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Chapter 36 Shareholders and the Internet

§ 36.01 Introduction

§ 36.02 URLs in Shareholder Proposals

§ 36.03 Evolution of Staff's Position

§ 36.04 Current Staff Position

§ 36.05 Possible Consequences of Staff's Position

§ 36.06 Announcing Voting Information on the Web

§ 36.07 Solicitation of Support for a Shareholder Proposal on the Web

§ 36.08 Solicitation Against a Company Proposal on the Web

§ 36.09 Online Sources of Information about the Shareholder Proposal Process

§ 36.10 Other Online Corporate Governance Related Resources

§ 36.11 Impact of the Internet on the Shareholder Proposal Process

Chapter 36 Shareholders and the Internet

§ 36.01 Introduction

The Web increasingly is being used by shareholders to communicate with management and with other shareholders. Not only are thousands of retail shareholders complaining on message boards; some more sophisticated shareholders are leveraging the Web to challenge management. Illustrative of this trend is the proxy contest at Luby Inc. (which was originated by shareholders who met on a Yahoo! Finance message board) and the fight at ICN Pharmaceuticals, where a dissident group established one of the first "ad hoc" Web sites to champion a particular issue, lobbying for board membership through www.ssp-specialsituationspartners.com.

Traditional shareholder activists have been online for some time, and they continue to find new ways to use the Web to wield their power. With some activists dissatisfied by recent corporate slights, such as the failure to take action after majority votes on nonbinding shareholder proposals, they are becoming more aggressive. This approach is exemplified by the decision by the Council of Institutional Investors — which already posts its letters to "majority vote" companies and those companies' responses (if any) on the organization's Web site — to study how to support members' efforts to nominate a "short slate" of directors at shareholders' meetings.

Retail investors — with limited resources — use simpler methods. Activist John Chevedden appears to use the message boards to ask shareholders to designate him their agent so that he can submit shareholder proposals at companies where he otherwise might not be eligible to do so. Although the SEC staff has thrown out one proposal on "alter ego" grounds,[fn1] Mr. Chevedden has successfully beaten back management challenges on other occasions.[fn2]

[fn1] See TRW Inc., 2001 SEC No-Act. LEXIS 102 (Jan. 24, 2001).

[fn2] E.g., Boeing Company, 2001 SEC No-Act. LEXIS 198 (Feb. 8, 2001). See supra Chapter 9.

§ 36.02 URLs in Shareholder Proposals

During the past few years, there has been a continuous debate whether a Web site address (also known as a "URL") should be permitted to be included in a shareholder proposal or its supporting statement. Over time, the SEC staff's position on this matter gradually evolved through responses given in a series of no-action letters.

In mid-July 2001, the staff issued a Staff Legal Bulletin on shareholder proposals that more definitively addressed this issue.[fn3] However, this probably is not the last time the staff will address this issue, since the Bulletin still places the staff in the unenviable position of having to make difficult subjective determinations regarding whether the content related to the URL is false and misleading.

[fn3] Division of Corporation Finance, Staff Legal Bulletin No. 14 (July 13, 2001) (available at www.sec.gov/interps/legal/cfslb14.htm).

§ 36.03 Evolution of Staff's Position

In 1998, the Division of Corporation Finance and the Division of Investment Management first addressed this issue in three no-action letters: Pinnacle West Capital Corp.,[fn4] Templeton Dragon Fund, Inc.[fn5] and The Emerging Germany Fund, Inc.[fn6] The Templeton Dragon Fund and Emerging Germany Fund letters were processed in the Division of Investment Management because they related to mutual funds and the Pinnacle West letter was processed by the Division of Corporation Finance because it related to an operating company.

In these no-action requests made under the shareholder proposal rule, the companies argued that they should be permitted to exclude proposals containing Web site addresses unless the proponents removed the addresses.[fn7] These arguments included:

The URL caused the proposal to violate the 500-word limitation (Rule 14a-8(d));
The URL is "contrary to the proxy rules" since the site's content was not "submitted" to the company (Rule 14a-8(i)(3));
The site's content contains false and misleading information (Rule 14a-8(i)(3)); and
The site's content relates to a personal grievance or is designed to further a personal interest not shared by other shareholders (Rule 14a-8(i)(4)).

