smith-assault-charge-raises-questions-about-corporate-governance-at-sonic-automotive

Smith assault charge raises questions about corporate governance at Sonic Automotive

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The scene described in the arrest warrant is disturbing. In the early hours of Oct. 5, a 46-year-old man shoved and began strangling a woman in her early twenties, knocking a phone out of her hand when she tried to call for help.

What the warrant doesn’t mention is that the accused assailant, David Smith, is the son of a billionaire, scion of a powerful North Carolina family and the CEO of Sonic Automotive Inc., a public company that owns one of the largest car-dealership chains in the U.S.

After spending a day in a Charlotte jail, Smith was charged with three misdemeanor counts and one for felony assault by strangulation, a charge that can carry a sentence of as long as two years in prison. He intends to plead not guilty once North Carolina courts fully reopen from pandemic shutdowns, his lawyer says. No trial date has been set.

Barely 24 hours after his release, Sonic’s board — more than a quarter of which is made up of Smith family members, including the CEO’s father and 93-year-old founder O. Bruton Smith — said it believed he was innocent and pledged its “steadfast” support. David Smith was absent from Sonic’s October earnings call, without explanation, and since then the company has been mum on his arrest. Smith declined to comment, as did O. Bruton Smith, who is chairman of the board. A company spokesperson declined to comment on what action, if any, it has taken on the matter.

Given the seriousness of the charges, corporate governance experts say Sonic should put the CEO on paid leave and convene a committee of independent board directors to retain counsel and investigate, even though the matter is connected to private behavior outside work. Law firms or management consultants can perform such an investigation, which could likely run concurrently with a police probe, they said.

“People are innocent until proven guilty, but the board should be looking into this and not making blanket statements about the innocence of the CEO,” said Nell Minow, vice chair of ValueEdge Advisors, a shareholder-advisory firm. “When there is such a powerful conflict of interest in terms of self-protection, it’s absolutely essential that people who are not related to the CEO oversee the investigation.’’

Davia Temin, founder of New York City crisis consultancy Temin and Co., warned that Sonic should be mindful of “cancel culture” and not punish a person who hasn’t been convicted.  She also agreed that putting Smith on paid leave while the company conducts its own investigation would be both “good practice” and “good governance.’’

“There is a very deliberate way to do it, in a fair way that does not cancel him, but does not ignore it either,’’ she said.

In a sign of just how seriously corporate America has treated #MeToo, iconic companies such as Intel Corp., McDonald’s Corp. and Eli Lilly & Co. have investigated alleged conduct that fell short of ethical standards, and ousted senior executives who engaged in consensual relationships with subordinates. While the Sonic CEO’s alleged behavior happened outside work, both scenarios fall under a larger issue of character and leadership, governance experts say.

Sonic’s ownership structure gives the company more room to shrug off any potential backlash. It’s not the only thing corporate governance watchdogs say is a concern.

Racetrack icon

O. Bruton Smith, who built the family’s fortune acquiring stock-car racetracks and auto dealerships, took Charlotte-based Sonic public in 1997. He passed the CEO title first to his elder son Scott in 2015, then to David in 2018. The Smith family has about 80 percent of the voting power despite holding only a third of the shares outstanding because of a dual-class structure with supervoting stock.

The younger Smith’s legal troubles put a dent in what otherwise was a good year for Sonic shares, which gained 24% in 2020, outpacing the S&P 500. Still, they dipped after the CEO’s arrest was made public Oct. 7.  The shares fell as much as 10% on Wednesday after Sonic reported fourth-quarter results that fell short of analysts’ expectations, and Smith didn’t appear on the latest earnings call.

In March, when the pandemic hit, car sales plunged and Sonic’s shares fell more than two-thirds. To save money, the company cut almost 3,000 employees, though about half later were called back, according to company filings.

