February 25, 2004
For Roundtable Discussion on the Proposed Security Holder Director Nominations Rules
On March 10, 2004, the Securities and Exchange Commission will host a roundtable to discuss the Commission's rule proposals with regard to security holder director nominations. The roundtable will start at 9:00 a.m. and conclude at 5:15 p.m., with a break for lunch. This paper contains the agenda of roundtable issues.
The Commission has invited representatives of public companies and investor groups, as well as members of the legal and academic communities, to participate in the roundtable. Following the roundtable, the Commission will accept written public comment until March 31, 2004 concerning the issues addressed in the roundtable discussion and otherwise regarding the proposed rule amendments.
On October 14, 2003, the Commission proposed rule amendments regarding security holder director nominations.1 As more fully described in the proposing release, the proposals would, under certain circumstances, require companies to include in their proxy materials disclosure regarding security holder nominees for election as director. The proposed rules would not provide security holders with the right to nominate directors. The proposed rules would operate where nominations are not prohibited by state law and would create a mechanism for disclosure regarding nominees of long-term security holders, or groups of long-term security holders, with significant holdings to be included in company proxy materials. The proposed rules are intended to be triggered where evidence suggests that the company has been unresponsive to security holder concerns as they relate to the proxy process. The proposed rules would enable security holders to engage in limited solicitations to form nominating security holder groups and engage in solicitations in support of their nominees without disseminating a proxy statement. The proposed rules also would establish the filing requirements under the Securities Exchange Act of 1934 for nominating security holders.
A. Are there flaws in the proxy process with respect to the nomination and election of directors? If so, do those flaws affect investors' ability to participate in the process?
The rule proposal of October 14, 2003 resulted from a directive by the Commission to the Division of Corporation Finance to review and formulate possible changes to the proxy rules regarding procedures for the election of corporate directors.2 On May 1, 2003, the Commission solicited public views on this review.3 The majority of commenters supported the Commission's decision to direct this review and expressed frustration over the level of responsiveness of boards of directors to security holder concerns and a growing concern that security holders lack sufficient input into decisions made by the boards of directors of the companies in which they invest.4 Two particular areas of concern were the nomination of candidates for election as directors and the ability of security holders to communicate effectively with members of boards of directors.
In particular, commenters urged the Commission to adopt rules that would enhance security holders' ability to participate in the nomination process, and their ability to exercise their rights and responsibilities as owners of their companies.5 Most of these commenters indicated that they consider the current process for the nomination and election of directors to be an ineffective means of providing security holders with the rights of company ownership. Security holder groups that supported proxy reform stated that, aside from providing security holders with a more effective ability to participate in the election process to nominate director candidates who would represent investors' best interests, such reform also would have the effect of making all corporate directors more responsive to security holder concerns.6 An explicit or implicit reason behind the desire for reform in several comment letters was that reform was particularly necessary in those cases where the proxy process and security holder communications were ineffective.
Currently, security holders who wish to effect a change in the composition of a board of directors may conduct an election contest, nominate a candidate at an annual meeting, or recommend candidates to a company's nominating committee or group of directors fulfilling a similar role. Election contests can require substantial expenditure by the security holder, who must prepare and disseminate proxy materials that comply with the Commission's proxy rules. Security holders may instead nominate directors at the annual meeting, subject to compliance with applicable state law requirements, as well as any requirements contained in the company's governing instruments; however, most security holders vote through the grant of a proxy before the meeting instead of voting in person. Accordingly, a nominee presented at an annual meeting has little chance of receiving sufficient support. Finally, although security holders generally may recommend candidates to a company's nominating committee or group of directors fulfilling this role, security holders have indicated that this is not effective, as companies rarely nominate candidates recommended by security holders.
1. Do security holders have sufficient means to express concerns to boards of directors? Are boards of directors responsive to security holder concerns?
2. Does Exchange Act Rule 14a-8 provide security holders a sufficient opportunity to express their views? Are companies responsive to Exchange Act Rule 14a-8 proposals that receive majority votes? If so, is that sufficient? If not, why not?
3. Are boards of directors self-perpetuating? If so, is this a problem?
4. Do security holders have adequate means to influence who is nominated and elected to the boards of directors of the companies in which they invest? Today, what is the proper allocation of responsibility between security holders and boards with respect to the nomination of directors?
5. Do security holders recommend director nominees (other than self-nominations) to company nominating committees? Are there examples of these situations? If so, what was the result?
