This Proxy Season, Excluding Shareholder Proposals Gets Trickier

Two significant trends about which shareholder proposals companies can or cannot exclude from the proxy statement are already setting the tone for this year's proxy season—and companies need to read regulators' response letters carefully to stay on top of developing precedents.

The Securities the Securities and Exchange Commission is not only granting fewer requests to strike resolutions based on the “ordinary business” exclusion; on a case-by-case basis, it is also signaling to companies which issues to watch out for, through brief explanations of its decisions in response letters.

The SEC narrowed its policy of allowing companies to omit shareholder proposals under the ordinary business exclusion in late 2009; this spring is the first time that companies are feeling the full brunt of that change, says Bruce Newsome, a partner in the law firm Haynes and Boone.

“This is the key year, since it's the first full year that people have had a chance to make their proposal with plenty of time to think about it and work with the company to see if it was going to accept their request or not,” Newsome says.

The SEC's Division of Corporation Finance published its new policy on Oct. 27, 2009, when it announced that previous applications of its ordinary business exemption (contained in Staff Legal Bulletin No. 14C) may have granted companies “unwarranted exclusion of proposals” because while those proposals related to risk evaluation (which often can be excluded), they also brought up “significant policy issues” (which cannot).

The SEC promised not to grant such exclusions anymore if the “proposal's underlying subject matter transcends the day-to-day business matters of the company and raises policy issues so significant that it would be appropriate for a shareholder vote.” It also singled out CEO succession as one of those significant policy issues, and said SEC staffers probably wouldn't grant many exclusions for that subject, either.

At the same time, the SEC has begun giving one-sentence explanations of why it decides on a company's exclusion request some particular way. The extra explanation is helpful; previously, two exclusion requests could look very similar but get different verdicts from the SEC, and nobody would really know why, says Ning Chiu, counsel at the law firm Davis Polk.

“The only practical thing to do … is to learn something about the decision-making criteria of your voters and respond to it, since ultimately you're going to have to win the vote, not block it.”

—Gary Lutin,

Chairman,

Shareholder Forum

That method of establishing a precedent via these explanations is somewhat like case law, since registrants often cite other no-action letters to bolster the case for their own—and the more examples you can cite, then the better your chance of success, Chiu says. The explanations lead to more refined arguments—which is especially important in the regulatory area, where the specific wording of the proposal is crucial, Chiu says.

The explanations can also suggest which social issues are on the SEC's watch list, that might become more significant in the future, Chiu says; that could help companies better understand which issues might be excludable now, but perhaps not for much longer.

The SEC's recent no-action letters to companies like AT&T, Comcast, and Verizon, for example, seem to signal that network neutrality is a topic of increasing social importance. In a Feb. 2 letter to Comcast, the SEC staff allowed Comcast to exclude a shareholder proposal about network neutrality. But, citing a similar no-action request from A&T, the SEC also warned: “We further note that although net neutrality appears to be an important business matter for AT&T and the topic of net neutrality has recently attracted increasing levels of public attention, we do not believe that net neutrality has emerged as a consistent topic of widespread public debate such that it would be a significant policy issue for purposes of Rule 14a-8(i)(7).”

One persistent question is just how much attention a social issue must receive before it rises to the level of a “significant” policy question that can't be bumped off the proxy. Must it lead the national news? Would heavy exposure in local media suffice? How about vocal members of Congress filing legislation?

RISK PROPOSAL EXCLUSION

The following excerpt from the SEC's Staff Legal Bulletin No. 14E (CF) provides information on what analytical framework will be applied in determining whether a company may exclude a proposal related to risk under Rule 14a-8(i)(7).

Over the past decade, we have received numerous no-action requests from companies seeking to exclude proposals relating to environmental, financial, or health risks under Rule 14a-8(i)(7). As we explained in SLB No. 14C, in analyzing such requests, we have sought to determine whether the proposal and supporting statement as a whole relate to the company engaging in an evaluation of risk, which is a matter we have viewed as relating to a company's ordinary business operations. To the extent that a proposal and supporting statement have focused on a company engaging in an internal assessment of the risks and liabilities that the company faces as a result of its operations, we have permitted companies to exclude these proposals under Rule 14a-8(i)(7) as relating to an evaluation of risk. To the extent that a proposal and supporting statement have focused on a company minimizing or eliminating operations that may adversely affect the environment or the public's health, we have not permitted companies to exclude these proposals under Rule 14a-8(i)(7).

We have recently witnessed a marked increase in the number of no-action requests in which companies seek to exclude proposals as relating to an evaluation of risk. In these requests, companies have frequently argued that proposals that do not explicitly request an evaluation of risk are nonetheless excludable under Rule 14a-8(i)(7) because they would require the company to engage in risk assessment.

