December 23, 1997
Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549
Attention: Mr. Jonathan G. Katz, Secretary
Re: File No. S7-25-97 (Amendments to Rules on Shareholder Proposals)
In Securities Exchange Act Release No. 34-39093 (September 18, 1997) (the "Release"), the Securities Exchange Commission (the "Commission") requested interested persons to submit their comments on the proposals described therein (the "Proposed Amendments") to amend 17 CFR 240.14a-8 (the "Shareholder Proposal Rule" or the "Rule"). In response to that request we are submitting the following comments on behalf of the Interfaith Center on Corporate Responsibility ("ICCR"). ICCR is a coalition of 275 religious institutions whose members have endowments or other financial investments in excess of $80,000,000,000. The purpose of the organization is to promote good corporate governance, which the coalition views as including not only many classic corporate governance issues, but also issues arising out of the need to encourage corporations to take into account in their operations the ethical and moral values of American society.
I. EXECUTIVE SUMMARY
We oppose the Proposed Amendments and, despite our intense desire to see the ill-conceived Cracker Barrel decision overturned, we would prefer that the SEC do nothing rather than enact the Proposed Amendments in their present form. We believe that the Proposed Amendments would (and were intended to) make the submission of shareholder proposals on so-called "social issues" much more difficult. We believe that there is no justification for attempting such a cut-back. We further believe that the Commission should simply restore (c)(7) to its status quo ante the SEC's attempt to rule out all employment related proposals (including those pertaining to discrimination in the workplace). Such a return to the status quo ante does not require a rule making proceeding since the Cracker Barrel decision was (according to both the Commission and the Second Circuit) not itself a rule. A rulemaking proceeding is therefore not needed to overturn Cracker Barrel.
II. THE SOCIAL CONTEXT
A. Social Investment Data
We do not believe that it desirable, appropriate or good regulatory policy for the Commission to denigrate the investment strategies of a substantial portion of the investment community. A significant number of American investors invest in accordance with social or ethical criteria. Their investment strategy and criteria are denigrated by the Proposed Amendments.
In November of this year, the Social Investment Forum published its survey of social investing in the United States. (The Social Investment Forum has provided the Commission with a copy of its study as part of the comment process on the Proposed Amendments.) Among the institutions which sponsored the survey were the Bank of America, the Calvert Group, one of the Dreyfus funds, Neuberger&Berman and Smith Barney Asset Management. The bottom line was that the survey found that close to 9% of the $13.7 trillion assets under profession management in the U. S. are invested with one form or another of social criteria. They found that $529 billion are invested in screened portfolios which exclude securities of certain companies based on one or more categories of social criteria. They also found that an additional $652 billion are invested in portfolios engaged in "shareholder advocacy" (e.g. proposing shareholder proposals on social issues or having guidelines which call for proxy voting in favor of certain shareholder social proposals). In addition, $4 billion is engaged in so-called "community investing", for a total of $1.185 trillion invested in a "socially responsible" manner. Indeed, this total is probably understated since other managers (such as bank trust funds) not included in the survey may similarly be engaged in socially responsible investing. In addition, the figures do not include individual investors. It is the experience of ICCR that individual investors are more likely to vote for socially responsible shareholder proposals than are institutional investors. Therefore it is probably safe to conclude that 8% to 10% (probably closer to 10%) of American investment is of a socially responsible nature.
We believe that these statistics are significant. The investment strategies of 10% of the investment community should not be denigrated or ignored. Such investors should not be deemed to be second class investors whose investment strategies are viewed by government officials to be less worthy than other investment strategies which apparently the government prefers. Indeed, it is clearly not the role of the government to tell investors that they are wrong or that they should not use such strategies in their portfolio. Yet that is precisely the message being sent by the SEC in the Proposed Amendments. The Proposed Amendments seem clearly calculated to decrease the number of socially responsible shareholder proposals. Indeed, that seems to be almost their exclusive purpose, although the Release does not explain why proposals of this type are less worthy than other proposals. Nor is it the role of the government to make such a determination.
In short, for reasons set forth hereafter, we believe that the Proposed Amendments would have a devastating affect on socially responsible shareholder proposals, to the detriment of a significant portion of the investment community.
We are strengthened in our belief in the importance of social responsibility in investments by recent public statements made by Ira Milstein, who is perhaps the most renowned and respected proponent of good corporate governance. We quote extensively from Mr. Milstein in the following section of this letter.
B. Why Social Responsibility Must Be Taken Into
Account By Corporations
In an article published earlier this year in The Business Lawyer Mr Milstein argued:
In the United States, such social concerns are far less exclusively the government's province than in many other advanced economies. These societal concerns can be labeled "extrinsics" because they fall outside a very narrowly defined corporate goal of profit maximization. This author contends, however, that corporations are expected, wherever possible, to integrate extrinsics with the corporation's primary obligation to maximize shareholder value. To the extent corporations attempt to do so, they are viewed as credible and accountable, and are less likely to be regulated. To the extent that they do not meet expectations in addressing extrinsics, there will be more governmental intervention and intrusion.
The challenge is to balance, wherever possible, society's demands with the goal of maximizing shareholder profit. The task is complicated because the public's view of what constitutes the minimum threshold of constructive action regarding extrinsics changes over time - the target is always moving. This is not mere "do-good" or "ethics" advice. The reality is that private sector responsiveness to public concerns is part of our system. (52 Business Lawyer at p. 408.)
In the author's view, the board of directors has at least a duel oversight function: overseeing management's dedication to the polestar of profit maximization and overseeing the integration of extrinsics. (At p. 409.)
(T)his author sees the integration of extrinsics - the corporation's efforts to balance societal concerns of employees, customers, suppliers, and communities, without compromising shareholder wealth - as central to the perpetuation of the corporation and our system, and central to the board's role. (At p. 410.)
For the corporation to be allowed to continue to enjoy its place and privilege, it must perform as an investment vehicle and contribute value to our economy; and it must achieve this integration of extrinsics at a level acceptable to the public. (At p. 412.)
Mr Milstein elaborated on this theme in the keynote address which he gave on October 27, 1997, at the Investor Responsibility Research Center ("IRRC")'s Conference on Investor Responsibility in the Global Era. In that speech Mr. Milstein emphasized the role model of the United States corporate system and the necessity for American corporations to act consistently with societal values:
We expect the corporation to not only treat fairly those with contractual claims -- such as investors, employees, suppliers and customers -- but we also expect the corporation to abide by society's expectations concerning the environment, communities, and philanthropies, among others. . . .
But moving beyond the role of corporate governance in corporate performance, what I really want to focus on today is another goal of corporate governance - one that is especially important to other nations and cultures. It is this: Corporate governance has an important role in accommodating the corporation's profit goal with local, societal, and cultural values. As one model other countries look to, we have some obligation -- if we hope to see a global market system, democratic governments and a vital private sector -- to demonstrate that good governance can accommodate societal concerns. I believe it is in the U.S. private sector's best interest to demonstrate an ability to accommodate. . . .
Therefore, we should consider whether our system, which is being observed by others, is really capable of accommodating even our own values -- and thus possibly able to accommodate the values of other societies. These issues are complex and have to do in part with what the corporation's role is in a just society. We need to recognize that in cultures where the corporate role is not as centered on shareholder gain, our recent experience with the massive layoffs associated with downsizing, and the disparity in wages between CEOs and factory workers, are leading to criticism of our system as both heartless and greedy.
This to me is the area where we in the U.S. need to do some significant new thinking: How do we in the U.S. -- as investors, directors and managers -- help the corporation accommodate societal values so that our system is acceptable to us, let alone the rest of the world? This is important if you assume, as I do, that our system can be the foundation of worldwide markets replacing command and control, supported by and supporting more democratic forms of government.
Is there a risk to our U.S. system at home, let alone to use of our system abroad, if corporations are perceived as unresponsive to societal values and out-of-sinc with cultural concerns? Yes -- there can be a backlash which will include increased regulation of the corporation and of the now-global market. There are some signs. The debate that is taking place in France is an example. That economy is not in great shape -- but the populace is suspicious of the black-box market -- and especially suspicious of large corporations and the impact of the profit motive on employment and quality of life issues. . . .
Clearly corporations -- as members of society -- cannot ignore societal mores. Accommodation to local societal values is largely a responsibility of government, but there is a role for the corporation as well. How a corporation handles issues of major public social significance has implications for the corporation's ability to survive. Not only does it impact the corporation's public reputation but it has implications for future regulation.
So, there is a risk to our system if our corporations don't pay some heed to societal concerns at home, but there is an even greater risk abroad that our market system, let alone our governance system, will be rejected even as a foundation. Europeans and others come from cultures that place higher priority on collective social values and they will be trying harder to preserve those values.
We are in a position to demonstrate that our market and governance systems can accommodate societal values -- maybe not to the extent that others would like, but nevertheless, the capacity to accommodate is there. In the end, foreign corporations may not be able to do all the accommodating they would like and at the same time remain competitive -- but at least our system provides the option to attempt a balance. . . .
We have active independent boards which, with peripheral vision, can endeavor to see the bigger picture, and can endeavor to balance without sacrificing shareholder gain. . . .
In my view a board faced with layoffs should consider the social environment and the "menu" of options with an eye towards the least harmful means of carrying out the layoffs for those workers and their communities: The board can consider alternatives, longer payouts, continued health care, and portable pensions, for example.
Consider next the distribution of the wealth created by the corporation. The recent U.P.S. strike graphically illustrated a maturing public opinion that -- whether true or false -- there is a significant and growing inequity in wages. While shareholder value has escalated beyond anyone's wildest dreams and executive pay has soared, employee wages have stagnated. A recent Business Week cover story reports that "wages and other compensation as a percentage of national income have declined for four consecutive years, from 1993 through 1996, while corporate profits as a share of national income rose sharply over the same period." And The New York Times recently carried a piece asserting that by foregoing wage increases, workers have paid for the recent economic success. . . .
With serious pragmatism, we need to begin to experiment with voluntary solutions -- we certainly don't want the government to attempt a legislative one. And the board -- and investors too -- have a serious role in the corporation's actions on this issue. Yet, in my experience, both investors and those at the senior managerial level find the gap all too easy to justify and support.
The board's responsibility concerning executive compensation includes not only creating an appropriate incentive scheme, but considering the broader issue of the balance and the level of executive pay vis-a-vis employee pay. At a minimum, in setting senior executive pay directors should seek information about wage distribution in the company. What is the salary or hourly wage of the lowest paid employee? What is the average salary or hourly wage of non-management employees? What mechanisms has management put in place to compensate employees for improvements in productivity, efficiency and profit levels? And generally, what is the state of employee satisfaction? . . .
