The Honorable Jonathan G. Katz
Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609

Dear Mr. Secretary:

The Employment Policy Foundation (EPF) is pleased to submit comments regarding the U.S. Securities and Exchange Commission (SEC)'s proposed new rule 14a-11 and related amendments to 17 CFR Parts 240, 249 and 274 regarding security holder director nominations (File S7-19-03). EPF is a non-partisan, economic research and education foundation that focuses on workplace trends and policies. From this perspective, we have carefully examined both the regulatory impact analysis and the substance of the proposed rule.

Summary

Our analysis of the regulatory impact analysis found that the SEC has greatly underestimated the administrative cost burdens that would be imposed on companies by the proposed rule. The actual cost may range from $89.4 million to $175.1 million per year. Our analysis on the substance of the proposal concludes that it would replace a structure of collaborative corporate governance among shareholders that has worked well for over 60 years. The rule would create an adversarial approach that is likely to encourage conflict that would be detrimental to general shareholder welfare and endanger the jobs and prosperity of millions of employees who depend on sound corporate governance to maintain the competitiveness of the American workplace.

Background

Proposed rule 14a-11 was developed in response to concerns raised by the SEC that current procedures afford shareholders too little access to the nominating process and frustrate security holders' ability to influence the membership of the boards of directors of the companies in which they invest. Under certain circumstances, the proposed rule requires that names and information regarding nominees proposed by individual security holders or groups of security holders be included in proxy materials prepared and distributed by companies. The proposed rule provides security holders' the right to include such information about their nominees in cases where:

1. Security holder nominations are permitted under relevant state law;
    
2. Nominating individuals or groups of security holders collectively have owned at least five percent of the company's outstanding stock for at least two years; and
    
3. One of the following triggering events has occurred: (a) a previous election resulted in at least one company-nominated director candidate receiving more than 35 percent "with-held" votes or (b) a security holder proposal to require inclusion of security holder nominee to information in company proxy materials has been submitted under SEC rule 14a-8 and approved by 50 percent of votes cast on that proposal.

The SEC proposal also amends existing rule 14a-8 (regarding presentation of shareholder-proposed resolutions for vote at shareholder meetings) to require companies to include in proxy statements information about security holder proposals to identify whether the proposal would trigger application of proposed rule 14a-11.

Economic Impact

The proposed rule is complex and far-ranging in its implications for corporate governance. It imposes significant new obligations on companies to monitor and report proposals from individual shareholders or organized groups of shareholders and to monitor and report the results of director elections in new ways. In view of the significant changes caused by the proposed rule, the SEC estimate that the total annual national cost to companies and others affected by the proposed rule would be $553,800 is not credible. This number amounts to only $62 for each of the 8,884 publicly traded companies likely to be affected in some way by the proposed rule. The SEC estimate reflects an estimated $155,400 as the cost of 1,828 company personnel hours for all companies affected by the rule ($85 per hour) and $398,400 in outside costs for attorneys and consultants (1,328 hours at $300 per hour). The SEC estimate of cost burden for this rule is plainly understated.

EPF's analysis found that the SEC analysis is significantly flawed on two counts:

1. The SEC failed to consider all elements of the burden that the proposed rule would impose on companies.
    
2. The SEC greatly underestimated the number of nominating proposals that would be generated by the proposed rule and the cost of handling each one.

Each of these categories of error is discussed in detail below.

1. Failure to consider all burden elements
    

The first category of error appears to stem from a failure to conduct a comprehensive analysis of activities that would be required for compliance with the proposed rule. The SEC analysis considered only costs associated with adding shareholder nominees to proxy materials and with adding associated information to required reports for valid shareholder proposals. It did not consider costs associated with the following significant activities that necessarily precede handling of valid proposals. They include:

• Read and comprehend the rule. The officers and directors of every company must review, analyze and understand the rights and obligations created by the proposed rule. Even if a company is not immediately affected by the rule, its officers and directors must first expend time and money to determine that fact and to understand the circumstances that might change the company's obligations under the rule. This is not a task that can be delegated to a clerk or dispatched in a de minimus time frame.
   
• At least every one of the 8,884 companies that file SEC 10-K forms will be affected to some degree, and the 5,800 companies whose shares are traded on national or regional exchanges will be most particularly affected. In addition, every firm that considers making an initial public offering in the future will need to spend some resources to review and understand its potential obligations under this rule. The SEC's regulatory impact analysis completely ignored this element of burden.
   
• EPF estimates that for 16 officers and directors of each of the 8,884 companies potentially affected by the rule to devote one hour to reading and comprehending the rule, the cost would be at least $12.1 million. The amount could easily exceed $25 million if additional hours of review, discussion and involvement of outside consultants are considered for the 5,000 exchange-traded companies most likely to be affected.
   
• Review and investigate every proposal. The company will be obligated to review, investigate, analyze and respond to every proposal of nominees or proposal to bring the company under the coverage of new rule 14a-11 submitted by individual shareholders or groups to determine if the proposal and its proponents meet the requirements of the rule for either triggering direct access rights or for placing nominees information on the proxy. Even proposals that are without merit will require time and effort to review, require written response to the proponents, and require notification of both the SEC and all shareholders of the proposal and the determination.
   
