Monthly Archives: May 2021

The SEC’s Latest Risk Alert Puts ESG Investing in the Crosshairs

Jason M. Daniel and Cynthia M. Mabry are partners and Kenneth J. Markowitz is a consultant at Akin Gump Strauss Hauer & Feld LLP. This post is based on an Akin Gump memorandum by Mr. Daniel, Ms. Mabry, Mr. Markowitz, Cynthia Perez Angell, Leana N. Garipova, and Bryan C. Williamson. 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); and 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).

The Securities and Exchange Commission’s (SEC, or Commission) Division of Examinations (Division) recently issued a Risk Alert highlighting staff observations from examinations of investment advisers, registered investment companies and private funds (firms) engaged in environmental, social, and governance (ESG) investing. This post summarizes the Risk Alert, including focus areas and observations of deficiencies and internal control weaknesses, as well as recommendations of effective practices relating to ESG investing that may be helpful in developing and enhancing a firm’s compliance practices.

As investor demand for ESG information rises, the need for investment firms to align their disclosure with actual practice and to integrate compliance personnel into their ESG-related practices will continue to grow.

I. On which areas has SEC staff focused its examinations of firms engaged in ESG investing?

The staff continues to examine whether firms accurately disclose their ESG investing approaches and adopt and implement policies, procedures and practices that accord with their ESG-related disclosures. In particular, the staff noted that its examinations would focus on, among other matters, portfolio management, performance advertising and marketing and compliance programs.


Why is Corporate Virtue in the Eye of the Beholder? The Case of ESG Ratings

Dane Christensen is an Associate Professor in the School of Accounting and Charles E. Kern Research Scholar at the University of Oregon Lundquist College of Business; George Serafeim is the Charles M. Williams Professor of Business Administration and the Faculty Chair of the Impact-Weighted Accounts Project at Harvard Business School; and Anywhere Sikochi is an Assistant Professor of Business Administration at Harvard Business School. This post is based on their recent paper, forthcoming in the Accounting Review. 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); and Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock by Leo E. Strine, Jr. (discussed on the Forum here).

Despite the rising use of environmental, social, and governance (ESG) ratings, there is substantial disagreement across rating agencies regarding what rating to give to individual firms. This is highly problematic because in the absence of agreement on what good ESG performance constitutes, market participants might be misled by ESG ratings. We also have very little evidence on why providers disagree so much. Without understanding the reasons for this disagreement, it is difficult to understand not only what the potential remedies could be, but also the plausible consequences of this disagreement.

To address this, we focus on a key firm attribute that we hypothesize is likely to be of first-order importance in causing providers to disagree on ESG ratings. Specifically, we focus on the extent of a firm’s ESG disclosure, as theory suggests that disagreement arises due to people having different information sets and/or different interpretations of information. Conventional wisdom and a plethora of evidence in other settings suggest that higher disclosure helps lower disagreement by reducing differences in the information that people have. We argue that in our setting, due to the subjective nature of ESG information, the opposite would be true, where higher disclosure would increase disagreement, as disclosure expands opportunities for different interpretations of information.


What BlackRock Gets Right in its Newly Minted Human Rights Engagement Policy

Malcolm Rogge is a Research Fellow in the Corporate Responsibility Initiative of the Mossavar-Rahmani Center for Business and Government at Harvard Kennedy School, and a Lecturer at the University of Exeter School of Law. This post is a response to BlackRock’s 2021 Engagement Priorities. Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here); Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); and The Specter of the Giant Three by Lucian Bebchuk and Scott Hirst (discussed on the Forum here).

In March 2021, BlackRock Investment Stewardship published a short but consequential document titled “Our approach to engagement with companies on their human rights impacts.” This represents a significant move by the investment management firm into the global “business and human rights” policy debate. Based in New York City, BlackRock Inc. is the world’s leading investment firm with assets under management worth close to $9 trillion. A publicly traded company, it holds at least a 5% stake in more than half of the firms in the S&P 500. The value of its stock has increased 300% over the last decade. BlackRock’s priorities for 2021 include engaging with firms “whose business practices have breached international norms set forth by the UN Guiding Principles on Business and Human Rights (UNGPs) and the OECD Guidelines for Multinational Enterprises.” What does BlackRock get right in its newly minted global policy on international human rights? The answer to this question might not be what you expect.

As in many countries, asset managers in the United States are governed by fiduciary trust laws that give primacy to creating value for investors. If human rights are to be considered at all, asset managers are strongly compelled to consider them only in terms of their instrumental and material value to investors. This situation creates a conundrum for decision makers at firms like BlackRock, since the calculated instrumentalization of human rights for shareholder gain might well be seen to debase the very foundation of human rights.


