CalSTRS to Challenge Corporate Auditors and Virtual Meetings

The investment committee of the California State Teachers’ Retirement System (CalSTRS) has approved new corporate governance initiatives that will target companies that continue to use the same auditor each year as well as corporations that hold annual meetings virtually without the option of an in-person meeting.

The new initiatives came as the pension plan presented its corporate governance plan for the 2018-2019 fiscal year at a November 7 investment committee meeting. CalSTRS will also continue to focus on its regular playbook, with plans to continue to engage companies over their release of carbon emissions, sustainability practices, pay practices of top management, and the diversity of corporate boards.

The corporate governance investment staff of the $220 billion pension system, the second-largest retirement system in the US, has also issued a draft of a new investment principle, human capital management. The principle will require that companies have a positive culture for employees. What exactly that means is to be firmed up by investment staff over the next few months, with a vote likely by the investment committee on the new rule in April before the start of proxy season.

On the auditor issue, Aeisha Mastagni, a portfolio manager with the CalSTRS corporate governance unit, said CalSTRS investment staff will engage with approximately 40-50 companies with lengthy auditor tenure of 75 years or more. She said issues related to auditor independence, audit reporting, and disclosure will be discussed.

 She told the investment committee that CalSTRS has found that some corporations have used the same auditing firm for 100 years.

“Currently, in the US, companies are not required to periodically rotate their auditors,” CalSTRS investment staff noted in a report also presented to investment committee members. “As a result, many companies have established long relationships with their auditor, some extending for many decades, causing concerns of potential independence issues with the extended relationship.”

Mastagni conceded that part of the issue is a “supply problem,” noting that there are only four major US auditing firms.

The CalSTRS report said in 2014, the European Union adopted a formal law of mandatory auditor firm rotation after 10 years. The law does allow an extension to 20 years if the audit is put out for a formal bid.

CalSTRS may consider a no vote against the reelection of board members if the targeted companies don’t change their auditing practices after engagement, the report said.

On the virtual annual meetings, Mastagni said CalSTRS investment staff has seen an increase in virtual-only meetings. “We just want technology to be used to include shareholders and not as an exclusive mechanism,” she said.

While most virtual meetings are allowing public comment, Mastagni said CalSTRS wants public meetings to be held with shareholders being given the opportunity to be heard in person.

A Harvard University Law School forum on corporate governance and financial regulation reviewed data from proxy advisory firm ISS in May, and identified 127 virtual-only US meetings taking place from January to May 2018, compared to 99 virtual-only meetings during the same period the previous year.

Mastagni said CalSTRS is also developing a formal rule on virtual annual meetings. The rule is also expected to be approved by the investment committee at its April meeting. The rule will lead with a suggestion by investment committee member Dana Dillon, stating that anyone who wants to attend an annual meeting should have the right to do so.

Regarding the human capital management rule, Mastagni called it “a work in progress.”

 “We’ve spent so much time on measuring financial aspects of companies and we don’t have a lot of metrics on the value-add metrics in terms of human capital,” she went on.

Mastagni said that would differ from company to company but said that CalSTRS wants to look at company training, worker safety issues, and how management assures that employees are engaged.

She told the investment committee that CalSTRS will continue to look at other issues as they arise regarding corporate practices in the coming months.

In one highly publicized case, the pension plan took on Facebook in February over its dual-share class voting rights. Those rights give firm founder, CEO and Chairman Mark Zuckerberg control of almost 79% of Facebook Class B shares, which have 10 votes each. Class A shares held by CalSTRS and other institutional investors have one vote each, meaning Zuckerberg has control of the votes of over 50% of the firm’s shares.

Facebook did not change its practices in light of the engagement by CalSTRS and other institutional investors.