As I blogged a few weeks ago, I’m thrilled that Lawrence Heim has joined our team to lead this new ESG platform. With Lawrence being a longtime ESG professional, you’ll be able to use his daily updates and more than 30 years of experience to get practice pointers and real talk on developments that affect your sustainability programs – including how to manage ESG data tracking and reporting.
Eventually, practicalESG.com will be home to membership-based portals that take a deeper dive into environmental, social & governance issues. We’ll be unveiling those features in the coming months, and of course we’ll also continue to cover corporate governance, proxy season issues and SEC rulemaking here on TheCorporateCounsel.net
Remember, help us celebrate by signing up for Lawrence’s free daily blog and getting a tree planted in your name!
More on “Senate Confirms Gary Gensler as SEC Chair”
Lynn blogged last week that the Senate had confirmed Gary Gensler’s nomination as the next SEC chair. He’s now been sworn in, meaning all 5 Commissioners are now in place! And while the original confirmation ran only through June 5th of this year, the Senate has now also approved (54-45) his nomination for the succeeding 5-year term that ends June 5th, 2026.
Transcript: “Shareholders Speak: How This Year’s Expectations Are Different”
We’ve posted the transcript for our recent webcast: “Shareholders Speak: How This Year’s Expectations Are Different.” If you’re gearing up for your annual meeting – or shareholder engagements – you’ll want to check this out. Sustainable Governance Partners’ Rob Main led a program with Yumi Narita of the Office of the NYC Comptroller, Ryan Nowicki of State Street Global Advisors, and Danielle Sugarman of BlackRock. Among the topics covered:
As if “materiality” under the securities laws wasn’t a difficult enough concept, investors supporting various ESG frameworks and standards have been adding to the complexity. Responsible Investor published a short piece that summarizes comments submitted by six global asset managers on the IFRS 2020 Consultation on sustainability reporting. Unfortunately for those working on the company side, it means having to play “mix and match” with ESG reporting frameworks to try to satisfy multiple investor mandates.
To break it down, we have:
1. Traditional materiality, which relates matters that are directly linked to financial impacts from the viewpoint of the “reasonable investor”. As has been long established. traditional materiality focuses on financial risks TO the company. SASB takes this approach with its standards.
2. What I call “new materiality,” reflecting the perspective of stakeholders and impacts of a company. New materiality goes beyond a pure financial perspective and compels companies to evaluate their impact ON stakeholders and the communities in which they operate. This is the direction GRI takes in its reporting framework.
3. “Double materiality,” which encompasses both traditional and new materiality matters. Under the EU Non-Financial Reporting Directive (EU NFRD), companies are required to assess and report on both financial and non-financial matters. The European Financial Reporting Advisory Group (EFRAG), which advises the European Commission, follows the double materiality path.
4. “Dynamic materiality” – a concept acknowledging that materiality is a moving target, stemming from the idea that “stakeholders of companies have the capacity to determine what is material for a company” enabled by technology and social media. Some see this as similar to traditional materiality (in that as new information becomes known, it adds to what is important to investors in the total mix of information); others may liken it to The Blob of materiality.
Traditional Materiality: Financial Costs and Risks
This is using the old-school materiality lens (i.e., TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976)) to a company’s ESG matters. The archetypal approach would be to gather and evaluate input from a variety of corporate departments/functions to reflect the multidisciplinary nature of ESG. However, counsel should assess potential liabilities to disclosing as newly material an activity or matter that is itself not new. In other words, why was something not considered financially material previously? Given that the SEC issued guidance on climate change disclosures in 2010, some may question why climate matters were not disclosed in the past.
New Materiality: Non-Financial Impacts Beyond the Fenceline
The two critical elements of new materiality that radically differ from traditional materiality are:
– Assessment and consideration of things that don’t directly affect corporate finances, or may be contingent/not estimable.
– Assessment and consideration of external stakeholders beyond investors. There is a hidden recursive double-whammy here as it requires understanding both what information external stakeholders consider important, and how the stakeholders will react (which rather depends on the extent and nature of the information made available to them).
Double Materiality: What Does Commissioner Peirce Think?
Acting Corp Fin Director John Coates suggested last month that global comparability would be a desirable thing for ESG reporting. Although he laid out some advantages to doing that, it doesn’t seem like people are rushing to embrace the idea. SEC Commissioner Hester Peirce made a statement last week to caution against a move toward global sustainability reporting framework. In particular, she took issue with the “double materiality” – here’s an excerpt:
The European concept of “double materiality” has no analogue in our regulatory scheme and the addition of specific ESG metrics, responsive to the wide-ranging interests of a broad set of “stakeholders,” would mark a departure from these fundamental aspects of our disclosure framework. The strength of our capital markets can be traced in part to our investor-focused disclosure rules and I worry about the implications a stakeholder-focused disclosure regime would have. Such a regime would likely expand the jurisdictional reach of the Commission, impose new costs on public companies, decrease the attractiveness of our capital markets, distort the allocation of capital, and undermine the role of shareholders in corporate governance.
Let us rethink the path we are taking before it is too late.
Dynamic Materiality: “Anything You Say Can and Will Be Held Against You”
The idea of dynamic materiality has potential significant legal uncertainty and complexity, but may also be an accurate reflection of where things stand today. As John pointed out a couple weeks ago, what is “material” took a recent odd (perhaps scary) turn when a supposed April Fool’s day joke by VW didn’t go as planned.
Richard Levick has long helped companies with crisis communication strategies (he also spoke on a webcast for us a couple years ago about “Politics as a Governance Risk” – even more relevant now). Richard recently wrote about companies being stuck between Scylla and Charybdis on responding to social issues of the day:
Brand neutrality is dead… Political contributions have become the new supply chain liability. But so is your DEI, environmental footprint, labor practices and more.
In the past, companies feared consumer boycotts. Today, the speed, ubiquity and ease of global social media – combined with intangible assets (including brand value) making up 90% of current company market valuation – make reputational risk a material matter regardless of which materiality you choose. And that could make an argument validating dynamic materiality.
President Joe Biden is set to issue an executive order on climate disclosure within capital markets, according to John Kerry, the US Presidential Special Envoy for Climate. Details are not available yet, but that one sentence pretty much says it all.
