On November 1, 2017, the staff of the US Securities and Exchange Commission’s Division of Corporation Finance (Staff) provided important guidance to companies and shareholders on how Staff will evaluate arguments to exclude shareholder proposals from proxy materials. Among other considerations, the Staff Legal Bulletin No. 14I (CF) (the Bulletin) deals primarily with the “ordinary business” and “economic relevance” exclusions found in Rule 14a-8 of the Securities Exchange Act of 1934 (the Rule). The Bulletin reflects Staff’s continuing effort to address issues arising under the Rule, and among other things, transfers to boards of directors the responsibility for analyzing whether a proposal can be excluded on either of these bases.
The “Ordinary Business” Exception (Rule 14a-8(i)(7))
Rule 14a-8(i)(7) deals with shareholder proposals that involves certain matters fundamental to management’s ability to run a company on a day-to-day basis. Where a proposal deals with such matters, companies can exclude the proposal from proxy materials unless it focuses on sufficiently significant policy issues that transcend ordinary business. Traditionally, Staff have been responsible for making difficult judgment calls under this rule, particularly to determine when a proposal that touches ordinary business matters nonetheless focuses on a sufficiently significant policy issues. The Bulletin shifts this responsibility to boards and identifies the type of information Staff expect companies to include in no-action requests.
The “Economic Relevance” Exception (Rule 14a-8(i)(5))
Rule 14a-8(i)(5) deals with shareholder proposals that relate to operations that account for less than 5% of the company’s total assets, net earnings and gross sales. Where a proposal relates to operations that fall below this 5% threshold, companies can exclude the proposal, but only if it is not “otherwise significantly related to the company’s business”. The Bulletin notes that Staff have often limited this rule’s application by not analyzing whether or not a proposal deals with a matter that is significantly related to the company’s business. In doing so, the Bulletin makes it clear that moving forward, Staff will focus on a proposal’s significance to the company’s business even if a proposal relates to operations that fall below the 5% threshold, and even if the proposal raises significant social or ethical issues.
Companies trading in the U.S. should review shareholder proposals in light of Staff’s guidance on the “ordinary business” or “economic relevance” bases for excluding proposals under Rule 14a-8(i)(7) and (5) of the Securities Exchange Act of 1934. Staff Legal Bulletin No. 14I (CF) shifts the responsibility for making difficult judgments under both bases of exclusions to the board of directors, noting that boards are generally better positioned to analyze and explain why a particular proposal should be excluded. Moving forward, no-action requests made under both bases for exclusion must include a discussion of how the board analyzed a policy issue that was raised, as well as of the specific processes the board used to arrive at “well-informed and well-reasoned” conclusions.
In practice, this means that boards in the U.S., and potentially in Canada and other jurisdictions in the future, should be prepared to allocate sufficient time to review, analyze and prepare a response to shareholder proposals, all while meeting the time constraints for submitting no-action requests. While the Bulletin appears to suggest that Staff will defer to boards’ judgment when evaluating no-action requests, it remains unclear how much detail Staff expect boards to include in the disclosure of a board’s processes and analysis.
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The author would like to thank Blanchart Arun, articling student, for his assistance in preparing this legal update.