Back to the Future: The SEC Radically Alters Rule 14a-8 Interpretive Guidance
By Sarah Fortt
Things are getting interesting, and the shareholder proposal and annual meeting season has only barely kicked off. On Wednesday, November 3, the Division of Corporation Finance (the “Division”) of the Securities and Exchange Commission (the “SEC”) issued new Staff Legal Bulletin No. 14L, rescinding Staff Legal Bulletins Nos. 14I, 14J and 14K and providing new guidance addressing the Division’s views on Rule 14a-8(i)(7), known as the ordinary business exception, and Rule 14a-8(i)(5), known as the economic relevance exception, as well as guidance regarding the use of graphics and images, proof of ownership letters and other procedural matters.
The changes the Division implemented, and the history regarding how we got where we are now, could have their own Netflix four-part miniseries for governance geeks, but in summary:
- The change to the “nexus” part of Rule 14a-8(i)(7). As a reminder, the ordinary business exception under Rule 14a-8(i)(7) contains two primary mechanisms for proposals to be excluded, the first relating to the subject matter of the proposal and the second relating to the degree to which a proposal “micromanages” the company “by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment.”1 The Division explained its complex approach to the subject matter prong of Rule 14a-8(i)(7), minus the now rescinded bits, in SLB 14H in response to the Trinity Wall Street v. Wal-Mart Stores, Inc.2 In summary, the “subject matter” prong of Rule 14a-8(i)(7) includes a complex line of arguments that has established that a proposal that focuses on a “significant policy issue” is generally not excludable under the ordinary business exception because the proposal “transcends the day-to-day business matters and raises policy issues so significant it would be appropriate for a shareholder vote.”3 These “significant policy issues” have been identified by the SEC over time, but have generally included very specific issues. Traditionally, in assessing the degree to which a proposal raises a significant policy issue, the Division staff (the “Staff”) would look to whether there is “a sufficient nexus … between the nature of the proposal and the company.”4
Under new SLB 14L, the Staff will no longer focus on determining the “nexus” between a significant policy issue and the specific company when assessing whether to concur with exclusion of a proposal on the basis of Rule 14a-8(i)(7). The Staff will instead focus on the social policy significance of the issue that is the subject of the shareholder proposal, and will consider whether the proposal raises issues with a broad societal impact, such that those issues transcend the ordinary business of the company. The Staff will also no longer expect companies to include a board analysis regarding the application of the exclusion.
What it means: In a nutshell, it will be harder for companies to exclude environmental and social proposals on the basis of Rule 14a-8(i)(7). The Division does not provide an example of a letter that would be decided differently under this change in approach, but examples could include proposals that ask companies to adopt policies for improving workforce diversity, assess the reputational and business risks associated with social media, or adopt a policy regarding the sustainability of their products.
- The change to the micromanagement prong of Rule 14a-8(i)(7). Under new SLB 14L, the Staff also will move away from its recent application of the micromanagement concept under Rule 14a-8(i)(7) as outlined in SLBs Nos. 14J and 14K. While the Staff will continue to recognize this argument, SLB 14L clarifies that the Staff will focus on the granularity sought in the proposal and whether and to what extent it inappropriately limits the discretion of the board or management. Proposals that include the level of detail that is necessary to enable investors to assess a company’s impacts, progress towards goals, risks or other strategic matters will generally not be excludable on this basis. The Division also notes that in determining whether a proposal probes matters “too complex” for shareholders it may consider the sophistication of investors generally on the matter, the availability of data, and the robustness of public discussion and analysis on the topic, as well as references to well-established national or international frameworks when assessing proposals related to disclosure, target setting, and timeframes as indicative of topics that shareholders are well-equipped to evaluate.
What it means: In a nutshell, proposals regarding climate change targets and related timeframes are probably not going to be as excludable under the micromanaging prong of Rule 14a-(i)(7) as they have been in the past, and the same applies for other environmental and social proposals that contain specific targets and timeframes.5 SLB 14L provides an example of its policy going forward in the form of a shareholder proposal no-action request submitted by ConocoPhillips in response to which the Staff denied no-action relief. The proposal requested that the company set emission reduction targets and it did not impose a specific method for doing so. The staff concluded that this proposal did not micromanage the company to such a degree to justify exclusion under Rule 14a-8(i)(7).
