Last week, the 3rd Circuit heard oral argument in the appeal of Trinity Wall Street v. Wal-Mart Stores, Inc., a decision by a federal district court in Delaware that had enjoined Wal-Mart from relying on the “ordinary business operations” exclusion, Rule 14a-8(i)(7), to exclude Trinity’s shareholder proposal from Wal-Mart’s 2015 proxy materials. (See this post for a more detailed discussion of the background of the case.) While the judges did not clearly betray the potential outcome, their questioning in the oral argument did provide some insight into the court’s thought process in this case.

After the district court’s judgment, in December 2014, Trinity resubmitted its shareholder proposal for inclusion in Wal-Mart’s 2015 annual meeting proxy statement. The proposal requested that several of Wal-Mart’s board committee charters be amended to require that the committees provide “oversight concerning the formulation and implementation of, and the public reporting of the formulation and implementation of, policies and standards that determine whether or not the Company should sell a product that:

1) especially endangers public safety and well-being;

2) has the substantial potential to impair the reputation of the Company; and/or

3) would reasonably be considered by many offensive to the family and community values integral to the Company’s promotion of its brand.”

District Court Decision. With regard to the substantive issue of whether the proposal related to ordinary business operations, the court analyzed the proposal under the guidance set forth in the SEC’s 1998 release on amendments to the shareholder proposal rules, quoting as follows (the court’s emphasis added):

“The general underlying policy of this exclusion is … to confine the resolution of ordinary business problems to management and the board of directors, since it is impracticable for shareholders to decide how to solve such problems at an annual shareholders meeting. The policy underlying the ordinary business exclusion rests on two central considerations. The first relates to the subject matter of the proposal. Certain tasks 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. Examples include the management of the workforce, such as the hiring, promotion, and terminations of employees, decisions on production quality and quantity, and the retention of suppliers. However, proposals relating to such matters but focusing on sufficiently significant social policy issues (e.g., significant discrimination matters) generally would not be considered to be excludable, because the proposals would transcend the day-to-day business matters and raise policy issues so significant that it would be appropriate for a shareholder vote. The second consideration relates to the degree to which the proposal seeks to ‘micro-manage’ the company by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment. This consideration may come into play in a number of circumstances such as where the proposal involves intricate detail, or seeks to impose specific time-frames or methods for implementing complex policies.”

The court concluded that the proposal was “best viewed as dealing with matters that are not related to Wal-Mart’s ordinary business operations” because “[a]t its core, Trinity’s Proposal seeks to have Wal-Mart’s Board oversee the development and effectuation of a Wal-Mart policy” The impact of the proposal, the court said, would be experienced by the board, which would then be obligated to develop its policy. The proposal does not, through a shareholder vote, “dictate to management specific products that Wal-Mart could or could not sell.” Perhaps more significantly, the court contended, even if it did relate to the selection of which products Wal-Mart may sell, the proposal nonetheless ‘‘focus[es] on sufficiently significant social policy issues’ as to not be excludable, because the Proposal ‘transcend[s] the day-to-day business matters and raise[s] policy issues so significant that it would be appropriate for a shareholder vote.’ …The significant social policy issues on which the Proposal focuses include the social and community effects of sales of high capacity firearms at the world’s largest retailer and the impact this could have on Wal-Mart’s reputation, particularly if such a product sold at Wal-Mart is misused and people are injured or killed as a result. In this way, the Proposal implicates significant policy issues that are appropriate for a shareholder vote.”

The court also noted that SLB 14E (2009) provides that where a proposal does raise such significant policy issues as to “be appropriate for a shareholder vote, the proposal generally will not be excludable under Rule 14a-8(i)(7) as long as a sufficient nexus exists between the nature of the proposal and the company …” Oversight of risk management by the board, the SLB observed, is widely recognized as “a significant policy matter regarding the governance of the corporation. In light of this recognition, a proposal that focuses on the board’s role in the oversight of a company’s management of risk may transcend the day-to-day business matters of a company and raise policy issues so significant that it would be appropriate for a shareholder vote.” Nor did the proposal “micro-manage” or involve “intricate detail” or impose specific timeframes.  Even though the SEC staff had allowed exclusion of the proposal, the court emphasized, citing the SEC’s own language, it was “undisputed that the final determination as to the applicability of the ordinary business exception is for the Court alone to make.”

Oral Argument. In the oral argument, the 3rd circuit was clearly angling for counsel to help the court make sense of apparent inconsistencies in decisions regarding the 14a-8(i)(7) exclusion – where to draw the line? Counsel for Wal-Mart seemed to argue for a more hard-and-fast line that, for retailers, decisions regarding sales of products are the “essence of ordinary business,” regardless of how the issue is framed.  Further, he argued, the only time that social policy matters can be permitted to transcend ordinary business and prevent exclusion of a proposal is where the social policy issue is not only significant, but is also so “integral” to the company that it is an “epic issue for the company that transcends day-to-day business.”  Counsel for Trinity seemed to argue for a more fluid approach. He contended that the district court had correctly applied the analyses set forth under the 1998 release and SLB 14E (outlined above), and asserted that any purported inconsistency in results reflects simply an evolution in society’s critical interests and values.