• The SEC's regulatory impact analysis completely ignored the burden associated with cases in which the company determines that it is not required to provide proxy access. The proposed rule will undoubtedly attract the attention of many individuals and groups who would seek to promote their political, philosophical, financial, social, religious or other interests though membership on prominent corporate boards of directors. It is reasonable to expect that at least one-in-five of the 5,800 exchange-traded companies will receive one such proposal every year that it must analyze and report, even though the proposal is ultimately deemed to be without merit. EPF estimates that the average cost of reviewing each such proposal would be at least $25,000. Significantly higher costs would be likely for cases in which the finding of the company is subjected to a court challenge and would raise the overall average to $50,000. The national cost burden for this element would be $29 million to $58 million.
   
• Create new data systems for director elections. Companies would be required to make reports to the SEC and to shareholders when an event that triggers shareholder rights under the proposed rule occurs. To comply with this obligation, companies will need to keep track of cases in which any company nominee for the board receives 35 percent "with-held" proxy votes. The SEC's own analysis noted that currently available data does not reveal the annual number of director nominees who received 35 percent or higher "with-held" proxy votes (a number needed to calculate the cost burden of the rule). The effect of the rule will be to force every public corporation to establish a records system for that purpose and continually track and monitor such data, regardless of whether or not such an event ever occurs.
   
• The SEC analysis completely ignored this significant burden element. EPF estimates that the cost of designing and implementing record-keeping systems to collect and report this information will average $1,000 to $1,500 per company for a total nationwide cost of at least $8.8 million to $13.3 million.
   
• Interaction with rule 14a-8. The proposed rule also provides for triggering of direct access to the company proxy for shareholder nominees in cases where a previous proposal under rule 14a-8 has received favorable response by 50 percent or more of votes cast. The potential power of attaining control of a board seat can reasonably be expected to encourage frequent attempts to trigger the operation of the proposed rule by submission of proposals under existing rule 14a-8. It seems reasonable to assume that at least one-in-ten and perhaps one-in-five of the 5,000 high visibility exchange-traded companies will be presented with one of these proposals each year.
   
• Even if the proposal fails to garner 50 percent favorable votes, the cost of handling the shareholder proposal will still be the same. The SEC discussion noted that average costs of handling shareholder proposals under rule 14a-8 had been reported as $50,000 per proposal. Based on this average cost, 500 to 1,000 new shareholder proposals would add a cost burden of $25 million to $50 million.
2. Under-estimated number and cost of proposals

The SEC estimated that the proposed rule would trigger action and cost for only 142 companies per year-111 operating companies and 31 investment fund companies. This number represents only 1.5 percent of the potentially affected companies. Given the potential that the proposed rule creates for special interest groups and self-interested individuals to gain influence over corporate operations and policies, it is reasonable to expect that five percent to ten percent of exchange-traded companies will be faced with a valid shareholder nominee proposal each year. The SEC estimated the average cost per company to handle a valid shareholder nomination proposal as $4,200, but also reported that the cost of handling shareholder resolution proposals under existing rule 14a-8 averaged $50,000 per case.

It is not credible to assume that the cost of handling a board of directors nomination proposal under proposed rule 14a-11 would be less costly than handling a resolution proposal under 14a-8. Based on the $50,000 cost benchmark and the expectation of 290 to 580 such proposals annually, the national cost of handling valid shareholder nomination proposals would be $14.5 million to $29.0 million.

The table below summarizes EPF's estimates of the various cost elements discussed above. The total cost burden of the proposed rule is likely to be between $89.4 million and $175.1 million per year. Significantly higher costs may result if success of shareholder nominations in some highly publicized cases were to generate added incentives for potential proponents.

Substantive Impact of the Proposal

Beyond the costs of the proposal, the Commission should also consider the substantive impact: How will the proposal change the performance of corporations and will shareholders benefit? In addition, it is appropriate to consider how this proposal will affect the 138 million employees in the American workplace whose jobs and incomes depend on the business success and competitiveness of corporate employers.

The proposed rule will introduce a dangerous new adversarial element in American corporate governance. Rather than protecting shareholder rights by encouraging more independence in board oversight, it will hurt shareholders by encouraging special interests to balkanize corporate boards into factions that represent narrow agendas and special interests. The overall goal of maximizing shareholder wealth may be lost to an escalating process of political conflict about control of corporate policies and power.

If this proposal is adopted, shareholders will lose. The American economy and American workers will lose as well because a corporate governance structure distracted by factional conflicts will be disadvantaged in the face of growing global competition for new ideas and new markets.

The proposal of new rule 14a-11 is the fourth time in the past sixty years that the SEC has considered proposals to change the basic operating rules of corporate governance and to facilitate minority nominations of company directors. On each previous occasion (1942, 1977 and 1992), the Commission decided not to adopt changes in the basic rules of corporate governance. For the reasons stated above, the Commission should decide not to adopt the proposed rule.

Sincerely yours,

Edward E. Potter
President