[Senate Hearing 110-953]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 110-953


                  SHAREHOLDER RIGHTS AND PROXY ACCESS

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                                   ON

                  SHAREHOLDER RIGHTS AND PROXY ACCESS


                               __________

                      WEDNESDAY, NOVEMBER 14, 2007

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


      Available at: http: //www.access.gpo.gov /congress /senate /
                            senate05sh.html




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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware           CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey          JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii              MIKE CRAPO, Idaho
SHERROD BROWN, Ohio                  JOHN E. SUNUNU, New Hampshire
ROBERT P. CASEY, Pennsylvania        ELIZABETH DOLE, North Carolina
JON TESTER, Montana                  MEL MARTINEZ, Florida

                      Shawn Maher, Staff Director
        William D. Duhnke, Republican Staff Director and Counsel
                       Dawn Ratliff, Chief Clerk
                          Jim Crowell, Editor















                            C O N T E N T S

                              ----------                              

                      WEDNESDAY, NOVEMBER 14, 2007

                                                                   Page

Opening statement of Senator Reed................................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby
        Prepared statement.......................................    30
    Senator Menendez.............................................     3

                               WITNESSES

Christopher Cox, Chairman, Securities and Exchange Commission....     4
    Prepared statement...........................................    31
    Response to written questions of:
        Senator Shelby...........................................   182
John J. Castellani, President, The Business Roundtable...........    18
    Prepared statement...........................................    36
Jeff Mahoney, General Counsel, Council of Institutional Investors    20
    Prepared statement...........................................    79
Anne Simpson, Executive Director, International Corporate 
  Governance Network.............................................    21
    Prepared statement...........................................   166
Dennis Johnson, Senior Portfolio Manager, Corporate Governance, 
  California Public Employees' Retirement System (CalPERS).......    24
    Prepared statement...........................................   172

 
                  SHAREHOLDER RIGHTS AND PROXY ACCESS

                              ----------                              


                      WEDNESDAY, NOVEMBER 14, 2007

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:31 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Jack Reed, presiding.

             OPENING STATEMENT OF SENATOR JACK REED

    Senator Reed. Let me call the hearing to order. Today we 
are holding a hearing on shareholder rights and proxy access.
    In July, the Commission had issued two distinct proposals 
regarding proxy access for shareholders. The first proposal, 
known as the ``short rule,'' would eliminate shareholder access 
to proxy. The second proposal, referred to as the ``long 
rule,'' would allow for it, but places what many investor 
groups and large institutional investors believe are untenable 
thresholds and excessive hurdles. These proposals were released 
by the Commission at a time when there was a full complement of 
five Commissioners, with the Chairman supporting each of the 
distinct proposals. When the comment period ended on October 2, 
2007, the SEC had received over 34,000 comment letters on the 
proposed rules.
    I am deeply concerned about both the process for approving 
these proposals as well as the substance of the proposals 
themselves. On November 1, 2007, I joined Chairman Dodd and 
seven of my colleagues from this Committee in sending a letter 
to the Commission asking it to refrain from adopting either one 
of the proposals and, rather, allow shareholders to make 
proposals pursuant to current standards set forth in the 
decision of the United States Circuit Court of Appeals for the 
Second Circuit in AFSCME v. AIG.
    This hearing is an opportunity to discuss shareholder 
rights, the significance of proxy access to shareholders, and 
the Commission's two proposed rules, their impact on investors 
and the Commission's decisionmaking process.
    According to the 2006 interim report of the Committee on 
Capital Markets Regulations, the strength of shareholder rights 
in publicly traded firms directly affects the health and 
efficient functioning of U.S. capital markets. Overall, 
shareholders of U.S. companies have fewer rights in a number of 
important areas than do foreign companies. This difference 
creates an important potential competitive problem. Without 
adequate shareholder rights, rational investors will reduce the 
price at which they are willing to purchase shares. Public 
capital markets will be smaller as a result of inadequate 
shareholder rights. The importance of shareholder rights also 
affects whether directors and management are fully accountable 
to shareholders for their actions.
    The report further concludes that there is a danger that 
the United States, compared with other countries, is falling 
behind best practices in shareholder rights. These findings are 
further supported by some of the largest global institutional 
investors, such as Hermes, Barclays Global Investments, and 
Universities Superannuation Scheme, who have written over the 
past year to the Commission and to our Committee will similar 
concerns.
    I know the Commission takes the issue of U.S. capital 
markets' competitiveness seriously and is prioritizing a number 
of efforts on that front. However, I believe that both of its 
proposals on shareholder access miss the mark.
    The short proposal would overrule the 2006 AFSCME v. AIG  
court decision and maintain that a company may exclude a proxy 
access proposal from its proxy materials. This clearly would 
take away the fundamental rights of shareholders to have a say 
in the election of directors unless they filed a separate 
proxy.
    The long proposal, in theory, allows shareholders access to 
proxies, but it sets a 5-percent ownership, which, according to 
some of the largest institutional investors, would make any 
subsequent rule meaningless in its application. As a matter of 
fact, research completed by the Council on Institutional 
Investors found that if CalPERS and nine of the other largest 
public pension funds would have successfully aggregated their 
holdings of a single public company's securities, those funds 
combined would likely to be unable to clear the 5-percent 
threshold. Furthermore, many investors have commented that the 
proposed disclosure requirements under the long proposal are 
excessive, and as Commissioner Nazareth recently commented, 
they are more extensive than that required of someone seeking 
to take over the company.
    Mr. Chairman, in some press reports you have indicated that 
the Commission plans to finalize the short rule, non-access 
proposal, before the end of this month and then revisit the 
issue to fix the proxy access rule in 2008. I am concerned by 
this process and the speed at which you are rushing to this 
decision. Particularly, it seems to indicate that you are 
acknowledging that the transient fix is not the final form.
    During the 2007 proxy season, in which the AIG case was the 
law, only three proxy access shareholder proposals were filed 
on corporate ballots to adopt bylaw amendments regarding the 
election of directors. The expectation is that only a handful 
will be filed in 2008. Thus, given the small number of 
resolutions expected in this area, it is highly unlikely that 
those resolutions would create any widespread uncertainty.
    Furthermore, as we all know, it is hard to undo rules once 
they are adopted. There are far more serious consequences for 
the Commission to enact one set of rules now and then basically 
go back to the drawing board within months of acting. This will 
cause far more uncertainty and confusion and result in public 
companies having to comply with three different regulatory 
schemes in 2 years. The Commission should take its time and get 
it right once and for all with the benefit of a full complement 
of Commissioners to consider the issue.
    There are many issues that I hope we have the opportunity 
to discuss this morning. There are certainly some positive 
trends, such as the movement by the United States and many of 
its companies to adopt majority voting in director elections in 
some companies like AFLAC, whose board approved a resolution 
giving shareholders the right to a non-binding vote on 
executive compensation. Nevertheless, we need to do much more 
to bring shareholder rights in alignment with international 
best practices. And given what we have seen in the Enron and 
WorldCom stock options back-dating and executive pay scandals, 
it seems a sensible idea that long-term investors should have a 
way to nominate generally independent directors to corporate 
boards. A company that delivers long-term shareholder value 
should expect the ongoing support of its shareholders. 
Shareholder access to proxies should not be viewed as seeking 
to place new burdens on businesses but as a way to ensure 
accountability and responsibility by both the shareholders and 
management. Ultimately, this is an opportunity for the 
Commission to lead and show the world that it takes shareholder 
rights and investor protection seriously.
    At this point, Senator Menendez, if you have a statement.

              STATEMENT OF SENATOR ROBERT MENENDEZ

    Senator Menendez. Thank you, Mr. Chairman. And thank you 
for keeping the room so cool. It might be necessary with the 
heat that this issue generates.
    Welcome, Chairman Cox, and to our other witnesses as well, 
welcome. I am pleased that you can appear before the Committee 
on this important issue of shareholder rights and proxy access. 
As we well know, the SEC stirred up the debate over proxy 
access back in July when it put forward two very distinct and 
conflicting proposals on proxy access, a rare move that has 
puzzled many struggling to figure out the Commission's 
direction on shareholder rights.
    Since then, there has been a great deal of speculation 
about the rationale behind the proposals, as well as the 
direction the SEC will ultimately take on this issue. So given 
that context and the interests clearly that exist on this issue 
and that has been created, I am particularly glad that we have 
the chance today to look carefully at what led to two starkly 
different proposals, and also to talk frankly about the road 
ahead for shareholder access.
    Much of the debate over proxy access comes down to the 
issue of what role shareholders play and how far their 
influence should reach. Personally, I believe the right of 
shareholders to elect directors and have a say in how those 
directors are chosen is paramount. In my mind, they own the 
company.
    I think it is unfortunate that this debate has opened the 
door to the potential weakening of shareholder rights, and I 
hope that at the end of the day this debate will not result in 
rolling back the right that shareholders already--already--
have. That would be a big mistake.
    I am also perplexed and deeply disturbed that, despite the 
amount of debate over these proposals, the Commission has 
indicated it will move forward with a vote before the end of 
the year, with possible further review next year. I am one of 
those that joined on to the letter Senator Reed referred to. It 
seems to me that if the objective here is to obtain clarity on 
what the policy for shareholder access should be, then we 
should have a sound debate that results in a clear ruling. 
Issuing one rule for next year and then reconsidering it 
shortly thereafter would likely lead only to more confusion and 
uncertainty at the end of the day.
    I do welcome the fact that the Commission is treating this 
issue seriously and is committed to bring about clarity and 
consensus. I would just submit that we make sure the end result 
does, in fact, bring about clarity, not more complexity. I do 
believe that there should be a full Commission to sit to have 
this vote.
    As this is certainly not the first time around in trying to 
hammer out a workable policy on shareholder access, I hope this 
time we will be able to find common sensible ground, and I look 
forward to your testimony.
    Thank you, Mr. Chairman.
    Senator Reed. Thank you very much, Senator Menendez.
    Senator Hagel, do you have a statement?
    Senator Hagel. No. Thank you.
    Senator Reed. I would at this point ask unanimous consent 
to introduce the statement of Senator Shelby into the record 
and also to announce that the record will remain open for 5 
days, and statements of my colleagues will be accepted, and 
without objection, so ordered.
    Mr. Chairman, thank you. Thank you for joining us. You have 
just returned from Japan, none the worse from wear, and we 
thank you for joining us today.

