by Cydney Posner

As we described in our last post on the saga of James McRitchie’s proxy access proposal submitted to Whole Foods Market, Inc., the SEC staff had granted the no-action request of Whole Foods, confirming that the company could omit McRitchie’s proposal from its proxy statement. That proposal would have permitted shareholders (or groups) that, for the preceding three years, had continuously held at least 3% of the company’s voting securities to nominate up to 20% of the board and to include those nominees in the company’s proxy statement. The basis for exclusion was Rule 14a-8(i)(9), which permits omission of a proposal where company management plans to submit a conflicting proposal. In its no-action request to the SEC, Whole Foods advised that it had determined to submit for a vote of its shareholders, at the same meeting, a proxy access proposal that would allow any single shareholder owning at least 9% of the company’s common for five years to submit nominations to be included in the company’s proxy statement — threshold levels that would have made proxy access unavailable to any current shareholder. In view of its success, a significant number of companies then followed the Whole Foods model –including a number that were among the 75 companies that received proxy access proposals from the NYC comptroller’s office — although most opted for lower thresholds in their conflicting management proposals. McRitchie then requested that the entire Commission reconsider and reverse the Whole Foods decision, arguing that the staff’s “interpretation effectively limits shareholders to consideration of proposals sponsored by the board of directors and eliminates any opportunity for shareholders to present alternative criteria. The interpretation is an unnecessary limitation on the shareholder franchise, effectively depriving shareholders of rights that exist under state law, and is inconsistent with the Commission’s intent in adopting subsection (i)(9).”

The Council of Institutional Investors also jumped into the fray. CII sent a letter to Corp Fin criticizing the SEC staff’s interpretation to the “conflicting proposal” exclusion as too broad an approach.  Rather, CII asserted, the exclusion should be available in only two circumstances: where there are two binding proposals on the same topic or, if the shareholder proposal is merely precatory, then, to be excluded, it must propose the opposite of the management proposal. (E.g., in the face of a shareholder proposal for proxy access, management’s proposal would, in effect, need to be against proxy access.) But, CII contended, where the proposals suggest reform in the same direction and just contain different thresholds or other terms, there is no real danger of “conflict”; the message is clear. In fact, CII argued, having only a single proposal blunts the communicative value of the vote shareholders do have. Certainly adding to the pressure on the SEC was Gretchen Morgenson’s column, characterizing the SEC in this instance as not fulfilling its role as a “defender of shareholder interests,” but rather “siding with companies keen to keep investors out of the nomination process.”

On Friday afternoon, the SEC responded, posting a “Statement” from SEC Chair Mary Jo White advising that, “[d]ue to questions that have arisen about the proper scope and application of Rule 14a-8(i)(9), I have directed the staff to review the rule and report to the Commission on its review.”  In response, Corp Fin announced that “[i]n light of Chair White’s direction to the staff to review Rule 14a-8(i)(9) and report to the Commission on its review, the Division of Corporation Finance will express no views on the application of Rule 14a-8(i)(9) during the current proxy season.”  In addition, the staff even reconsidered its prior no-action letter to Whole Foods, effectively withdrawing its prior favorable letter and indicating instead that it would express no opinion on the question of whether there was any basis for exclusion of the proposal. (Really, in light of all this commotion, what are the chances that the SEC will ultimately maintain the status quo?)

What does this mean for all of the pending proxy access and other proposals that would otherwise seek to rely on the “conflicting proposal” exclusion, not to mention the continued viability of the exclusion itself?  The exclusion has been available as currently interpreted for a number of years and has been successfully used by companies in several contexts – the right of shareholders to call shareholders’ meetings, elimination of supermajority voting provisions, and until now, proxy access. Now, companies desiring to exclude any of these types of proposals on the basis of a conflicting proposal are essentially on their own. There is no requirement that companies obtain a favorable no-action position from the SEC in advance of excluding the shareholder proposal in reliance on the exclusion; companies need only advise the staff of their intent to exclude and provide their rationales for exclusion. As the staff regularly states in its responses to no-action requests on shareholder proposals, the “determinations reached in these no-action letters do not and cannot adjudicate the merits of a company’s position with respect to the proposal. Only a court such as a U.S. District Court can decide whether a company is obligated to include shareholders proposals in its proxy materials.”

Each company will need to weigh a variety of factors in making a decision about the appropriate course of action, taking into account the nature of the proposal and its potential impact on the company, the proposal’s likelihood of success if put to a vote of the shareholders, the likely recommendations of proxy advisors ISS and Glass Lewis, the company’s litigation risk tolerance, the financial resources of the company and the shareholder proponent that might be allocated to litigating the proposal, the proponent’s anticipated level of perseverance, the fact that exclusion of the proposal on the basis of a conflicting management proposal does not preclude a proponent from submitting the proposal again the following year, among other factors.

