Keith F. Higgins, Director, Division of Corporation Finance
Practising Law Institute Program on Corporate Governance
New York, NY
Feb. 10, 2015
Thank you, Meredith [Cross], for that introduction and for the invitation to speak today. I can’t think of a better time or audience with whom to share my thoughts on a corporate governance topic that has recently received significant public attention: shareholder proposals. First, though, it is appropriately fitting that I give the standard disclaimer that the views that I express today are my own and do not necessarily reflect the views of the Commission or any other colleague on the staff of the Commission.
A matter of considerable interest in today’s corporate governance is the relationship between shareholders and management. Corporations are creatures of state law and the substantive and procedural parameters that define these relationships are primarily found in state law. State law, for example, provides shareholders with the right to amend a company’s bylaws, grants the board of directors the authority to manage the affairs of a company, and dictates what matters may be properly considered by shareholders at annual meetings.
Federal law, however, is also important. In particular, our federal proxy regulatory scheme, adopted under Section 14(a) of the Exchange Act, regulates the proxy process through which most shareholders in public companies exercise the voting rights granted to them under state law. It is designed not to supplant the rights granted under state law, but rather to help give them effect in a system in which shareholders rarely attend a meeting to vote in person. Section 14(a) and our rules provide shareholders with the information and means to make informed voting decisions. And the Commission adopted the shareholder proposal rule, Rule 14a-8, with this principle very much in mind. The rule allows a qualified shareholder to include in a company’s proxy materials a proposal that he or she could otherwise present at a shareholder meeting, subject to certain procedural and substantive exclusions. And while it is a federal rule, it is important to recognize that the right that it effectuates is the fundamental one under state law to appear at a meeting, make a proposal for a “proper purpose,” and have the proposal voted on by fellow shareholders.
Staff Role in Shareholder Proposals and Recent Litigation
Perhaps unsurprisingly, companies and shareholders often have differing views on whether a shareholder proposal must be included in the companies’ proxy materials. And this is where the staff of the Division of Corporation Finance comes into the process. Although Rule 14a-8 requires a company to include a qualified shareholder proposal in its proxy materials, companies may exclude a proposal for one of 13 reasons described in our rule. Companies must send a notice to the Commission if they intend to exclude a shareholder proposal setting forth the legal basis for such exclusion — a requirement that dates back to 1947. While the rule does not require the Division to respond to these notices, we have for years engaged in a practice of expressing — through no-action letters — our informal view on whether a company has demonstrated that it may properly exclude a proposal. Each proxy season, the staff therefore reviews and responds to hundreds of Rule 14a-8 no-action requests, and, having seen this program in action in two proxy seasons, I can attest that these requests receive very careful staff attention and multiple reviews by lawyers within the Division with substantial experience administering our program.
The Division has thus become an informal arbitrator in the shareholder proposal process, assisting both companies and shareholder proponents, who might otherwise have to resort to litigation to resolve their disagreements. Of course, the Division’s views are informal staff views, purely advisory, and non-binding. Only a court can determine definitively whether a company is obligated to include a shareholder proposal in its proxy materials. Both companies and shareholder proponents retain the option of pursuing legal remedies in federal courts, either in lieu of or despite the Division’s views. It is an option that an increasing number of companies and proponents have chosen in recent years. While it is not my goal today to discuss at length the ramifications of this trend, I would like to share one observation about the most recent court decision on Rule 14a-8, the Trinity Wall Street v. Wal-Mart Stores, Inc. decision by the U.S. District Court in Delaware.
By way of background, the proposal in that case had, in very general terms, requested that the board assign to one of its committees the responsibility of overseeing the formulation, implementation, and public reporting of policies that determine whether the company should sell a product that especially endangers public safety and well-being, has the potential to impair the company’s reputation, or would be considered offensive to the values integral to the company’s brand. The Division had not objected to Wal-Mart’s exclusion of the proposal from its proxy materials in reliance on the ordinary business exception of Rule 14a-8(i)(7), but the court concluded that the proposal had been improperly excluded.
