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Staff Issues Report on Shareholder Access to Proxies

Following an SEC call for a "thorough review of the proxy rules and regulations to ensure that they are serving the best interests of today's investors, while at the same time fostering sound corporate governance and transparent business practices," the Division of Corporation Finance staff published a report of its study and recommendations. After reviewing the input from 690 commenters, the staff recommended that the SEC should propose rules requiring 1) enhanced disclosure related to nominating committees and the nomination process, 2) specific disclosures regarding shareholder communications with board members and 3) conditional shareholder access to a company's proxy materials for purposes of nominating candidates for election as director.

As recommended by the staff, such shareholder access to company proxy materials would be "conditional." Shareholder access under the recommendations would not facilitate control contests, as both access and the number of shareholder candidates would be limited under the recommendations.

Initially, the staff concluded that any such access would have to be consistent with federal and state law as well as SRO listing standards. A key condition suggested by the staff, however, was that enhanced shareholder access would only be available upon the occurrence of "specific triggering events." According to the staff report, objective criteria "evidencing potential deficiencies in the proxy process such that shareholder views--especially those of a majority--may not otherwise be adequately taken into account" should be defined.

Review Process

The staff advised Citigroup, Inc. (¶78,503) that it could exclude a shareholder proposal submitted by the American Federation of State, County and Municipal Employees Pension Plan that would have required the company to include in their proxy materials the nominee of any shareholder or group of shareholders beneficially owning three percent or more of the company's outstanding common stock. According to the staff, the proposal could be excluded under Exchange Act Rule 14a-8(i)(8) concerning director elections.

Although the full SEC did not disturb the staff position, the agency directed the division to review the proxy rules and regulations regarding the election of corporate directors and solicited public comment on the matter. A summary of the comments may be found on the SEC Web site at http://www.sec.gov/news/studies/proxycomsum.pdf.

The majority of commenters, 424 of 690, were individuals. Institutional investors, attorneys, corporations and corporate officers, shareholder resource providers, investment advisers and managers and academics also responded. Most commenters supported the idea of modifying the proxy rules and regulations related to the nomination and election of directors, stated the staff, with the exception of the corporations and corporate executives, the attorneys and the business associations.

After reviewing the public comments, the staff identified several alternative approaches to the regulation of the electoral process for corporate directors. These included 1) requiring companies to include shareholder nominees in company proxy materials, 2) requiring companies to deliver nominating shareholder proxy cards along with company proxy materials, 3) requiring expanded disclosure regarding companies' nominating committees and the nominating process, 4) requiring expanded disclosure regarding shareholder communications with board members and 5) revising Exchange Act Rule 14a-8 to allow shareholder proposals relating to a company's nomination process.

Inclusion of Shareholder Nominees in Company Proxy Materials

Most individual commenters supported this alternative, under which a company would include shareholder nominees on its proxy card. According to several commenters, shareholder access to the company's proxy materials would be the most direct and effective method of giving shareholders a meaningful role in the election process. The comments also suggested that such access would make corporate boards more responsive and accountable to shareholders, as well as increasing the diversity of corporate boards.

Opponents of shareholder access, however, claimed that such a change would be disruptive and costly, as routine elections would often become contested. These commenters also suggested that such contests could discourage qualified candidates from agreeing to serve on corporate boards.

The staff stated that two fundamental considerations in proposing any shareholder access rule are "when the rule may be used and by whom." The staff's discussion of when the rule could be used focused on whether the availability of shareholder access should be conditioned on the occurrence of specific triggering events and on eligibility requirements, including ownership interests and holding periods.

The staff report described a balancing of interests that the SEC should undertake in its review. The staff conceded that a triggering event requirement would add additional complexity to the operation of the rule and would limit the circumstances in which shareholder access would be available. This approach could, however, address the concerns of some commenters regarding the adverse impact of such a proposal on all public companies, noted the staff.

