Sullivan & Cromwell LLP
125 Broad Street
New York, New York 10004-2498
September 12, 2003
VIA E-MAIL: email@example.com
Mr. Jonathan G. Katz,
Securities and Exchange Commission,
450 Fifth Street, N.W.,
Washington, D.C. 20549-0609.
Re: Proposed Rule Relating to Disclosure Regarding Nominating Committee Functions and Communications between Security Holders and Boards of Directors
(File No. S7-14-03)
Dear Mr. Katz:
We are pleased to respond to Release Nos. 34-48301, IC-26145 (the "Proposing Release") in which the Securities and Exchange Commission (the "Commission") solicited comments on proposed amendments to proxy statement disclosure requirements regarding nominating committee functions and communications between security holders and boards of directors.
We endorse the Commission's efforts to enhance the transparency of the board of director nominating process and communications between security holders and the board of directors. We have serious concerns, however, regarding the proposed disclosure regarding the nominating committee's deliberative process in connection with rejected nominees of some shareholders. We believe that such disclosure will inhibit the functioning of the independent nominating process in a manner contrary to the interests of most shareholders and will have other adverse effects. In addition, we have other specific suggestions regarding the proposed nominating committee and shareholder communications disclosures.
I. Enhanced Nominating Committee Disclosure
1. The proposed disclosure regarding nominees of some shareholders rejected by the nominating committee would inhibit the development and functioning of the board's independent nominating process and may have other adverse effects.
The proposed amendment would require disclosure of whether the nominating committee has decided not to nominate a candidate recommended by a 3% shareholder or group of shareholders, including the name of the nominating shareholder and the specific reasons for the committee's decision not to nominate the candidate. We believe that this disclosure requirement would inhibit the development and functioning of the board's independent nominating process and is likely to have other unintended negative effects on the nominating process. We believe that the nominating system contemplated by the pending stock exchange proposals will serve the interests of all shareholders. The New York Stock Exchange, the Nasdaq Stock Market and the American Stock Exchange have each proposed, as part of the changes to their corporate governance standards, that director nominations be required to be made by a nominating committee composed entirely of independent directors (or, in the case of Nasdaq and Amex, a majority of independent directors). These proposals implicitly recognize that independent directors have a fiduciary duty running to shareholders as a whole and are in the best position to weigh recommendations for director nominees - from management, shareholders and other sources.
We believe that the proposed disclosure requirement will have the following adverse effects:
- It will undermine the board's independent nominating process by having a chilling effect on nominating committee discussions.
- It will create a bias to accept marginal director candidates.
- It will create an opportunity for abuse by dissident shareholders.
- It will raise privacy issues for candidates and nominating shareholders.
- It will result in disclosure that would not be material to shareholders.
- It will create an implication that nominees of large shareholders are more worthy of consideration.
Nominating Committee Discussions Will Be Chilled. We believe that requiring disclosure of any aspect of the nominating committee's deliberations would undermine the goal of the independent nominating process and provide little meaningful information to shareholders. In particular, we are concerned that, if such disclosure were required, nominating committee members would not feel free to engage in unfettered discussions regarding the comparative merits of various candidates for fear that the discussion could become the subject of public disclosure. Thus, a nominating committee member who has legitimate reservations about a shareholder nominee may hesitate to raise them or to oppose the candidate in order to avoid disclosure that may be seen as embarrassing to the company or a shareholder or that may be used to paint the company as unresponsive to shareholder concerns or imply that a conflict with a significant shareholder exists. The qualities that make a good director are not easily or cleanly measured - significant judgment must be applied.
Bias to Accept Marginal Candidates. We believe that the proposed disclosure will have, at least in some instances, the unintended consequence of not only chilling discussion but, even worse, the reluctant nomination of some individuals not considered to be top quality candidates by the nominating committee. This will occur because the directors on the nominating committee may decide that it will be better for the company to accept a marginal candidate than to force the company to engage in a possible public relations war with the disappointed shareholder that has been accorded special status by the proposed rule and potentially an even more distasteful public debate about the merits of an individual. After all, the proposing shareholder, by definition, will be dissatisfied with the committee's decision to reject its candidate and may well seek to challenge the board's judgment and reasons for doing so.
