SEC Staff Guidance on Shareholder Proposals During 2012 Proxy Season

Posted by John F. Olson, Gibson, Dunn & Crutcher LLP and Georgetown Law Center, on Monday June 18, 2012 at 10:21 am
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Editor’s Note: John Olson is a founding partner of Gibson, Dunn & Crutcher’s Washington, D.C. office and a visiting professor at the Georgetown Law Center. This post is based on a Gibson Dunn alert, available (including footnotes) here.

There have been a number of significant shareholder proposals submitted during the 2012 proxy season to date. This alert summarizes notable responses by the Securities and Exchange Commission (the “SEC”) staff (the “Staff”) to no-action requests concerning many of these shareholder proposals. By way of background, according to Institutional Shareholder Services (“ISS”), 1,105 proposals have been submitted to companies to date for 2012 annual meetings. As of May 22, 2012, 303 no-action requests had been submitted to the SEC since October 1, 2011. This is comparable to the number of shareholder proposal no-action requests submitted during a similar period in 2011. Moreover, repeating the experience in 2011, the number of requests for reconsideration submitted by both companies and proponents was high. In addition, many companies successfully negotiated with proponents to withdraw shareholder proposals, illustrating that engagement with proponents can often eliminate the need to file a no-action request.

1. Staff Legal Bulletin No. 14F

At the beginning of the 2012 shareholder proposal season, the Staff issued Staff Legal Bulletin No. 14F (Oct. 18, 2011) (“SLB 14F”), reversing an earlier Staff position on proof of ownership issues that arise when proponents use an introducing broker. Specifically, the Staff stated in SLB 14F that “only [Depository Trust Company ("DTC")] participants should be viewed as ‘record’ holders of securities that are deposited at DTC,” meaning that only those firms that are DTC participants can provide valid Rule 14a-8(b) proof of ownership for proponents whose shares are held in street name. The Staff followed this position in Johnson & Johnson (avail. Mar. 2, 2012)*, concurring in the exclusion of a proposal when the shareholder’s proof of ownership was from an entity that was not a DTC participant. However, the Staff also issued a number of decisions this season rejecting proof of ownership arguments based on minor “foot faults” in the proof of ownership provided by proponents. For example, several companies challenged proof of ownership received from TD Ameritrade because the entity providing the letter intended to serve as proof of ownership, “TD Ameritrade, Inc.,” was not on the DTC participant list, although an affiliated entity was on the DTC participant list. As we expected, the Staff did not permit exclusion, noting that “the proof of ownership statement was provided by a broker that provides proof of ownership statements on behalf of its affiliated DTC participant.” Focusing on the relationship between the DTC participant and the entity providing the proof of ownership, instead of similarities in entities’ names, the Staff similarly concluded that proof of ownership provided by a “department” or a “division” of a DTC participant is sufficient.

2. Proxy Access Shareholder Proposals

Proxy access was one of the most closely watched shareholder proposal topics this season because this was the first proxy season in which Rule 14a-8(i)(8) did not provide a means for excluding proxy access shareholder proposals and the first proxy season after the D.C. Circuit vacated the SEC’s mandatory proxy access rule, Rule 14a-11. Although Rule 14a-8(i)(8) no longer provides for the exclusion of proxy access proposals, the SEC stated that these proposals may “continue to be subject to exclusion under other provisions of Rule 14a-8.” Other bases for exclusion under Rule 14a-8 were tested this season and were successful in many cases, although often due to issues that proponents can correct in future proposals. Nevertheless, these no-action decisions demonstrate the need to carefully analyze new proposals under traditional Rule 14a-8 standards.

a. U.S. Proxy Exchange Proposal

The Staff concurred that a shareholder proposal drafted by the U.S. Proxy Exchange and submitted to several companies could be excluded under two separate provisions of Rule 14a-8. The proposal sought to provide proxy access to any shareholder(s) that had continuously held one percent of the company’s voting securities for two years or to any group of shareholders “of whom one hundred or more satisfy SEC Rule 14a-8(b) eligibility requirements.” Among other things, the proposal also stated that “[a]ny election resulting in a majority of board seats being filled by individuals nominated . . . by parties nominating under these provisions shall be considered to not be a change in control.” Gibson Dunn submitted the first no-action request raising a number of bases for exclusion of the proposal, two of which have been successful to date. Several companies that notified the proponent within the rule’s 14-day deadline of their view that the proposal violated the one-proposal limit in Rule 14a-8(c) were able to exclude the proposal on that ground. The Staff concurred with these companies that the change-in-control provision constituted a “separate and distinct matter” from the other provisions of the proposal. The Staff also concurred that the proposal’s reference to the ownership requirements under Rule 14a-8(b) caused the proposal to be impermissibly vague and, therefore, excludable under Rule 14a-8(i)(3). The Staff noted that although “some shareholders voting on the proposal may be familiar with the eligibility requirements of [R]ule 14a-8(b), many other shareholders may not be familiar with the requirements and would not be able to determine the requirements based on the language of the proposal.”

