Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street NW
Washington, DC 20549-0609


Dear Mr. Katz:

I. Overview

As the scandals of the new millennium have illustrated, substantial concern has arisen over the effectiveness of the board of directors in the oversight of public companies. While a complex and difficult issue, one approach at reform has focused on the need to strengthen the role of independent directors on the board. Sarbanes-Oxley did this in connection with membership on the audit committee. Proposals from the NYSE would tighten the definition of independent and ensure that these directors had a greater role in important committees of the board.

The Commission's rule proposal contributes to this process. The proposal would require increased disclosure concerning the process for nominating directors to the board. The proposal continues a long history by the Commission of seeking to use disclosure to affect matters of corporate governance.

In practice, however, the approach has not worked. In some cases, such as executive compensation, it is likely that increased disclosure made worse the very problem the Commission was trying to resolve.1 Moreover, in general, the approach has resulted in boilerplate disclosure (despite the Commission admonition against this) and has not produced particularly useful information. The same is likely to occur in connection with these proposals.

Finally, wholly aside from the Commission's efforts, it is doubtful that any of the current reforms now under discussion will ensure that directors are truly independent. Executive officer influence over the nominating process cannot be eliminated. Similarly, no definition of independent can capture the myriad of relationships and interests that impair a director's ability to make decisions in a neutral fashion.

Removing barriers to the election of directors nominated by shareholders is a major step forward. For this to occur in any meaningful way, however, shareholders need more than additional disclosure. They need a mechanism that will allow them to defray the high costs associated with the election of directors. Until these types of barriers are removed, it is not likely to result in the election of any significant number of shareholder nominated directors.2

II. Past Efforts to Use Disclosure to Influence Corporate Governance

The Commission's rule proposals seek to use disclosure to improve shareholder access to the board's nominating process. While it is hard to argue with more disclosure in such an important area of governance, past experience (including, as the Commission acknowledges in the proposing release, in connection with nominating committee disclosure) suggests that the approach will not significantly advance the goals sought by the Commission and may even be counter-productive.

The Commission has, in the past, tried to use disclosure to affect the governance process.3 With respect to executive compensation, the Commission has required a report by the compensation committee in an apparent attempt to encourage a more deliberative process.4 The Commission has also required the audit committee to file a report, presumably in an effort to encourage greater responsibility in ensuring the accuracy of the financial statements.5 Finally, the Commission sought to step up board oversight by making sure that directors attend the meetings. 6

To the extent attempting to alter board behavior, these efforts by the Commission have not worked. First, there has not been meaningful enforcement of the requirements. Enforcement of the provisions would ordinarily fall to the Commission. With limited resources and perhaps 14,000 public companies7 to examine, the disclosure requirements do not and realistically cannot receive significant attention from the agency. There has apparently never been an enforcement proceeding brought for inadequate disclosure of audit and compensation committee reports. A private right of action does exist for violation of the proxy rules. In general, however, courts have not been particularly open to causes of action based on false compensation disclosure.8

Second, companies responding to these requirements often resort to boilerplate disclosure.9

Finally, the disclosure requirements have sometimes suffered from the rule of unintended consequences. Rather than cause the committee to reduce compensation, they may have had the opposite effect. By making total compensation clear, they provided officers with an argument that they should be compensated in a manner not unlike their counterparts. Thus, the disclosure may well have caused upward pressure on compensation.

III. The Rule Proposal

A. Overview

Many of these same concerns are likely to arise in connection with the current set of rule proposals. Most of them are in fact not likely to lead to specific information useful to investors but will instead result in boilerplate. Moreover, while this is to some degree always a risk, many of these particular proposals make boilerplate and vague disclosure inevitable.

In addition, these proposals may well result in some unintended consequences. In general, the proposals do not require boards to adopt policies; they only require disclosure if such policies exist. Companies may find it easier to have no policy rather than disclose procedures that will encourage submission of nominations by shareholders. This proposal will allow them to learn about other companies that have not adopted policies. This may encourage other companies to do the same thing. Thus, the disclosure may discourage rather than encourage the adoption of policies.10

B. Specific comments

a. Boilerplate

Proposed Item 7(d)(2)(ii)(E) by its nature will invariably result in boilerplate. The provision seeks disclosure of the committee's policies (if they exist) concerning nominations received from shareholders. By definition, the policy must be exceedingly broad. Shareholders submitting nominations may have small or large holdings. They may be motivated by a desire to improve the management of the company or by a desire to promote a specific political or social goal. Any policy of the nominating committee must be broad and vague enough to provide the board with maximum flexibility in dealing with these varying circumstances.

Even a statement that the committee will consider candidates recommended by shareholders will likely have little impact. Most boards will simply disclose (as they surely must in order to meet their fiduciary obligations) that they will consider competent candidates from any source, including shareholders. In short, these policies and their disclosure will not likely provide shareholders with much specific or useful information.

