Monthly Archives: May 2022

ESG Task Force “Lifts the Vale” on Its Scrutiny of ESG Disclosures

Posted by Alexander May, Charles Riely, and Gabrielle Sigel, Jenner & Block LLP, on
Tuesday, May 31, 2022
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Alexander May, Charles Riely, and Gabrielle Sigel are partners at Jenner & Block LLP. This post is based on their Jenner & Block 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); Will Corporations Deliver Value to All Stakeholders? by Lucian A. Bebchuk 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 Leo Strine (discussed on the Forum here); Stakeholder Capitalism in the Time of COVID, by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here).

Since early 2021, the SEC has emphasized that ESG-related issues are important to investors and a key SEC disclosure and enforcement priority. Although the agency’s heightened focus on these issues led to the recent proposal for new climate disclosures, the SEC also has made clear that it would seek to bring cases under existing law and not wait for new rules to be passed. 

The reality that the SEC Enforcement Division is on the ESG beat was reinforced late last month, when the Climate and ESG Task Force filed charges against a Brazilian mining company—Vale, SA. Vale describes itself as the world’s largest producer of iron ore, pellets, and nickel. The case stems from an investigation opened after one of the company’s dams collapsed, causing over 200 deaths and dramatic environmental damage. In its complaint, the SEC alleged that Vale made misstatements about its dam’s safety and engaged in deceptive conduct that concealed it had committed misconduct in obtaining required certifications related to dam safety. After the SEC filed action, Vale indicated that it denied the allegations in complaint and intended to defend the action.

The SEC’s approach to the Vale litigation provides a roadmap for public companies to consider how ESG-related disclosures and statements will be scrutinized when the company is impacted by adverse events that are ESG-related. It illustrates that companies should be prepared for the SEC to closely scrutinize statements about risk in ESG disclosures such as sustainability reports or climate impact analyses. This post discusses the SEC’s case against Vale and real-world “lessons learned” for all public companies when publishing materials about ESG, climate, and operational risks.

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Board Gatekeepers

Posted by Yaron Nili (University of Wisconsin), on
Tuesday, May 31, 2022
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Yaron Nili is Associate Professor of Law and the Smith-Rowe Faculty Fellow in Business Law at the University of Wisconsin Law School. This post is based on his recent paper, forthcoming in the Emory Law Journal. Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

In September of 2016, news broke that employees at Wells Fargo had been moving customers’ funds into newly created fake accounts—without customer consent—in order to boost their sales figures. For outsiders, the aftermath was shocking; regulators fined Wells Fargo $3 billion and Wells Fargo fired 5,300 employees. But for the board of directors, the now-infamous scandal must have been like watching a slow-moving freight train for years. The Office of the Comptroller of the Currency found that the Wells Fargo board had known about fudged sales numbers for eleven years before the scandal broke. And while four directors resigned in the aftermath of the scandal as a result of their lack of oversight, a central question remained: what had caused the board of a reputable, established, highly regulated enterprise to overlook a scandal in the making for over a decade? In other words, investors and regulators alike pondered: “[w]here were the Independent Directors?”

But the issues with Wells Fargo’s board went beyond the rank-and-file directors serving on the board. Wells Fargo’s board included a Lead Independent Director (LID) who was meant to serve as gatekeeper, limiting management’s influence over the boardroom and further solidifying the board’s independence. But, as the Wells Fargo scandal demonstrates, having a designated LID does not necessarily effectuate true independence. In fact, the Federal Reserve has placed direct blame on Wells Fargo’s LID, stating in a letter that “you did not appear to lead the independent directors in pressing firm management for more information and action, even after you were aware of the seriousness of the problems” and that “[a] lead independent director is appointed to… provide an alternative view of, and (when necessary) check on, executive directors of the board and the management of the firm. Your performance in that role is an example of ineffective oversight.”

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Corporate Governance Update: Solving the Board Composition Puzzle

Posted by David N. Katz and Laura A. McIntosh, Wachtell, Lipton, Rosen & Katz, on
Tuesday, May 31, 2022
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David N. Katz is partner and Laura A. McIntosh is consulting attorney at Wachtell, Lipton, Rosen & Katz. This post is based on an article first published in the New York Law Journal. 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).

