Gary K. Duberstein
455 East 86th Street
New York, NY 10028
June 12, 2003
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: File No. S7-10-03
Possible Changes to Proxy Rules
Dear Mr. Katz:
I applaud the Securities and Exchange Commission (the "SEC") for undertaking a broad reaching review of rules governing proxy solicitations and related matters. As a practitioner in this area for over twenty years and a founder of activist investor Greenway Partners and the Corporate Governance Advisor, I have been involved in many proxy contests for the election of directors, solicitations for shareholder proposals, and corporate governance matters. A fair proxy system designed to effectively reflect the will and record the votes of shareholders for the election of directors and the consideration of proposals cannot help but be the bedrock of effective corporate governance. The SEC rules that seek to accomplish this can be made better-and now is definitely the time to do so.
Effective corporate governance should be fair in principle, fair in practice, and perceived as fair by investors
In the face of recent scandals, the need for effective corporate governance has moved to the forefront. Effective corporate governance should be fair in principle, fair in practice, and perceived as fair by investors. The same principle that governs our nation and pervades the public perception of fairness applies to effective corporate governance: checks and balances. While a Chief Executive Officer and other members of management actually operate a company day to day, they are answerable to directors who are vested by corporate law with the power of managing the corporate enterprise. In turn, the directors are answerable to shareholders who own the company.
But the practice and perception of corporate elections do not live up to the principle. In practice, boards easily perpetuate themselves through control of the nominations process. As we all know, the slate chosen by the board runs unopposed virtually all the time-even at companies with pervasive problems. A shareholder's electoral "choice" is to vote "For" the board's nominees or display a gesture of pique with no real legal significance by checking the "Withhold" box. This smacks of one party rule far afield from the principle of checks and balances.
Although recent reforms contained in the Sarbanes-Oxley Act of 2002 and new listing requirements (the "Reforms") stressing, among other things, director independence and process, are a welcome step, the Reforms do not address the fundamental flaws in the corporate electoral process. Until the proxy voting system is fixed such that CEOs and directors perceive that they face effective shareholder scrutiny that can lead to the loss of their positions in the absence of a hostile takeover, until that time, I believe the CEO will still be the dominant, if not controlling voice on the board at most companies. And, the board will continue to control the nominations process.
The proxy system should make it easier for institutional shareholders to become actively involved in choosing nominees
The remedy to the problem of the self-perpetuating board lies in making the policy decision to empower and encourage shareholders to become more active in corporate elections. Of the various components of the shareholder universe, institutional shareholders are uniquely situated to make a difference if the rules are amended to encourage their participation. At present, proxy contests for election of directors are time-consuming and expensive because of the need to prepare and file a full proxy statement that may go through a number of iterations during SEC review-while those costly legal meters are ticking. In addition to high legal expenses, there is the cost of printing and mailing a proxy statement and proxy card which can add up in a large company with tens of thousands of beneficial owners. A small shareholder by definition would not have enough invested in a single company to justify the expense of a proxy contest or the know-how to navigate the proxy rules. A few "brave" private investors of means may concentrate sufficient resources and time on a single issuer or so, but there are few such private investors and so many companies. That leaves institutional shareholders-pension plans, mutual funds, and money management firms-many of whom own significant positions through indexing or other strategies that now cut a wide swath of ownership across virtually all of corporate America.
Under the present rules, institutional shareholders seldom instigate proxy contests for election of directors. But, changes in the proxy rules in 1992 to facilitate communications among institutions and allow solicitations for shareholder resolutions without pre-filing requirements led slowly over the past 10 years to increasing numbers of shareholder proposals filed by institutions and institutional support for them. In 2003, the recent scandals have seemingly opened the floodgates, with record numbers of proposals and support. All of which leads to the belief that if the proxy rules governing elections of directors are similarly changed to satisfy certain practical concerns, presumably more institutions will become involved.
At the risk of generalizing, institutional shareholders act understandably conservative because of their fiduciary duties and, depending on the institution involved, the aversion large bureaucracies have to deviating from a perceived norm. In my opinion, they will not become active in selecting nominees unless they can do so in a cost effective manner that has straightforward simple filings. In practice that means the ability to name nominees in management's proxy statement by a shareholder or group of shareholders holding a large block of stock. In addition, institutional shareholders must be assured that championing nominees will not subject them to filing requirements under Section 13(d) of the Securities Exchange Act of 1934 (the "Exchange Act") or to potential liability under Section 16(b) of the Exchange Act through a theory of deputization if their nominees are elected.
