December 4, 2003
Mr. Jonathan G. Katz
Via Electronic Mail
Re: Comments on File No. S7-19-03, "Security Holder Director Nominations"
Dear Mr. Katz:
This letter responds to your request for comment on the proposed rules to increase proxy access by shareholders to nominate directors through company proxy statements. We are partners in Jones Day, one of the world's largest law firms with about 2,200 lawyers in 30 cities around the world. Jones Day has a large, diverse base of corporate and financial clients, including over half of the so-called Fortune 500 companies in the United States. As such, while the views expressed below are solely those of the signatories and not Jones Day or any of its clients, we believe that we have a substantial basis for them.
In announcing the proposed shareholder nomination rules, Chairman Donaldson said they represented "a significant step towards fixing the current proxy rules." The Chairman's statement of course assumes that the existing rules are broken. It also implies that more actions are expected in this area. We respectfully submit that the current system works, albeit, like any other participatory governance system, not always perfectly in the eyes of every constituent. In all events, to us it is clear that the wiser course is to postpone making what is clearly a radical corporate governance change until we can better assess the ultimate impact of the Sarbanes-Oxley Act and the new stock exchange and NASDAQ rules.
Existing Rules are Effective
The proposed rules presume that shareholders do not currently have the ability to influence the process of board composition. This presumption is wrong as proxy fights are possible and tender offers happen often. Shareholders may propose Rule 14a-8 resolutions and may recommend nominees to a company's nominating committee. Additionally, boards of directors are receptive to comments and requests of shareholders, which are frequently communicated to them by shareholders both publicly and privately. This informal process of shareholder suasion has resulted in numerous top management changes by underperforming companies, and the stock markets have become so demanding of immediate performance that board-induced changes in top management of major U.S. companies are a more or less daily occurrence. Thus, in our view, it is not appropriate to start from the blanket assumption that shareholders do not currently have the ability to nominate directors or that public company boards are not responsive to shareholder interests.
Equally important, we believe that the better course is to assess the effect of the Sarbanes-Oxley-related rules requiring independent nominating committees, reports on the committee process, director nominations, committee charters and access to independent advisors before taking what must be acknowledged to be a major change in corporate governance. While many companies had implemented these types of procedures well before Sarbanes-Oxley, others had not and in all events there are new boardroom dynamics that are likely to mitigate if not eliminate many if not substantially all of the issues the proposed rules purportedly remedy.
Negative Consequences of Proposed Rules
The potential damaging consequences to companies, directors and shareholders outweigh any benefits to the shareholders that would be eligible to use the proposed process. As indicated above, boards are now, we believe, all too eager to push management out the door for short-term underperformance. Directors nominated by institutional shareholders would likely oppose any "antitakeover measure"--the content of almost all shareholder proposals--because institutional investors will sell their shares for above-market value regardless of intrinsic value. Institutional investors, after all, are in the business of investing and will just invest elsewhere; however, other shareholders will not sell and they do not have to sell. Boards have a legal duty to oppose inadequate takeover bids, and raiders do not bid at times when it would be most beneficial to target shareholders. As such, there are numerous examples of situations where shareholders fare better by having their boards fend off above-market bids. One of the consequences of the proposed rules would be, we believe, fire sales of companies at inopportune times, which would not be in the best interests of the U.S. economy or the capital markets long term.
Since the enactment of the Sarbanes-Oxley Act, it has become increasingly difficult for companies to attract qualified directors and the proposed rules would likely make it more challenging. Company-nominated directors will not want to serve if boards are always adversarial and if their companies will be subject to election contests every year.
Directors are obligated to consider many factors in selecting nominees and their decisions must be made in the best interest of the corporations they serve. Existing directors will not be able to participate in the selection of directors nominated by shareholders through the proxy process and, unlike boards of directors, shareholders have no duty to other shareholders in selecting their nominees. Such nominees will most likely be looking out only for the interests of the nominating shareholders and not all of the shareholders of the company.
Election contests will become frequent, if not annual, events. The disruption of the day-to-day operations of companies and associated expenses that inevitably result from election contests will distract management and the boards of directors during a time when their focus should be on the implementation of the new rules promulgated under Sarbanes-Oxley and the stock exchanges.
The proposed rules will only be available if state law provides shareholders with the right to make director nominations. Since corporate law is ultimately decided by the state, state legislatures may respond to these rules by amending their laws to prohibit shareholder nominations or otherwise establish obstacles to the shareholder nomination process. The result of such state actions would reduce the existing rights of shareholders to nominate directors and conceivably leave the shareholders with fewer rights than they had before the proposed rules were enacted.
The sweeping reforms enacted by the Securities and Exchange Commission and the stock exchanges are having a real effect in the boardrooms of corporations, even as rules continue to be implemented. While the ultimate merits of the recent reforms can be debated, the immediate effects are profound. In these circumstances, imposing yet another set of changes is premature and, we believe, ill-advised.
If you have any questions regarding our comments, please do not hesitate to contact any of us at the phone numbers listed below.
Very truly yours,