B. If there are flaws in the proxy process, is the approach of the proposed rule - disclosure of security holder nominees in company proxy materials in certain circumstances - an appropriate way to address them? Are there other approaches, or modifications of the proposed rule, that would be preferable?
The proposed rule would provide for required disclosure of security holder nominees in company proxy materials in certain circumstances, and would make corresponding changes to the rules regarding proxy solicitations, filing requirements for 5% beneficial owners and certain other matters. The Division's Staff Report relating to the proxy rules governing the election of directors, delivered to the Commission on July 15, 2003, discussed a number of possible approaches to improving the proxy process.7 Further, commenters have suggested alternatives during the comment process for the proposed rule.
In addition, on November 4, 2003, the New York Stock Exchange and the Nasdaq Stock Market adopted revised listing standards that, among other requirements, require listed companies to have independent nominating committees.8 Also, on November 24, 2003, the Commission adopted additional disclosure requirements regarding the operation of board nominating committees and new disclosure requirements concerning the means, if any, by which security holders may communicate with directors.9
A substantial majority of the commenters who opposed the rules in comments filed with the Commission during the October-December 2003 comment period recommended that the Commission not adopt or defer implementing the proposed rules until the Commission has had time to assess the impact of the Sarbanes-Oxley Act of 2002, the markets' amendments to their listing standards, and the Commission's own recent governance reforms.10 These commenters also expressed concern over purported detrimental effects that the proposed rules would have on companies and their boards.11
1. Is it appropriate for the Commission to adopt a rule taking the approach of the proposal in light of the recent adoption of the NYSE and Nasdaq corporate governance listing standards and the Commission's rules regarding disclosure in respect of the nominating process and security holder communications with directors?
2. Should the Commission withdraw or defer action on the proposed rule in favor of consideration by the national securities exchanges and national securities association of additional listing standards that would improve the proxy process regarding nomination and election of directors? If so, what types of additional standards should the exchanges and association consider?
3. Should the Commission withdraw or defer action on the proposed rule in favor of consideration by one or more states of amendments to the state corporation laws that would improve the proxy process regarding nomination and election of directors? If so, what amendments should the states consider?
4. Should the Commission consider a different approach or approaches from that taken in the proposed rule? If so, which approach or approaches?
C. Does the proposal limit the application of proposed Rule 14a-11 to the appropriate companies and properly address the potential costs to companies? Does the proposal provide security holders with appropriate opportunities to exercise their rights in the proxy process?
The proposed procedure would apply to all companies that are subject to the Exchange Act proxy rules, including investment companies registered under Section 8 of the Investment Company Act. The proposed requirements would not apply where security holders were seeking control of a board of directors and would apply only in those instances where security holders are not prohibited by applicable state law from nominating a candidate for election as a director.
In addition, the proposed requirements would apply only to those companies at which one of two triggering events has occurred and would remain in effect for two years after the occurrence of either or both events, each of which would provide an indication of security holder dissatisfaction with a company's proxy process. These events would be:
- the receipt of withhold votes from more than 35% of the votes cast with regard to one or more directors; or
- a security holder proposal submitted by a security holder, or group of security holders, that has held more than 1% of the company's voting securities for one year, which requests that the company become subject to the procedure and which receives support from more than 50% of the votes cast on that proposal.
Although not included in the Commission's proposal, the Commission also sought comment on and is considering the following alternatives:
- limiting the procedure to only those larger companies that are defined as "accelerated filers" for purposes of the deadlines for filing periodic reports under the Exchange Act; and
- including as a triggering event a company's non-implementation of a security holder proposal that was submitted under Exchange Act Rule 14a-8 with regard to any topic by a security holder who has held more than 1% of the company's voting securities for one year and received more than 50% of the votes cast at an annual meeting with regard to that proposal.
A company that is subject to the proposed procedure would be required to include in its proxy materials the name of (and specified information regarding) a security holder nominee for election as director only where the security holder or group of security holders making the nomination:
- has beneficially owned more than 5% of the company's securities for two years, with an intent to continue that ownership through the annual meeting at which the related election of directors will occur; and
- is eligible to report its ownership of company securities on Exchange Act Schedule 13G (rather than Exchange Act Schedule 13D), and has filed that Schedule, thus evidencing a lack of intent to control the company.
