File No. S7-10-03From: Con Hitchcock Sent: Friday, June 13, 2003 11:49 AM To: 'rule-comments@sec.gov' Subject: File No. S7-10-03 13 June 2003 Mr. Jonathan G. Katz, Secretary Securities & Exchange Commission 450 Fifth Street, NW Washington, DC 20549 Re: Possible Changes in Proxy Rules, Press Release No. 2003-46, File No. S7-10-03 Dear Mr. Katz: I am an attorney in private practice who represents institutional investors who have used SEC Rule 14a-8 to submit shareholder proposals as a way to promote better corporate governance at publicly traded corporations. I am submitting these comments in support of the proposed rulemaking initiative to allow shareholders who meet certain threshold qualifications and who may nominate candidates for the board of directors to have those candidates included in proxy materials prepared and circulated by the company. The outlines for such a reform are contained in submissions by institutional investors including the Council of Institutional Investors and the AFL-CIO. I will not repeat the policy arguments in favor of initiating a rulemaking on this topic. Instead, I have been asked to address and will address criticisms of this initiative that rest on the notion that this reform would be unlawful and beyond the Commission's statutory powers. For the reasons stated below, it is my conclusion that proxy access proposals of the sort supported by CII and AFL-CIO and lawful and appropriate. The criticism is perhaps best encapsulated in a memorandum dated 23 April 2003 from Wachtell, Lipton, Rosen & Katz, which deems it "far from clear that the SEC has the authority under the federal securities laws to include shareholder nominees in the company's proxy statement." It is argued that under state law the board of directors has the authority and responsibility to manage the business and affairs of the corporation and that one of the most basic responsibilities is to direct the process of electing new directors. The criticism relies heavily on the case of Business Roundtable v. SEC, 905 F.2d 406 (D.C. Cir. 1990), in which the District of Columbia Circuit that invalidated a "one-share, one vote" rule adopted by the Commission pursuant to section 19 of the Securities Exchange Act. The Business Roundtable case is said to be relevant because of language suggesting that the regulation at issue there strayed "far beyond matters of disclosure" and intruded into substantive areas of corporate governance traditionally left to the states. As I will discuss more fully below, the Business Roundtable case fails to provide a basis for declining to adopt a proxy access proposal of the sort being proposed here. To the contrary, the Business Roundtable case and the underlying history of SEC Rule 14a-8 indicate that the adoption of such a rule would rest on solid legal ground and would be firmly rooted in the purposes and policies that underlie Rule 14a-8. Rule 14a-8 and its predecessor regulation require that, in specified circumstances, a publicly traded company must include in its proxy card and proxy materials a proposal that a shareholder intends to present at the next annual meeting of the company. Rule 14a-8 was adopted pursuant to the Commission's grant of authority under section 14 of the Securities Exchange Act, which broadly empowers the Commission to regulate the solicitation of proxies. The Senate Report accompanying the 1934 Act indicated that the Commission was being empowered to regulate the solicitation of proxies as a means of assuring that shareholders will be given "adequate knowledge" about the "financial condition of the corporation [and] the major questions of policy, which are decided at stockholders' meetings." S. Rep. No. 792, 73d Cong., 2d Sess. 12 (1934). The House Report is to the same effect, noting the need for companies to inform its shareholders of "the purposes for which the proxies are to be used." H.R. Rep. No. 1383, 73d Cong., 2d Sess. 14 (1934). The House and Senate Reports noted phenomena that, if anything, has become more pronounced over the past 70 years: Corporate ownership is widely dispersed, shareholder meetings are poorly attended, and most voting occurs before the meeting through proxies, not after the give and take of an whatever in-person, policy discussion occurs on each issue discussed at the annual meeting. The House Report thus described the goal of federal proxy regulation as improving the control of a corporation as effectively as might occur if shareholders were attending a shareholder meeting in person. Id. Consistent with that Congressional purpose, the Commission adopted the predecessor to Rule 14a-8 in 1942, and that template has survived largely intact for over 60 years. The basic premise behind the Rule, consistent with Congress's intent when it adopted section 14 of the 1934 Act, is that there are certain categories of proposals that a shareholder intends to present at an annual meeting that should be disclosed in