One ground upon which the court reached this conclusion was its view that because the proposal merely sought board oversight of the development and implementation of a company policy, leaving the day-to-day aspects of implementation of this policy to the company’s officers and employees, the proposal itself did not have the consequence of dictating what products Wal-Mart could sell. In the court’s view, a board committee’s formulation and implementation of a policy is not a “task…so fundamental to management’s ability to run a company on a day-to-day basis that [it] could not, as a practical matter, be subject to direct shareholder oversight,” which is the standard for the ordinary business exclusion. By contrast, the Commission has stated that, in analyzing whether a proposal requesting the formation of a special committee is excludable under the ordinary business exception, the key is to consider whether the underlying subject matter of the committee involves an ordinary business matter. I know that the company has recently appealed the district court’s decision to the U.S. Court of Appeals for the Third Circuit, and I look forward to the appeals court’s views on this important question.
No doubt the biggest recent development in the Division’s shareholder proposals program was the decision that we announced on January 16, 2015, that we would not be expressing our informal views on requests for exclusion made under Rule 14a-8(i)(9), the “directly conflicts” exclusion. Under that exclusion, a company is entitled to exclude a shareholder proposal that “directly conflicts with one of the company’s own proposals to be submitted to shareholders at the same meeting.” This exclusion goes back to 1967 when the Commission made Rule 14a-8 inapplicable to “counter proposals to matters to be submitted by the management.” In 1998, when Rule 14a-8 was amended into a Q&A, plain English format, this exclusion was revised to its current “directly conflicts” language. The Commission stated in the proposing release that its proposed revisions were intended to reflect the Division’s long-standing interpretation permitting omission of a shareholder proposal if the company demonstrates that its subject matter directly conflicts with all or part of one of management’s proposals. The Commission said that including the word “directly” to modify conflicts was not intended to imply that the proposals must be identical in scope or focus for the exclusion to be available. The staff has generally agreed that a shareholder proposal conflicts with a management proposal where the inclusion of both proposals in the proxy materials could “present alternative and conflicting decisions for shareholders and that submitting both proposals to a vote could provide inconsistent and ambiguous results.”
Until relatively recently, the Rule 14a-8(i)(9) exclusion had been used infrequently, with companies most often using the exclusion for proposals relating to stock compensation plans. The substantial uptick in Rule 14a-8(i)(9) activity began in 2009 with proposals involving the right of shareholders to call a special meeting of shareholders. A typical proposal might request that the company amend its bylaws to permit shareholders holding 10% of the outstanding stock to call a special meeting of shareholders. The company would counter with a proposal that would set a 25% or even a 40% threshold. In such situations, the Division concurred in the analysis that the company could exclude such a shareholder proposal, as it “directly conflict[ed]” with the company proposal. These exclusions did not elicit widespread reaction. Then, late last year, Whole Foods used Rule 14a-8(i)(9) as the basis for requesting no-action relief to exclude a shareholder proxy access proposal and the Division concurred.
The shareholder had asked the board to adopt a form of proxy access that would have permitted a shareholder or group of shareholders holding at least 3% of the outstanding stock for at least 3 years to nominate up to 20% of the directors, but no fewer than two, for inclusion in the company proxy statement. The company responded by saying that it intended to include its own proposal asking shareholders to approve a board-adopted bylaw that granted any single shareholder holding at least 9% of the outstanding stock for at least 5 years to nominate for inclusion in the company proxy statement 10% of the directors, but no fewer than one. The Division concurred with the company’s view that the two proposals conflicted. The shareholder proponent requested Division reconsideration or that the matter be presented for Commission review. Others raised questions about whether this result was a proper interpretation of the (i)(9) exclusion. On January 16, 2015, the Chair directed the Division to review the proper scope and application of Rule 14a-8 (i)(9) and the Division decided not to express its view on the provision this proxy season, including in the Whole Foods matter.
I thought it might be worthwhile to spend a little time this morning discussing and analyzing some of the issues that have arisen about the scope and application of the exclusion and some possible ways to think about them. Of course, because the Division has just begun its review, all of these thoughts are very preliminary and, as mentioned in my disclaimer, do not reflect anyone’s views, in this case likely including my own. But, it’s a place to start.
First, the Division’s historical interpretation. In applying the Rule 14a-8(i)(9) exclusion, the Division has asked whether the inclusion of both the shareholder proposal and the management proposal create the possibility of confusing and ambiguous results. If both proposals receive majority approval, how would the board and shareholders interpret those results and how would the board determine which mandate to implement? The Division looked to this rationale when considering the Whole Foods shareholder proposal.
