On November 3, 2021, the staff (“staff”) of the Division of Corporation Finance (“Division”) of the U.S. Securities and Exchange Commission (“SEC”) published Staff Legal Bulletin No. 14L which reverses a series of interpretive positions and is likely to result in a significant increase in the number of shareholder proposals that involve climate change, human capital management and other significant social policy issues being included in proxy statements during the 2022 proxy season. The interpretive changes, which were effective upon publication, will reduce the ability of companies to obtain assurances that the staff will not recommend enforcement action (“no-action” letters) if the company excludes a shareholder proposal from its proxy statement under Rule 14a-8 of the Securities Exchange Act of 1934. The new interpretive positions sharply limit the ability to exclude shareholder proposals under the “ordinary business,” “economic relevance” and “micromanagement” doctrines. Moreover, under a 2015 interpretive position, it will continue to be difficult for companies to seek to exclude shareholder proposals under the “directly conflicts” doctrine. Although it is difficult to predict the full impact of the staff’s decision to reverse its three most recent interpretive positions on the exclusion of shareholder proposals from proxy statements under Rule 14a-8, it is clear that companies should be planning for the impact of these changes on their 2022 proxy statements.
What Companies Should Be Doing Now
The staff’s decision to rescind the interpretive positions taken in Staff Legal Bulletin Nos. 14I (2017), 14J (2018) and 14K (2019), combined with the restrictive position taken in Staff Legal Bulletin No. 14H (2015), is likely to change the approach taken by many companies to shareholder proposals in the 2022 proxy season. The staff’s interpretive changes may result in an increase in shareholder proposals, especially those that relate to ESG (environmental, social and governance) matters. Staff Legal Bulletin No. 14L specifically cites shareholder proposals that relate to climate change and human capital management as examples of shareholder proposals that the staff is likely to treat differently under its new interpretive positions, but the changes could extend to a broader spectrum of issues. Companies should be aware of these potential impacts on both their proxy solicitation process and their corporate governance policies going forward. With this in mind, companies should begin considering potential responses to shareholder proposals, both as they prepare their proxy statements and during the proxy solicitation period. Companies should also consider potential responses after any shareholder vote, giving particular consideration to how significant investors and proxy advisory services may respond if the company ignores or minimizes the policy concerns expressed in a shareholder proposal that is either approved by shareholders or receives significant shareholder support.
Exclusion on Substantive Grounds. The reversal of Staff Legal Bulletin Nos. 14I, 14J and 14K, combined with the staff’s very narrow interpretation of the “directly conflicts” doctrine in Staff Legal Bulletin No. 14H leaves companies fewer and less viable substantive grounds to seek no-action relief if they want to exclude a shareholder proposal. Under its current interpretive position published in Staff Legal Bulletin No. 14H (2015), the staff will not take a no-action position that supports a company’s exclusion of a shareholder proposal where management represents that it intends to offer a proposal on similar matters at the shareholders’ meeting unless shareholders could not logically vote for both proposals. The staff views competing shareholder and management proposals as complementary, rather than subject to a disqualifying conflict, unless the two proposals present a direct and irreconcilable conflict.
Exclusion on Procedural Grounds. Rule 14a-8 requires proponents to satisfy a variety of eligibility and procedural requirements, such as minimum share ownership amounts and time periods, timeliness, proposal length and attendance at the meeting. Companies can continue to exclude shareholder proposals that do not satisfy the procedural requirements of Rule 14a-8. Companies should note that in Staff Legal Bulletin No. 14L the staff has reiterated the position it took in Staff Legal Bulletin No. 14K encouraging companies not to rely on “overly technical” positions on shareholder proof of ownership letters as a reason to exclude a shareholder proposal.