In its responses to these letters, the staff required the proponents to remove the URLs from their proposals. Although the staff does not provide its reasoning for its decisions in no-action responses, these responses appeared to be based on the envelope theory — that the mere reference to a Web site was considered to incorporate the Web site's contents into the shareholder proposal so that it was deemed to exceed 500 words. This is borne out by commentators who, at the time, focused on the argument that inclusion of the URL allows shareholders to exceed the word limit. In response to this argument, proponents stated that the original intent of the 500-word limit was to keep the costs of printing and mailing proxy materials reasonable and to ensure that the length of proposals did not obscure other important matters disclosed in proxy materials. They noted that including a URL in proxy materials did not implicate these concerns.[fn8]

However, the next generation of no-action responses revealed that the real issue in this debate was whether the content associated with the URL is reliable.[fn9] The SEC staff appeared to respond to proponents' arguments that there should be equal freedom of communication. Proponents had noted that companies, in their SEC documents, are permitted to disclose their Web site addresses and could post solicitation materials if they desired on these sites (after they filed the materials with the SEC as additional soliciting material). Proponents also observed that shareholders can freely communicate with each other outside the shareholder proposal rule parameters about their proposals (so long as they do not solicit proxies) — how much real harm would a proponent cause if it communicated online regarding a proposal and advertised that communication in the company's proxy statement?

In 2000, the staff permitted the same proponent in two letters, Electronic Data Systems Corporation[fn10] and First Energy Corp.,[fn11] to include a URL for a Web site that was not controlled by the proponent and which did not directly solicit support for the proposal. In their no-action requests, the companies argued that allowing a Web site reference subverted the intent of the word limit. The companies also argued that the contents of a referenced Web site may evolve over time and could include false and misleading information or other information which the company might not be able to address in its statement in opposition due to timing considerations.

The proponent replied that it had no control over the Web site at issue, which was sponsored by the Council of Institutional Investors ("CII"). He noted that he was not a member of the CII. In contrast, the proponent noted that the company had numerous Web sites that showed shareholders the most favorable view of management performance and policy and that it was highly likely that shareholders would have more contact with the company's Web sites than with the CII's site. In addition, the proponent noted that a URL could benefit shareholders by directing them to other sources of information to evaluate the information presented in the proposal. The proponent distinguished the Pinnacle West letter because it involved a Web site developed by an individual scientist, as compared to the CII Web site, which was run by an established and respected corporate governance organization with major corporate members. In addition, the proponent noted that the Pinnacle West proponent had agreed that his cited Web site might be judged "too controversial" for the staff.[fn12]

In 2001, the staff appeared to go one step further. In a no-action letter to Gillette Company,[fn13] the SEC staff required the company to include a proposal even though it included a URL reference to the proponent's own Web site, which provided more information about the proposal. The company made the typical arguments noted above and sought to exclude the proposal's references to the Web site. The proponent observed that a proposal in the company's proxy statement from the prior year had referenced a URL — www.ceres.org — about which the company did not complain. In addition, the proponent offered to — and did — link from his Web site to the company's Web site as a way to alleviate some of the concerns expressed by the company. Although the staff sided with the proponent, it is unlikely that these factors played a role in its decision.

[fn4] Pinnacle West Capital Corp., 1998 SEC No-Act. LEXIS 390 (Mar. 11, 1998).

[fn5] Templeton Dragon Fund, Inc., 1998 SEC No-Act. LEXIS 664 (June 15, 1998).

[fn6] The Emerging Germany Fund, Inc., 1998 SEC No-Act. LEXIS 1083 (Dec. 22, 1998).

[fn7] The remainder of a proposal is not affected if the staff asks a proponent to remove a URL, unless the company is successful in making arguments under other provisions of the shareholder proposal rule.

[fn8] Howard M. Friedman, "Commentary on a Rare Luddite Victory — The Templeton Dragon Fund Shareholder Proposal No-Action Letter," Villanova J. Law and Investment Management (Winter 1999).

[fn9] Sanjay Shirodkar & Frank Zarb, Jr., "The Shareholder Proposal Rule in the Internet Age," wallstreetlawyer.com (Jan. 2000).

[fn10] Electronic Data Systems Corporation, 2000 SEC No-Act. LEXIS 460 (Mar. 24, 2000).

[fn11] First Energy Corp., 2000 SEC No-Act. LEXIS 353 (Mar. 7, 2000).

[fn12] The proponent also distinguished Emerging Germany Fund, Inc. because that letter involved a message board that had daily numerous postings by anonymous participants that could have included the proponent.

[fn13] Gillette Company, 2001 SEC No-Act. LEXIS 175 (Feb. 1, 2001).

