Dear Mr. Katz:
We are submitting these comments on behalf of some of our firm's reporting company clients in response to the publication by the Securities and Exchange Commission (the "Commission"), in Commission Release No. 34-47778 (the "Proposing Release"), of proposed rules regarding nominating committee functions and communications between shareholders and boards of directors. These clients include corporations that have been publicly traded and registered with the Commission for many years. In addition, these companies have had ample experience dealing with shareholder proposals and director candidates submitted by shareholders.
In short, these clients do not support the Commission's proposed rules regarding nominating committee functions and communications between shareholders and the Board. The Commission, shareholders and public companies have not had enough time to evaluate the impact of the current corporate governance reforms (Sarbanes-Oxley Act of 2002 (the "Act"), stock exchange corporate governance rules and proposals and other third party initiatives) to be able to conclude that the proposed rules are necessary or will effectively improve the transparency of Board processes without disrupting those processes. In addition, even if one could determine the necessity and effectiveness of these proposals at this time, interested parties should have the opportunity to evaluate these proposals in totality with the rules the Commission intends to publish regarding shareholder access to the proxy card to facilitate a complete understanding of the effectiveness of these proposals.
However, should the Commission still decide to adopt rules at this time or after considering all of the proposals, including shareholder access to the proxy card, this letter includes some suggestions that the Committee should consider. Most importantly among these suggestions, the Commission should eliminate certain specified disclosures and consider requirements fashioned in more general and flexible terms than the detailed disclosures the Proposing Release contains. By doing so, the Commission will (i) maintain the required levels of flexibility for Boards to appropriately consider director candidates, (ii) eliminate the time and cost that is inherent in certain of the proposed rules and (iii) avoid other unintended adverse consequences that would result from the adoption of the proposed rules "as is".
In general, we fear the proposed rules will intrude unnecessarily into the Boardroom and Board processes. Requiring too much disclosure regarding how directors think, act and operate can be counterproductive by, among other things, stifling the creativity, debate and flexibility that is required for directors, exercising the ultimate state-mandated oversight function of a corporation, to take into account all relevant factors in fashioning strategies for the company on whose Board they sit. Ultimately, a Board must have the opportunity to act effectively as a governing body through processes and dynamics that suit it as a group and a company's specific circumstances. Indeed, state law places the responsibility for managing a corporation in the interests of all shareholders in the hands of its directors, and it would be no defense for directors in any particular instance to assert that they took an action at the behest of one or more specific shareholders.
I. Reasons Not to Finalize the Proposed Rules
The Act was signed into law in July 2002. In addition, the New York Stock Exchange, the American Stock Exchange and the Nasdaq Stock Market (collectively, the "Exchanges") have issued proposed corporate governance rules, some of which are still pending before the Commission. Furthermore, numerous third party "corporate governance rating agencies" have recently come into the mix by communicating their views as to indicia of good governance. Public companies are scrambling to understand and comply with all of these requirements and influences. However, less than a year after the Act became law, the Commission directed its Division of Corporate Finance to formulate possible changes to the proxy rules regarding procedures for the election of corporate directors, communications with Boards and shareholder access to the proxy card.
Many commenters, including the Task Force on Shareholder Proposals of the Committee on Federal Regulation of Securities, Section of Business Law of the American Bar Association, have observed that the above-mentioned reforms are "the most sweeping since at least the New Deal enactment of the basic federal securities laws"1. Boards of Directors and executives are devoting substantial amounts of time and money to understand and comply with these reforms. Please consider that in a recent survey conducted by the American Society of Corporate Secretaries one-third of the respondents believed that company costs to comply with the Act would be between $1 million and $10 million. In addition, please also consider that another 20% of the respondents were unable to estimate the additional cost. Further, the Commission has not yet finished tying up loose ends regarding these reforms (e.g., the application of Section 402 of the Act to cashless stock option exercise and split-dollar insurance agreements; whether Section 906 certifications are required to be filed with Forms 11-K and implementation of accountant attestation under Section 404 of the Act).
