Gary K. Duberstein
455 East 86th Street
New York, NY 10028
December 22, 2003
Jonathan G. Katz
U. S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: File No. S7-19-03
Security Holder Director Nominations
Dear Mr. Katz:
As a securities law practitioner for over twenty years and a founder of activist investor Greenway Partners and the Corporate Governance Advisor, I have been involved in many proxy contests for the election of directors, solicitations for shareholder proposals, and corporate governance matters. I believe that Commissioner Harvey J. Goldschmid was exactly right when he proclaimed it a "proud historic day for the Commission" when the proposal requiring companies to include shareholder nominees for directors in their proxy materials was first publicly unveiled (the "Proposal" or "Proposed Rule").
Long overdue, the Proposal is a step towards the right regulatory direction of providing a potentially important check in situations where managements have failed to adequately manage, and boards and outside professionals have failed in their oversight roles over managements. Some may argue that in light of newly added procedural safeguards as to independence from managements of directors and third party professionals, and the strengthening of audit committees and the like, as embodied in the Sarbanes-Oxley Act of 2002 and stock exchange listing requirements, the Proposal should be postponed or watered down and this "new" regulatory scheme should be given a chance. I strongly disagree. While the "new" rules are welcome changes, they are largely procedural embellishments on a system whose theoretical underpinnings rely on the ability to police managements through the oversight of directors and professionals who presumably will always be independent and never co-opted by management either initially or at anytime during their service. For that to occur requires changes to innate human behavior that are beyond the power of these rules or any similar proposal to cause.
Consequently, before turning to specific changes to the Proposal, I will first discuss an alternative view based squarely on the premise that the only reliable system to serve as a check on a management allowed to perform poorly by a somnolent board is to provide a mechanism for major shareholders to quickly, efficiently, and in a cost efficient way add new directors of their choice to a board. Cutting through the legal jargon and niceties, the basic corporate governance for publicly traded corporations really comes down to managements operating companies and directors watching managements.1
But, the recent scandals underscore the need for somebody to `watch the watchers'. That somebody is major shareholders who should be able to nominate directors in management's proxy statement in a timely fashion based on a so-called single trigger event which would be ownership of at least five percent of the outstanding shares or $1 billion in share value. These shareholder nominees would then face the ultimate democratic trigger of running against management's slate with the final choice of directors left to a plurality vote of shareholders. In no event under the access rule would major shareholders be allowed to nominate a sufficient number of directors to have a majority of the board and therefore control.
The Philosophical Underpinning for Shareholder Access is Value Creation and the Advent of Major Institutional Shareholders
The philosophical underpinning of a rule for shareholder access is the substantive one of value creation that has never been a more crucial concept as we move into a new millennium that promises to bring global competition to new heights. While the 20th Century will no doubt be remembered in history as the century of the United States, one can only wonder what the next 100 years and more will bring as many farsighted eyes begin to look at economic developments in an East Asia that includes a surging market economy in China. Besides the ever increasing impact of globalization, we should also adjust our thinking to take account of the relatively new class of major shareholders-the mutual funds, private and public pension plans, and investment partnerships that collectively own a majority of publicly traded securities in the United States. Among this relatively new breed of major investor are many who have the resources of staff, financial expertise and, of course, market incentive, to assume part of the burden of monitoring corporations. This new paradigm of the unrelenting need to remain competitive in the face of globalization and the availability of sophisticated market driven major shareholders who may be willing to act as monitors should not be overlooked or minimized in any discussion of creating a better corporate governance system for the new millennium.
The reason we are now focusing on any proxy reform at all is because of the recent scandals. Although the United States has faced scandalous behavior at large numbers of its major corporations before, many will argue that the likes of Enron, WorldCom etc. rank up there as indicative of a systemic failure not seen since the 1930s in an era before the advent of the Securities and Exchange Commission (the "SEC") and some 70 years of national securities legislation, regulation, and enforcement.
In an ironic and painful way, in some societal fashion the billions of dollars lost to shareholders and pensioners because of greedy and unscrupulous managements and somnolent boards may in some sense be recouped if the scandals lead to the changes necessary to keep United States corporations competitive in the new world economy. To be blunt, corporate governance has always been important but it has taken these scandals and the loss of billions of dollars to bring the issue from a filler in the bowels of a newspaper to the front page. These scandals have prompted renewed interest in shareholder access to managements' proxy statements, a concept that should have been enacted long ago instead of shelved every few decades in favor of lesser measures2. The loss to society will be all the greater if an opportunity for meaningful reform is missed entirely or squandered on half measures.