STATEMENT OF CHRISTOPHER COX, CHAIRMAN, SECURITIES AND EXCHANGE 
                           COMMISSION

    Mr. Cox. Chairman Reed, thank you very much, and Members of 
the Committee. Thank you for inviting me to testify. This is a 
very important issue, and I am pleased to have the opportunity 
to go into it in some depth. The subject, of course, as you 
have described, is the Commission's ongoing rulemaking on bylaw 
proposals to establish director nomination procedures.
    As you know, the current rules do not permit shareholders 
to offer these bylaw proposals. In July I voted for a rule 
proposal to change that. The Commission has published that 
proposed rule for comment, along with a companion proposal that 
would essentially ratify the status quo. The breadth of the 
territory that was covered between these two proposals and the 
extensive questions that we submitted for public comment gave 
the Commission plenty of flexibility to address defects in the 
proposals or areas for possible improvement that might be 
identified in the comment process. The comment period on these 
rule proposals has just closed.
    I cannot predict exactly what the Commission will do on 
this subject this year. Obviously, we are currently reviewing 
the enormous number of comments that we received, most of them 
on the last day of the comment period last month. And today I 
can speak only for myself, since my testimony does not reflect 
the individual views of the other Commissioners or of the 
Securities and Exchange Commission. But I am happy to explain 
why I support strengthening the proxy rules to better vindicate 
the fundamental State law rights of shareholders.
    Our free enterprise system is built on a foundation of law. 
The enforcement of private property rights is an essential 
ingredient of a successful free market. At bottom, a share of 
stock is a bundle of private property rights--nothing more, 
nothing less. And the law's enforcement of private property 
rights is what gives it its value.
    America's investors in equities currently entrust over $20 
trillion of their assets in exchange for these property rights. 
It is only the precious few specific rights that the law gives 
to a common stockholder that undergird the investment of such 
enormous sums. And so it is of the utmost importance that what 
the stockholder does have is jealously guarded by our legal 
system. We cannot have capitalism without capital, and 
protecting the right of America's shareholders to choose the 
company's directors is vitally important to ensure a continued 
flow of capital to our companies and industries. It is also the 
best way to ensure that boards of directors remain accountable 
to the interests of investors.
    The issue of protecting investors' ownership rights is not 
a partisan one. As Chairman John Shad put it during the Reagan 
administration, ``The Commission has always encouraged 
shareholder participation in the corporate electoral process.'' 
More recently, commentators from across the spectrum have been 
making the case, as you, Mr. Chairman, noted in your opening 
statement. The distinguished group of experts, for example, 
that comprised the Committee on Capital Markets under the 
direction of Professor Hal Scott of the Harvard Law School; 
Glenn Hubbard, President Bush's former Chairman of the Council 
of Economic Advisers; and John Thornton, the former President 
of Goldman Sachs, devoted an entire section of their recent 
report to shareholder rights. In their words, ``The strength of 
shareholder rights in publicly traded firms directly affects 
the health and efficient functioning of U.S. capital markets.'' 
And they pointed out that because shareholders of U.S. 
companies have fewer rights than do their foreign counterparts, 
this creates an important potential competitive problem for 
U.S. companies.
    As one way of addressing that need, they recommended that 
the SEC take the opportunity of the court's decision in the 
proxy access case to ensure appropriate access by shareholders 
to the director nomination process, and that is exactly the job 
we have tackled.
    This is a significant undertaking. Rationalizing the 
potential input of 45 million shareholders while fulfilling the 
essential Federal role of ensuring disclosure and guaranteeing 
investors the full protection of the anti-fraud provisions of 
the securities laws is a complicated matter. If it were easy, 
my predecessor, who attempted to do it, would have succeeded 
over the several years that he tried. Indeed, when the 
Commission previously considered this issue in the 1990's, it 
determined not to pursue it. And as difficult as the basic 
proxy access problem is, we have another issue on our hands.
    Last autumn, the U.S. Court of Appeals for the Second 
Circuit invalidated the SEC's interpretation of our existing 
proxy access rule that had been applied at least since 1990. 
Indeed, in the staff's view, that interpretation had been in 
effect since 1976. But the court found the SEC's view since 
1990 to be inconsistent with its prior interpretation. At the 
same time, the court said that it would take no side in the 
policy debate regarding shareholder access to the corporate 
ballot because such issues are the appropriate province of the 
SEC. This decision applies in only one of the 12 judicial 
circuits in the United States, and so it has created great 
uncertainty in our public markets.
    This uncertainty is compounded by a subsequent decision of 
the U.S. Supreme Court which creates doubt about the state of 
affairs even in the Second Circuit. The Supreme Court reversed 
another panel of the Second Circuit in a similar case of an 
agency that changed its interpretation of its rules. Just as in 
the proxy access case, the Second Circuit rejected the agency's 
more recent interpretation. Justice Breyer's opinion for the 
unanimous court held that the agency's interpretation of its 
own regulations is controlling unless plainly erroneous. As a 
result of this decision, it is more likely today that even a 
court in the Second Circuit would uphold the Commission's 
longstanding interpretation of our proxy access rule.
    In this escalating state of legal confusion, the only rule 
across America at the moment is every litigant for himself. And 
yet the only legal question is what the SEC's rule means--the 
SEC's current rule, not the new rules that we have proposed, 
but the rule that is already on the books and has been for over 
30 years.
    There can be absolutely no excuse for our continuing to 
fail to answer that basic question. That is why I have said all 
year that we are committed to having a clear rule in place for 
the coming proxy season. The do-nothing alternative that is 
being urged by some is doubly dangerous. Not only will it 
provoke more needless litigation about the meaning of our rule, 
which in light of the recent Supreme Court decision might well 
be resolved in favor of the SEC's longstanding interpretation, 
but it will create a law of the jungle for any actual 
shareholder proposals that are advanced in the meantime. That 
is because unless we accept the Second Circuit's invitation to 
clarify the current rule, all of the protections of the proxy 
contest rules are out the window, including requirements for 
disclosure of conflicts of interest and possibly even the anti-
fraud rules that prevent deliberate lying to investors.
    It is obvious that many shareholders support the main 
effect of the Second Circuit decision, which is that the 
Commission's existing rule concerning proxy access is called 
into question because they want to have access to the proxy. 
You will hear from them on the next panel, and I personally am 
very attentive to their concerns. But it should be possible to 
gain the more effective use of the proxy that we all seek 
without abandoning other important shareholder protections such 
as our disclosure and anti-fraud rules. So whatever the 
Commission decides to do, we will restore certainty about the 
application of our rules. That is our fundamental 
responsibility.
    When Hammurabi erected his stone tablets in the city square 
of Babylon 3,800 years ago, it made a great advance for 
civilization. From that moment forward, the law was no longer 
arbitrary. For the first time, citizens could know in advance 
the standard to which they should conform their conduct. That 
is the difference between the rule of law and the rule of men.
    In our own time, when we highly prize the rule of law, we 
face the same risk as our ancient forbears, but for a different 
reason. All of our laws are written down, thousands of pages of 
them. On top of that, there are hundreds of thousands of pages 
of regulations, and beyond that an ever growing case law that 
interprets both the statutes and the regulations.
    The uncertainty generated by competing interpretations in 
so many gray areas creates a 21st century version of the pre-
Hammurabian days. Once again, citizens cannot know in advance 
the rules by which they should arrange their lives and their 
business affairs. There is nowhere that certainty in the law is 
more important than in our markets. Each day investors and 
businesses in this country and around the world execute make-
or-break choices that depend on knowing in advance what the 
rules are. We owe it to them to provide a clear answer. Each of 
our rules may not be precisely what a particular player wants, 
but it should, nonetheless, be precise. A vague or ambiguous 
rule can be just as bad as no rule at all.
    The rule of law that the SEC enforces has given America the 
most dynamic and vibrant capital markets in the world, and the 
rule of law includes both certainty in application and 
commitment to enforcement of the fundamental property rights of 
every shareholder--above all, the right to choose the directors 
of the companies in which they invest. So I agree with the many 
commenters on our two proposals who said we should go back to 
the drawing board and take a fresh look at this issue. We will 
do that. Although none of the 22 SEC Chairmen since the agency 
first looked at this issue in 1942 has successfully taken this 
step, I am committed to serious work on it, and I am intent on 
bringing it to a successful resolution. And I will be happy to 
take your questions.
    Senator Reed. Thank you very much, Mr. Chairman.
    You have described the process in which there is an initial 
attempt to create a fix as a prelude to a more comprehensive 
and thorough deliberation in the future, and this is designed, 
in your words, to address the uncertainty. But how does this 
eliminate confusion and uncertainty if, you know, you have 
already advertised that this is a transitory rule, it will be 
in effect for perhaps a few months, and also, by the way, it 
will be the product of a Commission that is not at full 
strength and the whole significant changes could come about 
with additional members of the Commission being nominated and 
confirmed. So how does this avoid uncertainty and confusion?
    Mr. Cox. It simply freezes the status quo. This is the rule 
that has been in place for at least 17 years, depending on your 
interpretation, you know, possibly going back to 1976. But, in 
any case, it is the longstanding and at least 17-year 
interpretation of the SEC's rule.
    Senator Reed. Well, the last proxy season, the status quo 
was the AFSCME v. AIG case, which allowed for shareholder 
proposals, the procedure. So the question really is: What is 
the status quo? I think many would argue the status quo is the 
decision of the Second Circuit.
    Mr. Cox. Well, as I said, there has been a subsequent 
Supreme Court decision that fuzzes up what the legal rule is in 
the Second Circuit, and the AFSCME v. AIG decision applied only 
in the Second Circuit and not in any of the other dozen 
judicial circuits in America.
    Senator Reed. And New York City is located in the Second 
Circuit.
    Mr. Cox. Indeed, and in each of the cases where people 
sought a no-action letter from the Securities and Exchange 
Commission, they argued that the Second Circuit was not the 
applicable jurisdiction. The jurisdictional question of whether 
or not a company which might have substantial contacts with New 
York is subject to the rule in the Second Circuit or the rule 
in the Fifth Circuit or the rule somewhere else is at the 
center of all of this, and it is the reason that our 
professional staff is seeking guidance from the Commission.
    Now, subsequently, the Supreme Court has unanimously 
decided a very similar case from the Second Circuit rejecting 
the Second Circuit's decision that the most recent 
interpretation of the agency should be rejected if inconsistent 
with a prior interpretation of the same rule without the rule 
itself having been changed.
    Senator Reed. Did you appeal the AFSCME v. AIG case, or did 
anyone----
    Mr. Cox. We were not parties in that case, which is one of 
the reasons, I think, that----
    Senator Reed. Was it appealed?
    Mr. Cox [continuing]. The understanding of the view of the 
SEC was lacking in that case.
    Senator Reed. So in the Second Circuit, at least, that is 
the law of the Second Circuit.
    Mr. Cox. I do not know that that is the case. The Second 
Circuit is bound, of course, by the decisions of the U.S. 
Supreme Court, and the Supreme Court decision is subsequent to 
the AIG case. There is legal uncertainty----
    Senator Reed. The Supreme Court was--under this specific 
rule that was adjudicated in the Second Circuit.
    Mr. Cox. On the Administrative Procedures Act question of 
whether----
    Senator Reed. On this specific rule.
    Mr. Cox [continuing]. The agency's interpretation of its 
rule subsequent to a prior conflicting interpretation is 
controlling and----
    Senator Reed. So your position is that the Supreme Court 
has overruled the AFSCME v. AIG case?
    Mr. Cox. The view of our professional staff at the SEC is 
that it has made it more likely that a court would reach a 
different interpretation than it did in the Second Circuit 
case. But this is a matter of predictions and probabilities. 
What we are certain about is that there is great uncertainty, 
first, in the Second Circuit and more so in----
    Senator Reed. How could there be great uncertainty in the 
Second Circuit if they have a decision which clearly 
invalidates your interpretation beginning in 1990 of this rule 
that has not been appealed to the Supreme Court, that is the 
law of the Second Circuit, which is the circuit which includes 
most of the financial institutions and, indeed, that is the 
Wall Street circuit.
