[Manufacturers Alliance/MAPI Inc. letterhead]
December 19, 2003
By e-mail to rule-comments@sec.gov
The Honorable William H. Donaldson
Chairman
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: Release Nos. 34-48626 and IC-26206,
File S7-19-03
Dear Mr. Chairman and Members and
Staff of the Commission:
Manufacturers Alliance/MAPI Inc. (Alliance or MAPI) is pleased to have this opportunity to comment to the Securities and Exchange Commission (SEC or Commission) on SEC's proposed rule to govern security-holder nominations for boards of directors of public companies.
The Alliance is troubled by this SEC proposal and we request that the Commission grant a continuance pending completion of related tasks. We also have recommendations on specific issues raised in the notice of proposed rulemaking.
The Alliance is a nonprofit business league incorporated in Delaware, quartered in the Washington, DC metropolitan area, and tax exempt pursuant to Internal Revenue Code Section 501(c)(6).
Established 1933, the Alliance conducts policy and economic research and operates continuing professional education forums for business executives. In addition, MAPI performs surveys of business practices, operates online executive information exchanges, and engages in occasional advocacy before public and private policymakers on matters of interest to Alliance members and to the business community at large.
Most Alliance members are manufacturers, but also include service enterprises that are suppliers to or customers of manufacturers. MAPI members generally are international in the scope of their operations, and most are public companies with securities registered with SEC (also known herein as issuers or registrants).
Many Alliance members that are SEC registrants are concerned about SEC's proposals in File S7-19-03. Consequently, we have a direct and immediate interest in this SEC proceeding.
The Alliance supports appropriate security-holder participation in the nomination and election of corporate directors, consistent with applicable laws of the states in which the subject companies are incorporated and consistent with the ownership terms and conditions of the securities held.1
In our opinion, SEC's proposals in File S7-19-03 would burden registrants adversely and unnecessarily while other governance changes of uncertain consequence are in process.
At the least, the proceedings should be stayed pending completion of other related business of the Commission. We also question SEC's approach to jurisdiction, and disagree with the proposed changes to security-holder nomination procedures.
Timing. We wish to underscore from the outset that the timing of SEC's security-holder nomination proceeding is quite inconvenient. Registrants currently are under pressure to implement extensive new SEC regulations resulting from the Sarbanes-Oxley Act (SOA or Act) of 2002.2 In our opinion, nothing about shareholder nominations is so urgent that this project could not have been stayed through the current and unusually active period of regulatory activity.
Disclosure. The Alliance also questions the propriety and need for SEC's involvement in the shareholder nomination process beyond regulating disclosures about the nominating committees of issuers of securities that convey ownership rights with voting privileges. In the current proceeding,3 the Commission is dealing-uneasily in our opinion-with sensitive issues of jurisdiction, potential conflicts of law, and states' rights.
We believe that the proposed accommodation of jurisdictional claims is inadequate, and that SEC should withdraw or reduce the scope of the proceeding pending further study. If the Commission wishes to build a representative public record on nomination issues, we recommend a concept release with a generous response date rather than a staff proceeding of the sort used.4
Alternative. For persons wishing to reestablish jurisdictional lines in some new way for the purpose at hand, the more direct course of action would have been to take the matter to Congress. The Alliance does not support such realignment, but the proponents seem not to be in the correct forum if seeking more than disclosure. Indeed, SEC's proposal would entail costly litigation and uncertainty because of competing claims of authority.
In that regard, we believe that public companies and the judiciary already are seriously impacted by unnecessary legal actions without adding more to the backlogs.5
The merits. On the merits, the "ownership" of a legal entity in the United States often comes with voting rights, but they may be limited, provisional, or absent, and rarely, if ever, are inalienable or immutable.
Where an ownership interest is valid and exercised properly, including a ballot marked clearly and cast in a timely way, one expects to have the vote be counted on the question-whether in favor, against, abstain, or otherwise. Moreover, the electoral process should have integrity and transparency, and be determinative of candidates and propositions submitted to a vote.
In sum. In sum, SEC seems in the current proceeding to be proposing to assert questionable jurisdiction in an untimely way using unduly intrusive rulemaking, and we recommend that the Commission discontinue the inquiry pending SOA implementation or reduce its scope to one of disclosure. Further, we believe that the supplicants6 who are pleading for "relief" of the type here in question are in the wrong forum, and may not represent the interests of majority shareholders.
In anticipation that SEC will pursue this matter if only to complete a public record that is under way, we have general recommendations and endeavor later in this letter to address key issues on the merits.
The Alliance's comments to follow consist of (1) an overall perspective on this SEC proceeding, (2) our general recommendations, (3) as just noted, views on selected items "on the merits," and (4) concluding comments.
