Section of Business Law
750 North Lake Shore Drive
Chicago, IL 60611

January 7, 2004

Via e-mail:

Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549

Attention: Jonathan G. Katz, Secretary

Re: Security Holder Director Nominations
(Release No. 34-48626; IC-26206; File No. S7-19-03; RIN 3235-AI93)

Ladies and Gentlemen:

This letter is submitted on behalf of the Committee on Federal Regulation of Securities of the American Bar Association's Section of Business Law (the "Committee")* in response to the Commission's request for comments on the above-identified Release issued October 14, 2003 (the "Proposing Release"). It was prepared by the Committee's Task Force on Shareholder Proposals.

The comments expressed in this letter represent the views of the Committee only and have not been approved by the American Bar Association's House of Delegates or Board of Governors and therefore do not represent the official position of the ABA. In addition, they do not represent the official position of the ABA Section of Business Law, nor do they necessarily reflect the views of all members of the Committee.


This letter addresses issues concerning the terms for shareholder access to company proxy statements proposed in the Proposing Release. We submitted a letter on November 3, 2003 with respect to the appropriateness of pre-adoption triggers proposed by the Commission and reiterate those views in this letter by reference.

We recognize that the proposals respecting access, together with the disclosure rules recently adopted by the Commission, result from a study of the shareholder electoral process undertaken by the Staff of the Commission as summarized in its report dated July 15, 2003 (the "Staff Report"). These are complex matters concerning which there are differing points of view. The final action taken by the Commission in this important area likely will have significant impact on corporate governance both in terms of legal considerations as well as business and practical consequences. We hope that our views and suggestions will contribute to a fair and balanced resolution of the issues inevitably raised when change is proposed in so complex and significant an area. We appreciate the difficulty of the Commission's task and particularly of avoiding unintended consequences.

Our comments are organized as follows:



  1. Summary

  2. General

  3. The Balance Between Shareholder and Director Roles Under State Law

  4. The Scope of Section 14(a)

  5. Rule 14a-8

  6. Accommodating Access Requirements to the Corporate Governance System

  7. An Additional Authority Issue


  1. General

  2. Withheld Votes

  3. Security Holder Opt-In

  4. Precatory Proposals

  5. Multiple Classes of Shares and Special Voting Situations


  1. Formation of a Nominating Group

  2. Proxy Voting Mechanics

  3. Interaction of Direct Shareholder Nomination and a Traditional Proxy Contest

  4. Maximum Number of Security Holder Nominees

  5. Agreement with Issuer Regarding a Security Holder Nominee

  6. Shareholder Nominee Independence Requirement

  7. Deadline for Submission of Shareholder Nominee

  8. Disclosure of Board Determinations of Exclusion of Shareholder Nominee





In view of the recent adoption of listing standards reforming corporate governance and new Commission rules mandated by the Sarbanes-Oxley Act of 2002, as well as evolving best practices, we do not believe that this is the appropriate time to adopt direct shareholder access rules. Our conclusion is based on the simple proposition that the newly enacted reforms that are now just beginning to be implemented should be given a fair opportunity to work before the Commission enacts additional, far-reaching rules on a matter as fundamental to corporate governance as director selection. Among other things, acting now may undermine the legitimacy and potential effect of the newly enacted reforms. This subject can be revisited in the future after evaluating whether these recently enacted reforms and other changes in company practices have resolved the concerns that the direct access proposals seek to address.

We note in particular that, at the Commission's behest and under its review, the New York Stock Exchange, Inc. ("NYSE") and The Nasdaq Stock Market Inc. ("Nasdaq") have significantly revised their listing requirements relating to corporate governance. These revisions require that, except in the case of controlled companies, a majority of the board of directors of every listed company be independent of management under a significantly tightened definition of independence. In addition, except in the case of controlled companies, director nominations must be made or endorsed by independent directors. Usually, nominations will be made by an independent nominating committee, which must have its own charter and operating procedures. The mandated independence standards and the more specific policies and procedures required in the nominating committee charter all are intended to, and will significantly reform, listed company board composition and culture. In addition, the NYSE further requires, and companies generally will have, corporate governance guidelines.

Moreover, in late November, the Commission adopted significant new disclosure rules relating to the nominating process, including the deliberations of nominating committees. These disclosure standards add additional teeth to the governance reforms of the NYSE and Nasdaq and will influence the practices of unlisted companies, particularly with respect to the selection process for director nominees.

The intended outcome of these significant corporate governance reforms, among other purposes, is to improve the independence of the board and its deliberations and to make it more responsive to investor concerns within the existing corporate governance structure. Reliance is placed on the traditional principle that directors, not shareholders, are responsible in the exercise of their fiduciary duties for the management of a corporation. Much time and intellectual energy has been devoted to the development and implementation of these Commission rules and listing standards, with the intention - and certain result - that they will significantly affect the behavior of all participants in the governance process. Although the rules are just being implemented, there is no reason to doubt their efficacy.

The vitality of our economy and securities markets depends on the stability and growth of our corporations. Therefore, we respectfully submit that moderation is the appropriate policy to follow in an area of such fundamental importance as director selection, and is, in fact, the policy that the Commission has historically followed in this area, even in times of apparent stress and crisis. Moderation is clearly the proper policy to follow in this area, for a number of reasons.

First, as the Commission itself recognizes, there are considerable risks and uncertainties entailed in establishing direct access rights. Direct access could (and many predict will) lead to a highly contentious and damaging regime of many election contests across Corporate America annually. Yet, just as the new disclosure rules and listing standards are being implemented, directors are (rightly) being encouraged to serve on fewer boards, fewer directors are qualified to serve on the audit committee and liability concerns are reducing the willingness to serve. This presents difficulties in recruiting qualified directors. In addition, a management participating in a proxy contest is a management unable to focus fully on the business itself. Creating such an outcome would be a high price to pay for a reform that may or may not be needed.

Second, creating direct access rights may have the additional and perverse effect of discouraging, rather than encouraging, fair and impartial nominating committee consideration of shareholder candidates and suggestions for board composition. This could be the result if shareholders are free to place nominees on the ballot, without any prior or contemporaneous discussions between the nominating committee and the same or other concerned shareholders about nominees and board composition. This could create a dynamic that reduces or eliminates the incentive of nominating committees to engage in dialogue with shareholders and to accept shareholder candidates on the nominating committee's slate.

Third, we note that, with the exception of so-called activist institutional investors, investors in general have not sought additional reforms of the director nomination and election process. For-profit money managers, for the most part, and individual investors are conspicuously absent from this debate, indicating that the proponents of the Commission's direct access proposals are relatively a limited, albeit organized and vocal, portion of the investor community that the Commission is charged with protecting.

Finally, we doubt that the adoption of the rules and the prescribed means of access would achieve the broader objective of good corporate governance.

We urge that at a minimum the Commission not act on its rule proposals until it has solicited and taken into account the views of informed representatives of all segments of the investor community through hearings held by the Commission. Alternatively or additionally, the Commission could hold a series of roundtables or discussion forums that bring together all relevant constituencies. Only in this way will the Commission be able to determine the investor community's true level of interest and support for direct access proposals, as well as whether their adoption is likely to fulfill the Commission's objective or have unwanted adverse consequences.

We strongly suggest that the Commission and its Staff consider the practical implications and mechanics of the voting process, particularly with respect to the vote on triggering events. Indeed, we believe it necessary to examine the process, including the usability of the proxy card, to ascertain whether there is any potential for confusion and consequent disenfranchisement of shareholders. Disclosure on the proxy card should be clear and uncomplicated so that the voting decisions by shareholders will in all cases represent an informed judgment. Furthermore, the structure of the proxy card should be neutral in terms of the ability of a shareholder to vote on an informed basis. This, together with a broad review of the proxy process generally, would be appropriate subject matter for analysis and discussion at a hearing or one or more roundtables.


A. Summary

The Commission's authority to regulate director nominations is confined to disclosure and voting procedures related to proxy solicitations. State corporate law otherwise governs the director nomination process and does not provide shareholders a right of access to the company's proxy materials**, although such a right may be established and the director nomination process may be regulated under organizational documents and by board action. Preemption of state corporate law in this fundamental area of corporate governance cannot be implied from the Commission's general powers; it can only result from direct Congressional action. Accordingly, the creation by the Commission of a substantive right of access for shareholders that would impinge on corporate law - including valid provisions of a corporation's organizational documents - would raise serious issues regarding the Commission's authority. This would include access requirements that conflict with the exercise of board or nominating committee responsibilities with respect to the nominating process or the use of company proxy materials, whether undertaken to implement listing standards or to achieve other legitimate corporate purposes. Rule 14a-8 is not precedent for creation of such an access right because matters relating to the election of directors are excluded from the Rule's scope, reflecting the design and use of Rule 14a-8 for other purposes. Therefore, the limited access to company proxy statements provided by Rule 14a-8 is not determinative of the Commission's authority to adopt an access rule involving the director selection process. The Commission's exercise of authority in this area must separately be supported by considerations involving disclosure or voting procedures.

