Curiouser and Curiouser – the Changing Dynamic of Shareholder-Corporate Engagement

POMERANTZ MONITOR | MARCH APRIL 2024

By Dr. Daniel Summerfield

In the world of corporate governance and stewardship, change is becoming the new status quo. We are witnessing significant shifts in how shareholders engage with corporations and how those companies respond. To paraphrase Alice in Wonderland, it’s becoming curiouser and curiouser as market participants adapt to the new normal. I outline below some recent developments that illustrate this evolving dynamic, in no particular chronological order.

Holding companies to account for climate change commitments

There is a growing realisation that the road to net zero under the 2015 Paris Climate Agreement will be rocky, even if a firm has prepared a detailed plan. This is, to a large extent, due to assumptions built into many such corporate plans, such as an expected presence of supportive government policies and customers’ capacity to deal with the transition. Such assumptions may be built on misplaced optimism, lack of proper due diligence, or some of each. As a result of the ever-changing context, there is an increased challenge for companies in terms of their corporate climate commitments, particularly where these are not backed up by adequate plans and policies.

Indeed, a recent study by USS and University of Exeter outlined four narrative climate scenarios out to 2030 based on a framework that embraces the radical uncertainties surrounding the potential positive as well as negative tipping points. The scenarios focus on the vicissitudes of politics and markets and, to a lesser extent, on the climate itself, in the form of extreme weather events. Only in the most optimistic of the four scenarios does it seem possible that global emissions will be halved by the end of the decade despite the best intentions – and perhaps due to the lack of best intentions – of market participants.

It should therefore come as no surprise that, as companies step back from their previous commitments, we are seeing an escalation of engagement approaches being employed by shareholders to hold management to account.

In January 2024, twenty-seven institutional investors backed a resolution against Shell plc filed by the Dutch shareholder activists at Follow This; the resolution will be voted on at Shell’s May 2024 Annual General Meeting (“AGM”). The resolution calls for the oil company to align its medium-term emissions reduction targets with the Paris Climate Agreement. It was co-filed by influential investors from Belgium, France, the Netherlands, the UK, the USA, Sweden, and Switzerland. These include, among others, Europe’s largest investor, the French asset management firm Amundi, as well as the Rathbones Group, Scottish Windows, and NEST.

Another interesting feature with this filing is that, despite the fact that the 27 investors manage assets with a combined value of $4.2 trillion, the investors collectively hold only 5% of Shell’s stock.

In mid-March, after the resolution was filed, Shell backtracked on its climate targets, lowering its emission reduction targets from 20% to 15-20% by 2030 and scrapping its emission reduction targets of 45% by 2035.

“With this backtrack,” stated Mark van Baal, founder of Follow This, “Shell bets of the failure of the Paris Climate Agreement … only Shell’s shareholders can change the board’s mind by voting for our climate resolution at the shareholders’ meeting in May.”

 A similar resolution at Shell last year was supported by only 20% of shareholders.

A comparable proposal which was filed against Exxon Mobil in the U.S. by Follow This and Arjuna Capital was met with an unprecedented and worrying response in the form of a lawsuit by the company that targeted the investors who filed this resolution. Exxon Mobil is justifying their litigation by alleging the SEC’s inability to enforce rules that govern when investors can resubmit shareholder proposals. According to ExxonMobil, a court “is the right place to get clarity on SEC rules,” adding that “the case is not about climate change.” To date, despite the proposal being withdrawn, the company is going forward with their lawsuit. It remains to be seen if this will have a dampening effect on the filing of shareholder resolutions in the U.S.

Challenging companies’ decision-making processes

Another interesting development in the U.S. was seen in a recent successful lawsuit by an individual shareholder who challenged the process by which Elon Musk’s $55 billion pay package was approved by Tesla’s board of directors. The Delaware judge overseeing the case voided Musk’s compensation package, stating that Musk controlled the board through his personality and influence and the board could therefore not demonstrate that the share grant had been executed at a fair price or through a fair process. In the judge’s words, “Musk was the paradigmatic ‘Superstar CEO and dominated the process that led to board approval of his compensation plan.’”

According to corporate experts such as Professor Charles Elson at the University of Delaware, a case such as this “has not happened before. It is extraordinary.” Although other academics have questioned whether it will set a precedent, there are likely to be significant reverberations felt in other boardrooms that may indeed lead to a review of the independence of board chairs of other companies. It also remains to be seen if Musk follows through with his threat to move Tesla from Delaware to Texas, the irony of which will not be lost on those who remember companies such as NewsCorp relocating to Delaware because of the state’s perceived light touch of protections for investors.

