Social Investment Forum
1612 K Street NW, Suite 650, Washington, DC 20006
Re: File No. S7-19-03
December 22, 2003
Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street NW
Washington, DC 20549-0609
Dear Secretary Katz,
The Social Investment Forum Ltd. (the Forum), a membership association representing more than 500 investment advisors, research firms, mutual fund companies, proxy voting specialists, and other institutional investors involved in socially responsible investing, submits the following comments in response to proposed rule S7-19-03 regarding shareholder nominations for corporate boards, also known as shareholder proxy access.
For over 18 years, the Forum's members have pressed for greater corporate transparency and accountability on a range of issues, including: composition and independence of boards and key committees; excessive executive compensation; shareholder rights; improved investor and stakeholder engagement; and disclosure of non-financial risks. Our members also file shareholder resolutions each year at major corporations, and consider themselves actively engaged investors.
We also acknowledge that access to the proxy is a very complex legal, political and regulatory issue, and we congratulate the Commission's staff on the work they've done to open the issue to robust discussion. It is a significant moment for the agency to be seriously addressing one of the biggest reforms in the SEC's history affecting corporate boards and shareholder rights. We also appreciate the opportunity to share our views, and our members' views, on this critical issue.
Feedback and Concerns from Our Members
The Forum has called for and heard the concerns, questions, and suggestions from our many members regarding equal access to the proxy, the triggers you have initially proposed, and the mechanisms and opportunities for allowing investors access to the nominations process. What we've heard overwhelmingly from these financial planners, advisors, mutual funds, researchers, and pension funds is that the proposed rule is far too onerous to allow small institutional or individual investors a place at the nominations table.
Yet small institutional and individual investors are the shareholders that are so often disenfranchised from the proxy process. Brokers have historically often voted on investors' behalf without their clients' best interests in mind. Small investors have much less access to important information that affects their investments. Market scandals, special deals, and legal maneuvers around fair disclosure have left many in the dark. When companies have abused the trust of their investors, when select directors have failed the company ethically, when a system of exclusion reigns, investors' confidence plummets even further. Creating greater opportunities for investors large and small to hold boards accountable, and to take part in the elections process, would go a long way to boosting confidence in our financial systems, and in the leaders of corporations.
So far, over 11,000 investors have spoken up in support of strengthening this rule, and allowing more investor access to put nominees forward. That appears to be a record at the SEC for letters in support of an issue. Many public pension funds have come out in support of stronger access and a less onerous rule, as have coalitions of labor funds, investment managers, the socially responsible investing industry, religious investors, a broad coalition of State Treasurers' offices, the Harvard Business School/Harvard Law School Committee on Corporate Governance, the Council of Institutional Investors, Corporate Governance, the Independent Corporate Directors Association, Barclays Global Investors, and others.
A recent Harris Interactive poll commissioned by the American Federation of State, County and Municipal Employees Pension Plan revealed that:
- More than half of the investors surveyed agreed that corporate management is NOT in the best position to decide who should be nominated to the board of directors; and
- 80% believe there should be a process to allow investors to nominate directors for corporate boards;
- 84% of investors expressed a strong preference for a system where ALL qualified candidates--whether nominated by shareholders or management--be listed on the proxy;
- 80% agree that open access elections of directors would increase investor confidence.1
The Commission notes that our current proxy resolution rules [Section 14(a)] stem from a congressional belief that "fair corporate suffrage is an important right that should attach to every equity security bought on a public exchange."2 We quite agree. A major misconception by investors and executives alike is that there is a state mandate for directors to be responsible for nominating director candidates. According to the Independent Corporate Directors Association, that is not the case: "No mention of the nomination process is made in the corporation codes of Delaware or California, and the New York code sets forth what is implicit in all the other codes surveyed, namely that this issue is to be dealt with in Articles...or Bylaws...drafted by attorneys for the original incorporators." The ICDA goes on to argue that where state law has been interpreted by the courts, the rights of shareholders "to both nominate and elect directors has been resoundingly confirmed."3 Opponents of access to the proxy have argued that shareholders are NOT the owners of the company, any more than stakeholders would be. Yet institutional investors and individuals across the country have asserted their authority as owners of companies in their comments on this rule. There is countless legal and agency precedent to confirm shareholder ownership of companies. The Delaware Court of Chancery goes beyond this notion, and says that shareholders have a fundamental right to nominate candidates for their board4: "Those precedents reaffirm the fundamental nature of the shareholders' right to exercise their franchise, which includes the right to nominate candidates for the board of directors."
