Creative Investment Research, Inc.
Social Investment Advisers
PO Box 55793
Washington, D.C. 20040-5793
Phone/Fax: 866-867-3795
http://www.creativeinvest.com
info@creativeinvest.com
Monday, September 8, 2003
Mr. Jonathan G. Katz
Secretary
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
450 Fifth Street, NW
Washington, D.C. 20549-0609
RE: File No. S7-14-03
Dear Mr. Katz:
I am writing concerning newly proposed "disclosure requirements and amendments to existing disclosure requirements to enhance the transparency of the operation of boards of directors." We understand that the SEC is proposing "enhancements to existing disclosure requirements regarding the operation of board nominating committees and a new disclosure requirement concerning the means, if any, by which security holders may communicate with members of the board of directors." The rule and rule amendments "are intended to make more transparent to security holders the operation of the boards of directors of the companies in which they invest."
Background
William Michael Cunningham registered with the U.S. Securities and Exchange Commission as an Investment Advisor on February 2, 1990. He registered with the D.C. Public Service Commission as an Investment Advisor on January 28, 1994.
Mr. Cunningham manages an investment advisory and research firm, Creative Investment Research, Inc. The firm researches and creates socially responsible investments and provides socially responsible investment advisory services. The company was founded in 1989. On November 16, 1995, the firm launched one of the first investment advisor websites.
The firm and Mr. Cunningham have long been concerned with the Commission's ability to carry out its primary mission: "to protect investors and maintain the integrity of the securities markets." We base this apprehension on the following:
- On July 9, 1993, Mr. Cunningham wrote SEC Commissioner Mary Schapiro to suggest the SEC warn the investing public about a certain investing "scam." A timely warning was not, to our knowledge, ever issued.1
- In an April 1995 article titled "Profit From Debt: The Black Enterprise Fixed Income Roundtable" Mr. Cunningham recommended investors not purchase municipal securities issued by the District of Columbia, given social and financial difficulties the city was experiencing. In retaliation, shortly thereafter, Mr. Cunningham was subject to certain "unfair regulatory practices" by the Public Service Commission of the District of Columbia (DC Public Service Commission Case 943-G.) He requested the Commission review this action, but no review of this matter was ever conducted.
- On June 18, 1998, Mr. Cunningham opposed the application, sanctioned by the Commission and approved by the Federal Reserve Board on September 23, 1998, by Travelers Group Inc., New York, New York, to become a bank holding company by acquiring Citicorp, New York, New York, and to retain certain nonbanking subsidiaries and investments of Travelers, including Salomon Smith Barney Inc., New York, New York. Mr. Cunningham based his opposition on the fact that Salomon Smith Barney Inc. had a history of attempting to monopolize markets and of defrauding investors.2 This rendered the merger potentially injurious to the public welfare.
Specifically, Mr. Cunningham challenged the merger based on 12 U.S.C. Section 1841 et. seq., the Bank Holding Company Act of 1956. The Act states that:
"The (Federal Reserve) Board shall not approve -
(B) any other proposed acquisition or merger or consolidation under this section whose effect in any section of the country may be substantially to lessen competition, or to tend to create a monopoly, or which in any other manner would be in restraint of trade.."
On April 28, 2003, Citigroup Global Markets Inc. and Salomon Smith Barney Inc. (SSB) settled Commission enforcement actions involving conflicts of interest between research and investment banking operations. Citigroup Global Markets Inc. and Salomon Smith Barney Inc. paid fines totaling $400 million. The firms were found to be operating schemes in restraint of trade.
- In an October 1998 petition to the United States Court of Appeals3, Mr. Cunningham cited evidence that growing financial market malfeasance greatly exacerbated risks in financial markets, reducing the safety and soundness of large financial institutions. He went on to note that:
"The nature of financial market activities is such that significant dislocations can and do occur quickly, with great force. These dislocations strike across institutional lines. That is, they affect both banks and securities firms. The financial institution regulatory structure is not in place to effectively evaluate these risks, however. Given this, public safety is at risk."
- From October 1999 to March 2002, Mr. Cunningham served as Manager, Social Purpose Investing for a pension fund. In that role, he was responsible for proxy voting activity. In 2001, he voted on 1395 issues impacting 401 companies. In 2000, he voted on 1903 issues impacting 422 companies. On Thursday, February 14, 2002, Mr. Cunningham wrote to Ms. Linda Snyder in the Office of the General Council to inquire about his responsibility under the duty of care standard to monitor corporate events and to vote proxies, as an SEC and State-registered investment adviser who also worked for a pension fund. Mr. Cunningham noted several incidents at work that led him to be concerned about his ability to carry out his duty to exercise proper care. As a result, he questioned Ms. Snyder about his liability for negligence on the part of his employer. The Commission responded in a timely manner. In Appendix B, attached, we have provided background memorandum concerning this matter.
