Dear Mr. Katz:
I am writing in response to the invitation of the Securities and Exchange Commission to express our views as part of the Commission's comprehensive review of proxy rules and regulations. I commend the Commission for its decision to undertake this review and for soliciting comments, particularly from institutional investors, and we appreciate the opportunity to provide you with our perspective on how the current proxy rules can be improved.
I am principal fiduciary of the Connecticut Retirement Plans and Trust Funds (CRPTF), which has approximately $18 billion in assets. In the five years of my administration, the CRPTF has become one of the most active public pension funds in the proxy voting arena, having filed numerous resolutions and engaged in discussions with companies on a wide range of corporate governance and shareholder rights issues. We have also communicated with the Commission and Commission staff on a number of shareholder rights and corporate governance issues.
In addition, we are an active member of the Council of Institutional Investors (CII), and share the views they have expressed to you as part of this review that revisions of the current proxy rules and regulations are necessary to reflect current market conditions and to correct past problems.
I would like to comment on several issues where, in our view, the Commission should consider making significant changes in the proxy rules.
- Shareholders must have more of a voice regarding who represents them on corporate boards.
I believe the election of directors is one of the most powerful ways that shareholders can influence the strategic direction of a company. However, using this influence has become almost meaningless, because nominees for corporate boards are controlled by the Board itself. Moreover, mounting a successful campaign to elect a person to the board that has not been nominated by the Board's own nominating committee can be quite expensive and almost impossible to achieve. In addition, when this does occur it is often as part of a battle for control of the company, rather than as a mechanism to improve the management and board oversight within its current structure.
As we have unfortunately seen recently, too many board members at too many companies have failed to adequately fulfill their responsibilities and have not been acting in the best interests of shareholders. When this happens shareholders need a process that allows them to replace those board members and install qualified replacements. Access to the company's proxy ballot is the best mechanism to achieve this goal.
Developing a system of access to the proxy ballot that meets this goal while not weakening the board's ability to work as a team, and ensuring that the board has a diversity of skills and backgrounds, may be difficult. However, it needs to be done, because, quite simply, it is clear the current system is not working.
As a starting point, I suggest you review the Council of Institutional Investor's policy on access issues:
Companies should provide access to management proxy materials for a long-term investor or group of long-term investors owning in aggregate at least 5 percent of a company's voting stock to nominate less than a majority of the directors. Eligible investors must have owned the stock for at least three years. Company proxy materials and related mailings should provide equal space and equal treatment of nominations presented by qualifying investors.
- The SEC should review and modernize the 13D filing requirements to ensure that the rule applies only to an investor or group of investors attempting to truly change or influence the control of a company.
This rule needs to be addressed as part of the changes necessary to implement shareholder access to the proxy ballot. When shareholders work together to elect board members to protect their interests, they should not be subject to the same rules as a group of shareholders who are seeking control of the company.
- The shareholder proposal rules should be updated to streamline the process for companies, shareholders and the SEC.
The major purpose of the shareholder proposal process is to provide an avenue for shareholders to bring issues of importance to the attention of management and the Board of Directors - hopefully leading to discussions of a substantive nature, resulting in corporate action on the issue that is beneficial to shareholders. Unfortunately much of this process is now centered on technical issues of whether the proposal is appropriate under SEC rules, and fought with lengthy (and expensive) legal briefs requesting and opposing requests to the SEC for no-action letters. This process has also become burdensome for SEC legal staff - many of whom spend four months a year reviewing these briefs, rather than working on the SEC's enforcement duties and protecting shareholders from corporate fraud.
The SEC needs a common sense approach to proxy rules, which encourages communication among shareholders, directors, and management on issues of importance to the corporation, rather than a process involving corporate lawyers and debates on the rules.
One place to start, as has been suggested previously by former SEC Chairman Harvey Pitt, would be to eliminate or modify the "ordinary business" exemption, which has been used too often to exclude resolutions addressing issues of great interest and importance to shareholders.
