On November 1, the staff of the SEC's Division of Corporation Finance issued Staff Legal Bulletin No. 14I (CF) (SLB 14I) to provide guidance on substantive exclusions and other aspects of Exchange Act Rule 14a-8, which sets forth the requirements applicable to proposals submitted by shareholders for inclusion in their company’s proxy materials for annual or special meetings. The new guidance will govern staff action during the 2018 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 14I, the staff announced positions that:
- Call on the company’s board of directors, in appropriate cases, to determine in the first instance whether a shareholder proposal raises a “significant policy issue” for the company that could preclude the company from excluding the proposal in reliance on the “ordinary business” exclusion in Rule 14a-8(i)(7)
- Signal the staff’s intention in applying the “economic relevance” exclusion under Rule 14a-8(i)(5) to focus on whether a social or ethical issue raised by a proposal is “significantly related” to the company’s business, and therefore excludable, and to consider the board’s determination on this issue and the process the board followed in its evaluation
The new guidance also addresses procedural requirements to be observed by shareholders who submit proposals "by proxy" through a representative, and clarifies the staff’s view on the inclusion of graphics or images in proposals.
SLB 14I is the most recent in a line of staff legal bulletins in which the Division of Corporation Finance has provided guidance on the requirements of Rule 14a-8. This latest bulletin highlights the need for companies and proponents to be sensitive to the staff’s evolving view of these requirements. SLB14I can be found here.
New guidance on substantive exclusions
Rule 14a-8(i)(7): “ordinary business” exclusion may involve board analysis of policy issues
Ordinary business exclusion. Rule 14a-8(i)(7) permits exclusion of a shareholder proposal that deals with matters that relate to a company’s ordinary business operations. The exclusion rests on two underlying considerations. First, certain matters are so fundamental to management’s operation of the business on a day-to-day basis that, as a practical matter, they should not be subject to direct shareholder oversight. Second, certain proposals that seek to “micromanage” the company’s operations inappropriately probe into complex matters on which shareholders generally are unable to make an informed judgment.
The staff typically has not deemed a proposal’s application to a company’s fundamental operations sufficient to warrant exclusion under Rule 14a-8(i)(7) where the proposal implicates a “significant policy issue.” The staff considers significant social policy issues that transcend ordinary business to be appropriate for shareholder consideration. The staff acknowledges in SLB 14I, however, that determining whether a proposal qualifies for the significant policy exception to the ordinary business exclusion often requires the staff to make difficult judgment calls.
New guidance. SLB 14I is intended to assist the staff in making these judgment calls in certain cases by calling on boards of directors, in the first instance, to determine whether a proposal raises a policy issue that is significant for the company. The staff has said that, if the board determines that a proposal does not raise a significant policy issue for the company, the company’s no-action request should include a discussion of the board’s analysis to facilitate the staff’s determination. The discussion should include a description of the process the board followed “to ensure that its conclusions [were] well-informed and well-reasoned.” The new guidance reflects the staff’s belief that a company’s board, charged with fiduciary duties, is best able to determine whether a policy issue is significant enough for the company that it transcends ordinary business.
Comments by the staff after it released the new guidance have clarified that not all no-action requests under Rule 14a-8(i)(7) will require inclusion of the board’s analysis of a policy issue, particularly where there is a well-worn path to the company’s exclusion determination in no-action precedent. However, where a proposal raises a policy issue the staff in the past has found to be significant, the staff will now consider a company’s argument that the policy issue is not significant for the company, as evidenced by the board’s analysis of the issue. In addition, the staff has indicated that an appropriate committee of the board, such as the nominating and corporate governance committee, may undertake this analysis, but that the analysis might carry more weight if the committee presented the analysis to the full board for approval.
The staff has not provided any guidelines regarding the nature or extent of the analysis the board should undertake. A board might make inquiries of management and advisors regarding the policy issue, its relevance to the company, and the steps the company has taken to address the issue; evaluate the financial impact of the policy issue on the company; and review the results of any engagement by the board and management with shareholders and other constituents regarding the issue. The staff also has not prescribed the types of documentation, if any, the staff would expect to see to support or evidence the board’s analysis. We believe, however, that it should not be necessary to provide the staff with copies of minutes of board meetings or board materials, although a company may find it useful to provide certain written presentations that were considered by its board if the company carefully reviews the information to ensure it has redacted any confidential information.
Overall, the staff’s guidance on the ordinary business exclusion is a clear request for assistance from issuers, as well as for board-level participation, in determining the significance of a social policy issue to the company. The introduction of potential board-level involvement in the analytical process will require attention as companies prepare their annual meeting calendars. In addition, companies and their boards should present their arguments carefully to avoid the appearance of declaring a significant social policy to be unimportant rather than merely a matter of the company’s ordinary business, particularly where the company has made public statements or published information on its website that highlight the issue’s importance to the company.
Rule 14a-8(i)(5): “economic relevance” exclusion to require more focus on whether a proposal is significantly related to the company’s business
Economic relevance exclusion. Rule 14a-8(i)(5) permits exclusion of a proposal that relates to operations accounting for less than five percent of the company’s total assets and for less than five percent of its net earnings and gross sales, and that is otherwise not “significantly related” to the company’s business.