The Alliance recognizes the desire of some shareholders to participate more actively in governance of their companies. In addition, we are well aware that a few sensational accounting, financial reporting, and audit irregularities during the recent recession put the public policy spotlight on "tone at the top" in public companies.
We view "shareholder nomination" as an appropriate topic for discussion in the context of corporate governance and accountability by public companies to their various constituencies. However, public company managers are not alone in this dialogue. Other parties with accountability to shareholders include public companies' directors, "insiders" generally, external auditors, institutional investors, and financial intermediaries.
Policy First
As already noted, we find the current proposal unsettling. In particular, some shareowners always can be expected to have purposes incompatible with those of majority owners and inconsistent with enterprise missions. Nonetheless, they would not hesitate to use the governance process to advance their agendas. Owner "diversity" of this sort is foreseeable. If not controlled, however, the consequences for the enterprise could be costly.
In our opinion, policy enacted in the name of "fair and orderly markets" and "shareholder protection" should ensure against misuse of the governance process. The federal securities laws and regulations pertaining to proxies, shareholder proposals, and takeover attempts typically have been constant in protecting majority interests. We question whether SEC's proposal does so.
Costs and Benefits
Further, the Alliance is keenly aware of the competitive, global markets in which its members operate and the potential of regulatory activity to have unintended side effects. Because regulation tends to be a blunt policy instrument-notably, for example, when compared with enforcement proceedings-we generally counsel moderation in the use of rulemaking and ask for reserve where such intervention is thought to be necessary.
SEC's task in the case at hand will be to consider the costs and benefits of alternative courses of action as compared to taking no action at all on behalf of minority security holders. In the spirit of thorough inquiry, the "alternative courses" should perhaps take into consideration less regulation as well as more of it.
Policy change is not a foregone conclusion, and less regulation-notably less regulating of the type that would alter governance processes rather than focus on disclosure opportunities-may be more promising than more of it. Moreover, the burden of proof, as always, should lie with the proponents of revision.
Past as Prologue
We trust that the Commission is learning from its past dealings with the shareholder nomination issue, and will regard the current context with all due care. For 71 years of its existence, SEC has thought better of exposing the proxy apparatus to abuse. During the same years, the Commission generally has opted for disclosures in lieu of intervention. Since inception, SEC-we are pleased to add-has been a bastion of sensitivity to the effectiveness of self-governance.
SEC will encounter many partisans as it progresses toward resolution in this proceeding. Observers are entitled to expect that the Commission will ensure due process and arrive at balanced conclusions. The conclusions should be consistent with and mindful of policy objectives, jurisdictional considerations, the standing of complainants, allegations, the weight of evidence, types of relief (if warranted), the integrity of financial capital markets, shareholder protection, and majority rule.
Common Ground
In that the Alliance is an organization largely representing registrants, we should mention in this perspective that the SEC's staff in its study7 preceding the instant proposal seems not to have found common ground with registrants' concerns. By contrast, we can see some merit in both sides of the shareholder nomination issue and can envision a common ground based on enhanced transparency.
Enhanced transparency moves in the direction of more complete information for the proponents while affording protection superior to that of the proposal to enterprises, majority security holders, and other major constituencies.
Our primary points of reference in these recommendations will be SEC's past experience with shareholder nomination issues and the same cost-benefit considerations we customarily urge for the Commission.
For SEC's review, our general recommendations are as follows:
1. Too far, too fast. — At Alliance invitation, a Commission representative attended a recent MAPI meeting to provide an update on SEC activity. Knowing that the attendees were au courant in matters of public-company regulation, the individual asked-to paraphrase-whether such persons thought that SEC in the wake of SOA was regulating with the right amount of dispatch and intensity, not enough, or "too far, too fast."
Commentators were cognizant of the legislatively mandated deadlines about which SEC lacks discretion. Nonetheless, they uniformly replied that the volume and pace of the Commission's activity have been unduly burdensome. As they view the matter, the derelictions of a few poorly governed corporations have saddled the great majority of public companies with new nonproductive costs that detract from their competitiveness.
Further, although SOA had driven most recent SEC activity, industry commentators specifically called attention to the current proceeding, which, at the time, had completed its staff-study phase but had not yet been proposed by SEC. The Commission's proposals on shareholder nominations were not ordered by SOA, rather having been undertaken by SEC as a separate project on a track of its own without a legislatively driven timetable.
Our reason for mentioning the "too far, too fast" anecdote is that the current shareholder nomination proceeding seems quite improvidently timed for an independent regulatory agency that has generated a maelstrom of directives over the last year and a half. One need not address the merits of the current proposal to arrive at this judgment, although we will do so presently.
