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Shareholder Arguments to Include Sample
Proposal (QSII 1999)
The letters copied below, to the SEC from attorneys
representing the shareholder arguing to require that the company include the
shareholder proposal in the company's proxy statement, were included as "Exhibit
D" in a
June 24, 1999 SEC Form 13D/A filing for Quality Systems, Inc..
EXHIBIT D
[LETTERHEAD OF WILSON SONSINI
GOODRICH & ROSATI APPEARS HERE]
May 14, 1999
Division of Corporation Finance
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Shareholder Proposal For Quality Systems, Inc.
Ladies and Gentlemen:
My firm is counsel to Lawndale Capital Management LLC,
which is the general
partner of Diamond A Partners, L.P. ("Diamond A"). Diamond A is a
shareholder of
Quality Systems, Inc. ("QSII" or "the Company"). On March 29, 1999, Diamond
A,
pursuant to Rule 14a-8 under the Securities Exchange Act of 1934 (the
"Exchange
Act"), submitted a shareholder proposal to QSII (the "Diamond A Proposal")
for
inclusion in its proxy materials for the upcoming annual shareholders
meeting
for the Company.
In a letter to Diamond A, dated April 8, 1999, the
Company stated that it
intended to exclude the Diamond A Proposal from its proxy materials,
purportedly
because the Company considered the Diamond A Proposal to be separate
proposals
excludable under Rule 14a-8(c). In a letter to QSII dated April 22, 1999, we
responded that the Diamond A Proposal was a single proposal for purposes of
Rule
14a-8(c), and that the items identified by the Company comprised only the
definitional elements of the Diamond A Proposal. As described in our April
22,
1999 letter, a copy of which is attached hereto and incorporated by
reference,
the Diamond A Proposal is a single proposal in favor of the establishment of
an
Independent Board of Directors for QSII. As such, and consistent with
several
recent no-action letters issued by the Division of Corporation Finance, we
believe the Diamond A Proposal is not excludable under Rule 14a-8(c).
We have received a copy of a letter dated May 5, 1999,
from the firm of
Rutan & Tucker, counsel to the Company, to the Division of Corporation
Finance
(the "Division"), requesting that the Division recommend no action to the
Securities and Exchange Commission (the "Commission") if the Company omits
the
Diamond A Proposal from its proxy materials for its 1999 annual meeting of
shareholders. The May 5 letter does not address (or even cite) any of the
recent
no-action letters discussed in our April 22 letter. Rather than respond to
the
authorities identified in our April 22 letter, Rutan & Tucker's May 5 letter
offers several new arguments- which were not identified in the Company's
April 8
letter to Diamond A - why the Company believes it may omit the Diamond A
Proposal from its proxy materials.
The following is Diamond A's response to the May 5
letter, pursuant to Rule
14a-8(k) promulgated under the Exchange Act. For clarity's sake, our
numbered
paragraphs correspond to
<PAGE>
those in QSII's May 5 letter. On May 10, 1999, we provided notice that we
intended to provide this response by May 13, 1999. For the reasons set forth
below, as well as those set forth in our April 22 letter, we request that
the
Division deny QSII's request for no action.
Argument No. 1: The Company argues that a shareholder may submit only one
proposal under Rule 14a-8, whereas Diamond A has submitted what are really
five
separate proposals.
Rule 14a-8(c) provides that a shareholder may submit no
more than one
proposal to a company for inclusion in the proxy materials for a particular
shareholders' meeting. The Division has repeatedly taken the position that,
as
here, a proposal for purposes of Rule 14a-8(c) may include the definitional
elements of the proposal provided that these elements all relate to the
specific
concept set forth in the proposal. Thus here, for example, the Diamond A
Proposal seeks only the creation of an independent Board of Directors to
govern
QSII, and we believe should be so considered by the Staff.
As discussed in detail in our April 22 letter, an
analysis of the Staff's
position on "single proposal cases" clearly supports this position. For
example,
in 1992 a shareholder submitted a proposal to McDonald's Corp. relating to (i)
potential conflicts of interest involving McDonald's officers and directors,
(ii) limitations on McDonald's executive Compensation, and (iii) limits on
McDonald's ability to award stock options. McDonald's, in its submission to
the
Staff, asked that the Staff take "no action" if McDonald's excluded the
revised
proposal on the grounds that it still constituted multiple proposals. The
Staff
rejected MacDonald's position, concluding instead that the shareholder's
proposal was a single proposal. The Staff's reasoning was that the separate
elements of the proposal related to the single concept of executive
compensation. McDonald's Corp., SEC No-Action Letter, 1992 SEC No-Act. LEXIS
----------------
1101 at *1, December 2, 1992.
