Who decides what products a company should sell, what prices it should charge, and so on? Is it the board of directors, the top management team, or the shareholders? In large corporations, of course, the answer is the top management team operating under the supervision of the board. As for the shareholders, they traditionally have had no role in these sort of operational decisions. In recent years, however, shareholders have increasingly used SEC Exchange Act Rule 14a-8 (the so-called shareholder proposal rule), to not just manage but even micromanage corporate decisions. The rule permits a qualifying shareholder of a public corporation registered with the SEC to force the company to include a resolution and supporting statement in the company’s proxy materials for its annual meeting. In theory, Rule 14a-8 contains limits on shareholder micro-management. The rule permits management to exclude proposals on a number of both technical and substantive bases, of which the exclusion in Rule 14a-8(i)(7) of proposals relating to ordinary business operations is the most pertinent for present purposes. Rule 14a-8(i)(7) is intended to permit exclusion of a proposal that “seeks to ‘micro-manage’ the company by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment.” Unfortunately, court decisions have largely eviscerated the ordinary business operations exclusion. Corporate decisions involving “matters which have significant policy, economic or other implications inherent in them” may not be excluded as ordinary business matters, for example, which creates a gap through which countless proposals have made it onto corporate proxy statements.

1. March 24, 2016
Revitalizing SEC Rule 14a-8’s Ordinary Business
Exemption
Stephen M. Bainbridge, UCLA School of Law

5. Current Issues
 CSR:
• Global human rights policies
• Contract supplier standards
• Sexual orientation non-discrimination
– Gender identity non-discrimination
• Global warming reporting
• Emissions reduction & energy
efficiency reporting
• Renewable energy sources
• Indigenous rights policy
• Recycling
• Pesticides and other toxic chemicals
• Israeli-Palestinian conflict
 Governance
• Political contribution disclosure
• Proxy access
• Takeover defenses
• Board diversity and independence
• CEO compensation
• Pay disparity
• Separate CEO and Chair

6. 6
~ 400 excluded or
withdrawn

7.  Allows qualifying shareholders to put a proposal before
their fellow shareholders
• And have proxies solicited in favor of them in the company’s
proxy statement
• Expense thus borne by the company
• Company may seek to exclude proposals for various reasons
– Procedural: E.g., not timely submitted, duplicative of company
proposal, proponent does not mean ownership thresholds, etc…
– Substantive: Not a proper subject of shareholder action, relates to
dividends or elections, personal grievance, etc…
Legal Basis for Shareholder proposals: SEC Exchange Act Rule
14a-8

8. Grounds for Exclusion

9. Trinity Wall St. v. Wal-Mart Stores, Inc.
992 F.3d 323 (3d Cir.), cert. dismissed, 136 S. Ct. 499 (2015).
 2014 Audited Financial Statement:
Total assets: $878,234,000
Investments (other than real estate):
$210,246,000
 April 1, 2014 letter from Rev. Dr. James Cooper to
Trinity parishioners:
“Trinity Wall Street has long recognized that our
considerable resources give us both a responsibility and
an opportunity to engage constructively with businesses
in which we invest where opportunities exist to enhance
returns for both shareholders and society.
“As part of this effort, we recently initiated dialogue with
certain companies toward assuring they balance the
benefits of selling certain products against the risks
these sales pose to the public and to the companies’
reputation and brand value.”
9

10. “Stockholders request that the Board amend the Compensation, Nominating and
Governance Committee charter (or add an equivalent provision to another Board committee
charter) as follows:
‘”’27. Providing oversight concerning the formulation and implementation of, and the public
reporting of the formulation and implementation of, policies and standards that determine
whether or not the Company should sell a product that:
1) especially endangers public safety and well-being;
2) has the substantial potential to impair the reputation of the Company; and/or
3) would reasonably be considered by many offensive to the family and community
values integral to the Company's promotion of its brand.’
“This oversight and reporting is intended to cover policies and standards that would be
applicable to determining whether or not the company should sell guns equipped with
magazines holding more than ten rounds o f ammunition ("high capacity magazines") and to
balancing the benefits of selling such guns against the risks that these sales pose to the
public and to the Company's reputation and brand value.”
Trinity’s proposal for inclusion on Wal-Mart’s 2014 proxy statement
for the annual meeting of shareholders
10

11. Part II
Why not let the shareholders decide?

12.  “The business and affairs of every corporation organized under this chapter
shall be managed by or under the direction of a board of directors” DGCL
141(a)
• The board’s powers are “original and undelegated” - Manson v. Curtis, 119
N.E. 559, 562 (N.Y. 1918)
– Shareholder control rights limited
– Voting rights limited to review of a few fundamental decisions
– Proxy system and 13(d) restrictions on shareholder voting and
communication
– Derivative litigation burdened by procedural barriers and BJR
– Market for corporate control hampered by combination of poison pill and
classified boards
The director primacy model

