The SEC, Rule 14a-8, and Shareholder Approval of the Auditor: Time for a Change in Policy (Part 1)

Rule 14a-8, the shareholder proposal rule, is often in the eye of the storm of the corporate governance storm.  The rule has been around since the 1940s (for a history see The SEC, Corporate Governance, and Shareholder Access to the Board Room).  It has allowed shareholders to submit proposals for inclusion in the company's proxy materials. 

Although the rule is widely used be shareholders, the original purpose was designed also to protect management.  Prior to adoption of the rule, management was required to alert shareholders to any proposal they knew would be submitted at the meeting in order to make the proxy materials accurate and complete under the antifraud provisions.  That, however, meant that companies were responsible for describing someone else's proposal.  The shareholder proposal rule effectively required those submitting the proposal to author the required disclosure that would appear in the proxy statement.

At the time of the adoption of the rule, the Commission had also circulated a proposal to allow shareholders to submit nominees for inclusion in the proxy materials.  That proposal did not make it into the final rule, setting the stage for the battle royal over shareholder access, although it would take over a half century to develop. 

The rule contained grounds for excluding proposals, although in the early days they were narrow.  In 1954, however, the Commission added the "ordinary business" exclusion.  Any proposal involving the company's "ordinary business" could be excluded.  The provision was signficantly modified in the 1970s.  After a bruising loss in court, the Commission acknowledged that proposals involving ordinary business might not be excluded, depending upon the social importance of the proposal. 

The exclusion therefore, required something approaching a two step analysis.  First, the staff had to assess whether the proposal involved excessive intrusion of shareholders into the affairs of management.  Second, assuming it did, the staff had to assess whether the importance of the subject matter was nonetheless sufficient to warrant inclusion in the proxy statement.

Yet the "ordinary business" exclusion has been filled with inexplicable positions and unexplained shifts.  The reigning interpretation often seems to defy the requirements of the actual meaning of the exclusion.  This can be seen in particular with the staff view on proposals seeking shareholder approval of the company's outside auditor.  We will deal with this issue in the next cluster of posts. 

The topic is developed more fully in Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.