The Staff has also concluded that a proposal which
contains multi-elements
should be considered a single proposal under Rule 14a-8(c) where all
elements of
the proposal related to the single issue. See, e.g., Ferrofluidics Corp.,
SEC
--- ---- -------------------
No-Action Letter, 1992 SEC No-Act. LEXIS 932, September 18, 1992 (elements
relating to base pay and warrants granted to executives); Westinghouse
Electric
---------------------
Corporation, SEC No-Action Letter, 1995 SEC No-Act. LEXIS 169, January 27,
1995
-----------
(elements including base compensation, bonuses, retirement compensation,
performance based pay found to relate to the single concept of executive
compensation). The Staff also concluded that a multi-element proposal was a
single proposal because it related to a "request to sell or merge the
company,
and suggested procedures for implementing this proposal." Todd Shipyards
Corp.,
--------------------
SEC No-Action Letter, 1992 SEC No-Act. LEXIS 876, August 13, 1992 (elements
included retaining an independent investment bank and establishing an
committee
of independent directors to consider and recommend to board best available
offers for merger or sale). Similarly the Staff held that a proposal
relating to
anti-takeover defenses was a single proposal, which included definitional
elements relating to (i) a termination of the company's shareholder rights
plan,
(ii) amending change of control agreements with officers and directors, and
(iii) eliminating other steps which might impede a takeover Computer
Horizons
-----------------
Corp., SEC No-Action Letter, 1993 SEC No-Act. Lexis 572 at *1, April 1,
1993.
-----
<PAGE>
Most recently, the Staff addressed a shareholder
proposal which, like the
Diamond A Proposal, involved the issue of corporate governance.
Specifically, in
1998 a shareholder of Boeing Co. requested that Boeing include in its proxy
materials a single proposal that contained a number of specific proposed
actions
relating to the election process for the Board of Directors. See The Boeing
--------------
Company, SEC No-Action Letter, 1999 SEC No-Act. LEXIS 232, February 18,
1998.
-------
The Staff rejected Boeing's argument. In rejecting
Boeing's position that
the proposal could be omitted under Rule 14a-8(c), the Staff stated that
"[Tire
revised proposal requests that the Board take the necessary steps to ensure
that
all Directors are elected annually and requests restriction on the ability
to
change that requirement."
As with Boeing, the Diamond A Proposal is a single
proposal for purposes of
Rule 14a-8(c). The Diamond A Proposal, if adopted by QSII's shareholders,
would
establish an independent board of Directors for QSII. The elements of this
proposal - i.e. the definition of an Independent Board at QSII- are not
separate
---
proposals. Rather, the elements of the Diamond A Proposal explain how the
board
shall operate to ensure that QSII is controlled by an Independent Board.
These (and other) authorities were all reviewed in
detail in our April 22
letter to the Company. Yet the Company's May 5 letter does not discuss,
respond
.to, or even cite, the Division's position as reflected in these letters.
Instead, the May 5 letter cites, without explanation, four no-action letters
for
the undisputed proposition that Rule 14a-8(c) limits shareholders to one
proposal. None of these letters are relevant to the Diamond A Proposal,
because
none discuss or relate to a single proposal which includes the definitional
elements necessary to implement the proposal./1/
As with Boeing, the Diamond A Proposal is a single
proposal for purposes of
------
Rule 14a-8(c). While the Proposal includes the necessary, definitional
elements
for the creation of an Independent Board, given the Staff's history of
concluding that such explanations or definitions are not separate proposals
which can be excluded from the company's proxy materials on Rule 14a-8(c)
grounds, we believe that the Company lacks a sufficient basis to oppose the
inclusion of the Diamond A Proposal on the grounds that it is more than one
proposal.
Argument No. 2: The Company argues that the proposal has been substantially
implemented, and is therefore moot.
A shareholder proposal may be omitted under Rule
14a-8(i)(10), if the
action requested by the proposal has been "substantially implemented" by the
registrant. Release No. 34-020091 (August 1, 1983). On this basis, the
Company
argues that the Diamond A Proposal may be omitted,
______________________
/1/ The principle authority relied upon by the Company is Edison
International,
--------------------
SEC No. Action Letter, 1997 SEC No. Act. LEXIS 142 (January 22, 1997). Yet
the
situation at issue in Edison is clearly distinguishable from the Diamond A
-------
Proposal. In .Edison, the proposals related to at least three separate and
-------
distinct concepts: (i) the number, composition and qualifications of the
Board;
(ii) the procedures for electing directors, including nomination of quorum
procedures; and (iii) procedures for the Annual Meeting, including how long
board candidates should be allowed to speak. In contrast, the Diamond A.
Proposal involves a single issue: the establishment of an Independent Board
of
Directors for QSII.
<PAGE>
purportedly because the Company has an independent board, and has recently
established nominating and compensation committees allegedly consisting of
75%
"independent" directors.
