Rule 14a-8(i)(2) — former Rule 14a-8(c)(2)

Question 9(2): Violation of law: If the proposal would, if implemented, cause the company to violate any state, federal, or foreign law to which it is subject.

Note to paragraph (i)(2): We will not apply this basis for exclusion to permit exclusion of a proposal on grounds that it would violate foreign law if compliance with the foreign law would result in a violation of any state or federal law.

§ 15.01 Background of the Exclusion

Under this exclusion, a company may exclude a proposal that, if adopted, would require it to violate state, federal or foreign law (except where compliance with the foreign law would itself violate any federal or state law).

§ 15.01[A] History of the Exclusion

In 1976, the SEC adopted this exclusion to codify an existing interpretive position. The SEC initially proposed that the exclusion would relate only to federal law. After receiving comments, it decided to adopt broader language to cover a wider range of laws. In addition, the SEC decided to fine tune the language of the exclusion so that it was clear that the exclusion deals with the implementation of the proposal.[fn1]

In 1998, the SEC renumbered the exclusion as 14a-8(i)(2) and made minor stylistic changes.[fn2]

[fn1] Exchange Act Release No. 12,999, 10 SEC Dock. 1006, 1010-11 (1976).

[fn2] Exchange Act Release No. 40,018, 1998 SEC LEXIS 1001 (May 21, 1998).

§ 15.01[B] Purpose of the Exclusion

The purpose of this exclusion is to prevent a company from putting proposals to a vote that it could not lawfully implement even if shareholders were to fully support its adoption. As the SEC states, "it does not appear appropriate to allow the inclusion in proxy materials of any proposal which, if implemented, would violate an applicable law."[fn3]

[fn3] Exchange Act Release No. 12,999, 1976 SEC LEXIS 326 (Nov. 22, 1976).

§ 15.01[C] Overlap with Other Exclusions

This exclusion overlaps significantly with Rule 14a-8(i)(1), which permits exclusion of proposals whose subjects are not proper for shareholder action under state corporate law, since a proposal that would not be a proper subject for shareholder action under state law also would violate state law under this exclusion. However, the violation of law basis is broader than the improper subject basis because the former encompasses violations of federal and foreign laws in addition to state laws.[fn4]

The SEC has acknowledged this overlap, stating, "Although this restriction on proposals reasonably may be implied from subparagraph (c)(1) of the present rule, since both federal and state law are applicable in an issuer's domicile, the Commission proposes to remove all doubt in this area by promulgating a separate exclusionary provision for proposals that violate U.S. laws."[fn5]

Companies often argue that this exclusion applies in conjunction with Rule 14a-8(i)(6), dealing with proposals the company lacks the power or authority to effectuate, because if a proposal would violate a law, the company would not have the power to implement it. Even when both exclusions appear to apply, the staff normally will rely solely on this exclusion if it is clear that the proposal's subject matter is illegal.[fn6]

[fn4] See supra Chapter 14.

[fn5] Exchange Act Release No. 12,999, 10 SEC Dock. 1006, 1010-11 (1976).

[fn6] See infra Chapter 19.

§ 15.02 Application of the Exclusion

§ 15.02[A] Identifying the Key Issues

The foremost challenge in applying this exclusion is determining the proper application of the cited law. If a company cites established precedent and provides a satisfactory legal opinion, the staff normally allows the exclusion of the proposal on these grounds.

Application of this exclusion, however, can be more difficult if the proponent also submits a well-reasoned legal opinion and the precedent cited by the company is not dispositive. In such situations, the staff will look to other exclusion bases raised by the company because the staff lacks the expertise to apply laws outside the securities arena. On relatively rare occasions, the staff may even express that it has "no view."

§ 15.02[B] Opportunity to Cure

In some circumstances, the SEC staff offers proponents an opportunity to revise their proposals to cure defects raised by potential illegality. This opportunity arises only in the cases where the cure involves only a relatively minor revision of the proposal. A common example occurs when the staff allows proponents to revise proposals to apply prospectively, so that the revised proposal would no longer cause the company to breach an existing agreement. In most of these cases, the staff gives proponents seven calendar days from the date of its response letter to make the requested changes.

§ 15.03 Legal Opinion Requirement

Under Rule 14a-8(j)(2)(iii), a company must provide a supporting opinion of counsel that compliance with the proposal would violate state, federal or foreign law before the SEC staff will allow omission under this exclusion.

§ 15.03[A] Form of Opinion

The required legal opinion can be rendered by either in-house counsel or outside counsel. The opinion may be included in the text of the no-action request or be attached as a stand-alone document. Either way, it must be clear that it is a legal opinion. Most companies make it part of the incoming request. It is important to note that these opinions become publicly available when filed.

