Law Office of James Marc Leas

37 Butler Drive

S. Burlington, VT 05403

802 864-1575

December 14, 2000

 

Office of the Chief Counsel, Division of Corporation Finance

Securities and Exchange Commission

450 Fifth Street, NW

Washington, DC 20549

 

Attention: Carolyn Sherman

 

Subject: IBM Stockholder Resolution on Executive Compensation, Transparent Profit Reporting, and Vapor Profit

 

Dear Members of the Office of the Chief Counsel, Division of Corporation Finance:

 

This letter is in response to the  December 4, 2000 letter from Stuart S. Moskowitz, Senior Counsel, IBM Corporation. IBM seeks to omit a proposal submitted by Donald S. Parry, entitled, “IBM Stockholder Resolution on Executive Compensation, Transparent Profit Reporting, and Vapor Profit.” I am a Vermont attorney, and I am representing Mr. Parry. In this letter I will respond to each of the points Mr. Moskowitz made. I will show that IBM has not met its burden under Rule 14a-8(g) to demonstrate that it is entitled to exclude the proposal under either Rule 14a-8(i)(7) or under Rule 14a-8(i)(3) and Rule 14a-9.

 

IBM erroneously states, “the Proposal requests three separate but interrelated items.” The resolution is very clear: only two interrelated items are requested. The proposal exclusively concerns executive incentive compensation: the first item recommends a change in the financial performance required for executive incentive compensation and the second item requests the disclosure of that financial performance. The discussion in the last two paragraphs that IBM characterizes as a third request is actually part of the supporting statement for the new executive incentive compensation and makes no additional request. The resolution begins as follows:

 

Shareholders request that the IBM Board adopt the following policy:

 

Resolved:

 

Thus, proponents request that executive incentive pay be determined by profit from real company operations and that IBM disclose this profit that determines the executive incentive compensation.

 

In support of these interrelated proposals the discussion in the last two paragraphs presents facts and describes the proponent’s beliefs and opinions as to what the pension fund surplus could otherwise be used for, explains why IBM executives are not choosing that alternative, and motivates the two interrelated items in the resolved clause:

 

IBM could be using this pension fund surplus as intended by the trust--to provide for retirees. Inflation has eaten over 33% of retirement pay since the last adjustment in 1990. But IBM is choosing not to use the vast pension fund surplus to adjust for inflation. The reason is that IBM executives have a self-serving purpose contrary to the interest of retirees, stockholders, and the IBM company.

 

Proponents believe executives should not get incentive pay based on FAS 87 profit; stockholders should receive transparent reports of profit from real company operations; and part of pension fund surplus is better used to adjust retiree pay for inflation instead of being hoarded to boost the report of profit based on FAS 87 and to boost executive compensation.

 

IBM is incorrect in its assertion that these paragraphs add a third item to the proposal. Saying how the pension fund surplus could otherwise be used is not the same as proposing that the pension fund surplus be otherwise used. The alternate use for the pension fund surplus provides good reason for stockholders to support the two items in the proposal. IBM’s assertion that there is a third item in the proposal, and that this third item is ordinary business so the proposal as a whole can be omitted should be rejected. IBM cannot make the proposal propose an item it does not propose, then seek to omit the resolution based on this fabricated third item. Thus, the proposal is about nothing but executive incentive compensation and reporting of the financial basis for that compensation.

 

 


I.                 IBM asserts that the proposal should be omitted under rule 14a-8(i)(7) as relating to the company's ordinary business operations

 

IBM bases part of its argument on its assessment of the intent of the proponents in drafting the proposal: “At its heart, the Proposal was drafted to incent the Company to increase payouts to its Company retirees.” Taking a phrase from the proposal out of context, IBM says, “the Proponent ultimately hopes to have IBM ‘using pension fund surplus as intended by the trust--to provide for retirees.’"

 

The three words omitted from the quotation by IBM show a meaning at variance with IBM’s point. The actual text says, “IBM could be using this pension fund surplus as intended by the trust--to provide for retirees.” IBM’s rewrite adding what the proponents ultimately hope distorts the text to conform to IBM’s needs in its argument to exclude the resolution. IBM characterizes the underlying purpose motivating the proponents, and then suggests that since this underlying purpose involves the ordinary business of deciding on adjusting retirement pay, the resolution may be excluded from a vote by the shareholders.

 

Proponents acknowledge that a resolution can be excluded if the proposal as written relates to ordinary business. But the SEC has no rule permitting exclusion based on a judgment of proponent’s intent or ultimate hopes. The SEC rule must be based on the text within the four corners of the document. Even if IBM is right about the proponents hopes, ultimately hoping is not the same as proposing. IBM is asking the SEC to allow IBM to omit the resolution based on what may be in proponent’s hearts instead of based on what the resolution says.

