Georgeson Shareholder Communications Inc.
By Electronic Delivery
May 22, 2003
Re. File No. S7-10-03
To the Commission:
The Securities and Exchange Commission (the "Commission") has instructed the Division of Corporation Finance to "examine current proxy regulations and develop possible changes to those regulations to improve corporate democracy." In response to this broad mandate, Georgeson Shareholder Communications Inc. ("Georgeson Shareholder") is pleased to submit these comments and recommendations.
Georgeson Shareholder is the country's oldest and largest firm specializing in proxy solicitation, corporate governance consulting, mergers and acquisitions, corporate control transactions and shareholder response services. For nearly 70 years the firm has worked closely with issuers, directors, shareholders (including institutional investors, retail investors, arbitrageurs and other Wall Street professionals), stock exchanges and regulators. With offices in nine countries, we work on engagements involving more than 1,000 companies annually. In addition to providing strategic advice and services to corporate clients, we are experts in the operations and back-office procedures that support the U.S. system of disclosure and proxy voting.
For many years Georgeson Shareholder has been a "thought leader" on matters of corporate governance and proxy regulation. In this role our objective has always been to help maintain a properly balanced system that protects the investing public, ensures a level playing field for control transactions, provides effective means of dispute resolution and fairly distributes power among managers, directors and shareholders. While we are committed to work within whatever regulatory requirements govern our services, we urge the Commission to carefully consider the practical and operational consequences of any proposed reforms.
We believe that the U.S. system of corporate governance is operationally the most efficient in the world. Nevertheless, a thorough review is timely. The bubble market collapse, corporate malfeasance and the regulations promulgated by the Sarbanes-Oxley Act raise important questions about the corporate governance infrastructure. The Commission's investigation provides an opportunity to clarify the rights and powers of shareholders, eliminate conflicts, reduce costs, make more effective use of technology and realign the proxy system to better serve the current needs of issuers and investors.
I. Shareholder proposals.
We believe that amendments to Rule 14a-8 are overdue. We recommend that the Commission revisit the proposed amendments set forth in SEC Release No. 34-39093, dated September 18, 1997. The innovative proposals in that release were not given due consideration at the time because of a highly emotional and politicized campaign against them. Reconsideration of those proposals should receive a different response today.
Specifically, we recommend the approach set forth in the article, "Ending the Stalemate: Taking a Look at the SEC's Latest Shareholder Proposal Release," attached as Exhibit 1. As discussed there, we recommend (1) that resubmission thresholds for shareholder proposals should be calculated as a percentage of outstanding shares (rather than as a percentage of votes cast) and (2) that resubmission thresholds should be increased. We suggest a resubmission threshold of 5% of outstanding shares for the first subsequent year, 10% for the second year, 20 % for the third year, 40% for the fourth year and a majority of outstanding shares thereafter. This up-or-out approach would reduce the use of corporate proxy statements as a billboard for special interests unless their proposals truly reflect the interests of the shareholders generally.
We recommend the adoption of an override mechanism to balance higher resubmission thresholds. Shareholders representing no less than 5 % of a company's outstanding shares should be empowered to override the exclusion of shareholder proposals under sections (i) (4), (i)(5) or (i)(7) of Rule 14a-8. In effect, shareholders could compel companies to include proposals excludable under these sections by demonstrating that a significant percentage of the company's investors endorses them. The same proposals could continue to be submitted through the override mechanism in subsequent years but only if the higher resubmission thresholds were achieved.
In addition to higher resubmission thresholds and an override, we recommend that Rule 14a-8 be amended to consolidate the interpretive questions that arise under section (i). We recommend that exclusions (i)(4) (personal grievance; special interest), (i)(5) (relevance), and (i)(7) (management functions) be consolidated into a single exclusion drafted along the following lines:
Admittedly, such a consolidation would not eliminate the difficult judgments that must be made by the staff in deciding whether the subject matter of a proposal is appropriate or relevant. However, the override provision would lessen the make-or-break impact of the staff's decisions. Where proponents could demonstrate threshold support for a proposal at the time of its submission, staff review could be avoided altogether.
