Long-Awaited ESG Rules

Mary Beth Houlihan, Brad Green, and David Marcinkus are partners at Kirkland & Ellis LLP. This post is based on a Kirkland & Ellis memorandum by Ms. Houlihan, Mr. Green, Mr. Marcinkus, Alexandra Farmer, Nicole Runyan and Jennie Morawetz.

Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); Companies Should Maximize Shareholder Welfare Not Market Value by Oliver Hart and Luigi Zingales (discussed on the Forum here); Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Max M. Schanzenbach and Robert H. Sitkoff (discussed on the Forum here); and Exit vs. Voice by Eleonora Broccardo, Oliver Hart and Luigi Zingales (discussed on the Forum here).

On May 25, 2022, in a long-awaited move, the U.S. Securities and Exchange Commission (“SEC”) issued a pair of rule proposals related to the use of environmental, social and governance (“ESG”) investment practices by open-end and closed-end registered investment companies, as well as by business development companies (“BDCs,” and collectively, “funds”). The SEC’s stated goals with these proposals are to increase transparency and confidence in funds that consider ESG factors as part of their investment process, given the recent and ongoing dramatic growth in investor interest in ESG investing. The SEC believes that investors looking to participate in ESG investing currently face a lack of consistent, comparable and reliable information among funds that claim to consider one or more ESG factors.

The first proposal seeks to create a robust disclosure and reporting framework for funds regarding their ESG investment practices. To effectuate this goal, the proposal would make a number of amendments to the registration and reporting forms utilized by funds in their securities offerings and ongoing periodic reporting. While the SEC does not generally prescribe specific disclosures for particular investment strategies, the SEC believes that ESG strategies and disclosures differ materially in certain respects that necessitate specific requirements and mandatory content standards to assist investors in making more informed investment decisions.

The second proposal would amend Rule 35d-1 (the so-called “Names Rule”) under the Investment Company Act of 1940, as amended (the “Investment Company Act”), to, among other things, add new requirements for funds that consider ESG factors in connection with their investment practices. The SEC believes that the Names Rule, which has not been amended since its adoption over 20 years ago, has not kept pace with industry developments and product evolution. Additionally, the SEC emphasized that competitive pressures may incentivize asset managers to include words in a fund’s name as a way to attract investor assets—for example, terms related to ESG. Further, the SEC expressed concern that the current Names Rule may permit funds to depart, over time, from the investment focus suggested by their name. Importantly, the proposed amendments to the Names Rule also would have significant implications for non-ESG funds, especially for those funds that may invest in more illiquid assets (including funds of private funds), and would mark a significant change, as the rule does not currently apply to commonly used fund names that focus on investment strategies instead of particular investments, such as “growth” or “income” funds.

Each proposal was approved by the SEC in a 3-1 vote along party lines, with Commissioner Peirce dissenting. The proposals will remain open for public comment for 60 days after their publication in the Federal Register.


Paying Well By Paying for Good

Phillippa O’Connor is a Reward & Employment Leader at PwC United Kingdom, and Tom Gosling is an Executive Fellow in the Department of Finance at London Business School. This post is based on their PwC UK memorandum. Related research from the Program on Corporate Governance includes The Perils and Questionable Promise of ESG-Based Compensation (discussed on the Forum here) and The Illusory Promise of Stakeholder Governance, both by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); and Companies Should Maximize Shareholder Welfare Not Market Value by Oliver Hart and Luigi Zingales (discussed on the Forum here).

Market practice in the FTSE 100 shows the changing nature of ESG targets in executive pay

ESG targets are increasingly prevalent in pay

  • 45% of FTSE 100 companies have an ESG target in the annual bonus, the Long-term Incentive Plan (LTIP), or both
  • 37% use ESG in annual bonus with an average weighting of 15%
  • 19% of the FTSE 100 use ESG in LTIP with an average weighting of 16%
  • The most common category of measure in the bonus is Social, including measures focusing on diversity, employee engagement, and health & safety
  • The most common category of measure in the LTIP is Environmental, typically measures focusing on decarbonisation and the energy transition

The nature of ESG targets is changing, with increased use of Environment and Social targets, particularly in LTIPs