 

Similarly, IBM incorrectly states that proponents are “expressing dissatisfaction with an existing accounting rule promulgated by the Financial Accounting Standards Board ("FASB"), known as SFAS 87, the Company's reporting of pension plan profits thereunder, . . .” However, the actual text of the resolution states the facts:

 

Accounting rule FAS 87 requires IBM to boost the profit report with part of the pension fund surplus--even though no money can be transferred to the company from the irrevocable trust.

 

The resolution does not request that IBM use any other accounting method and does not request reporting of pension plan profits differently. IBM is trying to adjust the resolution to fit the precedent it cites. The proposal and the supporting statement are exclusively about (1) executive incentive compensation being determined by profit from real company operations not including accounting rule profit from pension fund surplus; and (2) the supporting information needed for that change in executive compensation: the profit from real company operations. The proposals IBM wishes were included are not included in the actual stockholder resolution.

 

 

A.                                                  IBM asserts that the disclosure by the company of financial information in its periodic reports, and the compliance by the company with applicable financial accounting standards in effecting such disclosure, both fall within the company’s ordinary business operations under rule 14a-8(i)(7).

 

In its letter IBM correctly recognized two “central considerations underlying the ordinary business exclusion.” However, IBM quoted only part of these considerations in its letter. Omitted portions are equally important. The SEC explained the purpose of the ordinary business exception in Release 34-40018; IC-23200; File No. S7-25-97, “Amendments to Rules on Shareholder Proposals,” Final Rule, under section III. “The Interpretation Of Rule 14a-8(c)(7): The "Ordinary Business" Exclusion. Here is the full text (portions omitted from IBM’s letter are in bold):

The policy underlying the ordinary business exclusion rests on two central considerations. The first relates to the subject matter of the proposal. Certain tasks are so fundamental to management's ability to run a company on a day-to-day basis that they could not, as a practical matter, be subject to direct shareholder oversight. Examples include the management of the workforce, such as the hiring, promotion, and termination of employees, decisions on production quality and quantity, and the retention of suppliers. However, proposals relating to such matters but focusing on sufficiently significant social policy issues (e.g., significant discrimination matters) generally would not be considered to be excludable, because the proposals would transcend the day-to-day business matters and raise policy issues so significant that it would be appropriate for a shareholder vote.

 

The second consideration relates to the degree to which the proposal seeks to "micro-manage" the company by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment. This consideration may come into play in a number of circumstances, such as where the proposal involves intricate detail, or seeks to impose specific time-frames or methods for implementing complex policies.

 

First, the proposal does not deal with the fundamental task types of matters described by the SEC, such as “the management of the workforce, such as the hiring, promotion, and termination of employees, decisions on production quality and quantity, and the retention of suppliers.” IBM does not even argue that the proposal is related to a task that is fundamental to management's ability to run a company on a day-to-day basis. The subject matter of the proposal is executive incentive compensation and reporting of the information on which that compensation is to be based. This proposal is not a task that is so fundamental to management's ability to run a company on a day-to-day basis that it could not, as a practical matter, be subject to direct shareholder oversight.

 

In fact, executive incentive compensation is precisely the kind of subject matter that the SEC has found is subject to direct shareholder oversight. And for the shareholders to do their duty of oversight for the type of executive incentive compensation provided by the resolution they need precisely the information requested in the resolution.

 

IBM also does not argue that the proposal seeks to "micro-manage" the company by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment.  Nor does IBM argue that the proposal involves intricate detail, or seeks to impose specific time-frames or methods for implementing complex policies. Thus, although IBM mentions the SEC’s two central considerations, it presents no argument that the resolution fails either of these considerations.

 

Even if the commission found that a portion of the proposal related to such ordinary business matters, this proposal focuses on a sufficiently significant social and corporate policy issue that it  would not be excludable from a vote. The proposal transcends day-to-day business matters and raises policy issues so significant that it would be appropriate for a shareholder vote.

 

This proposal calls for future executive incentive compensation be determined by profit from real company operations, not including accounting rule profit from pension fund surplus. At present, executive incentive compensation at IBM is based on total profit per share, including accounting rule profit from pension fund surplus. This incents executives to build the pension surplus by cash balance plan conversion that slash pension fund obligation and by avoiding adjustment of retirement pay for inflation.

 

The SEC has already recognized cash balance plan conversion--one of the effects of the present executive incentive compensation system--as a significant social and corporate policy issue.  Earlier this year the SEC decided that the IBM stockholder resolution on Pension and Retirement Medical could not be excluded from a vote because cash balance plans were a significant social policy matter (Attachment A). The SEC staff ruled:

 

We are unable to concur in your view that IBM may exclude the proposal under rule 14a-8(i)(7). That provision permits the omission of a proposal that deals with a matter relating to the ordinary business operations of a registrant. In view of the widespread public debate concerning the conversion from traditional defined benefit pension plans to cash-balance plans and the increasing recognition that this issue raises significant social and corporate policy issues, it is our view that proposals relating to the conversion from traditional defined benefit pension plans to cash-balance plan cannot be considered matters relating to a registrant’s ordinary business operations. Accordingly, we do not believe that IBM may omit the proposal from its proxy materials in reliance on rule 14a-8(i)(7).

