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From Securities Regulation Daily, February 10, 2015

Director Higgins muses aloud on Whole Foods

By Mark S. Nelson, J.D.

Keith F. Higgins, director of the SEC’s Corporation Finance Division, tipped listeners to his early thoughts on what the agency’s CorpFin staff will mull as they rethink how the division forms its informal views on companies’ requests to exclude shareholder proposals that directly conflict with those offered by management. Higgins spoke to an audience at the Practicing Law Institute Program on Corporate Governance in New York. Today’s speech contains Higgins’s first published remarks on the topic since Chair Mary Jo White told CorpFin to report to the Commission on its review of Exchange Act Rule 14a-8(i)(9).

Whole Foods lineage. Higgins said the “directly conflicts” issue is murky and he noted that CorpFin’s review of the rule is still “very preliminary” so anything he says now may not reflect even his own views. Fast-forwarding to Higgins’s epilogue today: “…as I hope is evident, the issues are not black and white and what it means to ‘directly conflict,’ and the consequences of such a conclusion, deserve careful study.”

Higgins explained that since 1967 the SEC has provided a mode for excluding a shareholder proposal when management offers a counterproposal. According to Higgins, the latest revisions to Rule 14a-8(i)(9), embodied in the SEC’s 1997 proposal and the final rules adopted a year later, show that even though “directly” was added to modify “conflicts,” the new text was not intended to imply that the exclusion can apply only if a shareholder’s and management’s proposals are “identical.”

CorpFin, said Higgins, typically will see a conflict between shareholder and management proposals if they can yield “alternative and conflicting decisions” for shareholders and lead to results that are “inconsistent and ambiguous.” Higgins said this scenario is exemplified by CorpFin’s 2009 letter to EMC Corporation. That letter also suggested a few themes (mandatory versus precatory proposals, structural proxy issues, and corporate motives) that Higgins would return to later in his speech. But first, here is where things stand on Whole Foods.

Last October, Whole Foods Market, Inc. had asked the CorpFin to exclude a proposal by James McRitchie that any shareholder (or shareholder group) holding 3 percent of the company stock for three years be able to nominate up to 20 percent of the company’s board (at least two nominees if the board size is cut). Whole Foods invoked Rule 14a-8(i)(9) as the basis for exclusion because it planned to offer its own proposal that any shareholder (but not a shareholder group) holding 9 percent of its stock for five years be able to nominate the greater of one director or 10 percent of the board.

CorpFin initially replied in early December that Whole Foods likely could exclude the proposal without fear of an SEC enforcement action. Meanwhile, the proponent asked CorpFin to reconsider its informal view or to refer the matter to the Commission.

On January 16 of this year, CorpFin told Whole Foods and the proponent it had decided not to express a view on exclusion of the proposal under Rule 14a-8(i)(9). Chair Mary Jo White issued a statement that same day telling CorpFin to review the scope of exclusions permitted by Rule 14a-8(i)(9). Following White’s announcement, CorpFin issued a statement announcing that it would not express any views on Rule 14a-8(i)(9) for the current proxy season.

Mandatory-precatory jam. A key issue for CorpFin will be the presentation of shareholder and management proposals on the proxy and how boards and shareholders interpret proxy results. The dilemma is highlighted by the fact that most shareholder proposals are precatory while management proposals typically are mandatory.

Higgins said some commenters have urged a view that finds no direct conflict when one proposal is precatory and the other mandatory. But he also noted that some conflict may exist when mandatory and precatory proposals urge different results for the same subject matter. He cited the example of shareholders who seek an independent board chairman, and management who insist on one person to be CEO and chairman.

That example came from a letter the Council of Institutional Investors (CII) sent to Higgins in January. For the CII, whose members typically are long-term investors who make few shareholder proposals (but who are frequent submitters percentagewise), the issue is about “directionality.” CII said exclusion is best for a scenario in which the proposals vary, but their results would take the company in different directions.

