U.S. Securities & Exchange Commission
SEC Seal
Home | Previous Page
U.S. Securities and Exchange Commission

Request for Rulemaking to Amend Regulation S-K, Items 401 and 404, Concerning Director Conflicts of Interest

December 12, 2001

Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549

Re: Petition for rulemaking

Dear Mr. Katz,

The American Federation of Labor and Congress of Industrial Organizations (the "AFL-CIO") hereby petitions the Securities and Exchange Commission (the "Commission") to undertake a rulemaking proceeding to amend Items 401 and 404 of Regulation S-K to require more proxy statement disclosure regarding conflicts of interest on the part of directors and director nominees. We believe that recent events at Enron Corporation have made plain that the existing disclosures are simply inadequate to ensure that shareholders are informed of all relevant information about director conflicts of interest.


Our system of corporate governance relies heavily on independent directors to act as vigorous monitors of management behavior and to represent shareholder interests. For example, a committee of independent directors is often constituted to evaluate potential transactions or litigation involving a company. Similarly, the tax code requires that incentive compensation in excess of the $1 million cap on deductibility be awarded by a compensation committee composed of independent directors. Many institutional investors, following on that requirement, take compensation committee independence into account when voting on pay packages and deciding whether to withhold votes from director candidates.

One of the most important functions entrusted to independent directors is oversight of the financial reporting process, which is of vital importance both to a company's shareholders and the markets in general. To that end, listing standards of both the New York Stock Exchange and the Nasdaq market require listed companies of a certain size to maintain audit committees composed of independent directors, and the Commission requires companies to disclose information regarding the mandate, membership and functioning of the audit committee.

Current Disclosure Requirements

The Commission's rules also, in essence, define independence by requiring disclosure in the proxy statement of certain relationships between directors (or director nominees) and the registrant (and in some cases its executive officers) that could compromise the director's objectivity. These requirements focus on employment, family, and business relationships. Currently, the following relationships involving directors and director nominees must be disclosed:1

  1. Current or past employment by the registrant;
  2. Family relationships between the director or nominee and the registrant's executive officers;
  3. Transactions with the registrant or any subsidiary in which the amount involved exceeds $60,000 and in which the director or nominee has a direct or indirect material interest;
  4. Indebtedness to the registrant or any subsidiary in an amount in excess of $60,000;
  5. The ownership of certain equity interests in, or service as an executive officer of, a business or professional entity (a) that is a significant customer of the registrant, (b) that is a significant supplier of the registrant, or (c) to which the registrant is indebted in an amount exceeding a threshold;
  6. Status as a member of, or of counsel to, a law firm that the registrant has retained during the last fiscal year or proposes to retain during the current fiscal year, subject to a minimum threshold;
  7. Status as a partner or executive officer of an investment banking firm that has performed certain kinds of services for the registrant during the last fiscal year or that the registrant proposes to have perform services during the current fiscal year, subject to a minimum threshold; and
  8. Any other relationship similar in scope and nature to the relationships listed above.

Enron Corporation

As you are no doubt aware, Enron Corporation recently filed the largest bankruptcy case in U.S. history, precipitated by a massive crisis of investor and customer confidence. Enron has already announced plans to lay off or put on leave 7,500 workers, and the value of Enron stock held in employees' 401(k) retirement accounts has declined by $1.3 billion since the beginning of 2001. The market capitalization of Enron, which was the seventh largest company in the Fortune 500, plunged from over $60 billion at its peak last year to under $1 billion last week. Enron's inclusion in the S&P 500 index until shortly before the bankruptcy filing means that the broader market and the many investors who index their equity holdings are also suffering as a result of Enron's failure.

The AFL-CIO is a federation of trade unions that represent 13 million working men and women who participate in the capital markets as investors through defined benefit and defined contribution plans as well as through mutual funds and individual accounts. Our member unions sponsor benefit plans with over $400 billion in assets, and our members are participants in public employee and collectively bargained single-employer plans with over $5 trillion in assets. Our union-sponsored funds alone are the beneficial owners of approximately 3.1 million shares of Enron stock, through both actively-managed and passive (or indexed) portfolios.

Enron's meltdown was caused by a number of factors, among them a cavalier attitude toward disclosure, inadequate internal controls and an approach to accounting that at best can be characterized as careless and at worst constituted a conscious effort to mislead investors and the public about the profitability of Enron's operations. These problems point to an abject failure by Enron's board, especially its finance and audit and compliance committees, in the discharge of its monitoring duties. We believe that the lack of independence on Enron's board and key committees contributed to this failure.

At first glance, Enron's board and key committees appear to be composed primarily of independent directors. According to Enron's 2001 proxy statement, of the 14 directors nominated for reelection at the 2001 annual meeting,2 eight, or nearly two-thirds, lacked disclosable relationships with Enron. Of members of the audit and compliance committee, which was responsible for reviewing the effectiveness of internal controls and the application of accounting principles, only one, John Wakeham, has disclosable ties to Enron, in the form of a $72,000 per year consulting arrangement. A majority of members of the finance committee, which oversaw Enron's risk management activities, are similarly independent.