Theranos Redux? Why Governance Needs to Underpin E&S Commitments
Meeting greenhouse gas emissions/climate challenges will be a monumental undertaking for years to come and will require an array of solutions, some of which haven’t even been invented yet. Solutions will offer technological advances, social/environmental benefits and huge business opportunities. Fortunately for everyone, some will be successful and beneficial. Others may do more harm than good.
This Bloomberg article about a carbon capture company caught my attention for several reasons. One is that some form of ambient CO2 capture may be necessary to achieve reduction targets. But another reason is that in my years of auditing and fraud training, I’ve become somewhat competent in spotting patterns/trends in data and behavior. And – based solely on that piece – I see eerie similarities here to Theranos. And there is more reason this is top of mind given this week is the 20th anniversary of the Enron failure. This company is painting itself as a savior, but is it realistic?
Most companies know that chasing “E” goals needs to include using internal “G” processes and staff (indeed, the SEC’s recent Risk Alert on The Division of Examinations’ Review of ESG Investing points out this very thing). Here’s another reminder to proceed with caution. If you’re making public commitments of environmental/social progress based on third-party performance, you need to vet the service and qualify your statements. You may wind up with more risks & liabilities than you bargained for, especially if the third party doesn’t make good on their own promises.
Environmental Solutions & “The Law of Unintended Consequences”
Let’s look at an interesting element of technical solutions (such as carbon capture) that companies could end up getting dinged for: secondary impacts. Newton’s Third Law (with some poetic license) holds true in environmental solutions – a solution that solves one problem may create a secondary problem.
What is a “secondary impact”? In my view, a secondary impact is a meaningful environmental effect (or risk) that is created as a result of the intended benefit. Two examples of this are:
– I once visited a client site that had spent quite a bit of money to reduce their Scope 2 emissions (those that are associated with power purchased from the utility). The centerpiece of the reduction strategy was an on-site company owned and operated fuel cell. What the company had overlooked is that the fuel cell chemistry resulted in CO2 emissions that drastically increased the site’s Scope 1 (direct) emissions. I don’t recall the absolute emissions numbers and whether this resulted in an overall CO2 emissions reduction given the electricity production, but it had a real impact on how emissions were reported.
– An article on the Japan shipping industry’s evaluation of capturing and converting CO2 into methane as a fuel points out implementing the technology “would mean developing special vessels to transport the CO2. Key to commercialization would be the viability of shipping CO2 long distances.” So… transporting large volumes of CO2 in ocean vessels to reduce CO2 emissions from other ocean vessels? That’s a head scratcher.
This article from the Yale School of Environment also describes negative latent impacts of large scale tree planting.
… planting programs, especially those based on large numerical targets, can wreck natural ecosystems, dry up water supplies, damage agriculture, push people off their land — and even make global warming worse.
Unintended consequences can also show up as product issues that affect the business. More examples:
– Increasing the water recycling/reuse rate at one paper mill I audited years ago saved water and money, but made the paper turn brown. The mill was unable to remedy the problem and ended up reducing their water reuse.
– In order to reduce waste and save on raw material costs, one company dramatically increased their used product recovery and repair rates. Because the used products had to be washed before being put back into circulation, the more they upped their recovery, the more water they used.
The moral of the story is that companies should thoroughly evaluate identified solutions in advance. Use a wide angle “life cycle” view to eliminate surprises – and encourage directors to ask difficult questions.
On Friday afternoon, the SEC announced that it voted to reopen the comment period for the 2016 “universal proxy” proposal – which would amend Schedule 14A and related rules to require the use of a single proxy card in all non-exempt solicitations for contested director elections.
Last summer, it looked like this rule was nearing the finish line – and Acting SEC Chair Allison Herren Lee noted just last month that it was still on the near-term agenda. But – and this might be the greatest understatement to ever appear in this blog – a lot has happened since these amendments were proposed in October 2016. The 15-page reopening release says that the Commission wants more input in light of corporate governance developments that could affect how universal proxy cards work, such as:
– There have been several contests where one or both parties have used a universal proxy card
– Increased adoption of proxy access bylaws
– Use of virtual shareholder meetings
– New forms of advance notice bylaws that require dissident nominees to consent to being named in the company’s proxy statement and on its proxy card
The release identifies 25 topics on which the Commission would appreciate input – about half relate to fund-specific issues. The formal comment period will be open for 30 days after the release is published in the Federal Register, which often takes about a month. Here are all the comments submitted to-date. For even more background, see this Cooley blog.
The SPAC Bubble Is Leaking
The SEC’s recent scrutiny of SPACs (whichwe’vebloggedaboutrepeatedly) appears to be sidelining some deals. According to this WSJ article, there were only 12 SPAC offerings in the past 3 weeks. That compares to about 25 per week from January – March!
Last week, the CII Research & Education Fund also released this 17-page memo to investors. While it doesn’t expressly advocate against the SPAC model of going public, it does identify several reasons why the SPAC/de-SPAC process is particularly risky.
The memo notes that at particular risk are SPAC investors who elect not to redeem their shares in the de-SPAC transaction, especially if the combined company adopts weak shareholder rights provisions – like a dual-class share structure. It suggests that these investors may be better off by either selling or redeeming before the de-SPAC, or by negotiating a favorable subscription through a PIPE.
Although the memo is aimed at investors, it’ll also be helpful to companies and advisors who are considering SPAC deals. Not only does it foreshadow investor demands that could be coming in the future, it also examines & pokes holes in some perceived SPAC benefits. Here are a couple that caught my eye:
Speed to Market: From the standpoint of the private company entering the public markets through a de-SPAC, the process is sometimes touted for beingfaster than a traditional IPO. But is that speed meaningful, and does that speed benefit investors? The typical timeline for a de-SPAC is 10 weeks, while a traditional IPO usually takes 19 weeks, but preparation for IPOs tends to extend this difference. Investors should be aware that a speedier time frame may attract a pool of operating companies that is disproportionately focused on capitalizing on a hot market, a hot sector or “short-term fads.”