The U.S. Proxy Exchange subsequently revised its proposal in response to the arguments above, and proponents have begun submitting the revised version to companies. Medtronic, Inc. received the revised version, and its no-action request challenging the proposal is currently pending.

b. Norges Bank Proposal

Norges Bank, the central bank of Norway, submitted a binding bylaw proxy access shareholder proposal to six companies. The binding bylaw amendment would provide proxy access to shareholders who had continuously owned at least one percent of the company’s stock for one year. Four companies submitted no-action requests concerning the Norges Bank proposal and one of these companies, Staples, Inc., was successful in excluding the proposal based on unique facts. That company’s existing bylaws contained an unusual provision, stating that the bylaws did not obligate the company to include shareholders’ nominees in the company’s proxy materials. However, the Norges Bank proposal did not seek to amend that provision. Because adoption of the proposal would have created a conflict within the bylaws, the Staff stated that the proposal could be excluded as vague under Rule 14a-8(i)(3).

Three companies argued that a website address cited in the Norges Bank proposal could be excluded because it was materially false and misleading under Rule 14a-8(i)(3). After the companies pointed out to the Staff that accessing the website led to an error message, Norges Bank provided the companies and the Staff with the text it intended to place on the website. The Staff rejected the companies’ arguments for exclusion, noting that the companies did not “assert[] that the content to be included on the website is false or misleading, and the proponent has represented that it intends to include this information on the referenced website upon the filing [of the company's] 2012 proxy materials.” However, the no-action requests were successful in forcing Norges Bank to provide the intended website disclosure in advance of the companies drafting their statements in opposition to be included in their proxy statements.

c. Furlong Fund, LLC Proposal

The Furlong Fund, LLC submitted a proxy access shareholder proposal to KSW, Inc. that, like the Norges Bank proposal, was a binding bylaw amendment. It sought proxy access for shareholders who had beneficially owned at least two percent of the company’s stock for one year. The company argued that it could exclude the proposal under Rule 14a-8(i)(10) because it had recently adopted a bylaw providing proxy access for five-percent shareholders and had thereby “substantially implemented” the proposal. The Staff disagreed, citing the differences between the company’s bylaw and the proposal, including the difference in ownership levels required to nominate a director for inclusion in the proxy materials.

3. Shareholder Proposals Relating to Ordinary Business

The Staff continued its recent pattern of each year expanding the list of topics it considers to be significant policy issues. Other notable decisions this year under the Rule 14a-8(i)(7) ordinary business exclusion reaffirmed long-held positions and clarified important distinctions under the rule.

a. Net Neutrality

Dating back to at least 2006, the Staff has concurred in the exclusion of shareholder proposals relating to net neutrality in reliance on Rule 14a-8(i)(7). The Staff affirmed this position just last season, concurring that net neutrality was not a significant policy issue and stating that “net neutrality appears to be an important business matter . . . and the topic of net neutrality has recently attracted increasing levels of public attention.” Although the Staff did not cite any specific events that distinguished the current level of debate on the issue from that which prevailed last year, proponents of these proposals were successful in arguing that net neutrality had become a significant policy issue. As a result, the Staff reversed its prior position and did not concur that three telecommunications companies could rely on Rule 14a-8(i)(7) to exclude proposals asking them to commit to operating their wireless broadband networks in accordance with “net neutrality principles.” The Staff noted the “sustained public debate over the last several years concerning net neutrality and the Internet and the increasing recognition that the issue raises significant policy considerations.” The Staff subsequently clarified that this explanation of its determination should not be viewed as “a new or different standard for determining whether a proposal raises policy issues so significant that it would be appropriate for a shareholder vote.”

b. Auditor Rotation and Independence

The United Brotherhood of Carpenters Pension Fund submitted a shareholder proposal to numerous companies, requesting the establishment of a policy at each company to “rotate” the company’s audit firm periodically. Companies challenging this proposal argued that mandatory auditor rotation has long been a subject of consideration by the SEC, legislators and others, including throughout such times during which the Staff concurred in the exclusion of auditor rotation shareholder proposals, and thus, the recent PCAOB proposal on auditor rotation was not sufficient to elevate the topic to the level of consistent widespread public debate. The Staff agreed, stating that “[p]roposals concerning the selection of independent auditors or, more generally, management of the independent auditor’s engagement, are generally excludable under [R]ule 14a-8(i)(7).” The Carpenters appealed the decision, arguing that auditor rotation is a significant policy issue, but the Staff rejected this argument.

