Speech by SEC Commissioner:
Remarks Before the 38th Annual Rocky Mountain Securities Conference
Commissioner Annette L. Nazareth
U.S. Securities and Exchange Commission
May 19, 2006
I want to begin by thanking Don Hoerl and the SEC's Denver office as well as our former Regional Director, Randy Fons, and the Business Law Section of the Colorado Bar Association for inviting me to speak with you today. It is lovely to come out to Denver and participate in this conference. I am delighted to have the opportunity to discuss a number of recent initiatives that touch on the topic of corporate governance.
Today I want to talk about two proposals that have been published by the Commission since I became a Commissioner and that are currently under consideration. I believe that both of these proposals have the potential to improve corporate governance. If enacted, the proposals could work together to ensure that investors have access to understandable, high-quality information that they can use in a variety of ways. But first, let me remind you that my remarks represent my own views and not necessarily those of the Commission, my fellow Commissioners, or members of the staff.1
In December 2005, the Commission proposed amendments to its proxy rules to allow companies to provide their proxy materials to shareholders electronically. The amendments would permit a "notice and access" method of delivery, whereby a company could mail a paper notice to shareholders directing them to an electronic Web site on which the company had posted its proxy materials. The issuer could include the proxy card with the mailing or post it on the Web site along with the electronic materials. The mailing would provide the shareholder with a toll-free telephone number or an e-mail address to contact if the shareholder wished to receive the proxy materials in paper form. If the shareholder requested a paper copy, the company would be obligated to mail it promptly. Otherwise, the company's provision of proxy materials on a Web site would be sufficient. In essence, this proposal would allow companies to shift their default delivery method from paper to the internet, potentially saving the company, and by extension the shareholders, significant printing and mailing costs. Shareholders would benefit because electronic information is more easily searched and compared. As you know, for many Americans, the internet is now an essential part of daily life. An increasing number of people use the internet to keep track of their finances, pay bills, and make investment decisions. Thus, the Commission's proposal is a logical extension of trends in internet usage. At the same time, the proposal would ensure that investors who are more comfortable with paper copies can continue to receive hard copies if they so choose, at no additional cost.
We published this rule for public comment and have received a number of comment letters, which our staff is currently reviewing. Many commenters have expressed support for the proposal and have provided additional suggestions as to how to improve it.
One concern raised by investor groups is the availability of and familiarity with the internet among certain demographic groups, including older seniors. Groups representing older Americans have submitted letters as well as data regarding the internet practices of seniors. It is interesting to note the variance in internet usage and comfort among different age groups with the young, not surprisingly, being the most frequent users. It is certainly true in my family, and perhaps in many of yours, that my children are part of the internet vanguard; my husband and I work to improve our technology skills in part to keep up with our children; and my parents were somewhat slower to embrace internet technology (although I am proud to say that they are catching on). Even within the group of Americans at or approaching retirement, the data provided in comment letters indicates that those between ages 50 and 69 are much more comfortable with this technology than those 70 and over. We are all too familiar with the scams that are targeted at seniors. I am very sympathetic to those who worry about how to balance using the internet for all of its benefits with avoiding being the target of a fraud. It is a challenge to craft a solution that is equally optimal for the entire diverse American population. I do believe that a fundamental principle must be to require companies to provide paper materials to those investors who feel most comfortable with them. I hope we can find a way to allow investors to make a more comprehensive, permanent election to receive paper copies if they so choose, so they need not call or e-mail each of the companies in which they own stock each year. This may help ease the concerns of seniors in particular. We want to ensure that all who are interested can receive the benefits of our proposal without excluding segments of the population.
Commenters also have expressed a range of views as to whether it is best to require that the proxy card and the proxy statement always be delivered together which was one of the alternatives proposed or whether it would be possible to include the proxy card with the notice of internet availability of the proxy statement which was the other proposed alternative. The AFL-CIO in particular commented that the rule should require that the proxy card only be furnished together with the proxy statement. Their concern is that separate delivery of the proxy card and proxy materials would "dramatically increase" the likelihood of shareholders voting their proxies without reading the underlying materials. Although I sometimes wonder if investors read the underlying materials even when they arrive together with the proxy cards, as they do at present, some commenters worry that separating the two materials would imply that reading the proxy statement is not important. If investors are able to make a one-time comprehensive opt-in to receiving paper materials, it may alleviate these concerns about separate delivery of the proxy card and proxy materials, since those persons most comfortable with materials on paper will always receive the two in the same mailing.
While issuers generally have been supportive of our proposal, some have raised concerns about proxy contests being conducted by non-issuers via the internet for purposes other than election of directors. In particular, they are concerned about non-issuers conducting an internet proxy solicitation rather than filing proposals meeting the requirements of Rule 14a-8. Issuers are concerned that the number of such contests will dramatically increase and that issuers and shareholders thus will need to spend significant funds defending against contests. Commenters have suggested modifications to the proposed rules to deter "wasteful" contests, such as by permitting electronic solicitations, other than for election of directors, only by shareholders who hold a significant amount of stock. These concerns highlight one of the possible effects of the proposed rule the more cost-effective ability of both companies and their shareholders to solicit proxies in an electronic age.
