The “cost-benefit” analysis for federal regulatory reviews may be getting a makeover. Last week, the White House Office of Management & Budget announced two developments:
1. Executive Order on Modernizing Regulatory Review – which raises the threshold that defines “significant regulatory action” requiring additional steps for review, from $100 million to $200 million in annual effects, and makes other changes to how the review process is conducted.
2. Proposed changes to “Circular A-4” – which hasn’t been updated since it was first issued in 2003 and addresses how the government calculates costs & benefits.
These updates have the potential to impact securities disclosure rulemaking, particularly as we stare down significant changes that companies believe will vastly increase their SEC compliance costs. I blogged earlier this year that the “estimated compliance burden” under the Paperwork Reduction Act is an important part of the SEC comment process for proposed rulemaking, even though it often doesn’t generate a lot of responses from public commenters.
Circular A-4 touches on the Papwerwork Reduction Act – and bigger-picture, covers how to assess a regulation – including its impact on public health & safety, economic impact and non-monetized and non-quantified effects – when conducting a cost-benefit analysis. The White House Council of Economic Advisers summarized the context and a few of the changes – here’s an excerpt:
In the 20 years since Circular A-4 was issued, economic conditions and best practices for benefit-cost analysis have evolved, and updating the Circular will make it easier to promote regulations that most enhance wellbeing.
For example, the proposed update expands discussion of critical regulatory needs, addressing market power, behavioral biases, distributional fairness, civil rights, and more. Currently, Circular A-4 focuses on a limited set of market failures as potential reasons to regulate.
The benefits & costs of regs don’t always fall on the same groups & even when they do, research shows that a given gain or loss has larger impact on lower-income people than on higher-income people. Currently, Circular A-4 doesn’t discuss distributional effects in much detail. The proposed revision substantially expands guidance on assessing distributional effects. It helps empower agencies to use income-weighted estimates in their analyses by providing them with a weighting methodology if they choose to do so.
There’s a 60-day public comment period and review process for the proposed changes, with specific questions set forth in this preamble. If adopted, the impact of this update on rulemaking also will depend on how federal agencies – like the SEC – implement it. However, it does signal a potential shift towards a more holistic approach to cost-benefit analyses, which could have implications for future securities disclosure regulations.
I continue to team up with the experienced and delightful Courtney Kamlet – who spent time in Corp Fin and has been guiding boards in-house for nearly two decades – to interview women who are “movers & shakers” in the corporate governance field. These episodes not only give insight into the many ways to build a successful corporate governance career, they also equip you with a variety of perspectives on current corporate governance issues – so that you can tackle your work-day challenges with the benefit of our guests’ experience. Check out our latest episodes!
– 20-minute conversation with Betsy Atkins – Betsy is a 3-time CEO and serial entrepreneur. She’s served on 38 boards (currently Wynn Resorts, Gopuff and Google Cloud), and been involved with 17 IPOS! We were lucky enough to talk with Betsy in the immediate wake of the SVB receivership last month. We discussed “lessons learned” from recent financial and geopolitical crises, how boards can oversee emerging risks, and what advisors should do – and not do – to add value in the boardroom.
– 30-minute conversation with Kris Veaco – Kris founded the corporate governance advising firm Veaco Group in 2006 after a lengthy corporate secretary career. She shared insights into effective board & director evaluations and recommendations on how boards today can be as effective as possible in a demanding environment.
– 19-minute conversation with Laura Zizzo – Laura co-founded Manifest Climate – a risk-planning tool that provides climate-related insights, analytics and recommendations – after beginning her career as an environmental lawyer. Laura shared her take on how companies can get their arms around climate data and risks, what most excites her about the future of corporate governance, and advice on how to allocate your time and talents when you are getting pulled in many different directions.
You can find all of our “Women Governance Trailblazers” episodes on our WGT podcast page – as well as with all of the informative podcast series posted in the “Podcast Archives” on TheCorporateCounsel.net.