The person nominated also must meet specified criteria, including that:
- the nominee's candidacy or, if elected, board membership is consistent with applicable law and regulation;
- the nominee satisfies the applicable objective independence standards of a national securities exchange or a national securities association;
- the nominee does not have specified relationships with the nominating security holder or any member of the nominating security holder group; and
- the nominating security holder or any member of a nominating security holder group may have no direct or indirect agreement with the company regarding the nomination of the nominee.
The number of nominees a company would be required to include in its proxy materials would vary, depending on the size of its board of directors, as follows:
- boards with 8 or fewer directors would be required to include 1 security holder nominee;
- boards with 9-19 directors would be required to include up to 2 nominees;
- boards with 20 or more directors would be required to include up to 3 nominees; and
- where a company receives more security holder nominees than it is required to include in its proxy materials, the nominees to be included would be those of the largest nominating security holder or group.
1. What would be the costs (both the types of costs and the amounts) to companies if the Commission adopted proxy rules requiring companies to include security holder nominees in company proxy materials? Which of those costs would be necessitated to comply with the procedure? Which of those costs would be at the company's option - e.g., if the company chose to contest actively a security holder vote that would represent a triggering event or the election of a security holder nominee?
2. What are the likely or potential effects and costs of security holders indicating they intend to attempt to trigger the proposed rule? What are the likely or potential effects and costs of security holders indicating they intend to submit a nominee once the proposed rule is triggered? Would the proposal provide a small minority of security holders with an improper level of influence?
3. As proposed, the security holder nomination procedure would apply to all companies subject to the proxy rules. Would this broad application have a disproportionate impact on smaller operating companies? Are there modifications that would accommodate the needs of smaller entities while accomplishing the goals of the proposal? Would limiting the proposed rule to accelerated filers address the concerns that might exist for smaller entities?
4. Should companies be able to take specified steps or actions that would prevent application of the proposed nomination procedure where such procedure would otherwise apply? If so, which steps or actions?
5. As proposed, the procedure would require a triggering event for security holders to be able to use the security holder nomination procedure. Is the requirement of a triggering event appropriate? If so, would the proposed triggering events cause the proposed rule to apply to the appropriate companies, i.e., those where the proxy process has been ineffective?
6. As proposed, the nomination procedure could be triggered by withhold votes for one or more directors of more than 35% of the votes cast. Are security holders likely to participate in "withhold the vote" campaigns as a means to gain access to the proxy, even when they are not dissatisfied with the performance of the targeted director or directors? Does 35% of the votes cast appropriately evidence security holder dissatisfaction with the proxy process? If not, what would be a more appropriate percentage and why? Should the standards be based on votes withheld as a percentage of outstanding securities that are eligible to vote for directors?
7. Is dissatisfaction with one director (as indicated by a substantial percentage of withhold votes) appropriate evidence of dissatisfaction with the proxy process?
8. Should the security holder proposal nomination procedure triggering event apply only where a more than 1% holder or group that has held the subject securities for one year submits the proposal? If not, what would be a more appropriate threshold, if any?
9. As proposed, a security holder proposal could result in a nomination procedure
triggering event if it receives more than 50% of the votes cast with regard to that proposal. Is this the proper standard? Should the standard be based on votes cast for the proposal as a percentage of the outstanding securities that are eligible to vote on the proposal? Are investors likely to vote in favor of such a proposal even in the absence of dissatisfaction with the proxy process?
10. What will be the impact of proxy voting guidelines and proxy advisors such as Institutional Shareholder Services on the proposed triggering event thresholds? Are there steps that the Commission should consider in connection with the proposed rule that would address that impact? Will proxy guidelines and advisors adequately differentiate between companies in evaluating triggering events or elections involving security holder nominees? Is differentiation necessary in order for the proposed rules to apply to the appropriate companies?
11. Are the thresholds in the proposed procedure appropriate? If not, should there be any limitations regarding which security holder nominees for director would be required to be disclosed in the company proxy materials under the proposed procedure?
12. Is it appropriate to include a restriction on security holder eligibility that is based on percentage of securities owned? If so, is the 5% standard appropriate?
13. Should there be a restriction on security holder eligibility that is based on the length of time securities have been held? If so, is two years appropriate?
14. Should nominating security holders be required to express their intent to continue to hold their securities? Would this discourage professional money managers or other institutions from participating?
