Empowered Investors, Enhanced Accountability
POMERANTZ MONITOR | MAY JUNE 2023
My first encounter with environmental, social, and governance issues, or ESG, came 20 years ago when I was a college intern compiling survey results on “Corporate Citizenship and Sustainability.” At the time, the “G” – governance – was investors’ main area of focus. When they did turn their attention to environmental issues, investors primarily concentrated on how to distinguish companies that were “greenwashing,” – i.e., promoting environmental initiatives without making substantive changes – from those undertaking real reforms, and on developing tools to measure and report their returns on ESG investments.
Two decades later, as investors increasingly seek ways to integrate ESG into their investment decision-making processes, ESG issues have become a leading topic. Institutional investors are wielding their combined power to demand increased transparency, accountability, and opportunities for engagement from corporations and their boards. This article will address ESG investing from four vantage points: (1) recent trends in proxy voting; (2) what investors should expect from boards; (3) regulatory oversight and recourse under securities laws; and (4) the current backlash from conservative politicians.
In April 2023, Deloitte & Touche LLP released the results of their Global Boardroom Program’s analysis of the voting records of 101 large investors around the world. The results highlighted key concerns for the 2022 season of annual general meetings on topics including ESG, diversity, equity and inclusion (DEI), board composition and board independence, and executive pay. Deloitte’s analysis found that nearly half or more of investors across Australia, the UK, and the US called for reporting aligned with the Task Force on Climate-Related Disclosure (TCFD) guidelines. “Over half of US investors sought disclosures of industry-specific metrics published by the Sustainability Accounting Standards Board (SASB). In contrast, only one in five global investors expected that their investee companies should follow SASB industry-specific guidance. In the UK, over half of investors asked companies to align their targets with other specific metrics, such as the Paris Agreement’s 1.5°C target.”
Among investor votes on social issues, diversity stood out as a major concern. The voting policies of two-thirds of UK and three quarters of US institutional investors pointed to the importance of ethnic diversity considerations.
Deloitte’s April report dovetails with the results of their “Global Boardroom Program Frontier” survey, published in February 2023. There, respondents predicted that ESG and climate change would rank higher in priority than customer experience, innovation, and cybersecurity. Survey respondents placed responsibility for these priorities firmly with corporate CEOs and Board members, citing their leading role in cultivating and maintaining shareholder trust.
The Conference Board, a global, nonprofit think tank and business membership organization, recently convened more than 200 executives for a series of roundtables to discuss the changing role of the board in the era of ESG investing and stakeholder capitalism. Its findings confirmed that over the next five years, corporate boards should expect ESG issues to have a “significant and durable impact.” Paul Washington, Executive Director of the Conference Board’s ESG Center, identified “five key areas in which investors should expect more from boards—and be alert to red flags.” According to Washington, investors should:
1. Seek clear evidence the board is making well-informed decisions as to what ESG issues to focus on and how they are balancing the interests of stake holders.
2. Have heightened expectations of board composition and capabilities, demanding that board members have experience in strategic planning and human capital. Boards, according to Washington, should have “a robust and ongoing education program that ensures board fluency in key areas.”
3. Expect that boards have the right leadership and committees. “A board leader needs not only to be respected by fellow directors and management, but also to be open to change.”
4. Focus on how directors engage with their stakeholders; “investors should be alert to boards that seem to operate in a bubble.”
5. Look for boards to evaluate the company’s, senior management’s, and their own performance in ESG as an integral part of their annual review processes.
With increased scrutiny on ESG measures, there has also been a dialogue around enforceability, both through regulatory oversight and recourse under securities laws. An article posted on May 15, 2023, by Professor James Park of UCLA on the Harvard Law School Forum on Corporate Governance provides a useful description of the nexus between ESG and securities fraud. Park notes that courts have aggressively dismissed ESG securities cases, “primarily by applying the puffery doctrine – a longstanding presumption that rosy statements of optimism should not be taken literally.” Park argues that the current approach of courts “should be replaced by a more holistic approach that emphasizes assessment of the materiality of the ESG risk at issue.”
In January 2023, SEC Commissioner Mark Uyeda addressed ESG concerns in a talk given to the California ‘40 Acts Group, a nonprofit forum that facilitates discussions regarding matters that impact the investment management industry. Addressing the fact that ESG investment products often charge high fees, he said that touting a product as being ESG is good for business, but cautioned that “[a]lthough ESG investing is wildly popular, it is difficult to ascertain exactly what ESG means, so it is challenging to identify when an ESG investment strategy is properly labeled as such.”
Although the SEC has not to date given full guidance on ESG risk disclosures, Uyeda noted that beyond the risk of mislabeling a strategy as ESG, ESG strategies are often not adequately disclosed to clients. He stated that “an adviser can only pursue an ESG investment strategy if the client expresses a desire to pursue such a strategy after receiving full and fair disclosure regarding the salient features of the strategy, including the strategy’s risk and return profile.”
A final consideration is the impact of politics on investors’ access to ESG investing. When President Biden first took office, ESG issues were high on his list of priorities. As Robert Eccles of Oxford University and Eli Lehrer of R Street Institute commented in a recent post by the Harvard Law School Forum on Corporate Governance, the debate over ESG standards has revealed stark policy contrasts between red and blue states in the US. Blue states have considered mandating divestment from companies connected to such products as firearms and fossil fuels. On the other side, Florida Governor Ron DeSantis recently led an alliance of 18 states to push back such divestment. They propose to remove all state pension funds and state-controlled investments from firms that follow the ESG model that DeSantis and his colleagues label as “politics before fiduciary duty.”
According to Messrs. Eccles and Lehrer, neither the divestment strategy nor the anti-divestment strategy makes economic sense. They suggest a solution that they claim both the left and right should agree upon: “clear fiduciary duty laws that define who is responsible for state investment, allow them to consider ESG factors only when they contribute to economic value creation and assure that state employees in defined contribution plans can select non-ESG options.”
It is clear that the ESG landscape is changing significantly on a global level, with an increasingly complex range of challenges for investors that include, among many others, greenwashing, as described above, and “green hushing” – the under-reporting or under-communicating of sustainable practices.
Pomerantz has long championed ESG issues – whether by creating forums for institutional investors and governance experts to share knowledge, or by litigating for improved corporate governance and financial redress for damaged investors. In October 2022, Pomerantz opened an office in London, co-managed by Partner Jennifer Pafiti, who is dually qualified to practice law in the US and the UK, and Dr. Daniel Summerfield, Director of ESG and UK Client Services. Prior to joining Pomerantz, Dr. Summerfield spent 20 years at the Universities Superannuation Scheme, the UK’s largest private pension fund. Most recently, Daniel was Head of Corporate Affairs of USS, following a period of 16 years as Co-Head of Responsible Investment.
“ESG stands at a critical juncture in its development on both sides of the Atlantic,” according to Dr. Summerfield. “Its future will be determined by all market participants and their consideration of their fiduciary responsibilities and the needs and requirements of the ultimate pension fund beneficiaries.”