TASK FORCE ON SHAREHOLDER PROPOSALS
June 13, 2003
Via e-mail: firstname.lastname@example.org
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: Jonathan G. Katz, Secretary
Re: Proposed Changes in Proxy Rules and Regulations
Regarding Procedures for the Election of Corporate Directors
(Release No. 34-47778; File No. S7-10-03
Ladies and Gentlemen:
This letter is submitted by the individuals named at the end of the letter, each of whom is a member of the Task Force on Shareholder Proposals of the Committee on Federal Regulation of Securities, Section of Business Law of the American Bar Association, in response to the Commission's request in the above identified Release for comments to the Division of Corporation Finance concerning the director selection process. The Task Force was established to analyze and consider on behalf of the Committee the issues raised by the Commission's initiatives and by the proposals currently being advanced concerning changes in the regulation of shareholder proposals and shareholder participation in the director selection process.
The comments expressed in this letter represent the analysis and views of the named individuals only and not those of the Committee, the Section or the American Bar Association's House of Delegates or Board of Governors and do not represent the official position of any Association body. While the views expressed herein represent an overall consensus on the part of the named individuals, every statement herein is not necessarily endorsed by every individual.
Given the early procedural stage of the Commission's inquiry into this subject matter and the difficulty of a number of the subjects and issues discussed in this letter, we are not making specific recommendations with respect to changes in any of the Commission's regulations (including the proxy rules) or any of the federal securities laws. Rather our goals in this submission are to:
- identify what we believe are the fundamental policy issues that need to be addressed in connection with the Commission's inquiry;
- set forth alternative approaches which the Commission might consider if it concludes that changes in the proxy and other rules are desirable as a matter of public policy and investor protection;
- examine on a preliminary basis the pros and cons of each of these alternative approaches as an aid to analysis of their desirability and practicality; and
- examine on a preliminary basis the Commission's authority to promulgate revisions to the Commission's rules or to institute changes to relevant listing standards as may be pertinent to the alternatives discussed, and related state law and federalism issues.
In our view, important considerations in the analysis of the relevant issues include the following:
- Any change to be made in the director selection process should not encourage contested elections on a broad-scale basis. Widespread and ongoing contention of this kind involving public companies would be disruptive, expensive and contrary to the best interests of publicly-owned companies and investors. The consequences of such a development are difficult to predict with specificity but would likely be significantly adverse for the corporate governance system, the securities markets and the ability of companies to successfully conduct their businesses.
- When considering rule changes in this area, the Commission should address the disclosure and filing obligations of both a shareholder proponent and a director nominee with respect to their intentions regarding control of the issuer and any special interests they may have in regard to the issuer. It is important for investors to know what a shareholder proponent has in mind regarding control of the issuer and any interest or agenda it may have that may not be shared by the other shareholders. While matters of intent are inherently subjective, we believe that shareholders, nevertheless, are entitled to be informed as to the goals and plans of the proponent and its candidate(s), just as they are informed regarding the plans and intentions of the issuer and the incumbent directors. Transparency in respect of the interests, goals and plans of a director candidate is central to our disclosure system and can be provided in a manner that is not burdensome. We recommend that in the Division's report to the Commission consideration be given as to what disclosure in this area is to be required, in what timeframe and in what filings. In particular, the report should address in the context of any proposed changes in the director selection process the availability to shareholder proponents of Schedule 13G filings, "13D group" formation criteria and the need for disclosure respecting parallel action by shareholders, even where a "13D group" is not formed.
- Rule 14a-8 is not the appropriate vehicle to deal with the issues raised by enhanced shareholder involvement in the selection of directors. Rule 14a-8 has specifically defined uses and contains many exclusions. Administration of the rule is already burdensome for the Division and expanding the rule to address the intricacies of the director selection process would inevitably require increased involvement by the Division. We do consider below an approach that limits the existing exclusion in Rule 14a-8 relating to director election matters, but do so with the goal of permitting companies and shareholders to address the issues that arise in the area separately. If changes in the Commission's rules with respect to shareholder involvement in the director selection process are otherwise to be made, we believe such changes should be addressed in separate rules designed for this purpose.
- A realistic analysis of the current director selection system requires consideration of the role and impact of proxy advisors on voting decisions.
- The mechanics of shareholder voting are complex, particularly where shares are held in "street" or other nominee name. In considering amendments to the proxy rules with regard to the director selection process, we urge the Commission and the Staff to examine the current procedures closely in order to make certain that shareholders have adequate opportunity to vote and that the tabulated voting results reflect the wishes of the shareholders.
Our discussion of this subject is organized as follows:
- Observations on Fundamental Policy Issues
- Is a New Director Selection System Needed (or Are
More Focused and Incremental Changes Appropriate)?
- The Importance of Distinguishing Between "Bona Fide"
Director Nominations and "Stealth" Contests for Control
- The Importance of Maintaining Disclosure Standards.
- Eligibility Requirements for Expanded Access to
the Nomination Process
- The Voting of "Street Name" Shares
- The Principal Viewpoints Concerning Expanded
Shareholder Involvement in the Director Selection Process
- Discussion of Alternative Expanded Access Models
- Alternative I: Establish Nominating Committee Processes
For Considering Candidates Proposed By Shareholders
- Alternative II: Simplify the Process That Shareholders
May Use To Elect Shareholder Nominees in Non-Control
- Alternative III: Allot Specific Board Positions For
Nomination By Shareholders
- Alternative IV: Permit Shareholders To Use The
Company's Proxy Machinery To Solicit For Their
- Alternative V: Revise Rule 14a-8 To Allow in the
Company's Proxy Statement Shareholder Proposals
Concerning Director Election Process
- The Commission's Authority To Expand Shareholder Access
- SEC Authority With Respect To Alternatives I and III
- SEC Authority With Respect To Alternatives II, III
- State Corporate Law Issues
- Discrimination Among Stockholders and
Alternatives I, II, III, and IV
- Fiduciary Duty Requirements for the Use of
Corporate Mechanisms and Alternatives II, III
APPENDIX A: Possible Proxy Rule Modifications Relating
to Alternative II
I. OBSERVATIONS ON FUNDAMENTAL POLICY ISSUES
The proposals that have been advanced for revision of the director nomination and election process raise a number of fundamental policy issues which have implications beyond the specifics of any of the particular proposals. We believe these include the following.
A. Is a New Director Selection System Needed (or Are More Focused and Incremental Changes Appropriate)?
The threshold issue is whether a wholesale change in the current rules relating to the nomination and election of directors is required or should only more incremental changes be considered. This is not a simple inquiry for a number of reasons, including the following:
- First, the proxy and disclosure rules deal with only a part of the director nomination and election process. Listing standards for listed companies (a large part of, but hardly the entire, universe of public companies), state law and individual corporate charters and bylaws play a large and in many ways dominant role in the process. Notably, the state law provisions regarding the nomination and election of directors are part of a system of standards that include the fiduciary duties of directors and thus cannot be assessed separately.
- Second, there is no consensus about the goal to be achieved in revising the director selection process. For some it is about "shareholder democracy," for others the economic purpose of the modern corporation, for others the allocation of authority between boards and shareholders, for others the proper regulation of the power to influence corporate policies and decisions, for others a means of creating a solution to the perceived psychological proclivity of managers to seek the like-minded as directors, for others finding an antidote to corporate fraud and mismanagement.
- Third, the debate is mostly about ideas and theories of corporate governance, with little data to support or discredit the various arguments and points of view. For example, it is difficult to demonstrate empirically that direct shareholder nomination of directors in any form will have a specific effect on corporate performance, let alone that the effect will be "good" or "bad". Similarly, even if it were established that a specific director nomination process more often than not led to disagreement and potential dissension in the board room, would that be beneficial or detrimental to corporate performance?
- Fourth, any revisions to the director selection process must be considered in the context of the diversity that exists among the roughly 14,000 publicly-owned companies, which vary greatly in size, industry, complexity, resources, ownership and other circumstances, and the thousands of individuals who serve as their directors.
