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February 11, 2005
Mixed Messages and Flip-Flops as the SEC Director Nomination Rule Stagnates
    by William Baue

While the SEC retracts its promise to allow shareowners to file director nomination resolutions, lawsuits secure shareowner rights to nominate directors.

Investors, particularly those holding Ashland (ticker: ASH), Microtune (TUNE), and MCI (MCIP--formerly WorldCom), as well as Halliburton (HAL), Qwest (Q), and Verizon (VZ), are getting mixed messages regarding shareowner nomination of director candidates. On the one hand, lawsuit settlements in cases involving corporate governance failures require the first set of companies to allow institutional investors to nominate directors. On the other hand, this week the staff at the US Securities and Exchange Commission (SEC) Division of Corporate Finance allowed the latter companies to omit resolutions calling for shareowner access to the proxy to nominate directors.

The ironic twist is that the resolutions were filed in direct compliance with the SEC's own guidance in the October 2003 rule proposal for granting shareowners access to the corporate proxy to nominate directors under certain circumstances. The Business Roundtable and the US Chamber of Commerce, which both represent corporate interests, have lobbied intensively against the rule proposal, stalling the rulemaking process for over 15 months.

The proposed rule stipulates certain triggering events, one of which is the filing of a resolution (or "proposal" in SEC parlance) that would grant shareowners holding more than one percent of the company's stock the power to nominate directors.

"The staff has informed [the Commission] that it intends to take the position that such a proposal is not excludable under Exchange Act Rule 14a-8(i)(8)," states footnote 74 to the proposed rule. Rule 14a-8 regulates shareowner resolutions, and section (i)(8) addresses resolutions on director elections.

The "no-action" letters issued to Halliburton, Qwest, and Verizon allowing them to exclude the resolutions from their proxies seems to directly contravene this provision, which allows shareowners to submit such resolutions until the rule is enacted.

"Given the passage of time since the proposal of rule . . . without Commission action on that proposal," writes Alan Beller, director of the SEC Division of Corporate Finance, in his letter to Halliburton, the provision preventing exclusion "is no longer necessary or appropriate."

In other words, the SEC is using its own delay in enacting the rule as an excuse to circumvent its own provisional guidelines.

"The SEC has flip-flopped," said Rich Ferlauto, director of pension and benefit policy at the American Federation of State, County and Municipal Employees (AFSCME), which filed the resolution with Halliburton. "After they announced the rules of the game, they've changed the rules of the game."

"Our response is that this now obligates the commission to not hide behind the staff action process but to propose a final rule or propose a new interim rule that we can all discuss," Mr. Ferlauto told "We intend to move forward filing resolutions company-by-company and to press the Commissioners to establish what the rules of the game are regarding director elections."

Why is it that shareowners of Ashland, Microtune, and WorldCom (now MCI) are perforce permitted to nominate directors, while shareowners of Halliburton, Qwest, and Verizon are disallowed from even addressing the possibility of nominating directors? What distinguishes these sets of companies?

The former companies all experienced corporate governance meltdowns, and the primary remedy prescribed is shareowner nomination of directors. Preventative medicine promotes the idea of addressing problems proactively, before they metastasize into cancers.

"The call for proxy access reached a crescendo because of the litany of corporate scandals that even Sarbanes-Oxley hasn't prevented," said Mr. Ferlauto, citing the recent corporate governance implosions at Fannie Mae (FNM), Freddie Mac (FRE), and HealthSouth (HRC). "The actions we're taking are at individual companies where we believe boards have failed, and all we're asking is for the chance for shareholders to vote on whether there should be a proxy access process in place because their boards have not been responsible."

"There need to be boards that feel empowered to seriously monitor and challenge management in order to protect shareholders, because regulation isn't doing the trick," he added.

Besides filing shareowners resolutions that essentially seek to enact the rule proposal at individual companies (as directed by the SEC before this week's reversal), investors are also organizing campaigns to withhold votes for board-nominated director candidates. Last year, such campaigns sent a loud message (though they are impotent in actually preventing a director from being elected).

More than 60 percent of Federated Department Stores (FD) shareowners withheld votes for nominees Joseph Neubauer and Joseph Pichler. Michael Eisner was censured last year by more than 45 percent of shareowners at Disney (DIS), which hosts its annual meeting today under much less tense circumstances now that Mr. Eisner has agreed to step down as CEO. Less than 8 percent of shareowners withheld their vote for Mr. Eisner this year, mostly because proxy advisory firms such as Institutional Shareholder Services (ISS) that opposed him last year did not have the same reason to oppose him this year.


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