Senate Republicans are introducing legislation directing retirement plan sponsors to select investments solely based on monetary factors, an extension of the position adopted by the Trump Administration Department of Labor. The sponsors to the legislation defend it by arguing that retirement accounts should be off limits to politics. The debate stems from the increasing criticism of pension and mutual funds that incorporate environmental, social, and governance (ESG) factors into their investment policies.

In challenging investment managers’ focus on ESG data, however, critics conflate two distinct issues. A body of empirical literature makes the claim that ESG data is relevant to evaluating a company from an economic perspective. We term this a “value-based ESG strategy.” For example, portfolio managers may invest in companies that they believe face strong growth prospects because they have products to help in the mitigation and adaption of climate change, or in companies that have strategies which will enable them to transform their business models in the fact of climate change. This is a value-based strategy. Of course, this assumes a particular perspective on the risks associated with climate change—one can argue that climate change is not real or that, even if it is, regulators will not impose costly changes on companies. The point, however, for such portfolio managers climate change is an economic risk, and their incorporation of climate-related data is a value-based investment strategy.

Investors who believe you can make money by investing in companies that are addressing this problem can invest in the BlackRock Future Climate and Sustainable Economy ETF (BECO). Notably, BECO purports to be investing for value, not values, stating that it “seeks to maximize total return by investing in companies that BlackRock Fund Advisors (“BFA”) believes are furthering the transition to a lower carbon economy.” Similarly Morgan Stanley touts its sustainable equity funds as outperforming their traditional peer funds.

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Amendments to the charters of Delaware corporations are advisable as a result of a new amendment, effective August 1, 2022, to the Delaware General Corporation Law (the DGCL) that permits the extension of exculpation rights to executive officers.

Delaware law has long permitted a corporation to include a provision in its certificate of incorporation that eliminates or limits the personal liability of directors for monetary damages arising from their breaches of fiduciary duty, subject to basic exceptions. Delaware has now amended Section 102(b)(7) to expand this exculpation right to be available to cover executive officers as well.

This amendment to the DGCL is a response to the increasing frequency of shareholder suits where the plaintiffs name executive officers, including general counsels, as defendants. Often these suits follow the closing of a sale of the corporation. It is not uncommon for such suits to include a claim that the general counsel breached his or her duty of disclosure in connection with the preparation of the merger proxy statement or Schedule 14D-9. Others have alleged that the general counsel engaged in conduct that impeded the fulfillment of the Revlon duty to seek the best price reasonably available when selling control of the corporation. In some of these cases, the courts have dismissed claims against some of the pre-closing directors, because they were exculpated under the corporation’s charter, but allowed claims to proceed against the pre-closing officers, because, prior to this amendment to Section 102(b)(7), they could not be exculpated from personal liability in a similar manner.

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With political battle lines drawn over environmental, social and governance (ESG) disclosures, it is fair to ask whether the sustainability movement is itself sustainable. As a registered Republican (Crowley) and a registered Democrat (Eccles), we do hope that it proves to be sustainable because we see this movement as fundamental to how the capital markets can support the well-being of all Americans. But the movement is currently facing grave political challenges. The underlying reason for this is the conflating of material risk disclosures wanted by investors and resisted by companies with related political issues. Being clear about the distinction between the two would be useful to both parties.

Many Democrats see ESG as an opportunity to pursue desired social change through collective action in the form of democratic capitalism.  Most Republicans view the ESG movement as an offshoot of the Green New Deal and therefore akin to thinly-veiled Marxism.  While there may be some truth to both views, neither accurately reflects marketplace and regulatory developments over the past quarter century.  Indeed, the history of major downturns in our financial markets is largely a history of management failure to disclose known business risks in time for investors to avoid catastrophic losses.  When such failures have become widespread, Congress and the U.S. Securities and Exchange Commission (SEC) have routinely stepped in to require additional corporate disclosures.  This article will retrace some of the key developments in order to demonstrate that sustainability is not new, nor is it mainly about scoring social justice warrior points.  Rather, it is about what regulations are necessary to ensure that the assumption of risk by investors is adequately informed.

