submitted to the
Securities and Exchange Commission
in connection with the
"Problems With The Proxy Process" Panel
Roundtable Regarding Proposed Rules Relating to Security Holder Director Nominations
File No. S7-19-03
March 10, 2004
This statement is submitted in connection with a roundtable panel discussion concerning the Securities and Exchange Commission's proposed rules relating to Security Holder Director Nominations, File No. S7-19-03. I currently serve as Chairman of the Corporate Governance Task Force of the Business Roundtable, an association of chief executive officers of leading corporations with a combined workforce of more than 10 million employees in the United States and $3.7 trillion in annual revenues. I also am Chairman, President and CEO of Autozone, Inc., the largest auto parts chain in the United States, which employs more than 45,000 individuals. I appreciate the opportunity to speak on behalf of the Business Roundtable regarding the proposed rules, which would have significant, far-reaching implications for all companies and shareholders if adopted.
The Business Roundtable has long been-and will continue to be-a strong supporter of good corporate governance. We have advocated corporate governance best practices for more than three decades, beginning in the 1970s with our first statement on corporate governance, and continuing through the 1980s and 1990s with numerous publications addressing corporate governance best practices. We share the Commission's belief that corporate boards and management must hold themselves to the highest standards of corporate governance. In this regard, the Business Roundtable has issued numerous statements regarding corporate governance, including Principles of Corporate Governance in May 2002, and Executive Compensation: Principles and Commentary in November 2003 [and most recently, The Nominating Process and Corporate Governance: Principles and Commentary (March 2004)]. The Business Roundtable strongly supported enactment of the Sarbanes-Oxley Act of 2002, implementation of the Commission's rules related to the Sarbanes-Oxley Act, and revisions to the corporate governance listing standards of the New York Stock Exchange and NASDAQ Stock Market, Inc.
Although the Business Roundtable has supported all these recent reforms, we are opposed to the proposed rules as they do not represent good corporate governance. There are a number of reasons for our concerns. First, the proposed rules would be applicable to all public companies, contrary to the Commission's goal of targeting a limited number of unresponsive companies. Second, the rules would enable a small number of shareholders representing special interest agendas to impose costs on all shareholders, by triggering the rules' election contest procedures. Third, the election contests that would result under the proposed rules will be quite costly, and will divert the time and energies of corporate management from the business of running the company. Finally, the election of directors under the proposal will threaten the cohesion that is indispensable to an effective board of directors.
These adverse consequences are all the more regrettable, we believe, because there is not a problem with the proxy process that warrants adoption of the Commission's proposal. The Commission has stated that that the problem it intends to address through this proposal is a specific and discrete one. The proposal, it has said, "relate[s] to the proxy process in connection with the nomination of directors." Security Holder Director Nominations, 68 Fed. Reg. 60,784, 60,790 (Oct. 23, 2003). It is "dissatisfaction with a company's proxy process" in director elections that the Commission has said it intends to address. Id. The Commission's own data indicates, however, that there are not serious problems with the ability of the proxy process to produce nominees for corporate director positions that are acceptable to the vast majority of shareholders. Through one of the proposed triggering events, the Commission has indicated its view that a principal measure of whether the proxy process is flawed at a particular company is whether a substantial number of withhold votes have been cast against director nominees at the company. The Commission's data from the proposing release indicates that just 1.1% of companies experienced a withhold vote of 35% or more in the last two years. A situation affecting such a small percentage of companies hardly supports such a far-reaching and-we believe-costly rule as the Commission has proposed.
There are, in fact, a number of means by which shareholders currently can influence who is nominated for a seat on corporate boards of directors. Shareholders can and do submit director nominees to a board's independent nominating committee. New NYSE and NASDAQ listing standards that were strongly supported by the Business Roundtable require independence for each member of a company's nominating committee. Notably, independent nominating committees have a fiduciary duty to consider and select candidates in the best interests of a company and all of its shareholders. It is preferable to have an independent nominating committee select nominees for inclusion in company proxy materials rather than, for instance, a 5% shareholder as would be permitted by the proposed rules. A single shareholder may often select a candidate to further a specific agenda rather than to advance the best interests of the company and all of its shareholders.
Shareholders also are able (subject to state law) to run their own candidates to fill director positions. At companies where shareholders are dissatisfied with the director candidates presented, or with current management generally, they can and do prepare and disseminate their own materials in support of those candidates. Shareholders have used existing rules to launch successful election contests on numerous occasions. The Teachers Insurance and Annuity Association-College Retirement Equities fund successfully ran a seven-person slate to replace the entire board of directors at Furr's/Bishop's in 1998. Shareholders also have nominated and elected dissident directors at United Industrial, ICN Pharmaceuticals, Lone Star Steakhouse & Saloon, Hercules, Liquid Auto, and numerous other companies.