B. General

The director election process is a fundamental element of corporate governance provided for and controlled by state law. It includes the right of shareholders to elect directors and govern the director nomination process, and reflects a balance of rights and responsibilities between shareholders and directors that is important to our system of corporate economic enterprise. No statutory shareholder right of access to a corporation's proxy statement exists under state law, although access may be provided by the corporation's organizational documents or by action of its board of directors.

The Commission proposes to add to the director election process, through a new Rule 14a-11, a limited right of shareholder access to the corporation's proxy materials. In the Proposing Release, the Commission premises its authority to adopt the proposed rule on Section 14(a) of the Exchange Act, on the basis that access would help facilitate the full and informed use of security holder nomination and voting rights through the proxy process.i In particular, the Commission relies on its authority to regulate "disclosure regarding security holder nominees in company proxy materials." The Commission states that it does not seek by proposed Rule 14a-11 to create a security holder right to make nominations, but only to regulate the manner by which the right to nominate is exercised, as (and if) such right is permitted by state law.

We believe that the Commission's proposed rules relating to access should be considered not only in relation to the Commission's general authority over proxies but also from the perspective of the potential for intrusion in significant governance matters regulated by state corporate law. Both aspects are matters of serious concern from a legal and practical standpoint. We concur with the Commission that the proxy rules and state corporate law coexist in many areas - there is a degree of overlap between them. We also note that, apart from disclosure, regulation of the corporate electoral process has not been preempted by the Congress and therefore remains governed by state corporate law. Thus, the Commission's authority is limited to disclosure and voting procedures, whereas state corporate law defines the rights and responsibilities of shareholders and boards of directors in the director election process.

Where does the Commission's proposal to provide limited access to corporate proxy statements for the election of directors fit into this scheme of things? The current director election system carefully preserves the ability of shareholders to conduct director election contests, but balances that broad right by a requirement that shareholders be willing to expend their own funds to do so (or convince the board of directors, acting as a fiduciary for all shareholders, that it is in the best interests of the shareholders for the corporation to do so). Boards of directors must nominate candidates for election as directors and may use corporate funds to facilitate the election of their nominees. They are, however, limited by their fiduciary role in doing so and in their use of the corporate proxy machinery are barred from frustrating the shareholders' voting rights. Would the proposed access rights accommodate or supersede these fundamental aspects of corporate governance established by state law?

In this letter we identify certain policy and legal issues and provide some analysis, commentary and viewpoint relevant to the Commission's exercise of authority respecting access and make certain recommendations with respect thereto. However, we reserve any definitive conclusion with respect to the Commission's authority in this area until final rules can be analyzed in relation to these issues.

C. The Balance Between Shareholder and Director Roles Under State Law

Under the existing corporate governance system, the role of the shareholder is limited yet crucial. Most importantly, shareholders are the arbiters of value of a company's securities in the capital markets. Accompanying this role, shareholders have the ability to vote on an annual basis on the election of directors and also on certain major corporate transactions. This shareholder franchise is carefully protected by the courts.ii Moreover, shareholder voting rights generally include the right to nominate candidates for election as directors.iii In this structure, however, shareholders do not engage in corporate decision-making - that power is fully relegated to a board of directors. The directors, as fiduciaries, have a duty to shareholders to act in the corporation's best interests. Part of their duty is to propose to shareholders director candidates who will promote the interests of all shareholders. Because this is a fiduciary responsibility of the directors, the state law franchise system does not include a shareholder right of access to a corporation's proxy statement, although such a right can be provided in a corporation's organizational documents or through board policy.ivThe Scope of Section 14(a)

With respect to the Commission's authority in this area, in The Business Roundtable v. SEC,vthe Court of Appeals for the DC Circuit made a seminal finding about the extent of the Commission's authority over corporate governance. The court held that the SEC did not have authority to impose governance listing standards respecting voting rights, inasmuch as voting rights involve a fundamental area of state corporate law that Congress had not preempted. In short, the court found that the Commission could not derive authority to regulate on such matters from implied powers or through the backdoor of its authority over listing standards. The Commission had sought to base its authority on Section 14 of the Exchange Act and certain other statutory provisions. The court determined that the primary purpose of Section 14 related to adequate disclosure in proxy solicitations and otherwise dealt with voting procedures. The court stated, "With its step beyond control of voting procedures into distribution of voting power the [SEC] would assume an authority that the Exchange Act proponents disclaim any intent to grant." The court found that under the Exchange Act there was a clear Congressional determination not to make any broad delegation of power to the Commission with respect to voting rights since this would impinge on state corporate law.

The court also found that the SEC did not derive requisite rulemaking authority from other provisions of the Exchange Act under a standard that it "protect investors and the public interest." This was deemed too tenuous a standard to interpret as an indication of Congressional intent to permit a broad federal preemption of corporate governance and shareholder voting rights. The court noted that this broad language "simply piggybacks on the Commission's flawed view of Section 14 and therefore it must also fail." In the Proposing Release, the Commission cites comparable language in Section 14(a) as a source of its authority to adopt the proposed access rule.

D. Rule 14a-8

In the Proposing Release, the Commission cites the use of Rule 14a-8 and its coexistence with state law. We submit that the limited access provided by and the use of Rule 14a-8 is not persuasive as to the authority of the Commission with respect to the proposed access rules.

Rule 14a-8 has primarily been used to permit communications among shareholders in connection with subject matter that is not excluded under the terms of the rule. In practice, this ordinarily involves precatory proposals on social, governance and other issues, with an occasional binding proposal in the form of a bylaw amendment. In each of these cases, the rule is only used for permissible subject matter, which does not include access.

Rule 14a-8 contains 13 exclusions, one of which relates to the election of directors. The Commission has confirmed that, because of the director election exclusion, shareholders cannot have access pursuant to the rule for proposals relating to the election of Shareholder nominations and use of the company proxy statement to further shareholder candidates, in our view, clearly fall within that exclusion. Furthermore, the Proposing Release seems to confirm that conclusion insofar as it would retain the exclusion but create an exception for a shareholder proposal to opt-in to shareholder access under proposed Rule 14a-11.

Rule 14a-8 was neither designed nor intended for use in election contests. It is noteworthy that the director election exclusion ensures that the Commission's regulation of the proxy process does not overturn basic principles of corporate governance. This reflects recognition of the fact that the electoral process, including access to the corporate proxy machinery for such purpose, is the responsibility of the directors as fiduciaries. It is clear that the current terms and use of Rule 14a-8 do not constitute any precedent for the authority of the Commission to adopt access rules relating to the election of directors.

E. Accommodating Access Requirements to the Corporate Governance System

Given the balance between shareholder and director roles provided by state law, the question arises as to whether an SEC access proposal will, either directly or indirectly, impinge on state law by going beyond disclosure and proxy voting procedures, creating a federal substantive right that shareholders do not possess under state law and which may supersede board and nominating committee procedures allowed by state law.

Proposed Rule 14a-11 makes its access requirements applicable if "[a]pplicable state law does not prohibit the registrant's security holders from nominating a candidate or candidates for election as a director."vii In the Proposing Release, the Commission describes this provision as subjecting a company to the proposed access procedure:

only where the company's security holders have an existing, applicable state law right to nominate a candidate or candidates for election as a director. To eliminate any uncertainties in this regard, the proposed rule would state that the security holder nomination procedure would be available unless applicable state law prohibits the company's security holders from nominating a candidate or candidates for election as a director. If state law permits companies incorporated in that state to prohibit security holder nominations through provisions in companies' articles of incorporation or bylaws, the proposed procedure would not be available to security holders of a company that had included validly such a provision in its governing instruments.viiiWhile this provision recognizes that the federal proxy regulatory aspects of access are constrained by state regulation of corporate governance, we are concerned that it does not adequately address the effect of provisions and procedures regulating the shareholder nomination process validly adopted by companies under state law.

Effectively, the Commission is saying that, if state law gives shareholders the right to nominate directors, the Commission has the authority to create a right of access to the board's proxy statement based on disclosure. It is not clear that this conclusion follows because, as we have indicated above, this would represent creation by the Commission of a new substantive right in an area regulated by the states, with consequences that may be inconsistent with underlying fundamental state law principles regarding director authority and responsibility.

Thus, the proposals raise questions as to (i) whether they impinge on state corporate law by preempting or limiting the acts of directors and (ii) the practical effect and workability of proposed Rule 14a-11 in relation to the nominating process authorized by directors.

No explicit provision is made in the Proposing Release with respect to corporate action that may be taken regarding the director nomination process pursuant to state law. Specific provision is made in Proposed Rule 14a-11 only with respect to state law prohibitions on nominations and, to a limited extent, for compliance with listing standards regarding board composition. If a company has a charter or bylaw provision regarding the nomination of directors or access to the company's proxy materials or has established implementing procedures by board action, will such provisions be given effect as part of the state law governing the right to nominate a candidate for election as a director? Or, does Rule 14a-11 seek to preempt any of those measures? Undue intrusion by the Commission may well be beyond its authority. It could also stifle developments in this area on a state-by-state and corporation-by-corporation basis, as both independent nominating committees and shareholder proponents weigh in on the issues raised in this area and as different governance provisions begin to compete in the capital markets.