Along the same lines, commentators during the staff study portion of the current proceeding noted that proposals then before the Commission for consideration included proposed listing rules-since finalized-with new nominating committee requirements. The brief SEC response was to the effect that such requirements "do not address the role of security holders in the nomination process." Although accurate, SEC's comment also seems to have missed the point with respect to regulatory overload.
2. SOA and shareholder nomination. — Further as to SOA, the Act, by all accounts, was the most thorough overhaul of the federal securities laws since enactment in the 1930s. A few sensational governance, accounting/financial reporting, and audit scandals-augmented by recession-driven equity price deflation in the wake of the longest and perhaps most speculative bull market in recent memory-generated a severe and prolonged correction in financial capital markets.
Consequently, Congress addressed every known or potential governance shortcoming of any significance, the result being SOA followed by the many regulations since promulgated by SEC. One and one-half years into this new regime for public companies, affected enterprises may expect still more from SEC, the Public Company Accounting Oversight Board (PCAOB), the Financial Accounting Standards Board (FASB), and state securities regulators, among others.
SOA also commissioned a dozen or more studies to examine and report on remaining areas possibly in need of public-sector reinforcement. The findings and recommendations have been provided to Congress and SEC for further consideration.
Shareholder nominations of the sort broached in SEC's File S7-19-03 do not appear to have been contemplated by SOA or the studies ordered by the Act. Although perhaps not out of mind, the topic apparently did not rise to a threshold justifying inclusion. To the extent of congressional interest in board nominations, such interest seemed centered on retrofitting certain committees to ensure independence and effectiveness.
In other words, the key issue in SOA, we believe, was shareholder protection, not "shareholder suffrage."
3. Another point of order. — The current proceeding has both a disclosure component-not further dealt with in this letter-and the more intrusive regulatory initiative to which this comment is addressed. The better procedure for SEC, in our opinion, would have been to proceed first with promulgation of the nominating committee disclosures and then determine whether they, without more, would yield the transparency allegedly lacking.
As the Commission surely must appreciate, a failure of a past disclosure rule to prove efficacious to some intended end does not mean that the concept of "sunshine" as a spur to action is lacking. Disclosures can be more or less frequent, timely, broadly disseminated, and/or detailed. The federal securities laws basically are disclosure statutes,8 and we frankly are dismayed to witness SEC's drift into a "command and control" mode that is both more costly to administer and less efficient for all parties concerned.
What, then, prompted SEC, which normally is dedicated to the beneficent effects of sunshine on public opinion in free markets, to propose a supposedly useful disclosure rule about nominating committees and then, soon thereafter-before closure of the disclosure proceeding and evaluation of its effects-to tag on a decidedly more invasive shareholder nomination procedure? The answer may lie in the public record of the staff study preceding the current SEC proposal, a matter to which the Alliance will return.
4. The conundrum of costs and benefits. — The pleasure/pain principle is of the essence in "choice," and choices made about regulations are no exception.
Regulatory activity in the United States has increased inexorably in the last century or so, along with economic and population growth, globalization, advancing technologies, and this country's expanding domestic and international responsibilities. In that regard, one notes that regulatory burden increasingly is an "overhead" factor limiting the capability of enterprises and their people to compete effectively and provide for others.9
The eternal conundrum of costs and benefits in the regulatory framework is that (a) costs nearly always are demonstrable in some measure and they usually are underestimated, whereas (b) benefits frequently are in the realm of conjecture and tend to be overestimated. Federal law requires that federal regulators present cost-benefit analysis with proposed directives, but the output leaves much to be desired.
With respect to costs in this instance, SEC notes that security holders currently can participate in the director nomination procedure only by recommending candidates to the nominating committee or by undertaking an election contest. The former approach is said to be ineffective, and the latter is said to be too costly for persons not seeking control. Hence, although SEC's proposal "may impose additional direct costs," according to SEC, many "would be offset by the cost to security holders of undertaking an election contest."
On benefits, SEC speaks of better aligning board and security holder interests in three ways: (1) triggering events to limit frivolous use of the procedure and improve responsiveness by companies wishing to avoid the triggering events; (2) more disclosures to help security holders understand and evaluate board performance; and (3) enhancements to security holders' abilities to participate meaningfully in the proxy process.
Concluding on this matter of costs and benefits, SEC seems to accept that greater security holder participation may lead to better performing boards. Also, according to certain commentators, one should expect more board diversity conducive to new perspectives and better boardroom dynamics.