While affording the opportunity for reform, the scandals underscore shortcomings with the model in use: the so-called monitoring model with its emphasis on independent directors, audit committees, and outside professionals who will monitor managements. While the model has definitely been strengthened by the advent of Sarbanes-Oxley and the new listing requirements, no doubt many earlier advocates of the model in the 1970s thought the approach sound and problems solved when the SEC encouraged self-regulatory organizations to adopt audit committee requirements3 following the spectacular failure of the Penn Central railroad in the wake of a board that appeared as clueless to the true financial condition of its company as their more modern counterparts at Enron.
An inherent problem of the monitoring model is the propensity for independent directors and professionals to become co-opted over time by management. The congeniality of the boardroom-so praised by some commentators-will revert to being a tranquilizing narcotic when the scandals fade from the front page. It is human nature for directors chosen by incumbent directors/managements to feel somewhat beholden to incumbent directors/managements. Relationships form; and, too often in times of strife wagons are circled with boards either protecting, or blind to the foibles of, managements. Despite new hiring powers for audit committees and the ability of attorneys to report up/out or what have you, close relationships will still form between the professionals and managements. Over time, the tendency of directors and professionals alike will be to accept the plans of management, become their proponents, and `not rock the boat' even when the cold slap of a wave could do wonders.
The monitoring model can be vastly strengthened if major shareholders are willingly embraced as one of the monitors within the system instead of held suspiciously away at arms length, as is the case now. Major shareholders with capital invested in a company normally far in excess of the combined holdings of the board of directors and management are much less likely to be co-opted by management than any of the other monitors. For the most part major shareholders are influenced by the simple desire to maximize the value of their investment. Applying a holding period of one year is more than enough time as a standard to differentiate a trader who plays on market timing and peculiarities from an investor who is more concerned and motivated by the intrinsic long term value of a company. The latter type of investor is the ideal monitor because the unforgiving `invisible hand' of the market-seconded by value driven partners or an investment board-is most likely to spill that cold water all over a major investor when the other types of monitors are loath to `rock the boat'.
In such a situation, for the benefit of both our economy and system of corporate governance, major shareholders should at least have the possibility in a timely fashion to influence the direction of a corporation by placing a small number of nominees in managements' proxy statements, be able to run a cost effective campaign to communicate ideas to other shareholders, and then leave the ultimate decision to the collective wisdom of all shareholders in a corporate election that may actually afford a choice of candidates. Such a system harnesses the market itself and major shareholders as monitors in addition to independent directors and outside professionals, and will thus strengthen corporations. The goal is to help American corporations remain competitive by harnessing market forces through major shareholders and bringing those forces to bear in the selection process of directors.
All of which leads me to urge the abandonment of the "first trigger" involving as proposed at least a 35% withhold vote in a "Just Vote No" campaign or a majority vote for a proposal to adopt shareholder access as wasteful of time and potentially economic value. In our fast paced world and markets, too much can happen in the 18 month or so period between the time a shareholder starts the access process by initiating the first trigger and the second annual meeting thereafter when the shareholder sponsored candidates can be elected and seated in the board room. Such a period, especially from the viewpoint of a major shareholder holding an eroding position, seems too close to the Keynesian long term-by which time we are all dead!
Moreover, I respectfully disagree with what appears to be the SEC's philosophical underpinning for the access right that perhaps caused a perceived need for the first trigger, stated as follows at page 6 of the Release: "This limited access right . . . would apply only in those instances where criteria suggest that the company has been unresponsive to security holder concerns as they relate to the proxy process." The need for the access right goes beyond a "process" concern to the very substantive one of value. It is the concern that a board and management is squandering value that will cause a major shareholder to undertake the expense in funds and time to utilize an access procedure. Rest assured, the reasons put to the good sense of shareholders for them to support the first vote will not be about "proxy process", but about value. All that the double trigger does is to require two votes and the passage of two annual meetings in order for major shareholders to help all shareholders protect the value of their company. That is one year and one vote too many.
All this leads me to urge that the first trigger be eliminated completely and that the so-called second trigger in the Release, with some modifications, be treated as the entire shareholder access rule. It is to that construct that I now turn.
