NEW YORK, NY 10036-6689


December 22, 2003

Via email.
Securities and Exchange Commission
450 Fifth St., N.W.
Washington, D.C. 200549

Attention: Jonathan G. Katz, Secretary

File Nos. 34-48626; IC-26206; File No. S7-19-03
Proposed Rules: Security Holder Director Nominations

Ladies and Gentlemen:

This letter is submitted on behalf of a specially created ad hoc committee (the "Task Force") of the Association of the Bar of the City of New York, comprised of the members of the Association's Committee on Securities Regulation1 and its Special Committee on Mergers, Acquisitions and Corporate Control Contests. The Task Force was formed to respond to the Securities and Exchange Commission's release (the "Release") of Proposed Rules relating to Security Holder Director Nominations (the "Proposed Rules").

1. Effect of the Rule; Subsequent Evaluation; Subject Companies

The shareholder access rights contemplated by the Proposed Rules represent the most significant changes to the federal proxy rules in over 50 years. According to the Release, the goal of the Proposed Rules is to "improve disclosure to security holders to enhance their ability to participate meaningfully in the proxy process for the nomination and election of directors." The Release states that the Proposed Rules would create a "limited" right for nominees of "long term security holders" with "significant holdings" to be included in the company's proxy materials. This limited access right would apply only in "instances where criteria suggest that the company has been unresponsive to security holder concerns as they relate to the proxy process".

The Release analyzes historical experience with Rule 14a-8 proposals and withhold vote campaigns and concludes that the Proposed Rules will be used sparingly. The Proposed Rules also adopt standards to determine which stockholders are "long term" and possess "significant" holdings and again uses analysis of historical data to conclude that these standards strike an appropriate balance between providing appropriate access and preventing stockholders with an insignificant ownership interest from using the access right. The standards by which the Proposed Rules seek to establish the circumstances in which the access right will apply are, of necessity, arbitrary and represent the Commission's best guess of future and unpredictable events.

The Task Force is skeptical that, absent empirical evidence, the Release's analysis of historical data is of much practical use in determining whether the necessary balances have been achieved. What the Task Force does believe is that, if adopted, the effects of the Proposed Rules will be largely unpredictable. Overuse of the Proposed Rules by stockholders with insignificant stakes in a company or with narrow sets of concerns will not benefit either the company or its stockholder group as a whole. Alternatively, should the Proposed Rules prove to limit materially the ability of significant stockholders to propose serious nominees capable of winning broad support from a company's stockholders, the Proposed Rules will not have achieved their intended purpose.

The Release states that, if the Proposed Rules are adopted, the Staff will monitor their application and report to the Commission within three years regarding the effects of the rules and recommended improvements. Given the significance of the Proposed Rules to corporate governance and the proxy process and the unknowable effects and unforeseen consequences of the Proposed Rules, the Task Force is in favor of a second look at the Proposed Rules after sufficient time has passed to provide perspective. The Task Force believes that it will take at least three proxy seasons after adoption of the Proposed Rules for their effects and consequences to be fully apparent. Accordingly, the Task Force believes that the Proposed Rules should be adopted with an express direction to the Staff that, following the fourth anniversary of the adoption of the Proposed Rules, the Staff prepare a formal report to the Commission on the effect of the Proposed Rules, as adopted. The Task Force would also suggest that, as part of this process, the Staff solicit public comment and take due notice of the public comment in its report to the Commission.

The Task Force believes that applying the Proposed Rules to all companies that are subject to the proxy rules of the Securities Exchange Act of 1934 is not advisable. Smaller public companies are currently struggling with the new requirements of Sarbanes Oxley and the revised listing standards of the major securities exchanges. The Task Force is of the view that applying another untested governance concept to companies that are still digesting the numerous and complicated governance mandates of the past few years will make being publicly traded even less attractive for smaller companies. The Release recognizes this when it asks if the Proposed Rules should apply only to "accelerated filers". While the Task Force believes this is a step in the right direction, it also does not think limiting the application of the Proposed Rules to companies with market caps of $75 million or greater goes far enough. The Task Force thinks that, at least until there is some level of comfort with the way the Proposed Rules will work, it should not apply to micro and small cap companies. Accordingly, the Task Force would propose that, at least until publication of the Staff report discussed above, the Proposed Rules apply only to mid cap and large cap companies-a standard that would cut off the application of the rule to companies with market caps of less than $900 million. Under this standard, the Proposed Rules would still apply to companies comprising approximately 87% of the market value of all U.S. publicly traded companies.