§ 36.04 Current Staff Position

The staff's position in Gillette is mirrored in its recent Staff Legal Bulletin guidance. In Items C(2)(b) and F(1) of the Bulletin, the staff presented the following questions and answers related to this issue:

Does referencing a website address in the proposal or supporting statement violate the 500-word limitation of rule 14a-8(d)?

No. Because we count a website address as one word for purposes of the 500-word limitation, we do not believe that a website address raises the concern that rule 14a-8(d) is intended to address. However, a website address could be subject to exclusion if it refers readers to information that may be materially false or misleading, irrelevant to the subject matter of the proposal or otherwise in contravention of the proxy rules. In this regard, please refer to question and answer F.1.

May a reference to a website address in the proposal or supporting statement be subject to exclusion under the rule?

Yes. In some circumstances, we may concur in a company's view that it may exclude a website address under rule 14a-8(i)(3) because information contained on the website may be materially false or misleading, irrelevant to the subject matter of the proposal or otherwise in contravention of the proxy rules. Companies seeking to exclude a website address under rule 14a-8(i)(3) should specifically indicate why they believe information contained on the particular website is materially false or misleading, irrelevant to the subject matter of the proposal or otherwise in contravention of the proxy rules.[fn14]

[fn14] Staff Legal Bulletin, supra note 3, Items C(2)(b) and F(1).

§ 36.05 Possible Consequences of Staff's Position

From the Bulletin, it is clear that the 500-word limit argument will not succeed and that the SEC staff will apply a facts and circumstances test regarding whether the referenced Web site contains false and misleading information. Clearly, the staff does not have the resources to continuously check the evolving information on a Web site to ensure that it is not false and misleading, particularly during its busy period in the winter that leads up to the proxy season. As a result, it is important that a company carefully present its arguments when it first files its no-action request, monitor the proponent's Web site for any problematic developments after it files the request and inform the staff if more troublesome information is posted on the site.

As a practical matter, however, it is difficult for companies to "win the day" by arguing to the staff under the "false and misleading" exclusion. Since this is such a subjective determination in most cases, proposals rarely are excluded on this basis. It is possible that the staff will apply a different — and more flexible — standard for removal of URLs than it does for complete exclusion of proposals. Even if the staff takes company arguments to heart about false and misleading information, it may allow the proponent an opportunity to cure the offending content on a Web site before requiring the removal of a URL. This is the typical result when companies complain about false and misleading information in a proposal.

The probable result of the staff's position is that a more extensive "dialogue" between companies and proponents will be played out on the Web. The Gillette experience is a perfect example. After the staff sided with the proponent on including the URL, not only was the proponent able to post his proposal on his Web site; he added "Frequently Asked Questions" as well. Even more notable was that he posted the company's statement in opposition from the proxy statement and then added a rebuttal to that disclosure.[fn15] It is easy to imagine a scenario where a proponent and management go back and forth rebutting each other's statements about a proposal — right up until the date of the shareholder's meeting!

Since shareholders who vote on these matters get the benefit of more information, it remains to be seen whether such communication is ultimately beneficial. However, this sort of continuous banter may prove difficult for the staff to monitor if it occurs on a regular basis. More staff resources may be needed since such a dialogue more closely resembles the back-and-forth communication engaged in during a contested election of directors.

[fn15] This information was posted on the Corporate Monitoring Web site at www.corpmon.com.

§ 36.06 Announcing Voting Information on the Web

Generally, shareholders are permitted to announce publicly how they intend to vote (and why they intend to vote that way) without taking any action under the proxy rules, as long as they do not actually solicit proxies. However, as this issue applies to the Web, there is some uncertainty.

Rule 14a-2(l)(2)(iv) exempts certain announcements from the definition of a proxy solicitation and lists the types of forums as: speeches, press releases, published or broadcast opinions, statements or advertisements appearing in a broadcast media, newspaper, magazine or other bona fide publication disseminated on a regular basis. The question remains if announcements distributed online are "bona fide publications disseminated on a regular basis."

§ 36.07 Solicitation of Support for a Shareholder Proposal on the Web

Under the broad definition of "proxy solicitation," a proponent or other shareholder may unknowingly be engaging in proxy solicitation — even without asking other shareholders to take action (such as submit or revoke proxy cards)![fn16] The determination is based on the facts and circumstances, with the threshold issue being whether the shareholder's communications relate to — or have the effect of — changing or influencing the control of the company. If there is a proxy solicitation, the person conducting the solicitation is required to follow the SEC's proxy rules and file solicitation materials.