What if the directors on the nominating committee, for example, find the candidate too doctrinaire, too focused on one issue or personally abrasive? What if they become aware of some past dealings that are not clearly illegal, but may seem questionable or raise at least perception issues to those on the committee? In order to justify its decision, will the nominating committee need to conduct a detailed investigation into an individual's past, recognizing that the person nominated may well be a total stranger to them (or to any other shareholder)? To assure they have met their duty of care, what steps do the directors need to take to discover whether the individual has characteristics or has engaged in past activities that, if known, would make him or her unfit (or just not the best candidate available) to serve? If the candidate's name cannot be disclosed, can the nominating committee accurately state its "specific" reasons for rejecting him or her? Even if they can, no one serving on such a committee would wish to be associated with negative remarks about a specific, though unnamed, candidate.
Abuse By Dissidents. In addition, we are concerned that the proposed disclosure may have the unintended consequence of giving some shareholders leverage to use this requirement and threats of a public relations campaign, proxy contest or even litigation (i.e., alleging that the disclosure of the reasons for rejecting their candidate was false and misleading) to pressure directors to buy out the dissident shareholder at some premium that reflects the cost of engaging in a proxy contest or litigation.
Privacy Issues for Candidates. The proposed disclosure could also create the potential for embarrassment and privacy issues for candidates and nominating shareholders. While the proposed amendments would not require disclosure of the name of the rejected candidate, in many cases it may be possible for those interested in the company to infer his or her identity from circumstances and other facts required to be disclosed. In addition, the name of the recommending shareholder will be required to be disclosed. Disclosure of the mere fact that the candidate is not considered qualified by the nominating committee may be embarrassing to the candidate and may undermine the relationship between the company and the recommending shareholder. In a true public debate of the merits of a candidate, it will be practically impossible for the name of the candidate not to eventually become known. Disclosure may be required of personal facts about the candidate that were a factor in the committee's decision, which may raise serious privacy issues for candidates and a litigation risk for companies.
Immateriality of Proposed Disclosure. We believe that these possible adverse effects outweigh any disclosure benefits of the proposed amendment. We believe that the proposed disclosure would not be material to shareholders. Because the nominating committee's determination as to whether to nominate a particular candidate will necessarily involve considerations specific to that individual, we believe that disclosure of the specific reason for the determination will not be helpful to the shareholders' understanding of the nominating process in general and the potential treatment of other candidates in the future. The Proposing Release does not suggest that the disclosure is material and states only that the proposed disclosure requirement as to specific candidates is appropriate "given the particular concerns of [large shareholders that have a long-term investment interest] as to how they might participate in the nominating process." We believe that these concerns are adequately addressed by the rest of the proposed nominating committee disclosure requirements, including the committee's policy with respect to candidates recommended by shareholders and the process for submitting such recommendations as well as the process and criteria used by the committee to evaluate candidates. By way of comparison, we would point out that, while voters are interested in greater transparency in government operations, no government agency or other public entity is required to disclose if and why nominees for top positions in that entity were rejected. We believe this illustrates that the risks of public embarrassment and compromising a process directed at candidates' qualifications and other legitimate factors (as opposed to who has recommended them) outweigh any benefits associated with increased transparency.
Improper Favoring of Large Shareholders. Finally, we believe that the proposed disclosure requirement creates an implication, expressly endorsed by the Commission, that nominees proposed by large shareholders are more worthy of consideration than those proposed by other shareholders. We believe that in general this is contrary to state corporate law requirements, which do not differentiate in the treatment of shareholders based on the size of their holdings. We believe that this aspect of the Commission's proposal is also contrary to the spirit of the proposals by the stock exchanges to give shareholders greater access to the nominations process within the framework of traditional principles of corporate governance under state corporation statutes. More generally, we do not believe that the Commission has allowed sufficient time to reflect on the new stock exchange requirements, which have not yet even become final and effective, and their efficacy before imposing yet more requirements, the consequences of which may not have been adequately considered.
2. If the proposed disclosure regarding nominees of certain shareholders rejected by the nominating committee is retained, it should be limited to nominees of 10% shareholders who have held their shares for two years.
While we firmly believe for the reasons stated above that the proposed disclosure concerning rejected nominees is inappropriate and inadvisable, if the Commission cannot be convinced to withdraw this aspect of the proposal entirely, we would strongly recommend that it be significantly revised. In particular, we suggest that the amendment be modified to apply to 10% shareholders who have held their shares for not less than two years. We believe that a shareholder who has held its shares for only one year should not, for these purposes of creating such a special status, be considered a shareholder that has a long-term investment interest in the company. In addition, if a crude rule of thumb is to be used to distinguish between those shareholders who are to receive special treatment from the board, we suggest that the test used in Section 16 of the Exchange Act be adopted as a bright line distinguishing "insiders" from "outside" shareholders. The test would also distinguish those shareholders that have made a significant commitment to the issuer such that they are prepared to accept the short-swing trading restrictions of Section 16.
