Activist Investor Benny Landa : Why I Care about Teva

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The Board’s Formal Response

On July 3rd, 2014, Teva distributed our Position Paper to shareholders as required by law, together with its formal response.

Position Paper

Teva Response

Teva’s formal response lauds the Board’s achievements and extolls the virtues of its directors. It praises Mr. Slonim but misses the point entirely:

“Indeed, Adv. Slonim in particular has leadership roles on the boards of leading firms and expertise in risk management, governance and regulatory matters; his re-election as a designated independent director to the Board will serve Teva and its shareholders well.”

No one disputes Mr. Slonim’s credentials or expertise, nor does anyone doubt his “leadership roles on boards of leading firms”. In fact, Teva’s board has a plethora of individuals with stellar careers and remarkable achievements. It is not their expertise in their respective fields that is in question. It is their lackof expertise in the one field that counts,  big-pharma. And that is what Teva desperately needs on this board.

The Board mentions “governance” six times in its response:

“Our discussions regarding Teva’s corporate governance are ongoing. Corporate governance is a priority for our Board. We will continue, as we have done, to evaluate the size and composition of the Board to ensure that we maintain dynamic, exceptionally qualified leadership, and we will continue to take actions that are in the best interests of Teva and its shareholders.”

“As part of its periodic and organic evaluation of Teva’s corporate governance, our Board has reviewed, among other things, the size and composition of the Board. As part of this review, we first announced to shareholders earlier this year that we had decided to reduce the size of our Board and add new members with global healthcare experience, both of which we have begun.”

“Our corporate governance and nominating committee is working on a succession plan.”

“The Board has made substantial progress in enhancing the leadership and governance of Teva, and continues to work thoughtfully and decisively toward advancing these goals.”

 “Following the recommendation of Teva’s corporate governanceand nominating committee, the Board recommends that shareholders nominate and re-elect[existing directors + one new]”

The Board’s comments are mere proclamations and promises of actions-yet-to-come. How can a serious board offer such a shallow and dismissive response to the gravest shareholder concerns regarding corporate governance: director entrenchment, staggered board three-year appointments, interlocking directorships, conflicts of interest and an 85% supermajority requirement for amending the Articles of Association (improving corporate governance).

These are serious issues, yet they are completely ignored in the Board’s response. That response – actually, lack of response – itself makes the case for badly needed reform. Shareholder concerns about corporate governance appear to be of little interest to this Board. How else can one explain its dismissive response? Teva’s directors seem to be bulletproof, entrenched, protected by the Company’s Articles of Association from removal even by their own shareholders. Something is wrong with this picture.

In its response, Teva’s board attempts to divert attention from the core governance issues by highlighting the recent stock uptick, saying to shareholders, hey, look what a great job we’re doing, so don’t rock the boat!

since the start of the year, we have delivered 35.8% total shareholder return versus 8.0% for the S&P 500.In short, we believe we are on the right track to build sustainable value for our shareholders.”

The facts tell a somewhat different story. After all, this is the same board that shepherded the stock’s decline in the first place. I believe the recent lift is due, at least in part, to (perhaps misplaced) shareholder expectations that change may be just around the corner.

The following two charts tell the factual story. The bottom line: for the past four years, Teva’s stock has been underwater. Even taking into consideration the recent uptick,  it is still down 10%. By contrast, during the same period,  the S&P 500 is up 74% and the Bloomberg Generic Parma Index is up 90%.

BennyLast TEVA

Graph TEVA

The Board’s Public Response

Teva’s distribution of our Position Paper to shareholders was reported in last weekend’s local press. In Teva-initiated interviews, the Board’s spokesperson, Teva CFO Eyal Desheh,  a salaried Company employee, inserted himself between the Board and its dissident shareholders, defending the former and criticizing the latter. While praising Teva’s directors, Desheh heaped derision and personal insult on the Board’s detractors, its dissident shareholders.

It goes without saying that it is not Management’s place to publicly criticize the Company’s owners – its shareholders – even if they have differences with the Board. And it is certainly not Management’s place to defend directors from criticism by their shareholders. This behavior is unacceptable, damaging to the image of the Company, and a dangerous precedent. It is little different from a military commander vocally defending government politicians who come under public scrutiny.

But it appears that Eyal Desheh was simply doing the Board’s bidding. Has this Board become so accustomed to setting its own rules that it no longer differentiates between the roles of Board and Management? To what standard of governance does this Board, which sends Management to battle dissident shareholders, hold itself?

Clearly, something needs to change. But without an overhaul of Teva’s Articles of Association, at the present change rate of one new director per term, substantial change will take many years.

The Position Paper

As I stated to investors, we must send a clear message to Teva’s Board: the Company’s shareholders will not sanction the Board’s disregard for shareholder concerns. We insist on proper corporate governance – and expect the Board composition to be upgraded.  Teva should name a successor Chairman of international repute, befitting the position.