The board has a key role here, not only in its role of compensating managers, but also as part and parcel of its role in accommodating the views of society. In the long run, in my view, by paying attention to society's concerns the board perpetuates a value-creating enterprise.
In summary, we believe that Mr. Milstein makes six points which cannot be overemphasized and which have very considerable relevance to this proceeding and to the Shareholder Proposal Rule.
First of all, Mr. Milstein convincingly argues that there is no dichotomy between issues of corporate governance and "social responsibility" issues. He emphasizes that "corporate governance has an important role in accommodating the corporation's profit goal with (societal) values". In other words, social responsibility of corporations is a part and parcel of corporate governance. The relevance of this to the current proceeding is that there is no justification for the SEC to differentiate between shareholder proposals on corporate governance and shareholder proposals on social issues (as, for example, the Proposed Amendments attempt to do in connection with (c)(5)).
Secondly, Mr. Milstein emphasizes that corporations must act in ways which are consonant with societal values. This is, of course, the basic point of socially responsible shareholder proposals. There can be no justification for undermining the ability of shareholders to raise with corporations the very question of whether the company is acting in consonance with societal values.
Thirdly, "private sector responsiveness to public concerns is part of our system". Thus, the social responsibility of corporations and therefore the social responsibility shareholder proposal are not merely the work of "do-gooders", but an inherent part of the American capitalist system.
Fourthly, the failure of corporations to act in a socially responsible manner can predictably have two kinds of dire consequences. The failure of a corporation to properly handle "issues of major public social significance" can, on the micro level, affect "the corporation's ability to survive". It follows that the ability of shareholders to submit shareholder proposals on social responsibility issues is good, on the micro level, for the corporation itself.
Fifthly, on the macro level, a failure to handle issues of major public social significance will inevitably result in governmental intervention in the markets, to the detriment of the economy. Indeed, the ability of the corporate world to integrate "extrinsics" is "central to the perpetuation of the corporation and our system" and to the "place and privilege of the corporation". More broadly, Mr. Milstein ties the ability of American corporations to integrate extrinsics to the worldwide acceptance of open markets and democracy. Therefore, it follows that the ability of shareholders to submit shareholder proposals on social responsibility issues is good, on the macro level, for the
American economy, the capitalist system and the worldwide promotion of free markets and free peoples.
Finally, our corporate governance system is perhaps unique in allowing for the balancing of profit maximization with the integration of extrinsics. Mr. Milstein places on the Board a major portion of the responsibility for seeing to it that corporations act in ways consonant with societal values, as when he describes the necessity of the Board to examine wages not only of the CEO, but also "the balance and the level of executive pay vis-a-vis employee pay". Thus it is that the integration of extrinsics is "central to the board's role". But he also notes that investors "have a serious role in the corporation's actions" on these matters. Which is precisely the role played by the socially responsible shareholder proposal.
In summary, Mr. Milstein has eloquently made the case for the importance of the socially responsible shareholder proposal. It is evident that the ability of shareholders to submit such proposals should be enhanced. In contrast, the Proposed Amendments severely restrict such proposals. They are therefore poor public policy and should be abandoned.
III. ADDITIONAL BACKGROUND
A. The Proposed Amendments are Not Responsive
to the Congressional Mandate
Section 510 (b) of the National Securities Markets Improvement Act of 1996 required the Commission to conduct a study of:
(A) Whether shareholder access to proxy statements pursuant to Section 14 . . . has been impaired by recent statutory, judicial or regulatory changes; and
(B) The ability of shareholders to have proposals relating to corporate practices and social issues included as part of proxy statements
The statute went on to require the Commission to report to the Congress within one year:
on the results of the study. . . together with any recommendation for regulatory or legislative changes that it considers necessary to improve shareholder access to proxy statements. (Emphasis supplied.)
The bill was co-shepherded in the Senate by Sens D'Amato and Dodd, respectively the Chairman of the Senate Banking Committee and the ranking member of its Securities Subcommittee. Lest there be any doubt as to what the legislation was referring to, on the floor of the Senate, Senator Dodd specifically referred to recent "regulatory rulings that have limited the ability of shareholders to offer proposals at shareholder meetings regarding a company's employment practices." (Emphasis supplied.) He then went on to refer to the impact of these rulings on shareholder proposals concerning, inter alia, the "MacBride principles" and on the ability of shareholders to impact "loathsome discriminatory practices". (Emphasis supplied.)
In short, the Congress called on the SEC to expand the permissible scope of shareholder social issue proposals. What has been the SEC's response to this Congressional mandate? Not only to reduce the scope of permissible shareholder proposals on social issues, but to make the resubmission of corporate governance proposals far more difficult! And with no explanation of why the Commission, in contrast to Ira Milstein, believes social proposals are undesirable.
B. The Proposal is Markedly Unbalanced
The SEC submitted the required report to Congress in early October. The report consisted of a short introduction plus the Release. In the SEC's discussion of the mandated study, much of the statutory language set forth above is quoted. However, conspicuous by its absence is any reference to the fact that the Congress asked the Commission to "improve" shareholder access to the proxy statement.
In fact, the Proposed Amendments sharply limit shareholder access to the proxy statement. This is true for the following reasons:
1. The proposed revision of (c)(5) would markedly decrease the number of proposals. The present (c)(5) does not exclude any "corporate governance" proposals and social proposals need not pass the economic test if they are otherwise significant to the registrant. The Proposed Amendment would exclude many more social proposals because the lowering of the economic test will not nearly offset the additional exclusions resulting from the abolition of the "otherwise significant" language. In addition, as drafted, significant numbers of corporate governance proposals will be excluded by the Proposed Amendment.
2. The rewording of (c)(7) would alter its meaning in a manner adverse to proponents.
3. The resubmission thresholds will be markedly increased, in some cases tripled. The net effect will be to drastically curtail the number of shareholder proposals. For example, in the third year the "failure rate" for social responsibility shareholder proposals would approach 100% and the failure rate of corporate governance proposals would go up almost six fold. Overall, the failure rate in the third year would quadruple.
4. There would no longer be a mechanism to review management's statements in opposition for possible 14a-9 violations.
5. The SEC Staff would no longer provide advice on personal grievance claims, thus inviting, in our opinion, companies to omit legitimate proposals on that ground, with the only remedy being a costly law suit.
On the other hand, proponents gain virtually nothing:
1. An override set at 3% would be of no practical value to proponents because it would be almost impossible to achieve that percentage, except with respect to certain popular corporate governance issues. However, since those issues are never excluded under either (c)(5) or (c)(7), the addition of such an override would be meaningless.
2. The Release purports to reverse Cracker Barrel. However, it appears to do so in form only, but not in substance since EEO disclosure, MacBride Principles etc remain unclarified and, indeed, there is a negative implication that such matters will continue to be excluded. In addition, the proponent community gains little by the Cracker Barrel repeal since the courts have already ruled that the SEC Cracker Barrel decision was contrary to law and to the existing 14a-8(c)(7).
Therefore, rather than being a judicious balancing of the interests of issuers and of proponents, the Proposed Amendments are one-sided and heavily loaded against proponents.
C. Cost Analysis
We believe that the SEC has presented no credible evidence that shareholder proposals present any significant burden to registrants.
In the first place, one has to put the number of such proposals in proper context. There are approximately 14,000 registrants. According to a study done by the Social Investment Forum, in the ten years 1986-1995 some 1,434 shareholder proposals concerning social issues appeared on issuer's proxy statements. (The study was based on data available from IRRC.) Although this period included the late 80s when South Africa proposals reached their height, the average is only 143 per year. (According to IRRC data, there were 111 proposals on social issues voted on during 1995 and 103 in 1996.) Since many of the largest corporations include more than one proposal per year, it is safe to say that in any given year 99% of registrants do not include a social responsibility proposal in their proxy materials. Indeed, it is probable that the vast majority of registrants have never had to include such a proposal on their proxy statement. The costs of such proposals are borne almost exclusively by the very largest American corporations, i.e. those whose activities and "extrinsics" have the greatest impact on society. Even among those very large companies the numbers suggest that in any year no more than 20% of the S&P 500 companies have social responsibility shareholder proposals in their proxy materials. The study further revealed that corporate governance proposals were about 50% more prevalent, averaging somewhat over 200 per year. Even so, an average S&P 500 company could expect to include one corporate governance proposal approximately every three years. Smaller companies would include such proposals seldom, if ever. (The Social Investment Forum has provided the Commission with a copy of its study as part of the comment process on the Proposed Amendments.)
It is the undersigned's admittedly unscientific observation, based on over a quarter of a century working in this field, that a registrant can expect to have one shareholder proposal submitted per year for every 100,000 to 200,000 shareholders in its shareholder base. Needless to say, as already indicated, smaller registrants do not receive proposals. But the very largest companies with over 1,000,000 shareholders can expect to receive several per year. In between, the average company might expect a proposal once or twice a decade.
What is the cost per proposal? We submit that it is de minimis. Ten or even twenty thousand dollar expenditures are hardly likely to be of major importance to S&P 500 companies. Yet that is the range of probable costs for most companies. The undersigned understands that AT&T and Lucent Technologies have done careful studies of the costs of including shareholder proposals, and disclosed their results in public fora. They estimate that the cost is $30,000 to $50,000 per page and that proposals run one to two pages (they use a booklet size proxy statement). With a range of $30,000 to $100,000, it is probably fair to say that the average proposal costs AT&T or Lucent $75,000. But AT&T and Lucent have 3,500,000 shareholders each (only two of eight companies with a shareholder base in excess of 1,000,000.). Thus, the cost to them is about two cents per shareholder (not per share). Although costs may not be exactly proportional, one should not expect the costs per shareholder to be markedly different at smaller companies. In other words, the marginal cost of including a shareholder proposal at a company with a 100,000 shareholder base should not exceed a couple of thousand dollars per proposal. The foregoing figures do not include the non-direct costs, such as management time dealing with the issue. Yet, much of that same time would be consumed by management on the issue even in the absence of Rule 14a-8 (i.e. the company will have to deal with environmental or other issues raised by its shareholders whether or not they have the ability to submit a shareholder proposal).