Determining the proper composition of a public company board is a bit like trying to find the solution to a challenging, dynamic puzzle. Once solved, the puzzle updates to a slightly different configuration that then requires a new answer. With a limited number of board seats to fill, nominating committees must identify director candidates who satisfy the company’s substantive needs, applicable regulatory requirements, and investor demands. Moreover, as the needs of the company evolve and as directors complete their terms, board composition must be continually re-evaluated to ensure that the expertise and other qualities of the board as a whole are well-suited to the company’s ongoing challenges and strategy. Regulatory intrusion into board sovereignty, though intended for the benefit of the public interest, makes solving this puzzle much more difficult and risks reducing the effectiveness of directors, both individually and as a group. Recent state court decisions striking down board diversity mandates in California present an opportunity to consider the current regulatory context and the realities facing nominating committees and boards today.

Board composition is governed by an overlapping array of regulatory requirements. These laws and rules, while well-intentioned, have the effect of limiting board discretion in an area where it is vital. Early regulatory action focused on director independence, while more recent efforts—such as the California laws—have been aimed at increasing board diversity. In recent years, institutional investors and proxy advisors have also linked their voting recommendations to certain parameters of board diversity. Diversity is certainly a key factor in board composition today. Yet statutory diversity requirements have met with resistance even as momentum toward board diversity grows in corporate America. With this momentum has come a gradual expansion of the working definition of “diversity” among some of the strongest proponents of increased board diversity. A broader definition of “diversity” would be beneficial if it facilitates the work of nominating committees in identifying candidates whose skills, background, and personal characteristics represent the right solution at the right time for their boards and companies.

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Transparency Paves the Road to Net Zero

Posted by Subodh Mishra, Institutional Shareholder Services, Inc., on
Monday, May 30, 2022
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Subodh Mishra is Global Head of Communications at Institutional Shareholder Services. This post is based on an ISS ESG memorandum by Viola Lutz. 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 Leo Strine (discuss 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).

Key Takeaways

  • Transparency is the foundation of a successful Net Zero transition. Given heightened concerns about what has been described as ”the climate emergency,” transparency about where actors stand on climate issues is crucial. Companies and financial institutions alike need to disclose medium-term action so it can be scrutinised, allowing for the identification of gaps that need to be tackled.
  • Standards setters and regulators are driving transparency, from the Task Force on Climate-related Financial Disclosures (TCFD) to the US Securities and Exchange Commission (SEC) and the International Sustainability Standards Board (ISSB). The development of a comprehensive global baseline of sustainability disclosures could significantly promote transparency further.
  • Active ownership via engagement and voting, together with litigation by shareholders and other stakeholders, are increasingly motivating enhanced disclosure. Shareholder proposals requesting disclosure of emissions reductions goals remained one of the top climate-related proposals in 2021.
  • The market needs to become more transparent: 71% of companies in the STOXX USA 500 and 73% within the STOXX Europe 600 are disclosing all material Scope 1, 2 and 3 emissions and 23% (STOXX USA 500) and 47% (STOXX Europe 600), respectively, have an emission reduction target approved by the Science Based Targets initiative (SBTi). Larger companies are driving overall transparency performance, but there is pressure for the rest of the market to step up.
  • Financial institutions are increasingly expected to report transparently on their climate change-related governance practices. This could involve climate competency within boards, explicit structures for climate oversight, and clear responsibilities for climate strategy and risk management, along with prioritising real economic impact over “virtual” emission reductions.

Introduction

Addressing climate change will require increased transparency. The low-carbon transition is a hugely complex undertaking. Knowing where different actors stand in transition efforts and what unresolved technological and organizational problems exist can help direct investments, research and development efforts, and rapid policy responses to climate change. This post examines the drivers of an increased focus on transparency around climate change, how regulatory action is shaping up, and the non-regulatory measures being taken by a variety of actors, such as litigation and active ownership strategies. The complete publication (available here) concludes with an investigation into what this means for the finance industry.

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Board Gender Diversity

Posted by Holly Fetter, Stephanie Teh, and Aneta McCoy, State Street Global Advisors, on
Sunday, May 29, 2022
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Holly Fetter is Assistant Vice President of Asset Stewardship, Stephanie Teh is Vice President, and Aneta McCoy is Officer of Asset Stewardship at State Street Global Advisors. This post is based on their SSgA memorandum.

To understand market-specific challenges and equip companies with best practices for diversifying boards, we recently conducted an engagement campaign with portfolio companies in markets that have relatively high or low representation of women directors compared to their economic and regional peers. What follows are insights and best practices identified in these engagements.

Key Takeaways

Through our conversations with portfolio companies, we learned about challenges that boards encounter when recruiting women directors. For example, some companies described how regulatory requirements to diversify boards have led to an increased demand for a limited pool of qualified local director candidates who are women. We have observed that, in response to these challenges, boards have implemented a variety of practices, including:

  • Having a strong commitment to board diversity as a key element of effective governance;
  • Thoughtfully planning the optimal board composition;
  • Creating an inclusive candidate search;
  • Establishing robust board refreshment processes;
  • Setting measurable board diversity goals and implementing accountability measures;
  • Creating and cultivating a safe environment for diverse board members to share their perspectives; and
  • Preparing new directors to succeed with effective onboarding processes.

