The SEC's Division of Corporation Finance recently issued Staff Legal Bulletin No. 14H (CF) (SLB 14H) to provide guidance on two significant interpretive issues under Exchange Act Rule 14a-8, which sets forth the requirements applicable to proposals submitted by shareholders for inclusion in their company’s annual proxy statement. The new guidance will govern staff action in the 2016 proxy season on company requests for the exclusion of shareholder proposals under two of the 13 substantive bases for exclusion contained in the rule. In SLB 14H, the staff announced positions that:
- Narrow the circumstances in which a shareholder proposal will be deemed to “directly conflict” with a company proposal and thereby afford the company a basis for excluding the proposal in reliance on Rule 14a-8(i)(9)
- Reaffirm the staff’s long-standing approach to deciding whether a shareholder proposal that focuses on significant social policy issues precludes the company from excluding the proposal under Rule 14a-8(i)(7) on the basis that it relates to the company’s “ordinary business operations”
SLB 14H is the most recent of several staff legal bulletins in which the staff has provided guidance on the requirements of Rule 14a-8. The bulletins highlight the need for companies and proponents to be sensitive to the staff’s evolving view of these requirements. SLB 14H can be found here.
Exclusion under Rule 14a-8(i)(9) of shareholder proposals that directly conflict with a company proposal
Background. Rule 14a-8(i)(9) permits a company to exclude from its proxy statement a shareholder proposal that “directly conflicts with one of the company’s own proposals to be submitted to the shareholders at the same meeting.” The staff historically has interpreted the rule to allow exclusion of a shareholder proposal if (a) management intends to include in the proxy statement a proposal addressing the same matter and (b) inclusion of both proposals would present “alternative and conflicting decisions for shareholders” and create the potential for “inconsistent and ambiguous results.”
Companies have relied on this standard to exclude shareholder proposals that seek to implement a practice or policy which management concurrently proposes for a shareholder vote, but on different terms. For example, companies have been able to exclude shareholder proposals requesting action intended to enhance shareholder rights (such as approval of a bylaw allowing holders of a specified minimum percentage of the company’s voting securities to call a special meeting of stockholders) by including in the proxy statement a company proposal to establish a similar right, but containing different terms (such as a higher minimum ownership requirement for calling a special meeting).
During the 2015 proxy season, the staff’s interpretation of the exclusion was called into question by the response of many companies to a shareholder proposal seeking to implement “proxy access,” which would enable shareholders to include their own director nominees in the company’s proxy statement. These companies sought to exclude the proposal under Rule 14a-8(i)(9) by proposing to shareholders their own version of proxy access. After the staff issued a no-action letter to Whole Foods Market, Inc. early in the proxy season allowing it to exclude a proxy access proposal (avail. Dec. 1, 2014, recon. Jan. 16, 2015), SEC Chair Mary Jo White directed the Division of Corporation Finance to review the proper scope and application of Rule 14a-8(i)(9). As a result of this directive, the staff announced that it would express no views on the application of Rule 14a-8(i)(9) for the remainder of the 2015 proxy season.
New staff guidance. Following the mandated review, the staff issued guidance in SLB 14H that narrows the circumstances under which a shareholder proposal will be deemed to “directly conflict” with a company proposal for purposes of Rule 14a-8(i)(9). The staff noted that this exclusion was intended to prevent shareholders from using Rule 14a-8 to circumvent the stringent procedural and disclosure requirements that govern action by a shareholder soliciting proxies in opposition to a management proposal. Appealing to the rule’s history and this purpose, the staff concluded that a direct conflict will be deemed to exist only “if a reasonable shareholder could not logically vote in favor of both proposals, i.e., a vote for one proposal is tantamount to a vote against the other proposal.” The staff acknowledged that this formulation of the direct-conflict test might impose a “higher burden” on companies seeking to exclude a proposal than the prior formulation’s emphasis on “shareholder confusion and inconsistent mandates.”
According to the staff, a “direct conflict” between a shareholder proposal and a company proposal will be deemed to exist where, for example:
- a shareholder proposal asks shareholders to vote against a merger, while the company’s proposal seeks shareholder approval of the merger, or
- a shareholder proposal asks for the separation of the positions of company chairman and CEO, while the company’s proposal seeks shareholder approval of a bylaw provision requiring the CEO to serve as chairman at all times.
In contrast, the staff said that a “direct conflict” will be deemed not to exist where, for example:
- a shareholder proposal seeks to allow shareholders who have held at least 3% of the company’s stock for at least three years to nominate up to 20% of the company’s directors, while the company’s proposal would allow shareholders who have held at least 5% of the company’s stock for at least five years to nominate up to 10% of the company’s directors, or
- a shareholder proposal asks the compensation committee to implement a policy that equity awards under an incentive plan will be subject to at least four-year annual vesting, while the company’s proposal seeks shareholder approval of an incentive plan that gives the compensation committee discretion to establish the vesting provisions for equity awards.