    Mr. Cox. The reason is that the Second Circuit Court of 
Appeals is an inferior court and the decision of the Supreme 
Court is controlling and applicable to the courts of appeal and 
all the district courts in the Second Circuit. So if, in fact, 
the proper interpretation of the Supreme Court decision in this 
case is that the panel decision should be reversed, then a 
court in the Second Circuit is bound by that.
    Senator Reed. How many other rules of the SEC have been 
overturned by this recent Supreme Court case? How many other 
decisions of the Second Circuit have been overturned by the 
Supreme Court?
    Mr. Cox. I do not know the answer to that.
    Senator Reed. I do not think you can calculate the answer 
because it is not the same case, but let me just say that if 
this was so unsettled, why did you allow this proxy season past 
to operate under the AFSCME v. AIG case?
    Mr. Cox. The case came immediately prior to the proxy 
season last year, and there simply was not time for notice and 
comment rulemaking.
    Senator Reed. And the proxy season last year produced no 
earth-shattering result. There were several proposals. One 
proposal I presume passed, and there were two other proposals 
that received significant votes. There is no expectation that 
this season there is going to be a huge epidemic of proposals 
by shareholders in this regard, which begs the question: Why 
are we rushing to judgment for a temporary fix that will be 
overturned by you, apparently--or by the Commission, I should 
say--in the spring?
    Mr. Cox. Well, I have met with representatives of some of 
the large institutional shareholders, and I take them at their 
word that they are willing to forbear and to be responsible; 
and certainly that was the case in the last proxy season, 
although almost no one had much opportunity to respond to the 
new legal environment or the changed or questionable legal 
environment last year.
    The problem going forward is that there are 45 million-plus 
shareholders in the United States, and not all of them are 
large, responsible, long-term investors. The same rule, or lack 
of it, would apply, for example, to hedge funds, whether 
domestic or otherwise domiciled. They would have, if this law 
of the jungle were allowed to obtain, they would have no 
requirement to make any of the disclosures that the SEC has 
always required in the proxy contest situation because of a 
technicality and because of the fact that there were not two 
proxy cards but one. They would not perhaps even be bound to 
tell the truth under Rule 14a-9 because its application is now 
questions. I think the SEC would assert, if that came up, our 
full power, and we would want to make an argument to the court 
that, yes, the anti-fraud rules should apply, but they would be 
drawn into question. And to a certainty, none of the required 
disclosures about conflicts of interest and so on----
    Senator Reed. Why doesn't your proposed rules include these 
provisions? If that is the problem, why don't you fix it in 
your proposed rules?
    Mr. Cox. That is precisely the course, Mr. Chairman, that 
we would take.
    Senator Reed. But not now. That is subsequent to these two 
proposals you have made.
    Mr. Cox. Well, whatever the Commission chooses to do--and 
as I say, I cannot predict. I think the Commissioners are all 
looking at all of these comments with an open mind and that the 
accounts that everyone's mind is made up in advance are 
somewhat inaccurate in that respect. So while I cannot predict 
what we will do, I do know that we all have an interest in 
making sure that the fundamental disclosure rules and anti-
fraud protections of the Exchange Act are there for the benefit 
of every investor.
    Senator Reed. Well, Mr. Chairman, let me defer to my 
colleagues for questions. There might be a second round.
    Senator Hagel. Mr. Chairman, thank you.
    Chairman Cox, thank you for appearing this morning. What is 
your sense then of the process as it goes forward? You have 
noted in your testimony that the Commission is reviewing the 
enormous set of comments. These proposals in place before the 
next proxy season?
    Mr. Cox. I do not know that we will be able to find 
agreement on the Commission for a new set of rules that will 
improve the application of the proxy rules to shareholders' 
State law rights. I believe, as I have said, that the proxy 
rules should better vindicate those rights. But what at a 
minimum I think we will do is establish clarity so that the 
status quo will be preserved, the status quo that has 
maintained for the last 17 years uninterruptedly, and indeed, 
for the most part, since the 1940's.
    Senator Hagel. You noted in your testimony, and I believe 
as the Chairman introduced you, that you have returned recently 
from Japan, and you talk a little bit about the international 
competitiveness factor here. And if you could develop that a 
little more completely, the effect that these new rules would 
have on our competitiveness in the world market, and maybe go 
down a little deeper when we look at Japan, the United Kingdom, 
continental Europe, their regimes versus ours. Does that 
enhance the attractiveness of public companies to investors, 
especially to big funds, with more shareholder rights, less, 
does it matter? Would you develop those themes a little bit for 
the Committee?
    Mr. Cox. Sure. I think that the fundamental strength of 
America's capital markets is the high level of confidence that 
investors can have that their rights as investors in those 
markets will be protected. The certainty that our rule of law 
provides is very important. The high level of disclosure, the 
anti-fraud protection, all of these things undergird investor 
confidence and result, many economists have found, in a premium 
being placed on investment in this country as opposed to other 
markets. So as we go forward, we want to be sure that we 
provide shareholders the full level of anti-fraud and 
disclosure protection that our securities law provide for.
    There is absolutely no question that one difference between 
our markets and most of the other major markets in the world is 
our high level of retail investor participation. So it is not 
just the institutional investors from whom you will hear today, 
but also all the other millions of investors who are concerned 
here and who are at risk. Their interests are not always the 
same as a hedge fund, for example, and so we want to make sure 
that while we have one or two popular paradigms in mind, that 
we recognize that we are making rules to cover a variety of 
circumstances.
    Our shareholder protections and our anti-fraud protections 
have to be at least as sturdy and probably sturdier than other 
countries that have a preponderance of institutional investors 
and not so much retail participation.
    Senator Hagel. As you survey the marketplace, and 
recognizing your scope of responsibilities as the primary 
regulator of securities in this country is rather narrowly 
defined but, nonetheless, you are dealing in the marketplace, 
as you look down the market pathway, as you are looking at 
these comments and whatever action the Commission is going to 
take, do you sense a trend in any direction, take the 
differences in our regulatory regimes versus Japan, European 
Union, Great Britain? Or is there no difference as to as the 
competition gets keener for those investment dollars in these 
countries, will the regulatory regime that dominates and 
dictates the behavior and standards and laws, will they be more 
important, less important, or will it not matter that much?
    Mr. Cox. Well, I think it is becoming more important 
because our different regulatory systems are now coming in 
closer contact every day, and indeed, we are becoming more 
mutually dependent.
    On the enforcement side, for example, we really cannot 
succeed without the help of our foreign regulatory 
counterparts; whereas, in years past, we might have had much 
more of a parochial focus on our own, obviously, largest-in-
the-world markets.
    So working with other regulators is becoming a big part of 
my job and the role of the Commission and our professional 
staff. What we are finding is that other systems that are 
structurally different, perhaps more principles than rules 
based, nonetheless in many cases have common objectives, and 
there are ways for us to harmonize our approach in order to 
achieve those common objectives while eliminating regulatory 
friction. We are going to look for every opportunity to do 
that.
    At the same time, when we absolutely have different 
objectives that we must insist upon, for example, our U.S. 
insistence on protecting retail investors, then we have got to 
find a way to accommodate those concerns by ironing out 
needless differences with these other systems.
    So I think that as the world shrinks, which it has been 
doing for centuries--investing has always been global, but it 
is doing so at an accelerated pace right now. Our system will 
probably need to insist upon the high level of disclosure and 
anti-fraud protection for retail investors to which I have 
referred in another context this morning, and we will probably 
be seeking to form a coalition of high-standards countries so 
that we avoid this race to the bottom that could be the other 
result of increasingly global markets.
    Senator Hagel. Chairman Cox, thank you.
    Mr. Chairman, thank you.
    Senator Reed. Thank you, Senator Hagel.
    Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman.
    Mr. Chairman, one of our witnesses to come, Mr. Johnson, on 
behalf of CalPERS, says the following thing as it relates to 
why the SEC does not need to act before the 2008 proxy season. 
He says ``There is no uncertainty about the existing rule, 
which clearly allows shareowners to file proxy access proposals 
on corporate bailouts. The Second Circuit Court clarified in 
the AIG case that the current SEC regulation does not exclude 
proxy access.''
    He goes on to say ``There is no evidence of uncertainty 
about the application of the rule following the AIG decision. 
Since the decision was issued, shareowners have submitted three 
proxy access proposals in 2007, one non-binding proposal passed 
Cryo-Cell International. Two others received substantial 
support, exceeding 42 percent of votes cast, at UnitedHealth 
Group and Hewlett-Packard Company.''
    ``There will be no `tsunami' of harm in the marketplace if 
the AIG decision is left in place through the 2008 proxy 
season. In fact, the only uncertainty about proxy access comes 
as a result of the mixed messages from Chairman Cox concerning 
the SEC's intent to adopt a `new-and-improved' proxy access 
proposal next year.''
    ``No company challenged any proxy access proposal in court 
this year.''
    If that is the case, having the Commission just lost a 
member, very likely to lose a member before the end of the 
year, why this rush on such a complex and yet important issue 
to come to a decision before? It does not seem to me that we 
have a real chance of harm here of any considerable magnitude.
    Chairman Cox. Well, I think you are absolutely right to put 
the question by saying if that is the case. Because the 
fundamental disagreement here is whether that is, in fact, the 
case.
    Senator Menendez. So you disagree that that is the case?
    Chairman Cox. I do. Those who assert that there is no 
uncertainty, I think, are mistaken. The uncertainty is 
palpable. Indeed, even with the small number of proposals that 
we had in the last proxy season, there was palpable 
uncertainty. In the case of Reliant Energy, for example, there 
was a proposal submitted by Seneca Capital, an AIG-type 
proposal. The company asserted to the Securities and Exchange 
Commission that the rule not of the Second Circuit but of the 
Fifth Circuit applied. Reliant then filed for a declaration 
relief in the Federal Courts of Texas and the shareholders then 
withdrew their proposal.
    There is no question, because that was per the Supreme 
Court's decision in Long Island Care, that there is even more 
uncertainty now. Indeed, that uncertainty extends to the Second 
Circuit.
    Furthermore, with respect to the question of whether or not 
there will or will not be a tsunami of new proposals--as I say, 
I think we can rely on the assurance of responsible long-term 
institutional shareholders that either they will forbear and 
not offer these proposals or that, if they do, that even though 
the disclosure rules of the Exchange Act do not apply to them, 
and possibly the Anti-fraud rules do not apply, that they will 
behave well.
    Senator Menendez. But this is----
    Chairman Cox. I do not think that we could expect that 
absent the rule of law in this case that hedge funds and other 
investors, including millions of investors--some 34,000 of whom 
submitted comments to us on this rule----
    Senator Menendez. But there is a rule of law. Is it not 
true that even if the Federal District Court ruled differently, 
that there would be no split between Circuit Courts until 
another Federal Appellate Court addressed the issue from the 
Second Circuit?
    Chairman Cox. That is precisely the point, I think, that 
every single one----
    Senator Menendez. So it would hold----
    Chairman Cox [continuing]. Of the proposals would have to 
be litigated for anyone to know what the result is. And 
obviously litigation is time-consuming----
    Senator Menendez. But until that time, the Second Circuit 
would prevail. It would hold. There is no conflict.
    Chairman Cox. That is not what happened in the Reliant 
Energy case.
    Senator Menendez. Well, in that case, shareholders may have 
made a strategic decision to withdraw for whatever their 
reasons may have been. It may not have been just that decision. 
There may have been a multitude of reasons.
    Let me ask you this. If one of the other concerns that you 
raise is the fact about disclosure, isn't it true that 
shareholders primarily vote on the merits of proxy proposals 
versus what they know about proponents? That background 
information about proponents is usually secondary? And if 
disclosure is so crucial, that sort, companies that had proxy 
access resolutions on their ballots in 2007 surely would have 
expressed concern. None did.
    Chairman Cox. I think that it depends on whether or not the 
background of a proponent is relevant. I mean, let us say that 
the hidden agenda of a hedge fund that is moving in with one of 
these proposals--although superficially they are stating about 
corporate governance--is to put their own directors on the 