The Company's argument is wrong factually, and is
contrary to recent
opinions of the Division. Factually, the QSII board is not in "substantial
compliance" with the Diamond A Proposal. The Diamond A Proposal, if adopted
by
QSII's shareholders, would result in the establishment of an Independent
Board
of Directors at QSII, which is in sharp contrast to the current board's
procedures. Listed below are four specific differences between the way in
which
an Independent Board at QSII would operate and the practices of the current
board:
1. An
Independent Board would be led by an Independent Chairman,
rather than Mr. Razin, QSII's current chairman, president and CEO;
2. The
nominating and compensation committees would consist entirely
of Independent Directors./2/
3. An
Independent Board would have a significantly greater
percentage of independent directors than the current QSII board; and
4. Consistent
with the views expressed by The Blue Ribbon Committee
on Improving the Effectiveness of Corporate Audit Committees (Report and
-----------
Recommendations of the Blue Ribbon Committee on Improving the Effectiveness
of
------------------------------------------------------------------------------
Corporate Audit Committees (1999), hereinafter, the "Blue Ribbon Report")),
an
--------------------------
Independent Board would provide more effective oversight of management by
meeting on a regular basis outside the presence of management.
Given these changes -- which are structural changes and
do not include the
qualitative potential benefits to QSII and its shareholders which Diamond A
believes will occur once QSII is led by an Independent Board -- it is
difficult
to understand QSII's argument that the Diamond A Proposal has been
"substantially implemented" by QSII./3/
__________________
/2/ QSII's effort, in response to the Diamond A Proposal, to at last
establish
nominating and compensation committees of the Board, only demonstrate
further
that the Board is not independent. Each of these committees consists of the
---
identical four directors: Mr. Razin, and the three longest serving directors
at
QSII. Omitted from both committees is the only QSII director who has served
less
than five years on QSII's board, while Mr. Razin's position as committee
member,
in addition to his other roles at QSII as chairman, president, and CEO, only
further solidifies his control over QSII's board.
/3/ Equally difficult to understand is the Company's argument that the
Diamond
A Proposal's "definition of "Independent Director... goes far beyond the
usual
and customary definition of an "independent" or "outside" directors. In
fact,
the definition of Independent Director contained in the Diamond A Proposal
is
largely indistinguishable from the definitions the Company ascribes in its
letter to, for example, the Council of Institutional Investors and the
National
Association of Corporate Directors. What is clear, however, is that adoption
of
the Diamond A Proposal would result in meaningful and significant changes to
QSII's board.
<PAGE>
The Company's legal argument that "the proposed
requirement that more than
a majority of the directors be independent does not make any appreciable
difference" also is contrary to the Division's recent opinions on this
issue.
For example, the Division has consistently recognized
the real differences
which may occur if the percentage of independent directors of a Company's
board
increases, and if this level is mandated in the Company's by-laws. Thus, in
General Motors Corp., SEC No-Action Letter, SEC No-Act. LEXIS 387, March 3,
--------------------
1997, a shareholder requested that the Board take action to require that 90%
of
the directors be independent. General Motors Corp. ("GM") argued that its
bylaws, which already required a majority of independent directors,
substantially implemented the standards for director independence sought by
the
shareholder proposal. It further argued that the difference between the
shareholder request of 90% independence, and the existing GM by-law
requirement
of majority independence "did not appear to constitute a significant
difference
between the two proposals." General Motors at 387. GM argued that for
practical
--------------
purposes, the historical fact that the percentage of independent directors
exceeded 80% also showed that there was not a significant difference between
the
shareholder proposal and existing practice. GM argued therefore that the
proposal could be excluded because it had substantially implemented the
shareholder proposal.
The Division rejected GM's view that the proposal was
moot, and stated that
it did not believe that the proposal could be omitted in reliance on 14a-
8c(i)(10). Yet the differences between the existing situation and QSII's
situation if the Diamond A Proposal is adopted are even greater than the
distinctions in General Motors. These differences include the following:
--------------
1. QSII does
not have any by-laws that mandate an independent number
of
directors;
2. Prior QSII
history has led to a board that has been run by an
inside director (Mr. Razin) and had at best, a slight majority of outside
directors. In contrast, the GM board was historically 80% independent and
had a
long history of structural and practical independence; and
3. Diamond A
proposes changes from QSII's historical practice of
allowing the board to be controlled by inside directors, while at GM the
board
had a long tradition of independence and good corporate governance.
The Division's response to GM's arguments is
instructive, and has
application in the present discussion. Specifically, in GM, the discrepancy
between the shareholder proposal under consideration and the existing state
of
business at the time was considerably smaller than the discrepancy that
exists
-------
between the Diamond A Proposal and QSII's current board procedures, and
practices. Yet in GM's case, the Division refused to agree that GM's actions
constituted "substantial implementation."
Furthermore, even if the QSII Board presently happens
to have a slight
majority of outside directors, it has yet to commit itself formally to this
form
of governance. The Proposal urges that the independent majority principle be
grounded in the Company's By-Laws, and that the percentage of Independent
Directors be increased. These facts alone are sufficient to defeat the
Company's
<PAGE>
argument that the Diamond A Proposal is moot because the Company has already
been substantially implemented.
The Division has, in addition to the no-action request
cited above,
consistently rejected the types of arguments raised on behalf of the
Company.
For example, in Ametek, Inc., SEC No-Action Letter, 1995 No-Act. LEXIS 248,
(Feb
-----------
14, 1994), the Division indicated that even where an issuer claimed to have
a
truly independent board, a like shareholder proposal could not be considered
substantially implemented where differences remained in their definitions of
"independent."
