|
|
"Shareholder Access to the Ballot" Under pressure from investor groups, the SEC's Chairman has asked the Division of Corporation Finance to consider a wide-raging overhaul of the proxy rules, particularly the ability of shareholders to nominate director candidates and a new shareholder proposal framework. This topic already has fostered quite a battle because if shareholders win the right to include alternative nominees on the ballot, the nature of election contests could change dramatically. This webcast offered viewpoints from both the corporate and investor perspectives in this controversial area. Join these experts: Panel:
Table of Contents:
Broc Romanek, Editor, TheCorporateCounsel.net: Welcome to another webcast program on TheCorporateCounsel.net. I'm very excited about today's program, "Shareholder Access to the Ballot." I think this is a very timely program, particularly since the SEC issued a press release a few weeks ago announcing that they were considering a broad initiative to reform the proxy rules, including the question whether of shareholders should be able to nominate directors more easily. Let me go ahead and introduce our great panel. I believe we're going to get a variety of viewpoints during today's discussion, and I'm very excited about the quality of our panel. First we have Andy Brownstein, who's a partner at Wachtell Lipton up in New York City; Rich Ferlauto, the Director of Pension and Benefit Policy at AFSCME; Professor Larry Hamermesh from Widener University; Rich Koppes who's of counsel at Jones Day and a prominent member of the Stanford Director Education School staff; Ted White, Director of Corporate Governance at CalPERS; and Beth Young who's a senior research analyst at the TheCorporateLibrary.com who also serves as a free-lance corporate governance consultant. This will be a true roundtable discussion, but we are going to kick it off with Andy Brownstein providing a brief background of why the SEC took the action that it did. Other panelists will also pitch in as to their views of why investors are putting pressure on the SEC on the access issue at this time. Andy? Background of SEC's Request for Comments Andy Brownstein, Partner, Wachtell Lipton Rosen & Katz: Thanks, Broc, and thank you for having me on this program. As most of those in the audience are probably aware, shareholders as a matter of state law have the ability at any annual meeting to nominate a director for election, and most companies have bylaws establishing procedures to that effect. Shareholders also have the ability - under state and federal law - to solicit proxies for the candidate that they nominate. Under current rules, there are separate proxy statements and proxy cards - for candidates nominated by the Board and candidates nominated by shareholders and others. From time to time over the years, really going back as early as the 1940s, there has been discussion of the question whether or not the shareholders ought to have the right to include their nominee in the company's proxy statement and have the name of that nominee listed on the company's proxy card. This has been debated at the SEC, in Congress and among academics over the years, and the current system has remained. Earlier this year Rich's union, the AFSCME, a municipal employees union, submitted proposals to six companies for bylaws that would establish that stockholders representing three percent of the company's outstanding shares would have the right to have their nominee included in the company's proxy statement and on the company's proxy card. In three cases, these were to be mandatory bylaws - and in another three they were precatory or advisory bylaws. At the time AFSCME filed those proposals under Rule 14a-8 they publicized the fact and put other institutional investors and the press and the public on notice of the campaign for this sort of bylaw. All six companies opposed inclusion of that bylaw in their proxy statement under the 14a-8 exclusionary rules and made a number of arguments seeking exclusion, including that they would result in proxy contests (which are governed under Rule 14a-12) that they were inconsistent with the proxy rules and that the bylaws violated state law. The SEC staff ultimately determined that those bylaws were excludable under 14a-8(i)(8) that permits the exclusion of matters that can relate to election contests, relying on the precedent of its prior no-action positions in similar cases - although the AFSCME would debate the strength of the SEC precedent. The SEC staff didn't address the other arguments against the bylaw that we'll probably get into on this panel a bit so I won't foreshadow them. The Staff's decision was appealed to the full SEC by the AFSCME. The Commission supported the Staff's position. At the same time though, the Commission announced that it was going to do a full review of the proxy rules, in particular the 14a-8 process. The SEC staff has been increasingly burdened with an ever-increasing number of 14a-8 resolutions and the need to process them. The Staff is considering that and the burdens of that process, and as part of that will consider the subject of whether the company proxy statements ought to include the nominees of shareholders other than the Board of Directors. The Staff has requested comments by the middle of June and is due to issue a report by the middle of July, so this program I think is timely in that context. Reasons Why Investors are Upset Romanek: Rich, why did the AFSCME submit the proposals? What was the motivation? Rich Ferlauto, Director of Pension and Benefit Policy, AFSCME: It was our pension system, actually the employees' pension plan that submitted the proposal. Today I'm speaking as the director of investment policy for the union, however. We fundamentally believe that corporate governance can be improved through an access right that Board processes and that shareholder value in the long term is best determined or will receive its highest value when there's a process in which non-incumbent directors do not have the exclusive right to essentially picking who the new directors will be. Therefore, we're