You might recall that, in November last year, Corp Fin issued new Staff Legal Bulletin No. 14I, Shareholder Proposals, which, among other things, addressed the “economic relevance” exclusion of Rule 14a-8(i)(5). That rule 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.” The rule had been largely moribund for several decades, as the staff’s most recent restrictive interpretation generally deterred companies from invoking it. Now we have what appears to be the first successful use of the exclusion since the new SLB attempted to rejuvenate it. The letter is to Dunkin’ Brands Group.
Historically, staff interpretations of the “economic relevance” exclusion have reversed course several times. For the most part, the aspect of the interpretation that has in the past been most fraught relates to the potential impact of social or ethical aspects of the proposal. At one point, the staff took the position that proposals could be excluded if they bore no economic relationship to a company’s business, unless they “reflected social or ethical issues, rather than economic concerns, raised by the issuer’s business, and the issuer conducts any such business, no matter how small….” Then, considering that position to be unduly restrictive, the SEC reversed course, and, in 1982, adopted the current economic tests. (The SEC made clear at the time of adoption that the exclusion related “to proposals concerning the functioning of the economic business of an issuer and not to such matters as shareholders’ rights, e.g., cumulative voting.”) Then, in 1985, the DC District Court enjoined a company from excluding a proposal, notwithstanding the nominal relationship to the company’s business, “in light of the ethical and social significance” of the proposal. As a result, Corp Fin’s subsequent analyses reverted back, largely ignoring the 5% tests and the proposal’s significance to the company’s business, and instead “simply considered 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.” That position held firm, even though the SEC had previously expressed concern regarding the unduly restrictive nature of that approach.
In the new SLB, the staff revisited that approach, focusing on the second prong of the rule, the proposal’s significance to the company’s business:
“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. Accordingly, going forward, the Division’s analysis will focus, as the rule directs, 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. Under this framework, proposals that raise issues of social or ethical significance may be included or excluded, notwithstanding their importance in the abstract, based on the application and analysis of each of the factors of Rule 14a-8(i)(5) in determining the proposal’s relevance to the company’s business.” [Emphasis added.]
The SLB notes that the burden is on the proponent to show that a proposal is “otherwise significantly related to the company’s business.” That is, if the “proposal’s significance to a company’s business is not apparent on its face,” it “may be excludable unless the proponent demonstrates that it is ‘otherwise significantly related to the company’s business.’” In addition, because the determination of significant relationship to the company’s business can raise difficult judgment calls, the staff believed that the board is generally going to be in a better position to make that determination. Accordingly, the staff indicated that it would expect a company’s Rule 14a-8(i)(5) no-action request to include a discussion that reflects the board’s analysis of the proposal’s significance to the company, detailing “the specific processes employed by the board to ensure that its conclusions are well-informed and well-reasoned.” (See this PubCo post.)
In Dunkin’, the shareholder proponent had submitted a proposal requesting that the board issue a report assessing the environmental impact of continuing to use K-Cup Pods brand packaging, including an assessment of the reputational, financial and operational risks, as well as goals and timelines for phasing out this type of packaging.
Although the company attempted to obtain relief on the basis of several exclusions, the company’s argument for relief under the “economic relevance” exclusion turned out to be the most persuasive. First, the company confirmed that its revenues, net earnings and assets relating to K-Cup Pods for fiscal 2016 accounted for less than five percent of the company’s gross sales, net earnings and assets for fiscal 2016, and that the same was expected to be true for fiscal 2017.
Then, as instructed by the new staff guidance, the discussion turned to the second prong of the rule, the significance of the proposal to the company’s business. In light of the SLB’s admonition that the board is generally in a better position to resolve the difficult judgment calls that can arise in determining whether a proposal is “significantly related” to the company’s business, the issue was presented for consideration to the company’s nominating and corporate governance committee, and its recommendations were then submitted to the board.
The no-action request indicates that the committee considered the significance of both the economic contribution of the K-Cup Pods as well as whether the proposal was otherwise significantly related to the business. The committee concluded that the proposal’s relationship to the company’s business operations was, well, rather attenuated, First, the company contended that the proposal was not, on its face, significantly related to the company’s business: the proposal did not address the company’s primary business operations as a franchisor of restaurants, but focused instead on the packaging used in products licensed by the company and manufactured by third parties. Moreover, the company maintained that, since the proposal was not “significantly related” on its face, the burden was then on the proponent to establish the significant relationship, which, the company contended, it had failed to do: the proponent’s statements were “generic” or “inaccurate” and “provided no factual or other support…to carry its burden.”
In addition, the no-action request indicates that the committee also considered that the issue of the environmental impact of K-Cup Pods was never raised by any other shareholder during the company’s extensive engagement with shareholders and that, when, in the prior year, a substantially identical proposal had been submitted for a vote of the shareholders, the proposal received the favorable vote of less than 14% of votes cast. As a result, the committee inferred that the shareholders did not consider the proposal to be significant to the company’s business. And, as noted in the SLB, the mere possibility of reputational or economic harm was not sufficient to preclude relief. Based on this analysis, the committee recommended and the board determined that the proposal was not significantly related to the company’s business and could be excluded under Rule 14a-8(i)(5).
Based on the company’s submission and description of the board analysis, the staff agreed that the proposal could be excluded under Rule 14a-8(i)(5). More specifically, the staff noted the company’s representations regarding the less-than-five-percent economic contribution of the subject of the proposal. The staff also noted “that the Proposal’s significance to the Company’s business is not apparent on its face, and that the Proponent has not demonstrated that it is otherwise significantly related to the Company’s business.