State of Wisconsin Investment Board
June 12, 2003
VIA EMAIL email@example.com
Jonathan G. Katz, Esq.
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: File No. S7-10-03
SEC Review of Proxy Rules to Improve Corporate Democracy
Dear Mr. Katz:
The State of Wisconsin Investment Board ("SWIB") appreciates the opportunity to comment on Release No. 34-47778, in which the Securities and Exchange Commission (the "Commission") solicited public views on the following topics relating to corporate democracy: shareholder proposals, the corporate director nomination process, elections of directors, the solicitation of proxies for director elections, contests for corporate control, and disclosure and other requirements imposed on large shareholders and groups of shareholders. SWIB manages the tenth largest public pension fund in the U.S. and currently invests more than $57 billion of retirement funds and government assets.
While Commission and self-regulatory organization rulemaking under the Sarbanes-Oxley Act is bringing about many necessary reforms, a review of the Commission's proxy rules is needed to enhance director accountability to shareholders and restore investor confidence in our capital markets. We ask the Commission to grant shareholder access to company proxy cards, update the shareholder proposal rules, eliminate broker voting for beneficial owners who choose not to vote on director elections and make other changes to the regulatory framework, as discussed below.
Under state corporate law, directors are elected by shareholders and act as their fiduciaries. In reality, shareholders play a minimal role in the election of directors to represent their interests. Nominating committees have typically selected director candidates chosen by management, and the proxy ballot includes just enough candidates to fill the open board seats. Under the Commission's current proxy rules, companies are not required to include shareholder nominees or proposed by-law amendments relating to director elections in the proxy statement. Even if shareholders withhold votes for a director candidate, in the absence of a competing slate, the candidate will always be elected. As a result, the only way for shareholders to elect alternate directors is to engage in a proxy contest in support of an alternate slate of candidates, which is a lengthy and expensive process.
In a recent paper, William B. Chandler III, the Chancellor of the Delaware Court of Chancery, and Leo E. Strine, Jr., the Vice Chancellor of the Delaware Court of Chancery, described the director election process as "the forgotten element to reform."1
After the 2002 Reforms, it is unquestionable that Delaware, the Exchanges, and the federal government each have policies that express the belief that genuinely independent directors who owe their allegiances entirely to the corporation and its stockholders are valuable to investors . . . . If this philosophy is so central to our system of corporate governance, one can rightly ask why the current incumbent-biased corporate election process should be perpetuated. As of now, incumbent slates are able to spend their companies' money in an almost unlimited way in order to get themselves re-elected. As a practical matter, this renders the corporate election process an irrelevancy, unless a takeover proposal is on the table and a bidder is willing to fund an insurgent slate. The aberrational cases in which shareholder activists have actually mounted proxy contests tend to prove the incumbent bias of the system, rather than cast doubt on it.2
As noted by the authors, in order to address the core problems that contributed to abuses at companies such as Enron, Worldcom, Tyco, Global Crossing and HealthSouth, we must improve the effectiveness of the body empowered to protect the interests of shareholders - the boards of directors. We believe that allowing long-term shareholders to have access to management proxy ballots where there is a substantial level of support for a non-control slate of alternative director candidates would be a healthy reform. Together with related revisions to the proxy rules to facilitate competitive elections, these steps toward corporate democracy would enhance board accountability to shareowners and restore appropriate checks and balances to our system of corporate governance.
SWIB does not expect the right to access management's proxy for an alternate short slate would be used often. However, we expect that removal of the significant current roadblocks to shareholder-initiated election contests will help to improve the regular interaction between nominating committees and shareholders and improve the qualifications of director candidates put forth by nominating committees. With appropriate protections to prevent misuse (suggested below), these corporate democracy reforms should improve the effectiveness of corporate boards.
Suggested Revisions to Proxy Rules
SWIB supports the proposals set forth by the Council of Institutional Investors (the "Council") in its May 10, 2003 comment letter to the Commission on these issues. Specifically, we ask that the Commission consider the following reforms:
1. Long-term shareholders should be granted access to management's proxy cards to nominate less than a majority of director candidates.
As noted above, shareholders do not have a meaningful opportunity to elect directors to represent their interests under the existing regulatory framework. The Commission's proxy rules should not be used to perpetuate the incumbent bias of the director election system. Because shareholders pay for the corporate assets used to finance the re-election of management's candidates, it is only fair that long-term shareholders with substantial shareowner support be granted direct access to the proxy ballot using the same resources.
We ask the Commission to amend Rule 14a-8 under the Securities Exchange Act of 1934 to permit long-term shareholders to nominate director candidates, as well as to submit binding by-law amendments that would require a company to include director candidates nominated by shareholders in the company's proxy materials. SWIB recognizes that allowing shareholder access to management's proxy must be carefully structured in order to avoid undue cost and burdens on companies and to prevent abuse by shareholders. Accordingly, we support the Council's policy on access:
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. [Emphasis added.]
On a practical level, the Commission might also encourage communication between substantial shareholders and nominating committees by requiring that long-term investors contact the nominating committee and allow some minimum period of time for dialogue (e.g., ten days) prior to submitting an alternate slate. In addition, proxy materials should disclose the processes used by both the nominating committee and shareholders in selecting their candidates, and contain full disclosure of any familial and economic ties to the candidates. That information would be of importance to shareholders in deciding how to vote and should encourage identification of capable, independent director candidates.