Note that SEC's cost argument seems predicated on a baseline condition in which the security holder is presumed to have a right to participate actively and "meaningfully" in nomination rather than simply to vote on candidates presented by experts designated for that duty. In that the cost of an election contest is prohibitive, the procedure under consideration, which is less costly than an election contest, necessarily prevails by the Commission's reasoning.
As to benefits, no quantification evidently was found feasible, but SEC asserts that a combination of triggers and more shareowner involvement would enhance diversity. The concept of better boardroom dynamics is left to our imaginations.
5. Only by nominating candidates? — Under "costs" in the preceding segment, we pointed out SEC's concern that minority shareholders were limited to nominating candidates or to conducting election contests.
This alleged limitation begs for examination. What right beyond nominating candidates does SEC contemplate? Is the Commission (or its staff) thinking that boards of directors need, in addition to independent members, one or more board advocates of particular interests? Should minority shareholders have their own delegate to catalyze board diversity and improve boardroom dynamics?
We submit that an equity owner under provisions of state law (and federal law in the case of SEC-registered securities)10 should be informed in matters of governance and have a reasonable opportunity to cast a ballot where voting rights are an attribute of his/her securities. The Commission can endow the proxy process with all the transparency it takes to facilitate the foregoing, and disclosure strikes us as being the cost-efficient medium that works.
To make shareholder nominations easier or more difficult to do implies policy objectives we do not acknowledge and regulatory interference that is uncharacteristic of SEC. Neither the listing of a candidate on a ballot nor total denial of access is or should be an unqualified attribute of security ownership. The logical alternative is to allow voting for or against a slate assembled by qualified persons who were duly elected, appointed, or hired to do so.
In the staff study cited earlier, SEC personnel state that most responses supported a change to the proxy rules, but the majority thereof did not provide specific suggestions. This is informative because the implication is that significant numbers of persons voted for empowerment in some manner but did not have enough abiding interest to suggest how empowerment ought to happen. These respondents mostly were individuals, unions, pension funds, institutional investors (and affiliates), and social, environmental, and religious funds (and affiliates).
Persons who were not in favor of change suggested deferral of the entire project, espousing positions apparently similar to ones we thus far have articulated in this statement. Industry was not particularly well represented in the respondent group for the reasons given earlier, notably including preoccupation with SOA and other priorities versus replying to an untimely SEC staff proceeding.
6. Reflecting on prior consideration. — In SEC's principal prior visits to the question of security holder participation in the nomination of directors, the outcome has been to drop the proposal (as in 194211) or to call for disclosures (as in 1977-197812). Note, meanwhile, that 35 years passed between the 1942 and 1977 episodes and 25 years elapsed between the 1977 and 2003 visitations notwithstanding brief consideration paid to security holder nominations in 1992.
Further as to the 1992 event, the context was the bona fide nominee rule indicating that no person can be such a nominee unless he/she has consented to being named in the proxy statement and to serving if elected. In adopting the rule, SEC noted shareholders' difficulty in participating but also found that changes for that purpose would essentially mandate a universal ballot. The solution was to allow security holders seeking minority board representation to complete partial slates using management nominees. Still, we are informed, shareholders lack "meaningful" participation.
On prior occasions, SEC seems to have been subjecting the shareholder nomination topic to some kind of cycle audit. At times, this has occurred more or less coincidentally with other governance developments, such as the Foreign Corrupt Practices Act of 1977, the Treadway Commission in the early 1990s, and SOA in 2002. Rather than a "burning issue," however, the topic at hand has been more nearly in the nature of periodic but infrequent Commission due diligence. This suggests again that the timing of the current review was discretionary rather than urgent, and that the project might better have been delayed.
This is not to imply a lack of shareholder interest. In each past review of shareholder nominations, individuals and, in particular, institutional investors have been well represented in the public record. As in this proceeding, some allege failure of oversight or other shortcomings of the sort addressed by SOA. Assuredly-the revisionists aver-the corporate entity would perform better if their candidates were in charge.
Yet most persons who argue for "meaningful" participation would have to admit in candor that the existing nominating committee apparatus-now more independent than ever before-is better situated than they are to perform the task.
7. "Meaningful" participation. — We return again to SEC's repeated use of the adjective "meaningful" in connection with proxy process participation, a word of plainly indeterminate content that is proffered as if some universal connotation were intrinsic to it. What specifically should be the expectation of a minority security holder with respect to his/her right to nominate director candidates or otherwise participate in the management of a company that he/she owns?
Likewise, what is the responsibility of a nominating committee to take scarce time to evaluate the qualifications of persons nominated by minority shareholders, other than to acknowledge receipt and request staff investigation of the nominee without further commitment or explain why such inquiry cannot be made? Nominating committees normally do not lack for qualified candidates. Further, they must be certain that nominees are persons of achievement, would bring necessary skills to the job, and are interested in such duty.