board so that they can strip the assets of the company and 
manage for the short term. If investors knew that, obviously it 
would be relevant.
    Senator Menendez. Well, let me----
    Chairman Cox. If you have an environment in which----
    Senator Menendez. I think people vote on the----
    Chairman Cox [continuing]. Does not need to be disclosed--
--
    Senator Menendez. If the merits of the proposal are worthy 
for a shareholder to support, they will support it. If not, 
they will not, regardless.
    But let me ask you this. Isn't voting to adopt the SEC's 
short rule a clear and conscious decision to take away 
shareholder rights?
    Chairman Cox. Absolutely not.
    Senator Menendez. Well, can you explain--I do not 
understand how you voted for both of them because in the short 
rule it clearly seems to me that you are, in essence, 
eviscerating existing shareholder rights.
    Chairman Cox. Well, we start with the fact that at no time 
during the 73-year history of the Securities and Exchange 
Commission, have shareholders been afforded this kind of access 
that we are working on developing in a rule framework. If 
adopted, the longer proposal, in the parlance that we are using 
here, would represent a dramatic reform of the proxy rules.
    The rule reflected in the other proposal would be precisely 
the same policy that the Commission has followed without 
interruption for the last 17 years.
    Senator Menendez. You are saying that--first of all, I do 
not--Mr. Chairman, I know my time is--can I just finish up 
here?
    Would you agree this much, that the two proposals are 
diametrically different? Let's start there?
    Chairman Cox. Indeed. And----
    Senator Menendez. And you voted for both of them.
    Chairman Cox. The same reason animated that decision as 
animated my decision in many cases as a Committee Chairman in 
the Congress, to move proposals to full committee when offered 
by the majority and the minority, so that people could have a 
look at them. We have a public notice and comment process. The 
territory between the one proposal and the other was 
sufficiently broad that it would give the Commission and the 
Commissioners the opportunity to work out something among 
ourselves and with our staff and with the public that will cut 
this Gordian knot.
    This is a problem that, as I pointed out in my formal 
testimony, has perplexed the Commission for a half a century. 
It is, indeed, a very difficult problem.
    Senator Menendez. My time is expired, but let me just say, 
I hope the Commission returns to its root as an independent 
protector of shareholder interests. It seems to me that the 
United States is the only developed economy that does not give 
shareholders the right to place director nominees on corporate 
board election ballots. And you know, at the end of the day, 
you started off on a very eloquent statement, that there can be 
no capitalism without capital and there can be no capital 
without guaranteeing the security of your investments as best 
as can be achieved. And that security ultimately, from those 
who are the shareholders, who are the owners of an entity, 
ultimately have to have a say to ensure that corporate 
governance and malfeasance are at least as controlled as best 
as possible, humanly possible.
    That does not happen unless you have the wherewithal for 
shareowners to participate. And the proxy process is the best 
way by which they can aggregate to participate in that process. 
I hope the Commission takes--does not have to see itself as 
acting before it has a full body in order to achieve this.
    Thank you, Mr. Chairman.
    Chairman Cox. Senator, I should just add that I strongly 
agree with what you just said.
    Senator Reed. Senator Carper.
    Senator Carper. Thanks, Mr. Chairman.
    Chairman Cox, welcome. It is good to see you.
    I believe that both proposals issued by the SEC have real 
problems and do not take into account the important role that 
States play in this matter.
    In my own home State of Delaware, the Court of Chancery has 
jurisdiction over all business and corporate matters and has 
developed a long history of case law and precedent.
    As I mentioned in my earlier statement, my opening 
statement, Vice Chancellor Leo Strine of the Court of Chancery 
testified on this very issue before the SEC. Vice Chancellor 
Strine, in his youth, was my legal counsel when I was Governor 
and our policy director, and he is someone whose judgment I 
value a great deal.
    But in his testimony before the SEC, Vice Chancellor Strine 
tried to propose what he thought, and what seems to me maybe, 
to be a common sense solution. I just want to mention it here 
today.
    That solution would allow, on the ballot, stockholder bylaw 
ballot proposals related to the election process unless these 
proposals were clearly prohibited by State law. On first blush 
at least, I think this seems like a reasonable approach to 
take.
    I understand that some of the Commissioners objected to the 
proposal, but I would be interested in your thoughts here, in 
just a moment, on the subject, Mr. Chairman.
    Before you answer, you can have a minute to think about it. 
I just want to say I also wanted to caution the Commission. It 
is my understanding that if any action is taken on either of 
the two pending proposals, that action would only be temporary. 
And I would say, Mr. Chairman, I believe you may have said that 
you would start a complete review in the new year. I would just 
hope that the SEC would not approve a temporary rule that would 
have an adverse impact on my home State's legal system or any 
State's legal system, just to turn right around and start the 
process over in the new year.
    But if you would just think back to what I outlined as the 
suggestion of Vice Chancellor Strine and just tell me what your 
thoughts are on his approach, his recommended approach.
    Chairman Cox. Vice Chancellor Strine gave us exceptionally 
useful testimony at our roundtable. I agree with you, or at 
least I agreed with your implied endorsement of his brilliance, 
because I think he is really----
    Senator Carper. He is one smart cookie.
    Chairman Cox [continuing]. An able jurist and a very wise 
person with excellent judgment on this and other subjects.
    Senator Carper. I was just at a visitation for a funeral, 
before a funeral today, in Delaware last night with his mother. 
And he is almost as smart with his mother. And he has a brother 
who is just about as smart as him. They are quite a family. I 
do not know what they fed those kids, but we need a few more.
    Chairman Cox. The approach that he and others on the 
roundtable described to us was, in fact, the basis for one of 
the two proposals that we offered. The significant difference 
between the approach, as you just described it, and the 
proposal that we published for public comment was that there 
was, in addition, a 5-percent ownership requirement that 
attached to the disclosure provisions. That was meant to 
harmonize the Strine vision, as it were, with the existing 13D-
G disclosure regime with which everybody is familiar, so that 
we could have disclosures that would apply in this context that 
would not require the invention of a whole new system with 
uncertainty and so on.
    The 5 percent was sought to be, at least in the early 
drafting, acceptable to the investor community. Five percent 
was, in fact, the very figure that was in the ill-starred 
proposal that had been advanced during Chairman Donaldson's 
tenure before I arrived at the Commission.
    The objection to the 5 percent proposals seems not to 
extend to a 5 percent requirement for nominating directors 
under a bylaw, if one were in place. So this gets fairly 
rarified. Nonetheless, we have received an abundance of 
comments about the 5 percent provision, so the Commission is 
not under any illusion that that is not a popular provision of 
the proposal, as advanced.
    As I said, we have ample flexibility under the 
Administrative Procedure Act, to take into account all of these 
comments that we received.
    With respect to whether or not, going forward, we would 
adopt a temporary rule, I think our effort would be to try to 
do substantively something that--if we could not achieve 
consensus on--at least that the Commission felt was a quality 
proposal and that would improve the application of the proxy 
system from the standpoint of all investors. And that the 
minimum requirement that we would impose upon ourselves in the 
short run, in the current proxy season, would be to clarify the 
status quo. That is to say, not to come up with a third way, as 
some have said, one rule, a second rule, a third rule so that 
there are all sorts of different legal regimes. But rather, 
freeze in place the status quo over the last 17 years, 
including the period of time now when we have this great legal 
uncertainty but no replacement rule. And then work on this.
    We have been urged by commentators on many sides to go back 
to the drawing board, do not give up on this, and try and get 
it done. And I think there is a great open-mindedness on the 
Commission among my colleagues to do that.
    Senator Carper. I would just conclude by saying, Mr. 
Chairman, as you figure out how to get it done, keep in mind 
the counsel of my former counsel on this point. And it is my 
hope that when the new year comes that you do not have to go 
back and maybe spend a lot of time finding that third way.
    Thank you very much.
    Senator Reed. Thank you, Senator Carper.
    Mr. Chairman, I think it is important, since you have put 
so much reliance upon this recent Supreme Court case, to 
acknowledge that it is a Department of Labor case, interpreting 
overtime for health care aides under the laws of the Department 
of Labor that involved, I am told, two rules of DOL which were 
not interpreted consistently. And that we all recognize, I mean 
it is Hornbrook law that deference to regulatory agents is its 
premise. That deference was specifically rejected by the Second 
Circuit.
    So I think you are putting a lot of weight on a case that 
does not involve the laws that you are responsible for 
implementing nor the agency, your agency, which in fact 
implemented them.
    Chairman Cox. Senator, if I may clarify here, with respect 
to that decision, neither Second Circuit case, the Long Island 
Care case or the AIG case, was an interpretation of the 
securities laws, per se. The Exchange Act is not really in 
question here. There is no question about our statutory 
authority or the meaning of the statute that we are 
implementing.
    Rather, the question is whether or not an agency's 
subsequent interpretation of a rule that had been interpreted 
differently previously should be paid deference. So it is, in 
fact, the same issue that the Court addressed and it is the 
same statute, the Administrative Procedure Act.
    Senator Reed. That is an interesting interpretation, but 
you have a specific Circuit Court looking at what you have done 
and finding that it was deficient under the Administrative 
Procedure Act.
    Chairman Cox. And it is the same Circuit Court----
    Senator Reed. It was not appealed to the Supreme Court.
    Chairman Cox [continuing]. That was reversed on that point.
    Senator Reed. The Supreme Court has not----
    Chairman Cox. The Supreme Court, in the Long Island Care at 
home case.
    Senator Reed. I think it is important that this Long Island 
case was not your agency case. I think that makes a difference 
that would be distinguished. And I think it is the 
Administrative Procedures----
    Chairman Cox. Mr. Chairman, I agree with you that because 
it is not the same case that it raises a question. And all I 
have said today is that there is now greater legal uncertainty 
and that uncertainty extends to the Second Circuit. But I am 
certainly in agreement with you that this is not stare decisis. 
It is not the rule in this case. And so further litigation 
would inevitably be the result.
    Senator Reed. Well, we did not seem further litigation in 
the last proxy season and we are probably not likely to see a 
tidal wave this season.
    Senator Hagel, do you have any additional comments?
    Thank you very much, Mr. Chairman. Thank you.
    Chairman Cox. Thank you, Senator.
    Senator Reed. Let me call forward the next panel. This is 
the most organized panel I have ever seen.
    [Laughter.]
    I would like to now introduce our second panel. Mr. John 
Castellani is the President of the Business Roundtable. Prior 
to joining the Business Roundtable, he was the Executive Vice 
President of Tenneco. His Washington experience includes 
service as Vice President for Resources and Technology with the 
National Association of Manufacturers, and as Vice President of 
Government Relations for TRW, Incorporated.
    Mr. Jeff Mahoney joined the Council of Institutional 
Investors in 2006 as General Counsel. He also is an adjunct 
faculty member of the Washington College of Law at American 
University. Previously, he was counsel to the Chair of the 
Financial Accounting Standards Board. Before joining FASB, Mr. 
Mahoney was a corporate securities lawyer at Morgan, Lewis and 
Bockius. Jeff co-chairs FASB's Investor Technical Advisory 
Committee, serves on the NASDAQ listing qualifications hearings 
panel and was recently appointed to the Public Company 
Accounting Oversight Board's Standing Advisory Group.
    Ms. Anne Simpson is the Executive Director of International 
Corporate Governance Network whose members are located in over 
30 countries and hold more than $10 trillion in global assets. 
Previously, she was head of the Secretariat at the Global 
Corporate Governance Forum founded by the World Bank and OECD 
to support reform in developing and emerging markets. Prior to 
this, she was Joint Managing Director of Pensions and 
Investment Research Consultants, LTD, a United Kingdom Advisor 
on governance.
    Mr. Dennis Johnson is the Senior Portfolio Manager for the 
Corporate Governance at the California Public Employees 
Retirement Systems, CalPERS. Prior to joining CalPERS, he was a 
Managing Director of Citigroup Global Markets. Responsibilities 
throughout his 25-year career have included the development and 
management of proxy voting policies and advising and counseling 
clients on corporate governance.
    Thank you all very much. Your statements will be included, 
completely, wholly, entirely in the record. You may summarize 
and we would ask you to try to observe the 5-minute rule. Since 
you are so well organized sitting down, I suspect that will be 
no problem.
    So Mr. Castellani.