SWIB would also like to encourage the Commission to require that proxies report the votes of incumbent directors on important publicly-disclosed issues that have come before the board during their tenure. Shareholders usually have little information about a director's performance, and SWIB believes shareholders should know how directors have voted on executive compensation, poison pills, stock option plans, mergers, implementation of shareholder approved resolutions and other major items. Without such knowledge, it is difficult for shareholders to cast an informed vote on election of directors.
2. The shareholder proposal process must be improved.
Rule 14a-8 governs the procedures regarding shareholder proposals submitted for inclusion in management's proxy statement. Every year, the Commission must devote significant staff resources reviewing no-action letters from corporations proposing to exclude shareholder proposals from proxy statements based one or more of the grounds specified in Rule 14a-8. Currently, shareholders owning just $2,000 or 1% of company stock are entitled to submit shareholder proposals, which permits fringe shareholders to air grievances at the expense of company and Commission resources.
SWIB views issues relating to election of directors as the most important aspect of corporate governance. If current law were changed to allow a substantial group of long-term shareholders to access management's proxy for nominating director candidates, SWIB would support a higher eligibility threshold (such as 5%) for submission of shareholder resolutions. However, any increased threshold would have to be combined with changes to 14a-8 to provide a high degree of certainty that shareholder resolutions with the required level of support will ultimately be included in the proxy statement.
If the Commission were to eliminate the 14a-8 exclusions and/or create bright-line guidelines, the Commission staff could be removed from the shareholder proposal process. Higher eligibility thresholds would ensure that only proposals with substantial shareholder support are submitted. SWIB believes that shareholders, rather than Commission staff, are best able to identify areas of concern and proper items for shareholder action.
SWIB agrees with Chancellor Chandler and Vice Chancellor Strine that the need for shareholder proposals to continue as an outlet for shareholder concerns and frustrations may be lessened "if a genuinely fair process for electing directors became the norm."3 Until such time, shareholders will be forced to continue using the Rule 14a-8 process to express concerns to other shareholders and negotiate with management. SWIB's suggested corporate democracy reforms would create more certainty for shareholders, companies and Commission staff and reduce the amount of company and Commission resources required by the current system.
3. The Commission should revise the Schedule 13D filing requirements to exempt investors who seek minority representation on a board.
The requirement for 5 percent shareholders or groups of shareholders to file the long-form Schedule 13D and follow the related requirements prevents many shareholders from communicating with other shareholders and seeking to elect directors. In order to implement access to the ballot by substantial shareholders or shareholder groups, the 13(d) rules should be amended to exempt shareholder activity limited to seeking minority representation on a board from the Schedule 13D filing requirements. In such a case, the company and marketplace would already have notice of the shareholders' activities because the shareholder-nominated candidates would be included in the company's proxy statement.
In addition, SWIB and other shareholders currently have significant concerns about participating in discussions with other shareholders when seeking corporate governance reforms or engaging in other non-control activities for fear of creating a 13(d) "group" and incurring the artificially imputed liability exposure associated with being deemed part of a group. Accordingly, we ask the Commission to amend the statutory and regulatory framework to liberalize the ability of shareholders to elect a minority slate of directors and to communicate with each other for non-control purposes.
4. Eliminate broker votes on behalf of beneficial owners who do not to vote.
Although perhaps not within the scope of the Commission's request for comments, we are compelled to note the bizarre concept imbedded in the current director electoral system that allows brokers to step in and vote the shares of beneficial owners who choose not to vote, even when the votes are not required to meet a quorum requirement. Shareholders should have a right to not vote and can make a strong statement by sitting out of an election. SWIB questions whether a system that permits a third party to step in and take away a shareholder's right to remain passive in an election would pass constitutional muster if challenged.
Several years ago, a research paper was done by Jennifer E. Bethel of Babson College and Stuart L. Gillan of the TIAA-CREF Institute, which concluded that (1) broker votes need no longer be counted for purposes of establishing a quorum (the primary rationale for the current system), (2) companies often try to structure proposals so as to obtain broker voting, and (3) more than 5 percent of so-called "routine" proposals on which brokers may vote the shares of beneficial owners would probably not have passed without the broker votes. SWIB believes that the Commission should move with the stock exchanges to remove this outdated practice from our system of corporate democracy.
In order to enhance director accountability in the wake of corporate scandals and resulting investor losses, long-term shareholders should be given a meaningful voice in electing directors to represent their interests where there is no change in control contest. We believe the revisions to the proxy regulations set forth above will build on the important reforms brought about by Sarbanes-Oxley and Commission and self-regulatory organization rulemaking and help to improve the effectiveness of corporate boards.
We hope our comments will assist the Commission as it reviews the proxy rules, regulations and interpretations relating to the election of directors. If SWIB can be of further assistance, please do not hesitate to contact us.
STATE OF WISCONSIN INVESTMENT BOARD
Chief Legal Counsel
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|1|| William B. Chandler III and Leo E. Strine, Jr., "The New Federalism of the American Corporate Governance System: Preliminary Reflections of Two Residents of One Small State," February 26, 2003 working draft for Penn Law and Economics Institute Conference on Control Transactions.
|2|| Chandler and Strine, 66.
|3|| Chandler and Strine, 68, footnote 118.