Along similar lines, what are the rights of majority shareholders, if any, to oppose or limit minority shareholder intervention in governance processes? What board "diversity" is to be attained by minority representation? What are the enhanced boardroom dynamics foreseen by SEC or its staff? Persons who have seen nominating committees in operation will attest to the care taken in director-nominee selection and review and the desirability of consensus.
Most equity holders already have the right to vote for directors, even if they own but a single share. The prevalent form of governance is "representative" in nature, which is in keeping with democratic values even if short of "town meeting" directness. SEC's questions on the merits-to be discussed presently-run to this matter of qualification for security holder participation. However, does the Commission really intend to create de facto "classes" of security holders based on ownership thresholds, duration of holdings, or other attributes?
Do the proponents of change in these governance proceedings simply want to know that they have a role? Or do they seek more effective means to unseat incumbent overseers? Do these questions matter? How should SEC distribute their rights if the Commission has in mind some deviation from representative governance? Should nominating committees have a designated "minority shareholder advocate"? Should boards have minority shareholder committees, just as Congress has small business committees and just as minorities in Congress have their own delegations, coalitions, working groups, and caucuses?
The foregoing are questions gestating in SEC's proposal. Without intending to alarm or suggest more than a few palpable implications of altering the governance mechanism itself, we find the proposal troubling and again urge confinement to enhanced disclosure.
The commentary to follow relates to several key issues as to which SEC sought views. Our organization's principal concern is to protect shareholders by shielding the shareholder nomination process from waste or abuse.
We view "waste or abuse" in this context as any activity that: (1) threatens the cost-efficient operation of corporate governance and accountability mechanisms as in effect following implementation of the Sarbanes-Oxley Act of 2002 (SOA or Act), including Commission regulations pertaining thereto, or (2) may be impermissible under state corporation law.
As suggested by the foregoing, the better procedure here would be to stay the proceeding pending SOA implementation. Furthermore, Alliance comments on the merits are not to be construed as alternatives to or withdrawals from objections we already have stated.
Applicability of the Proposal
SEC inquires whether its proposal should be applicable "at the outset" only to accelerated filers.13 Should the rule state alternative exemptions or excludable categories of proposals?
Exemptions generally. Ordinarily, the Alliance favors universal applicability of securities law provisions that otherwise might yield undesirable exposures or inequities between companies that are exempted and those that are not. However, the federal securities laws have numerous examples of exemptions for public companies that are less well equipped than others to deal with regulatory burden or are less clearly implicated by shortcomings giving rise to a rule.
Accelerated filers. Because companies that are not accelerated filers, according to SEC records, constitute less than 10 percent of companies attracting shareholder proposals, we endorse their exclusion not only at the outset but also for as long as shareholder nomination procedures are in effect. Either the exclusion is warranted for reasons of disproportionate burden or it is not. Why treat it as temporary? If SEC wishes to do so, it can revisit the topic later and change the applicability in light of circumstances then operative.
Accommodative actions. In addition, we believe that companies agreeing to take accommodative action should be exempt. However, we should add that this is a regulatory and administrative complication. To the extent feasible, any new rule should be self-executing. Of course, an exemption procedure implies the existence of a ruling apparatus to administer it, possibly inconsistent with the desire to "keep it simple" and oriented to principles.
We do not dismiss the idea that an "accommodation" procedure could be self-executing. For example, one such approach might be for the issuer to offer, where appropriate, a meeting between the eligible proponent and a company ombudsman who reports periodically to the nominating committee.
Avoidance of complexity. If any accommodation procedure or other refinement were to require detailed regulatory definition, defined inputs and outputs, appeal procedures, or more than minimal cost to anyone, then we would regard the procedure as having departed from principle and as having become needlessly cumbersome. The shareholder nomination issue hardly is important enough to justify the creation of another regulatory quagmire.
As the Commission can see, more regulation and additional costs lurk at every turn in this proceeding.
Triggering Events
SEC asks for views about two proposed triggering events for shareholder nominations consisting of, to summarize, one or more board nominees receiving more then 35 percent "withhold" votes, or a proposal for direct access under Rule 14a-8 submitted by a 1 percent (and one year holding) security holder group receiving more than a 50 percent vote. The events would occur at an annual meeting held after January 1, 2004.
The Commission also has in mind a third non-implementation trigger premised on a company's failure to apply in a timely way a one percent security holder's proposal that is supported by a majority of votes cast.
Triggering events, in general. — We have no objection to the concept of a "triggering event." Rather, the thresholds within the triggers deserve exploration. SEC's records may indicate that a one percent shareholder with a one-year holding is an infrequent petitioner, but thresholds at such a low level strike us as affording rather effortless entrée to shareholder nomination by, among others, institutional investors.
