Last week the SEC issued Staff Legal Bulletin No. 14M. It makes some key changes in how the SEC will apply the shareholder proposal rule during the current proxy season.
In brief, the shareholder proposal rule (SEC Rule 14a-8) allows shareholders to submit proposals for inclusion in company proxy materials, provided the proposals are proper subjects for shareholder action under state law.
Initially envisioned as a mechanism to enhance shareholder participation, Rule 14a-8 has instead evolved into a tool for a minority of activists to advance agendas often unrelated to the company’s financial performance. This evolution has come at a cost: growing procedural complexity, increased compliance burdens, and the diversion of board attention from strategic priorities.
Rule 14a-8 is disproportionately utilized by a handful of "corporate gadflies," who submit proposals on personal, political, or social issues rather than matters of economic importance to the company. For instance, data indicate that a mere three individuals or groups account for a substantial portion of shareholder proposals submitted annually.
Moreover, union pension funds and other institutional investors often leverage the rule to advance private agendas, such as labor disputes or political initiatives, rather than promoting shareholder value. These practices deviate from the rule's intended purpose and impose additional costs on the majority of shareholders.
Rule 14a-8 also undermines board primacy by forcing directors to engage with proposals that delve into operational matters traditionally reserved for management. This distraction erodes the business judgment rule's protections and detracts from boards' focus on long-term value creation.
There are a number of grounds on which management can refuse to include a proposal. Two are particularly significant at the moment.
The first is the exclusion for proposals lacking economic significance. It 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.”
Activists seized on the "not otherwise significantly related" language to argue that proposals with ethical and social significance should not be excludable even if they had no substantial economic significance. The courts and the SEC under liberal administrations agreed. In recent years, under the execrable Gary Gensler, progressive proposals lacking any meaningful nexus to the company's business have been waved through by the SEC.
Not anymore:
The Division’s analysis 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. Under this framework, proposals that raise issues of social or ethical significance may be excludable, notwithstanding their importance in the abstract, based on the application and analysis of each of the factors of Rule 14a-8(i)(5) in determining the proposal’s relevance to the company’s business.
Because the rule allows exclusion only when the matter is not “otherwise significantly related to the company,” we view the analysis as dependent upon the particular circumstances of the company to which the proposal is submitted. That is, a matter significant to one company may not be significant to another. ...
... The proponent could continue to raise social or ethical issues in its arguments, but in accordance with these Commission statements it would need to tie those matters to a significant effect on the company’s business. The mere possibility of reputational or economic harm alone will not demonstrate that a proposal is “otherwise significantly related to the company’s business.”
I suggest that in applying this standard that the SEC 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 soapbox to disseminate their views.
The other is where the proposal speaks to the ordinary business of the company (Rule 14a-8(i)(7)).
As I explained in my article, Revitalizing SEC Rule 14a-8's Ordinary Business Exemption: Preventing Shareholder Micromanagement by Proposal, Rule 14a-8(i)(7) raises fundamental issues of corporate governance:
Who decides what products a company should sell, what prices it should charge, and so on? Is it the board of directors, the top management team, or the shareholders? In large corporations, of course, the answer is the top management team operating under the supervision of the board. As for the shareholders, they traditionally have had no role in these sort of operational decisions. In recent years, however, shareholders have increasingly used SEC Exchange Act Rule 14a-8 (the so-called shareholder proposal rule), to not just manage but even micromanage corporate decisions.
The rule permits a qualifying shareholder of a public corporation registered with the SEC to force the company to include a resolution and supporting statement in the company’s proxy materials for its annual meeting. In theory, Rule 14a-8 contains limits on shareholder micro-management. The rule permits management to exclude proposals on a number of both technical and substantive bases, of which the exclusion in Rule 14a-8(i)(7) of proposals relating to ordinary business operations is the most pertinent for present purposes. Rule 14a-8(i)(7) is intended to permit exclusion of a proposal that “seeks to ‘micro-manage’ 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.”
Unfortunately, court decisions have largely eviscerated the ordinary business operations exclusion. Corporate decisions involving “matters which have significant policy, economic or other implications inherent in them” may not be excluded as ordinary business matters, for example, which creates a gap through which countless proposals have made it onto corporate proxy statements.
In effect, the exclusion no longer fulfills its core function of preventing shareholders from micromanaging the company.
The new staff bulletin goes at least part of the way towards giving the exclusion teeth.
... the staff will take a company-specific approach in evaluating significance, rather than focusing solely on whether a proposal raises a policy issue with broad societal impact or whether particular issues or categories of issues are universally “significant.” Accordingly, a policy issue that is significant to one company may not be significant to another. The Division’s analysis will focus on whether the proposal deals with a matter relating to an individual company’s ordinary business operations or raises a policy issue that transcends the individual company’s ordinary business operations.
The new staff bulletin also reinstates two Trump 1.0 era staff bulletins on the exclusion that Gensler gutted. Both speak to the micromanagement issue. Bulletin 14J stated:
... a proposal may probe too deeply into matters of a complex nature if it “involves intricate detail, or seeks to impose specific time-frames or methods for implementing complex policies.”
A proposal thus can be excluded if it:
“micromanages” 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.”
Importantly, the bulletin made clear that a standard activist technique to end run the exclusion would no longer work:
This framework also applies to proposals that call for a study or report. For example, a proposal that seeks an intricately detailed study or report may be excluded on micromanagement grounds.
Bulletin 14K provided that:
In the past, proponents and companies have often focused on the overall significance of the policy issue raised by the proposal, instead of whether the proposal raises a policy issue that transcends the particular company’s ordinary business operations. The staff takes a company-specific approach in evaluating significance, rather than recognizing particular issues or categories of issues as universally “significant.” Accordingly, a policy issue that is significant to one company may not be significant to another.
... we believe the focus of an argument for exclusion under Rule 14a-8(i)(7) should be on whether the proposal deals with a matter relating to that company’s ordinary business operations or raises a policy issue that transcends that company’s ordinary business operations. When a proposal raises a policy issue that appears to be significant, a company’s no-action request should focus on the significance of the issue to that company.
In sum, the new bulletin is a good start. It addresses some key problem areas that have allowed activist shareholders to use the rule to advance social proposals largely unrelated to the business of the company.
More needs to be done. But that is a story for another post.