the company-prepared proxy statement - and not merely disclosed, but printed on the company-prepared proxy card with an opportunity for shareholders to vote "yes" or "no" on the proposal. Rule 14a-8 contemplates that there are certain proposals that will come before the meeting that are sufficiently important to shareholders that the shareholders should have an opportunity to consider the merits of those issues by reading the company-prepared proxy materials and by casting their vote on the company-prepared proxy card. This approach is fully consistent with the goal of disclosure that underlay Congress's adoption of section 14 of the 1934 Act. Recognizing that not every shareholder proposal may rise to the level of significance that it should be included in the company-prepared proxy materials, Rule 14a-8 and its predecessors created several filters to weed out proposals that fail to rise to a level of significance that disclosure to shareholders is required. The current version of the Rule contains a number of such elements. There are requirements that shareholders must have held a certain minimum level of stock in the company, measured either in dollar terms or percentage of the outstanding shares, depending on the size of the corporation. There is also a requirement that the proponents of any such resolution be something more than short-term holders of the stock, and for the past 20 years the submission of shareholder proposals has been limited to those who have held the minimum number or value of shares for at least one year. Finally, there are substantive screens, embodied in Rule 14a-8(i), that may be used to omit from a company's proxy statements those proposals that, in the Commission's opinion, are legally flawed or are unlikely to have a level of support sufficient to warrant full disclosure to all shareholders. These exclusions may include items that are illegal under state law, items that seek to advance a personal grievance rather than address a substantive policy issues, items that relate to a company's ordinary business, items that are moot because they have been substantially implemented, or items that have been presented at prior annual meetings, but have failed to obtain a certain minimum level of support from the shareholders. The Commission's rules have thus sought to provide for full disclosure of - and an opportunity to vote on - shareholder resolutions that will be put forward at the meeting by shareholders whose holdings demonstrate a certain level of long-term interest in the company and also are sufficiently "serious" or "important" enough to warrant notice to shareholders in the company's proxy statement that these items will be acted upon at the meeting. Rule 14a-8 thus compels publicly traded companies to do something that, in many instances, they would prefer not to do, namely, undertake the modest expense of printing those shareholder proposals in company-prepared proxy materials that meet the criteria set by the Commission for determining which proposals are sufficiently serious to warrant giving shareholders such notice and an opportunity to vote on the company-prepared card. The proxy access proposals being supported by institutional investors fall comfortably within that mold. The proposals contemplate that if the holders of at least three percent of the outstanding shares wish to nominate a candidate for the board of directors, and if those shareholders have held their stock for a certain minimum period of time, that nomination should be included in the company-prepared proxy materials and card, along with a statement of reasons why the shareholders are urging support for a particular candidate. This is hardly a radical proposal. The 1934 Act contemplates that the Commission should regulate the solicitation of proxies in a way that gives shareholders information about what is likely to happen at the upcoming shareholder meeting. It also contemplates that if the board is going to solicit proxies to oppose certain types of shareholder initiatives, it is reasonable to require that the shareholders be given adequate information about what exactly the shareholder proponent is asking shareholders to approve, as well as the board's reasons why shareholders should not adopt that proposal. It matters not at all that the shareholder resolution to be presented at the upcoming meeting involves the election of a candidate for director, rather than a policy-based resolution. The principle of disclosure is fundamentally the same, regardless of the content of the proposal: If long-term shareholders owning a certain level of stock intend to present a proposal at the annual meeting, and if the subject matter of that proposal meets a certain threshold of policy or other significance sufficient to warrant shareholder attention, then the board should be required to disclose that a fellow shareholder (or group of shareholders) intend to present a certain item for