Allow long-term holders of 3% or more to nominate directors in management's proxy statement
I subscribe to the threshold suggested by the AFL-CIO1 that a nominating shareholder group ("Nominating Group") should own a minimum of 3% of the outstanding shares.2 I would satisfy long-term ownership thresholds by requiring ownership for a minimum of one year of the lesser of (i) a majority of the shares owned by the Nominating Group at the time of submitting the nominations to the company, and (ii) 3%. The SEC should promulgate a straightforward form that a Nominating Group could fill in and submit to the company setting forth background information about the proposed nominees, share ownership of the nominees and Nominating Group, and up to approximately 2,000 words as a policy statement (the "Nominee Form"). The mantra should be to keep the form simple so that the Nominating Group can easily fill it in and have the Nominee Form appear verbatim in management's proxy statement. In an ideal world, the SEC would not even have to preliminarily review such proxy statements that would be prepared and mailed at the company's expense.
The Nominee Form would have to be submitted to the company no later than 30 days before the date of the company's proxy statement released to shareholders in connection with the previous year's annual meeting. As is presently the case for shareholder proposals, the company's proxy statement should set forth the deadline for submissions of a Nominee Form for the following year. A company should be required to post on its web site, press release and file with the SEC under cover of a Form 8-K at least 15 days prior to that deadline the number of directors to be elected at the upcoming meeting.
The AFL-CIO and other commentators lining up in favor of shareholder access have limited the number of their nominees to ensure that this access provision cannot result in non-incumbents acquiring majority control of a board. On a philosophical level, I oppose that restriction and would urge that a Nominating Group should have the right to designate for any meeting up to that number of nominees as the company names. Remember, that in a crucial change from the present system, a nominee would not automatically become a director. The subsequent shareholder vote would have meaning and substance. Shareholders would have a real choice, and if the owners of a company by majority vote approve a change of control of the board in a fair election, so be it.
Competing nominees on one proxy card would allow shareholders the choice of ticket splitting their vote among candidates selected by management and candidates selected by a Nominating Group
Moreover, having truly competing slates of nominees on the same proxy card opens up a whole new dimension to corporate governance-ticket splitting. A shareholder would be able to vote their shares for individual directors with, for example, some chosen from management's slate and others from the challenger's slate.3 Therefore, even in situations where an entire board as opposed to a "staggered class" is up for election, the choice confronting shareholders is no longer to support all incumbents or all outsiders. One can imagine situations in which shareholders may want to add one or two new voices to a board, but not support wholesale change. Nominees receiving the highest number of votes for the open seats win. What emerges would be a board with a true mix of ideas. With the actual debate that differences of ideas brings, this veritable congress in the board room would be perceived by shareholders as the product of a fair corporate electoral system.
Despite faith in the good judgment of shareholders and the impact of ticket splitting, on a practical level, I realize that it may be prudent to begin this "experiment in corporate democracy" at an introductory level of allowing a Nominating Group to name nominees for less than a majority of the board. Of course, such restriction would have practical application only for companies that elect their entire boards annually. For staggered boards, the Nominating Group could field a full slate if it so chooses because even the successful election of an entire single class of directors would not cause a change of board control.4
The AFL-CIO also has suggested that in the "relatively unlikely" case of multiple Nominating Groups, the one with the most shares would have the sole right of shareholder access to management's proxy statement. Admittedly, that approach does have the advantage of administrative ease. While agreeing that the scenario of multiple Nominating Groups is unlikely given the high shareholding thresholds involved, I believe a fairer rule would be to allow all qualifying Nominating Groups to name nominees. In those relatively few instances, there simply would be a somewhat larger proxy statement and card with more nominee choices for shareholders.
Besides relying on its information in management's proxy statement, the Nominating Group, at its initial expense, could prepare additional solicitation materials and they could enclose a duplicate of management's proxy card that names all candidates. These additional materials would be filed with the SEC either on the day of first use or not later than three days thereafter as would be the general case for additional materials sent in support of a shareholder proposal. Consequently, they would be available to all shareholders on the SEC website. Under the present system, management has full access to the corporate treasury to pay for the campaign of the incumbents who may have little if any capital invested and truly at risk in the company. It would be entirely justifiable for a major shareholder group to have their entire expenses for additional solicitation materials similarly reimbursed by the company. Alternatively, the Nominating Group could be required to pay some percentage in the spirit of a "co-pay" to head off any argument of abuse.