We also received a number of comments about the role of intermediaries in this process. Many investors hold their shares in "street name," and as a result they receive their proxy materials, and direct the voting of their shares, through their brokers. We recognize that the proposal may implicate the mechanics of this process, and we will need to be sure that any final proposal is workable.
We will continue to study these and other issues as we develop any final proposal. I am optimistic that we will be able to achieve a result that allows companies to use internet technology effectively to provide proxy statements to their investors. I hope that issuers who make their materials available electronically will take advantage of technological features such as hyperlinks, which will make this financial information more accessible and user-friendly. Investors are able to search electronic information more readily, thus enabling them to find quickly the information that is of greatest interest to them. Shareholders may more easily track the components of the proxy information that are most significant to them and perhaps more easily compare those components across companies. This proposal even may lead more shareholders to vote online after reviewing the proxy materials online. The end result could be greater shareholder participation in corporate governance at the companies they own. If the proposal also results in cost savings to the issuers and their shareholders, that certainly would be welcome as well.
Executive Compensation Disclosure
Another proposal that the SEC recently published that may help make information more accessible to investors concerns executive compensation disclosure. In January 2006, the Commission issued proposed rules concerning the disclosure of executive and director compensation, as well as other topics including related party transactions. The proposed disclosure rules focus on just that: disclosure. They do not provide any guidance or judgment as to an appropriate amount of executive or director compensation. Rather, they seek to ensure that shareholders are provided with comprehensive information about the total compensation paid to executives of the companies in which they invest. The Commission last revised executive compensation disclosure rules in 1992, and executive compensation packages have changed significantly since that time. The proposed rules would refine the existing tables and add new narrative disclosure. They also would include a more comprehensive disclosure of equity interests, retirement plans, and post-employment compensation. As we have seen in some notorious compensation packages, retirement benefits can be greater than an executive's salary and bonus. I think it is important that investors be aware of the extent of potential retirement and post-employment compensation in order to make an informed judgment about whether the Board, particularly the compensation committee, is fulfilling its role in determining appropriate compensation.
One element of our proposal is a new "total" column, which would provide a dollar total of the amount of compensation provided to certain executive officers. Another new component would be a Compensation Discussion and Analysis section that would clearly explain the company's reasons for the amount and allocation of executive compensation. By requiring an explanation of compensation, the Compensation Discussion and Analysis section may result in more careful consideration of what compensation packages are appropriate for the company's executives.
It is worth emphasizing that a fundamental principle of the proposed rules is that all means all. All forms of compensation would need to be disclosed, even if they are not specifically enumerated in the proposal. Boards, executives, and compensation consultants cannot simply devise new methods of compensation hoping to avoid required disclosure. We are mindful that new compensation methods may emerge over the years, and it is important that our rules be flexible enough and comprehensive enough to keep pace with changing practices. I also want to point out that our proposal would call for this disclosure to be in plain English, which will make it more understandable to individual investors. In fact, the plain English requirement may be the single most important aspect of this proposal to individual investors, as it will ensure that the information disclosed is meaningful to all investors.
The comment period for our executive compensation proposal recently concluded, and not surprisingly we received a large number of comment letters I believe that the last I heard the count was over 18,000. As with the electronic proxy proposal, the SEC staff is reviewing these comment letters, and the Commission will need to decide whether to issue formal rules at the conclusion of this process.
The press has focused attention on the concerns of many companies relating to the proposal to disclose the pay of up to three non-executive officers. Indeed, there has been much commentary concerning how the rule would require compensation disclosure of Hollywood or television personalities. This "Katie Couric" provision, as it has been called, does require reconsideration in my opinion. We need to take a hard look at this provision and consider what, if any, policy goals are furthered by its inclusion. Would this provision give investors truly useful information, or would it simply provide them with water-cooler gossip about well-known personalities? Many commenters have raised legitimate concerns about the privacy and competitiveness issues that these disclosures would raise. While retail investors may not be able to identify the non-executive officers, in many sectors, competitors quickly will be able to identify the individuals. Competitors will have information that potentially can be used to recruit those employees and could have information about the relative successes of the issuer's business divisions. If the competitor is a private company, the public issuer would not have corresponding information about that competitor.
Overall, however, the proposal enjoyed widespread support among all types of commenters. Clearly, executive compensation information is significant to investors, and issuers seem to agree with the overall goal of providing more comprehensive executive compensation disclosure. We are currently coming to the end of the annual proxy season, when the majority of reporting companies hold their annual meetings. Although this proposal has not been enacted, we have seen a number of companies voluntarily include information in their proxy materials similar to that suggested in our proposal. For example, some companies have incorporated a "total" into the summary table, and others have included a compensation table for directors. I also note that there seemed to be heightened focus on executive compensation, including stock options, at many companies' annual meetings this spring. For example, several companies faced shareholder campaigns to "withhold" votes from compensation committee members who approved executive pay packages. At these companies, certain directors received more than 20% "withheld" votes. While such votes are not binding on the companies, they do reflect shareholder concern about and increased attention to executive compensation. Observing these trends reinforces my belief that information about executive compensation is significant to investors.
