United States: SEC Staff Issues Staff Legal Bulletin On Shareholder Proposals

On October 16, 2019, the staff of the Division of Corporation Finance of the Securities and Exchange Commission (SEC) published Staff Legal Bulletin (SLB) No. 14K providing guidance on Rule 14a-8 under the Securities Exchange Act of 1934. SLB No. 14K addresses, among other things, issues related to the "ordinary business" exception under Rule 14a-8.

Background

Rule 14a-8 generally requires companies to include a shareholder proposal in its proxy materials unless 1) the shareholder has failed to comply with the requirements of Rule 14a-8 or 2) the proposal falls within one of the 13 exceptions under Rule 14a-8. As noted above, one of these exceptions is known as the "ordinary business" exception and provides that a company may exclude a shareholder proposal "[i]f the proposal deals with a matter relating to the company's ordinary business operations."

In 1998, the SEC adopted amendments to Rule 14a-8, which included, among other things, changes to the SEC's interpretation of the "ordinary business" exception. In its ensuing discussion of its position on the "ordinary business" exception, the SEC set forth the following two considerations that underlie this exception:

  • Significance Test. The first consideration relates to the subject matter of the shareholder proposal. The SEC noted that one of the bases for the "ordinary business" exception was that "[c]ertain tasks are so fundamental to management's ability to run a company on a day-to-day basis that they could not, as a practical matter, be subject to direct shareholder oversight." However, if such a proposal is focused "on sufficiently significant social policy issues" then it would not generally be excludable because it "would transcend the day-to-day business matters and raise policy issues so significant that it would be appropriate for a shareholder vote."
  • Micromanagement Test. The second consideration relates to the manner in which the shareholder proposal seeks to address the issue. The SEC stated, in pertinent part, that this "relates to the degree to which the proposal seeks to micro-manage' the company by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment." The SEC further noted that this "may come into play in a number of circumstances, such as where the proposal involves intricate detail, or seeks to impose specific time-frames or methods for implementing complex policies."

In addition, the staff periodically publishes Staff Legal Bulletins (SLBs) that provide guidance to companies and shareholders on various issues, including, in recent years, relating to the "ordinary business" exception to Rule 14a-8. In SLB No. 14I (published in 2017), the staff provided guidance on, among other things, the significance test of the "ordinary business" exception. Notably, the staff indicated that a determination as to whether a shareholder proposal is sufficiently significant raises "difficult judgment calls that the Division believes are in the first instance matters that the board of directors is generally in a better position to determine." Accordingly, the staff noted that future no-action requests should include a discussion of "the board's analysis of the particular policy issue raised and its significance" and that this "well-developed" discussion would be "most helpful if it detailed the specific processes employed by the board to ensure that its conclusions are well-informed and well-reasoned."

Following on this guidance, in SLB No. 14J (published in 2018), the staff provided further guidance on the significance test, and also provided guidance on the micromanagement test. The staff acknowledged that, following SLB No. 14I, it had received several no-action requests with discussions of board analyses, and that these analyses were most helpful when they included "the specific substantive factors the board considered in arriving at its conclusion." To assist companies in determining what substantive factors may be helpful, the staff included a non-exclusive and non-exhaustive list of substantive factors that the board may include in its analysis of the significance of the proposal to the company's business, and provided further guidance relating to one of these factors, "[w]hether the company's shareholders have previously voted on the matter and the board's view as to the related voting results." The staff also addressed the micromanagement exception, providing an example of where it concurred with a company's micromanagement argument. Of note, however, the staff said that its "concurrence with a company's micromanagement argument does not necessarily mean that the subject matter raised by the proposal is improper for shareholder consideration." Thus, if a proposal relating to a policy issue contains overly prescriptive implementation requirements, then the staff may concur with a company's request to exclude the proposal; however, if a proposal relating to the same policy issue provides for flexibility in the manner in which management and the board can implement the policy, then the staff may not concur with a company's request to exclude the proposal.

2019 Guidance

Following on its 2017 and 2018 guidance, the staff issued SLB No. 14K, providing further guidance on the significance test and the micromanagement test. This latest guidance included the following:

  • Significance Test. The staff noted that "companies have often focused on the overall significance of the policy issue raised by the proposal, instead of whether the proposal raises a policy issue that transcends the particular company's ordinary business operations." The staff clarified that the focus and the analysis should be company-specific, i.e., the focus "should be on whether the proposal deals with a matter relating to that company's ordinary business operations or raises a policy issue that transcends that company's ordinary business operations." [Emphasis added.]
    • Board Analysis. Consistent with its prior guidance, the staff reiterated its belief that a "well-developed discussion of the board's analysis of whether the particular policy issue raised by the proposal is sufficiently significant in relation to the company can assist the staff in evaluating a company's no-action request[.]" In addition, the staff noted that board analyses in recent no-action requests were "more helpful in determining whether the proposal was significant to the company's business" and that this was "largely attributable to a greater proportion of requests discussing in detail the specific substantive factors," including those factors that the staff set forth in SLB No. 14J. The staff also noted that in cases where a no-action request lacked a "robust" discussion of the board's analysis of the significance of the policy issue raised by the proposal, the staff's ability to analyze and state a view on the exclusion "may be impacted."
      • Delta Analysis. In SLB No. 14J, the staff noted that one of the substantive factors that a board could consider in analyzing the significance of the policy issue to the company was "[w]hether the company has already addressed the issue in some manner, including the differences – or the delta – between the proposal's specific request and the actions the company has already taken, and an analysis of whether the delta presents a significant policy issue for the company." In this latest guidance, the SEC distinguished this factor from the exclusion under Rule 14a-8(i)(10), i.e., a proposal may be excluded where a company has already substantially implemented the proposal, noting that "[a] delta analysis could be useful for companies that have already addressed the policy issue in some manner but may not have substantially implemented the proposal's specific request[.]" In addition, the SEC noted that such an analysis "is most helpful where it clearly identifies the differences between the manner in which the company has addressed an issue and the manner in which a proposal seeks to address the issue and explains in detail why those differences do not represent a significant policy issue to the company." The foregoing was contrasted with mere "conclusory statements about the differences that fail to explain why the board believes that the issue is no longer significant," which the SEC notes are "less helpful."
      • Prior Voting Results. One of the other substantive factors set forth in SLB No. 14J was "[w]hether the company's shareholders have previously voted on the matter and the board's view as to the related voting results." In the most recent guidance, the staff provided the following examples arguments it found to be unpersuasive: 1) the prior voting results were insignificant because a majority of the shareholders voted against it; 2) the impact of proxy advisory firms' recommendations mitigated the significance of the prior voting results; and 3) the prior voting results were insignificant if looked at on the basis of shares outstanding rather than on the basis of the votes cast. Rather, the staff noted that "the board's analysis may be more helpful if it includes, for example, a robust discussion that explains how the company's subsequent actions, intervening events or other objective indicia of shareholder engagement on the issue bear on the significance of the underlying issue to the company."
  • Micromanagement. The staff clarified its prior guidance that two proposals relating to the same subject matter "may warrant different outcomes based solely on the level of prescriptiveness with which the proposals approach that subject matter." To illustrate its point, the staff provided an example of two proposals relating to the Paris Climate Agreement. In the first example, the staff "agreed that a proposal seeking annual reporting on short-, medium- and long-term greenhouse gas targets aligned with the greenhouse gas reduction goals established by the Paris Climate Agreement to keep the increase in global average temperature to well below 2 degrees Celsius...' was excludable on the basis of micromanagement." The staff believed that this proposal effectively required the company to adopt "time-bound targets (short, medium and long) that the company would measure itself against and changes in operations to meet those goals[.]" Conversely, in the second example, the staff "did not concur with the excludability of a proposal seeking a report describing if, and how, [a company] plans to reduce its total contribution to climate change and align its operations and investments with the Paris [Climate] Agreement's goal of maintaining global temperatures well below 2 degrees Celsius.'" The staff believed that 1) this proposal represented a significant policy issue that transcended the ordinary business operations of the company and 2) that it "did not seek to micro-manage the company to such a degree that exclusion would be appropriate" because "it deferred to management's discretion to consider if and how the company plans to reduce its carbon footprint[.]" If a company seeks to exclude a proposal under the micromanagement test, then the staff indicated that it "would expect it to include in its analysis how the proposal may unduly limit the ability of management and the board to manage complex matters with a level of flexibility necessary to fulfill their fiduciary duties to shareholders." Other notable points raised by the staff included the following: 1) that the mandatory or precatory nature of the proposal "does not bear on the degree to which a proposal micromanages" and 2) that even if the "resolved clause" of the shareholder proposal is not overly prescriptive or problematic, "if a supporting statement modifies or re-focuses the intent of the resolved clause, or effectively requires some action in order to achieve the proposal's central purpose" then the staff will "take that into account in determining whether the proposal seeks to micromanage the company."

What To Do Now?

If submitting a no-action request, always check the SLBs for staff guidance, as well as prior SEC responses to no-action requests even though non-binding. Don't forget, in September 2019, the staff announced that starting with this year's proxy season, it may respond orally rather than in writing to some no-action requests, and it may decline to state a view. In the latter case, the staff indicated that this should not be interpreted to mean that a proposal must be included.

In addition, if you seek to exclude a shareholder proposal:

  • based on the significance test of the "ordinary business exception," then consider the following actions:
    • engage the board of directors in a "well-developed" discussion of the significance of the particular policy issue to the ordinary business operations of the company (i.e., be company-specific), including, among other things and to the extent applicable, each of the substantive factors set forth in SLB No. 14J;
    • following this discussion, include a robust discussion of the board's analysis, including each of the substantive factors discussed, in the company's no-action request; and
    • in circumstances where a delta analysis or a prior voting results analysis is applicable, a more meaningful and tailored analysis of those factors in-line with the guidance provided in SLB No. 14K would be most helpful both for the staff in evaluating the no-action request, and also for the company in supporting its argument for exclusion;
  • based on the micromanagement test of the "ordinary business exception," then review and focus on the prescriptive nature of any implementation requirements included in the shareholder proposal. Importantly, the staff looks at whether the shareholder proposal "imposes a specific strategy, method, action, outcome or timeline for addressing an issue, thereby supplanting the judgment of management and the board."
  • Also of note, in SLB No. 14K the staff cautioned companies against applying "an overly technical reading of proof of ownership letters as a means to exclude a proposal," noting that "companies should not to seek to exclude a shareholder proposal based on drafting variances in the proof of ownership letter if the language used is clear and sufficiently evidences the requisite minimum ownership requirements." The staff indicated that these types of technical arguments have not been persuasive, including in circumstances where the proof of ownership letters deviate from the format provided in its 2011 guidance, which was merely a suggested format, not a required format.

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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