Maura A. Smith
SENIOR VICE PRESIDENT, GENERAL COUNSEL & SECRETARY
|400 ATLANTIC STREET|
STAMFORD, CT 06921 USA
T 203 541 8652
F 203 541 8222
December 22, 2003
VIA EMAIL: email@example.com
Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: File No. S7-19-03
Dear Mr. Katz:
The following comments on the Securities and Exchange Commission's Release 34-48626 (October 14, 2003) are submitted on behalf of International Paper Company. Because a proposal of this magnitude raises many issues and questions and could produce unintended consequences affecting a large number of public companies, we appreciate the opportunity to provide you with our views on your proposal.
The SEC should allow time for the new governance reforms initiated by Congress, the SEC and the stock exchanges to work before imposing additional, unproven and costly requirements on companies. These recent reform initiatives, many of which have only been in effect for one or two months, will make boards more independent, accessible and accountable. They require, among other things:
These reforms already offer new avenues for shareholders to make their views known to the board and management. The governance of companies and boards, and specifically the election process, will become much more transparent and responsive to shareholders' concerns, if the new reforms are given time to work. We respectfully suggest that good public policy would permit adequate time to implement these reforms and monitor their effectiveness before imposing additional "fixes".
The proposed rules are contrary to the purpose of recent regulatory and legislative governance initiatives. The new stock exchange and SEC rules require more stringent independence of the full board to be certain they remain accountable to all shareholders. Directors nominated by special interest groups would not carry out this purpose. In addition, audit committee members are subject to financial literacy and financial expertise requirements. The current rules place the onus for conducting due diligence on these criteria on the company, since currently the company controls the nomination of its director candidates. Under the proposed rules, it is unclear how the due diligence regarding candidates in contested elections would be conducted. In addition, shareholder nominees, if successful in a contested election, would be removing current directors (who may be serving on the board's audit committee and, possibly, may be the sole "audit committee financial expert" on that committee) from the board. As a result, there is a serious concern that, if the shareholder candidates did not qualify as financial experts or even as financially literate, the company's audit committee may no longer be able to comply with the listing standards of its exchange.
Comments on Contested Elections and Proxy Disclosure:
A contested election is not the best way to select qualified board members. An independent governance committee of the board is best suited to select qualified directors with the unique mix of skills and experience needed for a particular company. Boards and governance committees are under a fiduciary duty to make decisions in the best interest of the company and all its shareholders. Shareholders, on the other hand, are free to make choices based on which candidate would serve their own self-interest. There is a great deal of concern that shareholder nominees will be beholden to the shareholders that nominated them rather than represent the interests of all shareholders. Groups of politically active shareholders are likely to take advantage of the proposed rules to advance their personal agendas over the economic performance of the company. The resulting board would be divided along special interest lines and would impede the board's proper functioning.
Annual election contests would be distracting and costly. The argument that the proposed rules would act as a deterrent and motivator to directors and management is unfounded. A public company facing an election contest typically devotes a substantial amount of management time and resources to the contest. Election contests are extremely disruptive and a diversion of corporate resources.
Including shareholder nominees in the company's proxy statement risks confusion. Permitting shareholders to run an election contest within the confines of a company's proxy statement is unwarranted and unwise. The current rules appropriately provide for clear identification of the group on whose behalf a solicitation is made. If a company's proxy contains shareholder nominees, then this identification will be much more complex. A company's proxy statement should remain the company's disclosure document and the company's request for proxies. By requiring shareholders who wish to conduct an election to file their own proxy materials, the fundamental purpose of the federal securities laws is furthered by promoting full and clear disclosure and appropriate accountability.
It will be very difficult for companies in contested elections to design a proxy card that is clear and understandable to shareholders. Shareholders do not tend to spend a lot of time checking off boxes on their proxy cards. If a single proxy card has more nominees than there are board seats, voters will need to limit the number of candidates they have checked. If they instead check all of the boxes, they will have over-voted and their vote will be deemed invalid. We have seen firsthand in Florida's presidential election the torrent of voter dissatisfaction that can result when ballots and voting instructions are unclear and a large number of ballots are voided.
The proposal would dissuade qualified individuals from serving as corporate directors. There is already concern that the governance reforms adopted in the last two years has caused directors to fear liability from an increasing number of lawsuits. This also deters otherwise qualified candidates from wanting to serve as corporate directors. Increasing the frequency of election contests, where directors are forced to campaign for their board seats, and the election of dissident directors will only exacerbate these problems and result in an even smaller pool of qualified candidates willing to serve on public company boards.
