» SEC Staff Reverses Two Controversial Interpretations

In Staff Legal Bulletin 14E released last week, the Staff of the Securities and Exchange Commission’s Division of Corporation Finance backed off of two troublesome interpretations of the SEC’s shareholder proposal rule, Rule 14a-8.  Rule 14a-8’s “ordinary business” exclusion allows companies to omit from their proxy statements proposals dealing with day-to-day matters that are more appropriately handled by management without shareholder input. 


Although the SEC has provided some guidance in its releases regarding the application of the ordinary business exclusion, it has been left to the Staff to decide whether companies can exclude the many proposals challenged each year by companies.  In doing so, the Staff formulates decision rules, such as allowing exclusion of proposals dealing with legal compliance programs, choice of suppliers and a company’s code of ethics.


One such decision rule has allowed the omission of proposals dealing with an internal “evaluation of risk” or “risk assessment.”  This reasoning was developed for highly technical proposals asking companies to do detailed cost/benefit analyses of environmental liabilities.  In the past few years, however, the Staff had expanded the application of this rationale to allow exclusion of a wide variety of proposals, including proposals addressing topics the Staff had held to be “significant social policy issues” to which the ordinary business exclusion should not apply.  Companies began to cite this reasoning even when proposals didn’t mention or suggest risk evaluation or a cost/benefit analysis. 


Unsurprisingly, companies were able to frame many kinds of proposals as touching on or somehow involving risk.  For example, a proponent might support a labor rights proposal by arguing that irresponsible practices could harm the company’s reputation or endanger a valuable contract; a company seeking exclusion would describe the proposal as requiring the company to assess the risks and benefits associated with its current labor practices, as compared with the practices urged in the proposal.  Governance proposals likewise often have a nexus with risk of some kind.


Sponsors began drafting to avoid this reasoning, which was difficult given its potential boundlessness and the existence of contradictory Staff determinations on the same proposal formulation.  Rather than squarely asking companies to disclose steps they were taking to respond to rising pressure to reduce greenhouse gas emissions—a formulation that was deemed excludable—proponents began filing proposals asking companies to set greenhouse gas emissions targets, one of the few climate-related proposals to survive the no-action process.


Sensibly, the SEC Staff has realized that the “evaluation of risk” decision rule resulted in the “unwarranted exclusion of proposals that relate to the evaluation of risk but that focus on significant policy issues.”  From now on the Staff will look to the underlying subject matter of the proposal in deciding whether it can be omitted on ordinary business grounds.  Although this approach does not eliminate all need for the Staff to exercise subjective judgment—a goal that is unachievable given the open-ended nature of the exclusion--it is an important step in the right direction. 


A second change made by the Staff in SLB 14E relates to proposals on succession planning.  In the wake of the high-profile botched leadership transitions at Citigroup, Merrill Lynch and other financial companies, shareholders submitted proposals asking companies to adopt policies on CEO succession planning that included certain elements. 


In a breathtaking example of missing the forest for the trees, the Staff allowed companies to exclude these proposals in reliance on the ordinary business exclusion, reasoning that they dealt with the “termination, hiring or promotion of employees.”  In other words, the Staff believed there was no meaningful difference between CEO succession planning by the board and the day-to-day managerial choice about whether John Doe gets promoted from grade 1 to grade 2.  SLB 14E reversed that interpretation and stated that proposals on CEO succession planning would not be excludable as ordinary business.


Activists will likely respond to SLB 14E by retooling proposals on key corporate accountability issues to ask for the precise changes they want to see, whether in disclosure or behavior.  Proposal formulations will likely vary more according to company-specific factors such as industry and current policies and practices.  Finally, sponsors will revive the CEO succession planning issue, which was in the spotlight again recently when Bank of America CEO Ken Lewis announced that he would retire at the end of 2009 and the board admitted that no successor had been identified.


Beth Young — Senior Research Associate


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