There have been several other incidents.4 In most cases the SEC reviewed Mr. Cunningham's activities, instead of looking at the facts surrounding the matters cited. We believe this behavior explains why the SEC does not receive more timely information from industry insiders concerning inappropriate activities.
These concerns led Mr. Cunningham, in April, 2002, to write U.S. Representative Richard Baker, Chairman, Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises of the Committee on Financial Services, to suggest that the SEC be required to create a hotline to field calls about corporate accounting practices from insiders and others who have concerns. In July, 2002, he wrote U.S. Senator Paul Sarbanes with the same suggestion.
Summary of the Proposal
The Commission is proposing "new disclosure requirements that would expand disclosure in company proxy statements regarding the nominating committee and the nominating process. This enhanced disclosure is intended to provide security holders with additional, specific information upon which to evaluate the boards of directors and nominating committees of the companies in which they invest. Further, we intend that increased transparency of the nominating process will make that process more understandable to security holders."
The Commission, in particular, has "proposed a number of specific and detailed disclosure requirements because we believe that each of these requirements may be necessary in order to assist security holders in understanding each of the processes and policies of the nominating committees and boards of directors of companies regarding the nomination of candidates for director."
We appreciate this effort, but note the following:
Repeatedly over the past twelve years signal market participants abandoned ethical principles in the pursuit of material well being.5 This has occurred in both bull and in bear markets and has taken place in the most materially advantaged country that has ever existed. Greed and malice, arrogance and callousness, have flourished in the capital markets, propelling ethical standards of behavior downward. Institutions charged with protecting the public interest, specifically investment banks, investment analysts, accounting firms, and so-called self regulatory organizations, failed to do so. All were compromised. These are the simple facts.
Courts have found that, "Section 10(b) of the Securities Exchange Act makes it `unlawful for any person ... [t]o use or employ, in connection with the purchase or sale of any security ..., any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe.'" Yet, investment analyst "buy and sell" recommendations became "manipulative or deceptive device(s)," part of "a (successful) scheme to defraud" the investing public.
Certain fully identifiable entities and individuals (investment banks and analysts) engaged in criminal activities. They have, for the most part, evaded criminal prosecution. They have, instead, paid fines of no real consequence, penalties amounting to an insignificant percentage of annual earnings. We note that one firm, Goldman Sachs, ostensibly fined $110 million by the Commission for allowing undue influence by investment banking interests on securities research, subsequently received $75 million in Federal Government tax credits.6 This prosecution strategy appears contrary to both common sense and to basic principles of fairness. This strategy is also contrary to basic principles of justice, since remuneration for crimes committed is divorced from any realistic measure of damage caused.
The lack of rational, effective and efficient regulation may actually encourage future illicit behavior. We understand that, given any proposed rule, crimes will continue to be committed.7
These facts lead some to suggest that regulatory authorities have been "captured" by the entities they regulate.8 We note that under the "regulatory capture" market structure regime, the public interest is not protected.
Summary comments on the proposal(s)
We appreciate the time and effort the Commission has devoted to this task. Our understanding is that the proposal is the first part of a two-part SEC rule revision process. The nominating committee disclosure and board communication revisions will be examined first. Sometime in the fall, the SEC will release a proposed revision to ballot access rules. In our opinion, the access proposal is the more important one and we urge the Commission to move expeditiously on this matter.
Regretfully, we believe the current proposal is too complicated and time consuming to be viable. As structured, it simply will not do what needs to be done.9 Further, we are concerned that the proposal will allow those opposed to changes in corporate governance practices an opportunity to claim that corporate governance reform efforts are, in their entirety, unreasonably time consuming, burdensome and costly.
We feel that nominating committee disclosure requirements and requirements concerning communications between security holders and Boards of Directors are important. We support the Commission's efforts to make changes in this area. In Appendix A, attached, we respond to the Commission's specific questions concerning this proposal. Below, however, we suggest a policy evaluation framework that we believe can be used to evaluate proposals designed to "enhance the transparency of the operation of boards of directors."
Policy Evaluation Rationale and Framework
We start by assuming there are only two types of shareholders: smart money and dumb money shareholders. Smart money shareholders are part of corporate management. They have more and better information than dumb money shareholders do concerning the exact nature of corporate activities. Thus, they are better informed about the true value of the shares they own.
All other shareholders are dumb money: if you are not "smart money" you are "dumb money". Most investors are "dumb money investors" - "outsiders", without access to market-relevant, non-public information concerning corporate operations.
Assume that, prior to investing, shareholders do not know whether they will be smart or dumb money. Further, assume they have an equal chance of being placed in either group. A fair policy is one which both smart and dumb money shareholders would be happy with or, at least indifferent to, prior to investing and prior to knowing which group they belong to.