 

Companies, like IBM, are converting to cash balance plans to reduce obligation to employees so as to boost the surplus in the pension fund. Under accounting rule FAS 87 the companies are then required to increase their profit report. This boost in the profit report helps executives meet their incentive pay target because incentive pay is currently tied to the total profit, including accounting rule profit from pension fund surplus.

 

The present resolution focuses on fixing that executive incentive compensation scheme so that executives derive incentive from profit from real company operations, not including accounting rule profit from pension fund surplus. This change would better align executive interest with stockholder interest. The resolution focuses on the executive compensation issue underlying the cash balance plan conversion issue that the SEC has already decided is a major social and corporate policy issue.

 

Although IBM recognizes the two central considerations underlying the ordinary business exception provided in the SEC guidance, IBM’s letter never addresses either of these considerations. It immediately diverges from these central considerations, and never shows how the present resolution meets either consideration. IBM states that “the portion of the Proposal seeking ‘transparent financial reporting of profit from real company operations’ can, to the extent it is understood, be read to require the Company to effectuate disclosures which differ from the disclosures required by existing laws, regulations and applicable financial accounting standards.” IBM also hinges its case on the resolution “taking issue with the company’s compliance with SFAS 87."

 

However, proponents would ask the staff to consider that the resolution does not request any different reporting than is required by financial accounting standards cited by IBM. Those standards relate to income from the pension fund. The present resolution does quite the opposite. It requests information about income from real company operations not including accounting rule profit from pension fund surplus. Thus, it requests precisely the information not covered by FAS 87. The resolution requests that the executive incentive compensation be determined by profit from real company operations not including accounting rule profit from pension fund surplus. It also requests that the company provide the income information from real company operations to back up this executive incentive compensation. This does not conflict in any way with FAS 87 reporting requirements or add to the requirements for reporting on pension income. FAS 87 has to do with the reporting of the information not wanted by the resolution. In fact, the present resolution relies on information about profit from the pension fund provided by FAS 87 so the amount can be subtracted. Thus, IBM can fully meet the requirements of FAS 87 and also provide the backup information on profit from real company operations to support the executive incentive compensation proposed in the resolution by simply subtracting the FAS 87 result in footnote W from the ordinary company profit report.

 

IBM cites Johnson Controls and Boeing, but the present case is distinguished since neither Johnson Controls nor Boeing resolutions appear to be executive compensation proposals, and the information requested in each of those resolutions was not back up information for a new executive compensation proposal. IBM makes much of the fact that it adheres to standards and is audited, but the proposal makes no request related to adherence to standards or to auditing. The resolution does not ask for a change in accounting methods or associated disclosures, as IBM’s letter maintains. The resolution is about executive incentive compensation and reporting related to that compensation. IBM mis-characterizes the subject matter of the present proposal in order to have an easier target to knock out under the ordinary business exception. IBM states:

 

The instant Proposal questioning IBM's pension plan disclosure relates to the same type of ordinary business matters as the proposals in Boeing, Johnson Controls, Traveller's and LTV Corp. - the choice of accounting standards by a registrant and the disclosures required through the utilization of such standards. Moreover, since the subject matter of the instant Proposal--our accounting for pensions under the applicable FASB standards--was specifically found earlier this year to involve a matter of ordinary business, and was therefore excluded in Boeing, it should similarly be so found and omitted here under Rule 14a-S(i)(7).

 

The present proposal is about executive incentive compensation and the reporting needed to back up the incentive pay given to executives under that proposal. It is not questioning IBM’s pension disclosure. The subject matter is not IBM’s accounting for pensions under the applicable FASB standards. The mis-characterization of the resolution demonstrates the weakness of IBM’s argument.

 

The present resolution is also distinguished from the GE proposal. IBM states, “specifically, the stockholder asked that GE (i) discontinue an accounting technique. . .” IBM further states that “in its no-action letter request, the registrant specifically argued that the proposal expressly related to the accounting principle used by GE for reporting the financial effect of the Company's principal pension plans on operations.” Since the present resolution is not asking the company to discontinue or otherwise change any accounting technique and since the present proposal does not relate to an accounting principle used at IBM, it is clearly distinguished from the GE proposal. IBM hinges its argument in bold type on the staff ruling: “the staff noted ‘in particular that a portion of the proposal relates to ordinary business operations (i.e., choice of accounting methods).’” (bold in IBM’s letter). Since the present resolution does not relate to choice of accounting methods, the GE no action letter does not help IBM.

