Andrew E. Shapiro
By Electronic Delivery
December 22, 2003
Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, NW.
Washington, DC 20549-0609
Re: File No. S7-19-03 Comments On Proposed Rule: Security Holder Director Nominations
To the Commission:
Lawndale Capital Management, LLC, a Sustaining Member of the Council of Institutional Investors ("CII"), is an investment advisor that specializes in "relational investing". Throughout our firm's eleven-year history, Lawndale has been an outspoken proponent of strong corporate governance as a means to protect and enhance shareholder value. Our experience and perspective on proxy issues is unique because our role as relational investors takes us to both sides of the boardroom wall. I am both an institutional investor as well as a public company board member with first hand experience of the positive impact of shareowner presence and influence in the boardroom.
As our previous comment letter submitted to the SEC on File No. S7-10-03, Release No. 34-47778 (found at http://www.sec.gov/rules/other/s71003/lawndale061303.htm), made clear, Lawndale strongly supports the Commission's proposal to amend the proxy rules to give shareowners improved access to management's proxy card to nominate directors. By now the Commission has received many comment letters from various sides of this debate discussing several needed changes with the proposed rule. Instead of repeating the many strong arguments in support of proxy access, Lawndale would like to focus on the following five inconsistencies with the proposed rule that conflict with its stated goal "to improve corporate democracy" and stand in the way of true "proxy reform":
1) II.A.2.b. Possible Limitation of Rule Only to "Accelerated Filers"
The effect of this possible limitation would be to exclude smaller public companies from the rule's requirements. This limitation makes no sense. The problems that create the need for improved proxy access are not isolated to larger companies. Larger companies simply get more media attention and have greater institutional ownership that submit shareholder proposals because they can better afford to surmount existing regulatory burdens and no-action fights for proxy access.
The need for easier shareowner access is far greater in smaller companies than larger ones. If a company benefits from the advantages of public ownership and trading then it should be held to the same high standard of investor protection regardless of size. In response to concerns of a smaller company's financial limitations, note that the proposed rule only mandates inclusion of alternative candidates in management's proxy. This in itself is not a substantial cost burden on any size company. The rule does not mandate the company to expend monies campaigning for management's slate. That is a decision for each company's board to individually weigh in the proper exercise of its fiduciary duties. The rule should apply to all companies subject to the proxy rules, regardless of size.
2) II.A.3.a. and b. Nomination Procedure Triggering Events
The focus on qualification for access should be solely on the amount of share ownership necessary to enable placement on the proxy rather than properly defining triggers. The implied purpose of the required triggering events is to narrow those companies to be subject to shareowner access. A trigger's problem is both one of time as well as definition that make it imprecise and arbitrary. Triggers will inevitably place the SEC or courts into the position of adjudicating whether triggers have been met. The appropriate debate between corporate and investor interests is better focussed on a simple bright line test of the share ownership necessary to enable alternative candidates to be immediately and unconditionally placed on the ballot.
The proposed rule's triggers contain such inherent time delay by their very terms as to render the whole improved democracy process ineffective. Under the proposed triggers, unresponsive managements and boards would have at least a two-year window to continue abusing shareowners before facing accountability. The triggers' fallibility should be clear by the fact that the proposed triggers would not yet be met in most governance dysfunctional companies that are now in bankruptcy.
Our suggestion is a 5% threshold test using a Nominator/Second approach whereby a "Nominator" would have to meet the same long-term shareholder qualifications as other 14(a)-8 submissions but if the Nominator owns less than 5% of the issuer, require a "second" in the nomination process by enough share ownership to equal 5% or more. In conjunction, we call for amendments to section 13d rules to allow for the "seconding" process to not trigger 13D filing status.
With the above 5% approach, in any given company, very few shareholders or groups of shareholders would garner such a threshold of support. Shareowner slates would only end up on proxies of the most egregious and unresponsive companies. The actual election of the alternative candidates still requires a majority of the shareowner vote. A long-term shareowner or group of shareowners owning a significant stake in a company should have the ability to act like an owner and participate meaningfully in the director nomination process without facing numerous lengthy and uncertain triggering hurdles.
3) II.A.5.a. Security Holder Proposed Eligibility Standards; exclusion of 13D filers
If the proposed rule's limits, triggers and prohibitions all illustrate a perceived negative from the placement of alternative shareowner director candidates on the management proxy, then it should be in the best interests of all sides to work out differences short of the proxy access action. Yet, there is an inherent inconsistency in the proposed rule that is likely to create unintended negative consequences.
The proposed rule prohibits proxy access to 13D filers without amending and narrowing the rules that currently broadly require a 5% holder or group's 13D filing (and prohibit a 13G filing) when such holder or group seeks to influence control of an issuer short of changing control. Such a prohibition without a narrowing of the 13D filing requirements and the proposed 5% threshold for alternative nominations will lead to the following consequences:
The desire to prevent a change of control enabled from the proposed rule is best addressed solely with a limit on the number of alternative directors to a minority slate and not by prohibiting 13D filers from use of an investor protection that should be available to all investors.