The foregoing estimate is consistent with some, but not all, of the estimates set forth in the Release. The Release in the text at footnote 123 recites that in response to the questionnaire registrants reported that their average printing (and related) costs were approximately $50,000. This figure appears to be highly unreliable. In the first place, it is wholly inconsistent with the actual studies made by AT&T and Lucent. Secondly, it may show the unreliability of using non-scientific survey techniques, especially when (a) the respondent is an interested party which may be tempted to exaggerate; (b) the respondent is, in effect, not asked to do an actual study of the matter, but rather to make a guess; and (c) the figures are based on only 67 responses. Thirdly, the figure is wildly inconsistent with figures elsewhere in the Release which state that a printing concern (Daniels Financial Printing) consulted by the Staff reported that adding up to three-quarters of a page to a proxy statement would not increase the cost to the company and that adding more than that would, on average, cost a company approximately $1,500. The unreliability of the $50,000 figure is further demonstrated by the inconsistency of that number with the median figure given in footnote 123. The median is only $10,000. The existence of an average five times the median suggests strongly that a few respondents were supplying wildly exaggerated figures. This is confirmed by the information set forth in the footnote that the highest reported number was $900,000. That is twelve times the AT&T/Lucent figure (based on actual studies), despite the fact that AT&T and Lucent, with 3,500,000 shareholders each, dwarf virtually any other registrant's shareholder base. (A similar statistical problem exists with respect to the costs considered in connection with the data set forth in the text at footnote 124; which text and footnote have the additional problem that the costs referred to therein include, or are predominately, the costs of unsuccessfully attempting to exclude the proposal, a cost which was voluntarily, and apparently foolishly, undertaken by management.)
In short, it is probably a safe assumption that placing a shareholder proposal on the proxy should cost the average registrant no more than about $10,000. (the median in footnote 123) and probably considerably less (perhaps $1,500 to $2,000). The costs to very large companies would be more, but except for the eight companies with shareholder bases in excess of 1,000,000 shareholders, would probably never exceed $25,000.
In light of these figures, it is hard to take seriously any contention that shareholder proponents are unfairly casting the costs of their proposals (or resubmitted proposals) onto other shareholders. Such costs are truly de minimis.
IV. THE MAJOR PROPOSED CHANGES
A. Rule 14a-8(c)(5)
We strongly oppose the proposed revision of (c)(5). In particular, we oppose the dropping from (c)(5) of the phrase "and is not otherwise significant related to the registrant's business". We believe that the retention of that phrase is essential. Our opposition to the suggested revision of (c)(5) is twofold. We are opposed to a straitjacket dollar approach which assumes that all material events can be quantified in exact dollar terms. Secondly, we are also opposed to the method suggested in the Release for quantifying the materiality of such matters.
A purely economic test is highly undesirable and would exclude matters which the SEC has traditionally deemed material.
The Commission has traditionally taken the view that matters can be material without regard to the dollar amount involved. For example, item 401(f) of Regulation S-K requires a five year lookback to uncover events in need of disclosure which would be "material to an evaluation of the ability or integrity of any director. . .or executive officer of the registrant". Materiality is obviously not determined by the amount of money involved, as is clear from subsection (2) of that item which requires disclosure of the matter if "such person was convicted in a criminal proceeding or is a named subject of a pending criminal proceeding". Other portions of item 401(f) require disclosure of bankruptcies and court or administrative injunctions or orders arising out of certain types of activities. Although each of these matters must be deemed to be material before disclosure is required, it is obvious that the test of materiality is not bounded by some arbitrarily set dollar amount. There is no reason why shareholder proposals should not likewise not be bounded by some arbitrary dollar amount, set without regard to whether the matter is otherwise significant to the issuer.
Even when the Commission has established dollar cut-offs for use in determining materiality it has, at times, set that cut off at a point much lower than $10,000,000. For example, registrants must disclose environmental litigation which could result in a fine or penalty of a mere $100,000. See instruction 5C to item 103 of Regulation S-K. The justification for mandatory disclose of a given item is that it is, by definition, information which a shareholder would deem important in her or his decision making process. (See TSC Industries, Inc. v Northway, Inc. 426 U.S. 438 (1976.)) It seems to be wholly without logic for the Commission to say, on the one hand, that a matter is so material to shareholders that it is subject to mandatory disclosure but that, on the other hand, the matter is not material enough for shareholders to be able to communicate with management or among themselves about it. Yet that would be the result of adopting the proposed (c)(5) which will set the standard for materiality for environmental matters at 100 times the standard of materiality mandated by item 103 of Regulation S-K. We believe that this enormous discrepancy illustrates the fatal flaw in attempting to set a rigid dollar definition of materiality for purposes of (c)(5). Put another way, what is the policy justification for the government to say that it is a criminal offense to fail to disclose to shareholders a given environmental problem but that it is not important enough for shareholders to discuss the matter among themselves or with management via their usual channel of communication, namely Rule 14a-8. Such a decision would appear to be arbitrary and capricious (and perhaps irrational). Thus, item 103 of Regulation S-K illustrates that there are obviously some matters which are significant to shareholders despite the fact that the matter involves less than ten million dollars. We therefore believe that it is essential to retain the "otherwise significantly related" language of (c)(5) in order to prevent an inflexible dollar cut-off from barring matters which are obviously material and important to shareholders.
Our basic point is well illustrated by a similar example based on item 402 of Regulation S-K, where, once again, a dollar cut-off of $100,000 is established. This cut-off is, of course, only 1% of the proposed cut-off proposed for (c)(5). Even more striking, the compensation of the CEO must be disclosed regardless of amount (even if less than $100,000). Therefore, again we have a situation where the government will be saying that it is a criminal offense to fail to disclose to shareholders certain information but that it is not important enough for shareholders to discuss the matter among themselves or with management via their usual channel of communication, namely Rule 14a-8. Again, such a decision would appear to be arbitrary and capricious (and perhaps irrational).
It is obvious that the proposed (c)(5) relates to compensation matters because it refers to the purchase by the registrant of "services". Thus, despite the fact that the Release says that "corporate governance" issues will not be affected by the change in (c)(5), it is perfectly clear that the actual wording of the proposed (c)(5) belies this assertion. Indeed, on the face of the proposed (c)(5), all proposals dealing with executive compensation would be barred provided the compensation was less than $10,000,000 per year. For example, a by-law proposal to require that the CEOs salary be approved by the shareholders if it is in excess of $1,000,000. would be barred. Furthermore, it would appear that the proposed (c)(5) would bar all proposals relating to director compensation, since such compensation never reaches the level of $10,000,000 per year.
An illustration of our point with respect to the executive compensation issue is instructive. On September 30, 1997, the SEC entered a cease and desist order against W R Grace & Co., following a finding that the Company had violated the securities law by inadequately disclosing certain matters relating to the retirement of J. Peter Grace on December 30,1992. The company's 10K and 1993 proxy statement had failed to disclose the value of the retirement package which he had been awarded, although that disclosure is mandated by Item 402 of Regulation S-K if the value of the package exceeds $100,000. (the level of materiality for executive compensation). Since adequate disclosure had not been made, the SEC took enforcement action. Yet if a shareholder of Grace were now to submit a shareholder proposal on the matter, the proposal would be banned under the Proposed Amendments because (i) although material for enforcement purposes it is not material under the proposed (c)(5), which has a materially standard 100 times higher than that set forth in item 402 of Regulation S-K; and (ii) (a point we will return to) the shareholder will have found out about the problem too late, the proposed (c)(5) being limited to payments made during the prior year (i.e., even if the dollar threshold were met, because of the "prior year" requirement, the shareholder proposal would have had to have been presented to the 1994 shareholder meeting for payments made in 1992, an obvious impossibility in this case since the company, in violation of law, concealed the fact of the payment until 1997).
Another example may be in order. In 1974 it was disclosed that American Airlines had in 1972 made a $55,000 illegal political contribution to a presidential election committee. The CEO, prior thereto one of Americas's premier businessmen, was forced to resign. Eventually this and similar illegal political contributions led to several years of SEC investigations of "questionable payments" made by a large number of companies at home and abroad. As a result of the SEC investigations, Congress passed the Foreign Corrupt Protection Act and revamped the law governing political contributions in this country. The SEC brought at least 14 enforcement actions in the courts and literally dozens of other companies filed reports on their activities. In 1976 the SEC submitted a report to Congress on the matter. That report revealed that up to that point in time they had discovered 103 companies which had made questionable payments. With the possible exceptions of Exxon (which listed 19 million which it was unable to account for) and Lockheed (whose 25 million in payments were not broken down by year), none of their companies had made $10,000,000 of questionable payments in any one year (and indeed none but Exxon or Lockheed had made over $10,000,000 in questionable payments in total; only a couple had made as much as $1,000,000 in any one year).
Presumably the SEC thought that the payments made by these companies were material. Indeed it devoted a significant portion of its resources for several years to this matter. Yet what would have happened under the proposed (c)(5)? Suppose that in 1994 a shareholder, upon discovering the illegal $55,000 payment made by American Airlines (which, remember, was such a material and important event as to force the CEO to resign) decided to submit a shareholder proposal to amend American Airline's by-laws to deal with illegal political payments. However, since the proposal pertains to a matter which involved an expenditure of less than $10,000,000. the proposal would be excluded under the proposed (c)(5). (The proposed rule talks in terms of "costs", which presumably describe most "questionable payments", especially since many or most or them take the form of payments to "consultants".) What is the logic of a public policy which says that matters involving the integrity and honesty of management are material but that shareholders may not communicate with each other on these material matters?
There are many instances in which shareholders and managements have viewed matters as being significant to the company, even though such matters would not be economically significant as measured by sales or expenditures. For instance, the proposed (c)(5) would have barred shareholder proposals to virtually every company which operated in South Africa, since most American companies operating there did not have South African sales or costs (after all, how much did they have to pay their black South African employees?) of $10,000,000. Yet eventually two-thirds of the publicly held American companies pulled out of South Africa. Similarly, 57 American company operate in Northern Ireland. The MacBride principles were developed to ameliorate religious discrimination in the workplace in Northern Ireland. Virtually all public pressure on American companies to agree to the MacBride Principles have revolved around shareholder proposals submitted to those 57 companies. Thirty-eight American companies have signed the MacBride Principles. Yet only one American Company, Emerson Electric, with 1300 employees in Northern Ireland, meets the $10,000,000 threshold, and it just barely meets it. South Africa and MacBride Principles illustrate the practical effect of the removal of the "otherwise significantly related" language from (c)(5). Virtually all South Africa and MacBride Principles shareholder proposals would have been barred under such a regime (despite the fact that the barring of MacBride Principles shareholder proposals was one of the motivating factors in causing Congress to insert into the National Securities Markets Improvement Act of 1996 the language requiring a report to Congress on plans by the SEC to improve shareholder access to the proxy statement; under the Proposed Amendments, virtually all MacBride Principles proposals would be barred).