 

The remaining cases cited by IBM also involve proposals related to accounting and financial statements, not to proposals related to executive incentive compensation. IBM is raising a straw man and knocking it down. But its argument and case citations have nothing to do with the present proposal.

 

IBM confuses the resolution with very different prior case resolutions. But this resolution is not about pension plan disclosure, as IBM asserts. Nor is it about IBM’s compliance with or adherence to applicable accounting standards, as IBM further asserts. The resolution is about basing executive incentive compensation on profit from real company operations and reporting that profit from real company operations so the stockholders can see the basis on which that incentive compensation is being paid. The reporting is needed to support the proposed executive compensation.  IBM reliance on prior cases, including Johnson Controls and Boeing, is therefore misplaced. None of the prior cases IBM cites have a pure executive compensation proposal with only reporting required to support the proposed executive compensation.

 

 

A.                                                  IBM asserts that seeking an increase in the pensions of IBM retirees relates to the company’s ordinary business operations.

 

Here IBM relies on its assertion that there is “a third part of the proposal,” and that this third part is “seeking an increase in the pensions of IBM retirees.” However, as shown above, there are only two parts to the proposal. Nowhere does the proposal seek an increase in pensions of IBM retirees. In this section of its letter IBM writes:

. . .the Proposal's suggestion that the Company utilize the pension plan surplus "to adjust retiree pay for inflation" clearly implicates no more than an excludable ordinary business matter under Rule 14a-8(i)(7).

 

The full paragraph of the supporting statement proposal states:

 

IBM could be using this pension fund surplus as intended by the trust--to provide for retirees. Inflation has eaten over 33% of retirement pay since the last adjustment in 1990. But IBM is choosing not to use the vast pension fund surplus to adjust for inflation. The reason is that IBM executives have a self-serving purpose contrary to the interest of retirees, stockholders, and the IBM company.

 

The paragraph begins with the available alternative that IBM is choosing not to select, to use the surplus to provide for retirees. The phrase in context is in a sentence describing what IBM is choosing not to do. No request is made. No action is proposed. The phrase is part of a factual statement concerning what IBM is choosing not to do. IBM had to add different words in front of that phrase so as to portray the phrase as a proposal for IBM action instead of providing a factual description of what IBM is choosing not to do. Then IBM argued that a proposal for the proposed action IBM itself wrote in to the proposal is excludable under the ordinary business exception. This is an illogical argument. Proponents respectfully request that the SEC reject this argument. Proponents would ask the SEC to consider that the fact that IBM resorted to this argument provides clear demonstration that IBM lacks good reason for excluding the resolution and has not met its burden under Rule 14a-8(g).

 

 

A.                                                  IBM asserts that where part of a proposal implicates ordinary business matters, the entire proposal must be omitted under rule 14a-8(i)(7).

 

IBM acknowledges that one item in the proposal addresses executive incentive compensation.  IBM writes:

 

The fact that one portion of this Proposal addresses executive incentive compensation calculations simply cannot carry the day and avoid the exclusion of the entire Proposal under Rule 14a-8(i)(7).

 

Thus, IBM recognizes that this item by itself is not excludable.

 

IBM compartmentalizes the two items in the proposal so the second item can be attacked individually. It attacks the second item as if it is not integral and needed for the first item. IBM fails to recognize that provision for executive pay determined by profit from real company operations requires disclosure of the performance on which the executive incentive pay is based. Instead, although IBM’s letter early on admits the interrelationship of the items (page 1 second paragraph, first line), IBM’s argument views the profit reporting request as if it is totally unrelated to the executive compensation request, and in a separate compartment.

 

IBM acknowledges that it is at least arguable that “the first part of the instant proposal–seeking to have the Company alter the way in which it calculates executive incentive compensation–falls outside the ambit of the ordinary business exception.” If a proposal for executive compensation based on profit from real company operations can fall outside the ambit of the ordinary business exception and can be placed before the stockholders for a vote, then a proposal which further requests disclosure of that profit from real company operations on which that executive compensation is to based must also fall outside that ambit and be included for a vote.

 

The report of the profit on which the executive compensation is to be based is needed for the executive compensation proposal to be meaningful. What is the point of paying executives for performance if the performance is to be hidden from the stockholders? Paying for something is inextricably linked with getting it and verifying it. If the company is to pay executives incentive pay for profit based on real company operations, the stockholders should have the information underlying the incentive payment. How else can they provide the oversight function described by the SEC in the section of the SEC final rule quoted on page 3 above? Thus, the proposal to disclose the profit from real company operation is necessary and fundamentally interrelated with the non-excludable proposal to provide executive incentive compensation based on profit from real company operation.