The decision of the Delaware Court goes on to add that "that those rights are fundamental does not mean that their exercise cannot be restricted...however, those restrictions must not infringe upon the exercise of those rights in an unreasonable way...such a by-law must, on its face and in the particular circumstances, afford the shareholders a fair opportunity to nominate candidates."
Most investors today believe we do not have fair opportunities to nominate candidates for board elections. In fact, when trying to utilize the legal remedies investors do have at their disposal to nominate directors, one of three things usually occurs:
- A contested election begins, where shareholders spend hundreds of thousands of dollars out of their own pockets and merely get to put a few names forward on a short slate;
- Shareholders can nominate a candidate at an annual meeting. Unfortunately, almost every shareholder has already cast his or her vote for the board, and there is no effort made by the company to get the nominee's name before a majority of shareholders in order for them to change their ballot;
- Shareholders present credentialed nominees to the nominating committee, and when they do, are almost always ignored entirely.
According to the Harvard Business School/Harvard Law School Committee on Corporate Governance, contested elections (outside of company sales and closed-end fund disputes) are very rare: "There are, on average, fewer than 15 such elections per year, with the large majority of them for companies with market capitalizations below $200 million." The group goes on to say, "We believe that increasing the number of contested elections beyond the current low levels would be desirable..."5 They and other institutional investors agree that the mere threat of a contested election and shareholder nominees for the corporate proxy would make directors much more attentive, and it would improve the communications and responsiveness between boards and investors.
Equal access to the proxy, we had hoped, was a robust attempt to address these significant "access" flaws, and provide more fair measures for investors to voice a say in the election of their representatives to a company. Yet one of the biggest weaknesses in the rule as it stands is the considerable timeframe (up to two years) from when a company sets off an access trigger, and the time when shareholder nominees could be considered for a board election. As the Commission staff well knows, a lot can happen at a company within two years -- and investors may not stick around that long to put nominees forward, if egregious violations or mismanagement are taking place. That is why the Forum and many pension funds, individuals, and institutional investors are in favor of eliminating the triggering events altogether. Two years of increasing barriers to allow possibly one investor nominee on the election slate is not very empowering to investors, and such obstacles further deter the accountability of boards and executives to shareholders.
Arguments Against Access Are Weak
Special interest directors, balkanzied boards, and loss of collegiality--these are the terms we've heard from corporation attorneys, corporate secretaries, and several business-lobbying groups this year. The outcries around "special interests" always seem to forget--or never address--the simplest of roadblocks to that happening: the fact that a plurality of shareholders has to vote investor-nominated candidates in, for them to be placed on a board. Because investors tend to vote with management in most cases for board slates, this outcry seems greatly exaggerated. Even if by small chance that a nominee were placed on the ballot that represented a specific interest, the "so-called special interest candidates," it seems highly unlikely that such a candidate would appeal to a majority of shareholders. Further, we hope the SEC would be implementing adequate disclosure reforms so that any connections between candidates and their nominators would be made clear in the proxy statement--a process we would like to see much more of regarding board nominees.
And in terms of balkanized boards or loss of collegiality, many investors believe creative tension on a board is not a bad thing. Exposing "group think" to fresh perspectives, challenging directors to think outside of the box, questioning decisions being made at the board level--this is what a healthy board often looks like. Tension can be quite useful and give boards perspective, when they are used to rubberstamping management decisions.