Based on our experience in reviewing these requests, we are concerned that our application of the analytical framework discussed in SLB No. 14C may have resulted in the unwarranted exclusion of proposals that relate to the evaluation of risk but that focus on significant policy issues. Indeed, as most corporate decisions involve some evaluation of risk, the evaluation of risk should not be viewed as an end in itself, but rather, as a means to an end. In addition, we have become increasingly cognizant that the adequacy of risk management and oversight can have major consequences for a company and its shareholders. Accordingly, we have reexamined the analysis that we have used for risk proposals, and upon reexamination, we believe that there is a more appropriate framework to apply for analyzing these proposals.

On a going-forward basis, rather than focusing on whether a proposal and supporting statement relate to the company engaging in an evaluation of risk, we will instead focus on the subject matter to which the risk pertains or that gives rise to the risk. The fact that a proposal would require an evaluation of risk will not be dispositive of whether the proposal may be excluded under Rule 14a-8(i)(7). Instead, similar to the way in which we analyze proposals asking for the preparation of a report, the formation of a committee or the inclusion of disclosure in a Commission-prescribed document—where we look to the underlying subject matter of the report, committee or disclosure to determine whether the proposal relates to ordinary business—we will consider whether the underlying subject matter of the risk evaluation involves a matter of ordinary business to the company. In those cases in which a proposal's underlying subject matter transcends the day-to-day business matters of the company and raises policy issues so significant that it would be appropriate for a shareholder vote, the proposal generally will not be excludable under Rule 14a-8(i)(7) as long as a sufficient nexus exists between the nature of the proposal and the company. Conversely, in those cases in which a proposal's underlying subject matter involves an ordinary business matter to the company, the proposal generally will be excludable under Rule 14a-8(i)(7). In determining whether the subject matter raises significant policy issues and has a sufficient nexus to the company, as described above, we will apply the same standards that we apply to other types of proposals under Rule 14a-8(i)(7).

In addition, we note that there is widespread recognition that the board's role in the oversight of a company's management of risk is a significant policy matter regarding the governance of the corporation. In light of this recognition, a proposal that focuses on the board's role in the oversight of a company's management of risk may transcend the day-to-day business matters of a company and raise policy issues so significant that it would be appropriate for a shareholder vote.

Source: SEC Division of Corporation Finance guidance on Rule 14a-8.

That subject came to the fore in December 2009, when the SEC reversed itself over excluding a shareholder proposal at Tysons Food about antibiotics in pig feed. The agency first said it wasn't a significant enough social issue; the proponent then submitted further examples of articles and debates and the SEC changed its mind, deciding it was important enough. In its second letter allowing the resolution to proceed, the SEC also cited the European Union's legislation on antibiotics as feed additives and recent legislation proposed in Congress.

Corporate secretaries and other securities professionals watching the SEC should remember to keep the larger picture in mind, because while the SEC might take a narrow view on what is “ordinary business” today, new agency leadership in the future might take a different view and any existing precedent could be discarded, says Charles Elson, head of the University of Delaware's Weinberg Center for Corporate Governance. “It's not like a court that has established precedents,” he says. “This is an administrative agency that basically goes all over the road.”

For now, in response to the SEC's more narrowly defined “ordinary business” exclusions, companies may simply choose to allow more proposals onto the proxy statement from the start. “You can assume in the aftermath of a financial crisis, that the SEC is not going to be more tolerant of excluding shareholder proposals, so my suggestion would be that corporate managers focus more on understanding and responding effectively to the voting decisions, rather than trying to block them,” says Gary Lutin, who runs the Shareholder Forum, an online corporate governance advocacy group.

From a company's perspective, Lutin argues, any shareholder proposal will have two outcomes. First, nobody will care about it—in which case, why bother spending money trying to fight it? Or people will care about it—and in that case, a company shouldn't be seen as trying to obstruct shareholder interests. “The only practical thing to do … is to learn something about the decision-making criteria of your voters and respond to it, since ultimately you're going to have to win the vote, not block it,” Lutin says.

Still, this attitude could be a challenge for companies given current shareholder activism, he says. “This whole process has been based on activists raising and defining issues, and corporate managers responding defensively to them. That has developed this habit pattern of defensive response to shareholder proposals—and almost everybody in the corporate secretary and compliance area has learned to respond that way,” Lutin says.

“Before companies go down the rabbit-hole of determining whether something should be excluded, they should think about … whether there are serious investor relations issues that they need to consider,” says David Drake, president of the proxy advisory firm Georgeson Inc. “That's not to say that maybe a majority of the time they still pursue that avenue, but there's a threshold question of: Is it worth it?”

As part of that decision, companies should consider whether the proposal even has a reasonable chance of passing, or if it did pass, whether it would really have any effect as a non-binding proposal, Drake says. “Is it really worth the battle and the potential public relations issues to exclude something that you could have allowed shareholders to vote on without much risk?” he asks.