Background

State Street Global Advisors encourages greater board diversity through engagements with portfolio companies and through our proxy votes. As described in our Guidance on Diversity Disclosures and Practices, we expect all portfolio companies across the globe to have at least one woman director on their boards. Since the launch of our Fearless Girl campaign in 2017, 948 (more than 60%) of the 1,548 companies we identified in major indices with all-male boards have added at least one woman director. [1]

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Top Three ESG Legal Issues to Watch in 2022

Posted by Paul Davies, Nicola Higgs, and Sophie Lamb, Latham & Watkins LLP, on
Sunday, May 29, 2022
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Paul Davies, Nicola Higgs, and Sophie J. Lamb Q.C. are partners at Latham & Watkins LLP. This post is based on a Hart Energy publication. 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 Leo E. Strine, Jr. (discussed on the Forum here); Stakeholder Capitalism in the Time of COVID, by Lucian 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).

Governments, regulators, non-governmental organizations, the private sector and other important stakeholders worldwide continued to emphasize ESG issues in 2021. The energy sector was no exception to this trend as companies and investors were confronted with a host of ESG issues including the transition to a net-zero economy, evolving emissions reporting requirements and a growing focus on supply chains. Given the societal importance that is now placed on ESG issues, Latham & Watkins LLP expect this growth trend to continue throughout 2022.

There are three ESG-related developments and trends that will likely impact the world of energy in 2022.

1. Supply chains: tracking new legal proposals

Governments and regulators are increasingly looking to require large (typically multinational) companies to take further steps to manage their value chain. The European Commission is expected to formally propose a mandatory supply chain due diligence law in early 2022.

In the U.S., on Dec. 23, 2021, President Biden signed into law the Uyghur Forced Labor Prevention Act (UFLPA) in response to purported human rights abuses against Uyghurs and other ethnic minorities in the Xinjiang Uyghur Autonomous Region (XUAR).

The UFLPA represents a significant expansion of existing U.S. restrictions on items imported from, or with links to, the XUAR. The previous restrictions were limited to specific categories of items and items produced by specific suppliers. However, the UFLPA goes further by imposing a rebuttable presumption against imports from, or linked to, the XUAR. This effectively prohibits the import into the U.S. of such products unless the importer can clearly demonstrate that the item was produced free from forced labor or human rights abuses.

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2021 Climate & Voting Review and Global Trends

Posted by Subodh Mishra, Institutional Shareholder Services, Inc., on
Saturday, May 28, 2022
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Subodh Mishra is Global Head of Communications at Institutional Shareholder Services, Inc. This post is based on a publication by ISS Governance Research.

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).

Key Takeaways

  • In 2021 as in 2020, the majority of environmental and social-related shareholder proposals around the world were related to climate change and/or climate lobbying. More than half of the climate-related proposals were seen in the financial sector, the oil & gas sector, and the mining sector.
  • Climate related shareholder proposals were seen in 14 markets in 2021—Australia, Canada, Denmark, Finland, France, Japan, New Zealand, Norway, South Africa, Spain, Sweden, Switzerland, the United Kingdom, and the United States—compared to 12 markets in 2020. There were 88 climate-related shareholder proposals that were voted on in 2021 compared to 65 in 2020.
  • Shareholder proposals requesting disclosure of emissions reductions goals remained one of the most prolific type of climate-related proposal in 2021. Globally, the average level of support received by these proposals was 42.1 percent in 2021, up from 29.2 percent in 2020. Shareholder proposals requesting “Say on Climate” votes received average 32.7 percent support in 2021.
  • 2021 was the first year in which management-presented “Say on Climate” proposals were seen, with 26 worldwide. 19 were at European companies, 3 in North America, 3 in South Africa and 1 in Australia. On average, the proposals received approximately 93 percent support in 2021. So far in 2022, the majority of similar proposals have also been at European companies.
  • The number of management-presented “Say on Climate” votes in 2022 to date is already higher than in full year 2021 (36 votes to date in 2022 compared to 26 for the full year in 2021). But the extent to which this will result in a sustained rise in Say on Climate votes beyond 2022 is difficult to forecast.

Introduction

This post follows the 2020 ISS Climate & Voting report that came out last year and first documented and explained the trends of climate-related issues as seen through the lens of shareholder voting at company general meetings.

