Yesterday, ExxonMobil filed its Form 8-K to report the voting results from its annual meeting. The preliminary count, which is not yet certified, indicates that Engine No. 1 won three board seats on the company’s 12-member board, one more than had been predicted after the meeting last week. Engine No. 1 had waged a campaign based on the impact of Exxon’s fossil fuel strategy on its financial performance.
The activist’s win is especially shocking in light of the fact that Exxon had appointed three other directors earlier this year in an attempt to appease investors. Two of those new directors – Michael Angelakis and Jeff Ubben – had the highest number of votes out of anyone. The third – Wan Zulkiflee (former CEO of Petronas) – was voted off the board after only four months of service.
The dissident directors who appear to have been elected are Kaisa Hietala (environmental scientist and former Neste EVP), Greg Goff (former CEO of Andeavor) and Alexander Karsner (strategist/PE investor/formerly at Google X and the Department of Energy). As Lynn blogged last week, shareholders also approved shareholder proposals calling for more disclosure of climate lobbying and other political activities, which weren’t supported by the board.
This probably won’t be the last we’ll hear of Engine No. 1. While it was busy making a big name for itself last week with Exxon, it also managed to file a pre-effective amendment to a registration statement to launch an ETF, which identifies Schulte Roth & Zabel as outside counsel, lists “activism” as a risk factor, and also includes this nugget:
Principal Investment Strategies: The Fund seeks investment results that closely correspond, before fees and expenses, to the performance of the Morningstar US Large Cap Select Index (the “Underlying Index”), which measures the performance of the 500 largest U.S. stocks by market capitalization, as determined by Morningstar, Inc. The Underlying Index consists of securities from a broad range of industries. As of March 31, 2021, the Underlying Index is represented by securities of companies in sectors including, but not limited to, consumer, energy, financial services, healthcare, technology, and utilities. The components of the Underlying Index are likely to change over time and the Underlying Index and the Fund are rebalanced on a quarterly basis. To the extent that the securities in the Underlying Index are concentrated in one or more industries or groups of industries, the Fund may concentrate in such industries or groups of industries. As of March 31, 2021, the Underlying Index is not concentrated in an industry or group of industries.
The Fund seeks to encourage transformational change at the public companies within its portfolio through the application of proxy voting guidelines developed by the Adviser that are based on a commitment to protecting and enhancing the value of its clients’ assets and to aligning shareholder and stakeholder interests through favoring actions that encourage companies to invest in their employees, communities, customers and the environment.
Our Adviser intends to measure the investment made by companies in their employees, communities, customers and the environment with financial, operational, and environmental, social and governance (“ESG”) metrics that are provided by (i) the companies themselves, (ii) third-party data providers, and (iii) the Adviser itself. These metrics include, but are not limited to, wages, workforce diversity, employee health and safety, capital expenditures, carbon emissions, and land use, among others. The Fund’s proxy voting guidelines will apply to all companies held by the Fund. The Adviser will generally follow the recommendations of an independent third party proxy voting service retained by the Adviser to implement the proxy voting guidelines when determining how to vote on any specific matter.
The Fund will invest at least 80% of its Assets in securities included in the Underlying Index.
With about 2 weeks to go before the expiration of the time frame that the SEC had set to collect public input on the possibility of climate change disclosure rules, the Commission has held at least a couple dozen meetings with corporate leaders and trade organizations. In connection with those meetings, companies including Apple and Salesforce have spoken out in support of rulemaking. Most seem to be falling in line with support for principles-based disclosure.
Uber is one of the only companies so far that has taken the extra step of submitting a comment letter. In it, the ride-sharing company says it supports using existing principles-based frameworks to harmonize climate disclosures. Here’s an excerpt:
We support a climate disclosure framework that incorporates TCFD or SASB standards and is generally principles-based, so as to be sufficiently flexible to adapt to market and scientific developments and to accommodate the needs of public companies in various industries and at differing stages in their life cycles. We believe this approach would build upon years of thought leadership and stakeholder engagement by TCFD and SASB whose recommendations and standards are already utilized as a basis for voluntary reporting on climate change by many public companies…
…Incorporating the TCFD or SASB frameworks into a new,comprehensive and harmonized climate disclosure framework, promulgated by the Commission, will facilitate faster and more widespread adoption which would ultimately serve the best interests of investors.
