On November 1, 2017, the staff of the Division of Corporation Finance issued Staff Legal Bulletin No. 14I (SLB 14I), providing guidance on the excludability of shareholder proposals under Exchange Act Rules 14a-8(i)(7) (proposals relating to the “ordinary business” of a company) and 14a-8(i)(5) (proposals that are not of “economic relevance” to a company), as well as other issues arising under Rule 14a-8. The guidance is effective immediately and therefore will be relevant to companies seeking to rely on those provisions to exclude shareholder proposals from their proxy materials for the 2018 proxy season. SLB 14I on its face gives rise to significant new requirements for companies seeking to exclude proposals under the “ordinary business” and “economic relevance” exceptions and leaves many questions open as to how these two exclusions will be applied in practice.
- The staff will now require no-action requests made in reliance on Rule 14a-8(i)(7) (the “ordinary business” exception) to include a discussion of the board’s analysis of the particular policy issue raised by the proposal and its significance to the company, as well as detailed disclosure of the board’s “specific processes” in reaching its “well-informed and well-reasoned” conclusions that the policy is not “sufficiently significant” to the company and does not “transcend the day-to-day business matters” of the company.
- Similarly, the staff will now require no-action requests made in reliance on Rule 14a-8(i)(5) (the “economic relevance” exception) to include a discussion of the board’s analysis of whether a proposal is “otherwise significantly related to the company’s business,” with a detailed disclosure of the “specific processes” used by the board in reaching its “well-informed and well-reasoned” conclusions that the proposal is not “otherwise significantly related to the company’s business.”
- New documentation will be required of a proponent when the proposal is submitted by proxy (i.e., on behalf of the shareholder proponent by a third party acting on behalf of the shareholder proponent).
- The staff has provided guidance on a proponent’s use of graphs and images in addition to the “500-words” limit imposed by the Rule.
“Ordinary Business” Exception under Rule 14a-8(i)(7)
The policy underlying the “ordinary business” exception recognizes that it is the role of the board of directors and management to manage the business and affairs of the company on a day-to-day basis such that certain ordinary business matters “could not, as a practical matter, be subject to direct shareholder oversight.” Accordingly, if a shareholder proposal is essentially a matter relating to the “ordinary business” of the issuer, it may be excluded pursuant to Rule 14a-8(i)(7), unless its focus is a policy issue that is sufficiently significant so as to be appropriate for a shareholder vote.
In SLB 14I, the staff acknowledges that in many of the no-action requests seeking to rely on the “ordinary business” exception, the central issue is whether this “significant policy issue” carve-out to the exclusion applies. In other words, whether the proposal deals with an ordinary business matter but nevertheless focuses on a significant policy issue. In SLB 14I, the Division describes these determinations as “difficult judgment calls” and states that they “are in the first instance matters that the board of directors is generally in a better position to determine.” The staff states that, going forward, a company’s request for no-action relief in reliance on the “ordinary business” exception should include a discussion reflecting the board’s analysis of the policy issue raised and its significance to the company, as well as disclosure of the “specific processes employed by the board to ensure that its conclusions are well-informed and well-reasoned.”
At first blush, it appears that the staff might be signaling that it will defer to the judgment of an issuer’s board of directors as to whether a particular policy issue is not “sufficiently significant” to that issuer such that it may be excluded. The practical and potential legal implications of meeting the expectations of the staff in this respect, however, raise several issues of concern.
First, many public companies may face timing issues in developing and implementing a process for the board of directors to analyze a shareholder proposal and reach conclusions in time for a no-action request to be prepared and timely filed under Rule 14a-8(j). Accomplishing those tasks within the confines of existing board meeting schedules and workload capacity among members of the management team will be challenging for many public companies.