 

IBM’s argument hinges on its assertion that (1) a proposal addressing executive incentive compensation is insufficient to avoid exclusion if there is any trace of ordinary business content in the resolution; and (2) the present proposal includes ordinary business content. However, in order to find a trace of ordinary business content, IBM had to compartmentalize out the reporting item from the executive compensation item, add a third item to the proposal it found in the supporting statement, rewrite and alter the clear meaning of the supporting statement to find that third item, and look to the intent and ultimate hopes of the proponents. Although IBM was able to find many examples of ordinary business content in the many other resolutions that it cites, IBM did not find any ordinary business content within the four corners of the present resolution as it is actually written. Proponents therefore respectfully ask the staff to reject IBM’s request to exclude the resolution based on there being ordinary business content.

 

 


I.                 IBM asserts that the proposal should be omitted from the company's proxy materials under rules 14a-s(i)(3) and 14a-9, as vague and indefinite as well as false and misleading to the company's shareholders as well as the company.

 

IBM raises thirteen issues that it says are either vague and indefinite or false and misleading. IBM is wrong on all thirteen issues.

 

1. IBM asks, “what does profit from real company operations mean? What is real?” This term is not defined, nor is it in any way clear. Would income from patent licensing qualify as real? How about income from litigation settlements, or income from sales of equity investments or other assets?

 

Proponents believe the definition is in the proposal, which states, “Future executive incentive compensation be determined by profit from real company operations not including accounting rule profit from pension fund surplus.” Thus, accounting rule profit from pension fund surplus must be excluded. Real company operations involve operations that generate real money for the company. The surplus in the pension fund remains entirely in the pension fund; none of it ever gets transferred to the company. Thus, profit from real company operations is profit from company operations not including accounting rule profit from pension fund surplus because, as the supporting statement explains, that is money that cannot be transferred to the company and it is money the company can report but cannot touch. 

 

On the other hand, patent licensing involves real money coming in to the company. Same for litigation settlements or income from sales of investments or other assets. These are included in profit from real company operations since they are not accounting rule profit from pension fund surplus and money is indeed transferred to the company.

 

2. IBM also states:

 

This first part of the Proposal also goes on to state that the Company not include accounting rule profit from pension plan surplus. How would the Proponent have this concept implemented in years where there was no pension plan surplus; or in years where there was a deficit? Would the Company be able to deduct losses from pension plan deficits in years in which the plan suffered a deficit?

 

The proposal states, “future executive incentive compensation be determined by profit from real company operations not including accounting rule profit from pension fund surplus.” There is one exclusion, and that exclusion is clearly stated. When there is no surplus there is nothing to not include. Since a deficit is not a surplus, the resolution does not change the way a deficit is treated. Only accounting rule profit from pension fund surpluses are not to be included, as stated in the resolution. The answers to these questions are clear from the face of the proposal. There is nothing vague and indefinite.

 

3. IBM states:

 

Confusion continues in the Proponent's second request for IBM to provide "transparent" financial reporting from real company operations. What does "transparent" mean? Is the Proponent suggesting we flout or otherwise abandon compliance with SFAS 87 and SFAS 132, detailed financial accounting standards, in favor of something which is wholly undefined? What may be "transparent" to one person may not be to another.

Transparent is defined in the resolution itself as “profit from real company operations.” Profit from real company operations was defined in the resolution as profit “not including accounting rule profit from pension fund surplus.” Thus, under the stockholder resolution, transparent financial reporting is reporting the profit on which the executive compensation is to be based. Transparent financial reporting is reporting company profit not including accounting rule profit from pension fund surplus.

 

There is no need to flout or otherwise abandon compliance with SFAS 87 and SFAS 132, detailed financial accounting standards, in favor of something which is wholly undefined, as IBM asserts. In fact those accounting standards would be the precise standards used to calculate the amount not to be included in the profit for determining executive incentive compensation under the proposal. The proposal is wholly consistent with present financial accounting and reporting standards, and depends on retaining and using those standards.

 

4. IBM states

 

Confusion also abounds throughout the Proponent's description of SFAS 87. The entire second paragraph following the Resolved section of the Proposal is false and misleading and should be omitted. The Proponent starts off with a statement falsely intimating that IBM has the discretion to manipulate its profits under SFAS 87.

 

The second paragraph following the Resolved section states:

 

Accounting rule FAS 87 requires IBM to boost the profit report with part of the pension fund surplus--even though no money can be transferred to the company from the irrevocable trust. IBM boosted its 1999 profit report by $762 million or 11% with FAS 87. 31% of IBM's year over year growth in pretax profit (excluding one time events) and 42% of after tax profit came from growth in this accounting rule profit. This is a "vapor profit" -- money the company can report but cannot touch.

 

The proposal actually starts off with a statement that IBM has no discretion. It says that “Accounting rule FAS 87 requires IBM” to boost the profit report. The word “requires” is the opposite of discretion. IBM’s letter misreads the resolution.