In addition, we encourage the Commission to consider requiring that companies perform a company-specific materiality assessment to identify the ESG issues most relevant to their businesses. We believe that the most useful ESG disclosures will be grounded in the specific issues that are relevant to the particular company,as opposed to generic ESG disclosures that may or may not apply in a company’s individual circumstances.
Not everyone supports mandatory disclosure. I blogged about a First Amendment threat by West Virginia’s AG. The US Chamber of Commerce seems to be opposed to any legislation or Commission rules that would require ESG disclosures, and this letter argues that extra disclosure would have a disproportionate effect on smaller companies.
About a year ago, everyone was jumping on the SASB bandwagon and predicting it would become investors’ preferred disclosure framework. According to Morrow’s recent Institutional Investor Survey, though, sentiment has shifted. Here are some takeaways from 49 participants that collectively have $29 trillion in assets under management:
– 75% prefer the TCFD reporting framework
– 53% prefer SASB (down from 77% a year ago)
– 39% prefer proprietary in-house frameworks focused on material topics (up from 9% last year)
The TCFD framework encourages companies to use existing disclosure processes to report on climate-related risks and opportunities – focusing on governance, strategy, risk management, and metrics & targets. SASB is very industry-based and has been adopted by many companies as a way to map through and disclose financially material ESG information.
These two frameworks are also complementary in some ways – both are incorporated in the World Economic Forum’s “Stakeholder Capitalism Metrics” – which is part of the effort that was announced last fall to promote a single comprehensive reporting system. With standard-setters collaborating, companies becoming more mature in their own reporting, investors evolving the type of info they want, and an SEC proposal potentially on the horizon, it will be interesting to see where this all stands in another year.
Yesterday, in response to a directive from SEC Chair Gary Gensler, Corp Fin announced that:
1. It’s considering whether to recommend that the Commission revisit the proxy advisor rules that were adopted last summer – which would require proxy advisors to meet new conditions beginning December 1st of this year – and the Commission-level interpretive guidance that was issued the year before.
2. The Staff won’t recommend enforcement action to the Commission during the period in which the SEC is considering further regulatory action.
3. In the event that new regulatory action leaves the 2020 exemption conditions in place with the current December 1, 2021 compliance date, the staff will not recommend any enforcement action based on those conditions for a reasonable period of time after any resumption by Institutional Shareholder Services Inc. of its litigation challenging the 2020 amendments and the 2019 Interpretation and Guidance. (ISS v. SEC, 1:19-cv-3275 (D.D.C.)
This is the latest chapter in the long, ongoing saga over proxy advisors. The 2020 rules and 2019 guidance define proxy advice as a “solicitation” and would require proxy advisors to disclose conflicts of interest and adopt policies that allow for companies to review & respond to voting recommendations, in order to be exempt from the information & filing requirements that would otherwise apply to a solicitation. The amendments also specify what circumstances would cause proxy advice to be “misleading” within the meaning of anti-fraud rules.
The rules were celebrated by many companies, but proxy advisors and their investor clients criticized the proposal process, took issue with the Commission’s statutory authority, and felt that the substance of the rules would delay and impair the proxy voting process. This, in turn, made some companies worry that the proxy voting timeline would become even more compressed. As mentioned in yesterday’s Staff statement, ISS even sued the SEC over its efforts to regulate the industry, and appeared to be moving forward with that proceeding as recently as last August.
In light of those issues and the fact that the compliance date has not yet arrived, I’ve been wondering whether we’d see some steps to unwind (or not defend) the rules. Some are pondering whether this is the beginning of a trend of “back & forth” rulemaking, which would create uncertainty.
Commissioners Hester Peirce and Elad Roisman issued a response to Chair Gensler’s statement yesterday, saying that the 2020 rules were the result of an unassailable process and that there is no data yet to evaluate whether the rules work in practice. Meanwhile, CII called yesterday’s directive “Christmas in June for investors.”