Indeed, these questions have already been affected by the newly adopted corporate governance listing standards of the NYSE and Nasdaq, as earlier discussed. From a state corporate law perspective, the provisions and procedures adopted by companies in implementing the listing standards will generally fall into the category of matters permitted in the discretion of the board of directors, acting as a fiduciary for the shareholders, and be subject to any charter or bylaw provisions.

If a board of directors, directly or through its nominating committee (which under corporate law must be created and empowered by the board), is to perform the functions prescribed by the listing standards or is otherwise to carry out its responsibilities concerning the nomination of directors, should it not be in a position to require that all nominations be submitted in accordance with appropriate procedures and standards for nominations that it has established? Of course, those who wish to engage in a proxy contest for control or other purposes could ignore the process. Why should a proponent seeking to use proposed Rule 14a-11 but who avoids the nominating committee process be given access so as to engage in a potential proxy contest?

We assume that boards of directors and their nominating committees in developing and applying procedures and standards for nominations will take into account timing and other practical considerations and will apply the same informational and other standards to all director candidates and their proponents. If the Commission were to adopt a final access rule and a proponent and/or his candidate under that rule does not comply with these procedures and standards, we submit that the proponent should be denied the right of access established by the rule. Otherwise, this will prevent the board or nominating committee from carrying out its role under state law and fulfilling its fiduciary obligations to assess all possible candidates from the perspective of the corporation and the interests of all shareholders. Forcing corporations to accept these nominees, and making the company's proxy materials available to them, would constitute an additional impingement on state law which would bear upon the Commission's authority to adopt proposed Rule 14a-11. Similar issues arise with respect to advance notice bylaws and permissible charter or bylaw provisions establishing qualifications for directors that are applicable to all candidates on a non-discriminatory basis.

It should be noted that a shareholder proponent has no fiduciary duty to the corporation or its shareholders and, under the Commission's proposal, can nominate and seek access for any "independent" candidate without qualification. It is important that companies be able, as part of their corporate governance practices, to take into account all considerations relevant to director nominations through reasonable means permitted by state law and that a shareholder proponent not be able to "do an end run" around such practices by invoking rights under Commission rules. Compliance with nominating committee or other corporate procedures should be a condition of access. On the other hand, a board of directors or its nominating committee would not be entitled to deny a complying proponent's candidate access under a valid Commission rule.

This accommodation between an SEC access rule and the state law authorized nominating process would enable boards of directors and their nominating committees to function and fulfill many of their fiduciary obligations as contemplated by state law. However, if an SEC-created right of access is independent of a valid state law nomination qualification process and shareholders are given a right by an SEC rule that does not exist under corporate law, it would be reasonable to conclude that there has been substantive rulemaking by the Commission in an area beyond disclosure and proxy voting procedures, raising the question of whether the Commission has the authority to preempt state regulation in this crucial area of corporate governance. That result would also create substantial uncertainty about the role of, and raise a serious question as to the reason for having, an independent nominating committee. Accordingly, from both a legal and practical standpoint, we recommend that the Commission, if it determines to adopt an access rule, provide definitive guidance on the relationship between any access rule and charter, bylaw or other corporate procedures respecting nominations and access. Otherwise, shareholders, directors and all other interested parties may face a quandary as to the applicable requirements. This would not be in the interests of investors or fulfill the policy objectives of the Commission as described in the Proposing Release.

While recognition by the Commission of the actions boards can take regarding the nomination process will not resolve all the authority issues, we do believe that a failure by the Commission to accommodate board and committee authority in this area will add to concerns as to the proper use by the Commission of its statutory authority.

F. An Additional Authority Issue

In our November 3 letter to the Commission, we expressed the view that the current use of Rule 14a-8 by shareholders to opt-in to shareholder access under proposed Rule 14a-11 during the 2004 proxy season will not be in accordance with the existing requirements of Rule 14a-8. Eligibility to use Rule 14a-8 under the terms of the current rule practice is determined at the time of submission of the proposal which, applying the 120 day rule, means that proposed Rule 14a-11 would not be finalized at the time of submission. Moreover, at this time and for most, if not all, of the 2004 proxy season, proposed Rule 14a-11 is only a proposal and therefore neither companies nor shareholders can be adequately informed as to the terms or consequences of an opt-in rule until it is finally adopted. The Proposing Release relies upon substantial shareholder dissatisfaction as the fundamental premise to support limited shareholder access. We submit that, under these circumstances, a favorable vote on a shareholder opt-in proposal, should one be included in a company's proxy statement, would not necessarily constitute evidence of such dissatisfaction because neither the company nor the shareholders will know, at the time they act on the proposal, the contents of the access rule they would opt into.

The other triggering event involving a percentage of the withheld votes cast for the election of a director also cannot establish substantial shareholder dissatisfaction before a final access rule is adopted because, among other things, shareholders cannot be fully informed of the consequences of the withheld vote. There is evidence that exempt solicitations have already commenced that target single directors. Therefore, adoption by the Commission of a final rule before an annual meeting this year will not enable an informed shareholder decision to be made as to solicitations that antedate the rule's adoption. Elsewhere in this letter we identify a number of problems with this triggering event, including the fact that it is likely that the specified withheld vote could be achieved solely through an organized campaign by proponents holding only a small percentage of outstanding shares. In addition, there are issues respecting the transparency of such solicitation activities, the appropriate method of calculation of "votes cast" and the requisite number of directors for whom the vote is withheld to qualify as a triggering event. Thus the terms of any such rule are inherently uncertain.

Neither triggering event contained in proposed Rule 14a-11 should be available until some period of time after final access rules are adopted. Nor should a failure to implement a shareholder approved precatory proposal be a triggering event before final access rules are adopted. This pertains not only to legal authority, but also full disclosure and fairness to all interested parties, including proponents, other shareholders and companies. This conclusion is consistent with the bedrock principle that shareholders should vote on an informed basis after considering the company's and proponent's views.


Our comments in this and succeeding sections relate to the triggering events for access and other related matters discussed in the Proposing Release are without consideration of issues of Commission authority or the timing or method of adoption of any such rules. Our comments relate to the rules as proposed.

A. General

We concur in the Commission's approach in any access rule of having a security holder nomination procedure apply to a company only if a triggering event occurs that demonstrates substantial shareholder dissatisfaction with the company's director selection process. Without a meaningful triggering event, the procedure would apply to all companies regardless of whether such a fundamental change in corporate governance involved in providing direct access is necessary or even desirable. As the Commission recognizes in the Proposing Release, this would not be good policy.

There is a serious question as to whether the two proposed triggering events represent significant shareholder dissatisfaction with the proxy process. We are concerned that activist shareholder support of triggering events would become commonplace, as has occurred, for example, in the case of Rule 14a-8 proposals for the repeal of shareholder rights plans. We address each of the proposed triggering events, recommend revisions that we believe are necessary to accomplish their intended purpose and also comment on the precatory proposal alternative raised in the Proposing Release.

B. Withheld Votes

We do not believe for the reasons set forth below that withheld votes for a single nominee is an appropriate triggering standard, and certainly not as proposed where the mere withholding of 35% of the votes cast would trigger the procedure.

The withholding of votes for any one particular director may have nothing to do with shareholder dissatisfaction regarding the director selection process. For example, a director may represent a point of view on a matter that is unpopular with some shareholders (which could be related to corporate governance or not, such as political beliefs) or the director could be associated with another company that has taken action unpopular with some shareholders.

Shareholders also frequently conduct withhold vote campaigns in connection with substantive single issue positions particular shareholders seek to impose on a company, rather than relating to a broader shareholder dissatisfaction. For example, certain holders may seek to have votes withheld from members of the audit committee if the auditors are permitted to provide non-audit services even though approved by the audit committee, as required by law, as being in the best interests of the company. Similarly, votes may be withheld if the audit committee fails to adopt a mandatory auditor rotation program. Certain holders also may seek to have votes withheld from members of the compensation committee if they disagree with compensation policies or the method of accounting for compensation that the committee or board approves in the exercise of its business judgment.