The proposed rule would operate in a perverse fashion. In some scenarios, the more reprehensible the behavior of the registrant, the more that registrant would be protected by the proposed (c)(5). Let us assume that three corporations, A, B, and C, each imports 1,000,000 pairs of shoes per year. Company A acts in a manner which would be consistent with Ira Milstein's views on the integration of extrinsics. It incurs costs of $12,000,000. for the shoes which it manufactures or purchases abroad. A shareholder proposal to A on this topic would pass muster under the proposed (c)(5). Company B has its shoes manufactured under sweatshop conditions and incurs costs of only $6,000,000. Company C's shoes are made by slave labor and it incurs costs of only $2,000,000. Proposed rule (c)(5) would bar shareholder proposals to Companies B and C, a perverse result which represents, in our view, extremely poor public policy. The government should not reward bad (and, in the case of C, illegal) behavior. Yet that would be how (c)(5) would operate if the "otherwise significantly related" language is dropped.
Perhaps a more dramatic scenario is in order to illustrate why the "otherwise significantly related" language of the present rule is needed. Let us suppose the date is 1943. The place is Buchanwald. The principle actress is Ilse Koch, the wife of the commandant of the Buchanwald prison. She has had the prison workshop make her some lampshades which she delights in. They are made of human skin, taken from the bodies of gassed prisoners, then dried and stretched. (So far, the story is a true one). Ilse, being of an entrepreneurial bent, suggests to her husband that she thinks that there could be a market for such pretty lampshades and suggests to her husband that the prison workshops be expanded and that lampshade production be increased. The Commandant agrees. The upshot is that 100,000 lampshades are produced. A 34 Act registrant, Le Diable Furniture Co., imports (in violation of the trading with the enemy act) these lampshades, paying $50 apiece for them ($5,000,000). A shareholder of Le Diable proposes a by-law amendment to prohibit the Company from buying products made with slave labor. Under the proposed (c)(5) the proposal would be barred. Why does sound public policy demand such a result? It is well to recall Ira Milstein's contentions that extrinsics must be integrated into the affairs of the corporation; that corporation must act in ways which are consonant with societal values; that "private sector responsiveness to public concerns is part of system" and that failure of corporations to act in a socially responsible manner can, on a micro level, affect "the corporation's ability to survive" and, on the macro level, affect the American economy and the acceptability of the capitalist system, to say nothing of the worldwide promotion of free markets and democracy.
It is therefore clear that a purely economic test, whether set at $10,000,000. or at any other figure, is unacceptable, not only to proponents, but to our economic system. Irreparable harm would be caused is the "otherwise significantly related" language were to be deleted from (c)(5) and issues such as South Africa and MacBride Principles were to be decreed by the government to be matters about which shareholders should never concern themselves.
Another recent executive compensation incident is instructive on the question of whether the proposed (c)(5) properly measures the economic impact of a matter on the registrant. Recently, the board of Occidental Petroleum bought out the CEO's contract. For 95 million dollars. They then gave him a new contract worth several million per year. In other words, the company paid him $95,000,000 in order to renegotiate his contract. Apparently, under the old contract, he never received as much as $10,000,000 in any year. Thus, under the proposed (c)(5) there could have been no shareholder proposal dealing with the CEO's pay. Yet the measurement of what is economically material is flawed under the proposal (c)(5). The proposed test is the cash actually paid in the most recent year (in this case, about $5-6,000,000 per year) and not the total value of the undertaking, which appears to have been $95,000,000.
Amending the proposed (c)(5) to make sure that it doesn't cover executive (or board) compensation does not solve the real problem illustrated by the Occidental incident. The problem is that there is a fatal flaw in the method of measurement used to determine the economic significance of a matter. The measurement proposed is the amount expended during the company's most recent fiscal year. However, that amount may have absolutely no bearing on the economic significance of the matter to the registrant. For example, at Occidental the expenditure was about $5,000,000 per year. Is that the proper measure of the economic significance of the contract? There is good evidence that the contract was worth $95,000,000., not $5,000,000. The fatal flaw is that the method of economic measurement proposed in the Release would be rejected by all financial analysts (and all economists). The proper measure should not be the number of dollars spent last year, but rather the total, long term economic impact on the company. In the case of Occidental, the value of a perpetual employment contact should be measured by the discounted value (presumably $95,000,000.) of all future payments, not by the amount paid in any one year.
What is the policy justification for decreeing that it is a criminal offense to fail to disclose to shareholders certain economic data, which is obviously material, but to prevent shareholders from communicating among themselves, or expressing via Rule 14a-8 to management, their concern about that very same matter of enormous economic significance?
Another illustration of the failure of the proposed (c)(5) to properly measure economic materiality is based upon the actual experiences of Shell Oil group a couple of years ago. Assume for the moment that Big Oil is a '34 Act registrant with $100 billion in worldwide sales, of which 25% are in the European Union. Big Oil is going to dispose of an oil drilling platform by sinking it offshore beyond the continental shelf. The cost will be, let us say, $5,000,000. Environmentalist protest. Big Oil goes ahead anyway and tows the rig out to sea. Boycotts ensure throughout the EU, and sales drop by 25% in Germany and Holland. The estimated impact of the boycotts is that they are costing about 10% of EU sales, or about two and a half billion dollars per year. Under the proposal (c)(5) the real economic impact of $2,500,000,000 is ignored in favor of the paltry cost of the five million dollars it cost Big Oil to dispose of the rig. This makes no sense. The economic impact in the Shell case was not the cost of removing the rig, but the cost of the boycott (which, in fact, caused Shell to recall the rig and abandon its plans sink it at sea). An economic test should measure the economic impact of an action and not some arbitrary slice of it. Indeed, under the SEC's disclosure rules, Big Oil would undoubtedly be required by Item 303 of Regulation S-K to discuss in its annual report, in the Management's Discussion and Analysis section, the prospective drop in sales as well as the reason for it, namely the boycott. Criminal penalties would attach if they did not, yet shareholders cannot discuss the issue via 14a-8. Indeed, the whole purpose of removing the "otherwise significantly related" language from (c)(5) apparently is to rule out consideration of the economic impact of events such as boycotts. Apparently even when any financial analyst would consider them highly material. And apparently even when the economic impact on the registrant is tremendous.
Perhaps even more distressing is the fact that the proposed (c)(5) will make it impossible for a shareholder ever to re-file a proposal concerning a given economically material event, even if the first submission has received 30% (or 75%) of the vote. Again to use the Grace situation as an example, suppose that the shareholder somehow discovers in 1993 the facts concerning the 1992 payment in time to file a proposal that year pertaining to the prior year's payment. That shareholder would be unable to re-file the proposal in 1994 because under the proposed (c)(5) the expenditure would have to have been made in the prior year, not two years ago. Therefore all resubmissions on matters of this type would automatically be barred.
In summary, even if one were to accept (which we do not) that (c)(5) ought to restrict shareholder proposals to matters which can be measured by dollar costs or sales, the proposal is nevertheless fatally flawed. It does not properly measure the economic impact of the matter actually at issue (Occidental); it does not measure the entire impact of the matter (Shell); it does not permit matters which have been concealed to be the subject of a proposal (Grace) and it does not permit the re-submission of proposals. These are not problems which can be solved by merely rewording the proposal. They really illustrate that no bright-line test is possible in this area. In other words, the "otherwise significantly related" language must be retained in (c)(5)
B. Rule 14a-8(c)(7)
1. The Repeal of Cracker Barrel
We are pleased that the Commission has stated that it is repealing Cracker Barrel. We are deeply troubled that that repeal, in the form described in the Release, will be in form only and not in substance.
We are troubled because although Cracker Barrel is being repealed in that the bright-line "automatic" standard is being abandoned there is very considerable evidence that almost exactly the same no-action letter outcomes will occur post-Cracker Barrel as occurred during the reign of Cracker Barrel. In other words, our concern is that the Staff will continue to rule exactly the same way under a case-by-case approach as it ruled under the automatic approach of Cracker Barrel.
For example, for many proponents of social responsibility in investments, the most devastating aspect of Cracker Barrel was that it barred shareholders from asking companies (like Texaco) about their equal opportunity policies and performance. In particular, so-called EEO shareholder proposals which had routinely been permitted onto the registrant's proxy materials since 1974 were abruptly ruled out, starting with a no-action letter granted to Capital Cities/ABC, Inc. (April 4, 1991). CapCities' CEO apologized at the annual meeting for having omitted the proposal and the company subsequently both petitioned the SEC to vacate its decision (which the Commission did) and, in a model report on diversity, made publicly available the requested EEO data. Ultimately, however, a lawsuit on the issue was brought against Wal-Mart. The proponents were successful and Wal-Mart was ordered by the court to place the EEO proposal in its proxy materials. Amalgamated Clothing & Textile Workers Union v. Wal-Mart Stores, Inc. 821 F.Supp.877 (S.D.N.Y. 1993).
The Staff and the Commission refused to follow the Wal-Mart decision. In the real world, however, many registrants did not omit such proposals even after they had obtained no-action letters from the Staff. Thus, we note that shareholder proposals dealing with discrimination in the workplace (either requesting that EEO data be disclosed or addressing the problem of the glass ceiling) were submitted to twenty registrants during the 1996 proxy season. Although six of the registrants received no-action letters based on Cracker Barrel, all but one of the recipients of such proposals either supplied the requested data or placed the shareholder proposal on its proxy statement. (The exception was Shoney's which received its no-action letter almost literally before the proponent received a copy of the Company's no-action letter request, with the result that the proponent was unable to undertake in a prompt fashion the requisite internal procedures to institute a lawsuit against Shoney's. In 1997 Shoney's again requested and received a no-action letter but subsequently agreed both to provide the data and to place the proposal on the proxy statement. Since the proponents received the data asked for, they did not insist that Shoney's also place the proposal on the proxy statement, but withdrew their proposal.) Presumably each of the remaining 19 registrants (five of which had received no-action letters), as well as Shoney's in 1997, either believed that the shareholder request was, indeed, in conformity to law or was afraid that it would lose in court when sued.
After this long history culminating in a successful lawsuit and subsequent registrant compliance with the results of the lawsuit, the Release announces that Cracker Barrel will finally be repealed. That is the headline! But what is in the footnotes? Footnote 79 lists some of the kinds of matters which will continue to be excluded post Cracker Barrel repeal. What no-action letter is cited? Capital Cities/ABC! The very no-action letter which had started the entire controversy. And which had been vacated!
We are therefore concerned that the although the Commission says that it is planning to "repeal" Cracker Barrel, that that repeal will be in form only, but not in substance.
The Cracker Barrel doctrine applied to all workplace issues. In addition to the citation of the Capital Cities/ABC letter there are a number of other indications in the Release that Cracker Barrel has not yet received a stake through the heart, but may yet rise up again from the dead.
For example, in the proposed note to the revised (c)(7) the Commission states that one of the matters which will henceforth be forbidden on proxy materials are any proposals dealing with the "wages of non-executive employees". That certainly sounds as if shareholder proposals dealing with "sweatshops", either in the USA or abroad, will automatically be barred. Just like under Cracker Barrel. Automatic, with no possibility that such a proposal could raise a significant policy issue. Although in the Release the Commission expressly states that it is reserving judgement on the includability of Maquiladora resolutions, it sounds like the issue may already have been decided. Automatically.