not only interested in promoting directors who are independent from the current Board; we're interested in the process that is much more democratic in its origins so that in companies where we feel there is a substantial corporate governance deficit, shareholders have an opportunity to make their voices known and to actually get somebody who will represent their interests on the Board. Brownstein: Rich, doesn't that opportunity exist today? I mean, why doesn't it? Shareholders can nominate; shareholders can solicit proxies. Last year there were more than 40 proxy contests. Ferlauto: That's actually a very good question. For most shareholders-or just about all shareholders that I'm aware of who are not interested in a hostile takeover-the cost and the complication of running a solicitation really makes the kind of reform initiative that they're interested in prohibitive. Larry Hamermesh, Professor, Widener University: Why is that, Rich? With someone who has three percent or more of a company's stock, I would have thought that putting one director up as a nominee, given the availability of the '92 amendments to the proxy rules and the availability of significant institutional holders influenced by ISS or whatever, wouldn't be such a big deal anymore. Am I wrong? Ferlauto: No, I think the solicitation costs still remain to be quite a hurdle. Where we've requested the action-again, at least in terms of the 14a-8 that we filed and some of the comments that we're filing with the Commission-is that we're not necessarily talking about a three percent holder or a large holder of outstanding shares, but a group of holders that would reach whatever threshold or benchmark would be appropriate. Brownstein: But somebody would have to solicit them. Ferlauto: These are holders that are seeking reform that don't necessarily have the deep pockets that have been behind just about every one of those contests, [unintelligible] contests that have happened in the past year. Romanek: One thing I've heard, and maybe Ted or Beth can flush this out, is that one of the other reasons that is a particular time where shareholders are seeking access is that the companies that have received majority votes on non-binding proposals did not take satisfactory action after the fact in response to that vote. Is that a major motivation? Ted White, Director of Corporate Governance, CalPERS: Yes, I think that's part of it, but I'll boil it down even just a little simpler than that. This is about accountability-that we need a little bit of a tweak to the system to raise the level of accountability of directors, of individuals, to shareholders. This is the most effective way to do that, in our opinion, and that's really what it's all about. Your question as to the response of this shareholder proposal that passed by majority vote-that's part of it. Not addressing underperformance in situations after it goes on for long periods of time-that's part of it. Abusive executive compensation-that's part of it. So it's all that rolled up into one. Beth Young, Senior Research Analyst, TheCorporateLibrary.com and Corporate Governance Consultant: I just would be careful about describing this as being sort of a mechanism for majority vote implementation, if you will, because I think that I see the majority vote issue as kind of a symptom of an underlying problem rather than the central problem to be solved. Rich Koppes, Of Counsel, Jones Day: Broc, can I speak as a director? As a director of three public companies, I just think it's about time that we commend the SEC for doing this initiative. Too often, in my experience, boardrooms are full of directors that still don't understand that they have a fiduciary duty to shareholders at large. I think what Ted White said was absolutely correct: it is the issue of accountability. I think it's time that we get more shareholder input here. After all, it's the Board of Directors where the real power is in Corporate America. Brownstein: I agree with Rich and Ted that the issue is about the performance of the Board. Not accountability per se; it's the performance of the Board and the effectiveness of the Board of Directors in furthering the interests of shareholders and the company. I think that there's a pretty low threshold to begin with respect to the ability to have a proxy contest. I think that there are many organizations today that have been effective in getting representation on Boards of Directors of a company without even undertaking a proxy contest, just by virtue of their ownership. There's David Batchelder and Ralph Whitworth's group, for example, which has made their investment thesis trying to get on the Board and influence the direction of the companies, and I don't believe they've engaged in any proxy contest yet-maybe one. But significant shareholders who have something to say and have something to add can get on Boards, particularly when it's clear they have the support or would have the support of other significant institutional shareholders. What this proposal will do is increase the nuisance value of groups that don't have the requisite level of interest to pursue a nomination today or the requisite level of support to be successful. On the other hand, at least from my experience counseling directors, boards function like any group - chemistry and collegiality develops over time. That's not to say that there shouldn't be dissent and debate on Boards of Directors; absolutely, there should be. It is to say that you don't need to politicize a Board of Directors so that you have a representative of one group of shareholders or a representative of another. All the directors represent all the shareholders together, and I think that what this proposal will do is in effect precipitate more disruption in the boardroom and decrease the effectiveness of boards by the nuisance of these "freebie" proxy contests and an increasing trend to politicize at a time when we're all focused on making them better and when we have just passed and are just starting to implement a whole host of new regulations designed to improve the effectiveness of the Board. Ferlauto: I think that's exactly the point is that most Boards, a number of Boards, have been asleep at the wheel, and that has led to a decline in investor confidence in the market to such an extent that at least the public funds that our members are with have suffered very significant declines and that we're looking for ways, as Ted said, to tweak the system to make Boards more responsive. The way to do that is absolutely to deal with Board functioning, and we believe that a Board will function much better, at least in the interest of the shareholders, if they don't function as an insider club that can self-perpetuate; and that is to have another input into the process. Brownstein: Why are you so convinced that the nominating process is ineffective, and particularly that it won't improve in light of the Sarbanes-Oxley and Stock Exchange regulations that have just recently been passed? At the same time, you need to recognize that open access is not a tweak. The whole structure of the proxy rules-the disclosure rules, the way the card works, the way the list works and the SEC Staff clearance process-are all predicated on separate disclosures for contesting parties. Would you propose that the insurgent proxy material gets slowed down at the SEC because there's some disclosure problem with the company or vice versa? Koppes: I think we have too much in boardrooms today a feeling that you have kind of a divine right to continue on the Board without anybody challenging that assumption. I think we need to have a dialogue about the proposals from AFSCME and CalPERS and understand that they're not radical - but yet they make people sit up and realize that there could be people that might challenge this "clubbish" atmosphere and somewhat unanimous view that people continue on Boards without any challenge. White: If I could add just one point to this, let's not forget that this process includes at the end of it a majority vote for somebody to get on. No matter where the thresholds are for somebody being nominated, they still have to be elected by over 50 percent of the shareholders. So if owners want to put somebody on and a majority of them vote to do it, then so be it. I'm not sure I understand where your concern is that it's going to politicize the process because owners want somebody new or different on the Board. Hamermesh: I think I can speak to one concern that does exist in an obviously different context. Many states have judges elected by popular vote, and I don't think anybody on this call would assert that the quality of democracy that goes into that choice is really aided significantly by having multiple candidates on the ballot. My concern, as a matter of effective use of the franchise and meaningful and valuable selection of Board members, is that the process unchecked will result in multiple candidacies and more confusion on the part of who's running, what their qualifications are, and perhaps even just other disaffection with the quality of shareholder voting. I realize-and I don't disagree-that with the phenomenon that, Rich, you pointed out, that some directors and some Boards feel they have something of a divine right of self-perpetuation, but I agree with Andy's point that we're in the middle...actually not the middle-we're at the very beginning of a process in which Boards through listing standard changes to some extent promoted by Sarbanes-Oxley, others by SRO initiative, are changing the rules dramatically in a way that I think will significantly affect the phenomenon that you've been talking about. The question I've got is whether it makes sense to undo or radically-and I think it is a radical alteration of the voting structure that's existed historically-to do that at a time when we really have yet to evaluate the efficacy of the reforms associated with the Stock Exchange and Nasdaq. Young: I just think it would be useful though for us to step back for a second and recognize that I'm getting the feeling from some of what people are saying that they anticipate that this is somehow a wholesale change to how all companies will be governed. Although this would apply to all '34 Act reporting companies, in reality this would be used very rarely. I don't think we will be seeing even 50 companies a year where this right was exercised, just knowing the institutional shareholder base as I do. There will be high enough hurdles that this will be something that will be used sparingly, and so I don't think that it will confuse the marketplace so much that we are not allowing the Sarbanes-Oxley and Stock Exchange reforms to also work their magic if that is what will happen. Hamermesh: What hurdles did you have in mind, Beth? Young: All of the proposals back many decades have included requirements for a minimum ownership threshold, in some cases for a holding period or other kinds of procedural requirements for this right to be exercised. I don't think anyone contemplates that I could go in with my 400 shares of Citigroup and have this right; that's not really what we're talking about. We're talking about something that would be used in pretty extraordinary circumstances at companies where there was a broad consensus that some serious changes were needed. Brownstein: But still, notwithstanding that consensus and not withstanding the ownership concentration among wealthy institutions, there would be unwillingness even to threaten one nominee on a short slate. I don't buy the fact that it's expense of solicitation because it's just not that expensive. Certainly any institution that either has three percent or could spearhead a coalition to get three percent of the shares of a large company can bear the cost of a mailing of a card and a letter to a shareholder list. Koppes: You make those contests sound like they're so inexpensive, but they're not. In my experience at ICN last year where I was a "dissident director" and the group did not advertise, they spent almost $3 million-I think that's outrageous-just so that they could have our names on the ballot. I don't know why a CalPERS or an AFSCME should not be able to use the company-not the management's proxy, the