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Nov 08, 2021

SEC reveals new guidance on shareholder proposal exclusions

Bulletin appears to offer more room for ESG measures

The SEC’s division of corporation finance has updated its guidance on the process whereby companies seek permission to exclude shareholder proposals, potentially opening the door for more ESG-related measures to end up on proxy statements in 2022 and beyond.

The division on November 3 issued a notice that it is rescinding three staff legal bulletins – 14I, 14J and 14K – following a review of staff experience applying the guidance in them. Each dropped bulletin was introduced during the Trump administration.

Rule 14a-8 provides a regulatory basis for shareholders to submit proposals for shareholders’ consideration in a company’s proxy statement. It includes several bases on which companies can seek no-action relief for excluding proposals, and the new bulletin outlines the division’s views on two of these possible bases: Rule 14a-8(i)(7), the ordinary business exception, and Rule 14a-8(i)(5), the economic relevance exception.

The new guidance states: ‘The division is issuing this bulletin to streamline and simplify our process for reviewing no-action requests, and to clarify the standards staff will apply when evaluating these requests.’

The division notes that the purpose of the ordinary business exception is ‘to confine the resolution of ordinary business problems to management and the board of directors, [as] it is impracticable for shareholders to decide how to solve such problems at an annual shareholders meeting.’

But it adds that following its review of the rescinded bulletins and the experience of applying their guidance, ‘we recognize that an undue emphasis was placed on evaluating the significance of a policy issue to a particular company at the expense of whether the proposal focuses on a significant social policy, complicating the application of commission policy to proposals.’

In particular, it says, focusing on the significance of a policy issue to a particular company ‘has drawn the staff into factual considerations that do not advance the policy objectives behind the ordinary business exception. We have also concluded that such analysis did not yield consistent, predictable results.’

In future, the division will determine whether a proposal relates to ordinary business using a previous standard that provides an exception for certain proposals that raise significant social policy issues. ‘This exception is essential for preserving shareholders’ right to bring important issues before other shareholders by means of the company’s proxy statement, while also recognizing the board’s authority over most day-to-day business matters,’ the division states.

‘For these reasons, staff will no longer focus on determining the nexus between a policy issue and the company, but will instead focus on the social policy significance of the issue that is the subject of the shareholder proposal. In making this determination, the staff will consider whether the proposal raises issues with a broad societal impact, such that they transcend the ordinary business of the company.’

Under this approach, proposals the agency previously viewed as excludable because they did not appear to raise a policy issue of importance to the company may no longer be seen as such. For example, the division says proposals dealing with human capital management issues with a broad societal impact would not be subject to exclusion simply because the proponent did not demonstrate the issue was significant to the company.

As a result of no longer taking a company-specific approach to evaluating the significance of a policy issue under Rule 14a-8(i)(7), the division will no longer expect a board analysis to demonstrate that a proposal is excludable. ‘Based on our experience, we believe board analysis may distract the company and the staff from the proper application of the exclusion,’ it states.

The division has also decided that its recent application of the micromanagement concept as outlined in the staff legal bulletins 14J and 14K expanded the concept beyond the commission’s policy directives. ‘Specifically, we believe the rescinded guidance may have been taken to mean that any limit on company or board discretion constitutes micromanagement,’ it says.

The staff will now assess companies’ micromanagement arguments on the basis that proposals seeking detail or seeking to promote timeframes or methods do not per se constitute micromanagement.

Under Rule 14a-8(i)(5), the economic relevance exception, a company may exclude a 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.’

Based on its review, the division says it is returning to a previous approach. ‘As a result… proposals that raise issues of broad social or ethical concern related to the company’s business may not be excluded, even if the relevant business falls below the economic thresholds of Rule 14a-8(i)(5),’ the division writes. ‘In light of this approach, the staff will no longer expect a board analysis for its consideration of a no-action request under Rule 14a-8(i)(5).’

