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September 15, 2003

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

Re: File No. S7-14-03

Disclosure on Nominating Committee Functions and Communications between Security Holders and Board of Directors

Dear Mr. Katz:

The Pennsylvania State Employees' Retirement System (SERS) is a $22 billion defined benefit retirement system with a fiduciary responsibility to provide for the retirement, disability and death benefits of over 200,000 members and beneficiaries.

As a major institutional investor, SERS strongly endorses the Securities and Exchange Commission's (SEC) proposal to require expanded proxy statement disclosure of the director nomination process and the means for shareowners to communicate with directors. SERS also urges the SEC to do more to enhance the role of investors and to enhance the accountability of boards of directors.

I. SERS Board endorses The Conference Board's Commission on Public Trust and Private Enterprise's Report recommending greater shareowner access.

During the past year, I had the privilege of representing institutional investors as a representative of a 12-member "Blue Ribbon" Commission on Public Trust and Private Enterprise convened by the Conference Board to address the causes of declining public and investor trust in companies, their leaders and America's capital markets.

The SEC initiatives currently being proposed are in the spirit of the following recommendations for more shareowner involvement contained in the Conference Board's Findings and Recommendations on Executive Compensation, Corporate Governance, and Auditing and Accounting. The following excerpts from the report address the shareowner access issue directly:

Shareowners, particularly long-term shareowners, should act more like owners of the corporation. As shareowners, they should have the ability to participate more readily in the corporation's election process through involvement in both the nomination of directors and in proposals in the company's proxy statement about business issues and shareowner concerns regarding the governance of the corporation.

The following Best Practice Suggestions were recommended in the Commission's report:

  1. Boards of Directors should develop procedures to receive and to consider shareowners' nominations for the board of directors and well as shareowner proposals related to serious business issues.

  2. In evaluating shareowner nominees and proposals, boards should not preclude proposals made by smaller, individual investors.

  3. The procedures of receiving shareowner nominations and proposals should include, where appropriate, meetings of shareowners with the nominating/governance committee or its representatives.

  4. Boards of directors should give serious consideration to adopting precatory shareowner proposals that receive a substantial percentage, even if less than a majority, of the votes cast. In the event that a board chooses not to implement a proposal that receives a substantial percentage, even if less than a majority, of the votes cast, it should publicly disclose its reasons for its actions.

II. The Breeden Report "Restoring Trust" strongly endorses greater shareowner access.

Greater shareowner access is also strongly supported in the many of the 78 "best practice" recommendations contained in the Breeden Report ("Report"), released in August 2003, entitled Restoring Trust. The Report was submitted to the Hon. Jed S. Rakoff in connection with an SEC enforcement proceeding brought against WorldCom, Inc., subsequent to the Company's admission in June 2002 that its earnings had been overstated by more than $3.8 billion, the largest accounting fraud in history. As the Report notes in its opening sentence...Restoring Trust is not just a study of corporate governance. It is intended as a blueprint for action.

The author of Restoring Trust, Richard C. Breeden, a former SEC Commissioner, continues to serve as a Corporate Monitor to MCI (formerly WorldCom), a position created by Court at the at the suggestion of the SEC. The WorldCom collapse tragically illustrates many fundamental weaknesses in the current U.S. corporate governance model - including the fact that investors have few, if any, meaningful and cost-effective ways to participate in the director nomination process. As a corollary, many boards of directors have had no meaningful accountability to the owners of the corporation.

The SEC should consider the "best practice" recommendations on shareowner access that are contained in the Report. Restoring Trust requires a completely new approach for nominating directors. For example, the recommendations require at least one new director to be elected each year. Most importantly, for the first time, a group of shareholders will have the power, if it does not agree with proposed candidates to fill board vacancies, to nominate their own candidates for inclusion in the management proxy statement.

Again, it may be beneficial for the SEC to look to the Breeden Report for guidance in establishing new corporate governance standards, as it seek to strike a balance among the shareowners, directors and managers.

Restoring trust definitely shifts the balance of power in governance... in the direction of a bit more power and authority for shareholders. This is a measured change, and one that seeks to avoid changing the internal balance of power too much. Rather than more regulation to protect shareholders, these recommendations seek to give more power to shareholders to protect themselves.

...In a broader sense, the issues considered by the Report go well beyond WorldCom. Fashioning better mechanisms to control abusive compensation practices, self-dealing, or business conduct that violates ethical norms or legal standards, while maintaining an ability to take risks and achieve commercial success, in an imperative for every publicly held company.

III. The Council of Institutional Investors and National Association of Corporate Directors Task Force on Shareowner-Director Communication supports greater shareholder-director communication.

The issue of increased shareowner-director communications is of such significant importance that the Council of Institutional Investors and the National Association of Corporate Directors have created a joint task Task Force on which I have the privilege of serving as Co-Chair along with Warren Batts. The goal of the task force is to investigate the current barriers to director-shareowner communication, evaluate how some companies and directors have overcome them and issue recommendations or "best practices" based on its findings.

IV. SEC Proposal

SERS concurs with CII's recommendations in its letter responding to this matter and believes that the proposed disclosures will provide shareowners with a more complete picture of the processes and policies of nominating committees and boards and some much-needed specifics on avenues for shareowner-director communications.

