On October 22, 2015, the staff of the SEC Division of Corporation Finance issued Staff Legal Bulletin No. 14H (SLB 14H), which provides significant guidance for companies about the Staff’s views on the scope and application of Rule 14a-8(i)(9) to shareholder proposals in light of the controversy that resulted from the Staff’s issuance of the Whole Foods Market, Inc. (March 20, 2014) no-action letter. The Staff’s new standard for conflicting proposals is likely to make it more difficult for companies to exclude a shareholder proposal that is different from a management proposal if the two proposals are not “mutually exclusive.”
SLB 14H also provides information about how the Staff will apply Rule 14a-8(i)(7) in light of the Third Circuit decision in Trinity Wall Street v. Wal-Mart Stores, Inc. The Staff states that it will continue to apply existing SEC and Staff views when reviewing company no-action requests involving the ordinary business exclusion and the exception for shareholder proposals that present a significant social policy issue. Although there will be no change in the standards for Staff review, results may differ if litigated in the Third Circuit, which has appellate jurisdiction over the District of Delaware, among others.
Shareholder Proposals under Rule 14a-8
Rule 14a-8 permits shareholders to have a public company include a shareholder proposal in a company’s proxy materials if the proposal satisfies specified conditions. In general, companies must include a shareholder proposal unless the proposal violates one of the eligibility or procedural requirements of Rule 14a-8 or the proposal is within one of the 13 substantive bases for exclusion.
Companies seeking to exclude a shareholder proposal typically request a no-action letter from the Staff with regard to whether the company may do so, although SEC rules require only that the company file its reasons for excluding a shareholder proposal with the SEC no later than 80 calendar days before it files its definitive proxy statement. In February 2015, Institutional Shareholder Services announced that it would generally recommend a vote against one or more directors if a company omits a properly submitted shareholder proposal from its ballot without obtaining no-action relief from the SEC or a ruling from a U.S. District Court or unless the shareholder proponent voluntarily withdraws the proposal.
Rule 14a-8(i)(9) and the “Directly Conflicts” Exclusion
Rule 14a-8(i)(9) is one of the substantive bases for exclusion of a shareholder proposal under Rule 14a-8. It 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.”
During the 2015 proxy season, the Staff suspended making no-action decisions on the basis of Rule 14a-8(i)(9) when questions arose after the Staff issued a controversial letter to Whole Foods that allowed the company to exclude a proxy access shareholder proposal under Rule 14a-8(i)(9). As a result of the controversy, SEC Chair Mary Jo White directed the staff to review the scope and application of Rule 14a-8(i)(9).
In SLB 14H, the Staff states that it will conclude that a direct conflict between a management proposal and a shareholder proposal exists only if a reasonable shareholder could not logically vote in favor of both proposals. In other words, the Staff will only treat proposals as directly conflicting if “a vote for one proposal is tantamount to a vote against the other proposal.” The Staff acknowledges that this standard may place a higher burden on companies in some cases when they seek to exclude a shareholder proposal than existed under the Staff’s previous interpretation of the 14a-8(i)(9) standard. The Staff also stated that in cases where a company’s proxy statement includes both a shareholder proposal and a management proposal on the same topic, Rule 14a-9 permits the company to include disclosure in the proxy statement that explains the differences between the two proposals and how the company would expect to treat the voting results.
Examples of the New “Directly Conflicts” Standard. SLB 14H provides four examples that illustrate how the Staff’s focus on whether a reasonable shareholder could logically vote for a management proposal and a shareholder proposal will affect how it applies the 14a-8(i)(9) exemption.
Examples that do not Directly Conflict
- If a company does not allow shareholder nominees to be included in the company’s proxy statement, a shareholder proposal that would permit a shareholder or group of shareholders holding at least 3% of the company’s outstanding stock for at least 3 years to nominate up to 20% of the directors would not be excludable if a management proposal would allow shareholders holding at least 5% of the company’s stock for at least 5 years to nominate for inclusion in the company’s proxy statement 10% of the directors. SLB 14H states that the Staff will view both proposals as generally seeking to give shareholders the ability to include their nominees for director alongside management’s nominees in the proxy statement, and the similarity of the two proposals does not present shareholders with conflicting decisions such that a reasonable shareholder could not logically vote in favor of both proposals, even though the shareholder might prefer one over the other.
