Just in time for the beginning of proxy and shareholder proposal season, Corp Fin has posted Staff Legal Bulletin No. 14I, Shareholder Proposals. The SLB addresses four issues:
- the scope and application of Rule 14a-8(i)(7) (the “ordinary business” exclusion);
- the scope and application of Rule 14a-8(i)(5) (the “economic relevance” exclusion);
- proposals submitted on behalf of shareholders (shareholder proposals by proxy); and
- the use of graphics and images consistent with Rule 14a-8(d) (the 500-word limitation).
Rule 14a-8(i)(7) permits a company to exclude a proposal that “deals with a matter relating to the company’s ordinary business operations.” Why? Because the resolution of these types of matters is considered to be more properly the province of management and the board of directors than of the shareholders. Here, the SLB addresses the application of the “significant policy exception” to Rule 14a-8(i)(7).
The ordinary business exception is based on “two central considerations”: one is the extent to which the proposal “micromanages” the company, and the other consideration—the one at issue in the SLB—is the “subject matter” of the proposal. Generally, proposals may be excluded under Rule 14a-8(i)(7) if they “raise matters that are ‘so fundamental to management’s ability to run a company on a day-to-day basis that they could not, as a practical matter, be subject to direct shareholder oversight,’” unless, that is, the “significant policy exception” applies. That exception would preclude exclusion of the proposal if the proposal focuses on policy issues that are so significant that “they transcend ordinary business and would be appropriate for a shareholder vote. Whether the significant policy exception applies depends, in part, on the connection between the significant policy issue and the company’s business operations.”
Whether a policy issue is sufficiently significant to fall under the exception
“often raise[s] difficult judgment calls that the Division believes are in the first instance matters that the board of directors is generally in a better position to determine. A board of directors, acting as steward with fiduciary duties to a company’s shareholders, generally has significant duties of loyalty and care in overseeing management and the strategic direction of the company. A board acting in this capacity and with the knowledge of the company’s business and the implications for a particular proposal on that company’s business is well situated to analyze, determine and explain whether a particular issue is sufficiently significant because the matter transcends ordinary business and would be appropriate for a shareholder vote.”
As a result, Corp Fin expects future no-action requests “to include a discussion that reflects the board’s analysis of the particular policy issue raised and its significance. That explanation would be most helpful if it detailed the specific processes employed by the board to ensure that its conclusions are well-informed and well-reasoned.” Only time will tell whether, given the predisposition expressed in this SLB in favor of judgments by directors in these instances, a respectable analysis of the policy issue by the board will almost invariably hold sway.
Rule 14a-8(i)(5) permits a company to exclude a proposal that “relates to operations which account for less than 5 percent of the company’s total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company’s business.” Will this rarely used exclusion be rejuvenated by Corp Fin’s new guidance?
To say that the interpretations of this “economic relevance” exclusion have been shifting might be a bit of an understatement. For the most part, the aspect of the interpretation that has in the past been most fraught relates to the potential impact of social or ethical aspects of the proposal. At one point, the staff took the position that proposals could be excluded so long as they bore no economic relationship to a company’s business, unless they “reflected social or ethical issues, rather than economic concerns, raised by the issuer’s business, and the issuer conducts any such business, no matter how small….” Then, considering that position to be unduly restrictive, the SEC reversed course, and, in 1982, adopted the current economic tests. (The SEC made clear at the time of adoption that the exclusion related “to proposals concerning the functioning of the economic business of an issuer and not to such matters as shareholders’ rights, e.g., cumulative voting.”) Then, in 1985, the DC District Court enjoined a company from excluding a proposal, notwithstanding the nominal relationship to the company’s business, “in light of the ethical and social significance” of the proposal. As a result, Corp Fin’s subsequent analyses reverted back, largely ignoring the 5% tests and the proposal’s significance to the company’s business, and instead “simply considered whether a company conducted any amount of business related to the issue in the proposal and whether that issue was of broad social or ethical concern.” That position held firm, even though the SEC had previously expressed concern regarding the unduly restrictive nature of that approach.
The guidance in the new SLB revives the significance of the second prong of the rule, the proposal’s significance to the company’s business:
“We believe the Division’s application of Rule 14a-8(i)(5) has unduly limited the exclusion’s availability because it has not fully considered the second prong of the rule as amended in 1982—the question of whether the proposal ‘deals with a matter that is not significantly related to the issuer’s business’ and is therefore excludable. Accordingly, going forward, the Division’s analysis will focus, as the rule directs, on a proposal’s significance to the company’s business when it otherwise relates to operations that account for less than 5% of total assets, net earnings and gross sales. Under this framework, proposals that raise issues of social or ethical significance may be included or excluded, notwithstanding their importance in the abstract, based on the application and analysis of each of the factors of Rule 14a-8(i)(5) in determining the proposal’s relevance to the company’s business. [Emphasis added.]
