As companies prepare for the 2016 proxy season, they should prepare for profound changes in how the Securities and Exchange Commission views attempts to keep shareholder proposals off the proxy statement.
The SEC’s new stance, articulated earlier this fall, is decidedly pro-shareholder. Campaigns to exclude shareholder proposals will be more difficult to win, and those battles you do fight will be on a much more complicated landscape.
“This is a dramatic change from past practice,” says Kimberley Anderson, a partner at law firm Dorsey & Whitney who specializes in corporate governance issues. “It is very clear that the effect will be that a far greater number of shareholder proposals are going to be included.”
For nearly 50 years, companies seeking to exclude a shareholder proposal have petitioned the SEC’s Division of Corporation Finance for a no-action letter under criteria established in Rule 14a-8 of the Exchange Act. Last January, SEC Chairman Mary Jo White took the unprecedented move of instructing staff to pause on any requests for no-action letters that addressed one specific point: The shareholder proposal directly contradicts one of the company’s own proposals going into the same proxy. (The moratorium was a reaction to Whole Foods’ plan to exclude a shareholder proposal for proxy access, in favor of a management proxy access proposal with a much higher threshold.)
That moratorium lasted until October, when new guidance from Corporation Finance said no-action letters would resume. On the question of denying a shareholder proposal because it directly contradicts one from management, “A direct conflict would exist if a reasonable shareholder could not logically vote in favor of both proposals because a vote for one proposal is tantamount to a vote against the other proposal,” the guidance says.
“This was an early Christmas gift, wrapped up in a bow,” for shareholders, Anderson says.
The guidance is easily applied, and to the advantage of shareholders. For example, if the company seeks shareholder approval of a merger, and a shareholder proposal asks to oppose it—that would be a direct conflict and the company could ask that the shareholder’s idea be excluded.
The SEC will not, however, consider a shareholder proposal as directly conflicting with a management proposal if a “reasonable shareholder” is presented with two ideas that generally seek a similar objective. For example, a shareholder proposal might direct the compensation committee to adopt a policy that equity awards have a four-year vesting period, while management propose an incentive plan that gives the committee the power to set whatever vesting period it deems wise. Those proposals would not directly conflict under the new guidance, so a company could not keep the first one off the proxy.
The policy change is a frustrating one for many companies and their counsel. “A proposal now has to absolutely, directly conflict before you can kick anything out, and there are so few that do,” Anderson says. “It becomes a nearly unusable exclusion.”
“This is a dramatic change from past practice. It is very clear that the effect will be that a far greater number of shareholder proposals are going to be included.”
Kimberley Anderson, Partner, Dorsey & Whitney
“I can understand from the [SEC] staff’s perspective that maybe they felt the precedent had gone in the wrong direction given the original underpinnings of the rule,” says David Lynn a partner with law firm Morrison & Foerster and former chief counsel at Corporation Finance. “Because we have started over again, the reasonable shareholder test will have to be developed through all the letters that will continue to push the envelope of what is acceptable or not.”
As companies consider whether to ask for a no-action letter, the SEC guidance, despite its examples, may not be very helpful. “They addressed the easy examples,” says Thomas Kim, a partner with law firm Sidley Austin. “They haven’t addressed the hard ones.”
He questions how wide the gap must be between two proposals before they go from similar to conflicting. For example, if one proposal says 10 percent of shareholders can call for a special meeting, and another requires 80 percent, do they conflict? “Yes, they are both asking for the same thing,” he says. “They are both trending in the same direction, I suppose, but 10 percent is very different than 80 percent.”
The term “reasonable shareholder” also gives Kim pause. “Quite frankly the reasonable shareholder is not the one submitting shareholder proposals,” he says. “Are they truly representative of the investor population as a whole? There aren’t many people who like playing their role as gadfly.”
Proxy Access Consequences
SEC AND THIRD CIRCUIT AT ODDS
The following, from a Division of Corporation Finance legal bulletin issued last month, addressed a recent court ruling on shareholder proposal exclusions.
