Speech by SEC Commissioner:
Getting to Know You:
Dealing with the Wired Investor
Commissioner Laura S. Unger
U.S. Securities & Exchange Commission
At the American Society of Corporate Secretaries
Greenbrier, West Virginia
June 25, 1999
Today, I want to talk about the role of technology in effective corporate governance. Before I begin, I must give the standard SEC disclaimer that the remarks I'm about to give are mine and mine alone, and do not necessarily reflect the views of the Commission, its staff, or the other Commissioners.
Issues involving corporate governance are taking on a high profile globally. In May, the Organization for Economic Cooperation and Development endorsed a set of nonbinding guidelines on corporate governance. The guidelines recognize that companies with basic corporate governance principles are more likely to attract investors.
They also recognize the links between good corporate governance and good corporate performance. In a world where transborder capital flows can occur nearly instantaneously, the OECD observed that countries wishing to attract "patient," or long-term investors, must have corporate governance principles that are credible and understood across borders.
I believe that the United States meets these standards by having one of the most developed corporate disclosure systems in the world, which leads to increased transparency and efficient capital markets. Indeed, the U.S. system is the template for many of the principles articulated in the OECD guidelines.
An important element of good corporate governance is the method through which companies communicate information to their shareholders. Because I have been focusing on technology issues as a Commissioner, I wanted to focus my remarks on how, using the Internet, companies can get to know and understand their shareholders more effectively.
Today, companies do communicate with shareholders through the required periodic disclosures and the time-honored ritual that is the annual meeting when directors are elected. Companies also now communicate to shareholders through information posted on their websites. According to the National Investor Relations Institute, about 90 percent of issuers have set up their own websites.
A 1998 NIRI survey of corporate information available on home pages found that over half of its respondents either had posted or planned to post on their websites: press releases other than earnings, quarterly earnings releases, detailed information on their products and services, SEC filings, fact sheets and corporate profiles, annual and quarterly reports, and transfer agent information.
In looking at some of your sites, I have also seen the delayed stock quotes, consensus earnings estimates, and names of analysts covering your companies. I have been particularly impressed with some of the multimedia add-ons to the periodic reports posted on your websites. For example, websites may link to a speech by a member of management, a factory tour, or a spreadsheet that lets investors analyze the numbers in your periodic reports.
They certainly look much better than what you can see on EDGAR. . . . But don't get me started on EDGAR. I can tell you though that we are working on adding multimedia capability in the next phase of EDGAR modernization to conform with our rulemaking proposal that would require companies to file "free writing" materials with us.
Investors have responded to company websites. According to a recent survey by CCBN.com, a company that hosts and updates investor relations sites, traffic at investor relations sites increased to 30,000 hits per site for the fourth quarter 1998, a 38 percent increase from the previous quarter.
According to this same survey, sites that offered multimedia features, such as analyst conference call replays and slide show presentations, experienced significantly higher traffic than sites offering only the more traditional text and data. While traffic to sites offering multimedia content increased 97 percent to nearly 50,000 hits on average during the fourth quarter, traffic to text and data sites increased just 14 percent in this time period. I guess this shows that presentation does matter.
NIRI also found that among the least popular categories of posted information were transcripts of analyst conference calls, annual meetings, and speeches. Given the popularity of sites that offer access to live analysts' calls, I guess reading the transcript is not quite the same as using audio or video.
You may know that I have urged in a number of speeches that companies increase investor access to analyst conference calls. Apparently, the most effective way to reach investors is through multimedia and not transcripts. My speeches are on the web if you are interested in this issue but I warn you that they are in transcript form. Maybe someday the Commission will catch up with technology and I will get to post them using multimedia.
I do think that this is only the beginning of the change that the Internet is making in investor relations. The same technology that lets companies communicate with investors also lets investors communicate with each other. The instrument of better investor relations can easily become the instrument by which investors challenge management, and it is no secret that investors are increasingly challenging management.
I'm sure that it will not come as news to any of you that this proxy season has seen its fair share of spirited debate. Some of the apparent acrimony this season seems to have occurred because boards ignored large shareholder votes on non-binding advisory proposals, which companies obviously are not required to accept. Dissident shareholders are increasingly opting to submit "binding" bylaw proposals instead.