company's proxy-to have their candidates on the ballot. Ferlauto: And then remember on top of that is that most of the large funds, or at least some portion, are broadly indexed and we may not be interested in one proxy contest as such but in two or three or four, which would be a very limited number as a percentage of our holdings, but that cost quickly escalates beyond what any fund or group of funds can afford. Brownstein: I think that the reason has to do with the fact that it is the company's proxy statement, and the decision to use that company asset, company space, is in essence a fiduciary decision in and of itself. The nominee of the Board, whether you like that nominee or not, has been vetted by a state law fiduciary process as a representative of all the shareholders. A nominee of a three percent stockholder, whether they're the best nominee or not, in the end of the day is just a nominee of that particular shareholder. Ferlauto: That's actually a very interesting question that you raise. Does that mean that you would think that shareholders would have standing to derivatively sue members of nomination committees in which follow-on directors were engaged in something that led to a dramatic decline in shareholder value or accounting fraud or a variety of other sins in the eyes of shareholders? Brownstein: Shareholders bring derivative lawsuits all the time when stock prices fall. I don't need to comment on the merits of those cases, but they're brought all the time. Young: So are you saying that the contents of the proxy statement reflect fiduciary decisions of the Board? Brownstein: As a matter of state law, the proxy statement is a corporate asset, and the use of any corporate asset is in effect the result of a fiduciary decision. Young: How is that consistent with 14a-8 then? Brownstein: Rule 14a-8 is a federal law that to that extent would preempt that element of the state law. Young: And so an SEC-created right of access to the proxy would similarly layer on a federally-created right to have certain disclosures regarding shareholder nominees in the proxy statement, notwithstanding the resistance of the corporation's Board. Hamermesh: That's right. Andy's right. Brownstein: Subject to the Business Roundtable case. I mean, there are Business Roundtable issues in any rule-making that would come out. But I was really making the point about fiduciary duty before, not so much as a legal argument-although we can get into it-but to get to the policy as to why it makes sense to have a screening for the use of a company asset as opposed to a personal asset. Availability of Shareholder Nominees and Who Selects Such Nominees Young: But then the question becomes who gets to decide what that screening consists of. I guess the proponents of shareholder access would say that to some extent shareholders should have input into that screening process by deciding that shareholders meeting a certain definition that guarantees a certain level of responsibility or whatever should be permitted to have material in the proxy statement as well. Brownstein: If the rule was passed and was a valid one under state and federal law, it would basically delegate that responsibility currently held by the Board to any three percent stockholder or group representing three percent of the stockholders. The question is whether that's an appropriate thing to do. Ferlauto: But it wouldn't delegate to them; it would share the responsibility with them. Brownstein: It would delegate because any three percent stockholder would have the right to have its nominee in the proxy statement. Koppes: One thing that you might consider, the SEC should consider, is whether there ought to be a process where these between three and five percent shareholder groups will be required or suggested-I don't know how you'd phrase it-to submit it to the Board of Directors nominating committee so that there would be some vetting. It could possibly be that the Board would find an excellent candidate that they might want to nominate without having to go to a contested vote on the proxy. Hamermesh: I think that goes a long way to meeting Andy's point, in my judgment. The question really is, and I wanted to raise this earlier and get the sense of the participants on it, to what extent if given the current environment are there genuine obstacles to a supply of qualified candidates. Who is really going to emerge from this process? What do people really think, and who is going to come out that can't come out now? Koppes: I think you're going to see a lot of people who have been on the shareholder side of issues, who have an understanding of that side, and they're not of a management bent. Hamermesh: Where have they been? Koppes: Hey, I've got a large file of them if somebody wants them - a lot of very good people. The search firms are just not looking for them and then Boards aren't considering them. Hamermesh: Are these people presenting themselves to the nominating committees these days? If not, why not? Koppes: Because most of them are thrown in the trash when they come into companies, and people know that self-nomination is a waste of time and effort. Hamermesh: If they are really qualified and we have independent director nominating committees, then I don't think there will be this problem of "throwing in the trash." Brownstein: I think there's a shortage of well-qualified director candidates, particularly for large, complicated companies where a substantial time commitment is required and a substantial level of sophistication is required in order to do an effective job. I think that there's a shortage of qualified director candidates, and I fear that this proposal, which I think could sort of trivialize the proxy contest process, will shrink the available pool. I think directors understand that they're subject to criticism in the press, they're subject to lawsuits, they're subject to proxy contests including short slates, and I mentioned before firms like Relational Investors that had real influence on several companies. But then if you sort of go beyond all of that and say that a group of people large