Similarly, Proposed Item 7(d)(2)(ii)(I) essentially asks for the process used by the committee to identify and evaluate nominees. Directors have a fiduciary obligation to nominate the most qualified persons. In responding to this Item, therefore, directors will, consistent with their fiduciary obligations, likely describe the broadest possible process to be used in identifying nominees. As a result, the information required by this Item is likely to be broad, vague and provide little specific information of use to shareholders.11

b. Useful Information

In other instances, the proposal is phrased in a way that will not elicit useful information. This is true with respect to Proposed Item 7(d)(2)(ii)(H). The provision requires disclosure of the minimum qualifications that must be met by a nominee. There are very few objective minimum qualifications that would automatically eliminate a candidate. For example, most boards probably consist of directors with a college degree. It would, however, not be appropriate in most instances to announce this as a minimum. Doing so would foreclose consideration of a nominee who otherwise had the skill and talent to sit on the board.12

Similarly, the subsection also asks for disclosure of "specific qualities or skills" that the committee believes one or more directors should possess. Unlike minimums, of which there are likely to be few, qualities and skills are likely to be numerous. The proposal does not require any discussion of the relative importance of the skills or whether they are already represented on the board in sufficient quantity. Thus, the requirement will lend itself to an undifferentiated list of skills/qualities that will have little specific meaning or provide little specific insight into the qualities of nominees.

The better question would be to ask for the four or five most significant qualifications (perhaps ranked in order of importance) necessary for board membership. The proxy statement should include a detailed discussion of the types of experience or education necessary to meet the qualifications and should describe how the qualifications apply to existing board members. While this could also result in broad boilerplate, it would be more likely to provide shareholders with information that would be useful in finding nominees who might be acceptable to the committee.

c. Need for Clarifications

Proposed Item 7(d)(2)(ii)(J) requires disclosure of the "specific source" for each nominee. The parenthetical refers to nominations received from "an executive officer, director, or other individual". First, the provision should be changed to make clear that it does not apply only to nominees submitted by corporate insiders (as the parenthetical suggests). It would be of interest for shareholders to know who submitted a nominee, whether a shareholder, corporate insider, or third party. This is particularly true if the person submitting the nomination has significant ties with the company.

Second, the information in this Item is presumably designed to inform shareholders about possible connections between nominees and persons associated with the company. The Proposed Item should, therefore, require that a "source" making a nomination disclose any affiliation or connection to the company. To the extent that the individual is an agent for an entity, the individual should disclose this fact and disclose the entity's affiliation or connection to the company.

Third, the Proposed Item should make clear that submission of a nominee to a search firm employed by the nominating committee is the same as submission to the committee. In many cases, the search firm will conduct a search and make recommendations. To the extent the search firm learns of a nominee from a source outside the firm, the proxy statement should disclose this fact.

It should be noted that this requirement could be circumvented with relative ease. An individual wanting to obscure his or her identity could simply ask someone else to propose the candidate. To make this more difficult, the Proposed Item should also require the disclosure of any significant business or personal relationship or interaction between a nominee and any director or executive officer.13

d. Omission of Information

Other provisions leave out important information. Proposed Item 7(d)(2)(ii)(L) provides for disclosure where the committee rejects a nominee submitted by a shareholder or group of shareholders owning 3% or more of the shares.

First, the provision should apply only to nominees who have consented in writing to the nomination. To the extent that the Commission has concern over privacy rights, the candidate could be required in the consent to agree to disclosure in the event the nominee is declined.

Second, the Proposed Item does not require identification of the nominee nor does it require disclosure of the nominee's qualifications. This is probably the most important information to shareholders. Shareholders would presumably need this information to assess the committee's reasons for rejecting the nominee. In fact, it is hard to understand the value in disclosing the reasons for rejection without also disclosing the identity and qualifications of the candidate. For example, it would be of little use to shareholders to state that a candidate was rejected because of inadequate industry experience without knowing what experience the candidate actually had.

One solution would be to give the nominating shareholder/shareholders 500 words (similar to Rule 14a-8) to identify the nominee and his/her qualifications and to provide a statement supporting the nomination. Management would of course still be required to disclose the "specific reasons" for rejecting the nomination.

Third, the provision allows any explanation for rejection to suffice. Companies will often be able to rely on the absence of openings on the board, particularly where all existing directors are renominated.14 This will allow the committee to avoid a discussion of the merits of the nominee. This may even occur where the board has the authority to expand the size of the board but chooses not to do so.15 In a case where the committee rejects a nominee due to the absence of an opening, the proxy statement should be required to include an explanation of the reasons why the size of the board was not expanded to include the nominee.

e. Unnecessary Complications

Other provisions are simply too complicated. With respect to Proposed Item 7(d)(2)(ii)(A), the provision makes it too difficult for shareholders to obtain a copy of the committee's charter. While many companies may voluntarily place the charter on their web site, thereby making it easily accessible, many others will not. In those circumstances, shareholders presumably must contact the company to obtain a copy, something that will result in some (albeit minor) cost and some (potentially significant) delay. Moreover, even for those posting the charter on the Internet, the version may not be current. The provision should, therefore, require the filing of the current charter either as an attachment to the proxy statement or as an exhibit to another Commission filing (such as the annual report on Form 10-K). In that way, the document can be easily obtained through EDGAR.

f. Incomplete Information

Finally, other Proposed Items ask for useful information but are not complete. Proposed Item 7(d)(2)(ii)(C) requires disclosure where a member has not met the definition of independent under the exchange/Nasdaq requirements. Subsection (D) requires non-listed companies to disclose whether directors on the nominating committee are independent based upon the definition used by an exchange or by Nasdaq.

