Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.
March 24, 2016
Revitalizing SEC Rule 14a-8’s Ordinary Business
Exemption
Stephen M. Bainbridge, UCLA School of Law
Current Issues
 CSR:
• Global human rights policies
• Contract supplier standards
• Sexual orientation non-discrimination...
6
~ 400 excluded or
withdrawn
 Allows qualifying shareholders to put a proposal before
their fellow shareholders
• And have proxies solicited in favor ...
Grounds for Exclusion
Trinity Wall St. v. Wal-Mart Stores, Inc.
992 F.3d 323 (3d Cir.), cert. dismissed, 136 S. Ct. 499 (2015).
 2014 Audited F...
“Stockholders request that the Board amend the Compensation, Nominating and
Governance Committee charter (or add an equiva...
Part II
Why not let the shareholders decide?
 “The business and affairs of every corporation organized under this chapter
shall be managed by or under the direction o...
The ABA Committee on Corporate Laws (2010)Hollinger Inc. v. Hollinger Intern., Inc. (Del.Ch.2004)
Klaassen v. Allegro Deve...
“Cheaper and more
efficient to transmit
all the pieces of
information to a
central place” that
makes “the collective
choic...
Kenneth Arrow
The Limits of Organization
 The power to review is the
power to decide:
• “If every decision of A is to
be ...
Endorsed the “board centric” model Why?
 Reaffirmed MBCA policy of vesting
“the power to direct and oversee
the managemen...
 Individual shareholders
lack sufficient stake to
justify monitoring
• Free-riding issue
 Interests of large
investors l...
Part III
The Law of 14a-8(i)(7)
18
The Trinity Standard
19
Discern subject
matter of proposal
Does subject
relate to
ordinary
business?
If not, no
grounds
fo...
Proposal nominally
requested a board
review process
But substance
prevails over form
“Clever drafting”
cannot rescue
impro...
“so long as the subject
matter of the proposal
relates—that is, bears
on—a company’s
ordinary business
operations, the
pro...
 “The first [issue] is whether the
proposal focuses on a significant
policy (be it social or, as noted
below, corporate)....
Prong B But
Social Significance
 A “shareholder must do more
than focus its proposal on a
significant policy issue; the
s...
Part IV
Our Proposal
24
“Although a core business of courts is to interpret statutes and
rules, our job is made difficult where agencies, after no...
Chevron (US 1984): Where Congressional intent is unclear
a reviewing court should defer to the agency’s interpretation
of ...
Substance
prevails over
form (no
“clever”
drafting
saves)
Look to state
law
(federalism
and SEC
authority)
Prong 1
Bylaw
a...
 CA, Inc. v. AFSCME Employees Pension Plan (Del. 2008):
• The “proper function of bylaws is not to mandate how the board
...
 The SEC claims:
“State law precedent … is rarely conclusive as to what is or
is not ordinary business, and the staff gen...
Prong 2: The Ordinary versus Extraordinary Matter Analogy
 Lee v. Jenkins Bros. (2d
Cir. 1959): The president of
a corpor...
Per se extraordinary Principles of Corp Gov
Prong 2: The Ordinary versus Extraordinary Matter Analogy
Acts that boards as...
 Compelled speech
• Giving soapbox to shareholders to advance proposals motivated more by
politics than economics
– At co...
Discern
• Influence decisions about product offerings
Substance/Process
• Substance: excludible
• Clever drafting as reque...
Discern
• Set process by which shareholders
can nominate directors
Substance/Process
• Procedure
Extraordinary Act
• Extra...
Discern
• Relates to how the company
conducts operations
Substance/Process
• Substance
Extraordinary Act
• Ordinary
Applic...
Discern
• Sets procedural limits on how
long directors can serve
Substance/Process
• Process
Extraordinary Act
• Extraordi...
Revitalizing Rule 14a-8's ordinary business exclusion for shareholder proposals
Revitalizing Rule 14a-8's ordinary business exclusion for shareholder proposals
Revitalizing Rule 14a-8's ordinary business exclusion for shareholder proposals
Upcoming SlideShare
Loading in …5
×

Revitalizing Rule 14a-8's ordinary business exclusion for shareholder proposals

2,760 views

Published on

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.