However, further research reveals that several of the eight ostensibly independent directors, including two who serve on the audit and compliance committee and one who serves on the finance committee, actually have relationships with Enron or its senior executives that could interfere with those directors' ability to be objective and to challenge company decisions and policies.3

  • Audit committee member John Mendelsohn is the president of the University of Texas M.D. Anderson Cancer Center. The Cancer Center has received contributions from Enron, and Enron chairman and CEO Kenneth Lay was part of what the Houston Chronicle characterized as a "coalition" to lobby the Texas legislature for $20 million worth of infrastructure improvements to support the development of the Southeast Texas BioTechnology Park, which will be built on University of Texas land and house the Cancer Center's Life Sciences Center. Compensation committee chairman Charles LeMaistre is the Cancer Center's president emeritus and serves on its Board of Visitors.
  • According to Enron's 2001 proxy statement, directors Norman Blake and John Duncan own common units of EOTT Energy Partners, L.P. ("EOTT"), a limited partnership whose general partner is a wholly-owned subsidiary of Enron. Enron thus exercises significant control over EOTT, which could affect the economic return available to Messrs. Blake and Duncan. Mr. Blake serves on Enron's finance committee; Mr. Duncan is a member of the audit and compliance committee.
  • Wendy Gramm, a member of the audit and compliance committee, is director of the Mercatus Center at George Mason University. According to a December 10, 2001 article in Time magazine, Enron contributed $50,000 to the Mercatus Center.

Uncovering the relationships described above was neither easy nor inexpensive. An investor thus cannot evaluate the independence of the board and key committees at all or even a substantial number of the companies in its portfolio without expending significant funds. Because of the economics involved in undertaking such research, even proxy voting and research services such as the Investor Responsibility Research Center-which exploit economies of scale in assembling corporate governance data-rely solely on the disclosures set forth in the proxy statement when evaluating boards and key committees. Accordingly, we believe that additional proxy statement disclosure regarding relationships between directors and director nominees, on the one hand, and registrants and their senior executives, on the other, is vital in enabling investors to select investments wisely, monitor companies in which they have invested and cast informed votes in director elections.

Specifically, we urge the Commission to amend the rules to require disclosure of:

  1. Relationships between the registrant or any executive officer of the registrant and any not-for-profit organization on whose board a director4 or immediate family member5 serves or of which a director or immediate family member serves as an officer or in a similar capacity. Disclosable relationships should be defined to include contributions to the organization in excess of $10,000 made by the registrant or any executive officer in the last five years and any other activity undertaken by the registrant or any executive officer that provides a material benefit to the organization. "Material benefit" should be defined to include lobbying efforts such as those engaged in by Mr. Lay on behalf of the M.D. Anderson Cancer Center as well as fundraising activities undertaken by the registrant or any executive officer on the organization's behalf.
  2. Relationships in which the registrant or any executive officer exercises significant control over an entity in which a director or immediate family member owns an equity interest or to which a director or immediate family member has extended credit. Significant control should be defined with reference to the contractual and governance arrangements between the registrant or executive officer, as the case may be, and the entity. For example, in most cases, a general partner exercises significant control over a partnership, while a limited partner may exercise significant control depending on the terms of the partnership agreement.
    It may be necessary to provide that the existence of significant control may depend, in part, on the overall ownership structure of the entity and not just the stake held by the registrant or executive officer. For example, the owner of less than a majority of a corporation's stock may nonetheless exercise significant control if the other stockholders are numerous and fragmented.
  3. Joint ownership by a registrant or executive officer and a director or immediate family member of any real or personal property.
  4. The provision of any professional services, including legal, financial advisory or medical services, by a director or immediate family member to any executive officer of the registrant in the last five years.

We understand that in 1998 the Council of Institutional Investors ("CII") filed a petition for rulemaking relating to disclosure of director conflicts of interest and that the Commission has not responded to that request. Although CII's proposed language is more general, we believe that our request covers many if not all of the conflicts that were of concern to CII.

We urge the Commission to take up these important issues immediately. Investor confidence in the United States capital markets depends in large measure on their transparency. Full disclosure of director conflicts of interest will improve transparency and enable investors to assess more accurately the quality of companies' governance structures.

If you have any questions regarding this petition, please do not hesitate to contact Damon Silvers on 202-637-3953. We look forward to discussing this with you further.

Very truly yours,

Richard Trumka


1 These disclosure requirements are set forth in Items 401 and 404 of Regulation S-K.

2 One of those directors, then-CEO Jeffrey Skilling, resigned from both his executive and director positions in August 2001.

3 We raised these concerns in a letter to Enron's special committee, which is attached to this petition.

4 For the sake of simplicity and readability, "director" also refers to director nominees.

5 "Immediate family member" should be defined to include a person's spouse, parents, children, siblings, in-laws and first cousins.



Modified: 01/09/2002