On November 1, 2017, the Staff of the Securities and Exchange Commission’s Division of Corporation Finance published new Staff Legal Bulletin No. 14I (CF) (available here) (“SLB 14I”), which is the Division’s tenth legal bulletin that seeks to provide guidance regarding shareholder proposals submitted under Rule 14a-8 of the Securities Exchange Act of 1934. SLB 14I addresses: (1) the scope and application of Rule 14a-8(i)(7) (the “ordinary business” exception); (2) the scope and application of Rule 14a-8(i)(5) (the “economic relevance” exception); (3) proposals submitted on behalf of investors by representatives (or “proposals by proxy”); and (4) the use of graphs and images in shareholder proposals.
The “ordinary business” exception under Rule 14a-8(i)(7) is one of the most complex and substantive bases to exclude a shareholder proposal. It permits a company to exclude a proposal that “deals with a matter relating to the company’s ordinary business operations.” In the past, if the Staff determined that a proposal focused on a policy issue which was sufficiently significant because it transcended ordinary business and therefore determined that the proposal would be appropriate for a shareholder vote, the proposal would not be excludable under the ordinary business exception. The issues identified by the Staff as “significant policy issues” have included many social and environmental matters, and historically the Staff has not concurred with the exclusion of proposals that it determined focused on such matters, even if the significant policy issue in question was not particularly relevant to the company or its business.
In a noteworthy policy shift, the Staff acknowledges in SLB 14I that determining whether a proposal a company desires to exclude under the ordinary business exception nonetheless focuses on a significant policy issue often raises difficult judgment calls. SLB 14I states that the Division believes these are matters that a company’s board of directors is generally in a better position to determine. Therefore, going forward, the Staff will expect a company’s “ordinary business” no-action request to include a discussion that reflects the board’s analysis of the particular policy issue raised and its significance to the company. In particular, the Staff believes that details regarding the specific processes the board employed to ensure that its conclusions are well-informed and well-reasoned would be helpful. This new approach will likely make ordinary business arguments even more complicated, may require greater time and involvement from the board than has been the case historically, and may result in companies making statements that critics will perceive as “taking sides” on delicate issues. On the other hand, the Staff’s new approach disavows the Staff’s prior one-size-fits-all method in applying its significant policy analysis and therefore gives hope that companies, through their boards, may influence the Staff’s decisions in the company’s favor to concur with the exclusion of more of these kinds of shareholder proposals.
The “economic relevance” exception under Rule 14a-8(i)(5) permits a company to exclude a proposal that “relates to operations which account for less than 5 percent of the company’s total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company’s business.” Despite the wording of Rule 14a-8(i)(5), traditionally the Staff has looked to its ordinary business analysis under (i)(7) when evaluating (i)(5) arguments, and the scope of (i)(5) has been further narrowed by old interpretations and case law regarding the rule such that it has been practically unusable for most companies.
The Staff acknowledges in SLB 14I that it has traditionally not agreed with exclusion for economic relevance even when a proposal related to operations that accounted for less than 5% of total assets, net earnings and gross sales, if the company conducted business—no matter how small—related to the social or ethical policy issue raised in the proposal. In a significant policy shift, the Staff states in SLB 14I that it will focus on a proposal’s significance to the company’s business when it otherwise relates to operations that account for less than 5% of total assets, net earnings and gross sales (regardless of whether the proposal raises a social or ethical issue), and, similar to the Staff’s new (i)(7) approach, the Staff will expect a company’s “economic relevance” no-action request to include a discussion of the board’s analysis of the proposal’s significance to the company, including details regarding the specific processes the board employed in reaching its determination. Moreover, when a proposal’s significance to a company’s business is not apparent on its face, a proposal may be excluded unless the proponent demonstrates that it is “otherwise significantly related to the company’s business.” In addition, the Staff will no longer look at its (i)(7) analysis when assessing (i)(5) arguments. Although this new approach may put a greater burden on boards to become involved in the analysis and decisions regarding shareholder proposals, it significantly opens the scope of (i)(5), effectively bringing the “economic relevance” exception back into play as a potentially feasible, substantive argument for the exclusion of shareholder proposals.
