November 10, 2017
On November 1, 2017, the staff of the Securities and Exchange Commission (the “Staff”) published Staff Legal Bulletin No. 14I (SLB 14I), available here, which sets forth additional Staff guidance on shareholder proposals submitted under SEC Rule 14a-8.
SLB 14I addresses the Staff’s views on four issues:
This alert provides an analysis of SLB 14I and highlights key considerations related to SLB 14I for public companies headed into the 2018 proxy season.
The Ordinary Business Exception permits the exclusion of a shareholder proposal where “the proposal deals with a matter relating to the company’s ordinary business operations.” The Securities and Exchange Commission (“Commission”) has long stated that one of the reasons for this provision is to allow the exclusion of proposals addressing matters that are “fundamental to management’s ability to run a company on a day-to-day basis” unless a proposal focuses on policy issues that are sufficiently significant because they transcend ordinary business and would be appropriate for a shareholder vote. In this context, the Staff has long conducted a company-specific analysis that takes into account whether “a sufficient nexus exists between the nature of the proposal and the company.”
Noting that some shareholder proposals present particularly difficult questions of whether the proposal focuses on a sufficiently significant policy issue in the context of a company’s business, SLB 14I states that the company’s board of directors, which has fiduciary duties to all shareholders, is well situated to analyze the implications of a particular proposal. Accordingly, SLB 14I states that the Staff expects future no-action requests to include, if relevant, a discussion that reflects the board’s “analysis of the particular policy issue raised and its significance,” and believes that “explanation 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.”
The issue of whether a proposal raises a significant policy issue has long been one of the more difficult aspects of Rule 14a-8. The Staff has long both taken a broad view of factors that it will take into account in assessing such matters and recognized distinctions in how a proposal may have different implications for different companies. Thus, we view the call in SLB 14I for information on a board’s perspective as consistent with the Staff’s past administration of the rule, particularly as considerations such as the extent of media coverage have ceased to provide meaningful insight in our media-heavy society. While SLB 14I is not entirely clear on the point, we understand that the board’s analysis is not required in every no-action request where a company is seeking to rely on the Ordinary Business Exception, and will not necessarily be dispositive in cases where it is provided. Instead, SLB 14I offers an additional avenue of analysis that companies should consider providing when addressing social or other policy considerations that are raised by a proposal. In those contexts, a board’s perspective on whether the specific actions called for under a proposal raise significant policy issues in the context of their company’s specific operations will provide relevant additional context for the Staff’s analysis.
The Economic Relevance Exception permits exclusion of a shareholder proposal that relates to operations which (1) account for less than 5% of each of a company’s total assets, net earnings and gross sales, and (2) are not otherwise significantly related to the company’s business. When the Commission amended this provision in 1983, it characterized the exemption as relating to proposals “concerning the functioning of the economic business of an issuer” and not to corporate governance matters such as “shareholders’ rights.” By adopting the economic relationship tests set forth in the rule, the Commission sought to break from past interpretations that had denied exclusion of a proposal when it raised social or ethical issues without regard to the economic significance of such matters. Notwithstanding that Commission action, the Staff’s past interpretation of the “otherwise significantly related” prong of the Economic Relevance Exception has largely collapsed the administration of the Economic Relevance Exception with the Ordinary Business Exception, taking the position that a proposal would be deemed to be “significantly related” to a company’s business if it raised significant policy issues.
In SLB 14I, the Staff announced that it will refocus on the language of the Economic Relevance Exception when administering the rule. Thus, going forward, the Staff’s focus in considering requests to exclude a shareholder proposal under the Economic Relevance Exception will be whether the proposal otherwise relates to operations that account for less than 5% of each of total assets, net earnings and gross sales. SLB 14I notes that, under this framework, “proposals that raise issues of social or ethical significance may be included or excluded, notwithstanding their importance in the abstract, based on the application and analysis of each of the factors” in the Economic Relevance Exception. In applying this standard, the analysis of whether a proposal raises significant policy issues under the Ordinary Business Exception will no longer be conflated with or germane to the Economic Relevance Exception. Instead, the Staff notes that a shareholder may be able to avoid exclusion by demonstrating other economic significance of the proposal to the specific company, such as demonstrating that the proposal has “a significant impact on other segments of the issuer’s business or subject[s] the issuer to significant contingent liabilities.” The Staff notes that social or ethical issues may continue to be relevant, but “[t]he mere possibility of reputational or economic harm will not preclude no-action relief.” In contrast, corporate governance proposals generally will not be excludable under the Economic Relevance Exception.