Companies are not necessarily accepting these binding bylaw amendments even where they receive the votes necessary under state law for passage. A prime example is the binding bylaw proposal submitted by a union to Chubb. While the proposal received nearly 70 percent of the vote, Chubb refused to institute the bylaw changes required by the proposal because they were invalid under the state law where Chubb is incorporated.
I don't know whether the union will challenge Chubb's rejection of the amendment. It is far from settled under state corporation law that a board must implement these "binding" amendments to its bylaws. So far, only one state, Oklahoma, has ruled that shareholder-initiated bylaw amendments are binding on the company.
It is unclear whether the Delaware courts will follow Oklahoma's lead. That leaves most boards, like the Chubb board, with the option of ignoring these binding proposals inviting further shareholder discontent.
So far, institutional investors, and most prominently, public pension funds and unions, have waged many of the corporate governance battles. However, companies may not be able to ignore individual investors in the future. Individual investors own close to half of the shares in U.S. companies. Internet-savvy individual investors are becoming increasingly interested in corporate governance issues.
One of the ways that the Internet gives individual investors a louder voice is by facilitating collective investor action. For instance, in 1996, a group of Cincinnati-based shareholders of Professional Bancorp designed a website to keep shareholders informed of the company's defensive measures as they waged a proxy contest against management. This group of dissident shareholders owned only 13 percent of the company, but ultimately won over 700,000 of the about one million votes cast.
In 1998, investors in the Emerging Germany Fund, a closed-end mutual fund, used an Internet bulletin board to discuss the fund's poor performance. One of the investors, a dissident shareholder who operates a $40 million hedge fund, advised the Fund of his intention to nominate his own slate of directors and ask the shareholders to nominate the adviser.
This story did not end well for the dissident shareholder, however. Around this time, the fund's lawyers noticed that a number of anonymous postings on the Internet suggested that shareholders send this dissident shareholder their "unsolicited proxies." The fund sued, claiming that the dissident shareholder had violated Sections 13(d) and 14(a) of the Securities Exchange Act of 1934 by soliciting shareholders through his bulletin board postings.
As most of you know, the proxy rules under Section 14(a) basically prohibit any dissidents from soliciting proxies from more than ten shareholders unless a proxy statement is first filed with the Commission and then distributed to any person solicited. Section 13(d) also prohibits coordinated voting activity by the beneficial owners of more than five percent of a company's shares unless a Schedule 13D is filed.
The defendants in the Emerging Germany case argued that the communications on Internet bulletin boards were not proxy solicitations, but were instead, "permissible meetings among shareholders who are all of the same mind." This issue is still being litigated.
In a third example, this year, the Internet enabled a group of small investors to band together and successfully obtain a place normally reserved for large creditors in a Chapter 11 hearing. Through their cyberspace relationship, they were able to debate and reach a consensus on what action to take by posting over 6,000 messages on a Yahoo bulletin board.
But investors want more. Not only do they want to communicate with each other, but they want the company to lead the way by pointing other shareholders to the investors' websites.
Basically, they want to be able to use the company's proxy statement to get around the 500-word limit. Some shareholders have tried to circumvent the word limit by including web addresses in the supporting statements. The staffs of the Divisions of Corporation Finance and Investment Management permitted companies to delete the reference to the websites thus, thwarting these shareholders' efforts to expand their proxy statements by incorporating by reference web site information.
Shareholders' use of the Internet to prod corporate action is not a new technique. Consumers have created "gripe sites" to complain about a number of large companies. These companies have been unable to stop their creation.
In fact, your own companies may have tried to preemptively register domain names that may be used as a "gripe site," to prevent critics from identifying these sites with your companies. However, imaginative consumers have outmaneuvered most companies, and companies obviously cannot register all of the possible domain names not that some have not tried. According to one story, technology-minded Charles Schwab registered about 60 possible names.
Investors also are using Internet chat rooms and bulletin boards to comment on companies. Some of these postings have been enormously helpful to investors and companies. Some other postings have not reportedly leading to wild fluctuations in stock prices on days where there is no legitimate news about the companies. For example, PairGain Technology's shares rose 30 percent based on a fake Internet posting announcing that the company had been purchased by a rival. What is interesting is that the stock price only dropped 20 percent after the fraud was discovered.
Some companies have started patrolling the Internet in search of these discussions, or hiring somebody else to do it for them. A quick check uncovered six firms that offer this service to companies. I know of one search service that already has nearly 300 issuers as clients.