Additionally, as with the current situation, the Ametek
board did not
appear to have formally sanctioned the principle of an independent director
majority. See also Phillip Morris Companies Inc., SEC No-Action Letter, 1995
No-
-------------------------------------
Act. LEXIS 248, (Feb. 15, 1995) (proposal to create independent director's
committee that would evaluate management proposals to the board and generate
independent alternatives not substantially implemented by existence of
current
non-employee director majority). Not only has the company failed to
implement a
by-law amendment -- but also the committee's view equating a simple
numerical
majority of arguably the Diamond A Proposal's request to establish an
Independent Board of Directors. Accordingly, the Diamond A Proposal was not
substantially implemented, and the Company's request for exemption based on
Rule
14a-8(i)(10) should be denied.
Argument No. 3: The Proposal fails under Rule 14a-8(i)(1) in that it
contravenes
the statutory framework established by California law and is therefore not a
proper subject for action by shareholders.
The Company sets forth a number of sub-arguments in
Section 3 of its
letter, under the general argument that the Diamond A Proposal violates the
California Corporations Code ("CGCL"). Although not always clear, it appears
that the Company argues that the proposal intrudes upon the board's
authority to
mange the business and affairs of the corporation in the following respects:
(a) the requirement of 75% independent directors
intrudes on the ability
of the Board to identify,
attract, and recommend to the shareholders
for approval a group of
director candidates who are sufficiently
familiar with the company
and its business to be able to competently
direct and manage the
business affairs of the company;
(b) the Proposal interferes with the statutory
requirement for the
management of the
business and affairs of the corporation and the
exercise of all corporate
power by the Board pursuant to Section 300
of the CGCL;
(c) the Proposal allocates authority to a subset
of directors that should
otherwise be exercised by
the full Board;
(d) the Proposal would cause the company to be in
violation of
Section 708(c) of the
CGCL;
<PAGE>
(e) the Proposal would cause one or more of the
Company's 1999 nominee
directors to be
improperly removed prior to the expiration of their
term of office; and
(f) The proposals intrude upon the Board's power
to exercise sound
business judgment.
The primary no-action letter relied upon by the Company
in support of all
of its arguments in this Section is Edison, supra. Yet Edison has no
relevance
------ ----- ------
--
to any of the Company's arguments on these issues, as it explicitly did not
reach any of these issues. Indeed, Edison states that it provided no-action
------
support because the six proposals at issue violated the single proposal
requirement; the Staff explicitly did not "address the alternative bases for
---
omission upon which the Company relies." Thus, the Company's legal support
for
its position has no merit.
The Company is wrong on each of these claims for other
reasons as well. Our
specific responses to each argument are set forth
below:
Argument No. 3(a:) The Company claims that the proposal may be eliminated
under
Rule 14a-8(i)(8) because the requirement of 75% independent directors
intrudes
on the ability of the Board to identify, attract, and recommend to the
shareholders for approval a ground of directors candidates that are
sufficiently
familiar with the company and its business to be able to competently direct
and
manage the business affairs of the company.
The Company's argument here has been repeatedly made
to, and rejected by,
the Division. For example, in General Dynamics Corp., SEC No-Action Letter,
1996
----------------------
SEC No-Act. LEXIS 156. (February 5, 1996), the Division rejected General
Dynamic's ("GD") argument that a proposal requiting the GD Board to be
composed
of a majority of independent directors be omitted on the grounds that
although
it may appear to fall into the category of proposals which would enhance
"corporate responsibility," the proposal would allegedly limit the persons
with
defense industry experience able to serve on GD's Board.
In the present case, QSII is repeating the very same
argument which was
rejected by the Division in General Dynamics- namely, that a proposal that
the
Board be composed of a majority of Independent Directors interferes with the
ordinary business operations of the Company because it prevents the Company
from
finding qualified director candidates, and therefore should be omitted from
the
proxy materials. The Division rejected this argument in General Dynamics,
and it
should do so again.
Argument No. 3 (b) The Proposal does not interfere with the statutory
requirement that the Board manage the business and affairs of the
corporation
pursuant to Section 300 of the CGCL.
The Company's claim that the proposal interferes with
the statutory
authority of the Board, pursuant to CGCL(S)300, to manage the business and
affairs of the corporation is based upon a gross distortion of the Diamond A
Proposal, as well as a misunderstanding of California law.
First, the proposal does nothing more than create an
Independent Board, in
part by having the Independent Directors meet separately at the end of each
board meeting. The proposal does not in
<PAGE>
any way change the nature of the Board responsibilities, nor does it attempt
to
interfere with the statutory authority of the Board. See, e.g., Philip
Morris
--- ---- -------------
Companies Inc., SEC No Action Letter. 1995 No-Act LEXIS 248, (Feb 15, 1995).
--------------
Second nothing in California Law prohibits independent
directors from
meeting on a regular basis. To the contrary, California Law has long
recognized
the value from having special committees composed of independent directors
review various matters as a group, without the presence of management and/or
"inside" directors. See, e.g., Gaillliard v. Natomas Co., 286 Cal. Rptr. 702
--- ---- -------------------------
(1989).