A just policy is one that treats smart and dumb money shareholders equally. Equal treatment is defined as follows: the proposed policies do not, from a monetary standpoint, favor either group.
Recently, we have observed several cases where corporate management unfairly transferred value from dumb to smart money shareholders.10 Abuses have been linked to faulty corporate governance safeguards and to the capture of regulatory authorities by those acting on behalf of smart money interests. This implies that faulty corporate governance practices mask a company's true value.11 This misallocates capital by moving investment dollars from deserving companies to unworthy companies. The changes to nominating committee disclosure rules and ballot access regulations are intended to make it more difficult for corporate management to unfairly transfer value from shareholders to management. The appropriate way for the Commission to do so is by crafting policies that are both fair and just.
The nominating committee disclosure and board communication proposal is neither. It is not fair to smart money shareholders. It requires them to spend a great deal of time, money and other corporate resources documenting nominating committee policies and procedures. Nor is it fair to dumb money shareholders. By significantly increasing the number of documents dumb money shareholders must review, it raises the cost of investing by increasing the amount of time that must be spent monitoring corporate activities. The proposed disclosure proposal may result is less transparency, not more.
Conclusion
While we feel many of the proposed disclosure items are important, we believe it is the responsibility of the SEC to collect, review, summarize and grade companies based on this data. We suggest the SEC do this by issuing an opinion on the fairness of the nominating committee process at a given company. Investors could then use this opinion to determine the chances they have of being treated fairly by corporate management and the probability that corporate management will unfairly transfer value from dumb to smart money shareholders. We believe any disclosure and board communication policies proposed by the Commission should be both fair and just, designed to "protect investors and maintain the integrity of the securities markets."
We cite the following:
"Above all, we must bear in mind that the critical issue should be how to strengthen the legal base of free market capitalism: the property rights of shareholders and other owners of capital. Fraud and deception are thefts of property. In my judgment, more generally, unless the laws governing how markets and corporations function are perceived as fair, our economic system cannot achieve its full potential. "
Testimony of Chairman Alan Greenspan, Chairman of the Federal Reserve Board, Federal Reserve Board's semiannual monetary policy report to the Congress. Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate. July 16, 2002
We agree.
We favor efforts to strengthen the property rights of shareholders and to increase fairness in our capital markets, in general, while opposing transparency for transparency's sake. Efforts to enhance transparency should boost the ability of investors and the public to efficiently make informed investment decisions. The current proposal does not.
We believe the efforts surrounding the review of shareholder policies and procedures economically significant and positive.
Again, we appreciate the time and effort the Commission has devoted to this task. Thank you for your leadership. Please contact me with any questions or comments.
Sincerely,
William Michael Cunningham
Social Investment Adviser
for William Michael Cunningham and Creative Investment Research, Inc.
cc:
Chairman William H. Donaldson
Commissioner Paul S. Atkins
Commissioner Roel C. Campos
Commissioner Cynthia A. Glassman
Commissioner Harvey J. Goldschmid
Alan L. Beller, Director, Division of Corporation Finance
Martin Dunn, Deputy Director, Division of Corporation Finance
APPENDIX A
1. Answers to questions regarding enhanced nominating committee disclosure
Would increased disclosure related to the nominating committee and its policies and criteria for considering nominees be an effective means to increase security holder understanding of the nominating process, board accountability, board responsiveness, and corporate governance policies?
In general, yes. As noted above, we believe it is the responsibility of the SEC to collect, analyze, summarize and distribute this data.
(a) If so, do the proposed specific disclosure standards, including those in each of the following areas, provide security holders with useful information that provides an understanding of a company's nominating process:
the existence of a nominating committee;
Yes.
the nominating committee charter, if any;
Yes. This data should be summarized by the SEC and posted on the internet in a way that allows for easy review and comparison.
compliance with applicable nominating committee independence requirements;
Yes. This data should be summarized by the SEC and posted on the internet in a way that allows for easy review and comparison.
the process for identifying and evaluating candidates;
Yes. This data should be summarized by the SEC and posted on the internet in a way that allows for easy review and comparison.
the qualifications and standards for director nominees;
Yes. This data should be summarized by the SEC and posted on the internet in a way that allows for easy review and comparison.
the source of candidates other than those standing for re-election;
Yes. This data should be summarized by the SEC and posted on the internet in a way that allows for easy review and comparison.
and
the involvement of third parties receiving compensation for identifying and evaluating candidates?
Yes. This data should be summarized by the SEC and posted on the internet in a way that allows for easy review and comparison.