 

5. IBM’s letter states:

 

By stating that IBM "boosted its 1999 profit" with SFAS 87, the Proponent is intimating, falsely, that IBM is acting in a manipulative manner. Nothing can be further from the truth. IBM is not "boosting" anything. IBM is complying with the terms of a well established financial accounting and reporting standard. IBM is not acting in derogation of any such standard.

IBM did increase its 1999 profit report with SFAS 87. IBM appears to believe that the word “boost” intimates manipulative behaviour. However, boost was used twice in this paragraph. In the context of this paragraph where the word boost was previously used to describe what accounting rule FAS 87 requires, IBM’s interpretation that there is a suggestion of manipulation is untenable. Furthermore, Merriam Webster’s Collegiate Dictionary, tenth edition, 1993 (Attachment B) has the following definitions of the verb boost: 1: to push or shove up from below  2: increase raise 3: to promote the cause or interests of 4: to raise the voltage of or across (an electric circuit) 5 slang: steal, shoplift. There is no intimation of manipulative behaviour in any of the relevant definitions. Thus, there is no basis for IBM’s assertion that the resolution intimates that IBM is acting in a manipulative manner from the use of the word “boost”.

 

6. IBM states:

 

Moreover, the use of the term "vapor profit" in the Proposal is also vague, indefinite and inflammatory, and should be omitted. We reject the Proponent's attempt to use this term to factually characterize pension plan profits, as such term appears nowhere in any accepted accounting literature.

 

The term vapor profit is used four times in the resolution. The first time is in the second paragraph after the resolved section. It is defined this first time: “This is a ‘vapor profit’ -- money the company can report but cannot touch.” This idea is first introduced earlier in the paragraph, “Accounting rule FAS 87 requires IBM to boost the profit report with part of the pension fund surplus--even though no money can be transferred to the company from the irrevocable trust.”  No money is transferred to the company from the pension fund. Accounting rule FAS 87 requires that additional profit be reported based on surplus in the pension fund, however.  IBM uses FAS 87 to calculate the magnitude of this adder to the report of profit and IBM reports this adder in footnote W of its annual report. The term “vapor profit” describes the increase in profit that is based on this accounting rule where no actual money is transferred to the company. It is legitimate for proponents to define and use a relatively new word in a stockholder resolution. IBM says that the term is vague, indefinite or inflammatory but IBM has not shown how it is so. It has just as clear a meaning as the parallel term, “vaporware” commonly used in the software industry to describe software that has been announced but does not actually exist. Here the profit reported is money that belongs to the pension fund; it is not money in the hands of the company. Providing a name for this form of profit is legitimate. It is not vague, indefinite, or inflammatory.

 

7. IBM states:

 

Furthermore, the Proponent's quote from Business Week (4/24/00), stating that "IBM was 'padding the profits'" in the third paragraph following the items in the "Resolved" section, is clearly misleading on its face and should be omitted. The article in question dealt with corporate pension plan profits and their effect on income, but nowhere in the text of the article was IBM singularly called out for any wrongdoing, as suggested here. In fact, IBM was found only in one place--in a table listing l0 corporations with pension plan income.

 

IBM omits mentioning that the table listing 10 corporations has a headline that states: “Pension funds are throwing off income that’s padding the profits of some big companies–and will continue to do so for years to come” (Attachment C) Thus the table in the Business Week article has IBM and nine other companies “padding the profits” with pension fund money.

 

8. IBM says:

 

The Proponent goes on to misquote a snippet from a New York Times article (6/4/00) in a manner which is false and misleading. In addition to the fact that the text of the snippet was selectively misquoted by the Proponent, the actual quote was attributable not to the New York Times, as stated by the Proponent, but rather to a consultant. Hence, the entire snippet should be omitted as both false and misleading.

 

The entire snippet in the resolution states: “A New York Times (6/4/00) article said "obfuscation is the name of the game" at IBM.”

 

The entire segment from the New York Times article is as follows:

 

To be sure, I.B.M. is just one of many companies that continues to bury details about its plans’ gains. But Big Blue could be clearer. Though still in a footnote, General Electric was much more direct, for example. G.E.’s report made it obvious at a glance how much pension income contributed to operations.

 

“I.B.M.’s annual report is one of the most complicated,” said Brad Perry, former chairman and now consultant at David L. Babson & Company, an investment advisory firm in Cambridge, Mass. “Obfuscation is the name of the game, not just for I.B.M. but for a lot of companies.” (Attachment D)

 

The proposal accurately captures the quote about IBM in the article in the New York Times. It is widely understood that a quote from a newspaper is not identifying the paper as speaking but the reporter or a source speaking to the reporter. There is nothing false or misleading about the quote or the attribution, and the date given in the resolution makes it easy to find the whole article.