Although the SEC staff has not explicitly addressed this issue in the Web context, to ensure that an online communication is not deemed a solicitation of proxies, a proponent should ensure that its communications merely inform the market about how it intends to vote and the reasons behind the voting decision — without explicitly urging others to vote the same way. Since most online communication is informal by nature, this line can easily be crossed inadvertently. At a minimum, shareholders should ensure that their communications do not cross the line into a discussion about a potential change of control.

[fn16] Rule 14a-1(l) of the Securities Exchange Act of 1934 defines "solicitation" to include communications that are made under circumstances reasonably calculated to result in obtaining, revoking or withdrawing a proxy.

§ 36.08 Solicitation Against a Company Proposal on the Web

Shareholders can post statements on the Web that urge other shareholders to vote against a company proposal, provided the shareholder has no special interest in the matter being voted on and the statements are not false and misleading. Rule 14a-2(b)(1) exempts these communications from the definition of a proxy solicitation. An institutional investor that owns more than $5 million of the company's stock who urges shareholders to vote a particular way must file a notice with the SEC. The notice must include a copy of the related Web site content.

§ 36.09 Online Sources of Information about the Shareholder Proposal Process

There are myriad resources on the Web regarding the shareholder proposal process, both for companies and proponents. These include:

Securities & Exchange Commission — The SEC's Web site (www.sec.gov) includes the text of Rule 14a-8 and the more recent releases amending the rule. It also contains a Staff Legal Bulletin from July 2001 that provides helpful guidance, primarily on procedural matters. However, it does not offer no-action letters, which are available at the SEC's headquarters in Washington D.C.
Lexis — Lexis (www.lexis.com) provides the SEC's no-action letters, as well as all of the SEC's other guidance over the years. However, this is a subscription-based service.
Westlaw — Westlaw (www.westlaw.com) also offers the SEC's no-action letters, as well as all of the SEC's other guidance, on a subscription basis.
CalPERS — Always at the forefront of the governance movement, for several years CalPERS has used its Shareowner Forum Web page (www.calpers-governance.org/forumhome.asp) to publicize how it intends to vote on certain matters for a number of stockholder meetings. This Web page also sets forth a list of the shareholder proposals that CalPERS has submitted since 1987 (accompanied by the voting outcomes on these proposals); CalPERS' corporate governance principles; a list of securities litigation class actions suits for which CalPERS has been the lead plaintiff; and the names of companies on CalPERS' "Focus" list as well as the process for selecting these companies.
Council of Institutional Investors — The Council of Institutional Investors also uses its Web site (www.cii.org) to post its corporate governance policies and its annual focus list. Recognizing the value of "sunlight," not only does the CII report how management responds after a majority of a company's shareholders vote in favor of a non-binding shareholder proposal, it scans the response letter itself on to the Web site. The "Hot Issues" Web page contains each comment letter CII has submitted to the SEC on various issues. Its "2001 Shareholder Initiatives" section is probably the best on the Web to keep track of the types of initiatives being pursued by shareholders.
The Corporate Library — Recently established by Nell Minow and Robert Monks, The Corporate Library (www.thecorporatelibrary.com) contains a wealth of resources relating to corporate governance, and is constantly growing. In addition to numerous articles on corporate governance issues, the site serves as a central repository of shareholder proposals for the recent proxy seasons. Proposals, which are available in full text, can be sorted by issuer, date, proponent or type of proposal.

The Corporate Library also provides a database of CEO employment contracts from the Fortune 500. The site selects the best and worst employment agreements from an activist's viewpoint, and offers a comprehensive bibliography of executive compensation articles. The site also includes a Director Screening Tool that covers the S&P Supercomposite Index of 1500 companies. This powerful feature allows a visitor to research a director's age, stock holdings, attendance record, and number of directorships — all of which may be relevant to shareholders deciding how to cast their vote.
Socialfunds.com — Socialfunds.com (www.socialfunds.com) focuses on socially responsible investing. Its "Shareholder Activism" section contains a database of shareholder proposals organized by category and keeps track of their status. It also contains social activism news, including a "spotlight" on certain issues, and "success" stories. It urges visitors to get involved and offers a four-step tutorial on activism.
Responsible Wealth — Responsible Wealth (www.responsiblewealth.org) — provides questions and answers about how to submit a proposal, as well as a summary of the types of proposals submitted over the past two proxy seasons.
Friends of the Earth — Friends of the Earth (www.foe.org) has a list of sample proposals and filing letters as well as tutorials about how to submit proposals and present them at shareholders' meetings.
Seattle Community Network's Northwest Corporate Accountability Project — The Seattle Community Network's Northwest Corporate Accountability Project (www.scn.org/earth/wum/2Whatsr.htm) sets forth questions and answers about how to submit a proposal and a checklist for proponents to help them properly prepare and submit the proposal.