Whatever the reverberations of the Tesla case, the perception by detractors that securities litigation simply serves to drain corporate funds has lost credibility. It is increasingly recognised that the two main goals of active and responsible shareholders that participate in securities litigation are a) to recover money lost as a result of corporate malfeasance and b) to increase the long-term value of the defendant companies through positive changes in corporate governance and corporate behaviour.

Indeed, securities litigation can be seen as an additional tool in shareholders’ engagement armoury by addressing corporate wrongdoing through the implementation of corporate governance changes. The reality is that, under the proper circumstances, shareholder litigation can bring about significant changes which will protect investors that wish to remain invested and increase shareholder value over the long term.

Looking forward

Another development we are beginning to see in markets such as those in the UK and Italy, is a perceived regulatory race to the bottom as listing regimes seek to find ways to attract IPOs by diluting hitherto sacrosanct investor protections as a way of enticing companies to list in their respective markets. This can only result in companies with poor governance standards taking advantage of these reduced standards by listing in these markets. If that is the case, then we are only likely to see an increased use by shareholders of tools such as securities litigation and shareholder proposals as a way of holding management to account and deterring other companies that might be tempted to follow a path that is not in their shareholders’ or stakeholders’ interests.

SEC Passes Climate Disclosure Rules After Two-Year Wait

POMERANTZ MONITOR | MARCH APRIL 2024

By Jonathan D. Park

On March 6, 2024, the United States Securities and Exchange Commission (“SEC”) approved a set of long-awaited regulations requiring securities issuers to provide climate-related disclosures in their annual reports and registration statements. The final rules significantly scale back the proposal released nearly two years prior, after a comment period that saw record levels of feedback from investors, industry groups, and other stakeholders. SEC Chairperson Gary Gensler, who was joined by two Democratic colleagues in a 3-2 party-line vote approving the regulations, stated that “[t]hese final rules build on past requirements by mandating material climate risk disclosures by public companies and in public offerings. The rules will provide investors with consistent, comparable, and decision-useful information, and issuers with clear reporting requirements.”

After the regulations are phased in, the final rule will require many registrants to disclose, among other things: certain greenhouse gas (GHG) emissions, subject to a materiality requirement; climate-related risks that have had or are reasonably likely to have a material impact on the registrant’s business strategy, results of operations, or financial condition; the actual and potential material impacts of any identified climate-related risks on the registrant’s strategy, business model, and outlook; and any oversight by the board of directors of climate-related risks and any role by management in assessing and managing the registrant’s material climate-related risks.

In financial statements, registrants will be required to disclose, in the income statement, aggregate expenditures and losses as a result of severe weather events and other natural conditions, as well as to disclose costs and charges recognized on the balance sheet due to severe weather events and other natural conditions. Both of these requirements are subject to a monetary threshold. If carbon offsets and renewable energy credits (“RECs”) are material to a registrant’s plan to achieve disclosed climate-related targets, the registrant must disclose a roll-forward of the beginning and ending balances. Registrants must also disclose whether, and if so, how, severe weather events and other natural conditions, as well as disclosed climate-related targets or transition plans, materially affected estimates and assumptions reflected in the financial statements. Large accelerated filers (issuers with a public float of $700 million or more) must begin making these financial statement disclosures in annual reports or registration statements that include financial statements for the year ending December 31, 2025, while accelerated filers (issuers with a public float greater than $75 million but less than $700 million) have an additional year to comply. The financial statement disclosures will be subject to audit requirements and management’s internal control over financial reporting. For large accelerated filers and accelerated filers other than smaller reporting companies (SRCs) and emerging growth companies (ERGs), the registrant’s auditor will assess controls over these disclosures.

During the comment period after publication of the proposed rule, significant attention was paid to the question of what information companies would be required to disclose outside of the audited financial statements. In particular, the final rule requires registrants to disclose “Scope 1” GHG emissions (i.e., those from the registrant’s owned or controlled operations) and “Scope 2” GHG emissions (i.e., those from purchased or acquired electricity, steam, heat, or cooling). In a change from the proposed rule, these disclosures are only required if they are material. Materiality, the SEC emphasized, is not determined merely by the amount of these emissions, but by whether a reasonable investor would consider the disclosure as having significantly altered the total mix of information made available. For instance, the SEC explained, “[a] registrant’s Scopes 1 and/or 2 emissions may be material because their calculation and disclosure are necessary to allow investors to understand whether those emissions are significant enough to subject the registrant to a transition risk that will or is reasonably likely to materially impact its business, results of operations, or financial condition in the short- or long-term.”

