New York State Bar Association
One Elk Street
Albany, NY 12207
Business Law Section
Committee on Securities Regulation
June 13, 2003
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
E-mail address: firstname.lastname@example.org
Attention: Jonathan G. Katz, Secretary
Re: File No. S7-10-03
Notice of Solicitation of Public Views Regarding Possible Changes to the Proxy Rules
Release No. 34-47778
Ladies and Gentlemen:
The Committee on Securities Regulation (the "Committee") of the Business Law Section of the New York State Bar Association appreciates the invitation in Release No. 34-47778 (the "Release") to provide its views on the topics listed in the Release regarding possible changes in the proxy rules for the election of corporate directors. The Release requests the public's views to assist the Division of Corporation Finance in formulating recommendations to the Commission. The Commission has directed the Division to provide its recommendations by July 15.
The Committee is composed of members of the New York Bar, a principal part of whose practice is in securities regulation. The Committee includes lawyers in private practice and in corporation law departments. A draft of this letter was reviewed by certain members of the Committee, and the views expressed in this letter are generally consistent with those of the majority of members who reviewed and commented on the letter in draft form. The views set forth in this letter, however, are those of the Committee and do not necessarily reflect the views of the organizations with which its members are associated, the New York State Bar Association, or its Business Law Section.
This letter addresses the topics in the Release as they apply to possible shareholder access to a corporation's proxy statement and proxy card for the nomination and election of directors.
A. Summary Of Comments
The Committee supports the Commission's general objectives to ensure that the proxy rules operate to serve the best interests of investors, and to foster sound corporate governance and transparent business practices. As a result of the Sarbanes-Oxley Act of 2002 ("Sarbanes Oxley"), recent Commission rule changes and soon to be adopted listing standards of Self Regulatory Organizations ("SROs"), substantial progress has been made recently in creating more effective corporate governance structures and mechanisms that will promote the Commission's objectives. We believe that these new initiatives, together with some refinements we propose in this letter, will meet legitimate concerns without requiring mandatory shareholder access to the corporation's proxy statement and proxy voting card to nominate and elect directors, or to present related shareholder proposals.
In all events, adequate time should be given for these new initiatives to operate before mandatory access provisions are proposed for adoption. Mandatory requirements for shareholder access are not necessary, at least not at this time, and would present substantial issues of cost, disruption, unnecessary complexity and other burdens on corporations, and serious issues regarding Commission authority and inconsistency with governing state corporate law. Moreover, there is no prohibition against shareholders proposing their own slate of directors under the current proxy rules.
The new requirements regarding the qualifications, composition and responsibilities of boards and board committees that are pending and are expected to be adopted soon specifically address the selection of director nominees. Time should be permitted for these requirements to be implemented and their effectiveness evaluated before dramatic changes are made in the proxy rules. In addition, we suggest that the SROs could consider requiring additional procedures and disclosures regarding shareholder proposals of nominees to the new independent nominating committees of boards of directors.
The election of directors is an area that traditionally has been governed by state corporate law. This raises serious questions about the Commission's authority under the federal securities laws to mandate inclusion of shareholder nominees for director in the company's proxy statement.
We believe that requiring shareholder access to a company's proxy statement to nominate directors would create significant problems and disruption without enhancing corporate governance. Shareholder nominees for director may not be independent. In addition, such a requirement could lead to under-representation of smaller shareholders in the voting process and make it more difficult for some corporations to obtain a quorum. Also, requiring inclusion of shareholder nominees in the company's proxy statement would require detailed new procedures and would shift expenses from the proposing shareholder to the company and all shareholders. Finally, we believe that special interest directors would be disruptive to the efficient functioning of the board of directors.