Furthermore this approach would appear to preclude shareholder proposals which attempt to implement Mr. Milstein's vision of the future of American capitalism, since among the major matters which Mr. Milstein says should be of concern both to the board and to the shareholders is the question of the wages of the lower level employees.
We are therefore concerned that the Commission is not making a clean break from the ill-conceived Cracker Barrel doctrine and that the ghost of Cracker Barrel will continue to haunt the no-action letter process.
Indeed, we are concerned that the entire discussion of (c)(7) in the Release has an anti-proponent flavor. As just one illustration, the text at footnote 79 states that proposals will remain ordinary business "if they seek to impose specific time-frames" and in footnote 79 itself, refers to the Roosevelt case in the DC Circuit. The trouble is, Roosevelt made no such sweeping statement. On the contrary, the DC Circuit held that timing could raise a significant policy issue. The history was that the proponent had submitted a shareholder proposal calling on DuPont to advance by five years the company's timetable for the phase out of production of CFCs. The Staff of the Division held that the proposal was excludable as an ordinary business matter. The Court of Appeals asked the SEC to submit a brief on the matter. Whereupon, the Commission reversed the Division position on the matter and said that the five year gap would raise important policy issues. After the brief had been, DuPont adopted a new policy to phase out CFCs four years earlier, thus reducing the gap between the company and the proponent to, at most, one year. Under these circumstances, the Court held that "(t)iming questions no doubt reflect 'significant policy' when large differences are at stake" as would be the case if the gap were still five years; but since it was now only one year the proposal could be excluded. The Release appears to revert to the Division policy which was repudiated both by the Commission in its brief and by the DC Circuit.
We therefore are concerned that, rather than expanding shareholder right as mandated by Congress, the Release is further restricting those rights.
2. The New Wording of (c)(7)
The Release states that the proposed rewording of (c)(7) is "intended to make the 'ordinary business' exclusion easier to understand, not to modify current interpretations". In fact, the new wording appears to make a major alteration in the meaning of the exclusion.
The term "ordinary business" has a well defined and established meaning. This meaning can be traced to Securities Exchange Act Release 34-12999 (November 22, 1976) (the "1976 "Release") where, in connection with a revision of Rule 14a-8, the Commission gave new content to the ordinary business exclusion. In the 1976 Release, the SEC explained what it intended the "ordinary business" phrase to really mean. The SEC there stated that proposals are excludable under the ordinary business rubric if they "involve business matters that are mundane in nature" and which do not "have significant policy, economic or other implications inherent in them." (The 1976 Release also refers to proposals which "do not involve any substantial policy or other considerations".) In other words, a shareholder proposal which raises a significant policy or economic issue cannot be excluded by virtue of Rule 14a-8(c)(7). The significant policy standard enunciated in the 1976 Release has been held by the Second Circuit to be a legislative rule, not an interpretive rule, and thus is itself actually a part of Rule (c)(7). New York City Employees' Retirement System v. Securities and Exchange Commission 45 F.3d 7 (2d Cir 1995). That the "significant policy" language is itself a part of the Rule was initially held by the Southern District of New York in New York City Employees' Retirement System et al v. Securities and Exchange Commission 843 F.Supp. 858 (S.D.N.Y. 1993). Although the lower court was reversed on other grounds, in reversing, the Second Circuit clearly affirmed the lower court on this issue, holding that "since the 'significant policy implications' rule announced in the 1976 Adoption provides a basis for SEC enforcement actions, this part of the 1976 Adoption was a legislative rule" (at p.13). This was clearly a holding by the court since, unless it so held, it would never have been able to reach the second issue in the case, the issue on which it reversed the lower court. Accord Amalgamated Clothing & Textile Workers Union v. Wal-Mart Stores, Inc. 821 F.Supp.877 (S.D.N.Y. 1993). In addition, the District of Columbia Circuit Court has similarly held that the meaning of the term "ordinary business" is that which is set forth in the 1976 Release. Roosevelt v. E.I. Du Pont de Namours & Co., 958 F.2d 416 (D.C.Cir 1992) (Opinion by Judge (now Justice) Ginsburg); Grimes v. Ohio Edison Company, 992 F.2d 455 (2dCir 1993); Grimes v. Centerior Energy Corporation, 909 F.2d 529 (D.C.Cir 1990). Indeed, each of these three Court of Appeals cases quotes (992 F.2d at 457; 958 F.2d at 426; 909 F.2d at 531), as did the Second Circuit in NYCERS, extensively from the 1976 Release in establishing the standard to be applied in construing the term "ordinary business".
Therefore, the plain English version of the present (c)(7) should read as follows:
If a proposal deals with a matter relating to the conduct of the ordinary business operations of the company. A proposal deals with a matter relating to the conduct of ordinary business if it involves business matters which are mundane in nature and if the proposal does not have significant policy, economic or other major implications inherent in it.
This plain English version clearly explains what the term "ordinary business" means. It does so in complete harmony with (indeed, it quotes) both the definition of that term as established by the Commission itself in the 1976 Release and the definition used in all four courts of appeal cases which have considered the matter. It is also in total harmony with (and quotes) the language which the Second Circuit recognized as being a legislative rule in New York City Employees' Retirement System v. Securities and Exchange Commission 45 F.3d 7 (2d Cir 1995).
In contrast, the new language proposed in the Release would change drastically the meaning of the exclusion. Furthermore, it is ambiguous. What exactly are those decisions which are "normally left to the discretion of management"? Does the answer to the question vary from company to company? Does it vary with the size of the company? Is there any consistency among boards with respect to how much authority they delegate to management? Is there some place where one can find out which decisions management normally takes? As such questions suggest, the concept of an area normally left to management's discretion is exceedingly vague and totally lacks consistency between companies. It was for this very reason that an almost identical concept was rejected by the Commission in 1976. In that rule making proceeding, the Commission initially proposed to amend (c)(7) by replacing the term "ordinary business" with somewhat different wording. Securities Exchange Act Release 34-12598 (July 7, 1976). However the Commission decided not to adopt the proposed change in terminology, stating:
The Commission suggested in Release 34-12598 that a possible standard for making such distinctions was whether it would be necessary for the board of directors to act on the matter involved in the proposal. If no action were necessary, the matter would be considered routine. The commentators pointed out, however, that board practices relating to the delegation of authority to management personnel vary greatly, and there would therefore be no consistency in applying such a standard. The potential lack of consistency of the proposed standard is a fatal drawback, in the Commission's view.
The proposed re-wording of the "ordinary business" exclusion has exactly the faults described by the Commission in 1976. Nor it that surprising, since it is exactly the same concept; namely, an attempt to differentiate between matters that can be acted on by management and those which require board consideration. The idea is no better today than it was in 1976. This is so because it suffers from the same flaw, i.e. that there would be no consistency between companies. Could a board delegate to management the choice of the site of the annual shareholders meeting? Could a by-law delegate to the CEO plenary authority to enter into any and all transactions on behalf of a company? Could a by-law restrict the CEO from entering into any contract in excess of a given dollar amount? Could the by-laws be silent on the question of the actual authority of the CEO?
Furthermore, if some uniform standard based on what managements "normally" do is intended, how would one ascertain what, in fact, managements normally do, especially since practice varies from company to company? How would one go about proving what managements normally do? Supply affidavits from 25 CEOs?
Aside from the potential lack of consistency or the potential impossibility of ever proving what managements normally do, there is an even more troublesome aspect to the proposed language. It appears to make a substantive change in the meaning of (c)(7). After all, managements normally decide significant policy issues. The proposed language would therefore appear to abandon the key portion of the present test. It therefore makes a substantive, and significant, alteration in the rule.
In summary, (1) the meaning of the proposed language differs markedly from the standard adopted by the Commission in 1976 and (2) it simply won't fly. Therefore, the proposed "plain English" version of (c)(7) should not be adopted. Rather the Commission should restate the rule in the language set forth earlier in this section of this letter. That language has the advantage not only of not changing the meaning of the rule, but also in spelling out for all to read what it is that the rule actually means (making it no longer necessary to consult the 1976 Release).
C. Rule 14a-8 (c)(12)
1. Resubmission Thresholds
In three places (Sections V, VI and VII) in the Release, the Commission states that although it is proposing a drastic increase in the resubmission thresholds, it does "not have a reliable way to estimate the future impact on the number of proposals companies are required to include in their proxy materials". The Commission then goes on to "request your comments, preferably supported by empirical data, on the potential impact of this proposal". The existence of the comment period required by the Administrative Procedure Act is indeed a fortunate requirement because the comment period has enabled that empirical data to be produced for the Commission's review and, hopefully, its reexamination of the desirability of raising the resubmission thresholds.
During the course of the comment period, the Social Investment Forum (the "Forum") undertook to do a study of the effect of the Proposed Amendment to (c)(12). (The study was based on data available from IRRC. As previously indicated, the Forum has provided the Commission with a copy of this study as part of the comment process on the Proposed Amendments.) The Forum studied shareholder proposals voted on during the years 1986-1995, and examined the impact that the new thresholds would have had on the ability of shareholders to resubmit proposals. The results are astounding. As a result of markedly increasing, actually tripling, the resubmission threshold, the "failure rate" in year three would quadruple overall, increasing to virtually 100% for social responsibility shareholder proposals, and increasing by almost six fold for corporate governance proposals. The failure rate in year one would double for corporate governance proposals and more than quadruple for social responsibility proposals. The second year failure rate would quadruple for corporate governance proposals and more than triple for social responsibility proposals. The overall failure rate, including those which would fail in years one and two as well as in year three, would be 95% overall, including 100% for social responsibility proposals and 85% for corporate governance proposals, compared with present failure rates of 27% and 61%, respectively. (Only two social proposals have ever received 30% of the vote, one on South Africa and one on the MacBride Principles.)
An example of the impact of the proposed rules is that more than 87% of cumulative voting proposals would fail by year three as would 100% of executive compensation proposals. Furthermore, more moderate increases in the thresholds would have almost as severe an impact. For example, the study reveals that small increases of only one or two percent in the thresholds would cause dramatic changes in the failure rates. For example, a 1% increase in the first year threshold would double the failure rate in that year for social responsibility proposals, while an increase in thresholds to 4%, 8% and 12% would halve the number of social responsibility proposals surviving beyond the third year.
We do not believe that there is any conceivable justification for the radical change proposed, or, indeed, for any change at all, in the resubmission thresholds. Furthermore, we are concerned that the increase in thresholds will cause registrants to be less willing to dialogue on important matters facing the company. Finally, we are also concerned that doubling the initial percentage will make it very difficult for emerging new issues to survive the first year, a time when many institutions may not yet have established a policy on the matter.
