Marty Dunn, Rose A. Zukin, and Scott Lesmes
Public Companies Counseling + Compliance
On November 1, 2017, the Staff of the SEC’s Division of Corporation Finance released Staff Legal Bulletin No. 14I (“SLB 14I”), which provides new guidance on how the Staff will evaluate arguments for omission of a shareholder proposal from their proxy materials under Rule 14a-8(i)(5), Rule 14a-8(i)(7), Rule 14a-8(d), the submission of a proposal by a representative on behalf of a shareholder (commonly known as “proposal by proxy”).
Given the significance of the topics addressed in SLB 14I, Division of Corporation Finance Senior Special Counsel Matt McNair took time to answer questions regarding the guidance in a webcast on a popular industry blog. Mr. McNair has played a leading role in the Staff’s Rule 14a-8 no-action letter program for many years. Below is a discussion of SLB 14I, as supplemented by Mr. McNair’s guidance. With regard to Mr. McNair’s discussion of SLB 14I, it is always important to note his standard disclaimer that his views were his own and did not necessarily reflect the views of other members of the Staff, individual SEC Commissioners or the Commission as a whole.
Rule 14a-8(i)(7) Guidance
Rule 14a-8(i)(7) provides that a proposal is excludable when it deals with a matter relating to the company’s ordinary business operations. The Staff has stated that the policy underlying the “ordinary business” exception rests on two central considerations: (i) whether the proposal raises matters that 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,” and (ii) the degree to which the proposal “micromanages” the company. Proposals that fall within the first consideration may be excluded, unless the proposal focuses on policy issues that are “sufficiently significant” such that they transcend ordinary business and would be appropriate for a shareholder vote. Whether the “significant policy issue” exception applies to a particular proposal depends, in part, on the connection between the significant policy issue and the company’s business operations (i.e., whether there is a sufficient “nexus” between a significant policy issue and the company’s operations).
Role of the Board of Directors
Recognizing that application of the significant policy issue exception under (i)(7) often raises difficult judgment calls, the Staff expressed its view in SLB 14I that a company’s board of directors is generally in a better position than the Staff to determine whether a proposal that addresses a significant policy issue is sufficiently connected to a company’s ordinary business matters to permit exclusion of the proposal. As the Staff stated in SLB 14I, “[a] board of directors, acting as steward with fiduciary duties to a company’s shareholders, generally has significant duties of loyalty and care in overseeing management and the strategic direction of the company. A board acting in this capacity and with the knowledge of the company’s business and the implications for a particular proposal on that company’s business is well situated to analyze, determine and explain whether a particular issue is sufficiently significant because the matter transcends ordinary business and would be appropriate for a shareholder vote.”
In SLB 14I, the Staff indicated that a company’s no-action request arguing for the exclusion of a shareholder proposal under Rule 14a-8(i)(7) may include a discussion of the board’s analysis of the particular policy issue raised in the shareholder proposal and the policy issue’s significance to the company. Particularly “helpful,” according to SLB 14I, would be a discussion that “detail[s] the specific processes employed by the board to ensure that its conclusions are well-informed and well-reasoned.” In this regard, Mr. McNair noted that a no-action request seeking exclusion of a shareholder proposal that clearly addresses ordinary business matters and does not mention a significant policy issue might not benefit from discussion of the board’s consideration of the issue. Rather, additional discussion of the board’s discussion is optional and may be especially useful regarding a company’s argument as to whether a nexus exists between a significant policy issue and the company’s ordinary business operations.
While SLB 14I was published on November 1, 2017, Mr. McNair noted that a company that had submitted a no-action request regarding Rule 14a-8(i)(7) to the Staff prior to that date and wished to provide a discussion of the board’s consideration of the proposal may supplement the no-action request to provide that information. If a company supplements the no-action request in that manner, the Staff will allow the shareholder proponent additional time to review and respond, which likely will delay the Staff’s response to the no-action request. Companies should keep the Staff informed of their expected printing date for proxy materials so the Staff can accommodate that schedule.
Board Consideration of a Proposal May be Made by the Full Board or May be Delegated to a Board Committee
In the webcast, Mr. McNair addressed whether the process of determining the substance of the additional discussion may be delegated to a board committee, rather than necessitate full board involvement. Mr. McNair indicated that there was no required format or method for the additional discussion of the board’s consideration and he indicated that such consideration may be delegated to a board committee if that is the preference of the board. However, Mr. McNair added that a consideration of the proposal that was discussed, reviewed and approved by the full board may carry more weight with the Staff than a discussion of a consideration made by a board committee.