Finally, in our view there is a significant risk that some shareholders may launch a withhold vote campaign against a single director not because of shareholder dissatisfaction, but as a means to effect a triggering event under the direct access rules. We are aware anecdotally that activist shareholders have already begun organizing a number of such withhold vote campaigns for the 2004 proxy season specifically in contemplation that they will serve as triggering events under Rule 14a-11 if and when it is adopted.ixAnother significant problem we perceive with the proposed withheld vote triggering event is that the proposed proxy rule revisions do not require sponsors of a withhold vote campaign to give any notice to the company or to shareholders of their campaign or their reasons for it, nor will they have to make any filings with the Commission so long as they do not solicit proxies (which are not needed for withholding votes) and do not form a 5% or greater group. The result of this ellipsis in the proxy rules is that "stealth" withhold vote campaigns are feasible and likely. These campaigns can be waged by telephone, email, fax and formal or informal networking through a variety of organizations and proxy advisors who may support such campaigns for good, bad or no reasons. Other shareholders, and too often the company, may have no idea that the campaign is in existence, nor do they have any practical way to counter-solicit effectively if the reason and bases of the campaign and the identity of its sponsors are not fully known and subjected to the disclosure standards of the proxy rules.

The Commission in its Proposing Release acknowledges that there is no reliable historical data on the size of withheld votes for given nominees, and more important, that there is a risk that creating a withheld vote triggering event might well change shareholder voting patterns. We think this risk is significant, particularly if the withheld vote trigger relates only to a single nominee. As a practical matter, shareholders, particularly activists, could view a withheld vote for a single director as worth the benefit of creating a triggering event. Enough shareholders, particularly institutions, will understand that voting for a triggering event is analogous to buying an option for no cost-an analysis that raises the specter that instead of operating as a meaningful screening device, a 35% withheld vote for one director would instead create a costless incentive to withhold votes.

There is an additional significant consideration that must be taken into account in ascertaining the effect of a voting standard based on votes cast. At this point it is unclear how the NYSE and other parties involved in processing votes held in street name will interpret Rule 452 in the context of withhold vote campaigns. Moreover, even if broker discretionary voting under Rule 452 is permitted, there is no assurance that brokers will vote shares for which they have not received instructions from beneficial holders. We understand that today many brokers simply do not exercise their discretion under Rule 452 with respect to proposals that are viewed as controversial, including many Rule 14a-8 proposals. Accordingly, there is a significant possibility that brokers, while submitting proxies, simply will not cast votes for any directors in the absence of instructions where there is a recognized withhold vote campaign. This, in turn, would lower the number of votes cast, although it would not affect the quorum present at the meeting.

Based on the foregoing considerations, we recommend:

  • Any withheld vote trigger should relate to more than one director. We recommend that instead, the relevant number be a majority of the directors then being elected. This would be a truer indication of shareholder dissatisfaction with the director selection process. Moreover, basing the trigger on withheld votes for a majority of the board's nominees will eliminate much of the "gaming" possibilities inherent in a single director withhold campaign. Finally, if a single director standard is used, it has the potential of being unfair to that director and to "personalize" a campaign when the individual is selected primarily as a means of seeking access.

  • Although 35% of the votes cast may be an appropriate level, those votes also should represent a minimum level of the shares entitled to vote to ensure that it is reflective of the overall shareholder will. Even with a majority quorum requirement, 35% of the votes cast could represent only 17.5% of the outstanding shares. Since quorum requirements can be less than a majority, the percentage could even be lower. Yet another and more striking anomaly of a 35% withheld standard is that if more than 77% of the shares entitled to vote do so (a reasonable turnout), a director can receive an absolute majority of votes entitled to be cast and still receive a 35% withheld vote. It is hard to understand why direct access should be triggered when a majority of shares entitled to vote support the candidate. Accordingly, we recommend that the requisite level of withholding should be 35% of the votes cast on the director's election, but only if

      (a) that number of withheld votes represents at least 35% of the voting power (with respect to that election); and

      (b) if the nominee did not receive the favorable vote of a majority of the votes cast on the election of the director.

    This standard would mean that a nominee who receives a majority of shares entitled to vote could not be the basis for a successful triggering event.

  • To avoid the problems of "stealth" withhold vote campaigns discussed above, in order to qualify as a triggering event any adopted rules should provide that holders who solicit the withholding of shares must disclose that they are doing so, their reasons (including who selected the candidates subject to the campaign) and the consequences of withholding in relation to the company's future elections. They also should be required to file with the Commission all written soliciting material (which should be explicitly defined in any new rules to include electronic communications, whether by e-mail, websites or chat room postings) on the day of first use and all such material should expressly be subject to Rule 14a-9.

    Further, as suggested in the Proposing Release, we believe that Section 13(d) may be applicable to shareholders who agree to act together to withhold votes with respect to specific directors. Accordingly, we believe it would be appropriate to allow any "group" formed solely for the purpose of triggering proposed Rule 14a-11 to file on Schedule 13G so long as each person involved makes the required certifications under existing Item 10 and, as suggested below in "Direct Shareholder Access Process - Formation of Nomination Group", the "group" is dissolved immediately after the election is concluded. By making the sponsor of the withhold vote campaigns subject to Schedule 13G public disclosure, all public stockholders will be served by knowing who is actively seeking to cause a Proposed Rule 14a-11 triggering event to occur.

  • To avoid subjecting companies and their shareholders to withhold vote campaigns on a continuous basis, if a shareholder conducts a campaign in support of withholding votes from any of the board's nominees (assuming that, as proposed below in "Direct Shareholder Access - Formation of Nomination Group," a notice of such an effort is required if more than 10 shareholders are contacted), then, if the requisite number of votes are not withheld so as to trigger access, this triggering event would not apply for the next two annual meetings.

  • Cumulative voting presents unique problems to the operation of a withheld vote trigger and must be considered in relation to the allocation and tallying of votes, as well as the form and content of the proxy card. Problems arise principally because under proposed Rule 14a-11 the withheld vote is considered for purposes of the rule as a "vote cast." Generally, under state law, particularly with respect to plurality voting, a withheld vote is not considered to be cast.

We believe that a Commission rule providing a withheld vote triggering event should specify that the cumulation of shares is not permissible with respect to the withheld vote tabulation. By way of illustration, if a company has a board of 10 directors and the shareholder owns 1,000 shares, that shareholder has an aggregate of 10,000 votes but should be treated for purposes of proposed Rule 14a-11 as having the right to withhold only 1,000 votes with respect to any nominee. The shareholder who wishes to vote in favor of the election of one or more nominees nevertheless can allocate his total votes among such nominees as he may determine. Thus, his voting rights would not be impaired by the Commission's rule. Most elections of directors are achieved by plurality voting. With respect to the relatively few companies that use a different standard, such as the majority of the outstanding shares, or where voting against the director is permissible, appropriate adjustment should be made with respect to those voting arrangements. We suggest that the construct of a proxy card in relation to cumulative voting needs to be considered with great care in order to provide clear and non-confusing voting instructions for shareholders. It is not clear that the proxy card can meet the clarity standard for cumulative voting for the purposes of proposed Rule 14a-11.

C. Security Holder Opt-In

We believe a shareholder opt-in would be an appropriate triggering event, but only if properly constructed. Accordingly, if providing a direct access right were warranted, an opt-in provision would be an appropriate triggering event.

Appropriate Opt-in Vote. We do not agree that greater than 50% of the votes cast (the "50% vote") is a an appropriate standard to measure true shareholder sentiment. As we point out in connection with our analysis of the 35% withheld test, a low shareholder turnout (particularly when coupled with low quorum requirements) could result in the anomaly of as few as 25% of shares entitled to vote (or lower percentages with lower quorums) deciding questions of fundamental governance rights.

Moreover, as with the 35% withheld vote proposal, the 50% vote proposal ignores the more than likely scenario that brokers will not exercise the discretion granted to them under NYSE Rule 452 and will not vote on opt-in proposals without specific instructions from beneficial holders or that the Rule will be interpreted so that brokers will not have discretion to vote without instructions. This would be consistent with the existing pattern of brokers not voting under Rule 452 for a large number of Rule 14a-8 proposals. The result, were this to occur, would be to reduce greatly the number of votes cast on an opt-in proposal, without affecting the quorum count and to undermine further the meaningfulness of achieving a 50% vote standard.

The risk of the 50% vote trigger becoming an ordinary event, rather than a meaningful condition on shareholder access, is exacerbated by the realities of how shareholders vote. Many institutional shareholders defer in practice (or in law when they grant a full proxy) to the recommendations of a proxy advisor. Most of the remaining institutional shareholders adopt rigid voting policies which are expressly intended to avoid the need for reviewing specific proxy issues, as well as public or private controversy. In this context, there is a high likelihood, if not a certainty, that there will be widespread adoption of voting policies in favor of all opt-in proposals, without regard to any demonstrated corporate governance weaknesses or failures at the company in question. After all, the opt-in vote in itself does not make any change other than to create the option for a direct access nomination. Like a director withhold vote, it is easy to argue there is nothing to lose and everything to be gained by creating an option that is without cost to the proponents. A system of recurrent election disputes, with the attendant costs to the corporation and disruption of its corporate affairs, may result, turning direct shareholder access into a virtually organic shareholder right unrelated to the objective of this rulemaking.