The Task Force believes the Commission should also consider exempting "controlled companies" from the purview of the Proposed Rules. Under applicable New York Stock Exchange, American Stock Exchange and NASD National Market System rules, controlled companies are not subject to certain of the corporate governance rules of those organizations. These exemptions recognize that in situations where there is a controlling stockholder, certain regulatory requirements designed to produce better corporate governance are not necessary.

The Task Force believes the Proposed Rules should not apply to controlled companies for similar reasons. A candidate nominated by stockholders under the provisions of the Proposed Rules and opposed by the controlling stockholder would never be elected. Requiring controlled companies to spend time and money complying with the Proposed Rules in circumstances in which such compliance could never result in the election of a shareholder proposed director is pointless.

2. Triggering Events

The nomination procedure set forth in the Proposed Rules would become operative for a company only after the occurrence of one, or both, of two triggering events: (i) at least one of the company's nominees for the board of directors for whom the company solicited proxies receives "withhold" votes constituting more than 35% of the votes cast at an annual or special meeting of security holders, or (ii) a Rule 14a-8 security holder proposal that the company become subject to the security holder nomination procedure is submitted for a vote of security holders at the company's annual meeting by a security holder or group of security holders that held more than 1% of the company's securities entitled to vote on the proposal for one year as of the date the proposal was submitted and such "direct access" proposal receives more than 50% of the votes cast on that proposal at the meeting.

As noted above, the Task Force does not know whether these triggering events and the proposed percentages will strike the requisite balance between the varying concerns sought to be balanced by the Proposed Rules. The Task Force does believe that the potential third triggering event, premised on a failure by a company to implement a stockholder adopted Rule 14a-8 proposal, is not advisable. Adding an additional triggering event that is not focused on the director election process poses numerous issues. Will shareholders recognize that voting in favor of any shareholder proposal could trigger the security holder nomination process? Should shareholder proposals that address social issues (as many shareholder proposals do), rather than corporate governance issues, become the predicates for initiating security holder nominations? What constitutes a failure to implement or, conversely, a reasonable implementation of a security holder's earlier proposal? If a proposal is not capable of being implemented within 245 days after an annual meeting, will the security holder nomination process nonetheless be implemented? Who will be available to resolve disputes over implementation? The Commission? The courts? Is inviting litigation over social and other non-governance issues into the annual meeting process desirable?

More broadly, the Task Force is concerned that such a triggering event could drive board and management decisions in directions contrary to sound corporate policy and business plans. Finally, as the Proposed Release notes, a disagreement between shareholders and a board over any such issues would not necessarily evidence shareholder dissatisfaction with corporate management.

If, however, the third trigger is adopted, the Task Force believes, for the reasons indicated above, it should relate only, and relate directly, to bona fide corporate governance proposals containing objective criteria for implementation, which criteria are capable of being satisfied within the specified time period.

3. Director Eligibility Standards

Given the significance of the direct access security holder proposed trigger and that the trigger is not intended to be part of a plan involving a change of control, the Task Force thinks the Proposed Rules should require that the putative 1% security holder furnish more detailed information concerning its beneficial ownership of securities than Rule 14a-8 would otherwise require. We recommend that Rule 14a-8(b) be amended to provide that a proponent submit to the issuer (i) a representation to the effect that, if the proponent beneficially owned more than 5% of the issuer's outstanding common stock, the proponent would be eligible to report beneficial ownership on Schedule 13G, rather than Schedule 13D, in reliance on Rule 13d-1(b) or (c), and (ii) the information required by Items 2, 4, 7, 8, and 10 of Schedule 13G. In addition, the rule should provide that the issuer, in turn, may, but is not required to, rely on the truth and accuracy of such submission, without investigation.

The Proposed Rules require that a shareholder nominee for director meet the requirements of applicable law and the objective independence criteria of any applicable securities exchange. However, new NYSE rules require, and many other companies have begun, to establish board member eligibility requirements intended to insure, among other things, minimum levels of competence, integrity, and independence. To the extent an issuer has established such board member eligibility requirements and such requirements are objective (e.g., maximum or minimum age, number of public boards on which a member may serve at one time, trading restrictions, absence of involvement in proceedings referred to in Regulation S-K, Item 401(f), and absence of any contravention of law or contract resulting from membership on the board), are applicable to all existing board members, and have not been waived with respect to any existing board members, the Task Force believes a nominee under the Proposed Rules should be required to comply with such requirements as a condition of being nominated, which should be reflected in the nominee's representations under Rule 14a-11(c). In that connection, the Task Force thinks the rule should provide that a nominee use reasonable efforts to assist the issuer (at the issuer's expense) in any due diligence review by the issuer solely for the purpose of confirming the accuracy of the information in the security holder notice.