It's also surprising that some of the leading opponents of proxy access today were supportive of it in the late 1970s. In August 1977, the Business Roundtable spoke out in support of greater access to the proxy by investors. A BRT memo sent to the Commission at that time recommended that the SEC should adopt amendments to Rule 14a-8 that would provide for shareholder nominations for boards of directors.6 It further noted that to allow shareholders a right to propose charter or bylaw amendments regarding access to the nominations process (through management's proxy materials) would do no more than enable shareholders to exercise rights acknowledged to exist under state law.7 Additionally, prominent corporate attorney Marty Lipton called for changes to the elections process, including that "eligible shareholders or groups of shareholders should have access to management's proxy card to nominate directors. To be eligible, a shareholder or group would have to hold 5 percent of the firm's shares or stock worth $5 million," according to a memo from the Council of Institutional Investors.8
Further arguments we have heard against granting access are that investors should allow time for the governance changes of Sarbanes-Oxley and the NYSE reforms to play out. This is not a credible argument. Creating greater oversight or independence of key committees in no way addresses the issue of shareholders having the right to nominate candidates for the board, nor does it address the lack of a real electoral process happening at the corporate board level.
Changes to existing rules to improve board elections should augment the ability for a true election to occur. Otherwise, if few investors can use the rule, and few companies in fact trigger the rules, then the complaints by investors of boards rubberstamping management decisions will continue.
Too often, some companies and their lawyers want to maintain the status quo. It's the status quo that has lead to unparalleled executive compensation, egregious conflicts of interest, self-dealing, and elite boards that often overlook the concerns of its investors.
Some opponents of access claim that the SEC has no authority to implement such rules. We disagree. According to the D.C. Circuit Court's decision in SEC v. Business Roundtable, it clearly demonstrated that the SEC does have the authority to regulate the proxy process and items involving Section 14(a). The use of the corporate proxy is clearly a proxy issue, as is the voting for directors done solely though the proxy by investors.
Additionally, several companies have already implemented greater access to investors to nominate directors for the board, including Apria Healthcare, MCI, Hanover Compressor, and Homestore, Inc., refuting the notion that the access rule would bring enormous harm to companies.
Recommendations for S7-19-03:
- The Forum supports direct access to nominate a candidate or candidates for the board by a single investor or group of investors owning 3% of the company, and holding these shares for at least two years consecutively up to the nomination date. This would allow for immediate corrective action at the board level without the two-year burden of the triggering process.
- Eliminate the triggers for gaining access to the nominations process. This shortens the time frame for actually getting investor nominations on the corporate proxy, and alleviates paperwork and oversight burden by corporate management, shareholders, and the SEC in tracking the triggering process. Management and directors need to be more responsive to shareholder concerns, not less, so shortening the timeframe for when boards could face competition for director positions would force directors to immediately begin addressing egregious issues of concern.
- Shareholders should not have to be independent of the people they are nominating or held to a higher standard than that expected of the nominating committee and executives themselves. However, there should be great clarity and disclosure to investors and the company as to the degree, kind, and nature of any relationships between candidates and their nominators--including board committee nominations. This would include disclosure of any familial, personal, business, or contractual relationships between the two parties. We additionally suggest that shareholder nominees be entirely independent of management and the existing board. This requirement serves as an additional barrier to executives attempting to "game the system" through the access process.
- The proposed rule's suggested limits for the number of nominees put forth by investors is far too limiting. Being able to only put one candidate forward for half of our nation's corporate boards, or two (and very rarely three), does not give shareholders much ability to create independent, shareholder representation on the board. The Forum proposes that the SEC increase the number of shareholder nominees to no more than 35% of board slots each election. We have no problems with reasonable restrictions you might put in place in addition to this number to prevent takeover or other control issues from surfacing.
