Federal District Court Disagrees With SEC No-Action Letter

Once upon a time, a company and its management would decide what products they wished to sell and those that they would not – it’s just business. But on November 26, 2014, the U.S. District Court for the District of Delaware ordered Wal-Mart Stores Inc. to let shareholders vote on a proposal to force tighter oversight of Wal-Mart’s sale of high-capacity guns and other potentially offensive products.

The Trinity Wall Street v. Wal-Mart Decision

Trinity is an Episcopal parish headquartered in New York City. In December 2013, Trinity submitted a proposal for inclusion in Wal-Mart's 2014 proxy materials seeking a shareholder vote to recommend amendment of the charter of Wal-Mart's governance committee to add a duty to provide oversight concerning the formulation and implementation of policies and standards that determine whether or not Wal-Mart should sell a product that endangers public safety, has the substantial potential to impair the company’s reputation or would be considered offensive to the values that are integral to the company’s brand. The narrative portion of the proposal stated that these oversight and reporting duties extend to determining whether Wal-Mart should sell guns equipped with high capacity magazines and to balancing the benefits of selling such guns against the risks that these sales pose to the public and to Wal-Mart’s reputation and brand value.

Staff Says Proposal Can Be Excluded. In March 2014, the SEC staff agreed in a “no-action letter” that Wal-Mart could exclude the proposal under Rule 14a-8(i)(7), which provides that a company may exclude from its proxy materials a shareholder proposal that "deals with a matter relating to the company's ordinary business operations." According to the SEC, 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. This is consistent with prior SEC no-action letters about shareholder proposals focused on company decisions to sell certain products, particularly controversial products such as sexually explicit materials through pay-per-view.

Two weeks after release of the no-action letter, Trinity filed its lawsuit seeking (i) a declaratory judgment that Wal-Mart's decision to omit the proposal from its 2014 proxy materials violated the SEC’s proxy rules, (ii) a permanent injunction to prevent Wal-Mart from excluding the proposal from its 2015 proxy materials, and (iii) a preliminary injunction to prevent Wal-Mart from issuing proxy materials in connection with its 2014 annual meeting that did not contain the proposal.

The District Court heard argument in April on the preliminary injunction motion. In view of the very brief time frame available for it to consider the matter prior to the printing and mailing of the proxy materials, the Court deferred to the judgment of the SEC in its no-action letter position and denied the preliminary injunction. The Court found that the proposal related to "guns on the shelves and not guns in society" and, therefore, was properly excluded from Wal-Mart's proxy materials because it dealt with an ordinary business matter. As a result, Wal-Mart excluded the proposal from its 2014 proxy statement and held its annual shareholder meeting as scheduled.

Wal-Mart then filed a motion to dismiss Trinity's original complaint. In response, Trinity filed an amended complaint seeking declaratory relief as to the 2014 proxy materials, as well as prospective relief based on Trinity's intention to submit its proposal for inclusion in Wal-Mart's 2015 proxy materials.

Court Says Proposal Was Improperly Excluded. On November 26, 2014, the District Court ruled that Trinity’s shareholder proposal was improperly excluded from Wal-Mart’s 2014 proxy materials and granted injunctive relief enjoining Wal-Mart from relying on Rule 14a-8(i)(7) to exclude the proposal from Wal-Mart’s 2015 proxy materials. Under the doctrine of “capable of repetition, yet evading review,” the Court reasoned that the Trinity’s action was neither moot nor unripe for review because (1) the challenged action was in its duration too short to be fully litigated prior to its cessation or expiration, and (2) there was a reasonable expectation that the same complaining party would be subjected to the same action again.

Noting the SEC’s published guidance for shareholder proposals relating to a company’s ordinary business operations, certain tasks can be 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, such as workforce management, production quality and quantity, and the retention of suppliers. According to the SEC’s guidance, however, “proposals relating to such matters [i.e., ordinary business operations] 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.”

According to the District Court, to the extent the proposal relates to such matters as 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" (emphasis in original). Moreover, the District Court also viewed the proposal as not excludable because it does not seek to "micro-manage" Wal-Mart or "prob[e] 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" and the proposal does not involve "intricate detail" or seek to "impose specific time-frames" or dictate a "method[] for implementing complex policies." In this regard, 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 District Court determined that the proposal implicates significant policy issues that are appropriate for a shareholder vote.

The District Court concluded that, “Given this guidance, Trinity's 2014 proposal is best viewed as dealing with matters that are not related to Wal-Mart's ordinary business operations.”

Practical Considerations

While purporting to follow principles of the SEC’s precedents on Rule 14a-8(i)(7), this decision narrows the SEC’s historical approach to Rule 14a-8(i)(7) arguments with respect to whether sales of particular products are within the realm of ordinary business. In ruling that the Trinity shareholder proposal could not be excluded from the proxy materials, the District Court opens the door to proposals that are of ethical or social significance and are meaningfully related to the company’s business that might otherwise be excludable, so long as the proposals request board or committee oversight of the issue without dictating details, timing or methods.

In the last couple of years, several companies have bypassed entirely the SEC no-action letter process regarding shareholder proposals and taken their positions directly to federal court. As noted elsewhere in this Alert, SEC no-action letters do not adjudicate the merits of a company’s position with respect to the proposal and only a U.S. District Court can definitively determine whether a company is obligated to include shareholder proposals in its proxy materials. It remains to be seen whether this case will embolden other shareholders to sue companies that exclude their proposals, particularly in view of the prospective relief that the Court granted Trinity respecting Wal-Mart’s 2015 proxy materials.

The District Court’s reversal of the SEC’s no-action position, coupled with the SEC’s announced reassessment of its interpretations of Rule 14a-8(i)(9), it seems less likely than ever that a federal district court would defer to the SEC’s no-action letter interpretations when deciding whether a shareholder proposal is properly excludable under Rule 14a-8.