September 8, 2003
Dear Mr. Katz:
I am writing on behalf of Connecticut State Treasurer Denise L. Nappier to comment on the Proposed Rule: Disclosure Regarding Nominating Committee Functions and Communications between Security Holders and Boards of Directors. As principal trustee of the Connecticut Retirement Plans and Trust Funds (CRPTF), which has approximately $18 billion in assets, Treasurer Nappier wrote to you on this issue in June when the Commission was soliciting comments for the staff report which is the basis for this proposed rule. The thrust of her comments then was that shareholders must have more of a voice in selecting who represents them on corporate boards. Our comments on the current proposal are along these same lines; however, we also offer several suggestions to strengthen various portions of the proposed rule.
We would like to congratulate the Commission for addressing these important issues and for acting promptly. Electing directors whose interests are aligned with those of shareholders is the most important stock ownership right that shareholders can exercise. By improving the process to permit shareholders to have a more effective role in determining their representation in the boardroom, shareholders can help to build boards that seek business practices that enhance financial performance while at the same time safeguard the long-term interests of shareholders.
The proposed rules are a welcome continuation of the initiatives by the Commission and other regulatory bodies to strengthen board accountability. While we believe all of these reforms, including the proposed rules on disclosure and the anticipated revisions to the proxy access rules are important improvements, more needs to be done to fully restore investor confidence. On behalf of the Treasurer, I offer the attached suggestions for improvement regarding disclosure and communication to shareholders on board matters.
We appreciate the opportunity to continue to share with you our view on the current proxy rules and ways they can be improved.
If you have any questions, please contact Meredith Miller, Assistant Treasurer for Policy at (860) 702-3294.
Proposed Rule: Disclosure Regarding Nominating Committee Functions and
Comments of Connecticut State Treasurer Denise L. Nappier
I appreciate the opportunity to comment on the proposed rule for disclosure and communication regarding board member and governance issues. I believe that in order to fully restore investor confidence, shareholder rights must be strengthened. Improving financial reporting and board composition is not the sole answer to ensuring accountable governance. The two issues being considered are important steps in properly asserting shareholder rights. Accordingly, I have addressed below the issues in sections A and B of the Proposed Disclosure Requirements.
A. Enhanced Nominating Committee Disclosure
The proposed rule contains disclosure requirements important for shareholders. However, as noted several times in the introduction, there is concern that disclosure requirements have in the past resulted in boilerplate disclosure; that is, minimal reporting with vague language. These proposed disclosure requirements will, in some areas, evoke this same result. Companies that wish to comply with the spirit of these new requirements will assist shareholders in better understanding their company's nominating process. However, those companies that want to continue to keep their nominating process a mysterious one can continue to do so within the letter of the proposed rules.
For example, if a company is not listed on an exchange that requires a nominating committee charter or does not have policy to consider director candidates recommended by securities holders, the rules would only require admission of this fact. If a company does not have a nominating committee the required statement as to why could be answered, "we don't want to" (or more artfully "we don't believe it is in the best interests of shareholders"). All companies should have a nominating committee comprised solely of independent members, and that committee should have a charter and operational policies, which should be available to shareholders (preferably on the company's website). If the Commission believes these to be sufficiently important to address in these rules, the Commission should make them an absolute requirement.
The proposed rule sets out a solid framework requiring companies to disclose criteria for selecting a candidate. The criteria include qualifications and skills sought in director candidates, the process for identifying and evaluating candidates, and identification of the executive search firm if one is used. This disclosure will give shareholders an enhanced understanding of the process used to select the candidates to oversee the company on their behalf. On the subject of disclosure and why certain candidates were or were not chosen, you raise several questions in the proposed rule (in # 8); "Should we require the company to disclose when it chooses candidates who do not meet the criteria? Should there be a specific disclosure requirement as to whether the company applies the same criteria to candidates
recommended by security holders as to company nominees?" In response to both these questions, I emphatically reply YES - the Commission should make these requirements.
I also recommend that you require in the description of the nominating process what role, if any, was played by management, particularly the CEO. Shareholders should know if any board candidate was recommended by the CEO, and whether the CEO was involved in any way in the screening process for directors. There are too many stories of boards packed with friends of the CEO, and of good candidates being eliminated from consideration because the CEO vetoed them.
Another significant enhancement is the requirement that the Nominating Committee formally consider nominee recommendations from large investors, or a group of investors, as well as the required disclosure of this process. This will assure not only that nominees other than those generated internally be seriously considered, but will permit shareholders to evaluate whether the nominating committee's recommended slate is the strongest it could be.
I would recommend that you reduce the required number shares for this rule to kick-in from 3% to 1%. The process you are recommending gives all discretion to the Nominating Committee. The proposed rule does not mandate a competition for board seats. With the breadth of holdings of our public companies, which you regulate, 1% is a sizeable holding, and will not be easily achievable by rank and file institutional investors. For this type of advisory process, I believe a 1% threshold will help open up the process without unduly burdening the nominating committee or its procedures.
I also believe that it is important that a nominating committee be required to report to shareholders its consideration of diversity issues as they relate to board nominations. I have attached nominating committee charter language developed by the Calvert Fund that the Commission may want to consider as it reviews disclosure requirements.
B. Disclosure Regarding the Ability of Security Holders to Communicate with the Board of Directors
Shareholders are the owners of the company. The members of the Board of Directors oversee the company for the benefit of the shareholders and to protect their interests. Boards of directors need to be responsive to shareholder interests.
By proposing rules regarding the ability of shareholders to communicate with the Board, the Commission is sending a clear message to the corporate community that board members must be responsive to shareholders. It is this message - as much as the details of the proposed rule - that is important here. That is because with any communication, you can require that messages reach directors, but you cannot mandate that they be read - nor can you require that directors respond (or respond in a meaningful way).
The Commission's proposed rules are not needed at companies that truly wish to enhance communication between directors and shareholders, and the rules will make no difference at companies, which are not interested in communication between the Board and shareholders. However, the fact that the Commission is focusing on the issue should in itself make companies more aware of the need for meaningful and responsive two-way communication with shareholders.
In addition, given the large number of shareholders, and the small number of directors, it would be counter-productive to require director response to every letter they receive. We must work together to create a mechanism that brings directors and shareholders into direct communication on issues of major importance to the company (as perceived by either the board members or significant portion of shareholders).
How to achieve this goal is crucial. That is why I am pleased to be representing institutional investors on a joint task force of the Council of Institutional Investors (CII) and the National Association of Corporate Directors (NACD) to work on this. The goal of the task force is to investigate the current barriers to director-shareholder communication, evaluate how some companies and directors have overcome them and issue recommendations or "best practices" based on its findings. We expect to release a report later this year.
There is one area of board - shareholder communication that I believe all companies and their shareholders would benefit from, and I believe would be beneficial for the Commission to address. Every company must have an annual meeting. This is an event usually attended by board members and shareholders, provides an opportunity for direct two-way communication, and is used to great advantage by many companies.
Unfortunately, some companies are trying to avoid such open communication (either through electronic only meetings or by holding meetings in remote locations, or by board members not attending). This is unfortunate. I recommend that the Commission consider a rule that would enhance board - shareholder communication at every company's annual meeting. This policy was endorsed by the Council of Institutional Investors in 2003 as the minimum amount of communication board members should have with shareholders.
I appreciate the Commission's willingness to address these issues, as well as the opportunity to address these proposals.