Those critical of this interpretation had a different view. For the most part, they reasoned, where the management proposal is mandatory and, by contrast, the shareholder proposal is precatory, the proposals do not directly conflict. Only the management proposal would be
implemented as a result of the vote. The vote on the shareholder proposal would simply provide the board of directors with additional data on the same subject matter and the directors could factor that information into their thinking on the topic. Some acknowledge a possible conflict where a binding management proposal and a non-binding shareholder proposal address the same subject matter but suggest wholly opposite courses, such as a shareholder proposal for an independent chair of the board and a management proposal requiring that the CEO serve as the chair.
The Division has not considered the precatory/mandatory distinction as factoring into our view of Rule 14a-8(i)(9) conflicts. There are two reasons for this. First, virtually all shareholder proposals are precatory. Applying the precatory/mandatory distinction to conclude there is no conflict would make the exclusion applicable to a small number of situations. Perhaps the exclusion was meant to be narrow; the regulatory history is not clear. Second, even accepting that the vote on the shareholder proposal would be a data point for the directors to consider, the concern was that the data, taken as a whole, may be ambiguous for the directors to interpret and, just as importantly, that it would make it difficult for shareholders to decide how to send their message. Take the example of the special meeting of shareholders and assume that both the 10% and the 25% proposals are on the ballot. If both proposals are approved, how should management interpret that result? Should management implement the proposal that received the highest number of votes for approval? A shareholder who favors 10% over 25%, but in all events believes that some percentage of shareholders should be able to call a special meeting, might vote yes on both. If that results in the 25% alternative receiving more “for” votes than the 10% proposal, how should the board interpret the result? And does this pose a dilemma for the shareholders in deciding how to vote? Some might say, however, that the shareholders have a similar dilemma if only the management proposal appears on the ballot, particularly if the shareholders are aware of the excluded proposal.
As we do our review, we may consider whether there may be a structural limitation in our current proxy rules that makes it difficult to have a side-by-side comparison. Exchange Act Rule 14a-4(b)(1) requires that a form of proxy permit a shareholder to vote for or against or to abstain from voting on each separate matter other than the election of directors or say-on-frequency votes. Putting the 10% and the 25% proposals side-by-side and asking shareholders to choose which one they prefer may provide the board with better information than full “for” and “against” votes on conflicting proposals, although it still would not accommodate the preferences of shareholders who either want a different threshold or do not believe that shareholders should be entitled to call a special meeting at all. But should Rule 14a-4(b) be amended to permit more flexibility than a thumbs up or thumbs down approach?
One of the concerns that has been expressed is that a management proposal made only “in response to” one from a shareholder should not operate to keep the shareholder’s proposal out of the proxy. A counter argument is that shareholders should want the board to be responsive and there should not be a disincentive for the board to present its own proposal. The rebuttal is that even if a company fails in its attempt to exclude a shareholder proposal, it still would have the option of presenting the board’s proposal alongside the proponent’s. So, how should we think about the “in response to” concern? Should the exclusion only be available if, for example, the board already approved its proposal for inclusion before it received the shareholder’s proposal?
There may be a concern that, where management opposes the substance of the shareholder’s proposal, the company will present a proposal principally to prevent shareholders from expressing their views on it. For example, if in response to a proposal to allow holders of 10% of the outstanding shares to call a special meeting of shareholders, management proposes a threshold of 90%, which appears totally unworkable, one might reasonably wonder whether the motive in presenting that proposal was solely to have a basis to exclude the shareholder proposal. Some also may question whether management’s motives are necessarily pure where it presents to shareholders a bylaw that the board of directors could adopt on its own, although soliciting shareholder support for a management by-law is generally seen as good corporate governance. In the end, the problem in examining motives is that the Division is not in a good position, recalling the words of a former President, to look management in the eye and get a sense of its soul. Making exclusion decisions by having the Division assess whether the management proposal is being made in good faith could be a perilous task.