Underwriting Costs: Underwriting fees for SPAC IPOs are based on a percentage of the proceeds raised, as with traditional IPOs. However, it is important to keep in mind that due to a SPAC’s redemption phase, cash raised can be different from cash received. The nominal fee percentage is often lower for SPACs than the usual 7% fee for traditional IPOs. It is unusual for SPAC underwriting fees to be adjusted for redemptions at the time of the de-SPAC. Without adjustment, that “attractive” 5% underwriting fee with a redemption rate of 50% is the equivalent of the merged company paying 10%.
Voting Statements: Can Anything Be “Non-Partisan”?
As I blogged a few months ago, businesses are now the most trusted institution in society. Unfortunately, that also means that 86% of people now expect CEOs to speak out on social challenges. Last week, hundreds of executives, companies, law firms and non-profits did just that – by signing their names to this 2-page ad in the WaPo and NYT.
The statement at the top of the ad is only 8 lines long and speaks of the importance of democracy. The two lines that drew the most attention (and were reportedly the most difficult to agree upon) were:
We all should feel a responsibility to defend the right to vote and to oppose any discriminatory legislation or measures that restrict or prevent any eligible voter from having an equal and fair opportunity to cast a ballot.
Voting is the lifeblood of our democracy and we call upon all Americans to join us in taking a nonpartisan stand for this most basic and fundamental right of all Americans.
Of course, the statement and the reporting on it was immediately criticized as partisan. People were looking to see whether or not their employers and local companies had signed, etc. I’ve been waiting for a statement from the Center for Political Accountability – haven’t seen one yet – about whether and how they’ll use companies’ endorsement/lack of endorsement in political spending proposals. (As this ICCR release notes, 81 institutional investors did send a statement on the risks of political spending to members of the Business Roundtable back in February.)
What’s clear is that this type of thing is very difficult for companies and their leaders to navigate. You’re bound to anger some people regardless of what you say. You’re bound to anger some people if you remain silent (contrary to some opinions that that’s typically the safer choice). And then, whatever choice you make is viewed through a lens of suspicion. Are you grandstanding? Who are you trying to appeal to? Have you said or done anything contradictory in the past?
This Perkins Coie memo outlines a framework for deciding when to speak out. It also lists a few factors that could trigger lobbying or ethics rules that you need to watch out for:
– Is the topic in which the company is engaging related to an election or ballot measure? If yes, the laws in many jurisdictions limit election-related activity but do not bar it entirely. For example, federal law provides corporations a number of opportunities to engage in voter registration, get out the vote, and other civic engagement activities as long as they do so on a nonpartisan basis. (Federal Election Commission regulations have specific requirements for what counts as nonpartisan in this context.)
– If the company is speaking out on legislation, is the bill still pending, or has the bill been passed and signed into law? Speaking out about a bill that has already been enacted will rarely be regulated (though companies will also have to weigh whether such after-the-fact statements are effective in addressing their strategic goals).
– If the legislation is still pending, does the communication or other activity include a call to action? A call to action is a statement urging employees, customers, or members of the public to contact their government official to support or oppose legislation or some other government action. Some jurisdictions do not regulate statements that don’t include a call to action.
– If the legislation is still pending, is the company paying to promote the communication in any way, such as by taking out a print or digital ad campaign or paying to boost social media posts? Some jurisdictions treat paid and unpaid content differently for ethics and compliance purposes.
At a bigger-picture level, this Korn Ferry memo makes the case that defining core values is now more important than ever. It sounds a little “woo-woo,” but clear values can give you something to lean on and return to when a novel issue arises. The devil’s in the details, though, because you have to make sure these values are consistently applied, and consistently articulated internally & externally. And while CEOs may have their own personal values that drive decisions, remember that CEO tenure averages about 7 years. Company values should be tied more to stakeholders than who is currently at the helm.
It’s also important to note that, at least for now, shareholders don’t appear to be making buy/sell decisions based on the statement or the ensuing commentary. This Economist article points out that after the ad was published, stocks performed almost identically for companies that did and didn’t sign.
Like many of you, I anxiously await the release of the new James Bond film No Time to Die. Sadly, this will be Daniel Craig’s final turn at the role, who in my opinion has been the finest Bond ever. It may also be the last time we see Bond’s stunning Aston Martin DB5. Although after the car’s total destruction in Skyfall, Q did rebuild it for the subsequent Spectre, so maybe there is hope.
One bond that isn’t going away is the sustainability-linked bond (SLB) – at least according to JPMorgan Chase. Last month, Marilyn Ceci, global head of the bank’s ESG developed capital markets (DCM) group offered this prediction:
The SLB market will grow from $6.9 billion (the volume for January-March 2021) to $100 – $130 billion before the end of 2021. She expects the global issuance of green bonds generally to grow almost 50% – to around $690 billion – in 2021 alone.
Shortly after Marilyn made that comment, BlackRock announced a $400 million expansion of a $4 billion revolving credit facility in which it pays slightly lower fees & interest if it meets targets for women in senior leadership and Black and Latino employees in its workforce. The filed amendment contains specifics. We don’t know whether it was BlackRock or its lenders who wanted to add these terms to the debt deal – it helps both sides show that they’re making commitments to ESG, and it could add momentum to the SLB trend.
The first SLB was issued in 2019, meaning SLBs are a newer subset of the broad category of green bonds. SLBs are an interesting animal, offering both carrots and a stick to issuers.
The carrots: SLB proceeds can be used for general corporate purposes rather than being limited to a specific green or social project, and the issuer gets a reputational bump for offering a sustainability instrument.
The stick: if the issuer misses the sustainability goals/performance metrics, they must pay bondholders a premium that is established at issuance. Some are saying this is a different shade of “say-on-climate” – with bondholders determining whether the metrics are appropriate and whether they’ve been satisfied.
Another unique aspect is the economic certainty of SLBs. When evaluating green upsides, much uncertainty is built into predictions – global market conditions, mercurial consumer behavior, pricing dynamics, supply chain risk. It can be difficult to demonstrate the ROI on expenditures related to sustainability performance monitoring or not achieving the sustainability goals. SLB covenants, on the other hand, specifically define the real cost of missing the mark – pre-emptively answering certain “what if?” questions and making an ROI calculation for project monitoring costs more defensible than other green investments.
