& Securities

On November 1^st, the staff of the SEC’s Division of Corporation Finance issued Staff Legal Bulletin (SLB) No. 14I on Rule 14a-8 shareholder proposals. Most notably, the Staff will now require a description of the board of directors’ analysis as a condition to granting a company’s request for no-action relief to exclude a proposal on “ordinary business” and/or “economic relevance” grounds.

SLB 14I also addresses “proposals by proxy” and the use of graphics in shareholder proposals.

“Ordinary Business” Exception

The “ordinary business” exception — Rule 14a-8(i)(7) – is one of the substantive bases for omission of a Rule 14a-8 shareholder proposal. It permits a company to exclude a proposal that “deals with a matter relating to the company’s ordinary business operations,” unless the proposal focuses on policy issues “that are sufficiently significant because they transcend ordinary business and would be appropriate for a shareholder vote.” SLB 14I adds a new analytical layer to the (i)(7) exclusion analysis companies must provide based on the Staff’s belief that, in light of its fiduciary duties and knowledge of the company’s business, a company’s board of directors is generally in a better position than the Staff to address the “difficult judgment calls” necessary to determine whether or not a proposal dealing with ordinary business matters presents a policy issue of sufficient significance to warrant a shareholder vote. Starting with this proxy season, a company seeking to exclude a proposal on “ordinary business” grounds will have to include in its no-action request a “well-developed” discussion that “reflects the board’s analysis of the particular policy issue raised and its significance,” and that describes in detail “the specific processes employed by the board to ensure that its conclusions [that the proposal does not raise a significant policy issue connected to the company’s business operations] are well-informed and well-reasoned.”

The Staff views the determination of a proposal’s policy significance to fall squarely within a board’s fiduciary duties to oversee management and the strategic direction of the company. However, the Staff does not appear to be ceding its own decision-making to the board, stating instead that that the board’s analysis will “greatly assist” its review. Thus, it remains to be seen, for example, how the Staff will respond to a “well-developed” board analysis that departs from the line of “ordinary business” no-action letters establishing the Staff’s view as to those matters that are “so fundamental to management’s ability to run a company on a day-to-day basis that they could not, as a practical matter, be subject to direct shareholder oversight,” and those that focus on a policy issue of sufficient significance to transcend ordinary business.

“Economic Relevance” Exception

SLB 14I creates a similar board analysis requirement for companies seeking to exclude shareholder proposals under the less frequently used Rule 14a-8(i)(5) – the “economic relevance” exception, which 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.” The Staff commented that the application of this exception was “unduly limited” because the second prong of the test was not “fully considered,” leading to the denial of no-action requests when a proposal reflected social or ethical issues raised by any amount of a company’s business, no matter how small. As with “ordinary business,” SLB 14I’s rationale for requiring corporate boards to weigh in on the (i)(5) analysis reflects the Staff’s belief that a company’s board of directors is better positioned to determine whether a matter is “not otherwise significantly related to the company’s business.”

“Proposal by Proxy”

To help the Staff evaluate whether shareholder eligibility requirements have been met, by persons purporting to act on behalf of shareholders, and to address concerns that shareholders may not be aware that a proposal submitted by proxy on their behalf, SLB 14I now requires proposals submitted through a shareholder’s representative to include documentation identifying: the shareholder-proponent and the person or entity selected as proxy; the company to which the proposal is directed; and the annual or special meeting for which the proposal is submitted. The shareholder must also sign and date the documentation.

Use of Images and the 500-Word Limit

A shareholder proposal can be excluded under Rule 14a-8(d) if the proposal, together with any accompanying supporting statement, exceeds 500 words. Though the use of graphics is not prohibited, the Staff recognizes the potential for abuse. Thus, going forward, a proposal is eligible for exclusion if the total number of words in the proposal, including words in the graphics, exceeds 500.

What to Do Now

SLB 14I’s board analysis requirement essentially gives investors another glimpse behind the veil into the boardroom and the board’s decision-making processes. Management should familiarize members of the board and, in particular, the nominating and governance committee, with the fact that they will now be more explicitly associated with the company’s decision to seek exclusion of a shareholder proposal on “ordinary business” or “economic relevance” grounds. Given the tight Rule 14a-8 timetable, companies will now have to build in sufficient time for a more formal process than they may have undertaken in the past if they wish to argue for exclusion on (i)(7) or (i)(5) grounds.