(b) If so, do the proposed specific disclosure standards, including those in each of the following areas, provide security holders with useful information that provides an understanding of the ability of security holders to participate in the nominating process:
policies for consideration of security holder candidates;
Yes. This data should be summarized by the SEC and posted on the internet in a way that allows for easy review and comparison.
procedures for submission of security holder candidates;
Yes. This data should be summarized by the SEC and posted on the internet in a way that allows for easy review and comparison.
and
specific information regarding consideration of candidates submitted by large, long-term security holders or groups of security holders?
Yes. This data should be summarized by the SEC and posted on the internet in a way that allows for easy review and comparison.
As noted above, the proposed disclosure requirements are intended to provide security holders with detailed, specific information that we believe is important. Are there alternative means to better achieve our objective?
Yes. While we generally support the review proposed in the release, as noted above, we believe it is the responsibility of the SEC to collect, analyze, summarize and distribute this data. To facilitate this effort, we suggest the Commission carefully review the experience of the Federal Financial Institution Examination Council (FFIEC) with respect to the implementation of the Home Mortgage Disclosure Act. HMDA requires banks and other financial institutions to report statistics on every home mortgage loan application received. The law requires the FFIEC collect millions of records12, and has resulted in no appreciable damage to banking operations. In fact, the law, by encouraging financial institutions to make loans to previously underserved but credit worthy borrowers, opened a new market, resulted in increased profitability.13
We suggest the Commission capture data related to the nominating committee and its policies and criteria for considering nominees. The SEC would have to maintain a database of nominating committee policies and criteria for considering nominees that it would then process and make available to the public.
Having the SEC maintain a database of nominating committee policies would clearly serve the public interest. A database would lower information search costs by making it easier for the public to review policies across companies.
We also suggest the Commission describe policies and procedures it believes are best practices in a separate set of documents.
For example, would it be more appropriate to include a broader, less detailed disclosure standard?
See above. The level of detail requested is appropriate, but asking shareholders to review this data is inefficient and burdensome.
Would any of the detailed disclosure requirements within the proposed standard result in disclosure that is unnecessarily detailed for the purpose of providing security holders with useful information regarding the management of the companies in which they invest? If so, describe specifically the basis for that conclusion.
See above. The level of detail requested is appropriate, but asking shareholders to review this data is inefficient and burdensome.
We propose to require disclosure of the material terms of the nominating committee charter. Instead of requiring companies to disclose the material terms of the charter, should we require that the company attach the nominating committee charter to the proxy statement?
No.
If so, should companies be required to attach it every year?
No.
Should we require that the charter be filed with the Commission?
Yes.
Should we require disclosure of any (or only material) amendments to the charter?
Yes. Require disclosure of any material amendments.
Does website disclosure provide sufficient access to investors?
Yes.
Should companies be required to provide investors a copy of the charter upon request?
Yes.
We propose to require disclosure of any instances where a member of a company's nominating committee did not satisfy the applicable listing requirements for independence. In addition, we propose to require similar disclosure for unlisted companies. We request comment on whether the disclosures will help inform investors about the independence of the nominating committee. If the markets do not adopt the proposed amendments to the listing standards, are there disclosures that we could require that would achieve the same purposes?
Yes.
Should we require companies whose securities are not listed on an exchange or quoted in the Nasdaq Stock Market to disclose whether the members of their nominating committee, if any, meet any of the independence definitions of the proposed amendments to the listing standards?
Yes.
Is it appropriate to let issuers choose which definition?
No. This should be set by the SEC.
Should disclosure be required even if the noncompliance has been cured by the time the proxy statement is prepared?
No, but this should be noted.
We propose to require disclosure concerning a nominating committee's policy with regard to the consideration of security holder recommendations. If a committee has no policy, should we require the company to disclose the reason it does not have a policy?
Yes.
In the absence of a formal policy, are there other disclosures a company should be required to provide to investors to help them understand the standard(s) a committee uses in determining a suitable candidate?
Yes. In the absence of a formal policy a company should be required to provide the reasoning for the lack of a formal policy.
Where security holders have the ability to recommend a nominee for a company's board of directors, meaningful participation by security holders should be facilitated by disclosure of information regarding the process for security holder nominations. As such, we have proposed to require disclosure of the procedures for submitting recommendations. Should we require disclosure during the year of any changes made to the procedure, for example in the next Form 10-Q or Form 10-QSB or on Form 8-K?
Yes.
We have proposed requiring disclosure of information regarding criteria used by a nominating committee to screen nominee candidates and the minimal qualifications that the committee believes must be met by a nominee. Are there other eligibility requirements or qualifications about which investors should be informed?
Yes.
Should we require the company to disclose when it chooses candidates who do not meet the criteria?
Yes.
Should there be a specific disclosure requirement as to whether the company applies the same criteria to candidates recommended by security holders as to company nominees?
Yes.
We have proposed that companies be required to describe the source of each of their nominees for director other than nominees who are executive officers or directors standing for re-election - including the name of each source - and their nominating committee's process for identifying and evaluating candidates. In addition to the name of each candidate's sponsor, should we require disclosure of any financial interest between the candidate and sponsor?
