SEC Reverses Position on Rules for Excluding Shareholder Proposals

This post is based on a Sullivan & Cromwell LLP client memorandum.

October 27, 2009, the SEC’s Division of Corporation Finance issued a Staff Legal Bulletin changing prior guidance on the application of Rule 14a-8(i)(7), and expanding the scope of matters that the Division considers permissible subjects for shareholder proposals in company proxy statements. Rule 14a-8(i)(7) permits a company to exclude a shareholder proposal from the company’s proxy statement insofar as the proposal deals with a matter relating to the company’s ordinary business operations.

In the Staff Legal Bulletin, the Division reverses its prior positions that proposals relating to environmental, financial or health risks and proposals related to CEO succession planning may be excluded under Rule 14a-8(i)(7). The Division’s action met with approval from environmental activists who have long sought to include shareholder proposals related to climate change issues in corporate proxy statements.

The Division also clarified that both companies and shareholder proponents may alert the Division in advance of their intent to submit correspondence in connection with a no-action letter request under Rule 14a-8.

Analyzing Shareholder Proposals Related to Risk

Rule 14a-8 addresses when a company may exclude a shareholder proposal in the company’s proxy statement and form of proxy when the company holds an annual or special meeting of shareholders. Rule 14a-8(i)(7) states that a shareholder proposal may be excluded if it “deals with a matter relating to the company’s ordinary business operations.” -2- Shareholder Proposals November 9, 2009

The historic position of the SEC’s Division of Corporation Finance (the “Division”) has been that proposals that focus on a company engaging in an internal assessment of the risks and liabilities faced by it as a result of its operations and, specifically, proposals related to minimizing or eliminating operations that may adversely affect the environment or the public’s health, may properly be excluded under Rule 14a-8(i)(7). On October 27, 2009, the Division issued a Staff Legal Bulletin to provide guidance under Rule 14a- 8(i)(7) regarding the application of the Rule to risk.

In the Staff Legal Bulletin, the Division noted there recently has been an increase in the number of noaction letter requests from companies seeking to exclude shareholder proposals as relating to an evaluation of risk. The Division stated that companies have frequently argued that proposals that do not explicitly request an evaluation of risk are excludable under Rule 14a-8(i)(7) because those proposals would require the company to engage in risk assessment. In reversing its position on these types of questions, the Division stated it was concerned that Rule 14a-8(i)(7) might have been applied to exclude proposals that focus on significant policy issues.

Under the Division’s new analytical framework, on a going-forward basis, in evaluating registrant requests to exclude risk-related shareholder proposals under Rule 14a-8(i)(7), the Division will focus on the subject matter to which the risk pertains rather than simply on whether a proposal relates to a company engaging in an evaluation of risk. The Division 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.”

Although the language of the Staff Legal Bulletin is sufficiently broad to cover a range of underlying issues, environmental activists, in particular, are applauding the change in position by the Division as a major victory that will support their efforts to challenge the environmental policies and activities of public companies. As a consequence, all companies, and especially companies engaging in activities that could arguably be a factor in climate change such as energy and mining companies, should expect to see an increase in shareholder proposals relating to their policies and activities.

CEO Succession Planning

The Staff Legal Bulletin also reverses the Division’s prior position on whether a company may invoke Rule 14a-8(i)(7) to exclude a shareholder proposal related to CEO succession planning.

These proposals generally seek to compel a company to adopt and disclose written and detailed CEO succession planning policies. In the past, based on the SEC’s statements in Exchange Act Release No. 40018 (May 21, 1998), the Division supported excluding proposals related to CEO succession planning -3- Shareholder Proposals November 9, 2009 because those proposals relate to ordinary business matters involving the management of the workforce and the hiring, promotion and termination of employees. However, that same release also stated that ordinary business matters may transcend a company’s day-to-day business matters and raise policy issues so significant that it would be appropriate to submit those matters to a shareholder vote.

In reversing its prior position, the Division stated that CEO succession planning raises a significant policy issue regarding the governance of a company that transcends the day-to-day business matter of managing the workforce. Going forward, the Division will take the view that a company may not generally rely on Rule 14a-8(i)(7) to exclude a proposal that focuses on CEO succession planning.

Communications Concerning No-action Letter Requests

The Staff Legal Bulletin also encourages companies and shareholder proponents who intend to submit a no-action letter request under Rule 14a-8 to contact the Division in advance of making their submission so that, if possible, the Division can review the related correspondence prior to issuing its no-action response. Companies and shareholder proponents can call the Division at (202) 551-3500 or send an e-mail to [email protected], and are encouraged to provide the date by which they intend to submit their correspondence. The Division noted that, as stated previously in Staff Legal Bulletin No. 14, if a shareholder proponent intends to reply to a company’s no-action letter request, the shareholder should try to send the reply as soon as possible after the company submits its no-action letter request.

Concluding Thoughts

The expansion of matters that are considered permissible subjects for Rule 14a-8 shareholder proposals is consistent with trends in recent years and the particular areas of this interpretation—environmental risks and CEO succession address topics high on the agenda of social/governance activists. The inclusion of proposals on these topics creates the potential that RiskMetrics, in the future, will determine that a Board’s failure to take a requested action should result in a “withhold” recommendation for director nominees. In the many companies that have adopted majority voting for directors, such “withhold” recommendation can jeopardize the ability of incumbent directors to obtain a majority vote.

Given the timeframe required under SEC rules for the submission of shareholder proposals, an increased volume of these proposals may be arriving in the coming days.

James Morphy is a mergers & acquisitions partner at Sullivan & Cromwell LLP.

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