- Fifth, changes in the director selection process should be considered in light of current technological advances, particularly with respect to the use of the internet and the increased availability of electronic communication.
Given these considerations, we suggest that any changes in the Commission's regulations in this area should have clearly specified goals, be adopted only after a full opportunity for interested parties to consider and comment on the goals and the means for achieving them and be implemented over a timeframe that will be sufficient to reduce the likelihood of unintended consequences.
B. The Importance of Distinguishing Between "Bona Fide" Director Nominations and "Stealth" Contests for Control
Any reform in the director nomination and election processes should be limited to situations in which the proponent of a director candidate (as well as the candidate) is not seeking to change control of the corporation or to effectuate a business combination or other corporate or ownership transaction or to otherwise influence control over the corporation's business and affairs. Existing systems of regulation appropriately address change of control, change of ownership and business combination transactions. Changes in the director selection process should not be made which would indirectly alter in any fundamental way the processes by which such transactions may be effected or sidestep the regulatory requirements applicable to such transactions. The key issue is how to distinguish nominations by shareholders who seek to improve the makeup of the board from efforts to exercise or influence control over the company's business and affairs.
A starting point would be the intent standard used to distinguish when a Schedule 13D, as contrasted with Schedule 13G, beneficial ownership report is required - that is, access to a revised nomination or election process would be limited to proponents and nominees who did not have an intent to change or influence control. However, the intent of the nominating party and the nominee may not be a sufficient criterion because of the difficulty of separating an intent to improve board performance from an intent to influence control in more far-reaching ways. (What other motive would prompt a nomination other than a desire to change or influence how the board exercises its governance role and how the corporation is managed and operates? When does a motive to improve the management and operations of a company become a motive to control (or divest) specific operations?). Another significant problem with an intent standard is that it does not deal with the risk that multiple nominating parties and multiple nominations made under a revised director selection process could produce a change in control without providing investors with the protections customarily afforded them in a change of control situation.
Moreover, it may be difficult to determine eligibility to participate in an enhanced access process based on the difference between shareholders acting in concert (which would trigger "13D group" consequences) and shareholders acting independently but in parallel (which presumably would leave shareholders eligible to file the less extensive Schedule 13G reports). Disputes over group formation and intent, and related reporting obligations, would, we believe, be frequent because of the incentives which both shareholder proponents and incumbent management and directors have to marshal shareholder support in the context of an election contest. These disputes, in turn, probably would lead to frequent litigation (e.g., concerning whether the role of shareholder organizations, persons maintaining "shareholder" websites or other intermediaries who facilitated parallel action by shareholders led to the formation of a "group," at least for purposes of making those shareholders ineligible to report on Schedule 13G or to use an expanded access rule).
Accordingly, we suggest that any proposed regulatory change that is intended to increase shareholder participation in the director selection process deal with these issues directly. One possibility to consider is to limit the number of board positions to which any enhanced access proposal may be applied.
C. The Importance of Maintaining Disclosure Standards.
Some proponents of expanded shareholder involvement in the director nomination process argue that the current proxy rules dealing with election contests are too complicated and require unnecessary and inappropriate disclosure, at least in situations not involving a classic contest to replace an entire board. While some revisions in non-control elections may be reasonable, we think it is mandatory that any proxy rule revisions not abandon or undermine the core disclosure principle enunciated in Rule 14a-9 and its underlying standard of materiality, which is based on the relevance of information to a shareholder's voting decision. We believe that arguments based on greater convenience or less expense do not justify lowering the standard for determining the information that is made available to shareholders or instituting separate disclosure requirements for some but not all nominees.
D. Eligibility Requirements for Expanded Access to the Nomination Process.
However formulated, a provision designed to expand shareholder access to the director nomination process will raise the question of which shareholders should be entitled to utilize the expanded access process to put forward a candidate - should all shareholders, no matter how small or recent their shareholding, have the same expanded access right?
If there are no eligibility standards, expanded access has the potential to overwhelm the nomination/election process with numerous candidates, many of whom would have no chance for election and many of whom might not be suitable for election. We do not think a system that would result in annual balloting for directors involving many nominees for each position will be manageable from the standpoint of shareholders casting votes, nor will it improve corporate accountability. The disclosure documents would inevitably be longer and more complicated and keeping the names of the players and their credentials straight, let alone dealing with inevitable profusion of positive and negative solicitation material, will at best be challenging for shareholders and at worst cast disrepute on a process which provides too many alternatives - and may even diminish the significance of nomination of those who are not part of the board of directors' slate. The existing proxy rules, as amended in 1992, already permit shareholders to solicit proxies in favor of a "short slate" of candidates, rather than requiring, in effect, that a nominee be presented for each directorship to be filled. Adding to this existing flexibility an unqualified ability to nominate candidates risks overwhelming the shareholder voting process.
Even if the expanded access reform relied on a screening body, such as the nominating committee, to weed out inappropriate nominees or to reduce the number of nominees to a manageable level, we must be cognizant of the burdens that could result from an unfettered right to nominate. If every shareholder were to have the right to force consideration of any number of candidates, it is not farfetched to be concerned about imposing on the nominating committee the obligation to make decisions on tens or perhaps hundreds of candidates.
Frequently mentioned eligibility standards include both a minimum number of shares held, computed either in dollar value or as a percentage of voting securities, and a minimum holding period. Rule 14a-8 recognizes a need for some limitation on shareholder access to a company's proxy statement with respect to non-election proposals and contains such an eligibility standard. We are concerned, however, that this standard may be too low in the context of expanded access to the director nomination process. On the other hand, some proponents of expanded access argue that an eligibility standard pertaining to the election of directors would raise significant issues about discrimination among shareholders, possibly contravening state law policies (as we discuss below), and would be inappropriate as a matter of federal policy. Accordingly, some balancing of objectives is necessary in addressing this subject.
With regard to the policy implications of eligibility standards, the most frequent arguments center around two related propositions. The first is that it is somehow "unfair" or "undemocratic" to impose any limits on the right of shareholders to nominate directors. The other is that eligibility standards based in whole or part on the size of the shareholding favor the "wealthy" or the "big" shareholder at the expense of the proverbial "man in the street." These arguments depend on an unstated premise that corporate governance should be based on a political model. A corporation, however, is not a polity. Its purposes and its effects are quite different. No one is required to be a shareholder. The modern publicly held corporation is primarily an economic entity whose function is to create wealth for its owners (institutional or individual). The distribution among shareholders under corporate law of voting power and the right to receive dividends reflect this. Moreover, state corporate law has long permitted variation between the equity interest shares represent and the voting power accorded the shares. As a result, any meaningful discussion of appropriate corporate governance mechanisms must at a minimum acknowledge the nature of the corporation as a commercial enterprise and the governance structure necessary to the accomplishment of its mission. Put another way, the debate should not center on whether, by misplaced analogy to the political process, a proposed change is more or less "democratic" but, rather, whether the proposal will contribute positively to the achievement of the function of the corporation.
In sum, we believe the policy arguments against meaningful eligibility standards are not persuasive. To the contrary, the policy goals of promoting efficiency in the operation of the corporate entity in furtherance of its primary economic goal and of promoting a director nomination and election process that will be functional and relatively easy to apply dictate that any expanded access rule include meaningful eligibility standards.
E. The Voting of "Street Name" Shares
An issue that is sometimes raised in the discussion of expanded shareholder participation in the director nomination process is whether it would be appropriate under such a system to permit brokers to vote without specific client instruction proxies for shares they hold of record or through a nominee for the benefit of their clients (in "street name"). This issue raises a number of difficult considerations.
