The staff of the Division of Corporation Finance of the U.S. Securities and Exchange Commission on November 1, 2017, issued a new Staff Legal Bulletin regarding shareholder proposals under Rule 14a-8. Staff Legal Bulletin 14I is the ninth update on this contentious topic since the release of SLB 14 in 2001. This new bulletin is most notable for encouraging board of director involvement when companies seek to exclude proposals under either the “ordinary business operations” or the “economic relevance” exceptions.
Rule 14a-8 under the Securities Exchange Act of 1934 provides a procedure by which a shareholder can require a company to submit a discrete matter to a shareholder vote at a shareholders’ meeting and to include that matter, and the shareholder’s supporting statement, in the company’s proxy statement. The rule includes specific procedural requirements for a proposal to be properly submitted. It also contains 13 different bases for a company to exclude a properly submitted proposal. The staff has the unenviable—and time consuming—task of evaluating company and proponent arguments over the applicability of these grounds for exclusion.
SLB 14I deals with two of the grounds for exclusion:
- Ordinary Business Operations. Rule 14a-8(i)(7) allows a company to exclude a proposal that relates to its ordinary business operations. The staff has stated that the purpose of this exception 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.”1 The staff has further commented that this exception relates to the extent that a proposal “micromanages” the company. An important, and ambiguous, condition has been added by the staff to this basis for exclusion, that being that a proposal may not be excluded if “sufficiently significant” social policy issues are presented in the proposal. Applying this overlay, numerous proposals dealing with matters that would otherwise be regarded as “ordinary business” have made their way into proxy statements.2
- Economic Relevance. Rule 14a-8(i)(5) allows a company to exclude a proposal that relates to operations accounting for less than 5 percent of a company’s total assets, earnings or sales and is not otherwise significantly related to the company’s business. Following a U.S. District Court ruling in 1985, the staff has deemed this exclusion to be inapplicable if the proposal was of broad social or ethical concern and the company conducted any amount of business related to the issue. In SLB 14I, the staff notes that it has only infrequently agreed to exclude a proposal based on this exception.
SLB 14I notes that applying the ordinary business operations exclusion involves difficult judgment calls for the staff because of the “sufficiently significant” aspect of the analysis. It asserts that a company’s board of directors is well situated to analyze, determine and explain whether an issue is “sufficiently significant” because the matter transcends ordinary business and would be appropriate for a shareholder vote. This being the case, the staff expresses its expectation that a no-action letter seeking to exclude a proposal on the basis of the ordinary business operations exception would discuss the board’s analysis of the particular policy issue and its significance. The staff goes on to say that such a discussion would be helpful if it “detailed the specific process” that the board employed to “ensure that its conclusions are well-informed and well-reasoned.”
While the staff does not comment on the appropriateness of its current application of the ordinary business operations exclusion, it does comment on the application of the economic relevance exception. SLB 14I expresses the staff’s belief that it has unduly limited the application of Rule 14a-8(i)(5) because it has failed to consider whether a proposal “deals with a matter that is not significantly related to the issuer’s business.” The staff indicates that in the future it will, as the rule clearly directs, focus on a proposal’s significance to the company’s business. This being the case, the economic relevance exclusion will depend on each company’s particular circumstances and may result in a matter being regarded as significant to one company and not significant to another. The staff further notes that where a proposal’s significance to a company is not apparent on its face, it will be incumbent on the proponent to demonstrate significance. While the staff’s new approach to applying the economic relevance exclusion will not be dependent on input from the company’s board, SLB 14I states that the staff will expect to see the board’s analysis of whether the subject matter is significantly related to the company’s business in the company’s no-action letter seeking to exclude a proposal on that basis. The staff notes, once again, that it will also be helpful if the no-action letter describes the board’s analytical process.
SLB 14I explains that in the past the staff has, essentially, applied the economic relevance exclusion of Rule 14a-8(i)(5) in lock-step with the ordinary business operations exclusion of Rule 14a-8(i)(7). Accordingly, if a proponent appropriately asserted that the subject matter of the proposal related to a significant social policy for the purposes of the latter, then that proposal would also avoid exclusion under the narrowly-applied economic relevance test. Going forward, the staff will no longer look to its analysis of a proposal under the ordinary business operations basis when determining the availability of the economic relevance basis.
In addition to the new guidance regarding the bases for exclusion as discussed above, SLB 14I provides specific guidance for proponents submitting a “proposal by proxy.” It also states that the proponents may include in their supporting statements graphics to convey information about their proposal. The staff notes that such use will continue to be subject to existing rules allowing exclusion of such images if they make a proposal false or misleading or inherently vague, or if they impugn someone’s character without factual foundation.
While the full impact of SLB 14I will only be known after it has been implemented in actual factual situations, we believe there are at least two repercussions that can be expected:
- Expanded scope of exclusions. We expect that boards of directors are more likely than the staff to determine that a proposal is not of sufficient significance to be presented to shareholders, and thus excludable on the basis of either, or both, of the economic relevance or ordinary business operations bases for exclusion. The staff has not indicated that it intends for SLB 14I to either expand or contract its application of either of these bases for exclusion. However, it would not seem logical for the staff to encourage greater board of director involvement in the Rule 14a-8 process than it has in the past, and to speak to the board being “well situated” to analyze the significance of proposals, if the staff did not intend to afford some deference to determinations made by boards of directors. As a side note, the economic relevance exclusion has been so narrowly applied in the past that the changes to be made in its application going forward can only increase the availability of this exclusion.
- Expanded scope of director involvement. In its commentary on SLB 14I, the staff has taken pains to characterize the board involvement described in SLB 14I as a new option that is being made available to companies, rather than a new requirement. Nonetheless, with the creation of this “option” we believe that companies seeking to exclude a proposal on the basis of Rule 14a-8(i)(7), and likely also 14a-8(i)(5), will feel the need to involve their boards of directors. The staff has stated in its commentary that it would recognize an analysis of significance by a duly appointed committee of the board, but also noted that the strength of the analysis would be bolstered by having the full board pass upon it.
We look forward to seeing whether companies will routinely seek to include their boards of directors in the process of seeking exclusions under the economic relevance and ordinary business operations tests of Rule 14a-8(i). Anticipating this response, one might observe that SLB 14I is somewhat presumptuous in its expectation of director involvement in the 14a-8 process, essentially affording a holder of as little as $2,000 of the company’s common stock to force a topic into the board of director’s agenda. We also look forward to the staff’s application of the guidelines of SLB 14I to specific no-action requests and observing whether SLB 14I provides meaningful relief under the two bases for the exclusion.