November 21, 2003
Desk Officer for the Securities and Exchange Commission
Office of Management and Budget
Re: Proposed rule regarding security holder director nominations,
Dear Sir or Madam:
Pursuant to the Paperwork Reduction Act of 1995, P.L. 104-13, 109 Stat. 195, the Business Roundtable submits these comments on the collection of information requirements contained in the proposed rule regarding security holder director nominations published by the Securities and Exchange Commission ("Commission") on October 23, 2003. Security Holder Director Nominations; Proposed Rule; Exchange Act Release No. 34-48626, 68 Fed. Reg. 60,784, 60,807-60,812 (October 23, 2003).
The Business Roundtable is an association of chief executive officers of leading corporations with a combined workforce of more than 10 million employees in the United States and $3.7 trillion in annual revenues. We respectfully request that the Office of Management and Budget ("OMB") raise and resolve with the Commission the concerns identified below with this important proposed rule, instructing the Commission to include all OMB comments in the preamble to a final rule, if one is adopted. See 5 C.F.R. § 1320.11(f).
1. Introduction And Summary Of The Proposed Rule.
For more than 60 years, the Commission periodically has considered and rejected proposals that would have provided shareholders with direct access to company proxy materials to nominate directors. The Commission most recently rejected such a proposal in 1992. See Release No. 34-31326 (October 16, 1992). At that time, the Commission acknowledged that "requir[ing] . . . compan[ies] to include shareholder nominees in the company's proxy statement would represent a substantial change in the Commission's proxy rules." Release No. 34-31326 (October 16, 1992) (emphasis added).
On October 23, 2003, without fully considering these substantial changes, the Commission proposed a rule that, under certain circumstances, would require companies to include in their proxy materials shareholder nominees for election as corporate directors. See generally 68 Fed. Reg. at 60,784-60,807. The Commission has stated that the proposed rule will enhance the ability of shareholders to participate in the proxy process for the nomination and election of corporate board directors, but only "in those instances where evidence suggests that the company has been unresponsive to security holder concerns as they relate to the proxy process." 68 Fed Reg. at 60,784.
The Commission has proposed two events that would trigger shareholder access to a company's proxy materials to nominate one or more directors:
68 Fed Reg. at 60,789-60,790. Upon the occurrence of one of these events, a shareholder or a group of shareholders beneficially owning at least 5% of the company's stock for at least two years would become eligible to submit director nominees for inclusion in the company's proxy materials at the next annual meeting. 68 Fed. Reg. at 60,794.
The Commission has provided interested parties only 60 days to comment on the complex proposed rule. Moreover, its proposing release poses hundreds of questions to the public. And, critical data-based analysis is absent from the proposing release. Accordingly, the Business Roundtable is still in the process of collecting and analyzing data necessary to provide full comments on this complex proposal to the Commission and OMB. (A request has been made to the Commission to extend the comment period by 60 days.) Because OMB must respond in the near future to the Commission's collection of information proposal, however, we submit these preliminary comments to OMB at this time.
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Even at this early stage, it is clear that the requirements of the Paperwork Reduction Act have not been satisfied and that OMB should disapprove the Commission's proposed collection of information requirements. First, the Commission has not evaluated adequately the true burdens that the proposed rule, if adopted, would impose on companies and their investors. Indeed, the Commission concedes that its burden estimates are unreliable. 68 Fed. Reg. at 60,811. Second, the Commission provides no substantive analysis of the practical utility of the proposed rule's collection of information requirements. In fact, the utility of the proposal is doubtful and does not justify the great burdens that it would impose.
Moreover, as discussed in the section immediately following, there are certain irregular aspects of this rulemaking that will interest OMB in light of the requirements not only of the Paperwork Reduction Act, but of the Administrative Procedure Act as well.
2. Unusual Procedures Followed By The Proposing Agency.
Although we write at this time to bring to OMB's attention to issues associated with the Paperwork Reduction Act, it is worth noting at the outset certain other aspects of the rulemaking that may be of interest to OMB and, specifically, to the Office of Information and Regulatory Affairs.
