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Shareholders seek changes at Rite Aid, Donegal

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Two midstate public companies are contending with investors who don't think they're getting their money's worth.

A dissatisfied shareholder at Rite Aid Corp. and one at Donegal Group Inc. recently petitioned to put resolutions up for votes at the firms' annual meetings. In both cases, the companies fought to keep the vote from happening. One prevailed, one didn't.

At Rite Aid, the pharmacy chain based near Camp Hill, shareholder Steve Krol submitted a resolution recommending that future board nominees have no pre-existing ties to Rite Aid or its senior management except as required by earlier merger agreements.

The U.S. Securities and Exchange Commission informed Rite Aid in a letter last week it is not entitled to exclude Krol's proposal from its proxy materials and a vote.

"This is a big win for shareholder rights and a setback for Rite Aid's continued stacking of their board with loyalists to its executive management," Krol said.

Donegal Group, the insurance holding company based near Marietta in Lancaster County, successfully fended off a resolution proposed by investor Gregory M. Shepard. The resolution called for hiring an investment bank to study a sale, merger or other "strategic alternatives" to maximize shareholder value.

In Donegal's case, the SEC said it would not take action if Donegal excluded Shepard's proposal from its proxy materials.

Companies need to cite "good precedent" to convince the SEC that an exclusion is valid, and Donegal did, said John Kauffman, a partner at law firm Duane Morris who represented Donegal in the case.

Technically, shareholder resolutions are nonbinding. Nevertheless, companies take them seriously, and rarely ignore ones that get approved, Krol said.

Managers generally dislike shareholder votes, viewing them as meddling, said Michael Hussey, associate professor at the Harrisburg campus of Widener University School of Law.

Companies prefer unhappy shareholders to sell their shares and move on, he said.

"Shareholders in publicly traded companies generally have a very passive role," Hussey said.

But passive acceptance may give way if an investor — particularly one with a large stake in a firm — concludes that disappointing results are due to inept or self-serving top management.

Krol has complained about Rite Aid's management for years, alleging top executives routinely ignore store-level quality control and customer service problems.

A particular sore point is Rite Aid's 2007 purchase of the Brooks and Eckerd chains from Canada's Jean Coutu Group Inc. The acquisition saddled Rite Aid with massive debt and has yielded little upside.

However, executives received six- and seven-figure bonuses for closing the deal. That gave them an incentive to overlook its risks, Krol said.

Most of Rite Aid's board members are insiders, Krol said, with ties to current and past management that make them reluctant to exercise proper oversight.

For that reason, Krol's resolution recommends that future board nominees "have no former or existing business or personal relationships, either directly or indirectly, with the senior management or the company."

"This, like any shareholder proposal, will be addressed and handled per the normal annual meeting process," Rite Aid spokeswoman Ashley Flower said in an email.

The company would not comment further, she said.

Rite Aid's board policy requires a majority of members to be independent, as defined by the New York Stock Exchange. Eight of 11 are considered independent, Flower said.

The NYSE's standards specify five criteria that automatically disqualify candidates from being considered independent, but otherwise recommend that boards make determinations themselves, "broadly consider(ing) all relevant facts and circumstances."

Investors besides Krol have expressed doubt that Rite Aid's considerations are broad enough. Only four Rite Aid board members truly qualify as "credible, independent directors," the union-affiliated CtW Investment Group said last year.

Of those four, two endorsed the Brooks-Eckerd acquisition and thus might lack "the objectivity to effectively weigh new strategic options," CtW said.

Last year, the SEC allowed Rite Aid to exclude a similar resolution Krol proposed, due to criticisms of top executives he included in a supporting statement. Krol said he revised the proposal to omit those statements and hew as closely as possible to SEC precedents.

This year, Rite Aid tried to argue Krol failed to prove he fulfilled the stock-ownership requirements for making a proposal. The SEC rejected the claim.

Krol said he's optimistic other shareholders will support him.

"I'm assuming this proposal has a fair chance of being voted in the affirmative, because it's common sense," he said.

Donegal Group Inc., on the other hand, will not have to put Shepard's proposal to its shareholders.

Donegal Group Inc. is a "downstream holding company," formed by Donegal Mutual Insurance Co. to gain access to capital markets. Such structures are fairly common among mutual insurance companies, which are owned by policyholders, not stockholders.

Donegal Mutual owns a significant majority of Donegal Group's shares, amounting to more than 60 percent of the voting power. Shepard is the company's largest independent shareholder, with about $50 million in shares, giving him just under a 10 percent vote.

Shepard's proposal calls for appointing an investment bank to study the sale or merger of Donegal Mutual. In a supporting statement, he said Donegal Group shares have declined in value in the past five years, but asserted investors could double their money if a sale or merger occurred.

In statements to the SEC, Donegal argued Shepard's proposal recommends actions relating to "ordinary business operations." That's prohibited under SEC rules: Shareholders aren't permitted to micromanage.

Shepard submitted revised proposals, but they missed the required submission deadline, Donegal argued.

The SEC said Feb. 16 it concurred with Donegal, and would not sanction Donegal if it rejected Shepard's submissions.

Shepard lists a Florida address in documents filed with the SEC. Efforts to contact him for this article were not successful, and messages left with his lawyers were not returned.

In the past decade, Shepard has sought buyouts of at least two other insurance companies, Kauffman said. In both cases, he began with shareholder proposals like those submitted to Donegal, he said.

Had matters come to a vote, Donegal Mutual would have voted "no," it said in a March 2 filing.

Obviously, given its two-thirds voting power, it would have prevailed. Still, raising the issue puts pressure on the Donegal board, Hussey said. Other investors might follow Shepard's lead, perhaps putting together an alternative slate of board member candidates.

Conceivably, Shepard and minority shareholders could take Donegal Mutual to court, Hussey said. In some cases, minority shareholders have argued successfully that a dominant shareholder must take their interests into account, he said.

It's not clear what Shepard's next step will be or if he has a candidate company in mind for a merger with Donegal, Kauffman said.

Contrary to Shepard's implied criticism, Donegal takes shareholder value seriously and constantly evaluates its decisions in light of that, Kauffman said.

In SEC filings, Shepard says he has no plans to seek control of Donegal Group, but reserved the right to "explore all options to increase shareholder value" and submit suggestions or proposals to Donegal management.

"My gut feeling is he's pressuring us to buy him out," Kauffman said. "But that's mere speculation on my part."

Write to the Editorial Department at editorial@cpbj.com

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