SLB 14I (CF): Issued During 28th Annual SRI Conference
The latest SEC Staff Legal Bulletin, SLB 14I (CF), was issued on November 1, while 800 attended the 28th Annual SRI Conference in San Diego. I was flipping though the agenda when I got an email from a Bloomberg reporter asking for feedback on SLB 14I, which will further discourage shareholders from submitting proposals, especially those focused on environmental and social issues. It is yet another move against the ability of shareholders to fight for a salubrious environment, while seeking a healthy return.
28th Annual SRI Conference
First, a brief few words about the SRI Conference (#AllinForImpact), then I will dive into SLB 14I. I should have been attending these conferences for 28 years but they did not seem focused enough on governance issues. Over the years, governance and engagement have become more of an issue for them, while environmental and social issues have become more important to me… a happy convergence.
[I’ll write at least a post or two more about the SRI conference as time allows. (Shareholder proposals are coming due. That is my main focus for a while.)] Just when I thought SRI Conference organizers and I had reached a point of convergence, their focus evolved. This year’s meeting had a lot more focus on educating and equipping registered investment advisors (RIAs)… exactly what pre-conference publicity touted. That make sense for their target audience, I’m not an RIA, so most of that focus was lost on me, although exhibits from Thomson Reuters and MSCI made me think I should become an RIA and join a local practice just to get access to some wonderful tools.
Additionally, more and more of the panels were focused on impact investing. Apparently, more clients of RIAs believe investing directly in companies or indirectly through mutual funds can’t have the measurable impact they want. In contrast to prior SRI Conferences, there were fewer discussions about proxy proposals, much more about community investment, conversion of conventional farmland to organic, creating an environmentally friendly cruise line and other private placement opportunities.
While I applaud such efforts, I hope we are not giving up on public companies as a means of increasing net wealth and creating a better world. I suspect there are still far more SRI dollars invested in mutual funds than private placements. Maybe next year we will have a few more panels on proxy proposals.
If I do post more about the SRI Conference, I will be sure to include the keyword, Twitter hashtag #AllInForImpact. Despite more focus on office operations, the SRI Conference was great for me… still a highly relevant program for anyone in with ESG concerns and shouldn’t that be everyone?
SLB 14I: Overview
On November 1, 2017, staff of the SEC’s Division of Corporation Finance issued Staff Legal Bulletin No. 14I (CF) (SLB 14I), which provides a roadmap to corporations on how to exclude shareholder proposals under Exchange Act Rule 14a-8(i)(7) (the “ordinary business” exception) when the significance of the proposal to the company’s business is at issue and Rule 14a-8(i)(5) (the “economic relevance” exception or 5% rule).
Additionally, the new guidance seeks to impose an additional information burden from shareholders for so-called “proposals by proxy” and clarifies how images can be excludable.
According Ross Kerber (New SEC guidance could raise bar for some shareholder measures):
SEC officials said the new guidance was not meant to tilt the scales. The report states that companies looking for SEC permission to skip votes should offer a board analysis of a proposal’s significance to the company, which could give activists their say with directors.
“We did not set out to try to make things easier or harder for one side or the other, we were trying to improve the process,” said Bill Hinman, director of the SEC’s Division of Corporate Finance.
It would be hard to see SLB 14I as fair and balanced, since it undoubtedly will result in more successful requests for no-action letters. My friend, Tim Smith of Walden Asset Management agrees. He is quoted by Kerber writing, “Clearly it will put new burdens of proof on investor proponents.”
SLB 14I: Rule 14a-8(i)(7) Ordinary Business Exclusion
Under Rule 14a-8(i)(7), a company may exclude a proposal under Rule 14a-8(i)(7) if it “deals with a matter relating to the company’s ordinary business operations.” However, companies have often cited this exclusion to no avail, since it does not apply in cases where a proposal transcends the company’s day-to-day business matters by raising a policy issue so significant that it would be appropriate for a shareholder vote. Think about proposals that used to be excluded, like asking Greyhound to integrate their waiting rooms. (Peck v. Greyhound, 1951)
The question often at issue is whether or not a policy issue is “sufficiently” significant. In the past, Staff rendered such decisions based on a combination of arguments presented and their interpretation of law, including case law such as Lovenheim v. Iroquois Brands. Additionally, Rule 14a-8(g) certainly clarifies where the burden of evidence falls:
Who has the burden of persuading the Commission or its staff that my proposal can be excluded? Except as otherwise noted, the burden is on the company to demonstrate that it is entitled to exclude a proposal.
