BY ELECTRONIC MAIL
19 December 2003
Jonathan G. Katz
Re: File No. S7-19-03
Dear Mr Katz,
We represent some of the largest foreign institutional shareholders1 and are jointly submitting this letter in response to the request of the US Securities and Exchange Commission (the "Commission") for comments in respect of the proposed Exchange Act Rule 14a-8 (the "Rule") which would, under certain circumstances, require companies to include in their proxy materials, security holder nominees for election as directors. We appreciate the opportunity to participate in this important undertaking and intend our comments to be helpful to the Commission in its efforts to ameliorate the process for shareholders to nominate directors onto the boards of investee companies.
Our respective trustees, directors and clients have mandated their fund managers to take into account material corporate governance issues in order to better safeguard and enhance the long-term value of our members' assets. Given that a significant portion of our members' assets are invested in the United States, and the growing convergence of capital markets globally, we have a strong interest in promoting good governance and corporate responsibility practice in that market.
We are writing to express our strong support, in principle, for a rule that provides shareholders with a procedure that ostensibly promotes better access to the proxy process. We believe this initiative has the potential to redress a significant distortion in the US capital market framework.
Although we commend the Commission for recognising the importance of addressing this issue now, we have a number of significant reservations and concerns regarding the proposed "trigger" events necessary to activate the mechanism for shareholder participation in the nomination process. Indeed, we are concerned that if these triggers do become incorporated into the nomination process, it could seriously undermine this unique opportunity by the Commission to deliver major change by, at the same time, erecting near-insurmountable obstacles in the path of investors.
Fundamental Aspect of Good Governance
The Commission has proposed certain "trigger" mechanisms to limit the use of the Rule to "situations where there is evidence that the proxy process may otherwise have failed to permit security holder views to be adequately taken into account". We fundamentally disagree with this concept. Proper access to the proxy is normally a basic ownership right which enables shareholders to act responsibly and in a timely manner when management is consistently under-performing or engaging in practices that are value destructive or inappropriate (eg aggressive accounting or personal excess). Measures that frustrate such rights in the US or continue to enable poor management to shelter from accountability should not be used to undermine effective change.
The right for shareholders to nominate (and remove) directors should be available to shareholders (except, of course, in connection with change of control contests) of all companies in order to align the interests of directors with the shareholders they represent. It should not be applied only in the case of companies with a poor corporate governance record, nor should it have to be earned.
Further, the Rule as proposed creates unnecessary hurdles for shareholders in order to participate in the nomination process. These hurdles could be removed without encouraging frivolous use of the nomination process by narrowly-tailoring that process to allow its use by shareholders meeting certain ownership requirements, for example along the lines of those provided in the Rule.
If the Rule is adopted as proposed, the United States will be out of sync with practices in other markets which give shareholders the authority to appoint and remove directors with comparative ease.
In the United Kingdom, for example, Section 376 of the Companies Act 1985 grants shareholders the right to include a resolution at an Annual General Meeting ("AGM") for the appointment of a director. The only qualifying condition for the filing of such a resolution is that the members represent at least 5% of the voting rights at the general meeting or they number at least 100 and hold shares on which there is an average amount paid up of at least £100 (UK Sterling) per member. A simple majority is all that is required to pass such a resolution - which is binding upon a company.
Unlike the United States, in the United Kingdom shareholders are also able to vote against the election of a director at the AGM following his/her appointment as well as the re-election of a director when his/her term of office is up for renewal. This vote also requires a simple majority and is binding on the company.
Alternatively, investors in UK companies are entitled to requisition an Extraordinary General Meeting ("EGM") if the shareholders calling for this meeting represent 10% or more of the voting share capital and put forward resolutions to appoint and/or remove directors. Ordinary Resolutions filed for an EGM also require a simple majority and are binding upon the company.
Similar rules apply in Australia, France, Germany, India, Ireland, New Zealand, South Africa and Sweden and other jurisdictions where statutes are modelled on UK company law.
We understand that the Commission has to manage expressed corporate fears about unstable boards but given the Commission's commitment to market reform, we would urge the Commission to focus its attention on experiences in other jurisdictions where provisions granting shareholders direct access to the nomination process have not resulted in the destabilisation of corporate boards. For example, in the United Kingdom, while the right to nominate directors is important to institutional shareholders, it is rarely used. Indeed, we would argue that the availability of this right is more likely to lead to board stability and a reduction in time-consuming, disruptive and expensive proxy battles and a shift of emphasis towards more serious, collaborative and constructive dialogue with corporations.
The timescales envisaged in the proposal also risk distorting the situation. Delaying access beyond the next annual meeting helps maintain and possibly exacerbate situations that are undermining the business and shareholder value. Limiting the time period for an application to two years risks forcing the hand of shareholders to nominate candidates rather than seeking to work for constructive change and resolution first. The events of the past two years testify to the rapid changes even the largest of companies can experience.
The 5% Threshold
The voting right thresholds should be set at levels which recognise the level of fragmentation and low concentration of ownership in the US. As barely half of companies listed on the NYSE, AMEX or NASDAQ markets have a single shareholder who could satisfy the proposed ownership requirement, according to the Release, the threshold needs to be adjusted accordingly. While 5% is the threshold in the United Kingdom for an AGM resolution, as explained above, we believe this is appropriate in that market given the relatively greater concentration of share ownership there.
If the Commission does adopt the Rule with the trigger mechanism intact, we would urge the Commission to include, as an additional triggering event, a company's failure to implement a shareholder proposal submitted in accordance with U.S. Securities Exchange Act of 1934 Rule 14a-8 that receives support from the majority of votes cast. We believe that those circumstances strongly evidence shareholder dissatisfaction with the proxy process and estrangement from the board of directors.
We would therefore urge the Commission to reconsider the Rule and be sensitive to both domestic and foreign investors' concerns that the nomination process outlined in the Rule would not be sufficiently responsive to a potential problem with an investee company. In the same way that we have learned from developments in the US, we believe the Commission would indeed benefit from considering the experience of jurisdictions other than the United States. We would be pleased to provide the Commission with further information regarding these processes or answer any questions in this regard.