SEC PROPOSES NARROWING GROUNDS FOR EXCLUDING SHAREHOLDER PROPOSALS

On July 13, 2022, the Securities and Exchange Commission (the “SEC”) proposed revisions to Rule 14a-8 under the Securities Exchange Act of 1934 to amend certain substantive bases on which U.S. public companies can exclude shareholder proposals from their proxy statements. The proposed amendments would make it harder for companies to exclude shareholder proposals based on the following three substantive bases for exclusion: substantial implementation, duplication and resubmission.

Background

Under Rule 14a-8, a company must include an eligible shareholder’s proposal in its proxy statement and bring it up for a vote at its shareholder meeting if the proposal meets certain procedural and substantive requirements. The rule has become a fundamental component of shareholder engagement, allowing shareholders to raise important topics for consideration at the annual meeting and to successfully advance certain corporate governance objectives, but has also created a corresponding burden for companies that are subject to numerous proposals that never achieve majority support.

First adopted in 1942, Rule 14a-8 has been the subject of various revisions, with the most recent significant amendments adopted in 1983. More importantly, Rule 14a-8 has been the subject of extensive SEC staff interpretive guidance through no-action letters that have served to define the scope of the procedural and substantive requirements and a number of Staff Legal Bulletins that have served, in part, to crystallize the Staff’s current thinking.^[1]

The rule contains several bases on which a company may exclude a shareholder proposal from its proxy statement. The bases for exclusion are intended to be sufficiently tailored to protect the ability of shareholders to be heard, while also discouraging misleading, extraneous or repetitive proposals and those that impact management discretion on day-to-day business matters for which shareholder consideration is ill suited.

The SEC’s views of the substantive exclusion bases have evolved over time. Most recently in November 2021, the SEC’s Division of Corporation Finance issued new interpretive guidance in Staff Legal Bulletin No. 14L. That guidance rolled back relatively recent expansions of companies’ ability to exclude shareholder proposals involving significant social issues on the grounds that the proposals dealt with a matter relating to the company’s ordinary business operations (Rule 14a-8(i)(7)), often referred to as “micromanagement,” or lacked economic relevance for the company (Rule 14a-8(i)(5)).

The new proposed amendments would revise the text of the substantial implementation exclusion (Rule 14a-8(i)(10)), the duplication exclusion (Rule 14a-8(i)(11)) and the resubmission exclusion (Rule 14a-8(i)(12)) in a manner which will lower barriers for shareholders to have their proposals included in proxy statements.

According to the proposing release, the proposed amendments are intended to facilitate shareholder suffrage and communication between shareholders and the companies they own, as well as among a company’s shareholders, on important issues. The SEC’s stated objective is to provide greater certainty and transparency to shareholders and companies regarding these three grounds for exclusion.

Substantial Implementation

The substantial implementation basis for exclusion (Rule 14a-8(i)(10)) currently permits a company to exclude a shareholder proposal that the company has already “substantially implemented.” This is intended to avoid the possibility of shareholders having to consider matters which have already been acted upon by the management.

In determining whether the company has substantially implemented a proposal, the SEC staff has focused on whether the company’s particular policies, practices and procedures compare favorably with the guidelines of the proposal, whether the company has addressed a proposal’s underlying concerns and whether the essential objectives of a proposal have been met. This sometimes involves dividing a proposal into its elements and evaluating which of them have been implemented. Importantly, however, a proposal may be viewed as substantially implemented even if a company has not implemented all of the proposal’s elements. Although the “substantial implementation” standard has effectively been in place since 1983, the SEC has now expressed concerns that it is difficult to interpret and apply in a consistent and predictable manner.

The proposed amendment provides that a proposal may be excluded where the company has already “implemented the essential elements of the proposal.” In determining which elements of a proposal are essential, the SEC staff’s analysis would be guided by “the degree of specificity of the proposal and of its stated primary objectives.” Companies would be permitted to exclude a proposal only if the company has implemented all of its essential elements.

This revision serves to partially shift back towards the pre-1983 version of this exclusion, when a proposal needed to have been fully effected in order to be excluded under Rule 14a-8(i)(10).

Duplication

The duplication basis for exclusion (Rule 14a-8(i)(11)) currently provides that a company may exclude a shareholder proposal that “substantially duplicates” another proposal previously submitted to the company by another proponent that will be included in the company’s proxy materials for the same meeting. This is intended to eliminate the possibility of shareholders having to consider two or more substantially identical proposals.

The SEC staff has treated proposals as excludable for duplication when they have the same “principal thrust” or “principal focus” as a previously submitted proposal. The proposing release notes that the principal thrust or focus may be subject to broader or narrower subjective interpretation, resulting in too many proposals being included or excluded. The release also notes that under the current rules shareholders are incentivized to be the first in time to submit a proposal to preempt other proposals on a particular topic, potentially preventing the inclusion of a later proposal that may have received more shareholder support if it was submitted for a vote.

The proposed amendment creates a new test for determining what constitutes substantial duplication, providing that a proposal “substantially duplicates” another one only if it “addresses the same subject matter and seeks the same objective by the same means.” The SEC notes that this revision is intended to promote greater clarity and more consistent outcomes and would allow consideration of later-received proposals that may be similar to and/or address the same subject matter as an earlier-received proposal but which seek different objectives or offer different means of addressing the same matter.

