September 15, 2003
Jonathan G. Katz
Re: Proposed Rule: Disclosure Regarding Nominating Committee
Dear Mr. Katz
We have discussed with some of this firm's public company clients (the "Clients") the Securities Exchange Commission's (the "Commission") proposed rules regarding nominating committee functions and communications between security holders and boards of directors. We are filing this comment letter on the proposed rules on behalf of the Clients. The Clients include corporations that have been publicly traded and registered with the Commission for many years. In addition, these companies have experience dealing with shareholder proposals and candidates submitted by shareholders.
The Clients appreciate the opportunity to comment on whether the proposed rules are appropriate and to provide additional suggestions regarding such rules. The Clients have requested that we submit this letter on their behalf.
In short, the Clients do not support the Commission's proposed rules regarding nominating committee functions and communications between security holders and the Board. They believe that (i) the Commission, (ii) public companies, (iii) their stakeholders and (iv) the public have not had enough time to evaluate the impact of the current corporate governance reforms (i.e., the Sarbanes-Oxley Act, stock exchange corporate governance rule proposals and other third-party influence) to be able to conclude that the proposed rules will effectively improve the transparency of Board processes without causing large additional costs for public companies. In addition, even if the effectiveness of these proposals could be determined at this time, in order to consider or 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.
However, should the Commission decide to review and possibly adopt rules (after considering all of the comments, including shareholder access to the proxy card) at a later date, the Clients have listed some suggestions in this letter that they believe the Commission should consider. Most importantly, with respect to these suggestions, the Commission should eliminate certain disclosures and consider broader requirements than the detailed disclosures contained in the proposed rules. By doing so, the Commission will (i) permit the required and appropriate levels of flexibility for Boards of Directors to consider director candidates, (ii) eliminate the time and cost that is inherent in certain portions of the proposed rules and (iii) avoid other unintended adverse consequences that would result from adoption of the proposed rules "as is."
I. Reasons Against Finalizing the Proposed Rules - Effectiveness
As the Commission is aware, the Sarbanes-Oxley Act of 2002 was signed into law in July 2002. In addition, the New York Stock Exchange ("NYSE"), the Nasdaq Stock Market and the American Stock Exchange (collectively, the "Exchanges") issued proposed corporate governance rules that are still pending before the Commission. Furthermore, recently numerous third-party "corporate governance rating agencies" have come into the mix. Public companies are scrambling to understand and comply with all of these requirements and influences. However, less than a year later, the Commission directed the 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 company proxy card.
Many commentators, 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 commented that the Sarbanes-Oxley Act and the other reforms mentioned above 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 understanding and complying with these reforms. A survey by the American Society of Corporate Secretaries, which represents approximately 2,800 companies stated that "Forty percent of the respondent companies have under $1 billion in revenues, and 45 percent of the respondents estimated their costs at under $1 million. Another 34 percent have revenues between $1 [billion and] $5 billion, and 31 percent [of the respondents] estimated costs at between $1 [million and] $5 million."2 (bracketed language added) In addition the Commission has not yet finished tying up loose ends regarding these reforms (e.g., the application of Section 402 of Sarbanes-Oxley to cashless stock option exercise and split-dollar insurance agreements; whether section 906 certifications are required to be filed with Forms 11-K). In addition, we believe that the Commission should not detract from efforts that need to be made in order to implement the already existing reforms.
Moreover, the Commission has not allowed time for the current reforms to take hold. Some of the rules issued pursuant to Sarbanes-Oxley were not effective for the past proxy season. Moreover, there are still unknown consequences from the passage of the Sarbanes-Oxley Act and because the Exchanges' proposed corporate governance rules have not yet been finalized, it is impossible to determine whether or not these reforms are appropriate. Therefore, the Clients believe that it is premature to determine the effectiveness of the rules that we currently have and to determine that new rules are necessary. In addition, until all of these rules have been finalized and implemented for at least two proxy seasons, it is premature for the Commission to implement a new and considerably more extensive set of reforms for companies to comply with in time for the 2004 proxy season.
Effectiveness of Current Processes
In the proposing release, the Commission states that they 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 security holders." 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, our Clients believe that current director nomination procedures are adequate for shareholders to be able to participate 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:
Our Client's believe that when shareholders make use of the methods listed above, companies are more likely than not to consider the shareholder's comments and work to reach an acceptable resolution. In addition, directors have a duty to consider bona fide candidates and to nominate candidates that they believe will best serve the interests of the company and all of its shareholders. Therefore, our Clients believe that the existing methods by which shareholders can make their voices known are adequate and appropriate. Furthermore, the Clients do not believe that the Commission has provided sufficient factual basis for concluding that these methods are inadequate. There is no evidence that facilitating the ability of shareholders to nominate directors would have prevented the recent accounting frauds. One can imagine, however, that a return to the active takeover days of the 1980s would be made more likely with these proposed rules. As you know, many people are of the view that the period of corporate raiders and takeover artists in the 1980s caused a vast waste of our country's resources in the chasing of deals for the sake of the one-time profits obtainable from them.