What You Can Do
If you have the opportunity to raise capital through SLBs, how can you make sure you can verify that you’ve hit your targets? First, knowing the cost of missing SLB sustainability goals in advance should make it easy to justify monitoring and assurance efforts – but here are some wrinkles that could arise:
– Is the company using emissions offsets to achieve at least part of its GHG reduction commitments? There are meaningful risks associated with offsets (see my blog below!) – therefore, additional monitoring activities are warranted.
– Are SLB targets related to social or workplace condition improvements in the company’s supply chain? Companies should consider augmenting industry-wide supplier audit/monitoring programs by either participating directly or engaging qualified third parties to conduct supplier evaluations in parallel with – or as a replacement to – industry programs.
– How is raw data concerning the goals collected and verified? Automated systems such as meters and probes are great, but they are not flawless and need ongoing maintenance. Procedures to detect errors or failure should be put into place and it may be optimal for those to be manual to some extent.
Carbon Offsets: Widespread “Sustainability” Practice is Under Internal Review
Liz blogged a few weeks ago about investors specifically discouraging portfolio companies from using carbon offsets to achieve net zero goals. As reported in this piece by World Oil, the Nature Conservancy is also launching an internal review of its carbon offset & trading projects and procedures. Offsets have a long history of controversy, misuse and fraud, yet play an outsized role in corporate Net-Zero pledges and strategies.
This is big news, as WorldOil points out:
The internal review is a sign that it’s [The Nature Conservancy] at least questioning some practices that have become widespread in the environmental world, and could carry implications for the broader market for carbon credits.
Carbon offsets can be a viable tool in corporate greenhouse gas reduction plans. It’s tempting to wave a hand, write a check and not give it much consideration. Yet offsets carry a large amount of risk in the mid to long term – both on a project-specific basis and in terms of maintaining a credible market.
To be valid, offsets are supposed to be “additional” – meaning that they arise from an activity that would not have occurred otherwise. As an example, offsets for not cutting trees that were intended to be harvested meets the “additionality” definition. But if those trees were never to be harvested, offsets cannot be claimed for doing nothing. Also, plant-based offsetting assets such as trees can disappear before their “job” is done, meaning the expected – and contracted – carbon uptake is incomplete. Forest fires, droughts, infestations, regulatory changes, nationalization/imminent domain and illegal harvesting are very real threats to their ability to absorb the promised amount of CO2 over the decades typically needed.
The article states that “in 2020, companies purchased more than 93 million carbon credits,” and the emissions trading market is expected to exceed $100 billion in the coming decades. That is a lot of hot air needing global credibility.
What You Can Do
If you’re using carbon offsets as part of your net-zero strategy, it’s good to be aware that they’re not a full solution – and that they’re coming under additional scrutiny right now. It’s not a bad idea to work with your internal risk management group to conduct a risk assessment exercise. Among the potential perils:
– Reputational risk
– Contract breach
– Customer mandate non-conformance
– Loan and bond covenant breach
– Regulatory non-compliance
– Materiality disclosure non-compliance
– Third-party exposure
Once the risk picture is in focus, you can develop specific mitigation strategies – such as:
– Risk transfer (such as insurance and contractual terms)
– Verifying project assumptions, calculations, controls and technologies
– Direct involvement in project verification, monitoring and auditing
– Contingency plans for offset losses
– Rebalancing the mix of tools used to achieve reductions
– Reconsideration of greenhouse gas commitments or strategy
Biden Infrastructure Plan May Pay to Avoid Emissions
Speaking of carbon offsets, here is an interesting thought. Biden’s Infrastructure Plan announced March 31 includes a proposal to
reform and expand the bipartisan Section 45Q tax credit, making it direct pay and easier to use for hard-to-decarbonize industrial applications, direct air capture, and retrofits of existing power plants.
For a short refresher, Section 45Q values a metric ton of qualified avoided CO2 emissions at $50 (for geologic capture/sequestration) or $35 (for other methods of capture/sequestration). As a tax credit, it only applies to the owner of the carbon capture/sequestration equipment or user of the captured CO2.
But changing to a “direct pay” model could open the doors to innovative revenue sharing arrangements between electricity producers, capture/sequestration technology providers and even other parties.
Yesterday, the Senate voted to confirm Gary Gensler’s nomination as the next SEC Chair by a 53-45 vote. Gary will likely be sworn in early sometime early next week – and many expect he will hit the ground running.
Usually, when the Senate approves a new SEC Chair, the person is approved to serve in that capacity for a 5-year term. In this case, the Senate approved Gary to serve only for the remainder of former SEC Chair Jay Clayton’s term, which ends on June 5th of this year. An SEC Commissioner can serve up to 18 additional months following expiration of their initial term if a successor isn’t named – but another Senate vote is required to serve beyond that.
Although there’s no imminent plan for another Senate vote on this position, the Senate Banking Committee already cleared the reappointment of Gary for a second five-year term ending on June 5, 2026 when they advanced his nomination. So it’s on the Senate calendar, but the vote is subject to Gary’s commitment to respond to testify before any Senate committee. This Cooley blog gives more detail about the confirmation hearing and potential priorities for a Gensler SEC.
ESG Reports: 7 Tips for a “Health Check”
I’m happy to share this guest post from Ashley Walter, JT Ho and Carolyn Frantz of Orrick – with 7 tips for conducting a “health check” on your ESG report:
Environmental, Social and Governance (ESG) reports are becoming “table stakes” for public companies, regardless of a company’s industry or market capitalization. Whether you have been publishing a report for years or you haven’t started the process yet, given recent SEC developments, and increased focus on ESG by various stakeholders, including investors, proxy advisors, commercial partners, customers and employees, now is the time to revisit and reassess your disclosure.
In this post, we offer guidance on how companies can perform a “health check” on their ESG reports:
1. The horse must come before the cart. As a result of the focus on disclosure by investors and other stakeholders as well as proxy advisors and ESG ratings organizations, it is easy for companies to fall into the trap of prioritizing disclosure over the underlying ESG framework that forms the basis for such disclosures. Companies should focus on implementing a tailored framework that identifies key performance measures, establishes effective oversight at the Board, committee and management levels, addresses commercial requirements, is responsive to stakeholder interests, and ensures legal compliance.