enough to own three percent of the stock of the company but are unwilling to invest in the amount necessary to elect one candidate can just have sort of a free ride, plus maybe have their own proxy solicitation on top, I just think you trivialize the process and shrink the pool of serious qualified people willing to participate. White: Let me weigh in on that a little bit. First, I'm not sure that it's just an issue about the number of candidates. I think that there is a large universe of very well-qualified candidates that don't get fair consideration under the current system, but I think this issue is broader than that. The issue here is about the process. The process leads to accountability for management, who by and large controls the nominating process. This tweak to the system will provide shareholders with some ability to have a larger role than that. That is what will bring the accountability-when the directors know that they can be re-nominated or nominated by shareholders, that's who they're going to feel accountable to. Again, that's what this is all about to us. More Disclosure as a Possible Solution Romanek: What about sort of baby steps as we wait to see how the recent reforms take hold what if the first step was merely a disclosure regime where the governance committee included a report in the proxy statement - just like the audit and compensation committees now do - about what their process is, whether they received shareholder nominations, whether the governance committee did consider them, and what criteria was used to assess the candidates? What are people's reactions to that? Brownstein: My question, Broc, is why do you need to enshrine that in an SEC rule. I think that if I were a shareholder advocate and I submitted a qualified candidate to the nominating committee that was rejected, I can ask the Board for an explanation just as I would ask them for a response on any other shareholder proposal. Boards respond to institutional shareholders as to their actions on shareholder resolutions. Shareholders may not always like the response, but Boards tend to respond and their responses are publicized. Do we really need to get the SEC in the business of monitoring that, regulating that, reviewing it? There will undoubtedly be issues as to compliance with such a rule. It seems to me that the disclosure regime can be self-generating, and if I were at the SEC I would ask why do we as an institution have to sort of get involved in that from a regulatory perspective. White: I'll add to that, Broc. I think actually disclosure in this particular case, while never bad, is really a weak solution to a fairly significant problem. We would never be against greater disclosure or the process for nominating committees; in fact, we focus on it a lot-it's important. But that's really not going to affect the accountability that much. Romanek: Anybody else? Koppes: I would agree with Ted. I think it's very much a baby step, but I would like to see something much stronger put in. Let me talk to the view that there's a scarcity of good directors; I just simply don't agree with that. That's not been my experience. What we're going to have a scarcity of, and we already do, is CEOs who serve on too many Boards - and directors that want to serve on six, seven or more boards. Yes, those people are going to be scarce, and that's a good thing. But I think we still have an excellent pool of potential directors out there. I think the search firms need to do a better job. I think these proposals will help that process. Romanek: I would imagine the search firms would also have a new line of business in that investors would be hiring them perhaps to help recruit their nominees as well. I don't know if that's been tapped into yet. Koppes: Certainly, and that's another good vetting process. Ferlauto: It hasn't been worthwhile for shareholders to search out directors when the likelihood that those directors are going to be moved through a nominating committee is very, very low. Importance of Board Collegiality Romanek: I know in Europe, at least Germany, boards must include labor representatives on the Board. I've talked to a few people that work inside companies who have attended Board meetings of those types and they believe those boards are not as effective as collegiality definitely suffers. Even if this only happened at 50 companies, if that's truly what happened, how would you imagine the scenario would play out at those companies to ensure that they had effective boards over time? White: In Germany they have a designated right to a number of seats to a constituency. I fail to see the comparison here. There's no designated right for a constituency at all. You have to get elected by 51 percent. That's fundamentally different. Ferlauto: I would imagine that as candidates were being run through this process were it to take place is that these would be credible candidates who've got a background in the industry and who are independent. Koppes: And who would understand that once elected they would have a fiduciary duty to all shareholders. Ferlauto: Absolutely. Brownstein: I think that that's not clear. Given the institutional share holdings at a lot companies nowadays, there are many companies where there are three percent shareholders or where a handful of institutions control a sufficient number of shares to get the election of one candidate. And who is to say that the nominee will have industry experience or will not view himself or herself as primarily the spokesperson of the nominating group. Its often more difficult to oppose a single candidate than a slate - because a slate, to take control, is fundamentally changing or usually is expected to have a proposal to fundamentally change the direction of the company. The attitude of many institutional shareholders with respect to another shareholder nominating a single candidate is: how could one person upset the apple cart so much, what's the downside? Which is why the short slate proposals enacted in 1992 have been so effective in changing the composition of Boards when they've been used or threatened. I think what all