In addition to requiring the nomination to comply with the company's own director eligibility requirements, the Task Force believes that Proposed Rule 14a-11 nominations should also be required to conform with a company's applicable bylaw requirements, at least to the extent these requirements do not conflict with the express provisions of the Proposed Rules. Many companies have adopted bylaws that contain advance notice provisions requiring stockholders to give a minimum amount of notice to the company when they intend to nominate directors at a meeting. These advance notice bylaws generally require that the notice also disclose basic information concerning the proposed nominee and the nominating stockholder. This information is used by the company's board and nominating committee to evaluate the proposed nominee. The Task Force believes advance notice bylaws have worked to the benefit of all participants in the director nomination and election process and should not be superceded by the provisions of the Proposed Rules any more than is necessary.

The Task Force also believes that the nominee eligibility criteria should exclude an otherwise eligible nominee or nominating security holder or group, where that nominee, or the nominee of that security holder or group, had been included as a candidate for election as director under Proposed Rule 14a-11 at any meeting held within the prior three years, but failed to receive sufficient votes to be elected a director. The purpose of such a provision would be to minimize the potentially disruptive effect of an election contest in circumstances where the nominating shareholder or group recently had nominated a candidate under Rule 14a-11 and shareholders had rejected the nominee. Since the Proposed Rules give preference to security holders or groups with larger ownership stakes, the provision suggested by the Task Force would also prevent larger security holders or groups from continuously putting forward nominees that fail to win election and thus permit smaller security holders or groups to nominate individuals that might have a better chance of being elected.

The Task Force believes that at any meeting of stockholders at which stockholders are permitted to make Proposed Rule 14a-11 nominations, a stockholder should not be permitted to make a number of nominations in excess of the number of stockholder nominees permitted by the Proposed Rules (i.e., one, if the board consists of fewer than eight members, two, if the board consists of more than eight but fewer than 20, etc.). Similarly, the Task Force believes, that a stockholder's ability to participate in group nominations should be limited to participation in that number of groups equal to the number of stockholder nominees permitted by the Proposed Rules. Without this limitation, the provisions of the Proposed Rules that give preference to the nominees of security holders or groups with the largest beneficial ownership would be largely meaningless.

4. Timing Considerations

In addition to the issues regarding the retroactive effect of the Proposed Rules discussed later in this comment letter, the Task Force is also concerned with other timing matters. Specifically, under the Proposed Rules, a nominating security holder must provide notice to a company of the holder's intent to require that the company include the security holder's nominee on the company's proxy card no later than 80 days before the date that the company mails its proxy materials for its annual meeting. A company must notify the nominating security holder of its decision not to include the nominee at least 30 days prior to the meeting. The Task Force believes that such time periods are insufficient.

First, a company must explore whether a proposed nominee is independent from the nominating security holder and whether such nominee meets the other requirements of the Proposed Rules. Second, if a dispute arises over a proposed nominee's inclusion in a company's proxy materials, it is unlikely that a 30-day period will suffice to resolve the disagreement. Therefore, in order to promote consistency and to enable companies and their security holders to have annual meetings proceed as scheduled, the Task Force believes a nominating security holder should submit its nominations to a company under the time periods set forth in Exchange Act Rule 14a-8. That Rule provides that proposals for a company's annual meeting must be received by the company not less than 120 calendar days before the date that the company's proxy statement is released to security holders in connection with the company's previous year's annual meeting. Further, the Task Force believes that companies should then be required to notify the proponent of a director nominee of any adverse decision no later than 80 days prior to the proposed mailing date of the proxy materials. It should be noted that, since the security holder nomination process will be triggered by the results of voting at the prior year's annual meeting, and that this will be reported in the company's periodic report following the period in which it occurs, security holders considering whether to make nominations will have more than adequate time to finalize their plans, to solicit the support of other security holders and to select their nominees.

5. Resolution of Disputes

Inevitably, disputes will arise concerning a nominee's eligibility or a nominating security holder's compliance with Proposed Rule 14a-11. In its proposed form, Proposed Rule 14a-11 would leave it to the parties to resolve the dispute through litigation. We think litigation of such a dispute would be costly and protracted, and therefore would vitiate various goals the Proposed Rules seek to achieve. Accordingly, we recommend that any such dispute be subject to expedited review and determination by the Staff, which has the expertise to resolve such disputes. While the expedited review could take various forms, the Task Force suggests that the review be modeled on the dispute resolution provisions of Rule 14a-8(j).