2. Review disclosure controls and procedures. Companies should consider employing some the same disclosure controls and procedures in reviewing and approving an ESG report that they employ in reviewing and approving SEC filings, which may require internal and external audit review. Given the amount of information included in such filings and the critical business issues addressed, the publication of an ESG report can expose a company to risk if the report is not vetted properly. Having disclosure controls and procedures in place will also enable an auditor to provide assurance with respect to the company’s disclosures, if the company deems that advisable.
3. Be cognizant of language describing the purpose of ESG measures and the timeline for implementation of ESG goals. Throughout its pages, an ESG report will, in various ways, address the connection between the ESG measures described in the report and the impact on value for stakeholders – this relationship must be articulated carefully and should be consistent across the report. Statements closely tying representations about ESG to financial performance may heighten litigation risks if those representations are later considered misleading. In addition, to the extent forward-looking ESG goals are presented, any timelines for implementation should be realistic and caveated appropriately. Special attention should be paid to this issue when it comes to letters composed by members of management or the board that are included in the report.
4. Refrain from employing the concept of materiality. Given the SEC’s stated intention to revise its guidance regarding what may be considered material with respect to climate-related disclosure, companies should refrain from using the word “materiality” in their ESG reports so that the term is not conflated with materiality as defined by the SEC. Alternatives include referring to “priority,” “significant,” or “relevant” ESG factors.
5. ESG report or website? Certain companies have opted to provide their sustainability disclosures on internal website pages as opposed to within a separate published report. While this approach enables a company to update the material more easily and avoid some of the costs associated with preparing a stand-alone report, it’s also possible that it may be more difficult for proxy advisors, ESG ratings organizations, investors and others to quickly find relevant information and, more importantly, it may work against the company’s efforts to ensure consistent disclosure controls and procedures are applied with respect to ESG disclosure.
6. Leverage your lawyer. Legal counsel can advise the company on governance, board fiduciary duties and director liability, and litigation risks associated with ESG programs and disclosures. Any communications with legal counsel may be privileged. Company counsel should be involved in a targeted fashion at key points in the process – most importantly at the outline stage, after an initial draft has been put together by the company/its consultant(s), and before the report is finalized.
7. Should we hire a consultant? There are many different types of firms that offer ESG reporting services, including traditional management consultancies, ESG-specific management consultancies, communications firms and engineering firms. Each brings a unique perspective and set of skills. A company should identify the resources it has internally and through its existing advisors and consider hiring a consultant to extent there are any gaps in its capabilities, and the company should select the type of consultant based on the consultant’s skill set and the nature of the identified gap(s).
Companies are under increasing pressure to publicly disclose a broad and detailed set of information regarding their ESG practices. Such information is used by institutional investors in their investment decisions by all major proxy advisors in developing their reports for shareholders (and may guide voting recommendations), and may also be used by potential and current commercial partners, consumers and employees. Given the potential opportunities and risks, companies preparing an ESG report for the first time should exercise great care in determining content and drafting language, and companies that have publishing reports for some time should reexamine their disclosures in the light of recent developments.
This Mediant announcement caught my eye as it says the firm offers proxy voting by voice with Alexa. It’s only available to a small subset of companies and retail shareholders right now – those who use Mediant – and shareholders with access to an Amazon Alexa device so they can tell Alexa their 12-digit control number in order to get access to voting. This could be big though – it could be a step up from voting by phone, especially if Broadridge ends up offering it down the road.
Retail voting is important because instances where retail shareholders tip the scales on a vote outcome do crop up – last year, I blogged about this on our “Proxy Season Blog.” The Alexa feature to vote all proposals at once could help companies get a positive retail turnout, because the default is to vote with management on everything. With Alexa, the possibilities for voice-enabled automation are seemingly endless, right now it’s unclear whether companies could also set up reminders. It’s kind of a fun concept, although I was disappointed that I didn’t have a 12-digit control number to test it…
Division of Examinations Observes Instances of ESG Proxy Voting Inconsistencies
Last week, the SEC’s Division of Examinations issued a risk alert with observations from its review of investment advisers, investment companies and funds that offer ESG investment products and services. The Division examined firms to evaluate whether they accurately disclose their ESG investment approach, and whether they implement policies, procedures and practices that synch with their ESG-related disclosures. The risk alert describes some of the Division’s observations relating to deficiencies and internal control weaknesses, including this excerpt about inconsistencies in proxy voting with advisers’ stated approaches:
The staff observed inconsistencies between public ESG-related proxy voting claims and internal proxy voting policies and practices. For example, the staff observed public statements that ESG-related proxy proposals would be independently evaluated internally on a case-by-case basis to maximize value, while internal guidelines generally did not provide for such case-by-case analysis. The staff also noted public claims regarding clients’ ability to vote separately on ESG-related proxy proposals, but clients were never provided such opportunities, and no policies concerning these practices existed.
The takeaway here is that companies, who think they may be doing and disclosing what certain investment companies and funds will value and evaluate, might not be able to count on these firms following their proxy voting guideline of a case-by-case analysis for a particular proposal. Whether this means the vote would be with management or not isn’t clear but when voting determinations are “case-by-case,” companies doing the right thing might think there’s a chance votes would be cast with management’s recommendation. This discrepancy highlights the need for companies, particularly those with ESG-related ballot items, to actively engage with shareholders to help stay on top of how different investment firms intend to cast their votes.
Commissioner Hester Peirce released a Public Statement about the ESG risk alert providing some added context. With respect to the risk alert discussion about inconsistencies in proxy voting, Commissioner Peirce reminds readers to keep the Commission’s previously issued proxy voting interpretive releases in mind. Commissioner Peirce notes that ‘While not applicable only to advisers using ESG strategies, these Commission statements remind advisers that proxy voting, when such authority is undertaken on behalf of the client, is subject to advisers’ fiduciary duty and must be undertaken in the client’s best interest.’
Corp Fin & OCA Staff Clarify How to Account for SPAC Warrants – Restatement Analysis Coming Your Way?
Warrants are a standard part of how SPACs raise money, and they’re often classified on balance sheets as equity. But as part of the SEC’s ongoing scrutiny of these deals – and as a follow-up to statements issued in early April – Acting Corp Fin Director John Coates and Acting Chief Accountant Paul Munter issued a Joint Statement on Monday saying that these instruments might instead need to be classified as liabilities, which means that they need to be revalued every period and cause fluctuations in net income that are complicated to explain.