B. The New Rules, Regulations And Listing Standards Resulting From The Sarbanes-Oxley Act and Commission Initiatives Have Made Far-Reaching Changes In Corporate Governance, And Should Be Given Time To Operate Before Dramatic Changes Are Made In The Director Nomination And Election Process
Beginning with the Commission's initiatives in late 2001 and early 2002 covering various areas of enhanced disclosures,1there has been a continuous rollout of proposals and adoption of regulations in response to the recent instances of corporate malfeasance, accounting fraud and the meltdown in the stock markets. Almost all areas of corporate governance, disclosure and reporting, including regulation of outside consultants and experts such as independent auditors and attorneys, will be affected. We believe that the newly adopted and pending requirements will transform corporate governance in ways that will significantly enhance board and management accountability to shareholders and corporate transparency. Both of these objectives are often cited as principal justifications for requiring direct shareholder access to the proxy statement to nominate and elect directors.
1. NEW REQUIREMENTS REGARDING QUALIFICATIONS, COMPOSITION, AND RESPONSIBILITES OF BOARDS OF DIRECTORS AND BOARD COMMITTEES, AND SELECTION OF DIRECTOR NOMINEES ARE PENDING
New standards for determining independence, requirements that the board of directors be composed of a majority of independent directors, and requirements that there be a nominating committee composed entirely of independent directors, are the changes that will bear most directly on the process for nomination and election of directors.
By way of example, pending New York Stock Exchange ("NYSE") listing requirement proposals would require that a majority of the board be composed of independent directors. Each corporation's board must affirmatively determine that a director is independent. Certain relationships such as receiving more than $100,000 a year in compensation (other than director fees and certain other exceptions) by the director or an immediate family member may render a director non-independent. The non-management directors would have to regularly meet without management, and procedures would have to be established for the audit committee of independent directors to receive complaints from third parties on accounting matters.
More specifically on the election of directors, each corporation would be required to have a nominating/corporate governance or other committee, in each case composed entirely of independent directors, to select or recommend nominees for election as director. Also, such committees would have sole authority to retain and terminate any search firm hired to provide candidates for director, and would be required to have and publish committee charters stating its purpose, its goals and responsibilities and provisions for an annual performance evaluation. Many corporations have already developed and made public their nominating committee charter and corporate governance procedures.
The Nasdaq Stock Market, Inc. ("Nasdaq") has also proposed revised listing standards that would require director nominations to be made by either a nominating committee consisting only of independent directors or a majority of the company's independent directors.
2. TIME IS NEEDED TO IMPLEMENT AND DETERMINE THE EFFECTIVENESS OF THE NEW REQUIREMENTS; ADDITIONAL NOMINATING COMMITTEE PROCEDURES COULD BE ADOPTED THAT WOULD STRENGTHEN ACCOUNTABILITY WITHOUT THE NEED FOR DIRECT SHAREHOLDER ACCESS TO THE PROXY MATERIALS
While SRO proposals have not yet been adopted, it appears very likely that the board and nominating committee independence requirements of each proposal will be part of the revised listing standards that are ultimately adopted. Permitting direct shareholder access could lead to directors representing special interest which would run counter to the initiatives for independent boards (see Section E.1 on page 7, below).
The Committee believes that during a time when new and widespread corporate governance procedures are being implemented by public companies, and the impact of such procedures is not yet known, the newly independent nominating committees called for by the NYSE and Nasdaq proposals and the other new procedures are all the changes that should be undertaken at this time. It is our view that the existing and pending corporate governance reforms have already begun to foster an increased emphasis on proper corporate governance and accountability, the result of which should be a substantial rise in shareholder confidence in corporate boards of directors.
3. IT WOULD BE IMPRUDENT TO MAKE A DRAMATIC CHANGE IN SHAREHOLDER ACCESS TO THE PROXY MATERIALS FOR THE ELECTION OF DIRECTORS AT THIS TIME.
In addition to allowing time to evaluate the governance changes already adopted or pending, which may very well obviate the need for any further action regarding the process for the selection of directors, implementing a proposal to provide direct access to the corporate proxy statements and ballots for the election of directors at this time would significantly overburden companies that are already expending much effort and expense to implement new procedures and practices to comply with Sarbanes Oxley and related Commission and SRO requirements. The new requirements and expense regarding management reports on internal controls are just one example.
Furthermore, the proposals for providing direct shareholder access to the proxy machinery would raise substantial questions about inconsistencies with governing state corporate law and related questions about Commission authority, as discussed more fully below. Moreover, direct shareholder access would introduce additional cost and other burdens on the corporation (and hence all shareholders) and tend to disrupt the board process, upon the request of a relatively small percentage of shareholders.
