Corporations trying to keep pesky shareholder resolutions off the proxy statement this season might find that one common strategy—the argument of substantial implementation—is getting, well, harder to implement.
A flurry of no-action requests rejected by the Securities and Exchange Commission this winter suggests that the agency is taking a more skeptical view of substantial implementation, where companies claim they should be allowed to keep a resolution off the proxy statement because they have already put into practice whatever the resolution is asking about. Historically such exclusions were common. Lately, however—not so much.
“It's the biggest thing this year in this space,” says Ning Chiu, counsel in the capital markets practice at law firm Davis Polk.
Consider, for example, the SEC's recent rejections of no-action letters to Disney, Boston Properties, General Dynamics, Navistar, General Electric, and others. The proposals ranged from executive compensation (Disney) to reporting political contributions (Boeing) to sustainability reporting (Boston Properties) to board oversight of safety practices (ConocoPhillips). In many of these cases, the SEC replied that the company's practices and policies “do not compare favorably with the guidelines of the proposal.”
In a letter to General Dynamics, for example, the SEC said it could not grant the exclusion based on substantial implementation because the proposal sought the ability to call a special meeting for shareholders who held more than 10 percent of the outstanding shares, while General Dynamics' existing policy used a threshold of 25 percent. That is, the crucial question was the threshold for the ability to call a special meeting—not the ability to call a special meeting itself.
“The trend is that it's becoming more difficult for certain types of proposals where the SEC has to exercise a fair amount of judgment,” Chiu says.
The SEC seems to be declining to issue no-action letters favorable to the company in close cases, and that's consistent with the more shareholder-friendly bent of the SEC, says Martin Rosenbaum, a partner with Maslon Edelman Borman & Brand.
“I sense that the SEC is tending to err on the side of facilitating shareholders having a voice in how their companies are run, and is narrowly construing the exceptions under Rule 14a-8 ...”
—Peter Fetzer,
Partner,
Foley & Lardner
Substantial implementation is tucked away in Rule 14a-8(i)(10) of the Securities Exchange Act, and its definition gives filers little to go on. The entire text reads: “Substantially implemented: If the company has already substantially implemented the proposal.” Not much help there.
In some cases, the judgment on whether the company has implemented the proposal is clear. For example, if a proposal asks a company to declassify its board of directors, whether a board is already declassified is pretty much a yes-or-no question.
At other times, the SEC is forced to make a judgment call. Consider a proposal asking a company to produce a report on climate change, human rights issues, or political contributions; in those cases, the SEC must decide whether what the company already produces is sufficient to constitute “substantial implementation,” Chiu says. And in those cases, the SEC is giving companies far less leeway.
EVIDENCE OF A TREND
Below are excerpts of recent no-action letters:
> No-action letter to Disney, Dec. 27 2010:
The proposal recommends that the company's compensation committee adopt a policy to only use one test to assess performance in determining eligibility for awards of stock in the Long Term Incentive Plan for senior executives, rather than allowing re-tests that increase the likelihood of executives receiving the awards.
?We are unable to concur in your view that Disney may exclude the proposal under ?rule 14a-8(i)(10). Based on the information you have presented, it appears that Disney's practices and policies do not compare favorably with the guidelines of the proposal and that Disney has not, therefore, substantially implemented the proposal. Accordingly, we do not believe that "Disney may omit the proposal from its proxy materials in reliance on rule 14a-8(i)( 10).?
?> No-action letter to ConocoPhillips, Jan. 31, 2011:?
?The proposal requests that the board prepare a report on the steps the company has taken to reduce the risk of accidents. The proposal further specifies that the report should describe the board's oversight of process safety management, staffing levels, inspection and maintenance of refineries and other equipment. We are unable to concur in your view that ConocoPhilips may exclude the proposal under rule 14a-8(i)(10). ?
?Based on the information you have presented, it does not appear that ConocoPhillips' public disclosures compare favorably with the guidelines of the proposal. Accordingly, we do not believe that ConocoPhillips may omit the proposal from its proxy materials in reliance on rule 14a-8(i)(10).??
?> No-action letter to Boeing, Feb. 14, 2011:?
?The proposal requests that Boeing prepare a report, updated semi-annually,?disclosing its policies and procedures for political contributions and expenditures and its?monetary and non-monetary political contributions and expenditures (direct and indirect) used to participate or intervene in any political campaign. [...]?
