Cambridge, MA 02138
December 3, 2003
Via e-mail: email@example.com
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549-0609
Re: Security Holder Director Nominations (Release No. 34-48626; IC-26206; File No. S7-19-03).
Dear Mr. Katz:
We are members of the Harvard Business School/Harvard Law School ad hoc group on the study of corporate governance. In our letter dated June 6, 2003, we responded to SEC Press Release No. 2003-46 and expressed general support for the idea that long-term shareholders should have some ability, with appropriate screens, to place their own nominees in the company's proxy materials. We now write to express our views on the specific proposal that the SEC has put forward in its release entitled "Security Holder Director Nominations," issued on October 14, 2003 (the "Proposed Rules").
Our overall view is that the Proposed Rules would improve the director election process at U.S. public companies in two ways. First, the Proposed Rules could increase the number of director elections in which there is some meaningful shareholder choice. Putting aside contests fought over a sale of the company and attempts to open-end closed-end mutual funds, contested board elections are exceedingly rare: one of us reports in current research that there are on average fewer than fifteen such elections per year, with the large majority of them for companies with market capitalizations below $200 million.1 We believe that increasing the number of contested elections beyond the current low levels would be desirable, and that the Proposed Rules could move us in this direction.
The second way in which the Proposed Rules would improve the director election process is by promoting productive communications between shareholders and the board. The "shadow" of a 14a-8 shareholder access proposal or withhold vote campaign would give long-term, significant shareholders more voice in the selection of candidates that the board itself nominates. Thus even if triggering events were rare in practice, we believe that the Proposed Rules would create a more productive behind-the-scenes negotiation between long-term shareholders and the board in the selection of candidates.
Critics of the Proposed Rules argue that shareholder access may lead to "special interest" directors, balkanization of the board, and adversarial relationships within the board room. We do not believe these fears to be warranted. It is important to remember that the Proposed Rules still require each successful candidate to receive a plurality of the votes cast. While it is possible that special interest candidates may be nominated under the Proposed Rules, these candidates will not win unless they can appeal to a substantial fraction of the shareholders. Finally, to the extent that a new board member who has received support from a shareholder plurality causes adversarial relationships within the boardroom, we believe that this tension would most likely be productive rather than destructive.2
The extent to which the benefits described above will be realized depends in large part on the design of appropriate triggering events. We are concerned that the two triggering events as currently proposed may set hurdles that are too high, and may deter shareholder access in some cases in which providing such access would be desirable. We therefore propose two refinements to the Proposed Rules.
First, we propose a third triggering event, allowing shareholder access to the company proxy statement for the current annual election of directors if proposed by a 10% shareholder or shareholder group.3 This proposed third trigger would create a two-tiered mechanism for shareholder access: under the existing SEC-proposed trigger, a 1% shareholder or shareholder group could put forward a 14a-8 proposal seeking access for the next election of directors; under the proposed new trigger, a 10% shareholder or shareholder group could nominate a candidate for the current election of directors. Under this proposed third trigger, a 10% shareholder (or 10% group) would be able to nominate one or more candidates (as described under the Proposed Rules) without having to go through the 14a-8 process, because the plurality vote required in order for the shareholder nominee(s) to be successful provides approximately the same screen as the majority vote required for the 14a-8 shareholder access proposal to succeed. The requirements and restrictions for a shareholder to meet the 1% threshold under the Proposed Rules, including the one-year holding period requirement, would also apply in order to qualify for the 10% threshold. We believe that a 10% threshold sets an appropriately high hurdle for immediate access: according to the SEC's own data, only 13% of filers have a single shareholder who could make use of this trigger unilaterally, and only 18% of filers have two or more shareholders that have each held at least 5% of the shares for the requisite one year.4
The justification for this third trigger is that it would allow the possibility of immediate corrective action in a situation in which a substantial fraction of shareholders thought immediate action was wise. This third trigger would therefore allow contested elections in some additional set of cases in which we believe such contests would be appropriate. In addition, as described above, the proposed third trigger would increase the bargaining power of a 10% shareholder or shareholder group in negotiating with the board over the slate of directors that the company will propose. We believe that providing the possibility of an immediate contested election for a 10% shareholder or shareholder group would further stimulate productive communication between large shareholders and the board.