The Company's argument that the proposal violates
Section 307's notice
requirement for a special meeting of the Board is equally misguided. Again,
Diamond A's Proposal only provides that, as part of each board meeting, the
Independent Directors meet separately as a group "to discuss such maters as
they
deem appropriate". No additional notice is required or appropriate for this
portion of the meeting. Rather, this portion of the meeting would presumably
be
part of the regular meeting, the only difference being that some directors
(i.e., the inside directors) would be excluded from this portion of the
meeting.
---
Having the independent directors meet separately as a group is common
practice
for well governed corporations today, See, e.g., Blue Ribbon Report and the
--- ---- ------------------
Company's argument that this practice violates California Law only
demonstrates
why QSII needs an Independent Board of Directors.
Argument 3(c).The Proposal does not allocate authority to a subset of
directors that should otherwise be exercised by the full Board.
Adoption and implementation of the Proposal would not
result in any
improper delegation of responsibilities of rights or responsibilities
established under California State law. The board recently established (in
response to the proposal) a nominating committee, and thus there can be no
question that this committee is appropriate. Yet this is the only committee
----
required pursuant to the Diamond A Proposal.
The Company's apparent argument that the Independent
Directors meeting
separately as a group somehow constitutes an illegal and unauthorized
committee
is unprecedented in law and contrary to the current practices of most well
governed corporations. Again, however, it must be emphasized that the
independent directors meeting separately as a group does not constitute a
"special committee" (other than the Nominating Committee) and their having
discussions outside the presence of management-directors cannot be
considered a
violation of California law.
Argument No. 3(d): The Company's argument that the proposal would cause the
company to be in violation of Section 708(c) of the CGCL is wrong.
Again, this argument has been previously rejected by
the Division and is
contrary to well-established principles of corporate governance. QSII's
argument
is that the candidate with the highest number of votes at the next 1999
meeting
may not be elected because of the requirement that 75% of the Board be
independent. According to the Company's argument, because the proposed
by-law
amendment imposes qualifications for the board as a whole, it may violate
Section 708(c) and
<PAGE>
would intrude upon the rights of shareholders to cumulate their votes, as
permitted by Section 708(b) of the CGCL.
QSII's argument is incorrect in several respects.
First, this line of
argument was rejected by the Division in Waste Management. Inc., SEC
No-Action
----------------------
Letter, 1991 SEC No-Act LEXIS 450. (March 8, 1991). The proposal in Waste
-----
Management similarly requested that "the bylaws of Waste Management be
amended
----------
to provide that the Board of Directors shall consist of a majority of
independent directors." In its argument that the Division take no action if
the
Waste Management omitted the proposal, Waste Management argued that the
proposal
would result in independent director candidates with fewer votes being
elected
over non-independent director candidates with more votes, in derogation of
state
statute. (Maryland corporate law similarly states that the candidates with
the
most votes get elected in elections for corporate directors.) The Division
rejected the company's argument and did not grant Waste Management's request
that it recommend no action to the Commission.
Second, the argument assumes that QSII and/or others
will nominate
directors such that the Board will not have independent directors comprising
75%
of the Board. In fact, however, QSII has not yet identified its director
nominees, and there is no reason to assume that a board, which has 75% of
its
members as independent, will not obtain the most votes.
Finally, QSII's argument must be rejected because it
would mean the end of
all eligibility requirements for boards. In fact, numerous companies, in
California and elsewhere, contain similar eligibility requirements for
directors. Such eligibility requirements have long been recognized as
appropriate, and the Diamond A Proposal is similarly legal under California
Law.
Section 212(b)(4), CGCL.
Argument No. 3(e): The proposal would cause one or more of the Company's
1999
nominee directors to be improperly removed prior to the expiration of their
term
of office.
QSII's characterization of the Diamond A Proposal is
distorted and
tortured. There is nothing in the Diamond A Proposal that calls for the
removal
of the Company's present directors, or of its 1999 nominee directors. The
Proposal simply recommends that the board be composed of Independent
Directors,
and defines the terms "Independent" as it is used in the proposal. The
Company
has failed to indicate how, under the Diamond A Proposal, it is or would be
required to remove any of its present or future directors. The proposal that
the
Board be composed of a majority of Independent Directors can be implemented
in
many ways that would not call for the removal of a single director. Among
such
measures, for example, would be an increase in the number of seats on the
board.
Based on the information provided, the Division should
be unable to concur
with the Company's opinion that, to implement the proposal, the Company
would be
required to remove directors and that the removal under these circumstances
would violate applicable state corporate law. Under the circumstances, the
Division should be unable to conclude that the company has met its burden of
demonstrating that omission of the proposal is proper, as is required under
Rule
14a-8. See, e.g., General Dynamics Corp., SEC No-Action Letter, 1996 SEC
No-Act.
--- ----
LEXIS 156, Feb. 5,
<PAGE>
1996 (Division declined to grant GD no action request regarding shareholder
request that the board of directors consist of majority of independent
directors.)