What justification does the Commission give for such a drastic curtailing of resubmission? Four are advanced in the Release. Let us examine each of them:
1. One argument advanced is that companies complain that they "receive too many proposals of little or no relevance to their business". This appears to be merely a statement by companies that they believe that under the rules they have to include too many proposals in their proxy materials and that they would prefer to include fewer proposals. So what's new? Even without the questionnaire one would know that companies would take that position. However, there is no more justification in raising the thresholds because companies complain that there are too many proposals than there is in lowering the thresholds because shareholders complain that too few proposals get into the proxy materials. (Also information "discovered by the questionnaire.)
Furthermore, to the extent that the argument is really based on the relevance of the proposals, resubmission and relevance are unrelated concepts. There is no logical connection between the question of relevance and the resubmission level. It would be improper to use (c)(12) as a underhanded way of amending (c)(5), but without any criteria which actually goes to the question of relevance.
In connection with this argument, the Release makes reference, via footnote 80, to part II of the Release. Presumably the cross-reference is to the text of the Release at footnotes 17 and 18. Footnote 17 cites seven companies which apparently have indicated that they are compelled to include shareholder proposals of little relevance to them and footnote 18 cites four companies which have suggested that this problem could be cured either by raising the resubmission thresholds or by raising eligibility requirements. (It is unclear from the Release whether one. two, three or all four suggested raising the resubmission requirements.) Since the questionnaire was sent out in early February, 1997, the undersigned undertook to investigate how many social responsibility shareholder proposals these eleven companies had received during the prior year (1996), and which proposals might have peaked their concern about the relevancy of the proposals received. Most revealing is that five of these companies had not received any social responsibility proposal at all during 1996. Nor did any of these five companies receive any social responsibility proposal during either 1995 or 1997. One of the remaining six companies is RJR Nabisco. It can expect to receive several tobacco proposals each year, all of which would appear to be extremely relevant to the company. In the view of the undersigned, RJR is a special case whose travails may have some predictive value to one or two other tobacco registrants, but no predictive value for the other 14,000 registrants. In the following statistics we have therefore excluded the tobacco related proposals (but not other proposals) submitted to RJR.
These six companies received a total of 12 social responsibility proposals during 1996. Of these, one was excluded by the SEC on (c)(12) grounds (!) and six were withdrawn. Therefore only five proposals were in the 1996 proxy materials and came to a vote (one environmental plus four which the Staff would have said were excludable under Cracker Barrel: two Maquiladora, one EEO and woe international workplace). Of these five, only two (EEO at RJR and Maquiladora at Cooper Industries) had been voted on the prior year, 1995. And of those same five only one (EEO at RJR) was voted on the subsequent year, 1997. Thus, these eleven companies which called for raising the threshold in order to prevent having to include irrelevant proposals received in 1996 only one proposal amongst them which the Staff would not have ruled out (the environmental proposal). That hardly seems an excessive burden of irrelevant proposals! Furthermore, these eleven companies received only one proposal all three years (EEO at RJR) and only one other proposal appeared a second time (Maquiladora at Cooper). One can, we believe, draw two conclusions from these statistics. First, that these eleven companies had hardly experienced harassment by repeated proposals and, secondly, that each of the proposals which were received was highly relevant to that issuer. Thus, it is not at all clear why the receipt of such proposals should be a ground for an increase in the resubmission thresholds. It is always possible that these companies are not representative, but they are the only evidence cited in the Release for the proposition that an increase in the thresholds is needed. In short, the Commission has cited no evidence either that repeated proposals are a problem or that registrants must place in their proxy materials repeated irrelevant proposals.
2. The second ground advanced for increasing the resubmission proposals is that the increase is needed to "balance" the increased number of proposals which would be permitted on the proxy materials because "of the proposed reversal of the Cracker Barrel position and the (institution) of the 'override' mechanism". We believe that this is the real reason behind the proposed increase in the threshold. Again, however, the logic is faulty. First of all, the resubmission thresholds were not lowered when Cracker Barrel was adopted. Why should they be raised when it is repealed? (And, in any event the courts have ruled that Cracker Barrel is not the law, with the result that it has had very little impact, in the real world, on the includability of EEO proposals, as witnessed by the fact that four of the five proposals voted on at the eleven issuers referred to above were theoretically excludable under Cracker Barrel.) Secondly, as discussed elsewhere in this letter, we expect that the override proposal will have de minimis impact, since 3% will be unobtainable. Therefore, the second, and key, ground advanced in the Release is wholly without substance.
3. The third ground advanced for increasing the thresholds is that the test for continued resubmission should be whether the proposal appears to stand "no significant chance of obtaining . . . (voting) approval". This is not a proper test. First of all, even when approved by a majority of the shareholders, a proposal need not be implemented by the board since virtually all shareholder proposals are precatory. Thus, even if a proposal is passed, boards can, and have, ignored them. On the other side of the coin vast numbers of companies have implemented shareholder proposals which have received small fractions of the vote. For example, in no year did the average vote received by "get out of South Africa" proposals exceed 13%. Yet, the vast majority of American corporations got out of South Africa. Similarly, almost two-thirds (37 out of 58) of the companies doing business in Northern Ireland have signed the MacBride Principles, despite the fact that of the 131 votes on MacBride Principles shareholder proposals during the decade 1986-1995, only one vote exceeded 30% Therefore, whether or not the proposal is implemented depends not on whether it gets a majority of the vote, but rather on whether it gets enough votes to cause management or the board to reexamine the issue and alter its course. Based on our experience with South Africa, MacBride Principles, Ceres etc, we believe that 10% is that figure.
4. Finally, the Release argues that the shareholders are the best judges of which proposals should be eligible for resubmission. We agree. However, that begs the question of what percentage of shareholder support should be required. Since the playing field is decidedly not level, has the proponent scored a major victory when the proposal receives 10%, 30% or 50%? We submit that the answer is 10%.
In summary. no case has been made for any change in the resubmission thresholds, no less for the drastic revisions proposed. We firmly believe that the present thresholds should remain unchanged.
2. The Counting of the Vote
The Release also raises the question of whether there should be any alteration in the present method of determining what percentage of the vote a proposal has received. The issues here are whether abstentions and broker non-votes should be counted in the denominator of the fraction. We agree with the Commission position that no change should be made, regardless of whether the thresholds are increased. In this connection, we note that including one or both of these categories in the denominator has the identical impact as treating them as votes against the proposal. There is no justification for such treatment since the shareholders who abstained obviously did not intend to vote against the proposal and may have abstained because no institutional policy on the matter had yet been formulated. As far as broker non-votes are concerned, the Delaware rule would appear to be correct, namely that they should not be counted in deciding whether a matter has passed.
Incidently, it is worth noting that a combination of the proposed increase in the threshold, together with a change in the denominator, could lead to a situation where a proposal passes as a matter of state law but would be ineligible for resubmission under (c)(12). (This could happen if the proposal received 29% yes votes, 28% no vote, 22% broker non-votes and 21% abstentions.)
D. Rule 14a-8(c)(4)
We believe that it is important for the Commission to remain involved in the interpretation and administration of (c)(4) and we therefore do not support the Commission's "no view" proposal. While we acknowledge the occasional difficulty the Commission has faced in administering (c)(4), we believe that, if the Commission believes (as we do not) that there is a genuine problem with this subparagraph, a more appropriate approach is to reexamine the underlying nature of that problem and to achieve a solution which addresses that underlying problem.
Our primary concern is that if the Staff fails to give advice, registrants, without the threat of SEC enforcement, may simply ignore the proponent's proposal and dare her or him to sue. This will be particularly devastating for small shareholders who will not have the resources to pursue the matter in court. In short, the change has the potential likely to lead to serious abuse by registrants. Indeed, some registrants may be tempted to allege a "personal grievance" or "special interest" without any factual foundation whatsoever, merely to have an excuse to omit the proposal from its proxy materials without fear of an SEC enforcement action.
Our secondary concern is that litigation is not in the best interests of either issuers or proponents. Yet likelihood of litigation would be greatly enhanced by the failure of the staff to give advice with respect to (c)(4). We are concerned not only with the dollar costs of such litigation but also with the possibility that such litigation would throw a monkey wrench into the timetable leading up to the annual meeting. In other words, both proponents and issuers need a decision in a timely fashion, and we believe that the abdication by the staff of its advice-giving function under (c)(4) will enhance the possibility of uncertainty surrounding the annual meeting, including the possibility that the meeting may have to be postponed. We are strengthened in this conclusion by the fact that both shareholder and registrant respondents to the Commission's questionnaire overwhelming supported continuing the Commission's role as "referee" in the 14a-8 process. (See footnote 31 of the Release.)
We therefore urge the Commission not to have the staff abandon the giving of advice concerning (c)(4).
Nevertheless, we agree that (c)(4) has occasionally caused problems in the past. These problems arise not because of the standard which the rule establishes, but rather because the purported proponent is submitting the proposal on behalf of another. If the Commission believes that there are serious problems in connection with (c)(4) (which, frankly, we doubt), that is the underlying problem which must be addressed. In other words, any difficulty arises not because of the "grievance" or "special interest" standard set forth in (c) (4) itself, but rather because of an evasion of the eligibility requirements set forth in (a)(1). We say this because it is our observation that the few problems which have arisen do not really involve a grievance or special interest on the part of the purported proponent, but rather involve the existence of another person hiding behind the curtain who has the actual grievance or special interest. It therefore appears to us to be the better approach, if the Commission really believes that there is a problem in this area, to address the eligibility issue directly, for example by requiring the proponent to affirm that the proposal is not being submitted at the request of another person, rather than to adopt a "no-view" approach in responding to (c)(4) no action requests.
In summary, we do not believe that (c)(4) needs any tinkering, but if the Commission believes that those few instances where there have been difficulties warrant some changes, those changes should address the underlying cause of the problem. A "no-view" approach does not do this, but rather is a clearly overbroad response to a minor problem, and a response which contains the seeds of disaster both for proponents and for registrants. We urge the Commission not to adopt this response.
E. The Override
The basic idea of an override is a good one. It is consistent with theories of corporate democracy and shareholder rights. The underlying model of the corporation (and the way business corporations were originally organized and closely held corporations are still organized) provides that any shareholder can bring up any matter (proper for shareholders to vote on) at the shareholder meeting, and the shareholders would then vote on the proposal. However, this model assumes that the shareholders are themselves physically present at the meeting. Today, they are not. The widespread dispersal of ownership in the modern corporation has led to the proxy system, where votes are really cast in the shareholder's own living room, rather than by having the shareholder attend and vote at the annual meeting. Since the proxy solicitation process, rather than the meeting itself, has now become the focal point of all voting, it is futile for a shareholder to make a proposal at the annual meeting unless that proposal has been included in somebody's proxy materials.