action at the meeting and give shareholders an opportunity to vote for or against that proposal. This is fully consistent with Congress's goal in adopting section 14 of the 1934 Act, which the House Report viewed as empowering the Commission to enact rules giving shareholders "adequate knowledge" about "major questions of policy" to be decided at the next shareholder meeting - it is apparent that shareholder proposals to elect directors should not be treated as somehow less worthy of inclusion or of disclosure to shareholders that other types of shareholder proposals that are routinely included in proxy statements today. It is also apparent that the Business Roundtable case has little relevance to the present discussion. In the first place, Business Roundtable involved not questions of disclosure under Rule 14a-8, but a more substantive regulation adopted pursuant to section 19 of the 1934 Act, which deals with SEC regulation of self-regulatory organizations such as the New York Stock Exchange. The SEC rule at issue there (Rule 19c-4) barred national securities exchanges and national securities organizations from listing the stock of a company that takes any corporate action "with the effect of nullifying, restricting or disparately reducing the per share voting rights of" common stock holders. This "one share, one vote" rule was deemed by the D.C. Circuit to go beyond the regulatory authority granted by section 19 of the 1934 Act over SROs by attempting directly to control the substantive allocation of powers among classes of shareholders. In an effort to defend the rule issued under section 19, the Commission in that case cited by analogy section 14's grant of power to regulate the proxy process, which was viewed as effectuating a congressional to ensure fair shareholder suffrage. The D.C. Circuit rejected the analogy, viewing Congress's concern as less one of "fairness" in corporate suffrage than of "disclosure." The Court was careful to add, however, that Business Roundtable was not "to be taken as saying that disclosure is necessarily the sole subject of § 14." It cited that fact that Rule 14a-4(b)(2) requires that a proxy to provide some mechanism whereby shareholders may withhold support from a candidate for the board of directors. At a certain level, requiring companies to open their proxy card by giving shareholders an opportunity to vote against the management nominees for the board represents an effort to impose a substantive obligation on the board that the board would prefer not to undertake. It also imposes costs on the company in terms of printing the card in a way that the board would not prefer. Nonetheless, the ability of shareholders to withhold support using the company-prepared card, as well as to vote "no" on shareholder proposals that the board opposes, are now regarded as a well-established part of the legal and regulatory landscape. Nothing in Business Roundtable undercuts this analysis, and the case dealt with a situation that is light years away from proposals to require disclosure in company-prepared proxy materials of shareholder proposals involving elections to the board. Business Roundtable noted that Rule 19c-4 dealt "much more interferes" than does Rule 14a-4(b)(2) with the substance of what the shareholders may enact. It prohibits certain reallocations of voting power and certain capital structures, even if approved by a shareholder vote subject to full disclosure and the most exacting procedural rules." Plainly we are not dealing with such a situation here. Rule 14a-8 arose only by way of analogy, and the D.C. Circuit did not attempt to delineate the precise contours of the Commission's rulemaking authority under section 14. Moreover, current proxy access proposals do not seek to advantage one category of shareholder over another or to take away voting power from one class of shareholders at the expense of another. The goal of this proposal is identical to the goal that has guided the Commission for years: If a shareholder or group of shareholders holding a certain level of shares for a certain period of time intends to present a proposal at the meeting, section 14 permits the Commission to require disclosure of that fact in the company-prepared proxy materials, along with a statement of why the shareholders are urging support for their candidates. Otherwise, the company is free to do precisely what the 73rd Congress wanted to eliminate, namely, the solicitation of proxies against a matter (in this case, the election of a shareholder-nominated candidate) without providing shareholders with an adequate explanation of why the independent candidate is running or why it is that the incumbent board believes that the arguments in favor of his or her candidacy are not persuasive. Thank you for your consideration of these comments. Please do not hesitate to contact me if I can provide further information. Sincerely yours, Cornish F. Hitchcock Washington, DC