6. Disclosure Requirements

The Release states that it is essential that a subject company make its security holders aware when a nomination procedure triggering event has occurred. The disclosure mechanism the Release proposes is to (i) disclose the security holder vote with regard to either of the nomination procedure triggering events in the subject company's quarterly or annual report, depending on the timing of the occurrence of the events, and (ii) disclose in the same report that it would be subject to the security holder nomination procedure as a result of such vote.

The Task Force believes that the proposed disclosure requirements in quarterly or annual Exchange Act reports will provide adequate notice to security holders, for several reasons. The security holder nomination procedure is a process rather than an actual event. Being subject to the procedure over a period of time would be one of the many material characteristics of a registered company that are required to be disclosed in a registered company's periodic reports. The nomination procedure would also be applicable over a relatively lengthy period of time, which is more in keeping with the contents of regular periodic reports than one-time disclosures. Finally, the disclosure of the material event that could arise as a result of the applicability of the security holder nomination procedure-the nomination of a candidate for the board or directors-is already adequately covered in a company's annual proxy statement and the related processes.

Under the Proposed Rules, after a subject company receives a notice from a nominating security holder or group, and determines that the notice complies with Proposed Rule 14a-11, the company would be required to include specified information regarding the security holder nominee, including reference to the web site the security holder intends to use to solicit on behalf of the nominee, in the company's proxy statement, as well as the name of the nominee on the company's proxy card. Although the proxy disclosure requirements included in the Proposed Rules raise a number of issues, the Task Force has chosen to address one in particular.

Under the Proposed Rules, if the company determines that the notice from the nominating security holder or group does not comply with Proposed Rule 14a-11 and that the subject company is permitted to exclude the nominee from its proxy, the company is required to so advise the nominating security holder or group and discuss the specific requirement or requirements that the company's board has determined permit the company not to include the specific nominee and the specific basis for the belief that the company is permitted not to include the specific nominee. The company would then be required to include in its proxy statement for the meeting for which the nominee was submitted a statement that it has made such a determination and the bases for the nominee's exclusion.

The Task Force is opposed to the requirement to include in the proxy statement disclosure regarding the specific bases for excluding a nominee. The determination of whether the nomination requirements have been complied with should be made by the nominating security holder and the subject company, and disputes resolved through the expedited process proposed above or in courts of applicable jurisdiction. Proxy statement disclosure and securities law liability are not the appropriate means and standard to enforce compliance with the nomination requirements. The specific grounds for excluding a nominee who has not complied with nomination requirements is not material information regarding the subject company or its included nominees on which security holders are voting. Nominees that are excluded for failing to meet nomination requirements should not be entitled to references in the proxy statement, let alone extended discussions.

The Task Force is also concerned that this particular disclosure requirement could become an end in and of itself for certain security holders and groups. Certain of the special interest and single issue groups that have been of concern to a variety of constituencies referenced in the Release could use the proposed nomination procedures to force discussion of their nominees and the reasons why they do not meet the prescribed criteria, achieving their dual goals of advancing discussion of their issue (for example forcing a company to describe why the nominee's ties to its nominating group preclude it from being independent) and being a nuisance to the companies they oppose.

In this regard, the Task Force notes that, in the Commission's Final Rule relating to Disclosure Regarding Nominating Committee Functions and Communications Between Security Holders and Boards of Directors, the Commission decided not to require companies to disclose their specific reasons for not nominating a candidate. The Task Force believes the reasons for the Commission's decision apply with equal force in this case.2

The Proposed Rules provide that liability for the statements in the nominating security holder or group's notice rests with the security holder or group and not the subject company, unless the subject company incorporates such statements into its Securities Act or Exchange Act filings. The Proposed Rules also provide that these statements will not be incorporated by reference into any filing, unless the company makes a specific determination to do so. The Release asks if it is appropriate to characterize these statements as security holder representations and not the company's. It also asks if these statements should be deemed incorporated into the company's filings.

The Task Force agrees with the approach of the Proposed Rules on these matters. The Proposed Rules rely in multiple ways on the accuracy of the nominating security holder or group's representations regarding independence and other matters. In order to ensure that this key element of the Proposed Rules functions correctly, liability must rest with the nominating security holder or group for these statements. It follows that such statements should not be deemed incorporated by reference by a reporting company unless expressly done so.

7. Application of Other Exchange Act Proxy Rules to Solicitations By the Nominating Security Holder or Nominating Security Holder Group

The Task Force believes the Staff should reconsider whether the adoption of Proposed Rule 14a-11(f) is necessary or desirable. Our views are based on the following observations.