The Carpenters later submitted a related proposal to several companies asking that the audit committee disclose to shareholders an annual audit firm independence report that would address a number of topics, including whether the audit committee has a policy of mandatory audit firm rotation. Once again, the Staff concurred that the proposal could be excluded under Rule 14a-8(i)(7) because it related to “the selection of the independent auditors or, more generally, management of the independent auditor’s engagement.”

c. Risk

Various letters this season gave further definition and clarification to the Staff’s position that shareholder proposals relating to risk oversight do not automatically implicate significant policy issues, as outlined in Staff Legal Bulletin No. 14E (Oct. 27, 2009) (“SLB 14E”). Exxon Mobil Corp. (avail. Mar. 6, 2012)* made it clear that if a risk-related proposal’s “underlying subject matter” is not limited to a significant policy issue but, rather, also broadly addresses ordinary-business matters, the proposal will be excludable. The Exxon Mobil proposal requested a report “discussing possible short and long term risks to the company’s finances and operations posed by the environmental, social and economic challenges associated with the oil sands.” The company pointed out that the underlying subject matter of the risks addressed by the proposal was not limited to the significant policy issue of the environment and that the proposal as a whole did not focus on the environment. The Staff concurred that the proposal could be excluded, noting that “the proposal addresses the ‘economic challenges’ associated with the oil sands and does not, in our view, focus on a significant policy issue.”

In Sempra Energy (avail. Jan. 12, 2012, recon. denied Jan. 23, 2012)*, the shareholder proposal asked the board “to conduct an independent oversight review” of the company’s management of risks posed by the company’s operations in certain countries. The Staff permitted the company to exclude the proposal, noting that “although the proposal requests the board to conduct an independent oversight review of Sempra’s management of particular risks, the underlying subject matter of these risks appears to involve ordinary business matters.”

4. Political and Lobbying Shareholder Proposals

Shareholder proposals relating to political contributions and lobbying expenditures are notable due to the high number submitted this season in light of the Citizens United decision and the 2012 elections. Despite the proliferation in the number and the scope of the actions or reports requested in these proposals, companies’ no-action arguments and the Staff’s responses were similar to those of past seasons.

a. Ordinary Business

The Staff has long held that proposals focusing on a company’s general political activities, including its general policies for political contributions and lobbying expenditures, cannot be excluded under Rule 14a-8(i)(7). However, proposals that address a company’s lobbying activities on a specific matter of ordinary business have been excludable, even if the subject matter of the lobbying is a significant policy issue. This position was affirmed with respect to a proposal submitted to Duke Energy Corporation requesting that the company’s board “prepare a report disclosing the Company’s global warming-related lobbying activities.” The Staff concurred that the proposal could be excluded under Rule 14a-8(i)(7), noting that “the proposal and supporting statement, when read together, focus primarily on Duke Energy’s specific lobbying activities that relate to the operation of Duke Energy’s business and not on Duke Energy’s general political activities.”

b. Substantial Duplication

Rule 14a-8(i)(11) permits a shareholder proposal to be excluded “[i]f the proposal substantially duplicates another proposal previously submitted to the company by another proponent that will be included in the company’s proxy materials for the same meeting.” Several companies received more than one proposal regarding political contributions and/or lobbying expenditures and argued that they should be able to exclude the later-submitted proposals. As we expected, the Staff generally agreed. First, consistent with precedent from last season, the Staff concurred that broadly phrased proposals about disclosure of political contributions and proposals about disclosure of lobbying expenditures substantially duplicated each other. Second, consistent with the longstanding Staff view that differences in proposals’ scopes do not necessarily preclude the proposals from “substantially duplicat[ing]” each other, the Staff concurred that a broad proposal seeking an advisory shareholder vote on several aspects of political contributions, including future contributions, substantially duplicated a previously received, but narrower, proposal requiring the company to obtain shareholder approval before making political contributions.