In cases where the shareholder proponent appears to be amenable to negotiation, Corp Fin’s action may propel a number of companies in that direction. As indicated in this podcast with the NYC Assistant Comptroller on, companies have been asking the NYC Comptroller’s office whether, if they remedy the underlying condition that led the Comptroller to submit the proxy access proposal to the company in the first place –e.g., make their Boards more diverse—will that suffice to cause the Comptroller to withdraw the proposal?  Apparently, the answer is no; the Comptroller will withdraw only if there is an agreement regarding proxy access.

However, where negotiation is not a practical option or is not otherwise successful, companies are faced with several choices: they can seek a no-action position from the SEC staff on another basis, such as omission of the proposal on the basis that it has been “substantially implemented,” Rule 14a-8(i)(10). In that regard, however, the SEC typically requires that the nature of the implementation “compare favorably”  with the proposal. Nevertheless, where the proposal has involved elimination of supermajority voting provisions and substitution of a “majority of votes cast” standard, there are a number of no-action letters that allowed companies to omit the proposal if they implemented a “majority of the outstanding” vote standard in lieu of the supermajority voting provisions.

Companies could simply exclude the shareholder proposal and include the conflicting management proposal, accepting the risk that they may face litigation from the shareholder proponent and perhaps others.  Alternatively, they could act proactively and seek a declaratory judgment in court that the shareholder proposal may be excluded on the basis of a conflicting management proposal (or another basis, if available).  In the past, a number of companies have used the strategy of going straight to court for a declaratory judgment and bypassing the SEC’s no-action process (although still advising the SEC of their intent and submitting their reasons for excluding the proposals), and some of these companies have been successful. See, e.g., this news brief, discussing the successful court action by Express Scripts against a John Chevedden proposal.  Among other things, the company argued that the proposal was misleading and vague, a basis that the SEC staff is often reluctant to accept.  There were several later direct-to-court cases involving Chevedden, where the companies were unsuccessful; however, the basis for the proponent’s success in those cases was the irrevocable promise by the proponent to withdraw the proposal, making the case moot and denying standing to the company. Note, however, that in at least one case, after using withdrawal of the proposal as a basis to succeed in court, Chevedden then refused to actually withdraw the proposal, requiring the company to ultimately seek no-action from the SEC to exclude the proposal. Although it appears that some courts are more lenient in allowing exclusions on bases that the SEC staff will frequently not accept, such as “vagueness,” it’s not clear how a court will view the “conflicting proposal” exclusion, which, as noted above, has received a fair amount of pressure-inducing media attention.

Finally, companies may just decide to go forward and include the proposal in their proxy statements, with companies seeking to defeat the proposal hoping that shareholder engagement and proxy solicitation efforts will be effective in winning a favorable vote.   On the one hand, with regard to proxy access, in the past three years, only about 20% of these proposals have passed.  However, more recently, proxy advisors have tended to favor proxy access proposals with 3%/3-year eligibility thresholds, and in the last year, five of these proposals have succeeded in winning favorable shareholder votes. There have, however, been occasions where proxy advisors have recommended against even 3%/3-year proposals and the proposal has gone down in flames, for example, in a recent instance where the proposal sought to allow proxy access for up to 40% of the board.  On the other hand, shareholder proposals for elimination of supermajority voting have had a success rate of about 75% over the past five years. Companies might also consider including both the shareholder proposal and management’s conflicting proposal to provide shareholders with an alternative positioned as a middle course.

Of course, even if the shareholder proposal were successful, its precatory nature means that it is up to the company to decide how – or even whether — to implement it.  Companies that choose to do nothing will almost certainly face the wrath of the proxy advisory firms, which will now recommend against board members if the company takes no action to implement a shareholder proposal that wins approval of the shareholders. Some institutional investors may take the same approach.  However, it is unclear where proxy advisors and others will draw the line with respect to companies that implement variants of the successful shareholder proposal, such as including slightly different thresholds or additional restrictions and limitations — e.g., precluding aggregation to achieve the threshold level, adding qualifications for the shareholder (beneficial ownership, absence of intent to change control) or qualifications for the nominee (independence, absence of any prior voting commitment, absence of other compensation for service on the board).  Companies determined to follow that course may also want to engage with shareholders to assess what may be acceptable and sufficient to deter a subsequent shareholder proposal on the same topic (and perhaps also convince proxy advisors that shareholders viewed the implementation as appropriate).




Posted by Cydney Posner