For these reasons, we believe that, to be meaningful as a selectively used trigger event, an opt-in proposal should require, at a minimum, a higher vote threshold than that provided in the Proposing Release. In our judgment and because of its binding and fundamental effect, an opt-in vote is as important as an amendment to the company's governance documents. Thus the vote required for opt-in should be comparable and analogous to the voting requirements for charter amendments. In most cases, this would require the affirmative vote of a majority of the outstanding shares. That would be an appropriate standard with regard to this proposed triggering event.

Qualification Standards for Proponents of Opt-in. We agree with the Commission that a threshold should apply to the shareholders eligible to propose the opt-in trigger. This ensures that there is sufficient shareholder support to justify putting the company and its shareholders to the burden of addressing the proposal. While the one-year ownership requirement is appropriate, we believe that the 1% ownership standard is too low for the threshold to achieve its purposes.

The Proposing Release underestimates the number of companies at which access will be requested. The Commission's own statistics indicate that "most companies have at least one security holder" that would be eligible to submit an opt-in proposal based on a 1% ownership test. The fact that few large shareholders have been active in making Rule 14a-8 precatory proposals is not predictive of their behavior under proposed Rule 14a-11. Moreover, as the Commission acknowledges, shareholders can easily band together to form a 1% group.

Footnote 198 in the Proposing Release presumes that shareholder access will only be requested at companies where the proponents "are confident" that they will have a 5% group able to make a nomination. We believe that, as a strategic matter, it is much more likely that proponents of access holding 1% of the shares will propose access at a large number of companies. After the first proxy season at which these proposals come to a vote, a group will determine at which companies a majority of votes for open access was obtained. Thereafter, they will invest the time, effort and money necessary to create a 5% group capable of nominating a candidate at companies where open access is available.

The mere ability to threaten a proxy contest with a shareholder access trigger proposal can give significant leverage to a shareholder group with its own agenda. Because support at the 1% level is too easily achieved and does not necessarily evidence shareholder dissatisfaction, it should not subject the company and its shareholders to the functional equivalent of a proxy contest. Accordingly, we believe that the ownership level required to nominate a candidate (proposed to be 5%) should also be the ownership level required to institute an opt-in contest.

Finally, as with the withheld vote trigger, we believe it is essential to protect companies and shareholders from repeated proxy contests on the same subject. If an opt-in proposal is defeated (or at least does not receive a greater than 50% vote), it should not be eligible for submission again by any holder until the third annual meeting following the meeting at which the proposal was defeated. In addition, if access is permitted under proposed Rule 14a-11 because an opt-in proposal was approved at the preceding shareholders' meeting, the rule should not permit an opt-in proposal to be presented for a vote at the next shareholders' meeting since there will automatically be access at that meeting and the meeting that follows.

D. Precatory Proposals

The Commission wisely refrained from proposing that the failure to implement a shareholder proposal under Rule 14a-8 be a direct access triggering event, notwithstanding that it was an alternative identified in the Staff Report. We urge that this concept not be adopted as a triggering event for the following reasons:

  • Imposition of such significant consequences would substantially change the dynamics surrounding precatory Rule 14a-8 proposals. This is already a difficult area that places huge burdens on the SEC staff. To increase the importance of the success or failure of such proposals would exacerbate the existing difficulties by increasing the number of proposals, encouraging disputes over their eligibility and expanding the scope of the contests. In addition, it would increase the leverage proponents have in negotiating settlements that may not be in the best interests of all shareholders.

  • The imposition under federal law of governance consequences for failure to implement proposals that are only permitted as precatory under state corporation law would be an encroachment on state law and therefore of questionable authority. For example, an SEC proxy rule cannot preempt state corporation law requirements or the provisions of a valid charter provision. Consider, for example, a precatory proposal to eliminate a staggered board. State law may require such a structure (see Massachusetts Business Corporation Law, § 50A) or it may be established by a charter provision that can only be amended by a high vote of shareholders. Precatory proposals often pass with a majority of the quorum but a minority of all outstanding shares. Indeed, the "no" votes may be sufficient to block the approval of a proposal to implement the precatory proposal under state law. Giving such collateral effect to the director nomination process for failure to implement a vote on such a proposal conflates different elements of the corporate governance system.

  • Moreover, the imposition of governance consequences for failure to implement a shareholder proposal may interfere with the ability of directors freely to exercise their business judgment in the best interests of the company and its shareholders on a shareholder proposal. We are already seeing directors responding to proposals not solely on their merits but with an eye toward the collateral consequences on the director selection process.

  • Determining whether a precatory proposal that has been approved by shareholders has been "implemented" would raise a host of issues and uncertainties that would require creation of a new dispute resolution regime that would rival, and we believe far surpass, the problems created by adjudicating the propriety of Rule 14a-8 proposals.

  • Precatory proposals and shareholder nomination procedures should not be linked. A vote on a precatory proposal, which may be on virtually unlimited subject matter, provides no indication of shareholder dissatisfaction. In fact, it is more likely to represent the proponent's agenda or special interest which may not coincide with the interests of shareholders generally. Also, a precatory proposal by its nature may not be considered significant to the business and may be approved for reasons unrelated to its merits by the vote of a relatively low percentage of outstanding shares. In addition, it is clear that many institutional shareholders vote on many precatory proposals virtually by rote and their vote is nothing more or less than a generalized statement of policy, not a criticism of any particular corporation's governance performance. Finally, shareholders may favor a precatory proposal but be opposed to the shareholder nomination procedure. The Commission has long recognized the importance of disaggregating unrelated matters for proxy voting purposes. It would also be burdensome for companies to explain in their proxy statements, as to every precatory proposal, the potential effect which a majority vote (which may be different from the vote required to adopt the proposal itself) may have on the future nomination process.

E. Multiple Classes of Shares and Special Voting Situations

All calculations of percentages based on share ownership should be based on the voting power of the shares owned in connection with the election of directors or other proposal for a triggering event, as the case may be. Class voting and variable voting rights should be taken into account in establishing voting power with respect to a particular triggering event. For the purposes of this rulemaking, the holdings of a security holder who is not entitled to vote on a particular triggering event should not be counted. Furthermore, if any class of security is entitled to elect one or more directors, the rule should provide that the proponent identify the class for which its nominee would be a candidate. The rule should apply only to the general election of directors, or any special elections of the board as a whole. The rule should not be applicable to any special election of directors such as the holders of a class of preferred stock which is entitled to elect one or more directors as a result of a default in the payment of a dividend or a special election to fill a vacancy on the board of directors.


A. Formation of a Nominating Group

As proposed, Rule 14a-11(f) would create a broad exemption for solicitations of not more than 30 persons in connection with the formation of a nominating security holder group without the need to make any public filings. We do not believe there is any reason to go beyond the 10 person maximum long contained in Rule 14a-2(b)(2) permitting a limited amount of "testing the waters" before applying the notice and filing requirements of the proxy rules. The proposed exemption, which would dramatically expand the number of solicitees that could be contacted privately, with no public filing of any solicitation materials, runs counter to the basic premise that the proposed direct access rules should not be used for "change in control" or "influencing control" purposes. We believe the 30 person exemption could be used for such control purposes: for example, a 4.9% stockholder could prepare written materials and enter into private discussions with 30 other stockholders about the need to change the board of directors of a company "in connection with" a stated intention to form a nominating group (a "13G Nominating Group"). After gauging the reaction of stockholders under the cloak of this exemption, the stockholder could decide to abandon the limited Rule 14a-11 shareholder access process and proceed to mount a full scale proxy contest based on the knowledge of other shareholders' attitudes toward management obtained through this secret solicitation process. Creating this potential for abuse is unnecessary because the proposed rule provides an alternative "public" mechanism by which a shareholder can "advertise" that it is seeking to form a group for this limited purpose. Accordingly, we believe the number of persons referred to in clause (i) should be no more than 10 to be consistent with existing limitations under the rules with respect to "unregulated" proxy solicitations. The positive effect of this change would be that a stockholder wanting to engage in a solicitation of more than 10 stockholders using written materials would be required to do so by means of written communication limited to the information set forth in Rule 14a-11(f)(ii).

Given its purpose, the exemption set forth in paragraph (f) should only apply to a shareholder eligible to use the Rule 14a-11 process. Therefore, the stockholder seeking to rely on Rule 14a-11(f) should satisfy the requirements of Rule 14a-11(b)(2) (i.e. must be continuous beneficial owners of more than 5% of the voting securities of the issuer for at least two years) before being able to avail itself of this exemption. Likewise, the written notice required by Rule 14a-11(f)(ii) should state the number of shares beneficially owned continuously over two years and advise other stockholders that only those holders similarly situated are eligible to become part of the nominating group.

Finally, to avoid continuing "actions in concert" by shareholders owning more than 5% of any issuer's outstanding stock, the rules should make clear that once a nominee supported by a 13G Nominating Group has been either elected or defeated at the next election of directors, the group should be dissolved by the filing of a final amendment to a Schedule 13G and the exemption provided by the newly proposed "Instruction to paragraphs (b) and (c)" should become inapplicable, so that the instruction cannot be used to mask continuing group activities beyond the scope of the original reason for forming the 13G Nominating Group. This is a matter of realistic concern and would be especially important where a 13G Nominating Group succeeds in placing a nominee on the Board, thereby attaining, virtually by definition, an ability to influence control.