By contrast, CII said proposals with similar directionality pose less risk of vote misinterpretation and may provide needed data points to a company. Put another way, shareholders who vote for both the shareholder and management proposals, or against both, or for one and against the other, can send a message that they prefer the proposed reform generally, not at all, they favor management, or they want a better proposal regardless of whether it comes from shareholders or management.

But Higgins said today that even if a vote on the shareholder proposal could function as a “data point” for companies, there remain issues of vote interpretation. Shareholders too may be worried about how best to send their message to the company. This mode of thinking, plus the lack of mandatory shareholder proposals, has often dissuaded CorpFin from taking on the mandatory-precatory divide in giving its informal views on exclusion under rule 14a-8(i)(9).

Structure and motives. Another set of stumbling blocks arises from the proxy form structure and corporate motives. The structure issue comes from the yea-nay-abstain requirement of Rule 14a-4(b), which spells out what kinds of votes shareholders may cast (except for elections to office and say-on-pay votes). Higgins asked if this rule should be amended to permit greater flexibility, but he also said the rule begs a few questions.

One concern is how to deal with company proposals made “in response to” one by a shareholder. Should only the management proposal go in the proxy? But wouldn’t shareholders want management to reply to their proposal to show that they hear them? When might exclusion be okay? On this last point, Higgins suggested that some may argue for exclusion only if the board decided to include its proposal before it got one from shareholders.

A related worry is that companies may put forward their own proposals just to hinder shareholders’ efforts to get a proposal in the proxy. But Higgins said CorpFin is poorly situated to judge companies’ motives. “Making exclusion decisions by having the Division assess whether the management proposal is being made in good faith could be a perilous task,” said Higgins.

Still on the topic of motives, Higgins said CorpFin has yet to see companies incrementally altering their own proposals over a course of years to block shareholder proposals. Higgins asked if a company should be limited in how many successive years it can invoke the exclusion.

Yet he also wondered if shareholders need more information about proxies that contain only management’s proposal on the same topic as an excluded shareholder proposal. Higgins asked if a background statement akin to those for merger proxy statements could help. This would force the company to explain the rationale for its proposal and how it viewed alternatives. He also asked if a disappointed proponent should get to include an opposition statement. After all, he said that is what management does when a shareholder proposal is included in a proxy.

A few more things. Higgins ended his speech by relating a few observations about how CorpFin staff approach the interplay between Rules 14a-8 and 14a-9. Under Rule 14a-8(i)(3), a proposal may be excluded if it violates the Commission’s proxy rules (e.g., Rule 14a-9). Higgins said this is an issue that has excited academics in recent years. It is also a point that could get lost in the shuffle because of the director’s emphasis today on Whole Foods.

Higgins said that while the CorpFin staff “did not abdicate” its role in reviewing shareholder proposals under Rule 14a-9, it has used Staff Legal Bulletin 14B to its advantage by taking a measured approach by doing less of the “line-by-line” editing it once did. Higgins said three factors now drive staff reviews of potentially false or misleading statements in shareholder proposals: (1) Is the statement a fact? (2) Is the statement false or misleading? and (3) Is the statement material (as in Northway’s total mix analysis).

Moreover, proponents do not get a free shot at a company under Rule 14a-9 just because the company issues a rebuttal. But Higgins said companies need to carefully focus on weeding out statements that are truly false or misleading from ones that are merely unfair. Higgins noted that when a company satisfies its burden, the staff is more likely to agree with its finding.

But Higgins had little to say about the pending appeal of a federal judge’s recent opinion holding that Wal-Mart Stores, Inc. improperly excluded a shareholder proposal by an Episcopal parish dealing with the retailer’s gun sales policy. Higgins noted that the SEC focuses on the meaning of “ordinary business matter” when reviewing requests to exclude under the ordinary business exception. Wal-Mart has asked the Third Circuit to upend the district court’s holding.

Companies: Whole Foods Market, Inc.; Council of Institutional Investors; Trinity Wall Street; Wal-Mart Stores, Inc.; EMC Corporation

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