Published in: Law
  • Be the first to comment

  • Be the first to like this

Revitalizing Rule 14a-8's ordinary business exclusion for shareholder proposals

  1. 1. March 24, 2016 Revitalizing SEC Rule 14a-8’s Ordinary Business Exemption Stephen M. Bainbridge, UCLA School of Law
  2. 2. Current Issues  CSR: • Global human rights policies • Contract supplier standards • Sexual orientation non-discrimination – Gender identity non-discrimination • Global warming reporting • Emissions reduction & energy efficiency reporting • Renewable energy sources • Indigenous rights policy • Recycling • Pesticides and other toxic chemicals • Israeli-Palestinian conflict  Governance • Political contribution disclosure • Proxy access • Takeover defenses • Board diversity and independence • CEO compensation • Pay disparity • Separate CEO and Chair
  3. 3. 6 ~ 400 excluded or withdrawn
  4. 4.  Allows qualifying shareholders to put a proposal before their fellow shareholders • And have proxies solicited in favor of them in the company’s proxy statement • Expense thus borne by the company • Company may seek to exclude proposals for various reasons – Procedural: E.g., not timely submitted, duplicative of company proposal, proponent does not mean ownership thresholds, etc… – Substantive: Not a proper subject of shareholder action, relates to dividends or elections, personal grievance, etc… Legal Basis for Shareholder proposals: SEC Exchange Act Rule 14a-8
  5. 5. Grounds for Exclusion
  6. 6. Trinity Wall St. v. Wal-Mart Stores, Inc. 992 F.3d 323 (3d Cir.), cert. dismissed, 136 S. Ct. 499 (2015).  2014 Audited Financial Statement: Total assets: $878,234,000 Investments (other than real estate): $210,246,000  April 1, 2014 letter from Rev. Dr. James Cooper to Trinity parishioners: “Trinity Wall Street has long recognized that our considerable resources give us both a responsibility and an opportunity to engage constructively with businesses in which we invest where opportunities exist to enhance returns for both shareholders and society. “As part of this effort, we recently initiated dialogue with certain companies toward assuring they balance the benefits of selling certain products against the risks these sales pose to the public and to the companies’ reputation and brand value.” 9
  7. 7. “Stockholders request that the Board amend the Compensation, Nominating and Governance Committee charter (or add an equivalent provision to another Board committee charter) as follows: ‘”’27. Providing oversight concerning the formulation and implementation of, and the public reporting of the formulation and implementation of, policies and standards that determine whether or not the Company should sell a product that: 1) especially endangers public safety and well-being; 2) has the substantial potential to impair the reputation of the Company; and/or 3) would reasonably be considered by many offensive to the family and community values integral to the Company's promotion of its brand.’ “This oversight and reporting is intended to cover policies and standards that would be applicable to determining whether or not the company should sell guns equipped with magazines holding more than ten rounds o f ammunition ("high capacity magazines") and to balancing the benefits of selling such guns against the risks that these sales pose to the public and to the Company's reputation and brand value.” Trinity’s proposal for inclusion on Wal-Mart’s 2014 proxy statement for the annual meeting of shareholders 10
  8. 8. Part II Why not let the shareholders decide?
  9. 9.  “The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors” DGCL 141(a) • The board’s powers are “original and undelegated” - Manson v. Curtis, 119 N.E. 559, 562 (N.Y. 1918) – Shareholder control rights limited – Voting rights limited to review of a few fundamental decisions – Proxy system and 13(d) restrictions on shareholder voting and communication – Derivative litigation burdened by procedural barriers and BJR – Market for corporate control hampered by combination of poison pill and classified boards The director primacy model
  10. 10. The ABA Committee on Corporate Laws (2010)Hollinger Inc. v. Hollinger Intern., Inc. (Del.Ch.2004) Klaassen v. Allegro Development Corporation (Del. Ch. 2013) Kevin L. Turner, 57 ALA. L. REV. 907 Larry Ribstein, 1 BERKELEY BUS. L.J. 183In re CNX Gas Corp. S'holders Litig. (Del.Ch.2010) Cases and Commentators “[D]irector primacy remains the centerpiece of Delaware law, even when a controlling stockholder is present.” Noting “the bedrock statutory principle of director primacy established by Section 141(a) of the DGCL.” “It is through … centralized management that stockholder wealth is largely created.” “Corporate governance is best characterized as based on ‘director primacy.’” “Delaware jurisprudence favors director primacy in terms of the definitive decision-making power …” Reaffirmed MBCA policy of vesting “the power to direct and oversee the management of the corporation in the board of directors, rather than in the shareholders.”
