We are discussing the proposal made by the Securities and Exchange Commission that would amend Rule 14a-8(i)(8) to clarify that proposals may not be excluded that would sometimes require management to include shareholder nominees in the company’s proxy statement (“access proposal”). The proposal is contained in Exchange Act Release No. 56160 (July 27, 2007). This Blog has already written extensively about the alternative proposal made by the Commission that would deny shareholders access for this purpose and has submitted to the Commission a comment letter on the non-access proposal and on the access proposal. The comment deadline expired on October 2, although the Commission invariably takes into account letters received after the closing date.
We are discussing the restrictions imposed on those seeking to make access proposals. In for this Blog, an unusual Sunday post, we take the opportunity to comment one one of the odder aspects of the access proposal, the inclusion of vague proposals relating to the use of precatory or non-binding shareholder proposals. As a practical matter, shareholders often submit proposals that are non-binding. These merely suggest or recommend that a board take certain action. Precatory proposals may be submitted for strategic reasons; shareholders are more likely to vote for a proposal that merely recommends. Sometimes they are submitted as non-binding because binding proposals would be invalid under state law and otherwise subject to exclusion under Rule 14a-8(i)(1)(improper under state law).
The Release asks for comments on amendments to Rule 14a-8 that would “enable shareholders, if they choose to do so, to determine the particular approach they wish to follow with regard to non-binding proposals.” It is clear that “particular approach” in many cases means limitations on the right of shareholders to include non-binding proposals in the company’s proxy statement. The proposal has nothing to do with access proposals and was apparently included in the Release in a last minute effort to obtain support from some commissioners. The approach didn't work and, as Commissioner Nazareth noted at the open meeting, it created the possibility that limitations in this area might be combined with aspects of the non-access proposal.
The source of, or need for, the proposal (other than as a political compromise) is not made clear. In explaining the impetus for the proposal, the Release asserted that it arose out the comments by “[s]everal participants” at the May 7 Roundtable that Rule 14a-8 somehow “expands rather than vindicates the framework of shareholder rights in state corporate law.” Exchange Act Release No. 56160 (July 27, 2007). A footnote in the Release references the testimony of Chancellor Strine of the Delaware Court of Chancery.
A review of the Roundtable transcript indicates that while Chancellor Strine did express some reservations about precatory proposals, his concern was mostly with the practices employed by the staff. Mostly under the exclusion in Rule 14a-8(i)(1), the staff often confronts the unenviable position of having to determine whether a proposal violates state law. The company will argue that it does, shareholders that it does not. In the May 7 Roundtable, Marty Dunn from the Division of Corporation-Finance made the following observation: “Every time we get a binding [shareholder proposal], we get competing state law opinions, one of which says form the company that 141 doesn't allow this, and then we get one that says 109 does allow this. We sit there and go we don't know. We are going to say you haven't met your burden of proof because we have competing opinions." State law usually provides no clear answer.
The use of precatory proposals has amounted to a Commission inspired method of avoiding the problem. As long as the proposal is non-binding, the staff will usually decline to exclude it, even if an argument exists that it violates state law. The approach is essentially codified in the shareholder proposal rule. See Note to paragraph (i)(1) of Rule 14a-8, 17 CFR 240.14a-8 (“some proposals are not considered proper under state law if they would be binding on the company if approved by shareholders. In our experience, most proposal that are cast a recommendations or requests that the board of directors take specific action are proper under state law. Accordingly we will assume that a proposal drafted as a recommendation or suggestion is proper unless the company demonstrates otherwise.”).
It was this practice that Chancellor Strine criticized. He advised the Commission to stop encouraging precatory proposals and instead let the Delaware courts sort out their legality. As he noted at the Roundtable:
- "I think those of us from Delaware would say one of the things the Commission could do to facilitate this is to make clear that if it's uncertain under state law and it's a by-law proposal, then it shouldn't be excluded and they should be able to put it on absent some showing, and then leave it to us, hold us accountable, and if we make the wrong decisions, you can bet we are going to hear about it from the institutional investor community and from the management community."
Chancellor Strine has the right take on this issue. The best way to reduce the number of precatory proposals is to have the Commission change its policy and, specifically, amend note (i)(1) in Rule 14a-8. Rather than assuming precatory proposals are valid under state law, the Commission should assume all proposals alleged to be improper under state law are valid “unless the company demonstrates otherwise.” This would put the burden on the company to demonstrate that the proposal is invalid, a burden that would not be met where the law was unclear. Such proposals, if adopted, could still be challenged under state law, the proper forum for determining validity. Such an amendment would likely reduce considerably the number of precatory proposals made by shareholders.
Otherwise, with respect to the determination of a “particular approach” by each company, we recommend that the Commission not build into Rule 14a-8 the right of companies to develop approaches with respect to precatory proposals. Despite the suggestion that these approaches will be adopted by shareholders “if they choose,” the practical effect of this proposal will be to permit boards to impose limitations on the use of pracatory proposals by shareholders.
The matter should be left to state law. Considerable discretion and authority already exists to regulate the proposal process. Thus, for example, many states provide that shareholder authority to propose bylaws can be regulated through the articles of incorporation. Some states allow for the restriction of shareholder authority in the articles. See A.C.A. § 4-26-809 (2007) (“The power to alter, amend, or repeal the bylaws or adopt new bylaws shall be vested in the board of directors except to the extent such power is reserved to the shareholders by the articles of incorporation.”). Others permit restrictions on the authority of the board. See Cal Corp Code § 211 (2007)(“Bylaws may be adopted, amended or repealed either by approval of the outstanding shares (Section 152) or by the approval of the board, except as provided in Section 212. Subject to subdivision (a)(5) of Section 204, the articles or bylaws may restrict or eliminate the power of the board to adopt, amend or repeal any or all bylaws.”).
This is an area that ought to be avoided by the Commission except to the extent it amends the note to Rule 14a-8(i)(1) as noted above.