The Proposed Rule 14a-11(f) exemptions from the proxy rules for activities related to the formation of Proposed Rule 14a-11 nominating shareholder groups and Proposed Rule 14a-11 solicitations are duplicative of existing exemptions. The Task Force believes that the existing proxy rules provide an adequate framework for the conduct, with minimal interference and appropriate safeguards, of many, if not all, of the activities a security holder (or group) is likely to engage in while in the process of either forming a nominating security holder group or soliciting support during a campaign for its nominees. In particular, Rule 14a-2(b)(1) provides an exemption from the proxy rules essentially as broad as that contained in Proposed Rule 14a-11(f) for solicitations by persons (other than issuers and certain other persons) who do not furnish or seek a form of proxy, provided they are not required to file a Schedule 13D. In light of the general requirement in Proposed Rule 14a-11 that any nominating shareholder (or group) that is a 5% holder be eligible to use Schedule 13G and the limitation on the availability of Proposed Rule 14a-11(f)(2) to persons who do not furnish or seek a form of proxy (a standard identical to that contained in Rule 14a-2(b)(1)), the Task Force believes that substantially all persons eligible to take advantage of the new proposed exemption for Rule 14a-11 situations, whether in soliciting others to form a nominating shareholder group or in conducting solicitation activities in support of a Proposed Rule 14a-11 nomination, would be equally eligible - and might well choose - to rely on Rule 14a-2(b)(1).

The limitation on permissible content in Proposed Rule 14a-11(f)(1)(ii) is inconsistent with the existing proxy rules. The exemption contemplated by Proposed Rule 14a-11(f)(1) would impose either a numerical limit on solicitees or a strict limitation on content in written solicitation materials, together with a day of first use filing requirement.

However, parties eligible for the exemption set forth in existing Rule 14a-2(b)(1) (a class, as noted above, that should include all persons intending and eligible to engage in a Proposed Rule 14a-11 nomination) are permitted to engage in solicitations to any number of persons without limitation on the content of written materials, provided all written materials were furnished to the Commission within three days of first use, if the soliciting party owns more than $5 million of the securities.3 This framework, coupled with Rule 14a-9, has generally been regarded as providing adequate protection for shareholders. Since the class of persons eligible to take advantage of Rule 14a-2(b)(1) would appear, as noted above, to include substantially all persons intending and eligible to engage in a Proposed Rule 14a-11 nomination, we question whether the proposed new exemption serves a useful purpose.

The public filing of Proposed Rule 14a-11(f)(1)(i) materials would render the 30 person limitation meaningless and unworkable, while the alternative of permitting a "secret" solicitation by eliminating the public filing requirement would invite abuse. As indicated in paragraph K.4 of the Release, the requirement to file on EDGAR all written materials used by a security holder in reliance on Proposed Rule 14a-11(f)(1)(iii) on the day of first use would render the 30 person limitation of Proposed Rule 14a-11(f)(1)(i) essentially meaningless. Even if a solicitation were initially directed to fewer than 30 persons, the filing requirement would make the materials, and thus the intentions, identity and activities of the soliciting security holder, available to an unlimited audience. Moreover, since there appears to be no limitation on the content of written materials used (and filed) in reliance on Proposed Rule 14a-11(f)(1), public filing of such materials would effectively gut the content limitation aspect in the purported alternative exemption in Proposed Rule 14a-11(f)(1)(ii).

On the other hand, the Task Force believes that eliminating the public filing requirement from an exemption that permits the solicitation of as many as 30 persons for the purpose of obtaining their commitment to join a nominating security holder group opens the door to possible abuse. The procedures for providing shareholders with direct access to an issuer's proxy statement and proxy card should not become the means for an end run around the protections afforded to shareholders by the existing proxy rules. The Task Force believes that more than a majority of the outstanding voting securities of many issuers are controlled by fewer than 30 institutional or other shareholders. In the absence of a public filing requirement, Proposed Rule 14a-11(f)(1)(i) would permit completely undisclosed and unregulated solicitations of such holders to agree to join a nominating shareholder group. Since such an agreement, the Task Force believes, reasonably implies, at the least, a commitment to vote for the nominees of the group, a 30-holder exemption that requires no public disclosure would effectively allow a holder (or group) to secretly solicit support for, and perhaps ensure the election of, its nominee under the rubric of simply forming a nominating group. While this issue is to a degree also inherent in existing Rule 14a-2(b)(2) (solicitation of 10 holders or less), the Task Force believes that enlarging the permitted number of solicitees to 30 greatly increases the danger of turning group formation activities into electoral faits accomplis.

