January 5, 2004
Mr. Jonathan G. Katz
Re: Proposed Rule: Security Holder Director Nominations File No. S7-19-03
Dear Mr. Katz:
We appreciate the opportunity to respond to Release Nos. 34-48626, IC-26206 (the "Proposing Release") regarding a proposed rule to require companies, under certain circumstances, to include in their proxy materials shareholder nominees for election as director.
We urge the Securities and Exchange Commission (the "SEC") not to adopt the proposed rule and instead to allow time for the major corporate governance initiatives so recently adopted by Congress, the SEC, the New York Stock Exchange, NASDAQ and individual companies to be fully implemented and their effectiveness understood before embarking in the direction of the Proposing Release.
We believe that the direct access proposal will not have the limited effect of reaching companies unresponsive to shareholders but will instead affect many companies on a recurring basis and become an unwarranted adjunct to shareholder proposals submitted under Rule 14a-8.
To strengthen corporate governance, Congress passed the Sarbanes-Oxley Act of 2002. The SEC has adopted a range of new regulations, including the final rule on Disclosure Regarding Nomination Committee Functions and Communications Between Security Holders and Boards of Directors, the NYSE and NASDAQ have thoroughly revised their listing standards and the boards of a great many companies, including JPMorgan Chase, have reviewed and revised their corporate governance practices with the objective of meeting prescribed requirements and adopting other thoughtful and useful practices.
The Proposing Release would introduce a new element by giving shareholders the right, under certain circumstances, to include one or more director nominees in the company's prosy materials and on the company's proxy card. The stated objective is to enhance the ability to participate meaningfully in the proxy process for the nomination and election of directors by creating a mechanism for nominees to be included in company proxy materials where there are indications that shareholders need such access to further an effective proxy process. The Proposing Release states that the mechanism would apply in those instances where evidence suggests that the company has been unresponsive to shareholder concerns as they relate to the proxy process.
We appreciate the SEC's objective in seeking to reach unresponsive companies and the difficulty of balancing competing interests in doing so, but we respectfully submit that the proposed rule does not meet the stated objective.
The Proposing Release contains, in summary, two proposed triggers to actuate a shareholder's right for direct access -
and requests comment on a third potential trigger -
With respect to a trigger based on a direct access proposal, there is no relationship between such a proposal and whether the company has been unresponsive to shareholder concerns as they relate to the proxy process. If shareholders holding the necessary 1% submit such a proposal, it is unlikely that the resulting vote will depend on the company's responsiveness. Instead, we expect institutional shareholders will develop set policies for voting on such proposals, or will adopt the recommendations of proxy voting advisors such as Institutional Shareholder Services ("ISS"), as they now do on governance proposals such as the separation of Chairman and CEO. Further, when presented with the possibility of a latent power that they would have the discretion to use or not at such future time as a shareholder nominee for director might be presented, the arguments will be strong to support the proposal. The SEC's rules requiring mutual funds to disclose their voting policies may also influence the policies that are adopted.
While we expect a tendency of institutional shareholders to vote for direct access, we are concerned that retail investors will be disenfranchised in this matter. We believe that most retail investors expect that their shares will be voted with the company, whether or not they provide voting instructions to their broker. Under existing NYSE rules, such retail investors not providing voting instructions would not have votes cast on a direct access proposal and it is likely that in any subsequent contested election arising from the direct access proposal that the NYSE would not permit brokers to vote customers' shares without instructions.
With respect to a trigger based on shares withheld for a director, a significant share withheld vote is indicative of an issue, but it need not be unresponsiveness to shareholder concerns as they relate to the proxy process. "Vote no" recommendations have a variety of objectives, including getting management's attention to specific policy issues favored by the proponent of the campaign. If the direct access proposal is adopted, more such campaigns can be expected for the added pressure they will bring. This linking has been acknowledged by a number of advocates of the direct access proposal. In some instances, a "vote no" recommendation may be caused by narrow concerns rather than broad dissatisfaction with the company's responsiveness or the company's overall corporate governance. For example, ISS has recommended that shareholders withhold their vote from directors who serve on a board committee that should be composed only of independent directors where the director met otherwise applicable independence standards but did not meet ISS's particular standards. In making this recommendation, ISS stated that they had no objection to the director's service on the board, they only objected to service on the particular committee. In such a circumstance, the company should have the opportunity to take responsive action before triggering direct access. We therefore recommend that if a withhold vote trigger is adopted, that the trigger not become effective unless any applicable thresholds were reached in two successive years.
With respect to a trigger based on failure to implement a proposal that receives more than 50% of the votes cast, there is again no necessary relationship between such action and a company's responsiveness to the proxy process. For example, a company may have exemplary corporate governance practices and a staggered board. Proposals to eliminate staggered boards often receive high votes in favor of the proposal, yet a board should be free to determine in the exercise of its fiduciary duty that such a structure is appropriate. Introduction of a trigger based on a failure to implement such a proposal could, however, affect a board's determination on how to react to the proposal because of the significant cost that would be associated with any subsequent proxy contest arising from a right of direct access. Further, if such a trigger were adopted, there would be a need for an interpretive role by the SEC as to what actions constituted implementation. For example, a company might reach agreement with a shareholder proponent as to a course of action slightly different than the literal terms of a proposal that had received more than 50% of the votes cast. If another shareholder challenged that action, the SEC would need to provide a dispute resolution process.
In contrast to the direct access proposal, significant steps have been taken by the SEC to enhance the process of communications between shareholders and directors and to provide additional information to shareholders on the director nomination process. Such steps foster positive dialogue.
When dialogue fails, and shareholders are convinced of the need for change, the regulatory structure already provides a mechanism to challenge incumbents through a formal proxy contest. Such a process is not undertaken lightly but offers clarity of purpose and procedure and avoids the confusion that would be likely in the proposed rule with its omnibus proxy card. To the extent that the proposed procedure might be more likely to be used by shareholder activists at larger companies, the cost of a formal proxy solicitation would be modest relative to the value of a 5% shareholding (the proposed required holding to submit a nominee) and is outweighed by the clarity of a separate solicitation made under well understood rules. The Proposing Release notes that this was essentially the SEC's determination when it considered this issue in 1992:
We believe the SEC's determination in 1992 reflected an appropriate balancing of issues.
A number of commentators on the Proposing Release have cited non-U.S. jurisdictions where shareholders with some specified percentage of shares have the right to put a director nominee in the company's proxy materials. If that is what shareholders truly wish, it should be sought through changes in applicable state corporate law.
In contrast to a legislatively established right of access, which has the benefit of uniformity and relative simplicity, the regulatory structure contained in the Proposing Release would be highly situation specific, complex and likely to encourage disputes. For that reason, as well as the desirability of experience with the many other corporate governance reforms that have been implemented, we again urge the SEC to defer action on this proposal.
In addition to the comments noted here, the Business Roundtable has identified a number of modifications that would be appropriate if the SEC were to proceed to a final rule. We endorse those comments.
We appreciate the opportunity to comment and would be pleased to discuss our views with you.
cc: Hon. William H. Donaldson, Chairman, Securities and Exchange Commission