In its preamble to the proposed rule, the Commission acknowledges (with considerable understatement) that its proposal is "somewhat complex." 68 Fed. Reg. at 60,787. Despite the proposal's great complexity, however, the Commission has failed to provide the sort of rationale for its proposal and detailed analysis that are customary in light of the many issues the proposal implicates. Instead, the Commission has largely shifted to the public the burden of data collection and analysis. For instance, the application, effect, and burden of the proposal will depend greatly on what the laws of the various states provide; yet, the proposing release places on commenters the burden of identifying and interpreting pertinent state laws, and, in large part, for estimating the proposed rule's true costs. See 68 Fed. Reg. at 60,787, 60,808.
Also indicative of the degree to which the agency has shifted to the public functions ordinarily performed by the proposing agency is the extraordinary number of questions the proposing release addresses to the public for response. SEC Commissioner Atkins has referred to the hundreds of questions in the proposing release as "unique," stating:
Commissioner Paul S. Atkins, Remarks at Open Meeting Regarding Shareholder Access Proposal (October 8, 2003).
Similarly, SEC Commissioner Glassman stated that "the release . . . may have broken all records in terms of the number of questions asked." Commissioner Cynthia A. Glassman, Remarks at Open Meeting Regarding Shareholder Access Proposal (October 8, 2003).
The proposal also is exceptional in its explicit attempt to direct steps to be taken by the regulated community now, before the rule becomes effective or is even finalized. (This aspect of the proposal has drawn objections from the Section of Business Law of the American Bar Association, whose comment letter to the Commission is Exhibit A hereto.) Under proposed Exchange Act Rule 14a-11, a direct access shareholder proposal adopted after January 1, 2004 would constitute a triggering event for shareholder access. 68 Fed. Reg. at 60,790. In the proposing release, the Commission explicitly states that, "pending final action" on the proposed rule, companies should advise shareholders in their 2004 proxy statements whether a 1% shareholder of group of shareholders has submitted a direct access proposal. Such a statement to shareholders is not required by current law and is designed solely as a step in implementing a proposed rule that remains in the early stages of the rulemaking process. Yet, the Commission suggests in its proposing release, failure to advise shareholders of the implications of such a direct access proposal could constitute a violation of the securities laws. See 68 Fed. Reg. at 60,790. The Business Roundtable respectfully submits that it is inconsistent with the notice and comment requirements of the Administrative Procedure Act to attempt to compel regulated entities to take steps that are not required by law now, and that would only be required if the rulemaking now underway resulted in a final rule in which the pertinent provisions of the proposals were retained without material change.
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The issues identified above are all aspects of the proposed rule that OMB may wish to examine more closely as this rulemaking progresses.
3. The Commission Has Provided Unreliable Burden Estimates That Greatly Underestimate The Burden The Proposed Rule Places On The Private Sector.
The Paperwork Reduction Act requires the Commission to provide "specific," "objectively supported," and "accurate" estimates of the burdens that would result under the proposed rule. 44 U.S.C. §§ 3506(c)(1)(A)(iv), 3506(c)(2)(A)(ii). "Burden" is defined by statute and regulation to mean "the total time, effort, or financial resources expended by persons to generate, maintain, retain, or disclose or provide information." 44 U.S.C. § 3502(2); 5 C.F.R. § 1320.3(b). The burden estimates in the proposing release are unreliable in the judgment of the Commission itself, and do not account adequately for the time, effort and financial resources that companies would expend to comply with the proposed collection of information requirements. See 68 Fed. Reg. at 60,811. Specifically, the Commission has failed to identify with any specificity whatsoever the scope of entities that would be covered by its proposed rule, and has gravely underestimated the frequency with which the rules' requirements would be "triggered" by corporations that are covered, and the costs the rules would impose when that triggering occurs.
a. The Commission Has Failed To Identify The Scope Of
As the Business Roundtable will demonstrate at length in comments to be filed subsequently in this rulemaking, the Commission's proposal to regulate the election of corporate directors intrudes on matters reserved for regulation by the states. In an (insufficient) attempt to overcome this improper intrusion on the prerogatives of the states, the proposed rule states that its requirements "would not provide security holders with the right to nominate directors where it is prohibited by state law." 68 Fed. Reg. at 60,784. And yet, although ascertaining the provisions of the laws of the various states is accordingly a necessary first step in determining the number of entities covered by the proposed rule, the Commission has nowhere determined the number of states that, in its judgment, explicitly or implicitly prohibit the form of regulation the Commission proposes. Instead, the Commission requests the public to provide such data and a substantive analysis of pertinent state laws. 68 Fed. Reg. at 60,808.