There are also questions as to the amount of detail expected by the staff regarding a board’s processes and analysis and the desirability and advisability of providing those details in a publicly available document with respect to certain of these topics. For example, employment, affirmative action programs, human rights, product design and marketing, environmental issues and matters pertaining to controversial products (tobacco, pharmaceuticals, weapons) have all been implicated in proposals considered by the staff under this exclusion. Previously, the staff has identified certain policy issues that were generally considered sufficiently significant (e.g., nuclear safety and net neutrality) and certain issues that were typically not sufficiently significant policy concerns and therefore were generally considered matters of ordinary business (e.g., customer and vender relationships). In determining whether an issue raised by a proposal was a “significant policy” concern, the staff in the past also has looked to whether the issue was “a consistent topic of widespread public debate.” It is unclear whether the staff will regard any of those prior decisions or analytical frameworks with any precedential value under the new approach, but SLB 14I, at least on its face, clearly indicates that in each instance the staff will be expecting a fresh, company-specific analysis to be presented – one that has been undertaken by the board of directors specifically pursuant to a disclosed process to ensure “well-informed and well-reasoned” conclusions.
Accordingly, even if a board determines to undertake the new analytical process contemplated by SLB 14I, the guidance raises numerous questions going forward about the application of Rule 14a-8(i)(7) and the role of the board in managing the ordinary business affairs of the company, including:
- whether the board can or should rely on historical no-action determinations under Rule 14a-8(i)(7) in its analysis and in determining the scope of its processes, including whether matters previously settled as “ordinary business” will be reviewed de novo or, conversely, whether matters previously settled as “significant policy” issues may be challenged anew by issuers;
- whether any of the prior standards articulated in past staff guidance for determining the applicability of Rule 14a-8(i)(7) can or should be applied in arguing for the exclusion going forward;
- whether the staff will require disclosure of “detailed” and “specific processes employed by the board” along with a “well-developed discussion of the board’s analysis” even if, in the board’s good faith judgment, the policy issue raised by the proposal is so broadly inapplicable to the company that it does not merit the the time and resources of the board; and
- the effect on long-standing principles of business judgment and director duties of creating a forum in which both shareholder proponents and the staff have the power to call into question and override the expressly articulated and detailed conclusions of the board on matters of ordinary business.
At a minimum, the proliferation of shareholder proposals generally and in particular so-called “ESG” proposals (those relating to environmental, social policy, and/or governance issues) may present a substantial additional burden to public company boards if management believes that a shareholder proposal is properly excludable under Rule 14a-8(i)(7). The tenor of SLB 14I suggests that the staff aims to provide greater deference to management, which theoretically could expand the application of the “ordinary business” exclusion. However, the more clearly the proposal deals with ordinary business matters, the less management may feel justified in using the time and resources of the board to engage in the processes contemplated by SLB 14I. As a consequence, the new requirements could have the effect of allowing some proposals to run in a company’s proxy materials that otherwise would be properly excluded under the “ordinary business” exception.
“Economic Relevance” Exception under Rule 14a-8(i)(5)
The “economic relevance” exception of Rule 14a-8(i)(5) permits exclusion of a proposal that “relates to operations which account for less than 5% of the company’s total assets” and is “not otherwise significantly related to the company’s business.” Decisions by the staff granting no-action requests made in reliance on Rule 14a-8(i)(5) have been exceedingly rare. The staff’s analysis with respect to Rule 14a-8(i)(5) evolved such that the focus of the staff has been whether the issue articulated in the proposal was related to the issuer’s business, regardless of the significance of the issue to the issuer’s business.
In SLB 14I, the staff announces a change of course:
“[The current] analysis simply considered is whether a company conducted any amount of business related to the issue in the proposal and whether that issue was of broad social or ethical concern. We believe the Division’s application of Rule 14a-8(i)(5) has unduly limited the exclusion’s availability because it has not fully considered the second prong of the rule as amended in 1982 – the question of whether the proposal ‘deals with a matter that is not significantly related to the issuer’s business’ and is therefore excludable.”
