Sullivan & Cromwell LLP
125 Broad Street
New York, New York 10004-2498
June 13, 2003
VIA E-MAIL: email@example.com
Mr. Jonathan G. Katz,
Securities and Exchange Commission,
450 Fifth Street, N.W.,
Washington, D.C. 20549-0609
Re: Solicitation of Public Views Regarding Possible
Changes to the Proxy Rules (File No. S7-10-03)
Dear Mr. Katz:
We are pleased to respond to Release No. 34-47778, in which the Securities and Exchange Commission solicited public views on possible changes to the Commission proxy rules. Because this proxy rule review seems to have arisen primarily from the recent shareholder proposals relating to shareholder access to companies' proxy materials in connection with director elections, this letter focuses on that issue.
We believe that it would not be advisable for the Commission to revise its proxy rules to give shareholders a right to have their own director nominees included in the proxy materials paid for and circulated by the company. In particular, it is our view that:
- Many of the concerns relating to shareholder democracy and management control of companies' boards of directors have been directly addressed by the current stock exchange corporate governance proposals relating to nominating committees and director independence, and the effectiveness of these reforms should be given time to work before further, potentially overlapping, steps are taken.
- All shareholders would be best served by permitting the independent directors to determine the slate to be included in the issuer proxy statement, rather than certain shareholders.
- A shareholder access rule could turn elections for directors into forums on parochial political or social issues and create divided boards with single-issue directors.
- Shareholder rights in general, and rights relating to the nomination and election of directors in particular, have traditionally been the province of state law, and the Commission should not set aside this traditional respect for state law in the absence of a convincing need to do so or a specific legislative directive.
- Permitting shareholders to include nominees in the companies' proxy materials would require a substantial increase in the Commission's resources devoted to reviewing annual proxy statements.
- Permitting direct shareholder access would ultimately make proxy materials and the voting process more confusing and time-consuming for shareholders, whether individual or institutional.
The proposal that appears to have served as the impetus for the current review of proxy rules was submitted to Citigroup Inc., Sears, Roebuck and Co. and several other issuers by the pension plan for the American Federation of State, County and Municipal Employees. In each case, the proposal called for the issuer to amend its by-laws to permit shareholders or groups of shareholders holding 3% or more of the issuer's stock to include their director nominees in the issuer's proxy materials. The Commission staff determined in each case that the issuer could exclude the proposal under Rule 14a-8(i)(8), which permits exclusion of proposals that "relate to an election for membership on the company's board of directors."1 The staff determined that exclusion of the proposal was consistent with the staff position, reaffirmed consistently in recent years,2 that the Rule 14a-8(i)(8) exclusion covered proposals to establish a procedure that may result in contested elections of directors, rather than procedures for nomination or qualification generally.
The staff's current view that proposals relating to election contests should be excludable is consistent with the historical development of the proxy rules. The Commission and Congress have debated, but rejected, the idea of opening up issuer proxies to shareholder nominees repeatedly over the past 60 years. For example, in 1942, the SEC solicited public comment on a shareholder access rule, but ultimately rejected the idea after determining that the process would be burdensome and unworkable.3 In the 1970s, the idea was proposed again, and again rejected.4 Members of Congress from time to time have introduced legislation that would provide shareholders with access to issuer proxies, but this legislation has never been enacted into law.5
II. Recent Corporate Governance Reforms Should Be Given the Opportunity to Work Before Further Steps Are Taken.
The New York Stock Exchange, the Nasdaq Stock Market and the American Stock Exchange, acting in response to a Commission request, have each proposed significant changes to their corporate governance listing standards. These proposed changes would, among other things, give the independent directors increased control over the director nomination process and heighten the requirements for a director to be considered "independent." In particular, nominations for director would be required to be made by a nominating committee composed entirely of independent directors (or, in the case of Nasdaq and Amex companies, a majority of independent directors). The stated purpose of these changes is, to quote the NYSE proposal, to "enhanc[e] the accountability, integrity and transparency of the Exchange's listed companies" and to "allow shareholders to more easily and efficiently monitor the performance of companies and directors."