  11. 11. “Cheaper and more efficient to transmit all the pieces of information to a central place” that makes “the collective choice and transmit it rather than retransmit all the information on which the decision is based” Asymmetric information Divergent interests Collective action problems Kenneth Arrow The Limits of Organization
  12. 12. Kenneth Arrow The Limits of Organization  The power to review is the power to decide: • “If every decision of A is to be reviewed by B, then all we have really is a shift in the locus of authority from A to B” 15
  13. 13. Endorsed the “board centric” model Why?  Reaffirmed MBCA policy of vesting “the power to direct and oversee the management of the corporation in the board of directors, rather than in the shareholders.”  Board centric model gives shareholders “the regular opportunity to elect the members of the board, but during the directors’ terms, the board has the power, informed by each director’s decisions in the exercise of his or her fiduciary duties, to direct and oversee the pursuit of the board’s vision of what is best for the corporation.”  If the actions of management were the subject of frequent shareholder review: • The ability to rely on management teams would be diluted • The time and attention of managers could be diverted from activities designed to pursue sustainable economic benefit for the corporation. • Particular shareholders may have interests that diverge from those of other shareholders or interests other than sustainable economic benefit. The ABA Committee on Corporate Laws (2010) 16
  14. 14.  Individual shareholders lack sufficient stake to justify monitoring • Free-riding issue  Interests of large investors likely to differ from those of shareholders as a whole  Transfer of authority from board to shareholders • Undesirable in itself – Less efficient decision making – Swapping consensus for authority under conditions favoring the latter Shareholders do not “own” the corporation Individual Shareholders Institutional Shareholders But what about the “ownership” rights of shareholders? 17
  15. 15. Part III The Law of 14a-8(i)(7) 18
  16. 16. The Trinity Standard 19 Discern subject matter of proposal Does subject relate to ordinary business? If not, no grounds for exclusion If yes, go to social Significance 1. Does proposal raise significant policy issue? 2. Does it “transcend” ordinary business If no, exclude If yes, include
  17. 17. Proposal nominally requested a board review process But substance prevails over form “Clever drafting” cannot rescue improper proposal Asking for a review or adoption of a policy no guarantor of inclusion Look to “ultimate consequence” of proposal [How?] The process of discernment 20 Proposal was really about selling guns
  18. 18. “so long as the subject matter of the proposal relates—that is, bears on—a company’s ordinary business operations, the proposal is excludable unless some other exception to the exclusion applies” A proposal bearing on decisions about product offerings is thus excludable even if the “proposal doesn’t direct management to stop selling a particular product or prescribe a matrix to follow” Does proposal “relate” to ordinary business? 21
  19. 19.  “The first [issue] is whether the proposal focuses on a significant policy (be it social or, as noted below, corporate).”  It “is hard to counter that Trinity’s proposal doesn’t touch the bases of what are significant concerns in our society and corporations in that society.” 1.Court provides no general metric for significance. 2.In this case, resolved by pure fiat: No explanation of why issue rose to requisite level in this case. But Prong A Result Social Significance 22
  20. 20. Prong B But Social Significance  A “shareholder must do more than focus its proposal on a significant policy issue; the subject matter of its proposal must ‘transcend’ the company’s ordinary business.”  The “transcendence requirement plays a pivotal role in the social-policy exception calculus.”  “Without it shareholders would be free to submit ‘proposals dealing with ordinary business matters yet cabined in social policy concern.’”  This is analysis by epithet and reasoning by pejorative : • Transcend is undefined in the opinion.  “A court's focus on labels rather than on reasoning not only impedes law students' understanding of what the law is and how to answer questions on an exam, but also lawyers' understanding of how to advise clients and how to present arguments to arbitrators and judges.” 23
  21. 21. Part IV Our Proposal 24
  22. 22. “Although a core business of courts is to interpret statutes and rules, our job is made difficult where agencies, after notice and comment, have hard-to-define exclusions to their rules and exceptions to those exclusions. For those who labor with the ordinary business exclusion and a social-policy exception that requires not only significance but “transcendence,” we empathize. Despite the substantial uptick in proposals attempting to raise social policy issues that bat down the business operations bar, the SEC’s last word on the subject came in the 1990s, and we have no hint that any change from it or Congress is forthcoming . . . We thus suggest that [the SEC] consider revising its regulation of proxy contests and issue fresh interpretive guidance.” The Trinity court was aware that a better test is needed
