Rule 14a-8, the Ordinary Business Exclusion, and the Need for Reform: Bank Policies and Loan Foreclosures (Part 4)

The proposal submitted to Citigroup and Bank of America called for a review of, and a report on, legal compliance and internal controls relating to loan modifications, foreclosures and securitizations. 

There were sound policy reasons for not challenging the proposal and, in fact, two banks (Wells Fargo and JP Morgan) apparently took that path.

But as a matter of legal analysis, Citigroup (and BofA) had a basis for challenging the rule and some likelihood of prevailing.  It is this conclusion that highlights the central weakness in the "ordinary business" exclusion in Rule 14a-8.  Given the state of the law under the "ordinary business" exclusion, almost any proposal can be challenged. 

How is this the case? 

First, almost every proposal other than those addressing structural issues (majority vote provisons, staggered boards, poison pills, etc) involves some aspect of the company's business.  Why?  Because otherwise the proposal would be subject to exclusion as irrelevant.  See Rule 14a-8(i)(5).  Given that the proposals invariably involve the company's business, it can always be challenged as implicating the "ordinary business" exclusion.  The language and the lack of standards, therefore, encourages challenges to proposals. 

The proposals submitted by the NYC Pension Funds illustrates the point.  It would have been impossible to write a proposal seeking information about legal compliance and internal controls without linking it so some aspect of the business of the financial institution.  Thus, like all proposals in this area, Citigroup could make the case that the subject matter implicated its ordinary business. 

Of course, merely implicating business interests is not enough.  It must be ordinary.  But that modifyer has also never been given meaningful content.  Indeed, sometimes the term has an Alice and Wonderland implication.  Thus, the staff has excluded proposals calling for shareholder ratification of auditors as implicating the "ordinary" business of the company despite the fact that the ordinary practice is to have shareholders vote on the auditor (90% of the S&P submit the matter to shareholders). 

Second, even where the proposals unquestionably implicates the ordinary business of the company, the vagueness of the legal regime under the exclusion provide a basis for shareholders to mount a strong (and often successful) defense.   

This is not an accident.  These sorts of submissions are almost always precatory and invariably fail.  As such, they have no realistic prospect of actually mandating a change in practice.  Shareholders know this.   Not surprisingly, therefore, the proposals are often intended to force reform not so much by shareholders but as a result of public pressure.  Said another way, the proposals are invariably designed to promote public debate.  As a result, the public policy exception is by design always arguably available. 

So all proposals can be challenged and all proposals can be defended.  This results in a great deal of unnecessary and expensive process, something we'll deal with in the next post. 

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.