Herrick partner Morris F. DeFeo Jr. examines how recent Securities and Exchange Commission initiatives may limit issuers' leeway to exclude shareholder proposals relating to environmental, social and governance matters.
Several regulatory initiatives this year by the Securities and Exchange Commission, the SEC, are significantly affecting how public companies assess and address environmental, social and governance (ESG) matters, including the impact of climate change on their financial condition and operating results.
More recently, the SEC staff issued guidance which makes it significantly more difficult for public companies to exclude stockholder proposals in their proxy materials. Taken together, these changes are likely to further fuel the increase in stockholder activism relating to ESG matters.
On February 24, 2021, the SEC's acting chair directed the Division of Corporation Finance to enhance its focus on climate-related disclosure in public company filings. On March 15, the SEC requested comments regarding its evaluation of the adequacy of existing SEC disclosure rules with a view to "facilitating the disclosure of consistent, comparable, and reliable information on climate change." On November 3rd, the SEC published a bulletin relating to proposed changes to Rule 14a-8 under Securities Exchange Act of 1934, which governs the inclusion of shareholder proposals in proxy materials.
For many years, many companies and investors considered ESG matters as either irrelevant to, or even in opposition to, the financial performance of a company. ESG concerns were viewed by corporate management as a regulatory burden companies had to bear. Those focusing on ESG considerations were often viewed as championing social, economic and political objectives that were at best disconnected from a company's bottom line and at worst contrary to financial growth.
Over time, a growing number of investors, including significant institutional investors, have placed greater importance on ESG matters as factors to consider when evaluating whether or not to invest in companies, and have been increasingly vocal and active in holding corporate management and directors accountable in this respect. Needless to say, these trends have elevated corporate awareness of and responsiveness to ESG considerations.
Perhaps more significantly, both private sector and public sector ESG-related funding has grown dramatically and shows every sign of continuing. For example, the increase in ESG-focused funds and other investment vehicles, the strong performance of these funds in 2020 and 2021, the significant increase in cash flowing into the ESG sector from investors, and political developments will continue to enhance the focus on ESG.
In the wake of SEC initiatives focusing on ESG matters, the SEC has recently announced changes to the SEC's rules governing the ability of public companies to exclude shareholder proposals from their proxy materials.
Under current rules, companies may exclude any shareholder proposals relating to the company's ordinary business operations. Shareholder proposals may still be included if they relate to a "significant social policy," which in the past, the SEC evaluated based on the significance of a policy issue to a particular company.
The SEC now has committed to realign its focus on the significant social policy exception, choosing instead to focus on the social policy significance of the issue that is the subject of the shareholder proposal.
In the words of the SEC, "[u]nder this realigned approach, proposals that the staff previously viewed as excludable because they did not appear to raise a policy issue of significance for the company may no longer be viewed as excludable."
Additionally, under existing SEC rules, companies may exclude shareholder proposals if they are deemed to "micromanage" the company, "probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment." The SEC indicates that it intends to loosen its determinations that shareholder proposals constitute micromanagement, stating that "proposals seeking detail or seeking to promote timeframes or methods do not per se constitute micromanagement."
Further, in assessing whether matters are too complex for shareholders, the SEC will look to take more facts into account, including the sophistication of investors generally on the matter, the availability of data, the robustness of public discussion and analysis on the topic, and reference to well-established national or international frameworks on the sought-after disclosure, target setting, and timeframes.
The SEC also intends to reconsider rules allowing companies to exclude proposals as not economically relevant if relating to operations which account for less than 5% of a company's total assets, net earnings and gross sales, returning to the prior SEC approach that proposals raising issues of broad social or ethical concern related to the company's business may not be excluded, even if the relevant business falls below the economic thresholds.
Finally, the SEC will reconsider various procedural requirements that enable the exclusion of proposals, such as limits on the length of proposals, proof of ownership letters and use of email in submitting proposals.
Issues for which solutions are long overdue, such as pay disparity, lack of diversity, and the inequities in inclusiveness and opportunity, have become more painfully apparent because of COVID-19. Investor focus and activism on social issues (along with environmental and governance matters), including through challenges to board elections, scorecards and voting recommendations, will continue to place substantial pressure on companies to address ESG concerns. For public companies, the SEC's recent pronouncements on ESG-related disclosures and shareholder proposals will certainly add to that pressure and provide additional momentum for shareholder activism.
Previously published February 23, 2022 – Westlaw Thomson Reuters.
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