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By Michael Greene
Jan. 26 — A recent district court ruling against Wal-Mart Stores Inc. on appeal before the Third Circuit is intensifying the debate regarding the SEC's “ordinary business” proxy exclusion rules—and the shareholder proposals process more generally.
Practitioners and academics interviewed by Bloomberg BNA gave diverse predictions about how this case and recent SEC developments could impact the ongoing proxy season and change how similar proposals will be reviewed by the commission and the judicial system.
Among the predictions if the district courts ruling is upheld include: increased litigation and costs to issuers, changes in companies' proxy strategies and more federalization of corporate law.
In a Nov. 26 opinion, the U.S. District Court for the District of Delaware found that Wal-Mart failed to comply with federal securities laws when it refused to include in its proxy materials a shareholder proposal seeking to provide more oversight and reporting regarding the guns sold at the chain's stores.
The decision came after the Securities and Exchange Commission staff granted Wal-Mart no-action relief that would have permitted the retailer to exclude the proposal from its proxy material under Rule 14a-8(i)(7) because it “deals with matters relating to the company's ordinary business.”
As result of the district court's decision, Wal-Mart filed an appeal with the U.S. Court of Appeals for the Third Circuit claiming that “[a]bsent reversal, the District Court’s erroneous ruling will leave the Rule 14a-8(i)(7) ordinary business exclusion in tatters”.
The ongoing appeal is not the only development that is that is causing concern among issuers in the middle of proxy season.
Recently, the SEC announced that it will not opine on applications for no-action relief under Rule 14a-8(i)(9) during the current proxy season.
Avrohom J. Kess, head of Simpson Thacher & Bartlett LLC's public company advisory practice, told Bloomberg BNA that companies plan their responses to shareholder proposals, and the Wal-Mart decision in tandem with the SEC's no-action announcement has made it increasingly difficult to navigate the federal securities laws.
He believes that the district court ruling represents a continuation of a troubling trend in which investors with special interests, and sometimes minimal investments, are using securities laws to cause issuers to incur large costs.
However, Robert J. Jackson, Jr. a professor at Columbia Law School, has a much different perspective on these ongoing developments.
“Despite repeated warnings from the Commission, Congress, and the courts, the SEC Staff has long taken a cramped view of shareholders’ freedom to place proposals on the corporate ballot, preventing investors from engaging in real oversight as to how their money is spent, ” he said in a statement e-mailed to BBNA.
According to Jackson, “many hope that these events will lead the Staff to reconsider the narrow, and frankly obviously incorrect, view they have recently taken on shareholder proposals.”
The district court's decision has faced strong criticism.
As of Jan. 28, amicus briefs have been filed in support of Wal-Mart's position by: The National Association of Manufacturers, the Washington Legal Foundation, the American Petroleum Institute, the Business Roundtable and the Chamber of Commerce, the Society of Corporate Secretaries and Governance Professionals and the Retail Litigation Center.
“The reaction to the lower court’s decision has been intense because there is a strong belief that the ruling was made in error,” Ning Chiu, counsel in Davis Polk & Wardwell LLP's capital markets group said in statement e-mailed to BBNA.
“There is a long line of SEC no-action letters that have come to the opposite conclusion when a retailer faces a shareholder proposal about controversial product sales,” she added. “Traditionally courts give deference to the regulator that is charged with interoperating the rules, and in this situation the SEC precedents were pretty straightforward.”
In its brief, Wal-Mart claims that the exceptions created by the district court will “swallow” the ordinary business exclusion.
“The ordinary business rule is one that has already been chipping away for some time,” said Chiu.
However, “[t]he concern expressed in the appeal is that the district court found it compelling that the proposal asked the board to oversee and implement a policy, and that seems to be a way to end run any kind of business decision.”
Kess and Yafit Cohn, an associate at Simpson Thacher, agreed that the Wal-Mart proposal related to “ordinary business.” Cohn said that the proposal—about what products a company should offer for sale—really relates to the epitome of ordinary business. If the lower court's ruling is allowed to stand, almost any proposal could be carefully drafted to avoid the ordinary business exclusion, she said.
Echoing these concerns Chiu stated, “[i]f all a proposal needs to do is ask for some business matter to be reviewed under a board policy, that would be an enormous exception to the rule that would not be hard for proponents to craft.”
Jackson, however, said that he believes that the district court's ruling was well-founded.
“I think that if you asked an ordinary investor, or really any American, whether a shareholder proposal relating to the sale of firearms related to the company’s ‘ordinary business,' they would say that it does not, and would think it quite ridiculous that the SEC accepted the company’s argument that it does,” he said.
“This proposal isn’t about where Wal-Mart buys its cash registers. It’s about the company’s role in a national debate about firearms and their place in our society,” Jackson continued. “The fact that the Staff have concluded that a proposal like this has to do with the company’s ‘ordinary business' shows exactly how far wrong the Commission’s approach is to this issue.”
Regardless of its merits, according to Kess, the district court's decision in tandem with the SEC's no-action announcement has left shareholder proponents and issuers with no recourse except to go to the courts. “I'm not sure there will be a floodgate, but there will be more litigation.”
Chiu predicted that more litigants could try to delay annual meetings as well, “which would introduce costly risks to companies and may cause them to agree to include the proposal instead of taking on those risks.”
According to Jackson, “If the Third Circuit upholds this decision, shareholders will be emboldened to bring more suits like this if the Staff continues to insist on granting no-action letters like this.”
Chiu said the SEC staff's guidance historically “helps regulate what could otherwise be an expensive and lengthy litigation process.” If companies and proponents start resorting to the courts, “that could potentially throw the entire scheme into turmoil, which would not benefit anyone, including shareholders.”
She said that given the short length of the proxy season, and the large number of issues and actions that a company must consider, an “orderly, and manageable” mechanism for excluding shareholder requests is important and “[i]ntroducing uncertainty would be detrimental to all those involved.”
In addition to those potential costs, the Third Circuit's decision could impact “the balance struck between the rights of shareholders and the statutory power of corporate boards under state corporate law,” according to Jack B. Jacobs, a former Delaware Supreme Court judge, who now is a senior counsel with Sidley Austin LLP. “Hopefully the Third Circuit will consider the broader corporate governance implications of the District Court ruling in arriving at its decision.”
Jacobs believes that if the proposal had taken the form of a bylaw amendment and been litigated before a Delaware state court, that court likely would have found the proposed bylaw unlawful on the basis that it would unduly infringe the board’s statutory power to manage the business and affairs of the corporation.
Jacobs said that before the district court overturned the SEC’s no-action decision, the SEC's administration of Rule 14a-8(i)(7)’s ordinary business exclusion was consistent with the allocation of intracorporate power between shareholders and the board under Delaware law.
Accordingly, unless overturned on appeal, the district court ruling may have created an incentive for shareholders seeking governance change within a publicly traded company to propose a non-binding precatory shareholder resolution, rather than propose a bylaw amendment as a vehicle to promote corporate governance change.
If the excludability of such proposals is now to be litigated in, and decided by, the federal courts rather than administratively by the SEC, Jacobs said that development may represent “one more small step along the path of federalization of state corporate law.”
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