§ 15.03[B] Opinion Content

The legal opinion submitted to the SEC staff must contain three essential elements. First, the legal opinion must clearly be an opinion and must contain language to that effect (e.g., "opines" or similar language). Second, the opinion must fully address the law that the proposal allegedly violates. Third, the opinion cannot contain excessive cautionary language that limits its scope or effect.

§ 15.03[C] Bar of Lawyer Rendering Opinion

If the law at issue is a state law, the lawyer providing the legal opinion does not have to be barred in that particular state. However, in determining how much weight to afford a legal opinion, one factor that the SEC staff considers is whether counsel is licensed to practice law in the jurisdiction where the law is at issue.[fn7]

Although not required by the SEC staff, companies occasionally submit two opinions to ensure that they are "covered," or the counsel that is not barred in a certain state may require that its opinion be backed by an opinion from someone who is barred in that state. For example, it is not uncommon for a Delaware company to submit two legal opinions to the staff, one rendered by counsel not barred in Delaware and the other from Delaware counsel.

If a federal law is involved, the issue is whether the opining lawyer has the requisite expertise since there is no federal bar. For example, if the proposal's topic relates to the environment, most companies do not have in-house lawyers with sufficient expertise in environmental law, so they hire an outside lawyer to render an opinion. However, some larger companies do have in-house counsel with such expertise and they may render an in-house opinion. If foreign law is involved, it is even more likely that a company will hire an outside lawyer with the necessary expertise.

[fn7] See Division of Corporation Finance, Staff Legal Bulletin No. 14B (September 15, 2004), Division of Corporation Finance, Staff Legal Bulletin No. 14 (July 13, 2001) and Item G1 (available at www.sec.gov/interps/legal/cfslb14.htm).

§ 15.03[D] No Requirement for Proponent to Submit Legal Opinion

Even though a proponent may argue that a law should be interpreted differently than the company, it does not have to provide a legal opinion to that effect because the company bears the burden of proof. Rule 14a-8(j)(2)(iii) requires legal opinions as part of the procedures that companies must follow; there is no counterpart legal opinion requirement for proponents. However, a proponent sometimes submits a legal opinion because it strengthens its case before the SEC staff.

§ 15.03[E] Dueling Opinions

Sometimes the staff receives "competing" opinions from the company and the proponent. In essence, the proponent provides an opinion that "rebuts" the interpretation of a law contained in the opinion submitted by the company. These are the most difficult situations for the staff because it becomes the arbiter of state law.

In these cases, the staff may determine that one party has provided a better reasoned opinion and decide in its favor. If neither opinion is persuasive, the staff may decide in favor of the proponent because the company has failed to meet its burden of proof. In some cases, the staff may decide to not take a position because the courts have not decided the matter and it is inappropriate for the staff to take a position in light of the competing opinions. Since companies have gone to the time and expense of complying with the Rule 14a-8 process, the staff rarely takes a "no view" position and only does so if the interpretation of the law clearly appears to be undecided."

EXAMPLE:

In Quaker Oats Company,[fn8] the SEC staff expressed "no view" with respect to whether the company could exclude a proposal amending the company's bylaws to prohibit adoption of any shareholder rights plan without prior shareholder approval and to require redemption of its existing shareholder rights plan. The company argued that while the law was still "unsettled," it believed that the proposal could be omitted. The proponent argued that its interpretation of New Jersey law did not permit exclusion. In its response, the SEC staff noted that both the company's counsel and the proponent's counsel cited Sections 14A:2-9, 14A:2-10, 14A:6-1, 14A:6-14, 14A:7-7 and 14A:7-15 of the New Jersey Business Corporation Act as potentially controlling the implementation of the proposal. The staff noted that neither counsel had opined as to any compelling state law precedent so that there was a "lack of any decided legal authority."

[fn8] 1999 SEC No-Act. LEXIS 417 (Apr. 6, 1999).

§ 15.04 Types of Law

This exclusion provides companies with an opportunity to object to including a proposal based on any type of law, regardless if it is a state, federal or foreign law.

§ 15.04[A] State Law

§ 15.04[A][1] State Corporate Law

For matters arising under state corporate law, this exclusion complements the improper subject exclusion in Rule 14a-8(i)(1), since both can apply to proposals that implicate such issues. Companies often cite both this exclusion and the improper subject basis when dealing with state corporate law issues.

EXAMPLE:

In Dayton Hudson Corporation,[fn9] the company was permitted to exclude a proposal amending the company's bylaws to require shareholder approval of any current or future rights agreement and to state that this requirement may not be amended, modified or repealed, except by holders of a majority of the outstanding shares. The company argued that implementation of the proposal would cause it to violate Section 437 of the Minnesota Business Corporation Act. Under Minnesota law, the company contended, only shareholders that hold 3% or more of the voting power of the shares entitled to vote may propose a bylaw amendment. The company noted that the proponent did not own this number of shares. The proponent responded that the Minnesota law did not preempt the shareholder proposal rule.