A few weeks later on April 10, the board canceled performance-based stock grants for the Smiths and a small group of executives and replaced them with options, company filings show. Sonic shares have more than doubled since then, making David Smith’s options worth about $11.2 million were he to exercise them today. That’s nearly three times what he would have earned had he met his target for the original stock grants, according to Dayna Harris, a partner at executive compensation firm Farient Advisors.

“There was an opportunity for a huge windfall,” Harris said.

Special treatment

The Smith progeny have received special treatment before.

David’s elder brother Scott resigned as CEO in September 2018 but stayed on for six months to provide what the company called ”strategic services.” At the time, he wasn’t eligible to receive severance or special exit payments, regulatory filings show.

But when he left in February 2019, filings show, Sonic’s board awarded him a deal that included $6 million in severance and early vesting of old equity awards worth millions of dollars.

The following month, two-thirds of Sonic’s outside shareholders rejected the executive-compensation program in a nonbinding vote at the company’s annual meeting. Among the dissenters were two of the world’s largest money managers, BlackRock Inc. and State Street Global Advisors, both of which rarely oppose executive pay plans. Because the Smith family controls the company through supervoting shares, the package passed with 88 percent support, according to Institutional Shareholder Services Inc.

“Shareholders on the outside don’t have a ton of power,” said Brett Miller, the head of data solutions for Institutional Shareholder Services ESG. “It’s a fairly common practice among founder-led firms.”

Scott Smith now is CEO of a closely held LED lighting company that counts some of Sonic’s dealerships among its customers. Both Scott Smith and O. Bruton Smith declined to comment through a Sonic spokesman.

Representatives of BlackRock and State Street declined to comment.

Low marks

Dual classes of shares, giving one group of investors greater voting rights, often allow a company’s founders or leaders to retain control, even if they raise a lot of outside capital. The structure used to be common among family-owned businesses and media companies, such as Ford Motor Co. or the New York Times Co. More recently, tech companies such as Google parent Alphabet Inc. and Facebook Inc. have adopted it and spurred wider use, even though investors grumble that it’s undemocratic.

Sonic’s board, meanwhile, gets low marks for independence: just 40 percent of the board is considered independent by ISS, ranking it in the bottom 2 percent among 3,000 companies in the Russell 3000 Index.

Three Smith family members sit on the 11-person board, and two more directors are directly affiliated with the company: Sonic President Jeff Dyke and William Brooks, an executive at both the holding company Sonic Financial Corp. and Speedway Motorsports Inc., O. Bruton Smith’s racetrack business, which he took private in 2019.

Another board member, John W. Harris III, is president of a commercial real estate developer that provided facility management services to Sonic’s Charlotte dealerships as part of a six-month pilot program. Although Harris is deemed independent under U.S. regulatory standards, ISS doesn’t consider him independent.

Harris didn’t respond to a request for comment.

ISS hasn’t yet included Keri Kaiser, a senior executive at Children’s Medical Center in Dallas, in its board independence analysis. Kaiser joined the board in July after the California Public Employees’ Retirement System, the largest public pension plan in the U.S., urged investors to vote against seven of the company’s directors, including O. Bruton Smith, for showing “a lack of responsiveness’’ to the fund’s requests to increase board diversity.

Maryann Keller, a veteran Wall Street auto analyst and industry consultant, sat on Sonic’s board from 2001 to 2004. She declined to stand for re-election in 2004 because of “governance issues,’’ she said, without elaborating.

Corporate governance reformers say the onus is on investment banks that underwrite equity offerings to stop setting up multiclass share structures that favor insiders. Stock exchanges could also discourage it by requiring sunset clauses, which would force listed companies to adopt a one-share, one-vote structure after a certain number of years, said Natasha Lamb, managing partner at Arjuna Capital, which has pushed banks and tech companies to disclose gender and racial pay gaps.

Without those changes, companies with dual-class shares will continue to operate with less accountability than their peers. In the case of Sonic, Lamb said, Smith’s alleged offense is problematic for the company, even though he wasn’t on the clock when it allegedly happened.

“You see these kinds of scenarios playing out over and over again,” she said. “The culture is still led by the tone at the top.”