SEC Resets the Shareholder Proposal Process

On November 3, 2021, the Securities and Exchange Commission (“SEC”) Division of Corporation Finance issued Staff Legal Bulletin 14L (“SLB 14L”). From the perspective of proponents, the bulletin resets the shareholder proposal process to: (a) align with the Commission’s original principles and structure of SEC Rule 14a-8 (the “Rule”), (b) reduce subjectivity arising from determinations made by the Staff of the Division of Corporation Finance (the “Staff”), and (c) bring the process into line with the growing importance to the capital markets of environmental, social & governance (“ESG”) issues.

The need for SLB 14L is clear. A series of Staff interpretations and now-rescinded bulletins had rewritten the ordinary business exclusion to add concepts inconsistent with other exclusions. The interpretations added complexity, cost, and subjectivity to the no-action process. Moreover, by disregarding previous Commission positions and the explicit language in other exclusions in the Rule, the Staff added a high degree of unpredictability to the process.

The adopted rules of the full Commission cannot be overturned by the Staff’s intervening guidance. The new bulletin SLB 14L has appropriately revoked nonconforming administrative guidance and realigned Staff interpretation with that of the Commission [1] and the language of Rule 14a-8. The result is an approach more consistent with investor concerns, current governance practices, societal norms, and systemic risks.

Representatives of the corporate bar have made “the sky is falling”type assertions, alleging that SLB 14L will allow a flood of inappropriate new shareholder proposals or even that it radically redefines the purpose of a corporation to demand socially conscious citizenship of corporations. These views are not well founded and largely ignore the serious legal concerns regarding the positions taken by the Staff since 2017.

The Basics of Rule 14a-8

Like a good architect renovating a historically significant building, the new bulletin has identified and restored the fundamental structure of Rule 14a-8. SLB 14L makes corrections that brings the no-action process back into alignment with the actual language of the Rule and interpretive positions espoused by the Commission.

Under the plain language of the Rule, augmented by Commission guidance in its formal releases, [2] there are a few key touchstones within the shareholder proposal Rule:

• Ask for specifics. A proposal should “state as clearly as possible the course of action” that the proponent believes “the company should follow” [3] as an advisory “request” for company action. Rule 14a-8(a).
• Demonstrate relevance. A proposal should be relevant to the company receiving it. Rule 14a-8(i)(5). [4]
• Evaluate implementation. A proposal should not ask for actions already implemented by the company. Rule 14a-8(i)(10). [5]

In addition to those “bones” of the Rule, the Rule allows exclusion of a proposal if it inappropriately intrudes on the discretion of board and management by addressing only the “ordinary business” of the company. Rule 14a-8(i)(7). However, the Commission has made clear that the ordinary business exclusion does not apply to matters of significant social policy.

Over time, Staff interpretations of the ordinary business exclusion have produced inconsistent add-ons to the clearly articulated principles of the Rule. Several Staff interpretations, beginning as early as 2009, deviated from core concepts of Rule 14a-8 as adopted by the Commission. Staff Legal Bulletin 14L resets the process to eliminate these deviations. The chart below summarizes the issues that will be discussed further in the following sections of this article.

Ordinary Business According to the Commission

In 1998, the Commission issued a release (the “1998 Release”) interpreting the Rule, both reiterating and clarifying past approaches. That release discussed at length the ordinary business exclusion. The release overturned the Commission’s prior position that employment-related proposals (e.g., affirmative action proposals) affecting rank-and-file employees were to always be treated as excludable ordinary business. [6]

In deciding to allow employment-related proposals that addressed a significant social policy issue to appear in the proxy, the Commission noted that it was adjusting the Rule to better meet the needs of investors:

We have gained a better understanding of the depth of interest among shareholders in having an opportunity to express their views to company management on employment related proposals that raise sufficiently significant social policy issues.

The Commission went on to summarize two central considerations in ordinary business determinations—significant social policy issues and micromanagement.

First, that certain tasks were generally considered so fundamental to management’s ability to run a company on a day-to-day basis that they could not be subject to direct shareholder oversight (e.g., the hiring, promotion, and termination of employees, as well as decisions on retention of suppliers, and production quality and quantity). However, proposals that related to such matters but focused on sufficiently significant social policy issues (i.e., significant discrimination matters) generally would not be excludable.

Second, proposals could be excluded to the extent they seek to “micromanage” a company by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment. The concern did not, however, result in the exclusion of all proposals seeking detailed timeframes or methods. As the 1998 Release indicated:

Timing questions, for instance, could involve significant policy where large differences are at stake, and proposals may seek a reasonable level of detail without running afoul of these considerations.

