Yesterday, the Third Circuit finally rendered its opinion  in Trinity Wall Street v. Wal-Mart Stores Inc, a case involving a shareholder proposal submitted by Trinity Wall Street requesting that Wal-Mart’s board develop a policy regarding the sale of high-capacity firearms and other dangerous products. Wal-Mart sought to exclude the proposal from its proxy statement under the “ordinary business operations” exclusion of Rule 14a-8(i)(7), and the SEC staff took a no-action position permitting exclusion. But Trinity went a step further and challenged the exclusion in court. The federal district court in Delaware enjoined Wal-Mart from excluding Trinity’s shareholder proposal from Wal-Mart’s 2015 proxy materials, notwithstanding the no-action position of the SEC staff. On appeal, the Third Circuit issued an Order, without an opinion, in April, vacating the injunction and thus permitting Wal-Mart to exclude Trinity’s proposal from its 2015 proxy materials.  (See this post.) The Third Circuit’s opinion  providing the rationale for its order has now arrived. One judge concurred in the judgment, but dissented as to part of the analysis. (See this post for a discussion of the oral argument and this post for a more detailed discussion of the procedural and other background of the case.)

By way of background, the Court observed that Trinity, an extremely wealthy Episcopal parish where George Washington worshipped after his first inauguration, had been “[a]larmed by the spate of mass murders in America, in particular the shooting at Sandy Hook Elementary School in December 2012… [As a result, Trinity] resolved to use its investment portfolio to address the ease of access to rifles equipped with high-capacity magazines (the weapon of choice of the Sandy Hook shooter and other mass murderers). Its principal focus was Wal-Mart.” In particular, Trinity viewed Wal-Mart’s product sales decisions as inconsistent, given that Wal-Mart sold products, “such as guns equipped with high capacity magazines, that facilitate mass killings, even as it prohibits sales of passive products such as music that merely depict such violent rampages.” Wal-Mart responded that its “merchandising decisions are based on customer demand” and that it sought to balance the need to serve hunters and sportsmen with the need to ensure that firearms were sold responsibly.

Trinity’s shareholder 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.”

The District Court had 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 District Court said, would be experienced by the board, which would then be obligated to develop its policy. The proposal did not, through a shareholder vote, “dictate to management specific products that Wal-Mart could or could not sell.” Perhaps more significantly, the District Court contended, even if the proposal did relate to the selection of which products Wal-Mart may sell, it 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.”

Wal-Mart appealed the District Court’s decision. The Third Circuit reversed, upholding Wal-Mart’s exclusion of the proposal: “Stripped to its essence, Trinity’s proposal—although styled as promoting improved governance—goes to the heart of Wal-Mart’s business: what it sells on its shelves.”

The Court first remarked that the ordinary business exclusion is particularly perplexing because the opaque term “’ordinary business’… is neither self-defining nor consistent in its meaning across different corporate contexts.” The SEC’s interpretive guidance, to which the Court largely deferred, has followed a somewhat jagged path on this issue, but Court endorsed the SEC’s conclusion that a case-by-case analysis of each proposal was necessary and invoked the SEC’s reaffirmation that “the term ‘ordinary business’ continues to ‘refer[] to matters that are not necessarily “ordinary” in the common meaning of the word’ and ‘is rooted in the corporate law concept providing management with flexibility in directing certain core matters involving the company’s business and operations.’” The Court held that “the proposal is excludable under the ordinary business proviso and that the significant social policy intended by the proposal is here no exception to that exclusion.”

Analysis

To frame its inquiry, the Court employed a two-stage analysis, with each stage (in the Majority’s view) composed of two steps. First, the Court had to determine whether the proposal related to ordinary business operations. Here, the Court was required to first discern the actual “subject matter” of the proposal and then consider whether that subject matter related to Wal-Mart’s ordinary business operations.  If yes, the inquiry shifted to the second stage of the analysis, the significance of the policy issues implicated by the proposal. In this context, the Majority’s questions were whether the proposal focused on a significant policy issue and, if it did, whether the significant policy issue transcended the company’s ordinary business operations. To succeed in excluding the proposal, Wal-Mart had to convince the Court that Trinity’s proposal did “not raise a significant policy issue that transcends the nuts and bolts of the retailer’s business.”

Does the Subject Matter Relate to Ordinary Business Operations?

