Monthly Archives: June 2022

Regulatory Solutions: A Global Crackdown on ESG Greenwash

Posted by Subodh Mishra, Institutional Shareholder Services, Inc., on
Thursday, June 23, 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 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.

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

Posted by John C. Coates (Harvard Law School), on
Wednesday, June 22, 2022
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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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Meeting Expectations for Board Diversity

Posted by David A. Bell, Dawn Belt, and Ron Llewellyn, Fenwick & West LLP, on
Wednesday, June 22, 2022
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David A. Bell and Dawn Belt are partners and Ron C. Llewellyn is counsel at Fenwick & West LLP. This post is based on their Fenwick 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).

Corporate boardroom diversity has increased significantly over the last few years, and the interest in and demand for gender and racial/ethnic diversity on boards of directors remain high. Lack of corporate board diversity has attracted the attention of shareholders, regulators, employees, customers and other stakeholders, resulting in regulations and various initiatives intended to increase the number of women and members of underrepresented communities serving on boards. Companies that fail to address this important issue do so at their own peril, as shareholders and other stakeholders have demonstrated an increased willingness to take action against companies lacking board diversity, including by voting against or withholding votes from existing directors or otherwise exerting public or commercial pressure. This post discusses board diversity trends and relevant regulations and initiatives and provides some recommendations for companies looking to achieve or increase board diversity.

Recent Board Diversity Trends

We have seen notable strides in achieving board diversity. According to the Missing Pieces Report by Deloitte and the Alliance for Board Diversity, in 2020 there were 347 companies with more than 30% board diversity in the Fortune 500, representing an approximately 21% increase from the number of companies exceeding 30% board diversity in 2018 and more than twice the number of companies in 2010. Similarly, the 2021 Spencer Stuart Board Index revealed directors from historically underrepresented groups—including women and Black/African American, Asian, Hispanic/Latino/a, American Indian/Alaska Native or multiracial men—accounted for 72% of all new directors at S&P 500 companies recently, with 47% of those new independent directors belonging to historically underrepresented racial and ethnic groups and 43% being women. There has also been a significant increase in gender diversity among the companies in the Fenwick – Bloomberg Law SV 150 List, with women directors of such companies representing 30.2% of directors, closing a historical gap with the larger companies in the S&P 100, as discussed in our 2021 Corporate Governance Practices and Trends report. Despite these recent gains, women and ethnic/racial minorities remain underrepresented in the boardroom. According to the Spencer Stuart Index, women and ethnic/racial minorities (including those identified as Black/African American, Hispanic/Latino/a, Asian, American Indian/Alaska Native and multiracial) still constitute only 30% and 21% of S&P 500 board members, respectively.

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Chancery Court Continues to Reject Demand Futility Claims Post-Zuckerberg

Posted by Sarah Runnells Martin and Daniel S. Atlas, Skadden, Arps, Slate, Meagher & Flom LLP, on
Wednesday, June 22, 2022
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Sarah Runnells Martin is counsel and Daniel S. Atlas is an associate at Skadden, Arps, Slate, Meagher & Flom LLP.  This post is based on their Skadden memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

In September 2021, in United Food and Commercial Workers Union v. Zuckerberg, the Delaware Supreme Court embraced the Court of Chancery’s suggestion that the analysis for evaluating demand futility in derivative cases should be streamlined. Rather than employing the prior Aronson v. Lewis or Rales v. Blasband standards, the Supreme Court set forth a new, three-part test that “is consistent with and enhances” those standards, so that “cases properly construing Aronson, Rales, and their progeny remain good law.” [1]

Under Zuckerberg, when ruling on a motion to dismiss where the plaintiff asserts demand futility, Delaware courts will examine whether a director: (1) received a material personal benefit from the alleged misconduct; (2) would face a substantial likelihood of liability on any of the claims that would be the subject of the litigation demand; or (3) lacks independence from someone who received a material benefit from the alleged misconduct, or would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand. If the answer to any of those questions is “yes” for at least half of the members of the board that would be considering the demand, then demand would be excused as futile. (See our September 28, 2021, client alert, “Delaware Supreme Court Issues Two Opinions Simplifying Delaware Law on Derivative Claims.”)