13. The ABA Committee on Corporate Laws (2010)Hollinger Inc. v. Hollinger Intern., Inc. (Del.Ch.2004)
Klaassen v. Allegro Development Corporation (Del. Ch. 2013) Kevin L. Turner, 57 ALA. L. REV. 907
Larry Ribstein, 1 BERKELEY BUS. L.J. 183In re CNX Gas Corp. S'holders Litig. (Del.Ch.2010)
Cases and Commentators
“[D]irector primacy remains the centerpiece
of Delaware law, even when a controlling
stockholder is present.”
Noting “the bedrock statutory principle
of director primacy established by
Section 141(a) of the DGCL.”
“It is through … centralized
management that stockholder wealth is
largely created.”
“Corporate governance is best
characterized as based on ‘director
primacy.’”
“Delaware jurisprudence favors director
primacy in terms of the definitive
decision-making power …”
Reaffirmed MBCA policy of vesting “the
power to direct and oversee the
management of the corporation in the
board of directors, rather than in the
shareholders.”

14. “Cheaper and more
efficient to transmit
all the pieces of
information to a
central place” that
makes “the collective
choice and transmit
it rather than
retransmit all the
information on which
the decision is
based”
Asymmetric
information
Divergent interests
Collective action
problems
Kenneth Arrow
The Limits of Organization

15. Kenneth Arrow
The Limits of Organization
 The power to review is the
power to decide:
• “If every decision of A is to
be reviewed by B, then all
we have really is a shift in
the locus of authority from
A to B”
15

16. Endorsed the “board centric” model Why?
 Reaffirmed MBCA policy of vesting
“the power to direct and oversee
the management of the corporation
in the board of directors, rather than
in the shareholders.”
 Board centric model gives
shareholders “the regular
opportunity to elect the members of
the board, but during the directors’
terms, the board has the power,
informed by each director’s
decisions in the exercise of his or
her fiduciary duties, to direct and
oversee the pursuit of the board’s
vision of what is best for the
corporation.”
 If the actions of management were
the subject of frequent shareholder
review:
• The ability to rely on
management teams would be
diluted
• The time and attention of
managers could be diverted from
activities designed to pursue
sustainable economic benefit for
the corporation.
• Particular shareholders may
have interests that diverge from
those of other shareholders or
interests other than sustainable
economic benefit.
The ABA Committee on Corporate Laws (2010)
16

17.  Individual shareholders
lack sufficient stake to
justify monitoring
• Free-riding issue
 Interests of large
investors likely to differ
from those of
shareholders as a whole
 Transfer of authority from board to shareholders
• Undesirable in itself
– Less efficient decision making
– Swapping consensus for authority under conditions favoring the latter
Shareholders do not “own” the corporation
Individual Shareholders Institutional Shareholders
But what about the “ownership” rights of shareholders?
17

18. Part III
The Law of 14a-8(i)(7)
18

19. The Trinity Standard
19
Discern subject
matter of proposal
Does subject
relate to
ordinary
business?
If not, no
grounds
for
exclusion
If yes, go to social
Significance
1. Does proposal raise
significant policy issue?
2. Does it “transcend”
ordinary business
If no,
exclude
If yes,
include

20. Proposal nominally
requested a board
review process
But substance
prevails over form
“Clever drafting”
cannot rescue
improper proposal
Asking for a review
or adoption of a
policy no guarantor
of inclusion
Look to “ultimate
consequence” of
proposal
[How?]
The process of discernment
20
Proposal was
really about
selling guns

21. “so long as the subject
matter of the proposal
relates—that is, bears
on—a company’s
ordinary business
operations, the
proposal is excludable
unless some other
exception to the
exclusion applies”
A proposal bearing on
decisions about
product offerings is
thus excludable even if
the “proposal doesn’t
direct management to
stop selling a particular
product or prescribe a
matrix to follow”
Does proposal “relate” to ordinary business?
21

22.  “The first [issue] is whether the
proposal focuses on a significant
policy (be it social or, as noted
below, corporate).”
 It “is hard to counter that Trinity’s
proposal doesn’t touch the bases
of what are significant concerns in
our society and corporations in
that society.”
1.Court provides no general metric for significance.
2.In this case, resolved by pure fiat: No explanation of why issue rose
to requisite level in this case.
But
Prong A Result
Social Significance
22

23. Prong B But
Social Significance
 A “shareholder must do more
than focus its proposal on a
significant policy issue; the
subject matter of its proposal
must ‘transcend’ the
company’s ordinary
business.”
 The “transcendence
requirement plays a pivotal
role in the social-policy
exception calculus.”
 “Without it shareholders
would be free to submit
‘proposals dealing with
ordinary business matters yet
cabined in social policy
concern.’”
 This is analysis by epithet
and reasoning by
pejorative :
• Transcend is undefined
in the opinion.
 “A court's focus on labels
rather than on reasoning
not only impedes law
students' understanding of
what the law is and how to
answer questions on an
exam, but also lawyers'
understanding of how to
advise clients and how to
present arguments to
arbitrators and judges.”
23