- The Commission should eliminate the limitation set out in the proposed rule for how many investors constitute a group for solicitation purposes. The SEC has proposed that no more than 30 investors can form a coalition for the sake of garnering the 5% (or whatever number is eventually deemed appropriate for nominating a candidate). This further excludes small shareholders from the process, as eight individual or small investors are unlikely to have 5% of a company's shares. A limit on how many investors are allowed to form a group for the sake of nominating should be abandoned altogether. The SEC staff's response was that there is no limit for a group of shareholders that form "spontaneously." However, if the group chooses to solicit through any formal means, such as a website, then there will be a limit of 30 shareholders, which seems exclusive and unfair to smaller shareholders.
- Opponents of greater investor access to the nominations process have questioned the authority of shareholders to nominate directors because it might wreak havoc on the new NYSE independence standards, or the Sarbanes-Oxley requirement for a financial expert on the audit committee. This weak argument is resolved quite easily by insisting that investors' candidates (either a large percentage, or all) meet these independence requirements, or if a financial expert position is at stake, to put forward another expert's name.
- If the commission finds no way to eliminate triggers, which we highly recommend that they do, then it is only reasonable that thresholds for gaining access should be significantly lowered for investors if triggers have been activated. (For example: If a trigger occurs, the shareholder threshold for proposing a candidate would be lowered from 3% to 1% of investors for direct access--effective immediately).
And if triggers must go forward, we offer the following suggestions to expand the level and scope of triggers to provide greater and more equitable access to the proxy in times of consequential malfeasance by the board or its executives:
- Failure for a company to act on a majority vote, as proposed initially in the rule and considered in the July report. More than 150 shareholder resolutions received majority votes from shareholders during the 2003 proxy season. Very few of these were implemented or acted upon. This shows investors a lack of responsiveness from the board and management to seriously consider shareholder input.
- Lowering the withhold vote to 20%. There is a strong bias by investors to support management's recommendations for the board slate; therefore a 20% withhold vote is substantial. According to the Commission's own estimates, only 1.1% of companies would be eligible to receive nominees under the 35% withhold trigger. This places a severe limit on shareholder participation to address board concerns.
- Immediate access, if the company has misrepresented earnings for 2 quarters in one fiscal year.
- If a company is under federal fraud, corruption, or other significant charges or indictments brought by a state or federal agency or regulatory body (SRO). This can be measured by SEC enforcement actions or sanctions, or criminal indictments of executive officers or directors, as suggested by CalPERS.
- If a company exceeds a certain level of fines, penalties or citations from governmental agencies such as the Department of Labor, the EPA, OSHA, the National Labor Relations Board, and others.
- A company being de-listed by the markets.
- A company lagging its peer index for two or more years.
- If a trigger is met, it seems unnecessary to require 1% of investors, in order to simply put forth a proxy access resolution to be voted upon by all investors. Such a proposal must receive a majority of support to finally trigger the nominations process, and it is unclear why it matters who presented the resolution. The main issue is whether or not a bulk of shareholders support it. This sets a dangerous precedent for other types of resolutions filed by investors, which currently need only $2,000 held for at least one year to be placed on the proxy if they pass the 13 exclusion rules set forth by the Commission. And according to the Commission, "The submission of security holder proposals by security holders that own 1% of the shares outstanding is currently relatively rare...a sample of 237 security holder proposals submitted in 2002 found that only three were submitted by an owner of more than 1% of the shares..." and those three came from the same owner. Typically, the largest shareowners in a company are also the most passive, and may stand to gain business from the company through contracts and consulting of some nature--as is the case with many mutual funds that hold large portions of shares.
The Forum would additionally like to see the following measures considered in your rulemaking process and beyond:
- Regarding the election process for directors, prohibit uninstructed broker voting that automatically casts votes for management's slate. Also, prohibit uninstructed share voting or unmarked proxy card voting that automatically casts votes in favor of management's slate.