In discussing the topic, the 1998 Release referenced Capital Cities/ABC, Inc. (Apr. 4, 1991), a no-action letter agreeing with the company’s arguments on the exclusion of a proposal that requested details on the company’s affirmative action policies and practices.

We did not intend to imply that the proposal addressed in Capital Cities, or similar proposals, would automatically amount to ‘ordinary business’. Those determinations will be made on a case-by-case basis, taking into account factors such as the nature of the proposal and the circumstances of the company to which it is directed. [emphasis added]

The case-by-case analysis would be applied to the second prong of ordinary business, micromanagement. Proposals that passed the first prong but for which the wording involved some degree of micromanagement could be subject to a case-by-case analysis of whether the proposal probes too deeply for shareholder deliberation.

The interpretation provided by the Commission was, however, altered in a series of legal bulletins starting in 2009.

Staff Legal Bulletin 14E

The 2009 Staff Legal Bulletin 14E (“SLB 14E”) [7] added a highly subjective and additional interpretive task to Rule 14a-8(i)(7)—a “significance to the company” inquiry—to evaluate under the ordinary business rule whether there was sufficient nexus between a significant policy issue and the company. While Staff had been informally considering this concept of nexus in no-action decisions, SLB 14E represented a formal adoption of the concept by the Staff and began a process of interpretation, and an array of decision principles, inconsistent with the language of the Rule itself.

The interpretation altered the ordinary business exclusion in a manner inconsistent with Commission interpretation and with the structure of the Rule and was unnecessary because the “nexus” concept already existed in a separate exclusion.

Rule 14a-8(i)(5) permits the exclusion of proposals that are not “relevant” to a company’s business. The exclusion originally applied to proposals involving “a recommendation, request, or mandate that action be taken with respect to any matter, including general economic, political, racial or religious, social or similar” nature that were “not significantly related to the business of the issuer.” [8] While undergoing changes and amendments over time, the “significantly related to the company’s business” language remained an important requirement. Proposals would be unlikely to pass muster under Rule 14a-8(i)(5) if unrelated to the company’s business: a proposal on animal cruelty related to foie gras submitted to a company that neither sold nor produced the product would be excludable, as would a proposal on human rights in a region of the world where the receiving company did not do business. Where, however, the proposal implicated the actual business of the company and involved matters of social policy, exclusion was rarely permitted. [9]

The search for a “nexus,” therefore was unnecessary and sidestepped and created potential conflict with the exclusion in Rule 14a-8(i)(5). Moreover, the shift led to more than a decade of lawyerly pontification in no-action requests of ever-increasing length and complexity as to whether a significant policy issue had sufficient nexus to the company’s business.

Staff Legal Bulletins 14I, 14J and 14K

Staff Legal Bulletins 14I, 14J, and 14K issued from 2017 to 2019 amplified the case-by-case “nexus” determinations of SLB 14E by offering a wide array of new “significance to the company” tests that expanded the concept of nexus. Bulletins 14I-J-K multiplied the number of significance to the company arguments that an issuer or its board of directors could present in an attempt to persuade the Staff to exclude a proposal under either Rule 14a-8(i)(7) or Rule 14a-8(i)(5). [10]

Using these new bases, the Staff began to deem proposals excludable in ways that increasingly deviated from and overshadowed the criteria of the relevancy exclusion in Rule 14a-8(i)(5) . Effectively issuers were given two bites from the apple in making the case that a proposal was not sufficiently connected to a company’s business. No-action letters became significantly longer and the process more complex. In addition, the “nexus” approach resulted in the exclusion of many proposals that would otherwise have survived an analysis under Rule 14a-8(i)(5).

For instance, the Staff in J.P. Morgan Chase & Co. (March 26, 2021) excluded a proposal on the company’s underwriting of dual-class share offerings by focusing on significance to the company under Rule 14a-8(i)(7). The Staff wrote:

In our view, the Proposal does not demonstrate how underwriting equity offerings with different class structures is a significant policy issue for the Company, such that it transcends the Company’s ordinary business operations and would be appropriate for a shareholder vote.

This determination ignored the fact that J.P. Morgan, due to its position as a leading underwriter, has a significant impact on the extent of multiclass share offerings, which would have made the proposal “otherwise significant to the company’s business” under Rule 14a-8(i)(5). Instead, the Staff exclusion appears to have focused only on the direct economic importance to JP Morgan, rather than other issues of proper concern to shareholders, namely the systemic impact of the company on its industry, society, and capitalism at large.

