Gary K. Duberstein
455 East 86th Street
New York, NY 10028
September 9, 2003
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: File No. S7-14-03
Disclosure Regarding Nominating Committee Functions and
Communications between Security Holders and Boards of Directors
Dear Mr. Katz:
As a securities law practitioner 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, and I thank the Securities and Exchange Commission (the "SEC") for the opportunity to comment on the proposed rules on the topic noted above.
The SEC is facing the daunting and important task of fixing a broken corporate governance system whose long ignored shortcomings became glaringly obvious in the harsh glare of recent scandals. A key problem lies in self-perpetuating boards that lack the independence, skill, and determination to preemptively analyze and solve problems before they become crises, especially in the face of a CEO and senior management embarked down a ruinous-and in some recent extreme cases, illegal-path. Although shareholders own corporations and are owed fiduciary duties by these directors, in practice, shareholders-even major ones-are generally kept somewhere beyond arms-length on all matters, including choosing the company's board nominees. Since the company's board nominees run unopposed virtually all the time, making their election a foregone conclusion, shareholders consequently have no meaningful input into board composition at either the level of choosing nominees or casting a vote. Mindful of how the system works, managements and board members know that they are safe from true accountability to shareholders-and, unfortunately, they have seemingly been acting that way.
While the proposed procedural rules governing disclosures concerning the nominating procedure and communications to boards are welcome and important, I am eagerly awaiting the SEC's rules on shareholder access to management's proxy statement for the purpose of naming a slate championed by one or more major shareholders. Shareholder access is not only a logical procedural outgrowth of ownership of corporations by shareholders but also of experience under the SEC's shareholder proposal rule. Owners of corporations should have some meaningful input into the choice of directors as a basic right of ownership. The present system that all but guarantees the "election" of the company's handpicked nominees seems designed for a stagnating totalitarian state rather than a dynamic democratic society.
Beyond that basic view of ownership, the statistics are mounting concerning the large number of shareholder proposals that have received majority votes over a number of years and still managements do nothing to heed them. The lack of response to shareholder proposals that repeatedly receive major support or a "just vote no" campaign that garners a large "withhold" vote clearly indicates the need for a means to "get the attention" of a board. Institutional shareholders who are increasingly proponents of shareholder proposals are witnessing this unfortunate phenomenon of corporate denial and are rightly searching for a tool to deal with it. In my experience, the only such reliable tool is to run a time consuming and expensive proxy contest to put the incumbency of the directors at risk.
Despite the vast holdings of institutional shareholders across the spectrum of public companies, they seldom instigate proxy contests for the election of directors. There is a growing realization that these institutions will not become active in selecting nominees unless the proxy system is reformed so that 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.
Towards that goal, I would urge the SEC to build upon its currently proposed rule affording special disclosure if a shareholder or group of shareholders with 3% or more suggest a candidate. A 3% holder has a substantial enough capital stake in a company to warrant not only the proposed special disclosures, but also access to management's proxy statement to in fact nominate a slate of candidates if they are rejected by the company's nominating committee. Giving shareholders the opportunity to "ticket-split" their vote on the same proxy card among nominees proposed by management and nominees proposed by a major holder would finally bring meaning to corporate elections. There would be a choice.1
Shareholders can pass their proposals repeatedly. They can proffer nominees and communications that companies will scrupulously deal with under applicable rules. But all can be ignored by companies regardless of the extent of shareholder support-unless incumbent directors know to do so puts them at risk of losing their directorships because they will face shareholder selected nominees in a real election. Therein lies the importance of the anticipated shareholder access rules.
Review of proposed rules on Nominating Committee functions
Knowing the shareholder access rules are coming, in commenting on the proffered rules, I feel like an opera buff, who has enjoyed an interesting first act, but really awaits the entrance of the diva. Nonetheless, this first act is important in shedding light for shareholders on the process of nominating directors and communicating with them. Some companies disclose much of the substance of the proposed rules in their proxy statements already (i.e., whether and how the company would consider candidates suggested by security holders) so these rules in that regard may be viewed as a welcome codification of best practices. While in my opinion the most substantive change is in the area of handling nominations submitted to the nominating committee by major shareholders, I fear the substance of the proposed rules do not yet quite live up to the spirit expressed in release 34-48301, which sets them forth (the "Release").
The Release repeatedly sets forth the aim and desirability of "increased transparency" and notes that "it is important for security holders to understand the application of the nominating processes specifically to candidates put forward by security holders." The Release further highlights the desirability of "specific disclosure" requirements regarding the treatment of candidates put forward by major long-term investors and emphasizes that: "Again, we believe that specific detailed disclosure requirements are necessary and appropriate to assure the desired degree of clarity and transparency regarding these matters, and that more general requirements may not achieve our desired objective."
I agree wholeheartedly with the above premise and would respectfully suggest that to accomplish the stated goal, the proposed rule2 should be clarified by adding an instruction that if the rejected nominee has offered in writing a specific plan for the company, management should state its position on such plan, and if differences over such plan were a factor in rejecting the nominee. While it may be argued that such disclosure is implied by the current language of the proposed rule, because disclosure of differences over future plans for a company would be of such central importance to shareholders, I think it appropriate to remove any ambiguity. A company should specifically not be able to hide behind some boiler-plate disclosure that a nominee was rejected because his or her qualifications or knowledge of the industry were inferior to management's preferred nominees, when in reality there was a difference over the strategic direction of the company. The submission of a plan in writing by a nominee proposed by major holders provides a bright line test to trigger this important disclosure requirement.
