mr. Dunlevie deserves more time to prove himself in his new committee role. After all, he was only named a member of the compensation committee last November.
Glass Lewis, through a spokesman, acknowledged to CorpGov that it had actually considered an endorsement of Mr. Dunlevie because he had been on the compensation committee for a short time (and it left some text to that effect in its report). But its ultimate decision was to recommend a vote against him. “Our report contained erroneous text that contemplated an exception to our policy,” the spokesman said. “We’ve corrected the analysis to remove this errant text, but there were no changes to our voting recommendations. We continue to recommend that shareholders vote against both compensation committee members based on ongoing compensation concerns.”
The company also reshuffled its executive suite at the end of last year, replacing the CEO, CFO, and COO in November and December. That could make for an argument to keep the new executives around for a while to see how they perform.
Bed Bath & Beyond Faced a Similar Experience with a Director who was Forced to Resign
But the shareholders didn’t vote on executives – they voted on directors. And Messrs. Dunlevie and Mendoza joined the board in 2004 and 2011, respectively, after which the company saw its operational and financial performance deteriorate. As Glass Lewis points out, ServiceSource posted an average total shareholder return (TSR) of -38.4% for the three years through 2018 versus 14.9% for its peer group and an average TSR of -33.6% over a five year period versus 11.4% for its peer group.
Ignoring the will of shareholders after such a period of underperformance could draw serious criticism. And the company is no stranger to activism, having seen four activists in the last five years, according to Shark Repellant. Two of those, Viex Capital Advisors and Altai Capital Management, won settlements. The other two, Cannell Capital and Edenbrook Capital, revealed positions recently and remain large shareholders.
Current and former shareholders interviewed by CorpGov suggested that the board of directors may not be aligned properly with investors. In particular, those shareholders said they believed the company may have received indications of interest from prospective buyers when the stock was at far higher levels than it is today. Indeed, the stock peaked above $20 shortly after its 2011 IPO and gradually fell to around $5 in 2016, with shares now trading just above $1.
Those shareholders also said some of the company’s directors, including Mr. Dunlevie, may look at the company like a venture capital investment. That creates a risk of betting on the company’s organic growth strategy over a long time period rather than entertaining potential M&A deals.
When contacted by CorpGov, Carlo Cannell of Cannell Capital declined to comment “for now.” But in a public filing dated April 2, he urged the company to put itself up for sale. “The market values SREV’s enterprise value at 0.83 times trailing 12 month gross profit. This is a very low value and arguably attractive to both financial and strategic buyers who possess a greater distribution platform over which to amortize SREV’s platform and services,” the filing said.
ServiceSource may find its decision to keep the two directors on draws more public criticism – from Cannell, Edenbrook, or yet another fund. “It’s blood in the water for another activist,” Mr. Elbaum said. “Clearly activism hasn’t worked but maybe the right activist just hasn’t come along yet.”
Other companies that recently kept on directors who weren’t supported by a majority of investors have a discouraging track record. Bed Bath & Beyond, for instance, faced a similar situation in 2018 when Victoria Morrison submitted her resignation after failing to win majority support. Like ServiceSource, Bed Bath & Beyond defied shareholders and kept her onboard.
Earlier this year, at the behest of a hedge fund consortium, the company removed several directors including Ms. Morrison.
John Jannarone, Editor-in-Chief