Finally, of course, it should be borne in mind that shareholders have other, quite effective means of expressing their view of current management in addition to the votes they cast (or withhold) in elections for directors. By making their initial investment in a company, shareholders effectively "vote" for existing directors, who are obliged to make decisions in the best interests of the company and all of its shareholders. Those directors should be permitted to act on behalf of the great majority of shareholders who support them, without having to fend off unnecessary and unwarranted election contests by a small number of shareholders as encouraged by the proposed rules. When shareholders become dissatisfied with current directors, they can and do "vote with their feet" by selling a company's stock if their concerns are not met.
Shareholders can also voice dissatisfaction through shareholder proposals, which can and do influence company behavior when they receive significant support at annual meetings. Among other companies, Merck, Bristol-Myers Squibb, Hewlett Packard, Circuit City, Kodak, and Union Pacific recently have adopted policies in response to majority votes on shareholder proposals. Companies clearly take shareholder concerns very seriously.
Although the Commission has suggested that the problem it intends to address through these proposed rules is the discrete and specific problem of the failure of companies to be responsive to shareholders during the proxy process, many commenters have attributed much broader objectives to the Commission's proposal. They believe that the proxy contest is too cumbersome and costly a process. Other proponents favor the proposals because they believe it will give them the leverage necessary to force a wide range of changes in the management and policies of American corporations. To these supporters of the Commission's proposal, the value of the proposed rules lies less in their changes to the proxy process, than in their potential to radically reorder the relative roles of corporate shareholders, directors, and management.
Such perceived "problems" are an inappropriate basis for this rulemaking. First, they exceed the Commission's authority and improperly intrude on the role of the states. The Commission's authority to regulate the proxy process is not intended to be a means of fundamentally altering the relative roles of shareholders and management in the selection of nominees for corporate board of directors. Unfortunately, it appears that this is the principal purpose of the proposed rules.
Second, the timing of these proposals is particularly inappropriate. There have been more reforms to corporate governance in the last twenty-four months than in the prior twenty-four years. The recent reforms implemented by Congress through the Sarbanes-Oxley Act of 2002, the Commission through its rulemaking implementing Sarbanes-Oxley, and the exchanges through their revised listing standards must be fully implemented, evaluated, and understood before we can know whether more change is needed, and what form any additional change should take. And yet, many of the NYSE and NASDAQ corporate governance listing standards largely do not even go into effect until later in the spring of this year. Similarly, the Commission only recently adopted new rules requiring enhanced disclosure about nominating committee processes and shareholder-director communications.
Data collected by the Business Roundtable and other sources indicate that recent reforms are working and that measures like the proposed rules are unnecessary. Among other things, most companies now have independent boards of directors, perform director evaluations, and encourage or require director education programs. For the Commission to impose a complicated, costly process on all public companies now, without knowing whether further reforms or what types of reform are needed, is to take inappropriate and unjustified risks with our economy.
Third, whatever problems some observers may believe exist in the proxy process, they do not justify the profoundly adverse consequences for public companies and their shareholders that would result under the proposal. The Commission has said that its objective in this rulemaking is to target a relatively small number of nonresponsive companies. But in fact, the proposed rules will affect virtually all public companies, regardless of their corporate governance practices or their responsiveness to shareholders. That is because even at healthy, well-managed companies, the proposed rules would enable a 1% shareholder to trigger the rules' election contest procedures. When these election contests do occur, companies' officers and directors often will determine that their fiduciary duties require them to expend considerable resources-both time and money-scrutinizing and challenging unqualified nominees who have been placed on the ballot by special interests. Finally, when alternative directors are seated under the proposed rules, the prospects for a divided and ultimately dysfunctional board will be sharply increased. In my experience, cohesion among the members of a board of directors is critical to board functioning. Under this rule, however, special interests would have a far greater ability to elect directors whose primary allegiance is to a particular issue, cause, or group of shareholders, rather than to the company as a whole and all its shareholders.
In sum, the Business Roundtable has long been a proponent of sound corporate governance. It is that very interest in upholding the best in corporate governance, together with the tremendous costs and complexity of this proposal and the Commission's doubtful authority in the area, that lead us to oppose these proposed rules so strenuously.