Topics for Additional Discussion of Board Consideration; Assessment of “Nexus” by Board
Mr. McNair emphasized during the webcast that there are no guidelines as to what the additional discussion of the board’s consideration should include, stating that the Staff purposefully did not include examples of this discussion in SLB 14I. This omission of examples was intended to allow a board to determine how to address the shareholder proposal in a way that was most relevant to the company’s facts and circumstances.
Mr. McNair further clarified that the discussion of the board’s consideration of the proposal should include any descriptions and/or findings of the board regarding the company and/or the significant policy issue that are sufficiently detailed to allow the Staff to make an informed decision regarding the nexus between the nature of the proposal and the company’s day-to-day business operations. Examples of such descriptions and findings may include a discussion of:
Mr. McNair emphasized, however, that these are merely possible topics for inclusion in the no-action request and a company should use its best judgment regarding the description of the process and information considered by the board.
While the historical framework of the Staff’s application of Rule 14a-8(i)(7) has not changed, seeking the board’s consideration of the proposal and the impact of a significant policy issue on a company’s operations marks a significant development for potential no-action relief this proxy season. Companies may have been hesitant to seek no-action relief for a shareholder proposal that focused on an established significant policy issue (such as human rights or greenhouse gases) in recent years, as the Staff would be unlikely to concur with the companies’ arguments. Following SLB 14I, companies – through the additional discussion of the board’s consideration of the proposal – now may have a new avenue to argue that a sufficient nexus between a significant policy issue and the company does not exist. This may lead to the ability to exclude shareholder proposals, which previously would have been included in proxy statements due solely to their focus on an established significant policy issue.
The Discussion of the Board’s Analysis Likely Will Differ from the Staff’s Analysis of Rule 14a-8(i)(7)
When determining whether a policy issue raised by a shareholder proposal transcends ordinary business and is appropriate for a shareholder vote, the Staff indicated that it has looked, in part, to the social impact of a policy issue. For example, the Staff has looked to, among other things, the discussion of the issue in the media and any pending or passed legislation relating to the issue.
Mr. McNair clarified that the additional discussion of the board’s consideration of a proposal is not required to address the social impact of a policy issue; such discussion should focus on the policy issue’s impact on the company. The Staff is equipped to use its best judgment regarding the social impact of the issue raised by the proposal, but – as noted in SLB 14I and repeated by Mr. McNair – the board itself is in the best position to address the impact of the issue on the company.
Materials to Supplement the Discussion of Board Consideration of the Proposal
Mr. McNair indicated that the additional discussion by the board need not be supported by board resolutions or other supplemental materials. If the board’s process for making its findings is documented in some way, however, Mr. McNair stated that it would be helpful for the board to provide the Staff with details of that documentation in the no-action request. However, that documentation need not be provided to the Staff. If a company believes that supplemental materials would be helpful to bolster its argument, then it may provide such documentation with its no-action request. In this regard, however, it is important to note that all materials provided with a no-action request will become part of the public record, and companies may not seek confidential treatment of such documents.
Rule 14a-8(i)(5) Guidance
Rule 14a-8(i)(5) provides that a company may exclude a shareholder proposal if it “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.”
Application of Rule 14a-8(i)(5)
Historically, the Staff’s analysis under Rule 14a-8(i)(5) assessed whether a company conducted any amount of business related to the issue in the proposal and whether that issue was of broad social or ethical concern. If so, the Staff would not concur that the proposal could be excluded pursuant to Rule 14a-8(i)(5).
In SLB 14I, the Staff noted that its historical application of Rule 14a-8(i)(5) “unduly limited the exclusion’s availability” because the Staff did not fully consider whether the proposal “deals with a matter that is not significantly related to the issuer’s business.” The Staff stated that its analysis going forward will focus, consistent with the language of the rule, on a proposal’s significance to the company’s business when it otherwise relates to operations that account for less than 5% of total assets, net earnings, and gross sales. Whether a proposal is significant to a particular company’s business depends upon the facts and circumstances of the company to which the proposal is submitted; accordingly, the same proposal may be excludable by some companies but not others, depending on the significance to the particular company. In this regard, the Staff stated in SLB 14I that it generally views substantive governance matters to be significantly related to almost all companies.
In circumstances in which a proposal’s significance to a company’s business is not apparent from its resolved clause or supporting statement, the Staff indicated that a proponent should demonstrate that it is “otherwise significantly related to the company’s business,” or the company may exclude the proposal from its proxy materials. SLB 14I provides an example a situation in which a proponent submits a proposal raising social and ethical issues. In such a situation, the proponent may provide information demonstrating that the proposal “may have a significant impact on other segments of the company’s business or subject the company to significant contingent liabilities.” This information may tie the policy issues raised by the proposal to a significant effect on the company’s business. SLB 14I stated that the possibility of reputational or economic harm will not be sufficient in these circumstances.
