BLACKWELL SANDERS PEPER MARTIN LLP
KARL R. BARNICKOL
DIRECT: (314) 345-6481
|FAX: (314) 345-6060|
Attention: Jonathan G. Katz, Secretary
|Re:||Security Holder Director Nominations
(Release No. 34-48626; IC-26206; File No. S7-19-03; RIN 3235-AI93)
Blackwell Sanders Peper Martin LLP is a full-service law firm with a substantial corporate practice representing publicly traded companies which will be subject to the rules proposed in this Release. We are providing comments on this proposal based inquiries to our clients as well as the problems and uncertainties that we anticipate if the proposed rules are adopted. In this letter we will address certain of the questions included the Release but initially want to note our particular concerns with the proposal and its operation if adopted:
Turning then to the specific questions raised in the Release (and using the numbering system of the Release)-
A.1. Should the Commission adopt revisions to the proxy rules to require companies to place security holder nominees in the company's proxy materials? Are the means that currently are available to security holders to address a company's perceived unresponsiveness to security holder concerns adequate?
In the past few weeks the SRO's and the Commission have adopted extensive new rules to require companies to explain and open up their director nomination process. The extent to which these rules will improve responsiveness is obviously unknown since we have not yet had a proxy season under these new rules. Adoption of the proposed rule should be deferred until the Commission and the SRO's can evaluate the effects of the existing new rules. Moreover, it is unlikely that a final new rule can be in place before at least some of the 2004 proxies have been mailed, thus leaving companies guessing as to the ground rules.
A.3. What direct or indirect effect would this procedure have on companies' corporate governance policies relating to the election of directors? For example, will companies be more or less likely to adopt cumulative voting policies and/or elect directors annually?
While the rule as proposed requires that the motivation of a nominating security holder shall not be to attempt a change of control, many directors will regard a director elected from outside the normal nominating committee process to be a potential ally of a raider, should one be in the wings or later appear. Thus, the majority of the board is unlikely to take any action, such as moving from a classified board to annual elections, that would weaken the boards' position in negotiations with a raider. The rule is likely to freeze corporate structures as they are today.
As noted above, a real risk of the Commission's proposal is that board meetings will become perfunctory and the real business of the board will be conducted outside the boardroom.
B.1. As proposed, the security holder nomination procedure in Exchange Act Rule 14a-11 would apply to all companies subject to the proxy rules. ... Would other limitations be more appropriate...?
The proposed rules should not apply to "controlled companies," as defined, e.g., in the rules of the New York Stock Exchange. Investors buying securities of a controlled corporation do so knowing that they cannot expect to displace the directors nominated by the controlling holder(s).
B.2. Should companies be able to take specified steps or actions that would prevent application of the proposed nomination procedure where such procedure would otherwise apply? If so, what such steps or actions would be appropriate?...
If a director who has received more than 35% "withhold" votes resigns prior to the end of the current fiscal year, then there should be no security holder right to nominate another director.
C.1. As proposed, the new procedure would require a triggering event for security holders to be able to use the security holder nomination procedure. Is this appropriate?
Limited specific triggering events should be a precondition to such a fundamental change in the voting process. Because the proposed rule will add significant costs and inevitably distract management and the board from the business objectives of the company, it should be reserved for the most egregious cases of board unresponsiveness.
If so, are the proposed nomination procedure triggering events appropriate?
The trigger based on a proposal for a new nominating system is appropriate, but the trigger based on the "withhold" vote is not. First, the percentage for the "withhold" vote proposed is too low. Given the extent of control over the vote which is in the hands of Institutional Shareholder Services, it is likely that this organization, which is not generally a record or beneficial holder of the securities, could create the 35% "withhold" vote trigger at a significant number of the listed companies. Second, some shareholders vote against a director for reasons unrelated to the company's or the board's responsiveness, as for example, when votes are withheld because of the director's presence on another company's board.
Are there other events that should trigger the procedure? For example, should the following trigger the procedure: lagging a peer index for a specified number of consecutive years; being delisted by a market; being sanctioned by the Commission; being indicted on criminal charges; or having to restate earnings once or restate earnings more than once in a specified period? Should the election of a security holder nominee as a member of a company's board of directors be deemed a triggering event in itself that would extend the process by another year or longer period of time?
Given the novelty of the Commission's proposal, proliferating triggering events which may or may not be linked to the current board being unresponsive turns this rule into a penalty for certain corporate events or conduct - which is not the stated goal of the proposal.