Alternatively, we suggest limiting the proposal to shareholders who have beneficially held more than 5% of the company's outstanding voting shares for not less than two years. Ownership above the 5% threshold is also recognized as a measure of significant shareholding by Congress in Section 13 of the Exchange Act. The additional benefit of using either a 10% or an over 5% threshold is that the filing requirements of Section 13, which apply at that ownership level, will offer the nominating committee and the other shareholders a better understanding of the motives (or lack thereof) of the nominating shareholder and serve to provide assurance, in the form of statements filed with the Commission, that there is no hidden agenda behind the proposed nomination. In particular, the certification requirements of Schedule 13G will give reasonable assurance that a nomination facilitated by the proposed amendments is not being used with a control intent. In addition, Section 13 filings will provide a convenient and reliable method for verifying that the nominating shareholder has held its shares for the minimum holding period.
3. The proposed amendments should clarify that the nominating committee may not consider a shareholder nominee if the nominating shareholder has failed to provide certain information necessary for the committee's evaluation.
Given the disclosure-oriented focus of the proposal, it is essential that the required disclosures in the nominating process to be utilized by shareholders be balanced. We believe that, as proposed, the required disclosures are one-sided. The disclosure requirement should be amended to provide the nominating committee with the specific ability to gather certain background information that may be relevant in considering a nominee's qualifications and independence from both the company and the sponsoring shareholder. Accordingly, the proposal should clarify that any shareholder seeking to nominate a director must be willing to provide: (1) a statement of its intent to maintain its level of shareholding for at least the initial term of the proposed nominee; (2) a statement, if true, as to whether it believes, and the reasons for its belief, that the nominee is independent with respect to the company and with respect to the nominating shareholder; and (3) a statement confirming that the nominee will be willing to serve on the board, if elected, and would consent to a reasonable background check. We believe that the nominating committee should not be required to consider a candidate in the absence of such information, which we believe is necessary for the committee's decision, or if the recommending shareholder has failed to demonstrate a commitment to the company for at least the initial term of its proposed nominee if he or she is elected to the board of directors.
4. Additional Comments Regarding the Proposed Nominating Committee Disclosure.
We also have the following specific suggestions regarding the proposed nominating committee disclosure:
- Description of the Nominating Committee Charter. The proposed amendments to the proxy statement disclosure would require a description of the material terms of the nominating committee charter. We believe that, to the extent a company includes the charter in its proxy statement or indicates that it is available on its website, the requirement to describe the charter's material terms would lead to duplicative disclosure and should be removed. The proposed amendments also require a description of the nominating committee's policy with regard to the considerations of shareholder nominees, the procedures to be followed in submitting such nominations, the qualifications of candidates and its process for identifying and evaluating nominees. For the same reason, we believe that the amendments should clarify that, in lieu of providing such disclosure in its proxy statement, a company can make a reference to its nominating committee charter, if it contains such a description, or another corporate document, such as the corporate governance guidelines required by the proposed listing standards of the NYSE, that is included in the proxy statement or made available on the company's website.
- Nominating Procedures. With respect to procedures by which shareholders can make nominations, we believe that the proposal should clarify that a company may establish and enforce specific requirements that must be met by nominating shareholders. For example, a company's nominating committee should not be required to consider a nominee if the nominating shareholder has failed to submit the nomination before the specified deadline or has failed to provide specified information that is necessary for the committee's evaluation of a candidate. It should be sufficient publication of these specific requirements if they are posted on the company's website at least 30 days prior to the relevant deadline for nominations.