Finally, we suggest in Section D below additional procedures and disclosures that the SROs could consider for the proposed nominating committees that, in the interim, would enhance accountability to shareholders and strengthen the nominating process without the need for more drastic action.
C. Serious Questions About Commission Authority Under The Federal Securities Laws to Act In Areas Traditionally Governed By State Corporate Law Would Be Raised If The Commission Were To Require Inclusion Of Shareholder Nominees For The Election Of Directors
1. PRESENT PROPOSALS FOR DIRECT SHAREHOLDER ACCESS TO THE PROXY MATERIALS FOR THE NOMINATION AND ELECTION OF DIRECTORS WOULD BE INCONSISTENT WITH GOVERNING STATE CORORATE LAW
A number of the proponents who advocate shareholder access to the corporation's proxy statement to nominate directors recognize that such access must be established in a way that avoids undue disruption and cost and prevents abuses by shareholders. To this end, some special interest shareholders propose that access to a corporation's proxy and proxy statement should be available only to those individuals or groups who own a certain percentage (e.g., 3% or 5%) of the corporation's voting securities. Other proponents object to such percentage thresholds on the basis that they constitute unequal access.
Permitting all holders of shares access to the corporation's proxy statement would create an unmanageable and disruptive morass. The only possible approach that would be practical would be to require a significant, minimum share ownership. However, treating large shareholders or shareholder groups differently from other shareholders discriminates among shareholders. This raises questions about fairness to small shareholders and, because state laws generally have required equal treatment of holders of the same class of shares, arguably violates state laws. Moreover, unless there is a requirement that the shareholder continue to hold the minimum percentage for some period of time, the standard will not be viable. Further, as discussed more fully below, since a director's fiduciary duty is to all shareholders, electing directors who represent the interests of limited shareholder groups runs counter to both state law and the new requirements for independent directors.
2. THERE ARE QUESTIONS ABOUT WHETHER THE COMMISSION HAS AUTHORITY TO IMPOSE A MANDATORY REQUIREMENT FOR SHAREHOLDER ACCESS TO THE PROXY PROCESS FOR THE NOMINATION AND ELECTION OF DIRECTORS.
Although Sarbanes Oxley requires Commission action in some areas that may traditionally have been left to the states, we are not aware of any provisions in that Act or the federal
securities laws that would authorize the Commission to mandate direct shareholder access to a corporation's proxy statement and proxy card in connection with the election of directors. It has long been the generally accepted policy that the Commission would not require shareholder access to the corporation's proxy machinery in election contests, which inevitably would be present if shareholder access to nominate directors in the corporation's proxy statement is required.
In addition, under state law the board of directors is given the authority to manage the affairs and business of a corporation. Moreover, the directors have fiduciary duties with respect to carrying out their responsibilities. Mandating shareholder access to the corporation's proxy statement to nominate directors would affect the use of corporate assets and control of the corporation's proxy mechanism, which are both key areas of director responsibility. This would interfere with the board's authority over the management of the corporation under state law, thereby in effect preempting state law. Congress has preempted state law in a number of areas, but it has not preempted state law in this area of director authority.
D. The SROs Could Consider Requiring Additional Procedures And Disclosures Regarding Shareholder Proposals Of Nominees To The New Independent Nominating Committees
As an interim measure to address concerns raised by many shareholder rights advocates while the effects of the new corporate governance rules are being evaluated, the Committee suggests that the NYSE and the NASDAQ could consider adopting the following requirements in their respective proposals dealing with independent nominating committees:
- Nominating committees shall consider proposed nominees for director submitted by eligible shareholders. The SRO would establish requirements for dates and procedures for submitting proposed nominees, which must satisfy state corporation law and the corporation's by-law requirements.
- In order to be valid, submissions must contain sufficient information for the nominating committee to make an initial determination as to whether a proposed nominee meets the basic criteria for a nominee as set forth in the nominating committee's charter and procedures.