Heads up! State Street Global Advisors has issued its “Proxy Voting & Engagement Guidelines” for 2023 – and they include what may be an unwelcome “Easter egg” for Russell 3000 companies. Thanks to Aon’s Karla Bos for calling this to our attention and highlighting key changes in the US & Canada Guidelines:
• Directors and Boards – Added: In our analysis of boards, we consider whether board members have adequate skills to provide effective oversight of corporate strategy, operations, and risks, including environmental and social issues. Boards should also have a regular evaluation process in place to assess the effectiveness of the board and the skills of board members to address issues, such as emerging risks, changes to corporate strategy, and diversification of operations and geographic footprint.
• Board Gender Diversity – We expect boards of all listed companies to have at least one female board member and the boards of Russell 3000 companies to be composed of at least 30 percent women directors [emphasis added]. If a company does not meet the applicable expectation, State Street Global Advisors may vote against the Chair of the board’s nominating committee or the board leader in the absence of a nominating committee. Additionally, if a company does not meet the applicable expectation for three consecutive years, State Street Global Advisors may vote against all incumbent members of the nominating committee or those persons deemed responsible for the nomination process.
Added: We may waive this voting guideline if a company engages with State Street Global Advisors and provides a specific, timebound plan for either reaching the 30-percent threshold (Russell 3000) or for adding a woman director (non-Russell 3000).
• Board Racial/Ethnic Diversity – We believe effective board oversight of a company’s long-term business strategy necessitates a diversity of perspectives, especially in terms of gender, race and ethnicity. If a company in the Russell 1000 [emphasis added – formerly S&P 500] does not disclose, at minimum, the gender, racial and ethnic composition of its board, we may vote against the Chair of the nominating committee. We may withhold support from the Chair of the nominating committee also when a company in the S&P 500 does not have at least one director from an underrepresented racial/ethnic community on its board [emphasis added].
• Virtual/Hybrid Shareholder Meetings – New policy describing support for proposals that maintain specific best practices.
• Advisory Vote On Executive Compensation – No change
• Employee Equity Award Plans – No change
• Risk Management – New policy: We believe that risk management is a key function of the board, which is responsible for setting the overall risk appetite of a company and for providing oversight on the risk management process established by senior executives at a company. We allow boards to have discretion regarding the ways in which they provide oversight in this area. However, we expect companies to disclose how the board provides oversight on its risk management system and risk identification. Boards should also review existing and emerging risks that evolve in tandem with the changing political and economic landscape or as companies diversify or expand their operations into new areas.
As responsible stewards, we believe in the importance of effective risk management and oversight of issues that are material to a company. To effectively assess the risk of our clients’ portfolios and the broader market, we expect our portfolio companies to manage risks and opportunities that are material and industry-specific and that have a demonstrated link to long-term value creation, and to provide high-quality disclosure of this process to shareholders.
Consistent with this perspective, we may seek to engage with our portfolio companies to better understand how their boards are overseeing risks and opportunities the company has deemed to be material to its business or operations. If we believe a company has failed to implement and communicate effective oversight of these risks, we may consider voting against the directors responsible.
Karla noted that if you’re working with small or mid-sized clients, you may want to highlight SSGA’s board gender diversity threshold of 30%. The 2022 CEO letter had stated the 30% threshold would apply in 2023 to “companies in major indices in the US, Canada, UK, Europe, and Australia.” Many had expected that to mean S&P 500 for the US, since SSGA often starts with S&P 500 when raising expectations for US companies, so this may also come as a surprise to smaller companies who thought the main US entity applying a 30% threshold this proxy season would be Glass Lewis.
Thanks again to Karla for this info! We always welcome tips from members – and we’re pretty friendly to chat with, if I do say so myself. If you see something that you think the community would want to know about, feel free to email John at john@thecorporatecounsel.net, me at liz@thecorporatecounsel.net, or anyone else on our team.