15. Should there be requirements regarding nominee independence from the company? Should the fact that the nominee is being nominated by a security holder or security holder group, combined with the absence of any direct or indirect agreement with the company regarding that nomination, be a sufficient independence requirement? Should the company's nominating committee have a role in determining independence of security holder nominees or otherwise vetting nominees? Should nominees and nominating security holders or groups be required to provide additional information at the request of the company or nominating committees? If so, what types of information?
16. Should nominees have to qualify under objective requirements imposed by the company on its board members, such as subject-matter expertise?
17. Should there be requirements regarding nominee independence from the nominating security holder or nominating security holder group? If so, are the proposed limitations appropriate? Is it appropriate to require nominee independence from the nominating security holder or nominating security holder group when company nominees are not subject to such a requirement? Should relationships between nominees and the nominating security holder or security holder group be a disclosure requirement rather than a condition for application of the rule?
18. Is it appropriate to include a limitation on the number of security holder nominees that must be included in a company's proxy statement? If not, how would the proposed rules be consistent with our intention not to allow the proposed procedure to become a vehicle for changes in control? If there should be a limitation, is the proposed limitation appropriate? Would the limited percentage of non-company nominees, if elected, disrupt a board? In what manner? What would be companies' responses to the inclusion of security holder nominees on the board?
19. We have proposed a limitation that permits the security holder or security holder group with the largest beneficial ownership to include its nominee(s) where there is more than one eligible nominating security holder or nominating security holder group. Is this proposed procedure appropriate? If not, should there be different criteria for selecting the security holder nominees that must be disclosed in the company proxy materials?
20. Does requiring Exchange Act Schedule 13G eligibility impose too great a restriction on the types or activities a nominating security holder could undertake?
21. The proposed rules would require an eligible nominating security holder or security holder group desiring access to a company's proxy first to submit a triggering security holder proposal and then to wait a year before actually nominating a director. Is this process too long? Should the rules contain an additional triggering event, with higher threshold requirements, that would permit immediate access to the company's proxy?
D. What are the consequences of the rule for retail and other investors?
One of the two proposed triggers - the "opt-in" proposal trigger - would require that a security holder owning more than 1% of the outstanding shares have submitted the security holder proposal requesting that the company become subject to the security holder nomination procedure. In order to meet this 1% threshold, individual investors would be able to aggregate their securities to meet the required level of ownership to submit a triggering proposal. Similarly, to nominate a director under the proposed procedure, the nominating security holder or security holder group would have to hold more than 5% of the company's securities and have filed an ownership report on Exchange Act 13G. Individual investors would be able to aggregate their shares to meet this threshold as well.
1. Is it appropriate to include an ownership threshold requirement for submission of an
"opt-in" proposal? Is it appropriate to include an ownership threshold requirement to nominate a director under the proposed procedure?
2. Would the requirements to use Exchange Act Schedule 13G preclude investors from participating in the nomination of a director or directors under the proposed rule?
3. Will individual investors be able to aggregate effectively their securities in order to meet the more than 1% threshold to submit a triggering security holder proposal? Will individual investors be able to aggregate effectively their securities in order to meet the more than 5% threshold to nominate a director or directors under the procedure? If not, in what respects should this issue be addressed?
E. What are the federal law and state law issues raised by the proposal?
Section 14(a) of the Exchange Act prohibits any person from soliciting proxies with respect to a Section 12-registered security where that solicitation is in contravention of Commission rules and regulations. Section 14(a) "stemmed from the congressional belief that `fair corporate suffrage is an important right that should attach to every equity security bought on a public exchange.' It was intended to `control the conditions under which proxies may be solicited with a view to preventing the recurrence of abuses which ... [had] frustrated the free exercise of the voting rights of security holders.'"12 Section 14(a) authorizes the Commission to prescribe proxy solicitation rules that are "necessary or appropriate in the public interest or for the protection of investors."13
Commenters that opposed the proposed rule generally questioned the Commission's authority under Section 14(a) of the Exchange Act to adopt the proposal.14 In the view of some of these commenters, a requirement that some companies include security holder nominees in their proxy materials impermissibly regulates corporate affairs directly and therefore exceeds the Commission's mandate under Section 14(a). These commenters were generally of the view that only state corporation law could impose such a requirement.15
As proposed, a company would become subject to the security holder nomination procedure in Exchange Act Rule 14a-11 only where the company's security holders are not prohibited by state law from nominating a candidate or candidates for election as a director. The proposed rule would state that the security holder nomination procedure would be available unless applicable state law prohibits the company's security holders from nominating a candidate or candidates for election as a director. If state law permits companies incorporated in that state to prohibit security holder nominations through provisions in companies' articles of incorporation or bylaws, the proposed procedure would not be available to security holders of a company that had included validly such a provision in its governing instruments.
