Nomination of Directors
Last year's AFSCME v. AIG decision by the U.S. Court of Appeals for the Second Circuit, and protests from other institutional investors that SEC regulation on director nominations is overreaching and unwarranted, has put pressure on the Commission to allow shareholders access to nominate directors. (For more information on the case, see the September 8, 2006, issue of Governance Weekly.) "We believe that the court's interpretation breaks a significant logjam in the evolution of procedures to encourage more responsive and responsible boards in the United States. We urge the SEC to allow shareholders access to the proxy for resolutions relating to the director election process," wrote one group of institutional investors representing more than $3.4 trillion in a statement to the SEC.

Ann Yerger of the Council of Institutional Investors echoed similar sentiments during one of the panel discussions. "There's no topic more important to our members than the issue of the process for nominating and electing directors, and we feel that’s definitely an area that should be permissible under the shareholder proposal rules," she said.

Precatory Proposals
In crafting a solution to these pressures, the Commission also seems mindful of a workload problem. The SEC Acting Director of the Division of Corporation Finance, Martin P. Dunn, who moderated many of the discussions, asked the first panel's attendees to congratulate SEC staff on processing more than 400 no-action letters. The SEC also acknowledged criticisms that it renders inconsistent decisions on what proposals are permissible under 14a-8, the rule that enables shareholders to file resolutions at companies, as long as they steer clear of the 13 exclusionary provisions. Dunn said that 14a-8 was not intended to be an invitation for the flood of social proposals the SEC now receives, suggesting the Commission is looking for an alternative to its role in the vetting process and is mostly focused on reducing traffic from social proposals.

In the past 20 years, the number of social proposals filed at companies has increased more than 200 percent, from 113 resolutions filed at 96 firms in 1987 to 359 resolutions at 214 companies this year.

Some panelists voiced annoyance with socially oriented proposals, which were often generically categorized as non-binding, or precatory, proposals. Others, however, urged the SEC to expand their assumptions about the ways precatory proposals are used. One such panelist was Paul A. Neuhauser, emeritus professor of law of the University of Iowa College of Law and a longtime consultant to religious investors. He commented that proposals that could be filed as binding are frequently filed as non-binding because "intrusions are not desirable; people basically don't want to command the company." He continued:

What do you want to use to prod [the corporations]? Do you want an elephant gun: i.e., let's have a proxy fight and kick out the board? Do you want a spear [in the form of], a binding proposal? Or, do you want to use a fly swatter and try to get their attention? That’s the function of the non-binding proposal, to get their attention without being intrusive.

Delaware Judge Leo E. Strine Jr. referred to precatory proposals as "pizza on the walls," a reference he also made in a speech at the University of Iowa where he argued, "In a real corporate republic with a vibrant election process, proxy access for stockholders seeking to propose bylaws, and strong voting power for stockholders over important transactions, where management is also disciplined by an active market for corporate control, there would be little justification for the continued cost of throwing pizzas at corporate boards every year."

Stanley Keller, an attorney with Edwards Angell Palmer & Dodge LLP, outlined what he views as three types of non-binding proposals: governance resolutions, social proposals that may relate to the business of the corporation, and proposals "by the new breed of investors, which '’ll call tactical, which are really the proposals maybe made for other motives, maybe to embarrass the corporation. Indeed, it may be to put the corporation in play."

While no one argued that every resolution is worthy of the recognition it receives, shareholder proponents questioned the characterization of all precatory proposals as illegitimate and reminded commissioners of the strides made possible through social activism among shareholders.

Socially oriented proposals have "frequently been ahead of the curve," Neuhauser said, citing current efforts to prompt corporate actions to reduce greenhouse gas emissions as one example. Ted White of Knight Vinke Asset Management likewise argued that precatory proposals "have served a unique purpose in our market in which they've been almost an incubation tank for what have turned out to be, over the course of a decade, best practices.” Some of the issues raised in shareholder proposals a decade ago were "considered somewhat of a joke, frankly," he said, arguing that they later become mainstream through the forum offered by the proxy process.