 

9. IBM states:

 

The entire next paragraph, beginning with the confusing and meaningless term "vapor profit" should also be omitted. In that paragraph, the Proponent also baldly asserts, without any foundation whatsoever, that the Company was involved in "other manipulations" in order to reach a profit target. Not only is this allegation wholly unsubstantiated, it borders on the libelous.

 

First, vapor profit is neither confusing nor meaningless. It was clearly defined and illustrated by example in the resolution, as described above. Second the “other manipulations” are clearly described in the cover story in Fortune Magazine article (Attachment E), and in the New York Times article mentioned in the paragraph above. They are therefore well known to many stockholders. One of these reported manipulations is stock buybacks. As described in the New York Times article:

 

Another area of I.B.M.’s financial report that is difficult to fathom concerns stock buybacks, which have totalled $14.2 billion in the past two years. By reducing the number of shares outstanding, the buybacks have helped I.B.M.’s per share earnings grow at a respectable 10.5 percent–masking the company’s slow growth in revenue and income, Mr. Perry said. (Attachment D)

 

IBM’s reports acknowledge that stock buybacks increase per share earnings without increasing company profit. Increasing per share earnings helps executives reach their per share profit target. The buybacks are a lever management controls to increase per share earnings and reach their per-share profit target for their incentive pay.

 

Similarly, by selling corporate assets, the company can increase the profit report, as happened at IBM in 1999 when IBM sold the Global Network to ATT. Share buybacks and selling assets were both described in the annual report and they were described and discussed in detail in the Fortune Magazine article where they were characterized as “hocus-pocus,” “tricks,” and “maneuvers.” This cover story in Fortune made IBM’s manipulations widely known.

 

10. IBM says:

 

In this connection, proponent is falsely implying some sort of illicit activity in suggesting that the company's five top executives "took $15 million cash plus $8 million in stock-equivalent as incentive pay." In addition to the fact that the Proponent does not explain the source of these figures, our executives lawfully earned the compensation reported in the proxy statement. For these reasons, this entire paragraph should be omitted under Rule 14a-8(i)(3) and Rule 14a-9.

 

The source of the figures is the proxy booklet IBM mailed to all stockholders before the meeting in April of this year. IBM is incorrect that the word “took” implies some sort of illicit activity. “Took” is the past tense of “take,” and the dictionary once again does not support IBM’s position. Because there are so many definitions of “take,” the page from the dictionary is attached. (Attachment F).

 

Furthermore, it is the opinion of proponents of the resolution that executives did not in fact earn the portion of the incentive pay related to accounting rule profit from pension fund surplus;[1] the proponents want executive incentive compensation to be based on profits from real company operations. The FAS 87 accounting rule profit does not involve actual dollars coming in to the company. All those dollars remain in the pension trust fund. It is the opinion of the proponents that executives do not earn money for the company if that money remains in a separate pension trust fund, and executives should not get incentive pay for a report of profit –vapor profit–that is not actually transferred in to the company.

 

11. IBM states:

 

The next paragraph suffers from the same infirmities and irresponsible hyperbole. It is wholly false and misleading to suggest that the top executives are spending time on "self-serving manipulations." The Proponent erroneously asserts that the top executives both have a hand in manipulating the pension plan investments (which would give rise to income), and that such same executives determine the basis for their own incentive compensation arrangements. In fact, both of these statements are utterly false and misleading. Pension fund investments are effected on a daily basis by independent investment managers, who act as fiduciaries strictly in accordance with the terms of the Employment Retirement Income Security Act of 1974 (ERISA). Further, compensation for the Company's senior executives is determined by the Executive Compensation and Management Resources Committee of the Board of Directors.

 

The paragraph in the stockholder resolution states:

 

Stockholders are at risk that the market eventually discounts FAS 87 accounting rule profit and then discounts IBM's stock price. Stockholders lose when real company money is paid out to executives based in part on vapor profit the company never gets. Everyone loses when top executives spend time on self serving manipulations instead of focusing on building real company operations.

 

Pension fund surplus increased both as a result of rising stock prices and as a result of executives spending time on self-serving manipulations. One of those manipulations was the cash balance plan conversion implemented in 1999. A huge amount of management time went into that manipulation of the surplus in the pension trust fund. Billions of dollars of anticipated obligation to employees when they are old and most in need was eliminated when IBM converted about 110,000 employees to the cash balance plan. Reducing the obligation boosted the surplus in the pension fund. That increased the report of profit under FAS 87. And that helped executives reach their profit target and get their incentive pay. Employees and stockholders both lost from that manipulation, as described in the present stockholder resolution. IBM does not have a good argument against this point and wishes to have the resolution omitted from the proxy booklet not because it is false but because it is true. IBM omits mention of the cash balance plan conversion and focuses exclusively on the independent fund managers who manage the $73 billion portfolio in the pension trust fund. But IBM admits in recent quarterly filings with the SEC that the cash balance plan conversion did indeed boost the profit report under FAS 87. The cash balance plan conversion was a self-serving manipulation by executives to boost the profit report and their own executive incentive compensation.