[fn9] 1999 SEC No-Act. LEXIS 387 (Mar. 25, 1999).

§ 15.04[A][2] Other State Laws

This exclusion is broader than the improper subject basis because it applies to state law other than a state's corporate law. In addition, the state law raised does not necessarily have to be a law from the state in which the company is incorporated, as long as the law applies to the subject matter of the proposal. Other than proposals involving breach of contract, proposals that implicate general state laws are not common.

§ 15.04[A][3] Breach of Contract

Most commonly, companies argue that the proposal would cause the company to breach a contract and thus violate state contract law. A breach of a contract is "a failure, without legal excuse, to perform any promise which forms part of [the] contract."[fn10] In the absence of a legal excuse for one party's performance of a contract, that party is "obligated to perform the contract according to its terms, or upon his failure to do so, he is liable to the [other party] for the damages resulting therefrom."[fn11]

The SEC staff consistently allows companies to omit proposals that would require them to breach a contract but requires inclusion of proposals that address matters that would prevent companies from entering into new contracts. As a result, sometimes the SEC staff requires proponents to recast their proposals so that they address only future contracts. Companies can enter into a contractual relationship after receiving a proposal and successfully request that the proposal be excluded.

Some commentators question whether breach of contract should be a basis of applying this exclusion. They argue that someone who breaches a contract might be subject to an action for damages, but normally does not violate a law. In addition, they point out that sometimes it may be in the best interests of a company to breach a contract and pay damages.

EXAMPLES:

Breach of contract

In Kroger Co.,[fn12] the proponent had to recast the proposal so that it was prospective for it to be included. The proposal required the company to limit the remuneration of officers and directors to no more than 2% above the lowest paid hourly employee or 2% above the C.P.I. The company, an Ohio corporation, argued that the proposal would cause it to violate Ohio law because the chairman and chief executive officer was party to an employment contract that provided a minimum level of compensation during his employment of at least $420,000 per year.

In International Business Machines Corporation,[fn13] the SEC staff granted no-action relief with respect to a proposal that related to the termination and renegotiation of the CEO's retirement package. The company argued that the board had no power to implement the proposal because it lacked the unilateral power to terminate and renegotiate his employment agreement. The company noted that there was no distinction between a proposal that requested that the board "ask" a CEO directly to reduce his retirement package or one that requested that the board amend "the governing instruments"; both had the same underlying purpose and were excludable because there was a binding employment agreement in place. The proponent argued that the company had not pointed to a provision in the employment agreement that would bar the company from asking the CEO to enter into a voluntary renegotiation.

EXAMPLES:

Contracts not breached

In Xcel Energy Inc.,[fn14] the company was required to include a proposal requesting that the board develop and implement policies and practices requiring the company to obtain power supplies from sources that did not have undue adverse impacts on a particular Indian tribe. The company argued that it could not effectively implement the proposal without violating state contract law because it had valid existing agreements with a company that lasted until 2005 and in some cases for many years beyond that. The proponent argued that the proposal would not require the company to terminate any contracts because it only requested that the board adopt a certain policy and because the new policy would be prospective, it would have no impact on existing contractual arrangements.

In Lockheed Martin Corporation,[fn15] the proponent successfully defended against a no-action challenge to a proposal asking the company to disclose promises made to foreign governments or foreign firms in connection with military sales that were intended to offset the U.S. dollar cost of weapons purchased by foreign nations. The company argued that in the ordinary course of its business, it frequently entered into contracts with foreign companies and foreign governments and that these contracts were awarded as a result of a competitive bidding process. The company noted that many foreign governments insisted the company provide so-called "offset" agreements and that the company's contracts typically include confidentiality provisions that prohibit it or its customer from disclosing various terms and conditions of the contract, including the terms and conditions relating to any such "offset" commitments. As a result, the company claimed, the proposal required it to breach its contractual obligations. The proponent did not submit a rebuttal.

[fn10] Williston on Contracts § 1290 (3d ed. 1968).

[fn11] Wills v. Shockley, 157 A.2d 252, 253 (Del.Super.Ct. 1960).

[fn12] 2000 SEC No-Act. LEXIS 583 (Apr. 21, 2000).

[fn13] 2000 SEC No-Act. LEXIS 239 (Feb. 27, 2000).

[fn14] 2001 SEC No-Act. LEXIS 153 (Feb. 5, 2001).

[fn15] 2001 SEC No-Act. LEXIS 137 (Jan. 31, 2001).