Considering the magnitude of the changes already in motion, the Commission has not allowed time for the current reforms to take hold and to evaluate the success of those initiatives. Some of the rules promulgated pursuant to the Act were not even effective for the most recent proxy season. Moreover, there are still unknown consequences from the passage of the Act,2 and some of the Exchanges' proposed corporate governance rules are not yet final. Accordingly, it is impossible to determine whether or not the Commission's proposed rules are necessary or the best way to proceed.
Therefore, it is premature to determine the effectiveness of the new Commission rules that are already in place and the likely effectiveness of the proposed Exchange rules and to determine the true extent to which the proposed rules are necessary. In addition, there is insufficient time for the Commission to implement a new and considerably more extensive set of reforms with which companies would need to comply in time for the 2004 proxy season, planning for which is not far off.
B. Effectiveness of Current Processes
In the Proposing Release, the Commission states that it received comments "reflecting concern over the accountability of corporate directors and corporate scandals." In addition, the Commission stated that many commenters noted that "current director nomination procedures afford little meaningful opportunity for participation or oversight by shareholders". Lastly, the Commission has asked for comment regarding whether increased disclosure relating to the nominating committee and its policies and criteria are an effective means to increase "board accountability".
First, current director nomination procedures are adequate for shareholders to have meaningful participation in the nominating process. Under the existing governance structure, shareholders have a number of methods at their disposal by which to voice their views. These methods include:
When shareholders make use of the methods listed above, companies are more likely than not to consider shareholder comments and work to reach an acceptable resolution. For example, the New York City Pension Funds and Retirement System recently began initiatives aimed at reforming corporate governance at twenty-five companies.3 In thirteen instances, these proposals resulted in either (i) company action to implement the proposal without a vote from shareholders or (ii) a majority vote from shareholders.4 In addition, directors have state law fiduciary duties to consider bona fide candidates and to nominate candidates that they believe will best serve the interests of the company and all its shareholders. Therefore, the existing methods by which shareholders can make their voices known are adequate and appropriate.
In addition to the sufficiency of the existing processes, it is arguably not appropriate or necessary for the Commission to require additional disclosures for the purposes of increasing "board accountability". The proposed rules, including requiring companies to disclose certain information when the nominating committee has decided not to nominate a candidate, would have the effect of influencing Boards' actions. Indeed, they may be designed to have that effect. But, directors' duties and accountability have traditionally been regulated by state corporate law and refined continually by state case law. In fact, in the past, courts and others have resisted the Commission's attempts to interject itself in this area. Accordingly, ensuring that Boards meet these duties, including the consideration of bona fide candidates, is and should remain the responsibility of the states.
C. Impact of Rules Still to be Proposed Regarding Access to the Proxy Card
The Commission has publicly stated that it will publish separately proposed rules regarding shareholder access to the proxy card. The impact of the proposed rules upon which we are commenting today should be considered together with the proxy card access rules. By addressing these as two separate proposals, the Commission will add confusion to this process and unnecessarily limit the ability to finalize rules that would serve the ultimate public policy goal of creating an integrated, balanced initiative on shareholder involvement in corporate democracy.
II. Comments to Proposed Rules
While the Commission should not finalize any of the proposed rules at this time for the reasons discussed above, we respectfully submit the following comments should the Commission nonetheless proceed now.
In general, requirements for any new disclosures should allow more general and flexible disclosure in response rather than more detailed disclosures that the proposed rules contemplate. Most importantly, with respect to these suggestions, the Commission should eliminate certain detailed disclosures contained in the proposed rules. By doing so, the Commission will (i) maintain the required levels of flexibility for Boards to appropriately consider director candidates, (ii) eliminate the time and cost that would be inherent in complying with certain portions of the proposed rules and (iii) avoid other adverse unintended consequences that would result from adoption of the proposed rules "as is".
A. Enhanced Nominating Committee Disclosure
1. Website Disclosure. It should be adequate for any additional disclosures to be placed on the company's website rather than in an annual report or proxy statement. Under the Exchanges' corporate governance proposals, the nominating committee's charter will be required to be a the company's website with a cross-reference contained in the Annual Report. It makes sense and would be convenient for shareholders to look in one place for information regarding director candidates. Therefore, the information required by the Commission and the Exchanges and should be in the same location. In addition, because website disclosures can be effected on a more rapid basis, disclosure of changes should not be required to be disclosed in 10-Ks, 10-Qs or 8-Ks, as this can be, in fact, a less timely method of disclosure.