Of course the best way of sending such a message would have been to place appropriate resolutions on the agenda and to submit a slate of credible candidates for election. With that option gone, the only way shareholders can now send a strong message to the Board is by rejecting one or more Board resolutions. We have selected two: rejection of one director candidate and rejection of D&O insurance.

The reasoning for rejecting at least one of Teva’s current directors for re-election is as follows:

  1. Teva undertook to significantly reduce the size of the Board.
  2. There is a desperate lack of global pharma experience amongst Teva’s existing directors.
  3. Therefore any new Board appointments should be of pharma-experienced directors.
  4. Moreover, one Board seat should be kept vacant, reserved for the next Chairman, which the Board claims to be seeking, for appointment in December 2014. It is important to bring to this position a person of high stature, who can offer pharma-seasoned advice, counsel and mentoring to Teva’s Board and the newly appointed CEO (who too has no pharma experience).
  5. Israel law and Teva’s Articles of Association allow for the Board to subsequently fill such Board seat, accordingly.
  6. Due to Teva’s staggered Board structure, appointments are for three year terms. Therefore, to the extent that non-pharma experienced directors are now elected, Teva’s Board upgrade will be delayed by three years.
  7. By rejecting this resolution, Teva shareholders will send a clear message to the Board that, for so long as Teva does not significantly improve its corporate governance and Board composition, its shareholders will not rubber-stamp the Board’s proposals.

The reasoning for rejecting the Board’s proposal for the purchase of D&O insurance for coverage of up to $600, 000, 000 is as follows:

  1. It is indeed customary for companies to purchase liability insurance for directors and officers (“D&O Insurance”) – provided that the payable premium for the policy is capped and the insurance period is limited in time.
  2. Israel Companies Law requires shareholder approval for purchase of D&O Insurance,  so that shareholders can examine the policy’s terms and cost versus the provided benefits.
  3. Moreover, the Voting in Writing Regulations promulgated under the Israel Companies Law require that any matter brought to the shareholders for voting shall include the specification of data required to fully understand the matter, which in the case of D&O insurance must include maximal cost of the insurance premium and the maximal period for the insurance renewal from time to time.
  4. Since the Board’s proposed resolution lacks even the most basic data required by law, such as the maximal cost of the insurance premium and the maximal period for the insurance renewal from time to time, the resolution cannot be approved by law.
  5. By rejecting this resolution, Teva shareholders will send a clear message to the Board that, for so long as Teva does not significantly improve its corporate governance and Board composition, its shareholders will not rubber-stamp the Board’s proposals.

Corporate Governance

Teva is a broadly held company, without a controlling shareholder or controlling shareholder block. De facto, the Board controls the Company. It carries the dual burden of acting both in the best interests of the Company and of its shareholders – never in its own interests or those of its directors. The Board must therefore maintain the highest standards of corporate governance so there can be no doubt as to the authenticity and legitimacy of its actions. At the same time, the Board must be accountable to, and at all times under the control of, its shareholders. That means that the shareholders must be in a position to judge the Board’s performance and must have the authority to make changes. That authority comes from the Law and the Company’s bylaws, its Articles of Association.

In Teva’s case, certain of those bylaws strip the Company’s shareholders of their ability to effect change. For example, Teva’s Articles of Association do not allow removal of an underperforming director and, hence, such removal requires amendment of the Articles by a supermajority of 75%, extremely difficult to achieve in the case of a broadly held company. Therefore, once elected, directors are entrenched for their full term. And due to Teva’s staggered board structure, that means they are entrenched for three years.

Notably, Teva’s Articles of Association require a supermajority of 85% for amendment of the staggered board mechanism, virtually impossible to achieve in the case of a broadly held company. Oddly, the Articles allow the Board (but not its shareholders!) to set a lower majority for amendment of any provision of the Articles, at the Board’s sole discretion.

An entrenched board, comprised of directors who, in practice, cannot be removed by their shareholders, is dangerous. It can, as appears to be the case in Teva, become a self-perpetuating club of mutually-supportive directors who keep re-nominating one another for successive terms. Such a board cannot meet accepted norms of corporate governance and is not in the best interests of the Company or its shareholders.

That is why Teva’s Articles of Association must be amended. That is why Teva’s board composition must be upgraded. That is why Teva must adopt normative standards of corporate governance. And that is why Teva needs the leadership of a credible  Chairman of repute who can ensure that all this happens.

And that is why I recommend Teva shareholders to vote their proxies:

Proposal 1 – AGAINST the election of Mr. Slonim as director; and

Proposal 4 – AGAINST the purchase of Directors’ and Officers’ liability insurance.

Please read more about Benny Landa here 

 

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