1. Is it appropriate to limit the availability of the proposed nomination procedure to those situations where state law does not prohibit security holders from nominating candidates for director? In this regard, is it appropriate for the proposed rule to possibly apply differently to companies depending on their state of incorporation? Is it appropriate to permit companies to limit the availability of the proposed procedure by limiting the right to nominate directors, when such a limitation is allowed by state law? Will the proposal's reliance on the pre-existence of a state law right, combined with the possibility that companies may limit security holders' rights in this regard, adversely affect the effectiveness of the proposal?
2. Is the proposal's reliance on the pre-existence of a state law right of nomination a proper balance between federal law and state law?
3. To what extent are security holders permitted to nominate directors under state law? Conversely, to what extent are security holders prohibited or limited in their ability to nominate directors under state law?
4. Are there other respects in which adoption of the proposed rule would conflict with provisions of applicable law? If so, which provisions and why? What modifications could be made to the proposed rule to eliminate such conflict?
5. Is the proposed rule consistent with the Commission's authority under the Exchange Act? If not, in what respect? If not, what modifications could be made to the proposed rule to address the issue?
F. How would the proposal affect voting mechanics, such as clarity of the proxy card and ability to tabulate proxies?
A number of commenters have noted potential issues with regard to security holder voting that would impact the operation of the proposed rule, including:
- companies' current inability to identify street name security holders or determine the number of beneficial owners of company securities;
- institutional security holder voting policies and proxy voting guidance; and
- broker discretionary voting authority under NYSE Rule 452.
Although these issues are not addressed in the proposed rule, it is important to understand the potential practical application of such issues, should the Commission determine to adopt rules that would require companies to include disclosure regarding security holder nominees in company proxy materials.
1. Will the current procedures for counting votes be adequate to support the rule's reliance on specific voting percentages? If not, are those procedures adequate currently?
2. What other voting issues may arise as a result of the proposal?
3. In what manner and to what extent, other than as already addressed in Section C, above, will proxy voting guidance impact the operation of the proposal?
4. To what extent will NYSE Rule 452 impact the operation of the proposal?
1 See Release No. 34-48626 (October 14, 2003) [68 FR 60784].
2 See Press Release No. 2003-46 (April 14, 2003).
3 See Release No. 34-47778 (May 1, 2003) [68 FR 24530]. In addition to receiving written comments, the Division spoke with a number of interested parties representing security holders, the business community, and the legal community. Each of the comment letters received, memoranda documenting the Division's meetings, and a summary of the comments are included on the Commission's website, www.sec.gov, in comment file number S7-10-03. [Summary of Comments in Response to the Commission's Solicitation of Public Views Regarding Possible Changes to the Proxy Rules (July 15, 2003)].
4 See File No. S7-10-03.
5 See id.
6 See id.
7 See Staff Report: Review of the Proxy Process Regarding the Nomination and Election of Directors, Division of Corporation Finance (July 15, 2003).
8 See Release No. 34-48745 (November 4, 2003) [68 FR 64154]. While the NYSE standards include a requirement that listed companies have an independent nominating committee (NYSE Section 303A(4)(a)), the Nasdaq standards provide that the nomination of directors may, alternatively, be determined by a majority of the independent directors (NASD Rule 4350(c)).
9 See Release No. 34-48825 (November 24, 2003) [68 FR 69204].
10 See File No. S7-19-03.
11 See id.
12 J. I. Case Co. v. Borak, 377 U.S. 426, 431 (1964) (citing H.R. Rep. No. 1383, 73rd Cong., 2d Sess. 13-14). See also Medical Comm. for Human Rights v. SEC, 432 F.2d 659, 676 (D.C. Cir. 1970), vacated as moot, 404 U.S. 403 (1972) ("Congress intended by its enactment of section 14...to give true vitality to the concept of corporate democracy.").
13 15 U.S.C. 78n(a). Cf. Medical Committee, 432 F.2d at 671 ("Through section 14 of the Act, Congress has invested the Securities and Exchange Commission with sweeping authority to regulate the solicitation of corporate proxies.").
14 See File No. S7-19-03.
15 See id.