To Realistically Reach Future Enrons and WorldComs the Threshold Should be Either 5% Ownership or $1 Billion Share Value
I am mindful that there is no perfect ownership level or holding period, and that one could reasonably argue as is done in the Release that "a threshold of more than 5% ownership for two years strikes an appropriate balance." However, the Release also supports that conclusion by finding that approximately 42% of filers have at least one security holder that can meet this threshold and approximately 50% of filers have two or more holders that each have held at least 2% for the two year period. The SEC should rerun these numbers based only on "accelerated filers", which according to the Release consists of those 3,159 of the 14,484 companies filing periodic reports under the Exchange Act with a common equity public float of at least $75 million. The SEC is right to phase the rule in targeting first these larger "accelerated filers", but I suspect that in so doing it may conclude that the proposed thresholds are too high when applied to larger companies.
To make sure that future Enrons and WorldComs even among our largest companies can be reached under the access rule, I would propose an ownership threshold of either more than 5% ownership or $1 billion in share value, certainly not an insignificant amount. As to time period, I would suggest a one-year holding period-which qualifies as long term in the eyes of the Internal Revenue Service-at the time of submission of the nominations, and a declaration of intention to own such securities through the date of the meeting, thus in practice requiring a minimum holding period of approximately 16 months.4
The Proposed Rule and Schedule 13G Should be Clarified to Allow Major Shareholders Who Do Not Have an Intent to Acquire Control of a Board, but May be Actively Attempting to Create Value, to Use the Access Procedure
I agree that the access rules should not be available to shareholders with a true "control intent". But, if the lack of "control intent" is a prerequisite for eligibility to use the proposed access rule, it is incumbent on the SEC to clearly and precisely define it, so that major shareholders who pursue a course of value maximization through shareholder proposals or send a message of discontent through a "Just Vote No" campaign are not inadvertently lumped in with those who are seeking to actively control a company. For purposes of eliminating eligibility to use the access rule, "control intent" should be clearly defined as a present intention either to acquire a majority of shares in order to provide the ability to name a majority of the board or to instigate an "old style" regulated proxy contest that would allow such person to name a majority of the board. Unfortunately, eligibility for the access rule keys off the amorphous eligibility language that permits use of a Schedule 13G only if the beneficial owners of securities have not acquired the securities with the purpose or with the "effect of, changing or influencing (emphasis added) the control of"5 the company.
Because the SEC noted, for example, in Exchange Act Release No. 34-39538 (January 12, 1998) that the determination of control intent is fact specific and declined "extensive guidance on this issue", major shareholders may have opted to be conservative and filed on Schedule 13D even though they arguably could have filed on Schedule 13G. The practical problem now arising is the SEC apparently takes the view that major shareholders who are proponents of a shareholder proposal under Rule 14a-8 calling for a sale of a significant amount of assets, a restructuring, or a sale of the company, are trying to "influence control" and therefore cannot use a Schedule 13G6.
Over the years, I have been the proponent of various proposals under Section 14a-8 calling for spin-offs and even sales of companies, and have engaged in "Just Vote No" campaigns. In each case, my purpose was to increase the value of such companies for the benefit of all shareholders, not to end up in a position to control the company and operate it. Indeed, except in instances of a proxy contest for election to the board or a tender offer for shares, my intentions-in my personal view-have not been to seek or influence control, but to increase value. I respectfully ask the SEC to focus on the distinction between seeking "control" and "value" now that the availability of the access rule makes the proper definition of control of key importance and not just a question of filing a Schedule 13G or Schedule 13D. Perhaps the answer will be to require major shareholders who are proponents of certain economically oriented proposals to continue filing on a Schedule 13D, but they would still be eligible to use the proposed access rule. In any event, the definition of "control" in cases of major shareholders who engage in proxy related activities should be revisited.
Revise Restrictions Regarding Who the Major Shareholders May Choose as Their Nominees
The SEC should rethink some of the restrictions imposed upon permitted nominees of the major shareholders. First, some easy clarifications. The Proposed Rule recites that the nominee cannot be "a member of the nominating security holder group". I would like to have clarified what happens if a major shareholder asks an outsider, who owns shares of the company, to be a nominee. Such person's counsel may request that the nominee join in a Schedule 13G7 filing as a part of a group with the nominating security holders, and that should not cause that outsider to be disqualified as a nominee. Similarly, the Proposed Rule recites that the nominee may not accept any "compensatory fees" from the nominating shareholder group. There should be a clarification that the group can pay on behalf of the nominee legal fees and expenses in connection with the proxy solicitation and indemnify the nominee for any related liabilities.
Second, on a more substantive level, I disagree with the position that, for example, a board member of a major institutional shareholder with impeccable credentials and much to offer should be disqualified from being named as a nominee under the terms of the Proposed Rule. Considering the limits on the permitted number of the shareholder nominees8 and consequently their clear minority status on the boards, the restrictions should be reconsidered.
