Category: Corporate Governance
Gensler talks about AI (and a bit about climate)
Yesterday, in remarks at Yale Law School, SEC Chair Gary Gensler talked about the opportunities and challenges of AI. According to Gensler, while AI “opens up tremendous opportunities for humanity,” it “also raises a host of issues that aren’t new but are accentuated by it. First, AI models’ decisions and outcomes are often unexplainable. Second, AI also may make biased decisions because the outcomes of its algorithms may be based on data reflecting historical biases. Third, the ability of these predictive models to predict doesn’t mean they are always accurate. If you’ve used it to draft a paper or find citations, beware, because it can hallucinate.” In his remarks, Gensler also addressed the potential for systemic risk and fraud. But, in the end, he struck a more positive note, concluding that the role of the SEC involves both “allowing for issuers and investors to benefit from the great potential of AI while also ensuring that we guard against the inherent risks.”
Does shareholder primacy mean just maximizing profits—and what does Exxon have to do with it?
As you know, the shareholder primacy theory is widely attributed to the Chicago school of economists, beginning in the 1970s, with economist Milton Friedman famously arguing that the only “social responsibility of business is to increase its profits.” Subsequently, two other economists published a paper characterizing shareholders as “‘principals’ who hired executives and board members as ‘agents.’ In other words, when you are an executive or corporate director, you work for the shareholders.” The idea, in effect, is that, as owners, shareholders may legitimately require that the company conduct its business in accordance with their desires. Of course, this idea has been subject to criticism by many as improperly ignoring the interests of other stakeholders, such as employees, customers and the community—so-called “stakeholder capitalism.” Under Friedman’s version of shareholder primacy, the desire of shareholders has long been presumed to be to maximize value and increase profits. But is it? The author of this article in Fortune makes the argument that the ongoing Exxon litigation against Arjuna and Follow This, two proponents of a climate-related shareholder proposal, throws into sharp relief a schism that has formed among adherents to the idea of shareholder primacy. The question posed is “what do shareholders really want, and are companies ever allowed to ignore them? Arjuna and Follow This own Exxon stock and are trying to dictate how the energy giant behaves. However, they are demanding more than dividends: They want Exxon to commit to more ambitious emissions reductions, and to some, that’s just as bad as companies admitting an obligation to workers or the community.” Does shareholder primacy necessarily mean just maximizing profits?
SEC Chief Accountant urges focus on professional skepticism and audit quality
SEC Chief Accountant Paul Munter has posted a new Statement. What’s on his mind? Apparently, he is disturbed that, in recent inspections of audits, the PCAOB has reported a “troubling” increase in deficiency rates—meaning the PCAOB found that there was insufficient audit evidence obtained to support the auditor’s opinion. Deficiency rates went from 29% in the PCAOB’s 2020 inspections to 34% in its 2021 inspections, up now to 40% in its 2022 audit inspections. This, he warned, was a “troubling trendline in PCAOB inspections results”—emphasis again on “troubling.” What does he prescribe? A “commitment to high-quality audits,” which, “in turn, calls for the auditor to exercise objective, impartial judgment and rigorous professional skepticism in gathering and evaluating evidence throughout the audit to support the audit opinions provided.” To be sure, both auditors and audit committees “should pay particularly close attention to areas that have been frequently identified as causes of deficiencies in PCAOB inspections.” In addition, he advises that “auditors should conduct engagements with a mindset that the investors, rather than management, are the audit client.” This commitment to high-quality audits, he contends, is the only way for auditors to protect the investing public. He offers advice for both auditors and audit committees.
What happened with proxy votes in 2023?
Starting off the new year, consultant Semler Brossy’s latest report analyzes proxy results for 2023 among the S&P 500 and the Russell 3000, including votes on say on pay, environmental and social shareholder proposals, director elections and equity plans. According to SB, last year saw improvements in say-on-pay vote results and a decline in approval rates for E&S shareholder proposals. There was little change in the rate of favorable votes for director nominees, while there was an increase in vote failures for equity plan proposals. And SB shows that unfavorable vote recommendations from ISS apparently do make a difference.
Exxon employs “direct-to-court” strategy for shareholder proposal. Will others do the same?