c. Resubmissions

Rule 14a-8(i)(12) permits the exclusion of a shareholder proposal if a proposal dealing with “substantially the same subject matter” was included in the company’s proxy statement(s) in the recent past and the most recent such proposal failed to achieve more than a specified minimum percentage of the shareholder vote. As with Rule 14a-8(i)(11), the Staff has long held that differences in the proposals’ scopes do not necessarily prevent exclusion under Rule 14a-8(i)(12). Consistent with this position, the Staff concurred that a proposal requesting a report on a broad array of information regarding a company’s political contributions dealt with substantially the same subject matter as proposals that had been included in the company’s past proxy statements that had more narrowly requested only a listing of the company’s political contributions.

5. Shareholder Proposals That Are Contrary to Federal or State Law

Rule 14a-8(i)(2) permits the exclusion of a proposal that “would, if implemented, cause the company to violate any state, federal, or foreign law to which it is subject.” This season, two companies–Gannet Co., Inc. and Pfizer Inc.–received a proposal that would have imposed mandatory arbitration for certain claims against the companies and also would have prohibited class actions for these claims. The Staff concurred that the proposal, which would have curtailed shareholders’ ability to bring actions under Section 10(b) of the Exchange Act, was excludable because, in the view of the companies and the Staff, it violated the anti-waiver provisions in Section 29(a) of the Exchange Act.

The Staff also considered proposals that companies argued would cause them to violate state law. Johnson & Johnson received a proposal to adopt a bylaw providing that if, in a director election, any member of the Compensation Committee receives more than a specified amount of “no” or “withhold” votes, then the Committee member who receives the highest number of such votes “shall be disqualified from serving on [the] board’s Compensation Committee for the 2-years following such vote.” The Staff concurred that the proposal violated New Jersey law, which provides that decisions regarding committee composition are exclusively left to the board of directors. The Staff also permitted the exclusion of a proposal submitted by John Harrington to JPMorgan Chase & Co. to “minimize the indemnification of directors” to the fullest extent permissible by Delaware law. Exclusion was based on legal opinions from Delaware counsel that the proposal’s “blanket prohibition on any director indemnification in situations where under applicable law it is permissive but not mandated” was inconsistent with Delaware’s indemnification provisions.

6. Shareholder Proposals That Are Vague

Rule 14a-8(i)(3) permits the exclusion of a shareholder proposal “[i]f the proposal or supporting statement is contrary to any of the Commission’s proxy rules,” including if the proposal is inherently vague or indefinite. In addition to the Rule 14a-8(i)(3) arguments and Staff determinations relating to proxy access shareholder proposals, discussed above, two other types of shareholder proposals presented notable issues under Rule 14a-8(i)(3) this season. First, John Chevedden submitted a new proposal to several companies, requesting an amendment to the companies’ governing documents to enable one or more shareholders holding not less than one-tenth of the company’s voting power (or the lowest percentage of outstanding shares permitted by state law) to call a special meeting. Companies argued, and the Staff agreed, that because the proposal contained alternative thresholds, the proposal was excludable because neither shareholders nor the company would know what actions or measures the proposal required.

Second, the Staff recognized a distinction between two types of proposals requesting a board chairman who qualified as independent under the New York Stock Exchange (“NYSE”) listing standards based on the specific wording of the proposals. A proposal requesting adoption of a policy that the board’s chair “shall be an independent director (by the standard of the New York Stock Exchange), who has not previously served as an executive officer of our Company” was determined not to be excludable as vague for at least two NYSE-listed companies. On the other hand, a proposal “to adopt a policy that the board’s chairman be an independent director according to the definition set forth in the [NYSE] listing standards,” but which did not mention the idea of previously serving as an executive officer of the company, was excludable as vague at a NYSE-listed company. Companies that received these proposals argued that the proposals were impermissibly vague since they did not describe the NYSE independence standards, which were a central part of the proposals.

Conclusion

The SEC shareholder proposal no-action letters issued this season demonstrate the importance of thorough and timely analysis of shareholder proposals and the careful drafting of no-action requests that are tailored to the specific language of the proposal and address applicable precedent. Whether a particular proposal is excludable often turns on minor language differences and the framing of arguments in the no-action request. Given the technical grounds on which some high profile shareholder proposals were excluded this year, particularly those concerning proxy access, and the continued development of new topics and new requests addressed in proposals, companies can expect to see revised versions of these proposals as proponents address the issues that rendered the proposals excludable.

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