  • ESG targets relating to long-standing social and governance metrics such as health & safety, risk, and employee engagement have appeared in bonuses for some time. 33% of FTSE 100
    companies incorporate such “Old” ESG measures, 31% in the bonus and 7% in the LTIP
  • “New” ESG targets relate to more recently emerging stakeholder concerns, particularly around
    climate change, sustainability and diversity. 28% of companies have such measures, 18% in the bonus and 15% in the LTIP

A slight majority of ESG measures are output rather than input measures, with only a minority operating as an underpin

  • 55% of ESG measures in bonus, and 50% in LTIP, are output measures with a quantifiable goal—for example scope 1 and 2 emissions reductions in tonnes against baseline numbers
  • 31% of ESG measures in bonus, and 27% in LTIP, are input measures relating to specific activities a company undertakes—such as making investments in green energy sources
  • Only 14% of ESG measures in bonus, and 22% in LTIP, operate as an underpin, despite this
    approach being popular with some shareholders

Nearly half of current ESG metrics are not linked to material ESG factors

  • Over half (55%) of ESG targets are based on ESG dimensions categorised as material to the
    company under the SASB Materiality Map®. But equally, nearly half are not
  • Of the 45% of targets not deemed material in the SASB framework, nearly half (45%) relate to employee engagement or diversity & inclusion—whether this should be deemed immaterial will be a matter of debate. Diversity metrics commonly appear in financial services incentives, following the Women in Finance Initiative


Avoiding “Entire Fairness” Review in Claims against SPAC Boards through Corwin

James Jian Hu and Andrew Hammond are partners at White & Case LLP. This post is based on a White & Case memorandum by Mr. Hu, Mr. Hammond, Joel Rubinstein, and Jonathan Rochwarger, and is part of the Delaware law series; links to other posts in the series are available here. This post represents the authors’ individual views which should not be attributed to White & Case LLP. Related research from the Program on Corporate Governance includes SPAC Law and Myths by John C. Coates (discussed on the Forum here).

Special purpose acquisition company (“SPAC”) business combinations have provided a novel and difficult context to apply traditional fiduciary duty doctrines in Delaware law. Recently, in In re MultiPlan Corp. Stockholders Litigation, [1] the Delaware Chancery Court issued a ruling denying a motion to dismiss breach of fiduciary duty claims brought against a SPAC’s fiduciaries in connection with the SPAC’s 2020 de-SPAC transaction. While noting that “Delaware courts have not previously had an opportunity to consider the application of our law in the SPAC context,” the Court evaluated breach of fiduciary duty claims brought against the SPAC’s directors, officers and controlling stockholder under the “entire fairness” standard of review, due to alleged conflicts between the SPAC’s fiduciaries and public stockholders in the context of a value-decreasing transaction. These conflicts included the fact that each of the SPAC’s directors held founder shares that would be worthless if the SPAC did not complete a de-SPAC transaction.

Since the issuance of the MultiPlan decision, commentators have amply covered its rationales and holdings, which will not be repeated in this post. The authors of this post believe, however, that by following the roadmap set forth by the Delaware courts in Corwin v. KKR Financial Holdings LLC [2] and its progeny, it would be possible to lower the standard of review for the conduct of a SPAC’s board in connection with its initial business combination to the more deferential “business judgement rule” without having to ensure that there are independent directors who do not hold founder shares.

Corwin and Conflicted Directors Transactions

In Corwin, the Delaware Supreme Court held that when a transaction otherwise subject to enhanced scrutiny under Revlon is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies. The Corwin court did not squarely address the question of whether Corwin’s cleansing effect applies when a majority of the directors are conflicted. However, in dicta, the Corwin court noted that “[f]or sound policy reasons, Delaware corporate law has long been reluctant to second-guess the judgment of a disinterested stockholder majority that determines that a transaction with a party other than a controlling stockholder is in their best interests,” implying that Corwin’s cleansing effect could still apply in the absence of a conflicted controlling stockholder. [3]


It Pays For Companies To Leave Russia

Jeffrey A. Sonnenfeld is the Lester Crown Professor in the Practice of Management at the Yale School of Management. This post is based on a recent paper by Prof. Sonnenfeld,  Steven Tian, Steven Zaslavsky, Yash Bhansali, and Ryan Vakil, all of the Yale Chief Executive Leadership Institute, Yale School of Management.

Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); For Whom Corporate Leaders Bargain (discussed on the Forum here); Stakeholder Capitalism in the Time of COVID (discussed on the Forum here); and Does Enlightened Shareholder Value Add Value? (discussed on the Forum here), all by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita.

I. Introduction and Methodology

Since Russia’s invasion of Ukraine began in February 2022, the first author has led an intensive effort to track the responses of well over 1,200 public and private companies from across the globe, with almost 1,000 companies publicly announcing they are voluntarily curtailing operations in Russia to some degree beyond the bare minimum legally required by international sanctions.

The list has been, and continues to be, continually updated with new additions and new announcements by the first author’s team of two dozen experts with diverse backgrounds in financial analysis, economics, accounting, strategy, governance, geopolitics, and Eurasian affairs; with collective fluency in ten languages including Russian, Ukrainian, German, French, Italian, Spanish, Chinese, Hindi, Polish, and English. The dataset is compiled using not only public sources such as government regulatory filings, tax documents, company statements, financial analyst reports, earnings calls, Bloomberg, FactSet, MSCI, S&P Capital IQ, Thomson Reuters, and business media from 166 countries; but also non-public sources, including a sui generis global wiki-style network of 250+ company insiders, whistleblowers and executive contacts.

When the list was first published the week of February 28, only several dozen companies had announced their departure from Russia. In the two months since, this list of companies staying/leaving Russia has already garnered significant attention for its role in helping catalyze the mass corporate exodus from Russia, with widespread media coverage and circulation across company boardrooms, policymaker circles, and other communities of concerned citizens around the world. The authors have also written short editorials for The New York Times, The Washington Post, Fortune, amongst others; each of which were the most-read articles in their respective outlets for at least 36 hours upon publication.


The Lessons Behind Women’s Gains in Board Leadership

Molly Stutzman is Analyst of Corporate Research at JUST Capital. This post is based on her JUST Capital memorandum. Related research from the Program on Corporate Governance includes Politics and Gender in the Executive Suite by Alma Cohen, Moshe Hazan, and David Weiss (discussed on the Forum here); Will Nasdaq’s Diversity Rules Harm Investors? by Jesse M. Fried (discussed on the Forum here); and Duty and Diversity by Chris Brummer and Leo E. Strine, Jr. (discussed on the Forum here).

Last week, a California judge struck down a law passed in 2018 requiring publicly traded companies headquartered in the state to have at least one woman on their board. The move follows a similar ruling from a judge last month, deeming a state law passed in 2020 requiring companies to meet a quota of at least one racially, ethnically, or otherwise diverse board director unconstitutional. While the decision is a blow to board gender diversity advocates, and the state is expected to appeal it, the law’s impact is already clear. Analysis of board growth among California-based companies in 2021 found that more than half of new board appointees that year were women.

This trend has continued beyond the confines of California-headquartered companies. JUST analysis found that average board gender diversity in the Russell 1000 rose from 23.8% to 28.2% between 2019-2021. When we break these gains down by representation thresholds of 30%, 40%, and 50%, we see gains across each of these groupings. (Figure 1).

Figure 1: Percent of companies with board gender diversity at or above 30%, 40% and 50%.

In 2021, almost half (44%) of the corporate boards JUST Capital analyzed were composed of at least 30% women. Far fewer boards were composed of 40% or more women and only 3% of boards reached parity or had more than 50% women). Moreover, from 2019-2021, the percent of companies in all three thresholds grew by over 50%. Nevertheless, board diversity still has a long way to go to achieve gender parity, as evidenced by the slow growth in the highest threshold of 50% or more.


Weekly Roundup: June 17-23 , 2022

More from:

This roundup contains a collection of the posts published on the Forum during the week of June 17-23, 2022.