A Staff Legal Bulletin cannot overturn case law or administrative law, such as regulations. Nonetheless, SLB 14I appears to announce the intention of Staff going forward to give deference to boards of directors.
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.
Deference to the opinion of boards will be conditioned on well reasoned arguments. A Sidley update of November 3, 2017 provides an excellent summary as follows:
Going forward, the Division Staff would expect a no-action request under Rule 14a-8(i)(7) making the argument that the proposal does not raise a significant policy issue for the company to include a discussion (i) reflecting the board’s analysis of the particular policy issue raised and its significance and (ii) explaining the specific processes the board employed to ensure that its conclusions are well-informed and well-reasoned. The new guidance does not provide examples or otherwise elaborate on what these processes may be.
SLB 14I: Rule 14a-8I)(5) Economic Relevance Exemption
Here I am simply going to quote from Sidley’s update. I have read analyses from several other firms. Sidley’s is the most comprehensive, so there is nothing to be gained by combining the analysis of several firms.
A company may exclude a proposal under Rule 14a-8(i)(5) if it relates to operations which account for less than 5% of the company’s total assets, net earnings and gross sales and “is not otherwise significantly related to the company’s business.” Historically, the Division Staff has not focused on a proposal’s significance to the company’s business, and has instead only considered whether the company conducted any amount of business related to the issue raised in the proposal and whether the issue was of broad social or ethical concern. The Division Staff believes this approach has unduly limited the exclusion’s availability.
New Analytical Framework: Going forward, the Division Staff will focus on a proposal’s significance to the company’s business when it otherwise relates to operations that account for less than 5% of total assets, net earnings and gross sales (regardless of whether the proposal raises issues of social or ethical importance in the abstract). In evaluating significance, the Division Staff will consider the proposal in light of the “total mix” of information about the company. The determination will depend on a company’s particular circumstances, but the Division Staff would generally view substantive governance matters to be significantly related to almost all companies.
Finally, going forward, the Division Staff will no longer consider its analysis of the proposal under the “ordinary business” exception in Rule 14a-8(i)(7) when determining whether a proposal is excludable under Rule 14a-8(i)(5). Each basis of exclusion will be analyzed separately to ensure that it serves its intended purpose.
New Guidance for Proponents: If a proposal’s significance to a company’s business is not apparent on its face, the proponent must prove that it is “otherwise significantly related to the company’s business.”
- The proponent can provide information demonstrating the proposal “may have a significant impact on other segments of the issuer’s business or subject the issuer to significant contingent liabilities.”
- The proponent must connect any social or ethical issues raised in its arguments to a significant effect on the company’s business. The potential for reputational or economic harm will not preclude no- action relief.
New Guidance for Companies: Similar to the “ordinary business” exception discussed above, the Division Staff is of the view that the company’s board is generally in a better position than the staff to make the determination as to whether a proposal is “otherwise significantly related to the company’s business.” Going forward, the Division Staff would expect a no-action request under Rule 14a-8(i)(5) to include a discussion (i) reflecting the board’s analysis of the proposal’s significance to the company and (ii) explaining the specific processes the board employed to ensure that its conclusions are well-informed and well-reasoned.
Again, a Staff Legal Bulletin cannot overturn case law or administrative law, such as regulations, which clearly place the burden of proof on companies seeking to exclude shareholder proposals. Nonetheless, SLB 14I appears to announce the intention of Staff going forward to give deference to boards of directors if specified conditions are met. I hope a shareholder will take the SEC to court for promulgating what we in California would term underground regulations, since SLB 14I appears to attempt an end run around Rule 14a-8(g).
SLB 14I: Proposals by Proxy
This part of the SLB is clearly aimed at John Chevedden, although many RIAs and others submit proposals on behalf of their clients. I don’t expect it to have any substantive impact. The impact will be much like the impact of SLB 14G (CF), which laid out new requirements for evidencing ownership. For example, after SLB 14G we had to request brokers include their DTSC clearinghouse number.
In this instance, involving SLB 14I, we will have to include a little more in our authorization letters. A few proposals may get caught in the cracks but this is a relatively meaningless additional burden to shareholders. Just as SLB 14G was unable to cite any instance of a bank or broker issuing false evidence of ownership, SLB 14I cites no instances of a shareholder ever complaining about unauthorized shareholder proposal filed in their name.
I find it disturbing that the SEC would interject itself between two contracting parties by specifying details of what must be included in such a contract. From the Sidley update:
The Division Staff allows a shareholder to submit a proposal by proxy (i.e., through a representative), but recognizes that this may raise concerns about whether (i) the eligibility requirements of Rule 14a-8(b) have been met and (ii) the shareholder knows that a proposal is being submitted on the shareholder’s behalf.