A case in point is ExxonMobil investors’ efforts to push the company to adopt more environmentally friendly policies. The company first received a social resolution on the climate change in 1990 when Friends of the Earth, a U.S. environmental group, proposed that the company "reduce production of carbon dioxide emissions from its energy production plants and facilities." The resolution received 6.3 percent support. Since then, proponents have continued to call on ExxonMobil to step up its response to global climate change, and in 2005, more than 28 percent of the shares voted endorsed a proposal that management report on efforts to cut GHG emissions in compliance with the Kyoto Protocol.

New Directions
The SEC appears to be weighing two major alternatives to the current proxy process: to remove itself from the process and allow state law to vet proposals, or to utilize an online forum with the aim of moving precatory proposals off the annual meeting ballot.

The SEC also discussed smaller changes that may reduce the number of precatory proposals, such as requiring proponents to own more shares or adding a materiality threshold, but commissioners were warned to avoid basing materiality on content. Larry E. Ribstein, an attorney with the University of Illinois, cautioned, "Given that we’ve got a mechanism for dealing with the dynamic evolution of corporate law, which is state law, the SEC should take as modest an approach as possible and that would include shying away from any kind of merit regulation, that is making substantive [decisions] about the kinds of proposal that ought to be brought."

For example, investors have reacted very differently to two types of proposals on political contributions. Evelyn Y. Davis has been asking companies for decades to disclose political contributions, but while her proposal has received only marginal support, another more recent shareholder campaign asking for similar information—but in a more convenient online report format—has been widely successful. A SEC rule regarding resolutions on political contribution likely would not reflect this subtle distinction.

But some panelists argued a materiality threshold could be based on objective criteria and still restrict proposals. Other suggested measures for restricting precatory proposals include raising the resubmission threshold, implementing a fee for filing proposals, and restricting proxy access to long-term shareholders. Proponents should have more "skin in the game," said Jonathan Gottsegen, Director, Corporate and Securities Practice Group at Home Depot.

One panelist argued that an investor group that should be restricted is hedge funds. R. Franklin Balotti, an attorney of business law with the American Bar Association, commented, "It's certainly important to hedge funds that they have the right to impinge upon the power of the directors to run the business and affairs of the company, but I submit to you it's for all the wrong reasons—the reasons being the short-term benefit of the hedge funds and not the long-term interests of the corporation or the shareholders."

Chat Room
The SEC envisions a chat room that would be confined to investors and would allow shareholders to engage with companies outside of the annual meeting. Evelyn Y. Davis argued that investors should be skeptical of any online forum that released shareholders’ identities to management, but Nell Minow of the Corporate Library said it is "essential to have identities disclosed" to ensure the participants dialogue in good faith.

SEC Chairman Christopher Cox noted that the chat room would operate year round 24 hours a day, seven days a week. Richard J. Daly of BroadRidge Financial Solutions (formerly ADP) said the technology is available to ensure the forum’s security. (He mentioned that the SEC had asked him to develop the idea more than a year ago.)
One corporate representative, William J. Mostyn III of Bank of America, suggested that the idea of a chat room would be "laudatory" if it were used to "siphon off what would have been precatory proposals and put them into a different forum and basically simplify the normal proxy statement process each year for our company." But if the chat room were merely "supplemental" to the proxy process, as investor representatives were suggesting, he said, it will require additional resources from his company without much benefit.

While companies' participation could be the added benefit that distinguishes the SEC chat room from other online forums where shareholders communicate, companies would be unlikely to participate if they suspected they would be held liable for their entries. There would be "uncertainty about the duty to update and duty to correct. It’s the equivalent of responding to market rumors," said Amy L. Goodman, an attorney with Gibson, Dunn & Crutcher LLP. Yet if the SEC set out that firms could not be held legally accountable for chat room discussions, then proponents would be unlikely to trust them. Also, legal experts were unwilling to give the SEC definitive answers on whether management would be violating proxy solicitation rules if it discussed an upcoming shareholder vote in the chat room.

More panel discussions and comments will follow when the SEC releases its proposal on rule changes this summer.