By failing to investigate and determine the actual consequences of the laws of the various states for the proposed rule, the Commission has failed to provide the most basic information about the scope and impact of its proposal: where in the United States (and to how many companies) the proposed rule would apply. The Commission states: "We do not know the precise number of states that prohibit security holders from nominating a candidate or candidates for election as director or the number of companies that are permitted to and do/or (would) include a prohibition against nominating a candidate or candidates in their articles or incorporation or bylaws." 68 Fed. Reg. at 60,808. Accordingly, the Commission does not know whether the proposed rule would take effect in no states or all fifty states. Moreover, the type and nature of state laws that would be pertinent are unclear from the proposing release. Due to these uncertainties, the Commission has not reliably estimated the number of companies that will be affected and burdened by the proposed rule.
b. The Commission's Estimates Are Concededly Unreliable
In the section of the proposing release addressing the Paperwork Reduction Act, the Commission concedes that "[a]ll of the [burden] figures [provided] are estimates because there is no reliable way to predict how many more security holder proposals would be submitted based on the proposed amendments, how often the events would be triggered or how many shareholders would be able to meet the applicable requirements." 68 Fed. Reg. at 60,811 (emphasis added). Indeed, the Commission's burden estimates are not merely unreliable, they also are artificially low. This is so in part because the Commission fails to account for the fact that the proposed rule would give rise to an increased number of shareholders seeking direct access to company proxy materials to nominate directors. If such increased shareholder activity were not to be expected, the proposed rule would lack practical utility. The Commission cannot have it both ways: if, as it suggests, the rules will have practical utility because they will lead to increased shareholder activity, then there will be a material burden resulting from that increased activity.
The proposed rule contains triggers to shareholder nominations that do not currently exist. Thus, if the proposed rule is adopted, shareholders would be encouraged to file more shareholder proposals, would expend more resources on achieving 35% or more "withhold" votes on board nominees, and would actually nominate more candidates for director in company proxy materials. Shareholders currently pay for proxy contests themselves. The proposed rule would shift some of the financial burdens of such contests to companies, thereby encouraging more shareholders to file direct access proposals. See, e.g., 68 Fed. Reg. at 60,800 (requiring companies to include shareholder nominees in the proxy materials that they send to all shareholders). The Commission's contention that any new costs to companies that arise as a result of the proposed rule would simply replace current costs to companies and shareholders combined is unfounded. See 68 Fed. Reg. at 60,814. Because of increased shareholder activity, companies would spend significantly more money than currently is spent (by all parties) to, among other things, print and mail proxy materials to shareholders, contest shareholder efforts to trigger direct access to company proxy materials to nominate directors, and engage in expensive election contests.
The Commission underestimates the burden that will result from the proposed triggers. For example, the Commission's burden analysis regarding the Rule 14a-8 / 14a-11 trigger appears to be based on an assumption that only individual shareholders with a stake of 1% or more will file such direct access proposals. 68 Fed. Reg. at 60,809 n.187 (calculating individual rather than group estimates of 1% shareholders). This is not the case. The proposed rule clearly provides that either an individual shareholder or group of shareholders with a combined 1% stake can file a direct access proposal. 68 Fed. Reg. at 60,790. Of eighty companies responding to a limited survey conducted by the Business Roundtable regarding the number of shareholders holding certain percentages of outstanding shares, the average number of shareholders holding specified percentages was as follows:
Even this limited survey demonstrates that, given the almost infinite number of combinations of shareholders holding even 1/4 of a company's outstanding shares, there would be a significantly greater number of 1% shareholder entities submitting direct access proposals than is accounted for by the Commission, whose analysis takes account of only individual shareholders with a stake of 1% or more.
