Institutions prepare to take Facebook out to the woodshed

Large institutional investors are ramping up their calls for governance reforms at Facebook Inc. following revelations that Cambridge Analytica, a data-mining company that was a digital consultant to Donald Trump's 2016 presidential campaign, harvested the personal data of about 87 million users.

Among the changes investors seek are increased board diversity and independence, equal shareholder voting rights, a separation of the roles of CEO and board chairman, and enhanced oversight and disclosure of Facebook data privacy policies.

While Facebook investors have raised their voices on several of these issues in the past, the corporate capital structure has helped insulate management from shareholders' pressures thus far. CEO and Chairman Mark Zuckerberg owns about 16% of the company's economic interest but controls 60% of its voting rights.

However, asset owners believe the time is nigh for Facebook to reform its corporate governance.

One of those investors is New York City Comptroller Scott M. Stringer, the fiduciary for the five pension funds within the $193 billion New York City Retirement Systems. In a March 27 letter to Facebook's lead independent director, Susan Desmond-Hellmann, the comptroller called on her and the board's other independent directors to take steps to "strengthen the composition and independence of the board, enhance its oversight and disclosure of data privacy ​ policies and practices, and establish a strong tone at the top for ethics and compliance."

The four steps outlined in the letter are:

• naming an independent board chair;
• forming an independent nominating committee to reconstitute the board with at least three new independent directors with racial and gender diversity;
• assigning an independent committee to oversee data privacy policies and enhancing disclosure of the processes underway to avoid data breaches; and
• enacting a "robust clawback policy to allow the board to recoup executive pay in the event of violations of law, regulation or company policy that cause significant financial or reputational harm to Facebook."

As of April 11, Mr. Stringer's office had not heard back on its requests.

"Given that Facebook is now confronting a crisis of confidence, and there is substantial value at risk, I think this is a moment for investors to elevate the governance issues we have been raising and to push for real change," said Michael Garland, the system's assistant comptroller for corporate governance, in an emailed statement.

In a telephone interview, he added: "As a long-term (Facebook) shareowner, largely through index strategies ... if we have concerns about the board or the management or the data privacy practices, we can't just walk away. And we want to make sure the company is sustainable over the long term."

Mr. Stringer added in an emailed statement: "The board has a fiduciary duty to represent the interest of all investors. Mark Zuckerberg is the CEO, but ultimately we are looking to the board. Right now, the silence from the board has been deafening."

System officials would not comment on any further engagement efforts with Facebook or how the funds are likely to vote at the company's annual meeting on May 31. Facebook released its proxy materials on April 13.

The NYC pension funds held 8 million shares in Facebook valued at $796 million as of April 11.

A Facebook spokeswoman declined to comment on Mr. Stringer and other investors' concerns.

Patrick Doherty, director of corporate governance in New York state Comptroller Thomas P. DiNapoli's office, said he hopes a shareholder proposal filed by the comptroller and money manager Arjuna Capital regarding Facebook's terms of service will gain significant shareholder support this year because of the Cambridge Analytica controversy.

Mr. DiNapoli is sole trustee of the $209.1 billion New York State Common Retirement Fund, Albany, which held 6.8 million shares in Facebook valued at $1.1 billion as of March 31.

As of April 11, the comptroller's office had not heard from Facebook on its proposal, which seeks information on how the social media giant enforces its terms of service to prevent election interference, fake news, hate speech, sexual harassment and violence from being posted to its platform.

The proposal was filed in November, before the Cambridge Analytica revelation.

Mr. Doherty said members of the comptroller's staff will attend Facebook's shareholder meeting in June to present the proposal and pose their questions to Mr. Zuckerberg in person.

CalSTRS, the second-largest pension fund in the U.S., also has turned up the pressure on Facebook since the Cambridge Analytica revelation.

In a written statement on April 5, Aeisha Mastagni, portfolio manager in CalSTRS' corporate governance unit, said the West Sacramento fund was "establishing contact with Facebook to learn more about what controls are in place today to protect users' data into the future. Additionally, we would like to understand what additional steps Facebook is taking to protect this data in order to regain the trust of their users, the public, and their shareholders."

The same day, CalSTRS' Chief Investment Officer Christopher J. Ailman announced via Twitter he was deleting his personal Facebook account. "Their lack of oversight and poor management is offensive. #DeleteFacebook," Mr. Ailman said in the tweet.

As of Dec. 31,the $224.4 billion California State Teachers' Retirement System held 4,094,475 Facebook shares; those shares were worth more than $676 million as of last week. Spokeswoman Michelle Mussuto declined a request for interviews with pension fund officials.

Like Messrs. DiNapoli and Stringer, CalSTRS previously raised governance issues at Facebook, in particular over the company's dual-class share structure, combined CEO/chairman structure and lack of board diversity.

Facebook's governance also has been a long-standing issue for pension fund officials in Florida and Oregon.

Jacob Williams, corporate governance manager at the Florida State Board of Administration, said in a telephone interview that while the Cambridge Analytica issue is concerning, the "bigger issue" for the state board is Facebook's dual-class share structure.

While dual-class proponents have argued the structure allows management to focus on long-term value creation and protects them from the short-termism in financial markets, Mr. Williams said a good chairman and CEO generally "don't need this type of protection in place."

"As long as they are doing a good job, shareholders are going to support them," Mr. Williams said.

The Tallahassee-based board — which oversees the $167 billion Florida Retirement System and held 4.1 million shares in Facebook valued at $651 million as of April 1, primarily through internally managed passive accounts — would like to see a one-share/one-vote structure implemented at Facebook.

Charles M. Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, echoed Florida's concerns about multiple share classes with unequal voting rights, saying they can foster a lack of accountability to shareholders.

"Ultimately, we're going to have to rethink this entire form of financing," Mr. Elson said.

The FSBA's Mr. Williams said the board has not yet decided how it will vote at Facebook's annual shareholder meeting.

Last year, the Florida state board supported shareholder resolutions at the company that called for an independent board chair and a change in shareholder voting to one share/one vote.

Although both proposals failed to gain a majority in 2017, the New York City Comptroller's office estimates a majority of outside investors voted in favor of both proposals.

The Oregon Investment Council, Tigard, which oversees the $78.9 billion Oregon Public Employees' Retirement Fund, will be "looking carefully at potential shareholder resolutions (at Facebook) this year," spokesman James Sinks previously told Pensions & Investments in an email. "For Oregon trust funds, governance has always been an issue at Facebook."

The retirement fund held 498,039 Facebook shares valued at $87.9 million as of Dec. 31.

"Facebook is going to have to step up their game with engagement," following the Cambridge Analytica revelation, said Kern McPherson, San Francisco-based senior director of North American research at proxy-voting advisory firm Glass Lewis & Co. "They are going to have to show a higher level of accountability" to investors who are asking for information on how they are managing data security and privacy, he said.

Mr. McPherson noted the latest controversy comes at a time when investors are paying increasing attention to how companies are managing their data privacy and security in general.

Facebook stock closed at $164.53 on April 13, down 11.1% from $185.09 on March 16, the day before the Cambridge Analytica news broke.

Arleen Jacobius contributed to this story.