Speech by SEC Chairman:
Electronic Shareholder Forum Rules; Codification of Interpretation of Rule 14(a)(8)(i)(8)
Chairman Christopher Cox
U.S. Securities and Exchange Commission
SEC Open Meeting
November 28, 2007
Good morning. This is a meeting of the Securities and Exchange Commission under the Government in the Sunshine Act on November 28, 2007.
The first matter on our agenda today is the consideration of amendments to the federal proxy rules to facilitate the use of electronic shareholder forums.
When we first raised the idea of an electronic shareholder forum at our proxy roundtables in May, many of our panelists — particularly those representing the institutional investor community — were very positive about its prospects as a supplement to the shareholder proposal process. That's because shareholders want cheaper, faster, and better ways to engage with each other and the companies they own.
Although the proxy process is of course one way of doing this, shareholders tell us that it can be a time-consuming and expensive process. After all, the proxy season usually comes only once a year. And then, the proposal has to comply with often detailed requirements of the proxy rules and their constraints on solicitation.
Our panelists noted that recent technological developments could provide a more effective and efficient means of communication than any that are currently available to shareholders. As Russell Read of CalPERS put it, using electronic shareholder forums as a supplement "might accomplish a lot of good things."
A number of facilities that might be called electronic shareholder forums already exist. For example, The Motley Fool and Yahoo! sponsor such forums, and shareholders use them today to communicate with each other. What has been missing from all this, however, has been any meaningful connection to what actually goes on in the company.
Despite the potential benefits of electronic shareholder forums, shareholders and companies alike have been reluctant to establish, maintain or operate them due, in part, to uncertainty over liability for statements and information provided by those participating in the forum. In addition, there is the very real concern whether views and statements expressed through the forum would be considered proxy solicitations.
Consequently, in July, we proposed a new exemption from the proxy rules for any solicitation in an electronic shareholder forum so long as it occurs more than 60 days prior to the date of the shareholders' meeting and satisfies the other conditions of the exemption.
We proposed the 60-day period to limit the potential for abuse, since companies are permitted to begin their solicitation of proxies for a meeting within 60 days of the meeting date.
We also proposed new Rule 14a-17 to provide liability protection for a shareholder, company, or third party on behalf of a shareholder, or company that establishes or maintains an electronic shareholder forum, regarding statements or information provided by a third party participating in the forum.
Today, we are adopting these amendments substantially as proposed to give greater currency to electronic shareholder forums by clarifying the responsibilities of those who establish and maintain electronic shareholder forums. These amendments will remove both real and perceived impediments to continued private sector experimentation with electronic shareholder forums.
By facilitating communications on the Internet among shareholders, and between shareholders and the companies in which they invest, we hope to tap the potential of technology to better vindicate shareholders' rights in ways that are potentially both more effective and less expensive.
In this regard, these rule amendments are similar to our e-proxy rules, which will be in effect for the 2008 proxy season. In both situations, we have harnessed the power and potential of technology to empower shareholders to exercise their rights — whether to conduct proxy solicitations online at cheaper cost, or to communicate with the company and with each other without fear of liability or the proxy rules, provided certain conditions are met.
Twelve years ago, in the early days of the Internet before Yahoo! and Google, when there were just dial-up services such as CompuServe and Prodigy, the New York Supreme Court ruled that someone who made a libelous statement about an investment bank on a Prodigy forum triggered liability for the service provider. In response, Representative Wyden — now, Senator Wyden — and I wrote a law, the Internet Freedom and Family Empowerment Act, which overturned this decision and enhanced free speech on the Internet by making it unnecessary for internet service providers to unduly restrict customers' actions for fear of being found legally liable for their conduct. This law established some of the key ground rules for the Internet and helped make our current level of personal interaction and communication on the Internet possible. And this has been the rule of law on the Internet ever since.
Today's rule amendments are, in essence, the federal securities regulation equivalent of that landmark piece of Internet legislation. I hope that these amendments, like the Internet Freedom and Family Empowerment Act, will spark the growth of online forums for shareholders, and stimulate experimentation and innovation in communications between shareholders and their companies.
I want to thank the staff of the Division of Corporation Finance for their excellent work on these rule amendments. In particular, I want to thank John White, Brian Breheny, Lily Brown, Betsy Murphy, Tamara Brightwell and John Fieldsend. I also want to thank the Office of General Counsel for their excellent work. And now I will turn it over to John White to explain the rule amendments.
[After discussion, the recommendation on electronic shareholder forums was approved on a Commission vote of 4-0.]