- Independence of nominating committee members. The proposed amendments would require that listed companies disclose in their proxy statements any instance during the last fiscal year where any member of the nominating committee did not satisfy the definition of independence in the applicable listing standards. We believe that this requirement is neither necessary nor appropriate. The proposed disclosure of "instances" where a director was not independent is inconsistent with the proposed SRO corporate governance listing standards, which tie director independence to affirmative determinations by the board of directors.1 In addition, all of the proposed SRO standards contain "look-back" tests for independence and therefore any problematic relationships with the company would prevent the director from being currently independent. Based on the foregoing and to avoid a confusing introduction of conflicting standards, we believe that the proposed nominating committee independence disclosure should be conformed to the new audit committee independence disclosure in Item 7(d)(iv) of Schedule 14A (effective for proxy statements for actions occurring at the first annual shareholder meeting after January 15, 2004), which requires listed issuers to disclose if members of the audit committee are independent, as defined in the applicable listing standards. Finally, the transition period for this requirement should ensure that disclosure is not required until the independence requirements for nominating committee members in the proposed listing standards have become effective.2
- Source of director nominees. The proposed amendments also require a statement of the specific source, such as the name of an executive officer, director, or other individual, of each nominee (other than nominees who are executive officers or directors standing for re-election). We believe that this requirement serves no useful purpose other than to suggest that a director may not be qualified or independent based solely on the source of the nomination. The premise of this part of the proposal appears to be that a director nominee, otherwise qualified to serve, who was first brought to the attention of the committee by the chief executive officer, may be suspect. As discussed above, the NYSE, Nasdaq and Amex have proposed new and more stringent criteria for independent directors. For candidates that do meet the proposed independence requirements, such disclosure will only serve to create an unwarranted negative inference that the director may not in fact be independent.
II. Disclosure Regarding the Ability of Security Holders to Communicate with the Board of Directors
1. The disclosure requirement should clarify that a purely administrative role by management in the security holder communications process does not constitute "filtering" for purposes of the disclosure requirement.
The proposed amendments require disclosure of the process by which security holders can send communications to the board and specifically, if communications are not sent directly to board members, a description of the process for determining which communications will be relayed to board members. We urge the Commission to clarify that the amendment is intended to require disclosure of a process whereby a department or other group within the company "filters" communications (which includes a determination not to send certain communications to the board of directors) and not a process whereby a department or group is designated to receive, collate and summarize communications for the board (including consolidating duplicative communications). We believe that this clarification is necessary because such disclosure may create a negative inference of management interference even where the only role of the department or other group within the company is to organize and categorize the communications and to provide summaries to the directors. Our experience is that some ministerial effort involving company personnel will often be necessary to enable board members adequately to address potentially numerous and lengthy communications from shareholders. Therefore, in order to encourage the most efficient use of board time and resources, we suggest that the proposed amendment be clarified to expressly state that disclosure of the role of an internal department or group in the security holder communications process is not necessary if that role is limited to organizing and collating the communications and, as appropriate, providing summaries to the directors (so long as the directors have access to the original communications).
In addition, in light of the concerns expressed above, we believe that companies should be expressly permitted to define how and in what form communications from security holders can be submitted. For instance, companies should be permitted to require that all communications be written (and not oral), reasonably limited in length and relate to subject matter of significance to the corporation and its shareholders, as a whole. In addition, given the ease with which hundreds, if not thousands of people can fire off an e-mail, taking little time to collect or organize their thoughts, we believe that companies should not be required to filter hundreds of such messages and, in effect, create a "director chat room." If the purpose is to communicate matters of substance to the directors of the corporation, it does not seem burdensome to require that the communications be in the form of a typed or hand-written letter. Such requirements would make the communication process more efficient and effective without substantially limiting shareholders' ability to communicate with directors.
* * *
We appreciate the opportunity to comment to the Commission on the proposed amendments, and would be pleased to discuss any questions the Commission may have with respect to this letter. Any questions about this letter may be directed to John T. Bostelman (212-558-3840), James C. Morphy (212-558-3988) or Donald C. Walkovik (212-558-3911) in our New York office.
Very truly yours,
SULLIVAN & CROMWELL LLP
cc: Giovanni P. Prezioso
Alan L. Beller
Director, Division of Corporation Finance
|1 || For instance, the proposed NYSE listing standards require an affirmative determination by the board that a director has no material relationship with the company. The proposed Nasdaq and Amex listing standards define independent director as a director that does not have a relationship, which, in the opinion of the board of directors, would interfere with the exercise of independent judgment.
|2 || For instance, under the proposed NYSE listing standards, companies will be required to have a nominating committee composed entirely of independent directors no later than 18 months following publication of the Commission's approval of the new standards. Under the proposed Nasdaq listing standards, as amended in July 2003, companies (other than foreign private issuers and small business issuers) will need to make director nominations either through a nominating committee composed entirely of independent directors or a majority of independent directors by the earlier of their first annual shareholders meeting after January 15, 2004 or October 31, 2004.