Exclusion without a No-Action Letter. Companies that intend to exclude a shareholder proposal from the proxy statement are not required to obtain no-action relief from the staff, although companies usually do so. Companies that are considering excluding a shareholder proposal without seeking no-action relief should evaluate the risks of litigation by the shareholder proponent and enforcement action by the SEC Division of Enforcement, as well as the potential consequences of such litigation on the company’s proxy solicitation and annual meeting. Companies could also seek to exclude a shareholder proposal by seeking judicial declaratory relief, although this has been uncommon historically and could involve significant expense and delays that could be inconsistent with the company’s usual annual meeting schedule. It could also have potential investor relations issues given the optics of a company suing a shareholder to prevent other shareholders from voting on a proposal.
Voluntary Withdrawal of a Proposal. Companies may seek to negotiate with a shareholder proponent in an effort to convince the proponent to withdraw a proposal. The inability to exclude a proposal on substantive grounds under Rule 14a-8 may very well place companies in a weaker position in trying to negotiate out a proposal.
Rule 14a-8 and Recent Interpretive Changes
Rule 14a-8 provides a method for shareholders to present proposals in a company’s proxy statement for consideration at a shareholders’ meeting. Rule 14a-8 sets forth a variety of procedural requirements that apply to the shareholder submitting the proposal and the substance of the proposal itself. Rule 14a-8 also sets forth several substantive bases on which a company can exclude a proposal. Companies seeking to exclude a shareholder proposal generally submit a request to the staff seeking assurance that the staff will not recommend enforcement action if the company omits the proposal based on one of the exclusions in Rule 14a-8. Additional discussion of Rule 14a-8 and the recent history of the staff’s interpretive positions on Rule 14a-8 is available in our earlier alerts on Staff Legal Bulletin Nos. 14H (interpreting the “directly conflicts” exclusion, 2015), 14I (interpreting the “ordinary business” and “economic relevance” exclusions, 2017), and 14J (further interpreting the “ordinary business” and “economic relevance” exclusions, 2018) and may also be obtained by reviewing Staff Legal Bulletin No. 14K (additional interpretations of the “ordinary business” exclusion, 2019). Further information on recent developments affecting shareholder proposals is available in our alert SEC Amends Requirements for Shareholder Proposals (Rule 14a-8 amendments, 2020).
As stated above, Staff Legal Bulletin No. 14L rescinds Staff Legal Bulletin Nos. 14I (2017), 14J (2018) and 14K (2019) in their entirety. To the extent that any other prior staff legal bulletin issued by the Division could be viewed as contrary to the interpretive positions stated in Staff Legal Bulletin No. 14L, the positions expressed in Staff Legal Bulletin No. 14L will control. The staff has republished in Staff Legal Bulletin No. 14L guidance previously published in the rescinded staff legal bulletins on the use of graphics and images in shareholder proposals and on proof of ownership letters, with changes that are primarily technical or conform the earlier guidance to more recent guidance. Staff Legal Bulletin No. 14L also provides new guidance on the use of email for submitting proposals, giving notice of procedural defects and responding to those notices.
The rescinded interpretive positions relate to Rule 14a-8(i)(7), the “ordinary business” exclusion, and Rule 14a-8(i)(5), the “economic relevance” exclusion, both of which provided substantive grounds for a company to exclude a shareholder proposal.
In responding to company no-action requests under the ordinary business exclusion, the staff had developed two tests. The first was whether the subject matter of a proposal involved matters that were “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.” In these situations, the staff would generally grant no-action relief unless the proposal dealt with policy issues that were so significant that they transcended considerations that would otherwise warrant shielding the company’s operation of its business from the impact of the proposal. This depended on the relationship between the nature of the company’s business and the significant policy issue raised by the proposal.
The second test under the ordinary business exclusion was whether a proposal “micromanaged” the company. This determination depended on the subject matter and specificity of the proposal and whether the proposal presents matters sufficiently complex that shareholders could not make an informed decision. The staff would often conclude that proposals that would require a company to adopt or achieve specific goals on specific timelines were excludable under the micromanagement test. More recently, however, the staff has been denying no-action relief in cases where a proposal requests that a company establish goals and targets – for example, for emission reduction – without dictating specific targets or methods. Staff Legal Bulletin No. 14L says that the staff will not in the future concur that companies may exclude proposals that “suggest targets or timelines so long as the proposals afford discretion to management as to how to achieve such goals.”