The next item on the agenda is consideration of an amendment to our proxy rules that would codify the SEC's long standing position concerning bylaw proposals to reform election procedures.
This proposal is one of two that the Commission submitted for public comment last July. It is the only one that, at this critical juncture as we enter the proxy season, can command the three votes needed to become final. Both of these two proposals had in common that they would clearly spell out to investors, to the companies they own, and to every marketplace participant, what the proxy rules mean. And both of the proposals would have ensured that the important disclosures of material information and the essential antifraud protections for investors required by the current proxy rules will not be circumvented.
If the Commission were to adopt neither of the proposals, and simply do nothing, then there would be no clear and authoritative interpretation of our rules. And there would be an easy end run around the Commission's required disclosures and our antifraud rules in proxy contests. We owe it to investors and the markets to at least ensure that this does not happen. And so I will vote in support of codifying our longstanding interpretation of Rule 14a-8 today.
If this proposal is adopted, it will result in absolutely no change in the way the rule has been applied for last 17 years, through five different SEC Chairmen appointed by Presidents of both parties. It is a status quo proposal, nothing more and nothing less, but it will preserve all of the rights that shareholders have today, and it will eliminate the need for lawsuits to determine what our rule means, and the opportunities to end run our disclosure and antifraud rules.
But merely preserving the status quo is not what many investors hope for — and I include myself in that camp. For over a year, I have been working to take the opportunity that the court decision in AFSCME v. AIG has offered us to improve upon the way the proxy rules give effect to the state law rights of shareholders. The extensive review of the issues surrounding this question included three Commission Roundtables, at which a number of public and private sector experts focused on the relationship between the federal proxy rules and state corporation law, proxy voting mechanics, and shareholder proposals. Because opinions had been hardened on this issue over years of argument, and emotions continue to run high on all sides, finding a way to go beyond the status quo has required a willingness to think anew, and to cross party lines.
When we put forward two proposals last summer, the principal purpose was to permit the ongoing discussion among all five Commissioners to continue, while staying on schedule to enact a final rule in time for the 2008 proxy season. There was not then — as there is not now — complete consensus on the Commission on broadening shareholder access to the proxy system, and as a result each of the proposals mustered only three votes.
Each of us in the majority that supported the broader reform proposal knew that in order to succeed in perfecting a final rule we'd have to be very attentive to public comment, because some parts of the proposal were new and untested. We learned from the comment process, for example, that the new disclosure requirements we proposed for proponents of election reforms would have to be refashioned if we were to meet the legitimate concerns of investor groups. And we discovered that tying those disclosure requirements to the existing 13D/G regime, with its 5% ownership threshold, was considered by many to be too high a barrier for investors in very large companies. None of these concerns, however, was beyond our ability to make necessary adjustments and to fashion a final rule that would truly improve the ability of shareholders to use the proxy system for the legitimate purpose of nominating and electing the directors of their choice. We had every reason to expect we could be here, at this open meeting in November 2007, with a final rule proposal that better vindicated shareholder rights through the proxy system.
The publication of two alternatives for comment was meant to provide a way for us to continue to explore the issues among Commissioners and possibly bridge the gap, but also to be something of a failsafe. It has ensured there is at least one viable alternative — the restatement of the status quo — which can command the minimum of three votes and which can succeed in achieving the objective of a clear, unambiguous rule that is in place in time for the next proxy season and that preserves today's disclosure and antifraud protections.
I have received requests from a number of people whom I respect to wait until next year to act on this issue, since presently we have one vacancy on the Commission. I fully understand why these requests are being made — because many believe that codifying the interpretation that has been applied over the last decade and more will take the wind out of efforts to improve the way the proxy system works for investors.
If preserving the momentum for change were all that is at stake this proxy season, I would be inclined to go along. But the approach that is being recommended would unfortunately require, in addition, that the Commission do absolutely nothing in time for this proxy season that would help market participants to understand what our proxy rules say about shareholder bylaw proposals. Worse, doing nothing would put all investors at risk. Doing nothing at this time would enable an easy end run around the Commission's required disclosures and our antifraud rules in proxy contests.
We can meet the fundamental objective of the commenters to replace the existing Rule 14(a)(8) with a better rule, and we can do it on the same schedule they contemplate, if only we are willing to press on and not give up. If we use the time between now and the next proxy season wisely, we can act on a new rule proposal next year that does more than perpetuate the status quo. We can adopt a rule that makes the federally-regulated proxy system fit better with the state-authorized rights of shareholders to determine the directors of the companies they own. But in order to do this, it is not necessary to subject everyone in the current proxy season to a regime of self help and the substitution of intentional ambiguity for the rule of law.