Since Zuckerberg, practitioners, companies and directors have watched to see how the new standard was applied, and if it would alter Delaware’s traditional approach to evaluating demand futility, including deference to directors’ ability to make decisions about litigation brought in the company’s name. In a series of opinions, discussed below, the Court of Chancery has applied the Zuckerberg formulation to evaluate director disinterest and independence and found that a demand would not have been futile.

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Competing Views on the Economic Structure of Corporate Law

Posted by Lucian Bebchuk (Harvard Law School), on
Tuesday, June 21, 2022
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Lucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance, and Director of the Program on Corporate Governance, at Harvard Law School. This post is based on his recent paper.

I recently placed on SSRN a new essay, Competing Views on the Economic Structure of Corporate Law.

This essay was written for the symposium issue of the University of Chicago Business Law Review celebrating the thirty-year anniversary of the publication of The Economic Structure of Corporate Law by Frank Easterbrook and Daniel Fischel (“E&F”). The essay discusses how my research in the economics of corporate governance over the years has engaged with E&F’s analyses, and our different approaches to the subject.

During the four decades since the E&F writings started to appear, my work has largely focused on the economics of corporate governance. In the course of this work, I paid significant attention to E&F’s writings. Indeed, a significant part of my research in the economics of corporate governance focused on issues also considered by E&F, engaged with their positions, and developed approaches different from theirs. The essay discusses these points in the context of five areas of corporate research that both E&F and I examined, offering substantially different conclusions:

Takeover policy and rules: I discuss E&F’s focus on the facilitation of hostile bids to the fullest extent possible, and I contrast it with my analysis of the benefits of takeover regulation that facilitates competing bids and ensures an undistorted choice for target shareholders.

Contractual freedom in corporate law: I discuss E&F contractarian approach, and I contrast it with my analysis of contractual imperfections and the role of mandatory rules in corporate law.

State competition in corporate law: I discuss E&F’s support for state competition in corporate law, and I contrast it with my analysis of the shortcoming of such competition and the beneficial role of federal law.

Efficiency and distribution in corporate law: I discuss E&F’s concern that any attention to fairness and distribution would impede efficient choices by corporate insiders, and I contrast it with my analysis showing how rules regarding the distribution of corporate payoffs can discourage opportunistic insider choices that would provide them with a larger fraction of the piece but would be overall value-decreasing.

Corporate purpose: Although both E&F and I oppose encouraging and relying on corporate leaders to protect stakeholder interests, we do so for different reasons and offer different approaches regarding the extent to which and the ways in which stakeholders should be protected by governmental rules and interventions.

The essay is available here, and comments would be most welcome.

When 9 is the Perfect Number

Posted by Rusty O'Kelley, Rich Fields, and Laura Sanderson, Russell Reynolds Associates, on
Tuesday, June 21, 2022
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Rusty O’Kelley co-leads the Board and CEO Advisory Partners in the Americas, Rich Fields leads the Board Effectiveness practice, and Laura Sanderson co-leads the Board and CEO Advisory Partners in Europe at Russell Reynolds Associates. This post is based on a Russell Reynolds memorandum by Mr. O’Kelley, Mr. Fields, Ms. Sanderson, PJ Neal, Jemi Crookes, and Elena Loridas.

No corporate director dreams of sitting on an ineffective board—yet many will find themselves serving on a board that underperforms relative to their expectations.

As part of our 2022 Global Director Behaviors and Board Culture study, over 1,100 directors shared insights about the people they serve with, how they focus their time and attention, and how well their board operates (including both its effectiveness and its overall culture). Not surprisingly, we are particularly interested in directors who rated their board as highly effective; a 9 or 10 on a 1-10 scale.