Kohl’s Corporation (February 19, 2021) presents another example of a company arguing, and the Staff accepting, a significance to the company argument based on Rule 14a-8(i)(7) instead of 14a-8(i)(5) to override the important social policy issue raised by the proposal. The proposal in Kohl asked the board to analyze and report on the feasibility of including paid sick leave as a standard employee benefit not limited to the time of COVID-19. Staff allowed exclusion based on ordinary business under Rule 14a-8(i)(7). In particular, the Staff decision noted that:

[P]roposals related to paid sick leave may raise a significant policy issue that transcends a company’s ordinary business operations. However, in our view, the Proposal does not demonstrate how offering paid sick leave as a standard employee benefit is sufficiently significant to the Company, such that it transcends the Company’s ordinary business operations and would be appropriate for a shareholder vote.

Kohl’s policy on sick leave has an evident impact on its stakeholders that would, under the rule, make the proposal not excludible under Rule 14a-8(i)(5) as an issue that is both economically significant to the company AND otherwise significant to the company’s business.

The bulletins also added new requirements to exclusions that appeared in other parts of Rule 14a-8. The Rule includes, in subsection (i)(10), an exclusion for proposals already implemented. [11] Yet, in 2018, Staff Legal Bulletin 14J established a new test which allowed a board to opine on whether it observed a sufficient “delta” between existing company activities and those requested by a proposal. This novel concept allowed a board to opine on its existing activities and whether it saw a significant difference between a proposal’s requests and existing company actions. The approach was inconsistent with Rule 14a-8(i)(10) which evaluates whether a proposal is substantially implemented by examining whether existing company activities fulfil the guidelines and essential purpose outlined by the proposal.

The 14I-J-K bulletins also radically expanded the concept of micromanagement beyond what was set forth by the Commission.

Instead of continuing to focus micromanagement analysis on the long-standing approach of whether the level of detail in the proposal delved too far into the minutiae of company operations, or whether it was written in a manner that “probes” at a level consistent with shareholder deliberation and debate, the bulletins added a new principle allowing an advisory proposal to be excludable if it suggested a specific outcome or strategy, a wholly new standard. [12]

This overly-expansive approach significantly broadened the subjective opportunities for Staff to block previously acceptable proposals, such as a request to set greenhouse gas targets aligned with global climate goals, a request that is neither too complicated for shareholder deliberation and debate nor delves too deeply into the minutiae of how to set and apply such targets. [13]

Assessing the Added Staff Interpretations

Each of the above add-ons and decision-making criteria were inconsistent with the original core principles of the rules regarding specificity, relevance, and implementation. Instead of empowering and protecting shareholders—which is the SEC’s mandate—these subjective Staff interpretations made the filing of proposals more expensive and uncertain.

Each also represented a significant deviation from the plain language and structure of the original Rule. They increased the number of grounds on which a given proposal could be challenged and made outcomes highly unpredictable and dependent on subjective board and Staff analysis. Proposals necessarily began to take an increasingly vague form to attempt to survive the greatly expanded concept of micromanagement only to be caught on the shoals of the substantially implemented provisions or other new Staff criteria; other proponents were simply discouraged from filing proposals given the uncertainties and costs.

What SLB 14L Accomplishes

The new bulletin effectively realigns Staff interpretation with the requirements of the Rule and prior positions taken by the full Commission. Its adoption should reduce uncertainty and the contentiousness of the no-action process regarding a number of pivotal issues:

Micromanagement

The right of shareholders to make the requests in their proposals as clear as possible—which is stated in the original Rule itself—has been restored. Advisory proposals on a significant policy issue—such as climate change—that request targets, or improvements in performance at the scale, pace, and rigor required by public policy goals are no longer considered micromanagement unless the proposal attempts to direct the minutiae of operations.

The new bulletin resets the interpretation of micromanagement to focus on whether the granularity of the proposal is consistent with shareholders’ capacity to understand and deliberate; i.e., proponents are expected to tailor proposals to a level of inquiry that is consistent with the current state of investor discourse and knowledge. The bulletin provides clear guidance consistent with the Commission’s 1998 Release on the criteria that Staff will use to ascertain whether a proposal “probes too deeply” and seeks to micromanage the company. As an example, it examines whether the issues in the proposal are discussed within the bounds of recognized national or international guidelines.

Significant policy issue and social impact

A policy issue is said to transcend ordinary business when it involves an issue of significant societal impact. This is consistent with the 1998 Release as well as the current needs and focus of investors. This is discussed further below.