The Commission further underestimates the number of direct access shareholder proposals that would be filed because its estimate is based on how many direct access shareholder proposals were submitted in 2003 rather than on how many would be filed if the proposed rule were to be adopted. The Commission's estimate does not provide for an increase of even one shareholder proposal over the number submitted in 2003, even though the new Rule 14a-8 / 14a-11 trigger was created specifically to facilitate shareholder access to company proxy materials to nominate directors. 68 Fed. Reg. at 60,809 n.189.
Moreover, even if it were sufficient to use historical data to predict future behavior under the proposed rule - which it is not - the Commission's use of estimated data from 2003 is inadequate. As this chart demonstrates, the number of shareholder proposals submitted, voted on, and passed by majority vote all have increased substantially over the last three years:
Source: Investor Responsibility Research Center's Database on Shareholder Proposals
*As of November 11, 2003
Accordingly, any estimates based on historical data would need to account for the increase in the submission and passage of shareholder proposals that has continued over time, separate and apart from the acceleration of this trend that would result from the proposed rule. The Commission's burden estimates do not account for these trends.
The Commission also does not account adequately for the number of times that the 35% "withhold" trigger likely would be tripped. It does not include any burden estimates in its proposing release for collection of information related to this trigger. See 68 Fed. Reg. at 60,809. Rather than evaluate the number of 35% "withhold" votes that are likely under the proposed rule, the Commission again relies on historical voting data from the last two years.
Yet, in the absence of the proposed rule, shareholders have had little motivation to organize to satisfy the 35% threshold. If the proposed rule take effect, however, activist shareholders will be incentivized to cast "withhold" votes by the possibility that a 35% "withhold" vote would, in turn, give them an opportunity to nominate their own candidates. They thus will be more likely to engage in campaigns to ensure that company nominees receive the requisite percentage of "withhold" votes to trigger direct access. Given the voting practices of many institutional investors - they usually either adhere to the voting recommendations of the Institutional Shareholder Services, a proxy advisor service that has adopted proxy voting policies that call for recommending "withhold" votes for directors in numerous situations, or have their own voting guidelines that call for withholding votes for directors - the 35% "withhold" trigger may be met frequently. Adoption of the 35% "withhold" trigger could spur revisions to the proxy voting guidelines of institutional investors and proxy advisory services that call for more frequent "withhold" votes for directors. See Ken Brown, Vanguard Gives Corporate Chiefs A Report Card, Wall St. J., November 10, 2003, at C1 (describing institutional investors' increasing willingness to cast "withhold" votes). Moreover, observers have noted that shareholders are likely to concentrate their efforts on tripping the 35% trigger at Spring 2004 annual meetings, a fact not considered in the Commission's analysis. Richard Ferlauto, director of pension investment policy at the American Federation of State, County and Municipal Employees "predicts that many activists will concentrate their efforts [on the 35% "withhold" trigger] mechanism that is more clear cut - `vote-no' campaigns." Proposed Proxy Access Rule Leaves Proponents Uncertain About Preparations For 2004 Proxy Season, 14 Corporate Governance Highlights (October 31, 2003).
The Commission's reliance on historical data regarding "withhold" votes is flawed for another reason: it relies upon the wrong historical data. The data cited by the Commission relates to how many "withhold" votes occurred at the level of the whole board rather than at the level of individual director. See 68 Fed. Reg. at 60,790 n.78. The trigger, however, would be tripped when an individual director - not the whole Board - receives more than 35% in "withhold" votes.
Finally, the proposing release fails to project the number of times that the third trigger - premised on a company not timely implementing a majority vote shareholder proposal - would be tripped. In addition to new costs associated with an increase in the number of shareholder proposals submitted as a result of the trigger, the trigger would require significant expenditures of executive time and legal resources to determine whether a particular proposal could be implemented consistent with both state law (i.e., fiduciary duty) and the company's business objectives.
c. The Commission Underestimates Costs.
Because the Commission fails to analyze critical information - such as pertinent state laws - and underestimates the number of times that shareholders would attempt to trigger and actually trigger the shareholder nomination process, the Commission's cost estimates are artificially low. For purposes of the Paperwork Reduction Act, the Commission estimates a total annual incremental expenditure of only 14 hours of company personnel time (at an estimated total cost of $1,200) and only 10 hours of outside professional time (at an estimated total cost of $3,000) for each "affected" company. 68 Fed. Reg. at 60,814.