- The nominating committee shall disclose in the corporation's proxy statement the number of proposed nominees received from eligible shareholders, if any, and whether any of such nominees are included in the current slate of directors.
We believe that our suggestion, together with the independence, self- evaluation and other governance requirements and proposals referred to above should alleviate the concerns raised by shareholder advocates by creating nominating committees that will give proper consideration to qualified candidates proposed by eligible shareholders.
E. Requiring Shareholder Access To A Corporation's Proxy Statement To Nominate Directors Would Create Significant Problems And Disruption Without Enhancing Corporate Governance
Permitting shareholder access to the proxy materials to nominate directors is not an approach we advocate. Considering the problems that would result, such an approach would not enhance corporate governance no matter how well intentioned some of the proposals may be.
1. SHAREHOLDER NOMINEES FOR DIRECTOR MAY NOT BE INDEPENDENT.
If individuals are nominated as directors by special interest shareholders, and elected, an immediate question would arise as to their "independence." Would such directors represent all shareholders, as required by state law, or would they represent the interest of the special interest shareholder? One example would be the event of labor/management negotiations for a corporation that has a director supported by a union on its board. In such a case, the director would have a conflict of interest, or the appearance of a conflict, raising a substantial question as to whether such a director could or should vote on related matters.
It also is questionable whether such directors would be independent under the proposed listing requirements of the SROs. Under the NYSE proposal, a director is not considered independent unless the board affirmatively determines that the director has no material relationship with the corporation. Where special interest directors are deemed not to be independent, they would be unable to serve on the nominating committee. They also would be barred from serving on the audit committee and the compensation committee. In addition, election of special interest directors could also affect whether the corporation meets the requirement for a majority of independent directors.
2. INCLUSION OF SHAREHOLDER NOMINEES IN THE CORPORATION'S PROXY STATEMENT COULD SKEW ELECTION RESULTS AND ADVERSELY AFFECT THE ABILITY OF SOME CORPORATIONS TO ACHIEVE A QUORUM FOR SHAREHOLDER MEETINGS.
Where shareholders propose nominees for director in opposition to the corporation's slate, it would appear to be an election contest. For example, the Commission Staff issued a letter last January regarding a shareholder proposal calling for a by-law provision on including shareholder nominees for the board in the company's proxy materials. The Staff letter determined that the company did not have to include the proposal in its proxy statement under Rule 14a-8(i)(8) because it appeared that the proposal may result in contested elections. In the case of contested elections, shareholders whose shares are held of record by their broker, bank or other institution may be structurally disenfranchised and corporations may find it difficult to obtain a quorum.
While brokers and banks vote the shares they own of record for clients on routine matters, they do not have discretionary authority to vote on behalf of their beneficial owners in the event of an election contest. They may vote only on the instruction of the beneficial owners. The proxy rules require issuers to canvas brokers to determine the number of underlying beneficial owners and then pay for the delivery of proxy materials to each underlying holder. However, we understand that many members of the brokerage community simply do not make follow-up contacts with beneficial owners to determine how they wish their shares to be voted. Since neither the issuer nor those proposing a counter-slate can directly approach a significant percentage of these beneficial holders, in the experience of proxy solicitors, the majority of the shares held in street name for retail customers may not be voted in contested elections without resort to expensive rounds of additional mailings2
This can be expected to result in the retail segment of shareholders being structurally disenfranchised and a greater likelihood that the failure of brokers to respond will make obtaining a quorum more problematic and expensive. Moreover, large institutional shareholders, especially those who hold securities in their own name, are likely to vote in disproportionate numbers, leading to under-representation of smaller, retail stockholders which could skew election results.
Finally, we believe that mandatory shareholder access to the company's proxy statement could make it more difficult for shareholders to evaluate the matters being voted on. For example, including shareholder nominees who would be in opposition to the company's slate of directors in the same proxy statement with the company's slate could be confusing to shareholders.
3. MANDATING SHAREHOLDER ACCESS TO THE CORPORATION'S PROXY STATEMENT WOULD REQUIRE DETAILED NEW PROCEDURES AND PRESENT DIFFICULT INTERPRETATION ISSUES.