§ 36.10 Other Online Corporate Governance Related Resources

Although the content is not directly related to the shareholder proposal process, these Web sites target corporate governance issues and may be useful when analyzing a shareholder proposal relating to a particular topic.

AFL-CIO's Executive PayWatch — Established in 1996, the AFLCIO's Executive PayWatch was one of the first online activist sites (www.aflcio.org/paywatch/index.htm). A tool on Executive PayWatch enables investors (and employees) to calculate how their compensation compares to that of senior managers. The site also has ten case studies on CEOs whose compensation is "out-of-this-world." In addition, the AFL-CIO posts information that is activist-oriented, such as a 1999 scorecard on how money managers voted on shareholder proposals sponsored by pension funds and a new section on CEO pay and global unfairness.
Lens, Inc. — Lens, Inc. (www.lens-inc.com) recently changed its mission from an activist fund to an "activist gun for hire," capitalizing on its skills learned as a long-time user of the Web. Before its transformation, Lens functioned as an activist money manager by targeting companies for corporate governance reform. For each targeted company (last year there were five), Lens posted two different sets of documents. The first set was publicly accessible and typically contained Lens' action plan; demand letters to management; profile of the target company and management; list of target companies' large stockholders; any related lawsuit filings; links to relevant news articles, SEC filings, company Web sites and stock history; and pertinent e-mail addresses at the target company. The second set of documents was password accessible solely by the Lens Group members so they could communicate confidentially. In its new capacity, Lens will help others become activists using these online tactics.
eRaider — After two professors discovered that the community on the Yahoo! Finance message boards for the failing United Companies Financial represented nearly a majority of the outstanding shares, they helped organize the group to take action. Eventually, a U.S. Bankruptcy trustee appointed a representative from the online community on the creditors' committee. Learning from this experience, the professors formed eRaider (www.eraider.com) to target perceived underperforming mid- and small-cap companies.

eRaider truly is among a new breed of activists — those who owe their existence to the Internet. An unaffiliated fund had been acquiring a 4.99% stake in the targeted companies, but the fund just closed due to lack of interest. Before the fund's close, six companies had been targeted. The site posts notices to alert visitors about when a new target will be announced.

eRaider engages in a variety of offline shareholder activities, including submitting shareholder proposals, negotiating with management and boards, speaking at annual meetings, and appealing to regulators. Many of these activities cross over to the Web as part of eRaider's online pressure tactics. Once a target is identified, eRaider posts articles related to the target's business and financial condition. The "State of the eRaid" includes an action plan related to each target company as well as related correspondence. For example, this section of the site has several letters from third parties addressed to SEC staff members urging them to take action regarding the target companies. Perhaps more significantly, there are message boards dedicated to each target company where frustrated shareholders can find each other.

There is a wealth of information about corporate governance matters abroad. The European Corporate Governance Network provides a useful global directory of corporate governance codes, principles and recommendations sorted by country, including the full text of these documents in some cases (www.ecgn.ulb.ac.be/ecgn/ codes.htm). The World Bank has posted thousands of articles, abstracts and references related to international corporate governance at www.worldbank.org/html/fpd/privatesector/cg. In addition, it sponsors the Global Corporate Governance Forum Web site (www.gcgf.org), which contains the text of numerous corporate governance speeches. So far, the International Corporate Governance Network's Web site (www.icgn.org) is most useful for finding information about this international association of institutional investors.

§ 36.11 Impact of the Internet on the Shareholder Proposal Process

Although it is clear that the Internet has affected the shareholder proposal process, the extent of this impact is not yet known. The Internet serves as a cheap, fast and more efficient platform for a shareholder's campaign to raise awareness of an issue — and this communication can be done, in some instances, outside the restrictions of the shareholder proposal rule.

However, some commentators believe that if shareholders can effectively organize online, the Internet may render the shareholder proposal process obsolete — shareholders would not have to depend on getting a proposal in a company's proxy statement to have their message widely distributed. Other commentators believe that more proposals will be submitted and they will be of lower quality as online tutorials drive more retail investors to submit meaningless proposals. While the number of proposals has increased recently, it may be too early to determine if it is primarily due to the Internet.[fn17]

[fn17] An interesting discussion of the future of shareholder proposals is contained in George Kobler, "Shareholder Voting over the Internet: A Proposal for Increasing Shareholder Participation in Corporate Governance," 49 Ala. L. Rev. 673 (1998).

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