Alston & Bird llp
Via Electronic Transmission
On April 14, 2003, the Securities and Exchange Commission announced that it had directed the Division of Corporation Finance to formulate possible changes in the proxy rules and regulations and the interpretations of the Division regarding procedures for the election of corporate directors. We are writing to express our views as to the matters addressed herein. Please note the views expressed in this letter are those of certain partners of the Firm who have participated in the preparation of this letter and not necessarily the views of our clients.
The Division's review follows the Commission's confirmation that the current proxy rules permit the exclusion of a shareholder proposal (American Federation of State, County and Municipal Employees' Pension Plan (AFSCME) proposal to Citigroup Inc.) mandating shareholder access to a company's proxy materials in order to include shareholder nominations for the board of directors. Accordingly, many observers have assumed that the primary purpose of this review is to consider methods of granting shareholder access to companies' proxy materials.
Shareholder activists have advocated for years for direct shareholder access to the company's proxy materials for director nominations. We note that the Commission has received a large number of comment letters, and likely will receive considerably more comment letters, expressing views on both sides of this issue. It is not our goal in this letter to replicate any of the extensive historical, legal and policy arguments articulated in those letters, but we share the view of many others that there is currently no demonstrated need for direct access to the proxy materials in light of recent changes in the corporate governance landscape.
All shareholders have a right to make recommendations to public company boards or their nominating committees for director nominees, and public companies should support those efforts and provide reasonable access and assistance to facilitate shareholder submissions of recommendations for director nominees. However, these rights and obligations should not require a company to provide shareholders with open access to its proxy statement, with the result that director nominees who have been proposed by one or more shareholders, rather than through the company's nominating process, would be included in the company's proxy statement to run against the nominees selected through the company's official nominating process.
Providing shareholders direct access to a company's proxy materials for nominations not supported by the company's board of directors could create contested elections of directors within the company's own proxy statement. In contested elections, shareholders are best served by requiring contestants to comply fully with the proxy rules and send their own proxy statements and other soliciting materials to shareholders. This assures transparency in the election process and allows both sides to the contest to present their cases. Open access for nominations would essentially create a contested election environment on an annual basis for public companies. This would be terribly disruptive to the corporate governance process.
We would urge the Commission to give the renewed focus on corporate governance created by Sarbanes-Oxley and the new rules adopted by the stock exchanges, and currently awaiting action by the Commission, a chance to operate before making such a fundamental change to the director nomination process. The pending New York Stock Exchange rules, for example, would generally require listed companies to have nominating/corporate governance committees made up entirely of independent directors and require boards of directors to adopt written charters for those committees that would address, among other things, the committee's process for selecting or recommending director nominees. Such committees should be given the opportunity to act in light of the new rules and to adopt policies and procedures to meet the needs of their particular companies and shareholders.
Because of Sarbanes-Oxley and related rule-making, boards of directors are focused more than ever on their fiduciary duties and their new statutory and regulatory obligations. In the current environment, boards of directors will be even more responsive to input from shareholders on board nominations.1
Boards of directors and their nominating committees are, and will be, best suited to finding qualified candidates to serve as directors and to evaluating those candidates, including candidates recommended by institutional and other shareholders, in the best interest of all shareholders. Although in our view there is little justification for providing shareholders open access to companies' proxy statements, we believe that there are certain measures that the Commission could consider if it felt compelled to make changes in this area. These measures are described below:
A. Enhanced Disclosure of the Nominating Process
Shareholders are currently permitted as a matter of state law to make nominations for directors and, if they so desire, to submit nominations directly to the board of directors for consideration by the board or a nominating committee. The Commission's current rules acknowledge this latter process, providing in Item 7(d)(2) of Schedule 14A that "If the registrant has a nominating or similar committee, state whether the committee will consider nominees recommended by shareholders and, if so, describe the procedures to be followed by shareholders in submitting such recommendations." In many cases, this requirement is satisfied by boilerplate disclosure to the effect that the board maintains a nominating committee that will consider recommendations for director nominees submitted to the company's corporate secretary. In cases where shareholder nominations for directors must satisfy particular substantive or procedural requirements contained in the company's bylaws or other governing instruments, the company typically will include at least a reference to these bylaw requirements, although such a reference is not expressly required under the Commission's rules.
Enhanced disclosure of the board's director nominating process would encourage appropriate shareholder participation in the process. If the Commission believes that additional disclosure concerning the nominating process is necessary, the Commission might consider expanding the requirements of Item 7(d)(2) to require:
We would discourage at this point any requirement that a nominating committee be required to publish annual reports (in a manner similar to audit committee and compensation committee reports required by Items 306 and 402(k) of Regulation S-K). Although the Commission might consider a limited report, for example, consisting of mere statistical disclosure of whether the committee received any recommendations from shareholders and, if so, whether any of those recommended candidates were nominated, we are concerned that such a requirement to include disclosure of the basis for the committee's decisions would either degenerate to boilerplate or unduly politicize the process. We are also concerned that detailed disclosure about the committee's reasoning would be potentially embarrassing to those whose nominations were rejected by the committee, thereby discouraging the most qualified candidates from permitting their names to be submitted and potentially implicating privacy concerns of those recommended without their prior written consent.