Yes.
Should we require disclosure of any other interest?
Yes.
Is the name of the source important to security holders?
Yes.
Instead, should we require disclosure of the person's title (e.g., chief executive officer) or simply whether the source is an officer or director of the company?
Yes, in addition to the name.
Should we require the name of the source only where the source is a director of the company, an employee of the company, or related to a director or employee of the company?
No. You should require the name of the source at all times.
If the source is not a director, an employee, or related to a director or employee, should we permit the source to be identified by category rather than name (e.g., security holder, third party firm paid by the company)?
No. You should require the name of the source at all times.
Are the proposed exceptions to the requirement appropriate?
No. You should require the name of the source at all times.
We have proposed requiring disclosure of information regarding the function performed by any third parties paid by the company. Should we require a company to disclose the methodology the third party uses to select candidates?
No.
Should we require a company to identify any such third parties?
Yes.
We propose to require disclosure regarding candidates that were recommended by certain security holders and rejected by the nominating committee. Would this type of disclosure raise privacy issues for rejected candidates, even if the candidates were not specifically named in the company's disclosure?
Candidates recommended by security holders and rejected by the nominating committee should agree to having their name revealed as a condition of nomination.
Would it raise privacy issues for the recommending security holders?
No.
The proposed disclosure requirements with regard to rejected security holder-recommended candidates would not preclude a company from naming the candidates, though such disclosure would not be required under the proposed rule. Should the rule specify that companies should not disclose the names of rejected candidates?
No.
Should the rule specify that companies must include the name of any rejected candidate who consents to being so identified in the company's proxy statement?
Yes.
Are the proposed threshold requirements for a security holder recommendation that would trigger additional disclosure requirements by the company (i.e., recommendations from security holders that have beneficially held more than 3% of the company's securities for at least one year) appropriate?
Yes.
If not, what ownership threshold, if any, would be appropriate (e.g., no threshold, 1%, 2%, 4%, 5%, or higher) and what holding period, if any, would be appropriate (e.g., no threshold, 2 years, 3 years, 4 years, or longer)?
N/A
Should we use a different threshold, such as the three, four, or five largest security holders who are not directors or officers of the company?
N/A
As proposed, the rules would not require that the nominating security holder indicate an intent to continue to own the securities for any specified period of time. Should we include such a requirement?
Yes.
If so, what is the appropriate period over which the security holder must intend to continue to own the securities (e.g., through the date of the related security holder meeting, six months after the recommendation, one year after the recommendation, or longer)?
One year.
Is the proposed method to determine whether a security holder or group of security holders meets the threshold requirements to trigger additional disclosure by the company appropriate?
Yes.
For example, are the means of proving ownership appropriate?
Yes.
If not, what would be a more appropriate means?
N/A
Is it appropriate to calculate ownership as of the date of the recommendation?
Yes.
If not, what other date would be more appropriate?
N/A
Should we include a specific method of determining beneficial ownership for purposes of this disclosure item?
Yes.
For example, should securities underlying options be included or excluded for purposes of calculating the ownership threshold?
Excluded, but evaluated on a case-by-case basis. Allowing securities underlying options to be included may give rise to manipulation.
Would the proposed disclosure requirements have unintended adverse effects on the nominating process?
Yes.
Would they increase the burdens on members of nominating committees or discourage service on nominating committees?
Yes.
If so, please provide specific reasons supporting your responses to these questions.
See our comments above. The proposed datapoints require the imposition of a time consuming data collection and analysis process, fully transparent. Many current and potential nominating committee members will not want to spend the time and effort required to meet these reporting requirements.
2. Answers to questions regarding Disclosure Regarding the Ability of Security Holders to Communicate with the Board of Directors - Questions regarding disclosure of the ability of security holders to communicate with the board of directors
Would increased disclosure relating to security holder communications with board members be an effective means to improve board accountability, board responsiveness, and corporate governance policies?
In general, yes. As we commented, we believe it is the responsibility of the SEC to collect, analyze and distribute data concerning board accountability, board responsiveness, and corporate governance policies.
Would this disclosure be useful to security holders?
Yes. This data should be summarized by the SEC and posted on the internet in a way that allows for easy review and comparison.
If so, do the proposed specific disclosure standards, including those in each of the following areas, provide security holders with important information that provides an understanding of a company's process for communications with the board:
the existence of such a process;
Yes.
a description of the manner in which security holders can communicate with the board;
Yes.
identification of board members to whom communications can be sent;
Yes.
the process, if any, for determining which communications will be passed on to board members;
Yes.
And a description of material actions taken as a result of security holder communications with the board?
Yes.
As noted above, the proposed disclosure standards are intended to provide security holders with specific, detailed information that we believe is important. Are there alternative means to better achieve our objectives?