The rule allows registrants to delay Scope 1 and Scope 2 disclosures until the due date of their Q2 quarterly report for the following year. Large accelerated filers must begin including Scope 1 and Scope 2 emissions disclosures in annual reports or registration statements that include financial statements for the year ending December 31, 2026. Accelerated filers have two additional years to comply. SRCs, ERGs, and nonaccelerated filers are exempt from the requirement to provide GHG emission disclosures.

Beginning with fiscal year 2029, large accelerated filers must attest with “limited assurance” as to the accuracy of the Scope 1 and Scope 2 emissions disclosures. Beginning two years later, such filers must attest to the accuracy of these disclosures with “reasonable assurance.” Accelerated filers (other than SRCs and ERGs) need only provide “limited assurance” attestations beginning with fiscal year 2033.

The rule will also require disclosure of processes for identifying, assessing, and managing material climate-related risks; information about any climate-related targets or goals that have materially affected or are reasonably likely to materially affect the registrant’s business, results of operations, or financial condition; and any oversight by the board of directors of climate-related risks and any role by management in assessing and managing such risks.

Notably, the final rule does not require disclosure of “Scope 3” GHG emissions, which are those produced along the registrant’s “value chain,” such as by the registrant’s suppliers. Though Scope 3 emissions can be substantial, and even greater than a company’s Scope 1 and Scope 2 emissions, the SEC eliminated this disclosure requirement in the face of vigorous opposition by business groups. This was likely an attempt to head off challenges and the prospect of a court decision invalidating the regulation.  Scope 3 disclosures are required by the European Commission’s Corporate Sustainability Reporting Directive (CSRD), as well as by California for certain companies doing business in that state, so many issuers will be obligated to assemble and report such information in any case.

Several lawsuits seeking to invalidate the rule have already been filed by Republican attorneys general of several states, industry groups, and energy companies.  Environmental advocates have also sued, arguing that the rule does not go far enough, in particular by removing Scope 3 disclosure requirements.  The cases have been consolidated in the United States Court of Appeals for the Eighth Circuit.  Many consider the Eighth Circuit a conservative court where the Republican and industry challengers will find a sympathetic ear.

If the final rule eventually becomes effective, investors will surely benefit from the disclosures it requires, despite its pared back scope. A company’s GHG emissions, and any plans to mitigate them or otherwise achieve climate-related targets, are increasingly necessary for investors to evaluate a company’s outlook. Moreover, disclosure of how extreme weather events have affected a company’s financial condition is increasingly material in light of the growing frequency and severity of such events.  If the rule becomes effective, lawsuits and investigations regarding alleged violations of the disclosure requirements are likely, and will further clarify company’s obligations under the rule.

The final rules are available on the SEC’s website (https://www.sec.gov/rules/2022/03/enhancement-and-standardization-climate-related-disclosures-investors) and will be published in the Federal Register.

ESG Disclosure in the Biden Era

POMERANTZ MONITOR | MARCH APRIL 2021

By Jennifer Pafiti

The Securities and Exchange Commission (“SEC”) requires companies to disclose their most significant risk factors in their filings in order to warn investors of the risks of either purchasing or continuing to own their company’s stock. Such disclosures may also serve as a “safe harbor defense” for public companies in securities litigation arising from their statements to investors, in that predictions, projections and expectations in offerings and other disclosure documents may not be construed as misleading if they contain sufficient cautionary language disclosing specific risks.

Law360 has just published the findings of a review that it, along with analytics provider Intelligize, conducted on changes in companies’ risk disclosures at the dawn of the Biden era. According to their review, at least 97 companies updated the “risk factor” sections of their SEC filings as of February 26 “to reflect President Biden’s arrival in office.”

Law360 and Intelligize found that fossil fuel-energy companies and drug developers are the most common stock issuers updating their risk disclosures to warn investors of potential policy changes that could harm their businesses under a Biden administration. Other industries, they report, have cautioned investors that a rise in corporate taxes could affect their profitability. According to Law360, “Fallout from the coronavirus pandemic has also been a recurring “risk factor.” ... Some banks are now warning investors that policies aimed at relieving borrowers may affect their bottom lines.”

