Category: Securities

What’s wrong with ESG ratings?

About a year ago, the Brookings Institution held a panel discussion regarding the role that the SEC should play in ESG investing and invited SEC Commissioner Hester Peirce to speak at the panel. It’s well known, of course, that she is not exactly a fangirl of ESG in any of its manifestations, and she came prepared to engage, armed with a voluminous speech consisting of 10 theses, footnoted to the hilt. One of her theses was that figuring out what “good” means in the context of ESG is very subjective—that’s why, she said, there’s a lot of debate over best ESG practices and that’s especially why ESG ratings firms are so inconsistent in their results. (See this PubCo post.) There may be even more to it than that.  This new paper, ESG ratings—a compass without direction, from the Rock Center for Corporate Governance at Stanford University, looks at ESG ratings and examines issues about their reliability. The authors conclude that, “while ESG ratings providers may convey important insights into the nonfinancial impact of companies, significant shortcomings exist in their objectives, methodologies, and incentives which detract from the informativeness of their assessments.” 

More prescriptive proposals, less support for 2022 proxy season

This proxy season, companies saw more shareholder proposals than in the past, a change that has been widely attributed to actions by the SEC and its Division of Corporation Finance that had the effect of making exclusion of shareholder proposals—particularly proposals related to environmental and social issues—more of a challenge for companies. As discussed in this article in the WSJ, investors are taking the opportunity to press for more changes at companies. Nevertheless, the prescriptive nature of many of the proposals, especially climate-related proposals, has prompted many shareholders, including major asset managers, to vote against these proposals. Will next season reflect lessons learned by shareholder proponents from this proxy season?

More financial information about human capital? FASB looks to require disaggregation of expenses on the income statement

In June, the Working Group on Human Capital Accounting Disclosure, a group of ten academics that includes former SEC Commissioners Joe Grundfest and Robert Jackson, Jr. and former SEC general counsel, John Coates, submitted a rulemaking petition requesting that the SEC require more disclosure of financial information about human capital. According to the petition, there has been “an explosion” of companies “that generate value due to the knowledge, skills, competencies, and attributes of their workforce. Yet, despite the value generated by employees, U.S. accounting principles provide virtually no information on firm labor.” (See this PubCo post.) The Group may be about to have its wishes granted—at least in part—but not by the SEC. Rather, the FASB is hard at work on a project to disaggregate income statement expenses, and high on all of the FASB board members’ lists was the need to separately disclose labor costs/employee compensation. Of course, as reported by Bloomberg (here and here), there has been a push for disaggregation of expenses on the income statement since at least 2016, but in 2019, the FASB voted (5 to 2) “to put its once-high priority financial reporting project on pause.” It’s been quite a lengthy pause, but, in February 2022—perhaps hearing the call from investors and others—the FASB decided to restart work on the project to “improve the decision usefulness of business entities’ income statements through the disaggregation of certain expense captions.” It seemed from the FASB Board discussion that the Board members were favorably inclined to proceed with a disaggregation requirement—especially with respect to labor costs.

SOX at 20! Happy birthday SOX!

SEC Chair Gary Gensler may just have some paternal affection for SOX, especially on the week of its 20th birthday.   In these remarks to the Center for Audit Quality,  he recalls having “a front-row seat” for the negotiations and signing of the bill, working as Senior Advisor to the late Senator Paul Sarbanes on this legislation. The bill passed the House almost unanimously and the Senate by a vote of 99 to 0—hard to imagine that ever happened, let alone only 20 years ago.  In giving SOX its 20-year review, he discusses the significant role SOX played in restoring public trust in the financial system after the Enron and WorldCom scandals, but also offers some, let’s say, opportunities for improvement. (He also drops the hint that the SEC may be taking a “fresh look at the SEC’s auditor independence rules.”)

How are boards addressing sustainability?

With regulators in the U.S. and around the world looking hard at the possibility of imposing sustainability disclosure requirements, and investors and other stakeholders continuing to focus on sustainability in their engagements with companies—according to a PwC survey, “ESG is the topic investors most want to discuss during engagements with shareholders”—one question that arises is just what corporate boards are doing to deal with sustainability—what are their attitudes and commitments? Are they even prepared to address sustainability issues? In an article reporting on a 2022 survey by consulting firm Russell Reynolds (published on the Harvard Law School Forum on Corporate Governance), the firm tried to answer these questions. One conclusion from the survey: “Rather than having a sole ‘ESG director’ or ‘sustainability director,’ expectations are increasing for the entire board to bring a minimum level of sustainability awareness—if not expertise—to their work, using it to identify both risks and new opportunities for value creation.”

