SEC Rule 14a-8 permits qualifying shareholders to force the issuer to include a proposal and supporting statement in the company's proxy materials and thereby to force a vote on the issue at the annual shareholders' meeting.
Shareholder proposals traditionally were used mainly by social activists. Prior to the end of apartheid in South Africa, for example, many proposals favored divestment from South Africa. The rule is still widely used by social activists, but the rule also is increasingly being used by institutional investors to press matters more closely related to corporate governance. For example, proposals in recent years have included such topics as repealing takeover defenses, confidential proxy voting, regulating executive compensation, and the like.
Not all shareholder proposals must be included in the proxy statement. Rule 14a-8 lays out various eligibility requirements, which a shareholder must satisfy in order to be eligible to use the rule. The rule also lays out various procedural hurdles the shareholder must clear. Finally, the Rule identifies a number of substantive bases for excluding a proposal.
Rule 14a-8(i)(5) provides that a proposal relating to operations accounting for less than 5 percent of the firm’s assets, earnings or sales, and that is not otherwise significantly related to the firm’s business, may be omitted from the proxy statement. The principal problem here is deciding whether a proposal falling short of the various 5% thresholds is “otherwise significantly related to the firm’s business.” The classic case is Lovenheim v. Iroquois Brands, Ltd., 618 F. Supp. 554 (D.D.C. 1985). The defendant imported various food stuffs into the United States, including pâté de foie gras from France. Lovenheim suspected that Iroquois Brands’ French suppliers forced fed their geese, which produces larger livers, and which Lovenheim believed was a form of animal cruelty. Lovenheim proposed that Iroquois Brands form a committee to investigate the methods used by the firm’s suppliers in producing pâté and report its findings to the shareholders.
Iroquois Brands pâté operations clearly did not satisfy Rule 14a-8(i)(5)’s five percent threshold tests. Pâté sales constituted a mere $79,000 per year, on which Iroquois Brands lost money, relative to annual revenues of $141 million and profits of $6 million. The result therefore turned on whether the pâté operations were “otherwise significantly related” to its business. Iroquois Brands contended that the phrase related to economic significance. Lovenheim contended that noneconomic tests of a proposal’s significance were appropriate.
The court agreed with Lovenheim, holding that while the proposal related “to a matter of little economic significance,” the term “otherwise significantly related” is not limited to economic significance. Rather, matters of ethical and social significance also can be considered. The court articulated four rationales for its interpretation: (1) the rule itself was ambiguous; (2) the SEC previously had required inclusion of important social policy questions even where less than 1% of the firm’s assets or earnings were implicated by the question; (3) in adopting the present 5% threshold tests, the SEC said proposals falling short of the thresholds still must be included if their significance appeared on the face of the proposal; (4) the earlier Medical Committee decision implied that proposals involving general political and social concerns were acceptable.
As evidence that Lovenheim’s proposal “ethical or social” significance, the court observed that humane treatment of animals was one of the foundations of western civilization, citing various old and new statutes, ranging from the Seven Laws of Noah to the Massachusetts Bay Colony’s animal protection statute of 1641, to modern federal and state humane laws. Additional support came from the fact that “leading organizations in the field of animal care” supported measures aimed at eliminating force feeding.
Rule 14a-8(i)(7) allows the issuer to exclude so-called “ordinary business matters.” The question here is whether a proposal is an ordinary matter for the board or an extraordinary matter on which shareholder input is appropriate. The answer hinges on whether the proposal involves significant policy questions. As for deciding whether a policy question is significant, most courts assume that Lovenheim-style ethical or social significance suffices.
On this issue, the federal district court decision in Austin v. Consolidated Edison Company of New York, Inc., 788 F. Supp. 192 (S.D.N.Y. 1992), is both instructive and troubling. The plaintiffs put forward a proposal that the issuer provide more generous pension benefits to its employees. The court authorized the issuer to exclude the proposal as impinging on an ordinary business matter. Acknowledging that shareholder proposals relating to senior executive compensation were not excludable, the court observed that the issue of “enhanced pension rights” for workers “has not yet captured public attention and concern as has the issue of senior executive compensation.” Does this mean that the significance of a proposal turns on whether its subject matter has become a routine story for CNBC or CNN?
Unfortunately, the answer appears to be yes:
... in this response to AT&T, the Corp Fin Staff explains how net neutrality "has recently attracted increasing levels of public attention" but that it hasn't emerged "as a consistent topic of widespread public debate such that it would be a significant policy issue." I imagine one could debate whether the Staff's statement foreshadows a possible change to the topic being deemed a significant policy issue - but my view is that the Staff is merely articulating a nuance on how to distinguish whether something is ordinary business.
I agree that that's what the staff is doing. But it is decidedly not what the staff should be doing.
The result in Austin—exclusion—doubtless was correct. The proposal was put forward by shareholders who were also officials of a union that represented company employees. The proposal mandated a specific change in company pension policy; namely, to allow employees to retire with full benefits after 30 years of service regardless of age. This was precisely the sort of (self-interested) micro-management that even the SEC agrees ought not be allowed. Yet, we need a better test.
Query whether we want federal bureaucrats or even federal judges deciding whether a politically-charged proposal has enough ethical or social significance to justify its inclusion in the proxy statement. Think about your least favorite political cause. Under Lovenheim, can the firm omit a shareholder proposal about that cause? If so, on what basis can you justify omitting that proposal and requiring inclusion of the Lovenheim proposal? The issue is particularly troubling because many proposals have less to do with a company’s economic performance than with providing a soap-box for the proponent’s pet political cause. In Lovenheim, for example, plaintiff knew that his proposal had little economic significance. Instead, he wanted to make a political statement about animal cruelty.
Here then is a plausible alternative to the Lovenheim approach: Courts should ask whether a reasonable shareholder of this issuer would regard the proposal as having material economic importance for the value of his shares. This standard is based on the well-established securities law principle of materiality. It is intended to exclude proposals made primarily for the purpose of promoting general social and political causes, while requiring inclusion of proposals a reasonable investor would believe are relevant to the value of his investment. Such a test seems desirable so as to ensure that an adopted proposal redounds to the benefit of all shareholders, not just those who share the political and social views of the proponent. Absent such a standard, the shareholder proposal rule becomes nothing less than a species of private eminent domain by which the federal government allows a small minority to appropriate someone else’s property—the company is a legal person, after all, and it is the company’s proxy statement at issue—for use as a soap-box to disseminate their views. Because the shareholders hold the residual claim, and all corporate expenditures thus come out of their pocket, it is not entirely clear why other shareholders should have to subsidize speech by a small minority.