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The American Law Institute (ALI) is currently working on a Restatement of the Law of Corporate Governance (“Restatement”). As with all Restatements, the purpose of the proposed Restatement is to clarify “the underlying principles of the common law” that have “become obscured by the ever-growing mass of decisions in the many different jurisdictions, state and federal, within the United States.” As I argued in my paper, Do We Need a Restatement of the Law of Corporate Governance?, corporate law is virtually unique in being dominated by the law of a single jurisdiction; namely, Delaware. Given the prominence of Delaware law in this field, the proposed Restatement is unlikely to be influential.

In my new paper, A Critique of the American Law Institute’s Draft Restatement of the Corporate Objective, I turn to an assessment of a key provision of the proposed Restatement; namely, § 2.01, which purports to restate the objective of the corporation. Section 2.01 differentiates between what the drafters refer to as common law jurisdictions and stakeholder jurisdictions. The latter are those states that have adopted a constituency statute (a.k.a. a non-shareholder constituency statute).

The tentative draft of § 2.01 was approved by the ALI membership at the Institute’s annual meeting. My article is intentionally agnostic on the underlying normative issue of whether corporations should focus exclusively on shareholder interests or should also consider stakeholder interests. Instead, it offers a critique of § 2.01 and offers suggestions so as to clarify important open questions and better align § 2.01 with current law.

The drafters assert that, in common law jurisdictions, the corporate objective is to “enhance the economic value of the corporation, within the boundaries of the law . . . for the benefit of the corporation’s shareholders . . ..” In doing so, corporation is allowed to consider the impact of its actions on various stakeholders, provided doing so redounds to the benefit of shareholders.

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ESG ratings are intended to provide information to market participants (investors, analysts, and corporate managers) about the relation between corporations and non-investor stakeholders interests. They do so by sifting masses of data to extract insights into various elements of environmental, social, and governance performance and risk. Investors rely on this information to make investment decisions, while corporations use ratings to gain third-party feedback on the quality of their sustainability initiatives.

Recently, ESG ratings providers have come under scrutiny over concerns of the reliability of their assessments. In this post, we examine these concerns. We review the demand for ESG information, the stated objectives of ESG ratings providers, how ratings are determined, the evidence of what they achieve, and structural aspects of the industry that potentially influence ratings. Our purpose is to help companies, investors, and regulators better understand the use of ESG ratings and to highlight areas where they can improve. We find that while ESG ratings providers may convey important insights into the nonfinancial impact of companies, significant shortcomings exist in their objectives, methodologies, and incentives which detract from the informativeness of their assessments.

Demand for ESG Information

Demand for ESG information has exploded in recent years. Ten years ago, the term ESG—although in existence—was rarely used by the investment community or in corporate boardrooms. Instead, public and professional interest was focused on the general concepts of corporate responsibility, sustainability, and impact investing. Only recently has the focus on ESG (environmental, social, and governance) as a unique concept come to the forefront and with it an explosion in the demand for information (see Exhibit 1).

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This post is based on a comment letter submitted to the SEC regarding the Proposed SEC Climate Disclosure Rule by Professor Rajgopal. Below is the text of the letter with minor adjustments to eliminate the correspondence-related parts.

I write in support of your proposed climate risk disclosures. To frame my comments, it is useful to summarize what the climate risk disclosure rule would require registrants to disclose:

• the firm’s governance of climate-related risks and relevant risk management processes;
• how any climate-related risks identified by the firm have had or are likely to have a material impact on its business and consolidated financial statements, which may manifest over the short-, medium-, or long-term;
• how any identified climate-related risks have affected or are likely to affect the firm’s strategy, business model, and outlook; and
• the impact of climate-related events and transition activities on the line items of a registrant’s consolidated financial statements, as well as on the financial estimates and assumptions used in the financial statements.