The adoption of higher resubmission thresholds for shareholder proposals, the creation of an override mechanism and consolidation of exclusion provisions would have several beneficial effects. First, these reforms would shift greater responsibility to shareholders for screening proposals and deciding whether they are important enough to merit inclusion in proxy statements. Second, they would eliminate the trivializing effect of repetitious proposals whose support peaks at relatively low levels. Third, they would reduce demands on the Commission staff to review and adjudicate the merits of proposals.
Operationally, these reforms would lead to the development of a new and largely unregulated intermediate stage in the shareholder proposal process during which shareholders would conduct informal straw polls and negotiate among themselves to prioritize and assemble support for proposals. The Internet would most likely be the preferred medium for this activity.
The Commission should ensure that these activities would not violate the proxy rules or trigger 13(d) group reporting requirements.
We do not believe these reforms would be harmful to the interests of small investors. The Internet now provides individuals and special interest groups with a powerful tool to promote their proposals and to enlist support from other investors. If a small shareholder's proposal truly represents the interests of shareholders, it stands the same chance of success as an institutionally-sponsored proposal.
II. The corporate director nomination process.
We do not believe that shareholders should have the power to unilaterally use a company's proxy statement for director nominations. The legal problems with such an arrangement have already been well documented. In addition, we are concerned that the ability of companies to attract capable directors would be adversely affected by adversarial or competitive annual election campaigns.
Despite these objections, we share the Commission's concern that director nominations and the proxy process are perceived as closed, self-perpetuating systems. We share investors' concern that our system of corporate democracy inhibits directors from communicating with the constituents who elect them. We sympathize with the demands of shareholders for more information about boardroom policies and decisions.
We believe that new procedures can be introduced to deal with these problems. Specifically, we recommend that the Commission require the regulated stock exchanges to introduce new listing standards relating to the nomination of directors. The new standards would require the board to open the nominating process to a qualified shareholder or group representing 10% or more of a company's outstanding shares owned for no less than three years. If more than one shareholder or group qualified, the one representing the most outstanding shares would prevail.
The "qualified shareholder representative" would work directly with the nominating committee of the board in proposing nominees, negotiating for the selection of favored candidates and commenting on the qualifications and suitability of incumbents. Precedents for shareholder participation in director selection can be found in situations such as the Lockheed proxy contest against Harold Simmons in 1990 and the role of the equity committee in the Texaco reorganization in 1988. Another case worth examining would be the special arrangement for a labor union representative on the board of Chrysler Corporation in consideration of its government loan in 1979.
The qualified shareholder representative's role would have to be carefully structured to avoid triggering section 13(d) group reporting requirements and section 16 insider status.
Shareholder participation in the deliberations of the nominating committee would open a window into the boardroom, promote dialogue between shareholders and the board, provide access to information about board decision-making and increase boards' understanding of shareholder perceptions and concerns.
III. Discretionary broker voting and shareholder disclosure.
With respect to the solicitation of proxies for the election of directors and other management proposals, we make the following recommendation. If the New York Stock Exchange decides to further restrict or eliminate discretionary broker voting under Rule 452 (the "10-day rule"), the Commission should adopt regulations granting issuers direct access to beneficial owners of securities in broker name.
The issue of discretionary broker voting has been raised repeatedly by the Council of Institutional Investors (CII). CII criticizes the 10-day rule for inflating the vote in support of management. In fact, the issue is far more complex. The 10-day rule is not a ballot-stuffing device. It is a means of compensating for issuers' inability to communicate with shareholders whose identity is hidden behind custodial barriers.