ESG Global Study 2022

New Climate-Related Financial Disclosures for Private Companies and LLPs

Corporate Racial Equity Tracker

The SEC’s Authority to Pursue Climate-Related Disclosure

“Minimum Standards” for Lawyers Practicing Before the SEC

When 9 is the Perfect Number

Chancery Court Continues to Reject Demand Futility Claims Post-Zuckerberg

Meeting Expectations for Board Diversity

Regulatory Solutions: A Global Crackdown on ESG Greenwash

Statement by Commissioner Peirce on the Regulatory Flexibility Agenda

Statement by Commissioner Peirce on the Regulatory Flexibility Agenda

Hester M. Peirce is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on her recent public statement. The views expressed in this post are those of Ms. Peirce and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

Chair Gensler’s Regulatory Flexibility Agenda [1] for the Securities and Exchange Commission sets forth flawed goals and a flawed method for achieving them. The agenda, if enacted, risks setting off the regulatory version of a rip current—fast-moving currents flowing away from shore that can be fatal to swimmers. Just as certain wave and wind conditions can create dangerous rip currents, [2] the pace and character of the rulemakings on this agenda make for dangerous conditions in our capital markets.

I. The Agenda Devotes the Agency’s Limited Resources to Rulemaking Proposals Disconnected from our Core Mission

The Agenda continues to shun issues at the core of our mission in favor of shiny objects outside our jurisdiction. We used to focus on companies’ disclosure of economically material information; we now focus on disclosure of hot-button matters outside our remit. [3] We once sought to protect retail investors; we now rush to the aid of professional investors. [4] We once worked to help small and emerging companies raise the funds that are their lifeblood; we now work to increase their costs and shrink their investor base. [5] We once hoped to increase the ranks of public companies by making it less costly and more beneficial to be public; we now look for ways to force companies to go public [6] since we are making it costlier to go public and be public. [7]


Proposal on Climate-Related Disclosures for Investors

Lawrence A. Cunningham is the Henry St. George Tucker III Research Professor at George Washington University Law School. This post is based on a comment letter by Professor Cunningham and 21 other Professors of law and finance.

Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy – A Reply to Professor Rock by Lucian Bebchuk, Alma Cohen, and Charles C. Y. Wang (discussed on the Forum here); and Stakeholder Capitalism in the Time of COVID, by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here).

This post is based on a comment letter sent to the SEC by Stephen M. Bainbridge (UCLA), Jonathan Berk (Stanford), Sanjai Bhagat (Colorado), Bernard S. Black (Northwestern), William J. Carney (Emory), Lawrence A. Cunningham (GW), David J. Denis (Pittsburgh), Diane Denis (Pittsburgh), Charles M. Elson (Delaware), Jesse M. Fried (Harvard), Sean J. Griffith (Fordham), Jonathan M. Karpoff (Washington), Scott Kieff (GW), Edmund W. Kitch (Virginia), Katherine Litvak (Northwestern) Julia D. Mahoney (Virginia), Paul G. Mahoney (Virginia), Adam C. Pritchard (Michigan), Dale A. Oesterle (Ohio State) Roberta Romano (Yale), Christina P. Skinner (Pennsylvania),and Todd J. Zywicki (George Mason).

We appreciate the contributions of colleagues who have commented on the SEC’s proposal for mandatory climate-related disclosure rules for public companies (the “Proposal”). In particular, we read with interest two letters analyzing whether the Proposal is within the SEC’s rulemaking authority: one from a group of thirty law professors (the “Thirty Professors’ Letter”) and another by Professor John Coates (the “Coates Letter”).

We are moved to offer additional thoughts because these two letters, compared to our prior letter, reflect divergent understandings of the nature and factual background of the Proposal. Moreover, we believe those different understandings will likely play a role in any challenge to final rules that may be adopted pursuant to the Proposal. Illuminating those differences will therefore assist the SEC and ultimately the federal courts.

We agree with the Thirty Professors’ Letter and the Coates Letter that the SEC has broad statutory authority to require disclosures for the protection of investors. We further agree that the relevant inquiry is whether a proposed disclosure requirement will protect investors, not whether it is material, although the two inquiries will generally overlap. Finally, we agree that the relevance of a disclosure requirement to a social issue or to non-shareholder constituents does not demonstrate, in and of itself, that it exceeds the SEC’s authority.

Indeed, the two letters make a strong case that the SEC’s 2010 guidance regarding climate change disclosures (the “2010 Guidance”) was a valid exercise of the SEC’s statutory authority. The 2010 Guidance reminded issuers that several elements of the existing disclosure framework, including disclosure of the material effects of compliance with laws and regulations, material pending legal proceedings, and material risk factors, may require disclosures relating to climate change.