1) no longer use numerical limits to identify overcommitted directors, and instead
2) vote against the chair of the nominating and governance committee at companies in the S&P 500 that do not disclose their internal policy on director time commitments.
This heads-up about the 2024 change to the firm’s overboarding policy is consistent with the preference that SSGA shared in “Managing Through a Historic Transition: The Board’s Oversight of Director Time Commitments.” It also aligns with the new policies on risk management and board & director evaluations. SSGA urges nominating committees to “evaluate their directors’ time commitments, regularly assess director effectiveness, and provide public disclosure on their policies and efforts to investors.”
Some companies may want to revisit their policies – and related disclosures – in light of this threat to the nom/gov chair. If changes are needed, it could take some time to prepare those and work through all of the channels for approval. It’s helpful that SSGA is giving us a year to do that.
R-Factor, we barely knew thee. Launched in 2019, State Street is apparently now bidding adieu to its proprietary scoring system, the R-Factor – which stood for “Responsible-Factor” – or at least, not incorporating it into voting decisions this season. Karla pointed out that it no longer appears in the firm’s “Proxy Voting and Engagement Guidelines” other than in the closing notes. Last year’s guidelines had said:
R-Factor™ is a scoring system created by State Street Global Advisors that measures the performance of a company’s business operations and governance as it relates to financially material ESG factors facing the company’s industry. R-Factor™ encourages companies to manage and disclose material, industry-specific ESG risks and opportunities, thereby reducing investment risk across our own portfolio and the broader market. State Street Global Advisors may take voting action against the senior independent board leader at companies on the S&P 500 that are R-Factor™ laggards and momentum underperformers and cannot articulate how they plan to improve their score.
As a follow-up to its position as a “long-term corporate partner,” which I blogged about on our Proxy Season Blog last fall, and consistent with BlackRock, SSGA has also backed away from hot-button “ESG” terminology and partnerships. Karla flagged these updates:
• About State Street Global Advisors – Revised wording somewhat to align with December 2022 changes to same section in “Global Proxy Voting and Engagement Principles,” primarily removing “As stewards, we help portfolio companies see that what is fair for people and sustainable for the planet can deliver long-term performance.”
• Environmental And Social Issues – Revised wording somewhat to align with December 2022 changes to same section in “Global Proxy Voting and Engagement Principles,” primarily removing “We use our voice and our vote through engagement, proxy voting, and thought leadership in order to communicate with issuers and educate market participants about our perspective on important sustainability topics.”
But perhaps the most significant change on the “ESG” front is that SSGA has significantly abbreviated its “Climate-Related Disclosure” policy. The old policy said:
We believe climate change poses a systemic risk to all companies in our portfolio.
State Street Global Advisors has publicly supported the global regulatory efforts to establish a mandatory baseline of climate risk disclosures for all companies. Until these consistent disclosure standards are established, we find that the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) provide the most effective framework by which companies can develop strategies to plan for climate-related risks and make their businesses more resilient to the impacts of climate change.
As such, we may vote against the independent board leader at companies in the S&P 500 and S&P/TSX Composite that fail to provide sufficient disclosure in accordance with the TCFD framework, including:
• Board oversight of climate-related risks and opportunities
• Total Scope 1 and Scope 2 greenhouse gas emissions
• Targets for reducing greenhouse gas emissions
The 2023 guidelines continue to encourage providing TCFD-related disclosures – but they no longer threaten “against” votes for companies that omit GHG emissions data or targets for reducing greenhouse gas emissions. Here’s the new language:
State Street Global Advisors finds that the recommendations of the Taskforce on Climate related Financial Disclosures (TCFD) provide the most effective framework for disclosure of climate-related risks and opportunities. As such, we may take voting action against companies in the S&P 500 and S&P/TSX Composite that fail to provide sufficient disclosure regarding climate-related risks and opportunities related to that company, or board oversight of climate-related risks and opportunities, in accordance with the TCFD framework.
