New Guidance under Rule 14a-8 Regarding the "Ordinary Business Exclusion" and Shareholder Proposals Relating to Risk and CEO Succession
November 4, 2009
On October 27, 2009, the staff of the Division of Corporation Finance (the "Staff") of the Securities and Exchange Commission (the "SEC") released Staff Legal Bulletin No. 14E ("SLB 14E"), which provides new guidance on the ordinary business exclusion of Rule 14a-8(i)(7). The new guidance will likely make it more difficult for companies to omit shareholder proposals concerning risk, as well as those relating to CEO succession planning.
Risk-Related Shareholder Proposals
In the past, the Staff's approach to shareholder proposals relating to environmental or public health issues under Staff Legal Bulletin No. 14C distinguished between shareholder proposals that asked a company to assess the risks that it faces as a result of operations that pose environmental or public health issues and proposals that a company minimize or eliminate those operations. The Staff permitted exclusion of the former as an ordinary aspect of engaging in business, while the latter were considered to be in furtherance of a significant social policy goal and thus did not fall under the ordinary business exclusion.
In light of the current focus on the adequacy of a company's risk management and oversight, the Staff has reconsidered its analytical approach to the numerous no-action requests it receives from companies seeking to exclude shareholder proposals related to environmental, financial, health and other similar risks under Rule 14a-8(i)(7). Under new SLB 14E, the focus is on the nature of the policy issue presented. If a proposal's underlying subject matter transcends the day-to-day business of the company and raises significant policy issues (such as, for example, climate change, human rights or health care) that merit a shareholder vote, the proposal will generally not be excludable under Rule 14a-8(i)(7). The policy issue must also have a "sufficient nexus" with the company. The Staff notes in SLB 14E that this analytical framework is already the standard used to determine the excludability under Rule 14a-8(i)(7) of proposals concerning the preparation of a report, formation of a committee or inclusion of disclosure in an SEC-prescribed document. The Staff notes in particular that a proposal that focuses on the board’s role in the oversight of a company's risk management may be considered to transcend the company’s day-to-day business and thus be appropriate for a shareholder vote.
The change announced in SLB 14E is perhaps not as abrupt as the bulletin may suggest, as there are a number of no-action letters that presage the Staff's shift towards greater emphasis on a proposal's underlying subject matter. For example, in connection with proposals involving adverse environmental effects for which the SEC did not permit exclusion, some shareholders have argued that "any measure designed to minimiz[e] or eliminat[e] operations that may adversely affect the environment can be said to involve some internal analysis, which might take into account factors such as cost or risk to the company," a rationale that the Staff also cited in SLB 14E. In the past, the Staff has also denied exclusion of shareholder proposals that explicitly request a risk assessment. For example, in the January 31, 2007 no-action letter to the General Electric Company, the Staff required GE to include a shareholder proposal that requested a climate change report with a risk assessment of the benefits and costs to GE of its global warming policy, as well as the specific scientific data used to formulate GE's climate policy and the extent to which GE believed a cost-effective strategy for mitigating any undesirable climate change was practical.
CEO Succession Planning
Shareholder proposals regarding succession planning for Chief Executive Officers ("CEOs") generally involve a request for the adoption and disclosure of CEO succession planning policies with detailed features and specific evaluation criteria. In the past, the Staff has typically permitted exclusion of these proposals under Rule 14a-8(i)(7) on the grounds that termination, hiring and promotion of employees is an aspect of the ordinary business operations of a company.
In light of recent events, the Staff now views CEO succession planning as a significant policy issue that transcends day-to-day company operations and therefore is appropriate for shareholder involvement. As a result, under SLB 14E, CEO succession planning proposals will generally not be excludable under Rule 14a-8(i)(7). SLB 14E does provide, however, that a CEO succession proposal could be excluded under Rule 14a-8(i)(7) if it sought "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."
We expect that this change will cause many companies to adopt formal written CEO succession policies. Although the adoption of a formal written policy may not, in and of itself, improve corporate governance, the likelihood of increased shareholder proposals in this area may encourage some boards of directors to focus on succession issues more carefully than they would have otherwise. In addition, we expect that the Staff will soon be required to grapple with the question of how the substantial implementation exclusion of Rule 14a-8(i)(10) applies in the context of CEO succession policy proposals.
Please feel free to contact any of your regular contacts at the firm or any of our partners and counsel listed under Corporate Governance or Executive Compensation and Employee Benefits if you have any questions.
Exxon Mobil Corp (Mar. 14, 2008), Meredith Corp. (Aug. 21, 2008), Ultra Petroleum Corp. (Mar. 6, 2008) and ONEOK Inc. (Feb. 25, 2008).
Standard Pacific Corp. (Feb. 28, 2008).