SEC Reopens Universal Proxy Comment Period

Laura D. Richman is counsel and Robert F. Gray, Jr. is partner at Mayer Brown LLP. This post is based on their Mayer Brown memorandum. Related research from the Program on Corporate Governance includes Universal Proxies by Scott Hirst (discussed on the Forum here).

On April 16, 2021, the US Securities and Exchange Commission (SEC) issued a release reopening the comment period (Reopening Release) on its proposal for a mandatory universal proxy to be used for all contested director elections (Universal Proxy Proposal). [1]

On October 26, 2016, the SEC issued a release (2016 Proposing Release) on the Universal Proxy Proposal. [2] Under the Universal Proxy Proposal, each universal proxy card would list all management and dissident nominees for director, enabling shareholders voting by proxy to pick and choose among the different slates of candidates, similar to the manner in which they would be able vote for directors in person at a contested shareholders meeting. The SEC also proposed changes to proxy cards and proxy statement disclosure regarding voting standards and options applicable to all director elections. The comment period on the Universal Proxy Proposal ended on January 9, 2017, and the proposal has not been finalized.


The Choice for CEOs on Political Issues is Not “Yes or No”, It’s “Helps the Brand or Hurts the Brand”

Nell Minow is Vice Chair of ValueEdge Advisors. Related research from the Program on Corporate Governance includes Corporate Political Speech: Who Decides? by Lucian Bebchuk and Robert J. Jackson Jr. (discussed on the Forum here); The Untenable Case for Keeping Investors in the Dark by Lucian Bebchuk, Robert J. Jackson Jr., James David Nelson, and Roberto Tallarita (discussed on the Forum here); and  The Politics of CEOs by Alma Cohen, Moshe Hazan, Roberto Tallarita, and David Weiss (discussed on the Forum here).

The Michael Jordan reason for staying out of politics—”Republicans buy sneakers, too”—is no longer an option. There is no question whether corporations and their CEOs will take political positions; the only question is what those positions will be and how they are decided on and communicated.

Every public company makes asset allocations that include campaign contributions to candidates of both parties and lobbying expenditures, directly and through trade associations and other groups. Increasingly, however, the prevalent policy of hedging with contributions to every elected official is unacceptable. The Business Roundtable statement in 2019 about the vital importance of stakeholders as the best guarantee of long-term, sustainable growth and shareholder returns puts the burden on CEOs to be more specific about priorities and policies.


How the Robinhood IPO is Different

Jonathan Macey is Sam Harris Professor of Corporate Law, Corporate Finance and Securities Law at Yale Law School and Professor in the Yale School of Management.

Robinhood is a wildly popular discount broker/dealer whose specialty is providing easy entry into the addictive world of day trading for the newcomers it creatively recruits into the exciting world of equity trading. When Robinhood goes public, these new inductees to U.S. capital markets are about to find out how much the playing field is tilted against Main Street investors.

Unlike other initial public offerings, Robinhood is considering giving its own customers first dibs on the newly issued shares. These investors likely are going to learn the important lesson that if a deal seems too good to be true, then it probably is.

The usual first step in a public offering is to pre-market the new securities to folks who are either connected with the issuer or have good contacts with the investment banks in charge of underwriting the new shares, or both. But sophisticated investors are acutely aware of two structural features of the capital markets that ordinary investors fail to consider at their peril. First, insiders in control of companies selling their shares have much better information about what is going on in their companies than anybody else.


Proxy Season: Early Highlights and Emerging Themes

Richard Fields and Elizabeth Morgan are partners at King & Spalding LLP. This post is based on their King & Spalding memorandum.

The COVID-19 pandemic, volatile market conditions, and increasing stakeholder attention to a range of environmental and social topics made 2020 a remarkably difficult year for many public companies. 2021 will bring new challenges, as major investors and proxy advisors signal enhanced scrutiny of director nominees and executive compensation programs, as well as more openness to environmental and social shareholder proposals.

As many companies prepare for upcoming annual meetings, we take stock of early proxy season activity, highlighting early results and emerging themes relevant to corporate leaders.

Say on Pay. In the early days of the pandemic, some investors and proxy advisors cautioned companies that their pandemic-related pay actions would be put under a microscope, as a referendum not just on corporate performance but also on the level of commitment to their current compensation design when times got tough. While acknowledging the unprecedented effects on public companies, many suggested positive adjustments to pay would be viewed skeptically.

Early results show more scrutiny of pay than last year. Based on Proxy Insight voting results available on April 28, 2021, average support for all say on pay proposals has dropped roughly 1% in the Russell 3000 compared to calendar year 2020. Failures are also up over last year, with 3% of Russell 3000 companies failing so far this year, compared to roughly 2% last year.