Historically, the Staff’s determination of whether a proposal is “otherwise significantly related” to a company’s business for purposes of Rule 14a-8(i)(5) been premised upon its analysis of Rule 14a-8(i)(7)’s “ordinary business” exception. As a result, whether a proposal is “otherwise significantly related” for purposes of Rule 14a-8(i)(5) typically has depended upon whether the proposal transcends ordinary business for purposes of Rule 14a-8(i)(7). In SLB 14I, the Staff indicated that it will no longer consider its analysis under Rule 14a-8(i)(7) when evaluating a company’s arguments under Rule 14a-8(i)(5).
Additional Discussion Regarding a Board’s Consideration of Rule 14a-8(i)(5)
As with the “ordinary business” exception in Rule 14a-8(i)(7), the Staff noted in SLB 14I that determining whether a proposal is “otherwise significantly related to the company’s business” can raise difficult judgment calls, and a board is in a better position than the Staff to make that judgment in the first instance. Accordingly, the Staff stated that a company’s Rule 14a-8(i)(5) no-action request may include a discussion that reflects the board’s analysis of the proposal’s significance to the company. If a company chooses to include such a discussion, it should detail the specific processes employed by the board to ensure that its conclusions are well informed and well-reasoned.
Mr. McNair stated that the discussion of the board’s consideration of the proposal should include any descriptions and/or findings regarding the company and/or the policy issue that are sufficiently detailed to allow the Staff to make a decision regarding the significance of the proposal to the company’s business. As was the case with the voluntary additional discussion for Rule 14a-8(i)(7), discussed above, the Staff provided no guidelines for the additional disclosure; a company may include whatever information regarding the board’s assessment that it believes would be most helpful to the Staff in making its determination.
Consistent with the discussion of supplementing Rule 14a-8(i)(7) no-action requests, Mr. McNair noted that a company may supplement a no-action request dated prior to November 1, 2017 if it so chooses.
Rule 14a-8(d) Guidance
Rule 14a-8(d), a procedural basis for exclusion of a shareholder proposal, provides that a “proposal, including any accompanying supporting statement, may not exceed 500 words.”
In two recent no-action decisions, the Staff indicated that the mere fact that Rule 14a-8(d) does not expressly reference graphics or images does not prohibit the inclusion of graphics and/or images in proposals; as such, Rule 14a-8(d) does not preclude shareholders from using graphics to communicate information about their proposals. The Staff confirmed this view in SLB 14I. The Staff noted, however, that any words in the graphics or images will be counted for purposes of the 500-word limit in Rule 14a-8(d).
The Staff recognized that companies may still argue for exclusion of a shareholder proposal that includes graphics and/or images under other provisions of Rule 14a-8. In this respect, SLB 14I referred to Rule 14a-8(i)(3), which allows issuers to exclude proposals if the proposal or supporting statement contain materially false or misleading statements. The Staff noted that exclusion under Rule 14a-8(i)(3) would be permitted if the graphics or images:
Proposals Submitted on Behalf of Shareholders
Shareholders frequently elect to submit proposals through a representative, a process often referred to as “proposals by proxy.” In SLB 14I, the Staff acknowledged the challenges and concerns that proposals by proxy may present, including, whether the shareholder proponent has met the eligibility requirements of Rule 14a-8(b) or whether a shareholder proponent is aware that a particular proposal is being submitted on his or her behalf.
To address these concerns, in SLB 14I, the Staff requested that shareholders who submit a proposal by proxy “provide documentation describing the shareholder’s delegation of authority to the proxy.” The Staff expects such documentation to:
Where this information is not provided, the Staff stated that there may be a basis to exclude the proposal under Rule 14a-8(b). In this regard, it is important to note that the Staff is of the view that a notice of such a deficiency must be provided to the proponent, with the proponent having an opportunity to correct any deficiencies.
In “proposal by proxy” situations, Mr. McNair clarified that the exclusion would be appropriate only if the company cannot reasonably conclude that the representative is authorized to represent a shareholder proponent with respect to a particular proposal. If the company can reasonably conclude that the representation is authorized, notwithstanding a failure to conform to the Staff’s expectations, seeking exclusion would not be appropriate. Mr. McNair further emphasized that the Staff will not permit exclusion based on “foot faults” and discouraged companies from submitting no-action requests on that basis.
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