Securities Law

SEC Provides Greater Deference to Public Company Boards

By Craig D. Miller, Partner

On Nov. 1, 2017, the Securities and Exchange Commission (SEC) issued Staff Legal Bulletin No. 14I(CF), which articulates important interpretive guidance relating to shareholder proposals submitted to public companies for inclusion in proxy statements. The bulletin, which addresses exclusions of shareholder proposals under the “economic relevance exception” and the “ordinary business exception,” appears to provide public companies and their boards with additional deference when attempting to exclude shareholder proposals from their proxy statements for this upcoming 2018 proxy season.

“Economic Relevance Exception”

Rule 14a-8(i)(5) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) allows a company to exclude a shareholder proposal if “the proposal 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.”

Historically, the SEC has rarely allowed companies to exclude shareholder proposals under the “economic relevance exception.” Under their prior rationale, as long as a company conducted any amount of business related to the issue and the issue was of broad ethical or social concern, the SEC would require a company to present the proposal in its proxy statement and deny requests for no-action relief to exclude such a proposal. Acknowledging that this manner of interpretation has been too limiting, the SEC has agreed, going forward, to more closely analyze whether or not a proposal is significant to a company’s business. In that regard, although a proposal may raise an issue of ethical or social significance in the abstract, the release indicates that a company could exclude that proposal if it is not actually significantly related to a company’s business.1

Further to the release, a shareholder proponent now bears the burden of clearly demonstrating that a shareholder proposal is significant as relates to a company’s business. According to the SEC, the “mere possibility of reputational or economic harm will not preclude no-action relief.” Instead, the staff will focus on such a proposal in light of the “total mix” of information that is available about an issuer.

In evaluating whether or not to exclude a proposal, the SEC acknowledged that making this decision is a judgment call, and that the board of directors of a subject company is in a better position to analyze whether or not a proposal is significantly related to its business. Accordingly, a company’s board of directors will now be charged with analyzing a proposal’s significance and detailing the specific processes which the board employed to demonstrate that its conclusions are well-reasoned and well-informed. The release implies that the SEC may be willing to provide substantial deference to boards of directors that clearly articulate why a proposal should be excluded under the “economic relevance exception.”

“Ordinary Business Exception”

The SEC also addressed the application of Rule 14a-8(i)(7) under the Exchange Act which allows a company to exclude a shareholder proposal under the “ordinary business exception.” Under Rule 14a-8(i)(7), a shareholder proposal may be excluded if the proposal deals with a matter relating to a company’s ordinary business operations. Historically, the SEC has focused its analysis in part on whether a proposal raises an issue that is significant enough that it would be appropriate for a stockholder vote—in such a case, the proposal would be one that “transcends ordinary business.” Similar to the analysis applied for the “economic relevance exception,” the SEC acknowledges in the release that it must apply a significant amount of judgment in acting on no-action requests to exclude such proposals. Again, the staff implies that a company’s board of directors is in a better position to make a determination about the significance of such a proposal and, therefore, is well-situated to explain and analyze whether the matter raised in the proposal is significant and therefore appropriate to put in front of shareholders. We believe that such thoughtful analysis should assist the SEC staff in its review of no-action requests.

As with Rule 14a-8(i)(5), the SEC appears to be setting a framework for providing greater deference to public companies in excluding shareholder proposals so long as a company’s rationale for exclusion is well-reasoned and thoughtful. The SEC also confirmed in SLB 14I that it will separately analyze whether or not a proposal should be excluded under the “economic relevance exception” or the “ordinary business exception” rather than allowing its determination under the “ordinary business exception” to inform its determination under the “economic relevance exception.”

Conclusion

In preparation for this upcoming proxy season, public companies and their boards of directors should assess the likelihood of being presented with a shareholder proposal and, to the extent they have any advance insight into what the substance of a proposal may be, should discuss in advance their approach to preparing a no-action letter. This advance preparation will assist the company with being able to rapidly respond to a shareholder proposal within the short time frames allotted by the SEC and may increase the likelihood of successfully excluding such a proposal under either the “economic relevance exception” or the “ordinary business exception.”

1The SEC notes that substantive corporate governance matters will generally be viewed as significant to almost all companies.