On November 1, 2017, the staff (the “Staff”) of the Division of Corporation Finance of the Securities and Exchange Commission (SEC) issued Staff Legal Bulletin No. 14I (SLB 14I) on shareholder proposals, which sets out a potentially meaningful repositioning of the role that the Staff has played in connection with its review of requests to exclude shareholder proposals under the “ordinary business” and “economic relevance” exclusions of Rules 14a-8(i)(7) and 14a-8(i)(5).
SLB 14I seeks to provide the Staff with the ability to rely on, and possibly defer to, a company’s board of directors in connection with its assessment of no-action requests pursuant to these exclusions. In addition, SLB 14I also clarifies procedural requirements for shareholder proponents who submit proposals by proxy and “codifies” thinking it has expressed in recent no-action letter requests related to the use of images in shareholder proposals.
We will briefly summarize the Staff’s new guidance on these matters and provide practical considerations for companies and their boards to consider in light of the Staff’s new guidance.
Background on “Ordinary Business” and “Economic Relevance” Exclusions
Background on “Ordinary Business.” Under Rule 14a-8(i)(7), a company is allowed to exclude a shareholder proposal that addresses “a matter relating to a company’s ordinary business operations.” When considering whether a shareholder proposal could be excluded under Rule 14a-8(i)(7), the Staff considers whether the proposal relates to a subject matter that is so fundamental to management’s ability to run the company that it should not be subject to shareholder oversight. There is an exception to this exclusion—if a shareholder proposal relates to “significant social policy issues” that “transcend” a company’s ordinary business operations, the Staff will not permit exclusion of the proposal.
Traditionally, the Staff has taken an active role in determining whether the subject matter of a proposal relates to a significant policy issue. While the Staff has not demarcated the boundaries of what is a significant policy issue (employing a “we know it when we see it” approach), past experience indicates that the Staff, in addition to the arguments presented by the company and the shareholder proponent, will also independently consider a number of factors, including the degree of public attention given to an issue, press and other media coverage, and recent legislative or regulatory activity. As a result, there is a well-developed body of specific issues that Staff considers to be significant policy issues, but these determinations have been developed on a case-by-case basis and then applied broadly to similarly situated companies.
Background on “Economic Relevance.” Under Rule 14a-8(i)(5), companies are permitted to exclude a shareholder proposal if the proposal relates to operations which account for less than 5% of a company’s total assets, net earnings and gross sales and is not otherwise significantly related to the company’s business.
Despite the appeal of an objective, bright-line 5% test, this exclusion has been infrequently relied upon by companies because of the expansive view the Staff has taken under the “not otherwise significant” prong of the exclusion. Where a proposal related to operations that did not meet the 5% test, if a company did any business related to the issue in question and the issue touched upon a matter of “broad social or ethical concern,” the Staff has been inclined to deny exclusion of the proposal.
With SLB 14I, the Staff has indicated that it wants to shift the determination of whether the subject of a proposal transcends the ordinary business operations of a company, in the case of the “ordinary business” exclusion, or is significantly related to a company’s business, in the case of the “economic relevance” exclusion, to a company and, more specifically, to a company’s board of directors.
The Staff has struggled with these determinations over the years and in SLB 14I it referred to these decisions as “difficult judgment calls.” In SLB 14I, the Staff indicated that it believes a company’s board of directors is “well situated to analyze, determine and explain whether a particular issue is sufficiently significant.” Going forward, when a company relies on either Rule 14a-8(i)(7) or 14a-8(i)(5), the Staff will expect to see a discussion of “the specific processes employed by the board to ensure that its conclusions [as to whether the issue transcends its ordinary business operations or if it is significantly related to its business] are well-informed and well-reasoned.”
For “economic relevance” exclusions, the Staff also indicated that the bar would be raised for proponents going forward. Proponents would need to demonstrate that a proposal was sufficiently related to a significant effect on a company’s business and that the “mere possibility” of reputational or economic harm will not preclude no-action relief.
Notably, the Staff emphasized that there is a presumption that “substantive governance matters” will be significant to almost all companies, which likely forecloses the possibility of using the “economic relevance” exclusion for corporate governance proposals.
It will take at least one full proxy season to assess the significance of the Staff’s repositioning on the “ordinary business” and “economic relevance” exclusions. As an initial observation, it appears that SLB 14I is a broad grant of deference to companies, recasting the role that the Staff played in determining the significance of any particular issue. How much the Staff will rely on the assessments made by a company’s board of directors is something we will have to wait to see, but it does appear that the Staff wants to ease out of these complicated decisions for which it is not entirely equipped to make. It is also, perhaps, an admission by the Staff that a “one size fits all” approach may not be most appropriate given that companies considering proposals on the same social policy issue can be in widely different industries with widely different considerations. SLB 14I may mark a change in the way the no-action process has played out over the years. It could mean that certain topics, such as executive compensation or environmental issues, which, in the past, have been considered open-and-shut issues, could potentially be reevaluated if a company can sufficiently show the relative significance (or insignificance) of such topic to its business operations. Additionally, proponents may no longer be able to defend against attempts at exclusion by shoehorning proposals into a topic that the Staff has deemed to be a significant policy issue for another company in the past.
What is certain, though, is that SLB 14I means direct engagement by the board of directors in the shareholder proposal process. Given the Staff’s new focus on the assessment by a company’s board of directors, specifically, the request for “a discussion of the specific processes employed by the board,” we expect that companies looking to rely on these exclusions will need to show engagement by the board in the no-action letter process and explain what the board did and considered.
What Do Boards Need to Do?
