October 27, 2015

Corporate Alert: SEC Issues Guidance on Shareholder Proposal Exclusions

On October 22, 2015, the SEC’s Division of Corporation Finance issued Staff Legal Bulletin No. 14H (SLB 14H) to provide guidance on the scope and application of Exchange Act Rules 14a-8(i)(9) and (7), two of the substantive bases for the exclusion of shareholder proposals from a company’s proxy materials.

Rule 14a-8(i)(9)

Rule 14a-8(i)(9) permits a company to exclude a shareholder proposal “[i]f the proposal directly conflicts with one of the company’s own proposals to be submitted to shareholders at the same meeting.” In response to interpretive questions arising during the last proxy season, SEC Chair Mary Jo White directed the Division to review the scope and application of this exclusion, and the Division suspended its consideration of company requests for no-action relief under Rule 14a-8(i)(9).

The Division’s decades-old approach to granting no-action relief under this rule permitted exclusion of a shareholder proposal if including it, along with a management proposal, could present “alternative and conflicting decisions for the shareholders” and create the potential for “inconsistent and ambiguous results.” After reviewing the history of the rule, however, the Division has significantly narrowed the scope of the exclusion by promulgating a new test for excludability—whether there is a “direct conflict” between the management and shareholder proposals.

As articulated in SLB 14H, a direct conflict would exist if “a reasonable shareholder could not logically vote in favor of both proposals, i.e., a vote for one proposal is tantamount to a vote against the other proposal” so that “they are, in essence, mutually exclusive proposals.” Two examples given of a direct conflict are: (i) a company proposal to approve a merger, and a shareholder proposal asking shareholders to vote against the merger; and (ii) a management proposal to approve a bylaw provision requiring the CEO to be the chair at all times, and a shareholder proposal asking for the separation of the chairman and CEO positions.

A shareholder proposal would not be viewed as directly conflicting with a management proposal, however, if a reasonable shareholder, although possibly preferring one proposal over the other, could logically vote for both. For example, SLB 14H notes that a shareholder proposal to permit a shareholder or shareholder group holding at least 3 percent of the company’s outstanding stock for at least three years to nominate up to 20 percent of the company’s directors would not be excludable if a management proposal would allow shareholders holding at least five percent of the company’s stock for at least five years to nominate up to 10 percent of the company’s directors. That these proposals generally seek a similar objective does not constitute a direct conflict, such that a reasonable shareholder could not logically vote in favor of both. Similarly, a shareholder proposal requesting implementation of a minimum four-year annual vesting policy for equity awards 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. Consequently, companies will not be able to rely on the inclusion of a different version of a shareholder proposal in their proxy materials in order to receive no-action relief under this rule.

The Division also noted that it may permit a proponent to cure a direct conflict by changing the proposal’s form from binding to non-binding. If revised within a specified time, and if a reasonable shareholder could otherwise logically vote for both proposals, the shareholder proposal would then not be excludable under Rule 14a-8(i)(9).[1] SLB 14H does not impact the availability of the other bases for exclusion of shareholder proposals set forth in Rule 14a-8(i), including 14a-8(i)(7) discussed below.

Where companies are concerned that including both management and shareholder proposals on the same topic could potentially be confusing, they may explain the differences between the two proposals, and how they would expect to consider the results of the shareholder votes.

Rule 14a-8(i)(7)

In Trinity Wall Street v. Wal-Mart Stores, Inc., a three-judge panel of the US Court of Appeals for the Third Circuit, reversing a decision by the US District Court of the District of Delaware, ruled that a shareholder proposal submitted to Wal-Mart Stores Inc. was excludable under Rules 14a-8(i)(3) and 14a-8(i)(7) (the latter permitting the exclusion of proposals related to a company’s ordinary business operations). The Division’s staff had previously agreed that Walmart could exclude the proposal under Rule 14a-8(i)(7).[2]

In analyzing whether the proposal was excludable under Rule 14a-8(i)(7), both the Third Circuit and the Division concluded that the proposal’s subject matter related to Wal-Mart’s ordinary business operations. However, in analyzing whether the proposal could not be excluded because of the “significant policy exception” to the ordinary business exclusion, the majority opinion in Trinity employed a new two-part test, concluding that “a shareholder must do more than focus its proposal on a significant policy issue; the subject matter of its proposal must ‘transcend’ the company’s ordinary business.”[3] To transcend a company’s ordinary business, the majority opinion found that the significant policy issue must be “divorced from how a company approaches the nitty-gritty of its core business.”[4] The court’s two-part approach differs from the SEC’s prior statements on the ordinary business exclusion, and the Division was concerned that it may lead to the improper exclusion of shareholder proposals.

As a result, SLB 14H states that the Division will continue to apply Rule 14a-8(i)(7) consistent with its own prior practice, as endorsed by the concurring judge in Trinity. Specifically, instead of treating the concept of “significance” and “transcendence” separately, the Division will continue to take the position that a proposal is sufficiently significant such that the ordinary business exclusion does not apply “because” it “transcends day-to-day business matters.”[5] Although the Division concluded that the significant policy exception did not apply to the proposal submitted to Walmart, it did not view the proposal’s focus as distinct from whether it “transcends” a company’s ordinary business. Thus, as stated in SLB 14H, “a proposal may transcend a company’s ordinary business operations even if the significant policy issue relates to the nitty-gritty of its core business.”

[1] SLB 14H notes that a binding shareholder proposal on the same subject as a binding management proposal may be excludable under Rules 14a-8(i)(1) (improper under state law) or 14a-8(i)(2) (violation of law) to the extent a company demonstrates that it is excludable under one of those bases.

[2] The Division was not asked to express a view on the application of Rule 14a-8(i)(3), and no view on that exclusion is addressed in SLB 14H.

[3] Trinity, 792 F.3d at 346-347.

[4] In the Trinity case, the shareholder proposal requested the development of standards for management to use in deciding whether to sell certain products (although couched more broadly, the proposal was aimed at the sale of assault rifles). The court, however, found that these types of decisions do not “transcend” ordinary business, because product selection is the “foundation of retail management.” 

[5] Id. at 353 (Schwartz, J., concurring)

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