§ 15.04[A][4] Renegotiations of Existing Contract Rights

Proposals that merely direct a company to renegotiate existing contract rights in good faith are generally includable because a renegotiation requires mutuality, eliminating the possibility that the company will breach a contract unilaterally as a result of the proposal.

EXAMPLE:

In ConAgra, Inc.,[fn16] the SEC staff required inclusion of a proposal requesting that the board's human resources committee undertake good faith negotiations with the Chief Operating Officer to amend the terms of his Incentive Agreement pursuant to a stock plan. The company argued that an alteration of the Chief Executive Officer's contractual rights under the Incentive Agreement would be illegal. Although the proposal was cast as a "renegotiation," the company stated that it had no right under the Incentive Agreement to renegotiate or unilaterally change its terms. The company concluded that achieving the results sought by the proposal would necessarily require it to breach contractual rights in violation of applicable law. The proponent's rebuttal did not address this specific exclusion, only the logic behind the proposal.

[fn16] 1994 SEC No-Act. LEXIS 578 (June 24, 1994).

§ 15.04[B] Federal Laws

A company ordinarily can exclude a proposal if it can show that the action requested in the proposal would cause the company to violate any federal law. To rely on this exclusion, a company must demonstrate how the law applies to the subject matter of the proposal.

EXAMPLES:

In Quaker Oats Company,[fn17] the company was required to include a proposal asking the board to adopt a policy of removing genetically engineered crops from its products. The company claimed there was a significant risk that labeling products as free of genetically modified organisms would be considered false and misleading in violation of the Federal Food, Drug and Cosmetic Act. The company noted that "GM-free" claims could be misleading because there was no consensus regarding the definition of this phrase and that there could be confusion concerning when a product is truly free of genetically engineered ingredients. The proponent argued that the lack of an FDA policy on the issue did not make the labeling of products illegal. As an example, the proponent cited the use of the terms "fat free," "low fat," and "light" before the FDA provided guidance on these labels.
In General Electric Co.,[fn18] the company was permitted to exclude a proposal recommending that the company not release information concerning an employee's Form W-4 or payroll status without permission of the employee, a search warrant or a court order. The company argued that the proposal would violate a regulation of the Internal Revenue Service, which had the force and effect of law until rescinded by the agency or challenged in court. The proponent responded that the regulation on which the company's argument was based conflicted with a provision of the Internal Revenue Code and thus was invalid.

[fn17] 2000 SEC No-Act. LEXIS 513 (Mar. 28, 2000).

[fn18] 1984 SEC No-Act. LEXIS 1601 (Jan. 13, 1984).

§ 15.04[C] Foreign Law

A proposal that would cause the company to violate the laws of another country is excludable on this basis, provided the company demonstrates the law's applicability to the subject matter of the proposal.

EXAMPLE:

In General Motors Corp.,[fn19] the SEC staff granted no-action relief with respect to a proposal seeking implementation of the MacBride Principles in Northern Ireland, which would require the company to undertake affirmative action and anti-discrimination measures. The company argued that the implementation of the procedures would require the company or one of its subsidiaries to violate the laws of Northern Ireland. The company explained that the chairman of Northern Ireland's Fair Employment Agency, as well as the chairman of Northern Ireland's Fair Employment Appeals Board, concurred with the company's assessment of the proposal's illegality. The proponent argued that nothing in the MacBride Principles required or implied unlawful or reverse discrimination.

[fn19] 1986 SEC No-Act. LEXIS 2015 (Apr. 7, 1986).

§ 15.04[C][1] Foreign Law Resulting in Breach of State or Federal Law

In a Note to this exclusion, the SEC makes clear that it will not apply this exclusion to permit the omission of a proposal on grounds that it would violate foreign law if compliance with the foreign law would result in a violation of any state or federal U.S. law. In other words, U.S. state and federal law takes precedence over the laws of other countries.

§ 15.05 Common Type of Proposals

§ 15.05[A] Shareholder Rights

Regarding the rights of shareholders, the SEC staff tends to allow proponents to include proposals so long as they do not encroach on the board's turf. This appears to make sense as shareholders should be able to take action regarding their own rights.