My support is based on my assessment of the costs and benefits of the proposal. Let us start with the costs.

1. Compliance costs are not a significant portion of market capitalization

On page 390 of the proposal, the SEC estimates costs in the first year of compliance to be around $640,000 and annual costs in subsequent years to be $530,000 for larger companies. On page 399, the SEC estimates assurance costs for large companies to be around $75,000 to $145,000. A well-done academic paper by Alexander et al. (2013) estimated the average annual costs of complying with section 404(b) for accelerated filers at $1.2 million.

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The ascendance of SPACs in U.S. capital markets has attracted intense regulatory scrutiny from federal officials, especially the SEC. This federal attention on SPACs is natural, as at first glance the SPAC appears to be simply an alternative to the conventional IPO, itself regulated chiefly at the federal level. The SPAC, however, is critically different from the IPO. An IPO is a transaction: the issuer sells stock, and public purchasers buy it, and the issuing corporation owes no fiduciary duty to the IPO purchasers. By contrast, the SPAC is an entity, not a transaction. And in fact SPACs are a very particular kind of entity: a standard corporation, organized usually under the laws of Delaware. My paper is the first to examine the corporate law dynamics of SPACs in detail, and it makes two distinct claims.

First, it demonstrates that the SPAC industry has exhibited a striking disregard of corporate law, failing to live up to basic equitable and statutory expectations under existing doctrine. Compared to other public corporations, the SPAC adopts a highly idiosyncratic governance model. The SPAC vests near-despotic control over all substantive decision-making in the hands of the sponsor. And SPAC boards are always populated by persons selected by the sponsor and often classified, making it impossible to wrest control from the sponsor during the life of the SPAC. The merger vote is engineered to achieve success, as the redemption right and warrants induce stockholders to vote in favor of a transaction regardless of their views on its merits, and the redemption decision likewise affords public holders limited influence. At the same time, the all-powerful sponsor has a deep conflict of interest with public holders. With a business combination, the sponsor secures a 20% stake, a potentially gargantuan reward. Without one, the sponsor’s stake is worth nothing. The result is that the sponsor has two incentives at odds with the public holders: to pursue any transaction, regardless of its advisability for public stockholders, and to obscure that fact from public stockholders to minimize redemptions. The sponsor acts unconstrained by any customary corporate mechanism for handling conflicted situations, as there are no disinterested decisionmakers anywhere in the SPAC. A SPAC thus offers its business combination to the public holder as a take-it-or-leave-it proposition, from which the investor has a custom-built remedy that is reputed to be complete. I call this approach the private fund model, as it broadly characterizes the structure that prevails among private investment funds.

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Human capital is a critically important source of corporate value creation in the modern economy, yet disclosures related to what executives commonly refer to as their “most important asset” have been extremely limited relative to those of other asset classes. This was supposed to change in November 2020 when the SEC’s amendment to Regulation S-K took effect. The new rules require that filers provide expanded discussion related to the firm’s human capital (HC) as part of Item 1 (i.e., the business description section) of their 10-K filing. The new rules are principles-based, however, so they allow for a tremendous amount of discretion without stipulating any specifics as to what companies should disclose. Early critics expressed concern that this approach would lead to too much heterogeneity in HC disclosures, that it was fraught with the potential for “greenwashing,” and that it would otherwise not yield the comparable quantitative data that investors need to properly assess corporate performance.

Our study provides the first comprehensive descriptive evidence required to assess the efficacy of the new regulation that has been subject to widescale criticisms in the investment community. We use textual analysis to extract the linguistic features and numerical intensity of HC disclosures for more than 3,000 unique public companies (i.e., all 10-K filers with corresponding financial data available), each reporting for the first time under the new regulation.