2. Description of the Material Terms of the Charter. A description of the material terms of the nominating committee charter should not be required in proxy materials. As noted above, the Exchanges' proposed corporate governance rules will require that the charter be posted on the company's website and, in addition, be made available in print to any shareholder who requests it. This disclosure is sufficient. To avoid unnecessary expense and administrative burden, companies should not be required to post the charter, or describe its terms, in two separate places.
3. Disclosure of a Policy with Regard to Consideration of Director Candidates Recommended by Shareholders. Companies should not be required to disclose their policies with regard to consideration of director candidates recommended by shareholders. The evaluation of director candidates includes many factors and is a dynamic process. In addition, companies should be able to assess whether or not to consider any director candidates on a case by case basis. Requiring disclosure of a fixed policy will force companies into a policy that caters to the opinions of institutional shareholders or another politically influential shareholder group, which could restrict directors from dispassionately considering what is in the best interests of a company at a particular time taking into account all the factors that directors are legally charged with considering. The adverse result of such standardized policies will be that a Board will not be able to exercise thoughtful judgment when deciding whether or not to consider candidates.
4. Disclosure of Minimum Qualifications That Must be Met. Once again, flexibility is essential when considering whether to nominate director candidates. The overall structure and composition of the Board must be allowed to adapt to meet regulatory needs (e.g. financial expertise), requirements of the Exchanges (e.g., director independence) and the company's needs (e.g. industry knowledge, diversity). By requiring companies to disclose minimum qualifications, the proposed rules would limit the Board's necessary flexibility to change its composition from time-to-time as may be appropriate to meet the company's changing needs.
In addition, if the proposed rules are adopted, then companies will likely be under increasing pressure from various activist or other politically influential groups to include their notions of director qualifications that do not take into account any company-specific needs or the totality of a company's needs. These groups will most likely develop their own concepts of qualifications based on their own agendas, which may or may not be in a company's best interests. This risks the breakdown of what, heretofore, has been an efficient process in the selection of directors and director nominees. Because directors can act in the interests of all shareholders, and not any individual shareholder groups, with full knowledge of a company's circumstances and are in the best position to evaluate what works and what does not with respect to any specific company needs, new rules should not lead to different results.
5. Disclosure Regarding Candidates Not Nominated. The Commission should not promulgate rules requiring disclosure of candidates that certain shareholders have proposed where the nominating committee chooses not to nominate them. As stated above, the nominating process is dependent upon a number of factors and requires a nominating committee to have flexibility to most effectively discharge its duty. Requiring public disclosure of candidates that are not nominated will put such decision up to public scrutiny and provide all investors (and other groups like corporate governance ratings agencies) the opportunity to second-guess the nominating committee's decisions, without having all of the information that the nominating committee had when it made the decision. Moreover, nominating decisions may involve factors that are not appropriate for public disclosure or involve information that could be harmful to the company or to the nominees if it were disclosed.
6. Shareholder Qualifying. If new rules will provide for consequences to a shareholder proposing director candidates, then the shareholder who proposes the candidates should be required to demonstrate share ownership for a minimum period prior to the submission (such as two years), state a good faith intent to continue to hold securities for a minimum period after the submission (such as one year) and hold a minimum amount of a company's outstanding shares (such as at least 5%). These criteria would at least assure the company that the nominating shareholder has a true interest in the company.
When shareholders act as a group for purposes of meeting the shareholding requirement suggested above or referred to in the Proposing Release, they should be subject to the reporting provisions of Sections 13(d) and 13(g) of the Exchange Act. There is no reason why shareholders who are acting in concert to influence the decisions of the corporation should not be required to follow the same rules as any other shareholders with such intent. There is no basis in the Williams Act itself or its legislative history to permit such an exemption from the Williams Act's provisions.