Consistent with the SEC’s approach (but in contrast to the District Court), the Court put aside the fact that the proposal was framed as a request for development of a board policy, elevating, in its view, substance over form.  The subject matter of the proposal was not to improve corporate governance, as Trinity contended, but rather, the “subject matter of the proposal is instead its ultimate consequence—here a potential change in the way Wal-Mart decides which products to sell.”  Citing the SEC staff’s no-action letter to Sempra Energy in January 2012 (among others), the Court viewed the subject matter of Trinity’s proposal to be “how Wal-Mart approaches merchandising decisions involving products that (1) especially endanger public-safety and well-being, (2) have the 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 the brand. promotion  of  the  brand.   A  contrary  holding—that  the proposal’s subject matter is ‘improved corporate governance’—would  allow  drafters  to  evade  Rule  14a-8(i)(7)’s reach by styling their proposals as requesting board oversight or review.”

For the second step — the question of whether the subject matter related to ordinary business operations – the Court agreed with Wal-Mart that the particulars of product selection and merchandising involved “operational judgments that are ordinary-course matters. Moreover, that the proposal doesn’t direct management to stop selling a particular product or prescribe a matrix to follow [as Trinity had argued] is, we think, a straw man.”  In the Court’s view, a “retailer’s approach to its product offerings is the bread and butter of its business.” In conclusion, the Court held that, “so long as the subject matter of the proposal relates—that is, bears on—a company’s ordinary business operations, the proposal is excludable unless some other exception to the exclusion applies.”

Does the Proposal Relate to a Transcendent Social Policy Issue?

The Majority first explained that an exception to the general ordinary business exclusion is set forth in the SEC staff’s 2009 legal bulletin 14E, which provides that  when “a proposal’s underlying subject matter transcends the day-to-day business matters of the company and raises policy issues so significant that it would be appropriate for a shareholder vote, the proposal generally will not be excludable under Rule 14a-8(i)(7).” While acknowledging that that line may be a hard one to divine, the Majority concluded that “because the proposal relates to a policy issue that targets the retailer-consumer interaction, it doesn’t raise an issue that transcends in this instance Wal-Mart’s ordinary business operations, as product selection is the foundation of retail management,” a conclusion that may ultimately be the most controversial aspect of the opinion.

The Majority also concluded that proposal did relate to significant policy issues.  Although, in this case, the policy was very broadly framed and its application was not limited to guns, and while the staff’s approach to social policy issues was viewed to be inconsistent, the Majority concluded that it was “hard to counter that Trinity’s proposal doesn’t touch the bases of what are significant concerns in our society and corporations in that society. Thus we deem that its proposal raises a matter of sufficiently significant policy.”

Still, to survive exclusion, the policy issues had to transcend ordinary business, a pivotal issue for the Majority in this case.  Crucially, the Majority interpreted the SEC’s use of the term “transcend” to “refer to a policy issue that is divorced from how a company approaches the nitty-gritty of its core business.” That definition turned out to be determinative in the case. Applying its definition, the Majority concluded that, for “major retailers of myriad products, a policy issue is rarely transcendent if it treads on the meat of management’s responsibility: crafting a product mix that satisfies consumer demand. This explains why the Commission’s staff, almost as a matter of course, allows retailers to exclude proposals that ‘concern[] the sale of particular products and services.’….. On the other hand, if a significant policy issue disengages from the core of a retailer’s business (deciding whether to sell certain goods that customers want), it is more likely to transcend its daily business dealings.” To illustrate the distinction, the Court contrasted two proposals: one proposal that “asks a supermarket chain to evaluate its sale of sugary sodas because of the effect on childhood obesity[, which] should be excludable because, although the proposal raises a significant social policy issue, the request is too entwined with the fundamentals of the daily activities of a supermarket running its business: deciding which food products will occupy its shelves” and another proposal “raising the impropriety of a supermarket’s discriminatory hiring or compensation practices[, which] generally is not excludable because, even though human resources management is a core business function, it is disengaged from the essence of a supermarket’s business.”

In this case, the Majority decided, the social policy issue was not “transcendent,” as the Majority defined the term:

[“But is how a retailer weighs safety in deciding which products to sell too enmeshed with its day-to-day business? We think it is in this instance. As we noted before, the essence of a retailer’s business is deciding what products to put on its shelves—decisions made daily that involve a careful balancing of financial, marketing, reputational, competitive and other factors. The emphasis management places on safety to the consumer or the community is fundamental to its role in managing the company in the best interests of its shareholders and cannot, ‘as a practical matter, be subject to direct shareholder oversight.’… Although shareholders perform a valuable service by creating awareness of social issues, they are not well-positioned to opine on basic business choices made by management.”]