C.2. How long after a nomination procedure triggering event should security holders be able to use the nomination procedure, if not two years, as is proposed (e.g., one year, three years, or longer)? Should there be other ways for the operation of the procedure to terminate at a company? If so, what other means would be appropriate? For example, should companies be able to take specified actions that would terminate operation of the nomination procedure? If so, what such actions would be appropriate?
The nomination procedure should only be available in the following year, given the rapid changes in a company's circumstances. Holders who wish to avail themselves of this procedure should want to do so at the earliest opportunity, i.e., the next year's annual meeting. See also the comment under B.2 above that resignation by a director who receives more than 35% "withhold" votes should terminate the opportunity for security holder nominations under proposed Rule 14a-11.
C.3. As proposed, the nomination procedure could be triggered by withhold votes for one or more directors of more than 35% of the votes cast. Is 35% the correct percentage? If not, what would be a more appropriate percentage and why? ...
As noted above, 35% is too low because ISS frequently controls that much of the vote by itself.
C.4. Should the nomination procedure triggering event related to direct access security holder proposals trigger the procedure only where a more than 1% holder or group submits the proposal? If not, what would be a more appropriate threshold, if any? For example, should the standards otherwise applicable for inclusion of a proposal under Exchange Act Rule 14a-8 apply? Should the required holding period for the securities used to calculate the security holder's ownership be longer than one year? If so, what is the appropriate holding period? Should that holding period be shorter than one year? If so, what is the appropriate holding period?
The impact of the proposed Rule 14a-11 on a corporation will be far more fundamental than virtually any of the proposals typically offered and permitted under Rule 14a-8. Thus, the thresholds should be higher than under 14a-8 so that security holders taking advantage of this rule clearly have a significant stake in the corporation. The 5% rule used for the Schedule 13-D/G requirement has provided an effective standard of that sort of significant stake, and it should also be a requirement for making a nomination.
The investors who have said they are most disadvantaged by the current system are those who are so large that their investments are essentially indexed to the entire market. Thus they argue that they are unable to address the problem of an unresponsive board via the "Wall Street Walk." As evidence of an investor being in that immobilized position, it is reasonable to require a two-year holding period and a stated intent to hold for two additional years. Anything shorter suggests that the investor can actively manage its funds and will solve its problem of lack of confidence in a board by selling its shares.
C.6. As proposed, a direct access security holder proposal could result in a nomination procedure triggering event if it receives more than 50% of the votes cast with regard to that proposal. Is this the proper standard? Should the standard be higher (e.g., 55%, 60%, or 65%)? Should the standard be based on votes cast for the proposal as a percentage of the outstanding securities that are eligible to vote on the proposal (e.g., 50% of the outstanding securities)?
Given the control which ISS has over the vote at a typical meeting, the standard should be 50% of the outstanding shares or 60% of the shares voting.
C.7. Should direct access security holder proposals be subject to a higher resubmission standard than other Exchange Act Rule 14a-8 proposals? If so, what standard would be appropriate?
As noted above under C.4, the impact of the proposed Rule 14a-11 on a corporation will be far more fundamental than virtually any of the proposals typically offered under Rule 14a-8. Rule 14a-8 proposals frequently garner just enough votes to barely meet the generous resubmission thresholds of 14a-8. An event as fundamental as that contemplated by proposed Rule 14a-11 should not give rise to repetition of the same vote in subsequent years at the low levels of support required for 14a-8. A requirement for support of 20% in the first year and 40% in second year, with no resubmission for five years if those thresholds are not reached, is a reasonable approach, allowing serious proposals to be heard, but eliminating nominations which receive only a "background noise" level of support.
C.8. We have proposed that nomination procedure triggering events could occur after January 1, 2004. Is this the proper date? Should it be an earlier date? Should it be a later date?
Given the necessary time and sequence of events needed for adoption of a final Rule 14a-11, it appears unlikely that calendar year companies will have a final rule for review by their boards or nominating/governance committees prior to the time they will have to approve their proxy statements for mailing to security holders. It is fundamentally unfair to have the 2004 proxy season serve as a generator of "triggering events" when the ground rules are unknown.
C.9. What are the possible consequences of the use of nomination procedure triggering events? Will there be more expense and effort related to votes on direct access security holder proposals? Will there be more campaigns seeking "withhold" votes? How will any such consequences affect the operation and governance of companies?