7. Unintended Adverse Effects. As noted above, we fear the proposed rules will intrude unnecessarily into the Board room and Board processes. Requiring too much disclosure regarding how directors think, act and operate can be counterproductive. Ultimately, a Board must have the opportunity to act effectively as a governing body through processes and dynamics that suit it as a group and a company's specific circumstances.
Among other effects, the rules as proposed could make directors reluctant to serve on nominating committees because they will feel that they do not have the flexibility needed to appropriately meet their state law duties and run the risk of increased liability under state law.5 This, coupled with directors' increasing disinterest in serving on other Board committees in general since the adoption of the Act, will make it even more difficult for companies to recruit directors and appoint them to these key committees.
B. Disclosure Regarding the Ability of Shareholders to Communicate with the Board of Directors.
1. Effectiveness. While our clients recognize that the Exchanges have similar proposals pending, it is unclear whether requiring companies to publish processes by which the shareholders can send communications to the Board members generally will be effective. In fact, such a requirement could be extremely costly, time-consuming and potentially disruptive. These rules would increase significantly the number and nature of communications that are sent to Board members. The increased activity will then lead to more time spent focusing on these communications, including training directors in the art and politics of investor relations.
Employee directors must ensure sufficient time is available to devote to the company's day-to-day business as well as strategic corporate planning. Furthermore, independent directors have other obligations in addition to service on a particular Board, and their accomplishments in these other obligations undoubtedly contributed to their attractiveness as a Board member in the first place. The more corporate directors are obligated to divide their time and energy, the more difficult it will be to find individuals willing to serve as directors and the less effectively they will discharge their competing functions.
Some of our clients have already experienced difficulty finding suitable director candidates given the state of the economy and the perception of increased personal director liability discussed above. Therefore, adding a process by which the Board will be required to address all shareholder communications will be overly demanding on Board members and contribute to supply-and-demand crisis for qualified directors.
2. Description of Material Action Taken as a Result of Shareholder Communications. Even if the Commission decides to implement procedures that require disclosure of a process by which shareholders can communicate with the Board, the Board should not be required, under any circumstance, to disclose any material action taken as a result of these communications. As the Commission is no doubt aware, today companies deal with all types of constituencies in formulating policies. In fact, it is commonplace for companies of any size to deal with at least one shareholder proposal per year and, for larger companies, three to four proposals is more typical.
Requiring companies to disclose actions taken will result in increased time and effort of Board members to appropriately consider and act upon these proposals. It is a fact that there is only so much time that is available by Board members and the more time they must spend on mandated matters, the less time they will have for the rest, including overseeing the running of the company. In addition, it is unclear whether the Commission has considered that many of these shareholder communications will (i) be for the purpose of advancing personal or political agendas, (ii) involve matters that may not be appropriate or legally defensible for public disclosure, (iii) be incompatible with other communications from different shareholders or (iv) conflict with strategic plans of the company. While a company and its shareholder are always free to agree to disclose consequences that flow from their communications, rules should not compel a company to do so.
Certain shareholder communications may address issues involving (i) material non-public information, (ii) information that may influence a shareholder's investment decision or (iii) matters that might be the subject of a Request for Confidential Treatment under the Freedom of Information Act ("FOIA"). It is unclear whether the Commission considered the potential consequences of the interplay between and among Rule 10b-5, Regulation FD and FOIA vis-à-vis the handling and processing shareholder communications, and the disclosure of material action (or lack of action) taken in the Proposing Release. The proposed rules should not be adopted without such consideration and study by the Commission and specific guidance, including exemptions and safe harbors, on the interrelationship of these tenets of the securities laws.
3. Shareholder Disclosure Requirements. Any final rules in this context should require shareholders to meet certain requirements before the rules would require a company to address shareholder communications. For example, shareholders should be required to provide certain information regarding the length of their shareholdings and the amount of shares held before the Company will be required to follow any processes that may be required by Commission action.