These burden and cost estimates - a total of 24 burden hours at a cost of $4,200 - allegedly would cover the work and expenses of all executive officers, in-house counsel, other company personnel, outside counsel, other outside professionals and consultants, and members of the board of directors that would result from the proposed rule. The Commission contends that the following tasks and expenses all would be covered by a total of 24 hours of work and $4,200:
68 Fed. Reg. at 60,809-60,811; Aranow & Einhorn On Proxy Contests For Corporate Control § 21.01(3d ed. 1998).
The Commission's contention that all of these activities could be performed in just 24 hours at a total cost of $4,200 fails on its face. Examples of just a few of the costs that would result from the proposed rule illustrate the inadequacy of the Commission's estimate:
First, the Commission's burden estimates fail to account adequately for the fact that companies would often treat direct access shareholder proposals as contested events. To prevent shareholders from triggering the process whereby shareholders may nominate directors in company proxy materials, companies will expend new resources to scrutinize, challenge and defeat direct access shareholder proposals. See Proposed Proxy Access Rule Leaves Proponents Uncertain About Preparations For 2004 Proxy Season, 14 Corporate Governance Highlights (October 31, 2003). Because more shareholder proposals would be submitted under the proposed rule, companies also would challenge more shareholder proposals at the Commission in an attempt to obtain permission to exclude them.
Although the Commission's analysis of the number of no-action requests that would result is based on past data rather than on analysis under the proposed rule, application of even the Commission's historical data demonstrates that its total burden estimate is artificially low. The Commission estimates "an annual incremental disclosure burden of approximately 25 hours for each Exchange Act Rule 14a-8 no-action contest that a company" undertakes. By comparison, the Commission estimates that the proposed rule would cause only a total of 24 burden hours a year for each "affected" company. Thus, a company challenging even one shareholder proposal as a result of the proposed rule (which all "affected" companies likely would do) would exceed the Commission's total annual burden estimate. 68 Fed. Reg. at 60,814 (adding the Commission's estimated burden hours for company personnel and outside professionals).
Second, the Commission's burden estimates fail to account adequately for increased printing and mailing expenses that would result from the proposed rule. Contrary to the Commission's statement that there would be no additional printing and mailing burdens under the proposed rule, all companies that are "affected" by the proposed rule would be likely to experience increased printing and mailing expenses that outpace current expenditures. See 68 Fed. Reg. at 60,814. Increased printing and mailing costs would result from companies distributing more materials (in frequency and/or size) to shareholders as a consequence of increased shareholder proposals and the inclusion of shareholder candidates in company proxy materials. See, e.g., 68 Fed. Reg. at 60,800 (requiring companies to include shareholder nominees in company proxy materials, and permitting supporting statements of all nominees in company proxy materials). The proposing release cites an estimate that an additional two ounces of proxy materials mailed to 100,000 shareholders would result in an increased mailing cost of $308,825. 68 Fed. Reg. at 60,814. Assuming the accuracy of this modest estimate, an "affected" company's printing and mailing costs for an addition two ounces of proxy materials would radically surpass the total annual financial burden that the Commission estimates for the "affected" company. Again, the Commission estimates the total annual burden for each "affected" company to be a mere $4,200. 68 Fed. Reg. at 60,814 (adding the Commission's estimated costs for company personnel and outside professional time).
Third, the Commission's burden estimates fail to account for the fact that the proposed rule has the potential to turn every director election into an election contest. Although it concedes the "high costs associated with undertaking an election contest," the Commission erroneously contends that resources that would be expended by companies for election contests under the proposed rule would merely offset current election contest expenditures. 68 Fed. Reg. at 60,814. In fact, as noted above, the proposed rule would give rise to increased opportunities for shareholder to nominate directors in company proxy materials. Accordingly, there would be by definition more instances where shareholder nominees are actually included in a company's proxy materials, giving rise to more election contests than currently exist. In such instances, and pursuant to their fiduciary duties, company directors would be forced to expend all necessary and permissible resources to defeat unqualified shareholder nominees.