Resubmission

The resubmission basis for exclusion (Rule 14a-8(i)(12)) currently permits excluding a shareholder proposal that addresses “substantially the same subject matter” as a proposal previously included in the company’s proxy materials within the preceding five years if the matter was voted on at least once in the last three years and such vote fell below specified thresholds. This is intended to relieve the management of the necessity of including proposals which have been previously submitted to security holders but failed to garner the requisite level of support.

Determinations as to whether proposals address substantially the same subject matter currently turn on whether they share the same “substantive concerns.” According to the proposing release, this standard can lead to an “umbrella effect,” where proposals are excluded for minor or vague overlaps with previous proposals and experimentation with different approaches is chilled.

The proposed amendment replaces the “substantially the same subject matter” standard for determining what constitutes a resubmission with the new proposed duplication standard from Rule 14a-8(i)(11). Accordingly, if the amendments are adopted as currently proposed, a shareholder proposal must “substantially duplicate” a previously included proposal to be excluded under the resubmission basis. As discussed above, “substantial duplication” would exist only where a proposal “addresses the same subject matter and seeks the same objective by the same means” as another. The SEC believes that this revised standard will not only align the duplication and resubmission substantive bases for exclusion, but also more accurately assess whether shareholders have already provided their views on a particular issue such that inclusion of a new shareholder proposal on that same issue in the company’s proxy statement would be unnecessary.

Our Take

If adopted as proposed, these amendments will make it more challenging for a company to exclude shareholder proposals from proxy statements on these substantive grounds.

The amendments reflect a belief on the part of the current majority of SEC commissioners that there are benefits of presenting shareholders with more shareholder-sponsored proposals, even if those proposals are already similar to existing company policies, are similar to each other, or are similar to other proposals that were recently voted on, and that those benefits outweigh the costs for companies and shareholders of including, analyzing or voting on those proposals.

• Substantial Implementation. In principle, focusing the “substantial implementation” analysis on the “essential elements” of a proposal could be helpful in incentivizing proponents to articulate what they view as “essential” about their proposals. This may provide greater clarity to companies that they will be able to exclude a proposal if they have implemented all of those elements, which may help streamline negotiations between companies and proponents about implementation. The SEC’s proposed deference to proponents for identifying “essential elements,” however, strikes us as problematic. While the proposing release notes that the more elements a proponent identifies, the less essential the staff would view each of them, its focus on the characterization of what is essential that is provided by the proponent will give proponents leverage. The release expressly notes that where a proposal contains only one essential element, that essential element would need to be implemented in order to exclude the proposal.
  
  This will likely make it easier for proponents to force inclusion of their proposals by identifying differences to the company’s existing policies or disclosures. One example cited by the proposing release is a proposal that calls for a company to issue a report about a particular topic (many proposals relate to company reports on broader social policy issues). If the plain language of the proposal explains how the company’s existing reports or disclosures about that topic are insufficient, the company may not be able to exclude the proposal even if the disclosure otherwise covers the same subject matter. Another example provided in the release is report authorship: even if the company has already issued a management report on the same subject, the proponent could force inclusion of a proposal for the preparation of such a report simply by stating that it must come from the board of directors instead and highlighting this as an essential element.


• Duplication. We believe there is some concern that the proposed changes to the duplication exclusion may result in the inclusion of multiple shareholder proposals in a single proxy statement that address the same subject matter, but within that subject matter seek different objectives or propose different means. The proposing release illustrates this by describing competing proposals: one proposal seeks the publication in newspapers of a company’s political contributions and attempts to influence legislation, and a separate proposal seeks a report on the company’s process for identifying and prioritizing legislative and regulatory public policy advocacy activities. While both proposals relate the company’s political and lobbying expenditures, they would be treated as seeking different objectives by different means and thus not duplicative under the rule proposal.
  
  The duplication exclusion has not often been relied on recently, but it had played a more important role a few years ago, and, with this proposed change, there is the potential of proliferating proposals by different proponents covering similar subject matters. The SEC did ask for public comment on whether the narrower conception of when proposals are deemed duplicative should be accompanied by other safeguards, such as a limit on the number of proposals relating to the same subject matter that would have to be included in any one proxy statement.


• Resubmission. The amendments to the resubmission exclusion in Rule 14a-8(i)(12) are an invitation to proponents to resubmit only modestly modified proposals year after year. With exclusion on this ground being permitted only if the new proposal “substantially duplicates” an earlier one, and with duplication itself being defined more narrowly, we may see less restraint on the part of proponents to resubmit.

We also anticipate public comment to raise that these amendments may subvert the SEC’s stated objective of providing greater certainty. It will take time for companies, proponents and the SEC staff to gather experience with the application of the new rules, with the rich body of precedent developed under the existing regime being of limited value. There may be an increase in no-action requests as companies attempt to understand how various fact patterns will be evaluated under these amendments.

Request for Comments

The SEC has requested comments on the proposed rules by September 12, 2022 (or 30 days after the date of publication of the proposing release in the Federal Register, if longer).

We will continue to track developments and keep you informed of the rules as they make their way to becoming final.