Cascade Investment, LLC
2365 CARILLON POINT
KIRKLAND, WASHINGTON 98033
T 425.889.7900 F 425.893.8758
July 3, 2003
The Honorable Jonathan G. Katz
United States Securities and
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: NYSE Proposed Rule Change relating to corporate governance, SR-NYSE-2003-33; NASD Proposed Amendments to NASD Rules 4200 and 4350 regarding board independence and independent committees, SR-NASD-2002-141.
Dear Mr. Katz:
Cascade Investment, LLC ("Cascade") submits this comment on both pending proposed amendments to the corporate governance listing requirements regarding board independence as filed by the NYSE and NASD.
Under both proposed amendments, "controlled" companies are exempt from certain of the key corporate governance reforms, namely independent director control of the board and key board committees. A controlled company is defined as a company in which an individual, group or another company, holds more than 50% of the voting power. Cascade believes that control of a majority of the voting power is not the appropriate standard for determining when to exempt a company from the board independence standards. It is critical that the proposed rules recognize that exemption from the independence requirement should apply only where the control measures both voting and economic control. Absent this modification, because the rule proposals cause unfair discrimination among issuers and stifle capital formation, they are inconsistent with the substantive Commission oversight standards for self-regulatory organizations in the Securities Exchange Act. In addition, the broad rule-making authority granted to the Commission by provisions of Sarbanes-Oxley Act of 2002 (the "Act") provides the Commission with additional power to reject or modify unwarranted rules by self-regulatory organizations as necessary in the public interest.
As explained in the NASD proposal, the purpose of this controlled company exception is to recognize majority shareholders, including parent companies, have the right to select directors and control certain key decisions, such as executive officer compensation by virtue of their ownership rights. The unstated premise for this justification is that voting control and economic control ordinarily coincide. Where economic control and voting control do not coincide, however, the justification for this exception does not withstand scrutiny.
Corporations with two-tier classes of voting stock, where the minority economic interests exercise voting control because of supermajority voting rights, are peculiarly subject to the potential for abuse. For example, Adelphia Communications Corp. had a two-tier class of voting stock that enabled the Rigas' family interests to exercise voting control to elect eight of nine corporate directors, while holding only 12.5 percent of the equity. This corporate governance structure has led in that case to spectacular abuses of the duty of loyalty. As the Commission summarized at the time of its civil law enforcement action against Adelphia and the members of the Rigas family:
Since at least 1998, Adelphia, through the Rigas Family and Brown, made fraudulent misrepresentations and omissions of material fact to conceal extensive self-dealing by the Rigas Family. Such self-dealing included the use of Adelphia funds to finance undisclosed open market stock purchases by the Rigas Family, purchase timber rights to land in Pennsylvania, construct a golf course for $12.8 million, pay off personal margin loans and other Rigas Family debts, and purchase luxury condominiums in Colorado, Mexico, and New York City for the Rigas Family.
SEC Litigation Release No. 17627 / July 24, 2002.
The corporate governance reforms requiring listed companies to have independent boards represent an important and long necessary reform of corporate governance. It is an important structural remedy to the enormous costs imposed on investors as a result of the repeated instances of self-dealing abuses at the center of such other recently highly publicized corporate failures such as Enron, WorldCom, Global Crossing and HealthSouth. The resultant costs to the capital markets of the United States are sufficient to make the need for reform a matter of paramount national public interest. It is clear from these repeated corporate failures that existing disclosure obligations and corporate governance structures did not function effectively to prevent these types of self-dealing abuses.
To the extent that the Commission deems these proposed corporate board independence reforms "consistent" with the provisions of the Securities Exchange Act, as amended by the Act, then the proposed exclusion from this independence requirement proposed by both self-regulatory organizations based solely on considerations of voting control is necessarily inconsistent with those statutory provisions. As shown by the Adelphia example, voting control does not always coincide with economic control. Shareholders in such entities are also entitled to the additional protection against self-dealing and managerial abuse promised by these structural reforms. The exception as drafted by the self-regulatory organizations unreasonably discriminates among issuers (contrary to Sections 6(b)(5) and 15A(b)(6) of the 1934 Act, 15 U.S.C. §78f(b)(5) and 78o-3(b)(6)), and stifles capital formation (contrary to Section 3(f) of the 1934 Act, 15 U.S.C. 78c(f)). Thus the proposed exception as now defined is not "consistent" with the requirements of the 1934 Act as set forth in Section 19(b)(2), 15 U.S.C. §78s(b)(2). Further, under Section 3(a) of the Act, 15 U.S.C. §7202(a), Congress gave the Commission substantial additional rule making and oversight powers to implement alternative corporate governance reforms than those imposed by self-regulatory organizations.
It is not enough to suggest that investors have a choice not to invest in such entities where the minority economic interests hold voting control. The same suggestion could be made about the proposed structural independence reforms for all companies. Cascade accepts that the persons and groups who have both the economic and voting control need not be required to abide by the independence reforms because in such cases the persons with the majority economic interests can adequately guard against the risk of self-dealing. A different question, however, is presented by cases where the economic and voting interests do not coincide; then there is a greater risk of self-dealing abuse by the minority at the expense of the majority. The question for the Commission is whether these entities that choose not to adopt independence reforms should have access to the national securities markets administered by the NYSE and NASD. Where a traditional family-run business no longer owns the majority economic interest, that company must be willing to play by the same rules as other listed non-family-run companies.
Our research has identified a significant number of other companies listed on the NYSE or NASDAQ where the minority economic interests hold voting power. But it is not impossible for such companies to implement internal corporate governance reform. According to their most recent proxy statements, two such companies, the New York Times Co. and the Washington Post Co., have already adopted corporate governance reforms that would meet the proposed NYSE listing requirements notwithstanding the retention of voting control by the traditional family interests.
Nor do we believe it will be difficult to craft a definition of economic control for purposes of a narrowing the control exception. In Cascade's experience the mechanism of control adopted by most companies is similar to the supermajority voting control methodology adopted by Adelphia. Economic control can readily be determined for each company.
Cascade appreciates the opportunity to comment on these important rule proposals. I can be reached at 425-893-6360 if you would like additional information.
Mark R. Beatty