this discussion ignores is that, at least in my experience, there's more open discussion, greater freedom to dissent and to ask questions on a Board of Directors that is not a politicized Board. It's my feeling that if you have the three percent "freebie proxy contest" regime, you'd have just more proxy solicitations and politicization of boards because it's just that much easier to wage a proxy contest. I think that will reduce the quality of Boards rather than increase it-which is the fundamental judgment we should all be talking about. White: One point. You've mentioned three percent here numerous times. I just want you to know that there's not universal agreement that three percent will be the right threshold. In fact, I think there's probably a larger universe at five percent, including the counsel and our own. That's not something that I would use as an arguing point if you're against this, to say that you should forget it because everybody's at three. Brownstein: I'm just responding to the AFSCME proposals that were made this year. I also believe that there was a request for rule-making last summer at the Commission also at three percent. The SEC can consider whatever percentage it thinks is appropriate - and obviously at very high percentages it's less of a concern to folks like me than it is at lower ones. I think that given the shareholder makeup of most large companies whatever percentage is picked I have to assume is going to be one that will be effective at increasing these "freebie proxy contests." This debate is not about shareholder nominations because shareholders can nominate director candidates and can solicit proxies if they choose. What it's about is freebie proxy contests. White: Actually it is about those two things because that doesn't exist. Koppes: I think we have a fundamental disagreement on that, too. Use of "Short Slates" Koppes: You know, Broc, Andy's mentioned and maybe other people-Larry, I believe the short slate idea, one of the "reforms of 1992." I wonder how often the short slate has even been used. I don't think all that often, but I don't know for certain. That would be one area that some research ought to be done - to see how "effective" the short slate reform of 1992 has been and how often its been used in the last ten years. Young: It's interesting. I can't speak to how often contests are threatened. I think Andy pointed out, this has been in the background of negotiations between companies and shareholders that sometimes don't result in consummated proxy contests; but I spoke with ISS about how often it is voting on proxy contests in its universe of 10,000 companies, and since January 1st of last year, 2002, it has voted on 45 which, when I kind of did the math, came out to about 33 in a year over that 18-month period. I went back to an old law review article about equal access to the proxy that reported IRRC statistics from well before 1988 or so that said that they had about 30 that year - which means that this "short slate reform" has not resulted in an increase in the number of contests overall. Keeping in mind of course that both of those totals include control contest proxy contests as well as short slates, but there has not been a large shift overall in the number of contested elections just in general. Brownstein: The short slate is a powerful threat, though. It is a powerful threat and has, at least in my experience, changed the composition of Boards when you have a serious stockholder that is proposing one or two nominees. Hamermesh: And what we're talking about today would not actually be reflected in significant new numbers of contests, but would rather be reflected in amicable negotiation and resolution- it would just be a factor in the discussion between management and the stockholder who wants to put a candidate on the slate. I think that the real question is what it does to the dynamics, and I'm not sure it's possible to tell how it will ultimately affect people in the long run. If, however, it's a significant point of leverage for a three percent or five percent or ten percent stockholder group, then the real question is what happens when that group's nominee enters the boardroom if it does. I just suggest, as Andy did, that there is an unhappy history of outright animosity between a person like that and the incumbent directors, and a process that encourages that kind of opposition will I think lead to the kind of problem that we see in German corporate governance with co-determination where the incumbents or the people who are actually managing day-to-day just simply don't cut in the other constituency on the decision-making or informational process. Ferlauto: That actually may be the very reason why we need it. You have to remember that this person-if they were elected from a three, five or ten percent group-would have to be elected by a majority of the shareholders, number one; and number two is that wouldn't be a constituency group nominee by the very fact of the election process, but would be broadly representative of shareholders who were moved to engage in this because they thought there was a fundamental deficit in corporate governance of a particular company. If that were case, maybe the directors should be upset and maybe there should be others that join that one- or two-person short slate. Romanek: Do you think in the cases where there were these types of contests, should discretionary voting still reside with management? Several: No. No. Absolutely not. Ferlauto: That would subvert the whole purpose for this. Number of Candidates and Disclosure Framework Romanek: And would the SEC Staff still referee the process of reviewing the materials and providing comments? I would imagine it would be the same proxy card. Ferlauto: We imagine that there would be one proxy card and that the SEC, as they would now, would review that for the various disclosure requirements. Brownstein: I think that the difference between then and now is that when the SEC reviews contested proxy contests, one side's materials do not hold up the other's. What you have in a common situation-everything gets held up