On November 3, 2021, the U.S. Securities and Exchange Commission (SEC) issued a Staff Legal Bulletin (SLB 14L) limiting the ability of public companies to exclude from proxy statements shareholder proposals that relate to significant social issues and providing clarification regarding certain procedural requirements applicable to shareholder proposals. SLB 14L rescinds prior SLBs 14I, 14J and 14K and is expected to ease the path for shareholder proposals, notably those related to environmental, social and governance (ESG) matters, to make it into the proxy statement.
SEC Chair Gary Gensler issued a statement in support of the adoption of SLB 14L. Commissioners Peirce and Roisman issued a joint statement criticizing the staff's approach and questioning the rationale behind the staff's actions.
Securities Exchange Act Rule 14a-8 (Rule 14a-8) provides a process whereby a shareholder can propose a matter to be voted on at the company's meeting of shareholders. Under Rule 14a-8, a public company must include a shareholder proposal in its proxy statement if the proposal meets the procedural requirements of the rule and the company does not have a substantive basis to exclude the proposal.
Ordinary Business Exception
One of the substantive bases for excluding shareholder proposals is Rule 14a-8(i)(7), known as the ordinary business exception. Rule 14a-8(i)(7) permits a company to exclude a proposal that "deals with a matter relating to the company's ordinary business operations."
Significant Social Policy - In SLB 14L, the staff announced that it will no longer evaluate the applicability of the ordinary business exception by focusing on the effect of the proposal on the particular company, but will instead consider whether the proposal raises issues with a "broad societal impact" (the staff noted this approach was realigning with its standard initially articulated in 1976 and affirmed in its final Rule 14a-8 rulemaking in 1998). Consistent with its recent focus on ESG matters, the staff referenced proposals that address human capital management and climate change as the types of proposals that are less likely to be excluded, because they advance policy objectives beyond the company's ordinary business. As a result of this shift in approach, the staff instructed that it will no longer expect a board analysis from companies seeking to exclude shareholder proposals under the ordinary business exclusion.
Micromanagement - The staff also announced that it will take a "measured approach" to the micromanagement concept, a rationale for excluding shareholder proposals that deal with matters related to the business of the company that are deemed too complex for the shareholders as a group to address. Going forward, a company may not reject a proposal solely because it limits company or board discretion. Instead, the staff will focus on the granularity sought in the proposal and evaluate to what extent a proposal inappropriately limits discretion of the board or management, noting that there are goals, risks or other strategic matters that may be appropriate for shareholder input. The staff referenced proposals that address climate change, and that request timeframes and targets, as the types of proposals that are less likely to be excluded so long as the proposals afford discretion to management as to how to achieve such goals.
Economic Relevance Exception
Another substantive basis for excluding shareholder proposals is Rule 14a-8(i)(5), or the economic relevance exception. A company is permitted to exclude a proposal that "relates to operations which account for less than 5 percent of the company's total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company's business."
Under the new guidance, proposals that raise issues of broad social or ethical concern related to the company's business may not be excluded, even if the relevant business falls below the economic threshold of Rule 14a-8(i)(5).
Procedural Grounds for Exclusion
Use of Graphics and Images - Rule 14a-8(d) is one of the procedural bases for exclusion of a shareholder proposal. Under the rule, a shareholder proposal may not exceed 500 words. SLB 14L clarifies that use of graphics and images in shareholder proposals is permitted pursuant to Rule 14a-8(d). Words included in any such graphics and images count toward the 500-word limit.
Proof of Ownership Letter - Another procedural hurdle, Rule 14a-8(b), requires that the shareholder making a proposal prove that it has held the required amount of company's securities for at least one year prior to the date the proposal is submitted to the company. The staff advised that companies may not use overly technical readings of proof of ownership letters as a basis for excluding shareholder proposals. To this end, SLB 14L provides sample language for shareholders or their brokers to use in the proof of ownership letters, but makes clear that the use of the exact language is not required, as long as the proof of ownership letter is clear and "sufficiently evidences the requisite minimum ownership requirements."
Email Communications - Finally, SLB 14L provides guidance relating to use of email as it relates to proving timely delivery of shareholder proposal communications. To ease delivery confirmation, the staff recommends senders to seek a reply email from the recipient acknowledging receipt of email and encourages companies and shareholders to acknowledge receipt of emails when so requested.
Timing of notices and other communications is important for both companies and shareholders. Rule 14a-8(e)(1) requires that shareholders submit their proposals by means that permit them to prove timely delivery. Rule 14a-8(f)(1) requires that the company notify the shareholder of any defects within 14 calendar days of receipt of the proposal and, in turn, requires a shareholder to respond to a deficiency notice within 14 days from the date of receipt of such notice of deficiency from the company. With increased reliance on email as the primary means of communication, in order to avoid disputes regarding the timely delivery of proposals, deficiency notices or responses to deficiency notices, the party with the burden of proving timely delivery is encouraged to seek a confirmation of receipt of email.
SLB 14L will ultimately make it more challenging for companies to exclude shareholder proposals under the two substantive exceptions discussed above, particularly when related to climate or social issues. As shareholder proposals on climate issues are becoming more prominent, the combined impact of SLB 14L and International Shareholder Services' (ISS) proposed policy changes discussed here may make it particularly daunting for companies trying to avoid inclusion of such shareholder proposals in their proxy statements. Nevertheless, companies can take a proactive approach to avoiding future climate-related shareholder proposals. For instance, companies can:
- Engage in dialogue with shareholders on climate-related topics in advance of proxy season.
- Take action to address or mitigate the stated concerns of shareholders.
- Continue to track developments and anticipate possible proposals and the company's response.
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