This new dynamic will certainly draw boards more directly into the shareholder proposal process. What the Staff expects to see from boards in terms of the process employed will become clear over time. The following are steps that a board should consider in demonstrating that a company has engaged in “specific processes” to evaluate the subject matter of a proposal:
Review past board work. Has the board considered the subject matter of the proposal before? If the board, in another context, has considered the policy issue or whether the issue in question is significantly related to the company’s business, the board should be able to rely on the analysis it has done in the past. We would recommend, however, that the board, where appropriate, refresh the analysis with some of the steps identified below and, at the very least, address the topic as a board or a committee of the board in the context of the shareholder proposal.
Consider prior shareholder and stakeholder engagement. Have shareholders raised the subject matter of the proposal directly to the company? Are these issues on which institutional shareholders have expressed views on broadly? Have the issues in the shareholder proposal been raised by customers, employees or by the communities in which the company operates? If so, the board should consider and assess the importance of these perspectives as part of its analysis.
Consider legislative, regulatory developments. Has the subject matter of the proposal been part of any legislative or regulatory activity? The board should consider the implication of those actions.
Consider peer companies and industry activity. The board should understand if and/or how its peers have considered the issue. In particular, the board should consider how peer companies addressed the same shareholder proposal. The board should also have an understanding if there are developing trends or best practices both among leading companies and industry peers.
There are also some procedural implications that companies will need to consider if they seek to rely on these exclusions.
Less time, with more to do. Practically speaking, companies may have as little as 40 days between receiving a shareholder proposal to when they need to submit a no-action letter. Companies should be prepared to have their boards meet if necessary during this period to consider responding to shareholder proposals under Rules 14a-8(i)(5) and (i)(7).
Does the whole board need to meet? It is unclear to what degree that the SEC will consider the analysis by a board committee to be sufficient in demonstrating that a board has undertaken “specific processes” in considering the issues underlying the shareholder proposal. Boards have wide latitude to delegate authority to committees and subcommittees, so we would expect that delegation to a properly constituted committee of a board to satisfy the requirement set out in SLB 14I.
Prior no-action letter precedent. It is unknown how much the Staff will rely on the prior history of Staff interpretations on a particular topic and the conclusions that the company’s peers may have reached regarding the same issue. While we expect that the Staff will not consider itself beholden to its past decisions on any particular issue given the new guidance in SLB 14I, it is also unlikely the Staff will wipe the slate clean. We expect that past precedent and peer practice will still play a role in the Staff’s assessment of a particular issue.
How much should you say about “specific processes” employed by the board? We will learn over time what the Staff is expecting with respect to a discussion of the specific processes it has employed in assessing the issues presented in the shareholder proposal, but, for now, we would expect that any no-action request should include a discussion of the process the board employed to evaluate the issue, the factors it considered in making its determination and the determination itself. We do not believe that “specific processes” entails a description of the inner workings of a board itself, including the dates on which it met and the topics and decisions covered. A more general description of the board processes that demonstrates thorough consideration, along with conclusions drawn may, however, be required so that the Staff can comfortably defer to the board’s assessment. Companies should consider the level of detail included in a no-action request as these disclosures will quickly become public disclosures of how the board operates.
It is common for shareholder proponents, including certain individuals who have historically been very prolific in submitting proposals, to use “proxies” to submit proposals where such proponents do not directly own the shares. While Rule 14a-8 does not have formal procedures that lay out the steps necessary for proponents to submit “proposals by proxy,” the Staff has consistently viewed such practice within the bounds of Rule 14a-8. SLB 14I clarifies, however, that the Staff may require proof that the shareholder of record has in fact delegated the appropriate authority to the proxy, in addition to any proof of ownership that may be required. The new documentation is required to: (i) identify the shareholder proponent and the person or entity selected as proxy; (ii) identify the company to which the proposal is directed; (iii) identify the annual or special meeting for which the proposal is submitted; (iv) identify the specific proposal to be submitted; and (v) be signed and dated by the shareholder.
We expect that these new requirements will be quickly adapted to by shareholder proponents, although on the margins it may lead to exclusion of shareholder proposals where delegation is not considered to be sufficiently proven by the Staff. The new requirements seem to reflect a moderated response from the Staff to the growing frustration with the practice.
Is a Picture Worth 500 Words?
SLB 14I also codifies into guidance recent decisions by the Staff relating to the use of images in shareholder proposals. Shareholder proposals are not prohibited from containing images; however, the images will be subject to compliance with the rest of Rule 14a-8, including, among other things, requirements that the images not be materially false or misleading, not impugn character, integrity or personal reputation, and not be irrelevant to the consideration of the subject matter of a proposal. In addition, should the image contain any text, such text will be counted toward Rule 14a-8’s 500-word limit.
Much remains to be seen regarding how the Staff will implement SLB 14I in practice. While we expect that SLB 14I indicates an increased deference by the Staff to companies in determining the significance of a shareholder proposal to its business, we also expect that the Staff will consider perfunctory analyses by boards inadequate for exclusion under Rules 14a-8(i)(5) or (i)(7). To what extent the Staff will be willing to grant deference to a company’s analysis and to what degree a company’s board will need to demonstrate sufficient engagement with a shareholder proposal are questions that everybody—companies and shareholder proponents alike—will be eager to understand.
Finally, many of the shareholder proposals submitted to companies direct the company, and often times, the board of directors, to evaluate and consider if not prepare a report on a particular issue. While these proposals cover a wide array of topics, they overwhelmingly focus on issues that, for companies seeking to exclude the proposal, raise questions of whether the issue transcends the ordinary business of the company or if it is of economic relevance to it. Interestingly, the change in the Staff’s position on Rules 14a-8(i)(5) and 14a-8(i)(7), is, to some degree, requiring boards to consider the very issues they were seeking not to have to address.