Inevitably, there will be more campaigns seeking "withhold" votes, particularly from groups with agendas that go beyond good governance. Given the low vote thresholds proposed, this will put control of the much of the voting process in the hands of ISS.
C.10. Should companies be exempted from the security holder nomination procedure for any election of directors in which another party commences or evidences its intent to commence a solicitation in opposition subject to Exchange Act Rule 14a-12(c) prior to the company mailing its proxy materials? If so, should the period in which security holders in such companies may use the nomination procedure be extended to the next year (assuming that a nomination procedure triggering event is required)? ...
If there is an actual proxy contest underway, dissatisfied investors clearly have an avenue to register their discontent such that deferral of their right to nominate to the following year, assuming the proxy contest fails, is a reasonable step toward minimizing expense and confusion in the voting process. If the proxy contest succeeds, there should be no security holder rights to nominate since the "offending" board has been displaced.
C.11. We have discussed our consideration of and requested public comment on the appropriateness of a triggering event premised upon the company's non-implementation of a security holder proposal that receives more than 50% of the votes cast on that proposal. Should such a triggering event be included in the nomination procedure?
No. The voting decisions on many of the governance-related security holder proposals are made on the basis of pre-existing policies of institutional investors and ISS without regard to the performance of the company or the responsiveness of the board to security holders.
E.1. Are the proposed thresholds for use of the proposed procedure appropriate? If not, should there be any restrictions regarding which security holder nominees for director would be required to be disclosed in the company proxy materials under the proposed procedure? If so, should those restrictions be consistent with the ownership requirements of Exchange Act Rule 14a-8? Should those restrictions be more extensive than the minimum requirements in Exchange Act Rule 14a-8?
The use of the 14a-8 standards is inappropriate to the fundamental nature of the proposed 14a-11 procedure. Please see the comments under C.4 and C.7 above.
E.3. Should there be a restriction on security holder eligibility that is based on the length of time securities have been held? If so, is two years the proper standard? Should the standard be shorter (e.g., 1 year) or longer (e.g., 3 years, 4 years, or 5 years)? Should the standard be measured by a different date (e.g., 2 years as of the date of the meeting, rather than the date of nomination)?
E.4. As proposed, a nominating security holder would be required to represent its intent to hold the securities until the date of the election of directors. Is it appropriate to include such a requirement? Would it be appropriate to require the security holder to intend to hold the securities beyond the election of directors (e.g., for six months after the election, one year after the election, or two years after the election) and to so represent?
Regarding both questions E.3 and E.4, as noted above, the investors who have said they are most disadvantaged by the current system are those who are so large that their investments are essentially indexed to the entire market, and they are thus unable to address the problem of an unresponsive board via the "Wall Street Walk." As evidence of an investor being in that immobilized position, it is reasonable to require a two-year holding period plus an indication of intent to hold the shares an additional two years. Anything shorter suggests that the investor can actively manage its funds and will solve its problem of lack of confidence in a board by selling its shares. In addition, failure to hold for those two future years should disqualify that investor from making nominations at the subject company for five years.
E.5. Is the eligibility requirement that a security holder or security holder group must file an Exchange Act Schedule 13G appropriate? Should there be a different mechanism for putting companies and other security holders on notice that a security holder or security holder group has ownership of more than 5% of the company's securities and intends to nominate a security holder? Is it appropriate to permit the filing to be on Exchange Act Schedule 13G rather than Exchange Act Schedule 13D? If not, why not?
The 13G standard is well understood and appropriate to indicate a significant stake in the company as well as the absence of an intent to undertake a change of control.
E.6. Should the procedure include a provision that would deny eligibility for any nominating security holder or nominating security holder group that has had a nominee included in the company materials where that nominee did not receive a sufficient number of votes (e.g., 5%, 15%, 25%, or 35%) within a specified period of time in the past? If there should be such an eligibility standard, how long should the prohibition last?
There should be a five-year prohibition unless, as noted in the response to C.7 above, the security holder nominee received the support of 20% in the first year and 40% in the second year.
E.7. Should security holders be allowed to aggregate their holdings in order to meet the ownership eligibility requirement to nominate directors? If so, is it appropriate to require that all members of a nominating security holder group individually meet the minimum holding period? Is it appropriate to require that all members of the group be eligible to file on Exchange Act Schedule 13G?
For the reasons discussed under E.4, requiring all members of the group to meet the holding period requirements is a reasonable standard and should not be a significant detriment to the investors most affected by an unresponsive board. All members of the group should be eligible to file on Schedule 13G to avoid the misuse of Rule 14a-11 for a "stealth" change of control.