Rule 452 of the New York Stock Exchange, a "rule" applicable to member firms of the exchange and approved by the Commission as a self-regulatory measure, covers discretionary voting by member organizations. There is pending a proposal by the New York Stock Exchange to modify the Supplementary Material to the Rule by adding a specific restriction that a proxy may not be given without instructions where the company seeks to authorize the implementation of any equity compensation plan or any material revision thereto. Discretionary voting has long been prohibited in a number of circumstances where a vote is contested, which include election contests. Such contested votes also include a matter that is the subject of a counter-solicitation or is part of a proposal made by a shareholder that is being opposed by management. Nasdaq has no such rule but as a practical matter the NYSE requirements affect Nasdaq-traded securities because Rule 452 applies to all member organizations and is not based on the listing of the securities which a member firm trades.
The interpretation of Rule 452 in the context of a contested election that occurs as a result of an expanded access rule will have great significance to and impact on the current proxy voting system. We presume that, if discretionary broker voting were to be barred in connection with an expanded access alternative, this would only be where there are multiple candidates for a specific seat on the board, consistent with the current rules for election contests. However, we have earlier postulated that any expanded access reform should be limited to non-control situations. Assuming this to be the case, there would be an important difference between the effect of the current discretionary broker voting rules in expanded access contests from their effect in traditional contested elections. Investors may hold and vote their shares directly and may instruct their broker as to how to vote shares held by it in street name and, thus, may avoid discretionary broker voting if they wish to do so. A large number, if not most, "street name" owners of stocks today understand that, if they don't provide voting instructions for the shares they beneficially own, their shares will be voted in favor of management's recommendations, except in the context of a traditional contest for control, which is usually a well-publicized occurrence. Changing this decades-old practice will likely lead to the unintended disenfranchisement of a large group of shareholders in expanded access contests, at least for an extended period of time. Indeed, there is risk that a change in practice in this area could have the consequence of skewing the outcome of shareholder votes by enhancing the influence of institutional holders at the expense of individual "street name" holders.
Broker discretionary voting in the context of an enhanced access proposal is only one aspect of a broader issue concerning the voting of shares held under arrangements that separate the ultimate beneficial owners of the shares from the voting of the shares, particularly in the context of collective investment vehicles. If it is to become a goal of federal securities regulation to ensure that in some or all circumstances beneficial owners of shares have a direct franchise without intermediation by their fiduciaries, the issue should be addressed in general, not only in the context of shareholder participation in the director election process.
F. The Principal Viewpoints Concerning Expanded Shareholder Involvement in the Director Selection Process.
There are a variety of possibilities for revising the proxy rules and, in some cases, listing standards to address expanded shareholder involvement in the director selection process. Without endorsing any of them, we examine below five alternatives that we believe cover the spectrum of realistic alternatives. Each, of course, has its own pros and cons, particularly in relation to the others. There are, however, differing viewpoints from which to assess the alternatives and we believe that recognition of these viewpoints is important in identifying their respective benefits and detriments.
Arguments for Expanded Shareholder Involvement:
Viewpoints that favor expanded shareholder involvement in the director selection process usually are based on one or a combination of the following views:
- The existing process for nominating and electing directors is dominated by management (often the chief executive) -- management is considered to control the search process and as a practical matter the nomination process. Independent director participation by a nominating committee and/or the full board is at best sporadic and tangential, more in the nature of ratification than selection. The practical result is that directors perceive themselves to owe their position to the company's executives, not the shareholders, undercutting effective management oversight by boards of directors.
- Even where management does not dominate the process, shareholder interests are often not sufficiently considered in the director nomination process. Even where formally independent, most directors are, psychologically if not in terms of other relationships, aligned with management and do not act with sufficient independence in considering potential nominees for director.
- Whatever the source of the deficiency, there have been too many egregious examples of boards that have failed to provide effective oversight of management for anyone to continue to believe that the current system, or any modest modification to the current system, will produce boards that will effectively oversee management and act as a voice for shareholders in the board room.
This viewpoint leads to a focus on mechanisms that will assure that shareholders will have an opportunity to vote regularly on candidates who are not selected by management or an incumbent group of directors. It emphasizes formal shareholder rights and discounts the value of the informal processes available to shareholders to influence boards in selecting a slate of nominees. It minimizes the significance to the effective governance of a company of a lack of collegiality in the boardroom and seeks through changes in the director selection process to assure more robust monitoring by directors of management, even at the expense of increased dissonance in the board room.
Arguments Against Expanded Shareholder Involvement:
Viewpoints that disfavor expanded shareholder involvement in the director selection process usually are based on one or a combination of the following views:
- Most expanded access proposals ignore the significant reforms to corporate governance that have been instituted in recent years. "Best practice" guides have proliferated recently and are having a significant impact on how directors think and act, with important consequences for corporate governance. In addition, extensive procedural and structural revisions in corporate governance and management responsibility have been mandated by the Sarbanes-Oxley Act of 2002 and its implementing rules. Further changes are imminent as a result of the new corporate governance listing standards of the New York Stock Exchange, the Nasdaq Stock Market and the American Stock Exchange now pending before the Commission. Included among these provisions are new requirements regarding independent director control of the nominating process and disclosure of the independent directors' role. These reforms, the most sweeping since at least the New Deal enactment of the basic federal securities laws, are just coming into place and it is important that they be given the opportunity to function before being superseded by other approaches to regulation of the director selection process. It is premature to judge these extensive reforms as inadequate and to embark now on another round of regulatory changes in an area as complicated and sensitive as the director selection process would detract from the efforts that need to be made to implement the current reforms.
- It is far from clear that expanded access will achieve the articulated goals of its proponents. The ability to nominate does not ensure an ability to elect. The history of proxy contests shows how difficult it is to elect directors in opposition to management's nominees, even where significant economic and control issues are the linchpin of an election contest. This is not principally a function of any inefficiency in the proxy regulatory process but is reflective of the nature of the securities markets, which put a premium on liquidity and investor confidence. Many shareholders who lack confidence in a company's management and board of directors will not take the time and incur the risk of market loss by holding the shares and incurring the expense associated with participation in the director nomination process or in a contested election. The exceptional cases are already adequately addressed by the current regulatory system. (Proxy contests for control are not rare; there have been each year for many years, with regularity, a modest but consistent number of election contests. New mechanisms to increase on a routine basis shareholder participation in director selection will not be worth their costs because they will not likely result in significant numbers of shareholder-nominated directors being elected. Nor is it clear that, if elected, the new directors will make a positive difference in the governance and culture of the company in question. .
- Expanded access risks destabilizing corporate boards and threatening their cohesion and effectiveness. The more appropriate regulatory policy is to preserve and strengthen board effectiveness, consistent with the governance reforms currently being implemented under the Sarbanes-Oxley Act and pending revisions in listing standards. Expanded access processes will likely distract the company's management and board and result in additional costs to the company. Management and the incumbent board may feel threatened and defensive about a expanded access nominee and the likely reaction in many instances will be an attempt to rally shareholders against the equal access nominee and in favor of the incumbents. This implies the equivalent of a full-scale election contest, at least from the company's side, replete with multiple mailings, institutional investor road shows and full page newspaper fight letters. The costs and distractions to companies - and their shareholders - of election contests on a regular basis far exceed the speculative benefits of expanded access.
- Effective, independent directors or director candidates may opt-out of board service if they perceive a risk of being unseated in favor of an expanded access candidate. Loss to an expanded access candidate will be perceived to have reputational and ego consequences unrelated to the merits of the event. This may be true even if the incumbent has not been specifically targeted by the proponent of an expanded access nominee, and likely will be the case if directors perceive they can too easily become specific targets either by reason of their service on the board in question (e.g., a campaign to unseat members of the compensation committee) or, perhaps worse, for their conduct in other contexts (e.g., membership on the board or board committee of another company that invokes the ire of an expanded access proponent). Any aversion to service on boards under an expanded access system would run counter to the increased importance and role of independent directors under the Sarbanes-Oxley Act and related reforms and the pressing need to attract the most highly qualified candidates for independent directors.
