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04 March 2019
In October last year, Corp Fin issued a new staff legal bulletin on shareholder proposals, 14J, that examined the exception under Rule 14a-8(i)(7), the "ordinary business" exception, addressing, among other topics, the application of the rule to proposals related to executive or director comp. Post-shutdown, Corp Fin has now posted several no-action responses that consider the exception in that context. Do they provide any color or insight?
Executive comp or ordinary business? One of the issues addressed in the SLB is how the staff approaches the application of Rule 14a-8(i)(7) to proposals that, in addition to implicating executive/director comp, also involve ordinary business matters. The question the staff then asks is: what is the real underlying focus of the proposal? Is it really concerned primarily with senior executive and/or director compensation, or is it just styled as an executive comp proposal, but "its underlying concern relates primarily to ordinary business matters that are not sufficiently related to senior executive and/or director compensation"? The goal is to avoid elevating form over substance so that "a proposal is not included simply because it addresses an excludable matter in a manner that is connected to or touches upon senior executive or director compensation matters." Elsewhere in the SLB, the staff notes that, in "determining whether the focus of a proposal is senior executive and/or director compensation or, instead, an ordinary business matter, we consider both the resolved clause and supporting statement as a whole."
In this letter to AT&T, the company received a proposal asking the board "to amend the compensation of the CEO and CFO to include the company's long-term issuer debt rating from S&P Global and Moody's, in an advisory manner, as an incentive metric weighting." The supporting statement, which discussed at length the company's debt load relative to that of several European countries, as well as its debt growth rate, cash flows and debt ratings, was probably very influential, if not determinative. The company argued that "[a]lthough the resolution is framed as a request to include the Company's credit rating as a performance metric for the CEO's and CFO's incentive compensation, the Proposal as a whole has nothing to do with executive compensation…. The Proposal focuses only on the Company's amount of indebtedness and its credit ratings by Moody's and S&P. As a result, the Proposal is effectively a shareholder referendum on management's decisions on managing the Company's debt levels and cash resources. The underlying concern of the Proposal is not senior executive compensation." Rather, the executive compensation aspect was simply "window dressing." The staff agreed that the proposal could be excluded under Rule 14a-8(i)(7) because it was related to the Company's ordinary business operations. "In this regard," the staff wrote, "we note that, although the Proposal relates to executive compensation, the focus of the Proposal is on the ordinary business matter of management of existing debt."
Executive comp or comp also available to the general workforce? SLB 14J advises that where the focus of the proposal is "on aspects of compensation that are available or apply only to senior executive officers and/or directors," companies may generally not rely on Rule 14a-8(i)(7) to exclude the proposal. However, where the proposal relates to forms of compensation to senior executives/directors that are "also broadly available or applicable to the general workforce," the proposal "does not generally raise significant compensation issues that transcend ordinary business matters." Accordingly, the SLB imposes a two-part test: "a proposal that addresses senior executive and/or director compensation may be excludable under Rule 14a-8(i)(7) if a primary aspect of the targeted compensation is broadly available or applicable to a company's general workforce and the company demonstrates that the executives' or directors' eligibility to receive the compensation does not implicate significant compensation matters." [Emphasis added.]
Verizon received a proposal requesting that the Board's Human Resources Committee publish a report "assessing the feasibility of integrating cyber security and data privacy performance measures into the Verizon executive compensation program which it describes in its annual proxy materials." The supporting statement discussed performance metrics that were used to determine executive comp and argued that "[c]yber security and data privacy are vitally important issues for Verizon and should be included too, as we believe it would incentivize leadership to reduce risk, enhance financial performance, and increase accountability." The company contended that the proposal related to general employee compensation because it applied to a broader group of "nearly 300 'key employees at the senior management level' and was not limited only to senior executive officers and/or directors." To be sure, the company maintained, "as a practical matter," the bonuses of other management employees were ultimately based on the same metrics.
The proponent, however, took a different turn, focusing less on whether the metrics applied beyond the group of executives and stressing instead the importance of the underlying policy issue: the "overriding consideration for the 14a-8(i)(7) analysis continues to be whether the proposal focuses on a significant issue that transcends ordinary business matters…. As such, the central issue presented in this no-action letter request is whether a report 'assessing the feasibility of integrating cyber security and data privacy performance measures into the Verizon executive compensation program' focuses on an issue that transcends ordinary business matters." In addition, the proponent argued, the issue was significant to the company's business and, as a result, it was appropriate to link this significant policy issue to executive compensation. Where the proposal "focuses on issues that do not transcend the ordinary business of the company, then it may be necessary to look at whether it is applicable to the general workforce. But that is not the case here." In essence, the proponent argued, in its request for no-action, the company was missing the boat: the "analytical through-line from the Commission's Release No. 34-40018 (May 21, 1998) all the way through Staff Legal Bulletin 14J in 2018 is the question whether the proposal focuses on a significant policy issue confronting the company." Ultimately, the proponent hoped to persuade the staff that "SLB 14J is not applicable to the 2019 Proposal." In response, the company then pointed out that the staff had not found cybersecurity and privacy to be transcendent policy issues; however, the staff had "treated senior executive compensation as a significant social policy issue since 1992."