     STATEMENT OF JOHN CASTELLANI, PRESIDENT, THE BUSINESS 
                           ROUNDTABLE

    Mr. Castellani. Thank you, Mr. Chairman, Senator Hagel.
    Thank you for inviting me to share our views on this issue 
of proxy access.
    Business Roundtable has long been a strong supporter of 
corporate governance reforms. Indeed, we supported the 
Sarbanes-Oxley Act as it went through, the enhanced listing 
standards of the exchanges, additional disclosures for 
executive compensation, and majority voting for directors.
    Similarly, we remain committed to promoting the 
accountability and responsiveness of boards, and enhancing 
transparency so investors can make informed decisions.
    As you know, the issue of proxy access has been debated 
over the years, and previous Commissioners have struggled with 
both the realities of state laws that govern election of 
directors and a host of implementation issues.
    There are numerous underlying issues that should be 
resolved before proxy access is considered. These include the 
role of proxy advisory firms, the impact of so called 
``borrowed voting'', and the reforms necessary to allow a 
company to communicate directly with all of their shareholders, 
rather than going through brokers and third parties.
    The heart of the issue involves how a corporate director 
elections are governed and how a company proxy is used. 
Director elections are governed by State law where the company 
is incorporated, and the proxy is a mechanism for shareholders 
to vote when not attending shareholder meetings. Shareholders 
do have the right to nominate directors, but not on the company 
proxy. This has been an important protection against 
shareholders having to pay for their own hostile takeover. The 
SEC has consistently recognized this and excluded such 
proposals.
    Proponents of access want to allow individuals or groups 
with small holdings to place their candidate directly on the 
company proxy. Our biggest concern is that board members would 
be forced into a political system, and concentrate on annual 
election campaigns to the detriment of their most important 
responsibility--protecting and enhancing the investment of all 
shareholders.
    Imagine a proxy card with multiple candidates, seeking 
shareholder votes based upon conflicting recommendations. In 
order to win board elections, nominees would be forced to 
campaign, run ads, and even seek financing, paid for with 
shareholder money.
    In this day and age of hedge funds, foreign government 
investment in U.S. corporations, and questions about our market 
remaining competitive in the global economy, the last thing we 
believe shareholders need is more politics in the board room, 
with fractured boards openly arguing and resulting in 
diminished shareholder confidence.
    We also believe that such a process will discourage 
qualified, independent directors from serving, and undermine 
the successful model that has produced enormous shareholder 
returns.
    The fact is that company boards and directors have 
transformed themselves, demanding greater accountability and 
exercising more oversight, as they should. Indeed, we have seen 
more governance changes in the past 5 years than we have seen 
in the previous 50 years.
    Each year the Business Roundtable surveys our member 
companies on governance practices, and the results this year 
speak for themselves: 91 percent of our boards are made up of 
at least 80 percent independent directors; 72 percent of our 
boards meet in executive session at every meeting and all meet 
at least once a year in executive session; 75 percent of our 
CEOs are precluded from serving on anymore than one other board 
than their own; and 84 percent of our boards have voluntarily 
adopted majority voting for directors in just 2 years.
    An interesting example of how boards have responded to 
shareholder pressure is that the mean tenure of a CEO of a 
Business Roundtable company is now down to 4 years. Now whether 
or not this is a trend that is in the best interests of 
shareholders remains to be seen but clearly it shows that 
boards are more dominate than ever.
    With majority voting, shareholders now have a true yes or 
no vote on board candidates, and have a meaningful voice in the 
director election process. Former SEC Commissioner Joseph 
Grundfest compares this to the ``advise and consent'' powers of 
the U.S. Senate. In a speech last week he said ``Effective 
advice and consent mechanisms already exist in our own 
corporate backyards. Shareholders have the right to veto any 
candidate to serve on any board.''
    Companies work to keep shareholders because it is in their 
obvious best interest to do so. And given these reforms, the 
challenge we now face is guarding against further erosion of 
our own competitiveness. Increasingly, we see public companies 
going private, and new companies listing in foreign exchanges. 
Indeed, Senator Schumer's commission identified this trend as a 
challenge facing our capital markets.
    In our view, proxy access could contribute to this trend, 
and rules allowing virtually anyone to force by-law amendments 
regarding director elections would provide another reason for 
companies to go private or list elsewhere.
    Now more than ever, boards need to attract qualified 
directors who can work together to innovate, to increase 
revenues and profits, and to grow shareholder value.
    Preserving this current balance between shareholders, 
boards, and management will allow corporate directors to 
continue to focus on what they are there to do: provide 
critical judgment and oversight, and help create long term 
value for all shareholders.
    Thank you.
    Senator Reed. Thank you very much, Mr. Castellani.
    Mr. Mahoney, please.

    STATEMENT OF JEFF MAHONEY, GENERAL COUNSEL, COUNCIL OF 
                    INSTITUTIONAL INVESTORS

    Mr. Mahoney. Chairman Reed and Senator Hagel, good morning. 
I am Jeff Mahoney. I am General Counsel of the Council of 
Institutional Investors. We are an association of more than 130 
public labor and corporate employee benefit plans with assets 
exceeding $3 trillion.
    Appreciate the opportunity to appear before you today on 
behalf of the Council. I respectfully request that the full 
text of my statement and all my supporting materials be entered 
into the public record.
    Members of the Council are responsible for safeguarding 
assets used to fund the retirement benefits of millions of 
Americans across the country. Our members have a significant 
commitment to the U.S. capital markets, with the average 
Council member investing about 75 percent of its portfolio in 
stocks and bonds of U.S. public companies. And they are long-
term, patient investors due to their heavy commitment to 
passive investment strategies. As a result, U.S. corporate 
governance issues are of great interest to our members.
    A key issue at today's hearing is whether shareowners 
should continue to have the right to file resolutions requiring 
or encouraging companies to adopt processes for including 
shareowner-suggested director candidates on companies' proxy 
cards.
    In our opinion, directors are the cornerstone of the U.S. 
corporate governance model, and the primary role of shareowners 
is electing and removing those directors. Thus, we believe 
shareowners should continue to have the ability to file proxy 
access resolutions and the marketplace at large should have the 
opportunity to vote yes or no, up or down, on whether those 
resolutions are in the best interests of the targeted companies 
and in the best interests of their investors.
    Chairman Cox has repeatedly suggested that the SEC must 
adopt a final rule prior to the 2008 proxy season that 
eliminates existing shareowner rights to file access 
resolutions. Chairman Cox has argued that such action is 
necessary to protect investors from one, legal uncertainty; and 
two, inadequate disclosures. The Council believes that Chairman 
Cox's arguments on this issue are less than convincing.
    More specifically, in response to Chairman Cox's concerns 
about legal uncertainty, we note that the Second Circuit Court 
of Appeals' 2006 decision in AIG clearly and unanimously set 
forth the law relating to shareowner resolutions that establish 
procedural rules governing director elections. In AIG, the 
Second Circuit concluded that those resolutions cannot be 
omitted from companies' proxy cards.
    Thus, under current law, any public company that would omit 
an access resolution from their proxy card during the 2008 
proxy season would be acting with the knowledge that they may 
be violating the Federal securities laws. Those companies would 
face the risk of litigation whether they were subject to the 
jurisdiction of the Second Circuit or any other Circuit.
    We also note that we have already gone through one proxy 
season, as you noted, with the AIG decision in place and this 
great legal uncertainty that Chairman Cox apparently fears 
never did materialize. In fact, there were only three access 
resolutions during the 2007 proxy season. And I would add that 
all of those resolutions received significant shareowner 
support; in one case a majority. We expect that the 2008 proxy 
season will yield similar results with only a handful of 
companies receiving access resolutions.
    In response to Chairman Cox's second concern about 
inadequate disclosures, we note that the three access 
resolutions brought during the 2007 proxy season that I just 
mentioned, those resolutions would have fully complied with all 
existing SEC disclosure requirements. In addition, Council 
members, and we believe most other investors, would oppose or 
vote against proxy access resolutions that fail to provide 
adequate disclosures about the proposing shareowners.
    If, as Chairman Cox suggests, adopting the SEC's non-access 
proposal prior to the 2008 proxy season is critical to ensuring 
adequate disclosures for investors, you have ask why is it that 
that proposal does not discuss in any detail, or solicit any 
comments on, the disclosure issue. We agree with SEC 
Commissioner Annette L. Nazareth's analysis of this point. She 
recently stated: ``If the problem is one of disclosure--and 
clearly fulsome disclosure concerning the proposing 
shareholders is appropriate--the solution is to address the 
disclosure directly, not to eliminate this bylaw avenue 
altogether.''
    Notwithstanding the Council's strong opposition to the 
SEC's current proposals, we continue to stand ready to work 
cooperatively with Chairman Cox and the Commission, this 
Committee, my fellow panelists, and all other interested 
parties to develop meaningful proxy access reforms that will 
best serve the needs of investors, companies, and the U.S. 
capital markets.
    Thank you, very much, Mr. Chairman, for inviting me to 
participate at this hearing. I look forward to the opportunity 
to respond to any questions.
    Senator Reed. Thank you very much, Mr. Mahoney.
    Ms. Simpson.

