Corporate Governance

Rule 14a-8, the Ordinary Business Exclusion, and the Need for Reform: Bank Policies and Loan Foreclosures (Part 3)

By J Robert Brown Jr.

We are discussing the "ordinary business" exclusion in Rule 14a-8 in the context of the staff's recent decision not to permit Citigroup and Bank of America to exclude proposals that requested reports connected to the current mortgage foreclosure crisis.  The proposals were brought by the NYC Pension Funds.  Their recent annoucement is here. 

Citigroup sought to exlude the proposal on a number of grounds (vague, substantially implemented), particularly the "ordinary business" exclusion.  See Rule 14a-8(i)(7).  The financial institution argued that the proposal implicated its day to day business operations.  The first part of the resolution (the need for the audit committee to conduct a review) "improperly attempts to control fundamental aspects of the Company's operations, including loan modifications, foreclosures and securitizations." 

As for the second portion, specifically the segment that asked for a report discussing whether management allocated sufficient an trained staff to the area, Citigroup had this to say:

• Presumably, the Proponent is referring to trained staff located in the businesses that cover loan  modifications, foreclosures or securitizations.  If this is the case, then the Proposal implicates the type  of fundamental  and complex matters that  are  improper for stockholder proposals because they involve tasks that are fundamental to  management's ability to run a company on a day-to-day basis and delve too deeply into the complex day-to-day operations of a company.

Admittedly the proposal implicated personnel matters.  But it merely asked the audit committee to undertake an evaluation.  Presumably, this allows management to consider all requisite complexities and to explain them to shareholders.  In other words, the process suggested in the proposals did not avoid the complexities but provided a mechanism for embracing them.

Citigroup also argued that the excludability of the provision was not overriden by its public importance.  Although ackowledging that "the Staff has found that certain proposals requiring reports  arguably touching  on  specific day-to-day  matters  are  not  excludable  as  relating  to ordinary business matters", the proposal in this case was distinguishable. 

• The  Company  believes,  however, that those proposals  are distinguishable because the reports requested touched on day-to-day matters that were directly related to a narrowly-circumscribed social policy issue, such that the reports did not request an undue level of intricate detail and did not implicate a broad range  of day-to-day management issues,  such as the  allocation of trained  staff in the mortgage  division.

Instead, the policy sought to "micro-manage the Company" and "directly implicates the detailed and complex day-to-day business decisions and policies  involving the Company's loan servicing and securitizations operations."  The financial institution likened the proposal to others that invovled "particular products or services" that hae been found "repeatedly" by the staff to be excludable.  Citigroud also conceded that the staff had not allowed the exclusion of proposals relating to "predatory lending practices" but that:

• the  main thrust of the Proposal is to micro manage the Company's lending  operations, including the  determination of whether it has allocated a sufficient number of trained staff or addressed financial  incentives relating to foreclosure.  As discussed above, the Proposal relates to ordinary business issues, including the Company's internal  controls,  lending,  personnel decisions and investment   activities. Thus, under the precedents  discussed above, the  Proposal  is  excludable under  Rule       14a­ 8(i)(7) regardless of whether the Proposal also touches upon a significant policy issue.

The staff ultimately rejected the reasoning.  The no action letter had only a short explanation.  The staff apparently found that the proposal invovled the "ordinary business" of the Company but could not be excluded because of the public importance of the matter.  According to the staff's letter issued to Citigroup: 

• We are unable to concur in your view that Citigroup may exclude the proposal under rule 14a-8(i)(7). That provision allows the omission of a proposal that "deals with  a matter relating to the company's ordinar business operations." In view of the public debate concernng widespread deficiencies in the foreclosure and modification processes  for real estate loans and the increasing recognition that these issues raise signficant  policy considerations, we do not believe that Citigroup may omit the proposal from its proxy materials in reliance on rule 14a-8(i)(7).

The issues surrounding the "ordinary business" exclusion and some proposed reforms are discussed in much greater detail in Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.

Full post as published by The Race to the Bottom on March 31, 2011 (boomark / email).