December 21, 2021

The SEC's New Staff Legal Bulletin: A Strengthening of the ESG Framework

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The Division of Corporation Finance of the U.S. Securities and Exchange Commission (SEC) issued a new SEC Staff Legal Bulletin outlining its views on excluding shareholder proposals under Rule 14a-8(i)(5), the economic relevance exception, and Rule 14a-8(i)(7), the ordinary business exception.

The Upshot

  • The SEC provided an update to Rule 14a-8 in order to streamline the process of reviewing no-action requests and to clarify the standards it will apply moving forward.
  • First, the SEC will shift away from determining the nexus between a social policy issue and a particular company. Instead, it will focus on the social policy significance of the issue that is the subject of the shareholder proposal.
  • Second, shareholder proposals raising issues of broad social or ethical concern related to a company's business now may not be excluded, even if the relevant business of the company falls below the previously applicable financial thresholds of the rule.

The Bottom Line

The SEC's new guidance will make it more difficult for companies to exclude environmental, social, and governance (ESG) shareholder proposals, and companies should not rely on previous SEC no-action letters on significant social policy matters.

The Securities and Exchange Commission (SEC) announced on November 3, 2021, that it is rescinding Staff Legal Bulletin Nos. 14I, 14J, 14K, and announced a new framework for its interpretation of Rule 14a, pursuant to which shareholders can present proposals for consideration in a company's annual proxy statement. The new Staff Legal Bulletin No. 14L (SLB 14L) predominantly addresses changes to Rule 14a-8(i)(5) and 14a-8(i)(7).

Rule 14a-8(i)(7), the ordinary business exception, is one of the substantive means by which a company can exclude a shareholder proposal. This rule allows a company to exclude a proposal dealing "with a matter relating to the company's ordinary business operations." The primary purpose of the ordinary business exception is "to confine the resolution of ordinary business problems to management and the board of directors." Rather than examining the significance of a social policy issue on a company-by-company basis, as it did in the past, the SEC staff announced in SLB 14L that it will now instead, "focus on the social policy significance of the issue that is the subject of the shareholder proposal." In applying this analysis, the SEC staff will determine whether the shareholder proposal "raises issues with a broad societal impact, such that they transcend the ordinary business of the company."

SLB 14L notes a specific example: human capital management. Proposals considering human capital management issues with a broad societal impact will not be considered automatically excludable just because the issue is not important to the company's underlying business. Instead, the SEC staff will assess the social policy significance of the issue that is the subject of the shareholder proposal.

With the rise in human capital management as an issue of heightened social policy significance, issuers should expect that human capital management proposals, including diversity-related proposals, may not be excluded from 2022 proxy statements. In addition, because the SEC will no longer conduct a company-by-company approach, the board of the company will no longer be required to submit a detailed analysis of why a proposal is excludable under the ordinary business exception.

The SEC staff also highlighted a second change in its approach to interpreting Rule 14a-8(i)(7) relating to whether a shareholder proposal "micromanages" the company "by probing too deeply into matters of a complex nature" on which the shareholders, as a collective, cannot make an informed judgment. In determining whether a proposal examines matters "of a complex nature[,]" the SEC staff has outlined it will consider the: (1) sophistication of investors; (2) availability of data; (3) robustness of public discussion on the topic; and (4) references to well-established frameworks in assessing proposals related to disclosure, timeframes, or target setting. The SEC staff also previously has clarified that a shareholder proposal identifying "specific methods, timelines, or detail[s]" do not amount to the micromanagement of the board or management, and are therefore, not dispositive of excludability.

In SLB 14L, the SEC staff cited a recent no-action letter by ConocoPhillips seeking to exclude a shareholder proposal that the company set targets for greenhouse gas emissions. The SEC denied ConocoPhillips' request for no-action relief, which was based on the argument that the shareholder proposal sought to micromanage the company. The SEC staff stated that, going forward, it will "not concur in the exclusion of similar proposals that suggest targets or timelines so as long as the proposal affords discretion to management as to how to achieve such goals." Companies facing climate change-related ESG proposals in the upcoming proxy season will have an exceptionally limited ability to exclude them on the basis of micromanagement.

The economic relevance exception, Rule 14a-8(i)(5), allows a company to exclude a shareholder proposal relating to the operations of its most recent fiscal year accounting for "less than 5 percent of the company's total assets" and for "less than 5 percent of its net earnings and gross sales[,]" as long as it is not otherwise "significantly related to the company's business." The SEC staff clarifies in SLB 14L that it will not exclude proposals raising issues of broad social or ethical concern related to the company's business, even if the relevant business falls below the financial thresholds outlined in the rule. Furthermore, the SEC does not expect boards to conduct a high-level analysis in determining whether a proposal raising broad social or ethical concerns is excludable.

Moving forward, the SEC staff will take positions about what constitute significant policy issues, rather than focusing on a company-by-company approach to its analysis. Under SLB 14L, it will likely be more difficult for a company to exclude an ESG-oriented shareholder proposal under Rule 14a-8(i)(5) and 14a-8(i)(7). Boards and management need to be prepared to effectively address proposals, including significant social policy initiatives, and, concurrently, deal with the shareholder groups bringing these types of proposals.

In addition to the changes affecting Rules 14a-8(i)(5) and 14a-8(i)(7) discussed above, SLB 14L also provides guidance on the use of images in shareholder proposals, proof of ownership letters, use of e-mail in submitting shareholder proposals, notices of defects and responses to notices of defects.

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