 STATEMENT OF ANNE SIMPSON, EXECUTIVE DIRECTOR, INTERNATIONAL 
                  CORPORATE GOVERNANCE NETWORK

    Ms. Simpson. Thank you very much.
    I hope that what I can contribute to the discussion is some 
views about how this issue is handled in other markets. There 
has been an important theme of competitiveness which has been 
raised by Chairman Cox and in some of the questions, and I 
think even Mr. Castellani raised a concern that companies under 
pressure would be listing in other markets or perhaps even 
going private.
    I would comment on both those points, that if companies do 
go to other markets, they will find that shareholders have the 
right to appoint, remove, and propose directors to the board. 
They will also find, if they go private, that one reason 
investors put money up for that to happen is so that they can 
have a closer oversight of the company, and the evidence is in 
both cases that the motivation is to improve performance. So I 
think we have to be careful about not trying to have this both 
ways.
    As you rightly said, our members are in many countries 
worldwide. They are responsible for many trillions. I think the 
important point is that of those 40 countries and our 500 or so 
members, they have something on the order of $4.5 trillion 
invested in the U.S. market. So they take a very close interest 
in the developments that are being discussed today.
    The point has already been made that capital is global and 
it is also mobile, and I think we see in every region the 
policymakers are finding that they do need to pay attention to 
the concerns of shareholders in ensuring an effective and 
efficient regime for corporate governance. And what we observe 
internationally is that the U.S. is almost alone in preventing 
shareholders being able to directly and in simple, effective 
ways hold boards to account. And such research that there is 
shows that when shareholders are able to pay attention to 
boards, there is a resulting improvement in performance, and 
certainly that is the experience from research in the U.K.
    I want to, I think, address two points which come from our 
international experience, points that have been raised both by 
Chairman Cox and I think in some of the questioning.
    One is that shareholders may put forward proposals which 
are in some way damaging to the company. We find this a very 
puzzling proposition because, among all the constituencies with 
an interest, shareholders are the one group who share the same 
interest as the company management, which is in building the 
wealth-creating potential of that organization. Shareholders 
are the ones who are at the end of the day concerned with 
value.
    So we are simply not persuaded with the notion that 
allowing shareholders to put proposals forward is in any sense 
going to undermine enterprise. Enterprise is the name of the 
game, whether you are a small investor, whether you are a hedge 
fund, or whether you are a pension fund.
    In other words, we want to emphasize that we take the view 
that shareholders have a core of common interest with the 
business community in promoting wealth creation. The question 
is how to make sure that accountability is practical and 
effective.
    The other point that we would like to make is to address 
the concern about what happens to boards and their ability to 
deliver on performance when shareholders have been involved in 
putting them forward. I think that it is important to remember 
that if a shareholder is about to nominate a director, that 
person will only be elected if the majority of the 
shareholders, their fellow shareholders, agree that they should 
go forward. The right to nominate is not the right to appoint, 
and the very purpose of having an election is so that 
shareholders can address a concern, address effectively through 
the proxy materials of their own company--it is not the company 
versus the shareholder; the company belongs to them. This is, 
in effect, their proxy material, in our view--address fellow 
shareholders on an issue of mutual concern, and the issue will 
be judged on its merit.
    The other important point to remember is that under the 
U.S. system, as in many jurisdictions, once a director is 
elected to the board, they will inherit a fiduciary 
responsibility to the company and to all its shareholders. 
There is simply no legal provision which would allow a 
shareholder to be elected by a majority of the shareholders, 
but then when he or she is in place, to somehow reflect or pay 
special attention to particular interests. This is simply in 
basic conflict with fiduciary duty, and I think it is important 
to make that point, too.
    For that reason, and as you know from our written 
testimony, and also in our letter to the SEC, we view 
shareholder rights as a tool kit for ensuring the efficiency of 
the private system. In other words, it is a capitalist system, 
and we are not comfortable with the idea that State bodies 
should attempt to intervene in the dialog between companies and 
their owners. It is up to owners to decide what is in their 
collective best interests for the company and for the processes 
that regulators and policymakers put forth to facilitate that 
process, not to decide what could or should go forward.
    Now, the other question that we are sometimes asked--and it 
may be helpful in the U.S. to think about this--is if you have 
this provision in all the other markets, how often is it used? 
I think the comment was made earlier--perhaps Chairman Cox is 
concerned about this--that there are 45 million individual 
investors, does this mean each one of them will want to put 
forward a proposal to each of the companies where they hold 
shares? I think not. What our experience says in other 
markets--and I would just like to quote from one of our 
members. We did a straw poll on this issue before we wrote our 
SEC letter because we thought it would be helpful to see how 
the system really did work and what the view of it was in other 
markets. And the comment was: How often do shareholders propose 
directors in other markets? And across the board, the answer 
was, ``Rarely.'' And this is because it is a reserved power 
which acts as a powerful incentive for communication, for 
consultation, and, most importantly, the development of 
solutions between shareholders and companies. And I would just 
like to quote from one of our members who is a large investor:

        ``These provisions are rarely used, but the fact of their 
        existence is a real spur to proper engagement by companies with 
        their shareholders. And shareholders seem to be very thoughtful 
        in their analysis of shareholder resolutions that do get on the 
        agenda. I am not aware of very many shareholder resolutions 
        having succeeded, but I think that is because the engagement 
        linked to the resolution (both by the proponents and others) 
        has produced from the company commitments to improve the 
        practice or to effectively address the question.''

    So if I can sort of borrow from an American approach, I 
think that the right here has been for shareholders to speak 
softly but carry a big stick. In other words, the Teddy 
Roosevelt solution was probably the one that we are looking 
for. For that reason, we really do consider that the two 
proposals are unnecessary. We think they are confusing in 
themselves. They are a source of potential uncertainty, and we 
would advise that both are left quietly on a shelf somewhere to 
be studied by students of corporate governance in the future, 
but certainly not implemented. Therefore, we are finished with 
Napoleon. ``Masterful inactivity'' is our counsel to the SEC, 
and we hope that nothing more happens. We think the judgment 
from AIG was very sensible, and we look forward to further 
improvement in the future.
    Senator Reed. Thank you very much, Ms. Simpson, and 
suggesting ``masterful inactivity'' around here is, I think, 
self-reinforcing. But, anyway----
    [Laughter.]
    Senator Reed. Mr. Johnson.

    STATEMENT OF DENNIS JOHNSON, SENIOR PORTFOLIO MANAGER, 
 CORPORATE GOVERNANCE, CALIFORNIA PUBLIC EMPLOYEES' RETIREMENT 
                             SYSTEM