As I stated at the Commission meeting when these rules were proposed, I think that this proposal has the potential to allow individual investors to easily find the information that is most useful to them. The proposal would provide for layers of disclosure, consisting of narrative, tables, and supporting footnotes. Individual investors could use one or all of these parts to make informed decisions about their investments. For example, an investor who wants a concise summary of the amount that an executive earns can look to the Summary Compensation Table, particularly the new "total" column. Those investors interested in greater detail concerning compensation arrangements can look to the relevant supplementary tables, such as the retirement and post-employment disclosure tables.
I am optimistic that there are synergies between the executive compensation disclosure proposal and the electronic proxy proposal. If enacted, the proposals will make proxy materials more user-friendly in both structure and content. They would also enable investors to more easily compare pay packages at various companies. Investor awareness is a key component of the SEC's mission of investor protection. Investors are keenly interested in how the executives at the companies they own are paid. Ultimately, the investors are the ones who need to decide whether executive and director pay is appropriate. Part of our role at the SEC is to ensure that they have accurate, complete, and understandable information on which to base their decisions.
Corporate Governance Generally
Both proposals reflect a focus at companies and the Commission on corporate governance. Recently, many companies have taken voluntary steps to improve their corporate governance practices, including developing corporate governance policies that are included in their proxy statements. Some companies now require that the Chairman of the Board be a different person from the Chief Executive Officer; some additionally require that the Chairman be an independent director. This proxy season, some companies have proposed shareholder-friendly measures directed at corporate governance. Examples include: elimination of super-majority provisions concerning business combinations or takeovers, and elimination of staggered Boards, meaning that the entire Board is up for election annually.
Shareholder proposals have also focused increased attention on corporate governance. For example, recent shareholder proposals have advocated that companies adopt majority voting policies. State corporate law permits, and most public companies' governing instruments provide for, plurality voting in the election of directors. Under plurality voting, a nominee need not receive the support of a majority of shareholders to win a seat on the Board. It is generally agreed that in a contested election, where the shareholders are choosing among candidates, plurality voting remains an appropriate system. However, today most director elections are not contested; there are the same number of proposed candidates as spots on the Board. Theoretically, a candidate can be elected with only one "for" vote. The federal proxy rules provide that shareholders can cast a "withhold" vote when plurality voting applies. Although this allows shareholders to express dissatisfaction, "withhold" votes don't have a legal effect under plurality voting. Nonetheless, they remain an important symbolic tool. There have been some high profile "withhold vote" campaigns in recent years, such as at Disney, in which a large percentage of shareholders withheld votes for Michael Eisner. Additionally, as I mentioned earlier, this proxy season some proxy service firms and institutional investors campaigned to withhold votes from compensation committee members who voted for large executive compensation packages at companies whose performance, such shareholders contend, does not justify that amount of compensation.
Some groups have argued that the plurality system should be replaced with a majority voting system, and in the last proxy season, shareholder proposals at a number of companies requested this change. Those proposals were not binding, but some received significant support. Possibly in response to this increasing interest by shareholders, some companies have implemented mandatory resignation policies under which a director who receives more "withhold" votes than "for" votes must tender his or her resignation. I view this as a positive step indicating that shareholder participation in the voting process is not a fruitless exercise, but rather has the potential to effect change within the company.
In the current proxy season, shareholder proposals have also recommended that companies tie executive compensation to company performance; others have requested a shareholder vote on executive pay. Some proposals have suggested limiting the number of Boards on which a director may serve, and imposing mandatory retirement ages for directors or ages beyond which a director may not be re-nominated. Some companies have voluntarily implemented such policies as well. Shareholders have also proposed that companies recover payments made to executives in the event of a restatement. While most, if not all, of these proposals are precatory and are not binding, they do demonstrate trends in shareholder demands that may, in fact, prompt companies to take steps to address the concerns raised. These proposals give shareholders a vehicle to make their concerns known to companies and can result in increased communication between shareholders and companies. Proposals that obtain significant support can signal to a company that an issue is of particular importance to shareholders, and perhaps the company should examine and address it.
Shareholder proposals that attract significant voting percentages may lead to a "middle ground" between the two traditional options available to dissatisfied shareholders: the "Wall Street Walk" in which unhappy investors sell their shares or a full-blown proxy contest to replace the Board or a member of the Board. A proxy contest involves substantial expenditure by the shareholder, who must prepare and disseminate proxy materials that comply with the Commission's proxy rules. Defending against a proxy contest often requires a significant use of company resources, thereby harming shareholder value as well. To the extent that compromises can be reached through negotiation before any proxy contest is initiated, both companies and shareholders can conserve resources. Shareholder proposals may indicate to companies potential areas of concern that could be resolved through negotiation.
Overall, I am optimistic that corporate governance in the U.S. is trending in the right direction and will continue to do so. All stakeholders are recognizing that it is in their best interests to develop sound corporate governance policies. I hope that the Commission's recent proposals will help facilitate these trends and will encourage continued shareholder participation in and engagement with their companies.