Rule 14a-8, the Ordinary Business Exclusion, and the Need for Reform: Bank Policies and Loan Foreclosures (Part 7)

The current interpretive regime under the "ordinary business" exclusion is designed to ferment challenges and generate unnecessary costs.  These costs are imposed on companies, shareholders, and the staff of the Commission.  Moreover, the fact that proposals can so easily be subjected to the no action letter process may discourage shareholders from submitting proposals in the first instance.

What needs to be done?  The goal has to be a reduction in the number of legal challenges to shareholder proposals.  The development of objective standards might be one approach.  This might involve a tighter definition of "business," one that would, for example, exclude challenges to proposals that in fact had no meaningful likelihood of interfering with the day to day operations of the company. 

The proposal submitted by the New York City Pension Funds is an example.  It did not seek changes in business practices or attempt to micro manage the company.  Instead, it sought a review of, and report on, legal compliance and internal controls.  Nothing in the proposal called for changes in business practices.  Indeed, even the possibility that a review would somehow interfere with the company's business was mitigated by the proposal's decision to leave execution entirely in the hands of the audit committee. 

To the extent any meaningful standards were adopted, they should be enacted by the Commission and stated in a release.  That format would make them harder to change as the make up of the Commission shifted. 

But in fact the better way to handle the issue is to delete the "ordinary business" exclusion.  The staff ought not to be in the business of deciding what is an "ordinary business" activity of a company.  The staff has no expertise on the subject.  States (and state courts) on the other hand do have the requisite expertise.  To the extent a mandatory proposal implicating the company's business was adopted, companies are free to challenge its legality in state court, something that has more or less been invited. 

Elimination of the exclusion does not mean that every proposal must be included, no matter how unimportant.  The staff ought to have the right to exclude proposals that are immaterial.  An amorphous standard admittedly (something just reaffirmed by the Supreme Court in Matrixx), but one where the staff has considerable expertise, something illustrated by, for example, SAB 99.  Allowing for elimination only because a proposal is immaterial to shareholders will result in the inclusion of more proposals but will also reduce the number of challenges.  That in turn will ratchet down the costs and uncertainties of the no action letter process.

And, with more proposals included, private ordering will be given a bit more opportunity to flourish.   

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.