That’s a big issue, especially for SPACs that have been filing financials for many reporting periods that could now be considered erroneous, and also for SPACs that are trying to go effective with registration statements.
When it comes to accounting for warrants, the statement discusses fact patterns and specific warrant terms that can impact whether the warrants can be classified as equity or as an asset or liability that requires a fair value assessment each period. Equity classification requires that the instrument (or embedded feature) be indexed to the company’s own stock (e.g., the payoff can’t depend on who the holder is). Another common situation that GAAP treats as a liability is if an event not within the company’s control could require net cash settlement. There’s a big emphasis on this being a “facts & circumstances” analysis – for each entity and each contract. Here are a couple of examples from the statement:
We recently evaluated a fact pattern relating to the terms of warrants that were issued by a SPAC. In this fact pattern, the warrants included provisions that provided for potential changes to the settlement amounts dependent upon the characteristics of the holder of the warrant. Because the holder of the instrument is not an input into the pricing of a fixed-for-fixed option on equity shares, OCA staff concluded that, in this fact pattern, such a provision would preclude the warrants from being indexed to the entity’s stock, and thus the warrants should be classified as a liability measured at fair value, with changes in fair value each period reported in earnings.
We recently evaluated a fact pattern involving warrants issued by a SPAC. The terms of those warrants included a provision that in the event of a tender or exchange offer made to and accepted by holders of more than 50% of the outstanding shares of a single class of common stock, all holders of the warrants would be entitled to receive cash for their warrants. In other words, in the event of a qualifying cash tender offer (which could be outside the control of the entity), all warrant holders would be entitled to cash, while only certain of the holders of the underlying shares of common stock would be entitled to cash. OCA staff concluded that, in this fact pattern, the tender offer provision would require the warrants to be classified as a liability measured at fair value, with changes in fair value reported each period in earnings.
Even though it may be painful, if you haven’t already talked with your auditors about this, it’s probably time to give them a call. If you determine there’s a material error in previously filed financial statements — such as a reclassification of warrants from equity to a liability that also experienced a material fluctuation in value — the statement includes a reminder about information to include in an amended Form 10-K and any subsequent Form 10-Qs. It also reminds companies of their need to maintain internal controls over financial reporting and disclosure controls and procedures to determine whether those controls are adequate.
This latest statement could have the effect of slowing the deluge of SPAC transactions, as companies will need to wrangle with their accountants and others over terms of any warrants. If you have questions about technical accounting matters involving SPAC warrants, you should contact the Office of the Chief Accountant – and for questions about restating financial statements, contact Corp Fin’s Chief Accountant’s Office.
If you’re looking for an easy way to get up to speed on rules and guidance relating to the confidential treatment process, check out the latest “Deep Dive with Dave” podcast.
In this 28-minute episode, Dave Lynn and Dave Meyers of Troutman Pepper provide a confidential treatment workshop with tips about how to navigate the confidential treatment process. Topics include:
– Overview of the Confidential Treatment Process
– The 2019 SEC Rule Changes – The “Ask for Forgiveness” Approach
– The Filing Review Process
– Seeking Extensions of Confidential Treatment Requests
– Farewell to Competitive Harm
Last week, John blogged about the March-April Issue of “The Corporate Counsel,” and the companion 22-minute podcast is now also available.
Earlier this month, following a comment period during which it received no comments, the SEC approved amendments to the NYSE Listed Company Manual relating to shareholder approval requirements for related-party equity issuances and private placements exceeding 20% of a company’s outstanding stock or voting power. The amended requirements bring the NYSE’s shareholder approval rules into closer alignment with Nasdaq rules and provide listed companies with greater flexibility to raise capital.
The NYSE initially issued a waiver to its shareholder approval requirements back in April 2020 as companies were trying to raise capital during the Covid-19 pandemic – the waiver was extended a couple of times and the rule amendments are substantially the same as the waivers. Steve Quinlivan’s blog details the amendments relating to Sections 312.03, 312.04 and 314.00 of the NYSE Listed Company Manual. This excerpt summarizes changes to Section 312.03(b):
– Shareholder approval would not be required for issuances to a Related Parties’ subsidiaries, affiliates or other closely related persons or to any companies or entities in which a Related Party has a substantial interest (except where a Related Party has a five percent or greater interest in the counterparty, as described below).
– Shareholder approval would be required for cash sales to Related Parties only if the price is less than the Minimum Price.
– Issuances to a Related Party that meet the Minimum Price would be subject to shareholder approval for any transaction or series of related transactions in which any Related Party has a five percent or greater interest (or such persons collectively have a 10 percent or greater interest), directly or indirectly, in the company or assets to be acquired or in the consideration to be paid in the transaction and the present or potential issuance of common stock, or securities convertible into common stock, could result in an increase in either the number of shares of common stock or voting power outstanding of five percent or more before the issuance.
“Robust” Disclosure about Virtual Shareholder Meetings: Glass Lewis Expectations
Earlier this year, I blogged about some refinements Glass Lewis made to its disclosure expectations for virtual shareholder meetings. Virtual shareholder meetings were new for many last year and this year, expectations relating to information about the meetings are likely higher. For companies short on resources, some may have relied on an if-it-ain’t broke, don’t-fix-it-model, which we’ve heard may have caught some companies off-guard when receiving a Glass Lewis recommendation “against” members of their nominating committee. As a reminder, here’s an excerpt from a Glass Lewis blog entry describing their expectations:
From 2021, our expectations of companies holding virtual meetings globally are as follows:
Glass Lewis believes that virtual-only meetings have the potential to curb the ability of a company’s shareholders to meaningfully communicate with company management and directors. However, we also believe that the risks of a reduction in shareholder rights can be largely mitigated by transparently addressing the following points:
When, where, and how shareholders will have an opportunity to ask questions related to the subjects normally discussed at the annual meeting, including a timeline for submitting questions, types of appropriate questions, and rules for how questions and comments will be recognised and disclosed to shareholders.
In particular where there are restrictions on the ability of shareholders to question the board during the meeting – the manner in which appropriate questions received prior to or during the meeting will be addressed by the board; this should include a commitment that questions which meet the board’s guidelines are answered in a format that is accessible by all shareholders, such as on the company’s AGM or investor relations website.