Significant, long-term stake. — We would not subject the nomination process to such casual access by minority holders, institutional or otherwise. Any opening of the process should contemplate participation only by established security holders clearly entitled by the triggers to take remedial action.
Of necessity, proponents should have a significant stake that has been held long-term, thereby excluding to the extent feasible transient owners, persons with petty grievances, advocates for causes already deemed unacceptable in the context of shareholder proposals, or holders with more in mind than minority representation.
Security holdings. We recommend that security holdings be in excess of five percent, an amount that is conformed to the threshold at which beneficial security holders usually must declare their intent merely to invest or to seek control. Security holder nomination of the sort envisioned would be a costly distraction to public companies, so qualifications for access should be reasonably demanding.
Holding period. An appropriate holding period might well be two years if only because respondents to the staff study ranged from one to three years, and two years is adequate to indicate a disposition to hold a security. Also, we regard one year as being too brief for this purpose-suitable for a capital-gain holding period but not indicative of commitment to the enterprise.
Aggregation. Aggregation is a very difficult issue. If accepted but not regulated with care, aggregation might subvert the purpose of the ownership threshold and the holding period, so we are inclined to suggest prohibiting it. On the other hand, equity would seem to favor allowing minority security nomination in some cases of identical interests that only qualify on an aggregated basis.
If SEC adopts suitable thresholds in the triggers, we do not expect concern with aggregation other than the mischievous penchant to "buy" or "sell" votes by persons so disposed. Of course, too, ownership and holding period thresholds could be made operative for all participants in an aggregation. Along those lines, we would exclude broker votes entirely. Brokers should be ineligible if only because allowing them to participate would aggravate conflicts of interest that already are too common among financial intermediaries.
As SEC will recall, the intermediaries are part of the governance problem and some of the prophylactic measures still remain to be administered. This risk should be apparent from the Commission's hands-on experience, enforcement proceedings, SOA's banker-broker provisions,14 SOA-prescribed studies,15 past governance failures in the self-regulatory organizations (SROs) overseen by the Commission,16 and recent anomalous behavior by certain investment companies.17
Low thresholds simply would invite trouble, in our opinion. SEC surely does not want-via aggregation and low or easily circumvented thresholds-to involve arbitrageurs, index investors, momentum investors, and other persons with no lasting stake in the organization, much less persons who can initiate costly corporate governance mechanisms at little cost or inconvenience to themselves.
We urge "defining" transients, petty complainants, and mischief-makers out of the system by setting appropriate thresholds, eliminating loopholes, and requiring proof of qualification from the proponents before requiring any corporate response.
Maximum Permissible Slate
In our opinion, any enhanced shareholder-access rule should limit shareholders to the nomination of candidates for less than a majority of the directors slated for election at the particular annual meeting.
This rule should apply whether the board is classified or not. In that connection, we would point out that the staggering of board seats up for election is conducive to continuity of management direction and oversight-the same concept underlying the staggering of seats for election in the United States Senate.18
Under no conditions should SEC "enhance" minority shareholders' ability to replace all or a majority of the board. In our opinion, the number of seats potentially eligible for displacement by shareholder nominees should be directly related to the security holdings of the nominees' proponents relative to total enterprise security holdings outstanding.
Obviously, a security holder's nominee might attract any number of votes. However, the number of nominees should bear some relationship to the proponent's relative stake in the enterprise.
Competing Nominating Shareholders
Questions of order, preference, or priority arise in the context of competing nominating shareholders who present more shareholder nominees that permitted. The preponderance of opinion to date in SEC's record seems to be to defer to the shareholder with the largest holding. Some parties not sanguine about such an approach fear collusive activity by companies using board-friendly nominating shareholders.
Much ado? Rather than limit the number of competing shareholders, why not let the ownership and holding period thresholds work at relatively demanding levels, as we recommended, to filter the participants? Also, we would expect that any questions of "competing" shareholders would sort out without SEC's intervention. Persons serious about nominating a director would understand that a united front is superior to a divided one.
Diversity? If boardroom diversity is an important objective, we doubt that limitations would be conducive to the desired end. Rather than accept the diversity premise, which rests uneasily with us because of incomplete definition, we leave the preceding observation without further comment.
Other Matters
On various other matters as to which SEC is gathering views: security holder nominees probably should have disclosure standards similar to those of board nominees; a safe harbor from Exchange Act Rule 13D would be in order at the customary level of beneficial ownership exceeding five percent; the corporation should not be expected to reimburse nominating shareholders for fees and expenses regardless of election outcome; and the entire proceeding clearly should be deferred.