In addition, it would be useful for minimum holding requirements (both time and amount) before these processes must be adhered to by the Board. In this regard, we strongly urge the Commission to consider the scenario by which shareholders routinely purchase small numbers of shares to gain admission to companies' shareholder meetings. Often they purchase these shares as a threat - "deal with my concern or I will attend and disrupt the shareholders' meeting". Then, following the meeting, these persons often sell their shares, having had no long-term interest in the company's success, goals and strategies.
It would also be advisable for 5% shareholders, acting alone or in concert with others as a "group" for purposes of Rule 13d-3 promulgated under the Exchange Act, to be reminded of their obligations under Sections 13(d) and 13(g) of the Exchange Act and make clear their intentions with respect to the information gleaned from shareholder communications. There would be fundamental unfairness if the company, all of its shareholders and the business community as a whole, were not properly and timely apprised of any situation that gives rise to Williams Act disclosure by such shareholders.
III. Disproportionate Impact of Cost of Compliance
We have been concerned by the disproportionate impact of the cost of compliance with the Act and other recent corporate governance initiatives on all but the largest public companies. As revealed in our first-of-its-kind study entitled: "The Increased Financial and Non-Financial Cost of Staying Public" (the "Study"), the total cost of being public is estimated by the typical middle-market company6 to result in a 90.4% increase in such expenses. It should be noted that this estimate was even before adoption of the rules implementing the provisions of Section 404 of the Act, commonly referred to as "accountant attestation". A copy of the Study, which has previously been furnished to the Staff of the Commission, is attached hereto as Appendix "B".
The additional burdens imposed by the Proposing Release, if adopted "as is", would add significantly to the financial burden on smaller reporting companies and are among the most deleterious of the "unintended consequences" of the Act. At a minimum, should the Commission decide to proceed at this time, or after consideration of the access to proxy card rules, the Commission should grant appropriate relief to smaller public companies who can ill afford even greater expenses of being public, the impact that will have on such companies' profitability and earnings per share, and the consequentially negative impact this will have on he price of the stock and shareholder value. Because the Proposing Release deals with matters that are not mandated by Congress, the Commission has the discretion to grant such relief, either on the basis of "small business issuer" status pursuant to 17 C.F.R. §228.10 or other equitable criteria, and that such relief is warranted.
For the reasons stated above, the clients on whose behalf we are writing do not support the Commission's proposed rules regarding nominating committee functions and communications between shareholders and the Board. We believe that the Commission, shareholders and public companies have not had enough time to evaluate the impact of the current corporate governance reforms to be able to conclude that the proposed rules are necessary or will effectively improve the transparency of Board processes without disrupting those processes. In addition, even if the effectiveness of these proposals could be determined at this time, to have a complete understanding of the effectiveness of these proposals, they must be evaluated in totality with the rules the Commission intends to publish regarding shareholder access to the proxy card. We also believe further that the shareholder communications proposals have not fully considered (i) competing time demands and obligations on directors and (ii) the interrelationship of the proposals with other provisions of the securities laws and the rules and regulations promulgated thereunder.
THE INCREASED FINANCIAL AND
|FY 2001 vs. FY 2000
|F& 2002 vs. FY 2001|
Small-Cap $50,000 - $500,000
Mid-Cap $100,000 - $1,000,000
S&P 500 $250,000 - $1,250,000
PUBLIC RELATIONS/INVESTOR RELATIONS
Small-Cap $25,000 - $300,000
Mid-Cap $55,000 - $480,000
S&P 500 $100,000 - $480,000
Small-Cap $24,000 - $240,000
Mid-Cap $36,000 - $300,000
S&P 500 $120,000 - $1,200,000
10-25% on both outsourced IR and PR.