We don’t know whether the SEC will take this change into account as it works towards finalizing its climate disclosure rule, but it seems to detract from the notion that investors resoundingly want emissions data.
As John noted in the blog last week, the timing of the SEC’s approval of exchange listing standards implementing Rule 10D-1 could be upon us sooner rather than later. That outcome could prompt a flurry of activity as issuers seek to implement compliant clawback policies within the 60-day window mandated by the SEC.
On Monday, a group of law firms submitted letters to the SEC responding to the requests for comments on the NYSE and Nasdaq clawback proposals, asking that the SEC not approve the adoption and effectiveness of the listing standards earlier than November 28, 2023. The letters outlined the many challenges that issuers are facing in determining how to implement a compliant clawback policy, on top of having to address other recent SEC rules changes such as the pay versus performance disclosure requirements and the Rule 10b5-1 amendments. The letters also note that adoption of a clawback policy would require board approval, and issuers would therefore be forced to hastily convene board meetings for such purpose given the uncertainty associated with the effective date of the listing standards and the subsequent short compliance period.
We can only hope that the SEC will carefully consider these comments when determining the timing for approval of the final listing standards.
One of the implementation challenges noted in the clawback comment letters that were submitted by a group of law firms to the SEC earlier this week is that if issuers already have an existing clawback policy, “they must evaluate whether and how to integrate the two policies, including whether to combine them into one policy or have separate stand-alone policies.”
This is definitely a topic that issuers have been wrestling with as they seek to formulate clawback policies based on Rule 10D-1 and the proposed listing standards. In the dozen years that it took the SEC to adopt the clawback requirement mandated by the Dodd-Frank Act, issuers generally “moved on” and adopted clawback policies based on their own considerations and market practice, and rarely do these policies look like the policies contemplated by Rule 10D-1. Policies that have been adopted by issuers over the years have a multitude of potential triggering events, from fraud and misconduct in connection with an issuer’s financial statements to causing the issuer reputational harm, and melding these triggering events into a Rule 10D-1 compliant policy is proving to be a challenge. Further, the lack of discretion accorded to the board in seeking to recover compensation under Rule 10D-1 is not consistent with the approach that many issuers take in clawback policies today, and some types of triggering events for recovery do not lend themselves well to such a strict implementation requirement. Finally, existing clawback policies may cover a broader group of individuals than the “executive officer” group contemplated by Rule 10D-1, and there will inevitably be timing considerations that must be accounted for in enforcement of the new Rule 10D-1 compliant provisions of the clawback policy.
Given these integration challenges, some issuers may be compelled to throw up their hands and just have two standalone clawback policies, the “legacy” policy and the new Rule 10D-1 compliant policy. This approach has its own complications, given that companies will have to try to explain in their disclosure why they have two clawback policies, while the Board or Compensation Committee will have to administer the two separate policies going forward. This is yet another area where we will have to see how all of this plays out.
We have posted the transcript for our recent webcast – “Managing Enterprise-Wide Risks: The Intersection of ERM & Legal” – in which J.T. Ho of Orrick, Derek Windham of Tesla, Jeff Levinson of NetScout, Ming-Hsuan Elders of American Express and Stephanie Bignon of WestRock Company address the focus on enterprise risk management and the role that legal departments play in this process. Here’s an excerpt from Derek Windham’s comments on the differences between traditional risk management and enterprise risk management:
One of the biggest differences for our listeners to understand between traditional risk management and enterprise risk management is that with traditional risk management, the focus has fundamentally been more on risk avoidance. Essentially, this view treats risk as a four-letter word, whereas ERM really is about risk balancing, in recognition of the fact that some risk-taking can be a good thing.
