Speech SEC Commissioner:
Remarks Before the International Corporate Governance Network
Commissioner Annette L. Nazareth
U.S. Securities and Exchange Commission
New York, New York
October 29, 2007
Good morning. I want to thank the International Corporate Governance Network for inviting me to be here in New York to speak before your 2007 mid-year meeting. I was asked to speak about what's happening with shareholder rights in America, a topic that is the subject of considerable discussion and debate at the moment. Along those lines, before I begin, let me remind you that my remarks represent my own views, and not necessarily those of the Commission, my fellow Commissioners, or members of the staff.1
In my mind, the most fundamental shareholder right in America is the ability to elect directors, and director elections form the core of shareholder power. Corporate governance trends in recent years have allowed shareholders to exercise this right more powerfully than in the past. Shareholder concerns about particular directors, expressed in forms such as "just vote no" campaigns, have gained significant support and have sometimes produced results.2 As an increasing number of companies have adopted some version of majority voting, shareholder votes concerning directors have more impact, and the annual meeting vote is no longer quite the equivalent of a Soviet "democracy." That said, the topic that has been at the forefront of much discussion in the context of director elections has been that of proxy access — allowing shareholders to place nominees for directors on the corporate proxy for a shareholder vote.
Regulation of the proxy process is a core function of the Commission and is one of the original responsibilities that Congress assigned to the agency in 1934.3 Our authority under Section 14(a) of the Exchange Act encompasses both disclosure and the proxy process.4 Our regulations are intended to reinforce state law rights with a uniform federal disclosure and proxy solicitation regime. Shareholders can avail themselves of the company's proxy by presenting proposals in accordance with Exchange Act Rule 14a-8. Shareholder access to the proxy for the purpose of proposing director candidates has been long-discussed, and the SEC published a proposal in 2003 that would have provided access under certain circumstances. That proposal was never finalized, and the issue lay largely dormant until last September, when the Second Circuit issued its decision in the case of AFSCME v. AIG.5
In that case, the American Federation of State, County and Municipal Employees ("AFSCME") had proposed a bylaw amendment at AIG that would establish a procedure under which shareholders could nominate directors subject to certain conditions and with certain disclosure. AIG sought to omit the shareholder proposal under one of the exclusions of Rule 14a-8: the "election exclusion" of 14a-8(i)(8), which prohibits a proposal that "relates to an election for membership on the company's board of directors or analogous body."6 At issue in the case was whether the exclusion applied only to proposals that immediately result in a contested election or to proposals that set forth procedures that at some point in the future might result in a contested election. After analyzing the language of the rule and, finding it ambiguous, looking for guidance from prior SEC interpretations, the Second Circuit concluded that the election exclusion applied "to shareholder proposals that relate to a particular election and not to proposals that . . . would establish the procedural rules governing elections generally."7
On September 7, 2006, the day after the Second Circuit's decision in AFSCME v. AIG, the Commission issued a press release stating that the Division of Corporation Finance would recommend an amendment to Rule 14a-8 to address issues raised by the AFSCME decision, and the Commission calendared the recommendation at an open meeting scheduled for October 18, 2006.8 In the press release, Chairman Cox stated "a final proposal will be considered at an open meeting of the Commission that will be scheduled to allow a final rule to go into effect in time for the 2007 proxy season."9 I was troubled by this rushed timetable, as the proxy process and the proxy access issue are complicated and deserving of thorough consideration. I did not view the Second Circuit decision as a crisis that needed an emergency "fix." Ultimately, the Commission did not propose or finalize any rulemakings concerning Rule 14a-8 last year, and there was no new rule in effect for the 2007 proxy season.