?We are unable to concur in your view that Boeing may exclude the proposal under?rule 14a-8(i)(10). Based on the information you have presented, we are unable to?conclude that Boeing's policies, practices and procedures compare favorably with the?guidelines of the proposal such that Boeing has substantially implemented the proposal. Accordingly, we do not believe that Boeing may omit the proposal from its proxy materials in reliance on rule 14a-8(i)(10).?
?> No-action letter to Boston Properties, Jan. 28, 2011:?
?The proposal requests that the board issue a report to shareholders on the?company's sustainability policies and performance, including multiple, objective statistical indicators. It further specifies that the report should include the company's definition of sustainability, as well as a company-wide review of company policies, practices, and indicators related to measuring long-term social and environmental sustainability.?
?We are unable to concur in your view that Boston Properties may exclude the proposal under rule 14a-8(i)(10). Based on the information you have presented, it appears that Boston Properties' practices and policies do not compare favorable with the guidelines of the proposal and that Boston Properties has not, therefore, substantially implemented the proposal. Accordingly, we do not believe that Boston Properties may omit the proposal from its proxy materials in reliance on rule 14a-8(i)(10).??
??> And finally, of course you are familiar with the Navistar reversal, January 4, 2011: ?
?This is in response to your letter dated December 20, 2010 concerning the shareholder proposal submitted to Navistar by the Teamsters General Fund. We also have received a letter from Navistar dated December 28,2010. On December 8, 2010, we issued our response expressing our informal view that we would not recommend enforcement action to the Commission if Navistar omitted the proposal from its proxy materials in reliance on rule 14a-8(i)(10).?
?We have reconsidered our position. Upon reconsideration, we are unable to concur in Navistar's view that it may exclude the proposal under rule 14a-8(i)(10). The proposal urges the board to adopt a policy of obtaining shareholder approval for future severance agreements in which the company contemplates paying out more than two times the sum of an executive's base salary plus bonus. The proposal does not request a shareholder vote on severance agreements already entered into and disclosed pursuant to Regulation S-K. We note that Navistar does not appear to have a policy of having to obtain shareholder approval for future severance agreements. Accordingly, we do not believe that Navistar may omit the proposal from its proxy materials in reliance on Item 402 of rule 14a-8(i)(10).
Source: SEC No-Action Letters.
The exclusion is clear that the company doesn't need to meet every objective of the proposal. The question is how much would be required to meet the “substantial” threshold, Chiu says. “In those cases I believe the SEC staff, in all fairness to them, are loath to step in and exercise their discretion and judgment to decide what the proponent is asking for in the proposal,” she says.
Amy Goodman, partner at the law firm Gibson, Dunn & Crutcher, says the trend toward the SEC taking a narrower view on substantial implementation exclusions has been developing for three to five years. “The SEC is getting stricter and stricter on substantial implementation,” she says. “They apply a very tough standard, and it seems to me that it's inappropriate, because if there's a given issue, where the board of directors has considered the issue and has determined how the company should proceed, it doesn't make any sense to require a shareholder proposal on the issue.”
The skirmishes over shareholder proposals are very much evolutionary, where issues rise and fall in cycles, says David Martin, a former director of the SEC Division of Corporation Finance who is now a partner at the law firm Covington & Burling.
The SEC staff, he says, has periodically had to remind companies citing substantial implementation, “You have to make a clear and compelling argument. They're not going to give you a free pass because you mutter the magic words ‘substantial implementation.'” The SEC does this to keep some rigor and precise thinking in how it administers the rule, he says.
The SEC is also moving in that direction because shareholders can be (very) vocal when proposals based on sloppy or imprecise arguments, are excluded, he adds. Administering the shareholder proposal rule generally, and substantial implementation exclusion more specifically, exposes the SEC staff to lots of interaction with the public. So the agency strives for “clearer and more consistent administration of the rule,” he says.
“I sense that the SEC is tending to err on the side of facilitating shareholders having a voice in how their companies are run, and is narrowly construing the exceptions under Rule 14a-8 based on reliance on the ‘substantially implemented' exclusion,” says Peter Fetzer, partner at the law firm Foley & Lardner.
Given the SEC's narrow view of the exclusion, companies need to demonstrate that their action on the matter is at least as effective (if not more effective), than that proposed by the shareholder, Fetzer says. Indeed, when you apply his logic to General Dynamics' case above, the SEC's rejection makes sense: a 25 percent threshold to call a special meeting can never be as effective as a 10 percent threshold, because 10 percent will always be an easier number to achieve.
“It is not enough only to partially address the shareholder's proposal, or to water down the proposal in a manner that is favorable to the company and claim that you have substantially implemented the proposal,” he says.
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