Companies have to worry about chat rooms and bulletin boards because the Internet allows for rapid dissemination of information to a large audience. Disgruntled employees can easily post information anonymously which may move a company's stock price. Some short sellers are getting into the act as well by posting "cybersmears" about a company. Conversely, corporate management anonymously hyping the stock is a problem with some small companies that have a more direct interest in seeing the company's stock price rise.
So, what should an issuer do in the Internet age? Should it patrol the Internet in search of rumors, innuendo, and outright lies? What should it do when it finds misinformation? As I mentioned earlier, how should it approach the proxy season?
I know that issuers are reluctant to correct misinformation or update information rendered misleading by subsequent events. If they correct once, they fear they must always correct and that their failure to do so would be interpreted as tacit approval of the information. In other words, correcting or updating once may cause a company to incur a continuing legal duty to correct or update forever.
But some issuers are already doing this. According to NIRI, about three percent of their members respond to chat room rumors. NIRI prefers that companies refrain from responding, but what should a company do when a chat room posts a rumor that the CFO is resigning and the stock drops 20 or 30 percent in value as a result?
I have heard of one issuer, a Boston biotech firm, that was engaging in an ongoing dialogue with investors through message boards on the Motley Fool and Silicon Investor. But that route is fraught with danger. I think the question regarding what issuers should do about misleading cyberspace communications will only become more important as time goes on.
Like the securities bar and the courts, I don't have the answers yet. Even if I did, they would be mine and would not necessarily reflect the views of the Commission. All I can say is that the Commission is aware that this is a complex and evolving area, and that we are sensitive to companies' strong desire for guidance.
I can offer some thoughts on the proxy season, however. When dealing with institutional investors and other shareholder activists, issuers have sometimes engaged in a productive behind-the-scenes dialogue. This raises the question of to what extent should those discussions be conducted without disclosure of their occurrence and content to all shareholders?
A Continuing Dialogue between Issuers and Shareholders
One possible solution suggested by a commentator at a 1998 Catholic University symposium is for an issuer to engage in a continuing two-way dialogue with all of its investors. She suggested, for example, that a company could establish a corporate website linked to a mailbox monitored by personnel trained to respond to shareholder issues. Alternatively, a company could establish e-mail links to shareholders to which regular communications could be sent.
She rightfully observed that the principal securities law provisions that apply to a company's communications with its shareholders do not invite a two-way dialogue. Further, she suggested that we are wrong in thinking that we can do little to direct how communications are carried on outside of the proxy process.
In her view, a useful development would be to standardize, to a certain degree, the level of corporate communications resources available to shareholders. This standardization could be accomplished by requiring that companies devise procedures for enabling shareholders to express their concerns to management. Further, she argues that we could encourage companies to proactively seek out shareholder feedback.
I think that a continuing dialogue between management and shareholders could help mitigate the negative stock price impact of any misinformation posted on bulletin boards and chat rooms. Eventually, selective disclosure of information would not be an issue because presumably, the issuer would post any material information for all Internet users to see.
Of course, the flaw with this plan is that large segments of the population still do not use the Internet. There is also a question of whether this information should be disclosed to the market in an SEC filing. This, of course, depends on the materiality of the information and the existence of a duty whether defined by the Commission by line item or antifraud precepts. Companies could also face liability if they entangled themselves with misleading information generated by the parties. Finally, companies should not be able to use this process to evade the proxy solicitation rules.
In other words, if these communications are designed or have the effect of influencing the vote under the broad definition of "solicitation" in the proxy rules companies could not avoid their obligation to file and deliver a proxy or information statement to all shareholders. As you can see, while increased communications may be a sound policy goal, we face significant issues in devising ways to promote that goal in cyberspace.
Introducing Efficiencies in Shareholder Proposals and Solicitations
We have been thinking about how technology could introduce efficiencies into the proxy solicitation and voting process. Perhaps companies could simplify the process of shareholder communications through the use of technology.
One way to effect direct issuer-shareholder communications would be to let beneficial owners register their share ownership directly on the books of the issuer as an alternative to the current "street name" model. While the shareholder would not receive a certificate, he would receive a statement of ownership and periodic account statements, dividends, annual reports, and other issuer mailings.
A direct registration system helps us reduce systemic risk and provides efficiencies by immobilizing certificates. It also provides a safe and transparent alternative for investors to holding certificates.