Not surprisingly, the sky did not fall. In 2007 there were three shareholder proposals on corporate ballots to adopt bylaw amendments regarding the election of directors, one of which passed and two of which did not pass but did receive significant shareholder support.10 One of the proposals that did not pass was included on the company's ballot after the company, Hewlett-Packard Co., had sought SEC no-action relief concerning its intention to exclude the proposal from its proxy.11 The staff of our Division of Corporation Finance expressed no view as to whether the company could exclude the proposal under Rule 14a-8(i)(8).12
In May 2007, the SEC convened three days of roundtables to discuss a number of issues relating to the proxy. The topics included: the federal proxy rules and state corporate law, proxy voting mechanics, and shareholder proposals. I found these very illuminating about the interplay between state and federal law, and I was struck that the Commission's rules in the proxy area sometimes prevent the exercise of fundamental state law rights. As Delaware Vice Chancellor Leo Strine observed, it is "a little bit perverse" that "a bylaw dealing with the election process that might well have been viable under state law was kept off the ballot when you could have something that was precatory mandated to be on the ballot."13 The roundtables were a step in the right direction for discussing the proxy system and the areas that may be appropriate for SEC action. What followed, however, did not build sufficiently upon the promise of the roundtables and reflects in my mind an unnecessary rush to put a new rule in place.
At an open meeting on July 25, 2007, the Commission voted to publish two diametrically opposing proposals — what I termed the access proposal and the non-access proposal. As it was originally contemplated, the proxy access proposal was intended to recognize the legitimate interests of shareholders in the governance of the corporations they own. The proposal was designed to enable a meaningful percentage of shareholders to come together to propose a bylaw amendment regarding the procedures for nominating candidates to a company's board of directors. It would facilitate shareholders' exercise of their fundamental state law and company ownership rights to elect the board of directors. The access proposal would eliminate some of the artificial barriers that the federal proxy rules have erected to the exercise of these state law rights, although as I will discuss in a minute, the access proposal also required high ownership thresholds and overly burdensome disclosure.
The proposal was intended to balance the rights of shareholders with the legitimate goal of leaving the management of companies largely to the board and the managers, whose primary focus should be on profit generation. At the open meeting, I noted that the concept of requiring a meaningful percentage of ownership and a holding period to trigger the access to the proxy seemed sensible to me, although I had concerns about and invited comment on whether the specific numbers proposed were appropriate.
I also have concerns about the disclosure requirements in the access proposal. The proposed disclosure requirements for someone seeking to nominate a director or propose a bylaw concerning the election of directors are more extensive than those in a proxy contest. In fact, the proposed disclosure would be more extensive than that required of someone seeking to take over the company. Such level of disclosure is unnecessary and grossly disproportionate when compared to the takeover context. To me, the proposed disclosure demonstrates the internal hostility to the proxy access issue — that somehow access to the proxy is seen as raising more concerns than a corporate takeover. Commenters have also noted that such disclosure would be "extremely impractical and expensive."14 Disclosure relating to the bylaw proposal or any candidates who might be nominated under such a proposal should not be more burdensome than would be required in a proxy contest.
An access proposal such as the one we published in July rests on another perfectly logical economic tenet. In a free market system, a majority of the shareholders will generally behave in their economic self-interest. When it comes to share ownership, their goals are profitability and integrity of the enterprise. In the vast majority of instances these incentives will be consistent with those of the company's management. Responsible management need not fear its shareholders. Unfortunately, there are notable instances, however, in which management acts in its own economic self interest, or chooses to ignore the express will of the shareholders and is unresponsive to them. In such instances, shareholders should have the ability to effect changes through the proxy process. Currently, (other than, to a limited degree, through certain majority vote initiatives) shareholders have virtually no chance to do so through access to the company ballot. Our proxy rules do not facilitate it, and shareholders are forced to solicit proxies on their own ballot, which is more costly and much less effective.
The proxy proposal published in July was modest in the degree of access it would provide. The proposal would allow shareholders to propose bylaws that would govern the procedures for shareholder nominations. It did not set forth a mechanism for direct proxy access. Rather, the proposal left the decision-making in the hands of the shareholders. A majority (or supermajority, depending on the state of incorporation) of shareholders would have to decide in the first instance whether to amend the bylaws to allow such nominations. Only if such a bylaw passed could its procedures then be followed. I viewed this as a measured step that would help balance competing concerns. Overall, I remain troubled about the thresholds and disclosure pieces of the access proposal. I strongly believed, however, that it was important to publish the proposal to solicit comment on these and other points, which will allow us to have a productive dialogue on this matter and arrive at a workable solution, either through revisions to the access proposal or perhaps as part of a larger look at proxy and voting issues.