The initial reaction to the SEC’s new bulletin has been unsurprisingly mixed. SEC chair Gary Gensler says in a statement: ‘The right to put proposals in front of other shareholders for a vote is an important part of the securities laws. In 1998, the commission finalized a 14a-8 rulemaking ‘to improve the operation of the rules governing shareholder proposals.’ Today’s legal bulletin aligns with the intent of that commission action…

‘[H]undreds of companies have come to the staff seeking no-action letters with respect to shareholder proposals. Today’s bulletin will provide greater clarity to companies and shareholders on these matters, so they can better understand when exclusions may or may not apply.’

As You Sow says in a notice that the rescinded bulletins ‘severely limited meaningful shareholder proposals, including vastly expanding the prohibition on micromanagement in a way that allowed exclusion of shareholder proposals containing almost any specific request, timelines or action. In rescinding bulletin 14K, staff clarified that proposals that raise significant social policy issues, and do not micromanage companies, will be allowed to move forward.’

Danielle Fugere, president of As You Sow, says in that notice: ‘This guidance, which underscores the original purpose of Rule 14a-8 – to allow shareholders to raise and vote on important issues – is timely and necessary. At this time of global upheaval, the stakes couldn’t be higher. The shareholder voice plays a critical role in ensuring companies are addressing issues that create risk and opportunity and can affect shareholder value.’

In a statement, the Shareholder Rights Group says the new bulletin will reduce costs and uncertainties involved in filing shareholder proposals, allowing proponents of measures tackling ESG issues to do so under a clear set of rules. ‘During the last four years, through informal staff rulings and staff legal bulletins 14 I, J and K, the interpretive guidance from the staff had grown increasingly burdensome, laying down numerous problematic new interpretive hurdles to successfully filing proposals,’ the group states. 

‘We congratulate the commission and staff for the new bulletin, which will empower shareholders to pursue ESG proposals at their companies. ESG issues affect long-term value as well as posing externalities that may otherwise affect portfolio values. The new staff legal bulletin is a laudable move by the SEC that should reduce costs and uncertainties for shareholder proponents as well as companies.’

Sean Donahue, partner and chair of Goodwin’s public company advisory practice, in emailed comments does not express support or criticism of the new bulletin but says it will make it more difficult for companies to exclude shareholder proposals – and particularly ESG proposals – from their proxy statements.

‘Companies unable to get proposals excluded in reliance on the SEC staff no-action letter process may choose to seek declaratory relief in federal court that a proposal is excludable under Rule 14a-8, potentially leading to increased litigation,’ he adds.

The new guidance also has critics. In a joint statement, commissioners Hester Peirce and Elad Roisman say: ‘Today’s bulletin furthers the recent trend of erasing previous commission and staff work and replacing it with the current commission’s flavor-of-the-day regulatory approach.’

They argue that although the bulletin presents a case for repealing the previous three bulletins, it does not address the issue those three bulletins were trying to tackle and does not explain how to assess whether a topic is socially significant or has a broad societal impact. They also argue that the bulletin does not explain what bad consequences arose from the rescinded bulletins. For example, they say, the division has often rejected micromanagement arguments for exclusion, including ones that relate to climate change proposals.

‘We have allowed proponents and companies to use our no-action letter process as a quick arbitration mechanism to determine questions of excludability, rather than present their arguments to a court of law. But it is hard to see how this resource-intensive review is time (or tax dollars) well spent, given that the proposals can involve issues that are, at best, only tangential to our securities laws,’ the commissioners write.

‘Why should the commission’s – or its staff’s – views about the ‘significance’ of non-securities issues be relevant to the analysis at all? Perhaps one day the commission will relieve the staff of this burden and either take on consideration of these proposals itself or, better yet, amend the rule to excise the commission and its staff from matters of state corporate law and areas outside our expertise.’

Tom Quaadman, executive vice president of the US Chamber of Commerce’s Center for Capital Markets Competitiveness has called for the SEC to reverse the new approach and says in a statement: ‘The SEC has sided with a small minority of activists over the vast majority of American investors. By repealing long-standing guidance about treatment of shareholder proposals, the SEC has stated its preference to turn boardrooms and shareholder meetings into political debate societies on issues the SEC admits have no nexus to the actual business of the company.

‘This will all come at the expense of companies’ ability to focus on long-term performance, including the welfare of their employees, customers and shareholders.’