II. DISCUSSION OF ALTERNATIVE EXPANDED ACCESS MODELS
As a starting point for analyzing possible proxy rule changes we have identified five basic approaches to expanding shareholder involvement in the director selection process. Each would provide shareholders of public companies an opportunity for greater participation, but balances in different ways the competing considerations raised by any effort to do so. For this reason, our discussion assumes that each would be implemented by itself and not in tandem with any other alternative. Some of these alternatives use the related mechanism of listing standards, along with proxy rule revisions, to achieve greater shareholder involvement, consistent with the historical practice for addressing corporate governance matters. While we recognize that these five approaches are not the only possibilities, they are intended to frame fairly the spectrum of proxy rule revisions that are likely to be addressed by commentators.
A. ALTERNATIVE I: Establish Nominating Committee Processes For Considering Candidates Proposed By Shareholders
- In this approach, the NYSE and Nasdaq listing standards regarding nominating committees (as currently proposed) would be amended to require that the nominating committee establish, disclose and administer a process for considering candidates presented by any "eligible shareholder" and for reporting to shareholders on this process. The proxy rules would be amended to require appropriate disclosure about these processes in the company's annual proxy statement for the election of directors. (Non-listed companies that have publicly traded equity securities that vote in the election of directors would be required to disclose the process they follow regarding such matters even though not required by listing standards to establish any particular process.)
- Eligible Shareholder: At Least a Minimum Level of Shareholding and No Control Intent: For a company to be obligated to consider a shareholder's candidate(s) under the required process, the shareholder would be required to meet certain minimum standards respecting the amount and duration of its shareholding and could not intend through the election of its candidates or otherwise to influence control of the company, alone or with others, or be presenting its candidate(s) for nomination as part of any plan or program to cause a business combination involving the company or a material change in ownership of the company (and would be required to so certify).
- Submission of Pertinent Information: The shareholder proponent would be required to submit pertinent information regarding its candidate(s), each of whom would be required to confirm his or her willingness to serve as a director if elected, and the proponent's and candidate's beneficial ownership of securities of the company, relationships with the company and intentions regarding the company. The shareholder could also include with its submission a statement of its reasons for proposing a candidate.
- Deadline for Submissions of Candidates: A reasonable deadline would be established (and disclosed by the company) so as to provide adequate time for the committee to consider shareholder candidates with other candidates the committee might identify, to respond to a shareholder proponent regarding its candidate (as further discussed below) and to make timely nominations for a slate of directors to be elected at the annual or other meeting of shareholders.
- Nominating Committee Diligence on Candidates: The committee would conduct such diligence on the candidates proposed by shareholders (such as meeting with the candidates) as it considered appropriate; candidates would be required to cooperate in order to be considered.
- Report on Candidates Considered: The committee would issue a report, which would be provided to shareholders who propose candidates and published in the proxy statement for the election of directors, indicating the number of candidates proposed by eligible shareholders, describing the process it followed in making nominations (including the committee's use of any professional director recruitment firm or other advisors, where material to the process) and the criteria it applied in making nominations. It would not be required to include personal information concerning any candidate or its reasons for not selecting a candidate proposed by a shareholder or for selecting one candidate over another. Notice of the committee's decision on proposed candidates would be provided to shareholder proponents in a timely manner so that a proponent who was dissatisfied with the committee's conclusions would have the opportunity of nominating and campaigning for its own candidate in the customary manner.
- Pro: would enhance, and provide a mechanism for testing the effectiveness of, the independent nominating committee system now being initiated as a marketwide standard;
- Pro: would "open up the process" by providing a regular and transparent mechanism for shareholders to interface with the independent nominating committee and in cases where shareholders propose appropriate candidates would likely often lead to a negotiated slate of board nominees, avoiding the disruption of election contests; this is likely because the committee would necessarily have to deal with the influence which proponents could have in the election of directors (which include the potential for a shareholder proponent to nominate and campaign for its own candidate(s) in the customary manner or to withhold its vote from the board's nominees, publicize its views on them and/or support any candidates nominated by any other shareholder proponent);
- Pro: would require only a minimal federal regulatory involvement in corporate governance matters traditionally regulated by the states;
- Pro: would continue to position the nominating committee to protect and further the corporate and shareholder interest in those circumstances where election of a shareholder proponent's candidate would threaten or disadvantage the corporate interest or the interests of shareholders generally or where other factors, such as the mix of skills and backgrounds among board members or the qualifications of other candidates, lead the committee to reject the candidates proposed by eligible shareholders;
- Con: does not provide a shareholder proponent with any greater legal right to nominate a director than the current system;
- Con: may have currently unpredictable consequences on the process by which boards of directors are assembled, possibly lessening companies' ability to achieve a board composition that includes an optimal mix of backgrounds and skills and appropriate continuity in service among its directors; and
- Con: may disincentivize from continued board service incumbent directors who would worry about being rejected by the nominating committee not for performance-based reasons but rather as a result of "political horse trading" with shareholder proponents of director candidates, a risk that could itself adversely alter the cohesion and effectiveness of boards.
B. ALTERNATIVE II: Simplify The Process That Shareholders May Use To Elect Shareholder Nominees In Non-Control Contests.
C. ALTERNATIVE III: Allot Specific Board Positions For Nomination By Shareholders.
- Under this approach, NYSE, Nasdaq and other exchanges would amend their listing standards so as to require that the nominees for a certain number of board seats ("allocated seats") be selected, on a favored or exclusive basis, by or with the participation of eligible shareholders, subject to the nominee being acceptable to the committee.
- Shareholder Nomination Would be Favored For Only a Limited Number of Seats: The number of allocated seats to which such nomination requirements would apply would be determined by the board and appropriately disclosed (and in any event would be less than a majority of the independent directors). Generally, at least one seat up for election at each annual meeting would be subject to these nomination requirements. Members of management and individuals affiliated with management (to be defined) would not be eligible to be nominated for an allocated seat.
- Eligible Shareholders -- At Least a Minimum Level of Shareholding and No Control Intent: The same eligibility requirements as discussed in the case of alternative I would also be appropriate here.
- Deadline for Submissions of Candidates: A reasonable deadline for submission of nominations would be established, in accordance with the same criteria discussed above in the case of alternative I.
- Submission of Information: The same informational requirements as discussed in the case of alternative I would also be appropriate here.
- Nominating Committee Diligence on Candidates: The committee would do such diligence on the candidates proposed by shareholders (such as meeting with the candidates) as it considered appropriate; candidates would be required to cooperate in order to be considered.
- Nominating Committee Acceptance of Shareholder Candidates or Nomination of Alternative Candidates: The company's independent nominating committee would have ultimate responsibility for selecting the individuals who would be nominated for the allocated seats. If more candidates than the number of allocated seats are proposed by eligible shareholders in accordance with this procedure, the nominating committee would select among such candidates. The committee, in its discretion, could decide not to nominate any such candidate if it determined that it was not in the best interests of the company and its shareholders to do so in light of all the circumstances (including in consideration of the overall composition of the board). If the nominating committee determined to nominate a candidate proposed by an eligible shareholder, the candidate would be included in the company's proxy statement and on its proxy card in the same way as any other nominee of the committee. If the committee decided not to nominate any of the candidates who has been proposed by shareholders in accordance with this procedure, then the committee would be required to advise each eligible shareholder who submitted a candidate of its decision and the company's proxy statement would be required to disclose the number of candidates submitted by shareholders in accordance with this procedure and that no such candidate was nominated by the committee.
- Treatment of Allocated Seats: The board or, if delegated to it, the nominating committee would determine if the allocated board seats are to be reserved exclusively for shareholder-nominated candidates. If it did not reserve particular seats for shareholder nominees, and if no shareholder nominated candidate is endorsed by the nominating committee, the committee would be free to make a nomination of its own for such seats. If the allocated seats are reserved exclusively for shareholder nominees, and no shareholder nominee is endorsed by the committee, no director would be elected to fill those seats (unless and until a shareholder nominee was elected to such a seat at a future director election), but such position would not be considered "vacant"(i.e., the size of the board would be adjusted appropriately).
- All Directors the Same: Except for the procedure by which candidates for the allocated seats are vetted for nomination by the nominating committee, the directors elected to hold allocated seats would have the same roles and responsibilities under state and federal laws as the other directors and no such director would be considered as a representative of the shareholder who nominated him or of any other shareholder or group of shareholders.
- Pro: significantly favors the election of some directors nominated by shareholders, making the company's proxy statement available for such purpose;
- Pro: does not result in multiple nominees for a single position on the board (and thereby avoids incumbent director concern about being dropped from the board by the nominating committee in order to make room for a shareholder nominee or about having regularly to stand for election in a contested election);
- Pro: would continue to position the nominating committee to protect and further the corporate and shareholder interests in those circumstances where election of a shareholder proponent's candidate would threaten or disadvantage the corporate interest or the interests of shareholders generally or where other factors, such as the mix of skills and backgrounds among board members or the qualifications of other candidates, lead the committee to reject the candidates proposed by eligible shareholders;
- Con: does not provide a shareholder proponent with any greater legal right to nominate a director than the current system;
- Con: may have currently unpredictable consequences on the process by which boards of directors are assembled, possibly lessening companies' ability to achieve a board composition that includes an optimal mix of backgrounds and skills and appropriate continuity in service among its directors; in particular, this process could disincentivize from continued board service incumbent directors who would be concerned about potential rejection by the nominating committee not for performance-based reasons but rather as a result of "political horse trading" with shareholder proponents of new nominees; a risk that could itself adversely alter the cohesion and effectiveness of boards;
- Con: may promote divisiveness on boards, as a result of directors being nominated by special interests and/or being perceived to represent the shareholder proponent or group who nominated them, effectively as if a separate class of director;
- Con: would require a complex determination as to the shareholders or group entitled to take advantage of this process; presumably, the nominating committee would make any discretionary determination as to shareholder eligibility;
- Con: would raise significant implementation issues, including issues regarding the extent of the Commission's rulemaking authority and federalism concerns - e.g., limitations on the listing standards that may be required under the Business Roundtable case; the permissibility of the contemplated nomination process under state law. (See the discussion of "Commission Authority to Implement Expanded Access" below.)
D. ALTERNATIVE IV: Permit Shareholders To Use The Company's Proxy Machinery To Solicit For Their Nominees.
- Under this approach, subject to eligibility, timing and disclosure requirements, shareholders would be granted the right to have their nominees identified in the company's proxy statement, to include in the company's proxy statement a supporting statement of defined length (some would argue of a length equal to management's supporting statement) and to have a proxy card in favor of the election of a shareholder nominee included with the company's proxy mailing.
- Eligible Shareholders - At Least a Minimum Level of Shareholding and No Control Intent: The same requirements discussed under alternative I would also be appropriate here. The significance of the rights to benefit from corporate assets that would be given to an eligible shareholder under this alternative strongly suggests imposing standards respecting the amount and duration of shareholdings substantially higher than the Rule 14a-8 standards.
- Submission of Pertinent Information: The shareholder proponent would be required to submit pertinent information regarding its candidate(s), each of whom would be required to confirm his or her willingness to serve as a director if elected, and its beneficial ownership of shares and relationships with the company and intentions regarding the company. As noted above, the shareholder proponent would also be permitted to include a statement in support of its nominee(s) of not more than a prescribed maximum length for inclusion in the company's proxy statement at the time when the proxy statement otherwise is ready to be mailed.
- Deadline for Submissions of Candidates: A reasonable deadline for the submission of candidates would be established so as to permit timely inclusion of shareholder candidates in the company's proxy statement.
- Limitation on Number of Candidates of Any One Shareholder Proponent: A limitation would be imposed on the number of nominees that any one shareholder proponent (or group of affiliated proponents) may propose for inclusion in the company's proxy materials, e.g., not more than one nominee unless the shareholder owns a larger percentage of the outstanding shares than one divided by the number of positions on the board.
- Limitation on the Total Number of Shareholder Nominees: A limitation would be imposed on the number of board seats for which nominations made by eligible shareholders in accordance with this procedure are to be included in the company's proxy materials, along with a means of selecting which among the shareholder nominations would be included.
- Pro: would assure shareholder proponents that their candidates would be voted on by shareholders generally, while reducing the costs to a shareholder proponent of supporting its candidate;
- Pro: would largely separate the director election process from the influence, by virtue of the nominating process, of the incumbent board of directors, but would also disable the nominating committee from protecting and furthering the corporate and shareholder interests in those circumstances where a directorship for a shareholder proponent's candidate would threaten or disadvantage the corporate interest or the interests of shareholders generally;
- Con: would be subject to abuse by shareholder proponents seeking to influence a change of control or having a special interest; also, would create significant disclosure and accountability issues relating to the effects on other shareholders of "control blocks" formed as a result of coordinated or parallel action by shareholder proponents;
- Con: might cause confusion among shareholders in regard to which nominees are supported by the incumbent board and which are supported by shareholder proponents (and which shareholder proponents support which candidates, where there are multiple ones, as seems likely to occur) because shareholders would receive one mailing relating to more candidates than positions;
- Con: would likely result in most director elections being contested, significantly increasing for corporations the overall costs of director elections (and increasing also the costs of appropriate SEC oversight of contested elections and possibly generating substantial litigation over eligibility), and producing on a commonplace basis the substantial disruption of corporate affairs caused by election contests;
- Con: would dissuade from board service individuals who would be excellent directors but who are not prepared to stand for election in a contested election (at least, in term of routine expectations);
- Con: might trivialize (and make more difficult) contested elections for control, reducing effective shareholder input in the director election process in the instances where this may be most important;
- Con: would complicate the assembly of boards having an optimal mix of backgrounds and skills;
- Con: may promote divisiveness on boards as a result of directors representing special interests.
E. ALTERNATIVE V: Revise Rule 14a-8 To Allow In The Company's Proxy Statement Shareholder Proposals Concerning the Director Election Process.
- Permit Shareholder Proposals Regarding the Director Election Process: Under this approach, Rule 14a-8(c)(8) would be revised so as to permit proposals establishing procedures for director nominations or otherwise relating to the election of directors. Such proposals might be precatory in nature or mandatory in nature, as permitted under the applicable corporation law. Shareholder proponents would thereby be able to bring to a shareholder vote in a simple and cost-effective manner a proposal for regulating the nominating and election process in a manner customized to the circumstances of the company and shareholders by adopting such proposals may be able to shape the company's nominating and election process.
- No Relaxation of Disclosure Requirements or Procedural Protections: Persons nominating directors pursuant to any process implemented pursuant to such a proposal would be subject to the proxy and other applicable rules, just as all other proponents and nominations would be. (A proposal that attempts to provide for a process that would excuse any nomination or shareholder proponent or the company from any of the proxy rules, or other SEC rules, would continue to be excludable under Rule 14a-8(c)(2) or (3).)
- Limited Exclusion of Proposals That Would Produce Election Contests: However, to preserve the integrity of the director election process and regulation thereof, a limited subcategory of shareholder proposals relating to the election of directors would continue to be excluded under Rule 14a-8(c)(8):
- Pro: avoids the government mandating a one-size-fits-all governance (director nomination/election) model in an area in which there is little or no experience and as to which there is substantial disagreement on policy goals.
- Pro: avoids the difficulty (and risks of over- or under-inclusiveness) of establishing different eligibility rules for some proponents or nominations than for others; the same rules would apply to all categories of proponents and nominations.
- Pro: requires a showing of substantial shareholder support at a particular company before the company would have to consider a change in its nominating/election process;
- Pro: continues to leave to state law the issue of whether a shareholder proposal regarding the nomination or election process can be binding on the company, or must be articulated as a precatory proposal; the SEC could decide as a policy matter that, if the company and proponent disagree as to the legality of a binding proposal and each provides a legal opinion supporting their position, the SEC will take no position on the exclusion; and
- Con: would lead to a confusing welter of rules and procedures for shareholder nominations; this would impose substantial burdens on proponents who would require significant expertise to sort through state laws and corporate charters and by-laws and determine how in any given case a shareholder nomination might be made and prosecuted; ultimately, the lack of uniformity would discourage shareholder nominations and make them more costly and more cumbersome.
III. THE COMMISSION'S AUTHORITY TO EXPAND SHAREHOLDER ACCESS.
The authority of the SEC to implement each of the alternatives discussed above, and the appropriate role to be played in implementation by listing standards (which require SEC approval and may in certain circumstances be required by the SEC), warrants examination.1 In addition, there are federalism issues which should be considered in determining the respective roles of the federal and state governments in implementing the alternatives. For discussion purposes, set forth below are some basic considerations respecting SEC authority and federalism concerns that pertain to the alternatives. A definitive examination of authority and federalism issues should accompany any rules proposed by the SEC or other initiatives by the SEC to implement expanded access proposals.
A. SEC Authority With Respect to Alternatives I and III
Alternatives I and III would each require the adoption of new listing standards by the exchanges and Nasdaq (the "SROs"), for which approval of the SEC would be required pursuant to Section 19 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The SEC's authority over a listing standard differs depending on whether the standard is proposed by the SRO or whether the standard is imposed by the Commission. Standards proposed by the SROs themselves need be "consistent with the requirements" of the Exchange Act applicable to the SROs (Section 19(b)). Standards imposed by the Commission on the SROs must be "necessary or appropriate... in furtherance of the purposes" of the Exchange Act (Section 19(c)).
When considering whether a rule proposed by an SRO meets the "consistency" test of Section 19(b), courts have repeatedly held that Sections 6(b) and 15A(b) of the Exchange Act set forth the "requirements" of the Exchange Act "applicable" to the SROs.2 Of these requirements, the provision that SRO rules may "not be designed to permit unfair discrimination between... issuers..."3 is the only provision that, on its face, is applicable to SRO rules affecting issuers (as opposed to exchanges, members or their associated persons). There is a point of view that the only limitation on an SRO's authority to adopt rules affecting issuers (i.e., the only instance in which the Commission could reject an SRO-proposed rule) is when such rule violates this "unfair discrimination" prohibition. Another view is that consistency with other Exchange Act provisions may be required with respect to a particular standard.
In Business Roundtable v. SEC, the D.C. Circuit Court of Appeals abrogated a corporate governance listing standard adopted by the Commission pursuant to Section 19(c) (Rule 19c-4) on the ground that it sought to "directly control the substantive allocation of powers among classes of shareholders" and was therefore "in excess of the Commission's authority under Section 19."4 The court held that the rule was not "in furtherance" of any of the "purposes" cited by the Commission. Moreover, the court concluded:
[A validation of the Commission's adoption of Rule 19c-4] would... overturn or at least impinge severely on the tradition of state regulation of corporate law... We read the [Exchange] Act as reflecting a clear congressional determination not to make any such broad delegation of power to the Commission.5
While Business Roundtable rejected SEC authority under Section 19(c), there has been no judicial consideration of the SEC's authority under Section 19(b). Inasmuch as the currently proposed governance listing standards are being submitted by the SROs under Section 19(b), the exercise of SEC authority regarding them must satisfy the consistency test. The extent to which the rationale of the Business Roundtable opinion extends to Section 19(b) bears upon federalism issues and any preemption by the Congress of specific corporate governance measures.
We recognize that the enactment of Sarbanes-Oxley Act of 2002 may expand in specific cases the "purposes" of the Exchange Act under Section 19(c) and may otherwise affect the SEC's authority under Section 19(b). It is, however, noteworthy that the Congress did not in that Act preempt state law except insofar as it mandated that the SEC require the SROs to adopt listing standards respecting audit committees which meet specified criteria. Accordingly, this may signify a limited intent by the Congress with respect to preemption of state law in the context of listing standards.
B. SEC Authority with Respect to Alternatives II, IV and V.
The implementation of Alternatives II, IV or V (and in certain limited respects, Alternatives I and III) would require SEC rulemaking concerning the proxy solicitation process. The SEC's authority over proxy solicitation is derived from Section 14(a) of the Exchange Act, which empowers the SEC to adopt rules which it deems "necessary or appropriate in the public interest or for the protection of investors."
Rule 14a-8, which was first promulgated in 1940, provides to shareholders a vehicle for expressing their views on corporate governance, social policy and other matters that are within the scope of the rule. There are numerous exclusions, including one on the use of the rule in connection with the election of directors. While these exclusions have changed somewhat over the years, the exclusion regarding the election of directors has been a part of the rule virtually from inception. Alternatives II and IV would specifically affect the director election exclusion under Rule 14a-8. Alternative V would modify the SEC interpretation of that exclusion with respect to the election process but does not eliminate the exclusion with respect to shareholder nominations.
Apart from the issue of whether Rule 14a-8 is an appropriate vehicle for addressing shareholder proposals regarding the selection of directors, amendment of the proxy rules to permit greater shareholder involvement in the director selection process would require a finding that the amendment is necessary or appropriate in the public interest. In considering this, it should be recognized that preemption and federalism issues may arise as to whether a specific amendment providing for open or limited access of shareholders to management's proxy statement would impinge on the statutory power of the board of directors to supervise the management of the corporation's business and to perform its fiduciary duties to shareholders, as provided by state corporate law. However, it must be kept in mind that the SEC undoubtedly has the authority to adopt appropriate rules regarding the solicitation of votes for the election of directors, as it has done with respect to contested elections of directors under Rule 14a-12.
C. State Corporate Law Issues
The solicitation of proxies for the election of directors involves a unique interaction between state and federal law. There is a point at which federal regulation of the solicitation of proxies may impinge on state substantive law and raise federalism issues, even if the federal regulation is limited to addressing procedural aspects of and disclosures in the context of solicitations. Exactly where that line exists has not been clearly delineated, and the state laws implicated will vary depending on the nature of regulation that the SEC proposes. However, it is possible that regulations which are similar to those now existing under Rule 14a-8 may be analyzed differently under state law when they substantively affect the election of directors, given the significance under state corporate law of the director selection process. 6
This is a complex subject but requires close examination in the context of the governance fundamentals inherent in shareholder participation in the nominating and electoral processes. Furthermore, state law is essentially enabling and not prescriptive. Therefore, certain mechanisms may be permissible if authorized by a board in the exercise of its fiduciary duty or mandated by charter or bylaw provision. For present purposes we confine our comments to an identification of certain of the state corporate law issues.
Our comments refer primarily to the law of Delaware but we note that the laws of other states such as Florida and Nevada may place even greater emphasis on the responsibilities of directors in comparison to the role of shareholders in the context of nominating or soliciting votes for directors.
1. Discrimination Among Stockholders and Alternatives I, II, III, and IV
As a general principle, Delaware courts enforce a doctrine of equal treatment of holders of the same class or series of stock of Delaware corporations.7 In addition, Delaware courts have taken the position that control over the director nomination process can be as significant as voting rights with respect to directors.8 Absent express authorization in the corporation's certificate of incorporation, we believe it generally9 would be inconsistent with Delaware law to provide a particular class of shareholders with a preferential right in the nomination process, just as it would raise issues if a subcategory of stockholders had preferential voting rights in the election of directors. Thus, to the extent that any of the alternatives are viewed as giving preference to the ability of a group of shareholders to nominate a director or to have a representative elected as a director, without providing equivalent access and capabilities to other members of the same class or series of stock, the alternatives may implicate Delaware's equal treatment doctrine.
Alternatives I, II, III and IV require that shareholder proponents satisfy at least a minimum level of shareholding, defined in terms of size and duration of the proponent's holdings, in order to be entitled to expanded access to the company's proxy materials or to the director nominating process. By providing shareholders that meet these requirements with a right relating to director selection that other shareholders do not have, these alternatives in a sense discriminate against shareholders who do not satisfy such requirements,10 thereby implicating the Delaware equal treatment doctrine by favoring large shareholders and discriminating against smaller shareholders.11 We recognize that there also is a point of view that such distinction in rights is permissible because the Delaware courts have distinguished between the rights attributable to shares of stock and the rights which shareholders may enjoy and thereby upheld disparate treatment of shareholders of the same class as long as all shareholders are treated fairly, but note that it is uncertain whether such a standard will be applicable in this context.12
2. Fiduciary Duty Requirements for the Use of Corporate Mechanisms
and Alternatives II, III and IV
The board of directors, rather than shareholders, manages the business and affairs of the company under Delaware law, subject to their fiduciary duties to act in what they believe in good faith is the best interest of the company.13 In its direction of the process of electing directors at the annual meeting, the board's role of designating director candidates differs from the role of shareholders who nominate director candidates because the board's discretion is limited by its fiduciary duties to the company and its shareholders. Though shareholders may nominate directors for self-serving reasons, the board of directors may not. Furthermore, the board of directors is unlike any nominating shareholder in that it is charged with duties under both state and federal law to ensure that the company's proxy statement does not contain false or misleading information, as well as to exercise appropriate care and responsibility in the nomination and solicitation process.
Directors, unlike shareholders, are also responsible for decisions concerning the use of corporate property.14 The board is entitled to use corporate funds and the corporate communications mechanisms so long as they are employed for corporate purposes consistent with the fulfillment of the board's fiduciary duties. As a generalization, only fiduciaries who manage the business of the company are entitled to use corporate property. Shareholders are not generally entitled to use corporate funds or have access to the corporate property resources unless a determination is made by the board of directors to permit them to do so. Recognizing that access to the corporate proxy solicitation machinery is viewed as a valuable benefit, Alternatives II, III and IV may implicate this principle since they would provide shareholders such access without a decision of the fiduciary in favor of providing such resources. Alternative V does not appear to raise any state-law concerns in this respect (but such issues may arise with respect to shareholder proposals permitted by such Alternatives.)
Possible Proxy Rule Modifications Relating to Alternative II
- Access vs. Delivery. The cost of printing and mailing a proxy statement and a proxy card is significant, especially for larger public companies. The internet, on the other hand, has become a highly efficient and cost effective method of making information available to large numbers of people. Accordingly, instead of requiring a written proxy statement complying with Rule 14a-3 and Schedule 14A to be delivered in connection with solicitation of proxies, the proxy rules would be amended to permit an eligible shareholder to solicit proxies for its nominee(s) through use of the internet without the distribution of a paper proxy statement, provided that the shareholder provides access to the required disclosure document on a website accessible to the general public.
The soliciting shareholder would be required to establish and maintain the website and provide access to the general public from the date of the commencement of the solicitation until the completion of the election or earlier withdrawal of the candidacy. The website could be one established or maintained by the soliciting shareholder or a third party, as long as it was accessible by the general public. In addition to posting the required disclosure document and the proxy card on the website, the soliciting shareholder should be required to post on this website, from the date of first use until completion of the election, any additional soliciting material used by the soliciting shareholder, whether or not it is required to be filed with the SEC. Accordingly, the website would serve as the complete repository for all soliciting materials used by the shareholder and would be readily accessible by other shareholders, the press, the general investing public, the SEC and the company.
Filing Requirement. The required disclosure document would have to be posted on the website and filed with the SEC no later than the time of first use, and delivered to the company no later than the first business day after the date of first use. Although the SEC would have the ability to review any these filings, it may decide as a matter of policy that it would generally not review such filings in the absence of a complaint by the company or another affected party of a material violation of the applicable rules, including Rule 14a-9.
Proxy Card. There are two alternative methods for dealing with "delivery" of a proxy card to shareholders. The first would maintain the longstanding policy under the proxy rules of requiring that a proxy statement "precede or accompany" the proxy card. A soliciting shareholder who has elected to provide access to the required disclosure document via the internet would only be permitted to provide a proxy card (or voting instructions to a broker-dealer or bank) through the same internet site. The proxy card (or voting instructions) could be printed by shareholders and signed and mailed in accordance with instructions on the card or the website. The proxy card would have to comply with the "short slate" requirements set forth in Rule 14a-4(d)(4).
If a soliciting shareholder wishes to provide a proxy card to a shareholder other than through the website, the soliciting shareholder would have to, prior to or concurrently with provision of the proxy card, either deliver a paper copy of the required disclosure document to the solicited shareholder or obtain from the solicited shareholder a signed confirmation that the shareholder has access to the website. The shareholder need not confirm that it has read the disclosure document.
The alternative approach to delivery of a proxy card would separate the mechanisms for getting the proxy card and proxy material to shareholders. A primary consideration impelling such a rule revision is that the proposed procedure for delivering proxy cards and voting instructions through the internet is inconsistent with existing procedures for proxies used by ADP on behalf of most of the financial intermediaries. We understand that, if a shareholder were to execute a downloaded proxy or voting instruction card and return it to ADP, it is unlikely that ADP would be able to process it because the card would not include the unique identifying number that ADP includes on each proxy or voting instruction card it mails and ADP would not be able to reconcile the shares voted to a position held by a financial intermediary on behalf of the shareholder. Accordingly, use of a downloaded form of proxy card would require either significant changes to existing systems or the development of new systems.
If such systems changes are either not feasible or economically worthwhile, as a alternative, the company could be required, consistent with Rule 14a-7, to mail the proxy or voting instruction card to its shareholders. The proxy card would have to be bear a prominent legend indicating the website on which the shareholders can find the required disclosure document and must not be transmitted until the required disclosure information is posted on the website. The company would not, in lieu of mailing, be able (as now provided by Rule 14a-7) to provide the shareholder list unless the soliciting shareholder agreed.
An important related issue is the implementation of existing exchange rules regarding broker discretionary voting. Our understanding is that the exchanges and ADP determine whether there is an election contest solely on the basis of a second proxy card being distributed to shareholders. Absent such a distribution, broker discretionary voting is permitted. As a consequence, under the existing NYSE rule and interpretation, if in alternative II the proponents of the nomination rely on the internet for delivery of the proxy card, broker discretionary voting would be permitted. If, on the other hand, companies are required to mail proxy cards under alternative II, then under the existing NYSE rule and interpretation broker discretionary voting would not be permitted. It does not seem appropriate that the issue of availability of broker discretionary voting should turn solely on how a proxy card is delivered to shareholders.
Required Information. Items 4 and 5 of Schedule 14A require detailed information regarding each "participant" in the solicitation as well as the "associates" of each participant. These requirements can be difficult to understand and not all the information seems essential to shareholders. The information requirement should be reviewed by the SEC and, to the extent possible, any information that shareholders do not need to make an informed decision should be eliminated. The required information should be specified in as "plain English" as reasonably possible.
- Additional Soliciting Material. Soliciting shareholders would be permitted to use additional soliciting material. Any additional soliciting material would be required to contain a prominent legend advising shareholders where they can find the required disclosure document on the website and the SEC's website and would be required to be filed with the SEC and delivered to the company no later than the date of first use. Additional soliciting material in the form of press releases, published or broadcast opinions or statements, or advertisements appearing in a broadcast media or newspaper, magazine or other bona fide publication disseminated on a regular basis would not have to be filed with the SEC, but would have to be posted on the website maintained by the soliciting shareholder for soliciting material as described above. For this purpose, soliciting material disseminated by webcast would not have to be filed so long as the webcast is made available on the website through the completion of the election.
- Eligibility. In addition to satisfying minimum size and duration of shareholdings requirements, a shareholder proponent would be permitted to rely on these streamlined procedures only where it is nominating only a limited number of candidates for election as a director. Only one nomination under this procedure by one shareholder or group of associated shareholders may be appropriate. Similarly, a shareholder who, either alone or as a member of a group, has previously nominated under the streamlined procedure a currently serving director would not be eligible to use the procedure unless such director's term will expire at the meeting for which it will solicit proxies. In addition, any shareholder intending to rely on these procedures should be required to file with the SEC, and deliver to the company, a certification that the shareholder is not nominating a director as part of a plan to control or influence control of the company, to effect any business combination or change in ownership of the company or any other fundamental changes in the operation of the company's business.
