22nd December 2003
Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Dear Mr Katz:
Re: File No. S7-19-03 - Proposed Rule: Security Holder Director Nominations
We are writing to comment on rule changes proposed by the SEC that would require companies, under certain circumstances, to include in their proxy materials security holder nominees for election as director. Hermes welcomes the SEC's aim to enhance shareholders' ability to participate meaningfully in the process for the nomination and election of directors and supports the proposals as they represent an improvement over the current situation. However, we note that should the proposals be implemented, the system for directors' re-election in the US would still fall far short of international standards. Regardless of the outcome of the current proposals Hermes encourages the SEC to use its authority to continue the reform process to reduce and ultimately eliminate the difference between US and international practice.
Hermes Pensions Management Limited is the fund management arm of the BT Pension Scheme; the UK's largest. Hermes also manages portfolios for Royal Mail Pension Scheme and a number of other major corporate and public pension funds. In total, Hermes has over $60 billion under management, of which around $4.5 billion is invested in the US. Hermes is involved in the governance debate in the US through its membership of the Council of Institutional Investors (CII) and its informal corporate governance alliance with CalPERS. We employ over forty people in our governance activities from a broad spectrum of professional backgrounds, including former corporate board members, giving us a unique view of what shareholders can reasonably expect from corporate boards and vice versa.
We believe the single most beneficial corporate governance measure in any market is the ability of a company's owners (its shareholders) to appoint and remove their agents (the directors) by a simple majority vote. That investors in US companies lack this ability is a conspicuous deficiency of the US governance model. In this context, the current initiative to allow shareholders access can be seen as an important step towards establishing an effective system of corporate accountability and restoring faith in US capital markets.
However, we believe the current proposals do not go far enough and we would like to make the following comments in this regard -
1) Trigger Events
If a significant proportion of a company's shareholders can agree that there should be a change in the composition of its board, then all shareholders should be allowed promptly to consider the proposal. That is, in place of the complicated and lengthy procedure currently suggested by the SEC, the action of 5% of shareholders proposing a director for election should be considered a "trigger event" in itself. This is the system used in the UK and we have found that the costs and time involved in organising a coalition of shareholders is the most effective deterrent against frivolous and disruptive action.
2) Long Term Shareholding
We understand and share the SEC's concern to protect long-term shareholders from opportunist investors who might seek a short-term gain through any new rules. However, we believe that these concerns would not be addressed by placing undue restrictions on shareholders' participation in director elections. In recent years, the stable long-term shareholders of US companies, such as pension funds, have shown an increasing willingness to act as responsible owners. Against this background, it would seem prudent to permit a company's shareholders to elect and, where they deem appropriate, select those who will represent there interests. Moreover, in common with certain other active and responsible investors, Hermes occasionally purchases shares in addition to its long-term indexed holdings to assist it in promoting improvements in long-term shareholder value. In suggesting that such shares are excluded from a quorum for access to the proxy, the commission risks inadvertently damaging the interests of companies and their long-term shareholders.
3) Independence of the Candidate
We would question the SEC's requirement that the nominated candidate be independent of the proposing shareholders. If a candidate has the potential to receive a majority vote to be appointed against management recommendations it would seem unnecessary for the SEC to impose independence criteria. Further, it is a peculiar suggestion to permit the incumbent board to appoint non-independent directors while preventing the company's owners from doing so.
4) Proxy Fights
The SEC proposals offer shareholders the ability to stage individual proxy fights. We understand that the 'proxy fight' in relation to director elections is unique to the US in that shareholders have to achieve two objectives in one resolution. First, shareholders must successfully agree to remove a director from the board and at the same time agree to elect another candidate in place of the departing director. In other markets the two stages are separate in that shareholders may elect an additional director and remove a director in separate resolutions. The effect of the US approach is to inflame an already adversarial situation and also to reduce significantly the chances of a successful shareholder action.
Before taking a final decision to take the current proposals forward we would encourage the SEC to review the systems currently in place in markets outside the US. Hermes has experience of director election processes in a number of countries through its engagement program and the vast majority of these are superior to the current US approach.
In the UK, the system for the appointment and removal of a director is simple and suitable to the task of allowing appropriate shareholder oversight. A company is obliged to include on the proxy card any resolution proposed by shareholders representing 5% or more of the issued share capital of the company. This includes resolutions to remove a director and a simple majority vote is binding. Further, shareholders representing 10% of the outstanding shares may call a general meeting of shareholders at any time and propose any agenda they wish. This includes the ability to appoint or remove directors. Again, a simple majority vote in favour of a resolution is binding. Hermes would encourage the SEC to adopt a similar approach to one that has been proven to work efficiently in the UK, Australia, New Zealand and many continental European markets. Our experience is that where provisions such as this exist they improve the effectiveness of dialogue between shareholders and the board and are seldom, if ever, abused.
If you would like to discuss this response or require further information, please contact our Director of Corporate Governance, Colin Melvin, in the first instance, on +44 20 7680 2251 or at firstname.lastname@example.org.
Corporate Focus Director