B. Proxy Voting Mechanics

Clause (b)(2)(iv) of proposed Rule 14a-4 would prohibit the grant of authority to vote for nominees as a group on a proxy card if a security holder nominee is included on the proxy card under the rule. We are concerned that this proposal will be highly disruptive to the proxy voting process. Many proxy cards are returned signed by the shareholder without checking particular boxes. We believe it is apparent that such shareholders are intending to vote as recommended by management or would not have otherwise signed and returned the card. In so voting, they are relying on a longstanding process under which they are voting for the board's recommendations if they do not otherwise direct. No matter what efforts are taken, it is highly likely that a substantial portion of those shareholders will continue to sign and return proxy cards in the way they have in the past. This will have the unintended consequence of disenfranchising these shareholders and distorting the vote on the election of directors.

In the interest of avoiding the almost certain confusion that would stem from a universal ballot, any rules pertaining to access that are adopted should require no more changes to the form of proxy than necessary. The more stockholders can rely on what has become customary, the lower the risk of returning invalid proxies. Furthermore, we question whether prohibiting "block voting" is necessary. Companies are currently required to provide on the proxy card for a way to withhold a vote for one or more directors. This currently gives shareholders the ability to withhold votes for one or more directors even if their names are included in a board-recommended list.

If the intent is to avoid having shareholders vote for too many nominees, we do not believe the proposed provision will be effective. For example, if a dozen individual candidates are listed on a proxy card for eleven board positions, inevitably some shareholders will vote for all of them no matter what warning is placed on the card. At the same time other shareholders will simply sign the card and return it with no boxes marked. Therefore we would recommend that the proxy be voted in essentially the same manner to which stockholders are currently accustomed but require a clear delineation of the "management slate" and the shareholder nominee(s) and state on the face of the proxy card in bold face that: "In order to vote for a shareholder nominee, you must check the box for that nominee and strike a candidate from the management slate." By this method, we believe there is less risk that a shareholder will either vote for all nominees - thus rendering the proxy invalid - or vote for only a partial slate - which will disenfranchise the shareholder with respect to his or her vote on the full slate of directors. The Commission should confirm that the procedure of Rule 14a-11 will govern in lieu of the "short slate" provision of Rule 14a-4.

Finally, any final rulemaking should require a nominating shareholder or group to include in its soliciting statement (which would be included in the board's proxy materials) the name(s) of the nominee(s) of the board who it recommends be replaced by its own candidate(s) (assuming the nominating shareholder group is making such a recommendation), i.e., specify from which nominee(s) of the board it recommends votes be withheld.

C. Interaction of Direct Shareholder Nomination and a Traditional Proxy Contest

The Proposing Release does not address the contingency of a traditional proxy contest occurring at the same shareholder meeting as a vote on shareholder nominated directors per Rule 14a-11. We believe this would be an extraordinarily confusing scenario. Shareholders would be confronted with a myriad of voting choices and contradictory solicitation campaigns by both groups of proponents. The proponent might disclaim any control intent but recommend a vote for the insurgent. The company, likewise, would find itself in the complicated position of arguing against two different election campaigns. Litigation over the outcome of the election is almost certain to result.

Accordingly, we recommend that the direct access rules explicitly provide that the company is not obligated to provide access to its proxy materials with respect to the election of directors for any meeting where it is subject to a traditional election contest that is announced prior to the first mailing of the company's proxy statement to its shareholders. Appropriate procedures should be established for this purpose, including announcement criteria.

D. Maximum Number of Security Holder Nominees

Under paragraph (d) of the proposed rule, a company will be required to include one shareholder nominee if it has a board of eight or fewer directors. We believe that the size of the board requiring the inclusion of one nominee should be nine or fewer directors. This is necessary in order to accommodate the customary practice of having an odd number of board members and, where the board is classified, a number divisible by three. In addition, as stated in the Proposing Release, the median public company board size is nine members. We do not believe, given the novelty of the proposal, that the number of directors in paragraph (d) of the rule should be set such that what is likely to be a majority of public companies will face the prospect of having to include two security holder nominees in one year if they become subject to the access process. Two nominees should be permitted only if a board of directors has a number of directors between 10 and 20 members. The size of the board should be determined and disclosed by the board of directors, except where the size of the board is fixed by the company's organizational documents.

In addition, we recommend that a shareholder nominee who is elected to the board of directors qualify as a "security holder nominee" for a minimum of three years (the same time period as would apply automatically if the issuer had a staggered board), so long as the nominee continues to serve on the board during this period.

E. Agreement with Issuer Regarding a Security Holder Nominee

Board representation by agreement is achieved for different purposes. Often, a board seat accompanies an investment in the company. In some cases, it results from discussions or negotiations with stockholders. From a public policy perspective, to the extent the agreement does not result from a transaction, it would be a mistake to disqualify for purposes of proposed Rule 14a-11(d) a stockholder nominee that the company's nominating committee has agreed to nominate to the board of directors, especially given the adoption of the new disclosure rules respecting the director nomination process. If the nominee is proposed by an unaffiliated stockholder or stockholder nominating group, it would be illogical to craft rules that would discourage the issuer and the stockholders from opting for a course of conduct that foregoes the cost and distraction of a mini-proxy contest. Indeed, the perceived inability of shareholder nominees to gain consideration from the nominating committee is the basis for support of an SEC rule to provide access. As drafted, issuers would never have any reason willingly to agree to put a stockholder nominee on the management slate if such person does not qualify as a "security holder nominee" under Rule 14a-11(d). Therefore, we propose that Instruction 1 to paragraph (d) be amended to permit the inclusion of such nominee and that proposed Rule 14a-11(c)(5) be similarly clarified. If the purpose of stockholder access rules is to give stockholders another avenue to the boardroom, the rule should encourage issuers to provide such access.

If the Commission agrees with the foregoing, there is the additional question of how long a "security holder nominee" should continue to be counted as such for purposes of proposed Rule 14a-11(d). As discussed above, we propose that the nominee qualify as a "security holder nominee" for a minimum of three years, so long as the nominee continues to serve on the board during this period. We discuss separately, under "Additional Comments," alternative procedures the company may adopt to provide access.

Further, in the event that the size of the board increases as a result of the board's agreement to add a shareholder nominee, we recommend that the addition of that shareholder nominee not be counted toward the size of the board for purposes of determining how many security nominees are permitted under proposed Rule 14a-11(d). If a Board has eight existing directors and that is the maximum number it can have without allowing two security holder nominees to become eligible, the issuer may be far less receptive to voluntarily adding such a nominee to the board. By changing how the number of directors is calculated under proposed Rule 14a-11(d), an impediment to the issuer and a large security holder agreeing on a nominee would be avoided.

F. Shareholder Nominee Independence Requirement

Proposed Rule 14a-11(a)(3)(i) allows for the exclusion of nominees whose candidacy would violate the rules of a national securities exchange or national securities association (other than rules regarding director independence). We believe the parenthetical clause regarding director independence should be deleted from the rule as adopted. We believe that providing access should not interfere with the governance best practice of electing independent directors. A board subject to the listing standards is obligated to have a majority of independent directors and, subject to the controlled company exception, to have only independent directors on its three major committees. It is hard to imagine why the shareholder submitting a candidate cannot provide a candidate who meets the independence requirements. Moreover, it will be a substantial impediment to corporate governance if a candidate who is not independent is submitted and is elected. That election will impinge upon the company's ability to retain other directors who may not be independent (possibly for inconsequential reasons) and still maintain a majority of independent directors. Moreover, the shareholder submitted candidate will not be able to serve on any of three major committees. For a board with nine members to find that two could not serve on any of those committees could raise a difficult and unnecessary problem. This is a consequence that can be avoided.

If the reason for the parenthetical is concern about bad faith determinations by a Board of Directors regarding a shareholder nominee's independence, we submit the concern can be adequately addressed by making clear that board determinations of independence in this context must be made in good faith.

We generally support the shareholder nominee eligibility requirements in the proposed rule, including the requirements regarding the lack of affiliation with the nominating security holder or group of security holders. In addition, as discussed above, a shareholder nominee under Rule 14a-11 should meet all independence criteria under the applicable listing standards (both the objective and subjective standards). Furthermore, the shareholder nominee should meet any additional independence standards that the company has adopted. The new NYSE rules allow companies to adopt categorical standards of independence that can be used to determine director independence, which are likely to include additional criteria to those included in the listing standards. Each shareholder nominee should also be required to meet, as any other board nominee, any other director qualification requirements that are established by the board, as long as any subjective criteria are applied by the board in good faith. The new nominating committee disclosure requirements adopted by the Commission in November require disclosure of any specific, minimum qualifications that the nominating committee believes are required for board members. We see no reason why shareholder nominees should not be required to meet the qualification standards adopted by the company which will be publicly disclosed and will apply to all director nominees.