Unfortunately, the night before the open meeting, I became gravely concerned that all of these efforts towards greater shareholder democracy would not be realized and that the chances of effecting meaningful shareholder access would be very small. That night, I received for the first time an entirely different, indeed diametrically opposite, alternative to this shareholder access proposal. As I said earlier, I termed this the "shareholder non-access proposal." While I knew that some were advocating a proposal to confirm the staff's pre-AFSCME position on proxy access, it was expressly understood that during the pendancy of the comment process on these two proposals we would maintain the status quo — namely, the Second Circuit position — and not issue any interpretation that purported to move the starting line, so to speak. But that is exactly what its supporters now claim the non-access proposal does. I note that the non-access proposal fails to acknowledge the change in the Commission's position that troubled the Second Circuit and provides no reasoned explanation for that change. For that reason, among others, the staff would be ill-advised to issue no-action letters in reliance on the non-access proposal's purported interpretation. The Second Circuit has already found that interpretation to be an unexplained — and thus unenforceable — departure from our original interpretation. We cannot now just un-ring that bell
I also disagree with the proposed rule amendment that would explicitly exclude shareholder proposals that relate to the procedures for nominating or electing Board members. The non-access proposal cites two primary concerns as reasons to foreclose shareholders' ability to introduce bylaws concerning the nomination process: confusion and disclosure. 15 The non-access proposal would eliminate confusion. It would make certain that there would be no shareholder access to the corporate proxy. I do not see a principled reason to provide certainty by excluding rather than including such bylaw amendments. In fact, under the non-access interpretation and proposed rule amendment, the Commission would be directly impairing shareholders' state law rights. Most state laws allow shareholders to amend the corporate bylaws unless limited by the bylaws or charter.16 The SEC's role in adopting the proxy rules stems from Congress's belief that "fair corporate suffrage is an important right," and the federal proxy authority is intended to reinforce, not supplant, state law rights.17 Our authority under Section 14(a) is to adopt proxy rules that are "in the public interest or for the protection of investors."18 The more principled way to eliminate confusion is to clearly allow such bylaw proposals, thereby affirming rather than denying shareholder state law rights. The ability to introduce such a bylaw is in the public interest and would serve the protection of investors by providing a method to ensure Board accountability in situations in which the investors determined it was necessary.
The second purported public policy reason for the non-access proposal is to ensure proper disclosure. On this point, the non-access proposal fails as well. It does not consider, address, or even solicit comments on ways to ensure proper disclosure, such as applying existing disclosure requirements and prohibitions on false and misleading statements to nominations done through bylaw procedures. Alternatively, the Commission could revise Rule 14a-8(i)(8) to allow companies to exclude proposals that do not require a nominating shareholder to comply with the proxy contest disclosure rules.19 If the problem is one of disclosure — and clearly fulsome disclosure concerning the proposing shareholders is appropriate — the solution is to address the disclosure directly, not to eliminate this bylaw avenue altogether.
So, where are we today? The comment periods for each of these proposals have closed and together they generated a record number of comments — over 34,000. The Commission staff is now considering what to recommend to the Commission, and I am certainly reviewing comment letters as well. The composition of the Commission has changed since these two proposals were published. Commissioner Roel Campos has left, and I have announced that I will be leaving, although I am still at the Commission and intend to remain at the Commission for the short term. Under the circumstances, this seems a particularly inopportune time for the Commission to be considering issues of this magnitude and divisiveness. Nonetheless, the Chairman has repeatedly stated that he intends to have a "clear, unambiguous rule in place in time for the next proxy season."20 In light of the importance of the issue and the number of comments received, I see no reason to rush to a vote. I do not think that the Commission should make hasty decisions that impair shareholder rights simply to fit within a self-imposed timeframe.
