United States: SEC Staff Legal Bulletin Clarifies Shareholder Proposal Exclusion Analysis

The Securities and Exchange Commission's (SEC's) Division of Corporation Finance (Division) has issued Staff Legal Bulletin No. 14H (SLB14H), which contains guidance on the exclusion of shareholder proposals that:

  • conflict with management proposals, or
  • involve the ordinary business of the company.

This alert discusses SLB14H and offers our views on some of the resulting practical considerations for the upcoming proxy season.

Exclusion of Conflicting Proposals.

Companies can exclude a shareholder proposal if that proposal "directly conflicts" with a company proposal to be submitted to shareholders at the same meeting. Rule 14a-8(i)(9).

Early in the 2014-2015 proxy season, the Division staff issued a no-action letter allowing Whole Foods Market, Inc. (Whole Foods) to exclude a proxy access shareholder proposal because Whole Foods was submitting its own proxy access proposal. While the Whole Foods proxy access proposal was more issuer-favorable in certain respects, it was similarly structured to the shareholder proponent's proposal and the argument supporting exclusion had been accepted by the Division staff on numerous previous occasions involving other proposals on shareholder rights such as those involving special meetings or majority written consents. The argument for exclusion was based on the then-current position of the Division staff that the "directly conflicts" exclusion was available if the shareholder and issuer proposals involved alternative and conflicting decisions for shareholders with the potential for inconsistent and ambiguous results.

The decision by the Division staff that the Whole Foods situation presented an excludable conflict resulted in a number of issuers responding to proxy access proposals with proposals of their own containing more favorable terms for the issuers.

Substantial objections were raised by shareholder proponents to the Whole Foods decision. In January 2015, SEC Chair Mary Jo White announced that she had directed the Division staff to review the direct conflict exclusion rule. Pending completion of this review, Division staff stopped expressing its view on the "directly conflicts" exclusion.

The Division staff has now published the analysis that resulted from this review. In SLB 14H, the Division states that it will view a shareholder proposal as directly conflicting with a management proposal only where a shareholder could not logically vote for both proposals. In other words, the proposals will be in "direct conflict" when they are mutually exclusive.

SLB14H illustrates this analytic framework with the situation where a company proposes a merger and the shareholder proposal asks shareholders to vote against the merger. SLB14H states that the Division staff would agree that these proposals directly conflict. SLB14H also illustrates the "direct conflict" scenario with a situation where a shareholder proposal asks for the separation of the company's chairman and CEO and the company is proposing a bylaw provision requiring the CEO to be chair at all times.

The Division staff also states that a precatory (nonbinding) shareholder proposal can directly conflict with a management proposal if a vote in favor of the nonbinding shareholder proposal is essentially the same as a vote against the company proposal.

Division staff will not find a direct conflict where "a reasonable shareholder, although possibly preferring one proposal over the other, could logically vote for both" proposals. SLB14H illustrates this point with the following example. The Division staff would not find a direct conflict where a company that does not allow proxy access has

  • a shareholder proposal that shareholders holding at least 3 percent of the company's stock for at least three years could nominate up to 20 percent of directors; and
  • a management proposal that shareholders holding at least 5 percent of the company's stock for at least five years could nominate up to 10 percent of the directors.

The Division staff states that these proposals do not directly conflict because both proposals generally seek a similar objective, to give shareholders the ability to include their nominees for director alongside management's nominees in the proxy statement, and the proposals do not present shareholders with conflicting decisions such that a reasonable shareholder could not logically vote in favor of both proposals.

Along the same lines, a shareholder proposal asking the compensation committee to implement a policy that equity awards would have no less than four-year annual vesting would not directly conflict with a management proposal to approve an incentive plan that gives the compensation committee discretion to set the vesting provisions for equity awards. The Division staff explains that a reasonable shareholder could logically vote for a compensation plan that gives the compensation committee the discretion to determine the vesting of awards, as well as a proposal seeking implementation of a specific vesting policy that would apply to future awards granted under the plan.

This position may lead to interesting situations, such as where a management proposal, and a shareholder proposal with similar objectives, but different terms and conditions, are both approved.

The Division staff acknowledges this possibility in SLB14H but states that "... the board of directors may have to consider the effects of both proposals if both the company and shareholder proposal are approved by shareholders." During the 2014-2015 proxy season, some issuers presented these kinds of choices to their shareholders in their company proxy materials. These situations generally resulted in a vote in favor of one of the alternatives, but not both. As a result of the new "direct conflict" position and the stated intentions of certain active proponents to submit proxy access proposals to a number of issuers, the upcoming proxy season is likely to produce many more of these situations presenting the potential for shareholder approval of "dueling provisions," in other words, management and shareholder proposals on the same topic, but with different terms.

Of course, this approach to the direct conflict exclusion is a change in position. This new approach will make it harder to convince Division staff to accept exclusion of a shareholder proposal on the "direct conflict" theory.