Back in 2014, a few companies, facing shareholder proposals from the prolific shareholder-proposal activist, John Chevedden, and his associates, adopted a “direct-to-court” strategy, bypassing the standard SEC no-action process for exclusion of shareholder proposals. In each of these cases, the court handed a victory of sorts to Mr. Chevedden, refusing to issue declaratory judgments that the companies could exclude his proposals. (At the end of the day, one proposal was defeated, one succeeded and one was ultimately permitted to be excluded by the SEC. See this PubCo post, and these News Briefs of 3/18/14, 3/13/14 and 3/3/14.) Now, ten years later, ExxonMobil has picked up the baton, having just filed a complaint against Arjuna Capital, LLC and Follow This, the two proponents of a climate-related shareholder proposal, seeking a declaratory judgment that it may exclude their proposal from its 2024 annual meeting proxy statement. In summary, the proposal asks Exxon to accelerate the reduction of GHG emissions in the medium term and to disclose new plans, targets and timetables for these reductions. Will Exxon meet the same fate as the companies in 2014? Perhaps more significantly, Exxon took this action in part because it viewed the SEC’s shareholder proposal process as a “flawed” system “that does not serve investors’ interests and has become ripe for abuse by activists with minimal shares and no interest in growing long-term shareholder value.” If Exxon is successful in its litigation, will more companies, likewise faced with environmental or social proposals and perhaps perceiving themselves beset by the same flawed process, follow suit (so to speak) and sidestep the SEC?
NYSE’s proposed listing standards for Natural Asset Companies bite the dust
Last year, the NYSE proposed to adopt new listing standards for the common equity securities of a “Natural Asset Company,” a new type of public company defined by the NYSE as “a corporation whose primary purpose is to actively manage, maintain, restore (as applicable), and grow the value of natural assets and their production of ecosystem services.” Although existing regulatory and listing requirements would continue to apply to NACs, the proposal contemplated, in addition, a fairly elaborate new NAC governance and reporting ecosystem involving specific provisions in corporate charters, new mandatory policies (environmental and social, biodiversity, human rights, equitable benefit sharing), new prescribed responsibilities for audit committees and a new reporting framework, including mandatory “Ecological Performance Reports.” (See this PubCo post.) Why did the NYSE introduce this proposal? Notwithstanding all of the developments in ESG disclosure and investing (such as ESG funds), the NYSE contended that “investors still express an unmet need for efficient, pure-play exposure to nature and climate.” According to the Intrinsic Exchange Group, which pioneered the NAC concept and advises public sector and private landowners on the creation of NACs, “[b]y taking a NAC public through an IPO, the market transaction will succeed in converting the long-understood—but to-date unpriced—value of nature into financial capital. This monetization event will generate the funding needed to manage, restore, and grow healthy ecosystems around the world and bring us closer to achieving a truly sustainable, circular economy.” At the time of the proposal, I asked whether this proposal would be a game changer to rescue our environment or merely a chimera? The answer, at least for now, seems to be chimera. In December, the SEC instituted proceedings to determine whether to approve or disapprove the proposal, asking for comment on a number of questions that were based broadly on concerns raised by commenters, such as issues regarding the licensing arrangements for NACs and the relationship between NYSE and IEG. Then, on January 17, 2024, the NYSE withdrew its proposal. Why?
Atlantic herring get their day in court—does it spell the end of Chevron deference?