We have already gone though one proxy season with the AFSCME decision in place, and as noted above, we saw only three proxy access bylaw proposals. Any fear about a flood of proposals has not materialized, and any perceived urgency that might have existed prior to the last proxy season has diminished. I am comfortable with maintaining the post-AFSCME status quo until the Commission addresses the underlying issues here. The AFSCME decision placed the issue of proxy access bylaws squarely before the Commission. We made a promising start at exploring those issues that now seems to have been foreclosed by an artificial deadline.
I think that what is important here is to get it right, not to hastily adopt a flawed proposal. The non-access proposal appears not to reflect any of the learning and input we solicited at the three roundtables, particularly about the vindication of shareholders' state law rights. It also contains no discussion of what actually happened in the 2007 proxy season. The non-access proposal appears simply to be a way to eliminate a perceived problem, rather than to address it. Unfortunately, it can seem easier to get agreement to avoid the tough issues rather than to tackle them. Nevertheless, it is my hope that we can build on the suggestions and comments from the roundtables and proposals, raising the level of dialogue to one of practicality and purpose, designed to address the issue in a principled way.
I think that the access proposal is a start. There is an intellectual appeal to me in addressing proxy access through the bylaw method. Allowing a bylaw proposal on the company ballot puts the decision about proxy access squarely in the hands of the shareholders. At least a majority of the shareholders would have to support the bylaw for there to be proxy access. The Commission would be taking no position as to whether shareholder access to the proxy is a good idea or what form it should take — that could be left to the company's shareholders. Shareholders at different companies may well have very different positions on this, and allowing these bylaws would also allow for variation in procedures among companies.21 Bylaws regarding nominations may be more appealing at companies that are truly broken and that have a track record of not responding to their shareholders. If a company and its Board are creating value for shareholders and are responsive to shareholder concerns, it seems unlikely that a majority of shareholders would support a bylaw change to the director nomination process. Access is necessary for the extreme cases. Some have argued that shareholders of such companies must either take the Wall Street Walk and sell their shares; engage in a full-blown proxy contest; or become involved in a corporate takeover. Each of these has flaws. Some form of meaningful access to the proxy would be a middle ground. We will need to craft a thoughtful proposal (or proposals) that will address concerns that have been raised.
Some worry that allowing access to the proxy will allow for a so-called tyranny of the minority, in which a small number of shareholders impose their concerns on the company and the rest of the shareholders. I find such fears overblown, particularly given that at least a majority of shareholders would have to support a change to the bylaws. I worry just as much about a tyranny of a different minority — that of an unaccountable board or management. Corporate governance in the U.S. is not well served by inattentive boards that are effectively unaccountable to shareholders and thus place the interests of management over the interests of shareholders. Unchecked management is a powerful minority, and it is not subject to meaningful shareholder oversight. Checks and balances are important here. The shareholder oversight comes through voting for the Board (not just through selling shares). A system in which there is a reasonable possibility that shareholders could nominate directors would serve as an important reminder to Boards that they are accountable to their shareholders. Even if a shareholder-nominated director never is elected, the real possibility of that election would serve a useful purpose in maintaining Board accountability. It could be a mechanism to make Boards work. As I said earlier, responsible management and Boards should not fear a majority of their shareholders. At least a majority of shares would be required to adopt a bylaw change providing a nomination procedure. Similarly, any director nominated through such a process would then need to be approved by the shareholders. The access proposal published last summer would require at least a two-proxy-season process before any shareholder nominee could appear on a company proxy. In that respect, it is a measured proposal, not likely to impose turmoil.