FASB plans to require supply chain financing disclosure beginning next year

For several years, the SEC staff and advisory committees, credit rating agencies, investors, the Big Four accounting firms and other interested parties have been making noise about a popular financing technique called “supply chain financing.” It can be a perfectly useful financing tool in the right hands—companies with healthy balance sheets. But it can also disguise shaky credit situations and allow companies to go deeper into debt, often unbeknownst to investors and analysts, with sometimes disastrous ends. Currently, there are no explicit GAAP disclosure requirements to provide transparency about a company’s use of supply chain financing. That may be why Bloomberg has referred to supply chain financing as “hidden debt.” In December, the FASB announced that it had issued a proposed Accounting Standards Update intended to help investors and others “better consider the effect of supplier finance programs on a buyer’s working capital, liquidity, and cash flows.” The proposed ASU would require the buyer in a supply chain financing program to “disclose sufficient information about the program to allow an investor to understand the program’s nature, activity during the period, changes from period to period, and potential magnitude.” On Wednesday, the FASB finalized the details of the plan and gave the go-ahead to draft the new ASU (which is expected to be available later this year). The new ASU would apply to both public and private companies. Although the final ASU has not yet been issued and is still subject to a final ballot, companies with supply chain financing programs may want to take note of this anticipated new requirement now. According to Bloomberg, there “will be a shorter turnaround than usual for complying with new FASB requirements”; compliance will be required retrospectively for fiscal years beginning after December 15, 2022, i.e., the first quarter of 2023.

SEC cuts key provisions of proxy advisor regulations

[This post revises and updates my earlier post primarily to reflect the contents of the proposing release.]

At an open meeting last week, the SEC voted, three to two, to adopt new amendments to the rules regarding proxy advisory firms, such as ISS and Glass Lewis—which the SEC refers to as proxy voting advice businesses, or “PVABs”—terms that the commissioners seemed to think…hmmm… needed some work. The amendments to the PVAB rules reverse some of the key provisions governing proxy voting advice that were adopted in July 2020 (referred to as the 2020 Final Rules). Those rules had codified the SEC’s interpretation that made proxy voting advice subject to the proxy solicitation rules, but added to the exemptions from those solicitation rules two significant new conditions—one requiring disclosure of conflicts of interest and the second designed to facilitate effective engagement between PVABs and the companies that are the subjects of their advice. (See this PubCo post.) Under the new final amendments as adopted last week, proxy voting advice will still be considered a “solicitation” under the proxy rules and proxy advisory firms will still be subject to the requirement to disclose conflicts of interest; however, the new amendments rescind that second central condition designed to facilitate engagement—which some might characterize as a core element, if not the core element, of the 2020 amendments. The amendments also rescind a note to Rule 14a-9, also adopted as part of the 2020 Final Rules, which provided examples of situations in which the failure to disclose certain information in proxy voting advice may be considered misleading. According to the press release, institutional investors and other clients of proxy advisory firms had “continued to express concerns that these conditions could impose increased compliance costs on proxy voting advice businesses and impair the independence and timeliness of their proxy voting advice.” In his statement, SEC Chair Gary Gensler observed that many investors expressed concerns that “certain conditions in the 2020 rule might restrain independent proxy voting advice. Given those concerns, we have revisited certain conditions and determined that the risks they impose to the independence and timeliness of proxy voting advice are not justified by their informational benefits.”

SEC proposes to narrow three substantive exclusions in the shareholder proposal rule

[This post revises and updates my earlier post on this topic primarily to reflect the contents of the proposing release.]

