Speech by SEC Commissioner:
Remarks at the SEC Open Meeting: Shareholder Proposals
Commissioner Roel C. Campos
U.S. Securities and Exchange Commission
July 25, 2007
Let me also add my thanks to the staff of the Division of Corporation Finance and all of the individuals who have worked long hours on these two proposals. It's been a mighty chore, and tremendous labor has been put into it. Let me echo my appreciation as well.
These issues have been around since I joined the Commission five years ago. It's incredible that as time goes by, we keep reflecting and dealing with the same issues. I do think the world has moved, and the latest three roundtables have added to the record and the investigation that the Commission has done in this particular area.
Essentially, it seems to me that all of this effort boils down to a situation that exists in America that is very different from any other developed market in the world. That is, only in the United States — as compared to other developed markets — are shareholders who hold the voting class of shares of public companies prevented from voting "yes" or "no" for directors. As we all know, shareholders can vote only "yes" or "withhold" their votes. Some have called this system "Soviet-style voting." As the Chairman said, this system seems to fly in the face of basic ownership rights under our capitalist system for property. Do shareholders have a right to vote and influence the election of directors, or is this right simply an illusion?
Under our laws, shareholders are not entitled to manage the day-to-day operations of a corporation. That is clear. Instead, however, they rely on the management efforts of the board of directors, who owe them fiduciary duties. So, it would seem logical and rational that shareholders who own voting stock have the right to vote for directors or influence their selection in a meaningful way.
It seems that opponents who fear shareholder access have greater issues and problems with it. Part of it is philosophical. Part of it is the view that shareholders are not really owners, which I think flies in the face of our corporate law. That view maintains that shareholders are simply free-riders and are not true owners. The solution for shareholders, it is said, is the "Wall Street Rule," which is to simply "walk away" when they don't like what is happening at a company.
What this proposition ignores is that the time to walk away is when the share price is highest. It seems hardly an option to sell one's stock when the price is at its lowest, instead of trying to influence and improve the company in a meaningful way and have the share price go up. Further, large institutional investors today are heavily invested in indexes and cannot simply move large blocks of shares. And if they sell a large block of shares, they affect the price of such shares in a negative way. This is a serious issue. That particular view does not deal with reality.
Another reason that is often cited reason is that shareholder access will somehow disrupt the conduct of business at companies and boards. In my view, this particular argument does not hold water. Shareholders, in my evaluation, don't want to be involved in the day-to-day business of companies. They intervene only when they have to, and only when there is repeated failure of performance and failure to take into account shareholder suggestions. So a company that is consistently underperforming should expect the attention of shareholders. Our proxy proposal, or any similar proposal for that matter, would not affect any company that is responsive to shareholders.
Finally, I also hear the argument made by some that, "There is so much to deal with SOX. Please don't add another requirement." Well, my answer is that the world today moves fast. The Commission didn't create the global economy. The Commission didn't create activist funds. The Commission didn't create all of the pressures and all of the financial competitive situations that exist. The Commission didn't create the effort of private equity and hedge funds who are interested in this particular world. So, I think it belies the issue. This is not something that a board can avoid by simply not having a rule that allows for shareholder proposals. Shareholder activism is something that occurs today in spite of what the Commission may do.
Essentially, what it comes down to is accountability. Under our capitalist system, boards need to be accountable. That is the way boards were designed under our laws, premises and the history of Anglo-Saxon law. There needs to be accountability to shareholders. Our particular proxy proposal today — the proposal that allows for a 5% shareholder to submit a proposal to establish a process for shareholder director nominations — would be a simple and elegant way to accomplish, under state law, the means to submit a proposal as a framework for shareholder access. Whatever that proposal would be would be between the company and shareholders, and would be governed by state law.
Having said that, I do support the proposal that involves the proposition that would allow shareholder proposals to go forward. But I do have some deep reservations. I'm aware that many investors have said publicly that a 5% ownership threshold is too high. This is especially the case, they argue, with respect to large accelerated filers. The reason for that is very simple. If you put together the holdings of all major institutional investors that make up one of the large organizations, the Council of Institutional Investors, with respect to large companies, their combined holdings generally do not equal 1%. There may be some exceptions, but that's generally the rule. So investors have posed the question: is a rule in which a 5% threshold is proposed useful to investors? Is this threshold too high as to be useless and in fact an illusion?
Several questions are asked in the release, which seek to elicit response from investors, commenters and academics about this particular question. In particular, one of the questions has to do with whether the Commission should consider some sort of differentiated standard for larger companies, which might means that the percentage should be substantially lower than 5 %, maybe even 1% or lower, or even higher. Also asked is whether a different set of standards should apply in terms of the threshold for smaller companies. I today want to encourage investors and other commenters to make their views known and to give us their thoughts on this proposal.
Separately, I have great reservations about the question raised in the proposal that would allow the opting out of the SEC's 14a-8 procedures for non-binding or precatory proposals. The question poses a situation in which either shareholder or management, through a bylaw proposal, could eliminate the non-binding proposals being considered at all by a company. That could be the ultimate result of a proposal that is adopted by the shareholders. I think the question is open as to whether such a proposal would require shareholder approval if the company or the board were to propose it. I am very concerned about whether it is good policy to eliminate a particular opportunity that nuns, rabbis, Christian sects, environmentalists and others have used to place non-binding proposals for consideration by management. As stated in our recent roundtables, this particular procedure, under our oversight under 14a-8, often presents ideas that actually get traction and develop into proposals that are adopted by the company.
I am interested in knowing what investors and commenters think about this particular question and the possible rule that may come out of this. Is it good policy to allow a system to take away this practice and force those types of activists to use other tactics? I look forward to those comments.