What is different about those boards that lead to such high performance? We developed a key driver model that assessed which behaviors among a 28-item inventory (related to communication, engagement, relationship building, perspective, and character, as well as specific leadership behaviors demonstrated by their chair) significantly impact board effectiveness. What we discovered was a framework we call the 7+2 Model for Highly Effective Boards:

To develop the most effective board possible, board leaders should look to assemble a group of directors who, as a collective group, always demonstrate seven behaviors:

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“Minimum Standards” for Lawyers Practicing Before the SEC

Posted by Jason Halper, Erica Hogan, and Adam Magid, Cadwalader Wickersham & Taft LLP, on
Tuesday, June 21, 2022
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Jason Halper and Erica Hogan are partners and Adam Magid is special counsel at Cadwalader Wickersham & Taft LLP. This post is based on their Cadwalader memorandum by Mr. Halper, Ms. Hogan, Mr. Magid, William Mills, James Orth and Jayshree Balakrishnan.

In remarks on March 5, 2022 on PLI’s Corporate Governance webcast, Commissioner Allison Herren Lee of the Securities and Exchange Commission stated that, 20 years after its enactment, it is time to revisit the “unfulfilled mandate” of Section 307 of the Sarbanes-Oxley Act of 2002 and establish minimum standards for lawyers practicing before the Commission. [1] Commissioner Lee, who announced that she will not seek a second term when her current one ends this month, took issue with what she called the “goal-directed reasoning” of some securities lawyers—that is, focusing primarily on the outcome sought by executives, rather than the impact on investors and the market as a whole. Such lawyering, Commissioner Lee observed, has a host of negative consequences, including encouraging non-disclosure of material information, harming investors and market integrity, and stymying deterrence. The solution, Commissioner Lee opined, is to fulfill the mandate of Section 307, which empowered the Commission to “issue rules, in the public interest and for the protection of investors, setting forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission in any way in the representation of issuers.” [2]

Over the last 20 years, the Commission has declined to adopt enhanced rules of professional conduct for lawyers appearing before the Commission. There are good reasons for the Commission’s inaction, including the attorney-client privilege, the goal of zealous advocacy, the fact-specific nature of materiality determinations, and the traditionally state-law basis for the regulation of attorney conduct. Commissioner Lee, moreover, did not propose specific new rules, and recognized that the task was difficult and should be informed by the views of the securities bar and other stakeholders. Nor did she say that action by the Commission was imminent; it is unclear whether the Commission has authority to promulgate new rules under Section 307 given a 180-day sunset under the statute that occurred in 2003. Indeed, neither Commissioner Lee nor any of the other SEC commissioners have issued statements on this topic since the PLI webcast. SEC Enforcement Director Gurbir Grewal has, however, indicated an increased emphasis on gatekeeper accountability in order to restore public trust in the market. [3] Nonetheless, given the Commission’s existing authority to impose discipline under its Rules of Practice, practitioners should be mindful of the potential for increased scrutiny moving forward.

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The SEC’s Authority to Pursue Climate-Related Disclosure

Posted by Jill E. Fisch (University of Pennsylvania), on
Monday, June 20, 2022
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Jill E. Fisch is the Saul A. Fox Distinguished Professor of Business Law and co-Director of the Institute for Law and Economics at the University of Pennsylvania Carey Law School. This post is based on a comment letter to the U.S. Securities and Exchange Commission by Prof. Fisch; George S. Georgiev, Associate Professor of Law at Emory University School of Law; Donna M. Nagy, C. Ben Dutton Professor of Business Law at Indiana University Maurer School of Law; and Cynthia A. Williams, Visiting Professor of Law at Indiana University Maurer School of Law and Professor of Law Emerita at the University of Illinois College of Law.

On behalf of the 30 undersigned law professors, all of whom teach and write on U.S. securities law and capital markets regulation, we welcome the opportunity to provide our views on the Commission’s recent proposal related to the enhancement and standardization of climate-related disclosures for investors (the “Proposal”). We focus on a single question—whether the Proposal is within the Commission’s rulemaking authority—and we unanimously answer this question in the affirmative. We base this conclusion on the analysis set out below. We do not all agree on the policy issues facing the Commission with respect to the optimal scope of environmental, social and governance (ESG) disclosure, including climate-related disclosure. But we all share the view that the Commission has ample, longstanding, and clear authority to promulgate disclosure rules in this area.