Proposals by Proxy
Rule 14a-8 does not address whether shareholders may submit proposals through a representative and the Staff historically has permitted wide latitude in this respect. Long a thorn in the side of many companies, the Staff’s approach has permitted individuals to submit proposals without requiring those individuals to provide clear evidence that they have been granted authority by a shareholder to do so. SLB 14I indicates that the Division is aware of the challenges and concerns that “proposals by proxy” may present and states that, going forward, the Staff will require proxies to provide delegation documentation. Specifically, the Staff will require documentation that (1) identifies the shareholder-proponent and the person or entity selected as proxy, (2) identifies the company to which the proposal is directed, (3) identifies the annual or special meeting for which the proposal is submitted, (4) identifies the specific proposal to be submitted, and (5) is signed and dated by the shareholder-proponent. While it is likely that shareholder representatives will adjust to these new requirements, the new approach by the Staff will make procedural compliance significantly more complex for these types of proponents, and the new approach may result in more proposals being excludable on procedural bases, including defects in delegation documentation.
Graphs and Images
Finally, SLB 14I addresses the use of graphs and images in shareholder proposals, probably because of no-action request letters filed over the past two annual meeting seasons requesting relief from including images that shareholder proponents submitted as part of their supporting statements. While the Staff acknowledges in SLB 14I that Rule 14a-8 makes no mention of graphs and images in the 500-word limit for shareholder proposals, it believes Rule 14a-8 does not prohibit the inclusion of graphs and images in proposals in general and believes the words in a graph (and not the message otherwise communicated by the graph) would count toward the 500-word limit. The Staff recognizes that there is the potential for abuses in this area, but the Staff states that it believes potential abuses can be addressed under the existing provisions of Rule 14a-8(d) (limiting the total number of words in a proposal) and Rule 14a-8(i)(3) (permitting exclusion where a proposal is materially false or misleading, among related issues). Therefore, exclusion of graphs and images will still require a separate argument based on an assertion that the total number of words exceeds 500 or an assertion that the graph or image:
- makes the proposal materially false or misleading;
- renders the proposal so inherently vague or indefinite that neither the stockholders voting on the proposal, nor the company in implementing it, would be able to determine with any reasonable certainty exactly what actions or measures the proposal requires;
- directly or indirectly impugns character, integrity or personal reputation, or directly or indirectly makes charges concerning improper, illegal, or immoral conduct or association, without factual foundation; or
- is irrelevant to a consideration of the subject matter of the proposal, such that there is a strong likelihood that a reasonable shareholder would be uncertain as to the matter on which he or she is being asked to vote.
Companies that wish to exclude a proposal under the ordinary business exception or the economic relevance exception should consider to what degree a “significant policy issue” is involved and whether it is necessary to include information regarding a board determination in the no-action request letter. If information regarding a board determination is deemed necessary, companies should consider what information should be submitted to the board, what process will be followed by the board and its committees, and how the board’s process and conclusions will be presented to the Staff in a no-action letter. Companies and their boards should keep in mind that eventually the no-action letter will be made public and available for scrutiny by institutional investors, proxy advisors, and activists beyond those submitting the proposal. Given that the no-action request letter drafting process can take time, companies should consider identifying a process for board and board committee review in advance.
Companies that receive proposals by proxy should review them in light of the Staff’s new guidance about the documentation necessary to establish representative authority and, when defects are found, notify the shareholder-proponent of the defects and provide an opportunity to cure, as required in Rule 14a-8(f). Finally, companies should evaluate graphs and images in shareholder proposals under the standards articulated in SLB 14I and not presume that information is excludable merely because it is presented in the form of a graph or image.
In summary, the Staff’s new guidance provides company’s boards of directors with new avenues for influencing the Staff’s decisions and may result in a greater number of shareholder proposals being deemed excludable on both substantive and procedural bases. This new guidance provided at the beginning of what promises to be an eventful annual meeting season is yet another reason for companies to begin their annual meeting preparations early and with the assistance of counsel. That SLB 14I is the Division’s tenth staff legal bulletin addressing Rule 14a-8 reminds us how contentious, expensive, and time-consuming this Rule continues to be for public companies and the various activists and others who use the shareholder proposal process.