One recent example of how the ordinary business rule excluded a resolution of great financial importance to shareholders is the Commission's 2003 no action decision at CINergy. The resolution addressed risk analysis related to climate change. I recently joined with a number of other shareholders writing a detailed letter to the Commission on this decision. Let me point out here that while CINergy omitted this issue from their proxy, a number of other companies included very similar resolutions in their proxies - all of which received shareholder support from the mid twenty percent range to the low thirties. The precedent set on the 2003 CINergy resolution will be used to argue for omission of these resolutions in 2004, even though there was substantial concern expressed by shareholders about the issue in 2003. This doesn't make sense, and highlights this problem with the proxy rules.
- Nominating committees should be required to disclose to shareholders the process they use to seek out candidates for the Board.
Because the election of the board is a significant responsibility of shareholders in the oversight of their investment, who is recommended for their vote is key. When questioned, Boards often respond with comments like:
"For Board membership we seek to select and recommend the best-qualified candidates based on relevant business experience, expertise, abilities and the desire and time to commit to a dynamic and fast moving Board such as ours. We do so without regard to race, creed, color, gender, age, religion, national origin, sexual orientation or physical limitations" (From American Power Conversion's reply to our shareholder resolution - 2003).
However, shareholders have no way of knowing whether this is the case. When disclosures show relationships between board members and the company, or with the CEO, shareholders are led to wonder what the board selection process really is. Did the nominating committee really look far and wide for the best-qualified candidate - or did they look only within their own -- or the CEO's -- circle of acquaintances? The Nominating Committee report should be more than a list of candidates - it should report in some detail the process the Committee used to determine its recommendations.
- Companies should be required to respond to shareholder resolutions that receive a majority vote.
In recent years a considerable number of shareholder resolutions have received the support of a majority of those shares voting. In many cases, corporations ignore these messages from a majority of their shareholders - year after year after year. (For more details, see the CII website section on majority votes -- http://www.cii.org/majvote.asp).
Shareholders are the owners of the company. When a majority of shares vote in support of a resolution, corporate boards should not be permitted to ignore the message. The proxy rules should have a mechanism, which mandates that companies consider these majority vote issues, and communicate with shareholders on these issues.
- There should be a mandatory process whereby shareholders can have two-way communication with Independent Directors.
The recent NYSE rules, as well as the Sarbanes-Oxley Act and SEC regulations recognize the importance of independent directors. The role of these independent directors can be either enhanced or stifled by how much communication they have with shareholders, or how little they hear from sources other than management. When shareholders communicate with a company they usually wind up talking with investor relations or the corporate secretary or some other appropriate representative of management. But it is the independent board members whose role it is to protect shareholders' interests. Management should encourage communication with independent directors, and SEC proxy rules should ensure this happens.
- There should be a majority of independent directors on dual class stock and dual structured boards.
Another area where recent reforms, which place importance on independent directors, is being thwarted is at companies with dual structure boards of directors - where shareholder action and board elections are not reflective of the economic interests of individual stockholders. In some cases (such as Dillard's), the family's control of the board (while holding less than 10% of the economic interest in the company) has made it exempt from all the new NYSE listing standards.
While there may be some instances where different rules for different classes of stockholders make sense that is not the case in this instance. Restoring shareholder confidence in public companies demands application of the imperative for independent directors.
All companies which are at least 50% owned (economic interest) by shareholders should be required to have a majority of independent board members, and all independent members on key board committees. In counting proxy votes, especially for non-binding resolutions, the standard should be one share, one vote. If a company wants to raise capital as a public company, it should be fully responsible to its public shareholders.
Finally, let me once again express my appreciation to the SEC for the opportunity to comment on these critical issues. I do hope that you will give careful consideration to the perspective that has been outlined in this correspondence. As your analysis proceeds, please contact our Assistant Treasurer for Policy, Meredith Miller, with any questions you may have.
I look forward to the results of this process, and the enactment of a series of policy changes that will help to restore public and investor confidence in our financial markets.