December 18, 2003
|Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
|Filed electronically at email@example.com|
Re: File No. S7-19-03: Security Holder Director Nominations
Dear Mr. Katz:
I am writing in support of the Commission's proposal to strengthen the capacity of shareholders to nominate directors at the companies they own. The proposed rule, while it could be further improved, is an important step forward in addressing a serious problem at too many publicly traded companies in this country: inattentive and compliant boards of directors that fail to protect shareholder interests and too often place the interests of corporate management ahead of the interests of the corporation's owners.
It is common knowledge that too many U.S. corporate boardrooms today place a high premium on comity. Directors who speak out, ask hard questions, or exercise detailed oversight are too often seen as intrusive, troublesome, or counterproductive. It is no surprise that many corporate executives prefer to operate with minimal oversight and do not willingly nominate directors who challenge management. But our capitalist system was not designed or intended to operate without meaningful board review of management actions. The SEC is correct about the need to change current boardroom dynamics and create conditions that will revitalize the independence and watchfulness of corporate board members.
The past two years have exposed the investing public to one disturbing example after another of corporate misconduct taking place either with the apparent knowledge and consent of the company's board of directors or with the board's apparent ignorance or indifference. The facts cry out for corrective action.
One prominent example involves the Enron Corporation, which was the subject of a year-long investigation by the U.S. Senate Permanent Subcommittee on Investigations, which I then chaired and on which I now serve as Ranking Minority Member. After interviewing thirteen Enron board members and holding a hearing on the role of the Enron board of directors in the company's collapse, the Subcommittee issued a bipartisan report that concluded the following:
"The Enron Board of Directors failed to safeguard Enron shareholders and contributed to the collapse of the company by allowing Enron to engage in high risk accounting,inappropriate conflict of interest transactions, extensive undisclosed off-the-books activities, and excessive executive compensation. The board witnessed numerous indications of questionable practices by Enron management over several years, but chose to ignore them to the detriment of Enron shareholders, employees and business associates."
A report exposing the failures of the WorldCom board of directors provides another disturbing example. This report was issued by the WorldCom bankruptcy examiner, Richard Thornburgh, former U.S. Attorney General, after months of investigative work. It identifies a host of deficiencies in WorldCom's corporate acquisitions, strategic planning, debt management, internal controls, executive pay and loans, and other activities, characterizing these deficiencies as marked by "egregiousness, arrogance and brazenness." The report states: "These deficiencies reflect a virtual complete breakdown of proper corporate governance principles, making WorldCom the poster child for corporate governance failures." It found that the company had been dominated by its top executives "with virtually no checks or restraints placed on their actions by the Board of Directors," despite "misgivings" and "under circumstances that suggested corporate actions were at best imprudent, and at worst inappropriate and fraudulent." Examples of poor board oversight included the following:
"Several multibillion dollar acquisitions were approved by the Board of Directors following discussions that lasted for 30 minutes or less and without the Directors receiving a single piece of paper regarding the terms or implications of the transactions. ... [The Board's Compensation Committee] agreed to provide enormous loans [of more than $400 million] and a [bank] guaranty for [Worldcom's Chief Executive Officer] without initially informing the full Board or taking appropriate steps to protect the Company."
The report concluded that "WorldCom's conferral of practically unlimited discretion" upon its top executives, "combined with passive acceptance of Management's proposals by the Board of Directors, and a culture that diminished the importance of internal checks, forward-looking planning and meaningful debate or analysis formed the basis for the Company's descent into bankruptcy."
A third example of failed Boardroom oversight is discussed by a court in the context of a shareholder lawsuit, In Re The Walt Disney Company Derivative Litigation, 2003 Del. Ch. LEXIS 52 (Del. Ch. 2003). In its opinion, the Delaware Court of Chancery refused to dismiss a shareholder complaint against the company's directors in light of allegations that the board had failed to exercise any meaningful oversight over the hiring, termination, and payment of $140 million to a person who was hired as president at the CEO's insistence, accomplished little while in office, and quit after less than a year. Characterizing the $140 million payment as a "huge personal payoff after barely a year of mediocre to poor job performance," the court stated:
"These facts, if true, do more than portray directors who, in a negligent or grossly negligent manner, merely failed to inform themselves or to deliberate adequately about anissue of material importance to their corporation. Instead, the facts ... suggest that the defendant directors consciously and intentionally disregarded their responsibilities .... Put differently, all of the alleged facts, if true, imply that the defendant directors knew that they were making material decisions without adequate information and without adequate deliberation, and that they simply did not care if the decisions caused the corporation and its stock holders to suffer injury or loss."
Enron, WorldCom, and Disney each provide evidence of a breakdown in boardroom oversight and corporate governance. Other corporate scandals over the last two years suggest they are not isolated examples. Corporations such as Tyco, HealthSouth, and Adelphia continue to demoralize investors with examples of inattentive and compliant boards of directors. The intractable problem of excessive executive pay unrelated to corporate performance - pay which is the sole responsibility of boards of directors to establish and review - provides still more proof of the need to create new incentives for meaningful boardroom oversight of management actions.