24. Part IV
Our Proposal
24

25. “Although a core business of courts is to interpret statutes and
rules, our job is made difficult where agencies, after notice and
comment, have hard-to-define exclusions to their rules and
exceptions to those exclusions. For those who labor with the
ordinary business exclusion and a social-policy exception
that requires not only significance but “transcendence,” we
empathize. Despite the substantial uptick in proposals attempting
to raise social policy issues that bat down the business operations
bar, the SEC’s last word on the subject came in the 1990s, and
we have no hint that any change from it or Congress is
forthcoming . . . We thus suggest that [the SEC] consider
revising its regulation of proxy contests and issue fresh
interpretive guidance.”
The Trinity court was aware that a better test is needed

26. Chevron (US 1984): Where Congressional intent is unclear
a reviewing court should defer to the agency’s interpretation
of the statute so long as it constitutes a permissible
construction of the statute
SEC and staff have consistently failed to apply the ordinary
business exemption consistently over time.
Multiple flip-flops (e.g., Cracker Barrel) that went
unexplained.
Nat'l Cable & Telecomms. v. Brand X Internet Servs. (US
2005): An “unexplained inconsistency is ... a reason for
holding an interpretation to be an arbitrary and capricious
change from agency practice”).
Is the SEC entitled to Chevron Deference?
26

27. Substance
prevails over
form (no
“clever”
drafting
saves)
Look to state
law
(federalism
and SEC
authority)
Prong 1
Bylaw
analogy
Prong 2
Extraordinary
act analogy
An Alternative Test
27

28.  CA, Inc. v. AFSCME Employees Pension Plan (Del. 2008):
• The “proper function of bylaws is not to mandate how the board
should decide specific substantive business decisions, but rather,
to define the process and procedures by which those decisions
are made.”
– “This distinction between substance (disallowed) and process (allowed) captures an
appropriate balance between authority and accountability. If shareholder
interventions directed at substantive decisions can be discouraged, the board’s
decision-making authority is respected. Indeed, if it is the case—as seems likely—
that private rent seeking most often will take the form of substantive interventions,
discouraging that category of interventions provides a useful prophylactic solution to
the rent-seeking problem. Conversely, process and procedural interventions do not
deprive the board of its authority but rather can be used to ensure that that authority
is used accountably.” (Bainbridge 2015)
Bylaw analogy
28

29.  The SEC claims:
“State law precedent … is rarely conclusive as to what is or
is not ordinary business, and the staff generally has had to
make its own determination as to whether a proposal
involves an activity relating to the issuer's ordinary
business.”
– But the SEC is wrong.
Prong 2: The Ordinary versus Extraordinary Matter Analogy
29

30. Prong 2: The Ordinary versus Extraordinary Matter Analogy
 Lee v. Jenkins Bros. (2d
Cir. 1959): The president of
a corporation “only has
authority to bind his
company by acts arising in
the usual and regular
course of business but not
for contracts of an
‘extraordinary’ nature ….”
 Restatement (Third) of
Agency § 3.03 cmt. e(3)
• “The apparent authority
of a president or chief
executive officer
encompasses
transactions falling within
the ordinary course of the
corporation's business.”
30

31. Per se extraordinary Principles of Corp Gov
Prong 2: The Ordinary versus Extraordinary Matter Analogy
Acts that boards as a
whole may not delegate to
board committees “would
normally not be within the
authority of the president
or other senior
executives.”
Acts that would require
shareholder approval.
Factors: “the economic magnitude of
the action in relation to corporate
assets and earnings, the extent of
risk involved, the time span of the
action's effect, and the cost of
reversing the action.”
“A useful generalization is that
decisions that would make a
significant change in the structure of
the business enterprise, or the
structure of control over the
enterprise, are extraordinary
corporate actions, and therefore are
normally outside the apparent
authority of senior executives.”
31

32.  Compelled speech
• Giving soapbox to shareholders to advance proposals motivated more by
politics than economics
– At company expense (and thus ultimately at expense of all shareholders)
– Under current law, the shareholder proposal rule is a species of private
eminent domain by which the federal government allows a small minority
to appropriate someone else’s property.
 Federal entanglement in disputes over social issues:
• Should federal bureaucrats or federal judges decide whether a politically
charged proposal has enough ethical or social significance to justify its
inclusion in the proxy statement?
The Case Against the Social Significance Exemption to the
Exclusion
32

33. Discern
• Influence decisions about product offerings
Substance/Process
• Substance: excludible
• Clever drafting as request for a policy unavailing
Extraordinary Act
• Ordinary
Applications: Trinity
33

34. Discern
• Set process by which shareholders
can nominate directors
Substance/Process
• Procedure
Extraordinary Act
• Extraordinary
Applications: Proxy Access
34

35. Discern
• Relates to how the company
conducts operations
Substance/Process
• Substance
Extraordinary Act
• Ordinary
Applications: Report on/Adopt policy re sustainability
35

36. Discern
• Sets procedural limits on how
long directors can serve
Substance/Process
• Process
Extraordinary Act
• Extraordinary
Applications: Director term limits
36