In addition to the sufficiency of the existing processes, our Clients believe that it is not appropriate to for the Commission to require additional disclosures in order to increase "board accountability." Requiring companies to disclose certain information when the nominating committee has decided not to nominate a candidate will discourage nominating committees from rejecting shareholder candidates. The Board's duties have been set forth in various state corporate laws and has been continually refined by state case law. Therefore, ensuring that Boards meet these duties, including the consideration of bona fide candidates, is the responsibility of the states and not that of the Commission.
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 company's proxy card. The Clients believe that the impact of the rules that we are commenting upon today should be considered together with the proxy card access rules. By addressing these as two separate proposals, the Commission will add additional confusion to this process and unnecessarily limit the ability to finalize any effective rules regarding shareholder access to the proxy card.
II. Comments to Proposed Rules
While our Clients strongly believe that the Commission should not finalize any of the proposed rules at this time for the reasons discussed above, we respectfully submit the following comments to the Commission's proposed rules on their behalf. In general, the Clients support broader disclosures than the more detailed disclosures contained in the proposed rules. Most importantly, with respect to these suggestions, the Commission should eliminate certain disclosures and consider broader requirements than the detailed disclosures contained in the proposed rules. By doing so, the Commission will (i) permit the continuation of the required and appropriate levels of flexibility for Boards to consider director candidates, (ii) eliminate the time and cost that is inherent in certain portions of the proposed rules and (iii) avoid other unintended adverse consequences that would result from adoption of the proposed rules "as is."
Enhanced Nominating Committee Disclosure
1. Website disclosure. Our Clients believe that any additional disclosures should be required to be on the company's website rather than in an annual report or proxy statement. Under the NYSE's corporate governance proposals, the nominating committee's charter will be required to be on the company's website with a reference to it contained in the Annual Report. It makes sense and would be convenient for shareholders to look in one place for information regarding the director candidates. Therefore, our Clients believe that the information required by the Exchanges and the Commission should be in the same location. In addition, because website disclosures can be done on a more rapid basis, the Clients do not believe that the new disclosures should be required in 10-Ks, 10-Qs or 8-Ks.
2. Description of the Material Terms of the Charter. The Clients believe that a description of the material terms of the nominating committee charter should not be required. The NYSE's proposed corporate governance rules will require that the charter be posted on the company's website and available in print to any shareholder who requests it. The Clients believe that this disclosure is appropriate and that companies should not be required to post the charter and describe its material terms in two separate places. In addition, this could be confusing to investors in a situation when the charter is modified shortly after a company files its proxy statement with the Commission.
3. Disclosure of a policy with regard to consideration of director candidates recommended by shareholders. Our Clients do not believe that companies should be required to disclose the material elements of policies with regard to consideration of director candidates recommended by shareholders. The evaluation of director candidates includes many factors, is often very subjective and is a constantly changing process. In addition, companies should be able to assess whether or not to consider these director candidates on a case-by-case basis. Requiring disclosure of a policy will force companies to come up with a boilerplate policy that caters to the opinions of institutional shareholders. The adverse result of these boilerplate policies will be that the Board will not be able to exercise broad and flexible judgment when deciding whether or not to consider these candidates.
4. Disclosure of minimum director qualifications and Board structure standards. Once again, the Clients believe that 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) and the company's needs. By requiring companies to disclose minimum qualifications, the Commission is limiting the Board's ability to change its composition to meet these constantly changing needs.
In addition, our Clients believe companies will be under increasing pressure from various shareholder activist groups and institutional investors to include their ideas of minimum qualifications and standards that do not take into account any company-specific needs. As we all know, these shareholders and groups will most likely develop these qualifications and standards based on their own agendas, which may or may not be in the company's best interests, without consideration of the company's needs. Because of this fact, our Clients believe that the Board, and not any shareholder groups, are in the best position to evaluate what does and does not work with respect to any specific needs. Therefore, companies should not be required to disclose minimum director qualifications or Board structure standards so that (i) such qualifications and standards, if any, may remain flexible to meet changing needs and (ii) institutional investors and shareholder groups are not allowed to influence these qualifications and standards based on their own agendas.
5. Disclosure regarding candidates not nominated. Our Clients strongly urge the Commission not to issue rules requiring disclosure of candidates proposed by certain shareholders that are not nominated by the nominating committee. Once again, the nominating process is dependent on many factors and requires the committee to have flexibility in order to most effectively discharge its duties. Requiring public disclosure of candidates that are not nominated will put the decision in the public eye and provide all investors (and other groups like corporate governance ratings agencies and shareholder activist groups) the opportunity to second guess the Board's decisions - without having all of the information that the Board had in front of it when it made the decision. Moreover, nominating decisions are often very subjective and may involve factors that are not appropriate for public disclosure (e.g., the nomination was made because the shareholder had a personal grudge against the company) or involve information that could be harmful to the company if disclosed. The Clients do not believe that these factors were appropriately considered during this rulemaking
6. Shareholder Concerns. Our Clients believe that shareholders who propose director candidates should be required to demonstrate share ownership for two years prior to the nomination, should state an intent to continue to hold securities for at least one year after the nomination and should be required to hold at least 5% of the shares outstanding in order to require the nominating committee's consideration of any candidate. When shareholders act as a group for purposes of meeting the shareholding requirement, they should be subject to the reporting provisions of Section 13D and 13G. No reason exists for why these shareholders, who are acting to potentially influence the decisions of the corporation, should not be required to follow the same rules as other large shareholders who attempt to influence the company's decisions.