 

12. IBM states:

 

For the same reasons, the Proposal's penultimate paragraph is also defective on its face. It states falsely that "IBM executives have a self-serving purpose contrary to the interest of retirees, stockholders and the IBM company." In addition to being untrue, there is no basis for the Proponent to suggest, again, that the Company's top executives are guilty of manipulating the pension plan to their own advantage. As explained above, these executives do not determine the specific investments made by the pension plan nor do they set the terms of their own incentive compensation. The paragraph should therefore be omitted in its entirety.

 

The cash balance plan conversion and the failure to provide cost of living adjustment to retirees for more than ten years are manipulations of the pension plan by top executives to their own advantage as explained above. While executives do not determine specific investments made by the pension fund, they did determine a part of the current $17 billion pension trust fund surplus by slashing retirement pay with the cash balance plan conversion and by not providing cost of living adjustment to retirees.

 

13. IBM states:

 

The final paragraph, which restates the three interrelated pieces of the Proposal, is itself false and misleading to the extent it again falsely suggests untoward actions by the Company's executives to "boost" profit under SFAS 87, as well as their own compensation.

 

Earlier this year the SEC ruled that the cash balance plan conversion at IBM raises significant social and corporate policy issues that permitted a resolution focusing on the cash balance plan conversion to be included in the proxy for a vote. That cash balance plan conversion was an action by company executives. It did boost the surplus in the pension fund, and that boosted profit under SFAS 87, which helped executives reach their profit target and take their millions of incentive pay dollars out of the company for themselves. Although IBM disputed many facts in the resolution it has not disputed these facts.

None of the cases IBM cites helps it overcome the deficiencies of its arguments. IBM has not met its burden and therefore its request should be rejected.

 

Significant Social and Corporate Policy Issue

 

The resolution proposes determining executive incentive compensation on profit from real company operations not including accounting rule profit from pension fund surplus. It also proposes that IBM report the precise information on which that executive compensation is to be based. The resolution seeks to align executive compensation incentives with the interest of the shareholders in the actual financial performance of the IBM company, undistorted by the required report of income from surplus in the pension fund.

 

The present executive compensation scheme in which incentive pay is determined in part on pension fund surplus distorts the incentive from the interest of stockholders.

 

It also underlies a major social and corporate policy issue that is affecting hundreds of American companies and millions of American workers. IBM and many other companies are angering their present employees and impoverishing their former workers when they are old and most in need to increase the surpluses in their pension funds, so as to increase the report of profit under FAS 87, so as to increase executive incentive compensation based on that report of profit.

 

Under the present executive incentive compensation scheme, executives are just as incented to increase pension fund surplus as to sell more products. Vapor profit from pension fund surplus is attractive since it can be obtained without investment in plant and equipment, without hiring employees, without marketing product, and without paying taxes. The resolution seeks to determine executive incentive compensation on real company financial performance.

 

The SEC staff already decided earlier this year that IBM’s cash balance plan conversion was a significant social and corporate policy issue. The present executive incentive compensation scheme incents cash balance plan conversions. The present resolution addresses this significant social and corporate policy issue by removing the incentive.

 

 

Conclusion

 

The resolution concerns a change in executive incentive compensation and the information needed to support that change. Please let the stockholders decide. This will help the stockholders restore IBM to practices that made it one of the most successful and most copied companies in the world.

 

If the SEC staff has any questions or concerns please do not hesitate to call. Thank you very much for your attention to this matter.

 

 

                                                                                          Sincerely,

 

 

                                                                                          James Marc Leas, Esq.

 

 

cc    Mr. Stuart S. Moskowitz, IBM Senior Counsel

Donald S. Parry, lead proponent

 

Attachments

A     SEC decision on IBM Stockholder Resolution on Pension and Retirement Medical, 2000.

B     Merriam Webster’s Collegiate Dictionary, tenth edition, 1993, “boost”

C     Business Week article (4/24/00), “The Perils of Fat Pension Plans, Investors beware, Corporate income is being puffed up, by Nanette Byrnes.

D     New York Times (6/4/00), Market Watch Column by Gretchen Morgenson, “What’s Hiding in Big Blue’s Small Print,” 

E     Fortune Magazine cover story (6/26/00) , “Hocus-Pocus, How IBM Grew 27% a year, Do you want to believe in the IBM miracle? Then don’t look to closely at the numbers,” by Bethany McLean.

F     Merriam Webster’s Collegiate Dictionary, tenth edition, 1993, “take”

 

 



[1] IBM admits as much later in its letter where IBM states, “Pension fund investments are effected on a daily basis by independent investment managers, who act as fiduciaries strictly in accordance with the terms of the Employment Retirement Income Security Act of 1974 (ERISA)”.