Argument 3(f) The proposals intrude upon the Board's power to exercise sound
judgment
In the matter under consideration, the Diamond A
Proposal sets forth the
language of a proposed amendment to the bylaws of QSII, which recommends the
implementation of an Independent Board of Directors. QSII argues that the
proposal would intrude upon the Board's power to exercise sound business
judgment. The Company further argues that "the authority for such action is
vested exclusively in a company's board of directors...the proposals mandate
action that is beyond the shareholder's authority and would invade the
province
of the Board."
In fact, it is well established under California law
that bylaws may be
adopted, amended or repealed by approval of the outstanding shares. CGCL
Section
211 states:
"Bylaws may be adopted, amended or repealed...by approval of the outstanding
shares."
Furthermore, under CGCL, the bylaws may contain any
provision for the
conduct of the affairs of the corporation including the qualifications of
directors. Section 212(b) (4) of the CGCL states:
"(b) The bylaws may contain any provision, not in
conflict with law or the
articles for the management of the business and for the
conduct of the
affairs of the corporation, including but not limited
to...
(4) The
qualifications...of directors."
Thus California law, contrary to the arguments of the
Company, expressly
grants shareholders the power to define qualifications of the directors
through
amendments to the bylaws. Therefore the Diamond A Proposal, which recommends
amendment of the bylaws to define the qualifications for an independent
board of
directors set forth in the Proposal does not violate of California law.
Furthermore, the Division has recognized the rights of
shareholders to
amend corporate bylaws through shareholder proposals. In Mapco, Inc., SEC
No-
-----------
Action Letter, SEC No Act LEXIS 2012, March 16, 1983, the shareholder
proposal
related to a demand that the Company's bylaws be amended to require the
Board of
Directors to establish a special committee of the board consisting of three
independent directors. Mapco argued that the proposal could be excluded on
the
grounds that the proposal was not a proper subject for shareholder action.
The
Division refused to concur in Mapco's argument that a shareholder proposal
was
excludable. In rejecting the argument, the Division cited specific sections
of
Delaware Law almost identical in language to corresponding section in the
CGCL.
Specifically, the Division stated:
"We note that under Section 109 of the DGCL,
shareholders "have the power
to make, alter and repeal by laws." The Commission has
stated that the
burden is on the issuer to
<PAGE>
demonstrate that the rule (14a-8) is available to
exclude a proposal from
the issuer's proxy material. We are unable to conclude
that you have met
your burden of demonstrating that the bylaw provision
contained in the
proposal is not a proper subject for shareholder
action." Mapco at 2.
-----
Thus, as it has in other instances, the Division should
not grant QSII's no
action request, as QSII has failed to meet its burden of demonstrating that
the
proposed bylaw provision contained in the Diamond A Proposal is not a proper
subject for shareholder action on the grounds that the proposal would
require a
violation of California law.
Argument No. 4: The proposals may be omitted under rule 14a-8(i)(7) on the
grounds that the proposal deals with matters relating to and in
contravention of
the ordinary functions of the Board of Directors and the ordinary business
of
the Company.
QSII next seeks to omit Diamond A's Proposal from its
proxy materials on
the grounds that the proposal, to the extent that it seeks the formation of
a
Nominating Committee (which QSII's current board has recently established),
as
well as a group of Independent Directors who will meet separate and apart
from
the other non-independent directors at the end of each board meeting relates
solely to and in contravention of the ordinary functions of the Board of
Directors and the ordinary business of the Company. Again, no legal support
is
offered for this view, and no such authority is available. To the contrary,
the
Division's recent rulings are directly to the contrary.
For example, in its recent consideration of a no action
request by RJR
Nabisco ("RJR"), (RJR Nabisco Holding Corp., 1998 SEC No-Act. LEXIS 337,
---------------------
February 23,1998), the Division refused to agree with the proponent of a
similar
argument. In RJR, the Company requested that the Division grant no action if
it
omitted a shareholder proposal which sought the formation of a Board of
independent directors. The company argued:
"To the extent that the proponent is seeking to direct
how board committees
will function and what matters they should considering
evaluating the
operation of the company and its subsidiaries, the
Proposal relates to the
conduct of ordinary business operations." (RJR at 17.)
----
In further support of its argument, RJR argued that the
Board was in a
better position to assure how the company was organized, and how management
and
staff resources should be allocated. The Division rejected that argument,
and
found that the proposal at issue could not be excluded under this provision.
Furthermore, the SEC has been very specific in
addressing the meaning of
the term "ordinary business." In its release accompanying the recent
amendments
to the rule, Release No. 34-40018, "Amendments To Rules on Shareholder
Proposals," 63 FR 29106, Fed Register, Vol. 63, No. 102, May 28, 1998), the
SEC
reiterated the standard for determining when a proposal relates to "ordinary
business." The standard originally articulated in the Commission's 1976
release,
provided an exception for certain proposals that raise significant social
policy
issues. See Exchange Act Release No. 12999 (Nov. 22, 1976) (41 FR 52994.)