The recurring difference of opinion, of course, is the view that being, or affiliated with, a major shareholder9 of a company somehow makes one less desirable rather than more desirable as a director. While the specter of some hidden "special interest"- whatever that means-can be hurled at any director however chosen, my abiding faith in the markets and human nature is that major shareholders want to maximize the value of the company and the stock, and that can only be accomplished by benefiting all shareholders.
Each Shareholder Nominee Should be Allowed a Statement of 500 Words in Management's Proxy Statement to Express Views or Plans for the Company
The Proposed Rule appropriately requires background information about the shareholder nominees for inclusion in management's proxy statement, including, of course, information required of management's nominees under the proxy rules. But, oddly, shareholder nominees are not allowed to include a position statement unless management decides to include a statement in the proxy statement supporting company nominees or opposing shareholder nominees. That strikes me as inadequate disclosure.
Shareholder nominees should be allowed, encouraged and-perhaps, even required-to include a statement of plans or proposals for the company.10 Adopting Rule 14a-8 as precedent, allow each shareholder nominee 500 words that each can use separately or in a combined statement if all such nominees agree.11 To be equitable, allow each management nominee 500 words if they choose to use them. Indeed, why not afford the opportunity for management's nominees to be individuals with their own ideas instead of a faceless-or sometimes photo included-resume. While backgrounds are important and should be fully disclosed, if there is need for a proxy contest, let it be about differing ideas for improving the company and creating value.
Rule Governing the Ability to Solicit Holders to Achieve at Lease 5% Threshold Should be Revised
The Proposal recites that a solicitation to achieve the 5% threshold would be exempt from various proxy rules provided that either (a) not more than 30 persons are solicited, or (b) each written communication includes only (i) a statement of intent to form a nominating group; (ii) aggregate percentage ownership of securities within the soliciting group; and (iii) means to reach the soliciting party. Moreover, any soliciting materials utilized shall be filed with the SEC no later than the first day of use, where it would be publicly available.
In Question K.3 of the Release, the SEC flags the important issue that the filing of all written communication obviates the 30 person limitation. Once a written announcement is publicly filed-as it should be-any limitation on the number of persons who can be solicited becomes meaningless and therefore should be eliminated.12 Turning now to (b) above, I suggest that the enumerated information be required in any communication, but not limited to it. I think it entirely appropriate that a nominating shareholder group be allowed to state its reasons for its actions if it so chooses. Indeed, that would be important information for shareholders to know. In practice, these procedures will be used sparingly and major shareholders will probably limit their solicitations to other large shareholders and will not be contacting small holders at the stage of trying to organize the 5% nominating group.13
Rejigger the Notice Period to Provide Sufficient Time for a Cure Period and if Needed an Appeal to the SEC
As proposed, the Proposed Rule calls for the major shareholder group to submit a notice including nominee information to the company 80 days14 before the scheduled day of mailing, requires the company to inform such group if the company will be failing to include the shareholder nominees in management's proxy statement for any reason under the Proposed Rule 30 days before the mailing, and fails to provide that the shareholder group has a period to cure any alleged defect and/or take the matter to the SEC for resolution. With the notice information fairly straightforward, companies easily should be able to determine compliance with the Proposed Rule within 15 days, leave 15 days for a cure period, and 50 days if SEC intervention is needed. From a practical point of view, a major shareholder group and the company will presumably have competent counsel aiding them, the required background information in the notice is straightforward and well known to securities law practitioners, and the notice does not seem to require subjective judgments on the order of what constitutes "ordinary business operations" as has plagued the 14a-8 process. In short, follow the form, have nothing to argue about, and be done 50 days early.
In the Unfortunate Event that the First Trigger is Not Totally Eliminated:
- The proposed 35% withhold vote threshold for a "Just Vote No" campaign as trigger should be dropped down to the 20% norm generally viewed as a defeat for management.
- A shareholder proposal advocating applicability of the shareholder access rule should be able to be brought by any shareholder who complies with the existing requirements of Rule 14a-8, not just a shareholder or group holding more than 1% as proposed. The more relevant number is that to be an operative trigger the shareholder access proposal needs to be approved by a majority of votes cast.
- Any shareholder proposal that receives a majority of votes cast and is not implemented by management should be viewed as a first trigger. If a company is not responding to the holders of a majority of votes cast on an issue, that would be evidence of the company being unresponsive to security holder concerns, and shareholders should at least have the possibility of placing a voice or two more in tune with their views on the board.
