This Settlement Raises the Governance Bar

Hanover Compressor's landmark agreement with shareholders to embrace major corporate reforms could have profound repercussions

As scandal after scandal has swept through Corporate America, shareholders are increasingly using litigation to wring more accountability from the corner suite. They're getting impressive results, too, racking up corporate-governance reforms that go considerably beyond the efforts Congress passed last year.

The latest example: Houston-based Hanover Compressor (HC ) announced on May 13 that it has settled a major shareholder lawsuit by embracing what some experts see as groundbreaking reforms. Among them: For the first time, according to governance experts, shareholders will get the power to fill board seats.

In addition, the settlement marks the first time a company has agreed to rotate its outside audit firm as part of the resolution of a shareholder class action. The 2002 federal Sarbanes-Oxley law requires companies to rotate only the lead partner of its outside audit firm, not the entire firm. The Hanover settlement also includes a number of restrictions on insider stock sales -- including an outright prohibition on sales of shares obtained through option exercises -- that significantly increase exposure for executives.


  The $80 million settlement with Hanover, which compresses natural gas for other energy companies, stems from a 2002 lawsuit that accused it and other defendants of insider trading, improper revenue reporting, and manipulation of stock value. But the agreement could raise the bar for what aggrieved investors seek in the future from other companies.

"Corporate governance is on the radar screen for a lot of investors these days," says Stephen Davis of Davis Global Advisors, a Newton (Mass.) corporate-governance consultancy. "Companies are going to have to meet higher and higher governance standards as a result."

Richard Bennett, a corporate-governance consultant in Portland, Me., agrees. "Hanover Compressor may not be a household name, but it's completely unprecedented to have a publicly traded company acknowledge that board members ought to be accountable to their shareholders," he says. "I think you're definitely going to see more [groundbreaking corporate-governance settlements] because shareholders are demanding it."


  Trial lawyers are certainly smiling. "Investors across the country are taking back the boardrooms that are rightfully theirs," says William Lerach, an attorney for the plaintiffs and partner with Milberg Weiss Bershad Hynes & Lerach LLP. "This agreement represents the latest victory for shareholders in remedying the excesses of the late '90s and is an example of an important trend -- there's no turning back now."

The Hanover settlement follows Sprint's (FON ) recent agreement with shareholders who sued over its attempted merger with WorldCom. The Sprint settlement requires the company to have a lead independent director with authority similar to its chairman; annual election of all directors, who can serve a maximum of 15 years; independent directors on key board committees; and consolidation of its various stock-option plans.

The Hanover settlement picks up from there. While Hanover continues to deny any wrongdoing, it will allow the dozen or so shareholders with more than 1% of outstanding shares to nominate two new independent directors. Going forward, two-thirds of Hanover's board will be made up of independent directors, a significant increase over the simple majority required under a New York Stock Exchange governance proposal.


  In addition, Hanover has agreed to change its outside auditing firm every five years. President and CEO Chad Deaton says these reforms are in addition to other governance improvements Hanover has made in the past year, including the appointment of three new independent directors, a new management team (including Deaton and a chief financial officer), and new general counsel.

"This settlement of the securities-related litigation is an important milestone for Hanover," says Deaton. "It demonstrates our commitment to putting these type of issues behind us so that we can focus on improving the operating performance of the company."

The $80 million settlement includes a $30 million cash payment to shareholders, of which $26.7 million will be paid by Hanover's insurance, issuance of 2.5 million shares of common stock, and some $9.2 million in contingent notes.


  In addition, GKH Investments LP and GKH Private Ltd., Hanover investors that each sold shares in its March, 2001, secondary stock offering, have agreed to settle claims that arose from the offering by paying 2.5 million Hanover shares to the plaintiffs.

Hanover says it recorded a pretax charge of $65.6 million, or $51 million aftertax, in its first-quarter results as a result of the agreement. Including the charge, Hanover lost $50.3 million on $274 million in revenue in the first quarter, vs. a $5.03 million profit on $256 million in revenue for the year-ago quarter.

Litigation is still pending in U.S. District Court in Texas against PricewaterhouseCoopers, Hanover's accounting firm, on allegations that it engaged in illegal practices that inflated Hanover's stock price. But Hanover's stock rose 10.8%, to $10.66, on the May 13 news of a settlement.

"We've entered a new era in American history, where corporate reforms can be achieved not only through legislation or federal regulation but through binding legal agreements," said Robert A. G. Monks, a pioneer in corporate governance and reform, and the founder of LENS, Institutional Shareholder Services, and the Corporate Library. "If companies want to restore the confidence of their public investors, they should look at these reforms as a model." If plaintiffs' lawyers have anything to do with it, Monks can be assured that they will.

By Stephanie Anderson Forest in Dallas

Edited by Douglas Harbrecht

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