- Rule 14a-8(i)(5) considerations. As a reminder, the economic relevance exception under Rule 14a-8(i)(5) permits a company to 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.”6 Under SLB 14L, the Division will not concur with the exclusion of proposals that raise issues of broad social or ethical concern related to the company’s business, even if the relevant business falls below the economic thresholds of Rule 14a-8(i)(5). Similarly to the Rule 14a-8(i)(7) approach, the Staff will also no longer expect companies to include a board analysis regarding the application of the Rule 14a-8(i)(5) exception.
What it means: Rule 14a-8(i)(5) arguments are made far less frequently than Rule 14a-8(i)(7) arguments – there have only been eight no-action request letters making economic relevance arguments submitted in 2021 to date. However, when submitted, they can often involve proposals that raise social issues. To the extent that these proposals are considered by the Division to raise broad social or ethical concerns, they may not be as easy to exclude as they once were.
- Other changes. The Division provided clarification on the use of graphics in shareholder proposals, largely reiterating its SLB 14I guidance (notwithstanding its recission). The Division also updated the suggested format for proofs of ownership under Rule 14a-8(b), reiterating its SLB 14K guidance (notwithstanding its recission) that companies should avoid applying an overly technical reading to proofs of ownership. SLB 14L also states that companies should identify any specific defects in a proof of ownership letter, even if the company previously sent a deficiency notice prior to receiving the proponent’s proof of ownership if such deficiency notice did not identify the specific defect(s). Finally, SLB 14L recommends that proponents who send proposals via email seek a reply email from the recipient acknowledging receipt of the email, and that both proponents and companies acknowledge receipt of emails when requested, and provides clarity on certain procedural implications of email use.
What it means: Companies should consider providing email addresses in their proxy statements, and should also consider sending deficiency notices and other correspondence by more than one method, including through trackable first-class mail. The Division’s new guidance also implies that companies may need to send more than one deficiency notice if any prior deficiency notice did not identify the specific defect(s) in a timely received proof of ownership. This change alone could reduce the number of proposals successfully excluded from companies’ proxy materials on procedural grounds.
I recently found myself discussing Rule 14a-8 with a group of friends, and described the history of this rule as part myth and legend. Ultimately, each layer of precedent and guidance adds to the complexity of this rule, and I predict this will not be the last time there are substantive changes made to the rule over the next year or two. Rule 14a-8 remains at the frontlines of more than one hotly contested war over environmental and social matters. Ultimately, companies should always consider whether their responses to the proposals they receive are consistent with their voluntary disclosures and efforts to engage stakeholders.
1 Release No. 34-40018 (May 21, 1998) (the “1998 Release”). For 2021 shareholder meetings, the Staff most often granted no-action relief on procedural grounds, but Rule 14a-8(i)(7) arguments ranked second among successful arguments, representing 28% of exclusions.
2 792 F.3d 323 (3d Cir. 2015). In Trinity v. Wal-Mart, the U.S. Court of Appeals for the Third Circuit addressed the application of Rules 14a-8(i)(3) and 14a-8(i)(7) following a determination by the Division staff to concur with exclusion on the basis of the 14a-8(i)(7), the ordinary business exception. Following the court’s decision, the Division released SLB 14H because, while the court’s ultimate ruling was consistent with the Division’s position, the court’s approach to interpreting Rule 14a-8(i)(7) was not consistent with Division practice.
3 1998 Release.
4 See Staff Legal Bulletin No. 14E (October 27, 2009) (stating that a proposal generally will not be excludable “as long as a sufficient nexus exists between the nature of the proposal and the company”).
5 The Division notes that, while the analysis in SLB 14L may apply to any subject matter, many of the proposals addressed in the rescinded SLBs requested that companies adopt timeframes or targets to address climate change.
6 Rule 14a-8(i)(5) under the Securities Exchange Act of 1934.
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.