At an open meeting last week, the SEC voted, three to two, to propose new amendments to Rule 14a-8, the shareholder proposal rule. Under Rule 14a-8, a shareholder proposal must be included in a company’s proxy materials “unless the proposal fails to satisfy any of several specified substantive requirements or the proposal or shareholder-proponent does not satisfy certain eligibility or procedural requirements.” The SEC last amended Rule 14a-8 in 2020 to, among other things, raise the eligibility criteria and resubmission thresholds. The SEC is now proposing to amend three of the substantive exclusions on which companies rely to omit shareholder proposals from their proxy materials: Rule 14a-8(i)(10), the “substantial implementation” exclusion, would be amended to specify that a proposal may be excluded as substantially implemented if “the company has already implemented the essential elements of the proposal.” Rule 14a-8(i)(11), the “substantial duplication” exclusion, would be amended to provide that a shareholder proposal substantially duplicates another proposal previously submitted by another proponent for a vote at the same meeting if it “addresses the same subject matter and seeks the same objective by the same means.” Rule 14a-8(i)(12), the resubmission exclusion, would be amended to provide that a shareholder proposal would constitute a “resubmission”—and therefore could be excluded if, among other things, the proposal did not reach specified minimum vote thresholds—if it “substantially duplicates” a prior proposal by “address[ing] the same subject matter and seek[ing] the same objective by the same means.” The SEC indicates that almost half of the no-action requests the staff received under Rule 14a-8 in 2021 were based on these three exclusions. In his statement, SEC Chair Gary Gensler indicated that the proposed amendments would “improve the shareholder proposal process” by providing “greater certainty as to the circumstances in which companies are able to exclude shareholder proposals from their proxy statements.” In the proposing release, the SEC contends that the amendments “are intended to improve the shareholder proposal process based on modern developments and the staff’s observations” and “would facilitate shareholder suffrage and communication between shareholders and the companies they own, as well as among a company’s shareholders, on important issues.” Notably, however, the two dissenting commissioners seemed to view the proposed changes—even though they stop well short of revamping the 2020 eligibility criteria and resubmission thresholds—as an effort to undo or circumvent the balance achieved by the 2020 amendments without actually modifying those aspects of the rules. For example, new Commissioner Mark Uyeda said that the proposed amendments could “effectively nullify the 2020 amendments to the resubmission exclusion and render this basis almost meaningless.”

SEC cuts key provisions of proxy advisor regulations and proposes amendments to Rule 14a-8: will they create regulatory whiplash?

At an open meeting yesterday morning, the SEC welcomed new Commissioner Mark Uyeda and bid farewell to Commissioner Allison Herren Lee.  The SEC also voted to adopt new amendments to the rules regarding proxy advisory firms, such as ISS and Glass Lewis—which the SEC refers to as proxy voting advice businesses, or “PVABs”—and to propose new amendments to three of the exclusions in Rule 14a-8, the shareholder proposal rule. The amendments to the PVAB rules reverse some of the key provisions governing proxy voting advice that were adopted in July 2020. In his statement, SEC Chair Gary Gensler observed that many investors expressed concerns that “certain conditions in the 2020 rule might restrain independent proxy voting advice. Given those concerns, we have revisited certain conditions and determined that the risks they impose to the independence and timeliness of proxy voting advice are not justified by their informational benefits.” With regard to the shareholder proposal rule, according to the press release, the proposed amendments were designed to “promote more consistency and predictability in application.” In his statement, Gensler indicated that the proposed amendments would “improve the shareholder proposal process” by providing “greater certainty as to the circumstances in which companies are able to exclude shareholder proposals from their proxy statements.” Both of the SEC’s actions received three-to-two votes—about the only consensus reached in the meeting was that the term “proxy voting advice businesses” and its acronym “PVABs” were clumsy choices. Interestingly, in the case of both of these actions taken by the SEC, amendments to these same rules were adopted in 2020. From the Democratic commissioners’ perspective, these new amendments were intended to clarify and strike a better balance in response to public comments and staff experience, while from the perspective of the Republican commissioners, the amendments ensured only “regulatory whiplash” from the “regulatory seesaw.” 

What happened with shareholder proposals for political spending in the 2022 proxy season?

What happened with shareholder proposals for political spending and lobbying in the 2022 proxy season? In these two articles, ISS Corporate Solutions provides us with an update on shareholder proposals for political contributions and lobbying disclosures submitted for the 2022 proxy season. According to ISS, many shareholder proposals addressing political spending and lobbying reflected investor concerns that support of certain candidates and causes or certain lobbying activities may be inconsistent with the stated values or public positions of the company. Drilling down, we also look at more specific data from the Center for Political Accountability regarding shareholder proposals for election spending submitted by its proposal partners for the 2022 proxy season, as well as a preview of what’s on the agenda from CPA for next proxy season.