- In determining whether the first trigger has been achieved, percentages should be based on votes cast for or against (or withheld), and so-called "broker non-votes"15 should be eliminated from consideration.
- As floated for comment in the Release, add certain objective first triggers such as if a company lags a peer index for a specified period; is delisted by a market; has been sanctioned by the SEC; has been criminally indicted; has had to restate earnings; or has had its stock price drop by a certain percentage.
- Add a "safety valve" procedure that circumvents the two step process, whereby a shareholder or shareholder group with at least 10% are allowed access in the current year to management's proxy statement16
Notwithstanding the above, no degree of tinkering will change the fact that the necessity of a double trigger and near two year waiting period is bad policy. An unexpected and unfortunate consequence of retaining a first trigger, may be to force major shareholders as a matter of policy to vote for all possible triggers at all companies so that by the next annual meeting the shareholder access rule would be available-if need be.
I commend the SEC for addressing this important issue and thank them for the opportunity to comment. Any steps towards affording major shareholders their proper role as monitors is welcome, and I believe will serve to strengthen the United States in this increasingly competitive global economy. Please contact me at 212-289-3346 with any questions.
Very truly yours,
Gary K. Duberstein
cc: Commissioner William H. Donaldson
Commissioner Paul S. Atkins
Commissioner Roel C. Campos
Commissioner Cynthia A. Glassman
Commissioner Harvey J. Goldschmid
Alan L. Beller, Director, Division of Corporation Finance
Martin P. Dunn, Deputy Director, Division of Corporation Finance
|1|| See, e.g., Delaware General Corporation Law, Sec. 141(a): "The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors . . .", New York Business Corporation Law, Sec. 701: "the business of a corporation shall be managed under the direction of its board of directors," and Sec. 715(g): "All officers as between themselves and the corporation shall have such authority and perform such duties in the management of the corporation as may be provided in the by-laws or, to the extent not so provided, by the board."
|2|| See Proposed Rule: Security Holder Director Nominations, Exchange Act Release No. 34-48626 (the "Release") at Section IB.
|3|| See Exchange Act Release No. 34-47137, "Proposed Rule: Standards Relating to Listed Company Audit Committees, Sec. I. (February 18, 2003).
|4|| The nominations must be submitted 80 days before mailing and there is normally a solicitation period of 30 days or so.
|5|| See Rule 13d-1(b)(1)(i) and 13d-1(c)(1).
|6|| Securities Act Release No. 34-39538 (January 12, 1998) at page 24.
|7|| Or Schedule 13D filing if my above point is accepted.
|8|| One shareholder nominee if the whole board is eight or fewer, two if the whole board is greater than eight and less than 20, and three if the whole board is 20 or more. As to numbers, I would favor allowing major shareholders to name that number of nominees up to a majority of the board minus one. At the very least, major shareholders should be allowed to name at least two nominees since one lone voice can more easily be systematically isolated and marginalized in a board room.
|9|| For purposes of discussion a shareholder with ownership of several percent.
|10||Modeled after Item 4 of Schedule 13D, as appropriate.
|11|| A maximum of 1,500 words for large boards where there might be three shareholder nominees.
|12|| As further reason to eliminate any numerical limitation, recall the practical problems with the so-called 10 person exemption that was the only one available before the welcome 1992 proxy rule amendments. Because no institution could be sure that they were not the 11th person spoken to, there was a chilling effect that hindered the intended use of that numerical exemption.
|13|| If the first trigger is retained, solicitation of a 1% group should be exempted from certain proxy rules in the same fashion as for the more than 5% group.
|14|| The 80 day period, while still too long, is at least closer to the time in which the proxy process can and should operate. If the SEC believes the shareholder access process for directors can be done in 80 days, certainly the process for inclusion of a 500 word shareholder proposal under Rule 14a-8 can be shortened from the current 120 days before mailing to 80 days, if not less. This can make the shareholder proposals more timely and helpful to companies facing immediate problems.
|15|| Under this antiquated New York Stock Exchange rule, brokers may vote on certain matters-including an "uncontested" election which is maddeningly defined by the NYSE to include "Just Vote No" campaigns"-if the beneficial owner has not provided voting instructions by a certain time before the meeting. These "broker non-votes", submitted by rote, are always voted in favor of management and thereby skew the results.
|16|| See letter from Lucian A. Bebchuk et.al. to Jonathan G. Katz, Secretary, Securities and Exchange Commission (December 3, 2003).