We believe that these stock exchange proposals, which aim to take the director nomination process out of the hands of management and put it into the hands of independent directors, obviate the need for direct shareholder access to the issuer proxy statement. As the Commission has previously recognized, use of independent nominating committees addresses the same concerns that underlie the shareholder access proposals.6 The exchange rules are likely to have a major impact on the director nomination process, and we believe that the Commission should give these carefully considered, heavily debated reforms an opportunity to work before determining whether direct shareholder access to the issuer proxy is necessary.
III. All Shareholders Are Best Served if the Independent Directors Determine the Slate of Director Nominees in the Issuer Proxy
We believe that the system contemplated by the pending stock exchange proposals, which emphasize the role of independent directors, is a superior system for protecting the interests of all shareholders as compared to the shareholder direct access proposals. The independent directors have a fiduciary duty running to all shareholders, and the pending stock exchange rules, as well as the Commission rules under the Sarbanes-Oxley Act of 2002, will help enable independent directors to act in a manner independent of management. The independent directors are in the best position to weigh all recommendations -- from management, shareholders or other sources -- and select the slate of director nominees for inclusion in the issuer proxy.
The selection of director nominees for inclusion in the issuer proxy is an important component of the management of a company's business and affairs, and therefore is properly the function of the company's board of directors. The use of the issuer's proxy materials to promote an election contest would inevitably lead to a major commitment of time and attention by management and the board, which would affect all shareholders. In addition, the expenditures for creating and distributing the issuer proxy statement come from the issuer's funds, and therefore impact all shareholders. The independent directors, who have a fiduciary duty running to all shareholders, are in the best position to maintain control over these matters.
In contrast, non-controlling shareholders do not owe a fiduciary duty to the corporation or to other shareholders. Therefore, there is no reason to think that a shareholder seeking to use the issuer's own proxy materials to promote an election contest or to cause the issuer to expend funds to include a director nominee in the issuer proxy will strive to act in the best interests of the other shareholders or of the corporation. In effect, this would lead to all shareholders indirectly incurring the cost (whether in funds or in the time and attention of management and the board) for one shareholder (usually a large shareholder) to advance that shareholders' specific interests. The interests of all shareholders would be best served by having the independent directors serve a gate-keeping function in connection with the selection of director nominees.
Furthermore, the potential negative effects of a shareholder access rule on the election process and the functioning of boards of directors need to be carefully considered. A large shareholder could use a right to include director nominations in company proxy statements as a vehicle for promoting parochial interests or political or social issues having little to do with enhancing stockholder value. To the extent that shareholders are actually successful in electing single issue or "protest" directors, the effect may be to create divided boards of directors with a diminished capacity to manage the company effectively.
IV. The Commission Should Not Set Aside Traditional State Law Control Over Shareholder Rights in the Area of Director Elections
Corporations are creations of state law, and state corporation law has traditionally set forth the rights of shareholders, including the right to nominate, vote for, and remove directors. A corporation's charter and by-laws, the contents of which are driven by state law requirements and prohibitions, generally address the nomination and election process in greater detail. Together, the state law and the organizational documents (together with the pending stock exchange rules discussed above) establish a carefully considered balance of power among the shareholders, management and directors of a company.
We believe that the Commission, absent either a demonstrated need for regulation or a clear legislative directive, should not upset this balance by creating a rule that would inevitably foster election contests. There is no doubt among both proponents and opponents of direct shareholder access rules that such a rule would seriously impact the relationship between a corporation and its larger shareholders. There may be questions as to whether such a rule falls within the Commission's authority under Section 14(a) of the 1934 Act.7 However, even assuming that such a rule would be valid, it is our view that the Commission should not make changes that would drastically affect issuer/shareholder relations as to director nominations absent a demonstrated need or a legislative directive.8 This is particularly the case in light of the pending stock exchange reforms, as discussed above.
