(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

SEC Will Soon Consider Shareholder Election of Directors

As the deadline for a staff report on shareholder election of directors nears, the SEC is evaluating a great number of comments on the issue. A number of commenters urged the Commission to go slow and allow the Sarbanes-Oxley Act corporate governance reforms to take root and prove their efficacy, while others recommend permitting significant, long-term investors to place their nominees on the company's proxy ballot.

Earlier this year, the Commission directed the Division of Corporation Finance to formulate possible changes in the proxy rules for the election of corporate directors. The review will address shareholder proposals, the nomination process, elections of directors, the solicitation of proxies for director elections, contests for corporate control, and the disclosure and other requirements imposed on large shareholders and groups of shareholders. As part of this process, the SEC asked the staff to consult with all interested parties and produce recommendations by July 15, 2003.

Members of an ABA Task Force on Shareholder Proposals urged the SEC not to broadly encourage contested elections when changing the director selection process. They believe that widespread and ongoing contention of this kind involving public companies would be disruptive, expensive and contrary to the best interests of both companies and investors, and would likely be adverse for the corporate governance system and the ability of companies to successfully conduct their businesses.

In addition, the members do not believe that Exchange Act Rule 14a-8, the current shareholder proposal rule, is the appropriate vehicle to deal with the issues raised by enhanced shareholder involvement in the selection of directors. Rule 14a-8 has specifically defined uses and contains many exclusions. Administration of the rule is already burdensome for the staff, the members reasoned, and expanding it to address the intricacies of the director selection process would inevitably require increased staff involvement.

The members posit the principle that transparency in respect of the interests, goals and plans of a director candidate is central to the disclosure system and can be provided in a manner that is not burdensome. In this regard, the task force members urged the SEC to address the disclosure and filing obligations of both a shareholder proponent and a director nominee with respect to their intentions regarding corporate control and any special interests they may have in regard to the company.

It is important for investors to know what a shareholder proponent has in mind regarding control and any interest or agenda it may have that may not be shared by the other shareholders. While matters of intent are inherently subjective, acknowledged the members, shareholders are entitled to be informed as to the goals and plans of the proponent and its candidate, just as they are informed regarding the intentions of the company and the incumbent directors.

The members recommend that consideration be given as to what disclosure in this area is to be required, in what timeframe and in what filings. In particular, the report should address, in the context of any proposed changes in the director selection process, the availability to shareholder proponents of Schedule 13G filings, 13D group formation criteria and the need for disclosure respecting parallel action by shareholders, even where a 13D group is not formed.

Finally, the ABA members noted that the mechanics of shareholder voting are complex, particularly where shares are held in street or other nominee name. Thus, in considering amendments to the proxy rules with regard to the director selection process, they urged the Commission to examine the current procedures closely in order to make certain that shareholders have adequate opportunity to vote and that the tabulated voting results reflect their wishes.

In its letter to the SEC, the American Society of Corporate Secretaries pointed out that directors have a duty to nominate persons they believe will serve the best interests of all shareholders, while no similar fiduciary duty is imposed on shareholders. In addition, the society believes that contested elections will result in constituency boards, which it said is counter to the focus of recent regulatory and legislative reform initiatives.

As a result of new independence requirements, board nominating committees must perform an extensive amount of due diligence on both candidates and current directors, noted the society. Moreover, audit committee members are subject to financial literacy and expertise requirements. The Commission has placed these responsibilities solely on the company in the apparent belief that the current board will control the nomination of director candidates. The society queries whether the nominating committee would have the authority to do the same type of due diligence regarding the candidates in the contested election context.

While acknowledging that shareholder democracy is an appealing notion, a task force of the Association of the Bar of the City of New York emphasized that such a notion can be misleading if it is mistaken for a tonic to cure all corporate governance ills. An access proposal poses a substantial risk that it would not improve corporate governance, said the task force, but rather would increase the risk of "balkanized" boards lacking independence in the most significant sense of owing their undivided loyalty to the shareholders as a whole.

The bar group urges the SEC to give the changes to the corporate governance scheme reflected in the Sarbanes-Oxley Act a chance to work before any significant change to the proxy scheme is considered. Finally, the task force believes that any change in the fundamental way in which nominations of board candidates are made, a subject traditionally committed to the business judgment of the board, should be the province of state, rather than federal, regulation.

The American Corporate Counsel Association also asked the SEC to proceed cautiously in this area until the full impact of the Sarbanes-Oxley Act and its related rulemakings can be assessed. The corporate culture truly is changing at a number of companies, the ACCA noted, and the need to allow these changes to take root is great.

Similarly, the Investment Company Institute urged the Commission to defer deciding whether to undertake a comprehensive review of Rule 14a-8 until the many proposed improvements to the corporate governance structure of public companies have been implemented and their consequences made clear to regulators, shareholders, issuers and the marketplace.

In the view of Institutional Shareholder Services, the SEC should allow reasonable access to significant investors to place their nominees on the company's proxy ballot, but the power to offer such nominees should be limited to significant, long-term investors not seeking to change corporate control. According to ISS, long-term should mean at least one year of continuous ownership of the qualifying block of shares. In addition, qualifying significant shareholdings should vary with the size of the company. At the very largest public companies, holdings of as little as 3 percent to 5 percent of the outstanding shares should suffice. At smaller companies, however, qualifying holdings of 10 percent or more may be prudent. ISS also believes that groups of smaller shareholders should be allowed to combine their holdings to reach these ownership thresholds.

In order to prevent the filing of director candidates from triggering poison pill or other takeover devices, the ownership threshold should be set below the triggering level at companies that have such takeover defenses. In addition, ISS recommends that each qualified shareholder or group should be limited to one nominee at a meeting for each qualified investment stake that it holds. Thus, a shareholder with a ten- percent stake would be eligible to place two candidates on the ballot at a company where the access threshold is five percent. ISS also urges that the number of shareholder nominated candidates at any meeting be limited to less than a majority of the entire board.