Regulatory Solutions: A Global Crackdown on ESG Greenwash

Subodh Mishra is Global Head of Communications at Institutional Shareholder Services, Inc. This post is based on a publication by ISS Governance Research by Thomas Harding, Associate Vice President of Regulatory Solutions Product Development at ISS ESG; William Cowper, ESG Product Manager of Regulatory Solutions at ISS ESG; Karina Karakulova, Director of Regulatory Affairs and Public Policy, ISS; and Manpreet Singh Sandhu, ESG Specialist (Canada) at ISS ESG.

The meteoric global rise of ESG investing is increasingly being met with an equally ambitious regulatory disclosure regime, and, targeting greenwashing, policymakers are beginning to bare their teeth. In the latest salvo, on 25 May the US Securities and Exchange Commission (SEC) voted 3:1 to approve two proposals enhancing scrutiny of ESG funds and advisers’ ESG practices. One proposal seeks to expand the rule governing fund naming conventions and the other proposes additional disclosure requirements by funds and investment advisers about ESG investment practices.

Overview of SEC proposals

While the proposed changes to the Names Rule are ostensibly engendered by the growth in ESG-marketed funds, the proposal also captures other funds that have historically been out of scope of the Names Rule. The Commission estimates that ~ 8,250 (62%) funds are currently subject to the Names Rule and that the proposed rule amendments would increase this estimate to ~ 10,000 (75%) funds.

In a departure from its historical approach, the SEC now proposes to extend the 80% investment policy (i.e., a minimum of 80% of a fund’s assets must be consistent with its name) to apply to fund names that incorporate terms related to investment strategy, such as “growth” or “value,” and proposes circumstances under which deviations from the 80% policy are temporarily permitted. The proposal would require funds to define the terms used in a fund’s name in a way that is consistent with the term’s ‘plain English’ meaning or established industry use. These requirements would also extend to funds where the investment decisions incorporate one or more ESG factors.


Proposal on Climate-Related Disclosures Falls Within the SEC’s Authority

John C. Coates is the John F. Cogan, Jr. Professor of Law and Economics at Harvard Law School. This post is based on his recent comment letter. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy – A Reply to Professor Rock by Lucian A. Bebchuk, Alma Cohen, and Charles C. Y. Wang (discussed on the Forum here); Stakeholder Capitalism in the Time of COVID, by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); and Corporate Purpose and Corporate Competition by Mark J. Roe (discussed on the Forum here).

I write to comment on legal authority. The proposal is well within the Commission’s authority to adopt. Critiques on legal grounds fall far short of what would be needed for a court to overturn the rule.

Congress, having made a fundamental policy judgment to require “full and fair” disclosure to protect investors, directed the Commission to make ongoing subsidiary choices of precisely what details of disclosure to require and when, after engaging in fact-finding and analysis that Congress chose not to try to do itself.

Here, the proposal frames difficult, subsidiary choices, which divide reasonable observers. Those choices I do not here address. They require fact-finding and expert factual judgments about likely effects, costs, benefits and risks of alternatives, including inaction, in the face of investor needs that have led most large companies to publish inconsistent and variable climate-related disclosures. The Constitution, and Congress, have given the Commission—and not the courts—authority to make those judgments.

Throughout I describe rather than argue for what the law should be. Many legal issues are open to reasonable debate. However, many legal questions have clear answers. The proposed rule specifies the details of disclosure, just as Congress directed the Commission to do. It does not regulate climate activity itself (e.g., greenhouse gas emissions) and would have modest effects on the economy as a whole. It is authorized by clear statutes, is consistent with settled understandings, and addresses disclosure topics covered by rules adopted long ago by the Commission and ratified by Congress. It is not a “transformative” surprising regulatory departure, raising such a “major question” as to justify interpretive methods other than those of a faithful agent of Congress.

Nor has the “major questions doctrine” ever been used to overturn authority unambiguously granted by the plain text of a statute. “Clear statement” canons play no role when statutes speak clearly. Striking down regulations adopted pursuant to clear and limited delegated authority would turn the doctrine’s purpose against itself, prevent Congress from assigning traditional fact-finding and implementation roles to agencies, turn courts into unelected mini-legislatures, and subvert rather than reinforce the separation of powers.

Overturning this rule as unauthorized on that basis would wipe out most of the Commission’s disclosure rulebook. Nothing at stake in this proposed rule justifies such judicial lawmaking.


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