(Proposals "which have significant policy, economic or
<PAGE>
other implications inherent in them" will not be excluded by Rule
14a-8(c)(7)
and that the Rule would only restrict those "proposals that deal with truly
'ordinary' business matters...that are mundane in nature and do not involve
any
substantial policy or other consideration.")
A shareholder proposal may not be excluded under Rule
14a-8(i)(7) if it
raises important policy issues. The Proposal to establish an Independent
Board
of Directors clearly raises such important policy matters. The issue of the
independence and/or governance practices of a Board of Directors of a public
company cannot be considered "mundane in nature," especially in a situation,
such as that at QSII, where significant corporate governance problems exist
and
how to address these problems raises profound policy issues that are the
continuing subject of public debate.
Argument No. 5: The Company also states that the proposal may be eliminated
under Rule 14a-8(i)(8) on the grounds that the requirement of 75%
independent
directors is exclusionary and narrow in scope, and intrudes on the ability
of
the Board to identify, attract, and recommend to the shareholders for
approval a
ground of directors candidates that are sufficiently familiar with the
company
and its business to be able to competently direct and manage the business
affairs of the company.
This argument is the same that was set forth under
several previous
arguments, and fails for the same reasons set forth above.
Respectfully submitted,
/s/ David J. Berger
David J. Berger
cc: Mr. Andrew E. Shapiro
Mr. Thomas J. Crane
<PAGE>
[Letterhead of Wilson Sonsini Goodrich & Rosati, Professional
Corporation]
April 22, 1999
VIA FACSIMILE AND OVERNIGHT DELIVERY
Sheldon Razin
President and CEO
Quality Systems, Inc.
17822 East 17th Street, #210
Tustin, CA 92780
Re: Shareholder Proposal for Inclusion in
Proxy Materials by Diamond A Partners
Dear Mr. Razin:
My firm is counsel to Lawndale Capital Management, LLC,
which is the
general partner of Diamond A Partners, L.P. ("Diamond A"). On March
29, 1999,
Diamond A, an eligible shareholder of Quality Systems, Inc. ("Quality
Systems"
or the "Company") under Rule 14a-8 of Regulation 14A under the Securities
Exchange Act of 1934 as amended, submitted a shareholder proposal to Quality
Systems for inclusion in its proxy materials for the upcoming annual meeting
of
the Company. We have been asked by Diamond A to respond to your letter
dated
April 8, 1999, in which you contend that Diamond A's shareholder proposal
("Diamond A's Proposal") may be excluded from the Company's 1999 proxy
statement
under Rule 14a-8(c), promulgated under the Securities Exchange Act of 1934
("Rule 14a-8(c)"). Based upon our review of the relevant materials, we
do not
believe that Diamond A's Proposal is excludable under the cited sections.
Rule 14a-8(c) provides that a shareholder may submit no
more than one
proposal to a company for inclusion in the proxy materials for a particular
shareholders' meeting. The Staff of the Division of Corporation
Finance of the
Securities and Exchange Commission (the "Staff") has repeatedly taken the
position that, as here, a proposal for purposes of Rule 14a-8(c) may include
the
definitional elements of the proposal provided that these elements all
relate to
the specific concept set forth in the proposal. Thus here, for
example, Diamond
A's Proposal defines the role of an independent Board of Directors to govern
QSII, and we believe would be so considered by the Staff.
An analysis of the Staff's position on "single proposal
cases" clearly
supports this position. For example, in 1992 a shareholder submitted a
proposal
to McDonald's Corp. relating to (i) potential conflicts of interest
involving
McDonald's officers and directors, (ii) limitations on McDonald's executive
compensation, and (iii) limits on McDonald's ability to award stock options.
After objection by McDonald's, the shareholder resubmitted his proposal,
eliminating the conflicts of interest issue. McDonald's, in its
submission to
the Staff, asked that the Staff take "no action" if McDonald's excluded the
revised proposal regarding executive compensation and stock options on the
grounds that it still constituted multiple proposals.
The Staff rejected MacDonald's' position, concluding
instead that the
shareholder's proposal was a single proposal. The Staff's reasoning
was that
the separate elements of the proposal related to the single concept of
executive
compensation. McDonald's Corp., SEC No-Action Letter, 1992 SEC No-Act.
LEXIS
----------------
1101 at *1, December 2, 1992.
(16 of 18)
<PAGE>
A similar situation arose out of the request by
Computer Horizons Corp. for
a no-action letter after a shareholder had proposed that: (1) the company's
shareholder rights plan be modified or terminated; (2) existing contracts
with
directors or officers providing additional compensation after a change in
control be modified or terminated; (3) existing contracts with directors or
officers providing for additional assurances of continued employment after a
change in control be modified or terminated; and (4) each plan, contract or
arrangement which would significantly discourage potential offers to acquire
the
company be modified or terminated. Computer Horizons argued that such
proposals
were actually four different proposals, and that the shareholder was merely
"attempting to circumvent the single proposal requirement of the Rule by
characterizing disparate proposals as action implementing a single policy."