The OECD endorses the view that, in order to broaden shareholder participation, companies should consider using technology to facilitate voting, including telephone and electronic voting. Because of the increasing globalization of share ownership, the OECD observes that companies should strive to use technology to let their shareholders around the world vote.
For example, the OECD suggested that shareholders could effectively participate in meetings by developing secure electronic means of communication and allowing shareholders to communicate with each other without having to follow the formalities of proxy solicitation.
Introducing efficiencies into the proxy solicitation process by letting issuers communicate directly with their shareholders has been a Commission goal for a number of years now. In the 1996 Disclosure Simplification Task Force Report, the staff raised the feasibility of amending the proxy rules to allow direct issuer communication with its non-objecting beneficial owners, or "NOBOS," without going through their banks, brokers, or other intermediaries.
Such a system would be voluntary to allow those companies who wanted to experiment to do so without forcing all companies into a direct delivery regime. The Commission itself raised the question of permitting direct delivery of proxy materials to issuers' NOBOS in last year's M&A proposing release.
About four years ago, we approved a direct registration pilot program submitted by the Depository Trust Company. Today, over 235 mostly blue chip issuers offer direct registration through the DTC. Unfortunately, the system still needs improvement because transferring shares between DTC and the broker is still very paper-intensive and time consuming.
We may see other efficiencies introduced into the proxy process. We previously said that issuers may deliver a proxy card electronically to shareholders who hold shares in their own name, so long as a definitive proxy statement accompanies or precedes it. Unfortunately, state law may sometimes create problems because of signature requirements. In some states other than Delaware, New York, and California, it remains unclear whether that means a manual signature on a paper ballot.
Currently, when a company is delivering proxy materials over the Internet to its recordholders, shareholders are typically directed to print out the proxy card, fill it out, and mail it back to the company or its transfer agent. This process is obviously cumbersome. To have an effective electronic proxy voting process, shareholders must be able to complete their proxy cards online. This is, however, a state law issue right now.
The states understand this challenge and currently, over one-third have amended their corporate statutes to explicitly permit proxies to be returned electronically.
As I mentioned earlier, we have also been thinking about further liberalizing communications between management and shareholders. In the M&A proposing release that I mentioned, we proposed to expand permissible communications by companies to their shareholders and the markets during tender offers and mergers by providing a safe harbor for certain communications.
In order to use the safe harbor, all pre-filing communications would have to be filed with the Commission when first used. An investor would still have to receive the required document before responding. Public commenters have been overwhelmingly favorable on this proposal. The proposal recognizes the difficulties companies experience trying to avoid selective disclosure on an impending deal.
We noted that an expanded safe harbor could reach beyond takeover-related communications. For example, management could rely on the proposed safe harbor to learn what shareholders thought about certain issues, such as the adoption or amendment of executive and director compensation plans, an increase in the number of authorized shares to be issued, or the adoption or redemption of a shareholder rights plan.
We also floated the possibility of easing shareholder communications further by creating a broad safe harbor under the proxy rules to permit "testing the waters" communications with shareholders without requiring the filing or delivery of a proxy statement.
This possibility would, I think, primarily benefit management. Investors, of course, are now free to test the waters without a proxy card, and if they want to solicit proxy votes, they can talk to as many as ten shareholders for this purpose. Such a safe harbor might cover the types of shareholder-management discussions that I mentioned earlier at least under the proxy rules.
This idea has not been proposed just floated. We are the "testing the waters" as well. In many respects, we will be testing the statutes and existing regulatory scheme in the coming months and years to see if they can survive the test of time and technology.
Technology obviously brings with it many positive developments for investors and the Commission. It has democratized individual investors and opened up access to the markets and market information. As I discussed today, it could significantly change the investor-company relationship or at least its communications.
With these positive developments come many questions about how to make them fit into our current regulatory scheme. Do we need to tweak the system here or there or will we eventually have to make some significant changes to capture the benefits of technology?
I would encourage you here today, though, to take advantage of the technology that is available to your companies. As the Commission noted in the M&A proposing release, we believe that management's ability to disseminate more timely information may produce more informed voting decisions by increasing the amount and quality of information at shareholders' disposal. It is seeming increasingly inevitable that if management does not make an effort to communicate with its shareholders, they will certainly communicate with each other.