SERS strongly supports the proposed disclosures regarding the director nomination process, particularly the disclosures about the process for identifying and evaluating candidates, the qualifications and standards for director nominees, the source of candidates, and the policies and procedures for shareowner-suggested candidates. We believe the expanded disclosures will help investors understand and more effectively participate in the director nomination process.

Like CII, SERS also applauds the enhanced disclosure applicable to companies not nominating candidates suggested by an investor or group of investors owning at least 3 percent of the stock for a year. Such disclosure will give shareowners an additional tool to evaluate the responsiveness of their elected representatives.

Furthermore, we agree with CII that the proposed changes should apply to all companies-including small companies and mutual fund companies-with registered securities.

Like CII, SERS believes the following modifications would strengthen the proposed rules and provide greater transparency to investors.

  1. Companies should be required to provide prompt 8-K disclosure of any changes to procedures for shareowners to submit recommendations for director candidates. Such disclosure would ensure that shareowners interested in submitting candidates are fully aware of relevant procedures.

  2. Companies should be required to disclose whether the same criteria are used for shareowner-submitted and nominating committee-nominated candidates, and if not, what the differences are. This would ensure that shareowners have adequate information to identify and submit qualified director candidates.

  3. Companies should have to disclose the names of third parties used to identify director candidates and whether the company's management, the board or the nominating committee retained the third party. This information would help investors evaluate the independence and effectiveness of search firms or other consultants retained to identify director candidates.

  4. In addition to the name of each candidate's sponsor, companies should be required to disclose the sponsor's title and firm and any professional, familial or financial relationship between the candidate, sponsor, company and company executives. Certain relationships, no matter how small, may compromise a director's objectivity and loyalty to shareowners, and these relationships should be disclosed to shareowners.

  5. Companies should have to include the name of any rejected candidate-suggested by a 3 percent holder or holders-who consents to being identified in the company's proxy statement. Shareowners can use this information to assess the board's performance in the nominating process and to decide whether they would suggest the candidate or join other shareowners in recommending the candidate in future years.

Some issues were not addressed in the proposal release. To further strengthen the rule changes, SERS supports CII's following recommendations:

  1. Require disclosure of company policies regarding director attendance at shareowners' meetings and specific attendance details in the 10-Q along with the voting results. Directors are elected by and are accountable to shareowners. Accordingly, it is appropriate that shareowners have an opportunity at least once a year to look their elected representatives in the eyes and ask questions. Too often directors-and sometimes even corporate executives-do not attend annual shareowners' meetings. We believe it is appropriate for companies to disclose whether or not they have policies regarding director attendance at shareowner meetings. Also, SERS believes shareowners should be provided specific information on whether each director did or did not attend the meeting. Such disclosure could readily, and at minimum cost, be added to the voting result detail disclosed in 10-Qs, and it would be of tremendous value to investors.

  2. Clarify that any shareowner or group of shareowners submitting a director candidate will not jeopardize their 13G filing status. SERS believes that the SEC's intent is that such an activity would not result in loss of 13G status. However, continued concerns over certain gray areas have chilled investor interest in pursuing certain actions. We urge the SEC to create a safe harbor for the following activities: submitting director candidates for consideration by company boards or nominating committees; "short slate" campaigns that do not constitute a majority of the board, and "just vote no" efforts in which shareowners urge other shareowners to withhold votes from directors.

  3. Require enhanced disclosure of relationships between directors, corporations and corporate executives. Details regarding the director nomination process are of vital importance to investors, but so are meaningful disclosures of director links to companies and company executives. Investors should have access to sufficient information for them to make their own assessments of a director's independence. Current disclosures are weak and definitions proposed by the exchange fall short of ones used by most investors. Too often in the past shareowners have learned of ties between directors when it's been too late, with a company mired in a scandal and director independence called into question. We urge the Commission to act on the Council's rulemaking petition submitted in October 1997 and amended and resubmitted in October 1998.

Finally, few do have serious concerns with the current SEC proposals that shareowner access to the ballot for the nomination of directors is predicated on demonstrated corporate governance unresponsiveness and misbehavior. The first concern is that corporations that deserve greater shareowner attention and better governance will avoid it by manipulating the "letter" of the regulation thereby negating the spirit of the proposal. The second is that by the time the poor governance thresholds have been breached and investors are allowed input severe damage may have already been done to the corporation and the shareowners' investments.

Nevertheless, as institutional investors, SERS applauds the SEC's efforts to increase corporate board accountability and transparency to shareowners. The SEC proposed disclosure reforms are a good beginning but should only be a prelude to more meaningful reform for investors-the adoption of rules giving shareowners access to management's proxy card to nominate potential directors.

The Commission's initiatives in these important areas will further enhance the changes mandated by the Sarbanes-Oxley Act of 2002, and the totality of these reforms will be of lasting importance to investors in the U.S. capital markets.


Peter M. Gilbert
Chief Investment Officer

CC: Chairman William H. Donaldson
Commissioner Paul S. Atkins
Commissioner Roel C. Campos
Commissioner Cynthia A. Glassman
Commissioner Harvey J. Goldschmid
Alan L. Beller, Director, Division of Corporation Finance
Martin Dunn, Deputy Director, Division of Corporation Finance