Rule 14a-8 is one method devised to solve this problem. The basic dilemma to be solved under Rule 14a-8 is deciding in which instances it is appropriate to exclude a proposal from the registrant's proxy statement. The underlying rationale of (c)(5) and (c)(7) (and indeed of most of the exclusions) is that proposal should be excluded if it will not be of concern to the shareholders. With respect to such matters, it is thought to be inappropriate to require that the corporation (i.e. the shareholders) pay for the taking of a poll on a matter as to which the shareholders are presumed to have little or no interest or concern. In the ideal world, one would be clairvoyant and be able to ascertain in advance which aspects of an issuer's business the shareholders are concerned about. In the absence of such clairvoyance, the United States government has promulgated exclusions (c)(5) and (c)(7), rules based upon a presumption about what is of interest to shareholders, permitting those proposals which raise substantial policy issues to be included in the proxy materials, while excluding those proposals which do not raise such issues.
Nevertheless, the government has to draw a line between proposals which raise policy issues and those which do not. It does so based on its assumptions as to what matters will be of genuine policy concern to shareholders. If it knew in advance, for instance, that a majority of the shares planned to support a given shareholder proposal on some aspect of the issuers' business, it would be inconceivable that the government, or a governmental agency, would substitute its own judgment for that of the shareholders and decide that no serious policy issue was raised by the proposal. In a democratic society, the government listens to its constituents rather than arrogantly proclaiming that it knows best. In other words, the government's role is to act as a surrogate for the shareholders, deciding before the fact what is likely to be of serious concern to them. This is an important function. Nevertheless, the government may misread the minds of the shareholders, who may decide that something which the government didn't deem important is nevertheless important to them. Is there another surrogate available? Obviously, the shareholders of the company themselves, or some subset of those shareholders, could fulfill the surrogate role. Since it is impractical to have all the shareholders participate in a referendum on the question of the importance of the proposal (after all, that is what the proxy vote itself is), an alternative is to turn to some subset of shareholders to make the decision. Thus, a proposal would be included if some critical mass of the shareholders wanted it to be included (which is the system primarily used in the European Union). That is exactly the function of the override, a concept which endorse.
The difficult question is to decide the size of the critical mass. We believe that 3% is far too high. In the real world, an override set at that percentage would seldom, if ever, be availed of. Corporate governance issues are almost never excluded under either (c)(5) or (c)(7). The override would therefore be of little or no use to corporate governance proponents. On the other hand, (c)(5) and (c)(7) are often used against social responsibility proposals. However, it is our belief that it would be virtually impossible to get 3% to support the filing of such a proposal for the following reasons:
1. It will be impossible to locate and contact small shareholders. This problem is exacerbated by the fact that the SEC has failed to propose making shareholder lists available for this purpose. In the absence of such lists, we do not believe that it will be possible to contact any significant number of small shareholders, although at some distant time in the future the internet might be a method of contact. At the present time, however, there is no evidence that the internet would be practical for this purpose. Although our largest companies frequently have more shares owned by institutions than by individuals, this is not true of smaller, or even medium, sized companies. (The dividing line is probably at or near the S&P 500, since index investors automatically own those stocks.) Since most smaller and medium sized companies do not have large institutional ownership, the override would, as a practical matter, be of no use at these companies. Thus, even though footnote 84 of the Release indicates that 4,166 registrants have a single institutional holder with at least 3% of the stock, this is not probative. First of all, that is less than 30% of all registrants. Secondly, the odds of getting any one institution to give its support is very small indeed. Therefore the existence of one, or a few, large institutional holders says nothing about the likelihood of such institutions supporting a shareholder proposal on a social issue. Therefore, unless there are many institutions with large holdings, it will be impossible to contact a sufficiently high percentage of the stock to make obtaining 3% a realistic goal.
2. Because of the 13F filings, it is possible to identify institutional owners. However, we doubt that many would be willing to support inclusion of any shareholder proposal. Very few institutions sponsor socially responsible shareholder proposals, although many of them vote for them. Which side of that divide would the request for support fall? We think it far more likely that such institutions would view such support as more akin to the sponsorship of a proposal than to voting for the proposal. We therefore believe that almost all institutions would decline to support such a shareholder proposal.
3. For those few institutions which would be willing to support a proposal, another difficulty arises. Let us say that institution M is favorably inclined toward proposal A, and would consider supporting its inclusion in company X's proxy. However, M will not know whether there are proposals B, C or D out there drafted by other shareholders of X, and which it would prefer to support. Therefore, M will be unwilling to sign on to proposal A until the very last minute. Since other institutions can be expected to act similarly, it will be difficult or impossible to obtain support for A until the very last minute, which, in the real world, may mean that proposal A will simply never be able to garner the requisite support.
We therefore believe that setting the override at 3% is essentially equivalent to having no override. On the other hand, an override set at 1% might occasionally be availed of. (By analogy, in France shareholders have an absolute right (with no (c)(12) or other exclusion possible) to place a proposal on the proxy in accordance with a sliding scale, with the percentage reduced to 1% for companies with about $17,000,000 or more in capital.)
In short, we are supportive of the proposed override but do not believe that 3% is a workable number and that, as noted above, an override set at that level is essentially equivalent to no override.
In answer to some of the specific queries in the Release, we believe:
1. It is necessary to include the proponent's own shares in the required percentage, even when the proponent owns that percentage. If an attempt were made to exclude a proponent's ownership position, such attempted exclusion would be easily evaded by merely having another shareholder (with perhaps one share) be the nominal sponsor of the proposal, with the large shareholder "supporting" the proposal.
2. We believe that the override should depend on the economic interest of the supporters, not their number. The issue is analogous to "one share - one vote".
3. There are a number of technical issues which would need to be addressed if an override is adopted. These include questions of revocation, whether the supporter must hold the stock through the annual meeting etc. We suggest that the Commission look to the Delaware written consent procedure for analogous answers to many of these questions. That procedure requires the shareholder to be such on the date that the consents are presented to the company (the equivalent of the record date), but there is no subsequent holding period. Such a rule is also appropriate for the override in light of the fiduciary duties which would preclude most institutional shareholders from committing to hold for any given period. Furthermore, by analogy, there is no requirement that a shareholder continue to hold the stock after having signed a proxy. It is the record date which controls, not who holds the stock at the time of the meeting. There is no reason to require that supporters continue to hold their stock although voters need not do so.
4. The 120 day requirement appears to be reasonable, provided the proponent is able to get a prompt reply by the Staff on the question of includability if she or he first submits the proposal under the "normal" rules (e.g. if the proposal is submitted 180 days in advance, assurance is needed that a Staff decision will be rendered in time to utilize the override, otherwise company counsel will delay making its submission to the Staff until just before the 80 day deadline of Rule 14a-8(d)). We therefore support the Commissions plan to amend 14a-8(d) to require company submissions within 40 days after receipt of the shareholder proposal.
5. We think that the Commission struck the correct middle ground in permitting a shareholder to be the supporter of only one proposal, but permitting a supporter to sponsor its own shareholder proposal. Without the latter permission, those institutions which otherwise might be most willing to support a proposal would shy away from doing so if such support would preclude the possibility that the institution would be able to submit its own proposal, should the need to do so suddenly arise.
6. We believe that the safe harbor under 13D is essential to make the override work since otherwise we believe that institutions, rightly or wrongly, will be reluctant to support a proposal for fear of triggering 13D. Similarly, we believe that if an override is adopted there will be the need for an exemption from the definition of solicitation found in Rule 14a-1. Such an exemption may be needed even though we recognize that shareholder proponents not seeking agency authority are themselves deemed to be exempt without any such formal provision in the Rule itself. We believe that the override exemption from the solicitation definition should be in the Rule itself because the proponent will be obtaining signed papers from the supporters and therefore the whole process will more closely resemble the obtaining of agency authority. Consequently, a specific exemption provision would appear to be in order. However, since such solicitations of support may be made in connection with a contest for control, we also believe that the restrictions set forth in Rule 14a-2(b)(1) should equally apply.
7. There is a need to address the problem of ascertaining how many shares constitute 3% of the outstanding when the registrant has had a stock split or other recapitalization, or a significant sale of securities or significant buy back. The Proposed Amendments refer to the outstanding as of the close of the registrant's prior fiscal year. However, if one of the events mentioned above has occurred since that date, the prescribed method of calculation may give a result which is radically different from the actual percentage held. This problem could be partially (but not completely) obviated by reference to the most recent 10Q on file rather than the 10K.
F. Repeal of Rule 14a-8(e)
We believe that the repeal of Rule 14a-8(e) would be a great mistake. That rule was enacted in Securities Exchange Release 34-15384 (December 6, 1978) following a series of serious problems concerning the accuracy of certain management's statements in opposition to shareholder proposals. The reasons for its enactment were set forth by the Commission at that time:
First, it simply would be more equitable if shareholder-proponents were permitted to see management's opposing statement before it is mailed to shareholders. Second, in light of the problems associated with a total reliance on judicial remedies and the limited Commission resources available for review of proxy materials, it appears appropriate for an effective administration of the proxy rules that a shareholder-proponent be given the opportunity to examine management's opposing statement for accuracy. Finally, it would appear to be in the best interests of all parties that questions concerning the factual accuracy of the opposing statements be resolved during the comment period.
These reasons remain equally valid today. An after the fact lawsuit by the proponent or an enforcement action by the Commission is usually not practical because of the costs involved. It is therefore far better to nip the problem in the bud by giving the Staff the ability to review management's statement before it is mailed. Furthermore, it should be borne in mind that a "contest" is occurring in connection with the proposal. For example, because of the existence of a contest, the rules of the NASD and of the New York Stock Exchange prohibit brokers from voting the stock held for their customers on the shareholder proposal unless they have obtained voting instructions from the customer. As with other contests, it is appropriate for the Staff to have the opportunity in advance of mailing to review for fraud the statements being made by both sides. Finally, it would appear that 14a-8(e) provides a more level playing field. Management has the opportunity to present to the Staff its contentions that portions of the proponent's proposal violate Rule 14a-9. Likewise, the proponent should have an equal opportunity to present to the Staff its contentions that portions of management's statement violate Rule 14a-9. In connection with this last point, it should be noted that although it is undoubtedly true that in most instances proponent's objections to management's statements are not found by the Staff to have merit, it is equally true that most of management objection's to the proponent's statements are likewise found to be without merit.