“Because the test only allows exclusion when the matter is not ‘otherwise significantly related to the company,’ we view the analysis as dependent upon the particular circumstances of the company to which the proposal is submitted. That is, a matter significant to one company may not be significant to another. On the other hand, we would generally view substantive governance matters to be significantly related to almost all companies.”
The SLB notes that the burden is on the proponent to show that a proposal is “otherwise significantly related to the company’s business.” That is, if the “proposal’s significance to a company’s business is not apparent on its face,” it “may be excludable unless the proponent demonstrates that it is ‘otherwise significantly related to the company’s business.’” For example, the proponent might be able to point to the impact of the proposal on segments of the business or that it may “subject the company to significant contingent liabilities.” While the “proponent could continue to raise social or ethical issues in its arguments,… it would need to tie those to a significant effect on the company’s business. The mere possibility of reputational or economic harm will not preclude no-action relief. In evaluating significance, the staff will consider the proposal in light of the ‘total mix’ of information about the issuer.”
As with the “ordinary business” exception in Rule 14a-8(i)(7) discussed above, Corp Fin would expect a company’s Rule 14a-8(i)(5) no-action request to include a discussion that reflects the board’s analysis of the proposal’s significance to the company, again detailing “the specific processes employed by the board to ensure that its conclusions are well-informed and well-reasoned.”
The guidance also reverses Corp Fin’s past practice of generally applying the analysis used for the “ordinary business” exclusion, Rule 14a-8(i)(7), to determine the availability of the “economic relevance” exclusion. In the past, “the availability or unavailability of Rule 14a-8(i)(7) has been largely determinative of the availability or unavailability of Rule 14a-8(i)(5). Going forward, the Division will no longer look to its analysis under Rule 14a-8(i)(7) when evaluating arguments under Rule 14a-8(i)(5). In our view, applying separate analytical frameworks will ensure that each basis for exclusion serves its intended purpose.”
Proposals submitted on behalf of shareholders
The SLB reaffirms the availability of Rule 14a-8 for “proposals by proxy,” that is, where a shareholder submits a proposal through a representative, a favored practice of the group associated with John Chevedden, that most frequent proponent of shareholder proposals. However, recognizing that the practice presents a number of challenges (such as questions regarding eligibility and authority), in the future, the staff will expect shareholders who submit a proposal by proxy to provide documentation describing the shareholder’s delegation of authority to the proxy, which would include the following information:
- “identify the shareholder-proponent and the person or entity selected as proxy;
- identify the company to which the proposal is directed;
- identify the annual or special meeting for which the proposal is submitted;
- identify the specific proposal to be submitted (e.g., proposal to lower the threshold for calling a special meeting from 25% to 10%); and
- be signed and dated by the shareholder.”
If this information in not included—and the company has notified the proponent under Rule 14a-8(f)(1) of the specific defect within 14 calendar days of receiving the proposal so that the proponent has an opportunity to cure the defect—“there may be a basis to exclude the proposal under Rule 14a-8(b).”
Corp Fin notes that this guidance applies only to proposals submitted by proxy after the November 1 SLB publication date.
Rule 14a-8(d) permits exclusion of a proposal that, including any accompanying supporting statement, exceeds 500 words. The exclusion “is intended to limit the amount of space a shareholder proposal may occupy in a company’s proxy statement.” The issue here is how this limitation applies to graphics or images.
In the new guidance, Corp Fin reaffirms its position that the Rule’s use of “500 words,” without reference to graphics or images, does not preclude the use of graphics and/or images in shareholder proposals. To be sure, the SLB advises that companies “should not minimize or otherwise diminish the appearance of a shareholder’s graphic. For example, if the company includes its own graphics in its proxy statement, it should give similar prominence to a shareholder’s graphics. If a company’s proxy statement appears in black and white, however, the shareholder proposal and accompanying graphics may also appear in black and white.”
However, to avoid potential abuses, the staff suggests that companies look to other provisions of Rule 14a-8 for possible relief, such as Rule 14a-8(i)(3), which prohibits violations of the proxy rules, particularly, materially false and misleading statements. For example, Rule 14a-8(i)(3) would permit exclusion if the graphics or images would:
- “make the proposal materially false or misleading;
- render the proposal so inherently vague or indefinite that neither the stockholders voting on the proposal, nor the company in implementing it, would be able to determine with any reasonable certainty exactly what actions or measures the proposal requires;
- directly or indirectly impugn character, integrity or personal reputation, or directly or indirectly make charges concerning improper, illegal, or immoral conduct or association, without factual foundation; or
- are irrelevant to a consideration of the subject matter of the proposal, such that there is a strong likelihood that a reasonable shareholder would be uncertain as to the matter on which he or she is being asked to vote.”
In addition, the SLB points out that companies can still rely on Rule 14a-8(d) with regard to graphics or images if the total number of words in the proposal, counting any words in the graphics or images themselves, exceeds 500.