The procedure and requirements to participate in the meeting and/or access the meeting platform.
Technical support that is available to shareholders prior to and during the meeting.
We believe that shareholders can reasonably expect clear disclosure on these topics to be included in the meeting invitation and/or on the company’s website at the time of convocation.
In the most egregious cases where inadequate disclosure of the aforementioned has been provided to shareholders at the time of convocation, we will generally recommend that shareholders hold the board or relevant directors accountable. Depending on a company’s governance structure, country of incorporation, and the agenda of the meeting, this may lead to recommendations that shareholders vote against:
Members of the governance committee, or equivalent (if up for re-election);
The chair of the board (if up for re-election); and/or
Other agenda items concerning board composition and performance as applicable (e.g. ratification of board acts).
On Friday, Corp Fin updated its guidance for conducting shareholder meetings in light of COVID-19 concerns. Here’s the new stuff:
Exchange Act Rule 14a-8(h) requires shareholder proponents, or their representatives, to appear and present their proposals at the annual meeting. In light of the possible difficulties for shareholder proponents to attend annual meetings in person to present their proposals, the staff encourages issuers, to the extent feasible under state law, to provide shareholder proponents or their representatives with the ability to present their proposals through alternative means, such as by phone, during the 2020 and 2021 proxy seasons.
Furthermore, to the extent a shareholder proponent or representative is not able to attend the annual meeting and present the proposal due to the inability to travel or other hardships related to COVID-19, the staff would consider this to be “good cause” under Rule 14a-8(h) should issuers assert Rule 14a-8(h)(3) as a basis to exclude a proposal submitted by the shareholder proponent for any meetings held in the following two calendar years.
Some have noted that encouragement falls short of a mandate – but companies are already reacting. Following the Staff’s announcement, Reuters reported that Berkshire Hathaway is now permitting As You Sow to present a diversity-related proposal remotely for the company’s upcoming annual meeting. As You Sow welcomed the accommodation and said Berkshire cited the updated Staff guidance when it contacted As You Sow.
SPACs: Less Risky Than IPOs? Corp Fin Chief Says “Don’t Bet On It”
As I’ve previously blogged, some commentators have suggested a driving force behind the SPAC boom may be the availability of the PSLRA safe harbor for a de-SPAC merger. The availability of the safe harbor supposedly provides greater freedom for sponsors to share projections than would be the case in an IPO, to which the safe harbor doesn’t apply. The presumed availability of the safe harbor is one reason why some have suggested that a de-SPAC transaction involves less risk than a traditional IPO.
In a statement issued yesterday, the Acting Director of Corp Fin, John Coates, called the assumption that de-SPAC deals involve less liability risk than traditional IPOs into question. Here’s an excerpt:
It is not clear that claims about the application of securities law liability provisions to de-SPACs provide targets or anyone else with a reason to prefer SPACs over traditional IPOs. Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst. Indeed, in some ways, liability risks for those involved are higher, not lower, than in conventional IPOs, due in particular to the potential conflicts of interest in the SPAC structure.
More specifically, any material misstatement in or omission from an effective Securities Act registration statement as part of a de-SPAC business combination is subject to Securities Act Section 11. Equally clear is that any material misstatement or omission in connection with a proxy solicitation is subject to liability under Exchange Act Section 14(a) and Rule 14a-9, under which courts and the Commission have generally applied a “negligence” standard. Any material misstatement or omission in connection with a tender offer is subject to liability under Exchange Act Section 14(e).
De-SPAC transactions also may give rise to liability under state law. Delaware corporate law, in particular, conventionally applies both a duty of candor and fiduciary duties more strictly in conflict of interest settings, absent special procedural steps, which themselves may be a source of liability risk. Given this legal landscape, SPAC sponsors and targets should already be hearing from their legal, accounting, and financial advisors that a de-SPAC transaction gives no one a free pass for material misstatements or omissions.
Director Coates also highlighted the limitations of the PSLRA’s safe harbor for forward-looking statements. Among other things, he noted that it only applies in private litigation, not SEC enforcement proceedings, applies only to forward-looking statements, and doesn’t apply to statements that are made with actual knowledge of their falsity. He also suggested that a de-SPAC merger may well be regarded as an “initial public offering” not subject to the safe harbor, and raised the possibility of clarifying rulemaking from the SEC concerning the scope of the safe harbor and its application to SPAC transactions.
PCAOB Issues Audit Committee Resource About 2021 Inspections
The PCAOB recently issued an Audit Committee Resource aimed at helping audit committees engage with their auditors about the PCAOB’s planned focus areas for 2021 inspections of public company audits. The resource provides a list of questions for audit committees as suggestions to spur dialogue between the audit committee and the company’s auditor. The suggested questions relate to the auditor’s risk assessments, auditor quality control systems, how auditors comply with auditor independence requirements, fraud procedures, critical audit matters, implementation of new auditing standards and supervision of audits involving other auditors.
Also, the PCAOB will continue to seek feedback from audit committee chairs as part of its effort to support improvements in audit quality. Like it has done in previous years, the PCAOB will seek feedback from audit committee chairs of companies where the PCAOB conducted inspections of the audit.
Netflix’s newest documentary Seaspiracy is all over social media and the news. You may have already watched it, or maybe it’s in your queue for this weekend. The movie looks at wide ranging environmental and social impacts of the seafood industry – it’s hard to watch and there’s a lot to unpack. Some are saying they went too far. But for now, let’s look at one topic with which I have direct experience: ESG claims and assurance systems.
The film’s producer interviews Mark Palmer, Associate Director USA for the Earth Island Institute’s International Marine Mammal Project (IMMP), which operates the “Dolphin Safe Tuna” label program. The “Dolphin Safe” mark is used on canned tuna to indicate dolphins were not killed as bi-catch during tuna fishing. The interview as presented in the film can be summed up in this exchange:
Producer: You [Dolphin Safe] have observers, but they are rarely there [on the fishing vessels], and they can be bribed and so you can’t guarantee that dolphin safe tuna is dolphin safe.
Palmer: That’s certainly true in terms of how the system works.
Producer: But it’s not guaranteed to be dolphin safe.
Palmer: Nothing can guarantee it’s dolphin safe.