The relevance test under Rule 14a-8(i)(5) permitted a company to exclude a shareholder proposal if the proposal related to matters that were not significant to the company’s business. In quantitative terms, this meant that a company could exclude a proposal that related to business operations that were less than five percent of the company’s total assets, revenues and net income. In these cases, the staff would then determine whether the subject matter of the proposal was relevant to the company based on its significance to the individual company’s business rather than its general social or economic significance.
All three of these tests required the staff to engage in time-consuming factual analysis of the company’s business and the subject matter of the proposal. Staff Legal Bulletin No. 14L states that the nature of these reviews, depended in part on whether the company submitted a complete factual discussion and could lead to inconsistent results.
Guidance on Use of Images, Proof of Ownership Letters and Use of Email
Staff Legal Bulletin No. 14L essentially reiterates prior guidance on the use of images in shareholder proposals and how shareholders can use proof of ownership letters to prove that the shareholder has continuously held the required number of shares for the required period of time. It also includes new guidance on the use of email to submit proposals and to deliver and respond to notices under Rule 14a-8.
Rule 14a-8 limits shareholder proposals to 500 words or less. The staff will generally not permit companies to exclude images in shareholder proposals unless the images violate specific tests such as making the proposal materially false or misleading, or rendering the proposal so inherently vague or indefinite that it is not possible for shareholders or the company to determine with reasonable certainty exactly what actions or measures the proposal would require.
Staff Legal Bulletin No. 14L also reiterates prior guidance about proof of ownership letters. In order to make it easier for shareholders to prove that they had satisfied appliable ownership amount and length of ownership requirements in Rule 14a-8, the staff had published a form of ownership letter. Some companies have applied an excessively technical interpretation of this requirement as a reason to exclude a proposal. Staff Legal Bulletin No. 14L says that the staff will take a plain language view when reviewing company no-action requests to exclude shareholder proposals based on perceived defects in the proof of ownership letter, and goes on to say that “companies should not seek to exclude a shareholder proposal based on drafting variances in the proof of ownership letter if the language used in such letter is clear and sufficiently evidences the requisite minimum ownership requirements.”
The pandemic accelerated the use of email to submit shareholder proposals to companies and to deliver notices of defects and responses to such notices. Staff Legal Bulletin No. 14L places the burden of proving timely delivery to the appropriate recipient on the sender, and encourages senders to seek confirmation that the recipient actually received the email, while also encouraging recipients to confirm receipt. It notes that spam filters or incorrect email addresses can prevent delivery to the appropriate recipient, and that server logs and sender delivery confirmations, which confirm that an email was sent, may not adequately prove actual receipt for purposes of satisfying the requirements of Rule 14a-8.
Proxy Advisory Services and Institutional Investor Policies
Although less likely to be an important consideration until after shareholders have voted on a shareholder proposal, it may in some cases be helpful when considering how to respond to a shareholder proposal that proxy advisory services such as Institutional Shareholder Services and Glass Lewis have voting policies that can lead to “against” recommendations on the election of directors, especially those who serve as committee chairs, based on how a company responds to shareholder proposals that receive a majority of shareholder votes or, in some cases significant shareholder support even if not approved, at a shareholders’ meeting. On November 4, 2021, ISS published proposed updates to its U.S. voting policies that (1) would clarify its current analytical frameworks for analyzing management and shareholder proposals that involve management’s climate action plans, including “say on climate” proposals and (2) would generally result in ISS issuing an “against” or “withhold” recommendation for the responsible incumbent director(s) or committee members, or the full board, in cases where ISS determines a company that is a significant greenhouse gas emitter has not made appropriate climate-related disclosures or has not established quantitative goals to reduce greenhouse gas emissions.