Significance to the company is evaluated under Rule 14a-8(i)(5)

The bulletin eliminates misdirected interpretive guidelines regarding significance—such as the application of “delta,” and the interjection of board opinions. Significance to the company of a policy issue is evaluated under Rule 14a-8(i)(5)—rather than Rule 14a-8(i)(7)—and a proposal that does not meet the economic tests of the Rule will be deemed “otherwise significantly related” to the company under Rule 14a-8(i)(5) if it addresses societal impacts or ethical issues that are relevant to the company’s business.

That said, a key requirement under 14a-8(i)(5) remains—a proposal that addresses a social or ethical issue must be relevant to the company’s business. [14] A proposal that seeks a general plebiscite on a social or ethical issue on which the company has no impact or involvement would be unlikely to pass 14a-8(i)(5)’s ‘otherwise significantly related to the company’s business’ test.

Email, Graphics, and Proof of Ownership

SLB 14L also contains technical guidance on several logistical and technical issues in filing. For instance, it encourages proponents to use email to file proposals and respond to deficiency notices, while warning that proof of receipt should demonstrate that a person actually opened the email on the receiving end. In addition, the bulletin reiterates that graphics can be included in proposals provided they do not violate other exclusions under the Rule. It also reinforces the notion that proof of ownership should not devolve into a game of technical “gotcha” and that reasonable proof of continuous beneficial ownership should suffice.

Fit for purpose: Supporting the rights and responsibilities of all investors

Resuming the renovation metaphor—an architect undertaking renovation looks to restore the structure to its original elegance, but to also meet the needs of current users — the Staff’s renovation of the no-action process achieves high marks on both counts. The no-action process has been restored to reflect the original intentions and efficiencies of the Rule.

Considering the needs of users, SLB 14L reinstates a fundamental principle laid out by the Commission—that important social policy issues can be addressed through shareholder proposals. This appropriately reflects the groundswell of investor concern about materially important environmental, social, and governance (“ESG”) matters. SLB 14L’s restatement that societal impact transcends ordinary business considerations is entirely consistent with the Rule and with our changing times. Echoing the words of the 1998 Release, the new bulletin reflects an understanding of the “depth of interest among shareholders in having an opportunity to express their views to company management.”

The 2021 proxy season saw record voting support for ESG proposals. This underscores that shareholder democracy is a critical tool for investors to drive improvements in disclosure and performance on issues they deem materially important, such as social and environmental matters, that are understood to drive long-term profitability for companies and portfolios. ESG is mainstreaming because of demonstrated correlations to material financial outcomes and considerations of systemic risks and opportunities (such as climate change) which are concerns for all long-term, diversified investors. [15] In this way, SLB 14L goes hand-in-hand with the important Commission efforts underway to propose mandatory ESG disclosure rules.

SLB 14L does make it easier for shareholders to write clear and specific proposals that will survive a no-action challenge—which is a good thing. In 2021, it was reported that 71% of no-action challenges were successful, confounding the goal of giving shareholders a voice on issues of material concern. Allowing more proposals to make it into the proxy for review and consideration by shareholders, management, and boards is both useful and appropriate.

It is important to remember that while the original intent of the Commission has been restored by SLB 14L, and certain types of proposals that were previously excludable will now be permitted again (because they are of clear and appropriate interest for investor deliberation), filing a shareholder proposal is still a quite substantial and heavy lift for most investors, and there is little evidence that the overall number of proposals filed will surge in 2022.

In Closing

Ultimately, the ability of a shareholder proposal to produce beneficial change at a corporation is grounded in a fundamental test—whether shareholders vote in favor of the proposal. This inevitably turns on shareholders’ assessment of whether the proposal will advance value on a short- or long-term basis, whether at the individual company or across the economy. For this reason, the corporate bar’s alleged concern that the shareholder proposal process could turn into a plebiscite on general issues of political or social debate is entirely unfounded. Indeed, exclusion of a too-general political or social proposal is the most likely outcome when a proposal is not relevant to a company’s core business.

SLB 14L strengthens Rule 14a-8 within the larger matrix of evolving rights and responsibilities of investors. It has become clear that the process of investors exercising their legal right to file proposals is accomplished within a broad framework of accountability—including public and legal scrutiny of institutional investor voting, and whether fiduciaries are engaged in sufficient due diligence in accordance with a transparent set of principles. To the extent that a fiduciary has adopted ESG principles, their votes on shareholder proposals will be scrutinized as one of the most visible means of determining whether their commitment to ESG is bona fide. [16]

A shareholder proposal provides an essential opportunity for a company to hear from its shareholders as to whether a given issue should be given elevated attention by board and management. For this reason, Staff Legal Bulletin 14L is the right reform undertaken at the right time in a way that will benefit all investors, not just those looking to implement important ESG missions and principles.