Producer: But if it’s not guaranteed to be dolphin safe, why is it called dolphin safe?
Palmer: We can pretty well guarantee it’s dolphin safe… it’s not guaranteed in the same way that, uh.. the world is a difficult place sometimes.
To be fair, in the “they’ve gone too far” camp, the IMMP has issued a statement expressing concern about how the film presents the interview.
In the bigger picture, though, there’s some merit to examining these programs – and the “Dolphin Safe” folks certainly aren’t the first responsible sourcing assurance mechanism to be on the hot seat. Another high-profile example is the London Bullion Marketers Association (LBMA) – and their “Good Delivery List” that’s intended to incentivize responsible gold production. Recent developments include NGOs claiming systemic flaws and a major assurance provider acknowledging shortcomings in managing conflict of interest. Many other metals and the mining industry have their own – but very similar – responsible sourcing due diligence mechanisms (the proliferation of these systems is a topic for another day). Responsible timber due diligence assurance uses the same basic construct, so these issues may not be limited to gold due diligence assurance programs.
Encouragingly, these mechanisms aren’t deaf to the feedback. They are aware of improvements needed and are working to implement changes – but it takes time to develop, field test and launch solutions.
One takeaway for companies who rely on some of these programs is that major investors and financial institutions will soon be looking over your shoulder too. Jamie Dimon, CEO of JPMorganChase, stated in his 66-page Letter to Shareholders (2020):
… we will measure our clients’ carbon performance against sector-based GHG reduction targets that we’re setting for 2030 – with the goal of helping the reduce emissions from their direct operations and, in the case of oil and gas and automotive companies, reduce GHG from the use of their products.
What does this all mean? Basically, it’s reinforcement of companies’ misgivings around ESG assurance and certifications. They don’t offer the impenetrable protection of Captain America’s shield, and you can embrace that and add checks & balances. You never know when the next “Seaspiracy” will attract stakeholder attention – and investors are already developing their own systems to track, verify and question fundamental ESG information.
More on ESG Assurance: Using a Belt & Suspenders
While it’s true that many of the myriad ESG certifications/assurance mechanisms have responded to criticism by making systemic improvements, some have not. And even with improvements, gaps still exist. Either way, they don’t provide blanket protection from liability or business losses. Let’s dive in to how you can use industry assurance and labeling mechanisms in a prudent way.
In my opinion, there are two major elements to the risk:
Becoming a movie star villain. Seaspiracy is only the most recent example of becoming a reluctant movie star. A few years ago, another Netflix documentary brought economic devastation to one of my old consulting clients, and they are still struggling to get back where they were. Before that happened, I brushed off the idea that the film would have such impact. Having now seen it firsthand, I strongly suggest not ignoring it. Who knows what ESG matters – or companies – will be targeted next, and these documentaries have a track record of going viral.
Following the crowd. There are certainly advantages to using industry ESG assurance mechanisms, including the “safety in numbers” philosophy. In my experience, this tends to lead to complacency by individual companies about assurance quality and execution. But as previously discussed, those mechanisms are not perfect and you can essentially become a hostage to their flaws. Continuing to participate in or rely on these programs without doing something more may create more problems than expected.
Once a company recognizes the exposures, it should implement mitigation strategies. As a friend of mine at OECD frequently says: “You can’t outsource due diligence responsibility.” Perhaps the most effective of ways of taking responsibility are actually easy to do:
– Invite your Internal Audit group to learn more about industry assurance programs your company uses. Ask them to do a deep dive into the program’s procedures, practices, standards and auditors/assurance providers.
– Take an active role in shaping the industry assurance program(s) to close gaps or address concerns you or your Internal Audit group identified.
– Do your own monitoring of the assurance program(s) by participating in their audits where possible. Compare your experience and results with the programs’ final results. Where differences are identified, explore those with the program(s).
Finally, while not necessarily easy, it is worth considering augmenting your company’s use of industry programs with your own activities, including further use of Internal Audit to evaluate ESG risks of business partnerships or hiring qualified and screened third party ESG assurance experts.
Will Climate Pledges Outlive the Companies that Make Them?
Forever is a long time, except in corporate timelines. I remember visiting the Hoover Dam in the early 1990s and marveling at a plaque listing the construction contractors. Although construction was completed in 1936, a handful of the companies listed were still operating at the time I was there. But the world has changed in the past century. Companies aren’t really built to last.
Credit Suisse noted in 2017 that “the average lifespan of a S&P500 company is now less than 20 years, from 60 years in the 1950s.” Management is not necessarily stable over the long term. A Harvard Law study showed that CEO tenure has been on a downward trend and, for large cap companies, “the plurality of large-cap CEOs have been in the corner office between one and five years.”
These trends matter for a few reasons, but nothing may be as obvious as corporate climate commitments, especially the oh-so-popular Net-Zero pledge. This article from Canary Media does a fine job of summarizing last month’s analysis by Climate Action 100+ that benchmarked current corporate climate commitments against company actions and schedules (spoiler alert: there are substantial gaps between commitments made public, what those commitments should address and plans for execution).
Yet what I found most compelling is this perspective related to the current trends on company and CEO lifespan:
This shifts the critical question from whether we believe today’s corporate giants genuinely want to make good on these commitments to whether we think they, or their leadership, will even be around at all. Rather than congratulating companies that promise to clean up their act for a tomorrow they may never see, we need to be holding them to account for what they’re doing today.
Given the unprecedented complexity of the climate issue, uncertainty is to be expected. I hope that companies making long term climate pledges will last longer than most celebrity marriages – and it’s heartening to see companies making commitments, while recognizing this is a long term play. But will investors – many of whom already have short-term horizons – see corporate climate action from this perspective and push for nearer term goals/solutions? For companies making climate pledges that face the risk of no longer being a going concern – how will they manage or disclose the risk of failing to meet climate commitments?
This is one reason why it’s probably inappropriate to “shame” companies for favoring annual incentive programs as the vehicle for ESG metrics – it may be an annual program, but if you incentivize the correct year-over-year building blocks, it can lead to lasting change. In the fervor of this push for big change, it is worth considering the risk that a corporate climate pledge may outlive the company itself. Short-term stepping stones are a valuable part of the bridge to the future.