In addition, opening the door to shareholder nominations most certainly could yield disruption, polarization, undue cost, special interests, more election contests, and more nominees who simply do not qualify. The process scarcely would qualify as "neat and clean."
The desirable alternatives to the type of shareholder nomination proposed by SEC would include more disclosures and more ways for security holders to communicate with independent directors. Elsewhere in this communication, we noted the possibility of having a shareholder's ombudsman who is acceptable to the nominating committee. We urge exploration of this or similar accommodations, if anything need by done beyond disclosures already proposed and under review.
Ordinarily one would think of security holders who undertake nominations as being aggrieved in some way. Such persons perhaps then should have a relatively clear channel to a designated party within the enterprise who will see that his/her message is conveyed to the nominating committee. That individual also could be charged with responding to the shareholder proponent.
Although not entirely similar, SOA Section 301 provides persons with accounting, financial reporting, or audit complaints with a mechanism for communicating to the audit committee. The mechanism to our knowledge has not done much to date but attract non-germane human resources complaints and recommendations. Whatever it has or has not accomplished, the communication channel exists and now is familiar to all who might care to use it with reasonable expectation that it will be given due consideration.
The Alliance recognizes that shareholder rights "go with the territory" for companies that seek public financing, and that property rights go hand-in-hand with ownership. We also understand that securities regulation in this country has a very significant interstate and foreign component. As securities markets inexorably become a nonstop, global phenomenon, the United States-with the most prolific such markets in the world-sets standards to which other nations and international institutions look for guidance.
Further as to the matter of property rights, SEC must help ensure against infringement. Although the gap is narrowing, ownership and management still remain to some extent separated in many public companies.19 Consequently, management must be diligent to honor the interests of the public owners whose savings are entrusted to them. Additional transparency might go a long way toward satisfying the proponents of security-holder nominations for directorships, and would be much less burdensome than alternatives under examination.
As noted, the Alliance is deeply concerned about competitiveness and cost-efficiency, even while appreciating the imperatives of shareholder democracy. Owners already can recommend director candidates and petition their co-owners appropriately in other enterprise affairs. In contemplating more shareholder empowerment, we trust that SEC will be attentive to the delicate balance among parties with jurisdiction and keep in mind that enterprise managers and their public owners have much in common.
To summarize, the shareholder-nomination question now before SEC comes down to whether to do anything more than currently provided for security holders who want to participate more actively in governance and, if so, "when" and "how."
In our opinion, shareholders should be able to recommend directors, as they now do. They further are entitled to a courteous, thoughtful, and expeditious reply, whether affirmative or negative. When their proposals are included on a ballot and earn a majority vote, the security holder proponents most certainly are entitled to entity responsiveness and should have recourse if they prevail and are ignored.
As to "when" any enlargement or clarification of security holder rights should occur, we have not seen the evidence of alleged management disregard and previously was unaware of any such charges. Assuming that the charges are infrequent and/or are anecdotal, the matter should be turned over to SEC's Division of Enforcement, and we do not acknowledge urgency or suggest a time frame for disposition.
Further, we repeat that the Commission's timing in conduct of this proceeding is distressingly awkward for many affected issuers and, with due deference to SEC and its pressing regulatory schedule, we urge favorable consideration of our request to stay the proceeding.
Looking ahead, we hope to see more reflection restored to the Commission's ongoing governance proceedings as compared to the pre- and post-SOA din. Deferral of the shareholder nomination issue seems in order and would be favorably received by regulated parties. Also, deferral would signal SEC's awareness of SOA-related burdens to many prudently managed companies, as we have described in this communication.
Regarding "how" shareholder rights might be enlarged we counsel reserve, giving particular attention to jurisdictional prerogatives, compatibility, disclosures rather than governance overhaul, and other recommendations discussed in this communication.
The Alliance thanks SEC once again for this opportunity to present views. If Commission members or associates assigned to this matter have questions regarding our statement, please do not hesitate to call me.
We hope to continue our participation on this topic, including such public hearings as the Commission may conduct with respect to the proposed regulation. In that regard, we would be pleased to comment generally in such proceedings or address particular items of concern to the members and staff.
Respectfully submitted,
Francis W. Holman, Jr.
Vice President and Secretary
Manufacturers Alliance/MAPI Inc.
1525 Wilson Boulevard, Suite 900
Arlington, Virginia 22209
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1 Voting rights typically are a characteristic of "equity" instruments. We use SEC's "security holder" nomenclature in this letter because equity and debt characteristics of financial instruments often are blended. Hybrid instruments increasingly are common, and the attributes of ownership can differ significantly from one to the next. For the definition of the phrase "equity security" under the Securities Exchange Act of 1934, see Rule 13a11-1, at http://www.law.uc.edu/CCL/34ActRls/reg3A4.html.