F.1. Should there be any other or additional limitations regarding nominee eligibility? Would any such limitations undercut the stated purposes of the proposed process? Are any such limitations necessary? If so, why?
The proposed rule does not address the situation of a company with voting by class of securities or voting rights (including springing rights) to nominate and elect same numbers of directors. The classic example would be a preferred stock issue with rights to a class vote for certain director seats if the dividend on the preferred was omitted. Just as proposed Rule 14a-11 should not override a properly adopted charter or by-law provision on director nomination and voting procedures, it should not nullify or dilute contractual rights. If, for example the company had a ten member board, but the preferred holders became entitled to two of the seats on the board, then for purposes of Rule 14a-11, the board should be deemed to have eight members and the security holders should have no right to run a director against the nominees of the preferred holders under Rule 14a-11.
F.2. Is it appropriate to use compliance with state law, federal law, and listing standards as a condition for eligibility?
There should be no difference in the standards applicable to board nominees and security holder nominees.
F.3. Should there be requirements regarding independence from the company? Should the fact that the nominee is being nominated by a security holder or security holder group, combined with the absence of any direct or indirect agreement with the company, be a sufficient independence requirement?
All nominees should be independent under the applicable listing standards and the company's own standards of independence in its published governance guidelines. The nomination or election process is not in itself a guarantee of independence and the board should not be saddled with a director who is unable to serve on certain committees, particularly as the total number of directors on boards has generally become smaller in recent years.
F.5. Where a company is subject to an independence standard of a national securities exchange or national securities association that includes a subjective component (e.g., subjective determinations by a board of directors or a group or committee of the board of directors), should the security holder nominee be subject to those same requirements as a condition to nomination?
Yes, for the reasons noted under F.3, assuming the standard for the subjective component has been published.
F.6. Should there be requirements regarding independence of the nominee from the nominating security holder, nominating security holder group, or the company? If so, are the proposed limitations appropriate? What other or additional limitations would be appropriate? If these limitations generally are appropriate, are there instances where they should not apply?
Yes. Such a requirement would help ensure that the motivation of a nominating security holder is not to promote that security holder's individual interests. Directors have a fiduciary duty to all security holders and demonstrated independence from the nominating security holder will help to ensure that fiduciary duties are met.
F.7. Should there be any standards regarding separateness of the nominee and the nominating security holder or nominating security holder group? Would such a limitation unnecessarily restrict access by security holders to the proxy process? If such standards are appropriate, are the proposed standards the proper standards? Should other standards be included? Should any of the proposed standards be eliminated?
Unless the nominator and the nominee are completely independent of each, there is no reason to believe that the nominee will in fact represent the interests of all the holders. As a practical matter, the perception of being a special-interest director would cripple the security holder-nominated director in his/her ability to influence the other directors in the give-and-take of a board or committee meeting.
F.9. Should there be exceptions to the prohibition on any affiliation between nominees and nominating security holders or nominating security holder groups? If so, what exceptions would be appropriate?
Any exceptions will jeopardize the functioning of the board and make the director's credibility suspect in the eyes of the other directors, as discussed under F.6 and F.7 above
F.10. Should there be a nominee eligibility criterion that would exclude an otherwise eligible nominee or nominating security holder or nominating security holder group where that nominee (or a nominee of that security holder or security holder group) has been included in the company's proxy materials as a candidate for election as director but received a minimal percentage of the vote? If so, what would be the appropriate standard (e.g., 5%, 15%, 25%, or 35%)?
The 20%/40% standard proposed in response to E.6 above would be appropriate here.
F.11. As proposed, the rule includes a safe harbor providing that nominating security holders will not be deemed "affiliates" solely as a result of using the security holder nomination procedure. This safe harbor would apply not only to the nomination of a candidate, but also where that candidate is elected, provided that the nominating security holder or nominating security holder group does not have an agreement or relationship with that director otherwise than relating to the nomination. Is it appropriate to provide such a safe harbor for security holder nominations? Should the safe harbor continue to apply where the nominee is elected?
Many, perhaps most, companies treat their outside directors as affiliates because of their position of control in the company. That determination is based on their duties and responsibilities as directors, not the process by which they became directors. Giving the security holder-nominated directors a "pass" is inconsistent with the objective of the proposed rule of having security holder nominees who are not special-interest directors and would suggest that the security holder nominees are in some way "second class" directors.