Some commenters argue that the primary issue in considering proxy access is one of costs — and they note that providing access to the proxy means that the proposing shareholder does not bear the direct cost of an election. Cost is not the only issue here. Having competing candidates for directors appear on the same ballot allows for meaningful choice and conveys a legitimacy of all candidates in a neutral fashion that multiple ballots in a proxy contest does not. Cost is certainly a valid concern, but it is one that can perhaps be addressed in other ways. One of the beauties of allowing bylaw proposals concerning the director nomination process would be that a company's shareholders could vote on the proposal and decide for themselves whether the cost allocation is appropriate. The cost allocation could even be part of the bylaw proposal.22 Shareholders might decide that a bylaw allowing proxy access is a bad idea because of cost concerns. They can vote against the proposed bylaw. They would be the ones deciding who should bear the cost, not the SEC. Allowing these bylaw proposals allows for experimentation and tailoring to particular companies. It has a significant safety valve in that a majority (or supermajority) of shareholders would be needed for approval.23
Our roundtables addressed a number of other issues relating to the proxy and voting process that deserve attention and thought, perhaps in conjunction with questions about access to the proxy. In particular, issues such as broker voting, over-voting and under-voting, and shareholder communications (the "NOBO / OBO" distinction) all merit focus and improvement. There was also much discussion about precatory proposals. It seems to me that precatory proposals serve a useful purpose and should be retained. As we learned at the roundtables, they can lead to companies engaging with the proponents on the issues, and they do result in meaningful change.
Corporate governance changes in recent years seem to reflect a trend towards greater board accountability and shareholder participation. Proxy access should be part of this trend. It would promote accountability in a way that the current avenue for nominating directors does not. The Committee on Capital Markets Regulation, which made a number of recommendations concerning improving the competitiveness of U.S. markets, noted that "shareholders of U.S. companies have far fewer rights in a number of important areas than do their foreign competitors," and that this difference "creates an important potential competitiveness problem for U.S. companies."24 The Committee's report stated that the SEC should address and resolve "appropriate access by shareholders to the director nomination process."25 I think that access is appropriate. We have the most highly developed, sophisticated capital markets in the world. It is high time that we grant America's shareholders the protections under the federal proxy rules that they should rightly expect.
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publications or statements by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission, any other Commissioner, or the staff.
An example is the "withhold vote" campaign against Walt Disney’s former Chairman and CEO Michael Eisner.
See, e.g., Shareholder Proposals, 72 Fed. Reg. 43466, 43466 (Aug. 3, 2007), and Shareholder Proposals Relating to the Election of Directors, 72 Fed. Reg. 43488, 43489 (Aug. 3, 2007).
American Federation of State, County & Municipal Employees v. American International Group, 462 F.3d 121 (2d Cir. 2006).
17 C.F.R. § 240.14a-8(i)(8).
AFSCME, 462 F.3d at 129-130.
See Press Release 2006-150, U.S. Securities and Exchange Commission, Commission Calendars Proposed Amendment to Rule 14a-8 Governing Director Nominations by Shareholders (Sept. 7, 2006) available at http://www.sec.gov/news/press/2006/2006-150.htm.
A binding proposal at Hewlett-Packard Co. received 43% of the vote cast, a non-binding proposal at UnitedHealth Group received 45.3% support and an access proposal at Cryo-Cell International received majority support. See RiskMetrics Group 2007 Postseason Report: A Closer Look at Accountability and Engagement (Oct. 2007) at 16, available at: http://www.issproxy.com/pdf/2007PostSeasonReportFINAL.pdf.
Two others initially sought no-action relief but later withdrew their requests. See letters to Reliant Energy Inc. and UnitedHealth Group, Incorporated, noting the withdrawals of the no-action requests, available at: http://www.sec.gov/divisions/corpfin/cffreqreq.shtml.
See Letter from Ted Yu, Special Counsel, SEC, to Amy L. Goodman, Gibson, Dunn & Crutcher LLP (January 22, 2007) available at: http://www.sec.gov/divisions/corpfin/cf-noaction/2007/hp012207-14a-8.htm.
See Unofficial Transcript of the Roundtable Discussion on Proposals for Shareholders, May 25, 2007, comments of Leo E. Strine Jr., Vice Chancellor, Court of Chancery of the State of Delaware, at 112, available at: http://www.sec.gov/news/openmeetings/2007/openmtg_trans052507.pdf.
