SEC Denial of H&R Block’s Request to Exclude Proxy Access Proposal

On July 21, 2016, the Staff of the SEC’s Division of Corporation Finance denied H&R Block Inc.’s request to exclude a shareholder proposal to amend the company’s existing proxy access bylaw. Like many companies earlier this year who adopted proxy access bylaws, H&R Block had sought to exclude the proposal under Securities and Exchange Act Rule 14a-8(i)(10) on the grounds that the company had already “substantially implemented” the proposal, but the Staff denied H&R Block’s request, signaling a potential shift in the Staff’s position on substantial implementation of proxy access.

Companies that have already adopted proxy access bylaws are now much more likely to see shareholder proposals in the upcoming proxy season, requesting amendments similar to those described below, as well as challenges to eligibility requirements for proxy access nominees that are more rigorous than requirements for other board nominees. It remains to be seen whether the broader investor base will support these proposals at companies that have already adopted “mainstream” proxy access. Among other data points, we will watch for ISS’s recommendation on the shareholder proposal at H&R Block, as well as voting results at the company’s annual meeting on September 8, 2016.

James McRitchie, a well-known and frequent proponent of corporate governance proposals, submitted the proposal to H&R Block. It is important to note that he adopted a multi-stage approach towards implementing his version of proxy access, a tactic that has been used in the past and now may be applied more frequently to other governance policies, practices and procedures. Last year, Mr. McRitchie had withdrawn his proposal to adopt proxy access based on H&R Block’s agreement to adopt its current bylaws. He then submitted the current proposal for amendments, contending that since the company’s proxy access bylaw did not include certain provisions which he considered “essential elements” of his proxy access template, there had not been substantial implementation of the current proposal.

While we acknowledge the merits of the debate on the proposed amendments during this formative period for proxy access, [1] evaluating substantial implementation based on the amendments in isolation, without considering them in the context of the bylaws originally adopted, prioritizes form over substance and may lead to overly narrow conclusions on substantial implementation that allow proponents to make multiple requests on the same issues over multiple proxy seasons. Furthermore, this approach discourages thoughtful, comprehensive discussions at the outset, since proponents may revisit the issues in subsequent years. Substantial implementation of shareholder proposals should be considered in the context of the company’s recent actions on the same policies, practices and procedures, with particular attention to issues that have already been negotiated and withdrawn by shareholders. This is especially appropriate for lengthy and procedurally specific bylaws such as proxy access that could otherwise become the subject of a series of shareholder proposals for ancillary changes, year after year.

For many companies, the Staff’s conclusion in H&R Block appears to be a shift from its prior no-action relief on substantial implementation of proxy access. In February and March of 2016, the Staff had granted no-action relief on the basis of substantial implementation to more than 30 companies that had adopted proxy access bylaws and received alternate proxy access proposals. Typically, under these bylaws, groups of 20 or fewer shareholders holding at least 3% of outstanding shares for at least 3 years may nominate up to the greater of 20% or two members of the company’s board of directors. Other terms of the companies’ bylaws differed from the shareholder proposals, or remained unaddressed by the proposals, but such differences did not prevent the Staff from concluding that the companies had substantially implemented proxy access. In the aftermath of this series of no-action letters, additional companies adopted “mainstream” proxy access bylaws with the provisions described above. To date, over 240 companies have adopted some form of proxy access.

The differences between Mr. McRitchie’s proposal and the existing H&R Block bylaws are summarized below. As H&R Block observed in its no-action request, the Staff had recently concurred in the exclusion of shareholder proposals with these same terms, or that were silent on these terms, when the receiving companies had adopted bylaws similar to H&R Block’s:

In its letter to H&R Block, the Staff was unable to conclude that the company had met its burden of establishing that it may exclude the proposal under Rule 14a-8(i)(10), and based on the information presented, the Staff was unable to conclude that the company’s proxy access bylaw compares favorably with the guidelines of the proposal. The Staff has previously stated that, in determining whether a shareholder proposal has been substantially implemented, it will consider whether a company’s “particular policies, practices, and procedures compare favorably with the guidelines of the proposal.” Texaco, Inc. (March 28, 1991).

The Staff has allowed for differences between a company’s actions and a shareholder proposal so long as the company’s actions satisfactorily address the proposal’s “essential objective.” See, e.g., Exelon Corp. (February 26, 2010) (proposal requesting a political contributions report was substantially implemented by company’s existing report); Hewlett-Packard Co. (December 1, 2007) (proposal requesting that the board permit shareholders to call special meetings was substantially implemented by a proposed bylaw amendment to permit shareholders to call a special meeting unless the board determined that the specific business to be addressed had been addressed recently or would soon be addressed at an annual meeting); Johnson & Johnson (Feb. 17, 2006) (proposal that requested the company to confirm the legitimacy of all current and future U.S. employees was substantially implemented because the company had verified the legitimacy of 91 % of its domestic workforce); Intel Corp. (March 11, 2003) (concurring that a proposal requesting Intel’s board submit to a shareholder vote all equity compensation plans and amendments to add shares to those plans that would result in material potential dilution was substantially implemented by a board policy requiring a shareholder vote on most, but not all, forms of company stock plans); and Masco Corp. (March 29, 1999) (allowing exclusion of a proposal seeking specific criteria for outside directors where the company adopted a version of the proposal that included modifications and clarifications).

In concluding that H&R Block did not meet its burden as articulated under no-action letters such as Texaco and Exelon, the Staff presumably focused on the amendments at issue, and whether they compared favorably with the terms of the existing proxy access bylaw. There is an underlying question of whether the amendments are “essential elements” of proxy access. The proponent Mr. McRitchie framed his arguments along those lines. He contended that the proposed amendments are essential elements of proxy access, that there is a conflict between the proposed amendments versus the existing terms, and that the existing terms do not compare favorably with the amendments. Mr. McRitchie pointed to how the disputed terms are important and problematic for investors, citing positions published by the Council of Institutional Investors and the SEC on each of the terms. For example, he cited research by the Council of Institutional Investors that even if the 20 largest public pension funds were able to aggregate their shares they would not meet the 3% criteria at most of the companies examined, and the SEC’s rejection of a cap when it was formulating its proxy access rule in 2010.

Companies that have already implemented proxy access with terms differing from the proposed amendments received by H&R Block, as well as companies that have established disproportionately rigorous eligibility requirements for proxy access candidates, may receive proposals in the coming proxy season. Unless the Staff alters its position, companies that submit no-action requests will need to apply the substantial implementation analysis to the amendments at hand. Other companies may rely on investor support for the existing bylaws in order to defeat the proposals. However, especially if ISS and certain large institutional investors voice support for the amendments, companies may wish to make conforming changes consistent with the proposed amendments.

Beyond proxy access, if H&R Block signals a trend in the Staff’s interpretation of the substantial implementation basis for excluding shareholder proposals, where amendments are evaluated on their own rather than in the context of the original proposal, then we may see more liberal and more frequent use of shareholder proposals to promulgate other governance reforms going forward, with proponents using follow-up proposals to fine tune policies, practices and procedures as originally adopted through approval or negotiation of shareholder proposals.