Moreover, the decision on affiliate status is a legal judgment for the company and its counsel, not for the security holders.
G.1. Is it appropriate to include such a limitation on the number of security holder nominees? If not, how would the proposed rules be consistent with our intention not to allow the proposed procedure to become a vehicle for changes in control?
Without a limit on the number of security holder nominees as envisioned in proposed Rule 14a-11, it will become a route to a change of control without the safeguards that normally accompany that process.
G.4. Rather than a limitation on the maximum number of security holder nominees, should there be only a limitation on the number of security holder nominees that may be elected?
No. There are substantial mechanical challenges in implementing proposed Rule 14a-11 which will be severely aggravated by expanding the number of nominees, in addition to adding to the cost of the process.
H.5. What should be the consequence to the nominating security holder or nominating security holder group of submitting the notice to the company after the deadline? Should such a late submission render the nominating security holder or nominating security holder group ineligible to use the nomination procedure, as is currently proposed under the rule? What should be the consequence to the nominating security holder or nominating security holder group of filing the notice with the Commission late? Should such late filing be viewed exclusively as a violation of Exchange Act Rule 14a-6 or should it affect eligibility to use the nomination procedure? Should the failure of a nominating security holder or nominating security holder group to file the notice with the Commission be viewed exclusively as a violation of Exchange Act Rule 14a-6 or should it affect eligibility to use the nomination procedure?
Companies not only have fixed printing and mailing deadlines, but they schedule board and committee meetings on the basis of timetables developed by applying the rules of the SEC and the applicable SRO. It is fundamentally impractical as well as unfair to the sitting directors to allow proponents to come in late.
H.7. As proposed, Exchange Act Rule 14a-11 includes a number of notice and other timing requirements. Should these timing requirements incorporate or otherwise address any advance notice provisions under state law or a company's governing instruments? If so, should any advance notice provisions govern? Should they instead be provided as an alternative to the timing provisions set out in the rule?
Advance notice provisions under the company's governing instruments, having been properly adopted, are valid limits under state law on the right of security holders to nominate directors. Thus, the Commission's authority to override them is questionable. Moreover, it is impractical to have multiple notice provisions applicable to various security holder proposals and the notice provisions adopted by the company (if any) should apply.
I.3. Proposed Exchange Act Rule 14a-11(a)(3) provides that a company is not required to include a security holder nominee where either: (a) the nominee's candidacy or, if elected, board membership, would violate controlling state law, federal law or rules of a national securities exchange or national securities association, (b) the nominating security holder's notice is not adequate, (c) any representation in the nominating security holder's notice is false in any material respect, or (d) the nominee is not required to be included in the company's proxy materials due to the proposed limitation on the number of nominees required to be included. Instruction 4 to proposed Exchange Act Rule 14a-11(a)(3) provides that the company shall determine whether any of these events have occurred. Should the nomination procedure include a procedure for a company to gather information additional to that included in the notice that is reasonably necessary for the company to make its determination in this regard? If so, please respond to the following additional questions.
The comments under F.1 above regarding voting by class and special nomination rights apply to this question. Allowance needs to be made for any contractual rights of certain holders.
I.5. As proposed, the rule would not provide a mechanism by which a nominating security holder or nominating security holder group could "cure" a defective notice. Would such a "cure" period, similar to that currently provided under Exchange Act Rule 14a-8, be appropriate? If so, how and by what date should a company be required to notify a nominating security holder or nominating security holder group of a defect in the notice? How long should the nominating security holder or nominating security holder group have to cure any defects? Are there any defects that would not require notice by the company, for example, where a defect could not be remedied?
The comment under H.5 above also applies here. The timetable for the proxy process is so tight that there is no "fat" in the schedule to give proponents a second chance. Given the holding and ownership requirements, it is unlikely that the proponents under Rule 14a-11 will be unsophisticated investors who might be confused.
M.2. Should nominating security holders, including groups, be deemed to have a "control" purpose that would create additional filing and disclosure requirements under the Exchange Act beneficial ownership reporting standards?
Deeming the nominating holder to have a control purpose is inconsistent with the premises of the proposed rules and should not be required.
Please call the undersigned should you have questions about the comments provided in this letter.
Very truly yours,
/s/ Karl R. Barnickol
Karl R. Barnickol
cc: Hon. William H. Donaldson
Hon. Paul S. Atkins
Hon. Roel C. Campos
Hon. Cynthia A. Glassman
Hon. Harvey J. Goldschmid