7. Unintended Adverse Effects. The Clients believe that the rules, as proposed, would force the nominating committee to give up flexibility in the nominating process in order to meet the demands of institutional shareholders or shareholder activist groups (which we have discussed above). One consequence of this will be that directors will become reluctant to serve on nominating committees because they will believe that they do not have the flexibility needed to appropriately meet their state law duties. This, coupled with directors' increasing disinterest in serving on other Board committees, will make it extremely difficult for companies to (i) find directors to serve and (ii) find directors willing to be appointed to these key committees.
Disclosure Regarding the Ability of Security Holders to Communicate with the Board of Directors.
1. Effectiveness. The Clients do not believe that requiring companies to publish processes by which the shareholders can send communications to the Board will be effective. Such a requirement will be extremely costly and disruptive. These disclosures will increase the number of communications that are sent to Board members to further individual (rather than the corporate) objectives. The increased activity will then lead to more time spent focusing on these communications (rather than focusing on corporate strategy). In turn, Boards will feel less like they are spending the appropriate time on advising the company on how to run the business. Because of decreased satisfaction by Board members resulting from lack of time to focus on key business issues, Directors will become discontent and leave service, thereby increasing the time and cost that the Board and the nominating committee will spend to find suitable replacements.
The Clients have experienced great difficulty finding suitable director candidates given the state of the economy and the increasing potential for director liability (whether real or perceived). Therefore, adding a process by which the Board will be required to address all shareholder communications will be overly demanding on Board members and lead to increased time and cost to find suitable replacements.
In addition, we would like to point out that companies continue to have Annual Meetings at which shareholders can voice their concerns - with the additional feature of having other shareholders participate. Annual meetings have been and continue to be an appropriate forum for shareholders to voice their concerns.
2. Description of Material Action Taken as a Result. Even if the Commission decides to implement procedures that require disclosure of a process by which shareholders can communicate with the Board, our Clients believe that 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 to deal with at least one shareholder proposal per year and for larger companies, three to four proposals is more realistic.
Requiring companies to disclose actions taken will result in an increasing number of proposals, leading to increased time and effort of Board members to appropriately consider and act upon these proposals. In addition, our Clients do not believe that the Commission has considered that some of these communications will be (i) personal grudges, (ii) related to matters that should not be publicly disclosed and (iii) incompatible with the agendas of other large shareholders. Therefore, our Clients believe that disclosure of any action taken should be left to the decisions of the shareholder and the company.
3. Shareholder Disclosure Requirements. The Clients were concerned to see that the Commission has not proposed any rules requiring shareholders to meet certain requirements before any company process regarding shareholder communications would be required. For example, our Clients believe that 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 are in place. In addition, there should be minimum holding requirements (both time and amount) before these processes must be adhered to by the Board. An additional good faith standard should be added to prevent the company from having to respond to communications that are in bad faith. Finally, the Commission should consider requiring the shareholder demonstrate a proper corporate purpose before the Board would have to respond. These additional standards are well-developed under state laws and should help to prevent harassing, bad faith and improper shareholder communications.
The Commission should also consider the scenario by which shareholders routinely purchase small numbers of shares to gain admission to a public company's shareholder meeting. Often they purchase these shares as a threat - "either deal with my concern or I will attend and disrupt the entire meeting." Then, following the meeting, these persons often sell their shares, having had no long term interest in the company's success but having received something of personal gain. We hope that this example will cause the Commission to issue minimum requirements should it determine that it is appropriate to finalize rules in this regard.
Our Clients do not support the Commission's proposed rules regarding nominating committee functions and communications between security holders and the Board. The Clients believe that (i) the Commission, (ii) public companies, (iii) stakeholders and (iv) the public have not had enough time to evaluate the impact of the current corporate governance reforms (i.e. the Sarbanes-Oxley Act, stock exchange corporate governance rule proposals and other third-party influence) to be able to conclude that the proposed rules will effectively improve the transparency of Board processes without causing large additional costs for public companies. In addition, even if the effectiveness of these proposals could be determined at this time, in order to consider and 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.
However, should the Commission decide to review and possibly adopt rules (after considering all of the comments, including shareholder access to the proxy card) at a later date, the Commission should eliminate certain disclosures and consider broader requirements than the detailed disclosures contained in the proposed rules. By doing so, the Commission will (i) permit the required and appropriate levels of flexibility for Boards of Directors to consider director candidates, (ii) eliminate the time and cost that is inherent in certain portions of the proposed rules and (iii) avoid other unintended adverse consequences that would result from adoption of the proposed rules "as is."