EXAMPLES:

In UnitedHealth Group Incorporated,[fn20] the proponent prevailed in a challenge to a proposal relating to the use of confidential voting and independent election inspectors in its proxy procedures. The proposal only permitted the company to disclose the identity of any shareholder if such disclosure was required by the law of Minnesota, the company's state of incorporation. The company argued that it could violate federal law or a law in a different state if it was prohibited from disclosing the identity of any shareholder. The company argued that several such laws did exist, including the SEC's disclosure requirement concerning the identities and holdings of specified classes of shareholders in proxy statements and the Hart-Scott-Rodino Act's requirement to provide the identities and holdings of specified classes of its shareholders in antitrust filings. The proponent did not submit a rebuttal.
In International Business Machines Corporation,[fn21] no-action relief was granted on a proposal recommending that "proxy balloting" be tabulated according to the categories "in favor," "opposed," "abstain" and "returned unmarked," and be decided solely by the votes in favor and opposed. The company argued that numerous contractual and New York State statutory requirements would be violated if the proposal were implemented and that federal law would be derivatively violated. The proponent did not submit a rebuttal. In its response, the SEC staff noted that the proposal would require shareholders to specifically mark proxies for or against a matter to have any proxy counted, and this would result in shareholders having their discretionary proxy disregarded in contravention of their rights under New York law.
In Home Depot, Inc.,[fn22] the SEC staff required inclusion of a proposal recommending reinstatement of simple majority voting on all matters submitted to a shareholder vote. The company, a Delaware corporation, argued that Section 242(b)(1) of the Delaware General Corporation Law specifically required that the board initiate any change to the company's certificate of incorporation. The company urged that the proposal sought to circumvent this statutory requirement by having stockholders "recommend" a proposal that would require amendments to the company's charter not initiated by the board. The company also argued that the proposal was silent as to what "simple majority vote" would be required; under Delaware law, some shareholder actions required a vote of only a majority of the shares present and entitled to vote, while other actions required at least a majority of a corporation's outstanding shares. The proponent argued that the company preferred to exclude this proposal challenging management to adopt a higher standard of corporate governance, rather than implement it and lose some measure of control. The proponent also noted the similarity between this proposal and one from 1998 that was required to be included over the company's objections.
In PG&E Corporation,[fn23] the proponent successfully defended against a no-action challenge to a proposal requesting that the company not count abstentions as votes cast on a proposal, while recognizing that abstentions may be counted as present for quorum purposes. The company, a California corporation, contended that Section 152 of the California General Corporation Law (CGCL) specified that a matter is "approved by the outstanding shares" if the matter is approved by the affirmative vote of a majority of the outstanding shares entitled to vote. It noted that because abstentions and "no" votes both are included in the pool of outstanding shares entitled to vote, for these purposes, abstentions must legally have the same effect as a "no" vote. In addition, the company noted that Section 708(c) of the CGCL specifies that, in any election of directors, the candidates that receive the highest number of affirmative votes of the shares entitled to be voted for them, up to the number of directors to be elected by such shares, are elected. It noted that because the criteria looked only to the affirmative votes cast in favor of any director, abstentions and "no" votes had the same effect through operation of law. The proponent argued that similar proposals had been included in the company's proxy statements.
In Citigroup Inc.,[fn24] the company was required to include a proposal asking the company to adopt a "matching gift program" for shareholders to enable them to donate dividends to qualifying organizations and requesting that the company match any such contributions to an extent determined by the board. The company argued that given the indeterminate amount of shareholder-directed contributions, the proposal would undercut the ability of the board to fulfill its legal responsibility to declare and pay dividends out of surplus or net profits under Sections 170-174 of the Delaware General Corporation Law. The proponent did not address this exclusion in his rebuttal.
In Harrah's Entertainment, Inc.,[fn25] inclusion was required of a proposal recommending that all employees who invest in the company's stock through its savings and retirement plan be given the same rights as investors who buy the company's stock on the open market. The company argued that the proposal would violate federal laws applicable to employee benefit plans; specifically, that by giving beneficial owners the rights and privileges of shareholders of record would stop stock from being held in trust and thereby violate Section 403(a) of ERISA. The company also argued that the proposal's attempt to give participants in the stock fund "all rights as any other common stockholder" was inconsistent with the assets of the stock fund continuing to be held in trust and that if the assets of the plan were not held in trust, the tax benefits enjoyed by the participants in the savings and retirement plan would be lost. It noted that in such event, the assets held in trust would be deemed to be distributed to all participants and the participants would be taxed immediately on those assets. The proponent did not submit a rebuttal.

[fn20] 2001 SEC No-Act. LEXIS 35 (Jan. 8, 2001).

[fn21] 1999 SEC No-Act. LEXIS 90 (Jan. 27, 1999).

[fn22] 2000 SEC No-Act. LEXIS 514 (Apr. 4, 2000).

[fn23] 2000 SEC No-Act. LEXIS 173 (Feb. 22, 2000).

[fn24] 2000 SEC No-Act. LEXIS 216 (Feb. 17, 2000).

[fn25] 1999 SEC No-Act. LEXIS 287 (Mar. 11, 1999).