Where to draw the line for ordinary business?  Although he acknowledged that the SEC had not expressly drawn any line between retailers and others, such as manufacturers, Wal-Mart counsel advocated that, in determining whether a proposal should be excluded on the basis of the ordinary business exception, the line should be drawn for retailers at product selection. In support of his basic argument, counsel for Wal-Mart maintained that decisions by Wal-Mart regarding product merchandising are generally made by management and store managers under rigorous guidelines. He emphasized that these are the types of ordinary business decisions — even where products are controversial or involve reputational risk — made every day by management.   (Under questioning, counsel acknowledged that Wal-Mart policy decisions not to sell adult movies or music with parental warning labels involved both management and the board; however, he contended, the fact of board involvement in those decisions does not cause the issue of product selection to transcend ordinary business.) Moreover, he contended, exclusion of the proposal does not eradicate shareholders’ voices from the process because they can still contact the company to express their views or attend annual meetings and make proposals from the floor. (In response, the judge suggested that the suggested alternative might not be practical or consistent with the purposes of the proxy process.) To the extent that determining the proper shareholder/board balance involved a line-drawing exercise, counsel argued, great deference should be shown to the SEC’s determination to exclude the proposal.  In addition, allowing this proposal to go forward would open the door for hundreds of other proposals on other potential policy issues, such as sugary sodas, non-organic foods, books, etc., a position echoed in some of the amicus briefs supporting Wal-Mart.

Not surprisingly, there was little debate about whether sales of guns was a significant policy issue. Rather, Wal-Mart counsel implied that, even if it was significant, that wasn’t determinative in this case, because gun sales were not central to Wal-Mart, i.e., the nexus between Wal-Mart and gun sales was weak. Exploring further the line drawn by Wal-Mart counsel at product selection, one of the judges asked him how to explain decisions refusing to exclude proposals regarding sales of products such as napalm or tobacco? How should the court view the SEC staff’s refusal to grant no-action relief to Denny’s (proposal involving the sale of cage-free eggs ) and Kroger (proposal involving the sale of genetically engineered foods)?  Wal-Mart counsel argued that the instances involving tobacco and napalm involved manufacturers, not retailers, and that, in each case, the nexus was very close to the companies involved; Wal-Mart, on the other hand, sells 100,000s of products around the world, and, while guns are certainly a significant contemporary social issue, the product is not of such significance to Wal-Mart as to be at the core of what the company does. Similarly, he argued that the sale of eggs was more important to Denny’s than guns were to Wal-Mart.  Acknowledging that the Kroger letter was a closer case, he maintained that there was, nevertheless, a preponderance of letters that permitted exclusion of proposals related to product sales.  Asked what product-related proposal would be excludable, counsel responded with the example of a prior proposal to Wal-Mart asking for supplier sustainability reporting, for which the SEC denied no action. One judge commented that, if he were a board member, he would be much more concerned about the gun issue than about supplier sustainability issues.

Counsel for Trinity argued that, in considering the ordinary business exclusion, the court should draw the line as had the district court below: it should apply the analyses set forth in the 2009 SLB 14E and in the SEC’s 1998 release.  In response to a question similar to the one posed to Wal-Mart counsel regarding the SEC staff’s consistency in allowing some proposals {e.g., regarding tobacco and eggs) to be excluded, but others not, Trinity counsel explained that the staff strives to be consistent but, as discussed in the 1998 release, Corp Fin may, from time to time, adjust its view regarding social policy proposals that relate to ordinary business to reflect changing societal values.  When asked what he would anticipate the board doing if the proposal succeeded, counsel responded that he would expect the board to oversee policy development in this area.

Trinity counsel emphasized that Trinity is not proposing that Wal-Mart cease gun sales. Rather, consistent with the 2009 SLB, the proposal at issue related to board oversight of risk, thus transcending “ordinary business.” The risk here, he contended, relates to reputational, brand and event risk: Wal-Mart found itself pulled into the gun debate several years ago (e.g., invited to the presidential summit on guns) and could potentially be at the center of that debate if a gun purchased at Wal-Mart (or even if the same model sold by Wal-Mart) were used in a tragic event.  Because Wal-Mart is so prominent and can easily find itself in the cross-hairs of the press and public on these issues (resulting in reputational risk), counsel argued, it is important that the board be involved and that shareholders have some say. The board can then decide whether to stop sales in some areas or altogether, taking into account community values and reputational risk.  When asked how he would address the consequences suggested by Wal-Mart that, if this court upheld the lower court, there would be a flood of proposals on myriad social topics that would drain time and money from companies, Trinity counsel responded that the shareholder proposal process has been ongoing over many years and continually requires the SEC to work through the various proposals presented on a case-by-case basis. He expected that process to continue.

Form of the Proposal. With regard to the form of the proposal, some of the judges observed that the proposal was not detailed or directive, but instead requested that the board consider a broad policy. Wal-Mart counsel argued that the fact that the proposal requested a board policy did not take it outside of “ordinary business”; rather, it was the underlying subject of the proposal that should be examined.

[Sidebar: The concept that proponents should not be able to circumvent the “ordinary business” exclusion by simply framing the proposal as a request for a board policy was echoed in some of the amicus briefs filed in support of Wal-Mart. Amicus briefs in support of Trinity argued that the idea of a “board action exception” was essentially a straw man created by Wal-Mart and that the basis of the district court’s opinion was not so facile; rather, the district court considered whether the proposal respected the board’s authority or attempted to dictate to management those products that could be sold.]

In addition, Wal-Mart counsel contended, the proposal here was too broad in that it went beyond guns and, therefore, beyond a significant policy issue. The judges also asked Trinity counsel various questions regarding the form of the proposal, including whether, because of the phrasing of the proposal, the board would need to evaluate every product, raising the issue of micromanagement?  Counsel responded that micromanagement was not involved because there no request for the board to survey every item: Wal-Mart had the means to filter for the appropriate products to consider.

Vague or indefinite. One judge raised the issue of vagueness regarding some of the terms in the proposal, such as “family values.” Trinity counsel responded that the board, as custodian of the brand (which, he suggested, implicates “family values”), can assess through market research whether sales of some products might harm the brand. That is, the proposal was not so vague that Wal-Mart would not know how to address it.