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Wachtell Lipton Discusses SEC’s Guidance on Shareholder Proposals

The SEC Division of Corporate Finance recently provided useful guidance on excluding certain Rule 14a-8 shareholder proposals (Staff Legal Bulletin No. 14I).  While helpful, we hope the SEC will undertake a much-needed comprehensive review of Rule 14a-8, including its outdated eligibility requirements.

“Ordinary Business” and “Economic Relevance” Exclusions.  A shareholder proposal relating to a company’s ordinary business operations may generally be excluded from the company’s proxy statement unless significant policy issues transcending ordinary business are involved (Rule 14a-8(i)(7)).  Noting that this exclusion often involves difficult judgment calls (and without addressing the distinction between the SEC’s interpretive approach to this exclusion and the approach taken by the U.S. Court of Appeals for the Third Circuit in Trinity Wall Street v.Wal-Mart Stores, Inc.), SLB 14I expresses that these judgments are better made by the company’s directors and states the expectation that no-action requests submitted under Rule 14a-8(i)(7) will include discussion of the board’s analysis of the issues.  This guidance is helpful as it indicates that the SEC Staff should defer to boards in determining what matters relate to their companies’ ordinary business operations:

A board of directors, acting as steward with fiduciary duties to a company’s shareholders, generally has significant duties of loyalty and care in overseeing management and the strategic direction of the company.  A board acting in this capacity and with the knowledge of the company’s business and the implications for a particular proposal on that company’s business is well situated to analyze, determine and explain whether a particular issue is sufficiently significant because the matter transcends ordinary business and would be appropriate for a shareholder vote…. That explanation would be most helpful if it detailed the specific processes employed by the board to ensure that its conclusions are well-informed and well-reasoned.

A company may also exclude a shareholder proposal on an issue that accounts for less than 5% of the company’s assets, net earnings and gross sales unless it is otherwise significant to the company’s business (Rule 14a-8(i)(5)).  The Staff has in recent years been slow to agree that a proposal lacked significance to a company.  SLB 14I indicates that, going forward, the SEC Staff will give more weight to the 5% test in evaluating a proposal’s significance to the company’s business but, as with the “ordinary business” exclusion, would expect that no-action requests under Rule 14a-8(i)(5) will include a discussion of the board’s analysis.

By allowing boards to make such determinations, this new guidance is intended to provide the SEC Staff with additional information when it evaluates a company’s exclusion request.  Thus, the information provided to the board and the processes undertaken to review shareholder proposals will take on increased importance.  Since these determinations will be made public as part of the no-action process, institutional shareholders and others will have insight into the board’s decision-making and additional scrutiny or pressure on boards could result.

Going forward, companies should consider using the nominating and corporate governance committee in the first instance to review shareholder proposals that they seek to exclude from the proxy statement under the “ordinary business operations” and “economic relevance” exclusions in order to develop a process and a record for the exclusion determination.

Proposals by Proxy.  In light of concerns that a shareholder may be unaware that others have submitted proposals on his or her behalf and that eligibility requirements may not have been met, SLB 14I sets forth documentary requirements for shareholder proposals submitted by third-party representatives (“proposals by proxy”).  To the extent that such a proposal does not include the required documentation (or meet other requirements), companies may be able to exclude the proposal under Rule 14a-8(b).

Use of Images in Shareholder Proposals.  The SEC Staff allows shareholder proposals to include graphs and images.  A picture may be “worth a thousand words” but only words in the graphics count against the 500 word limit.  SLB 14I also provides guidance as to when graphs and images may be excluded under Rule 14a-8 (though not necessarily the entire shareholder proposal), including because they are materially false or misleading or improperly impugn character. The Staff also advises companies not to “minimize or otherwise diminish the appearance” of a shareholder’s otherwise permissible graphic.  Companies should expect more proposals to use infographics.

We applaud the SEC for providing additional clarity in the area of Rule 14a-8 shareholder proposals and are hopeful that this will be the first step to reforming the entire process.

This post comes to us from Wachtell, Lipton, Rosen & Katz. It is based on the firm’s memorandum, “SEC Provides Guidance on Shareholder Proposals,” dated November 3, 2017.

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