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Repricing Underwater Options

Posted by Colin J. Diamond and Henrik Patel, White & Case LLP, on
Saturday, May 28, 2022
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Colin J. Diamond and Henrik Patel are partners at White & Case LLP. This post is based on their White & Case memorandum.

Public companies in a number of sectors have recently experienced a significant decline in their share price. In addition, the conflict in Ukraine and macro-economic factors continue to impact the economy. Nevertheless, the labor market remains tight and companies are struggling to retain talent. This goal can be undermined when stock options awarded during better times are “underwater” and have therefore lost much of their incentive value. Pressure can quickly mount on boards and management to address this mismatch by “repricing” such underwater options.

This is not the first time that a large number of public companies have faced this challenge. The need to conduct repricings occurs during prolonged downturns or sector realignments. There were a total of 264 stock option repricings announced between 2004 and 2009. [1] This included high-profile companies, such as Alphabet (then Google), Intel, Starbucks and Williams Sonoma. [2] Since that time, generally favorable market conditions have made repricings less common, with only a handful occurring each year. It is therefore of particular importance that companies facing this challenge understand the lessons and practices from earlier waves of repricings.

1. Structuring Repricings

1.1 One-for-One Exchanges

Option repricings were traditionally effected by the relatively simple mechanic of lowering the exercise price of underwater options to the then-prevailing market price of a company’s common stock. This was achieved either by amending the terms of the outstanding options or by canceling the outstanding options and issuing replacement options. The majority of repricings that occurred during the 2001 and 2002 market downturn were one-for-one option exchanges. At that time, the majority of new options had the same vesting schedule as the canceled options and only a minority of companies excluded directors and officers from repricings.

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Statement by Chair Gensler on Proposed Updates to Names Rule

Posted by Gary Gensler, U.S. Securities and Exchange Commission, on
Friday, May 27, 2022
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Gary Gensler is Chair of the U.S. Securities and Exchange Commission. This post is based on his recent public statement. The views expressed in this post are those of Chair Gensler, and do not necessarily reflect those of the Securities and Exchange Commission or the Staff.

Today [May 25, 2022], the Commission is considering a proposal to update the Names Rule. I am pleased to support this proposal because, if adopted, it would modernize this key rule for today’s markets and enhance the transparency of the asset management field.

A fund’s name is often one of the most important pieces of information that investors use in selecting a fund. Thus, when first enacting the Investment Company Act of 1940, Congress included provisions about fund naming conventions. These provisions were amended in 1996 to authorize the Commission to define registered investment company names as “materially deceptive or misleading.” [1]

Based on that authority from Congress, the agency adopted the Names Rule in 2001. Under the current Names Rule, if a registered investment company’s name suggests it has a focus in particular investment types, industries, or geographies, or that it has tax-exempt status, the fund must adopt a policy to invest at least 80 percent of the value of its assets consistent with its name.

A lot has happened in our capital markets in the past two decades. As the fund industry has developed, gaps in the current Names Rule may undermine investor protection. In particular, some funds have claimed that the rule does not apply to them—even though their name suggests that investments are selected based on specific criteria or characteristics.

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Statement by Commissioner Peirce on Proposed Updates to Names Rule

Posted by Hester M. Peirce, U.S. Securities and Exchange Commission, on
Friday, May 27, 2022
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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.

Thank you, Mr. Chair, and thank you to the staff in the Divisions of Investment Management and Economic and Risk Analysis, and the Office of the General Counsel, and to others at the Commission who worked on this proposal. Thank you for meeting demanding deadlines under considerable pressure and for fielding my many questions with unwavering professionalism. Despite my admiration for the effort that went into this initiative and my appreciation for some of the motivating concerns, I cannot support today’s proposed amendments to the Names Rule.

A fund’s name helps investors cut through the jungle of investment company options available to them. It only does so, however, if it accurately describes the fund. Section 35(d) of the Investment Company Act, which outlaws “deceptive or misleading names,” [1] and the Names Rule, which the Commission adopted in 2001, recognize the outsized role a fund’s name plays in the investment selection process. [2] Of course, even a perfectly fitting name carries only a bit of information about a fund, and we must encourage investors to look beyond names to fund disclosure documents.

In the twenty-one years since the Names Rule’s inception, much has changed in the mutual fund industry and the way investors consume information. Revisiting Rule 35d-1 to see if it is performing for investors as designed and, if not, issuing additional guidance or even amending the rule makes sense. Hence, the Commission’s March 2020 request for comment on the rule. [3] I therefore was hoping to be able to support the proposal to amend to the Names Rule. The proposed amendments, however, may create more fog than they dissipate and may place unnecessary constraints on fund managers. Accordingly, I cannot support it.

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