* * *
The Release also posed specific questions relating to the proposed election contest rules, some of which we would like to respond to in the remainder of this letter.
The proposed 1% threshold and one year holding period for shareholder access proposals is too low and too short to protect against abuses from short-term owners with special interest agendas. Because of the large percentage of institutional ownership in many public companies, the 1% shareholder group would not be difficult for special interest constituencies, such as pension funds and vulture funds, to form to propose a shareholder access proposal. Ownership for one year does not signify a long-term commitment to the long-term performance of the company. These special interest groups would be gaining significant leverage from such a low threshold and short holding period to push for concessions from a company that would not benefit the company and its shareholders as a whole. While a higher threshold and longer holding period might reduce this risk, they would not eliminate it since many of these special interest groups, which often pursue self-interested agendas, are long-term holders of substantial amounts of stock.
In the very realistic case that a 1% group submits a shareholder access proposal, proxy advisory companies (such as ISS), which control a large portion of the vote in many companies, are likely to recommend a vote in favor of the access proposal making it highly likely that it would receive a majority vote, thereby triggering shareholder access the following year. One of the unintended consequences from the proposal will be to place an unprecedented amount of power and influence in the hands of proxy advisory companies.
As a result, frequent contested elections could become the norm. Even companies that are performing well could face annual election contests since there is nothing that ties this trigger to the unresponsiveness of a company.
Eligibility for the shareholder nomination procedure should be above 5% and require that the securities be held for a long-term period beyond the election of directors. While we strongly believe that the shareholder nomination procedure should not be adopted at all, if it is, there needs to be a higher ownership percentage threshold to prevent the worst potential abuses by short-term shareholders. Our comments above to the 1% threshold apply equally here. Concentrated institutional stock ownership and increased activism among shareholder groups makes the 5% threshold relatively easy to meet.
In addition, a requirement that the shares be owned well beyond an election is appropriate. It would be difficult for a shareholder or group of shareholders nominating director candidate(s) to argue that they have a compelling interest in the nomination process if they sell their shares before or shortly after the election. We suggest that the nominating shareholders, if successful in electing their candidate, be required to own the threshold amount of shares for the full term for which their candidate is elected.
Implementing a third trigger tied to a company's non-implementation of a shareholder proposal that receives a majority vote would permit the shareholder nomination procedure to be used as retribution for a board's good faith determination not to implement a shareholder proposal that it deems not to be in the best interest of the company. This is inappropriate and could have disastrous consequences. Including this triggering event would confer increased power on Rule 14a-8 proponents and encourage an increased number of 14a-8 resolutions. It should remain the board's responsibility to determine what the board believes in good faith to be the company's best interests as opposed to complying automatically with the results of the shareholder vote. If such a trigger is adopted, however, directors will feel enormous pressure to enact the shareholder resolution, regardless of their independent determination as to the company's best interests.
In addition, there would likely be disagreements between companies and shareholder proponents over whether a proposal was implemented. The Staff would need to devote significant resources to settling disputes as to whether a proposal was sufficiently implemented.
We urge the SEC not to blur the important distinctions between the issues surrounding majority vote proposals and issues involving control of the corporation. This trigger would suggest that voting results on shareholder proposals are a good measure for shareholder dissatisfaction with a company or its board of directors. This is incorrect. Shareholder proposals are voted in large part in a mechanical and standardized way, without much analysis or thought to long-term business performance. Proxy departments, where shares are voted at institutional investors, are generally completely separate from the investment managers, who consider company performance and management quality in making their investment decisions.
Effective Date of Proposal:
Shareholder action or voting results during the 2004 proxy season should not qualify as a trigger for shareholder access under the proposed rule. Companies should have a reasonable amount of time to anticipate and prepare for actions and events that may ultimately qualify as a triggering event for shareholder access under the proposed rule. There will be tremendous shareholder and company confusion with disclosures in 2004 proxy statements that attempt to provide information about a shareholder access process that has not been finalized.
Legal Authority for Proposed Rules:
The comments we have provided do not address the very fundamental issue raised in the Release of whether the SEC has legal authority under the Securities Exchange Act to adopt these rules. We believe this issue has been addressed by several comment letters, including the American Bar Association and the Business Roundtable.
We would be happy to discuss our comments further with the Commission. Any questions about this letter should be directed to Maura A. Smith, General Counsel and Corporate Secretary (203) 541-8526.
Maura A. Smith
General Counsel and Corporate Secretary