On Wednesday, SCOTUS heard oral argument—for over three and a half hours—in two very important cases, Loper Bright Enterprises v. Raimondo and Relentless, Inc. v. Dept of Commerce, about whether the National Marine Fisheries Service (NMFS) has the authority to require Atlantic herring fishing vessels to pay some of the costs for onboard federal observers who are required to monitor regulatory compliance. And they’re important because… why? Because one of the questions presented to SCOTUS was whether the Court should continue the decades-long deference of courts, under Chevron U.S.A., Inc. v. Nat. Res. Def. Council, to the reasonable interpretations of statutes by agencies. The doctrine of Chevron deference mandates that, if a statute does not directly address the “precise question at issue” or if there is ambiguity in how to interpret the statute, courts must accept an agency’s permissible interpretation of a law unless it is arbitrary or manifestly contrary to the statute. Of course, the conservative members of the Court have long signaled their desire to rein in the dreaded “administrative state,” especially when agencies are advancing regulations that conservative judges perceive as too “nanny state.” And overruling Chevron is one way to do just that. (See, for example, the dissent of Chief Justice John Roberts in City of Arlington v. FCC back in 2013, where he worried that “the danger posed by the growing power of the administrative state cannot be dismissed,” not to mention the concurring opinion of Justice Neil Gorsuch in the 2016 case, Gutierrez-Brizuela v. Lynch, where he referred to Chevron as an “elephant in the room” that permits “executive bureaucracies to swallow huge amounts of core judicial and legislative power.” And then there’s Justice Brett Kavanaugh’s 2016 article, Fixing Statutory Interpretation, in which he argues that Chevron is a “judicially orchestrated shift of power from Congress to the Executive Branch.” See the SideBars below.) But, in recent past cases, SCOTUS has resolved issues without addressing Chevron, looking instead to theories such as the “major questions” doctrine. (See this PubCo post.) The two cases now before the Court, however, may well present that long-sought opportunity. Depending on the outcome, their impact could be felt far beyond the Marine Fisheries Service at many other agencies, including the SEC and the FDA. Will we soon be seeing a dramatically different sort of administrative state? To me, it seemed pretty clear from the oral argument that SCOTUS is likely to jettison or significantly erode Chevron. Among the most conservative justices at least, there didn’t seem to be a lot of interest in half-measures—been there, done that. (The concept of the Court’s limiting its decision to whether statutory silence should be treated as ambiguity, as some had hoped, did not even come up for serious discussion.) But what approach the Court might take—overrule Chevron with no alternative framework suggested, adopt a version of “weak deference” as outlined in a 1944 case, Skidmore v. Swift & Co., or possibly even “Kisorize” (as they termed it) Chevron by imposing some serious limitations, as in Kisor v. Wilkie—that remains to be seen.
What’s new in best practices for board governance in 2024?
In this brand new report, The Conference Board looked at several of the less glitzy areas of board governance to identify some evolving best practices for attaining board excellence, such as board continuing education. From AI to ESG, corporate boards are bombarded by new and important issues about which they must attain some level of understanding and fluency. But how? Is there anything new in best practices for continuing education? Other areas of focus in the report are board self-evaluations, director overboarding and committee rotation. Are there any developments in best practices in those areas? TCB has some data and some advice, discussed below.
Is ESG backlash triggering a change in policies or just a change in terminology?
As discussed in this article from the WSJ, The Latest Dirty Word in Corporate America: ESG, ESG backlash is driving many company executives to drop any reference to “ESG” and instead use terms like “sustainability” or “responsible business,” or opt for “green hushing” altogether. Citing an analysis from FactSet, the WSJ reported that, on “earnings calls, mentions of ESG rose steadily until 2021 and have declined since…. In the fourth quarter of 2021, 155 companies in the S&P 500 mentioned ESG initiatives; by the second quarter of 2023, that had fallen to 61 mentions.” But are companies just turning down the volume while still pursuing the same aspirations or have they trimmed their objectives too?
Are there best practices for linking executive compensation to climate goals?
In this new paper, Feet to the Fire: How Should Companies Tie Executive Compensation to Climate Targets?, from the Rock Center for Corporate Governance at Stanford, the authors looked at how some companies bolstered their commitments to climate action—the authors refer to it as “institutionalizing” their climate goals and commitments—by including climate-related metrics in executive compensation plans and agreements. The authors observed that, increasingly, even in the absence of regulation, companies have made voluntary pledges to reduce their carbon emissions. Citing MSCI, the authors report that about “half of large, publicly traded companies have established carbon emissions targets, and a third have pledged to achieve net zero emissions by 2030 or 2050.” But is there anything to these promises? Have any of these carbon reduction objectives been fully integrated into the company’s strategy, operations or corporate culture? One way that some companies have sought to realize their climate goals is by tethering them to a measure of compensation. These climate metrics can function as both a signal of seriousness to the public and a mechanism for bringing accountability. In employing climate metrics as performance conditions in compensation programs, are there best practices to effectively achieve the kind of “institutionalization” that the authors advance?
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