Endnotes

1 See SLB 14L (“Going forward, the staff will realign its approach for determining whether a proposal relates to “ordinary business” with the standard the Commission initially articulated in 1976, which provided an exception for certain proposals that raise significant social policy issues, and which the Commission subsequently reaffirmed in the 1998 Release.”).(go back)

2 For a general overview of the history of the Rule, see Brown, J. Robert, The Evolving Role of Rule 14A-8 in the Corporate Governance Process (April 20, 2016). Denver University Law Review Online, Vol. 93, p. 151, 2016, U Denver Legal Studies Research Paper No. 16-16, Available at SSRN: https://ssrn.com/abstract=2767712(go back)

3Rule 14a-8(a).(go back)

4Rule14a-8(i)(5) provides for exclusion “[i]f the proposal 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.” (emphasis added) Note that this Rule in its genesis was originally referred to as a test of “insignificance to the company.”(go back)

5 Rule 14a-8(i)(10) provides for exclusion “if the company has already substantially implemented the proposal.”(go back)

6The position delineated in Cracker Barrel (October 13, 1992).(go back)

7SLB 14E made an important breakthrough determination that shareholder requests for a company to conduct a risk analysis of a social policy issue—risk being an obvious core interest to investors—would not be routinely excludable as ordinary business, provided that the underlying subject matter addressed a significant social policy issue.(go back)

8SEC Securities Exchange Act Release No. 34-9784, 1972 WL 125400 (Sept. 22, 1972).(go back)

9www.denverlawreview.org/dlr-online-article/2016/5/6/sec-rule-14a-8i5-is-it-still-relevant.html#_ftn53 “For the most part, the Staff found that proposals involving a small percentage of earnings or assets, but that nonetheless raised important social issues were significantly related to the company’s business.”(go back)

10 Rescinded Staff Legal Bulletin 14J integrated several new and problematic factors of “significance to the company” for a board of directors to opine on in their arguments for exclusion, such as “whether the company has already addressed the issue in some manner, including the differences—or the delta—between the proposal’s specific request and the actions the company has already taken, and an analysis of whether the delta presents a significant policy issue for the company,” and “whether anyone other than the proponent has requested the type of action or information sought by the proposal.”(go back)

11For a discussion of this exclusion, see: www.denverlawreview.org/dlr-online-article/2016/5/6/rule-14a-8i10-how-substantial-is-substantially-implemented-i.html(go back)

12Staff Legal Bulletin 14 J stated: “In considering arguments for exclusion based on micromanagement… we look to whether the proposal seeks intricate detail or imposes a specific strategy, method, action, outcome or timeline for addressing an issue, thereby supplanting the judgment of management and the board.” [emphasis added] This contrasts with the explicit language of Rule 14a-8(a), which says that the proponent should be “as specific as possible” in a proposal’s request to a company. The new considerations awkwardly placed the Staff in a highly subjective decision-making process with little helpful guidance.(go back)

13The climate proposals that were allowed to be excluded in the prior administration involved advisory proposals asking a company to develop greenhouse gas targets aligned with particular external policy or scientifically designated goals, e.g. net zero by or alignment with the Paris agreement temperature goals.^⁠ e.g., PayPal Holdings Inc. (March 6, 2018), Deere & Company (December 27, 2017), Apple Inc. (December 21, 2017), Verizon Communications Inc. (March 6, 2018), Apple Inc. (December 5, 2016), Amazon.com, Inc. (March 6, 2018). The Staff decisions asserted that the proposals were “probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment.”(go back)

14In a recent podcast former SEC Special Counsel Keir Gumbs suggested that it was only nexus under Rule 14a-8(i)(7) that prevented a proposal on guns from being excludable at a company that neither produces nor sells guns. Yet, a proposal that fails the 5% economic criteria of Rule 14a-8(i)(5) would still be required to address a social or ethical issue that is “otherwise is significantly related to the company’s business” in order to qualify as relevant under Rule 14a-8(i)(5).(go back)

15See, for instance, Gordon, Jeffrey N., Systematic Stewardship (February 14, 2021), forthcoming 2022 Journal of Corporation Law. Available at SSRN: https://ssrn.com/abstract=3782814 or http://dx.doi.org/10.2139/ssrn.3782814(go back)

16A newly proposed Rule to require data-tagged reporting of proxy votes is likely to drive demand for better alignment of votes with ESG brands. See proposed Rulemaking, S7-11-21 re enhanced reporting of proxy votes, which would enable more vote comparisons.(go back)