§ 15.05[B] Board Nominations

The SEC staff has allowed omission of a proposal recommending that the board permit a union to designate persons to fill vacancies on the board. By contrast, the staff did not permit the omission of a proposal that urged the board to consider "other qualified persons" to be nominated for director positions. The staff's reasoning appears to be that the first proposal improperly delegated authority for nominating directors to a third party (i.e., the union), whereas the second proposal kept that authority with the board.

The SEC staff has rejected the argument that plurality voting as established by state corporate law statutes directly conflicts with and thus precludes proposals asking that two or more persons be nominated for each directorship. Finally, proposals establishing director qualifications are excludable if the qualifications would violate anti-discrimination or other laws governing employment.

EXAMPLES:

In Dominion Resources, Inc.,[fn26] the proponent prevailed in a challenge to a proposal urging the board to nominate at least two candidates for each open board position. The company, a Virginia corporation, claimed that Section 13.1-669 of the Virginia Stock Corporation Act precluded the proposal because it provided that directors of a Virginia corporation are elected by a plurality of the votes cast, unless otherwise provided in the corporation's charter. The company's charter contained no provision limiting the operation of that statute. As a result, the company urged, those nominees who received the highest number of votes would be elected to the company's board. The company argued that the proposal — by requiring the nomination of two individuals for each open board position — would cause it to violate Virginia law by requiring the company to seat a board member who had not received a plurality of the votes cast. The proponent did not submit a rebuttal.
In Technology Research Corporation,[fn27] the SEC staff required the company to include a proposal establishing a mandatory retirement age for directors. The company argued that the proposal would violate both the Florida Civil Rights Act and the federal Age Discrimination in Employment Act (ADEA). The proponent argued that the staff had previously considered and rejected similar assertions for the proposed exclusion of an identical director retirement policy proposal. The company acknowledged the precedent cited by the proponent, but attempted to distinguish it by showing the differences between Florida law, on the one hand, and Oklahoma law and the ADEA, on the other, regarding the exemption for bona fide executives and policy makers from the prohibition against mandatory retirement.

[fn26] 2001 SEC No-Act. LEXIS 127 (Jan. 23, 2001).

[fn27] 1999 SEC No-Act. LEXIS 580 (May 12, 1999).

§ 15.05[C] Board Structure

In general, proponents are able to include proposals that deal with the structure of the board. The principal concern in this area has been the declassification of boards and proponents normally are successful in getting such proposals included. An exception is that companies typically can convince the SEC staff to allow the exclusion of proposals that attempt to dictate a board structure that would violate a state law.

EXAMPLES:

In TRW Inc.,[fn28] the company was allowed to exclude a proposal requesting that the entire board be elected each year. The company, an Ohio corporation, noted that its governance documents provided for a classified board, with terms of three years. It noted that under Section 1701.11 of the Ohio General Corporation Law, amendments to the company's governing documents could be adopted only at a shareholders' meeting by the affirmative vote of the holders of shares entitled to vote, unless the governing documents provided otherwise or by written consent of holders of two-thirds of outstanding shares. The company noted that even if its governing documents were amended to provide for the lowest threshold permitted under Ohio law for approving amendments (a majority of the voting power), the company could not implement the proposal's standard of a "majority of shareholder votes cast." The proponent's rebuttal did not address this exclusion.
In CVS Corporation,[fn29] the proponent defeated a no-action challenge to a proposal requiring the company's board to be elected at every third annual meeting, rather than annually. The company, a Delaware corporation, noted that Section 211(b) of the Delaware General Corporation Law required that an annual meeting of stockholders be held for the election of directors and that Section 141(d) of the DGCL sets forth the only two circumstances in which directors may serve a term longer than the period between annual meetings: in the case of (i) directors serving on a classified board or (ii) one or more directors elected by a class of stock in addition to the common stock, pursuant to the voting rights of such class set forth in the company's certificate of incorporation. The company also noted that, absent a charter or bylaw provision establishing a classified board of directors, the term of office of each director elected by stockholders was required to be coextensive with the period between mandated annual meetings. The proponent did not submit a rebuttal.
In Comair Holdings, Inc.,[fn30] the SEC staff required the company to include a proposal urging the company to declassify the board. The company argued that the proposal would cause it to violate Kentucky Business Corporation Act Sections 271B.8-060 and 271B.10-030(b) because it urged the company's board to amend the company's charter, which it could not do unilaterally under Kentucky law. The company noted that the articles could be amended to declassify the board only by shareholder action.

[fn28] 2000 SEC No-Act. LEXIS 416 (Mar. 6, 2000).

[fn29] 2000 SEC No-Act. LEXIS 136 (Jan. 31, 2000).

[fn30] 1999 SEC No-Act. LEXIS 452 (Apr. 20, 1999).