As to the second release, I find myself in a position of not being able to support it. The second release has many problems, not the least of which is that, if finalized, would essentially put investors in a position where they can no longer make any proposals regarding procedures for the nomination of directors. However, I find that it is deficient in that it does not really answer many of the questions that the Second Circuit raised. Without doing a full legal analysis, I note that the Second Circuit stated that "the SEC fails to so much as acknowledge a changed position, let alone offer a reasoned analysis of this change. The amicus brief is curiously silent on any Division action prior to 1990 and characterizes the intermittent post-1990 no-action letters which continued to apply the pre-1990 position as mere mistakes."
So, for that and for other reasons, I believe that this particular proposal will not change the status quo. As I read it, there is nothing in this release — apart from the proposed rule — that is new. Thus, the interpretation in this release, without more, is — to quote the Second Circuit — "plainly at odds with the interpretation the SEC made in 1976." Given this, I hope and expect that the agency will not be taking the position in the upcoming proxy season that this release — without adopting a final release of some sort — changes the current situation.
Additional Remarks by Commissioner Campos on Shareholder Proposals Relating to the Election of Directors1
I have grave concerns about the substance of this release, and I believe that it represents a complete step backward from where we should be going.
The shareholders own the company. They are the principals. The directors are the agents. Yet the current plurality voting system means that a director nominee with a single vote could be elected to the board. This is not an example of how the principal-agent relationship is supposed to work. Further, this is not an example of good corporate governance, for it means that directors are far less accountable to shareholders. Thus, I voted against this proposal, which would amend Rule 14a-8(i)(8) to prohibit shareholders from presenting bylaw amendments to establish procedures for the election of directors. It is my hope that this proposed rule change is never finalized.
I am also writing to make it clear that this proposal does not represent a currently effective interpretation of the Commission. I made this point clear in my questions to John White (the Director of the Division of Corporation Finance) and Brian Cartwright (the General Counsel) at the Open Meeting held on July 25, 2007, when the Commission voted to approve this proposal by a 3–2 vote. This second release does not in any way address the concerns raised by the Second Circuit,2 and it does not present any new analysis or new interpretation of Rule 14a-8(i)(8). As Mr. Cartwright noted, the agency's brief before the Second Circuit was a "full explication of our position. This release would restate that conclusion."
Given that there is nothing in this second proposal that is new, the interpretation suffers from the same fatal flaws that it did when the Commission staff submitted their letter brief to the Second Circuit. Simply restating the same conclusion does not make this an effective interpretation of Rule 14a-8(i)(8).
Therefore, in the absence of an approved final rule by the Commission, I understand that the Division of Corporation Finance will continue to refuse to issue no-action letters, and will take no view, as to whether a company may exclude, under Rule 14a-8(i)(8), shareholder proposals that would amend a company's bylaws to establish election procedures. This is what the Division did during the last proxy season, and it is the proper action to take during the upcoming proxy season unless a final rule is adopted. The staff should take this position whether or not the company in question is located in the territory covered by the Second Circuit.
This is consistent with what John White stated at the open meeting. In particular, in response to my questions, he stated: "If we were to have a no-action letter request prior to a final rule being adopted, based on our current thinking and advice of the general counsel's office, and remembering that any shareholder proposal is very fact specific, we would be analyzing it and approaching the same way that we did last season." Further, Brian Cartwright agreed with this, stating: "I think that the Division would be very much in same position it was last time. And so it would be not inappropriate to take the same position." Specifically, this position was that the Division refused to concur that a company could exclude a proposal to amend a company's bylaws to establish procedures for the election of directors.
This is consistent with the decision of the Second Circuit in the AFSCME v. AIG case, which found that the language of 14a-8(i)(8) was ambiguous. Consequently, the key issue faced by the court was to find guidance in agency interpretations. And, in particular, it looked at statements made by the Commission when it proposed and adopted the mostly current version of 14a-8(i)(8) in 1976. After analyzing these statements, the court held as follows: "The 1976 Statement clearly reflects the view that the election exclusion is limited to shareholder proposals used to oppose solicitations dealing with an identified board seat in an upcoming election and rejects the somewhat broader interpretation that the election exclusion applies to shareholder proposals that would institute procedures making such election contests more likely." The court further noted: "That the 1976 statement adopted this narrower view of the election exclusion finds further support in the fact that it was also the view that the Division [of Corporation Finance] adopted for roughly sixteen years following publication of the SEC's 1976 Statement."
Moreover, the Second Circuit criticized the agency for changing our position about the meaning of 14a-8(i)(8), and noted that we had not provided reasons for our changed position. Notably, the Second Circuit stated that "the SEC fails to so much as acknowledge a changed position, let alone offer a reasoned analysis of this change. The amicus brief is curiously silent on any Division action prior to 1990 and characterizes the intermittent post-1990 no-action letters which continued to apply the pre-1990 position as mere mistakes."
Notably, the same statement that the Second Circuit made with respect to the position before that court also applies here. This release continues to ignore no-action positions taken by the staff in the first 15 years after the 1976 Statement. Thus, despite the fact that some might read this release as a current interpretation of Rule 14a-8(i)(8), it is not. And it has not changed the status quo.
There is nothing in this release — apart from the proposed rule — that is new. Thus, the interpretation in this release, without more, is — to quote the Second Circuit — "plainly at odds with the interpretation the SEC made in 1976." Given this, it is not a currently effective interpretation, and I expect that the Division of Corporation Finance — absent the adoption of a final rule — will not take a position on whether companies may exclude proposals similar to the one discussed in the AFSCME v. AIG case.