Analysis of SEC Ruling on Apple Shareholder Proposal

Arthur H. Kohn and Sandra Flow are partners, and Mary E. Alcock is counsel at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb publication by Mr. Kohn, Ms. Flow, Ms. Alcock, and Related research from the Program on Corporate Governance includes Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).

On November 1 2017, the Securities and Exchange Commission (“SEC”) released guidance (Staff Legal Bulletin No. 14I (“SLB 14I”)) clarifying the scope and application of the ordinary business and economic relevance grounds for excluding a shareholder proposal under Rule 14a-8 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) from a company’s proxy statement. [1] On November 20, Apple Inc. became the first corporation to attempt to use this guidance in a request for no-action relief from the staff of the SEC’s Division of Corporation Finance (the “Staff”), in response to governance activist Jing Zhou’s proposal that Apple create a board committee focused on human rights (the “Proposal”). On December 21, 2017, the Staff responded, denying Apple’s request to exclude the Proposal from its proxy materials.

In seeking no-action relief, Apple specifically relied on SLB 14I, which Apple characterized as “new staff policy regarding the application of [the ordinary business exclusion that] the Company believes supports the Company’s exclusion of the proposal.” Since Apple’s application was filed after the 80-day deadline for a no-action relief request, Apple argued both that the release of SLB 14I was good cause for a waiver of the timing requirement and that the policy announced in it provided a substantive basis for exclusion. The Staff denied Apple’s request, commenting specifically on the application of the ordinary business exclusion (the Staff’s reply does not specifically address the timing issue). The Staff’s reply clearly indicates that the guidance in SLB 14I should not be construed as providing an automatic pass for companies whose boards of directors can be shown to have deliberated on the issues raised by a particular shareholder proposal. That posture is consistent with informal statements by members of the Staff since the release of SLB 14I, and should give governance advocates some comfort that SLB 14I will not be applied as broadly as some have speculated.

In its request, Apple argued that issues related to human rights are fundamental to its business operations and therefore should be excludible under the ordinary business exception of Rule 14a-8(i)(7) under the Exchange Act. Apple explained that human rights concerns are integrated into its business, citing supplier compliance initiatives, prominence on its website, action that goes beyond relevant minimum standards set by the laws in various jurisdictions in which it operates and its dedication of resources to the issues. The request detailed various ways in which human rights concerns factor into the company’s operations, and went so far as to state that “the observance of human rights standards factors into every decision made by management in the day-to-day operations of the Company.” (emphasis added)

In light of SLB 14I’s focus on board process, [2] Apple’s no-action request also contained significant details regarding its Board process. It stated that the Board specifically considered and deliberated about the Proposal.

The challenge for Apple was to show that while the topic of human rights was integral to ordinary business operations, it did not raise a “significant policy issue” that transcends the Company’s ordinary business. Apple argued, unsuccessfully, that because it already had significant oversight in place concerning human rights issues, the Proposal was “redundant” and therefore not a “significant policy issue.” The Staff used language from Apple’s no-action letter in citing its reasons for denial, finding that Apple’s argument that human rights issues are an “integral component of the [company’s] business operations” tended to provide more support for inclusion of the shareholder proposal. The SEC also cited a lack of analysis, including at the board level, that explained why the proposal would not “raise a significant issue for the [company].”

Notably, Apple did not make an argument for exclusion based on economic relevance. Rule 14a-8(i)(5) under the Exchange Act permits companies to exclude a proposal that “relates to operations which account for less than 5 percent of the company’s total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company’s business.” The discussion in SLB 14I raised the possibility that companies would argue that proposals related to environmental, social and governance (“ESG”) issues do not meet the economic relevance standard. The Apple request highlights a further difficulty that companies may face in taking advantage of the new SLB 14I guidance: under what circumstances, if any, could a company argue on the one hand that ESG issues are ordinary course and permeate operational decisions so that they should be excludible under the ordinary business exclusion, and also argue on the other hand that they are not “economically relevant”—i.e., that they are not related to substantial business operations?

While the Staff was not persuaded by Apple’s arguments, it remains to be seen whether and how a similar argument could be presented to take advantage of the apparent opportunity afforded to SLB 14I’s discussion of board process. That is, how does a company show that an issue is ordinary course and without significant policy implications, but also that it was important enough for the board to have considered it in a way that evidences that conclusion? Could a company argue, for example, that an ESG or other issue is operationally important, but the board never had reason to consider it (because it raises no significant policy issues) until the company received a shareholder resolution about it?

In sum, many commentators initially assumed that SLB 14I signaled a new willingness by the Staff to defer to companies in regard to shareholder proposals, in line with the new administration’s overall regulatory attitude. While it is not yet clear that this view should be adjusted, the Staff’s response to the Apple request indicates that the citation of board process and an involvement of the board in an assessment of a shareholder proposal will not give rise to an automatic pass with the Staff. We continue to believe that companies should carefully consider the role that boards should play in the Rule 14a-8 process in light of SLB 14I.

Endnotes

1See our prior Alert Memo, discussed on the Forum here.(go back)

2SLB 14I states that “at issue in many Rule 14a-8(i)(7) no-action requests is whether a proposal that addresses ordinary business matters nonetheless focuses on a policy issue that is sufficiently significant. These determinations often raise difficult judgment calls that the Division believes are in the first instance matters that the board of directors is generally in a better position to determine. 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. Accordingly, going forward, we would expect a company’s no-action request to include a discussion that reflects the board’s analysis of the particular policy issue raised and its significance. 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. We believe that a well-developed discussion of the board’s analysis of these matters will greatly assist the staff with its review of no-action requests under Rule 14a-8(i)(7).”(go back)

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