We suggest the Commission capture data related to security holder communications with board members. The SEC would also maintain a database of policies concerning security holder communications with board members that it would then process, summarize and make available to the public.
A database would lower information search costs by making it easier for the public to review policies across companies. Given these time savings, we believe having the SEC create a database of policies concerning security holder communications with board members and a data retrieval facility will be in the public interest.
We also suggest the Commission offer manuals describing policies and procedures the Commission believes are best practices.
For example, would it be more appropriate to include a broader, less detailed disclosure standard?
See above. The level of detail requested is appropriate, but asking shareholders to review this data is inefficient and burdensome.
Would any of the detailed disclosure requirements within the proposed standard result in disclosure that is unnecessarily detailed for the purpose of providing security holders with important information regarding the process of communicating with the board?
See above. The level of detail requested is appropriate, but asking shareholders to review this data is inefficient and burdensome.
If so, please describe specifically the basis for that conclusion.
Security holders who desire to communicate directly with individual directors, committees, and independent members of boards are often uncertain of the procedures to follow to contact directors. As such, we have proposed requiring disclosure with regard to security holder communications with board members. If no director accepts communications individually, should the company disclose why?
Yes.
Should companies be required to disclose the process they use to record and keep security holder communications?
Yes.
We have proposed requiring disclosure of the means by which companies "filter" security holder requests to communicate with board members. Should there be disclosure of the specific person who determines which communications are sent to board members?
Yes.
Should there be disclosure of whether management plays a role in "filtering" the security holder communications that are intended for directors?
Yes.
We have proposed requiring disclosure regarding any material actions taken in response to security holder communications. Are there any categories of communications or actions that should be excluded from coverage of the rule?
Yes.
For example, should the rule only apply to formal petitions to the entire board?
No.
Should this rule address specifically security holder proposals under Exchange Act Rule 14a-8?
Yes.
For example, should the rule make clear that disclosure is not required with regard to communications relating to proposals under Exchange Act Rule 14a-8? Alternatively, should those communications be included specifically within the disclosure requirement?
Do companies currently provide a means for allowing security holders to communicate with board members?
Few do. Most don't.
If so, how effective have these methods been in improving board accountability, board responsiveness, and corporate governance policies?
Not very.
Is it easier for larger minority security holders to communicate with board members?
Yes.
Because not all companies would be subject to any listing requirements that would allow security holders to communicate with board members, would a disclosure requirement alone be sufficient with regard to companies not subject to those listing requirements?
Yes.
Should communications with board members that are addressed in the disclosure requirements be limited to independent directors or extend to the entire board?
Extend to the entire board.
We are using the term "communications" very broadly to discourage companies from taking a formalistic view as to disclosure regarding which communications are relayed and considered. We do not, however, intend this disclosure standard to require disclosure regarding communications with the board of directors from management of the company, employees of the company, or other agents of the company, where such persons happen also to be security holders. Should we include a specific limitation on the term "communications" in this disclosure standard?
Yes.
If so, how do we prevent companies from taking an unduly restrictive view of the term "communications" for purposes of this disclosure standard?
By making sure companies fully understand and comply with the sprit of the regulation, which is "intended to make more transparent to security holders the operation of the boards of directors of the companies in which they invest" and by establishing stiff penalties for companies that take an unduly restrictive view of the term "communications" for purposes of this disclosure standard.
The proposed rules relating to communications are disclosure standards only and would not require companies to establish procedures for security holders to communicate with directors. Should we nonetheless provide guidance to companies or otherwise address what we would view as appropriate procedures for companies to implement with regard to security holder communications with board members?
We suggest the Commission offer documents describing policies and procedures the Commission believes are best practices.
If so, what procedures would be most appropriate and why?
See our comments regarding smart and dumb money shareholders. We suggest the Commission promote policies and procedures that are fair and just. A fair policy is one which both smart money and dumb money shareholders would either be happy with or, at least indifferent to, prior to investing. A just policy is one that treats smart and dumb money shareholders equally.
What would be the cost to companies of implementing and maintaining such procedures?
We expect initial costs to be significant.
How much time would directors and other company personnel be required to expend in implementing and maintaining such procedures?
The amount of time directors and other company personnel will be required to expend implementing and maintaining procedures will depend upon the extent to which a given company intends to abide by the spirit of the proposal. Many companies will spend a significant amount of time seeking to fully and fairly comply with the proposal. Other companies will spend an equal amount of time seeking to avoid compliance. Some companies will seek to avoid compliance because they feel avoidance is in the best interest of smart money shareholders. Others will seek to avoid compliance because they feel this course of action will be in the best interest of all shareholders. We believe that the extent to which a company complies with the proposed rule will be a factor some investors use in determining where to invest. As these rules are adopted, we believe investors will begin to prefer companies that are "noisily transparent." Market participants may imply that management at these companies have "nothing to hide" and that companies that are "silent" and "opaque" are to be avoided or discounted.