A number of interesting, stylized facts emerge from our analysis. First, consistent with anecdotal accounts, we provide systematic evidence that there is tremendous cross-sectional variation in the amount, numerical intensity, tone, readability, and similarity of HC disclosures both in absolute terms, and when benchmarked against the rest of the contents of the firm’s Item 1 disclosures. Although this may seem like good news from a regulatory perspective to the extent that it suggests that firms are not providing totally uninformative boilerplate disclosures, a less sanguine interpretation of the evidence is that the low level of similarity—even for firms within the same industry—will make it harder for investors to compare HC performance across firms.

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Many in politics and the media question the economic efficacy and ethical provenance of share repurchases, a ubiquitous corporate financial activity. Most recently, the federal government’s proposed 2022 budget disclosed their aims to curb repurchase activity with a one percent tax on all repurchases and to bar executives from selling shares for three years after a repurchase (see recent coverage by the New York Times). Our key question is whether evidence supports the critiques used to justify these and other anti-repurchase initiatives.

Our primary contribution is large-sample evidence on the trends and effects of share repurchases by US corporations. Specifically, we document trends in repurchases, and compare trading volume, share price performance, CEO pay, and corporate financial activities (e.g., investment and profitability) of firms in three groups: those that intensively repurchase shares, those that do so sparingly, and those that do not at all. We also provide a brief outline of the common economic rationale for and criticisms of share repurchases. However, our goal is not to rehash the numerous conceptual rationales in defense of share repurchases, nor argue that there are no cases when repurchases could be misused. Instead, we provide large-sample evidence on whether repurchases are systematically abusive, as suggested by some proponents of significant regulation.

There are several reasons why corporations might prefer using share repurchases instead of or in addition to dividends, including (i) maintaining flexibility in determining the amount of cash returned to shareholders, (ii) an ability to award repurchased shares to employees as equity compensation, (iii) a modest tax advantage to shareholders (that became less pronounced after the 2003 dividend tax cut), and (iv) the ability to send a credible signal of the firm’s (good) prospects.

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This post is based on a comment letter submitted to the SEC regarding the Proposed SEC Climate Disclosure Rule by James R. Copland and Bernard S. Sharfman. Below is the text of the letter with minor adjustments to eliminate the correspondence-related parts.

We respectfully submit this letter as a means to bring to the Commission’s attention deficiencies that we have found in its proposed rule, The Enhancement and Standardization of Climate-Related Disclosures for Investors (“the Proposed Rule”). In our view, the Proposed Rule fails to comply with Congress’s demand that agency actions not be “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law,” as interpreted by the Supreme Court to require an agency to “examine the relevant data and articulate a satisfactory explanation for its action including a rational connection between the facts found and the choices made.” Nor does the Proposed Rule comport with the “unique obligation” Congress has given the SEC to “to consider or determine whether an action . . . will promote efficiency, competition, and capital formation.” The Proposed Rule also runs afoul of the Constitution’s commitment to federalism and separation of powers, both by substantially interfering with corporate governance, a creature of state law, without an express Congressional mandate, and by resolving a “major question” of policy clearly within the province of the legislative branch. Because the Proposed Rule’s disclosure requirements are not “purely factual and uncontroversial,” they also implicate the First Amendment’s prohibition against government-compelled speech. Although our analysis can apply more broadly to much of the Proposed Rule, we are providing comments clarifying this critique in significant detail as to two Sections of Part II of the Proposed Rule: Section G: GHG Emissions Metrics Disclosure (“Section G”) and Section D: Governance Disclosure (“Section D”).

I. Section G: GHG Emissions Metrics Disclosure

Our analysis of Section G focuses on how the Proposed Rule fits within the statutory requirements laid down by Congress in the Administrative Procedures Act (“APA”) and the securities laws. We divide our analysis into three Parts. Part A focuses on the Proposed Rule’s required disclosures for Scope 1 and 2 emissions, which are not limited by a materiality standard. Part B focuses on the required disclosures for Scope 3 emissions, which purportedly do face a materiality requirement. Part C focuses on deficiencies in the Proposed Rule’s articulation of “investor demand” purporting to justify the need for Section G disclosures.

