October 3, 2003
Mr. Jonathan G. Katz
Re: Review of the Proxy Process Regarding the Nomination and Election of Directors
Dear Mr. Katz:
The following is submitted on behalf of ConocoPhillips. We appreciate the opportunity to provide you with our views on the Securities and Exchange Commission's ("SEC" or "Commission") initiative to examine possible changes in the proxy rules and regulations and their interpretations regarding procedures for the election of corporate directors (the "Initiative").
ConocoPhillips strongly supported the enactment of the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"), and we applaud the Commission's efforts to implement the Sarbanes-Oxley Act. We further believe that the Commission's efforts, and the related actions of the New York Stock Exchange, Inc. ("NYSE"), the NASDAQ Stock Market, Inc. ("NASDAQ") and other exchanges to propose amendments to their listing standards, have created a new framework that balances the various legitimate corporate interests and constituencies as it continues a trend towards more transparent business practices and increased sensitivity and responsiveness on the part of directors and managers to shareholder input.
In our opinion, the Commission is now considering a course of action with potentially significant ramifications on corporations and their directors and shareholders. A proposal to allow direct shareholder access to company proxy statements would be a major change with potentially unintended consequences and should not be implemented without careful analysis of all possible consequences.
I. The Role of the Board of Directors
The Board operates within a set of legal constraints and duties that clearly recognizes the advisory role of the Board. A Board has the fiduciary duty under state law to act in the best interest of the Company and all its shareholders. One of the responsibilities of directors under state law is the nomination of director candidates. This responsibility is based upon the understanding that the board is best positioned to assess the qualifications of nominees. In considering who the nominees should be, a company's nominating committee must consider many factors, such as the need to have at least a majority of independent board members, the need to insure that the board has at least one independent financial expert who is qualified to serve on the audit committee, the need to have sufficient international expertise on the board if the company has international issues, and the need to have a variety of strengths and expertise that will result in a well-rounded board of qualified individuals who will act in the best interest of the corporation and its shareholders as a whole. While boards may consider shareholder nominees, the board has the ultimate responsibility for the nominees included in a company's proxy materials.
In contrast to the duties imposed on directors, the shareholders of a large public corporation are allowed to act purely in their self-interests. They have no fiduciary duties to the company or other shareholders and corporate constituencies. They may nominate director candidates for any number of purposes, regardless of whether those purposes are self-interested or designed to promote other agendas. Direct shareholder access to company proxy statements would undercut the role of the board and its nominating committee in the important process of nominating director candidates. Moreover, bypassing the nominating committee, which must be composed solely of independent directors under the proposed NYSE listing standards, would diminish board accountability to shareholders.
If the nomination and election of directors would cause the company to violate federal law or fail to comply with SEC, NYSE or NASDAQ requirements, directors have the fiduciary duty to engage in an election contest, the result being an unfortunate disruption and diversion of company resources. The proposed new requirements regarding director qualifications would make it even more likely that the fiduciary duty of a board member will be triggered, thus setting up the potential for annual election contests. For example, shareholders could nominate and elect a director who may not be independent, which could make it difficult for a company to comply with the NYSE or NASDAQ proposed listing standards that generally require companies to have a majority of independent directors and prohibit non-independent directors from serving on certain board committees. Shareholders could nominate and elect a director who may be replacing a financial expert. If the new director does not qualify as a financial expert, the company's audit committee may no longer comply with the listing standards. In these situations, since directors cannot escape their obligation to consider nominees in the best interest of the corporation and its shareholders as a whole, providing shareholders direct access to company proxy material has the potential to turn every director election into a divisive proxy contest. The contentious and public nature of such proxy contests could substantially disrupt corporate affairs, result in significant costs to the company, and dissuade from board service well-qualified individuals who do not want to routinely stand for election in a contested situation.
II. NYSE and NASDAQ Proposed Corporate Governance Listing Standards
A substantial number of the provisions of Sarbanes-Oxley and the proposed stock exchange rules address the composition, independence and qualifications of the public company board of directors, precisely the same issues as the proposals to permit shareholders to run election contests through the company's proxy statement seek to address. The proposed NYSE and NASDAQ corporate governance listing standards establish standards for when a director is deemed to be independent and provide that a majority of the board, and all the members of audit, governance/nominating and compensation committees, must be independent, and. The rules specify certain relationships that automatically or presumptively disqualify a director from being considered independent.