What other unintended burdens or other consequences would fall on directors as a result of such procedures?
The number of unintended burdens or other consequences that may fall on directors as a result of these procedures are too numerous to fully catalog. Some directors may unintentionally impact share value through the inadvertent transmission of confidential information. Investment analysts and others may use these procedures to try to predict share value.
Could we give useful guidance in this area and, if so, how?
The Commission may wish to try to fully catalog the most likely burdens or other consequences.
Questions regarding the application of the proposals to funds
Should the proposed amendments that would require disclosure regarding the operations of board nominating committees apply to funds?
Yes.
Should the proposed amendments that would require new disclosure concerning the means by which security holders may communicate with members of boards apply to funds?
Yes.
Are there any aspects of the proposed amendments that should be modified in the case of funds?
Yes.
Should we apply the "interested person" standard of Section 2(a)(19) of the Investment Company Act in requiring disclosure regarding the independence of members of a fund's nominating committee?
No comment.
Should we instead apply a different standard to funds, such as the listing standards of national securities exchanges or national securities associations?
No comment.
General Request for Comment
We request and encourage any interested person to submit comments regarding:
the proposed amendments that are the subject of this release;
additional or different changes; or
other matters that may have an effect on the proposals contained in this release.
We request comment from the point of view of companies, investors, and other market participants. With regard to any comments, we note that such comments are of great assistance to our rulemaking initiative if accompanied by supporting data and analysis of the issues addressed in those comments, as well as a discussion of specific alternatives if applicable.
3. Answers to questions regarding Cost-Benefit Analysis
Request for Comment
Benefits
We solicit quantitative data to assist our assessment of the benefits of increased disclosure regarding nominating committees and security holder-director communications.
Are there any public companies that currently provide information to the public regarding their policies and procedures related to the functioning of the nominating committee or security holder communications with directors?
Yes.
If so, is there any data on whether investors find this information to be useful?
We suggest the Commission contact the Social Investment Forum, the Investor Responsibility Research Center, Institutional Shareholder Services, Inc., the Interfaith Center on Corporate Responsibility or GovernanceMetrics International to obtain information that can be used to answer this question.
We also suggest the Commission see:
Fields, M. Andrew and Phyllis Y. Keys. "The Emergence of Corporate Governance from Wall St. to Main St.: Outside Directors, Board Diversity, Earnings Management, and Managerial Incentives to Bear Risk" The Financial Review, February 2003.
Gill, Amar. "Saints and Sinners: Who's Got Religion?" CLSA Emerging Markets report, April 2001.
Gompers, Paul, Joy L. Ishii, Andrew Metrick. "Corporate Governance and Equity Prices." National Bureau of Economic Research, Working Paper 8449, 2001.
Repetto, Robert, and Duncan Austin. Pure Profit: The Financial Implications of Environmental Performance, Washington, D.C.: World Resources Institute, 2000.
Repetto, Robert, and Duncan Austin. Coming Clean: Corporate Disclosure of Financially Significant Environmental Risks, Washington, D.C.: World Resources Institute, 2000.
Waddock, Sandra A., and Samuel B. Graves. "Assessing the Link Between Corporate Governance and Social/Financial Performance." International Association for Business and Society: 1999 Proceedings, forthcoming.
Ziegler, Andreas, Klaus Rennings, and Michael Schroder. "The Effect of Environmental and Social Performance on the Shareholder Value of European Stock Corporations." Centre for European Economic Research (ZEW). November 20, 2002.
Costs
What are the direct and indirect costs associated with the proposed rules?
The nominating committee disclosure and board communication proposal will require corporations to spend a great deal of time, money and other corporate resources creating and documenting nominating committee policies and procedures. These resources will come from shareholders.
By significantly increasing the number of documents dumb money shareholders must review, the proposal as currently structured raises the cost of investing by increasing the amount of time that must be spent monitoring corporate activities.
Should staff wish to more fully discuss direct and indirect costs associated with this proposal, please contact us.
What are the costs in the first year of compliance versus subsequent years?
As currently structured, this proposal will result in significant compliance costs. First year costs are likely to be higher than subsequent year costs. These costs include legal fees associated with structuring and reviewing policies, management time cost related to structuring policies, fees paid to accountants for managerial and financial statement creation and review, opportunity costs related to missed business opportunities, and many other costs. Social costs relate to the capture of regulatory authorities by those acting on behalf of smart money interests. Again, should staff wish to more fully discuss these and associated costs, they should contact us.
To the extent that the proposals influence corporate behavior, what costs would a company incur to institute responsive policies and procedures regarding director nominations and security holder communications?