In denying relief to the company, the staff did not appear to buy the company's contention that the proposal targeted compensation was broadly applicable to the general workforce. But neither did the staff appear to be persuaded by the proponent's contention that the proposal involved a transcendent policy matter. Rather, in denying relief to the company, the staff highlighted the focus of the proposal on executive compensation: "We note that the Proposal transcends ordinary business because it focuses on the performance measures used by the Human Resources Committee to determine the value of the compensation awards of the named executive officers as disclosed in the Company's proxy materials."
In this letter, Verizon was again unable to obtain no-action relief from the staff to exclude a proposal related to executive comp, but for a different reason. In this instance, the proposal requested that "the board to seek shareholder approval of any senior executive officer's golden parachute "with an estimated 'total value' exceeding 2.99 times the sum of the executive's base salary plus target short-term bonus, including the value of unearned equity as to which vesting is accelerated or performance conditions are waived." In essence, the proposal would amend the company's existing golden parachute policy to require the inclusion of equity in the calculation when vesting is accelerated. Here too Verizon contended that the proposal addressed an aspect of senior executive compensation that is also available or applicable to the general workforce, citing as virtually identical the specific example in SLB 14J regarding golden parachutes. The proponent, however, maintained that the precise subject of the proposal was "not golden parachutes per se, but 'excess' golden parachutes for a very small number of Verizon executives, namely, its 'senior executive officers.'" In addition, the "size of golden parachutes to senior executives has mushroomed," and "public concern over 'excessive' golden parachutes…has only increased." The staff denied relief. Whether or not the company had adequately shown that the proposal addressed forms of compensation to senior executives that were also broadly available or applicable to the general workforce, the company had failed to carry its burden on the second part of the test: the no-action request failed to "include a discussion that demonstrates that senior executive officers' eligibility to receive the severance or termination payments does not implicate significant compensation matters."
Micromanagement. Another aspect of the SLB addressed the staff's decision to reverse prior policy and allow the issue of micromanagement to be applied, under Rule 14a-8(i)(7), to exclude proposals related to executive comp. As explained in SLB 14J, a proposal may be considered to "micromanage" the company where it probes "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." With regard to proposals addressing senior executive and/or director compensation, where they "seek intricate detail, or seek to impose specific timeframes or methods for implementing complex policies," the staff may now agree that they can be excluded under Rule 14a-8(i)(7) on the basis of micromanagement. The SLB emphasized that "micromanagement addresses the manner in which a proposal raises an issue, and not whether a proposal's subject matter itself is proper for a shareholder proposal under Rule 14a-8."
The staff agreed that exclusion would be appropriate on the basis of micromanagement under Rule 14a-8(i)(7) in substantially the same proposals submitted to AbbVie and Johnson & Johnson. In both cases, the companies received proposals requesting the board "to adopt a policy that no financial performance metric shall be adjusted to exclude legal or compliance costs when evaluating performance for purposes of determining the amount or vesting of any senior executive incentive compensation award." In its supporting statement, the proponent contended that "senior executives should not be insulated from legal risks, particularly on matters that are core to the company's business. These considerations are especially critical at [the company] given the potential reputational, legal and regulatory risks it faces over its role in the nation's opioid epidemic." The companies first argued that, while the proposal was "framed in terms of executive compensation, the incentive compensation that is the subject of the request is broadly applicable to [the company's] workforce and, as such, does not raise a significant policy issue." In addition, the companies both contended that, in seeking to prohibit them from adjusting financial performance metrics on specified bases—a complex process that typically involves specific judgments concerning whether and how, if at all, to adjust financial performance metrics—the proposals sought to micromanage the companies: the "Proposal's attempt to categorically prohibit any adjustment whatsoever of the broad categories of expenses covered by the Proposal without regard to circumstance and without any reasonable exceptions would impose specific methods for implementing complex policies and therefore, probes too deeply into matters of a complex nature upon which shareholders, as a group, are not in a position to make an informed judgment."
In response, the proponent argued that the proposal related only to executive comp and that it implicated significant comp matters in any event. Moreover, the proponent contended, the request in the proposal was not complex or prescriptive at all: the proposal "would affect a single aspect of this process, asking the Committee not to exclude the impact of [legal and compliance costs and settlements] in the calculation of [earnings and EPS] metrics for senior executive incentive pay purposes. That change would require only that the amount of [legal and compliance costs and settlements be added back to earnings,] a single arithmetic operation." In both cases, the micromanagement argument won the day. According to the staff, the proposal "micromanages the Company by seeking to impose specific methods for implementing complex policies. Specifically, the Proposal, if implemented, would prohibit any adjustment of the broad categories of expenses covered by the Proposal without regard to specific circumstances or the possibility of reasonable exceptions."
For further information on this topic please contact Cydney Posner at Cooley LLP by telephone (+1 415 693 2000) or email (firstname.lastname@example.org). The Cooley LLP website can be accessed at www.cooley.com.
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