Ordinary Business Exclusion

A company can also exclude a shareholder proposal that relates to its "ordinary" business operations. Rule 14a-8(i)(7).

In July 2015, the U.S. Court of Appeals for the Third Circuit allowed Wal-Mart to exclude a proposal that asked Wal-Mart's Compensation, Nominating and Governance Committee to provide oversight of the formulation and implementation of policies and standards that determine whether Wal-Mart should sell certain products, including certain types of guns. 1

The Third Circuit held that a policy issue "must target something more than the choosing of one among tens of thousands of products it sells." The majority opinion in the Third Circuit case used a two-part test:

  1. The shareholder proposal must focus on a significant policy issue.
  2. The subject matter of the proposal must "transcend" the company's ordinary business operations, meaning that the policy issue must be "divorced from how a company approaches the nitty-gritty of its core business."

SLB14H states that the Division staff has concern that this two-part approach goes beyond the SEC's prior approach and would lead to unwarranted exclusion of shareholder proposals.

A concurring judge took a different approach, which viewed significance and transcendence as interrelated concepts, stating that a proposal is sufficiently significant because it transcends day-to-day business matters. The Division staff stated that it would follow the concurring opinion. As a result, a shareholder proposal can "transcend" ordinary business operations even if the significant policy issue relates to the "nitty-gritty of its core business." Accordingly, Division staff states that proposals that focus on a significant policy issue transcend a company's ordinary business.

This interpretation in effect continues the Division's previous approach to the "ordinary business" exclusion.

Practical Implications

Expect Continued Flow of Proxy Access Proposals. The primary proponents of these proposals in the 2015 proxy season are no less enthusiastic this year about the proposition that proxy access is a basic shareholder right. More than half of the 100 proposals submitted in 2015 passed, with an average 55 percent vote in favor. Proxy advisory firm ISS is recommending a vote in favor of proposals that are structured in a manner similar to the SEC's Rule 14a-11, which was vacated by the courts. With the effective elimination by the SEC staff of the "directly conflicts" grounds for exclusion of these proposals, and the experience gained by proponents in the previous season, it is likely that there will again be a heavy flow of submissions for the coming annual meeting season.

Educate Governance Committees and Boards Regarding Proxy Access. Whether or not a proposal is received for 2016, governance committees and boards will want to educate themselves about the key features of proxy access bylaws (required level of holdings/required holding period/limitations on the size of the group whose holdings are aggregated to reach the threshold/maximum number of seats available for proxy access nominees), as well as other procedural and disclosure features typically included.

Consider Potential for Other Governance Proposals. In addition to proxy access, other governance proposals garner high levels of support and are recommended by proxy advisory firms when presented to shareholders. These include board declassification, majority voting in uncontested director elections, elimination of supermajority vote proposals, shareholder ability to call special meetings and shareholder ability to act by majority written consents. The latter three topics have in the past been subject to exclusion under the "directly conflicts" grounds where the company presents its own similar proposal that employs more company-favorable thresholds. The position of the staff as expressed in SLB14H will eliminate these grounds for exclusion.

Expect Similar Tightening of "Substantially Implemented" Exclusion Grounds. If a board of directors determines, in the presence of a shareholder proposal or prior to receiving one, to implement a proxy access bylaw, it may be able to argue successfully against inclusion of a shareholder proposal dealing with the topic under Rule 14a-8(i)(10). General Electric recently used this exemption with success after adopting its own proxy access bylaw. 2 However, the General Electric bylaw was identical to the shareholder proposal in its key features (3 percent/three years/limit of 20 percent of board seats). The only notable difference was that General Electric's bylaw limited the size of the group whose holdings could be aggregated to reach the 3 percent limit to 20 shareholders, while the shareholder proposal was silent on this topic. The analysis that led the staff to conclude that two proposals must be mutually exclusive in order to be in direct conflict will likely lead to similar views on the subject of substantial implementation.

Consider and Engage the Issuer's Specific Shareholder Constituents. The extent to which an issuer desiring a more company-friendly version of proxy access will be able to present its approach successfully to shareholders will be largely dependent on who those shareholders are. Retail holders have shown themselves to be more likely to support the approach recommended by the board of directors. Certain institutional holders have been reluctant to jump on the proxy access bandwagon, at least in this initial period of adoption when the manner in which such provisions may actually be used is unknown. Other institutions appear currently to have some flexibility about the key features of a proposal. The issuer should investigate the positions of its shareholder base and unless shareholders appear inflexible, engage with them on the company's preferred approach. While the SEC staff may not consider a more company-friendly version of a proxy access bylaw to be substantial implementation, certain shareholders, institutional and retail, may be sufficiently satisfied with it to vote against a shareholder proposal.

