Saturday, July 11, 2015
This week, the Third Circuit issued is long-awaited decision in Trinity Wall Street v. Wal-Mart Stores, Inc. (.pdf), detailing its reasons for its earlier holding that Trinity Wall Street’s shareholder proposal addressing gun sales was excludable from Wal-Mart’s proxy statement. The decision is interesting in several respects, not the least of which is an apparent split among the panelists regarding the shareholder wealth maximization norm.
[More under the jump]
As most readers probably know, Trinity Wall Street, a wealthy Episcopal parish and Wal-Mart stockholder, submitted a stockholder proposal to Wal-Mart requesting that the Board provide oversight and standards regarding the sale of products that threaten public safety. Though the proposal did not address guns specifically, the narrative explained that the proposal was aimed at guns with high-capacity magazines. The proposal noted that the sale of dangerous products threatened Wal-Mart's reputation and its brand.
Wal-Mart sought to exclude the proposal as pertaining to “ordinary business operations”; the SEC concurred in a no-action letter. Trinity filed a lawsuit in Delaware federal court seeking to force the inclusion of the proposal in Wal-Mart’s proxy materials. The district court ruled in favor of Trinity; on appeal, the Third Circuit reversed. The Circuit acted quickly, in a brief order, to allow Wal-Mart to print its proxy materials; it has now issued its full opinion.
The opinion begins and ends by scolding the SEC for failing to develop any workable guidance as to what counts as “ordinary business operations” in the context of social responsibility proposals. In this, the Third Circuit is in good company; the SEC’s inconsistency in this area has been a source of scholarly and judicial ire for decades. In truth, the SEC’s own words on the topic are comical in their circularity – proposals that deal with day-to-day business are excludable unless the “underlying subject matter transcends the day-to-day business matters of the company and raises policy issues so significant that it would be appropriate for a shareholder vote.” 2009 WL 4363205. In other words, a proposal is excludable as too mundane for a shareholder vote as long as it is not significant enough for a shareholder vote. Good to know.
After acknowledging the SEC’s inscrutability on this issue, the panel nonetheless sought to determine the scope of the ordinary business exclusion by reference to the precise wording of SEC regulations and guidance. And here, the panel split, offering slightly different interpretations of the rule.
In particular, two members of the panel – Judges Ambro and Vanaskie – held that a court must determine whether a proposal addresses ordinary business operations and, if so, whether the proposal nevertheless “transcends” the day-to-day business of the corporation. The latter prong requires that the proposal be “divorced from how a company approaches the nitty-gritty of its core business.”
Under this test, Trinity’s proposal was excludable. It failed to “transcend” ordinary business because, despite the larger social goals at stake, the proposal itself addressed Wal-Mart’s precise product mix, which constitutes the “meat” of a retailer’s responsibility. The majority distinguished this case from proposals dealing with discrimination in hiring (one of the key contexts in which the law regarding social responsibility proposals was developed) because hiring, while important, is not the “essence” of a business.
So, as I understand the majority’s view, no matter how socially significant a proposal, there are some aspects of a company’s core business that are off-limits to shareholder commentary. For a retailer, that includes the actual products on the shelves.
The majority sought to reconcile its interpretation with the SEC’s past decisionmaking in this area. In particular, the SEC refused to allow Phillip Morris to exclude a proposal that would have asked it to exit the tobacco business, and refused to allow a gun manufacturer to exclude a proposal requesting that it exit the firearms business. In the majority’s view, these situations were distinguishable from Trinity's proposal because they concerned a company's single product line, and decisions about whether to continue to manufacture that one product line did not involve matters of day-to-day judgment. Or, as the majority put it, when a company only manufactures a single product, “its daily business deliberations do not involve whether to continue to sell the product to which it owes its reason for being.” Thus, any proposals on that subject do not concern day-to-day business operations. For a retailer like Wal-Mart, by contrast, decisions about which products among many to include on its shelves are “precisely the sort of business decisions a retailer makes many times daily,” therefore constitute “ordinary business.”
I find the majority’s reasoning here to be deeply unconvincing. First, as the amicus brief of corporate and securities law professors points out, there are other situations – such as The Kroger Co., 2000 WL 486232 (April 12, 2000) – where the SEC has refused to allow retailers to exclude proposals concerning individual product lines.
But more importantly, the majority’s reasoning, unmoored from any serious policy engagement, misses the forest for the trees. Stockholders have three basic methods for signaling their disagreement with management: they can vote, they can sell, or they can sue. Voting and suing are sharply limited by legal rules that embody the principle that the details of management are best left to managers; selling is meant to be the default stockholder response to unsatisfactory management. The problem, though, is that selling is often a very weak signal, because the source of the stockholder’s discontent may not be clear. Arguably, then, the stockholder should have greater power to vote his or her views when selling will not be sufficiently communicative.