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Recent financial market events have splashed onto the front pages of newspapers the often-overlooked plumbing found in those markets: the clearinghouses that handle trillions of dollars’ worth of securities and derivatives trades. During the Robinhood and GameStop events, the National Securities Clearing Corporation, a securities clearinghouse, played a critical role when it required Robinhood to provide collateral to guaranty its open positions. And recently, FTX US Derivatives, a cryptocurrency exchange, brought further attention to the clearing business and the critical risk mitigation and containment function it provides to the financial system when it applied to the Commodity Futures Trading Commission to offer clearing services for non-intermediated margined crypto derivatives.

Given the magnitude of the trades crisscrossing clearinghouses every day, these vital market infrastructures warrant more scrutiny than they have received. My article calls for policymakers to focus on the existing governance and financial structure of clearinghouses and urges them to seriously address a critical open issue in their organization: the misaligned incentives across clearinghouses’ main stakeholders—particularly their shareholders and their members—and how that misalignment might affect clearinghouses’ risk profile and financial resilience.

Clearinghouses are, in fact, corporations with a unique financial structure. Clearing members are financial institutions that access clearing services. While such members are the ultimate risk bearers of the business, they lack any formal governance rights over the firm. Instead, clearinghouses are controlled by their shareholders, who are large publicly-listed for-profit financial infrastructure groups. These shareholders retain all governance rights, yet have extremely limited financial skin in the game.

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In The Long and Winding Road to Financial Reporting Standards we reviewed the history of how accounting standards came to exist in the U.S. as Generally Accepted Accounting Principles (U.S. GAAP) issued by the Financial Accounting Standards Board (FASB) and international Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). We showed that it took years and was simultaneously tedious and contentious. Such is the world of standard setting of any kind. Here we examine the state of financial reporting standards today to draw some lessons for the work of the International Sustainability Standards Board (ISSB) which has just begun.

As our previous piece made clear, standards are social constructs, not something grounded in the laws of physics. While there may be technically worse answers there is never a single “scientifically correct” one. Standards enable and influence the dialogue between the companies who use them for reporting and investors who use the reported information for decision making. Human judgement and compromises are involved. The process takes place in a broader regulatory context which is itself nested in a political context of competing interests.

People who are unfamiliar with financial reporting assume it’s all pretty cut and dried. Their belief is that the clear standards which have been around for decades make it easy for companies to know how to report and straightforward for auditors to know how to audit. Most of all they assume that reported figures like revenue, profit, liabilities, and assets are absolute, and that a true and calculable measure of company “value” exists.

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The regulatory landscape for ESG disclosure by U.S. public companies faces potentially dramatic changes, with the Securities and Exchange Commission (“SEC”) proposing rules that would mandate comprehensive climate change disclosures and integrate key aspects of sustainability reporting with annual reports. [1] Against this backdrop, White & Case surveyed the SEC filings of 50 companies in the Fortune 100 to assess the latest trends in ESG disclosure.

Survey of ESG Disclosure—2020 to 2022

For its fourth annual survey of ESG disclosure in SEC filings, [2] the White & Case Public Company Advisory Group reviewed the annual meeting proxy statements and annual reports of 50 companies in the Fortune 100. [3] In these 100 SEC filings, we focused on 12 categories [4] of ESG disclosure in annual reports and proxy statements filed with the SEC in 2020, 2021 and 2022. The key trends and takeaways from our survey are discussed below.

Climate-Related Disclosure Takes the Spotlight in 2022

In the fall of 2021, ahead of Form 10-K filings, the SEC issued a sample comment letter on climate disclosure [5] and also issued bespoke comment letters to a number of companies questioning their materiality assessments with respect to climate disclosure. Climate-related disclosure significantly increased in both Form 10-K and proxy statement filings of the surveyed companies, with many companies including such disclosure for the first time in 2022. Our survey focused on the ways climate disclosure changed year-over-year among the surveyed companies.

