New SEC Guidance Makes Excluding Shareholder Proposals More Difficult

In Staff Legal Bulletin 14H released on October 22, 2015, the staff of the SEC’s Division of Corporation Finance weighed in on two important means by which a company may exclude a shareholder proposal from company proxy materials: 

• Rule 14a-8(i)(9), which permits exclusion of a shareholder proposal that “directly conflicts” with a management proposal 
• Rule 14a-8(i)(7), which permits exclusion of a shareholder proposal that relates to the company’s “ordinary business operations” 

Direct Conflicts with Management Proposals - Rule 14a-8(i)(9) 

In the past, companies could use the “directly conflicts” provision under Rule 14a-8(i)(9) to exclude shareholder proposals that were similar to, but not mutually exclusive with, management proposals. The staff drew attention to its application of the rule when it initially concurred in a no-action letter with Whole Foods Market’s exclusion of a proxy access shareholder proposal that permitted access for 3% shareholders who held for 3 years due to a conflict with a management proposal requiring a 9% shareholder who held for 5 years. The staff subsequently withdrew its concurrence with the Whole Foods Market’s exclusion and announced it would undertake a general review of the Rule 14a-8(i)(9) exception. In the bulletin, the staff announced that, based on its review of the history and purpose of the exception, its view is that a shareholder proposal is excludable under the rule due to a direct conflict between the management and shareholder proposals only “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.” 

Going forward, the staff is not likely to concur with a company’s exclusion under the rule unless the two proposals are “mutually exclusive.” In particular, with respect to the growing wave of proxy access proposals, the staff states that shareholders can reasonably vote for both a “3/3/25” shareholder proposal (permitting 3% shareholders or groups who hold for 3 years to nominate up to 25% of the board) and a more restrictive management proposal (such as a “5/3/20” proposal that increases the ownership threshold to 5%, reduces the number of directors to 20% of the board and may include other provisions such as limits on the number of shareholders who can form a group for purposes of the ownership threshold). Accordingly, companies will not be able to exclude proxy access proposals by countering with more restrictive management formulations of proxy access. 

Ordinary Business Operations - Rule 14a-8(i)(7) 

In a recent Third Circuit case, Trinity Wall Street v. Wal-Mart Stores, Inc.¹, the panel addressed a shareholder proposal requesting that the board create a written policy for evaluating whether to sell products “that especially endanger public safety,” “ha[ve] the substantial potential to impair the reputation of Wal-Mart” and/or “would reasonably be considered by many offensive to the family and community values integral to [Wal-Mart]’s promotion of its brand.” In particular, the proposal was aimed at reconsidering the sale of high capacity assault rifles. The Third Circuit panel overruled the district court and held that the proposal was excludable. In so doing, it created a two-part test which requires a shareholder’s proposal to both present a significant policy issue and transcend the company’s ordinary business operations in order to evade exclusion under Rule 14a-8(i)(7). In the bulletin, the staff reiterated its stance that proposals focusing on a significant policy issue inherently transcend a company’s ordinary business operations and are not excludable under Rule 14a-8(i)(7). Going forward, the staff intends to continue to apply this approach to requests for exclusions notwithstanding the majority opinion in the Third Circuit. 

Practical Implications 

• The staff’s approach to Rule 14a-8(i)(9) essentially removes a recently used tactic of companies to exclude shareholder proposals on a range of topics which contain core threshold provisions that make the matters more likely to be triggered. For instance, it will no longer pass muster with the staff to counter a shareholder proxy access proposal having a 3% ownership requirement with a management proposal having a 5% requirement (or requiring 9% share ownership, as was the case in the Whole Foods Market situation), or to counter a special meeting proposal, for instance, that includes a 10% ownership requirement to call a special meeting with a management proposal having a 20% ownership threshold. 
• Although the bulletin represents the Division of Corporation Finance staff’s views, rather than a formal SEC rule, and is inconsistent in some respects with judicial precedent such as the Trinity Wall Street case, many companies can be expected to follow the staff’s views in order to avoid both friction with the staff and potential litigation. 
• In response to the bulletin, companies will likely look to utilize side-by-side or preemptive tactics and other alternative methods to address certain shareholder proposals. For example, as was seen in the proxy season last spring with respect to many proxy access shareholder proposals, a company may include both the shareholder proposal and a dueling management proposal in the proxy statement, provide a clear description of the differences and recommend that the shareholder proposal not be approved in the company opposition statement. Or, as some others did with respect to proxy access shareholder proposals, a company might before or after receipt of a shareholder proposal, preemptively adopt a provision in order to stave off or effectively argue against a shareholder proposal with a looser version of the provision (e.g., adopt a proxy access provision with a 20%-of-the-board limit on the number of shareholder nominees before or after receiving a shareholder proposal with a 25%-of-the-board-limit). 
• Companies may also increasingly look to the other bases for exclusion specified in Rule 14a-8, such as the “substantial implementation” exception under Rule 14a-8(i)(10). General Electric recently used this exemption successfully by arguing that a shareholder proxy access proposal was mooted by the proxy access bylaw General Electric had already adopted.² However, given the views expressed in the bulletin, we expect the staff to narrowly construe the other exclusions as well. 
• The “directly conflicts” exclusion of Rule 14a-8(i)(9) remains relevant with respect to binding shareholder and company proposals that are mutually exclusive. However, the relevance to non-binding or precatory proposals is less clear. On the one hand, the bulletin notes that if a shareholder proposal is, or is modified to be, non-binding, a direct conflict may not exist. On the other hand, the bulletin also notes that the staff “believe[s] that a precatory shareholder proposal, while not binding, may nevertheless directly conflict with a management proposal on the same subject if a vote in favor is tantamount to a vote against management’s proposal.” 
• As the staff notes in the bulletin, boards will have to consider what to do if both a shareholder proposal and a management proposal on the same subject (but not mutually exclusive) are approved by shareholders, such as a 3% proxy access proposal and a 5% proxy access proposal. The company may have to discuss in its proxy materials its expected approach to this outcome. 
• The staff’s new position should give shareholder proponents and proxy advisors, such as ISS and Glass Lewis, more leverage against companies in pursuing governance policies. Losing shareholder votes on 14a-8 proposals will have greater consequences given the widespread prevalence of majority voting policies, the increasing prevalence of proxy access, the stock exchange positions on broker non-votes and the ISS/Glass Lewis position on withholding votes for directors who do not implement shareholder proposals approved by a majority of shareholders. Both ISS and Glass Lewis, as well as several institutions, have indicated that they will continue to support shareholder proposals based on their preferred forms of governance mechanisms such as proxy access even if companies have adopted competing forms. 

Conclusion 

Though the bulletin reinforces the staff’s existing interpretation of Rule 14a-8(i)(7), the decision to reject the Third Circuit’s more stringent formulation of the rule, combined with the staff’s renewed stance on Rule 14a-8(i)(9), portends a more difficult road ahead for companies seeking the staff’s concurrence in excluding shareholder proposals, particularly with respect to proxy access to shareholders. 

Footnotes 

_{1) 792 F.3d 323 (3d Cir. 2015).
2) See Letter from David R. Fredrickson, Securities and Exchange Commission (March 3, 2015).}