Lawndale Capital Management, LLC
Andrew E. Shapiro
By Electronic Delivery
June 13 2003
Johnathan G. Katz,
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re. File No. S7-10-03, Release No. 34-47778
Solicitation of Public Views Regarding Possible Regulatory Changes to improve Corporate Democracy
To the Commission:
Lawndale Capital Management, LLC, a Sustaining Member of the Council of Institutional Investors, is an investment advisor that specializes in active relational investments in publicly traded companies. Lawndale is often one of the largest shareowners in its portfolio companies. We regularly propose improvements to a portfolio company's governance structure to create and/or protect shareholder value including board representation. Throughout our firm's more than ten-year history, Lawndale has been an outspoken proponent of corporate governance advancement. Certain features of the August 1999 Corporate Governance By-Law implemented as a result of our proxy contest at a former portfolio company, Quality Systems (O-QSII), are now encompassed in the stock exchanges' minimum listing requirement proposals currently in front of the SEC. Also, as part of an agreement with the another portfolio company, Earl Scheib (A-ESH), I participate in most of its board meetings as a non-voting Board Observer in a role quite unique to a public company. I am also a member of the National Association of Corporate Directors.
I have personal experience in the topic of short slate elections and their subsequent impact from both sides of the board room wall. Presently, I am the independent Vice Chairman of the Board of Arlington Hospitality (O-HOST). In August, 2002, an alternative short slate of directors was proposed by a long-term investor (now independent Chairman) who had suffered years of declining shareholder value. This short slate of directors was overwhelmingly elected by over 80% of the shareowner vote. In light of the substantial mandate of this contested vote, further changes were made to the board including the invitation for me to join as Chairman of Arlington's Corporate Governance/Nominating Committee.
You are seeking comment on "possible changes to ... regulations to improve corporate democracy." The general definition of "democracy" according to Collins English Dictionary is "government by the people or their elected representatives." Collins' defines "election" as "the selection by vote of a person or persons from among candidates [emphasis added on plural] ...; the act or an instance of choosing." Another commentator on this issue defined "election" as the "the right, power, or privilege of making a choice." Unfortunately, there are no voting choices in the present system of electing our corporate board representatives but for the proverbial "voting with our feet". This is all the more wrong when shareowners send a resounding mandate for change via a majority vote on a shareholder proposal that their so-called "elected" representatives then ignore.
I advocate improving corporate democracy by considering the following prudent changes that would increase the likelihood directors are the freely elected choice of the shareowners and are responsive as their fiduciary agents.
Shareowner access to company proxies / providing a real choice of alternatives
- Each year, allow up to a majority of the entire board less one nominee to be designated as "Shareowner Nominee", placed on the company proxy and provided with equal statement space as company nominees. We propose more than two directors but less than control because, from my experience in the boardroom, there needs to be a meaningful number of "elected" directors to garner a second on motions as well as to serve on board committees without unduly burdening individual "Shareowner Directors." The "Nominating Group" names which "Company Nominees" are being "contested".
- Require the alternative short slate to have substantial backing before being added as choices on the company proxy. Somewhat similar to CalPERS' March 17, 2003 staff analysis http://www.calpers.ca.gov/whatshap/calendar/board/invest/200303/Item08d.doc), we think the process should require a "Nominator" to meet the same qualifications as other 14(a)-8 submissions but if owning less than 5% of the issuer, require a "second" in the nomination process by enough shareownership to equal 5% or more. Provide for the process of "seconding" the nomination to qualify the nominees for inclusion on the company ballot, to not trigger section 13D status nor obligate the "second" to even vote for the slate. The issue here is just nominating a candidate to be a choice on the company's ballot for shareowners to consider.
- We concur with Mr. McRitchie's comment letter of May 26, 2003 regarding competing Nominating Groups. Liberalize 13D filing obligations to allow communication between the "competing" group's to allow compromise on one slate of candidates without triggering 13D filing obligations. Absent agreement, provide for the two largest shareowner groups nominees to be placed on the ballot versus company nominee slots solely determined by the largest shareholder group. Where there are three candidates for the same slot, provide for the instant run-off voting (IRV) described by Mr. McRitchie whereby shareowners rank the three candidates by preference and if no candidate wins a majority of the 1st choice vote, the 3rd' place candidate is dropped and the 2nd choice on those votes get counted to determine a majority winner between 1st and 2nd place.