G. Deadline for Submission of Shareholder Nominee

We are concerned that the deadline for the submission of candidates and the required information about them is too close to the date when proxy material must be prepared for mailing and filing with the Commission. Under proposed paragraph (c) of Rule 14a-11, the shareholder must provide notice to the registrant 80 days before the first anniversary date the registrant mailed its proxy materials for the prior year's annual meeting. By proposed instruction 4 to paragraph (a) of the Rule, the company must then advise the nominating shareholder whether it intends to include disclosure supporting its nominees or opposing the submitted candidate. The notice must also state the date by which the nominating shareholder must provide its supporting statement, which may not be less than 10 business days after the company's notice to the nominating shareholder. That effectively cuts the lead time for proxy statement preparation down to 66 days. We believe the 10 business day requirement is unnecessary. A group submitting a candidate should easily be able to provide its supporting statement by the same deadline as for submitting candidates. That process has worked for Rule 14a-8 for years and should certainly be workable for the proposed rule.

More importantly, Rule 14a-8(e) provides that proposals under that rule must be submitted 120 calendar days before the company's proxy statement was released to shareholders for the previous year's annual meeting. The proposed direct access rules will have substantially more consequences than the typical precatory proposal under Rule 14a-8, which only requires a $2,000 investment.

In addition, eligibility is determined at the time of submission. If there is a dispute, sufficient time would be allowed for resolving the differences. This practical consideration also favors earlier notice.

There is another significant timing issue. Most companies have adopted advance notice bylaws which provide timing and informational requirements for any director nominations that require compliance in order to entitle a shareholder to place the nomination before a shareholders' meeting. Such bylaws are permissible under state law. We assume that the Commission does not intend to preempt these bylaws in its direct access rules. Nominations made under an access proposal should be required to satisfy a consistent timeframe.

Accordingly, we urge that the deadline for submission of proposals under the proposed rule should be no later than the first to occur of the last date for submission of proposals under Rule 14a-8 and the last date for valid shareholder nominations as established by advance notice bylaws or similar shareholder or board adopted policies

H. Disclosure of Board Determinations of Exclusion of Shareholder Nominee

Paragraph (h) proposed to be added to Rule 14a-5 requires proxy statement disclosure of the board determination that it is not required to include a nominee submitted under the proposed direct access rules. We do not believe that this is either necessary or appropriate. In the final rules recently adopted on disclosure of the nominating committee functions, the Commission wisely chose not to require discussion of the individuals submitted by shareholders but not nominated by the committee. See Section II.A.3.e of Rel. No. 33-8340 (11/24/03). This is appropriate as a privacy matter and to avoid public debate about subjective evaluations of a candidate's qualifications. We believe that the description of the specific basis for the board's belief that it could exclude nominations submitted under the proposed rule would inevitably lead to the same problems. We also do not know why it is necessary. Either the company complied with the proxy rule requirements or it did not. If the shareholder making the submission believes that the company violated the rules, it can at no cost raise that issue with the Commission. Alternatively, a 5% group that has made such a nomination should be able to bear the cost of asserting its point of view in court.

Nor do we understand the reason for disclosure of a board's belief that the exclusion is permitted. This does not differ from compliance with any other proxy rule. Normally compliance with proxy rules would be based on the board's reliance on advice of counsel and management that the proxy statement complies with the rules. The board does not make independent determinations as to each element of rule compliance. We considered whether the proposed rules should simply indicate that more candidates were submitted under the proposed rule but were not included in the proxy statement. However, we concluded that this objective statement would be as likely to mislead shareholders as it was to inform them. If the registrant is complying with the proxy rules, the reasons that a submission could be excluded may not reflect on the attitude of the board either about shareholder nominees in particular or corporate governance in general.


There appear to be no substantive reasons for treating investment companies differently from operating companies for purposes of implementing the proposed rule (other than as set forth in the proposing release). We suggest, however, that the final rule take into account the special nature of open-end investment companies.

Series funds. Many open-end investment companies are structured as "series" funds. Investment companies structured as series funds consist of one or more separately managed series portfolios ("portfolios"), each with its own investment objective, policies and restrictions. The investment company's board of directors must approve, on behalf of each portfolio, contractual arrangements with the portfolio's investment adviser, distributor and other service providers, as well as Rule 12b-1 distribution plans. Moreover, some agreements and plans require approval of the shareholders of each portfolio, voting separately. Generally, no portfolio is responsible for the liabilities of any other portfolio in the series fund. Shareholders of one portfolio own an undivided interest in that portfolio alone, and this ownership interest by itself does not confer any right to the assets of any other portfolio. Portfolios are treated as separate entities for purposes of federal taxation, accounting, and regulation under the Investment Company Act of 1940, as amended (the "1940 Act"), each being treated as "affiliated persons" of the other, among other things.

While portfolios generally are treated as separate entities for many purposes, they are not viewed as separate entities for certain other purposes. Most significantly, they are not viewed as separate entities for purposes of electing a board of directors (or trustees, as the case may be). Typically, the shareholders of all portfolios, in the aggregate, vote to elect a single board of directors, which oversees the functions of all portfolios of the series fund.

The final rule should clarify that it applies to the series fund in its entirety, and not to the individual portfolios that comprise the series fund.

Definition of "interested person." We concur with the Commission's approach requiring any nominating security holder or group of security holders to represent that its nominee to the board of a fund is not an "interested person" of the fund as defined in Section 2(a)(19) of the 1940 Act.

We note that the Proposing Release would require any nominating security holder or group of security holders to represent that its nominee to the board of a fund is not an "interested person." We suggest that there be a requirement that each security holder nominee promptly complete a director's questionnaire provided by the fund's nominating committee (or board members serving a similar function) so that the nominating committee can assess whether the nominee qualifies as a disinterested person. This due diligence process is essential, especially in the case of funds with several sub-advisers, as the failure to qualify as a disinterested trustee could have serious consequences for an investment company and its shareholders.*** A nominating shareholder should not be entitled to access for a nominee whose qualifications as a disinterested person are in doubt. This reflects the broader need, as discussed above, for boards and nominating committees to be able, in carrying out their fiduciary duties, to establish appropriate procedures and standards that will apply to security holder nominees, including candidates presented under any access rule that may be adopted. Accordingly, we suggest that a provision be included, or an instruction be added to any access rule specifying that a security holder nominee's eligibility for access is conditioned on compliance with nominating committee standards and procedures and, specifically in the case of an investment company, that the nominating committee retains ultimate authority to determine whether a security holder nominee qualifies as a disinterested person of the fund.

We also suggest that the rule address situations when a director has been elected in reliance on a nominating security holder's representation that the individual is not an "interested person" of the fund but that representation is later determined to be erroneous. In these situations, the rule should provide exemptive relief to the effect that all actions taken by the board in reliance on the nominator's representation shall be valid notwithstanding the 1940 Act provision that would treat the board as improperly constituted.

To further ensure the integrity of the shareholder nomination process, and to ensure the independence of director nominees, we suggest that the Commission require in the case of investment companies that each director nominee not be an "interested person" (as defined by Section 2(a)(19)) of the nominating security holder or group of security holders. This independence requirement would be consistent with the Commission's stated purpose of strengthening the independence of fund boards, while further ensuring that access is not abused to serve special interests.


In Section II.A.2.b of the Proposing Release, the Commission indicates that it is considering limiting the applicability of the proposed rule to those companies that are subject to the accelerated deadlines for filing Exchange Act periodic reports. Sufficient information is not presently available regarding the costs and burdens on small companies for their compliance with the proposed rules, and therefore an informed conclusion cannot currently be made on this issue. The Commission should inquire into these matters as part of the series of roundtables or similar discussion forums proposed above.

Question B.2 in the Proposing Release asks whether companies should be able to adopt shareholder nomination and access procedures which supersede the application of the proposed rule to them. We believe that companies should have the ability and should be encouraged to establish procedures regarding shareholder nominees and access to the board's proxy materials that may be different but are not less favorable in material respects than those established by rules of the Commission. The Commission should consider establishing a process for confirming the adequacy of such procedures, so that a company may reliably opt out of the access rules while the voluntary procedures are in effect. This would facilitate the development of precedent in terms of qualified alternative processes. These procedures could take different forms, including the reservation of a requisite number of slots on the proxy card for candidates of qualified shareholders. Factors to be considered in determining qualification include the independence of the nominees and proponents, the number of shareholder nominees, the lack of control intent, the provision of requisite information by the shareholder proponent and the nominee, compliance with the nominating committee process and other variables. With this kind of encouragement from the Commission, we believe companies would adopt and maintain alternative measures providing access, which would fulfill the objectives specified in the Proposing Release without the need for federal regulatory involvement.