Many. See comments above.
We solicit quantitative data to assist our assessment of the costs associated with increased disclosure regarding nominating committees and security holder-director communications.
See comments and bibliography listing above.
APPENDIX B
Inquiry concerning responsibility under the duty of care standard to monitor corporate events and to vote proxies, as an SEC and State-registered investment adviser who also worked for a pension fund.
Mr. Cunningham noted several incidents at prior job that led him to be concerned about his ability to carry out his duty to exercise proper care. As a result, he questioned the Commission about his liability for negligence on the part of his employer. Background memorandum are included below.
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| 1 | We note that at least one U.S. citizen was murdered as a result of this scam. Certainly, the SEC failed, in the most direct and critical sense, to protect this investor.
| | 2 | According to published reports, "the integrity of the entire U.S. Treasury securities auction market was called into question when Salomon Inc., now Salomon Smith Barney Inc., admitted in August 1991 to serious violations of the auction rules during 1990 and 1991." In essence, the firm attempted to "monopolize" or "corner the market" in a particular U.S. Treasury security.
| | 3 | Case Number 98-1459.
| | 4 | From 12/5/2002 to 4/5/2003, Mr. Cunningham forwarded 37 financial market "scam" email messages to the Division of Enforcement of the SEC. It is not clear that the Division took action in any of these cases. Again, the public interest has not been served by this lack of action.
| | 5 | We refer the Commission to the following, abbreviated listing of market related ethical lapses since 1991:
According to published reports, "the integrity of the entire U.S. Treasury securities auction market was called into question when Salomon Inc., admitted in August 1991 to serious violations of the auction rules during 1990 and 1991." In essence, the firm attempted to "monopolize" or "corner the market" in a particular U.S. Treasury security.
The National Association of Security Dealers was found by the U.S. Securities and Exchange Commission to be "failing to police wrongdoing the NASDAQ Stock market, the second largest stock market in the world." The Washington Post (August 8, 1996. Page A1.)
The failure of Long-Term Capital, an investment partnership started in 1994, was "laid on the kind of capitalism .. where a closed, secretive and incestuous elite held absolute sway over politics, the economy and finance, where banks lent to cronies and crooks, and the state miraculously came to the rescue when the time came to balance (or cook) the books." From "LTCM, a Hedge Fund Above Suspicion," by Ibrahim Warde, Le Monde Diplomatique, November 1998.
| | 6 | The tax credits were awarded under the U.S. Department of the Treasury New Markets Tax Credit (NMTC) Program. (See: http://www.cdfifund.gov/programs/nmtc/).
| | 7 | We assume that "employees are `rational cheaters,' who anticipate the consequences of their actions and (engage in illegal behavior) when the marginal benefits exceed costs." See Nagin, Daniel, James Rebitzer, Seth Sanders and Lowell Taylor, "Monitoring, Motivation, and Management: The Determinants of Opportunistic Behavior in a Field Experiment,"The American Economic Review, vol. 92 (September, 2002), pp 850-873.
| | 8 | See George J. Stigler, "The Theory of Economic Regulation," in The Bell Journal of Economics and Management Science, vol. II (Spring 1971), pp. 3-21.
| | 9 | For example, the issue of shares held in street name by a broker is not addressed.
| | 10 | Including, but not limited to, Adlephia Communications, Enron, Global Crossing, ImClone, Tyco, and WorldCom. We believe there are hundreds of other examples.
| | 11 | Accounting firms, including Arthur Andersen, and every major investment bank, including Merrill Lynch, Citigroup, Credit Suisse First Boston, Morgan Stanley, the Goldman Sachs group, Lehman Brothers Holdings, J.P. Morgan Chase, UBS Warburg, and U.S. Bancorp Piper Jaffray aided and abetted efforts to do so.
| | 12 | According to the FFIEC, "In 2002, there were approximately 28 million loan records for calendar year (CY) 2001 reported by 7,631 financial institutions. In 2001, 7,713 financial institutions reported approximately 19 million loan records for CY 2000. In 2000, 7,829 financial institutions reported approximately 23 million loan records for CY 1999. In 1999, 7,836 financial institutions reported approximately 24.7 million loan records for CY 1998. In 1998, 7,925 financial institutions reported approximately 16.4 million loan records for CY 1997." See: http://www.ffiec.gov/hmda/history.htm.
| | 13 | This is our view. For a detailed review of the law's impact, see: "The Impact of the Community Reinvestment Act on Bank and Thrift Home Mortgage Lending." March, 2001. Eric Belsky, Gary Fauth, Michael Schill, Anthony Yezer, presented at Changing Financial Markets and Community Development: The Federal Reserve System's Second Community Affairs Research Conference. Available on-line at: http://www.chicagofed.org/cedric/2001/Aprilconference.cfm.
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