To support its position, the Majority noted that Corp Fin has consistently allowed “retailers to omit proposals that address their product menu.”  Recognizing that it was creating precedent by extrapolating a “rationale that the SEC never in fact advocated, ” the majority took solace in the fact that the SEC can in essence supersede the Majority’s interpretation by issuing new corrective and binding interpretive guidance.

Similarly, with regard to Trinity’s claim that its proposal raised a “transcendent” corporate policy issue, the Majority concluded that “Wal-Mart’s consideration of the risk that certain products pose to its ‘economic success’ and ‘reputation for good corporate citizenship’ is enmeshed with the way it runs its business and the retailer-consumer interaction” and, therefore, not “transcendent.”  What products to sell and where to sell them is a quintessential management call.  Even where a shareholder proposal concerned a company’s reputation or brand, the proposal may be excluded when it “is woven with the way the company conducts its business.” Accordingly, the Majority held that, “even if Trinity’s proposal raises sufficiently significant social and corporate policy issues, those policies do not transcend the ordinary business operations of Wal-Mart” and, therefore, the proposal could be excluded. 

Conclusion

In its conclusion, the Court expressed its frustration with the absence of helpful guidance from the SEC on these issues (a frustration that some might contend is experienced by practitioners from time to time) and admonished the agency to issue new guidance:

[“Although a core business of courts is to interpret statutes and rules, our job is made difficult where agencies, after notice and comment, have hard-to-define exclusions to their rules and exceptions to those exclusions. For those who labor with the ordinary business exclusion and a social-policy exception that requires not only significance but ‘transcendence,’ we empathize. Despite the substantial uptick in proposals attempting to raise social policy issues that bat down the business operations bar, the SEC’s last word on the subject came in the 1990s, and we have no hint that any change from it or Congress is forthcoming…. We have no doubt that the Commission is equipped to collect ‘relevant data and views regarding the best direction for its regulatory policy.’ … We thus suggest that it consider revising its regulation of proxy contests and issue fresh interpretive guidance.”]

Concurring Opinion

In a concurring opinion, the judge agreed with the majority’s judgment that the proposal was excludable based on the ordinary business exclusion, but argued that the test employed  “may remove many company actions over which shareholders should have a say from shareholder oversight.” Citing a 1998 release, the concurring judge contended that “whether a proposal focuses on an issue of social policy that is sufficiently significant is not separate and distinct from whether the proposal transcends a company’s ordinary business. Rather, a proposal is sufficiently significant ‘because’ it transcends day-to-day business matters…. Thus, the SEC treats the significance and transcendence concepts as interrelated, rather than independent.” Moreover, there is no requirement that the proposal be “disengaged” from the company’s business to be “transcendent”; rather, this judge argued, the 1998 release

[“expressly permits a shareholder to submit a proposal that relates directly to ordinary business matters, including ‘decisions on production quality and quantity, and the retention of suppliers,’ so long as it ‘focus[es] on’ an issue of ‘sufficiently significant social policy.’… Thus, to ‘transcend’ ordinary business,… a proposal need not be divorced from ordinary business, as the Majority proposes, but instead must focus on a policy issue that in some ‘transcend[ent]’ way trumps ordinary business in importance.” ]

The Majority’s test undermines the purpose of Rule 14a-8 because “it practically gives companies carte blanche to exclude any proposal raising social policy issues that are directly related to core business operations.” Nevertheless, the concurring judge concluded, Trinity’s proposal was excludable because, as broadly drafted, the proposal lacked the necessary focus. It was not directed solely to the sale of guns — which might have raised a significant policy issue — and the other components of the proposal related to reputation and brand were not of “broad societal concern.”

Two of the three judges also agreed that the proposal could be excluded on the basis of vagueness under Rule 14a-8(i)(3). The third component of the proposal, which related to the sale of products that “would reasonably be considered by many to be offensive to the family and community values integral to” Wal-Mart’s brand, failed to “provide any concrete guidance as to what constitutes ‘many’ or what ‘family values’ should be considered,” notwithstanding Trinity’s efforts to tie these concepts to prior Wal-Mart statements.