B. Exemption for Schedule 13G Filers to Nominate an Unaffiliated Director
As discussed above, we have concerns as to the effects of providing direct shareholder access to the proxy statement for nominating directors. However, as the Commission considers changes to rules relating to the nomination process, one alternative the Commission might consider is to provide an exemption for institutional investors qualified to report beneficial ownership on Schedule 13G pursuant to Rule 13d-1(b), permitting them to recommend unaffiliated nominees to the nominating committee without losing Schedule 13G eligibility.
The Commission and the staff have long interpreted the phrase "purpose or effect of changing or influencing control of the issuer," as it applies Section 13(d) reporting and Schedule 13G eligibility, as broadly as possible to capture any activity that could arguably have an influencing effect on control of the company. This has included the view that even one director's seat has a controlling effect since the director can attend board meetings and is privy to all information about the company that the board receives. We believe, however, that the Commission might reconsider this view and consider permitting director recommendations by institutional investors, that can otherwise continue to certify as required by Item 10(a) of Schedule 13G that they do not hold their securities for the purpose or effect of changing or influencing control of the company, without losing their Schedule 13G eligibility.
In 1998, the Commission took a very important step toward increasing shareholder communication by adopting Rule 13d-1(h), allowing Schedule 13G filers who engage in control-related activities and, therefore, lose their Schedule 13G-eligibility, to switch back to Schedule 13G once they have ceased their control-related activities. The Commission adopted Rule 13d-1(h) in response to institutional shareholders' claims that the loss of Schedule 13G-eligibility "chilled" shareholder communications. At the same time the Commission adopted Rule 13d-1(h), the Commission provided interpretive guidance (in the form of a five-factor test) as to whether certain shareholder activities should be considered control-related activities, thereby jeopardizing Schedule 13G eligibility.
In light of the corporate governance changes required by Sarbanes-Oxley and the proposals of the exchanges with respect to nominating committees, there should be more willingness on behalf of nominating committees to consider recommendations of significant shareholders. Increased dialogue between a board of directors and significant shareholders would be a positive consequence of Sarbanes-Oxley and should be encouraged by the Commission. The Commission should consider providing, either through formal rulemaking or further interpretive guidance, a Schedule 13G safe harbor for large institutional investors making recommendations to nominating committees. The proposed safe harbor might be limited as follows:
II. ELECTRONIC VOTING INSTRUCTIONS
The Commission has encouraged use of electronic and telephonic means to enable record owners to vote their shares and to permit beneficial owners to direct their nominees how to vote. The availability and legal effect of electronic voting by record holders are primarily matters of state law. The use of electronic means to permit beneficial owners to direct their nominees how to vote their shares, however, is not governed by state law, but is a matter over which we believe the Commission may exercise its rulemaking authority under Section 14(b)(1) of the Securities Exchange Act of 1934.
It is our understanding that Automatic Data Processing, Inc. (ADP), the primary provider of computerized proxy vote tabulation services, does not provide electronic and telephonic voting instruction services for beneficial owners in connection with shareholder meetings at which dissidents have proposed a slate of directors or are otherwise contesting management proposals. We believe that beneficial owners should be able to direct their nominees in exercising their franchise in the most convenient methods possible. In contested situations of any significance, the inspector of elections is frequently an outside specialist and the process of certifying the vote is rigorous and subject to review by the company and the dissidents. Furthermore, electronic and telephonic voting are statutorily prescribed methods of voting in Delaware and many other states and should be available to beneficial owners, not just record owners. The fact that electronic and telephonic voting would be used in connection with many important non-routine matters such as mergers and charter amendments certainly indicates the widespread use and utility of electronic and telephonic voting. Accordingly, we suggest that the Commission should consider whether additional rulemaking or other initiatives should be undertaken to assure that electronic and telephonic voting instruction services are available to beneficial owners in contested election situations to the same extent as it is available to beneficial owners in uncontested elections.
III. NON-SHAREHOLDER INFLUENCE
Voting advisory services, such as Institutional Shareholder Services, Inc. ("ISS"), have tremendous influence in connection with matters presented for shareholder vote. In this regard, we note the June 6, 2003 article on page A-1 of The Wall Street Journal concerning ISS's governance scoring system as evidence of the keen interest marketplace participants have in the activities of voting advisory services such as ISS. It is generally recognized that a substantial number of customers will follow the recommendation of voting advisory services in connection with a particular vote. Furthermore, we believe that once public disclosure is made of a voting advisor's position with respect to a particular proposal, the voting advisor's position may have a derivative effect in that shareholders who are not customers of that voting advisory service nevertheless may follow its recommendation. In many cases, recommendations of voting advisors are outcome determinative. As part of an overall theme of greater transparency in connection with corporate governance concerns generally, the Commission should review the impact that voting advisors have on the voting process, the processes by which, and the information upon which, they develop their recommendations, and any conflicts of interest that arise out of their different lines of business.
We appreciate the opportunity to submit this letter and look forward to a concept release and eventual rule-making proposals.
cc. William H. Donaldson, Chair