  23. 23. Chevron (US 1984): Where Congressional intent is unclear a reviewing court should defer to the agency’s interpretation of the statute so long as it constitutes a permissible construction of the statute SEC and staff have consistently failed to apply the ordinary business exemption consistently over time. Multiple flip-flops (e.g., Cracker Barrel) that went unexplained. Nat'l Cable & Telecomms. v. Brand X Internet Servs. (US 2005): An “unexplained inconsistency is ... a reason for holding an interpretation to be an arbitrary and capricious change from agency practice”). Is the SEC entitled to Chevron Deference? 26
  24. 24. Substance prevails over form (no “clever” drafting saves) Look to state law (federalism and SEC authority) Prong 1 Bylaw analogy Prong 2 Extraordinary act analogy An Alternative Test 27
  25. 25.  CA, Inc. v. AFSCME Employees Pension Plan (Del. 2008): • The “proper function of bylaws is not to mandate how the board should decide specific substantive business decisions, but rather, to define the process and procedures by which those decisions are made.” – “This distinction between substance (disallowed) and process (allowed) captures an appropriate balance between authority and accountability. If shareholder interventions directed at substantive decisions can be discouraged, the board’s decision-making authority is respected. Indeed, if it is the case—as seems likely— that private rent seeking most often will take the form of substantive interventions, discouraging that category of interventions provides a useful prophylactic solution to the rent-seeking problem. Conversely, process and procedural interventions do not deprive the board of its authority but rather can be used to ensure that that authority is used accountably.” (Bainbridge 2015) Bylaw analogy 28
  26. 26.  The SEC claims: “State law precedent … is rarely conclusive as to what is or is not ordinary business, and the staff generally has had to make its own determination as to whether a proposal involves an activity relating to the issuer's ordinary business.” – But the SEC is wrong. Prong 2: The Ordinary versus Extraordinary Matter Analogy 29
  27. 27. Prong 2: The Ordinary versus Extraordinary Matter Analogy  Lee v. Jenkins Bros. (2d Cir. 1959): The president of a corporation “only has authority to bind his company by acts arising in the usual and regular course of business but not for contracts of an ‘extraordinary’ nature ….”  Restatement (Third) of Agency § 3.03 cmt. e(3) • “The apparent authority of a president or chief executive officer encompasses transactions falling within the ordinary course of the corporation's business.” 30
  28. 28. Per se extraordinary Principles of Corp Gov Prong 2: The Ordinary versus Extraordinary Matter Analogy Acts that boards as a whole may not delegate to board committees “would normally not be within the authority of the president or other senior executives.” Acts that would require shareholder approval. Factors: “the economic magnitude of the action in relation to corporate assets and earnings, the extent of risk involved, the time span of the action's effect, and the cost of reversing the action.” “A useful generalization is that decisions that would make a significant change in the structure of the business enterprise, or the structure of control over the enterprise, are extraordinary corporate actions, and therefore are normally outside the apparent authority of senior executives.” 31
  29. 29.  Compelled speech • Giving soapbox to shareholders to advance proposals motivated more by politics than economics – At company expense (and thus ultimately at expense of all shareholders) – Under current law, the shareholder proposal rule is a species of private eminent domain by which the federal government allows a small minority to appropriate someone else’s property.  Federal entanglement in disputes over social issues: • Should federal bureaucrats or federal judges decide whether a politically charged proposal has enough ethical or social significance to justify its inclusion in the proxy statement? The Case Against the Social Significance Exemption to the Exclusion 32
  30. 30. Discern • Influence decisions about product offerings Substance/Process • Substance: excludible • Clever drafting as request for a policy unavailing Extraordinary Act • Ordinary Applications: Trinity 33
  31. 31. Discern • Set process by which shareholders can nominate directors Substance/Process • Procedure Extraordinary Act • Extraordinary Applications: Proxy Access 34
  32. 32. Discern • Relates to how the company conducts operations Substance/Process • Substance Extraordinary Act • Ordinary Applications: Report on/Adopt policy re sustainability 35
  33. 33. Discern • Sets procedural limits on how long directors can serve Substance/Process • Process Extraordinary Act • Extraordinary Applications: Director term limits 36

×