Take into Account Positions of Proxy Advisory Firms. In assessing the available alternatives, issuers should keep in mind not only the proxy advisory firms' positions on specific proposals, but also the impact of any particular course of action on their governance profile with the major proxy advisory firms. In cases where a board acts unilaterally to adopt or amend a bylaw in a manner that reduces shareholder rights and the action is not subsequently presented to shareholders for ratification, the result may be adverse vote recommendations for directors at subsequent annual meetings.

Determine Whether and When to Act. Whether or not a proxy access or other governance proposal is presented, the board should determine its own preferred outcome on the topic. Assuming this outcome is one that enhances, rather than limits, existing shareholder rights, unilateral preemptive adoption is one option. This fait accompli can then be used if a shareholder proposal is submitted to argue with the SEC staff for exclusion based on substantial implementation. If that argument fails, the adopted bylaw can be presented to shareholders in the proxy statement as an argument against adoption of the shareholder proposal, or presented as a side-by-side proposal to shareholders for ratification. Alternatively, the board can postpone adoption of its preferred provision unless a shareholder proposal is submitted and, if the two approaches are different, the board can then proceed in a similar fashion to that outlined above. As a third option, the board can postpone adoption of any bylaw until after the shareholders have been provided the opportunity to vote on both the shareholder proposal and the board's proposal. While negotiation with a shareholder proponent for withdrawal is normally an option, given the degree of success that shareholder proponents have had with proposals incorporating the key features of now-defunct Rule 14a-11, negotiation is unlikely to be fruitful unless the issuer is willing to adopt a bylaw substantially along the lines of the proposal it has received.

Consider Alternatives to a No-Action Letter. Of course, SLB14H will make it harder to obtain an SEC no-action letter with respect to the "directly conflicting" exclusion. However, companies are not required to obtain no-action relief to exclude a proposal. Rule 14a-8(j) requires that an issuer file its reasons for an exclusion with the SEC no later than 80 calendar days before it files its definitive proxy statement. SEC staff determinations do not bind shareholders or the issuer. It is possible that issuers may seek declaratory relief with respect to the exclusion of the shareholder proposal in a federal district court.

Some issuers may even consider excluding a proposal unilaterally. Issuers should note that proxy advisory firms may react in a negative manner if an issuer decides to exclude a proposal without a no-action letter or court decision. In February 2015, ISS announced that it would generally recommend votes against directors at companies that exclude a shareholder proposal without obtaining no-action relief from the SEC or judicial relief from a U.S. district court. ISS 2015 Benchmark U.S. Proxy Voting Policies, Frequently Asked Questions on Selected Topics, Published February 19, 2015, Question 2.

Realize That It's Not Over Until It's Over. Given the manner in which the SEC staff is viewing the "directly conflicts" grounds for exclusion, and the manner in which the staff is likely to view "substantially implemented" grounds, an issuer that adopts a version of proxy access or another governance proposal may very well be revisited by a proponent even after an initial version of the relevant bylaw is in place. For example, at least one active proponent has stated that he intends to make proposals seeking to remove a limit on the number of shareholders whose holdings may be aggregated to reach a necessary threshold where a proxy access bylaw with a limit has been adopted.

It remains to be seen whether this type of activity will fall by the wayside, at least temporarily, as the resources of the supporters of proxy access are deployed in seeking to spread the feature as widely as possible. However, issuers who are able to begin with a more issuer-friendly bylaw than is preferred by the active proponents should not be surprised to hear another knock at the door at some point in the future.

Ordinary Business Exclusion Grounds will Remain of Limited Utility. The staff, in enunciating its plans to follow the concurring, rather than the majority, opinion in the Wal-Mart case, has made it clear that the guiding principal on one prong of the exclusion analysis will remain whether the proposal focuses on a significant policy issue. The fact that the proposal is interrelated with the manner in which the issuer approaches the nitty-gritty of its core business will not be the guiding principle in the staff's issuance of no-action guidance on this exclusion grounds. Whether a proposal involves a significant policy issue changes with the times. Based on staff statements in recent no-action letters, the analysis is based on whether the topic has attracted a high level of public attention or has emerged as consistent topics of widespread public debate. We do note that the staff has previously also acknowledged a second prong in the ordinary exclusion analysis which allows exclusion of proposals that seek to micromanage the issuer and deal with matters that are so complex that shareholders are not qualified to make informed decisions due to their lack of business expertise and knowledge of the issuer's business. Exclusion requests based on the latter prong are still presumably viable, but only a limited number of typical shareholder proposals fall into this category.


1. The SEC had granted no-action relief allowing Wal-Mart to exclude the proposal. The U.S. District Court for the District of Delaware ruled that Wal-Mart could not exclude the proposal, and the Court of Appeals sided with the SEC.

2. See Letter from David R. Fredrickson, Securities and Exchange Commission (March 3, 2015).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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