- The SEC needs to set up clearer arbitration processes, so as to not let nominating committees entirely govern the process of what constitutes "legitimate candidates," "qualified nominees," or other points of disagreement between investors and Directors.
- What happens when a company or companies constantly trigger the process for access? There need to be more systemic solutions to boards and companies that have ongoing, systemic governance and accountability problems.
- The annual election of directors should be mandatory at all companies. The access rules may propel some companies to maintain a staggered board, or possibly change its bylaws to revert to a staggered board, in order to bypass the access process as often as possible. If all companies are subject to the access rule, it seems they should be operating from a more level playing field in terms of the elections of directors. This includes mutual fund and investment companies.
- There should be a distinct separation of chairman and CEO positions to improve independence of boards.
- Management's opposition statements to resolutions should be limited to the 500-word limit that shareholders face in addressing issues before shareholders. Both parties should have equal opportunities to discuss their side with investors. Investor money pays for the proxy, and companies should not be able to spend endlessly from the corporate coffers to "out persuade" investors.
- Limit amount of corporate funds used to campaign against shareholder candidates, or else, mandate that management must disclose these amounts in the proxy each year.
- Small and large cap companies should fall under the access rules. The rule should not be limited to "accelerated filers" only.
- Companies faced with a proxy access resolution, or a nomination activated by a trigger, should disclose this information on their web site (IR section), in proxy statements mailed to investors, and an attachment to the proxy card. Additional information like a mailing, telenews conference, or press release would also be helpful to investors.
- It's also troubling to note that in the proposed rule, proxy access would only apply to companies that incorporate in states that provide such rights, thus unequally applying the right to certain investors, and not others. A solution is definitely warranted for this unequal application of federal proxy rights. It seems highly likely that campaigns will soon surface to attempt to change state corporate law to disallow proxy access. Therefore, the SEC must consider alternate means of enforcing equal access across states and to all investors.
Shareholders are indeed quite capable of putting forward well-credentialed, independent, fiscally-expert nominees for the board. If we trust the citizenry of the U.S. to nominate and appoint the highest offices in the nation, why can we not trust some of these same people that invest enormous sums of money in the capital markets to choose a few representatives at corporations they are financially supporting? Richard Breeden, in his report "Restoring Trust" to the U.S. District Court regarding reforms for MCI, noted strongly that more democracy for shareholders is warranted to protect themselves from the malfeasance the markets have witnessed. He stated that strengthening shareholder democracy was more beneficial than more regulation by government to protect investors.
We agree with many supporters of access to the proxy that democratizing the director elections process will instill greater checks and balances amongst executives and directors, and serve as a check on the abuse of executive power.
We thank you for the chance to offer our perspective on this historic rulemaking. If you have any questions or concerns, please don't hesitate to contact myself at (617)726-7155, or our staff (202)872-5313.
|Timothy H. Smith, President
Social Investment Forum
|| Fran Teplitz, Managing Director,|
Social Investment Forum
|1|| AFSCME/Harris Interactive poll results in document received by the Commission on Sept. 24, 2003 from Gerald McEntee, AFSCME International President.
|2|| Proposed Rule S7-19-03, pg. 5.
|3|| Comments submitted to SEC on behalf of S7-19-03, on Nov 22, 2003.
|4|| R. D. Hubbard v. Hollywood Park Realty (1991.DE.50).
|5|| Harvard University Business School/Harvard Law School comments dated Dec 3, 2003 to SEC regarding S7-19-03.
|6|| Memo from the Council of Institutional Investors: "Equal Access: What is it?" pg. 2.
|7|| Memo submitted by then Coca-Cola Chairman J Paul Austin to SEC regarding call for comments on corporate governance, shareholder communications, and the corporate electoral process. August, 1977. Comments excerpted in CII's "Equal Access: What is it?"
|8|| Council of Institutional Investors: "Equal Access: What is it?" pg. 2-4