In Trinity Wall Street v. Wal-Mart Stores, Inc., the U.S. Court of Appeals for the Third Circuit addressed the application of Rules 14a-8(i)(3) and 14a-8(i)(7).
The panel also considered whether the significant policy exception to the ordinary business exclusion applied. The majority opinion employed a new two-part test, concluding that “a shareholder must do more than focus its proposal on a significant policy issue; the subject matter of its proposal must ‘transcend’ the company’s ordinary business.” The majority opinion found that to transcend a company’s ordinary business, the significant policy issue must be “divorced from how a company approaches the nitty-gritty of its core business.” This two-part approach differs from the Commission’s statements on the ordinary business exclusion and Division practice.
Although we had previously concluded that the significant policy exception does not apply to the proposal that was submitted to Wal-Mart, we are concerned that the new analytical approach introduced by the Third Circuit goes beyond the Commission’s prior statements and may lead to the unwarranted exclusion of shareholder proposals.
Whereas the majority opinion viewed a proposal’s focus as separate and distinct from whether a proposal transcends a company’s ordinary business, the Commission has not made a similar distinction. Instead, as the concurring judge explained, the Commission has stated that proposals focusing on a significant policy issue are not excludable under the ordinary business exception “because the proposals would transcend the day-to-day business matters and raise policy issues so significant that it would be appropriate for a shareholder vote.” Thus, a proposal may transcend a company’s ordinary business operations even if the significant policy issue relates to the “nitty-gritty of its core business.”
Therefore, proposals that focus on a significant policy issue transcend a company’s ordinary business operations and are not excludable under Rule 14a-8(i)(7). The Division intends to continue to apply Rule 14a-8(i)(7) as articulated by the Commission and consistent with the Division’s prior application of the exclusion, as endorsed by the concurring judge, when considering no-action requests.Source: SEC.
Whole Foods’ opposition to a shareholder proxy access proposal sparked today’s current guidance, and many believe one side effect of the change will be a surge in companies submitting their own proxy access proposals simply to stay ahead of the trend.
A recent survey by law firm Shearman & Sterling found an increase in proxy access proposals submitted during 2015 annual meetings: 112 companies received shareholder proxy access proposals in 2015, up from just 20 in the previous proxy season. That number could rise as companies look to beat shareholders to the punch with their own attempts to craft more agreeable thresholds.
“You really have seen a lot of the marquee names in Corporate America adopting proxy access, whether they were prompted to do so by a shareholder proposal or they saw the writing on the wall and decided to go in that direction,” Kim says. “However, if a company adopts proxy access today, nothing stops a shareholder proponent from submitting their own proxy access proposal in the future.”
Kim’s point raises another governance question: Will the SEC have a similar change of heart regarding another exclusion criterion, one that allows companies to set aside proposals that have already been “substantially implemented?”
If so, again the question is where to draw the line between varying thresholds.
Lynn suspects that debate will be the “next frontier” in the seemingly endless proxy wars. “How much variation between what the company did, and what the proponent wants, is going to be permissible?” he asks.
The confusion might even prod some companies to skip the SEC altogether and seek redress in court. “Will this force companies to go to court, or is it just going to result in more shareholder proposals being thrown into proxies?” Kim asks.
Theoretically a company could seek relief in federal court, but even that route needs to be considered carefully given the differences in interpretation between the SEC and federal courts. Indeed, Walmart went to court over one proxy issue and an appeals court even ordered the SEC to provide more clarity around its “substantial implementation” criteria. The SEC hasn’t done so.
“Staff basically said they don’t care what the court said, we are just going to keep doing it our way,” Lynn says, adding that “we may see some proxy access cases where people resort to the courts, but its going to be a tougher road to go.”
And while conversation about the SEC guidance has largely been around how it applies to proxy access proposals, many other corporate governance matters may be affected. “This change in the interpretation of the rule will permit many more shareholder governance proposals to go in,” Kim says.