Question I.6 in the Proposing Release asks whether, contrary to the approach taken by the proposed rule, the inclusion of a shareholder nominee should be viewed as a solicitation in opposition that would require the company to file its proxy statement in preliminary form. We believe that the inclusion of a shareholder nominee under Rule 14a-11 should not result in the proxy statement being treated as involving a solicitation in opposition that requires filing of a preliminary proxy statement under Rule 14a-6.

Question J.3 in the Proposing Release asks if information provided by nominating security holders or groups should be deemed incorporated by reference into Securities Act or Exchange Act filings. We believe that paragraph (e) of the rule, in addition to providing that the company is not responsible for any information in the notice from the nominating shareholder or otherwise provided by the nominating shareholder, should specifically confirm that information regarding a shareholder nominee furnished by a shareholder proponent and included in a company's proxy statement in accordance with Rule 14a-11 will not be deemed incorporated by reference in any other SEC filing.


We hope that these comments will be helpful to the Commission and its Staff. We would be pleased to discuss with the Commission or its Staff any aspect of this letter. Questions may be directed to Robert Todd Lang (212) 310-8200, Charles Nathan (212) 906-1730 or Dixie Johnson (202) 639-7269.

Respectfully submitted,

/s/Dixie Johnson
Dixie Johnson, Chair,
Committee on Federal Regulation of Securities

/s/ Robert Todd Lang
Robert Todd Lang, Co-Chair,
Task Force on Shareholder Proposals

/s/ Charles Nathan
Charles Nathan, Co-Chair,
Task Force on Shareholder Proposals

Task Force on Shareholder Proposals:

Robert Todd Lang, Co-Chair
Charles Nathan, Co-Chair

Frederick Alexander
Jay G. Baris
Richard E. Gutman
Stanley Keller
John M. Liftin
Michael R. McAlevey
Robert L. Messineo
James C. Morphy
Ronald O. Mueller
Alan H. Paley
Eric D. Roiter

cc: Hon. William H. Donaldson
Chairman of the Securities
and Exchange Commission

Hon. Paul Atkins

Hon. Roel Campos

Hon. Cynthia A. Glassman

Hon. Harvey Goldschmid

Alan L. Beller, Director
Division of Corporation Finance

Annette L. Nazareth, Director
Division of Market Regulation

Paul Roye, Director
Division of Investment Management

Giovanni Prezioso
General Counsel

Martin Dunn, Deputy Director
Division of Corporation Finance

* References herein to "we" and "our" refer to the Committee.
**All references in this letter to the proxy statement or proxy materials distributed by a company are to those that have been approved by its board of directors.
*** For example, an improperly constituted fund board could void certain critical actions, such as approval of investment advisory contracts, distribution plans under Rule 12b-1 and transactions with affiliates, among others.
i In footnotes 46 and 47 in the Proposing Release, the Commission cites J. I. Case Co. v. Borak, 377 U.S. 426 (1964), and Medical Comm. for Human Rights v. SEC, 432 F. 2d 659 (D.C. Cir. 1970), as recognition of its broad authority to regulate proxy solicitations. These cases do not address state regulation of corporate governance. For the reasons explained at length in this letter, we do not believe that the Commission can derive authority to provide access from its broad disclosure powers under the proxy rules. As discussed in The Business Roundtable decision, such fundamental federal powers cannot be implied but must be explicitly granted by the Congress.
ii For example, the Delaware courts have consistently rejected corporate action that is intended to thwart stockholder votes. See, e.g., Blasius, 564 A.2d 651 (holding that where the board's principal motive in increasing the size of the board of directors from 7 to 9 was to prevent or delay the stockholders from possibly placing a majority of the members of the board in a contested election, the board had breached its fiduciary duty of loyalty); Wisconsin Inv. Bd. v. Peerless Sys. Corp., C.A. No. 17637, 2000 WL 1805376 (Del. Ch. Dec. 4, 2000), reh'g denied, 2001 WL 32639 (Del. Ch. Jan. 5, 2001) (holding that adjournment of stockholder meeting for the primary purpose of garnering additional support for proposal to add one million shares to the corporation's stock option plan required a compelling justification); Hewlett v. Hewlett-Packard Co., C.A. No. 19513-NC, 2002 WL 549137, slip op. at 16 (Del. Ch. Apr. 8, 2002) (denying motion to dismiss vote-buying claim where plaintiffs had alleged that the corporation had bought votes from a large stockholder by threatening that the corporation's future business relationship with the stockholder would suffer where "no steps were taken to ensure that the stockholder franchise was protected").
iii Indeed, state law zealously protects the right of stockholders to participate in the nomination process. One Delaware court expressed this protection as follows:

Because of the obvious importance of the nomination right in our system of corporate governance, Delaware courts have been reluctant to approve measures that impede the ability of stockholders to nominate candidates. Put simply, Delaware law recognizes that the "right of shareholders to participate in the voting process includes the right to nominate an opposing slate." And "the unadorned right to cast a ballot in a contest for [corporate] office . . . is meaningless without the right to participate in selecting the contestants. As the nominating process circumscribes the range of choice to be made, it is a fundamental and outcome-determinative step in the election of officeholders. To allow for voting while maintaining a closed selection process thus renders the former an empty exercise."

Harrah's Entertainment, Inc. v. JCC Holding Co., 802 A.2d 294, 310-311 (Del. Ch. 2002) citations and footnote omitted. Nor are such statements empty rhetoric. Courts do not hesitate to ensure that stockholders have a choice; for example, courts refuse to enforce advance notice bylaws where the enforcement would be inequitable. See Linton v. Everett, C.A. 15219, 1997 WL441189, slip. op. at 20 (Del. Ch. July 31, 1997); Hubbard v. Hollywood Park Realty Enterprise, Inc., 1991 WL3151, slip. op. at 24 (Del. Ch. January 14, 1991). Moreover, the state courts not only require that stockholders be entitled to nominate competing slates of directors, they also preclude actions that would prohibit the formation of stockholder groups large enough to run a proxy contest. See Moran v. Household International, Inc., 500 A.2d 1346 (Del. 1985) (addressing question whether a rights plan would prohibit a formation of groups large enough to run a proxy contest). Once a proxy contest is initiated, Delaware courts have guarded the stockholder franchise from encroachment by corporate management. Most recently, in MM Companies, Inc., v. Liquid Audio, Inc., 813 A.2d 1118 (Del. 2003), the Delaware Supreme Court held that the board of a corporation must show a compelling justification for actions taken with the primary purpose of interfering with the stockholder franchise.

iv For this reason, the courts have ruled that incumbent directors may use corporate funds to pay their expenses involved in defending proxy contests only as long as the contest involves issues of "policy" and does not involve simply a personal fight for control, and so long as the expenses are reasonable. See Hibbert v. Hollywood Park, Inc., 457 A.2d 339, 345 (Del. 1983), Campbell v. Loew's, Inc., 134 A.2d 852, 862 (Del. Ch. 1957); Hall v. Trans-lux Daylight Picture Screen Corp., 171 A. 226, 229 (Del. Ch. 1934). For example, in Trans-lux, the seminal case supporting reimbursement, the court reasoned that incumbent directors were justified in using corporate funds in a proxy contest because they had a fiduciary duty to inform the stockholders of the policy matters at stake. Nominees other than those supported by the company's current board are not permitted to piggyback on the company's proxy machinery, even if backed by company management. See Empire Southern Gas Co. v. Gray, 46 A.2d 741, 744 (Del. Ch. 1946). In Empire, the Court enjoined officers of the corporation from sending out proxy material on behalf of the Company where the nominees were not supported by a majority of the board. The Court held that only directors were entitled to decide what the corporation's proxy material would say because "the right of the incumbents to speak for the corporation is inherent in our system of corporation law itself." Id. at 102. The Court went on to state that the democratic process required allowing the board to speak on behalf of the corporation in proxy contests:

Whatever benefit may redound to the incumbent board of directors because of the right given them, speaking through the corporation, to exclude others from purporting to speak for the board, is inherent in the democratic process which governs our corporation law, as well as long accepted corporate practice.

Id. at 103.

v 905 F.2d 406 (D.C. 1990).
vi See, e.g., Citigroup Inc., SEC No-Action Letter (Jan. 31, 2003); AOL-Time Warner Inc., SEC No-Action Letter (Feb. 28, 2003).
vii We note that the Commission defines the term "security holders" as referring only to shareholders having a right to vote at the meeting and on the matter in question. We suggest that in regard to opt-in proposals under Rule 14a-8, the term should refer to those entitled to vote on the subject matter under state law and the company's organizational documents.
viii Security Holder Director Nominations, Exchange Act Release No. 34-48626, Fed. Sec. L. Rep. (CCH) ¶60,784, at 60,787-60,788 (Oct. 23, 2003).
ix See, e.g., Proposed Proxy Access Rules Leave Proponents Uncertain About Preparations for 2004 Proxy Season, 14 Corporate Governance Highlights (October 31, 2003).