In addition, it is our experience that the requirement that the company send a copy of the proposed statement in opposition to the proponent often serves to prevent problems from developing. Proponents will sometimes call the company to register their concerns about wording and an amicable agreement will be worked out, thus negating not only a costly lawsuit, but also the necessity of the proponent going to the Commission after the fact with an allegation of a violation of 14a-9.
G. Rule 14a-4
We agree that more clarity is called for in connection with 14a-4 solicitations. During the 90's there have been about ten of these solicitations per year, often in connection with control contests. Uncertainty creates unnecessary costs for the registrant (up to and including resolicitations and postponing the annual meeting) and perhaps for the proponent. It also means that shareholders, especially beneficial owners, may not receive their proxy materials in a timely fashion.
The "reasonable time" requirement of Rule 14a-4 needs to be replaced with a time certain. We believe that a 45 day advance notice requirement appears to be a reasonable period to permit the registrant to take appropriate action. This is especially true because the 45 day period is really only a default provision, since so many registrants have advance-notice by-laws. More important than the actual number of days chosen is the fact that registrants will now have a time certain, thus eliminating frantic scurrying and unnecessary costs.
We also like the idea of placing a box on the proxy card to permit shareholders to withhold discretionary authority. Indeed, such a box would be desirable even in the absence of a 14a-4 contest. Presently, a shareholder who is a record owner can withhold discretionary authority simply by crossing out the line on the proxy card which grants such authority. Providing a withhold box would regularize this procedure (according to the Release, ADP reports that such a box would not increase tabulation costs). On the other hand, a beneficial owner normally has no ability to withheld discretionary authority since what that shareholder receives is not the proxy card itself, but rather a paper ballot listing the items to be voted on and providing voting boxes. Normally there are no boxes pertaining to granting of discretionary authority. Nevertheless, the undersigned is aware of the fact that from time to time ADP does place boxes on the paper ballot (all three boxes: for, against and abstain), thus enabling beneficial owners to decide whether or not to grant discretionary authority. (Most recently, the undersigned observed such boxes in connection with the solicitation by Caliber Systems, Inc. on its proposed merger with Federal Express.) It is therefore not unheard of for there to be the equivalent of withhold boxes in connection with the granting of discretionary authority. We would support extending this practice by routinely giving shareholders the opportunity to check a box in order to grant, or not to grant, discretionary authority to management (whether via a "withhold" box or, as ADP does in the case of Caliber Systems and others, via the normal three boxes).
Although we would favor a requirement of a "withhold" box as a routine matter, there are complications when there is a 14a-4 contest. These difficulties revolve around state law doctrines which state that a subsequently executed proxy revokes the earlier executed proxy. Any new rule in this area must take that fact into account. In illustration, suppose that X, a shareholder of registrant Z, commences a 14a-4 solicitation. X sends out its proxy card which provides for voting on this matter, but on no other matter. Shareholder A votes for X's proposal on X's card. Subsequently, Z solicits (or, more likely, resolicits) A. In accordance with the Proposed Amendment, Z's card includes a "withhold" box on the matter of granting discretion to management. Since A does not wish to grant management discretion on this matter (since A is, after all, in favor of X's proposal), A checks the withhold box. It would seem that by doing so, he has executed a subsequently dated proxy on the matter of X's proposal. This subsequently dated proxy would, therefore, under state law revoke the authority which A had previously granted to X. The only way to avoid this result is to provide not that there be a "withhold" box on Z's proxy card, but that Z be required both to have X's proposal listed as a separate voting item and to have all three boxes on its card, so as to enable A to again vote in favor of Z's proposal. Otherwise, A's vote to withhold discretionary authority will revoke the earlier proxy to X, with the net effect that A will not have his vote in favor of X's proposal counted. At the meeting, A's shares will not be voted one way or the other on the proposal. This is, of course, contrary to A's wishes. The only way to be sure that A's vote will be tabulated in favor of the proposal is to require the registrant (Z) to include "for" and "against" boxes on the actual proposal. This is the present solution under Idaho Power, and it seems to be the only possible solution to the problem.
If the registrant will be required to describe the proponent's proposal and to place all three boxes on the proxy card, the registrant will need some assurance that the proponent will actually be soliciting the shareholder base. This can be accomplished by requiring that the proponent provide some sort of certification or affidavit that the proponent will solicit some minimum percentage of the registrant's shares (under Idaho Power, 50% of the shares). Both the percentage and the method of certification should be specified in the rule itself, and not merely in the release, so that there can be no uncertainty with respect to these requirements.
We have two final comments pertaining to the exercise of discretionary authority. First of all, we believe that shareholders are entitled to rely on the deadline dates supplied by the registrant to its shareholders in its proxy statement. Such a date is presently required by the rules for 14-8 proposals. See Rule 14a-5(e). Nevertheless, Staff no-action letters have opined that if the date thus published is incorrect, shareholders cannot rely on that published, but incorrect, date, but must submit their proposals in accordance with the actual 120 calculation of Rule 14a-8(a)(3). This ruling defeats the entire purpose of having the registrant publish the date in the proxy statement. If shareholders cannot rely on that date, what is the purpose of requiring the registrant to specify it in the proxy statement? Indeed, shareholders are worse off under this interpretation of the rule than they would have been if the 5(e) rule had never been enacted, since absent the false date in the proxy statement the proponent would have done its own (presumably more accurate) calculation. This problem will be exacerbated when, as proposed, the registrant will also be required to specify the 45 day date in its proxy statement. (See footnote 101 in the Release.) Will shareholders be allowed to rely on that statement? It would certainly seem that they ought to be able to so rely. It would therefore seem necessary and appropriate that the enacting release repudiate past Staff letters on this topic and affirmatively declare that registrants are estopped from contesting the date which they have specified in their own proxy statement.
On final point pertains to a related matter. Under NASD and New York Stock Exchange rules, brokers are not permitted to vote without instructions the shares of their customers on any matter, including shareholder proposals, which is contested. They may, however, vote, when uninstructed, on non-contested matters. In recent years, there has developed the practice of "just vote no" campaigns against incumbent directors, pursuant to which shareholders are urged to "withhold" authority to vote for the nominees for the board. The SROs have taken the position that these are not contests, and that therefore brokers can vote although uninstructed (presumably for re-election of the nominees). We believe that this is an unrealistic view of the matter and urge that the SEC prod the SROs to re-examine this matter or, if need be, institute its own rule-making proceeding under the authority granted to the Commission by Section 14(b)(1) of the Securities Exchange Act of 1934.
V. SMALL BUSINESS REGULATORY ENFORCEMENT FAIRNESS ACT
We believe that it may be necessary for the Commission to submit the Proposed Amendments to Congress under the Small Business Regulatory Enforcement Act ("SBREFA") because the impact on the economy may exceed $100,000,000. and/or because of adverse effects on investment. As the Commission notes in its discussion of this matter, "corporate governance matters. . .are most likely to affect shareholder wealth". The Commission also notes that the governance proposals most likely to affect shareholder wealth are those pertaining to board elections and poison pills. As noted in our discussion of (c)(12), the Proposed Amendments would result in raising the overall failure rate over a three year submission cycle from 27% to 85% for corporate governance proposals. Thus we believe that the Proposed Amendments may require submission to Congress under SBREFA.
VI. OTHER PROPOSED CHANGES
A. Question and Answer Format
We have no objection to this change, but doubt that it will significantly improve matters.
B. Plain English
We are in favor of writing rules which are understandable. The challenge in re-writing the rules in plain English is to do so without changing their meaning. In this we do not believe that the Commission has been wholly successful, since the re-wording of (c)(1) and (c)(7) appears to have changed their meaning. We are concerned that there may be other such instances of changed meaning which we have not discovered and are therefore leery of any changes of the wording of the Rule which attempt to make the Rule more user-friendly.
C. Definition of Proposal
We are not sure that there is any real need for this definition since many or most such proposals would be excludable under 14a-8(c)(5). Furthermore, there is a very strong argument that the Pacific Gas letter was correctly decided. In that letter the proposal concerned a political stand taken by the registrant on a state ballot referendum issue. Under First National Bank of Boston v. Bellotti 435 U.S. 765 (1978), corporations have a constitutional right to take political stands. But surely the shareholders ought to have the right to question or oppose those political stands. We therefore believe that the proposed definition will unduly restrict the ability of shareholders to influence the political stands taken by the corporations of which they are owners.
D. Minimum Stock Requirement
We believe that it is appropriate to adjust the dollar figure for inflation and to round that figure up. We therefore support raising the minimum dollar amount from $1,000. to $2,000.
E. Minimum Holding Period
We believe that the present holding period is too long. Since the rule measures the holding period from the time the shareholder submits the proposal, rather than from the date of the meeting at which it is to be considered, as a practical matter the rule really imposes a holding period of a year and a half (one year plus 120 days plus average solicitation period). This is too long. If the holding period were to be reduced to six months, shareholders would still have had to have been owners for approximately one year prior to the meeting. We therefore suggest that the holding period be reduced to six months.
F. Shareholder Response Time
We believe that a uniform response time is desirable. However, we are concerned that the response time is proposed at 14 days rather than 21 days. This is true because it is sometimes a very time consuming process for a shareholder to obtain proof of beneficial ownership from a bank or brokerage house. This problem is exacerbated if the mails are used. In this connection, we point out that, for Regulatory Flexibility analysis, the proponent is far more likely to be a small entity than is the registrant.
G. Deadline for Submission
Subject to our earlier comment concerning the ability of the shareholder to rely on the date published by the registrant, we believe that the proposals are worthwhile.
H. Attendance at the Meeting
We believe that the advisory is desirable, since otherwise some shareholders may be caught unawares by the requirements of state law.
I. Rule 14a-8(c)(1)
We believe that the new version of the note to this rule is an improvement since it better spells out the Staff position.
However, we are concerned that the new plain English text of (c)(1) has inadvertently limited (c)(1) to corporations incorporated under the laws of some state of the United States. However, other types of entities may be subject to the Rule. For example, limited partnerships or trusts appear to be inadvertently excluded by the reference to incorporation. In addition, corporations may not incorporated under the laws of any state (of the United States). For example, foreign corporations, such as Schlumberger (incorporated in Curacao) may be subject to the Rule, as may corporations incorporated under the laws of the United States, the District of Columbia etc. Some broader term, such as "the laws of the jurisdiction of the company's organization" is therefore needed.
In the form proposed, the Proposed Amendments would devastate the ability of shareholders to submit proposals on social issues. The new (c)(12) would also have a major adverse impact on corporate governance proposals. There is no justification for this attack on shareholder rights. Therefore, the Proposed Amendments should not be enacted in their present form.
We thank you for this opportunity to submit our views.
Paul M. Neuhauser
Attorney at Law
cc: All Commissioners
Tim Smith, ICCR