As alluded to above, discussions or an agreement among shareholders for purposes of choosing nominees should be exempt from triggering any filing requirements under Section 13(d). Also, participation in such discussions or agreement should not cause a loss of eligibility to file a Schedule 13G. The rationale for not requiring special filings on a Schedule 13D is that the market will be informed through the filed management proxy statement itself of the identity and shareholdings of the Nominating Group. Before the proxy statement is publicly available, the fact of the filing of a Nominee Form should be an optional disclosure on the part of the company and the Nominating Group because-as is often the case in the shareholder proposal world-a compromise might be reached and the Nominating Group may withdraw the filing.
Champion the elimination of age discrimination against nominees who may be older, as well as wiser
If they choose to run nominees, institutional shareholders may search for "wise men and women" who have the experience and time for modern board service post-Sarbanes-Oxley. Likely candidates include retired executives. It is unfortunate that many companies have enacted mandatory retirement provisions set at or around 70 years of age. While this may have been designed as a graceful way to retire long serving directors and bring in fresh blood, it smacks of age discrimination and an unwarranted restriction. After all, SEC Chairman William Donaldson is 72 and Federal Reserve Chairman Alan Greenspan is 77. The SEC should consider if it can do anything in this area, even if it is to "jaw-bone" companies and state legislatures to take appropriate action.
As we are trying to make corporate elections more like political ones, I have always been struck by the note to the anti-fraud rule stating that claims regarding the "results of a solicitation" may be actionable. Reporters always ask politicians how the vote is going, they all predict victory, and the electorate knows enough to discount the prediction. Rather than have both sides and their lawyers squirm at the inevitable question and answer before a shareholders meeting, I suggest that the note be deleted and faith placed in shareholders.
If the proxy rules are changed to allow for the naming of management nominees and Nominating Group nominees on the same proxy card, the SEC should harmonize its rules to allow for that procedure in all election contests, including those in which a non-management group is required to file its own proxy statement. The non-management group should give timely notice of their nominees to the company so there can be a unified proxy card.
Also, the SEC should prioritize its resources and consider whether it should require the filing of preliminary proxy statements for prior review in any contested election situation. The 1992 proxy rule amendments provided that additional proxy materials disseminated after the proxy statement in a contest no longer had to be filed on a preliminary basis. The SEC should consider applying that rule to the proxy statement itself. If something truly objectionable were found in a proxy statement, the SEC could always require curative disclosure as it may for additional proxy materials and cash tender offer documents, which also are not subject to preliminary filing and review requirements.
Eliminate the "ordinary business" exemption and shorten the lead time for submission of shareholder proposals
In your review of the existing shareholder proposal structure, I highlight the desirability of eliminating the "ordinary business" exemption and the need to shorten lead times for submission. As many have noted, the concept of "ordinary business" is too amorphous and has been used by companies to eliminate proposals dealing with important public policy issues. In practice, yesterday's "ordinary business" often becomes tomorrow's front page policy questions. In any event, far too much SEC and company time is consumed because of the existence of the "ordinary business" exemption. Apart from the problems of definition, I fail to see the harm to a company of including and voting on a 500 word submission involving "ordinary business". Managements might even pick up a good idea from shareholders concerning their "ordinary business". Dealing with shareholders in this manner and allowing them some collective voice once a year is just a cost of doing business-and in today's world, a fairly minor cost for most companies.
In our fast changing world, it makes little sense to require a proponent to submit its shareholder proposal some 120 days before the expected date of the proxy statement (which generally translates to five months before the Annual Meeting!). This time period is especially troublesome to proponents who submit proposals designed to enhance shareholder value. A company's prospects and the environment in which it operates can change so much between the date of submission and the date of the company's proxy statement, let alone the state of affairs during those few days before the annual meeting when voting decisions are actually made.
I believe that the entire shareholder proposal submission process can be telescoped into the 45 days prior to the expected date of the company's proxy statement. A proponent's submission should be delivered to the company 45 days prior to the expected date of its proxy statement. Surely that 45 day period is more than ample for a company to respond to a shareholder's 500 word proposal and supporting statement. If the company alleges it can omit the proposal, it should file its reasons with the SEC and the proponent not more than 20 days after receipt of the proposal. The SEC would than have 25 days to decide the company's challenge. A company which challenges a proposal should prepare a possible response for inclusion in its proxy statement-which is normally not more than a printed page or two-some time during the 45 day period in the event its challenge to the SEC is unsuccessful.