because the staff adds another layer to the process. It's all in the company's materials, and how does the company protect itself against that? The whole structure of the proxy rules in contested situations is premised on separate cards and separate statements and reviews. It will undoubtedly be, in a contested situation, quite confusing to have it through one document. I think that this is not a tweak to the system. I think that all the rules would need to be thought through with respect to how they would apply in a hard fought contested situation if you have sort of single card, single statement. And then I say, why? Is it true that the cost of the current system is that significant for large companies with five percent stockholders or even three? And is it true that there's not today sufficient pressure through the short slate mechanism to effect change? What you're really talking about is somebody who has the ability today to elect a director and has the ability to nominate a director. Up to this point they've been unwilling to bear some expense, and that's proposed to be shifted over to the company in a format that could engender significant confusion and a significant number of nuisance situations. Koppes: I just don't feel we have enough proof or statistics on the effectiveness or the power of the short slate. I just don't think that it has been much of an effective form, but I don't think we have enough proof or statistics to say one way or the other on that. Brownstein: If that's true, why do you think that this... Koppes: Because the expenses are still there for the short slate. I just think it's an outrageous situation and I disagree that it's going to be more confusing. Frankly, it will be less confusing for shareholders to have one ballot. Ferlauto: Clearly it's confusing for shareholders at this point. If they don't want to vote for the director and want to vote against them, what do you do? You don't vote. The way we have elections right now are really quite cryptic is you withhold votes and then you read the tea leaves by comparing vote totals as to who's down and who's up. I can't think of a more convoluted, confusing system than that where there's no clarity to the ballot at all. Brownstein: But at least you know who is nominating and supporting each candidate. You can't compare a contest to a non-contest. You're right-if you want to vote against - and there is no contest - you can withhold because there's no opponent. But that is not what we are talking about. You can't compare a single ballot in a non-contested situation to a proxy contest where today there are two ballots. In the current system, it's very clear who is the company nominee, who is the alternative nominee. They have different colors, there's different recommendations, there's different materials. White: Why would you assume that shareholders be confused because their choices are on one page instead of two? Brownstein: Who's making the recommendation, and what is the reason for the recommendation? Koppes: You can say that in plain English on the card - on either side of the two sides of a proxy card. White: You're assuming that there would be some kind of prohibition from management saying this is an incumbent and a shareholder saying this is a dissident. That seems ridiculous to me. Neither side would want their candidates to be put into a blind pool and shareholders just sort of take a lottery; that's not the point. Hamermesh: You're also assuming there's just going to be one non-management or non-incumbent nominee. What if we have multiple ones? White: Multiple ones for the same seat, you mean? Hamermesh: Well, I don't know if it's for the same seat or not; that's the problem. It's very confusing. White: Right, I would call for less than a majority in a situation for seats to be up for open access, but I don't think it would be productive to have multiple shareholder groups putting up multiple candidates, nor do I think it would be possible. Brownstein: What would we do to prevent that? White: I think the rule could be pretty simply designed to do that. For example, shareholders can't put in two shareholder proposals on the same issue, and it's based on a first come, first served. In any event, if you left that alone, the likelihood that two shareholder groups independently could get a mass of the thresholds together and would end up running two individual slates is remote, at best. Brownstein: Again, we're all sort of speculating on what would happen, on how many of these things you would have, on whether they'd win or not. It's still not clear to me that it is worth changing, particularly at this point. There are a lot of things that have been done in the past year in particular to improve the effectiveness of Boards of Directors. Young: I want to just step back for one second again and make a point that seems really painfully obvious but that nobody has articulated here. I've heard a lot about "freebie proxy contests," and essentially this is shifting the cost to the company. Shareholders are the company in a real sense, and though there are many other groups and constituencies with claims against the company, but in the end shareholders are not shifting costs to an entity with which they have no relationship. Brownstein: Yes, but a three percent stockholder is not the company. Young: I guess I'm not really talking about this in a legal sense. I'm talking about this in the sense that there's been a lot of rhetoric here that makes it seem that shareholders have no relationship to the company. I'm just trying to stress that ultimately all of this is geared toward...however we may disagree about particular mechanisms, shareholders are interested in doing this because they believe it will improve the performance of the Board and thereby improve the performance of the company. The idea that the corporate treasury is somehow something to be used only by the incumbent Board and management, it strikes me as wrong-headed. Brownstein: I don't disagree with the notion that what we're about here is improving the company and the effectiveness of the Board for the benefit of the