PUBLIC COMPANY OFFICER SURVEY
Based on 32 in-depth questionnaires completed by small- and mid-cap public company senior officers from companies with <$1 billion in annual revenues:
A Great Deal 28.1%
A Little 3.1%
Not At All 9.4%
(See slide 3)
THE COST OF BEING PUBLIC
Based on the responses of senior management, the mean costs of being public for a middle market public company are:
|Item||Before Reform|| After Reform|
|$ 329,000||$ 639,000||94.2%|
|$ 243,000||$ 499,000||105.3%|
|$ 212,000||$ 404,000||90.6%|
|$ 197,000||$ 221,000||12.2%|
|$ 107,000||$ 212,000||98.1%|
|$ 47,000||$ 85,000||80.9%|
|$ 46,000||$ 93,000||102.2%|
|$ 36,000||$ 132,000||266.7%|
|$ 35,000||$ 58,000||65.7%|
Other SOX Costs
|$ 26,000||$ 83,000||319.2%|
|$ 25,000||$ 37,000||48.0%|
Director Search Firms
|$ 0||$ 18,000||*|
What does this mean for the future of small-cap and mid-cap companies?
private or selling the company as a result of new corporate governance and disclosure
No Answer 20.0%
(See slide 5)
the focus on running the business"
Foley & Lardner worked with national research firm KRC Research to measure the true financial impact of corporate governance reform on public companies. Due to the complexities of current reforms and the myriad of governance issues facing companies today, the firms implemented a variety of approaches to gather the necessary data. The study consisted of a survey designed to measure attitudes toward current reform among top executives; a comprehensive review of recently filed proxy statements among small-, mid- and large-cap companies; and interviews with service providers impacted by recent reforms. A full description of each approach appears below.
Survey of Proxy Statements Foley & Lardner conducted a review of proxy statements file d by 450 public companies from September 2002 to April 2003. The companies were chosen randomly from a database maintained by Standard and Poor's Investment Services Custom Business Unit. All companies whose fiscal year ended July 31, 2002, or earlier were removed, as were those companies where data was missing on key metrics for any of the years 2000, 2001, or 2002. Once these companies were removed from the database the total sample size was 328 public companies.
Survey of Corporate Executives
In March of 2003, Foley & Lardner mailed a survey to 5,000 CEO's, CFO's, general counsel, chief compliance officers and other corporate executives as well as 1,000 additional CFOs from Fortune 1,000 companies. In addition, 1,237 companies were emailed the same survey. A total of 32 surveys were returned from companies with revenues under $1 billion, 8 surveys were returned from companies with revenues over $1 billion for a total of 40. A large number of respondents cited an inability to easily provide cost estimates, the time of year with year-end reporting obligations, and the length of the detailed survey itself, as reasons for not responding to the survey.
Individual Interviews among Service Providers
In April 2003, Foley & Lardner conducted a small number of individual interviews among service providers as follows:
Sarbanes-Oxley Snapshot Survey
Overview & Methodology
As the one-year anniversary of President Bush signing the Sarbanes-Oxley Act into law approached (July 30), Foley & Lardner surveyed corporate executives from across the country to obtain insight into their opinions on the implementation, effectiveness and success of corporate reform. The study consisted of seven questions aimed at gauging attitudes toward some of the past year's most widely discussed reform topics, including personal liability, cost of doing business, investor confidence and board performance. The short opinion survey was a follow-up to the firm's in-depth look last April into the "true cost of corporate governance."
Survey of Corporate Executives
On July 21, 2003, Foley & Lardner distributed the survey via e-mail to nearly 2,000 CEOs, CFOs, general counsel, chief compliance officers and other senior corporate executives from around the country. Totals of 192 responses, or approximately 10 percent of the survey population, were completed.
|Foley & Lardner Sarbanes-Oxley Snapshot Survey|
|Results with 192 respondents|
|1) Do you believe that Sarbanes-Oxley has made investors more confident in the integrity of your financial and other public reporting?|
|2) We know Sarbanes-Oxley has increased the cost of doing business one year later. Do you expect further significant increases (i.e., accountant attestation)?|
|3) Do you believe the continued emphasis on corporate governance by regulators (i.e., SEC) has been appropriate?|
|4) Do you believe the SEC has been effective in developing the rules mandated by Sarbanes-Oxley?|
|5) Do you believe that you are personally exposed to increased liability as a result of Sarbanes-Oxley?|
|6) One year after Sarbanes-Oxley reform, do you believe your board of directors is more effective, equally effective or less effective than one year ago?|
|7) Do you believe corporate governance reform has gone too far or not far enough?|
|not far enough||30||15.6|