    Mr. Johnson. Mr. Chairman, Senator Hagel, thank you for the 
opportunity to comment on the issue of shareholder access to 
corporate election ballots. I am here for an institutional 
investor with more than $250 billion in assets under 
management. I represent the California Public Employees' 
Retirement System, which provides retirement and health 
benefits to 1.5 million members in State and local government.
    Since we own shares of more than 7,500 publicly traded U.S. 
companies, regulations affecting corporate governance are 
vitally important to us. To date, we are concerned that the 
proposed short rule by the Securities and Exchange Commission 
would eliminate our present right to place binding and non-
binding proposals on corporate ballots. It would also prevent 
shareowners from filing proposals that request companies to 
adopt a proxy access provision for director nominations.
    The Committee has asked us to comment on whether the SEC 
needs to change the current practice before the 2008 proxy 
season, also on the right timing for any rule change, and on a 
shareowner's right to proxy access.
    Chairman Cox says the SEC needs to act soon to address 
uncertainty about current applications of the rule. Uncertainty 
is a red herring. In fact, when a court of appeals gives an 
opinion, there is absolute certainty. The Second Circuit Court 
clarifies in the AIG case that the current SEC regulations does 
not exclude proxy access. Shareowners subsequently submitted 
three proxy access proposals in 2007. No company challenged any 
proxy access proposal in court.
    Chairman Cox also says a change is needed now to safeguard 
shareowners from the risk of not knowing more about the 
background of proxy access proponents. He says we need to know, 
for example, if a proponent had acquired shares to effect or 
influence a change in a company control. But shareowners have 
not requested this information and if disclosure of this sort 
is so crucial, companies that had proxy access resolutions on 
their ballots this year surely would have expressed concern. 
None did.
    The SEC failed to act on the proxy access issue for years 
when it had a full Commission. Why rush to judgment now? In 
fact, the right time to act on such a crucial issue is after 
the thoughtful deliberation of a full five-member bipartisan 
Commission. A fundamental right of corporate law is the right 
of shareowners to protect their interests by ensuring fair 
director elections and accountability to the companies' owners. 
To secure that right, we investors prefer self-government to 
regulation and legislation, except when reasonable checks and 
balances are threatened. In such cases, we ask regulators and 
legislators to do the right thing.
    Today we urge this Committee to send a very strong message 
urging the SEC to reconsider its timing and start anew at the 
right time when it has a full Commission. If there was a 
tsunami of harm that needed to be addressed within a month or 
so, it would be a different matter.
    Speaking of harm, the SEC's highest priority should be to 
do no harm to do no harm to the shareowners in their 
decisionmaking. This ill-timed proposal before a subset of a 
Commission is unfair, unwise, and violates the core principle 
of ``do no harm'' to shareowners, and is contrary to the very 
purpose for which the SEC was established.
    One final note. We should stand for more democracy, not 
less. For all the sophistication of our markets in the U.S., we 
continue to lag other countries in corporate democracy. We are 
the world's only developed economy that keeps shareowners from 
placing director nominees on company ballots.
    Thank you, and I welcome your questions.
    Senator Reed. Thank you very much, Mr. Johnson. Thank you 
all for your excellent testimony.
    Let me begin, Ms. Simpson. We have made these comparisons 
between other countries, but in Great Britain and in other 
places, shareholders have access to the proxy statement. Is 
that correct? Could you give us sort of just a quick sketch of 
access?
    Ms. Simpson. Yes, how does it work in the U.K., which is 
where I am from, although I should say I do have to emphasize 
our members are from 40 countries; 160 of our 500 are here in 
the U.S.; we are an international group.
    In the U.K. the provision has existed since the mid-19th 
century. This is nothing new. When the company was invented, it 
was intended that shareholders were the best monitors of 
corporate activity. It could not be done by Parliament or the 
Queen or the King. It should be done by those with the economic 
interest, and this is how it works.
    If a shareholder wishes to propose a directive, they put 
forward a resolution directly to the company, and there were 
two hurdles. Either you must represent 5 percent of the shares, 
which is a familiar threshold that has been talked about in 
this market, or--and this is very important--100 shareholders 
can come together. And that means that, for example, in a very 
big market like the U.S., as has been widely said, 5 percent is 
an impossible hurdle to reach.
    The other issue is costs. The company must include the 
proposals on the paperwork that goes out. We do not call it a 
proxy, but the paperwork that goes out. And they can legally--I 
do not think this has happened, but the company could insist 
that the proposers pay what are called under the law the 
``reasonable costs of circulation.''
    Now, the reasonable costs of including 500 words on 
material that is already going out are obviously pretty 
minimal, so we do not see that as a barrier.
    Something like in the last--since 2000, there is some 
research that Yale has commissioned, which is not yet published 
but it is comparing the impact of proposals in the U.K. and the 
U.S., shows that there has been around 500 proposals in the 
last 6 or 7 years in the U.K., and they have had a significant 
impact on performance because they almost exclusively targeted 
companies where the board is doing a very bad job. Other 
countries have different proposals. In Germany, an individual 
shareholder can put forward a directive. In the Netherlands, it 
is a 1-percent rule, not a 5-percent rule. So I think it is 
very important, depending on the size of the market, that you 
find the right balance to ensure that the shareholders are 
viewed as legitimate, they are properly owners, but at the same 
time you do not make the hurdle impossible, which would 
actually mean the rule is effectively not going to work.
    Senator Reed. Thank you.
    A question, Mr. Mahoney, in terms of the issue of 
disclosure which you raised, and you noted that this is a 
concern that is not reflected in the Commission's proposed 
rules. Under the securities laws, if the management had 
information they thought was significant with respect to a 
potential candidate proposed by an individual, could they 
legally include that in the proxy? Could they point out that 
the individual represents a certain faction? Is there any 
possibility of doing that?
    Mr. Mahoney. I believe there is. I think that, as I 
mentioned before, those proposals that have been set forth, 
there has not been--and Mr. Johnson mentioned it as well. There 
has not been any concerns expressed from anyone that there was 
something missing that some party, whether it be the company or 
other shareholders, felt was necessary.
    Senator Reed. Mr. Castellani, at present, the rule, at 
least the one that is before the case, the AIG case, left the 
selection of directors to other directors, basically, and there 
is, I think, at least a potential there for too inclusive a 
group and not reflecting shareholders. Is that a concern that 
you share?
    Mr. Castellani. It is not a concern because of the way the 
process is structured. First, as you know, under listing 
standards, the majority of the directors of the board must be 
independent; and, second, all of the members of the nominating 
committee or governance committee, the committee that does the 
nomination of the directors, must be independent directors--
that is, independent of the management, which is something that 
is indeed different in our system than, for example, the U.K. 
system, which has many more insiders on the board, are allowed 
on their boards of directors.
    All of our companies have processes by which they 
communicate with shareholders, and they all have processes 
which are published by which they both set out qualifications 
of directors and solicit from the shareholders director 
nominees. They go to the nominating committee. The difference 
is the nominating committees are independent directors 
exclusively.
    Senator Reed. Does it make a distinction--and I think this 
is a point that perhaps was not made as explicitly as we should 
have in the first panel with the Chairman. We are not talking 
about the individual selection of directors. We are talking 
about a procedure, a general procedure. The individual 
influencing of an election would still be prohibited by the SEC 
interpretation, any interpretation. But we are talking about a 
procedure. Why would it be difficult for a company to have 
shareholders introducing a resolution that sets up a procedure, 
a general procedure that allows much more access by shareholder 
nominees?
    Mr. Castellani. Well, we are focusing on the underlying 
issue, which is how directors are elected. The procedures that 
exist are now as you all know and what we had described. What 
our concern is is that if a board goes through a process--a 
nominating committee goes through a process of consulting with 
shareholders, receiving shareholder input, which they do; 
determines a director nominee and puts that director nominee 
forward; if that director nominee is going to face a 
competitive race, then he or she will be less likely to serve, 
and we will lose the ability to get high-quality people to 
continue to serve as directors. Or if a nominee is put forward 
that has an interest that is specific to a particular 
shareholder group but not representative of the broad base of 
shareholders to which all directors must be responsible in the 
fiduciary rights, that it causes distraction in the boardroom 
and actual erosion in shareholder value.
    So we are focusing on the next step after that as opposed 
to the step which is whether or not the shareholders have a 
right to put that proposal forward.
    Senator Reed. Mr. Johnson, your response to these general 
issues about the--since your organization invests in a broad 
range of companies and you have experience with the proxy 
process going back 25 years, what is your comment?
    Mr. Johnson. Mr. Chairman, the comment is as follows: No. 
1, to consult and to receive input from shareowners we believe 
is not sufficient. We believe shareowners should be directly 
involved in the process for being able to nominate for 
consideration by other shareowners the director candidates.
    And with regards to a competitive environment for the 
director nomination process, we have that today. We call it a 
proxy contest. And we believe that we have not seen any 
detrimental impact on the value of the firms or the quality of 
the candidates that are being considered and voted upon to join 
the board of portfolio companies.
    Senator Reed. And the previous comments about, you know, 
the difficulties within the board if this process goes there, 
you are a shareholder in major companies. You get, presumably, 
consulted or at least you provide input. But what is your 
impression in terms of how directors are really selected? I 
guess that is my question. I know they are independent, but 
sometimes the independence is one based on just they do not own 
stock in the company, but they certainly have relationships 
with other directors.
    Mr. Johnson. Well, there are two elements here, Mr. 
Chairman: there is the selection process and the election 
process. In the selection process, it is clearly our view that 
directors select directors. There is little tangible evidence 
of shareowners having direct input if not actually deciding who 
the actual candidates are that will be voted upon by other 
shareowners.
    Then, second, you do have shareowners voting for directors, 
and clearly these directors are being held to an even higher 
standard as we see higher withhold votes for directors at 
companies where they are failing to perform and to create value 
for shareowners.
    Senator Reed. There is one issue here that we have all 
talked about, and that is--and, Ms. Simpson, you alluded to it, 
too--that in specific markets, the 5-percent threshold is much 
too great; in other markets it might be appropriate. With 
respect to these proposals by the SEC, the 5-percent threshold 
in your view would be too high a wall to scale, effectively?
    Ms. Simpson. Yes, that is our view, and the other market 
which we know well, the U.K., which has the 5-percent rule, 
provides an alternative so that 100 shareholders can come 
together. And I think the U.K. has the highest provision by 
percentages. So, you know, you have to give more than one 
practical route.
    I just would like to make one quick comment on the issue 
that Mr. Johnson was just discussing. I think it is highly 
unlikely that a company in deep trouble where the board is the 
problem that the board would be looking for, you know, renewal 
and resurrection and improvement. It is precisely those 
companies where shareholders need to be able to take matters 
into their own hands. You know, the companies that are 
functioning well and the boards are functioning well, this is 
not where the activity needs to be focused. So I think it is 
highly unlikely that, you know, boards would fall on their 
sword when things were going wrong. Those are the circumstances 
where we need to intervene.
    Senator Reed. Let me address a final question, and I will 
give you an opportunity to comment if you have a specific 
comment. There are two proposals before the SEC, and they seem 
to, directly or indirectly, exclude meaningful shareholder 
participation in setting up procedures for the selection of 
directors. One would deny it outright, basically, and the 
second would set such a high threshold that literally no large 
shareholder could comply--no shareholder could comply. So, in 
effect, we have a situation where there is no real choice here 
as the Commission goes forward if those two proposals are--
either one is adopted. Essentially you have excluded--you have 
overturned the AIG-AFSCME case, and you have excluded any type 
of participation by shareholders in establishing a procedure to 
nominate and elect directors.
    Am I missing something? Let's start with Mr. Johnson and go 
down the line.
    Mr. Johnson. You are not.
    Senator Reed. OK. Ms. Simpson?
    Ms. Simpson. It seems perverse.
    Senator Reed. Thank you.
    Mr. Mahoney. We agree with you, Mr. Chairman.
    Senator Reed. Mr. Castellani? And you have other comments, 
Mr. Castellani.
    Mr. Castellani. Well, my other comment relates to the 
threshold of 5 percent, just as a point of information. We did 
look at the top 28 largest of our members, and--25 largest of 
our members, and the top 20 of them have a shareholder of 5 
percent or greater, and in the remaining 5 it would take two 
shareholders to reach 5-percent threshold. So just as a point 
of information from the perspective of the largest.
    Senator Reed. Let me, because this is a point--Mr. Johnson, 
CalPERS is one of the biggest investors. Do you have 5-percent 
ownership in any major company in the United States?
    Mr. Johnson. We are the largest public pension fund in the 
United States, and our average position is between 0.5 and 0.6 
percent of the shares outstanding of our portfolio companies.
    Mr. Castellani. And, Senator, that is typical for pension 
funds and funds like CalPERS, State pension funds. They are a 
very important voice in the systems of corporate governance. We 
appreciate that they are long-term holders, but the fact of--
the ownership profile is that there are 5-percent holders----
    Senator Reed. No, I do not dispute you, but if you could 
provide us that information, that would be helpful.
    Mr. Castellani. Sure.
    Senator Reed. Because this is sort of an ongoing debate 
about is this an effective way to have a threshold or not have 
a threshold. And your other point, sir?
    Mr. Castellani. Well, you asked the question, and 
thankfully, as you read in my bio, I am not an attorney, but I 
am told by our counsels that we do need clarification of the 
AIG-AFSCME case and the SEC's position on it.
    Senator Reed. Good. Well, thank you all very much for your 
patience and your participation and your excellent testimony 
and excellent responses. We will keep the record open for 5 
more days. There might be additional questions from my 
colleagues who are not here at the moment, and we would like 
you to respond in a very timely manner if you receive such 
questions.
    The hearing is adjourned.
    [Whereupon, at 12:06 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]
            PREPARED STATEMENT OF SENATOR RICHARD C. SHELBY
    Thank you Mr. Chairman.
    The committee meets today to examine the SEC's proposed rules 
regarding shareholder access to a company's proxy materials.
    Last year, the Second Circuit ruled that corporations can not 
exclude from their proxy materials shareholder proposals to change the 
company's bylaws requiring it to include shareholder nominess in its 
proxy statement.
    In reaching this decision, the Second Cirucit overturned the SEC's 
long-standing position that shareholder proposals relating to the 
election of directors may be excluded from a company's proxy statement.
    As Chairman Cox noted in his testimony during his last appearance 
before this Committee, the decision created a great deal of 
uncertainty.
    Consequentially, this past July, the SEC proposed two separate and 
mutually exclusive rules addressing shareholder access to proxy 
materials.
    The first proposal would expressly require corporations to include 
in their proxy materials certain shareholder proposals for changing a 
company's bylaws to include shareholder nominated directors in the 
company's proxy materials.
    The second proposal would effectively restore the status quo by 
clarifying that such shareholder proposals can be excluded from 
corporation's proxy materials.
    Either of these proposals, if adopted, could have a significant 
impact on the corporate governance of public companies.
    I look forward to hearing from Chairman Cox on how the SEC plans to 
move forward with these proposals and to eliminate the uncertainty 
created by the Second Circuit's decision.
    With the 2008 proxy season fast approaching, it is important that 
these issues be addressed in a timely, but thorough manner.
    Thank you Mr. Chairman.

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    
     RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM 
                        CHRISTOPHER COX

Q.1. The Commission appears sharply divided over its ``long 
proposal,'' which would require companies to include in their 
proxy materials shareholder proposals to change a company's 
bylaws on shareholder nominated directors. In the past you have 
expressed your hope that the Commission could operate on a 
consensus basis. Because the long proposal would enact a 
dramatic change in corporate governance, it would seem that 
reaching a consensus on the proposal would be particularly 
valuable.
    If a consensus can not be reached on the ``long proposal,'' 
what are the circumstances, if any, under which you would 
support moving forward with the proposal?