The concern about management’s motives goes further. We have heard the concern expressed that management could continue year after year to come up with a slightly different proposal for the purpose of keeping the shareholder proposal from ever making it into the proxy materials. While we have not yet seen this concern materialize, it is certainly not beyond the realm of possibility. Should the Commission consider addressing this concern by, for example, amending Rule 14a-8(i)(9) so that the exclusion is not available to a company two years in a row for the same shareholder proposal or perhaps another shareholder proposal on the same subject matter?
One additional question we need to ask ourselves is whether shareholders are getting the information they need to make an informed voting decision when they receive a proxy statement that includes a management proposal but that excludes a shareholder proposal on the same subject matter. Reading the proxy statement — and nothing more — the shareholder might get the impression that management had independently arrived at a decision to present a governance proposal to shareholders and the proposal in the proxy statement is the result. And that may in fact be the case. But it also may not be the entire story. Should the Commission, for example, require that when management uses Rule 14a-8(i)(9) to exclude a shareholder proposal, it needs to include in the proxy statement something akin to a “Background of the Merger” discussion that appears in a merger proxy statement to explain the circumstances that led it to present its proposal, a discussion of alternatives and management’s rationale for crafting its proposal as it did? Another approach might be to require the company to allow the shareholder proponent whose proposal was excluded to include a statement in opposition, much as management does when it is required to include a shareholder proposal in the proxy.
In any event, as I hope is evident, the issues are not black and white and what it means to “directly conflict,” and the consequences of such a conclusion, deserve careful study. As the Division studies the issue, we welcome input from interested parties. We have set up a mailbox for that purpose. You can send your comments to email@example.com and we look forward to receiving them.
Rule 14a-8(i)(3) Materially False and Misleading Statements
Before concluding, I want to touch very briefly on Rule 14a-8(i)(3), which permits the exclusion of a proposal or supporting statement that is contrary to the Commission’s proxy rules, including Rule 14a-9’s prohibition on materially false or misleading statements. As many of you know, this exclusion has received much academic attention recently, and it has always been a difficult one for the Division to administer. Prior to the issuance of Staff Legal Bulletin No. 14B (SLB 14B) in 2004, the staff received many requests that asserted deficiencies in nearly every line of a proposal and its supporting statement in an effort to get the entire proposal excluded. The staff spent a significant amount of time analyzing the alleged deficiencies for factual accuracy and essentially editing the proposals line-by-line. Because this effort may not have yielded better disclosure for shareholders to make voting decisions, and imposed on the staff’s limited resources an unrealistic due diligence burden, we concluded in SLB 14B that we would limit the circumstances in which we would consider a Rule 14a-8(i)(3) request to exclude or modify a statement in a proposal.
To be clear, we did not abdicate our responsibility over shareholder proposals that may be materially false or misleading. From our perspective, there are three threshold questions we consider when asked to exclude a proposal or supporting statement as false or misleading. First, is it really a “fact”? Sometimes, we are asked to exclude based on inferences and opinions. These generally seem like issues best addressed in the opposition statement. Second, is it false or misleading? The Commission’s rules make clear that the company has the burden of demonstrating that it is entitled to exclude a proposal. So the staff is looking for objective, demonstrable evidence of falsity. Finally, is it “material”? The Supreme Court in TSC v. Northway articulated the following test for Rule 14a-9: “there must be a substantial likelihood that the disclosure of the omitted fact [or the misstatement] would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”
We recognize that these standards are not easy to apply. A few things are clear to the staff, however. First, the fact that companies may make a rebuttal in their statements in opposition does not absolve proponents from complying with Rule 14a-9 in the proposal and supporting statement. Second, companies need to remember that Rule 14a-9 prohibits material “false or misleading” statements, not what may seem to management to be “unfair” statements. The company bears the burden of demonstrating objectively that any false statements or omissions are material, taking into account the total mix of information. Assessing the materiality of misstatements or omitted facts to the voting decisions of a reasonable shareholder is difficult, but if a company meets its burden the Division is prepared to concur.
As you can tell by now, Rule 14a-8 is an area of considerable Division focus. The issues I discussed today are just some of the difficult issues that we are tackling in what is already a very exciting shareholder proposals season. I would like to conclude my remarks today by again inviting you and any other interested parties to send us your thoughts, ideas, and concerns as we conduct our review. With that, I would like to thank you for your time and the opportunity to share my thoughts.
 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues upon the staff of the Commission.