The proposed rule directly tackles the problem of inattentive and compliant boards of directors. It does so by ending the effective monopoly that corporate management currently exercises over director nominations. The proposed rule would, instead, give shareholders a more meaningful opportunity to place a shareholder nominee in the boardroom by allowing shareholders, in narrow circumstances, to nominate at least one of the directors of the company they own.
The inclusion of a shareholder nominee on a corporation's board of directors is hardly a radical proposal. A recent Harris poll, as reported in a comment letter dated September 24, 2003, indicates that more than 80% of investors "think there should be a process to allow shareholders to nominate candidates for boards of directors," while 85% agree that "shareholders should be able to use corporate proxy materials to nominate candidates for election to the boards of directors." Giving shareholders a modest opportunity to nominate directors at the companies they own will not only help restore investor confidence, but also help revitalize corporate governance at U.S. publicly traded corporations.
While the proposed rule is clearly an important advance, the proposed triggering mechanisms for shareholder nominations are currently too restrictive and could be improved. As currently proposed, the suggested triggering mechanisms would not allow shareholder nominations to take place in a timely or responsive manner.
The key excessive restriction is the requirement that two years elapse before shareholders can require management to include a shareholder-supported nominee in the company's proxy materials. Two years is an excessive span of time in today's fast moving markets and, in many cases, this delay may be unwise or open to misuse by senior management seeking to stave off increased oversight and reform. To allow a more timely shareholder response to boardroom failures in at least some circumstances, the Commission should adopt an additional triggering mechanism that has been proposed in the comment letter dated December 3, 2003, submitted by15 members of the Harvard Business and Law Schools' ad hoc group on the study of corporate governance. In addition to the triggers now included in the proposed rule, the Harvard group would allow shareholders to include a nomination in a company's proxy materials for the current annual election of directors, if proposed by 10% of the shareholders. This proposal would enable shareholders to obtain corrective action within the span of a year where a significant proportion of shareholders support such action. Allowing shareholders to nominate a director under these circumstances would make the proposed rule more effective and responsive to poor boardroom performance.
The Commission should also adopt the alternative triggering mechanism described in the proposed rule, for which comments are solicited. This triggering mechanism would allow a shareholder nomination in the company's proxy materials if the company failed to implement a shareholder proposal which, during the previous year's annual meeting, had received a majority of the shareholder votes cast during the meeting. Few shareholder proposals receive majority support; those that do usually address egregious management conduct, such as actions by management to award themselves excessive executive compensation or retirement benefits. This triggering mechanism would alter boardroom dynamics by creating a straightforward incentive for directors and management alike to take notice of and respond to shareholder concerns commanding a majority of shareholder votes. Such a requirement would not only help restore investor confidence in U.S. publicly traded corporations, but also establish a new incentive for boardroom attentiveness to shareholder concerns.
In addition to adding these two triggering mechanisms, the proposed rule would be improved if it lowered the proposed threshold for shareholder nominations, which currently requires each nomination to be supported by 5% of the shareholders. This threshold is excessively high when combined with a two-year, two-step process requiring majority shareholder votes. Legislation which I introduced in 1991 (S.1198) and 2002 (S. 2460) to facilitate shareholder nominations to corporate boards would have set the threshold at 3%. In today's market, a 3% threshold means that qualifying shareholders would have to have a collective investment of more than $500 million in an average S&P 500 company. Surely a $500 million investment is significant enough for shareholders to be able to nominate at least one member of their company's board of directors.
Finally, the proposed rule solicits comments on whether the proposed shareholder nomination process should be applied not only to operating companies, but also to investment companies, often known as mutual funds. In light of the unfolding mutual fund scandals, the answer must be yes. Effective corporate governance, including meaningful boardroom oversight, is as important for a mutual fund as for an operating company, particularly in light of their 95 million investors, many of whom are average Americans who want their mutual fund to operate in an above-board, lawful manner with transparent expenses and fees. The fact that U.S. mutual funds also hold corporate stock worth an estimated $3 trillion provides another reason for this Commission to ensure that their corporate governance structures are functioning well, and that mutual fund board members are attentive and responsive to shareholder concerns.
Shareholders have long pressed for a greater role in nominating directors, reasoning that a director nominated by investors would analyze issues with investor concerns in mind, would represent those concerns in boardroom discussions, and would help remind other board members that their paramount duty is to company shareholders, not management. Without proxy access, shareholders can nominate a board candidate only through distribution of a separate ballot to shareholders. As experience has shown, the difficulty and expense of such a distribution has effectively deprived shareholders of a voice in the nomination process, leaving company management in effective control of director nominations. The result has been boards of directors that, in too many cases, have functioned as captives of management rather than protectors of shareholder and investor interests. It is time for the Commission to give shareholders a more meaningful role in the companies they own.
Thank you for this opportunity to comment on the proposed rule.
Carl Levin, Ranking Minority Member
Permanent Subcommittee on Investigations