Second, in response to Question C.3. of the Release, we propose that the nomination procedure should be triggered by a 25% withhold vote out of total votes cast for one or more directors, rather than the 35% withhold vote that would be required under the Proposed Rules. Because of the strong bias that shareholders generally exhibit toward management's recommended slate, we believe that a 25% withhold vote would indicate significant shareholder dissatisfaction that would warrant access to the company proxy statement. By extension, we believe that requiring a 35% withhold vote may deny access in some cases in which a large fraction of the shareholders are dissatisfied with the board's performance.
Overall, we commend the Commission's efforts in proposing limited shareholder access to the company proxy statement. We look forward to final rules in this area.
/s/ Lucian A. Bebchuk
Lucian A. Bebchuk, William J. Friedman and Alicia Townsend Friedman Professor, Harvard Law School
/s/ John C. Coates IV
John C. Coates IV, Professor, Harvard Law School
/s/ Dwight B. Crane
Dwight B. Crane, George Fisher Baker, Jr. Professor, Harvard Business School
/s/ Alexander Dyck
Alexander Dyck, Associate Professor, Harvard Business School
/s/ Boris Groysberg
Boris Groysberg, Assistant Professor, Harvard Business School
/s/ Brian J. Hall
Brian J. Hall, Professor, Harvard Business School
/s/ Paul M. Healy
Paul M. Healy, James R. Williston Professor, Harvard Business School
/s/ Howell Jackson
Howell Jackson, Finn M.W. Caspersen and Household International Professor, Harvard Law School
/s/ W. Carl Kester
W. Carl Kester, Professor, Harvard Business School
/s/ Rakesh Khurana
Rakesh Khurana, Assistant Professor, Harvard Business School
/s/ Reinier H. Kraakman
Reinier H. Kraakman, Ezra Ripley Thayer Professor, Harvard Law School
/s/ Jay W. Lorsch
Jay W. Lorsch, Louis E. Kirstein Professor, Harvard Business School
/s/ Krishna G. Palepu
Krishna G. Palepu, Ross Graham Walker Professor, Harvard Business School
/s/ Mark J. Roe
Mark J. Roe, David Berg Professor, Harvard Law School
/s/ Guhan Subramanian
Guhan Subramanian, Joseph Flom Assistant Professor, Harvard Law School
For further information, please contact Guhan Subramanian (617-495-9784, firstname.lastname@example.org) or Mark Roe (617-495-8099, email@example.com).
|1|| See Lucian Arye Bebchuk, Shareholder Access to the Ballot, forthcoming Business Lawyer (2003), available at http://ssrn.com/abstract=426951.
|2|| Some commentators also claim that the SEC does not have authority under the federal securities laws to adopt the Proposed Rules. The members of our group from the Harvard Law School disagree with this conclusion. Section 14(a) of the 1934 Act gives the SEC broad power over the regulation of the proxy process. The D.C. Circuit court's decision in SEC v. Business Roundtable, 905 F.2d 406 (D.C. Cir. 1990), which invalidated the SEC's attempt to eliminate dual class recapitalizations at exchange-traded companies, is distinguishable because the SEC's power to regulate self-regulatory organizations under Section 19(c) of the 1934 Act is narrower than the SEC's powers to regulate the proxy process under Section 14(a). Section 14(a) allows regulation of the proxy process "as necessary or appropriate in the public interest or for the protection of investors," while Section 19(a), in relevant part, allows regulation of SRO's "in furtherance of the purposes of [the 1934 Act]."
|3|| A 10% threshold resonates with other corporate governance practices. Under most states' corporate law (thirty-two states) the default rule requires a special meeting on the call of 10% of the shareholders. See, e.g., Rev. Model Bus. Corp. Act §7.02(a)(2); Cal. Corp. Code §600(d); Mich. Comp. Laws. Ann. §450.1403; Tex. Bus. Corp. Act Ann. 2.24(C).
|4|| See Proposed Rule: Security Holder Director Nominations (Release No. 34-48626; IC-26206; File No. S7-19-03), at II.A.5.a.