June 30, 1999
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Mail Stop 0609
Washington, D.C. 20549
Re: File No. S7-30-98 – Securities Act Release No. 7606A (Nov. 13, 1998)
BY ELECTRONIC DELIVERY (firstname.lastname@example.org)
Dear Mr. Katz:
Institutional Shareholder Services (ISS) is pleased to submit this comment letter in response to Securities Act Release No. 7606A from the Securities and Exchange Commission ("SEC" or "Commission"). ISS is the world’s largest provider of proxy voting and corporate governance services. Serving more than 700 institutional and corporate clients throughout North America and Europe, ISS analyzes proxy proposals and issues vote recommendations for nearly 9,000 U.S. and 9,000 non-U.S. shareholder meetings each year. The firm has satellite offices in Boston, New York, and London. Founded in 1985, ISS is a Thomson Financial company.
Late last year, the Commission steered its massive 600-page "Aircraft Carrier" regulatory reform package into one of the world’s most protected harbors: the corporate boardroom. To battle increasing acts of marketplace piracy, the SEC proposed to expand the role of outside directors in ensuring the integrity of corporate disclosures.
Several proposals aimed at raising directors’ involvement in the periodic reporting process are included in the SEC’s release. Amendments to the signatures section of certain periodic reports filed under the Securities Exchange Act of 1934, most notably the quarterly report (Form 10-Q), would require a majority of a registrant's directors and its top executives to "certify" that they have read the report and that, to their knowledge, it "does not contain any material misstatements or material omissions." While the SEC doesn’t propose asking board members to sign more time-sensitive reports, such as the Form 8-K, that detail material current developments, it would require the management signatories of such forms to certify that they had provided a copy of those reports to directors.
Critics have responded to the SEC’s proposal with a broadside. They have called the proposals "overly burdensome," "impractical," and a "liability pit." Speakers at the American Society of Corporate Secretaries’ recent open meeting at the SEC even attacked the release’s tone. "The Commission and staff seem to feel that directors and management are out to deceive investors," scolded former SEC Commissioner Edward Fleischman. "That is not the case."
While these attacks have put the SEC on the defensive, the debate over certification centers on the evolving role of corporate directors. Vocal critics view the SEC as a modern-day press gang that seeks to force directors to play a role in day-to-day corporate management. At the other extreme, some supporters look at certification as a panacea that will cure all governance ills. In our view, neither of these viewpoints is correct.
No matter how much these critics long for the days when directors passively ratified management actions, they are gone. For better or worse, the role of directors is no longer "purely supervisory" in nature. Although investors deride governance by board micromanagement, they also reject the minimalist view of directors as just another cog in the corporate bureaucracy.
Once dismissed as figureheads, directors now play the critical role in the governance of corporations. Greater independence, heightened stock ownership, and attention to governance issues in boardrooms have led investors to view directors as their elected representatives. Accordingly, they demand that directors play an "active" role in monitoring management. In some cases, this role may require directors to rock the boat¾ to ask tough questions and to go beyond their handlers if they’re not satisfied by the answers.
There is plenty of evidence that directors at some companies fall short of this standard. Speaking to the attendees at the 19th Annual Ray Garrett, Jr., Corporate and Securities Law Institute in Chicago on April 22. Brian Lane, director of the SEC’s Division of Corporation Finance, expressed concern over reports that some directors sign disclosure documents without having looked at them. "Those directors that are currently taking a less-than-attentive approach to disclosure in periodic reports may need to be spurred on by the proposed certification to pay closer attention."
Some comment letters filed in opposition to "certification" leave the undeniable impression that the disclosure process has become more important than its substance for many companies. In its April 5 comment letter, the Association of the Bar of the City of New York argues that "practical considerations," such as hitting filing deadlines, "outweigh the perceived benefits" of certification. Specifically, the City Bar urges that directors be permitted to review reports in "draft" form, rather than final form, as is the "widespread current practice." They also seek SEC endorsement of the practice of signatories "granting, for practical reasons, powers of attorney" that allow company insiders to execute documents. They could have added the common practice of having directors sign blank pages and then appending them to the filings.
While such shortcuts may not be abusive by themselves, they are an open invitation to abuse. They also raise the possibility that directors play a far less significant role in the filing process than many investors now believe. If this is the case, certification may prove to be an essential element in reestablishing active boardroom participation in the disclosure process.
Critics contend that the SEC’s anticipated benefit ("to enhance the quality of disclosure") is not worth the cost of compliance (delay). They argue that the SEC’s proposed oversight standard would impose greater burdens on directors than the "business judgment" rule now requires under state laws. Fears of heightened legal liability and "litigation exposure," they assert, will deter qualified candidates from becoming directors and might lead some sitting board members to quit.
We share these concerns over liability issues, but we note that the SEC (under the current 10-K signature requirements) has made it clear that directors are responsible for disclosures "if they know that the disclosure is materially misleading or has material omissions, or would have known had they read them." This "certification" requirement has not led to a mass exodus from boards.
We have other lingering reservations about certification.
Signature and certification requirements may run counter to the Commission’s proposal to accelerate the filing due dates for Forms 10-Q and 10-K. In finalizing the proposals, the Commission must set deadlines that are reasonable. We believe that the boost in the quality of disclosures that will be provided by the engagement of directors in the process is more important than moving up filing deadlines by a couple of days. Most of the problems in the market today are the result of poor quality of information that is disclosed rather than its untimely availability.
In this regard, the Commission’s proposals concerning Form 8-K may hold the key. Timely 8-K filings (and related press releases) are the markets’ most promising weapons to battle selective disclosure. The Commission’s proposals to speed up delivery of 8-Ks and to expand the list of issues that trigger their filing should keep shareholders fully informed until new and improved, director certified 10-Q and 10-K filings arrive. In particular, we support the SEC’s addition of issues that impact "shareholders’ rights" in the list of items that must be disclosed via the 8-K.
We also are concerned that some directors will be forced to certify unaudited financials in quarterly reports. In our view, members of audit panels may be better qualified for this task.
Assuming the SEC addresses these concerns, however, we hold with those who favor signature and certification. Signing a document without reading it is not justifiable for anyone who is acting in a fiduciary capacity. If certification causes even one director on every public company board to spend a little more time and effort in living up to his or her mandate to monitor management, the benefits to shareholders will eclipse the speculative costs voiced by the critics.
Certification also may bring some unanticipated benefits to investors.
First, it may accelerate movement toward "plain English" filings. If directors must "sign off" on disclosures, we believe that they will put pressure on drafters to drop the legalese that still dominates 1934 Act filings.
Second, it may allow shareholders to spot scofflaws more easily. It is highly debatable whether a board member’s signature on a document is evidence of her diligence in monitoring management. Directors who habitually duck "certification," however, would clearly send the opposite message. If the SEC’s proposal helps companies to remove such rust from the decks of their boardrooms, it will be a boon for shareholders.
We appreciate your consideration of our views, which we would be pleased to discuss further at your convenience.
Patrick S. McGurn
Vice President, Director of Corporate Programs
Institutional Shareholder Services, a Thomson Financial Company