Companies faced with a shareholder proposal submitted under Rule 14a-8 often seek to exclude the proposal from the proxy statement by submitting a no-action letter to the SEC Staff, citing procedural or substantive deficiencies in the proposal. Based on raw data from the 2009 proxy season these exclusion requests appear to be facing more resistance from the Staff. According to RiskMetrics Group (RMG) as of March, 1,126 shareholder proposals were submitted to 481 companies in the 2009 season, addressing governance, compensation and social and environmental issues. Companies that sought to exclude governance proposals prevailed only 48% of the time, down from 69% in 2008. Companies that sought to exclude social and environmental resolutions prevailed 67% of the time.
Moving beyond the raw data, our own tracking shows that from September 2008 to early June 2009 there were approximately 354 no-action requests submitted by 189 companies. As to these letters 17% of the proposals were found excludable by the Staff on “procedural” grounds (e.g. the proposal was untimely, or the shareholder failed to demonstrate the requisite ownership of company shares), and another 14% of the letters were withdrawn. Of the remaining letters that the Staff decided on “substantive” grounds, the Staff sided with companies only 33% of the time.
Divining patterns from all of this data is tricky, because the mix of proposals varies from year to year and because Staff decisions are generally unaccompanied by stated reasoning. But we do think there are some useful lessons to be drawn from this year’s experience.
“Substantial implementation” is being narrowly construed.
One of the 13 specified “substantive” grounds for exclusion under Rule 14a-8 is that the proposal has already been “substantially implemented”. The SEC has said that this standard is something less than “strict” implementation, that the means and manner of implementation are not determinative, and that it is only necessary that companies addresses the proposal’s underlying interest and implement the proposal’s essential objective. Many social proposals have over the years been successfully excluded under this theory.
But proposals containing numerical tests can leave companies little room to argue substantial implementation. Take, for example, the rapidly growing area of proposals giving shareholders the right to call special meetings. In 2008, several proposals sought a bylaw change permitting shareholders at or above specified percentage triggers to call a special meeting, and suggesting triggers in the range of 10-25% of a company’s shares, noting that the proponent “favors” a 10% trigger. The Staff at that time permitted exclusion if a company adopted such a bylaw with a 25% trigger. This year, when proponents tightened the language to provide for a fixed 10% trigger, companies that had adopted 25% triggers were not permitted to exclude the proposal on the basis of substantial implementation. This suggests that, for example, shareholder proposals under the proposed proxy access rules that would specify lower ownership thresholds, shorter holding periods or more available seats will be difficult to exclude on substantial implementation grounds.
The Staff’s standards for concluding that a proposal is “vague” and “indefinite” can be, well, vague and indefinite.
Special meeting proposals came in two seemingly indistinguishable flavors this year. Both forms of proposal asked the board to take necessary steps to amend the bylaws to provide a 10% trigger. One flavor further provided “that such bylaw and/or charter text will not have any exception or exclusion conditions (to the fullest extent permitted by state law) applying to shareowners only and meanwhile not apply to management and/or the board”. In the second flavor the proviso read “that such bylaw and/or charter text shall not have any exception or exclusion conditions (to the fullest extent permitted by state law) that apply only to shareowners but not to management and/or the board”. See the difference? Neither do we, other than the somewhat clunkier phrasing of the original. Yet the Staff found that the first flavor could be excluded, while the second could not. This result illustrates that there continues to be a fundamental unpredictability to the exclusion process, which is a source of frustration to companies and proponents alike.
The Staff is the final arbiter of the “violation of law” exclusion, even in the face of uncontested local counsel opinions.
“Violation of law” was another basis that companies used to argue for exclusion of special meeting proposals, often with supporting legal opinions from local counsel, generally Delaware firms. In most situations the proponent did not provide a counter legal opinion, but the SEC Staff rejected this argument without explanation.
The Staff examines the entire record when reviewing a proposal.
This year many companies that had received funds under the Trouble Asset Relief Program (TARP) also received proposals seeking a shareholder vote on a number of additional limitations on executive compensation. Some expressed surprise when the Staff permitted the exclusion of SunTrust Banks’ proposal early in the season on vagueness grounds. When the Staff later declined to permit Regions Financial to exclude a very similar proposal, several reports inferred backpedaling in reaction to political pressure. But these reports overlooked that in the SunTrust decision the Staff took the unusual step of explaining that although the text of the proposal contained no limitation on the duration of the executive compensation reforms sought, the proponent had stated in a letter to the Staff that they intended for the reforms to remain in effect so long as SunTrust participates in TARP. In other words, the decision was based on the inconsistency between the clear language in the proposal and the proponent’s intent as expressed in its letter.
Proponents refine proposals over time and eliminate defects from prior years.
Proponents often learn from prior experiences and “fix” formerly excludable proposals. In 2009, as described above, proposals permitting shareholders to call special meetings were tuned in a way that made them non-excludable. A similar result occurred with respect to social proposals calling on boards to adopt universal health care principles. In another example, last year almost half of the proposals seeking the adoption of cumulative voting were found excludable as improper under state law, with the Staff appearing to agree with arguments that the resolution as then formulated – “the shareholders recommend that our board adopt cumulative voting” – would require the board to unilaterally amend the charter. This year, proponents modified the language slightly to read that “the shareholders recommend that our board takes steps necessary to adopt cumulative voting,” which was then found not to be excludable. (The Staff also rejected arguments that the revised text was vague and misleading for failing to explain how cumulative voting would be compatible with majority voting provisions.)
In fairness to the Staff we should note that during proxy season it operates under the pressures of an enormous volume of requests and very tight deadlines, so it should be no surprise that odd results occasionally occur. And this situation will only get more challenging: note that the SEC’s recently proposed proxy access rules would use the basic Rule 14a-8 dispute-resolution process, so the Staff can expect an even greater workload next year. The more that the SEC is called upon to insert itself in this process, the more important it will be for those seeking to make or exclude proposals to understand the Staff’s thought processes.
Please click here for a copy of the Davis Polk memorandum "SEC Publishes Proxy Access Proposal" and an archived copy of the webcast "Proxy Access: What Will it Mean for Your Company?".