Similarly, in light of the above cited need for "specific disclosures" if nominees proposed by major shareholders are rejected by the nominating committee, it is unfortunate that the rule as proposed eliminates the suggested disclosure set forth in the Staff Report3 as to "whether each member of the nominating committee believes it was in the company's best interest not to nominate the candidate and, to the extent members of the nominating committee do not have such belief, why the candidate was not included as a nominee." The actions of a nominating committee are that of individuals. True insight into the "process" and "increased transparency" requires knowledge at the very least of the vote "for" and "against" the candidate suggested by a major shareholder, and I would urge the further step of disclosing how each member of the nominating committee voted. With directors as fiduciaries, they should each stand up and be counted in connection with a decision as important as choosing nominees and thereby shaping a company's future. The vote should be publicly available and not shrouded in secrecy. I thought that was where the Staff was heading, and hope that the proposed rule is revised back in that direction.
Finally, on nominations, the proposed rule makes clear that a single holder or a group that holds greater than three percent triggers a special response. In order to be a three percent holder that achieves special status under the rule, a group may have to be formed that would show ownership that even exceeds five percent. To encourage the involvement of institutional investors in the nominations process, many commentators have previously suggested the need to exempt coordinated behavior in naming candidates from tripping filing requirements on Schedule 13D or, at the very least to clarify that such activity would not change a present Schedule 13G filer into a Schedule 13D filer. The proposed rule is silent on this important issue.4
Review of proposed communication rule
It is in some sense an unfortunate commentary on the state of corporate governance and the relationship companies have to their shareholders that a rule to establish procedures for shareholders to communicate with directors is even required. One would think-or like to believe-that such communications would simply be delivered.
Because that apparently is not the case, the rule is laudable in that it clearly encourages companies to adopt a system that facilitates shareholder communication with board members. This is vitally important to help repair the recent erosion of faith in companies and their boards as a result of the recent scandals. But, how can this goal best be accomplished, especially for small shareholders who do not have the clout of large investors?
The SEC site may provide the answer not only by the substance of comments posted, but by its structure as something of a model. The SEC should be commended in providing through its site a means by which all interested parties may review the thoughts of those on all sides of proposed rules and provide their own comments. As an adjunct to the proposed rule, in this electronic age, why not encourage companies to emulate the SEC and post letters from shareholders concerning any company related matters on their websites for all directors, managers and other shareholders to see. The company would be "encouraged"5 to post all such letters and any responses by the company to them. The process of email makes it relatively easy and cheap for a company to post them. To ensure decorum, shareholders would be required to sign their names and also provide proof of ownership of at least one share, which for beneficial owners could be the forwarding of a confirming email from a broker attesting to ownership. The company could choose to respond or not to any particular letter. Such letters and responses would remain posted for some period of time-say one year.
This proposed public email forum should not be the only means of communication. Some shareholders may want to submit letters in private to a company or anonymously. By all means, have a mechanism in place for that also as the proposed rule provides. But, in this internet age, do not miss the opportunity to include shareholders in the governance process by at least giving them an electronic forum where they know their views will be accessible by all directors, management and their fellow shareholders.
Once again, I thank the SEC for the opportunity to express my views on these proposed rules. Please contact me at 212-289-3346 with any questions.
Very truly yours,
Gary K. Duberstein
|1|| Or, at least the possibility of a choice. Even with shareholder access rules, I suspect any form of contested election will remain the exception rather than the norm. A three percent threshold is a formidable barrier, and any contest is time consuming and will entail expense. Moreover, challenging an entrenched management is never pleasant.
|2|| The relevant part of the proposed rule states that if the registrant's nominating committee receives and rejects a recommended nominee from a security holder or group who beneficially owned greater than 3% of registrant's voting common stock for at least one year as of the date the recommendation was made, management's proxy statement should: "(2) State the specific reasons for the nominating committee's determination not to include the candidate as a nominee."
|3|| Staff Report: Review of the Proxy Process Regarding the Nomination and Election of Directors, July 15, 2003.
|4|| The absence of such relief could lead to the result of a two percent shareholder avoiding discussions of a potential candidate with a three percent holder if there were another two percent shareholder available and amenable. The company, the nominating committee, and all shareholders would be better served if the full extent of shareholder support for a potential nominee could be made apparent without the peripheral issue of tripping filing requirements and the cumbersome need for obtaining institutional sign-offs. While the nominating committee is considering a potential candidate suggested by a group holding in excess of five percent, all interests may best be served by allowing a period of "quiet" negotiations instead of requiring a 13D filing that may need name such candidate. Such disclosure might make it more difficult for the nominating committee and the major shareholders mutually to select a compromise candidate, for example.
|5|| As in other contexts, if the SEC does not want to directly mandate this approach, its rule could provide that a company disclose if it has such a shareholder email forum in place on its website and, if not, why not.