Institutional Shareholder Services

Dec. 18, 2003

Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street N.W.
Washington, DC 20549-0609

Re: File No. S7-19-03

Dear Mr. Katz:

We appreciate the opportunity to submit our comments on the Securities and Exchange Commission's proposed rule on security holder director nominations. This statement represents the views of Institutional Shareholder Services (ISS) and not necessarily those of our clients.

ISS Supports the SEC's Shareholder Access Rule Proposal

ISS supports ballot access. Providing significant investors with reasonable access to place their nominees on corporate proxy ballots will improve the performance of boards and, as a result, boost the confidence of investors in corporations. Reform is needed to right a steeply tilted playing field on which management and board incumbents dominate the election process. Shareholder access builds on the Sarbanes-Oxley Act reforms and the new corporate governance listing standards adopted by the major stock exchanges. While those reforms enhance boardroom oversight of management, ballot access will enable shareholders to hold boards of directors more accountable. Ballot access is a market-based reform that provides investors with the tools that they need to fulfill their responsibilities as the owners of America's corporations.

The rule provides numerous safeguards against the potential for special-interest abuses:

  • Triggering events -- a 35 percent "withhold" vote or majority support for a ballot access resolution -- must take place before qualified shareholders can nominate directors

  • Authority to nominate director candidates will be limited to significant, long-term investors

  • Contests for corporate control are excluded

  • Nominees must satisfy listing standards for independence

  • Nominees must win a contested election to join the board

Recommended Changes

While we generally support the current Commission proposal, we recommend one major change --an override feature that would enable very substantial shareholders to respond with appropriate speed to redress urgent and egregious problems, such as financial malfeasance, insider trading or other criminal conduct. Such abuses demand swifter action than that envisaged by the two-step, multi-year process of triggering event and subsequent director nomination. Therefore, the SEC should grant a shareholder or group of shareholders who have very significant, long-term stakes in a company the unfettered right to propose candidates even in the absence of a triggering event.

The bar for such unfettered access should be set high. If the SEC keeps the proposed thresholds (1 percent ownership to propose a triggering access resolution and 5 percent ownership to nominate a director), then eligibility for the unfettered right to nominate a director should be set at 7 percent to 10 percent. As a better alternative, ISS recommends that the SEC adjust its thresholds to require 1 percent ownership to file an access resolution calling for shareholder nominations; 3 percent ownership for the right to make nominations after a triggering event; and 6 percent ownership for the unfettered right to nominate director candidates.

In addition, we recommend that the Commission also move to adopt three more changes to improve the corporate election process:

  • Eliminate broker voting on board elections and other substantive voting issues. The SEC should urge the stock exchanges to eliminate voting at annual shareholder meetings by financial intermediaries on "routine" items when they receive no instructions from their clients. The New York Stock Exchange's practice of allowing brokers to vote (under its "10-day rule") uninstructed shares held by their clients on ballot items that the NYSE labels "routine" distorts voting results. In the current corporate governance environment, there are no routine voting items.

    In June, the SEC approved NYSE rule changes that ban uninstructed broker votes on equity compensation plans. In December, the Commission approved similar rules for the American Stock Exchange. (The Nasdaq Stock Market does not have separate rules that allow uninstructed broker voting.) Thus the national markets, along with all regional exchanges, now prohibit uninstructed broker voting at least on equity plans. We urge the Commission to extend the ban to all substantive items on the ballots of all publicly listed companies and allow broker votes for the sole purpose of meeting quorum requirements for conducting business at annual meetings.

    Failure to change the stock exchanges' brokers-may-vote rules would undermine the Commission's proposed 35-percent withhold vote trigger. It is not uncommon for broker votes to account for 10 percent or more of the tally in favor of incumbent board nominees. No one disputes that all uninstructed broker votes are cast for management. If the stock exchanges do not eliminate the use of broker votes in the election of directors, the SEC should alter its proposal by lowering -- to 25 percent -- the "withhold" vote required to trigger access.

