We are discussing the issue of mandatory rotation of auditors and the impediments imposed by the SEC staff to any resolution of the issue through private ordering.
The ordinary business exclusion in Rule 14a-8 provides that management may exclude from the proxy statement matters that fall within the ordinary or day to day business of the company. The theory is that state law vests in the board, not shareholders, the authority to make ordinary business decisions. The problem, however, is that there is very little state law dileneating what is and is not an ordinary business decision. As a result, for the most part, the matter is within the discretion of the staff, unguided by state law, to determine.
Moreover, whatever state law suggests, the SEC has grafted onto the exclusion an exception that is not contained in state law. Since 1976, the staff has allowed the inclusion of proposals that implicate this exclusion so long as it implicated issues of important public or social policy. The SEC was forced into this position after a history of allowing the exclusion of proposals that called for the end of segregation on buses and the production of napalm. All of this is discussed in detail in Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.
This is another area where the staff has no meaningful guidance. These are not terms of art. There are no recognized standards. And, because it is not an exception recognized under state law, there is not even meaningful philosophical guidance on when to apply the public/social policy exception. Thus, this is determined entirely by the staff, a matter not within its traditional expertise and one that changes from Commission to Commission (another matter discussed in Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors).
The problems with the interpretation of the ordinary business exclusion can be seen with particular vigor in connection with the auditor rotation issue.
In AT&T Inc. (Jan. 5, 2012), for example, shareholders submitted a proposal that called for the following:
Be it Resolved: That the shareholders of AT&T Inc. hereby request that the Company's Board Audit Review Committee establish an Audit Firm Rotation Policy that requires that at least every seven years the Company's audit firm rotate off the engagement for a minimum of three years.
The staff, however, allowed for the exclusion of the proposal. The reason? It fell within the "ordinary business" of the company. As the staff reasoned:
There appears to be some basis for your view that AT&T may exclude the proposal under rule 14a-8(i)(7), as relating to AT&T's ordinary business operations. In this regard, we note that the proposal relates to limiting the term of engagement of AT&T's independent auditors. Proposals concerning the selection of independent auditors or, more generally, management of the independent auditor's engagement, are generally excludable under rule 14a-8(i)(7). Accordingly, we will not recommend enforcement action to the Commission if AT&T omits the proposal from its proxy materials in reliance on rule 14a-8(i)(7).
The analysis was repeated in a number of other letters. See ITT Corp. (Jan. 13, 2012), ConocoPhillips (Jan. 13, 2012), Dominion Resources (Jan. 4, 2012). Moreover, the staff took the position irrespective of the particular circumstances at each company. Thus, the staff allowed GE to exclude a mandatory rotation proposal (See GE (Dec. 23, 2011)) despite the fact that GE has been sanctioned for accounting problems (See SEC v. General Electric, Litigation Release No. 21166, Aug. 4, 2009) and appears to have a very, even excessively, close relationship with its auditor.
We will discuss the analysis use by the staff in the next post.