New SEC Staff Guidance Reverses Course on Excludability of Shareholder Proposals Ahead of Upcoming 2022 Proxy Season
Sharply Narrowed Ordinary Business and Economic Relevance Exceptions Likely to Increase the Number of Environmental and Social Proposals Proceeding to a Shareholder Vote
On November 3, the staff of the Division of Corporation Finance (the “staff”) of the U.S. Securities and Exchange Commission (the “SEC” or “Commission”) issued new Staff Legal Bulletin No. 14L (“SLB 14L”) relating to shareholder proposals under Rule 14a-8 of the Securities Exchange Act of 1934 (“Rule 14a-8”). SLB 14L rescinds three previously issued legal bulletins and expressly states that the staff may no longer permit companies to exclude from their proxy statements certain shareholder proposals that raise significant environmental or social issues that would have been excludable in the past.
Rule 14a-8 enables shareholders to present proposals for all shareholders’ consideration in a public company’s proxy statement, and sets forth several substantive and procedural bases for exclusion of such proposals. Companies often request assurance that the staff will not recommend enforcement action (“no-action relief”) if they omit a proposal based on one of these exclusions. The stated purpose of SLB 14L is “to streamline and simplify [the staff’s] process for reviewing no-action requests, and to clarify the standards staff will apply when evaluating these requests.”
SEC Chair Gary Gensler said the updated guidance is consistent with the Commission’s original intention and “will provide greater clarity to companies and shareholders on these matters, so they can better understand when exclusions may or may not apply.” The staff’s interpretive changes also align with Chair Gensler’s investor-centered policymaking agenda and prioritization of environmental, social and governance (ESG)-focused initiatives, which seek to improve transparency and support heightened investor interest in ESG matters. As part of this effort, rulemaking proposals to enhance issuer disclosures in the areas of climate risk, human capital management, corporate board diversity and cybersecurity risk governance are anticipated in the coming months. The SEC is also expected by next spring to revisit the eligibility thresholds for submitting and resubmitting shareholder proposals under Rule 14a-8, which were substantially increased last year.
The reversal in policy was not subject to a Commission vote. Reflecting the current SEC’s deep division along partisan political lines, the two Republican-appointed commissioners released a joint statement expressing disappointment with the focus on climate and human capital issues, which they noted was “not altogether unsurprising given current SEC priorities.” They also derided the new guidance for “further[ing] the recent trend of erasing previous Commissions’ and staffs’ work and replacing it with the current Commission’s flavor-of-the-day regulatory approach.”
In summary, SLB 14L, which took immediate effect:
- replaces, in their entirety, Staff Legal Bulletin Nos. 14I, 14J and 14K (issued in 2017, 2018 and 2019, respectively), which afforded companies significantly greater latitude to omit shareholder proposals from their proxy statements under Rule 14a-8’s ordinary business and economic relevance exceptions, and supersedes any other potentially conflicting prior guidance;
- outlines the staff’s views specifically with respect to two substantive bases for exclusion of a shareholder proposal under Rule 14a-8: the ordinary business exception (Rule 14a-8(i)(7)) and the economic relevance exception (Rule 14a-8(i)(5));
- for purposes of the ordinary business exception, rejects the previous company-specific approach to evaluating the significance of a policy issue that is the subject of a shareholder proposal, in favor of a new focus on the relevance of the policy issue to society as a whole;
- for purposes of the ordinary business exception, reverses previous guidance that may have implied that any limit on company or board discretion constitutes micromanagement, identifying as likely no longer excludable shareholder proposals that seek detail, or suggest targets or timelines, but provide management with discretion as to how to achieve such goals;
- for purposes of the economic relevance exception, disallows exclusion of shareholder proposals that raise issues of broad social or ethical concern solely on the basis that the issue is not economically significant to the company;
- retracts the use of board analyses as part of demonstrating that a shareholder proposal is excludable under the ordinary business and economic relevance exceptions;
- explicitly highlights as likely no longer excludable under the ordinary business exception proposals requesting that “companies adopt timeframes or targets to address climate change” (so long as they do not dictate specific implementation methods) and proposals “squarely raising human capital management issues with a broad societal impact” (even if not significant to the company’s business), although a much wider range of ESG-focused proposals may also be implicated;
- republishes previous guidance relating to the use of graphics and images in shareholder proposals, and proof of ownership letters, adding a new staff view that a second deficiency notice may be required in certain situations; and
- provides new guidance on the use of email communications between companies and shareholder proponents, including how to prove timely delivery.