When the stockholder’s objection is to the company’s entire business model – its raison d’etre – selling actually does send a pretty clear signal. If enough investors share the stockholder’s views, the company (and its peers) will suffer from depressed stock prices, and it won’t be hard to infer that investors are steering clear of certain industries.
But when the stockholder only objects to a single product line among many at a particular retailer, selling won’t send much of a signal at all – even if other investors follow suit. There are just too many variables involved. Therefore, the case for allowing a stockholder vote – if only to allow investors to communicate their views to management – is stronger.
Moreover, as a practical matter, it is impossible to imagine that any significant number of stockholders would vote to tell Phillip Morris to exit the tobacco business, precisely because any shareholders who feel that strongly about the matter are not likely to invest in the first place. But it is easy to imagine a company might have a significant number of stockholders who generally agree with a company’s business strategy but would like to see adjustments on moral grounds. The Third Circuit’s rule has the perverse effect of allowing a stockholder vote only on those proposals least likely to garner significant support.
Judge Shwartz's concurrence, which reached the same result but for different reasons, was equally odd. Judge Shwartz disagreed with the majority’s approach to distinguishing excludable ordinary business proposals from nonexcludable ones; in Judge Schwartz’s view, even proposals concerning the company’s core business are permissible so long as they implicate a sufficiently significant social policy. Fair enough.
But Judge Shwartz found that Trinity’s proposal failed to implicate a “significant” social policy because Trinity framed its proposal in terms of the benefits to Wal-Mart – namely, its brand and its reputation. As Judge Shwartz put it, “How Wal-Mart would like others to view it is a unique company interest, and while certainly important to shareholders seeking a return on their investment, it is not of broad societal concern.”
In other words, social responsibility proposals will only transcend ordinary business when they are couched in moral terms, unmoored from the specific benefits conferred on the company itself.
This is remarkable for a number of reasons.
For one thing, it would exclude almost all social responsibility proposals as they are currently drafted. These kinds of proposals almost always include some kind of company-benefit “hook,” even though the proposing stockholder’s actual interest in the topic is transparently much broader in scope. So, for example, in the infamous case Medical Committee for Human Rights v. SEC, 432 F.2d 659 (D.C. Cir. 1970) – which Judge Shwartz cites – the Medical Committee proposed that Dow Chemical cease selling napalm for use as a chemical weapon. Obviously, the Committee’s interest was moral, but it couched its proposal in terms of the public relations harm to the company. Similarly, the Cracker Barrel case – concerning sexual orientation discrimination – inspired the SEC’s modern approach to social responsibility proposals. That proposal, too, was couched in terms of public confidence in the company, and the need to obtain the productive services of employees.
There are good reasons why social responsibility proposals are drafted in this manner. First, the SEC will only allow stockholder proposals to be included in the proxy at all if they are “significantly related” to the company’s business. 17 C.F.R. 240.14a-8(i)(5); see also 2009 WL 4363205 (requiring that a “sufficient nexus exist between the nature of the proposal and the company”). Stockholders who do not discuss the impact on the company itself risk having their proposal excluded for relevance.
Second, there is an ongoing question regarding the extent to which institutional stockholders – pension funds, etc – may, consistent with their fiduciary duties, vote for proposals that accomplish social goals that are financially detrimental to the company itself. Cf. Andreas G. F. Hoepner, Michael Rezec & Sebastian Siegl, Does Pension Funds’ Fiduciary Duty Prohibit the Integration of Environmental Responsibility Criteria in Investment Processes?; David H. Webber, The Use and Abuse of Labor’s Capital.
Third, corporate directors arguably are barred from explicitly adopting value-destroying policies that advance social causes without providing offsetting benefits to the corporation. This is particularly true in Delaware (where Wal-Mart is incorporated), because Delaware does not have a constituency statute allowing directors to consider non-stockholder interests. Thus, a stockholder proposal that does not at least include a figleaf of a corporate benefit might be excludable on the ground that it requests directors to violate their state-imposed fiduciary duties to the company.
In faulting Trinity’s proposal for recognizing the benefits to Wal-Mart, Judge Shwartz seems to be implicitly rejecting the notion that directors have a fiduciary duty to manage the corporation only in the stockholders' interests. This stands in notable contrast to the views of Judges Ambro and Vanaskie, who held that Wal-Mart’s management has a duty to “manag[e] the company in the best interests of its shareholders.”
In sum, the Third Circuit's ruling is unmoored from any broader corporate theory and adds to the perpetual confusion on the issue of the proper scope of the stockholder franchise. That said, as the court itself acknowledges, the real fault here can be laid at the feet of the SEC - and it's up to the SEC to fix it.