Indeed, elections may well be contested even where no shareholder nominee appears on the ballot, since companies now will have incentive to expend resources to ensure not merely that their nominees win, but that they do so with less than a 35% "withhold" vote. Company costs in this area, which also are unaccounted for in the Commission's burden estimates, could include executive and director time and distraction from regular duties, increased legal fees, the use of proxy solicitors, and increased costs of printing and mailing resulting from the inclusion of additional information in company proxy materials and additional shareholder communications. See, e.g., 68 Fed. Reg. at 60,800 (companies may include supporting statements of nominees in their proxy materials). The cost of even one proxy contest likely would exceed the total $4,200 cost burden estimated by the Commission. See Aranow & Einhorn On Proxy Contests For Corporate Control § 21.01 ("Proxy Contest Expenses"), Exhibit 21-1 (3d ed. 1998).
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Given that the Commission has provided unreliable, artificially low estimates of the burden that would result from year-round process related to shareholder proposals and director nominations and elections, OMB should disapprove the Commission's proposed collection of information.
4. The Commission Provides No Evidence That The Collection Of
The Commission's proposed collection of information also lacks practical utility. See Paperwork Reduction Act, 44 U.S.C. § 3506(c)(2)(A)(1) (requiring practical utility). The Paperwork Reduction Act provides that "[b]efore approving a proposed collection of information, the Director shall determine whether the collection of information by the agency is necessary for the proper performance of the functions of the agency, including whether the information shall have practical utility." 44 U.S.C. § 3508. Practical utility is defined in the regulations as "the actual, not merely the theoretical or potential, usefulness of information." 5 C.F.R. § 1320.3(1). The Commission provides no rationale for the proposed rule, and offers no substantive analysis of the practical utility of the rule's collection of information requirements. See 68 Fed. Reg. at 60,808-60,815.
The Commission's position that the proposed rule would apply only "in those instances where evidence suggests that the company has been unresponsive to shareholder concerns as they relate to the proxy process" is unfounded. 68 Fed. Reg. at 60,784. Rather, as discussed above, the proposed rule would empower shareholders in most if not all companies (not just "unresponsive" companies) to seek direct access to company proxy materials to nominate directors, thereby triggering collection of information burdens. Even companies with good corporate governance records would be burdened by the Commission's collection of information requirements. For example, a disgruntled shareholder or group of disgruntled shareholders with a 1% stake in a company could take advantage of the low 1% shareholder access threshold to submit a direct access proposal to the company, thereby subjecting the company to collection of information burdens. 68 Fed. Reg. at 60,790.
The role of state law in the area of shareholder access also suggests that the proposed collection of information lacks practical utility. State corporate law largely governs shareholder access to a company's proxy for director elections. 68 Fed. Reg. at 60,788. The Commission acknowledges this fact, stating that the proposed rule "would apply only where the company's security holders are permitted under state law to nominate a candidate or candidates for election as a director." 68 Fed. Reg. at 60,787, 60,808. The traditional supremacy of state law in the director nomination and election process, and the Commission's purported acknowledgment of that supremacy in its proposing release, suggest that the practical utility of the collection of information requirements outlined in the proposal would be dependent on pertinent state laws. Even if that were not the case, potential conflicts between state and federal law could affect the Commission's authority and ability to collect information.
Because the proposing release provides no substantive analysis let alone actual evidence of practical utility, OMB should disapprove the Commission's proposed collection of information requirements.
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The Paperwork Reduction Act requires the disallowance of the Commission's collection of information proposal. The Commission provides unreliable burden estimates that are artificially low because they fail to account for the true number of companies affected by and the true costs of the proposed rule. Moreover, the Commission provides no substantive analysis of practical utility.
The Business Roundtable appreciates this opportunity to provide its views to the OMB.
cc: Jonathan G. Katz Hon. William H. Donaldson Hon. Paul S. Atkins Hon. Roel C. Campos Hon. Cynthia A. Glassman Hon. Harvey J. Goldschmid Giovanni P. Prezioso Alan L. Beller