The narrower exceptions for ordinary business and economic relevance outlined in SLB 14L will likely result in an increase in the submission of climate change, human capital and other environmental and social shareholder proposals during the 2022 proxy season, as well as an increase in the number of such proposals reaching a shareholder vote.
Ordinary Business Exception
The ordinary business exception under Rule 14a-8 permits a company to exclude a proposal that “deals with a matter relating to the company’s ordinary business operations.” The stated purpose of the exception is “to confine the resolution of ordinary business problems to management and the board of directors, since it is impracticable for shareholders to decide how to solve such problems at an annual shareholders meeting.”
Significant Social Policy
A proposal dealing with the company’s ordinary business operations nevertheless may not be excludable if it raises a policy issue so significant that it transcends the day-to-day business matters of the company. Past guidance, now rescinded, explained that the staff “takes a company-specific approach in evaluating significance, rather than recognizing particular issues or categories of issues as universally ‘significant.’”
In a substantial reversal of longstanding policy, however, the staff now asserts that “an undue emphasis was placed on evaluating the significance of a policy issue to a particular company at the expense of whether the proposal focuses on a significant social policy.”
Accordingly, going forward, SLB 14L provides that the “staff will no longer focus on determining the nexus between a policy issue and the company but will instead focus on the social policy significance of the issue that is the subject of the shareholder proposal. In making this determination, the staff will consider whether the proposal raises issues with a broad societal impact such that they transcend the ordinary business of the company.”
SLB 14L explicitly states that proposals the staff previously viewed as excludable because they did not appear to raise a policy issue of significance for the company may no longer be viewed as excludable. As an example, SLB 14L states that “proposals squarely raising human capital management issues with a broad societal impact would not be subject to exclusion solely because the proponent did not demonstrate that the human capital management issue was significant to the company.”
SLB 14L cites matters related to employment discrimination as an example of workforce management proposals that may rise to the level of transcending the company’s ordinary business operations, but does not otherwise specify how the staff will determine which policy issues have a broad societal impact.
In addition, SLB 14L states that because the staff is rejecting a company-specific approach in evaluating significance, it will no longer expect a board analysis as part of demonstrating that the proposal may be omitted under the ordinary business exception.
In determining whether the ordinary business exception applies, the SEC has also historically considered the degree to which the proposal seeks to micromanage the 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.” SLB 14L notes that, at the time of Rule 14a-8’s adoption, the SEC clarified that specific methods, timelines or detail do not necessarily amount to micromanagement and are not dispositive of excludability.
SLB 14L rejects the staff’s recent application of the micromanagement concept as excessively broad because it “may have been taken to mean that any limit on company or board discretion constitutes micromanagement.”
In contrast, going forward, SLB 14L provides that “the staff will take a measured approach to evaluating companies’ micromanagement arguments—recognizing that proposals seeking detail or seeking to promote timeframes or methods do not per se constitute micromanagement. Instead, we will focus on the level of granularity sought in the proposal and whether and to what extent it inappropriately limits discretion of the board or management. We would expect the level of detail included in a shareholder proposal to be consistent with that needed to enable investors to assess an issuer’s impacts, progress towards goals, risks or other strategic matters appropriate for shareholder input.”
The staff emphasizes that not “all proposals seeking detail, or seeking to promote timeframes or methods, necessarily amount to ‘ordinary business.’ … 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.”
Additionally, SLB 14L states that when evaluating whether a proposal probes matters “too complex” for a shareholder vote, the staff may consider “the sophistication of investors generally on the matter, the availability of data, and the robustness of public discussion and analysis on the topic. The staff may also consider references to well-established national or international frameworks when assessing proposals related to disclosure, target setting and timeframes as indicative of topics that shareholders are well-equipped to evaluate.”
Under the staff’s new approach to micromanagement, shareholder proposals requesting that companies adopt specific timeframes or targets to address climate change, or other environmental or social matters, will unlikely be excludable, “so long as the proposals afford discretion to management as to how to achieve such goals.” As an example, the staff cites its recent response to a request for no-action relief, where it concluded that a shareholder proposal requesting that the company set greenhouse gas emission reduction targets for its operations and products, without imposing a specific method for doing so, did not micromanage to such a degree as to justify exclusion. While many of the proposals addressed in the rescinded guidance involved climate change, the staff notes that the analytical framework articulated in the new guidance may apply to any subject matter.