  • Remove the proposed disqualification of nominees who are affiliated with the nominating shareholders. The proposal requires nominees to meet exchange standards on independence, and that qualification alone should suffice. Moreover, alignment between the nominee and nominating shareholders should be encouraged, not discouraged. A shareholder with a significant stake in a company should be able to nominate affiliated individuals.

  • Disclose timely post-election reports. The SEC should require meaningful and accurate real-time disclosure -- via press release and related 8-K filings -- of vote results. The current rules are inadequate: companies may wait until the filing of their next quarterly report to disclose voting results.

    Given the importance of the voting process, the SEC should require companies to file (as an 8-K or via a new post-election report filing) and publish (via press release and on their websites) the best available results of the voting at the annual meeting (including a breakout, if applicable, of broker votes) and an estimate of the total expenditure made by the company on its solicitation efforts. Requiring real-time, material event disclosure will close the existing communications gap. Follow-up quarterly filings would provide investors with the official certified vote results and a full accounting (line-item breakouts, for example, of out-of-pocket solicitation costs) of the expenditures made by the issuer with regard to the proxy solicitation.

    Such a requirement is not burdensome. Some issuers already announce voting results at meetings, and some firms even issue press releases with preliminary results at the time of the meeting.

Recent Voting Trends

Some opponents of the ballot access proposal argue that shareholders will fail to use a thoughtful process, or will be stampeded by special-interest groups, in voting on both the triggering events -- the election of directors and the newly proposed ballot access resolutions -- and any subsequent elections involving shareholder nominees.

Past proxy voting behavior by institutional investors shows this rhetoric is not in line with reality. ISS has identified only a handful of situations in the 2003 proxy season when "withhold" votes topped 35 percent for incumbent board nominees. The most common explanation for these substantial "no" votes is the failure (often the repeated failure) of boards to take action in response to majority votes on non-binding shareholder resolutions. These outcomes conform with the Commission's stated desire to allow shareholders to gain access in situations where the proxy process has been "ineffective."

The evidence also contradicts critics' claims that proxy voters will support shareholder nominees in a knee-jerk fashion. A distinct minority of the dissident nominees put forth in recent proxy seasons have been elected by shareholders. In 2003, for example, incumbent directors have held onto their seats in 14 of the 24 election contests tracked by ISS that have reached the voting stage. (This small number of formal proxy challenges in recent years undermines critics' arguments that shareholders already have a meaningful, cost-effective means of challenging incumbent directors.)

Moreover, as noted earlier, the proposed rule contains many safeguards to prevent abuses by special-interest groups.

ISS's Role in the Proxy Voting Process

ISS serves more than 700 institutional clients worldwide with its core business -- analyzing proxies and issuing informed research and objective vote recommendations for more than 10,000 U.S. and 12,000 non-U.S. shareholder meetings each year.

ISS advises our institutional investor clients on all matters that appear on proxy ballots, including the election of directors and shareholder proposals. All of ISS's proxy voting recommendations are driven by an in-depth analysis of the economic impact of the ballot issue on shareholders' stake in the issuer. Recommendations on "uncontested" board elections, binding shareholder resolutions --comparable to the proposed ballot access resolution -- and contests involving shareholder-nominated director candidates all involve multi-tiered, case-by-case analyses.

In the case of board nominees, ISS also provides issuers with an opportunity to explain (presenting bona fide excuses, such as sudden illness, for poor board attendance) or cure (removing a non-independent director from the audit, compensation or nominating/governance committee) defects that led to a withhold recommendation.

Using this shareholder value-centric analytical process, ISS has typically backed fewer than half of the insurgent candidates for boards in recent proxy seasons. In 2003, for example, ISS has backed dissident candidates in only 10 of the 27 contests where ISS has issued recommendations.