- A shareholder proposal that asks the compensation committee to implement a policy that equity awards would have no less than four-year annual vesting 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. SLB 14H states that these proposals are not in direct conflict because the Staff believes that a reasonable shareholder could logically vote for a compensation plan that gives the compensation committee the discretion to determine the vesting of awards, as well as a proposal seeking implementation of a specific vesting policy that would apply to future awards granted under the plan.
Examples that Directly Conflict
- If a company seeks shareholder approval of a merger, and a shareholder proposal asks shareholders to vote against the merger, the Staff would view the proposals as being in direct conflict.
- The Staff would also view a shareholder proposal that asks for the separation of the company’s chairman and CEO as being in direct conflict with a management proposal seeking approval of a bylaw provision requiring the CEO to be the chair at all times.
Prior Staff Guidance. Before issuing SLB 14H, the Staff had for many years allowed companies to exclude shareholder proposals on the same general subject matter if a management proposal provided for different terms than the shareholder proposal. The Staff evaluated competing proposals to determine whether the proposals could present “alternative and conflicting decisions for the shareholders” or could create the potential for “inconsistent and ambiguous results.”
Prior Staff guidance on the 14a-8(i)(9) exemption focused on the potential for shareholder confusion and inconsistent mandates. Going forward, the Staff will instead focus more specifically on the nature of the conflict between a management and shareholder proposal. As described above, SLB 14H indicates that the Staff will find a direct conflict only if a reasonable shareholder could not logically vote in favor of both proposals.
Rule 14a-8(i)(7), the “Ordinary Business” Exclusion and the Trinity Wall Street Decision
SLB 14H also indicates that the Staff disagrees with the interpretation of the significant policy exception to the “ordinary business” exclusion under Rule 14a-8(i)(7) adopted by the majority opinion in Trinity Wall Street v. Wal-Mart Stores, Inc.
Rule 14a-8(i)(7) permits companies to exclude a shareholder proposal if it “deals with a matter relating to the company’s ordinary business operations.” The SEC and the Staff have developed an exception for shareholder proposals that present a significant social policy issue for consideration. Some commentators (and the majority opinion in Trinity Wall Street) have felt that the distinctions drawn by the Staff in its no-action letters have not always clearly and consistently distinguished between proposals dealing with ordinary business operations (which a company may exclude) and proposals that raise significant social policy matters (which a company may not exclude).
The Trinity Wall Street Majority Opinion. The majority opinion in the Trinity Wall Street decision employed a new two-part test. The first step in this analysis is whether the proposal “deals with a matter relating to the company’s ordinary business operations.” If it does, the Third Circuit test proceeds to the second step. In order to avoid being subject to exclusion under the “ordinary business” exclusion, the majority opinion requires 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.” The majority opinion found that to transcend a company’s ordinary business, the significant policy issue must be “divorced from how a company approaches the nitty-gritty of its core business” and the opinion closed by suggesting that the SEC consider issuing fresh guidance on the “ordinary business” exclusion.
The “Ordinary Business” Exclusion After SLB 14H. The majority opinion in Trinity Wall Street differs from existing SEC and Staff guidance that has stated that companies may not exclude proposals focusing on a significant policy issue under the ordinary business exclusion if “the proposals would transcend the day-to-day business matters and raise policy issues so significant that it would be appropriate for a shareholder vote.” Unlike the majority opinion in Trinity Wall Street, the SEC has treated significance and transcendence as related concepts, not separate tests. Thus, under SEC and Staff guidance, 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,” and is not excludable under Rule 14a-8(i)(7).
SLB 14H states that the Staff is concerned that the new approach introduced by the majority opinion in Trinity Wall Street goes beyond the SEC’s prior statements and may lead to the unwarranted exclusion of shareholder proposals. SLB 14H indicates that the Staff will continue to apply the Rule 14a-8(i)(7) “ordinary business” exclusion as previously articulated by the Commission and consistent with the Staff’s prior application of the exclusion, and will not adopt the approach adopted by the majority opinion in Trinity Wall Street.