§ 15.05[D] Business Combinations

EXAMPLES:

In Fab Industries, Inc.,[fn31] the SEC staff denied no-action relief on a proposal asking the company to hire an independent outside expert to prepare a study concerning a possible sale, liquidation, or other course of action for the company and prepare a report to stockholders. The company, a Delaware corporation, argued that the proposal might require the board to take steps toward the company's dissolution without prior board consideration, contrary to the requirements of Delaware law. The company contended that Section 275 of the Delaware General Corporation Law required the adoption of a resolution recommending dissolution by a majority of the entire board prior to the mailing of notice of such proposed action to the stockholders and that the board had neither considered nor adopted such a resolution. The proponent did not submit a rebuttal.
In Whitman Corporation,[fn32] the company successfully excluded a proposal that required the board to rescind a merger agreement with another company and to demand damages resulting from implementation of that agreement. The company noted that the merger had already been consummated and that even a unilateral repudiation by the company of the merger agreement would not unwind the merger. The company noted that the merger agreement referred to in the proposal did not allow unilateral termination, so the rescission recommended in the proposal would breach the terms of the merger agreement and violate Delaware law. The proponent's rebuttal did not address this exclusion.
In SL Industries, Inc.,[fn33] the SEC staff required the proponent to recast the proposal as precatory to avoid exclusion. The proposal mandated that any cash offer at 20% or more above market value must be presented promptly to shareholders. The company noted that while the New Jersey Business Corporations Act provides generally that shareholders have the right to approve or reject a proposed acquisition of the company, such shareholder action may only occur after the board has recommended the consummation of such acquisition. The company argued that implicit in this mechanism was the impracticability of removing from the board's discretion the ability to deal with proposals to acquire the company and placing such discretion in the hands of the shareholders. The company noted that shareholders did not have any practical means of properly evaluating offers and were not subject to a fiduciary standard of care with respect to one another. The proponent did not submit a rebuttal.

[fn31] 2000 SEC No-Act. LEXIS 427 (Mar. 23, 2000).

[fn32] 2000 SEC No-Act. LEXIS 203 (Feb. 15, 2000).

[fn33] 1999 SEC No-Act. LEXIS 715 (Aug. 30, 1999).

§ 15.05[E] Rights Plans

As indicated previously, the SEC staff's responses on proposals relating to shareholder rights plans have varied depending on the current state of the law in the particular jurisdiction and the quality of opinions provided.[fn34]

EXAMPLES:

In Health Risk Management, Inc.,[fn35] the company was allowed to exclude a proposal requiring that the company not adopt or maintain any rights plan without shareholder approval, and prohibiting amendment of the shareholder approval requirement except by a majority of shareholders. The company argued that only the board had authority to redeem a shareholder rights plan under Minnesota law. The proponent argued that at best, it is an unsettled question under Minnesota law whether a poison pill could be redeemed by shareholders and that the Minnesota Supreme Court was about to decide that issue. The proponent argued further that Minnesota law specifically recognized that the board's authority to adopt a poison pill was not supreme, and that once adopted by the board, a poison pill could be repealed by the "corporation" by amendment. The proponent argued that the term "corporation" included the company acting through its shareholders. In its response, the SEC staff cited the opinion of the company's counsel that implementation of the proposal would cause the company to violate Section 437 of the Minnesota Business Corporation Act.
In Illini Corporation,[fn36] the SEC staff required inclusion of a proposal requesting that the board redeem the rights issued pursuant to, or otherwise terminate or rescind, its rights plan and refrain from adopting any similar plan in the future without shareholder approval. The company argued that the rights agreement was the subject of certain lawsuits pending in Illinois, in which the plaintiffs alleged the rights agreement had already been triggered and asked the court to specifically enforce the rights agreement. If the Illinois court determined that the rights agreement had been triggered, the company urged, shareholders' rights under the rights agreement would have already vested. The company argued that requiring the board to redeem such rights or to try to amend or supplement the rights agreement under those circumstances would cause the company to breach its contractual obligations under the rights agreement. The proponent responded that the company had repeatedly taken the position publicly that the rights agreement had not been triggered. In addition, the proponent contended that if the rights agreement had already been triggered, any attempted redemption would constitute a null and void act and would not violate any law.

[fn34] See supra § 15.05[A].

[fn35] 2000 SEC No-Act. LEXIS 503 (Apr. 3, 2000).

[fn36] 1999 SEC No-Act. LEXIS 167 (Feb. 12, 1999).

