Council of Institutional Investors
May 10, 2003
Re: File No. S7-10-03
Dear Mr. Katz:
The Council of Institutional Investors, an association of more than 130 corporate, public and union pension funds collectively holding more than $3 trillion in pension assets, commends the Securities and Exchange Commission for its decision to review the proxy rules and regulations. A review of these important issues, coming as it does on the heels of the Commission's Herculean efforts to implement the Sarbanes-Oxley Act, shows both a genuine commitment to investor interests and personal courage. This is the missing piece that is needed, not just to restore investor confidence but, in fact, to clean up our financial markets.
Council members have long been at the forefront of corporate governance issues. They have consistently pressed for reforms to improve shareholder rights and strengthen corporate governance standards for U.S. companies. They have also consistently called for changes to rules that aren't providing adequate protections for investors or ensuring full and fair disclosure of critical information to investors.
Council members agree that it is time for the SEC to review the current proxy rules and regulations and to modernize them to reflect current market conditions and to correct past problems. We believe several issues warrant close attention.
First, the Council believes that the single most important reform is to give shareholders more of a voice regarding who represents them on corporate boards. The Council believes that reasonable access to company proxy cards for long-term investors to nominate candidates for directors would substantially contribute to the health of the U.S. corporate governance model and U.S. corporations by making boards more vigilant about their oversight responsibilities.
The cornerstone of our private sector is the concept that wealth is maximized when owners control-maintain and care for-their own property. Car owners maintain their cars better than car-renters, whether or not they are car experts. But, at publicly traded U.S. companies, this function is not working.
It is clear why the current system is not working. In theory, shareholders are given the right to select individuals to oversee the company on their behalf. This delegation of oversight authority is necessitated by the fact that there are simply too many shareholders at most publicly traded companies for shareholders to oversee managers themselves.
However, current regulations prevent shareholders from exercising this important right. Indeed, current regulations largely prevent shareholders from having any meaningful input at all. Boards of directors, all too often dominated by management, select the director candidates. Shareholders have no meaningful opportunity to suggest alternate candidates. Management's proxy card includes just enough candidates to fill the open board seats.
Shareholders can now only recommend their own candidates by launching an expensive and complicated proxy fight. And while companies can freely tap company coffers to fund their campaigns for the board-recommended candidates, shareholders must spend their own money to finance their efforts. And companies often erect many obstacles, including expensive litigation, to thwart investors running proxy fights for board seats.
We cannot expect our economy to be the dominant force it has been if we allow rules like this to stand. All great civilizations have eventually fallen-and they fall when special interests pervert the mechanisms that had made the society great. If we do not let shareholders act like owners, rather than just buyers and sellers, of the biggest employers and wealth creators of our private sector, we cannot expect to have as bright a future as we have had a past. Despite all the details that swirl around these issues, it is really that simple.
The issue of shareholder access to management proxy cards has been around for decades. The SEC first considered the issue in 1942, when it proposed giving shareholders access to nominate director candidates.
In the 1970s, in response to a series of corporate scandals and several highly publicized bankruptcies, the SEC solicited comments and held hearings on corporate governance issues, including shareholder communications and shareholder participation in the corporate electoral process. The Business Roundtable responded to the SEC request by expressing support for the equal access concept and recommending that "the SEC should adopt, if necessary, amendments to Rule 14a-8 that would permit shareholders to propose amendments to corporate bylaws which would provide for shareholder nominations of candidates for election to boards of directors."
The Council believes it is time for the SEC to act on this important, and long overdue, reform.
Second, we believe enhanced shareholder access to management's proxy cards must be carefully structured to ensure that such a mechanism would not impose unnecessary costs or burdens on companies and not be used for change-in-control purposes.
There are models in our democracy that provide some guidance here. Citizens largely delegate government authority to elected officials, as they should. But citizens retain the ability to put initiatives on public ballots if enough citizens sign petitions to support placing the issue on the ballot. Currently, candidates for corporate boards are almost never selected by shareholders; there needs to be an initiative-like mechanism that would allow a substantial number of long-term shareholders to select one or more directors to be their eyes and ears on the board.
This process needs to be established in a way that avoids undue disruption and cost and prevents abuses by shareholders. The Council believes it is possible to define a process, complete with necessary hurdles (a certain percentage of shareholders supporting the inclusion of a candidate or candidates is just one example), that facilitates the nomination of one or more shareholder-selected directors.
The Council's policy on access issues addresses these concerns by recommending that:
Companies should provide access to management proxy materials for a long-term investor or group of long-term investors owning in aggregate at least 5 percent of a company's voting stock to nominate less than a majority of the directors. Eligible investors must have owned the stock for at least three years. Company proxy materials and related mailings should provide equal space and equal treatment of nominations presented by qualifying investors.
Contests for corporate control are another matter. They are currently governed by complex rules that are justified as investor-protective. There is little doubt that any director-selection process that has the potential to shift corporate control needs to be governed differently than processes that can only result in shareholders having their own eyes and ears on a board. Whether the current control contest regulations unduly burden the dynamic and continual modernizing that our markets are supposed to allow is a complex question, and one on which there is a lot of anecdotal and statistical information. The Council would be happy to work with the Commission to collect this information to ensure that any changes in the regulations in this area properly balance competing interests.
