You might remember this no-action letter to Johnson & Johnson granting relief to the company if it relied on Rule 14a-8(i)(2) (violation of law) to exclude a shareholder proposal requesting adoption of mandatory shareholder arbitration bylaws. (See this PubCo post.) In that letter, the staff relied on an opinion from the Attorney General of the State of New Jersey, the state’s chief legal officer, which advised the SEC that the proposal was excludable under Rule 14a-8(i)(2) because “adoption of the proposed bylaw would cause Johnson & Johnson to violate applicable state law.” The issue was so fraught that SEC Chair Jay Clayton felt the need to issue a statement supporting the staff’s hands-off position: “The issue of mandatory arbitration provisions in the bylaws of U.S. publicly-listed companies has garnered a great deal of attention. As I have previously stated, the ability of domestic, publicly-listed companies to require shareholders to arbitrate claims against them arising under the federal securities laws is a complex matter that requires careful consideration,” consideration that would be more appropriate at the Commissioner level than at the staff level. However, mandatory arbitration was not an issue that he was anxious to have the SEC wade into at that time. To be sure, if the parties really wanted a binding answer on the merits, he suggested, they might be well advised to seek a judicial determination. And, you guessed it—Clayton’s words to the proponent’s ears—the proponent filed this complaint on March 21.
In what seemed to be an odd role reversal, a Harvard professor and shareholder of Johnson & Johnson submitted a proposal requesting that the board adopt a mandatory arbitration bylaw applicable to “disputes between a stockholder and the Corporation and/or its directors, officers or controlling persons relating to claims under federal securities laws in connection with the purchase or sale of any securities issued by the Corporation.” The bylaw would also prohibit class actions and include a five-year sunset provision unless re-approved by the shareholders. And again, curiously, the company fought to exclude the proposal on the basis of Rule 14a-8(i)(2), that the bylaw would violate federal and state law.
Among other things, the company contended that the proposal, if implemented, would violate state law, resulting in costly litigation. In support, the company submitted the NJAG opinion, which advised the SEC that the proposal was excludable under Rule 14a-8(i)(2) because “adoption of the proposed bylaw would cause Johnson & Johnson to violate applicable state law. Longstanding principles of New Jersey law limit the subject matter of corporate bylaws to matters of internal concern to the corporation. Under New Jersey law, as under Delaware law, forum-selection provisions relating to claims under the federal securities laws do not address matters of internal concern, and bylaw provisions purporting to dictate the forum for such claims—including but not limited to mandatory arbitration provisions—are void.” Moreover, the NJAG argued, recent amendments to the New Jersey code specifically addressed forum-selection bylaws, but did not authorize forum-selection bylaws relating to federal securities law claims, thus reinforcing the NJAG’s position. The proponent urged the SEC not to give the NJAG Letter “any special weight” because the AG was just interpreting Delaware law to reach a conclusion about New Jersey law.
But to no avail. The staff gave plenty of special weight to the NJAG—in fact, the staff’s no-action relief rode entirely on the back of the NJAG: “When parties in a rule 14a-8(i)(2) matter have differing views about the application of state law, we consider authoritative views expressed by state officials….We view this submission [by the NJAG] as a legally authoritative statement that we are not in a position to question.” In addition, the staff made the point, in granting the no-action request, that it was “not expressing its own view on the correct interpretation of New Jersey law [or] whether the Proposal, if implemented, would cause the Company to violate federal law. Chairman Clayton has stated that questions regarding the federal legality or regulatory implications of mandatory arbitration provisions relating to claims arising under the federal securities laws should be addressed by the Commission in a measured and deliberative manner.” In light of the staff’s position as a dispenser of only informal views regarding the propriety of Enforcement action, not as a body opining on the legality of the proposal, Corp Fin suggested that the “[p]arties could seek a more definitive determination from a court of competent jurisdiction.” Chair Clayton agreed, more generally emphasizing that the non-binding, informal nature of staff views expressed as part of the no-action process “do not and cannot definitively adjudicate the merits of a company’s position with respect to the legality of a shareholder proposal. A court is a more appropriate venue to seek a binding determination of whether a shareholder proposal can be excluded.”
After the staff determination, the proponent then submitted to the staff a petition for review, asking the staff to forward the petition to the SEC for review of the staff’s decision. Under the rules, Corp Fin may forward a petition for review of a no-action response relating to Rule 14a-8 if the staff concludes that the request involves “matters of substantial importance and where the issues are novel or highly complex.” In this instance, the staff replied that, after applying that standard, it had determined not to present the proponent’s request to the SEC.
After that rejection, the proponent took Clayton’s advice and filed this complaint in the US District Court for the District of New Jersey “Trenton Vicinage,” seeking a declaratory judgment that “Johnson & Johnson violated the federal securities laws by excluding the [proponent’s] proposal from these proxy materials, as well as an injunction that: (1) requires Johnson & Johnson to issue supplementary proxy materials that include the [proponent’s] proposal; (2) requires Johnson & Johnson to announce in those proxy materials that the [proponent’s] proposal is legal under federal and New Jersey law; and (3) prevents Johnson & Johnson from excluding proposals of this sort from future proxy materials.”
The proponent argued that the proposal would not cause the company to violate federal law, because “the Federal Arbitration Act requires the enforcement of arbitration agreements, and Johnson & Johnson has been unable to identify any federal statute that ‘manifest[s] a clear intention to displace the Arbitration Act.’” Nor, according to the proponent, would the proposal cause the company to violate NJ state law because “neither Johnson & Johnson nor the New Jersey Attorney General has identified any New Jersey statute or court decision that prohibits the enforcement of the arbitration agreements,” and, even if the NJ courts declined to enforce, that still would not mean that including the provision in the company’s bylaws would amount to a violation of NJ law. That is, a “company does not ‘violate’ state law by entering into an arbitration agreement that happens to be unenforceable under the law of that state.” Finally, even if state law were shown to prohibit enforcement, it would be preempted by the Federal Arbitration Act and void. The proponent also stated that he intends to submit the “proposal again for the 2020 shareholder meeting, and it will continue submitting this proposal each year until the proposal is adopted by the shareholders.” Worth watching!