A.1. I believe there is a consensus on the Commission, as 
presently constituted, that the federally regulated proxy 
system should vindicate and not supplant the rights of 
shareholders under state law to determine the directors of the 
companies they own. The extensive and informative comments we 
received on the ``long proposal,'' particularly with respect to 
the concerns surrounding the proposed new disclosure 
requirements tied to the existing 13D/G regime and the 5% 
ownership threshold, mirrored the growing concerns of various 
Commissioners with aspects of the proposal. The result is that 
while there is consensus in the general principle, the specific 
approach of any reforms will have to be given further thought. 
I intend to work toward building support on the Commission for 
a new rule proposal that will strengthen the proxy rules to 
better facilitate the fundamental state law rights of 
shareholders.

Q.2. If the Commission adopts its ``long proposal'' would it be 
opening the door for shareholders seeking to include in 
companies' proxy materials proposals for bylaw amendments 
involving matters other than the election of directors? And if 
all shareholder proposals for bylaw amendments do not need to 
be included in companies' proxy materials, by what principle 
would you determine whether or not shareholder proposals for 
bylaw changes could be excluded?

A.2. The answer to the first part of your question is no. 
Adoption of the ``long proposal'' would not have any impact on 
other types of bylaw amendment proposals and would affect only 
those proposals that companies traditionally have been 
permitted to exclude pursuant to the election exclusion. 
Currently, under Rule 14a-8 shareholders are permitted to 
submit proposals regarding bylaw amendments to be included in a 
company's proxy materials, so long as the shareholder meets 
certain eligibility requirements and the proposal does not fall 
within one of the thirteen bases for exclusion in the Rule. 
Rule 14a-8(i)(8), commonly known as the ``election exclusion,'' 
is one of these thirteen bases for exclusion and is the subject 
of the proposed rule amendments. So the answer to the second 
part of your question is that whether shareholders may submit 
proposals for bylaw amendments on other subjects and companies 
would be required to include such proposals will continue to 
depend on whether the proposal did not fall within one of the 
other bases for exclusion in Rule 14a-8.

Q.3. The Commission has historically permitted companies to 
exclude from their proxy materials shareholder proposals that 
relate to the election of directors.
    Could you please explain the rationale for this policy?

A.3. The election of directors is of fundamental importance to 
shareholders and to the company. For this reason, Rule 14a-
8(i)(8) provides that a proposal that relates to an election 
may be omitted from a company's proxy materials in order to 
prevent the circumvention of proxy rules that are carefully 
crafted to ensure that investors receive adequate disclosure 
and an opportunity to make informed voting decisions in 
election contests. Allowing shareholders to include their 
nominees in company proxy materials would create what is, in 
fact, a contested election of directors, but without the 
numerous protections of the federal proxy rules that are 
triggered only when there are opposing solicitations. As the 
Commission explained when it proposed the election exclusion in 
1976, its principal purpose ``is to make clear, with respect to 
corporate elections, that Rule 14a-8 [governing other kinds of 
shareholder proposals] is not the proper means for conducting 
campaigns or effecting reforms in elections of that nature, 
since other proxy rules, including Rule 14a-11 [governing proxy 
contests], are applicable thereto.''

Q.4.a. During the 2007 proxy season the Commission received 
only three requests for no-action relief by companies seeking 
to exclude shareholder access proposals. In testimony submitted 
for the hearing, it is argued that the lack of requests for no-
action relief demonstrates that there is no uncertainty about 
the application of the Commission's proxy access rules.
    How do you interpret the lack of requests for no-action 
relief?

A.4.a. The small number of no-action requests was directly 
related to the small number of shareholder bylaw proposals 
governing director election procedures that were submitted 
during the 2007 proxy season. The legal uncertainty regarding 
the appropriate interpretation of Rule 14a-8(i)(8) resulting 
after the Second Circuit's decision in AFSCME v. AIG, may have 
contributed to the small number of such proposals to companies. 
Shareholders may have decided not to incur the costs of 
submitting these proposals, particularly since a shareholder 
can submit only one proposal to a company, until there was more 
certainty as to whether such a proposal would be required to be 
included in a company's proxy materials or whether a company 
could exclude the proposal. Additionally, the Second Circuit's 
decision was issued in September 2006, which may not have 
afforded shareholders enough time to prepare and submit these 
types of proposals to companies before each company's deadline 
for submitting proposals for the 2007 proxy season.

Q.4.b. Could you please elaborate on your testimony that the 
Second Circuit's AIG decision could undermine the Commission's 
proxy disclosure rules?

A.4.b. The Second Circuit's decision in AFSCME v. AIG would 
have permitted a bylaw proposal to establish director election 
procedures without the disclosures and clear antifraud 
protections that have long been required by the proxy rules 
governing contested elections.
    Several Commission rules regulate contested proxy 
solicitations so that investors receive adequate disclosure to 
enable them to make informed voting decisions in elections. The 
rules, which would not have applied under the Second Circuit 
approach, require disclosure regarding the participants in the 
solicitation, as well as disclosure regarding the nominee for 
director. Because the inclusion of shareholder nominees for 
director in a company's proxy materials normally would create a 
contested election of directors, the protections of the proxy 
solicitation rules designed to provide investors with full and 
accurate disclosure are of vital importance in this context. 
The numerous protections of the federal proxy rules are 
triggered only by the presence of a solicitation made in 
opposition to another solicitation. The proper functioning of 
Rule 14a-8(i)(8) is critical to assuring that investors receive 
adequate disclosure in election contests, and that they benefit 
from the full protection of the antifraud provisions of the 
securities laws.

Q.5. Presently, most directors of public companies are selected 
by boards of directors' nominating committees. Directors 
serving on a nominating committee have a fiduciary duty to act 
in the best interest of the company and all its shareholders 
when they select directors. In contrast, a shareholder in a 
public company does not generally owe a fiduciary duty to other 
shareholders.
    Do you have any concerns that including shareholder 
nominees for directors in the proxy materials of public 
companies will undermine the role of nominating committees and 
reduce the quality of the directors elected?

A.5. State law, not federal law, governs this question. State 
laws generally allow shareholders to nominate candidates for 
director at a company's annual meeting. State law also 
generally allows shareholders to present proposals for a vote 
at the annual meeting, including nominations for director, 
subject to compliance with requirements contained in a 
company's bylaws. The federal proxy rules already permit any 
shareholder to conduct a separate proxy solicitation for votes 
in favor of the shareholder's director nominee. If a 
shareholder-nominated candidate is elected, that person will be 
subject to the same fiduciary duties as a board-nominated 
candidate who wins a seat on the board. The Commission's 
interest in the nomination process is to ensure full and fair 
disclosure to shareholders so that they can make informed 
voting decisions, not to change the prevailing state-law rule 
that shareholders can nominate directors. Regardless of whether 
a nominee is nominated by a shareholder or a nominating 
committee, it is of the utmost importance that shareholders 
receive the disclosures required by the federal proxy rules. 
Armed with this information, shareholders can choose whether to 
vote for a nominee put forth by the nominating committee or to 
vote for a nominee put forth by a shareholder.

Q.6. Chairman Cox, you recently spoke on the topic of Sovereign 
Wealth Funds and raised questions about the ability of the 
Commission to carry out its enforcement and regulatory 
responsibilities when dealing with sovereign actors who also 
happen to be participants in our securities markets.
    Could you expand on these concerns and discuss the 
implications associated with regulating sovereign investment 
entities?

A.6. The rise of sovereign wealth funds and state-owned 
corporations with minority public ownership (``sovereign 
business'') portends a greater degree of state ownership in the 
economy, raising many of the same questions that any program of 
state ownership entails. In my view, government ownership is 
very different from foreign ownership: the former is often a 
threat to free markets, and the latter completely consistent 
with them. Both the Commission and the Congress need to inquire 
where this trend will lead and what the logical outcomes of 
growth in state ownership in the economy might be. There are 
possible good and ill effects of increased direct participation 
in the world's capital markets by governments. In the short 
run, governments and regulators, in the U.S. and throughout the 
world, need to help in the process of structuring norms and 
practices to maximize the potential benefits and minimize the 
risks. This important work is well underway in a number of 
venues, including the President's Working Group on Financial 
Markets, of which the SEC is a member, as well as in the G-7, 
the World Bank, and the IMF.
    Enforcement: In theory, the Commission has the power to 
pursue sovereign businesses for violating U.S. securities laws. 
Neither international law nor the Foreign Sovereign Immunities 
Act renders these funds immune from the jurisdiction of U.S. 
courts in connection with their commercial activity conducted 
in the United States. Today, when a foreign private issuer is 
suspected of violating U.S. securities laws, the SEC's 
experience working with our overseas regulatory counterparts 
indicates that the SEC could almost always expect the full 
support of the foreign government in investigating the matter. 
But if the same government from whom we sought assistance were 
also the controlling person behind the entity under 
investigation, there is reason to expect that the same level of 
cooperation might not be forthcoming.
    Conflicts of Interest: A related issue is the conflicts of 
interest that arise when government is both the regulator and 
the regulated. Rules that might be rigorously applied to 
private sector competitors will not necessarily be applied in 
the same way to the sovereign who makes the rules. A corollary 
of such conflicts of interest is that the opportunity for 
political corruption increases. When individuals with 
government power also possess enormous commercial power and 
exercise control over large amounts of investable assets, the 
risk of misuse of those assets, and of their conversion for 
personal gain, rises markedly.
    Market Efficiency: Investors and regulators have to 
question whether government-controlled companies and investment 
funds will always direct their affairs in furtherance of 
investment returns, or rather will use business resources in 
the pursuit of other government interests. And if the latter is 
the case, what will be the effect on the pricing of assets and 
the allocation of resources in the domestic economies of other 
nations?
    Transparency: In many industrial countries today, the 
ability of journalists and citizens to inquire into government 
affairs, or to criticize the conduct of government, is severely 
limited. Is it reasonable to expect that these same governments 
will be fully forthcoming with investors?
    Information Disparities: If ordinary investors--an 
estimated 100 million retail customers in America who own more 
than $10 trillion in equities and stock funds in U.S. markets--
come to believe that they are at an information disadvantage 
when they compete head to head in markets with government, 
confidence in our capital markets could be seriously eroded. It 
is for this reason that so much of the SEC's effort is focused 
on full and fair disclosure to all market participants, and the 
prevention of fraud and unfair dealing such as insider trading. 
There are significant disparities in the information that is 
available to government as compared to private marketplace 
actors. Unlike private investors and businesses, for example, 
the world's governments have at their disposal the vast amounts 
of covert information collection that are available through 
their national intelligence services. Current legal 
restrictions in some countries on the domestic collection and 
use of such information might serve to protect the civil 
liberties of that nation's citizens. But there are normally no 
concomitant protections for foreign nationals, or for 
intelligence collection activities conducted in other 
countries. Unchecked, this could be the ultimate insider 
trading tool.
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