shareholders. It's not for the benefit of the management or for the benefit of the Board of Directors. The only point is that you're giving...if it's three percent or whatever percent, it could be one percent...you're giving that percentage of shareholders a call on the company assets that no other group has. Every other call on company assets passes through a fiduciary decision. If the federal government seeks to impose such an obligation preempting state law fiduciary principles we'd need to consider the implications of the Business Roundtable case. Ideal Frameworks for SEC's Consideration Romanek: We just have just a couple of minutes-so I will ask each panelist to spend a minute or two laying out what they think would be the ideal framework for the SEC to propose. Why don't we start with Rich Ferlauto. Ferlauto: This is the framework that we've laid out is that we're looking for an access threshold. We think that three percent is appropriate - but that could be under discussion. If it were to be five percent or above, there would have to be some relief from 13d that we haven't discussed, but so be it. Number two is that there should be a holding period of some length so that this couldn't be used by arbitrage or short sellers or other types of short-term holders but definitely somebody who is intent on holding their stock for a long term. Number three is that this only be used for short slate purposes. There's some discussion about what that right number should be-whether it's less than a majority, which is what we think is appropriate-but there should be some number of thoughts more than one and less than a majority. Number four is that there be true equal access, and that is that the shareholder statement be a reasonable length and that there be some equity in the distribution of the campaign materials-there's been some discussion about use of the web, for example-so that there be equal access between the management and the shareholders for doing that. Not all disclosure requirements should equally apply to the incumbent director and the shareholder-sponsored candidates. So I think that's the general framework that we're looking for. I think it will be up to the Staff to get wide input from shareholders to hone the specific rules, but that's certainly the context that we're looking to frame this type of shareholder right. Koppes: I would say that a five percent minimum is a good place to start, and I guess I would go with two years holding. I think one year is just too short, and I think frankly beyond two years you're a long-term holder by any means these days. I would agree with Rich Ferlauto on the other limitations, and particularly this being used only for short slate purposes. Hamermesh: I think the real question that the SEC needs to come to grips with as it reviews this is, first of all, the subject matter jurisdiction or authority issue that Andy referred to; and second, and perhaps even more important, the question of whether or not or the extent to which existing mechanisms work or the extent to which there really are supplies of qualified individuals out there who will be freed up for this purpose. I think that's something that really ought to be considered -- is there really a bang for this buck? Young: I'm not wedded to any particular formulation. I think that the SEC will weigh how best to ensure that this right is available and usable - but not abusable - and that it will be used responsibly by the kinds of shareholders who can be expected to really have the long-term interest of the company at heart. Brownstein: I think that this is an issue that has sort of a surface political appeal, but when you really bear down and think about how it would work, there are lots of complexities and problems that the SEC needs to focus on. It's just not consistent with the current structure of the proxy rules. It's not a simple tweak. In the end, I think you get to Larry's question: Where's the bang for the buck? I don't think it's there. I think this proposal ultimately would have a negative impact on the quality of people serving on Boards of Directors - and on the effectiveness of Boards. This also is the wrong time to consider any change. We should have time to assess the impact of Sarbanes-Oxley and the new SRO rules. White: We actually have a policy statement on our website from the March agenda item if anybody cares to look through it, but I'll just briefly touch on it. We address really what we consider to be the three primary policy issues. First is the threshold-we think five percent is the right starting point and with 13d relief. We have a one-year holding period, but I would tend to agree that there's absolutely no problem with having that longer. On the control issue, we believe that it should be for less than a majority; and on the expenses, that there should be no automatic reimbursement provisions in this for shareholders but some mechanism where they might be able to seek it through like a concurrent proposal. I'll just add one thing from the comments that were made. In regards to the supply of directors, with all due respect I don't think that's the SEC's purview. I think that's really the shareholders' purview-that it's really up to us to source and identify candidates and to solve the supply issue, so I don't that should really be a concern. Then on one last point since I get the last word, I guess, is if you want a signal on how shareholders feel about this issue you should look at the policies that are being developed and the positions that are taken by organizations like the Council of Institutional Investors and us. Shareholders clearly think that there's something wrong with the current system, and so the statement that we shouldn't worry about it because it because there's nothing wrong with the existing nominating process I think is really deflated by the fact that shareholders are calling for this from all angles. Romanek: I want to thank all the panelists for engaging in this debate. I believe it's a healthy debate and important in framing the complex issues that the SEC should consider during their deliberations. |