On November 1, 2017, the Division of Corporation Finance of the U.S. Securities and Exchange Commission ("SEC") released Staff Legal Bulletin No. 14I (the "Bulletin") (available here) to provide guidance on four topics related to the exclusion by a company of a shareholder proposal from the company’s proxy statement pursuant to Rule 14a-8 under the Securities Exchange Act of 1934. The Division’s views discussed in the Bulletin concern:
- the "ordinary business" exception under Rule 14a-8(i)(7);
- the "economic relevance" exception under Rule 14a-8(i)(5);
- the eligibility requirements under Rule 14a-8(b); and
- the use of images in shareholder proposals under Rule 14a-8(d).
The Ordinary Business Exception
The "ordinary business" exception provided in Rule 14a-8(i)(7) permits a company to exclude a shareholder proposal that "deals with a matter relating to the company’s ordinary business operations." Under this exception, the SEC has historically permitted the exclusion of shareholder proposals that raise 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", unless the shareholder proposal "focuses on policy issues that are sufficiently significant because they transcend ordinary business and would be appropriate for a shareholder vote" (see Release No. 34-40018 (May 21, 1998), available here).
Such a determination is highly fact specific, and the SEC believes that a company’s board is best situated to make this determination; however, the SEC has observed a recurring trend of no-action requests focusing on whether a shareholder proposal that addresses ordinary business matters nonetheless focuses on a policy issue that is sufficiently significant to transcend ordinary business and override the exception in Rule 14a-8(i)(7).
In light of the foregoing, the Bulletin provides guidance that, going forward, any no-action request under Rule 14a-8(i)(7) must include a discussion that reflects the board’s analysis of the particular policy issue raised by the shareholder proposal and its significance. The Bulletin further instructs companies that such discussion would be "most helpful if it detailed the specific processes employed by the board to ensure that is conclusions are well-informed and well-reasoned."
The Economic Relevance Exception
The "economic relevance" exception provided in Rule 14a-8(i)(5) permits a company to exclude a shareholder 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."
Following a decision by the District Court for the District of Columbia in Lovenheim v. Iroquois Brands, Ltd., 618 F. Supp. 554 (D.D.C. 1985), however, the SEC’s application of the rule to shareholder proposals related to a matter of social or ethical significance has resulted in only infrequent exclusion under the "economic relevance" exception, even where a shareholder proposal relates to less than 5% of total assets, net earnings and gross sales, if the company conducted business, no matter how small, related to the issue raised in the proposal.
The Bulletin acknowledges this interpretation has unduly limited the availability of the exclusion under Rule 14a-8(i)(5) because it has largely ignored the portion of the rule related to whether the proposal "deals with a matter that is not significantly related to the issuer’s business." Therefore, going forward, for shareholder proposals that raise issues of social or ethical significance, the SEC will focus on a shareholder proposal’s "significance to the company’s business when it otherwise relates to operations that otherwise account for less than 5% of total assets, net earnings and gross sales." The Bulletin further clarifies that the SEC will "generally view substantive governance matters to be significantly related to almost all companies."
The SEC also indicate that where a shareholder proposal’s significance to a company’s business is not apparent on its face, the proposal is excludable unless the proponent can demonstrate that the proposal is "otherwise significantly related to the company’s business." Upon such a showing, the SEC will consider the proposal in the light of the "total mix" of information about the company.
As with the "ordinary business exception" under Rule 14a-8(i)(7), the SEC believes the board of the company is in the best position to determine wither a particular proposal is "otherwise significantly related to the company’s business." Accordingly, the Bulletin provides guidance that going forward the SEC will expect a company’s Rule 14a-8(i)(5) no-action request to "include a discussion that reflects the board’s analysis of the proposal’s significance to the company." The Bulletin further instructs companies that such 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."
Finally, the Bulletin instructs that, while historically the SEC has historically analyzed whether a proposal is "otherwise significantly related" under the "ordinary business exception" of Rule 14a-8(i)(5), the SEC now will apply "separate analytical frameworks [to] ensure that each basis for exclusion serves its intended purpose."
Proposal by Proxy
Historically, the SEC has viewed a shareholder’s submission of a shareholder proposal through a representative as consistent with Rule 14a-8, although the rule does not address the ability of a shareholder to do so. The Bulletin reaffirms the SEC’s view that proposal by proxy is consistent with Rule 14a-8.
The Bulletin acknowledges the challenges and concerns that proposals by proxy may present with respect to the eligibility requirements of Rule 14a-8(b) and explains that the SEC will look to whether the shareholders who submit a proposal by proxy provide documentation describing the proposing shareholder’s delegation of authority to the proxy. The required documentation must:
- identify the shareholder proponent and the person or entity selected as proxy;
- identify the company to which the proposal is directed;
- identify the annual or special meeting for which the proposal is submitted;
- identify the specific proposal to be submitted; and
- be signed and dated by the shareholder.
In the event that such information is not provided, the Bulletin recognizes that there may be a basis to exclude the proposal under Rule 14a-8(b).
Use of Images in Shareholder Proposals
In two recent no-action letters, the SEC has expressed the view that, due to the "500 words" rule and the absence of an express reference to graphics in Rule 14a-8(d), the inclusion of graphs and/or images in shareholder proposals is not prohibited. The Bulletin recognizes that the potential for abuse is mitigated by the ability of a company to exclude graphs and/or images under Rule 14a-8(i)(3) in the event that they are:
- materially false or misleading;
- inherently vague or indefinite;
- directly or indirectly impugn character, integrity or personal reputation; or
- are irrelevant to a consideration of the subject matter of the proposal.
In addition to exclusion under Rule 14a-8(i)(3), the Bulletin further clarifies that the 500 word limit of a shareholder proposal applies to the entire proposal, including words in any graphs and/or images.
In addition to providing much needed clarity to certain rules governing the exclusion of shareholder proposals, the Bulletin makes clear the importance of a detailed analysis by the board of a company with respect to the application of Rules 14a-8(i)(5) and 14a-8(i)(7) when seeking to exclude a shareholder proposal through the no-action letter process. The company’s board must take great care not only to conduct a detailed analysis under the applicable rule, but also to document the steps taken by the board in the books and records of the company. Doing so will assist the company in providing supporting documentation required by the SEC when seeking an exception to include a shareholder proposal under Rules 14a-8(i)(5) or 14a-8(i)(7).
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