There can be no denying the fact that in the wake of two recent court decisions, one by the Second Circuit and another by the U.S. Supreme Court, there is widespread public confusion and disagreement over what our 31-year-old Rule 14a-8 says about bylaw proposals for director elections. Even on this Commission and among our professional staff there are differing opinions, and firmly held ones at that. Mind you this difference of opinion isn't just about what the rule might be amended to say — that kind of disagreement is to be expected. But there is also disagreement about what the existing rule says — the rule that has been in place since 1976. The disagreement has not been caused by any recent ambiguity in the Commission's interpretation of the rule, but by the recent court decisions, by our differing interpretations of what those decisions mean, and by our varying expectations of what the Commission staff should tell the public our rule means in the absence of any further clarification by the Commission itself.
It is worth pointing out why the recent court decisions have created confusion about the current meaning of the current rule. The first reason is that the AFSCME decision applies only within the Second Circuit, which covers three of the 50 states. It is not controlling in the other 11 judicial circuits and the other 47 states and territories; but courts in those other circuits could adopt or reject the view of the Second Circuit depending upon whether they found it persuasive. No one can know whether a particular circuit might adopt the Second Circuit view or reject it until there is a lawsuit, and then a decision, and then an appeal. Of course even this process of further litigation could produce conflicting results in different circuits, and lead to even greater uncertainty.
If all that weren't enough, after the AFSCME decision was issued on September 5, 2006, the U.S. Supreme Court reversed another panel of the Second Circuit in a similar case. In Long Island Care at Home, the Second Circuit said that a federal agency changed its interpretation of its own rules. Just as in the proxy access case, the Second Circuit rejected the agency's more recent interpretation. Justice Breyer's opinion for the unanimous Supreme Court held that an agency's change in interpretation presents no separate ground for disregarding its present interpretation. Rather, the Supreme Court said, the agency's interpretation of its own regulations is controlling — and should be granted deference — unless it is plainly erroneous or inconsistent with the regulation. As a result of this decision, it is more likely today that even a Second Circuit court would uphold the SEC's longstanding interpretation of our proxy access rule, which has been consistently applied for far longer than the rule at issue in Long Island Care at Home.
So in the upcoming proxy season, unless the SEC clarifies things, no one can possibly know to a certainty that the Second Circuit rule in the AFSCME case is the correct one, or that the SEC's pre-AFSME interpretation is the correct one, or whether there is some other interpretation altogether. To permit this state of affairs to continue for the 2008 proxy season and possibly beyond would effectively require shareholders and companies to go to court to determine the meaning of the Commission's proxy rules. Inaction by the Commission might satisfy some parties who believe they benefit from the current legal fog, but it would also replace the rule of law with deliberate vagueness and uncertainty to the detriment of all shareholders — the very shareholders the Commission is bound and determined to protect.
Since the only legal question is what the SEC's over 30-year-old rule means, it is a straightforward matter for the SEC to provide an answer. The legal uncertainty does not involve any statutory interpretation. It does not involve any question about the agency's authority. Rather, as the Second Circuit told us, resolving the question is only a matter of explaining ourselves. There can be absolutely no excuse for the Securities and Exchange Commission not to do so.
It is also worth pointing out why, if the SEC were to do nothing before the next proxy season, the disclosure and antifraud protections applicable to proxy contests could be out the window.
It starts with the fact that the basic function of the proxy rules is to ensure full and fair disclosure about any questions on which shareholders are asked to vote. There are specific disclosures required for proxy contests, and they're very important. They include information about a nominee's conflicts of interest, and background information such as criminal convictions. There are also specific antifraud rules that apply to deliberate lying about these things. But since at no time during the 73-year history of the SEC have shareholders been afforded access to the company's own proxy statement, the rules say that these disclosure and antifraud protections are triggered only when there are two competing proxy solicitations.
The investor groups that we commonly hear from at the SEC represent large institutions, pensions funds, and other responsible players who could be counted upon to self police. They would probably make these important disclosures voluntarily and truthfully. But the antifraud rules exist because when billions of dollars are at stake in our markets, not everyone plays by the honor system.
It's not difficult to imagine an offshore hedge fund with a focus on short-term returns that sets its sights on a public company, and devises a scheme to strip out the cash and leverage up. They wouldn't care about the damage to the share price and the existing investors, because they'd have completely hedged their tiny position — so they'd have voting rights, but no economic risk.