The premise of one of my favorite parenting books is that standard negotiation techniques – logic, bribes, threats – aren’t going to deliver when it’s 8pm and my 3-year-old has been refusing to leave the playground for the last 45 minutes. In that situation, the only way out is to use a Jedi mind trick to reverse engineer and validate his deepest desires, and make the ride home even more magical and exciting than another trip down the 2-story slide.
It seems like that’s kind of the position that the SEC finds itself in with Elon Musk, especially after reading this WSJ article yesterday about the Enforcement Division’s attempts to follow up on tweets that the Commission believed went against its 2018 settlement with the Technoking. Here’s an excerpt:
From the start, the social-media policy was difficult for the SEC to enforce. The SEC accused Mr. Musk of violating the rules in February 2019 and asked a Manhattan federal court to consider holding him in contempt. The judge signaled she wanted the two sides to settle the dispute and they agreed to modify the policy by clarifying which topics required pre-approval. Those were identified as including communications about production figures, new business lines and the company’s financial condition.
Within months, the SEC was writing Tesla again, questioning a tweet Mr. Musk wrote on July 29, 2019, that stated: “Spooling up production line rapidly. Hoping to manufacture ~1000 solar roofs/week by end of this year.”
It’s not surprising that this notion of “pre-clearing” tweets isn’t playing out smoothly – the question all along has been, what can the SEC do about it? The WSJ says that the latest dispute, over a May 2020 tweet, appears to have ended in a stalemate. The Enforcement Division encouraged the company to apply its disclosure controls & procedures, Tesla said it hadn’t done anything wrong, the SEC threatened to go back to court, and nothing happened.
Yes, the SEC is still working through the permissible ways for companies to use social media. The board and Elon are also defendants in shareholder suits because of these tweets. Maybe for this high-profile CEO, someone also needs to find a way to make compliance as fun as public taunting.
– COVID-19 resurgence: The fight against COVID-19 falters in the developed world.
– Climate policy gridlock: Developed economies fail to take policy actions consistent with their goals to reach net-zero emissions.
– Emerging markets political crisis: Failure to arrest the COVID-19 pandemic severely stresses EM political systems and institutions.
– Global technology decoupling:Technology decoupling between the U.S. and China significantly accelerates in scale and scope.
The unique thing about BlackRock’s dashboard is that it includes indicators that show whether the risks are on investor radar screens, and it analyzes how much markets have already priced in each risk. BlackRock finds that investors have been feeling pretty good since the change in the US administration, and attention to geopolitical risks is below the average of the past four years. Unfortunately that means that if some of these risks materialize, they could catch the markets off-guard.
This HLS blog from Nell Minow predicts that we’ll see more ESG-focused proxy fights in light of the results last week at ExxonMobil. Here’s her concluding recommendation:
Every board should have a committee that oversees investor communications and lead directors should be liaisons for shareholder concerns. They should expect a lot more interest from shareholders in the quality of the board, with emphasis on independence that goes beyond resume disclosures. Wise boards will solicit suggestions from investors and make sure that all directors know that their obligation as fiduciaries is to shareholders, not executives, and that their actions make that message clear to shareholders as well. Engine No. 1 is the first of a new kind of activists; its success makes it clear it will not be the last.
Internal audit oversight is typically part of the audit committee’s charter because of listing exchange rules. It’s also part of ensuring the directors are getting quality info about the company’s risk profile & financial results.
The Institute of Internal Auditors recently launched a tool to help audit committees make sure the internal audit function is working well. Here are the sample questions it proposes the committee consider with regard to risk management:
– Does the IA activity expand the board or AC’s knowledge about current and emerging risks to the organization?
– Are there clear links between the audit plan and the organization’s strategic objectives and risks?
– Does the CAE explain to the AC how the audit plan covers challenging and critical areas, including emerging or existing risk areas that will or could impede the organization’s objectives?
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 DealLawyers.com 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:
