The Business Roundtable
Mr. Jonathan G. Katz
Re: File No. S7-10-03
Dear Mr. Katz:
The following is submitted on behalf of The Business Roundtable, an association of chief executive officers of leading corporations with a combined workforce of more than 10 million employees in the United States and $3.7 trillion in revenues. We appreciate the opportunity, at this preliminary stage, to provide you with our views on the Securities and Exchange Commission's ("SEC" or "Commission") initiative to examine possible changes in the proxy rules and regulations and their interpretations regarding procedures for the election of corporate directors (the "Initiative").
The Business Roundtable strongly supported the enactment of the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"), and we applaud the Commission's efforts to implement the Sarbanes-Oxley Act. We further believe that the Commission's efforts, and the related actions of the New York Stock Exchange, Inc. ("NYSE"), the NASDAQ Stock Market, Inc. ("NASDAQ") and other exchanges to propose amendments to their listing standards, have created a framework that will protect investors by fostering sound corporate governance and responsiveness, and encouraging transparent business practices. We strongly encourage the SEC to approve the proposed listing standards as quickly as possible.
The proposed listing standards, together with the requirements of the Sarbanes-Oxley Act, impose tough new standards on the composition and operation of boards of directors. The requirement that boards consist of a majority of independent directors and that nominating committees consist entirely of independent directors will, in our view, emphasize to boards of directors their responsibility to act independent of management and in the best interests of their company and its shareholders. This, coupled with the requirement that boards annually evaluate the effectiveness of the board of directors and its committees, creates new standards for corporate governance. Our companies are aggressively implementing these new standards. While they represent significant change, we embrace them because such reforms are necessary to instill a renewed sense of confidence in our corporate governance systems.
Even before the enactment of the Sarbanes-Oxley Act, our companies had begun the process of thoroughly reviewing and revising their corporate governance practices. In May 2002, we issued our Principles of Corporate Governance, which set forth our guiding principles of corporate governance. This was followed shortly thereafter by a report of the NYSE's Corporate Accountability and Listing Standards Committee recommending significant corporate governance enhancements to the NYSE's listing standards and by passage of the Sarbanes-Oxley Act and related SEC rulemaking. Our companies have responded to both the spirit and the letter of the statute, its implementing rules and the proposed changes in corporate governance listing standards.
The Commission is embarking on a course of action with potentially significant ramifications on corporations and their directors and shareholders. Our policy and legal concerns are discussed in more detail below. Our concerns primarily address direct shareholder access to company proxy statements. Any such proposal would be a major change with potentially unintended consequences and should not be implemented without careful analysis of all possible consequences.
I. NYSE and NASDAQ Proposed Corporate Governance Listing Standards
Proposed NYSE and NASDAQ corporate governance listing standards strengthen the role and independence of nominating committees and boards of directors as a whole. Under the proposed NYSE corporate governance listing standards, for example, the nominating committee must, among other duties: (1) have responsibility for the board's criteria for selecting new directors; (2) identify individuals qualified to become board members; (3) develop and recommend to the board a set of corporate governance principles applicable to the corporation; and (4) oversee the evaluation of the board and management.
The proposed NYSE listing standards also require listed companies to establish a mechanism for interested parties, including shareholders, to communicate with non-management directors. These rules offer the opportunity for shareholders, both large and small, to communicate with directors with respect to potential board nominees and other matters. To this end, the SEC already requires companies to disclose whether its nominating committee considers shareholder nominees and requires disclosure of the process for shareholders to follow in order to nominate a director.
In its rule filing submitted to the SEC, the NYSE explained that these proposed listing standards are predicated on the understanding that director and board committee nominations are among a board's most important functions. By placing this responsibility in the hands of a company's nominating committee, consisting solely of independent directors, the independence and quality of director nominees will be enhanced. Moreover, the nominating committee is best positioned to assess the skills and qualities desirable in new directors in order to maximize the board's effectiveness. In this regard, nominating committees are able to take into account the composition of the board as a whole when identifying director candidates.
Direct shareholder access to company proxy statements to nominate directors is inconsistent with the proposed NYSE corporate governance listing standards (as well as similar NASDAQ proposed standards) and detracts from the role and independence of nominating committees (as discussed further in Section II below). For instance, a nominating committee may determine to seek out a board candidate who has desired industry or financial expertise, based upon the belief that a nominee with such a skill-set will strengthen the overall functioning of the board of directors. However, as a result of shareholder access to the company proxy statement, such a candidate might fail to be elected because of the election of a shareholder nominated director who does not possess such expertise.
II. Role of the Board of Directors in Nominating Director Candidates
One of the responsibilities of directors under state law is the nomination of director candidates. This responsibility is based upon the understanding that the board is best positioned to assess the qualifications of nominees. And while boards may consider shareholder nominees, the ultimate responsibility for the nominees included in a company's proxy materials rests with the board.
A board's discretion in designating director nominees is subject to the duties that directors owe to the company and its shareholders under state law. Whereas certain shareholders may nominate directors for self-serving reasons, such as personal gain or to further a political agenda, the board is required to act in the best interests of the company and all its shareholders. Direct shareholder access to company proxy statements would undercut the role of the board and its nominating committee in the important process of nominating director candidates. Moreover, bypassing the nominating committee, which must be composed solely of independent directors under the proposed NYSE listing standards, would diminish board accountability to shareholders. It also may result in the nomination and election of directors that will cause the company to violate federal law or fail to comply with SEC, NYSE or NASDAQ requirements.
By way of example, shareholders could nominate and elect a director who is employed by a company's competitor, which could result in the company violating Section 8 of the Clayton Act of 1914. Additionally, shareholder nominees may not be independent, which could make it difficult for a company to comply with the NYSE or NASDAQ proposed listing standards that generally require companies to have a majority of independent directors and prohibit non-independent directors from serving on certain board committees.
III. Shareholder Involvement under Existing Proxy Rules
As you know, the board of directors represents all shareholders, and meaningful shareholder involvement in director elections already is provided under existing proxy rules. Shareholders may propose candidates for consideration by nominating committees. In addition, shareholders may undertake their own solicitation of other shareholders to elect one or more directors. Existing proxy rules enable shareholders to solicit proxies for one or more director candidates, while ensuring that such solicitations provide investors with the information necessary to vote in an informed manner. While there are expenses in connection with such a solicitation, it is exactly the same shareholders who stand to benefit from the proposal to allow direct shareholder access to company proxy statements (i.e., those with significant stock holdings) that are best positioned to finance these solicitations. In addition, with the advent of the Internet, and the increasing availability of electronic modes of communication, the expense and efforts of a proxy solicitation can be significantly reduced.
IV. Proxy Contests
When shareholders undertake their own solicitation in connection with the election of directors, the board's duties to the company and its shareholders may require it to act to counter the shareholder solicitation. This will stem from the board's good faith judgment that the board's slate of director nominees will better manage the business and affairs of the company in the best interests of its shareholders. Since directors cannot escape their obligation to consider nominees in the best interests of the corporation and its shareholders as a whole, providing shareholders direct access to company proxy material has the potential to turn every director election into a divisive proxy contest. Multiple shareholder mailings, the engagement of proxy solicitors, and widespread public relations campaigns would become routine, leading to board elections being waged through full-page ads in newspapers. The contentious and public nature of such proxy contests could substantially disrupt corporate affairs, result in significant costs to the company that would be borne by all the company's shareholders, and dissuade from board service well-qualified individuals who do not want to routinely stand for election in a contested situation.
V. State Law Concerns
Permitting shareholders direct access to company proxy statements also may raise state law concerns. We understand that two fundamental principles of state corporate law may be implicated by permitting shareholders direct access to company proxy statements. First, as discussed in Section II, state corporate law generally vests with the board of directors the authority to manage the business and affairs of the company, including the process of considering and nominating qualified directors. Second, some state corporate laws, including Delaware and New York, prohibit shares of the same class from being treated disparately. The proposal to allow direct shareholder access to company proxy statements raises this concern as it would provide a right to a single large shareholder or a block of shareholders that would not be available to all shareholders.
VI. Conflicts With Existing SEC Rules
Direct access to company proxy statements also appears to conflict with a number of existing SEC rules. Accordingly, significant amendment to existing rules would be required if the SEC were to provide shareholders direct access to company proxy materials for the purpose of nominating directors. For example:
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In conclusion, The Business Roundtable recognizes that the strengthened corporate governance standards our members have and will continue to implement are critical to restoring the credibility of the U.S. corporate governance system. To this end, we support the SEC's actions to implement the Sarbanes-Oxley Act, as well as the NYSE's and NASDAQ's proposed corporate governance listing standards. We encourage the SEC to expeditiously approve the proposed NYSE and NASDAQ listing standards so that they can be fully implemented. With the increased independence of boards of directors, the strengthened role and independence of nominating committees, and the enhancement of shareholder/director communications, we believe that many, if not all, of the issues the Initiative is intended to address will be achieved by the ongoing dramatic changes in corporate governance.
We would be happy to discuss our comments or any other matters that you believe would be helpful.
cc: Hon. William H. Donaldson-Chairman, U.S. Securities and Exchange Commission