Cambridge, Massachusetts 02138
June 6, 2003
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: File No. S7-10-03
Dear Mr. Katz:
We are members of the Harvard Business School/Harvard Law School ad hoc group on the study of corporate governance. We write in response to Securities and Exchange Commission Press Release No. 2003-46, in which the Commission announced it had directed the Division of Corporation Finance to formulate possible changes in the proxy rules and regulations for the election of corporate directors.
We have the following thoughts on the general topic:
- Elections for US public company boards rarely have competition for board seats, outside the unusual and disruptive context of hostile takeover bids for control. In part, these results follow from the rational interests of dispersed shareholders, but these results can also be attributed in part to rules that provide incumbent directors with advantages over, and which impose legal costs and legal risks on, shareholders who wish to nominate a minority of directors. Shareholders typically cannot use the company-paid proxy statement; incumbents can. We applaud the Commission's efforts to explore whether there are practical changes that could create a more level playing field for board nominations and elections, and thus increase the capacity of legitimate, majority-elected shareholder representatives to enter the boardrooms of under-performing public companies via "short slates."1
- While some boards would be improved by having a minority of directors nominated and elected directly by shareholders, most boards would not. A re-design of aspects of the proxy rules should seek that "short slates" be used only sparingly, particularly when first introduced and untested, not as a widespread feature of annual elections; they would presumably focus on firms with enduring signs of poor performance.
- Although most shareholders - including most institutional shareholders - share the goal of maximizing the profitability of their portfolio firms, some shareholders at times have a special agenda not fully shared by most shareholders. Any mechanism that would facilitate shareholders' ability to nominate and elect directors directly should bear this in mind, and should minimize the number of "special interest" nominations, where the underlying motives or likely goals of the nominees do not relate to broad-gauged corporate performance.
- The most important "screening" tool is implicit in the election process itself: the need for a shareholder that nominates a director to attract favorable votes from sufficient other shareholders to ensure election. The other obvious screening tool would be to require a shareholder to hold a minimum percentage to gain access to the company's proxy statement.2 We would also encourage consideration of the benefits of requiring a minimum holding period for stock held by a group of nominating shareholders. Such a rule would make the nominating shareholders resemble the large shareholder with a significant long-term commitment to the company. Similarly, a well-designed proposal would encourage more constructive engagement from long-term holders, helping them to be less prone to follow the "Wall Street rule" of selling their stock when disappointed. Finally, although the nomination might be made by shareholders holding a fraction of the company's stock, the directors must be elected in the same way as other directors; we would discourage a rule that would foster "constituency" directors.
- If such screens are carefully designed, we believe that special interest shareholders would be unable to use any direct nomination procedure without engaging shareholders on issues that unite them in improving company performance, and the use of such a procedure by special interest shareholders would not pose an undue risk. A natural path to follow would begin with strong screens (high minimum, long holding period) and consider relaxing those screens only after substantial experience demonstrated that greater shareholder participation in the director selection process would not have significant negative effects on corporate performance or boardroom cohesion of successful companies.
- More generally, the Staff's review may usefully include some alternatives or additions to the basic idea of shareholder nominations in a company's proxy statement. For example, it may also be appropriate to consider permitting some degree of proportional access to company funds for the advertising and solicitation expenses of shareholders that pass screens similar to those outlined above. Similarly, mechanisms would be needed to assure that companies made appropriate disclosure regarding whether any short slates elected by shareholders would be given full access to indemnification, insurance, and information about and the right to participate in the deliberations of board committees. It should be clear, as it is under the law of most states, that any "short slate" directors are responsible to the corporation and all of its shareholders, not to any constituency.
- Finally, as part of the overall Staff initiative, it may also be worth considering whether the current rule on shareholder proposals should be modified. Shareholder proposals may be another means of shareholder voice, and the ability of shareholders here depends on the Staff's application of the shareholder proposal rule. A more effective mechanism for shareholders to nominate and elect directors, if one develops, would diminish the need for shareholders to rely on shareholder proposals. Accordingly, some adjusting of shareholder rights under the shareholder proposal rule might be appropriate if the director alternative presents itself.
Overall, we view the possibility of "short slate" additions along the lines outlined in this letter as a useful reform. We welcome the Commission's efforts here towards the possibility of facilitating limited shareholder access to the proxy statements of under-performing companies. We look forward to a concept release and eventual rule-making in this area.
For further information, contact Mark Roe (617-495-8099, email@example.com) or John Coates (617-496-4420, firstname.lastname@example.org).
Very truly yours,
__/s/Lucian A. Bebchuk_______________________________
Lucian A. Bebchuk, William J. Friedman and Alicia Townsend Friedman Professor, Harvard Law School
__/s/John C. Coates___________________________________
John C. Coates, Professor, Harvard Law School
__/s/Dwight B. Crane_________________________________
Dwight B. Crane, George Fisher Baker, Jr. Professor, Harvard Business School
Alexander Dyck, Associate Professor, Harvard Business School
Boris Groysberg, Assistant Professor, Harvard Business School
__/s/Brian J. Hall_____________________________________
Brian J. Hall, Associate Professor, Harvard Business School
__/s/Paul M. Healy____________________________________
Paul M. Healy, James R. Williston Professor, Harvard Business School
Rakesh Khurana, Assistant Professor, Harvard Business School
__/s/Jay W. Lorsch____________________________________
Jay W. Lorsch, Louis E. Kirstein Professor, Harvard Business School
Howell Jackson, Finn M.W. Caspersen and Household International Professor, Harvard Law School
__/s/Reinier H. Kraakman______________________________
Reinier H. Kraakman, Ezra Ripley Thayer Professor, Harvard Law School
__/s/Krishna G. Palepu_________________________________
Krishna G. Palepu, Ross Graham Walker Professor, Harvard Business School
__/s/Mark J. Roe______________________________________
Mark J. Roe, David Berg Professor, Harvard Law School
Guhan Subramanian, Joseph Flom Assistant Professor, Harvard Law School
Andy Zelleke, Research Associate, Harvard Business School
cc. William H. Donaldson, Chair
Paul S. Atkins, Commissioner
Roel C. Campos, Commissioner
Cynthia A. Glassman, Commissioner
Harvey J. Goldschmid, Commissioner
Alan L. Beller, Director of Corporation Finance
|1|| Indeed, one or more members of the group would urge the SEC to consider expanding the proposal to control contests; they may write a separate letter. Others found a "short slate" and a "holding period" attractive precisely because they would militate for constructive engagement apart from a control contest.
|2|| Whatever screens are chosen, they would need to aggregate shares from holders. This would raise technical issues involving Regulation 13D, the proxy rules, and coordination with state law. To be effective the rules would have to countenance early solicitation by one investor of others for participation in the nominating process. Some of these technical issues may be addressed in a separate letter that law professors who are member of this ad hoc group are considering submitting.