In November 2021, the Division of Corporation Finance of the Securities and Exchange Commission (“SEC”) published CF Staff Legal Bulletin No. 14L and simultaneously rescinded its last three bulletins (14I, 14J, and 14K). This new bulletin and recission of its prior guidance is another strong signal that the SEC Staff is focused on environmental, social, and governance (“ESG”) issues because the guidance will likely have the practical effect of requiring public companies to include more ESG shareholder proposals in their proxy statements under the process in Exchange Act Rule 14a-8 (“Rule 14a-8”).
Rule 14a-8 provides a mechanism for shareholders to submit proposals for public companies to include in the company’s proxy statement and proxy card when the company holds an annual or special meeting of shareholders. The rule provides procedural requirements for the proposal and exceptions that allow companies to request the SEC provide no-action relief if the proposal is excluded from its proxy materials.
Changes in Guidance for Excluding Shareholder Proposals
The new bulletin and recission of prior SEC guidance will likely narrow the scope of permissible reasons for excluding shareholder proposals from a public company’s proxy materials and shareholder meetings. In the bulletin, the SEC Staff clarified how its future application of the ordinary business exception and the economic relevance exception will represent a departure from prior practice.
Ordinary Business Exception
The “ordinary business exception” in Rule 14a-8(i)(7) allows a public company to exclude a shareholder proposal if the proposal “deals with a matter relating to the company’s ordinary business operations.” This exception is intended to leave the day-to-day operations of the company and related problem solving to the board of directors and management, because those types of issues would not be practical for shareholders to resolve at a meeting. Historically, this exception has been used to exclude proposals that the company argues relate to broad social policies that are best addressed in the ordinary course of business by the company’s board and management team.
For shareholder proposals on social policy issues, the SEC Staff will consider the social policy significance of the issue instead of the connection between the particular company and the issue, as had been its prior practice. The SEC Staff will consider whether the proposal raises issues that transcend the ordinary business of the company because they have a broad societal impact. The bulletin noted that their past practice caused the SEC Staff to delve into factual considerations that did not advance the original policy objectives behind the ordinary business exception. Accordingly, companies will no longer need to provide a board analysis as described in the past bulletins to address these issues when submitting a no-action request under this exception.
For shareholder proposals that could have previously been excluded under the “micromanagement” interpretation of the ordinary business exception, the SEC Staff clarified that a proposal seeking to impose a timeline or particular detail about the company’s activities does not constitute micromanagement. Instead, the SEC Staff will consider whether the shareholder proposal inappropriately limits company or board discretion. The bulletin explicitly notes that the SEC Staff will not allow the exclusion of proposals that suggest targets or timelines for a company to meet as long as they allow management and the board discretion on how to meet the targets or timelines. To determine whether the issue is too complex for shareholders to resolve at a meeting, the SEC Staff will consider the sophistication of shareholders on the issue, the availability of data, public discussion and analysis on the topic, and the availability of well-established national or international frameworks for disclosure and setting targets or timelines.
Given the ESG-related activity in shareholder proposals in recent years, a specific example used in the bulletin is instructive for future no-action requests. The bulletin noted that a proposal requesting a company set emission reduction targets, without dictating how to do so, did not constitute micromanagement that would support exclusion under the ordinary business exception. Public companies should expect shareholder proponents will read this guidance carefully to craft proposals that fall within these guidelines, whether the proposal is for setting goals for reducing greenhouse gas emissions or committing to net zero carbon emissions by some target date.
Economic Relevance Exception
The “economic relevance exception” in Rule 14a-8(i)(5) allows companies to exclude proposals that do not relate to a significant portion of their assets, operations, or general business. Under prior guidance, companies were able to exclude proposals relating to issues that accounted for less than five percent of the company’s total assets at the end of the most recent fiscal year, less than five percent of the company’s net earnings and gross sales for the same period, and were not otherwise significantly related to the company’s business.
Under the policy described in the new bulletin, the SEC Staff will not find proposals excludable if they raise issues of broad social or ethical concern related to the company’s business, even if the thresholds are not met. Due to this change, companies will no longer need to provide a board analysis of the proposal to the SEC Staff when seeking to exclude a proposal under this prong of the rule.
Use of Email
In the bulletin, the SEC Staff provided guidance on best practices for using email for sending, receiving, and responding to shareholder proposals. Generally, the Staff suggests requesting reply emails for confirmation of receipt and sending such reply emails when requested. Companies should keep in mind that automatic email delivery confirmations and company server logs may not be sufficient to prove receipt of email as they only serve to prove that the email was sent.
Reiteration of Past Guidance
Because this bulletin served to rescind prior bulletins, the SEC Staff reiterated some elements of guidance from the prior bulletins that will continue to apply to future proposals and no-action requests.
Use of Images in Proposals
As indicated in prior guidance, the SEC Staff noted that images and graphs are acceptable in shareholder proposals, as long as they are not false or materially misleading and do not violate any other provision of Rule 14a-8. Notably, any words included in the graphic will count toward the 500-word limit for the shareholder proposal. If the shareholder proposal were to exceed that limit, it could be excluded from the proxy materials under the technical provisions of Rule 14a-8.
Proof of Ownership Letters
Rule 14a-8(b) requires a shareholder proponent to submit a statement proving their eligibility to submit the proposal along with the proposal itself. The SEC Staff reiterated its position that minor deviations from the SEC’s proposed language for these proof of ownership letters will not constitute grounds for excluding a proposal if the letter provides sufficient evidence of the ownership requirement. The bulletin updated the proposed language to conform to the changes to the ownership thresholds adopted in 2020, but did not change the substance of the SEC’s prior guidance.
This new guidance for applying Rule 14a-8 will likely increase the number of shareholder proposals that are included in public company proxy materials. Management teams should keep this revised guidance in mind when analyzing any shareholder proposals received under the Rule 14a-8 framework, because prior gut reactions about excluding proposals may no longer be viable alternatives under this guidance. It will likely be more important than in prior years to open a constructive dialogue with shareholder proponents as soon as possible to ensure that the shareholder meeting process runs smoothly.
If you have any questions about this guidance, please contact a member of Harter Secrest & Emery’s Securities and Capital Markets group at 585.232.6500 or 716.853.1616.