V. Permitting Shareholders to Include Nominees in Issuer Proxy Materials Would Require a Significant Expansion of Commission Resources for Reviewing Proxy Statements
The proxy rules recognize that in the case of contested elections, additional Commission involvement is necessary to protect shareholders. Rule 14a-6 provides that any materials relating to an election contest need to be submitted to the Commission for comment in preliminary form at least 10 calendar days prior to being sent to shareholders. Issuer's annual proxy statements are usually not subject to pre-clearance by the Commission because they do not involve election contests. If issuer proxy statements are regularly the situs of election contests, the burden on the Commission, as well as issuers, will be increased dramatically. If the Commission is not able to allocate significantly more resources to the proxy review process, the inevitable result will be a reduction in the accuracy and quality of proxy materials ultimately delivered to shareholders.
VI. Permitting Shareholders to Include Nominees in Issuer Proxy Materials Would Require Numerous Changes to the Existing Proxy Rules and Would Make Proxies More Confusing for Shareholders
Enacting a rule that would permit shareholders to include nominees in the issuer proxy would require changes that run through many of the proxy rules, upsetting established procedures in a number of areas. The end result of these changes would, in our view, be a system that ultimately makes proxy materials less reliable and the voting process more confusing for shareholders, whether individual or institutional.
The existing proxy rules are structured under the assumption that shareholders who wish to advance their own nominees for directors will produce separate proxy statements containing the requisite information. If the proxy rules were amended to provide for direct shareholder access to issuer proxies, the issuer proxy would be a significantly more complicated document. In particular, the disclosure requirements of the following provisions would likely need to be standard features of annual issuer proxies:
- Rule 14a-4(d) lists certain undertakings and disclosure requirements for a shareholder submitting less than a full slate of director nominees - i.e., a "short slate". If shareholders were permitted direct access to the issuer proxy, these undertakings and requirements would need to be imported into the issuer proxy so that nominating shareholders could not avoid them.
- Rule 14a-12(c) provides for additional disclosure in the case of proxies for contested elections. This disclosure would need to be imported into issuer proxies that contain shareholder nominees.
- Rule 14a-4(a) requires proxies to state in boldface type on whose behalf the solicitation is made. If issuer's proxies contain shareholder's nominations, then this identification will become a more complex matter, and it will be more difficult for shareholders to determine the party that is advancing each specific nomination.
Having this additional disclosure become a standard feature of annual proxies would make the proxy voting process more confusing for many shareholders. It might also lead to increased liability exposure for issuers, because no matter how diligently an issuer acts to ensure that the required information concerning a shareholder nomination is accurate and complete, the issuer could be subject to greater liability exposure under Rule 14a-9, which prohibits false or misleading statements in proxy statements, because the issuer is dependent to some extent on the shareholder for this information. Any change to the proxy rules to permit direct access to the issuer proxy would need to include adjustments to the liability provisions in this regard.
Finally, if the standard annual director election is a contested election, with more nominees listed on the proxy card than there are open board seats, then purely as a mechanical matter voting will be more difficult for shareholders. This is particularly the case for large institutional investors who need to perform the process for a large number of issuers.
* * *
We appreciate the opportunity to comment to the Commission on possible changes to the proxy rules, and would be happy to discuss any questions the Commission may have with respect to this letter. Any questions about this letter may be directed to Donald C. Walkovik (212-558-3911) or John T. Bostelman (212-558-3840).
Very truly yours,
SULLIVAN & CROMWELL
|1|| See, e.g., Sears, Roebuck & Co., 2003 SEC No-Act. LEXIS 285 (Feb. 28, 2003); Citigroup, Inc., 2003 SEC No-Act. LEXIS 160 (Jan. 31, 2003).