Third, the SEC needs to review and modernize the 13D filing requirements to ensure that the rule applies only to an investor or group of investors attempting to truly change the control of a company.
The Council agrees that a shareholder or group of shareholders attempting to change the control of a company should be subject to the SEC's more stringent 13D disclosure requirements. However, the Council does not believe that 13D requirements should be tripped in situations when investors are merely seeking minority representation on a board.
The Council believes that any new access mechanism should expressly provide 13D relief for any investor or group of investors suggesting an alternative to certain of management's hand-picked candidates.
And regardless of whether the SEC proposes an access mechanism, the Commission needs to update the 13D rules to ensure that the intent of the 1992 changes to shareholder communications rules can be fully realized. In particular, the SEC needs to amend the 13D rules to expressly provide relief for certain non-control activities. Otherwise, shareholders will remain passive captives of management, unable to have their voices heard-as management disregard of the passage of non-binding proposals clearly evidences.
While the 1992 rule changes, endorsed by the Council, relaxed the communications rules for situations when shareholders are not seeking proxy authority or are not attempting to change or influence the control of the company, they failed to provide concurrent 13D/G relief for many of these situations. This failure has created some gray legal areas that have hampered the full effectiveness of the intent of the1992 rule changes.
The Council urges the SEC to consider amending the rules to clarify that the 13D/G regulatory scheme is intended to only capture shareholders or groups of shareholders who intend to change or modify control of a public company, either through a tender offer or a proxy contest for board control. The SEC should create a safe harbor for the following activities: "short slate" campaigns that do not constitute a majority of the board and "just vote no" efforts in which shareholders urge other shareholders to simply withhold votes from directors.
Fourth, the Council believes that to ensure that shareholders have a meaningful opportunity to vote on directors, broker votes should be prohibited on contested and uncontested elections of directors.
Currently, the New York Stock Exchange allows companies to stuff the ballot box for management-nominated directors by allowing brokers to vote on uncontested elections of directors. Under the NYSE's "10-day rule," adopted in 1937, brokers may vote on certain proposals if the beneficial owner hasn't provided voting instructions at least 10 days before a scheduled meeting. These broker votes are always cast in favor of management.
The exchange justifies this unfair system by claiming that these proxy items are "routine." However, if investors have learned anything in the wake of the recent extraordinary corporate scandals and market collapse, it's that the election of directors is hardly a "routine" matter. Indeed, it may be the single most important vote cast by shareholders.
The Council believes this rule-now more than 60 years old-is out of date and unfair to shareholders, and we have repeatedly called on the NYSE to repeal it. The Council believes that there is no public policy justification for the current "broker may vote" policy.
Fifth, the Council believes that the shareholder proposal rules should be updated to streamline the process for companies, shareholders and the SEC.
While there are, no doubt, strongly different views on how director elections should be regulated, there is probably general agreement that the shareholder proposal process is in desperate need of repair.
The Council believes that over the long term, the need for shareholder proposals may decline if shareholders have meaningful ways to communicate with independent directors and the securities rules are amended to facilitate shareholder nominations of independent directors. But in the meantime, shareholder proposals continue to be an important mechanism for investors to communicate with companies and with other shareholders. It's time to review and modernize these rules.
One area worthy of consideration is the "ordinary business" exemption, which the Council believes has been used too often to exclude resolutions addressing important and longstanding public policy issues.
Another area ripe for review is the requirement that proponents must attend annual meetings to introduce their resolutions. Current rules don't require company executives or directors to attend the annual meetings to present management proposals. Why should shareholders be held to a higher standard?
The Council supports changing the rules to eliminate the "ordinary business" exemption, a reform suggested in September 2002 by former SEC chairman Harvey Pitt, and it would support other changes to improve the shareholder proposal process.
Finally, it's time for the SEC to improve the disclosure requirements regarding director relationships, executive compensation and director compensation.
The recent corporate scandals have highlighted the importance of truly independent directors and the need for improved disclosure of executive and director pay details. Unfortunately, the current disclosure rules are lacking in these areas.
Since basic, yet material, information about director relationships doesn't have to be disclosed, shareholders cannot assess the independence of directors serving on the boards of companies. And in the decade since the SEC last amended the compensation disclosure rules, compensation practices have changed dramatically, and it's increasingly difficult for shareholders to understand how much an executive or director is paid. It's time to for the SEC to review and modernize the current disclosure rules.
In October 1997, the Council submitted to the SEC a rulemaking petition requesting an amendment to paragraph (d) of Item 401 of Regulation S-K to require company disclosure of "personal, professional and financial relationships" between directors and top management. Recognizing that personal relationships may be too difficult to depict clearly in regulatory language, the Council amended its petition language in October 1998 to require disclosure of "familial, professional and financial relationships."
The Council urges the Commission to act on the Council's rulemaking petition.
Reforms designed to help investors have a meaningful role in the governance of the companies they invest are long overdue. The Council has repeatedly called for these changes. And so have other investors, including Warren Buffett and Jack Bogle, who have called on large shareholders to get more involved in governance issues. It's time for the SEC to move forward to enable shareholders to act like the owners that they are.
The Council appreciates this opportunity to comment. Please contact me or Ann Yerger with any questions.