The provision has a number of problems. First, there are two critical sources for the definition of independent director - those emanating from the SROs and those emanating from the states. Directors deemed independent under the rules of the SROs may not be independent under state law (and visa versa).16 As a result, disclosure that directors meet the independence test promulgated by the SROs might actually mislead investors into thinking the directors are independent under all relevant standards. Disclosure of compliance with state definitions should also be required.

Second, the provision merely requires, in the case of non-listed companies, a statement that directors are independent. For listed companies, they need only disclose any "instance" in the prior year where directors on the nominating committee were not independent. The provision should also have to disclose the reasons why the directors did not meet the requirement. .

Third, the provision should require more disclosure about the information used by the board of directors in determining the independence of the directors on the nominating committee. At a minimum, the proxy statement should disclose all relationships and interactions with the company and/or directors/executive officers that were examined by the board but deemed insufficient to impair independence.

III. The Long Term Solution

If the goal is to increase shareholder access to the nominating process, it is not enough simply to provide additional disclosure about how a board committee selects nominees. Even without rule changes, management already has an incentive to listen to suggestions about board candidates from large shareholders. Thus, it is small shareholders and large shareholder adverse to management who are most in need of additional access. No matter what procedures are in place, it is unrealistic to think that nominees from either of these groups of shareholders will receive positive attention from the nominating committee.

The best way to increase access is to remove barriers that interfere with shareholder nominations. A significant barrier is cost. One way to reduce cost would be to allow shareholders representing a certain percentage of voting shares to include their nominee in the company's proxy statement and proxy card. Even this approach is unlikely to result in the election of a significant number of shareholder nominated directors, particularly given management's right to use the corporate treasury to oppose the nominees. Nonetheless, in rare cases, non-management supported directors could be elected.

These efforts to increase shareholder access to the nominating process are to be lauded. In the end, however, they are only a first step. Without the additional steps, such as direct access to the proxy statement, they will not likely lead to significant improvement in shareholder access.

Thank you for this opportunity to comment on this important proposal.

With regards,

J. Robert Brown, Jr.
University of Denver College of Law

1 Disclosure of executive compensation allowed officers to compare their compensation packages. This has enabled them to argue that they should receive salary increases to match their counterparts. Thus, the disclosure placed upward pressure on executive compensation.
2 The Commission has indicated that it will likely propose reforms in this area. See Exchange Act Release No. 48301 n. 10 (August 8, 2003).
3 A more complete discussion of this approach takes place in J. Robert Brown, Jr., The Irrelevance of State Corporate Law in the Governance of Public Companies, to be published in the University of Richmond Law Review in December 2003.
4 See Item 402(k) of Regulation S-K.
5 See Item 306(a) of Regulation S-K. See also Exchange Act Release No. 42266 (Dec. 22, 1999)(adopting release).
6 The Commission, therefore, has required companies to disclose in their proxy materials the attendance record of directors at meetings of the board and board committees. Presumably directors would rather attend meetings than publicize their absences. See Item 7(f), Schedule 14A.
7 See Exchange Act Release No. 47226 (Jan. 22, 2003).
8 See Seinfeld v. Bartz, 322 F.3d 693 (9th Cir. 2003) ("We conclude that SEC regulations do not require the use of the Black-Scholes valuation and that the proxy statement is not materially false and misleading."). See also Shaev v. Hampel, 2002 U.S. Dist. LEXIS 20497 (SD NY Oct. 25, 2002).
9 See Susan J. Stabile, One For A, Two For B, and Four Hundred For C: The Widening Gap in Pay Between Executives and Rank and File Employees, 36 U. Mich. J.L. Ref. 115, 130 (Fall 2002)("An examination of some of the compensation committee reports of large public companies reveals much boilerplate language about the value of incentive-based compensation and general compensation philosophy, but they say little about the policies of the particular company in question.").
10 Ultimately the better approach would be to require companies to adopt policies in this area.
11 One possible way to obtain more specific information would be to ask for a description of the method used to identify each new director nominated for the board. This will at least provide specific information on each candidate.
12 Among others, Bill Gates, Larry Ellison and Steve Jobs apparently did not graduate from college.
13 Presumably this type of requirement would ensure the disclosure of the type of information deemed relevant by the court in In re Oracle, 824 A.2d 917 (Del. Ch. 2003).
14 Even where an existing director is not renominated, the board can avoid the need to fill an opening by shrinking the size of the board. See note 15.
15 Generally the size of the board is expressed as a range and set forth in the articles. The actual number within the range is determined by board resolution.
16 For example, issues of independence under state law arose in In re Oracle, 824 A.2d 917 (Del. Ch. 2003). These same directors may well have been independent under the standards of the SROs.