If Proposed Rule 14a-11(f) is adopted (or, indeed, even if it is not), the Commission should clarify whether or not a nominating security holder or group may furnish shareholders with copies of the company's proxy card for purposes of that Rule and/or Rule 14a-2(b)(1). As proposed, the exemption in Proposed Rule 14a-11(f)(2) would not be available to a nominating security holder or group that "furnishes or requests" a form of proxy. The Task Force believes the rule as proposed is not clear as to whether supplying shareholders with additional copies of the company's proxy card containing the group's nominees, together with the nominating security holder's materials, is consistent with this language. It is common practice in election contests for shareholders to be mailed successive sets of proxy cards during the course of the solicitation, as only the latest dated proxy is effective at the meeting. The same question arises in connection with Rule 14a-2(b)(1) and, to the extent that the Commission determines not to adopt Proposed Rule 14a-11(f)(2), a similar clarification would be appropriate.

We do not believe that further exemptions from the proxy rules for solicitations to form a group to submit a direct access securityholder proposal are necessary or advisable. The Task Force believes the proxy rules and exemptions currently in force - as well as Regulation 13D-G - provide a tested and adequate framework with minimal interference and appropriate safeguards for communications among shareholders seeking to form a "one percent"-plus group to submit a direct access security holder proposal under Rule 14a-8 and/or to solicit proxies in support of any such proposal. We do not believe there is a reason to treat group-formation or proxy solicitation activities regarding one shareholder vote differently from any other shareholder-supported proposal (whether brought pursuant to Rule 14a-8 or independently of that rule) merely because it may become a triggering event under Proposed Rule 14a-11.

8. Beneficial Ownership Reporting Requirements; Lack of Control Purpose

The Proposed Rules provide that for a security holder or group to be eligible to submit a nomination under Proposed Rule 14a-11, the holder or group must (i) be eligible to file a Schedule 13G rather than a Schedule 13D, and (ii) have filed a Schedule 13G (or an amendment) with the proposed certification before submitting the nomination. The proposal includes a few specific modifications to Schedule 13G.

Central to Schedule 13G eligibility is that the holder is a passive investor that has acquired the securities without the purpose or effect of changing or influencing control of the company. Accordingly, the Proposed Rules include an instruction to Schedule 13G to clarify that a beneficial owner who acquires or holds a company's securities in connection with a nomination, soliciting activities, or the election of a nominee under Proposed Rule 14a-11 should not be deemed to have a purpose or effect of changing or influencing control of the company solely by engaging in such activities.

The Task Force believes that the absence of a control purpose is fundamental to the rationale for permitting certain stockholders preferential access to a company's proxy statement for their nominees. Accordingly, the Task Force believes that the Proposed Rules should require stockholders making nominations under Proposed Rule 14a-11 to retain this lack of a control purpose through the date of the relevant stockholders meeting. Failure to satisfy this requirement should have serious consequences in the judgment of the Task Force. At a minimum, the stockholder's nomination (whether made individually or as a member of a group) should be automatically withdrawn and the offending stockholder prohibited from making future Proposed Rule 14a-11 nominations (or participating in nominating groups) for a period of several years.

In the 1998 release adopting the amendments permitting passive investors to use Schedule 13G, the SEC provided guidance with respect to whether certain shareholder communications and proxy related activities in favor of Rule 14a-8 shareholder proposals would disqualify a holder from passive investor status. (Exchange Act Release No. 39,538 (Jan. 12, 1998) (the "1998 Release")). If Proposed Rule 14a-11 is adopted as proposed, the Task Force would recommend that any clarification regarding control purpose and nominating activities address issues similar to those in the 1998 Release. Furthermore, the Task Force would suggest that the covered Proposed Rule 14a-11 activities extend to the formation of a group for such purposes.

Similarly, any proposed instruction should include specific guidance regarding "vote no" campaigns by holders or groups who are attempting to trigger the nomination procedure. (The Proposed Rules and the related commentary may be read to suggest a position contrary to the 1998 Release concerning the significance of a solicitation of votes against a director in the evaluation of control purpose or effect.)

The Proposed Rules would amend Schedule 13G to add "check-the-box" disclosure to identify the filer's intent to make a nomination (for existing filers, by means of an amendment). The Task Force believes that an existing filer should be required to amend its Schedule 13G to make the same disclosure. In addition, the Task Force believes that the relatively limited disclosure called for by Schedule 13G is inadequate and that filers should be required, in connection with the initial filing for Proposed Rule 14a-11 purposes or an amendment to an existing filing to include such purpose, to provide more detailed information about the filer and its security ownership. In particular, the Task Force believes the information required by Items 5 and 6 of Schedule 13D should be provided.