Section 13 was promulgated primarily as a disclosure section and created for "the proper protection of investors and to insure fair dealing in the security" whereby investors possibly selling away control of a company could build that information in their chosen sale price and competitive purchasers of a company's shares could similarly adjust their bid price, if desired. The Commission through rules and regulations prescribes disclosure obligations for 5% holders under Section 13d, "as necessary or appropriate in the public interest or for the protection of investors." Existing Section 13d applies to all 5% or greater shareholders unless exempted or specifically allowed to file otherwise (e.g. Form 13G). The effect of Section 13d(5) or (6) and clearly stated in Rule 13(d)-1 (b)(1) is that investors whose purpose is to have the effect of changing or influencing the control of the issuer must file Form 13D. Consider certain enumerated topics required in Item 4 of Form 13D that illustrate pertinent issues of influence short of change of control:
Lawndale is often one of the largest shareowners in its portfolio companies, regularly owning more than 5% of its portfolio companies. In Lawndale's eleven-year history, we have yet to seek a change of control of a company and have only put forth short slates of alternative directors. However, it is a core precept of our active and relational investment philosophy to seek to influence our portfolio companies with respect to the enumerated Item 4 items, above, for purposes of creating and protecting shareholder value. Our dialogue and requests on governance enhancements with an investment's board and management (as part of a hierarchy of steps) early in our investment process almost always trigger a 13D filing requirement when we reach 5% ownership, but still long before we may feel the need to seek board representation. This similarly would seem to be the case for most governance sensitive investors. It should not be the intended consequence of this proposed rule that either:
As long as the number of alternative nominees is limited to a minority of directors under the proposed rule, it should not then also prohibit 13D filers of a mechanism intended to improve corporate democracy. Further, we support the CII's request that the Commission reform section 13d rules to allow for meaningful discussion and actions on non-control matters and extend full 1992 communication reforms to such filers. These 5% or greater filers are already subject to certain disclosure obligations under Item 4. To impede or make more onerous what non-13D filers can discuss and do in non-control campaigns (short slates, "vote no" contests, shareholder proposal campaigns, etc.) seems absurd.
4) II.A.6.b. Prohibited Relationships Between the Nominee and the Nominating Security Holder or Group
As both an institutional investor as well as a public company board member, I have directly observed the positive impact of shareowner presence and influence in the boardroom. To require candidates to be independent of the nominating shareholder or group is illogical, unfair and, in our opinion, not in the best interests of the issuer.
All directors of a public company, whether nominated by a shareholder, management or the board, have the same legal obligation and liability to serve shareholder interests. It is illogical to require that a shareowner nominee be independent of such shareowner, when fiduciary obligations applying to all directors already exist to mandate prioritizing all shareholders' interests over any special interest.
Corporate boards are currently free to nominate candidates with various links to the company and its executives that may or may not qualify as independent under exchange definitions. With the obligation that the shareowner nominees must qualify as independent under exchange definitions, it is patently unfair for shareowner nominees to be held to a further expanded standard than board-nominated candidates, that of independence from shareholder nominators.
We are of the view (and studies support) that shareholder value is enhanced when directors own a substantial equity stake in their company. These directors think and act like owners and act most aligned with shareholder interests. The importance of this alignment is most valuable on matters where management agent's interests inherently differ from those of shareowners like executive compensation, severance arrangements, allocation of corporate resources in addition to the obvious control contests. Under the proposed rules, the required ownership threshold makes the nominator(s) one of the largest shareholders of the issuer. Assuming the exchange's independence standards are met, a shareholder nominee's relationship with its nominator would link that nominee to the issuer solely through a large shareholding. Having a director own shares in a company is in the best interests of its shareholders and not a bad attribute. The more independent the nominee is from the shareholder nominator(s), the further distanced that director is from shareholdings and the more incremental share compensation necessary to align that director's interests.
5) II.A.7. Proposed Limitation to Security Holder Nominees
The proposed rule's limit on the number of allowed shareowner nominees makes this proxy reform ineffective. Far from a majority of a company's board, the variable number of nominees mechanism targets a de-minimus low percentage of a company's board that sets the stage for such lone or few "dissident" directors to be excluded from key committees and key discussions. The use of the infamous "executive committee" which is often delegated the same powers as the board as a whole and is not part of the exchange's 100% independence requirements will inevitably be used to have management govern itself.
It is a shame that, after all the ownership thresholds and triggering delays that are built into the proposed rule, a majority shareholder vote can only elect an ineffective amount of directors. There needs to be a meaningful number of "elected" directors to garner a second on motions as well as to ensure presence on key board committees. As we stated in our original comment letter on this issue, we propose the rule always enable more than two directors, but less than control.
Don't let the strong emotions on both sides of the debate dissuade you or let this momentous opportunity escape your grasp. The issues created by the proposed rule changes are quite large but so immensely important for returning influence in public companies to their shareowners that the pace of proxy reform needs to remain deliberate. The purpose for creating the securities laws and the Commission itself was for the protection of investors. Improving corporate democracy and increasing the likelihood directors are the freely elected choice of shareowners and are responsive as their fiduciary agents certainly meets that purpose. If you truly want to improve corporate democracy, you must change securities laws to reduce and eliminate barriers your rules create which impede shareowner's selection of alternatives.
Thank you for the opportunity to submit comments on the proposed rule. We welcome the opportunity to discuss our suggested improvements and those of others with the Commission and its staff.
Andrew E. Shapiro
President and Managing Member
Lawndale Capital Management, LLC
591 Redwood Highway #2345
Mill Valley, CA 94941