Should the Commission adopt the proposed rule, ISS's Proxy Voting Policy Committee -- with input from investor clients -- has decided to take a case-by-case approach to analyzing ballot access resolutions. ISS's analysis will examine the issuer's performance, corporate governance structure and its record of responsiveness to shareholders. The proponent will be required to show cause to support its call to trigger ballot access. Issuers will be provided with the opportunity to refute the proponent's arguments.

Contrary to some misinformation submitted to the Commission via the comment process, ISS's clients retain full discretion to vote on all issues and do not vote in lockstep with ISS's recommendations. As befits a diverse group with many different investment philosophies and objectives, ISS's clients vary considerably in their voting policies and practices.

A subscriber to ISS's Proxy Voting Research Service receives a proxy voting analysis and vote recommendations for any meeting (or written consent) held by an issuer whose stock is part of the investor's portfolio. Subscribers typically use ISS's research as part of their decision-making process. Most investors maintain detailed proxy policies. Many investors involve investment professionals and proxy committees in the decision-making process. While ISS clients give weight to our recommendations, they are fully capable of reaching their own judgments, which often differ from those of ISS.

Some clients also hire ISS to act as Voting Agent. Under this agency voting relationship, ISS handles the physical portion of the voting process (i.e., receiving proxy materials, reconciling ballots, casting votes, and keeping records). Many Voting Agent Service clients instruct ISS to apply voting policies other than ISS's Core Voting Policy. During the 2003 proxy season, for example, ISS applied more than 320 distinct voting policies for our Voting Agent Service clients. These client-supplied voting policies often result in vote decisions that run counter to the recommendation made under ISS's Core Voting Policy. While some Agency Voting Service clients elect to use ISS's Core Policy as their default position on recurring voting issues (such as perennial shareholder proposals or stock option plans), these clients maintain, and frequently exercise, discretionary authority to override ISS's recommendations.

On extremely rare occasions, existing clients ask ISS to take full discretionary voting authority to cure an otherwise irreconcilable conflict of interest. Typical users of this service include money managers who own shares in their parent company and pension plan trustees or other fiduciaries who serve on boards of issuers whose stock appears in their funds' portfolios.

Positive Impact

We believe that ballot access will have a significant and positive effect. Indeed, the proposal itself already has had a marked impact. Boards appear to have developed a greater willingness to respond to shareholder mandates in light of the Commission's ballot access proposal. Boards at more than two dozen firms have taken actions in recent months that respond, in full or in part, to mandates at 2003 annual meetings on shareholder proposals. This new trend contrasts markedly with the record of past years, when only a handful of boards typically took action in the year following the mandate. If the Commission fails to adopt the ballot access rule, there is a clear danger that boards will backslide to their previous level of unresponsiveness.

Ballot access will have a positive impact not only on board behavior, but also on the confidence of investors. Despite the stock market rebound in 2003, the need to restore investor confidence remains high. Recent survey data show that investors remain skeptical of board oversight of corporate financial reporting and accounting practices. Investors also doubt the traction of Sarbanes-Oxley and related reform efforts. By providing investors with a cost-effective tool to exercise their rights as owners, ballot access will rightly be perceived as a significant step in creating meaningful checks and balances. Access equals enhanced accountability.

In conclusion, we believe that adoption of this landmark proposal would have a significant impact, focusing shareholder energy and fostering positive outcomes. The triggers will transform "vote-no" campaigns at recalcitrant companies from the symbolic to the consequential. Recognizing the tangible impact of a 35-percent vote withheld from any one director, boards and management will likely adjust their behavior. Corporations will gain new incentives to remove unqualified directors from their boards and will likely prove more responsive on non-binding (precatory) proposals as well. And by improving corporate governance, shareholder access will help restore investor confidence.

We commend the Commission for the courage to propose these reforms, and we strongly urge their adoption.


James E. Heard
Chief Executive Officer
Institutional Shareholder Services