If ranking preferences, we favor directors being elected with a majority of the votes cast. IRV is intended to allow this to happen in one election. However, if the dual Nominating Group approach and IRV are determined by the SEC to be too burdensome or the adopted dual Nominating Group process allows corporate directors to be elected with less than a majority of the votes cast, we then favor the single largest Nominating Group approach but with very strong rules, regulations and disclosure preventing company's from co-opting the process or Nominating Group.
- Provide a level-playing field encouraging responsible activity and expenditures by both sides.
- While the risk of abusing open access is greatly reduced by the substantive 5% size of the nominator group, we suggest requiring a reimbursible nomination fee (eg. $2000) from the Nominator per Shareowner Nominee. The nomination fee reimbursement should be made for each Nominee that receives at least the vote % total necessary for resubmission under 14(a)-8 in a subsequent year. This will ensure nominators select Nominees of sufficient quality to maintain the support of Seconding shareowners and others. Discourage fights over the nominating process by providing for reimbursement of nominator legal costs if the company takes legal action to block shareholders from their right to nominate and run candidates.
- Furthermore, for each Nominating Group, provide for an accompanying SEC standard form shareholder proposal for automatic inclusion in the company proxy authorizing reimbursement of campaign costs. The amount would be up to documented cash costs no greater than the Nominator Group discloses in the proxy. To the extent, the proposed amounts are perceived to be too high, shareowners can reject the proposal even though they vote for the alternative slate. To the extent the amount seems reasonable in relation to the value being added by the Nominating Group, shareowners can support reimbursement even if they didn't vote for the alternative slate. The proposal can be precatory but see my suggestions, below, regarding board ignoring majority votes on shareholder proposals including reimbursement proposals.
- To the extent that Shareowner nominees are barred from re-nomination for failure to hit certain vote thresholds, (whether via 14(a)-8 or otherwise imposed) Company nominees whose vote total falls short of the same thresholds should not be allowed renomination for the same time period. Company nominees that lose shouldn't be subsequently added back by the board. Similarly The Company should be barred from other activities either before or after the election meant to circumvent the proportionate influence that shareowners expected to gain with their victory (eg. increase in the number of board members either before or after the election). Such rules should be consistent with the Delaware Court's recent Liquid Audio decision.
- Facilitate disclosure and communcation between all side's nominees and shareowners via a requirement of written statements on certain enumerated issues such as compensation, independence, anti-takeover policy, corporate strategy, etc. Provide for rules facilitating public teleconference/webcast (thus within Reg FD) of the director nominees allowing for shareowner questions.
- There is nothing routine about director elections, eliminate broker voting but for establishment of a quorum. Proponents of broker voting claims these non-voting shareowners would be disenfranchised if the practice was stopped. But, in fact, the practice of broker voting is disenfranchising those shareowners who are doing the actually voting by diluting their vote from brokers who aren't the true owners and who may be conflicted.
- Reform section 13D rules to allow for meaningful discussion and actions on non-control matters and extend full 1992 communication reforms to such filers. These 5% or greater filers are already subject to certain disclosure obligations under item 4. To impede or make more onerous what non-13D filers can discuss and do in non-control campaigns (short slates, "vote no" contests, shareholder proposal campaigns, etc.) seems absurd.
- While probably requiring federal legislation for such power, review should be conducted toward using listing requirements to require annual elections of all directors. The most direct measure of shareholder accountability for poor performance is the election of directors. When only 1/3 of a board is truly accountable in a given year, as is typical in most staggered boards, the improved corporate democracy benefits of the above-mentioned reforms are highly diluted.