Comment letter on SEC File Nos. S7-17-07 and S7-16-07 from Knut Kjer, CEO, Norges Bank Investment Management, et al., Sept. 28, 2007, available at: http://www.sec.gov/comments/s7-16-07/s71607-499.pdf. See also, e.g., comment letter on SEC File Nos. S7-17-07 and S7-16-07 from Michael O’Sullivan, President, Australian Council of Super Investors, et al., Oct. 2, 2007, available at: http://www.sec.gov/comments/s7-16-07/s71607-445.pdf.
See Shareholder Proposals Relating to the Election of Directors, 72 Fed. Reg. 43488, 43491 (Aug. 3, 2007).
See Comment letter on SEC File Nos. S7-17-07 and S7-16-07 from Gerald W. McEntee, International President, American Federation of State, County and Municipal Employees, Sept. 28, 2007, at 4, available at: http://www.sec.gov/comments/s7-17-07/s71707-65.pdf. See also Unofficial Transcript of the Roundtable Discussion on Proposals for Shareholders, May 25, 2007, comments of Jill E. Fisch, T.J. Maloney Professor of Business Law, Fordham University Law School, at 92-93; comments of Donald C. Langevoort, Thomas Aquinas Reynolds Professor of Law, Georgetown University Law Center, at 95.
See Shareholder Proposals, 72 Fed. Reg. 43466, 43466-67 (Aug. 3, 2007).
15 U.S.C. §78n(a)
See, e.g., Comment letter on SEC File Nos. S7-17-07 and S7-16-07 from Gerald W. McEntee, International President, American Federation of State, County and Municipal Employees, Sept. 28, 2007, at 4, available at: ; see also comment letter on SEC File No. S7-17-07 from Peter H. Mixon, General Counsel, California Public Employees’ Retirement System, Sept. 27, 2007, at 3, available at: http://www.sec.gov/comments/s7-17-07/s71707-38.pdf. (generally agreeing with the principle that a shareholder should provide the information that would ordinarily accompany a proxy contest).
Christopher Cox, Chairman, SEC, Opening Remarks at the SEC Open Meeting (July 25, 2007), available at: http://www.sec.gov/news/speech/2007/spch072507cc.htm.
See Unofficial Transcript of the Roundtable Discussion Regarding the Federal Proxy Rules and State Corporation Law, May 7, 2007, comments of Leo E. Strine Jr., Vice Chancellor, Court of Chancery of the State of Delaware, at 79, available at: http://www.sec.gov/spotlight/proxyprocess/proxy-transcript050707.pdf (noting that allowing binding bylaw proposals that relate to an election process to go on the proxy would allow stockholder innovation and would be "giving life to the state law right").
See Unofficial Transcript of the Roundtable Discussion Regarding the Federal Proxy Rules and State Corporation Law, May 7, 2007, comments of Leo E. Strine Jr., Vice Chancellor, Court of Chancery of the State of Delaware, at 48-49, available at: http://www.sec.gov/spotlight/proxyprocess/proxy-transcript050707.pdf ("if the proxy proposals facilitated the presentation of bylaws that were company specific, then the stockholders could propose a reimbursement scheme if they liked. . . . The SEC would be facilitating the presentation of that without having to design a system.").
See Unofficial Transcript of the Roundtable Discussion Regarding the Federal Proxy Rules and State Corporation Law, May 7, 2007, comments of Jill Fisch, T.J. Maloney Professor of Business Law, Fordham University Law School, at 121-122, available at: http://www.sec.gov/spotlight/proxyprocess/proxy-transcript050707.pdf (noting that the courts and state legislatures provide additional safety valves).
Committee on Capital Markets Regulation, Interim Report (Nov. 30, 2006) at 93, available at: http://www.capmktsreg.org/pdfs/11.30Committee_Interim_ReportREV2.pdf
Id. at 106.