Allowing companies under the present rule 40 days to submit challenges (if any) to the SEC over a mere 500 word proposal is an unreasonably long period. Indeed, companies have long been able to prepare entire quarterly reports within 45 days and are expected under new rules ultimately to do so in 35 days. As for the SEC, the 25 days suggested for their turnaround of company challenges (as opposed to the present 80 days) is still over twice the 10 day period during which the SEC must respond under
Rule 14a-6(a) for the review of an entire preliminary proxy statement. Moreover, eliminating the "ordinary business" exclusion should significantly reduce the number of challenges filed with the SEC.
Eliminate so-called "broker non-votes" in any election for directors
The New York Stock Exchange rule which allows managements to stuff the ballot box for themselves cries out for reform. Under this NYSE rule, brokers may vote on certain matters-including "uncontested" elections as defined by the NYSE-if the beneficial owner has not provided voting instructions by a certain time before the meeting. These "broker non-votes" are always voted in favor of management. As unfair as the rule appears in principle, I am sorry and chagrined to say it is even more unfair in practice.
As noted above, a problem under the current system is the expense of a proxy contest for election of directors, including mailing costs of proxy materials to small shareholders. In an effort to control expenses in such a contest, I mailed our shareholder group's proxy statement and proxy card only to accounts with 5,000 shares or more. Under its Kafkaesque rules, the NYSE declared that despite there being a clear election contest "broker non-votes" would be allowed for all those accounts containing under 5,000 shares that did not receive our mailing. The NYSE reached that conclusion despite all our proxy materials, including the proxy card, being publicly available at the SEC, the NYSE and on our website.
In an earlier experience, I undertook a spirited "Just Vote No" campaign with numerous letters, urging shareholders to withhold votes to send a message to a board. Despite all the mailings, the NYSE ruled that no "contest" existed at all because no opposing proxy card had been provided to shareholders. Consequently, "broker non-votes" were allowed to be cast for management for all brokerage accounts that did not send timely voting instructions. There certainly is no justification for the NYSE to treat an election of directors by any class of shareholders or a "Just Vote No" campaign as "routine". The overriding need for fair election results should trump any concerns that one sometimes hears over quorums. To the extent quorums are a valid concern, if need be substitute another legal fiction, such as the "broker non-votes" being cast solely to indicate presence for quorum purposes.
These are interesting times in the field of corporate governance, and I thank the SEC for the opportunity to make these comments. Of all the reforms suggested, granting major shareholders simple and inexpensive access to management's proxy statement and proxy card is the most important. Allowing a mechanism for shareholder input into board membership in this manner would ensure a proper "check and balance" to an under-performing incumbent board, and would be a major step towards more effective corporate governance and improved corporate democracy. Please contact me at
212-289-3346 with any questions.
Very truly yours,
Gary K. Duberstein
|1|| Letter from Richard L. Trumka, Secretary-Treasurer, American Federation of Labor and Congress of Industrial Organizations ("AFL-CIO"), to Jonathan G. Katz, Secretary, Securities and Exchange Commission (May 15, 2003).
|2|| Another commentator has suggested a threshold of 10%. Such a high percentage would make the provision virtually meaningless, especially in regards to large cap companies. For example, 10% of General Electric Company would require holders of nearly one billion shares with a market value of approximately $30 billion to come together.
|3|| Assume a staggered class of three directors is up for election. Management names candidates A, B and C, and a Nominating Group names candidates D, E and F-all on the same proxy card. A shareholder with 1,000 shares, for example, could decide to ticket split and vote 1,000 shares for management's candidate A, 1,000 shares for management's candidate B, and 1,000 shares for Nominating Group's candidate D. As a practical matter, this cannot effectively be done under the present system in which management and insurgents each have separate cards naming only their candidates, and the latest dated proxy card governs the voting of all shares.
|4|| If shareholders elect nominees of a Nominating Group and the same or a different Nominating Group returns to the company a year later for an annual meeting, they should be allowed to submit a full slate of nominees even if a majority of the board might be composed of non-management candidates after a second annual vote. Certainly, if shareholders vote for a change two years in a row, that should not be ignored.