The debate over discretionary broker voting points directly to a conflict that arises from the securities laws' competing goals of (1) protecting investor privacy and (2) requiring disclosure by issuers to all shareholders. Investor privacy protections create serious practical obstacles when issuers attempt to fulfill their disclosure obligations. In fact, the proxy system's cumbersome daisy-chain structure that governs the transmission of disclosure documents and voting instructions through successive layers of custodians and agents is a direct result of these conflicting goals. A partial effort to deal with this conflict in 1983 gave rise to the NOBO/OBO system, which further increased the proxy system's complexity and costs without providing as much ownership information as expected.
We recommend that the Commission look for ways to simplify the complex infrastructure of proxy communications. Direct access to street name accounts would allow companies to bypass intermediary layers and communicate directly with beneficial owners or their designated decision-makers. In addition to eliminating procedural steps and reducing costs, direct access would permit greater use of electronic technology to streamline the transmission of disclosure documents and voting instructions.
The privacy of small investors would not be compromised by direct access. They would still be free to register shares in nominee or trust accounts to conceal their personal identity.
With respect to institutional investors, a direct access system would be much more controversial but not operationally difficult. Institutional investors might be willing to voluntarily disclose to issuers on the record date their share holdings and voting arrangements. Further, they might agree to reveal to issuers how their shares are distributed among custodians and other agents in order to facilitate development of the long-sought system of end-to-end electronic vote confirmation. Access to this type of information was granted on a confidential basis by six global institutional investors participating in a recent study of cross-border voting sponsored by the International Corporate governance Network. The study is available at www.icgn.org. A survey of institutional investors would be useful to ascertain their willingness to consider such disclosure.
The difficult questions surrounding institutional investor disclosure and voting have been debated recently in connection with the Commission's new rules mandating public disclosure of votes by investment managers. We urge the Commission to continue the discussion and to look for practical solutions that would increase the efficiency of the proxy system, reduce costs and still provide suitable levels of protection for institutional investors.
IV. Takeovers and corporate democracy.
No discussion of governance reform can ignore the closely related topic of takeovers and control bids. The U.S. governance system is unique in its heavy reliance on takeovers as the ultimate accountability mechanism. Consequently, at the heart of many governance controversies is a philosophical disagreement over the proper role of takeovers, particularly hostile cash tender offers.
We have lived with this disagreement for 35 years, since passage of the Williams Act in 1968. In the Williams Act Congress took a hands-off approach to cash tender offers, largely ignoring control implications, permitting coercive tactics and depriving shareholders of a vote on the merits of the bid. This was done in the name of market efficiency and free market purity. Although amendments (plus the creation of "poison pill" shareholder rights plans) have mitigated many abuses, the Williams Act is still inconsistent with the most fundamental principle of corporate democracy - the right of shareholders to vote on matters that affect the value of their investment.
Resolving conflicts between the proxy rules and tender offer regulations is beyond the scope of the Commission's current deliberations. Nevertheless, it is important to bear in mind the degree to which takeovers polarize relations between issuers and investors and color their attitudes toward governance reform. Managers and directors often think shareholders want nothing more than to facilitate a quick sale of the company and collect a takeover premium. Shareholders in turn worry that managers are intent on self-entrenchment without regard to performance or shareholder value. Such high levels of mistrust leave little room for discussion, much less collaboration.
Over the long term, the Commission may wish to examine whether takeover regulation should be consistent with our system of corporate democracy. In light of the problems at Enron, Tyco, WorldCom and other serial acquirers, the Commission might well consider whether shareholders of both target and bidding companies should have voting rights on takeover bids. The response of investors to such a proposal would be revealing. They would have to decide which matters most, short-term profit or governance integrity.
We encourage the Commission to consider regulatory reforms that simplify proxy operations, improve communications and encourage collaboration between issuers and shareholders, and we are committed to assist the Commission with this process.
We are prepared to discuss these matters with the Commission and the staff at any time. Please feel free to contact the undersigned by email or telephone. You may also contact my colleagues, Bruce H. Goldfarb, Senior Managing Director and General Counsel (212-440-9829, firstname.lastname@example.org) or David S. Drake, Managing Director (212-440-9861, email@example.com).