Hermes Pensions Management Limited
Mr J G Katz
Dear Mr Katz
Re: File No. S7-10-03;
We are writing in response to your announcement that you have directed your Division of Corporation Finance to formulate possible changes to the proxy rules and regulations and their interpretations regarding procedures for the election of corporate directors.
Hermes Pensions Management Limited is one of the largest fund managers in the UK with around $59 billion under management, of which $3.4bn is invested in 530 US listed companies. We manage the assets of two of the four largest UK pension funds. As the only significant fund manager owned by a pension fund - the BT Pension Scheme - Hermes devotes all of its resources to managing its clients' assets. We take seriously our responsibility as stewards of our clients' investments and we are active in ensuring that companies are run in the long-term interests of our clients as shareholders. In effect, we act as long-term owners of the businesses in which our clients hold shares. This leads us to take an active approach towards corporate governance, voting and shareholder rights.
The nature of the relationship between the shareholders and directors of a company is central to the proper functioning of our capital markets. This was set out clearly over ten years ago in the Cadbury Committee's Report -
An enduring fallacy in the corporate governance frameworks of several markets, including the US, is that the resolution of a company's problems is best dealt with by `independent' directors who are invariably nominated under a self-perpetuating system. Moreover, their `independence' is generally defined negatively rather than in terms of the qualities they bring to the board. Hermes believes that by allowing shareholders to remove and nominate directors, market regulators can establish a connection between directors' independence and the interests of the shareholders that they serve. Indeed, there should also be an obligation on shareholders to put forward candidates when appropriate.
We believe that significant improvements are required to standards of corporate governance in the US, which could be achieved by clarifying and enhancing shareholder rights relating to the procedures for the election of corporate directors. Moreover, such improvements are critical to aligning the interests of shareholders and directors and restoring confidence in the US capital markets. Therefore, we strongly endorse your stated aim of "improving corporate democracy" and ask that you consider the following comments in this regard.
The right of shareholders to move a resolution at an annual general meeting (AGM) is largely illusory in the US, as they cannot ensure that the board includes their proposal in the notice of the meeting.
Of particular concern to Hermes is the "ordinary business" exemption, which has been used to frustrate shareholders from raising matters material to their interest in a company.
We suggest that the SEC adopt a new rule requiring a company's directors to admit a shareholder proposal to the notice of a meeting providing that it is supported by shareholders representing not less than 5% of the total voting rights. The SEC should make clear that if this condition were satisfied then the directors would be unable to argue that the nature of the resolution was not one which could properly be dealt with at an AGM. Moreover, the directors should be obliged to include the resolution on the agenda for the meeting providing that sufficient notice is given. In this regard, we suggest that shareholders should deposit their requisition at the company's registered office at least six weeks before the AGM.
The costs associated with circulating the proposal should be met by the requisitioning shareholder, however the company should endeavour to keep these to a minimum by including the proposal within its normal AGM mailing when effectively there would be negligible costs to shareholders. To assist shareholders in taking advantage of this, companies should disclose their timetable for the production of AGM materials.
We also consider that shareholders should be able to call an extraordinary general meeting (EGM) at any time, provided they represent at least 10% of the total voting rights.2 We recognise that this may not be possible under the current framework, however we believe the SEC should seek such powers so as to ensure that shareholders are able to exercise this important right. In the UK, although directors are generally elected for three-year terms, shareholders' right to call an EGM allows the removal of a director at any time.
The corporate director nomination process
The procedures and rules relating to the right of shareholders to put resolutions to a company meeting, described above, should also apply to the nomination and removal of directors, provided that there are appropriate safeguards preventing a minority of investors from obtaining control over the company. Moreover, in order to improve corporate democracy, we consider it essential that shareholders be allowed to vote on each director separately, whether the individual is a shareholder or board nominee.
Although their right to nominate directors is rarely used by UK shareholders, we consider that its presence has contributed significantly to the quality of UK corporate governance.
The disclosure and other requirements imposed on shareholders
Shareholders should be prepared to recommend or put forward candidates for the board, where they have serious concerns about a company's management. Such a provision should be dealt with in `best practice' guidance.
Contests for corporate control
In the UK, safeguards preventing a minority of investors from obtaining control over the company are provided by the City Code on Takeovers and Mergers which is administered and enforced by the Takeover Panel. We recommend that the SEC consider adopting or promoting an approach that provides equivalent safeguards.
However, as a minimum or interim measure we recommend that the current Rule 13D disclosure requirements be revised to ensure that they apply only to shareholders attempting to obtain or change control. That is, Rule 13D should be amended to provide relief for certain non-control activities, allowing shareholders their legitimate voice as part owners of the company.
The solicitation of proxies for director elections
In order to ensure that the results of director elections reflect the views of the shareholders, the SEC should repeal the "10-day rule" which allows brokers to vote on certain proposals if the beneficial owner hasn't provided voting instructions at least 10 days before a scheduled meeting. Invariably, such "broker votes" are cast in favour of management.
Directors' remuneration and other matters
Lastly, in light of recent US corporate scandals and to promote the alignment of interests between management and shareholders, we urge the SEC to improve the disclosure requirements regarding director relationships and directors remuneration.
We support the Council of Institutional Investors' comments in this regard and request that the SEC amend paragraph (d) of Item 401 of Regulation S-K to require company disclosure of "familial, professional and financial relationships" between directors and top management.
We also consider that more information should be made available to shareholders on directors' remuneration, as this has become increasingly opaque in the US. Moreover, we encourage the SEC to adopt the International Corporate Governance Network's recommendation3 of allowing shareholders an annual, advisory vote on a standardised remuneration report at each AGM, which has already been adopted in the UK.
We would be grateful if you could consider our comments in connection with the current consultation and we would be pleased to answer any questions that you have in this regard.