As discussed in this PubCo post, both ISS and Glass Lewis recommended voting against a proposal to ratify the appointment of GE’s auditor, KPMG, at the 2018 GE annual shareholders meeting, a pretty unusual event in itself.  The shareholders meeting was held yesterday, and, in an even more rare occurrence, as reported by the WSJ, 35% of the shareholders did not vote to retain KPMG.  Not exactly token opposition. According to Audit Analytics (reported here), that vote level “represents one of the highest levels of shareholder opposition to an auditor at any company in recent years.”  What‘s a company to do? KPMG signed on to audit GE’s books 109 years ago—as CNN Money points out, that was back when William Howard Taft was president of the United States.

According to Audit Analytics, for the period 2014 through 2016,

“on average, 98% of votes were cast in favor of auditor ratification. The remaining 2% is comprised of votes against auditor ratification (1%) and abstained votes (1%). Similarly, in [Audit Analytics’] last analysis of auditor ratification votes, [it] found that 95 out of 100 times, fewer than 5% of votes were cast against the auditor….There were 8,422 ratification proposals, for example, in which the votes against ratification were between 0% and 1.0% of the total number of votes cast. In all, about 96% of auditor ratification proposals had 5% or less of the votes cast against ratification. On the other hand, just 19 votes (0.2%) had more than 25% of the total votes cast against ratification.”

Activist Insight cites one example “where both proxy advisers apparently recommended a change, at $1.2 billion market cap company [but] only 15% of shareholders voted against the auditor.”

In its analysis justifying its negative recommendation, ISS cited the SEC investigation of GE’s revenue recognition practices and internal controls related to long-term service agreements, as well as a $9.5 billion increase in future policy benefit reserves for the GE’s insurance operations. Nevertheless, ISS observed, KPMG issued unqualified reports on the financial statements throughout those periods. In addition, ISS saw no discussion in the proxy statement regarding how or whether the board took into account KPMG’s role in GE’s two accounting  problems or any other regulatory issues involving KPMG, such as  the charges against former KPMG and PCAOB employees arising out of the leaks by former PCAOB staffers to KPMG regarding the plans for PCAOB inspections of KPMG. (See this PubCo post.) Auditor tenure was also noted as a factor in its recommendation. Glass Lewis indicated that it usually supports management’s choice of  auditor except when GL believes the auditor’s “independence or audit integrity has been compromised.” In its analysis, GL raised the same concerns as ISS regarding the SEC investigation of GE and problems at KPMG, noting in particular the large increase in fees to KPMG in the prior year, as well as its long tenure as GE’s auditor, which has “thrown KPMG’s effectiveness and relationship with the Company into question.”

In the WSJ article, governance experts characterized the level of opposition vote as “extraordinary,” and told the WSJ that “for the (GE) board it’s got to be a rather sobering vote.” As reported, GE said “that its audit committee, which reviews the appointment of the company’s outside auditor each year, ‘will certainly be taking this indication from our shareowners into account.’”

With that level of opposition vote, failure of GE’s audit committee to be “responsive” to the vote of the shareholders could have ramifications beyond the auditors.  Glass Lewis “believes that any time 20% or more of shareholders vote contrary to the recommendation of management, the board should, depending on the issue, demonstrate some level of responsiveness to address the concerns of shareholders…. While the 20% threshold alone will not automatically generate a negative vote recommendation from Glass Lewis on a future proposal (e.g., to recommend against a director nominee, …. etc.), it may be a contributing factor to our recommendation to vote against management’s recommendation in the event we determine that the board did not respond appropriately.” In making vote recommendations for directors, ISS says that “[d]irectors should respond to investor input, such as that expressed through significant opposition to management proposals….”

While the proxy advisors do not specifically address what would be minimally required to be “responsive” in this particular circumstance, presumably it could involve, at least initially, shareholder outreach, disclosure regarding that outreach and the issues that led to the low level of support for the proposal, and disclosure of any actions taken by the board to address these concerns. That may require some creativity on the part of KPMG and the audit committee, assuming the committee chooses, at least  at this point, to continue the KPMG engagement.


Posted by Cydney Posner