You use the word opportunity and that’s a good concept. Often, risks can lead to opportunity and competitive advantage. Rather than being about risk avoidance, ERM is more like a framework of informed risk-taking. To weigh and balance risks effectively in this framework, you need to define your company’s risk culture and your risk appetite, and then manage risk to fit within this risk profile. In other words, you have to clearly define your strategic operational and financial risk tolerances so you can align your risk choices and optimize with return. The reason that this is one of the most important distinctions for this group to be aware of is that it directly aligns with the core functions of good business-aligned attorneys. To be most effective as business partners, it’s fundamental for attorneys to move away from the risk avoidance mindset and customize it to enable informed and strategic risk balancing by their clients.
Another core difference is highlighted by use of the word “enterprise” in ERM. Whereas traditional risk management was siloed with each department identifying and managing risks within their own towers, ERM is focused on a holistic cross-departmental view. This is an important distinction for this group because it ties directly into how the board should best oversee ERM, how management should define and execute on an ERM program and how legal can support these processes.
Yesterday, the SEC’s Office of Minority and Women Inclusion (OMWI) released its fiscal year 2022 Annual Report to Congress. This Annual Report summarizes “the SEC’s actions and achievements towards promoting diversity, equity, inclusion, and accessibility in the SEC’s workforce, increasing opportunities for minority-owned and women-owned businesses, and leveraging DEIA for mission effectiveness.”
The press release announcing Annual Report notes the following highlights:
– The representation of minorities among Senior Officers (Senior Officers are equivalent to Senior Executive Service at other federal agencies) increased from FY 2021 to FY 2022;
– 37.6 percent of the SEC contract payments made in FY 2022 were to minority- and women-owned businesses;
– The SEC increased the number of paid internship programs from FY 2021 to FY 2022; and
– 35.9 percent of the workforce identify as minorities.
The report notes how OMWI’s DEIA initiatives extend outside of the SEC. OMWI maintains a network of Diversity Partners, including minority- and women-focused professional associations and educational organizations, to further the SEC’s DEIA objectives. In fiscal year 2022, OMWI hosted its Biannual OMWI Partners Meeting to enhance these personal connections and further shared goals of promoting diversity in the financial services industry.
The SEC’s Office of Minority and Women Inclusion was created after my time at the SEC, and until recently I was not aware of the office’s history and the considerable impact that it has had on the agency. A recent SEC Historical Society event, which is available online, recounted the founding of OMWI (referred to as “OM-WEE”) and the office’s DEIA efforts over the past decade with a panel discussion involving OMWI’s Director, Pamela Gibbs, and former SEC Chairs Mary Shapiro, Mary Jo White and Jay Clayton.
OMWI was started thanks to, of all things, the Dodd-Frank Act. Section 342 of the Dodd-Frank Act required the SEC and other federal financial agencies to each establish an Office of Minority and Women Inclusion to be responsible for all matters relating to diversity in management, employment, and business activities. In accordance with Section 342 of the Dodd-Frank Act, the SEC established OMWI in July 2011.
OMWI’s efforts are both inward facing toward the SEC and outward facing toward the financial services industry. In 2015, the SEC’s OMWI and the OMWIs of the other federal financial regulators created joint standards that were issued as a Final Interagency Policy Statement Establishing Joint Standards for Assessing the Diversity Policies and Practices of the entities they regulate (Joint Standards) as required by Section 342 of the Dodd-Frank Act. The Joint Standards provide five areas that a regulated entity may consult to develop its diversity policies and practices:
– Organizational Commitment to Diversity and Inclusion;
– Workplace Profile and Employment Practices;
– Procurement and Business Practices;
– Practices to Promote Transparency and Organizational Diversity and Inclusion; and
– Self-Assessment.
It was clear from the SEC Historical Society program that the SEC’s OMWI had made a lot of progress, particularly at the agency, in promoting DEIA initiatives, while working hard to promote more diversity in the financial services industry. It is great to hear the perspectives of the former SEC Chairs on this topic, and it was particularly gratifying to hear how committed to these efforts they were during their tenures with the SEC.