1. The Plain Text, Legislative History, and Judicial Interpretation of the Securities Laws Support the Commission’s Authority to Mandate Climate-Related Disclosures

The federal securities laws establish the Commission as the primary regulator of the capital markets, and Congress instructed the Commission, through those laws, to regulate the markets through an extensive disclosure regime for publicly traded companies. The Commission’s statutory authority over disclosure is broad. In 2018, then-Chairman Jay Clayton described the Commission’s disclosure system as “powerful, far reaching, dynamic and ever evolving” and noted that “[a]s stewards of this . . . system, a key responsibility of the SEC is to ensure that the mix of information companies provide to investors facilitates well-informed decision making.”

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Corporate Racial Equity Tracker

Posted by Kavya Vaghul and Ashley Marchand Orme, JUST Capital, on
Monday, June 20, 2022
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Kavya Vaghul is Senior Director of Research and Ashley Marchand Orme is Director of Corporate Equity at JUST Capital. This post is based on a JUST Capital memorandum by Ms. Vaghul, Ms. Orme, Aleksandra Radeva, Daniel Krasner, Kim Ira, and Molly Stutzman. 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).

In the two years since the killing of George Floyd and other Black Americans ignited a national reckoning with racial injustice, dozens of America’s largest companies have made unprecedented commitments to advancing racial equity in their workplaces and communities. Last year, we began tracking these commitments—as well as the concrete actions corporate America was beginning to take—as part of our 2021 Corporate Racial Equity Tracker. Below, we’ve updated our Tracker with the latest corporate performance data on these issues, tracking whether companies are making progress toward their goals, two years on.

With our recent survey research showing that 92% of Americans overall (up from 79% last year) and 95% of Black Americans believe it is important for companies to promote racial diversity and equity in the workplace, the demand for action on corporate commitments has only increased—especially considering that 68% of Americans, and 87% of Black Americans, agree companies have more work to do.

The 2022 Corporate Racial Equity Tracker offers an in-depth accounting of the commitments and actions announced by the 100 largest U.S. employers, through 23 metrics across six specific dimensions of racial equity:

  • Anti-Discrimination Policies
  • Pay Equity
  • Racial/Ethnic Diversity Data
  • Education and Training Programs
  • Response to Mass Incarceration
  • Community Investments

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Proposed ESG Disclosure Requirements for Investment Advisers and Investment Companies

Posted by Laura Ferrell, Sarah Fortt, and Betty Huber, Latham & Watkins LLP, on
Monday, June 20, 2022
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Laura Ferrell, Sarah Fortt, and Betty Huber are partners at Latham & Watkins LLP. This post is based on a Latham memorandum by Ms. Ferrell, Ms. Fortt, Ms. Huber, David Berman, Paul Davies, and Nicola Higgs. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Will Corporations Deliver Value to All Stakeholders? (discussed on the Forum here) both by Lucian A. Bebchuk and Roberto Tallarita; 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 A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here).

Key Points:

  • The proposal on ESG disclosures for investment advisers and registered investment companies would introduce requirements for advisers and registered funds that consider ESG factors in their investment processes to disclose more about those factors’ role in investment decisions.
  • The Names Rule proposal would extend the 80% investment policy requirement to registered funds with names that suggest the fund focuses on investments/issuers with particular ESG characteristics.
  • Together, the proposals make the United States just the latest in a series of jurisdictions to establish sustainability disclosure regimes for investment products, increasing global compliance challenges.

On May 25, 2022, the US Securities and Exchange Commission (the SEC or the Commission) proposed rules that would require registered and exempt investment advisers (Advisers) as well as registered investment companies (Registered Funds) to provide standardized environmental, social, and governance (ESG) disclosures to their investors and the Commission (referred to herein as the ESG disclosures proposal). The SEC also proposed amendments to Rule 35d-1 (the Names Rule), which governs naming conventions for Registered Funds (referred to herein as the Names Rule proposal).

The proposed rules, if adopted as proposed, would require information on the ESG factors that Advisers and Registered Funds consider in making investment decisions, as well as how those factors are used in the investment process.

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