In recent years, the staff rarely has permitted exclusion of proposals on the basis that they are not significantly related to the company’s business. Instead, the staff generally has disallowed exclusion of a proposal that raised a broad social or ethical issue so long as any amount of the company’s business was implicated by the issue, even where the affected operations fell below the five percent thresholds specified in the rule. The staff acknowledges in SLB 14I that this application of Rule 14a-8(i)(5) has “unduly limited the exclusion’s availability” by not focusing on the proposal’s significance to the company’s business.
New guidance. The staff will now analyze the economic relevance exclusion in a manner it believes is more consistent with the language and purpose of Rule 14a-8(ii)(5). If a proposal relates to operations that account for less than five percent of the company’s total assets, net earnings and gross sales, the staff will analyze whether the issue raised by the proposal is significant to the company’s business, regardless of whether the policy issue raises important social or ethical concerns. This guidance potentially extends the economic relevance exclusion to proposals that raise significant policy issues and therefore would not have been excludable in the past despite their marginal financial relevance to the company.
The staff observes in SLB 14I that the analysis of any policy issue’s significance to a company’s business will depend on the circumstances of the individual company, and that an issue might be significant to the business of one company but not to that of another. Where the significance of a particular policy issue to the company’s business is not readily apparent, the proponent will bear the burden of demonstrating its significance. The staff notes in SLB 14I that the “mere possibility of reputational or economic harm” to the company will not mean that the proposal must be included, and that the staff will consider the proposal in light of the “total mix” of information available about the company. The staff cautions that substantive governance matters are likely to be significantly related to the business of most companies.
The staff emphasizes that, as with the ordinary business exclusion, determining whether a social policy is significantly related to a company’s business can involve a difficult judgment call. Accordingly, consistent with its guidance on the ordinary business exclusion, the staff believes that a company’s board is in the best position to make the significance determination in the first instance. Thus, the staff believes it will be helpful if no-action requests under Rule 14a-8(i)(5) disclose the board’s analysis of the policy issue’s significance to the company’s business and describe the process the board employed to reach its conclusion.
New guidance on other aspects of Rule 14a‑8
Rule 14a-8(b): “proposals by proxy” will require additional documentation to demonstrate eligibility
Proposal by proxy. Shareholders frequently submit proposals through a representative in a practice known as “proposal by proxy.” The staff considers the practice to be consistent with the proponent eligibility requirements of Rule 14a-8(b). In recent years, however, companies have expressed concern that some representatives may be abusing the process by obtaining from eligible shareholders written appointments that do not make clear whether the shareholder is aware of the proposal being submitted or the company receiving the submission.
New guidance. To address these concerns, the staff has outlined several types of information that would more clearly allow companies to assess whether a shareholder’s delegation of authority to a representative satisfies the eligibility requirements of Rule 14a-8(b). Generally the staff would expect appropriate documentation to:
- Identify the shareholder and the representative selected as a proxy
- Identify the company to which the proposal is directed
- Identify the meeting for which the proposal is submitted
- Identify the specific proposal to be submitted
- Be signed and dated by the shareholder
The staff has stressed that documentation would not have to include all of the items listed above if a company otherwise is able reasonably to conclude that the proposal is being submitted with the shareholder’s knowledge. The information identified by the staff, however, would provide companies greater certainty in assessing whether an eligible shareholder actually authorized the submission of a proposal by a representative.
Rule 14a-8(d): staff will continue to evaluate use of graphs or images in proposals using existing provisions of Rule 14a-8
Rule 14a-8(d). Rule 14a-8(d) permits exclusion of a proposal that, when combined with any accompanying supporting statement, exceeds 500 words. The rule does not address whether the inclusion of graphs or images in a proposal is considered in evaluating compliance with the 500-word limit. Further, because Rule 14a-8 does not provide for the use of graphs or images in proposals, some companies have objected to their inclusion. In recent years, the staff has disagreed with company arguments that the inclusion of graphs or images in proposals is not contemplated by Rule 14a-8.
New guidance. In SLB 14I, the staff confirms that the inclusion of graphs or images in a proposal will not alone serve as a basis for excluding the proposal. The staff clarifies that any words that are contained in a graph or image that is part of a proposal will count towards the 500-word limit.
In its guidance, the staff recognizes the potential for abuse in proponents’ use of graphs or images, but states that those concerns may be addressed by existing provisions of Rule 14a-8. The staff notes, for example, that, in accordance with the rule’s provisions, exclusion of a proposal may be appropriate if the proposal contains graphs or images that:
- Make the proposal materially false and misleading in violation of Rule 14a-9, the anti-fraud provision of the proxy rules
- Render the proposal inherently vague or indefinite
- Impugn character, integrity or personal reputation, or make charges of improper, illegal or immoral conduct or association, without factual foundation
- Are irrelevant to a consideration of the subject matter of the proposal
Some companies might have favored an outright prohibition on inclusion of graphs or images in proposals. The staff’s guidance in SLB 14I, however, is consistent with its position expressed in recent no-action letters and other statements.