In the case of a group of shareholders, each member of the group must be eligible to rely on these streamlined procedures in order for the group to so rely. A shareholder would be permitted to participate in only one such group in connection with any election.
- Obligations of Broker-Dealers and Banks. Because such a large proportion of shares is held in street name, the procedures must enable beneficial holders to provide instructions to the institutions holding the shares on such beneficial owners' behalf as to how to vote the shares held for such holders. Accordingly, Rules 14b-1 and 14b-2 should be amended to obligate broker-dealers and banks to provide clear instructions on how beneficial owners can provide voting instructions to them and, upon receipt of any such voting instructions from a beneficial owner, to vote the shares held by such beneficial owner in the manner so instructed.
We appreciate the opportunity to submit this discussion and analysis to the Division and the Commission in connection with this important inquiry. The ultimate conclusions of the Commission and resulting initiatives are likely to have a meaningful impact on corporate governance including the influence of shareholders on corporate affairs. We hope that our comments are helpful to the Commission and its Staff. We will be pleased to discuss with the Commission and its Staff any aspect of this letter. Questions may be directed to Robert Todd Lang (212) 310-8200 or Charles Nathan (212) 906-1730.
Robert Todd Lang, Co-Chair,
Individually and on behlaf of the other members of
the Task Force on Shareholder Proposals
Charles Nathan, Co-Chair,
Individually and on behalf of the other members of
the Task Force on Shareholder Proposals
Task Force on Shareholder Proposals
|Richard E. Gutman
Robert Todd Lang
John M. Liftin
Michael R. McAlevey
Robert L. Messineo
|Ronald O. Mueller|
Alan H. Paley
Linda C. Quinn
Eric D. Roiter
cc: Hon. William H. Donaldson
Chairman of the Securities and Exchange Commission
Hon. Paul Atkins
Hon. Roel Campos
Hon. Cynthia A. Glassman
Hon. Harvey Goldschmid
Alan L. Beller, Director
Division of Corporation Finance
Annette L. Nazareth, Director
Division of Market Regulation
Martin Dunn, Deputy Director
Division of Corporation Finance
Paula Dubberly, Chief Counsel
Division of Corporation Finance
Lillian Cummins, Special Counsel
Division of Corporation Finance
Grace Lee, Special Counsel
Division of Corporation Finance
Stanley Keller, Chair
ABA Committee on Federal Regulation of Securities
|1|| For a broad discussion of authority, See Special Study on Market Structure, Listing Standards and Corporate Governance reprinted in the August 2002 issue of The Business Lawyer.
|2|| See Belenke v. SEC, 606 F.2d 193 (7th Cir. 1979); Clement v. SEC, 674 F.2d 641 (7th Cir. 1982); and Timpinaro v. SEC, 2 F.3rd 453 (D.C. Cir. 1993).
|3|| Exchange Act, Section 6(b)(5) and 15A(b)(6).
|4|| Bus. Roundtable v. SEC, 905 F.2d 406 (D.C. Cir. 1990).
|5|| Bus. Roundtable, 905 F.2d, at 412-13.
|6|| See, e.g. Durkin v. Nat'l Bank of Olyphant, 772 F.2d 55, 59 (3d Cir.1985) ("[T]he unadorned right to cast a ballot in a contest for [corporate] office...is meaningless without the right to participate in selecting the contestants. As the nominating process circumscribes the range of choice to be made, it is a fundamental and outcome-determinative step in the election of officeholders.").
|7|| See e.g., In re Sea-Land Corp., Del. Ch., 642 A.2d 792, 799 (1933) (stating that "it has long been acknowledged that absent an express agreement or statute to the contrary, all shares of stock are equal"); Jedwab v. MGM Grand Hotels, Inc., Del.Ch., 509 A.2d 584, 593 (1986) (indicating that "at common law and in the absence of an agreement to the contrary, all shares of stock are equal").
|8|| Durkin v. Nat'l Bank of Olyphant, 772 F.2d 55.
|9|| In certain circumstances, Delaware courts have allowed for the disparate treatment of shareholders in the same class if the board of directors made a fiduciary determination that such unequal treatment was reasonable in light of the benefit to the company from doing so. See e.g. Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 957 (Del. 1985) (allowing discrimination against a stockholder in the context of a selective exchange offer where the stockholder was a raider posing a threat to the corporate enterprise).
|10|| See Harrah's Entertainment, Inc. v. JCC Holding Co., 802 A.2d 294, 310 (Del.Ch. 2002) ("Because of the obvious importance of the nomination right in our system of corporate governance, Delaware courts have been reluctant to approve measures that impede the ability of stockholders to nominate candidates."); Lerman v. Diagnostic Data Inc., Del. Ch. 421 A.2d 906 (1980) (invalidating as inequitable an advance nomination bylaw intended to preclude a dissident shareholder from effecting his announced plan of conducting a proxy contest at the annual meeting).
|11|| The result of shareholder access proposals such as Alternatives II, III, and IV is to confer a valuable right upon larger shareholders that is denied to small shareholders without the board of directors deliberating in the exercise of its fiduciary duty on the question whether any benefit to the company justifies this unequal treatment. This type of discrimination among shareholders implicates Delaware's equal treatment doctrine. See Mobil Corp., SEC No-Act. LEXIS 225, correspondence (avail. Feb. 19, 1988) (suggesting that a shareholder proposal requiring the corporation to permit holders of at least $1 million in value of common stock to provide commentary on the corporation's director nominations to be included in the company's proxy statement would encroach upon the equal treatment doctrine); Citigroup Inc., SEC No-Act. Letter, Attachment 1 at 10 (avail. Jan. 31, 2003) (stating that "[b]ecause the [shareholder access proposal] clearly contemplates that several large holders of the Company's common stock will have the special nomination rights not available to the vast majority of the Company's other shareholders..., the Proposal is inconsistent with the equal treatment doctrine, as recognized by Delaware courts and embodied in the one-share-one-vote principle enunciated in the DGCL.").
|12|| See id., citing Nixon v. Blackwell, 626 A.2d 1366, 376 (Del. 1993) ("[i]t is well established in [Delaware] jurisprudence that stockholders need not always be treated equally for all purposes."); In re The Times Mirror Co. Shareholders Litig., No. CIV.A. 13550, 1994 WL 1753203, at *2, Allen, C. (Del.Ch. Nov. 30, 1994) ("such a discrimination may be made but it is necessary in all events that both sets of shareholders be treated entirely fairly"). See also, Jayne W. Barnard, Shareholder Access to the Proxy Revisited, 40 Cath. U.L. Rev. 37, at 94 (1990) ("States have recognized that shareholders with large holdings may be treated differently, generally more harshly, than shareholders with smaller holdings.").
|13|| See Del. Gen. Corp. Law § 141(a). See also Maldonado v. Flynn, 413 A.2d 1251, 1255 (Del. Ch. 1980) (citing "the well settled and salutary doctrine of corporate law that the board of directors of a corporation, as the repository of the power of corporate governance, is empowered to make the business decisions of the corporation"); Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 181 (Del. 1985) (discussing the directors' general broad powers to manage the business and affairs of the corporation, subject to fiduciary standards requiring "the directors to determine the best interests of the corporation and its stockholders").
|14|| See Norte & Co. v. Manor Healthcare Corp., C.A. Nos. 6827, 6831, slip op. at 9 (Del.Ch. Nov. 21, 1985) ("Stockholders are the equitable owners of the corporation's assets. However, the corporation is the legal owner of its property and the stockholders do not have any specific interest in the assets of the corporation. Instead, they have the right to share in the profits of the company and in the distribution of its assets on liquidation. Consistent with this division of interests, the directors, rather than the stockholders manage the business and affairs of the corporation..." (citations omitted)).