May 14, 2021

Preparing for “Corporate Governance Gaming”

Looks like we can add “predictable proxy voting outcomes” to the list of things that Millennials are blamed for killing – along with doorbells, voicemail and the birth rate. Although the retail investor segment has exploded, there’s a chance it may not continue to deliver reliable support for management recommendations.

Recent changes to broker no-vote policies are partially responsible for this emerging issue – but it may also be due to the “eat the rich” mentality of recent stock market entrants. Last week’s “Investor Sentiment Study” from Broadridge & Engine Group found that over 60% of retail investors thought that companies they invest in should be taking active steps to improve E&S issues – and 46% of Millennial investors, the highest percentage of any generation, say they will vote their proxy this year. (For more details about retail voting trends & communications, see the Proxy Season Blog that Lynn ran for members earlier this week.)

This forthcoming article from LSU Law Prof. Christina Sautter and Monash (Australia) Law Prof. Sergio Gramitto Ricci explores whether this new generation of Millennial & Gen Z investors – who might come to stocks through online forums & gaming dynamics – will band together to pursue ESG voting initiatives. Here’s an excerpt:

If disintermediation and wireless investors reach a critical mass, wireless investors could cause a radical shift in the way corporations are run by exercising their aggregate power in shareholders’ meetings. If wireless investors are able to determine who sits on the board of directors and pick directors who have displayed an ESG record, the shift in the governance of corporations would be so deep-seated that the very purpose of the corporation would be impacted. After decades of debates on whether corporations should pursue any goals,but maximizing returns for share-holders, shareholders themselves would align the aim of a corporation with that of socially and environmentally conscious citizens. …

The wireless investors’ movement to make corporations serve people and the planet will also benefit from brokers no longer voting uninstructed shares. As brokers are transitioning out of voting uninstructed shares, unless shareholders express their votes, their shares will go unvoted. In fact, retail investors would not be able to rely on discretionary or proportionate voting by brokers. Discretionary voting involves brokers voting in line with board recommendations while with proportionate voting they vote uninstructed shares in proportion to how the broker was instructed by the other holders of those shares.351Hence, either they express their votes or they leave the corporation’s destiny in the hands of other unknown investors.

Furthermore, corporations risk failing to obtain quorums at shareholders’ meetings. In response, corporations might have to nurture their relations with retail investors and solicit them to vote, and retail investors would have an additional reason to internalize the frictional cost attached to inform themselves, possibly through online communication venues, and vote their shares. Compelled to stay informed and vote, other retail investors might vote with wireless investors and take part in the game-changing movement to make corporations serve people and the planet.

If this comes to pass, it could alleviate the voting apathy that others have recognized negatively impacts corporate governance, which companies have been trying to cure for many years through “swag bags” and donations. Prof. Sautter suggests that that gaming dynamics are a good thing because they’re making shareholder meetings more accessible – investors are even using gaming platforms like Twitch & Discord to communicate.

That said, a gaming approach to shareholder voting likely would terrify companies. The GameStop frenzy showed how difficult it is to control the “mob mentality” – and we wouldn’t be able to consult published voting policies to predict voting behaviors (although perhaps new advisory services would pop up). The Boadridge/Engine Group survey found that 43% of new market entrants are trading every week, so you can’t even predict whether they’re in your stock for the long haul! Similar to the “Clubhouse” trend that I wrote about a few weeks ago, this WSJ article says that some companies are getting ahead of the game by using social media channels to communicate with their retail holders.

Personally, my guess is that the retail revolution is still a ways off. I missed the Gen X cutoff by only a few days, so maybe I’m less idealistic – or less downtrodden? – than others in my assigned cohort. But I think institutional investors are going to do whatever they can to keep a lot of assets under their control. Profs. Ricci & Sautter suggest that big investors’ new emphasis on E&S could be one way to keep shareholders in their fold. This 2020 study – “Index Fund ESG Activism and the New Millennial Corporate Governance” – also makes that suggestion, and has been getting quite a bit of traction.

Cyber Disclosure: “Risk Ratings” Could Help Tell Your Story

Cyber issues continue to plague organizations big & small. Last week’s big pipeline shutdown due to a ransomwear attack on a privately held energy company emphasizes the need for boards to be paying attention. This Aon memo also suggests that cyber risk disclosures from public companies might get more detailed due to recent ISS QualityScore changes. The dilemma facing companies from a disclosure perspective is that, while investors need transparent disclosure to be able to assess risks, explaining technical shortcomings and incidents can also create a roadmap for the bad guys.

This 10-page report from NACD, Cyber Threat Alliance, IHS Markit, Security Scorecard and Diligent says that cyber-risk ratings could be the answer to that dilemma, because they’d convey information about threat levels without disclosing sensitive technical information. The report says that companies have been disclosing more info about board oversight of cyber risks and acknowledging vulnerabilities, but that recent events underscore the need for continued attention to this area. Here’s an excerpt:

In the wake of SolarWinds and the increased supply-chain security scrutiny in Washington DC, companies should be explaining to investors the specific risks they face from cybersecurity threats, including, among others, operational disruption, intellectual property theft, loss of sensitive client data, and fraud caused by business email compromises. Companies should also be explaining the categories of both technologies and processes they employ to mitigate those risks. Failure to do so is increasingly costly and is described by former SEC Commissioner Robert J. Jackson Jr. as “the most pressing issue in corporate governance today.”

In practice, businesses are slowly but unmistakably moving in the direction of increased transparency. This trend must continue for investors to begin deriving actionable value from cyber-risk disclosures. For example, certain companies are beginning to identify the specific technologies they are using in their program through their cyber-risk disclosures; others have started noting the materiality of their vendor risk exposure, to which regulators are paying particular attention in the aftermath of the 2020 SolarWinds attack. The next logical step is for these evolutions to converge.

Mark your calendars for our June 17th webcast – “Cyber, Data & Social: Getting in Front of Governance” – to hear VLP Law Group’s Melissa Krasnow, Lumen Worldwide Endeavors’ Lisa Beth Lentini Walker, Serna Social’s Sue Serna and Stroz Friedberg/Aon’s Heidi Wachs discuss unique governance challenges presented by cybersecurity, data privacy and social media and how it’s essential to proactively manage your risks, response plans and disclosure processes.

Transcript: “ESG Considerations in M&A”

We have posted the transcript for our recent webcast – “ESG Considerations in M&A.” This was a really excellent program and it’s worth perusing the remarks. Richard Massony of Hunton Andrews Kurth, Andrew Sherman of Seyfarth Shaw and Bela Zaslavsky of K&L Gates discussed:

1. Introduction to ESG Issues and Trends

2. ESG & Fiduciary Duties

3. ESG Opportunities in Transaction Financing

4. ESG Due Diligence and Risk Mitigation

5. Negotiating ESG-Related Deal Terms

6. Post-Closing Considerations

Liz Dunshee