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May 15, 2007

Opening Up Pandora's Box: SEC Proxy Roundtable Questions Role of Non-Binding Resolutions
    by Bill Baue

SEC officers and panelists discuss the possibility of removing non-binding resolutions from the proxy and replacing them with online communications between shareowners and companies. -- Last week, the Securities and Exchange Commission (SEC) hosted the first in a series of three roundtables scheduled this month to consider the proxy process, writ large. Four panels discussed with SEC commissioners and staff the value of binding and non-binding (or "precatory") resolutions, and the role of federal regulation vis-�-vis state law. Both the webcast and a transcript of the proceedings are archived on the SEC website, along with public comments.

Visit the
Prospectus Ordering CenterThe idea was floated that only binding resolutions proposing bylaw changes should be allowed on proxies, while discussion of issues currently covered in precatory resolutions should happen online on electronic discussion boards between shareowners and companies. This line of discussion raised concern among socially responsible investors (SRIs), seeing as non-binding resolutions are a primary avenue for addressing social and environmental issues with companies.

"The SEC cast a wide net--rather than this being limited to proxy access for board nominations, they're really looking back to first principles on ballot access on any issue," said Rich Ferlauto, director of pension and benefit policy at the American Federation of State, County, and Municipal Employees (AFSCME.) "There was significant time spent on a line of reasoning that precatory resolutions were basically a figment of the SEC's intervention in state law."

"I think we're really opening up Pandora's Box: any significant change or requirement that proposals be moved as bylaw changes would open the door to a huge amount of litigation, both at the state level and at the SEC level," Mr. Ferlauto told "What's problematic is that it's not clear how many SRI-type proposals, for example, are clearly allowable as bylaw changes, as rights that shareholders would have to effect the structure of the company--it would force shareholders to think about whether they could frame issues in terms of bylaw changes."

It is ironic that the SEC is considering denying shareholders a current right of access to the proxy when the event triggering these roundtables was a federal court decision chiding the SEC for�denying shareholders a current right of access to the proxy. In September 2006, the Second Circuit Court of Appeals issued its decision on AFSCME v. AIG, denying American International Group (ticker: AIG) the right to exclude AFSCME's shareholder proposal seeking proxy access to nominate directors.

Since then, the SEC has twice scheduled meetings to announce a new rule (presumably aligned with the court decision) only to cancel them, a move that some criticized. The SEC is facing increasing pressure over its policies. Representative Barney Frank (D-MA) recently announced the US House Financial Services Committee, which he chairs, will hold a hearing next month to scrutinize the SEC over allegations its policies more and more favor companies over investors.

The SEC plans to release a draft rule addressing the court decision this summer. The SEC allowed the rule it proposed in October 2003, allowing shareowners proxy access to nominate directors in certain circumstance, to die on the vine due to opposition by the Business Roundtable and the US Chamber of Commerce, which threatened a lawsuit. The issue first arose in August 2002 when Jim McRitchie of and Les Greenberg of the Committee of Concerned Shareholders filed a rulemaking petition seeking proxy access to nominate director candidates.

An SEC briefing paper framing issues for the roundtable points out that Congress intended the proxy process created by the Securities Exchange Act of 1934 to "replicate as nearly as possible" shareholder rights as if they were at meetings, such as nominating directors or moving proposals. The paper acknowledges both benefits and detriments to the current system on non-binding resolutions, and suggests electronic communication supplanting or supplementing the proxy machinery "could offer shareholders more powerful means to advance non-binding proposals." Whether the proposed solution is indeed "more powerful," however, is up for debate.

"It could be information overload--a situation where more turns out to be less," said Mr. Ferlauto, pointing out that portfolio managers monitoring thousands of companies are hard pressed to stay current on issues presented once a year on the proxy, much less 24/7. "What gives the proxy value is ERISA and the Department of Labor and the Avon Letter that says that the proxy vote is an asset, therefore it mandates that investment fiduciaries actually cast votes--so if you take SRI-type issues out of that context, whether anyone will pay attention to them or not is an open question."

In the day's second panel on the role of federal proxy regulations, Ted White of Knight Vinke Asset Management countered the line of discussion denigrating the value of non-binding resolutions, pointing out that they often function as an incubation tank for best practices. John Wilcox of TIAA-CREF pointed out that environmental, social, and governance (ESG) issues are often resolved in dialogue with companies, and non-binding resolutions result when shareowners and companies cannot agree. Commissioner Paul Atkins, a Bush appointee, questioned whether such behind-the-scenes negotiation amounted to "tyranny of the minority," undermining the goal of transparency.

The day's third panel, on non-binding resolutions, addressed the core issues. University of Iowa College of Law Emeritus Professor and longtime Interfaith Center on Corporate Responsibility (ICCR) counsel Paul Neuhauser followed in Mr. White's footsteps by characterizing the precatory resolution as the "canary in the coalmine." In other words, it flags potential future problems, allowing them to be addressed proactively. He also noted that democracy functions perfectly well, as resolutions addressing issues that shareowners deem relatively unimportant get low votes.

Prof. Neuhauser exposed another irony of the proceedings. He likened a proxy contest, where shareowners publish their own ballot to nominate their candidate, to an elephant gun; a binding resolution to a spear; and a precatory resolution to a flyswatter, which "gets their attention without being intrusive." The roundtable paid most attention to the weakest mechanism.

Even those who rely most on non-binding resolutions--shareowner activists--recognize their inherent limitations.

"Precatory resolutions are the best we can do within a very imperfect system," said Mr. Ferlauto.

That said, they represent an important mechanism for addressing ESG issues. Two more roundtables are scheduled for May 24 and 25--Institutional Shareholder Services (ISS) surmised that "the final roundtable will likely feature comments from investors and corporate advocates."

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