SEC Examinations Risk Alert: Compliance Issues in ESG investing

Amy S. Matsuo is ESG and Regulatory Insights Lead at KPMG LLP. This post is based on her KPMG memorandum. 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); and 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).

The release of this SEC Division of Examination Risk Alert dramatically increases the velocity with which compliance and controls must be expanded to cover ESG-related activity. Firms that engage in ESG investing should review their current compliance controls in light of the compliance weaknesses outlined by the SEC, with particular focus on the accuracy of ESG-related disclosures and marketing materials and their alignment with actual ESG investing practices. Consistent with the identified effective practices, firms may also want to consider establishing documentation and record keeping requirements at various stages of the investment process (e.g., research, due diligence, selection, and monitoring). As a general matter, firms should consider the Risk Alert as applying traditional core concepts such as accurate and meaningful disclosure, due diligence (including KYC and third-party oversight), and customer/investor protections in a new and increasingly prevalent area. Likewise, chief compliance officers must consider this alert as impacting the scope and nature—and accelerating the timeline of change—of the annual reviews under the Investment Company Act of 1940 and the Investment Advisers Act of 1940. READ MORE »

Peer Effects in Corporate Governance Practices: Evidence from Universal Demand Laws

Alan Marcus is a Professor of Finance at Boston College Carroll School of Management. This post is based on a recent paper, forthcoming in the Review of Financial Studies, authored by Prof. Marcus; Pouyan Foroughi, Assistant Professor of Finance at York University; Vinh Q. Nguyen, Assistant Professor of Finance at The University of Hong Kong; and Hassan Tehranian, Professor of Finance at Boston College. Related research from the Program on Corporate Governance includes What Matters in Corporate Governance? by Lucian Bebchuk, Alma Cohen, and Allen Ferrell.

Corporations that share board members with other firms tend to have similar corporate governance practices. But this commonality is difficult to interpret. It may reflect peer effects, where governance practices propagate from one firm to another. Alternatively, it may reflect selection effects, where firms with similar preferences self-select into linked groups. Specifically, associations between corporate practice and board membership could arise from firms’ decisions to recruit directors who have already exhibited similar governance preferences. Moreover, omitted variable bias can result from unobserved common shocks that cause all firms in a board-interlocked network to adopt similar practices. We seek to identify the degree to which commonality can be cleanly attributed to the propagation of practice from one firm to another. In so doing, we provide evidence for a specific transmission mechanism: the interlocking board network.

We exploit the staggered adoption across states of changes in the legal environment, specifically, passage of Universal Demand (UD) laws, to disentangle peer effects from self-selection effects. We show that firms not subject to new legislation nevertheless change corporate practice when they are board-interlocked with peer firms that become subject to that legislation.


UK Proposals to Reform Listing Rules to Attract SPACs and Technology Companies

James Scoville is Partner, Vera Losonci is International Counsel, and Laurence Hanesworth is an Associate at Debevoise & Plimpton LLP. This post is based on a Debevoise memorandum by Mr. Scoville, Ms. Losonci, Mr. Hanesworth, and Milo Gordon-Brown.

Key takeaways:

  • The recent UK Listing Review has proposed changes to the UK’s listing rules and prospectus regime. This is seen as a positive step in bringing the UK equity market in line with more attractive non-UK financial centres, particularly the US.
  • One of the key recommendations is to relax rules for special purpose acquisition companies (SPACs), so that trading is not suspended once a potential acquisition is announced.
  • Financial Conduct Authority consultation is still required before any changes are brought into effect.

UK Listing Review—“Closing a Gap” with Other Markets

The UK Listing Review, chaired by Lord Hill and commissioned by Chancellor Rishi Sunak, published on 3 March 2021, has set forth a number of recommendations for amending the UK’s listing rules and prospectus regime. The proposals are intended to make the London Stock Exchange a more attractive listing venue for special purpose acquisition companies (“SPACs”) and technology companies, and to enhance the City’s post-Brexit standing. Lord Hill stated that the proposals are concerned with “closing a gap which has opened up” with respect to other markets.

Key Changes to SPAC and Tech Landscape

The proposals are aimed at attracting high-growth technology companies and SPACs. SPACs have gained significant popularity in the US markets, in part due to the relatively low risk of such transactions to investors, where shareholders in US-listed SPACs are typically able to vote on the acquisition of the target company and can redeem their shares immediately at the time of the business combination if they do not agree to the acquisition. By contrast, the UK SPAC market is considered to lag behind. In 2020, there were only a handful of SPAC listings in the UK, as opposed to 248 SPACs raising $83.4 billion in the US, a number that is expected to be even larger in 2021.

The key features of the new proposals are set out below.


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