New Guidance for Proponents: Going forward, if a shareholder submits a proposal by proxy, the Division Staff will consider whether the shareholder provides signed and dated documentation which describes the shareholder’s delegation of authority to the proxy and identifies the:
- shareholder proponent and the person or entity selected as proxy;
- company to which the proposal is directed;
- annual or special meeting for which the proposal is submitted; and
- specific proposal to be submitted.
A failure to provide this information may be a basis to exclude the proposal under Rule 14a-8(b). However, under Rule 14a-8(f)(1), a company must notify the proponent of a specific defect within 14 days of receiving the proposal, which triggers a 14-day period in which the proponent may cure the defect.
SLB 14I: Rule 14a-8(d) Use of Graphs and Images
I have never submitted graphics and have little opinion to offer on these changes. Again from the Sidley update:
Under Rule 14a-8(d), a “proposal, including any accompanying supporting statement, may not exceed 500 words.” The Division Staff is of the view that Rule 14a-8(d) does not prohibit shareholders from using graphs or images in their proposals but recognizes the potential for abuse in this area.
New Guidance: The new guidance confirms that a proposal would be excludable under Rule 14a-8(d) if the total number of words in the proposal, including words in the graphics, exceeds 500. Furthermore, graphs and/or images in a proposal would be excludable under Rule 14a-8(i)(3) (addressing vague and indefinite proposals) where they:
- make the proposal materially false or misleading;
- render the proposal so inherently vague or indefinite that neither the shareholders voting on the proposal, nor the company in implementing it, would be able to determine with any reasonable certainty exactly what actions or measures the proposal requires;
- directly or indirectly impugn character, integrity or personal reputation, or directly or indirectly make charges concerning improper, illegal or immoral conduct or association, without factual foundation; or
- are irrelevant to a consideration of the subject matter of the proposal, such that there is a strong likelihood that a reasonable shareholder would be uncertain as to the matter on which he or she is being asked to vote.]
New Guidance for Companies: In a footnote to SLB No. 14I, the Division Staff cautions that companies should not “minimize or otherwise diminish the appearance of a shareholder’s graphic.”
- A shareholder’s graphics should have similar prominence to company graphics in the proxy statement.
- Including a black and white version of a shareholder’s color graphic is acceptable if the rest of the proxy statement is in black and white.
SLB 14I: Conclusion
I think it is disturbing that SEC staff appear to have taken it upon themselves to provide a roadmap to companies regarding how to argue the applicability of two exemptions (economic relevance and ordinary business).
Staff cite something of the history around the impact of Lovenheim v. Iroquois Brands, but don’t remind readers of Rule 14a-8(g), which clearly places the burden of proof on the company to demonstrate it is entitled to exclude a proposal. Staff cannot overturn the courts or preempt a rule, so we will have to see how their advice plays out.
Clearly, SLB 14I is likely to result in more no-action requests being filed and more being granted under (i)(5) and (i)(7). The one positive that might come out of it is more involvement by boards of directors. Perhaps if boards are actually provided with the legal arguments used against proposals they will question some cases of knee-jerk opposition and will seek to implement what is requested or to negotiate.
Re proposals submitted on behalf of shareholders, I find it disturbing that SEC staff would interject itself between two contracting parties by specifying details of what must be included in a contract for submitting a shareholder proposal. For example, SLB 14I requires documentation signed off by the shareholder concerning “the specific proposal to be submitted.” How specific is specific? Will SEC staff attempt to weigh the shareholder’s understanding of the details of proxy access proposals? Will there be a test?
SLB 14I is one more troublesome missive discouraging shareholders from acting as shareowners. The SLB will encourage more shareholders to be disengaged absentee owners. The business judgment rule already protects boards from shareholder claims of negligent mismanagement. [Fisch, Jill E., “From Legitimacy to Logic: Reconstructing Proxy Regulation” (1993). Faculty Scholarship. 1287.] Under SLB 14I, incumbent boards have even less incentive to be responsive to shareholder issues or avoid self-interested actions.
In a world facing almost insurmountable challenges, such as climate change, it seems foolish to discourage shareholder participation in corporations. When selling off ownership becomes their only viable option, short-termism will increase even more. That is not good for earth or for us.
SLB 14I: Other Views
- Update: Corp Fin Senior Special Counsel discusses new SLB on shareholder proposals
- Update: New SEC Staff Legal Bulletin Raises Questions and Uncertainties for Investors and Companies
- SEC Issues New Guidance on Several Exclusions under Rule 14a-8