In the latter case, according to the staff, a reasonable shareholder could logically vote for both proposals. The staff observed that the inclusion of competing proposals in a company’s proxy statement could result in shareholder approval of both proposals, which would require the board of directors to “consider the effects of both proposals” in assessing the outcome of the vote. The staff concluded, however, that the board’s decision on how best to proceed in these circumstances is not the kind of direct conflict the rule was intended to address.
Significant social policy exception to exclusion under Rule 14a-8(i)(7) of shareholder proposals that relate to the company’s ordinary business operations
Background. Rule 14a-8(i)(7) permits a company to exclude a shareholder proposal that relates to the company’s “ordinary business operations.” The exclusion is based on the general principle of state corporate law that a corporation’s directors and officers, not its shareholders, are responsible for conducting the corporation’s day-to-day operations, and shareholders therefore should vote only on major corporate issues. The uncertainty regarding the scope of the exclusion, which has long been the subject of contention between the shareholder and corporate communities, and the case-by-case basis on which the staff applies the rule have resulted in frequent appeals to the courts to resolve disputes over the scope of the exclusion. Recent court decisions prompted the staff to issue guidance in SLB 14H on the exception to the exclusion that is afforded to proposals that raise “significant social policy issues.”
The SEC first articulated the “significant social policy” exception to the ordinary business exclusion in 1976. The exception is not contained in the rule itself, but has been developed in numerous no-action letters issued by the SEC staff. Under the exception, if a proposal that deals with ordinary operations “focuses” on “significant social policy issues,” it generally is not excludable, because such issues “transcend day-to-day business matters.” The scope of this exception has never been clear, particularly the extent to which the proposal must “focus” on a significant social policy. In some cases, even proposals that raise a significant social policy issue may be excludable under Rule 14a-8(i)(7) if the proposal implicates other ordinary business matters not related to the social policy issue.
The litigation that resulted in the recent guidance arose in a shareholder proponent’s challenge to the staff’s issuance in March 2014 of a no-action letter to Wal-Mart Stores, Inc. (avail. Mar. 20, 2014). The staff concurred that a proposal which, in substance, sought to require Wal-Mart’s board to develop and oversee guidelines governing Wal-Mart’s decision to sell certain products, particularly guns equipped with high-capacity magazines, was excludable under Rule 14a-8(i)(7). Wal-Mart noted in its letter to the staff that, although the staff previously had determined that proposals addressing issues of gun violence address significant social policy issues, the proposal received by Wal-Mart was not limited to matters concerning gun violence, but instead applied more broadly to other types of products as well.
The proponent subsequently petitioned a federal district court to enjoin Wal-Mart from distributing its proxy materials without including the proposal. The district court declined to enjoin Wal-Mart, but later held that the proposal was not excludable under Rule 14a-8(i)(7), because the proposal did not require that Wal-Mart cease selling certain products but rather asked the board of directors to oversee a policy that might affect the sales of certain products. The district court also held that the proposal raised a significant social policy issue (gun violence) and thus qualified for the exception to the ordinary business exclusion.
On appeal, the U.S. Court of Appeals for the Third Circuit reversed the district court, holding that the proposal was excludable because it was related to Wal-Mart’s ordinary business operations and did not fall within the significant social policy exception. The majority of the Third Circuit panel employed a two-part test to analyze the exclusion. It said that, for the significant social policy exception to apply, “a shareholder must do more than focus its proposal on a significant policy issue; the subject matter of its proposal must ‘transcend’ the company’s ordinary business,” and therefore that, in this analysis, the significant policy issue must be “divorced from how a company approaches the nitty-gritty of its core business.” The court’s two-pronged approach, which requires consideration of both the significance of the social policy issue and whether it transcends ordinary business operations, departs from the staff’s traditional one-step approach to the exception, which, as discussed below, treats the “significance” and “transcendence” determinations as interrelated, rather than independent, concepts.
New staff guidance. Although the Third Circuit agreed with the staff’s conclusion that the proposal submitted to Wal Mart was excludable under Rule 14a-8(i)(7), the staff expressed concern in SLB 14H that the court’s two-part test to the social policy exception might “lead to the unwarranted exclusion of shareholder proposals” by introducing an additional requirement not present in the staff's traditional analysis of the exception. Under the two-part test, a shareholder proposal that focuses on a significant policy issue nevertheless could be excludable if it pertains to ordinary business matters. In contrast, under the staff's approach, any proposal that focuses on a significant policy issue necessarily must transcend a company's ordinary business. As the third judge on the Third Circuit panel explained in a concurring opinion sympathetic to the staff’s analysis, the Commission has stated that proposals focusing on a significant policy issue are not excludable under the ordinary business exception “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 staff announced in SLB 14H that it will continue to utilize its one-step test to determine the availability of the significant social policy exception. Under that test, the staff confirmed, “proposals that focus on a significant policy issue transcend a company’s ordinary business operations and are not excludable under Rule 14a-8(i)(7).” In the Rule 14a-8 no-action letter process, therefore, companies should continue to analyze the excludability of ordinary business proposals under the staff’s traditional approach.