The requirements for membership on an audit committee are even more stringent. No audit committee member may receive any direct or indirect compensation from the company except for director fees. Also, no audit committee member may be an affiliated person of the company and companies are required to disclose whether at least one member of the audit committee is a financial expert, as that term is defined by SEC rules.
Under the proposed NYSE corporate governance listing standards, the nominating committee must, among other duties: (1) have responsibility for the board's criteria for selecting new directors; (2) identify individuals qualified to become board members; (3) develop and recommend to the board a set of corporate governance principles applicable to the corporation; and (4) oversee the evaluation of the board and management.
The proposed NYSE listing standards also require listed companies to establish a mechanism for interested parties, including shareholders, to communicate with non-management directors. These rules offer the opportunity for shareholders, both large and small, to communicate with directors with respect to potential board nominees and other matters. To this end, the SEC already requires companies to disclose whether its nominating committee considers shareholder nominees and requires disclosure of the process for shareholders to follow in order to nominate a director.
Director and board committee nominations are among a board's most important functions. By placing this responsibility in the hands of a company's nominating committee, consisting solely of independent directors, the independence and quality of director nominees will be enhanced. Nominating committees are able to take into account the composition of the board as a whole when identifying director candidates and it is best positioned to assess the skills and qualities desirable in new directors in order to maximize the board's effectiveness.
Direct shareholder access to company proxy statements to nominate directors is inconsistent with the proposed NYSE corporate governance listing standards (as well as similar NASDAQ proposed standards) and detracts from the role and independence of nominating committees. For instance, a nominating committee may determine to seek out a board candidate who has desired industry or financial expertise, based upon the belief that a nominee with such a skill-set will strengthen the overall functioning of the board of directors. However, as a result of shareholder access to the company proxy statement, such a candidate might fail to be elected because of the election of a shareholder nominated director who does not possess such expertise.
III. Existing Proxy Rules
The board of directors represents all shareholders, and meaningful shareholder involvement in director elections already is provided under existing proxy rules. Shareholders may propose candidates for consideration by nominating committees. In addition, shareholders may undertake their own solicitation of other shareholders to elect one or more directors. Existing proxy rules enable shareholders to solicit proxies for one or more director candidates, while ensuring that such solicitations provide investors with the information necessary to vote in an informed manner. While there are expenses in connection with such a solicitation, it is exactly the same shareholders who stand to benefit from the proposal to allow direct shareholder access to company proxy statements (i.e., those with significant stock holdings) that are best positioned to finance these solicitations. Requiring a shareholder who nominates a director candidate to file and take responsibility for his or her own proxy statement allows a level of scrutiny, disclosure and accountability that an insert in the company's proxy statement is not able to provide.
IV. State Law Concerns
Permitting shareholders direct access to company proxy statements also may raise state law concerns. Two fundamental principles of state corporate law may be implicated by permitting shareholders direct access to company proxy statements. First, state corporate law generally vests with the board of directors the authority to manage the business and affairs of the company, including the process of considering and nominating qualified directors. Second, some state corporate laws, including Delaware and New York, prohibit shares of the same class from being treated disparately. The proposal to allow direct shareholder access to company proxy statements may provide a right to a single large shareholder or a block of shareholders that would not be available to all shareholders.
V. Conflicts With Existing SEC Rules
Direct access to company proxy statements also appears to conflict with a number of existing SEC rules. Accordingly, significant amendment to existing rules would be required if the SEC were to provide shareholders direct access to company proxy materials for the purpose of nominating directors. For example:
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In conclusion, ConocoPhillips recognizes that the Sarbanes- Oxley Act and the proposed NYSE and Nasdaq rules have had, and will continue to have, a significant impact on how public companies are run. With the increased independence of boards of directors, the strengthened role and independence of nominating committees, and the enhancement of shareholder/director communications, we believe that many, if not all, of the issues the Initiative is intended to address will be achieved by the ongoing dramatic changes in corporate governance. To this end, we support the SEC's actions to implement the Sarbanes-Oxley Act, as well as the NYSE's and NASDAQ's proposed corporate governance listing standards. In the context of a newly adopted regulatory framework that is already designed to address the issues of board composition and director performance, the adoption of proposals to facilitate election contests is an unwarranted step that offers little apparent benefit while threatening significant harm. We encourage the SEC to weigh these costs against the absence of any clear benefit and reject these proposals.
We would be happy to discuss our comments or any other matters that you believe would be helpful.
cc: Hon. William H. Donaldson-Chairman, U.S. Securities and Exchange Commission