The responsibility and liability for the accuracy, completeness and compliance of the company's proxy statement would be uncertain if the company were required to include shareholder nominees. For example, who would determine and be responsible for the accuracy of information about relationships of shareholder nominees that may bear on independence or fitness to serve as a director? Even before addressing that question would be the need to establish the procedures and requirements for the complete set of specific information that would have to be provided for inclusion in the proxy statement. It also would be necessary to confirm from the candidate that he or she agrees to serve as director if elected. These procedures would be necessary to insure that only nominees who are serious candidates and would undertake the demands, and be willing to assume the potential responsibilities and liabilities, that accompany being a director of a public company would be nominated.
Mandating shareholder access would also raise difficult interpretation issues under Regulation 13D. This could create a large area of contention with conflicting interpretations by the various parties in the process.
4. REQUIRING INCLUSION OF SHAREHOLDER NOMINEES IN THE CORPORATION'S PROXY MATERIALS WOULD SHIFT THE EXPENSE OF CONTESTED ELECTIONS FROM THE PROPOSING SHAREHOLDER TO THE CORPORATION AND ALL SHAREHOLDERS.
Requiring inclusion of shareholder nominees in the corporation's proxy would necessarily result in a contested election. The proxy rules presently provide for disclosure and accountability standards in such contested elections, with the cost to be borne by the proposing shareholder. Proponents contend that the proxy contest rules are too costly for shareholders. Their proposals to permit shareholder solicitation outside of those rules would shift the costs from special interest shareholders to the corporation and thus all shareholders.
Furthermore, institutional and special interest shareholders and shareholder groups have access to substantial funds. For example, the Council of Institutional Investors is an association of funds holding more than $3 trillion in pension assets, and the AFL-CIO and its members as individual investors and through benefit plans represent over $5 trillion in assets of which $400 billion are in union-sponsored pension plans. The shareholder proposal which the Staff determined Citigroup did not have to include in its proxy statement, discussed above, would have required that shareholders own about $5.7 billion of Citigroup stock in order to be able to nominate candidates for director. Shareholders with access to such assets surely can afford the costs of a contested election without the need for any change in the Commission's rules.
5. SPECIAL INTEREST DIRECTORS WOULD BE DISRUPTIVE TO THE EFFICENT FUNCTIONING OF THE BOARD.
Introducing a special interest director into the boardroom is completely different than the objective of having different points of views and areas of knowledge represented among the board's directors. The presence of a director who may have a special agenda as the representative of a special interest shareholder could lead to a confrontational atmosphere in the board. We believe that the opportunity for frank and open discussion also may suffer as a result. There is no need at this time for changes to the proxy rules that would create risks of dissension within the board of directors.
x x x x x x x x x x x x x x x x x x x x x x x x x x x
We hope the Commission and the Staff find these views and suggestions helpful. We would be happy to meet with the Staff to discuss these matters further.
COMMITTEE ON SECURITIES REGULATION
By___Michael J. Holliday
MICHAEL J. HOLLIDAY
CHAIRMAN OF THE COMMITTEE
Gerald S. Backman
Margaret A. Bancroft
Richard E. Gutman
Richard R. Howe
Kathleen A. Warwick
The Honorable William H. Donaldson, Chairman
The Honorable Paul S. Atkins, Commissioner
The Honorable Roel C. Campos, Commissioner
The Honorable Cynthia A. Glassman, Commissioner
The Honorable Harvey J. Goldschmid, Commissioner
Alan L. Beller, Esq., Director of Division of Corporation Finance
|1|| Commission pronouncements and regulations covered equity compensation plan information, use of "pro-forma" financial information in earnings releases, MD&A disclosure about off-balance sheet arrangements, and disclosures about critical accounting policies.
|2|| According to proxy solicitors, reaching retail shareholders who are beneficial owners who have not consented to disclosure of their identity, is an expensive process since those soliciting proxies will need to attract attention through the use of multiple mailings, sometimes using overnight couriers to draw attention to the solicitation. Even with multiple mailings, non-consenting beneficial shareholders may not respond.