Rule 14a-8, the Ordinary Business Exclusion, and the Need for Reform: Bank Policies and Loan Foreclosures (Part 1)

We just spent much of the week talking about the SEC staff's approach to proposals under Rule 14a-8 with respect to shareholder approval of auditors.  The position -- which we assert is incorrect -- arises in part because of the lack of objective standards under the "ordinary business" exclusion in the rule. 

The exclusion first requires the staff to determine whether the relevant behavior is within the ordinary business of the company and, if it is, to determine whether the matter is of sufficient public importance that it cannot be excluded.

But the staff does not have expertise in determining what is ordinary.  The concept arises out of state law and early on in the history of Rule 14a-8 was meant to exclude matters that fell within the exclusive jurisdiction of management.  In other words, the provision arose out of the need to determine the appropriate division of authority between boards and shareholders.

The dearth of law on the subject and the shifting nature of the issue, however, effectively left with the staff almost unlimited discretion in determining this division.  Yet at the same time, the absence of objective standards has resulted in an exclusion that shifts constantly, particularly as the political makeup of the Commission changes.

Likewise the public policy exception is an area unbounded by meaningful standards.  For one thing, it is not a concept that is likely even recognized under state law.  Whatever the appropriate division between shareholders and managers under state law, there is little evidence that the standard changes depending upon the public importance of the matter.  Moreover, in the area of corporate responsibility, shareholders rarely submit proposals that do not have at least some public importance.  As a result, the staff is not really asked to determine whether the matter is important to public debate but whether it is important enough to overcome the presumption that ordinary business matters can be excluded.

The result is confusion in application.  More importantly, the uncertainty provides considerable incentive for issuers to challenge proposals through the no action process at tremendous cost to the governance system.  In this series of posts, we will discuss how this works in a specific context.  The staff just issued decisions informing a pair of banks that they cannot delete proposals under the "ordinary business" exclusion that related to the current mortgage crisis.  The proposals were filed by the New York Employees Pension Fund and the Fund just issued an announcement on those letters. 

The issues surrounding the "ordinary business" exclusion and some proposed reforms are discussed in much greater detail in Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.