Sunday, May 27, 2007

The Invitation That Isn’t in the Mail

Published: May 27, 2007

INVESTORS who attend annual shareholder meetings — ritualistic though the gatherings usually are — often do so to catch a glimpse of management and directors and to hear how their companies are faring.

Shareholders of Sunrise Senior Living, a provider of housing and services for the elderly, may have been especially eager to hear from their company’s executives and board this year.

After all, the company is in the sixth month of an internal accounting review; is fielding questions from the Securities and Exchange Commission about well-timed insider stock sales and option grants; and has recently fired its chief financial officer, Bradley B. Rush. Mr. Rush’s exit, the company said, followed actions taken by him that were “not consistent with the document retention directives issued by the company.”

As interested as they may be in learning more about these matters, Sunrise shareholders have not been given the chance for the edification that an annual meeting might bring. Even though last year’s meeting took place on May 16, this year’s has not been scheduled.

Sunrise, which was founded by its chief executive, Paul J. Klaassen, is something of a throwback. Its seven-person board is clubby — the five outside directors have either had business dealings with the company over the years or serve on other boards with Sunrise’s chief executive — and “classified.” That’s corporate-speak for a board whose directors have staggered terms, a setup that prevents an ouster of the board en masse.

In addition to Mr. Klaassen, who is the chairman, the other inside director is Teresa M. Klaassen, his wife and the “chief cultural officer” at Sunrise. According to filings, her unusual job title means that she develops “programs that help the company remain focused on its commitment to core values and principles of service.”

Almost six months ago, Sunrise hired an outside law firm and tasked a “special independent committee” of the board to do two things: scrutinize questionable option grants and examine $32 million in insider stock sales that Mr. and Mrs. Klaassen (as well as three outside directors) made before Sunrise publicly disclosed an accounting change that trounced its shares. The company spokeswoman has said that the executives and directors could not have had knowledge of the accounting review when they sold their stock.

Sunrise decided to examine itself after an institutional shareholder, S.E.I.U. Master Trust, a pension fund that benefits members of the Service Employees International Union, pushed for the move.

Sunrise’s accounting change has prevented it from filing audited financial statements for 2006 and revised ones for several other years. It is waiting for the S.E.C. to comment on its accounting practices to file a restated 2005 annual report.

The company has estimated that its restatement will shave $100 million off of earnings for the years from 1999 through 2005 — equal to about 29 percent of total income for the period.

According to S.E.C. rules, a company cannot file a proxy unless it has produced audited financial statements for the previous year, and cannot hold an annual shareholder meeting without a proxy.

But under the laws of Delaware, where the company is incorporated, if a public company does not hold an annual meeting within 13 months of its last, its shareholders can petition the state’s Chancery Court to compel a meeting. Sunrise is less than a month away from the Delaware deadline.

It will be interesting to see whether a Sunrise shareholder invokes the Delaware rules and calls on the company to hold a meeting.

In the meantime, Sunrise owners remain in the dark not only about their company’s option grants and stock sales, but also about two other accounting problems that emerged in February. Those involve how the company books its contract services reimbursement revenues and costs, and how it capitalizes interest expenses. Because Sunrise has made no proxy filing, shareholders have no information about executive compensation for 2006, either.

It is perhaps not surprising, then, that the S.E.I.U. Master Trust has written another letter to the Sunrise board, asking that it replace its outside directors with “truly independent persons who have the range of abilities and experiences necessary to lead a company of Sunrise’s size and complexity.”

Stephen Abrecht, executive director of benefits funds at the S.E.I.U. Master Trust, said that his organization has waited for the company to answer the questions that it submitted months ago. None have come, he said.

“But the list of problems keeps getting longer — accounting troubles, questionable insider trading, possible options backdating, material weaknesses in internal controls, S.E.C. inquiries, and now, the dismissal of the C.F.O.,” Mr. Abrecht said. “There is a leadership problem that needs to be fixed. The board should step up and appoint new, truly independent outside directors and implement governance reforms.”

Adding to the urgency of the matter, significant merger and acquisition activity has occurred in Sunrise’s industry, making it a possible takeover target, Mr. Abrecht said. “The board’s conflicts of interest make it virtually impossible for shareholders to have confidence that the current group of outside directors will place shareholders’ interests before all others in assessing opportunities to enhance value,” the letter said.

Meghan Lublin, a spokeswoman for Sunrise, said that the company had referred the S.E.I.U. letter to the board’s nominating and corporate governance committee for consideration.

“Both the New York Stock Exchange listing standards and Sunrise’s corporate governance guideline require that a majority of the company’s directors be independent,” she said in a statement. “Sunrise’s board of directors is comprised of highly experienced individuals and each of the non-management directors comprising more than two-thirds of the board has been determined to be independent under these standards and guidelines as described in our 2006 annual meeting proxy statement.”

Among those outside directors are Thomas J. Donohue, the chief executive of the United States Chamber of Commerce, on whose board Mr. Klaassen serves, and Ronald V. Aprahamian, a private investor, who previously served as a consultant to the company while on its board.

Craig R. Callen, a senior executive at Aetna and a Sunrise director, invested in a company venture while he was on its board, and William G. Little is a director at the chamber and chairman of the National Chamber Foundation, its research group. J. Douglas Holladay was a director at CNL Hotels and Resorts, formerly an affiliate of the CNL Financial Group, which has owned assisted-living facilities that Sunrise managed.

Among the insider sales under scrutiny are $4.8 million worth made by Mr. Donohue, Mr. Aprahamian and Mr. Holladay. None of the five outside directors returned phone calls seeking comment.

Sunrise’s most recent unaudited results indicate that the company’s operations are growing. It opened four new communities in the quarter ended March 31 and started construction on five others, bringing the total communities it oversees to 444 in the United States, Britain, Canada and Germany. Same-community revenue increased 5.1 percent in the March quarter, but expenses at these operations rose more — 6.5 percent — during the period.

As is the case with many companies that have not filed audited financial statements — largely because of option backdating investigations — Sunrise shares have held up remarkably well. They closed on Friday at $38.84 a share, up 26 percent this year.

STILL, it will be interesting to see if a Sunrise shareholder tries to force the company to hold an annual meeting without a proxy on file.

Beth Young, a lecturer at Harvard Law School and an adjunct professor at Fordham Law School, said that if a shareholder did so, owners could attend the meeting, nominate a slate of directors and force a vote of those in attendance, possibly winning.

“That scenario would worry companies,” she said. “People come to the meeting to cast their votes to elect a new board member — it’s something that an opportunistic shareholder could really take advantage of.”

Such is the law of unintended consequences.