Without disclosing anything about themselves or their plans, let's say they propose a procedure that will let them have access to the company's proxy statement to nominate directors. Their written statement, which goes into the proxy, says they're submitting the proposal because they want a seat on the board to advance corporate governance and integrity. If the AFSCME decision applied without any new SEC rule to make sense of it, potentially there would be no meaningful disclosure about who made this proposal, or why, other than name, address, and number of shares. And even if all of the disclosures that were made were intentionally and materially false and misleading, there would be serious question whether our existing Rule 14a-9, the antifraud rule, would apply to the hedge fund. That's because the rule is directed to a person conducting a proxy solicitation — and since the hedge fund is riding on the company's proxy, it's the company that's doing the soliciting.
In a case like this, which is unfortunately all too easy to contemplate, shareholders would have no knowledge of the background and designs of the hedge fund. They'd have no way of knowing that its tiny share ownership is hedged, and that it has none of the economic risk that every other shareholder bears of the company's stock price falling. They'd have no knowledge about any plans the hedge fund has to loot the company or manipulate its securities.
I know of no investor advocate who wants to see any of this happen. We need not support the indefinite perpetuation of the Second Circuit's decision in lieu of Commission rulemaking in order for the case to have a positive effect: after all, it has gotten us all focused on this issue in a serious way. We will not lose that momentum in the coming year. But what the AFSCME case cannot be is a replacement for a permanent SEC rule that addresses the unintended consequences of abandoning our long standing interpretation of Rule 14a-8. And until a majority of the Commission sees fit to create broader proxy access for shareholders than presently exists, the best we can do is to clarify that the status quo maintains, and ensure that investors keep all of the disclosure and antifraud protections to which they're entitled.
As Chairman, I will continue to work to strengthen the proxy rules to better vindicate the fundamental state law rights of shareholders. There is simply no question that the enforcement of private property rights is an essential ingredient of a successful free market, and that the law's enforcement of shareholder rights is what gives common stock its value. America's investors in equities currently entrust over $20 trillion of their assets in exchange for these property rights. And so it's of the utmost importance that the most fundamental and ironclad legal right that a shareholder has — the right to choose the company's directors — is jealously guarded by our legal system.
No proposal in Commission history has received as many public comments as the one before us today and the companion release — altogether, more than 34,000. The Commission has thoughtfully and carefully considered each and every view, which leads us to where we are today. But today is not the end, and I hope all stakeholders will continue to work with us. Changing the proxy system to address the collective action problem while rationalizing the potential input of 45 million shareholders, fulfilling the essential federal role of ensuring disclosure, and guaranteeing them the full protection of the antifraud provisions of the securities laws, is a complicated matter. None of the 22 SEC Chairmen since the agency first looked at this issue in 1942 has successfully taken this step. Indeed, when the Commission previously considered the issue of shareholder access to the company's proxy statement in the 1990s, it determined not to pursue it. The Commission stated at the time that "Proposals to require the company to include shareholder nominees in the company's proxy statement would represent a substantial change in the Commission's proxy rules. This would essentially mandate a universal ballot including both management nominees and independent candidates for board seats." So the Commission adopted the short slate rules instead. Nonetheless, I am committed to seeing to it that this time, shareholders do see tangible improvements in their ability to use the proxy system for the election of directors.
In the third year of my Chairmanship, the Commission can point with pride to a number of truly significant accomplishments for investors that we have achieved with the support of all five Commissioners. That's because we have made it a habit to listen to one another, to learn from one another, and whenever possible to try to square the others' points of view with our own. That has not guaranteed unanimous votes, but it has improved the final product in every case. And it may yet lead us to a broader consensus on the wisdom of vindicating shareholder rights through the proxy system. The fact that we continue to work on the challenging question of proxy access in this collegial way has improved even the status-quo proposal that we are considering today. I want to thank each of the Commissioners for their contributions, and in particular Commissioner Nazareth — who made constructive suggestions that are reflected in the proposal, even though I know she is not supporting it.
I also want to thank the staff of the Division of Corporation Finance for their excellent work on this rule amendment. In particular, I want to thank John White, Brian Breheny, Betsy Murphy, Lily Brown and Tamara Brightwell. It's a special pleasure to congratulate Brian on his promotion last week to Deputy Director of the Division of Corporation Finance. I also want to thank Brian Cartwright and his outstanding team in the Office of General Counsel for their excellent work. And now I will turn it over to John White to explain the rule amendment in more detail.
[After discussion, the recommendation to codify the Commission's long standing interpretation of Rule 14a-8(i)(8) was approved on a vote of 3-1.]