Going forward, the analysis will focus on the proposal’s significance to the company’s business when it otherwise relates to operations accounting for less than the 5% threshold. Even social or ethical issues of significance may be excluded if not sufficiently relevant to the issuer’s business. Importantly, the new analytical framework provides that the burden to establish, with specificity, the proposal’s significance will be on the proponent when the proposal’s significance to the company is not otherwise apparent. “The mere possibility of reputational or economic harm will not preclude no-action relief.” The staff will consider a proposal in light of the total mix of information about the issuer.
And, mirroring the new requirements under the “ordinary business” exception, going forward, the staff will expect an issuer’s no-action request to reflect the board’s analysis of the proposal’s lack of significance to the company, which should include detailed disclosures of the “specific processes” used by the board “to ensure that its conclusions are well-informed and well-reasoned.”
Finally, the staff announced that it will abandon its practice of linking this exemption to its analysis under the “ordinary business” exemption. Previously, the availability of relief under Rule 14a-8(i)(7) has been largely determinative of the availability or unavailability of of relief under Rule 14a-8(i)(5)). Each exemption will now stand on its own, with distinct analytical frameworks, and will be analyzed independently by the staff.
These changes will give rise to similar concerns and issues as described above for the “ordinary business” exemption. It remains to be seen how this will evolve, the level of detail the staff will expect to see with respect to the processes and analyses of an issuer’s board of directors and whether and how the timing issues can be addressed appropriately. Whether the result of the staff’s positional shift gives rise to more proposals being excluded on the grounds of lack of “economic relevance” also remains to be seen, although it appears to be the point of the change.
Proposals by Proxy
Although Rule 14a-8 does not specifically address the ability of a shareholder to submit a proposal through a proxy, the staff viewed this practice as not inconsistent with the Rule. SLB 14I reflects the staff’s acknowledgment that proposals by proxy give rise to legitimate concerns. In an effort to more clearly address those issues, SLB 14I includes new guidance on the documentation that will be expected for proposals by proxy, to include identification of:
- the shareholder-proponent and the person who will serve as proxy;
- the company to which the proposal is to be directed;
- the annual or special meeting for which the proposal is to be submitted; and
- the specific proposal to be submitted.
In addition, the documentation must be signed and dated by the shareholder-proponent.
If an issuer intends to seek exclusion of a proposal based on the failure of the shareholder or its proxy to provide the documentation described above, the issuer must first notify the proponent of the specific defect within 14 days of receiving the proposal so that the proponent has an opportunity to cure pursuant to Rule 14a-8(f)(1).
Companies should carefully monitor compliance with these new procedural requirements and clearly articulate any deficiencies in their notice to the proponent. In general, a shareholder-proponent's failure to strictly comply with any and all procedural requirements warrants no-action relief from the staff.
Use of Graphs and Images
A shareholder proposal and its accompanying supporting statement may not exceed 500 words. Questions have arisen with proposals that include graphs and images. The staff has taken the position that Rule 14a-8(d) does not preclude shareholders from using graphics and images to convey information about their proposals. SLB 14I provides further guidance on this topic by confirming that potential abuses can be addressed with a no-action request for exclusion when appropriate under Rule 14a-8(i)(3) where graphs or images:
- make the proposal false or misleading;
- render the proposal inherently vague or indefinite such that shareholder voting on it and the company in implementing it, would be unable to determine exactly what actions or measures the proposal requires;
- impugn character, integrity or personal reputation, or make charges concerning improper, illegal or immoral conduct or association without factual foundation; or
- are irrelevant to consideration of the subject matter of the proposal.
Finally, the staff confirmed that exclusion would be appropriate if the total number of words in a proposal, including words in the graphics, exceeds 500.
As indicated above, it is not clear how some of the changes articulated in SLB 14I will operate in practice. The challenges presented by the new requirements related to board consideration and disclosures of board processes and analyses may create serious challenges for issuers. Whether the staff will issue further guidance to provide any clarification before the next round of shareholder proposal no-action letter requests is unknown. Because the guidance is effective immediately, issuers should start considering how they might be able to build in processes to existing board schedules to accommodate board consideration of shareholder proposals.