The Task Force also suggests that the Proposed Rules should require that Schedule 13G filings or amendments disclosing a filer's intent to make a nomination be coded or tagged to easily distinguish those Schedule 13Gs on the Commission's web site from other Schedule 13Gs. Otherwise, the Task Force believes that the disclosure that a particular stockholder intends to make a Proposed Rule 14a-11 nomination could easily be overlooked in the case of companies that have numerous Schedule 13Gs on file.

The Proposed Rules contemplate that existing filers would be required to amend their Schedule 13G filings in accordance with the existing timing requirements for qualified institutional investors and passive investors. The Task Force advises that both first time and existing filers should be required to file or amend promptly to disclose the intention to make the nomination. The Task Force believes that, in some cases, the fact that a significant stockholder or group has formed an intent to make a Proposed Rule 14a-11 nomination would be material information that could affect the trading of the company's stock. As currently drafted, the Proposed Rules would permit a significant stockholder or group to keep this information from the public until just prior to the giving of notice to the company.

The Task Force believes that existing beneficial ownership reporting rules are sufficient to address the question of whether a group is formed or terminated for purposes of Proposed Rule 14a-11. Nevertheless, the Task Force would suggest that the rules include an assumption (if true) that the holder or group's nomination intent only applies to the company's next annual meeting following the filing or amendment of the applicable Schedule 13G, thereby vitiating the need for a filing to terminate the group.

With respect to the Release's request for comments on whether there are any qualified institutional investors under Exchange Act Rule 13d-1(b) that should not be permitted to nominate a director under Proposed Rule 14a-11, the Task Force does not believe that any particular type of investor should be excluded. While the issue is not limited to institutional investors, the Task Force does believe, however, that holders that disclaim beneficial ownership of shares should not be permitted to include those shares for purposes of determining whether the holder owns a sufficient number of shares to make nominations under Proposed Rule 14a-11. In addition, as noted above, security holders that fail to retain a lack of control purpose or nominate a candidate who is not elected should be precluded for a specified time from making another nomination.

9. Section 16 of the Exchange Act: Amendment to Rule 16a-1:

The Task Force agrees with the Commission that a group formed solely for the purpose of nominating a director pursuant to the Proposed Rules would not be the type of group that should be viewed as being aggregated together for purposes of Exchange Act Section 16 and that amendments are required to Exchange Act Rule 16a-1(a)(1) to exclude a bona fide Proposed Rule 14a-11 nominating shareholder group from the definition of a 10% "beneficial owner" for Exchange Act Section 16 purposes.

As recognized by the Commission, however, it is important that any such rule amendment ensure that any such groups remain subject to the general condition of the Proposed Rules that they not have the purpose or effect of changing or influencing control of the issuer. Thus, Proposed Rule 14a-11 nominating groups should be protected from being subject to the requirements of Section 16 only to the extent that they do not have a "control" purpose or effect. The Task Force believes that having a control purpose or effect at any time during either the holding period or while the nomination is extant should disqualify a person from this protection. As drafted, the Proposed Rules appear to grant this protection to all members of nominating groups that do not have a control purpose at the time of the nomination, even if that member, or the group as a whole, changes its purpose to a traditional "control" purpose after making the nomination. Thus, the Task Force proposes that new paragraph (a)(1)(ii)(K), which is part of the Commission's proposed amendment to Section 16a-1(a)(1), should be refined along the following lines (in what follows, we indicate any suggested deletions to the language of the Proposed Rules by brackets, and any suggested additions by double underlining):

(K) Members of a nominating security holder group formed in accordance with §240.14a-11, but only to the extent that such member does not have the purpose or effect of changing or influencing control of the registrant or engaging in any arrangement subject to §240.13d-3(b).