§ 15.05[F] Operations

EXAMPLES:

In E.I. du Pont de Nemours and Company,[fn37] the proponent prevailed in a challenge to a proposal requesting that the board consider establishing a committee, to be comprised of members drawn from specified groups, to report to the board regarding the impact of the closure of company plants on various communities and to consider ways to mitigate this impact in the future. The company argued that the proposal would cause the company to violate the National Labor Relations Act because by including union representatives on the committee, the representative would be "making decisions on behalf of other units." The proponent responded that the proposal merely required the company to appoint a committee to submit a report to the board, who was free to accept or reject the report. The proponent noted that this was not bargaining and cited a labor court decision in support of this position. In addition, the proponent contended that when employees or union representatives are appointed to a committee, as trustees of a Taft-Hartley fund or even as corporate directors, they cease to act as representatives of the union, and must take a broader view. The proponent distinguished an earlier no-action letter because that letter had been issued before the cited labor court decision and because that proposal sought to require the company to bargain by providing for the committee to "weigh decisions on the closure of facilities. . . ."
In Storage Technology Corporation,[fn38] the company was required to include a proposal requesting that the company obtain shareholder approval for any expenditure exceeding $500,000 that was not clearly required in the normal course of its business. The company argued that the proposal could result in the violation of federal or state law and provided examples, such as not following a court order that required the company to make a payment (such as a payment in settlement of litigation or a payment of damages for which the company was found liable in litigation). The company noted that if it refused to pay such amounts due to the failure to obtain shareholder approval, the company would violate the law pursuant to which the payment was due. In addition, the company contended that it was a party to many existing contracts and debt obligations that from time to time required payments and that failure to make a contractually required payment would result in a breach of contract. The proponent urged that the company's examples were invalid, because these hypothetical situations would constitute normal business operations.

[fn37] 2000 SEC No-Act. LEXIS 384 (Mar. 6, 2000).

[fn38] 1999 SEC No-Act. LEXIS 341 (Mar. 18, 1999).

§ 15.05[G] Executive Compensation

EXAMPLES:

In Coca-Cola Company,[fn39] the SEC staff required the company to include a proposal requesting that the board adopt a policy to restrict the exercise of stock options by management within one year of an announcement of a significant workforce reduction. The company noted that it had issued stock options to officers under several option plans and that those options, by their terms, became exercisable on particular dates, which the company did not have the power to change unilaterally. Accordingly, implementing the proposal would cause the company to breach contractual obligations and thus violate state law. The proponent argued that it was neither the goal nor intention of the proposal to force the company to violate any laws and stated that he was willing to change the wording at the end of the proposal to add "provided that no state, federal or local law is violated by implementation." The staff did not require this revision.
In International Business Machines Corporation,[fn40] the company successfully excluded a proposal that related to the termination and renegotiation of the CEO's retirement package. The company argued that the board had no power to implement the proposal because it lacked the power to terminate and renegotiate his employment agreement unilaterally. The company noted that both a proposal requesting that the board "ask" a CEO to reduce his retirement package and one requesting that the board amend "the governing instruments" to accomplish the same purpose are excludable, as neither type of proposal can be implemented unilaterally if there is a binding employment agreement in place. The proponent replied that the company had not pointed to a provision in the employment agreement that would bar the company from asking the CEO to enter into a voluntary renegotiation.

[fn39] 2001 SEC No-Act. LEXIS 80 (Jan. 16, 2001).

[fn40] 2000 SEC No-Act. LEXIS 239 (Feb. 27, 2000).

§ 15.06 Practice Pointers

Company Practice Pointers

Spare legal opinion expense if possible. In its incoming request, a company is required to include a legal opinion that the law would be violated if a proposal is implemented. Since the staff will accept opinions from counsel that are not barred in a state, it is typically not necessary to obtain two opinions just because primary counsel is not barred in the company's state of incorporation. In other words, there normally is no reason to obtain an opinion from counsel barred in the applicable jurisdiction to back up another legal opinion if the matter is not complex.

Tie law to proposal. The manner in which a company frames its argument is important. First, companies should clearly demonstrate that the law relates to the subject matter of the proposal. Then, it should lay out precisely how the proposal would cause the company to violate the law. To bolster its case, a company should consider providing one or more examples of possible fact patterns that illustrate how the implementation of a proposal would violate the law.

Proponent Practice Pointers

Challenge the company's application of the law. If possible, proponents should demonstrate that the law cited by the company does not relate to the subject matter of the proposal. In addition, a proponent should try to explain how the proposal would not cause the company to violate the cited law.

Counter with own legal opinion. If a proponent believes that the company's interpretation of a law is not correct or that the law is unsettled, the proponent should include a legal opinion to that effect. The staff then has a basis to question the company's opinion and is much more likely to require the inclusion of the proposal or take a "no view" position.

Modify the proposal to avoid violating the law. If a proponent is unable successfully to challenge a company's legal opinion (or cannot afford to pay for a "competing" opinion), it should modify its proposal so that implementation would not violate the law. If the staff does not provide an opportunity to cure, this revised proposal can be submitted to the company for inclusion in the next year's proxy materials.

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