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New e-proxy system packs rewards and risks


When it begins July 1, the Securities and Exchange Commission's new program to provide proxy materials to willing shareholders by posting them on an Internet site will reward the many, though it may create some new risks for a few.

Issuing companies, which include many insurers and agent/brokers, will experience the rewards of significant savings in printing and postage costs while society generally will benefit from fewer felled trees and less trash.

In addition, shareholders—especially dissident ones—will benefit from easier access to proxy materials and new rules that the SEC says will make it easier and less expensive for a shareholder to challenge a board's proxy recommendations.

The new risks may surface among shareholders, especially trusting seniors who may face "phishing" attacks that could result in the theft of personal information, some observers say.

In addition, issuing companies may face claims under their cyber risk and directors and officers policies, sources say.

"As with any fundamental change in e-commerce, e-government or e-business that increases the use of the Internet as a permissible medium, there will be privacy and security issues," said Jon Neiditz, an attorney in the Atlanta office of Lord, Bissell & Brook L.L.P.

The amendments to the Securities Exchange Act of 1934 are taking advantage of technological developments and the growth of electronic communications, the SEC said in describing the final rule on the Internet availability of proxy materials in the Jan. 29 Federal Register.

The amendments require issuing companies to send a notice to shareholders, who have provided affirmative consent for the company to do so, to inform them that the proxy materials are available and how to access them.

The amendments also require companies to provide the materials on a publicly accessible Web site—other than the SEC's own EDGAR site—at least 40 calendar days before a shareholder meeting date, or if there is no meeting, before corporate action may be taken. Then, the issuer must wait at least 10 days before sending a proxy card to a shareholder, to ensure that he or she has time to access the proxy materials, or request them.

The e-proxy program is among "dramatic changes" the SEC is adopting to remake the very nature of communications between companies and investors, SEC Chairman Christopher Cox said in a statement earlier this year.

"Issuers that rely on the amendments may be able to significantly lower the costs of their proxy solicitations that ultimately are borne by shareholders," the SEC said in its discussion of the final rule.

They speak for the trees

In 2006, issuers and other persons soliciting proxies from beneficial owners spent about $962.4 million for printing and mailing costs, the SEC said. In addition, the environmental costs of the traditional print-focused proxy solicitation process include paper, printing ink and adverse impact from cutting down trees as well as using fossil fuels, chemicals and bleaching agents.

If 81% of shareholders agree to the electronic delivery of proxy materials the amendments could save $48.3 million to $241.4 million annually, the SEC estimated.

In addition, shareholders will get more rapid dissemination of proxy information.

Another SEC goal of the e-proxy process is "to improve the ability of shareholders to participate meaningfully in the proxy process by reducing the cost of undertaking a proxy contest." That change "may increase management's accountability and responsiveness to shareholders due to heightened concern about the possibility of a proxy contest. This, in turn, may enhance the value of shareholders' investments," the SEC said.

Supporters of the change cite several positive goals of the program.

"The e-proxy can be a tool for an activist shareholder," said Donald A. Glazier, a Chicago-based principal with Integro Insurance Brokers based in New York

A dissident shareholder "may selectively choose the shareholders from whom it desires to solicit proxies without the need to send an information statement to all other shareholders," which an issuing company is required to do, the SEC said.

The issue of shareholder access arose late last year when the 2nd U.S. Circuit Court of Appeals in New York ruled in a case involving New York-based American International Group Inc. and the American Federation of State, County and Municipal Employees.

"In that case, the AFSCME union sought to include a proposal on AIG's proxy statement that would amend the company's bylaws to permit certain shareholders to nominate a competing candidate for director," according to a statement by SEC Commissioner Paul S. Atkins earlier this year. "The SEC staff agreed with AIG that it could exclude the proposal from its proxy statementÖ(but) the court, however, disagreed with the staff's position and ruled in favor of the shareholder," he said.

Although the new SEC amendments reduce the cost of a proxy contest, they do not eliminate all of them, such as costs of preparing the soliciting material and related fees. "We believe these surviving costs should discourage frivolous contests," the SEC said.

will more vote?

In deliberations about the e-proxy proposals, the SEC acknowledged there was, however, "significant disagreement" among those making comment regarding key issues related to the amendments, especially about security and privacy as well as whether it would increase voting by shareholders.

For example, some critics—including representatives of public entity retirees—were concerned whether seniors had adequate Internet access.

"We believe that current levels of access to the Internet merit adoption," the SEC said in discussions. The SEC based its decision on data from Automatic Data Processing Inc. showing that approximately 80% of investors in the United States have access to the Internet in their homes.

Also, the SEC attempted to mitigate concern about access by requiring that any shareholder lacking Internet access, or preferring delivery of a printed copy of the proxy materials, can ensure that he or she will receive a free copy of proxy materials by making a single, permanent request, which can be revoked at any time.

Several of those making comments also expressed concern about the potential theft of investors' identification or control numbers from the company's notice or instructions for executing proxies.

In response, the SEC said, "We understand that these numbers, which are in common use today, usually provide the user only with access to execute proxies or provide voting instructions: They do not enable the user to buy or sell securities in a shareholder's account or transfer funds from that account." In addition, the SEC noted that "85% of shares voted already are voted electronically using such identification or control numbers."

Also, the SEC said it did not believe that the rules "would provide significant opportunity for abuse through phishing," or tricking shareholders into disclosing personal information to persons purporting to be issuers or their intermediaries. In addition, the rules permit an issuer to include a protective warning that no personal information other than the identification or control number is necessary to execute a proxy.

Other observers disagree.

Attorney Mr. Neiditz said, "I think there is certainly a risk for phishing and similar types of fraudulent solicitation of seniors and others" to provide personal information about themselves. It's "remarkable" how people respond to such requests, especially when they come from a phishing Web site that looks much like an issuing company's Web site, he said.

License to phish

Mickey Estey, a San Francisco-based senior associate with Integro, agreed. "Phishing is potentially an issue," he said.

For example, a class of individuals whose confidential information was disclosed might seek to file a class action lawsuit claiming that their privacy was violated, he said. they brought a lawsuit in their capacity as shareholders, it might trigger a claim under the issuing company's D&O coverage. they brought it as individuals, it might trigger a cyber risk policy, he said.

A claim under a cyber risk policy also could include costs for notification of other victims as well as credit monitoring, he added.

An issuing company also may face risk from the actions of third parties, such as a Web site operator it hired to handle proxy materials, Mr. Glazier said. A third party's misstatements about the impact of a proxy proposal could create a burden on the issuing company to correct such misstatements, he said.

Any issuing company would want to have an appropriate indemnification agreement with a third party involved in the proxy issuance, Mr. Estey said.

Other critics were concerned that an issuer might use shareholder information inappropriately, such as selling e-mail addresses to third parties for advertising purposes. The SEC responded by revising its final rules to clarify that an issuer or its agent must post the proxy information in a way "that does not infringe on the anonymity of a shareholder accessing that Web site."