In the staff’s view, its revised approach to micromanagement is “consistent with the Commission’s views on the ordinary business exclusion, which is designed to preserve management’s discretion on ordinary business matters but not prevent shareholders from providing high-level direction on large strategic corporate matters.”
Economic Relevance Exception
The economic relevance exception under Rule 14a-8 permits a company 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.”
Under SLB 14L, the staff has determined that proposals that raise issues of broad social or ethical concern related to the company’s business may not be excluded, even if the relevant business falls below the stated economic thresholds, an approach the staff believes is consistent with its earlier interpretation of the economic relevance exception. Accordingly, going forward, the staff has stated that it will no longer expect a board analysis to support no-action requests under this exception.
Use of Graphics and Images
SLB 14L republishes the staff’s view that shareholder proposals may use graphics and images, and that any words included in such graphics and images will be counted toward the 500-word limit in Rule 14a-8(d). If a company includes its own graphics in its proxy statement, it should give similar prominence to a shareholder’s graphics. SLB 14L also reaffirms that, in light of the potential for abuse in this area, exclusion of graphics and images may be appropriate where they make the proposal materially false or misleading, or inherently vague; directly or indirectly impugn character, integrity or personal reputation; or are irrelevant to a consideration of the subject matter of the proposal.
Proof of Ownership Letters
SLB 14L updates the suggested (but not mandatory or exclusive) format for shareholder proponents to evidence their ownership to reflect the revised ownership thresholds in Rule 14a-8(b) adopted in the SEC’s 2020 amendments to the shareholder proposal rule, as follows:
“As of [date the proposal is submitted], [name of shareholder] held, and has held continuously for at least [one year] [two years] [three years], [number of securities] shares of [company name] [class of securities].”
SLB 14L reiterates that the staff generally does not find persuasive overly technical readings of proof of ownership letters as a means to exclude a proposal based on perceived defects, but rather expects companies to take a plain-meaning approach in their review of such letters, advising that “companies should not seek to exclude a shareholder proposal based on drafting variances in the proof of ownership letter if the language used in such letter is clear and sufficiently evidences the requisite minimum ownership requirements.”
SLB 14L additionally clarifies that brokers are not required to calculate the share valuation, which instead may be done by the proponent and presented to the company consistent with the 2020 amendments to the shareholder proposal rule.
In addition, SLB 14L expresses a new staff view that companies should identify any specific defects in the proof of ownership letter, even if the company previously sent a deficiency notice prior to timely receiving the proponent’s proof of ownership, if the deficiency notice did not identify the specific defects. Companies therefore may be expected to send more than one deficiency notice in such circumstances.
Use of Email
In recognition of the growing reliance on email as the primary means of communication in the shareholder proposal process—a trend accelerated by the pandemic—SLB 14L provides new guidance on the use of email by companies and proponents to transmit shareholder proposals, deficiency notices and responses to deficiency notices.
SLB 14L advises that, to prove timely delivery of an email, the sender should seek a reply email from the recipient in which the recipient acknowledges receipt of the email. The staff also encourages both companies and proponents to acknowledge receipt of emails when requested, and notes that email read receipts, if received by the sender, may also help to establish that emails were timely received. Sender delivery confirmations and server logs, which only function to prove that emails were sent, may not be sufficient to prove actual receipt of emails for purposes of satisfying the requirements of Rule 14a-8.
Proponents wishing to submit a proposal via email should contact the company to obtain the correct email address in instances where it is not disclosed in the proxy statement, and companies are encouraged to provide such email addresses upon request.
SLB 14L also clarifies that the burden to show proof of timely delivery when using email in the shareholder proposal process rests on the sending party.
As noted above, the narrower exceptions for ordinary business and economic relevance outlined in SLB 14L will likely result in an increase in the submission of climate change, human capital and other environmental and social shareholder proposals during the 2022 proxy season, as well as an increase in the number of such proposals reaching a shareholder vote. To successfully exclude such proposals from their proxy statements next year, companies will need to (i) persuasively frame their arguments within the sharply narrowed scope of the revised interpretive approach (by arguing, for example, that the proposals inappropriately attempt to limit the discretion of management and the board, or that the issues they raise lack broad societal impact); (ii) effectively argue for exclusion on other substantive or procedural grounds; or (iii) constructively engage with proponents to negotiate a voluntary withdrawal of the proposals.