The
Staff rejected this argument, stating that the proposal was a single
proposal,
and that all the elements of the proposal related to one concept -- the
elimination of anti-takeover defenses. Computer Horizons Corp., SEC
No-Action
-----------------------
Letter, 1993 SEC No-Act. Lexis 572 at *1, April 1, 1993.
The Staff has also concluded that multi-element
proposals should be
considered single proposals under Rule 14a-8(c) where all "elements" of a
proposal related to the single issue of executive compensation. See
---
Ferrofluidics Corp., SEC No-Action Letter, 1992 SEC No-Act. LEXIS 932,
September
-------------------
18, 1992 (elements relating to base pay and warrants granted to executives);
Westinghouse Electric Corporation, SEC No-Action Letter, 1995 SEC No-Act.
LEXIS
---------------------------------
169, January 27, 1995 (elements including base compensation, bonuses,
retirement
compensation, performance based pay found to relate to the single concept of
executive compensation). The Staff also concluded that a proposal
which defined
numerous issues relating to a change of control transaction was a single
proposal because it related to a "request to sell or merge the company, and
suggested procedures for implementing this proposal." Todd Shipyards
Corp., SEC
--------------------
No-Action Letter, 1992 SEC No-Act. LEXIS 876, August 13, 1992 (elements
included
retaining an independent investment bank and establishing a committee of
independent directors to consider and recommend to the board the best
available
offers for merger or sale).
These situations are all directly analogous to Diamond
A's Proposal.
Diamond A's Proposal, like those above, relates to a single issue, albeit
the
issue of an independent board of directors. Nothing in Diamond A's
Proposal
relates to other issues such as, for example, executive compensation,
Shareholder Rights Plans, or change of control transactions. Rather,
Diamond
A's Proposal is one proposal, specifically defining the role of an
independent
board at QSII, and we believe this is how it would be viewed by the Staff.
The Staff recently addressed a shareholder proposal
which, like Diamond A's
proposal, involved issues of corporate governance. Specifically, in
1998 a
shareholder of Boeing Co. requested that Boeing include in its proxy
materials a
single proposal that contained a number of specific proposed actions
relating to
the election process for the Board of Directors. See The Boeing
Company, SEC
--- ---------- -------
No-Action Letter, 1999 SEC No-Act. LEXIS 232, February 18, 1998. The
shareholder proposal requested that the Board of Directors take certain
steps to
amend the company's governing instruments, including the company's by-laws,
to
provide for the annual election of the full Board of Directors. The
proposal
also required that a majority vote of outstanding shares be required to
change
this resolution.
Boeing, like QSII here, requested that the Staff agree
that the proposal be
excluded on Rule 14a-8(c) grounds, arguing that the proposal consisted of
the
following three proposals:
-that the Board of Directors
"take the necessary steps to amend the
company's governing
instruments" to provide for the annual election of
the full Board of
Directors;
-that the Board of Directors
take the necessary steps to limit director
service to 15 years; and
-that any change in the by-law
provisions created by the first two
proposals must be
approved by the holders of a majority of Boeing's
outstanding shares.
(17 of 18)
<PAGE>
The Staff rejected this argument, finding that the
proposal was in fact one
proposal. In its letter rejecting Boeing's argument that the proposal
could be
omitted under Rule 14a-8(c), the Staff stated that "[T]he revised proposal
requests that the Board take the necessary steps to ensure that all
Directors
are elected annually and requests restriction on the ability to change that
requirement."
Also during the 1998 proxy season, a shareholder
proposal submitted by
TIAA-CREF was included in Walt Disney Co.'s proxy materials for its 1998
annual
stockholder meeting. The proposal, which is very similar to Diamond
A's
proposal, requested that the company restructure the Board of Directors so
that
it be largely composed of "Independent Directors." It also requested
that the
Audit, Compensation, and Nominating Committees of the Board of Directors
consist
entirely of independent directors. It also defined the term,
"Independent
Directors." Walt Disney Co. does not appear to have objected to this
proposal on
Rule 14a-8(c) grounds -- presumably because the issue has been settled in
light
of the "no action" letters cited above.
As with Boeing and Disney, Diamond A's Proposal is a
single proposal for
purposes of Rule 14a-8(c). Diamond A's single proposal defines the
role of an
independent board of directors to govern QSII. The definitional
elements of
this proposal are not separate proposals, but rather merely explain how the
board shall operate to ensure that QSII is governed by an Independent Board.
Given the Staff's history of concluding that such explanations or
definitions
are not separate proposals which can be excluded from the company's
proxy
materials on Rule 14a-8(c) grounds, we believe that the Company lacks a
sufficient basis to oppose the inclusion of Diamond A's proposal on
the grounds
that it is more than one proposal. Accordingly, we hereby request that
QSII
include the Diamond A Proposal in its 1999 proxy so that QSII shareholders
may
resolve this critical issue.
Please call me if you have any further questions on
this matter.
Very truly yours,
WILSON SONSINI
GOODRICH & ROSATI
Professional Corporation
/s/ David J. Berger
David J. Berger
cc: Andrew Shapiro
Page Mailliard, Esq.
(18 of 18)
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