With regard to what events would be appropriate triggers, the staff cited a company's failure to act on shareholder proposals that receive majority votes, the receipt of significant percentages of "withhold " votes in director elections or the approval of a shareholder proposal to activate the shareholder access rule. According to the report, these triggers would involve the use of " objective evaluative criteria " and are directly tied to the effectiveness of the proxy process, as compared to general indicators of company performance.

Shareholder eligibility also generated significant public comment. Many individuals argued that the SEC should not impose minimum ownership requirements, because holders of such large stakes would have the means to run their own slate of directors through a separate proxy statement. According to the staff, the most frequently suggested ownership minimums were between three and five percent of a company's outstanding common stock.

Issues presented by the establishment of ownership thresholds include whether shareholder interests could be aggregated to reach the requisite level. Similarly, the staff noted the question of whether such agreements could create reporting obligations under Exchange Act Section 13 or short-swing profit concerns under Section 16.

Another area of concern with regard to ownership thresholds involves the triggering of "poison pill" takeover defenses. According to comments from Institutional Shareholder Services, in order to prevent the filing of director candidates from triggering these takeover devices, the ownership threshold should be set below the triggering level at companies that have such takeover defenses. According to the staff report, under state law, the acquisition of a 15 percent interest is often sufficient to trigger the poison pill provisions.

As recommended by the staff, the revised proxy rules should contain minimum standards with regard to shareholdings and the length of time those shares have been held by a nominating shareholder or shareholder group. The staff did not recommend any specific ownership levels or holding periods, however, and suggested that the SEC solicit public comment on these matters.

Disclosure Recommendations

According to the division, the SEC should propose new requirements for disclosure in company proxy materials relating to nominating committees and the company's procedures, if any, for allowing shareholders to communicate with board members. The recommendations call only for enhanced disclosure concerning the nomination process and do not require the inclusion of shareholder nominees.

The staff noted that currently, the New York Stock Exchange and Nasdaq have proposed revised listing standards that would require listed companies to have independent nominating committees. The exchanges have not, however. proposed any changes that would require nominating committees to consider shareholder nominees.

As recommended by the staff, the SEC should propose rules requiring companies to include disclosure regarding a company's nomination process. This disclosure should include: 1) the nominating committee charter, if any, 2) nominating committee member independence policies, 3) candidate selection criteria and procedures, 4) policies with regard to candidates recommended by shareholders, 5) procedures for shareholder nominations, and 6) information concerning decisions by the nominating committee not to include a candidate named by a shareholder who has beneficially owned greater than a specified amount of the company's voting common stock for a minimum specified period of time.

The staff cited enhanced disclosure concerning nominating committees as a cost-effective way for shareholders to influence board composition without requiring extensive changes to the proxy rules or implicating state law issues surrounding the nomination and election of directors. Such an option, however, does not ensure that shareholder recommended candidates are included in the company's proxy materials. Many commenters also raised concerns that companies may include boilerplate disclosure in their proxy statements to satisfy any expanded disclosure requirements.

The staff also called for enhanced disclosure regarding shareholder communications with board members. Such disclosure should include information concerning 1) the manner in which shareholders can send communications to the board, 2) the names of those board members to whom shareholders can send communications, 3) the company process for deciding which communications are relayed to board members if not all communications are presented, 4) the number of times individual board members met with shareholders in the prior year and 5) any action taken by the board as a result of the communications.

SEC Chairman William H. Donaldson stated that "an effective proxy process has never been more important to restoring investor confidence, " and added that the SEC " will continue to work with the markets to put in place listing standards and rules that increase both the role of independent directors and the voice of shareholders." The next step, he concluded, " is to assure that the proxy process reinforces these important advances." The chairman indicated that the SEC hopes to consider disclosure proposals next month and may address proxy access proposals by September 2003.

¨ Staff Report: Review of the Proxy Process Regarding the Nomination and Election of Directors is reported at ¶86,938 .