|2|| See, e.g., Goldfield Corp., 2002 SEC No-Act. LEXIS 561 (Apr. 9, 2002); Storage Technology Corp., 2002 SEC No-Act. LEXIS 418 (Mar. 22, 2002); United Road Services, Inc., 2000 SEC No-Act. LEXIS 631 (May 5, 2000); Toys "R" Us, Inc., 2000 SEC No-Act. LEXIS 544 (Apr. 3, 2000); Kmart Corp., 2000 SEC No-Act. LEXIS 476 (Mar. 23, 2000); Boykin Lodging Co., 2000 SEC No-Act. LEXIS 466 (Mar. 22, 2000); Coca-Cola Co., 2000 SEC No-Act. LEXIS 80 (Jan. 24, 2000); Black & Decker Corp., 2000 SEC No-Act. LEXIS 35 (Jan. 18, 2000). This approach is in contrast to the earlier view taken by the staff prior to 1989 and in isolated cases during the 1990s that such proposals could not be excluded since they did not relate to a specific election, even though the effect was to set up the next election as a contested one. See, e.g., Dravo Corp., 1995 SEC No-Act. LEXIS 308 (Feb. 21, 1995); Pinnacle West Capital Corp., 1993 SEC No-Act. LEXIS 539 (Mar. 26, 1993); Chittenden Corp., 1987 SEC No-Act. LEXIS 1755 (Mar. 10, 1987).
|3|| See Release No. 34-3347, 33-2887, SEC Releases on Securities Act of 1933, Vol. 17, at 2 (Dec. 18, 1942) (adopting release noted that the staff recommendation that "minority stockholders be given an opportunity to use the management's proxy material in support of their own nominees for director" was not adopted); Securities and Exchange Commission Proxy Rules: Hearings Before the House Comm. on Interstate and Foreign Commerce, 78th Cong., 1st Sess. 161 (statement of SEC Chairman Ganson Purcell).
|4|| See Re-examination of Rules Relating to Shareholder Communications, Shareholder Participation in the Corporate Electoral Process and Corporate Governance Generally, Release No. 34-13482, [1977-78 Transfer Binder] Fed. Sec. L. Rep. ¶ 81,130, at 87,892-93 (Apr. 28, 1977) (announcing re-examination of rules and inviting comment); SEC Staff Report on Corporate Accountability Printed for the Use of the Senate Comm. On Banking, Housing and Urban Affairs, 96th Cong, 2d Sess. A61-62 (Sept. 4, 1980) (recommending that shareholder access rule not be adopted).
|5|| See, e.g., Shareholder Bill of Rights Act, S. 2460, 107th Cong. 2d Sess. § 5(a) (2002); Corporate Pay Responsibility Act, S. 1198, 102d Cong., 1st Sess. § 3(a) (1991); Tender Offer Reform Act of 1987, S. 2172, 100th Cong., 1st Sess. (1987); Protection of Shareholders Rights Act of 1980, S. 2567, 96th Cong., 2d Sess. § 8(a) (1980).
|6|| See SEC Staff Report on Corporate Accountability Printed for the Use of the Senate Comm. On Banking, Housing and Urban Affairs, 96th Cong, 2d Sess. A61-62 (Sept. 4, 1980). The staff supported the use of nominating committees as an alternative to shareholder access rules, but noted that they were not yet as common as they should be. Partially due to the pending exchange proposals, independent nominating committees that consider shareholder recommendations are much more prevalent today than they were in 1980. Of the proxies filed during 2003 by Fortune 100 companies, 95% disclose that they have independent nominating committees, and 91% of these affirmatively state that the committees will consider shareholder nominees and provide a process for shareholders to submit nominees.
|7|| Courts have held that absent an express legislative directive the Commission's general authority to promulgate rules in certain areas does not extend to matters of corporate governance traditionally left to the states. See Santa Fe Industries v. Green, 430 U.S. 462, 478-79 (1977) (§ 10(b)); Business Roundtable v. SEC, 905 F.2d 406, 408 (1990) (§ 14(a) and § 19(c)).
|8|| We note that the extensive corporate governance reforms included in the Sarbanes-Oxley Act of 2002 did not address the issue of shareholder access to issuer proxies. In addition, the Shareholder Bill of Rights Act, which was proposed in Congress in May 2002, includes a specific legislative directive prohibiting the exclusion from proxies of director nominees of 3% shareholders. S. 2460, 107th Cong. 2d Sess. § 5(a) (2002). This legislation, however, has not advanced beyond the committee stage, presumably having been superseded by the more comprehensive Sarbanes-Oxley Act. We believe that the omission of direct access from recent legislation, despite the fact that it clearly was considered by Congress, should make the Commission more hesitant to use its general legislative mandate in Section 14(a) to enact such a direct access rule.