In addition, the Task Force believes that the language of the accompanying Note should be revised to clarify the circumstances under which solicitation against a director nominated by the issuer is deemed not to be a control purpose. As drafted, it appears that a person that participated in making a nomination pursuant to the Proposed Rules could be entitled to the "non-control purpose" exemption in connection with a solicitation against any number of the issuer's nominees, even if the group's nominee had been withdrawn or ultimately had been nominated or recommended by the issuer. The Task Force believes that solicitation against a full slate of issuer nominees, or against issuer nominees where the issuer has recommended a vote in favor of the shareholder nominees, is not within the protections contemplated by the Commission and should be viewed under traditional "control" concepts. Thus, the Task Force proposes the following revisions to the proposed Note to proposed paragraph (a)(1)(ii)(K):

Note to paragraph (a)(1)(ii)(K). A member [Members] of a security holder group formed in order to nominate a director under §240.14a-11 [are not] shall not be deemed to have the purpose or effect of changing or influencing control of the issuer solely by virtue of such group membership or by virtue of a director nomination pursuant to §240.14a-11, a solicitation for the election of that director nominee [or against that registrant nominee, or], the election of that director nominee, or a solicitation against such number of nominee(s) of the registrant at an election at which such group has made a director nomination as is equal to the number of nominees included in the proxy statement pursuant to §240.14a-11 (reduced by the number of such included nominees whom the registrant's board of directors has recommended that shareholders vote to elect); provided, however, that this paragraph shall not apply to any solicitation against any nominee of the registrant if the registrant's proxy statement recommends that shareholders vote for the election of the nominee proposed by such member's security holder group.

The Task Force further believes that the Commission should make clear in its published comments on the Proposed Rules that, except as specifically set forth in the new sub-section 16a-1(a)(1)(ii)(K) and the Note thereto, the Commission does not intend to change in any way the interpretation of the question of whether a person or group is a "beneficial owner" of any securities, whether acquired or held with or without the purpose or effect of changing or influencing control of the issuer.

10. Retroactivity

The Commission stated in the Release that, even if Proposed Rule 14a-11 is not adopted by this calendar year's shareholder meetings, shareholder action at such meetings may constitute a triggering event. The Task Force believes this will open the door to countless questions during this next proxy season.

Companies will be dealing with Rule 14a-8 proposals prior to the adoption of Proposed Rule 14a-11. Companies with spring annual meetings will have Rule 14a-8 deadlines in November, December and January. There is a fair chance Proposed Rule 14a-11 will not be finalized and adopted until late winter or early spring, well after companies with spring shareholder meetings will have mailed their proxy materials. The Proposed Rules will require that companies put Proposed Rule 14a-11 opt in proposals before their stockholders before the general details of the rule are finalized. Full and fair disclosure is a cornerstone of the federal securities laws, something that the Release itself recognized in Proposed Rule 14a-5(g) (requiring that stockholders be informed as to the consequences of approving an opt in proposal). Until the rule is finalized, that disclosure cannot be complete or accurate.4 The Task Force does not believe that companies or their stockholders can meaningfully evaluate proposals to opt in to Proposed Rule 14a-11 until the rule is finalized. Accordingly, as a matter of good disclosure and corporate governance the Task Force believes it is not advisable to provide a mechanism to ask stockholders to opt in to Proposed Rule 14a-11 until it is finalized. Accordingly, the Task Force believes that no Rule 14a-8 proposal should qualify as a "triggering event" until a final rule is adopted and duly noticed.

Moreover, current Rule 14a-8(i)(8) permits companies to exclude proposals that relate "to an election for membership on the…board of directors." A Proposed Rule 14a-11 opt in proposal unquestionably relates to an election for membership on the board of directors and would not be permitted under the plain meaning of Rule 14a-(8)(i)(8). Accordingly, the Release proposes to amend Rule 14a-8(i)(8) to provide that Proposed Rule 14a-11 opt in proposals are not excludible under Rule 14a-8(i)(8). But the Release also indicates that the Staff intends to apply Rule 14a-8(i)(8) as proposed to be amended (thus permitting opt in proposals) prior to adopting Proposed Rule 14a-11. The Commission has the authority to amend its rules, but the Task Force questions whether, pending the effectiveness of those amendments, the Staff has the authority to "interpret" the Rule as proposed to be amended when that interpretation flies in the face of the plain meaning of the rule and the way it has been applied historically.

The Task Force also believes that applying the 35% withhold votes trigger prior to the effectiveness of the rule is also not advisable for many of the same reasons. Stockholders should be informed of the consequences of their actions. Until Proposed Rule 14a-11 is finalized and adopted, a stockholder deciding whether or not to make a withhold vote cannot be sure of the consequences of that vote. The Task Force does not believe this to be advisable. Accordingly, the Task Force advises that the proposed "35% withheld vote" triggering event of Proposed Rule 14a-11(a)(i) should not qualify as a trigger event until a final rule is adopted and duly noticed

Respectfully Submitted,

Committee on Securities Regulation

Committee on Mergers, Acquisitions and Corporate Control Contests

By: Mark C. Smith
Chair, Task Force on Security Holder Director Nominations