2 Public Law 107-204, 116 Stat. 745, http://www.pcaobus.org/rules/Sarbanes_Oxley_Act_of_2002,pdf.
3 The Alliance's comments in the current letter pertain only to File S7-19-03, which, in effect, is Part II of the "shareholder nomination" proceeding. Our views here are exclusive of Part I, that is, Release No. 34-48301 (File S7-14-03) of August 8, 2003, http://www.sec.gov/rules/proposed/34-48301.htm.
4 In addition, responses to the concept release should be available online in full text as compared to staff summaries.
5 See How Structural Costs Imposed on U.S. Manufacturers Harm Workers and Threaten Competitiveness, Manufacturers Alliance/MAPI, Arlington, VA, and The Manufacturing Institute of the National Association of Manufacturers, Washington, DC, December 2003. Also see I Pay, You Pay, We All Pay: How the Growing Tort Crisis Undermines the U.S. Economy and the American System of Justice, Manufacturers Alliance/MAPI, Arlington, VA, May 2003.
6 A review of the record compiled to date suggests strongly that institutional investors and their representatives are the supplicants. For a discussion of ancillary issues about institutional ownership and board representation that are not addressed here by SEC, see "Savings and Investment, Capital Allocation, and Corporate Governance: A Summary and Critique of Certain Findings and Recommendations in Capital Choices: Changing the Way America Invests in Industry, MAPI Policy Review PR-121, Manufacturers Alliance for Productivity and Innovation, Inc. (predecessor of Manufacturers Alliance/MAPI, Arlington, VA), November 1992.
7 See summary of comments at http://www.sec.gov/rules/extra/s71403summary.htm.
8 "Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman," Louis D. Brandeis, "What Publicity Can Do," Other People's Money, Chapter 5, p. 92 (1932); originally published in Harper's Weekly, December 20, 1913.
9 See footnote 5, supra. In addition, public policy students may find of interest that periods of regulatory exuberance in the 20th and 21st Centuries to date have occurred with wavelike regularity, peaking at roughly 25-year intervals. The most recent peak will include 2000 to 2005, preceded by high activity in 1970 to 1980, 1933 to 1945, and 1910 to 1920. Although military engagement was a factor in several cycles, other regulations have played a role. SEC is a factor now, as in the 1970s and 1930s. Our observations are unrelated to Kondratieff waves, and too few to support a wave theory.
10 That is, security transactions affecting interstate and foreign commerce. See U.S. Constitution, including Article I, Section 8, Clause 3, online at http://www.house.gov/house/Constitution/Constitution.html.
11 We understand that the public record of the 1942 proceeding does not explain why SEC chose to reject the proposals then under consideration.
12 Release No. 34-14970 of July 18, 1978 [43 FR 331945]. Also see Release No. 34-15384 of December 6, 1978 [43 FR 58522].
13 See "Acceleration of Periodic Report Filing Dates and Disclosure Concerning Website Access to Reports," at http://www.sec.gov/rules/final/3308128.htm.
14 See, for example, SOA (op. cit., footnote 2), Title V, "Analyst Conflicts of Interest," at Section 501 (treatment of securities analysts by registered securities associations and national securities exchanges).
15 See, for example, SOA (op. cit., footnote 2) Title VII, "Studies and Reports." In particular, refer to Sections 702 (credit-rating agencies), 703 (violators and violations, including securities professionals), and 705 (investment banks).
16 See, for example, http://www.sec.gov/news/press/2003-173.htm, December 17. 2003, concerning SEC's approval of New York Stock Exchange (NYSE) governance structure changes.
17 SEC's Release No. 33-8343 of December 11, 2003 is indicative. The release proposes regulations to require disclosures as to market timing and selective disclosure of portfolio holdings by investment companies, available online at http://www.sec.gov/rules/proposed/33-8343.htm.
18 "The mutability in the public councils arising from a rapid succession of new members, however qualified they may be, points out, in the strongest manner, the necessity of some stable institution . . . [Moreover] a continual change even of good measures is inconsistent with every rule of prudence and every prospect of success." Publius (nom de' plume for Alexander Hamilton, James Madison, and John Jay), Federalist Papers: Federalist No. 62, "The Senate."
19 The most systematic study ever undertaken of the separation of control and ownership in public companies-still a business classic-is The Modern Corporation and Private Property, Adolph A. Berle, Jr., and Gardiner C. Means, 1932. Subsequently a member of President Franklin D. Roosevelt's "brain trust," Berle was influential in design of the federal securities laws.