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The SEC’s Whole Foods reversal

December 1, 2015

It’s been a little over a month, presumably enough time for the dust to settle, since the SEC’s Division of Corporation Finance published its long-anticipated guidance  on requests to exclude shareholder proposals under subsections (i)(7) and (i)(9) of Securities Exchange Act Rule 14-8(a).

The October 22nd staff legal bulletin represents the Division’s response to a controversy from the past proxy season that centered around a No-Action Letter request from grocery retailer Whole Foods, Inc. (not the most likely poster child, by the way, for the rights of corporate boards over shareholders).  Whole Foods sought to exclude a shareholder proposal requesting a right of access for shareholders under Rule 14-8(a)(i)(9) by claiming thereconsider_Flickr proposal conflicted with its own alternative proposal. As J. Robert Brown Jr., Professor at the University of Denver Strum College of Law, details in a recent blog post, after the Division granted Whole Foods’ no-action request, it found itself inundated with requests from companies seeking similar relief, as well as a request for reconsideration by the Whole Foods shareholder. In response, SEC staff withdrew the no-action letter issued to Whole Foods, along with several other no-action letters, and declined to consider no-action requests under subsection (i)(9) during the remainder of the proxy season pending staff review of the rule.

In its legal bulletin, the Division indicated that it will reverse course in its application of Rule 14-8(a)(i)(9) going forward. The Division explained that it will no longer consider a shareholder proposal to be in direct conflict with a management proposal if a reasonable shareholder could logically vote for both proposals. The bulletin provides hypothetical examples of proposals that the Division would no longer consider to be in conflict, noting that although variations may exist between the shareholder and management proposals, “both proposals generally seek a similar objective … and the proposals do not present shareholders with conflicting decisions.” As Professor Brown points out, the guidance attempts to draw a clear line between conflicting proposals and merely alternative proposals, although he also notes that the guidance “leaves open the possibility that companies submitting alternative proposals can obtain exclusion of a shareholder proposal by arguing that the two proposals have sufficiently antagonistic terms, even though seeking the same broad goal.”

The staff bulletin also addresses potential confusion regarding the application of the ordinary business exclusion under Rule 14-8(a)(i)(7) in light of the U.S. Court of Appeals for the Third Circuit’s decision in Trinity Wall Street v. Wal-Mart Stores, Inc. In its opinion, the Third Circuit devised a two-part test to determine whether a shareholder proposal involving a significant policy issue transcends the ordinary business exclusion under the rule, concluding that the significant policy issue cannot involve day-to-day business matters. The bulletin noted that the Third Circuit’s interpretation of subsection (i)(7) departs from the SEC’s application of the rule, which does not make a distinction between a proposal’s significance and its transcendence and allows for a significant policy issue to transcend ordinary business operations even if it involves the daily business concerns. The bulletin indicated that the Division will continue to apply Rule 14-8(a)(i)(7) in keeping with its prior interpretation.

So how has the SEC guidance been received?  Initial reactions have been mixed.  The Wall Street Journal notes that proponents of proxy access including labor unions and pension funds lauded the staff bulletin as a welcome decision in support of shareholder rights, while groups representing CEOs cautioned that the guidance will confuse shareholders and create ambiguity in the results of shareholder votes. Although the implications of the SEC’s guidance will not become clear until proxy season commences, the initial evidence of the effect of alternative proposals on voting results does not reflect ambiguity or inconsistency. According to Professor Brown in a recent blog post, the last proxy season included seven instances where shareholders were presented with alternative proposals submitted by shareholders and management. In six of the seven cases one of the alternative proposals received a clear majority of votes, and in no instances were both proposals adopted. Professor Brown concludes that the initial data rejects the argument that the exclusion of alternative, rather than conflicting, proposals benefits shareholders.

The true test of the SEC’s guidance will, of course, come in a few months as the next proxy season begins and companies submit no-action requests to test the limits of the SEC’s interpretation. And, according to a recent article in Forbes, Whole Foods may once again be at the forefront of the debate, as it has already received a shareholder proposal seeking to revise its proxy access bylaw to allow investors to nominate a quarter of the board of directors, among other things. How public companies will address such shareholder proposals in light of the SEC’s guidance on shareholder proposal exclusions remains to be seen.

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