The Seven ESG Topics on the Rise in 2022

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IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE

TWITTER, INC.,

Plaintiff, v.

ELON R. MUSK, X HOLDINGS I, INC., and X HOLDINGS II, INC.,

Defendants.

Verified Complaint

Plaintiff Twitter, Inc. (“Twitter”), by and through its undersigned counsel, as and for its complaint against defendants Elon R. Musk, X Holdings I, Inc. (“Parent”), and X Holdings II, Inc. (“Acquisition Sub”), alleges as follows:

Nature of the Action

1. In April 2022, Elon Musk entered into a binding merger agreement with Twitter, promising to use his best efforts to get the deal done. Now, less than three months later, Musk refuses to honor his obligations to Twitter and its stockholders because the deal he signed no longer serves his personal interests. Having mounted a public spectacle to put Twitter in play, and having proposed and then signed a seller-friendly merger agreement, Musk apparently believes that he—unlike every other party subject to Delaware contract law—is free to change his mind, trash the company, disrupt its operations, destroy stockholder value, and walk away. This repudiation follows a long list of material contractual breaches by Musk that have cast a pall over Twitter and its business. Twitter brings this action to enjoin Musk from further breaches, to compel Musk to fulfill his legal obligations, and to compel consummation of the merger upon satisfaction of the few outstanding conditions.

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This post is based on a comment letter submitted to the SEC regarding the Proposed SEC Climate Disclosure Rule by Chairman Richard C. Breeden, Chairman Harvey L. Pitt, Commissioner Philip R. Lochner, Jr. Commissioner Richard Y. Roberts, and Commissioner Paul S. Atkins. Below is the text of the letter with minor adjustments to eliminate the correspondence-related parts.

We write to provide our perspective on the Commission’s recent proposal in the above-referenced release (the “Proposal”). In our view, the Proposal suffers from several serious deficiencies, many of which have been raised and examined by other commenters. We focus here on deficiencies that place the Proposal at odds with the Commission’s appropriate role and statutory mandate, into which, as former Chairmen and Commissioners, we believe we have particular insight.

We fear that the Proposal’s disregard of financial materiality, together with what we view as the almost certain judicial reaction (based on existing case law) to inevitable challenges to an eventual rule, ultimately will do irreparable damage to the SEC’s regulatory and enforcement program. The Commission’s reputation and ability to pursue its mission would be placed at risk. We strongly urge the Commission to rescind or substantially modify the Proposal.

I. The Standard for Climate-Related Disclosure Should Remain Financial Materiality

The Commission has long recognized that materiality is the “cornerstone” of the federal securities laws. [1] Familiar black-letter securities law holds that information is material if “there is a substantial likelihood that a reasonable investor would consider it important” in making an investment decision; [2] or alternatively, if there is a “substantial likelihood” that, in the eyes of the reasonable investor, the facts at issue “significantly altered the ‘total mix’ of information made available.” [3] The “reasonable investor” is the critical reference point in this analysis. The standard is objective; [4] the subjective desires of particular investors, whether few or many, do not change it. The standard is oriented toward financial outcomes, [5] for it inquires about the relevance of information to investors in securities, and the Supreme Court has explained that the defining feature of such financial activity is the expectation of profit. [6] Information is relevant to someone whose aim is the expectation of profit if it bears on whether that expectation will be realized. Such information is the only sort that passes muster as material under the objective standard, for that standard abstracts investors from their subjective, particular preferences, sweeping in only information that is relevant to all reasonable investors—and information relevant to risks and returns is the only sort that all reasonable investors necessarily care about.

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Introduction

An early examination of 2022 proxy season voting statistics yields a number of notable observations:

We have seen several types of proposals that attracted majority support for the first-time this season, including shareholder proposals addressing racial equity and civil rights audits, sexual harassment concerns and gender pay equity.

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