As with the Ordinary Business Exception, SLB 14I notes that a company’s board is well positioned to determine whether a particular proposal is “otherwise significantly related to the company’s business.” Accordingly, the Staff again states that a company’s request under the Economic Relevance Exception should include, if relevant, a discussion that reflects the board’s analysis of the proposal’s significance to the company, and as in its discussion of the Ordinary Business Exception, further notes that an “explanation 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.”
Rule 14a-8 does not address the submission of proposals by non-shareholders, and states that “The references [in Rule 14a-8] to ‘you’ are to a shareholder seeking to submit the proposal.” Accordingly, Rule 14a-8 does not explicitly address a third party’s ability to submit proposals on behalf of a shareholder, a process frequently referred to as Proposals by Proxy. In SLB 14I, the Staff reaffirms its position that a shareholder’s submission of a proposal by proxy is permissible as long as the submission is consistent with Rule 14a-8.
As Proposals by Proxy have increased in recent years, there have been numerous instances where the shareholder’s involvement with the shareholder proposal was at best tenuous. Recognizing that Proposals by Proxy raise concerns as to whether a shareholder truly stands behind a proposal and whether the eligibility requirements of Rule 14a-8 are satisfied, the Staff in SLB 14I has addressed the documentation that a shareholder should provide to document its delegation of authority to submit a proposal.
Under SLB 14I, shareholders who submit Proposals by Proxy will be expected to provide documentation to:
The Staff’s guidance in this regard applies only to proposals submitted by proxy after November 1, 2017, the date SLB 14I was published. When a shareholder has not provided such documentation, a company will need to provide a timely deficiency notice that specifically identifies the defects with the shareholder’s submission. If a shareholder fails to correct the defects within the 14-day time period established under Rule 14a-8, the proposal may be excludable.
While the Staff’s position is helpful in recognizing one of the concerns that have contributed to the current debate over the shareholder proposal rules, it addresses only a very minor aspect of the Proposal-by-Proxy issue and does not go far enough to address other abuses of Rule 14a-8 that harm both companies and their shareholders.
Rule 14a-8(d) is a procedural basis for exclusion of shareholder proposals, and provides that a “proposal, including any accompanying supporting statement, may not exceed 500 words.” In recent years, the Staff has conflated the issue of whether Rule 14a-8(d) prohibits the inclusion of graphs and/or images in proposals with the fact that the rule was designed to limit the amount of space a shareholder proposal may occupy in a company’s proxy statement. Accordingly, the Staff has not concurred that proposals containing images or graphics in addition to words can be excluded.
Recognizing the potential for abuse in this context, the Staff believes that Rule 14a-8(i)(3) can address these issues. In SLB 14I, the Staff notes that graphs and/or images can be excluded under Rule 14a-8(i)(3) if they:
While the Staff’s reaffirmation that images and graphics remain subject to the substantive bases for exclusion under Rule 14a-8, SLB 14I stops short of addressing the key issue of how a graphic or image is to be evaluated under the objective 500-word procedural standard of the rule. Instead, SLB 14I notes only that exclusion of a proposal would also be appropriate under Rule 14a-8(d) if the total number of words, including words in the graphics, exceeds 500. As well, SLB 14I addresses only the exclusion of an image or graphic, and does not address when the inclusion of an image or graphic will justify exclusion of the entire proposal.
The Staff further indicates that “companies should not minimize or otherwise diminish the appearance of a shareholder’s graphic,” and gives two examples of how graphics should be treated in a company’s proxy statement:
Below are some considerations for companies in assessing the Staff guidance.
Overall, SLB 14I provides important guidance for companies as well as for shareholder proponents on the Staff’s administration of the rule. Nevertheless, the shareholder proposal process remains under intense scrutiny, and there remain calls for the Commission to take further action on the rule. For example, on November 8, 2017, Chairman Jay Clayton remarked that “[q]uestions exist about the appropriate level of ownership that should be required to submit shareholder proposals, as well as whether our current resubmission thresholds are too low.”
 See “Remarks at the PLI 49th Annual Institute on Securities Regulation: Governance and Transparency at the Commission and in our Markets”, available at https://www.sec.gov/news/speech/speech-clayton-2017-11-08.
The following Gibson Dunn lawyers assisted in the preparation of this client update: Ronald O. Mueller, Elizabeth Ising, Lori Zyskowski and Gillian McPhee.
Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following lawyers in the firm’s Securities Regulation and Corporate Governance practice group:
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, [email protected])
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
Lori Zyskowski – New York (+1 212-351-2309, [email protected])
Gillian McPhee – Washington, D.C. (+1 202-955-8201, [email protected])
Maia Gez – New York (+1 212-351-2612, [email protected])
Michael Titera – Orange County, CA (+1 949-451-4365, [email protected])
Julia Lapitskaya – New York (+1 212-351-2354, [email protected])
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