Improve Board responsiveness to shareowner mandates (Shareholder proposals)-
We think the desperate need for more open access to company proxies has come to a head because of so many board's gross disregard of the clear mandates from majority votes on shareowner proposals. Board failure to take heed of such majority votes is also the cause of an increase in the volume of proposals as the majority vote proposals repeat while proposals on new topics emerge. This is an unfortunate waste of resources not only for the proponents and companies but also for the SEC which is called upon repeatedly to adjudicate increasing loads of no-action requests. Shareholder access to board nominations may reduce the submission of many shareholder proposals. However, access to nominate director candidates may not be made open enough and the proposal route may remain the most cost-effective means of shareholders weighing on important matters. Below are our suggested regarding the shareholder proposal process primarily meant to increase board responsiveness to majority votes.
- Eliminate the ordinary business exemption or greatly reduce what items are considered "ordinary business". It is absurd that proposals regarding the audit process and auditors have been excluded as '"ordinary business". The accounting and board oversight scandals of the past few years, have clearly shown the such areas are anything but ordinary day/day business that should be left solely to management's control.
- Level the playing field and no longer require proponents to personally present their proposal. Company proposals are voted on all the time and remarkably, directors don't have to attend their own annual meetings.
- While enforcing implementation of shareholder proposals may be a matter of state law and also hinge on the language of the proposal, the Commission can improve corporate democracy by tightening/relaxing certain rules applying to issuers who fail to implement proposals that receive a majority vote. For example, if a proposal gets on the ballot and then gets a majority vote and the board then ignores the mandate, allow the identical proposal to be submitted again by the same proponent the next year automatically (disallow no-action fights). In addition, expand the statement word limit for resubmitted proposal. Finally, provide for a reimbursement of costs proposal to be automatically included side by side in the proxy making this proposal a second one that could automatically recur each year if a majority vote on it is also ignored. Companies faced with the prospect of perpetual submission of majority vote proposals with no way to exclude them or outspend and outlast the proponents would be more likely to sit down and work out a compromise. Either through automatic resubmission of the proposal or more parties sitting down to compromise, the no-action workload of SEC staff would be reduced.
- More, novel is to provide additional rights to shareowners in company's that ignore majority vote mandates. For example, for either the majority vote proposal proponent or for all shareowner's, drop the 5% threshold requirement to nominate an alternative short slate. Additionally, if some form of repetitive disregard of majority vote mandate persists, drop the cap on the number of directors that can be nominated onto the company proxy and allow a control slate. Remember, a majority vote would still have to be obtained on the director slate at the election but I would guess the prospect of an alternative director slate, especially a control slate, would get the company and the proponent of a majority vote proposal talking. Again, SEC staff no-action workload would be reduced.
Control contest reforms
- A contest for control of a company is inherently disruptive and confusing. Proxy rule reform that could reduce confusion and costs but maintain a level playing field should be desirable. Review should be given to the concept of putting both side's slate of directors and measure's on one proxy card and in one universal mailing. Thereafter, all the remaining proxy contest communication and campaign can continue as currently provided for in the regulations. When and if supplemental proxy cards are sent out, require it to be the same universal card. This consolidation reform may then allow for more enhanced methods of voting such as via the internet.
To "choose" is "to select (a person, thing, course of action, etc.) from a number of alternatives". According to Collin's "cannot choose" means "to be obliged"! Sounds a lot like former communist Russia where there was a single slate of candidates selected by the 'party' and they too call their elections "democratic".
If the SEC truly wants to improve corporate democracy, it must change its rules and regulations to reduce and eliminate barriers these rules create which impede shareowner's selection of alternatives and their ability to choose elected representatives who will be responsive fiduciary agents.
McRitchie wrote it quite well in his comment letter- "In civil society, democratic transitions have long been recognized as preferable to war or armed revolution. The same principles should apply to corporate governance transitions. Current SEC rules are an impediment to peaceful transitions in corporate governance...." Presently, a shareowner's only current real choice is to accept the director slate given, mount a costly contest for control or sell the stock.
We appreciate your soliciting comment and views in this process. We welcome the opportunity to discuss our suggested improvements and those of others with the Commission and its staff. Please contact me at the phone number below.
Andrew E. Shapiro
President and Managing Member
591 Redwood Highway #2345
Mill Valley, CA 949491