Under the former SEC Chair, Jay Clayton, the SEC adopted more than 90 new rules. Investor advocates and state securities regulators criticized the “principles-based” rules enacted under Clayton for leaving too much to interpretation and providing inadequate guidance as to their scope of and compliance. For example, Regulation Best Interest (Reg B1), prohibits brokers from placing their own interests ahead of their customers, yet does not require brokers to meet the same rigorous “fiduciary standard” that is imposed on investment advisers.

One of the keystones of President Biden’s agenda is his commitment to protecting the environment. He has promised to hold polluters accountable by establishing “an enforcement mechanism to achieve net-zero emissions no later than 2050.” Biden’s ambitious environmental goals may face challenges in the Senate, but he will have some leeway to pursue them via the SEC.

Biden has nominated Gary Gensler, an academic, former investment banker, and former government finance official in the Obama administration, to serve as the SEC’s 33rd chair. During his confirmation hearing on March 2, Gensler told the Senate Banking, Housing and Urban Affairs Committee that he supports more climate risk disclosure, pledging that the SEC will undertake economic analysis and seek public feedback on how to advance it. “There are tens of trillions of investor dollars that are going to be looking for more information about climate risk,” he said, adding that “issuers will benefit from such disclosures.”

SEC Commissioner and Acting Chair, Allison Herren Lee, is strongly critical of policies adopted under Clayton’s tenure. She has called the agency’s failure to require the disclosure of environmental, social, and governance (ESG) related risks such as diversity and climate change “an unsustainable silence” – evoking, for some, Rachel Carson’s seminal 1962 book, Silent Spring, which helped to inspire an environmental movement that led to the creation of the U.S. Environmental Protection Agency. In her September 23, 2020 Statement to the Amendments to Rule 14a-8, Lee wrote, “Climate change, workforce diversity, independent board leadership, and corporate political spending, as well as other ESG-related issues, are increasingly important to investors—and increasingly present on proxy ballots. ... Environmental and social proposals have been ascendant in recent years, making up more than half of all proposals filed in recent seasons.” She criticized Clayton’s SEC for moving to restrain those efforts “just as they are gaining real traction.”

On March 5, SEC Commissioners Hester M. Peirce and Elad L. Roisman – both Republicans – published a joint statement in which they appear to dig in their heels to privilege the status quo. Referring to the recent “steady flow of SEC “climate” statements” they ask:

What does this “enhanced focus” on climate-related matters mean? The short answer is: it’s not yet clear. Do these announcements represent a change from current Commission practices or a continuation of the status quo with a new public relation twist? Time will tell.

It is certainly likely, though, that the SEC under Biden will scrutinize claims made by investment firms and financial advisors regarding their ESG funds, on the lookout for “greenwashing” attempts to make a fund appear more sustainable or ESG-compliant than it actually is.

Congressional Democrats, meanwhile, have been promoting legislation that would require companies to disclose ESG-related risks for years. Senator Elizabeth Warren’s proposed Climate Risk Disclosure Act of 2019 “would require public companies to disclose more information about their exposure to climate-related risks, which will help investors appropriately assess those risks, accelerate the transition from fossil fuels to cleaner and more sustainable energy sources and reduce the chances of both environmental and financial catastrophe.”

Representative Juan Vargas introduced the ESG Disclosure Simplification Act of 2019 to establish a Sustainable Finance Advisory Committee within the SEC that would “submit to the Commission recommendations about what ESG metrics the Commission should require issuers to disclose.”

Treasury Secretary Janet Yellen, who has called climate change “an existential threat,” intends for her department to play an integral role in fighting it. She is expected to appoint a “climate czar” and to use the Financial Stability Oversight Council to crack down on climate-related financial risks.

On March 10, 2021, the U.S. Department of Labor announced that it would suspend enforcement of Trump- era regulations limiting socially conscious investments by retirement plans while crafting new regulations that “better recognize the important role” of ESG investments in retirement plans.

The Investment Company Institute (“ICI”), which manages over $34 trillion in assets globally, has called upon public companies in the United States to provide ESG disclosure consistent with standards set by the Task Force on Climate-Related Financial Disclosure (TCFD) and Sustainability Accounting Standards Board (SASB).

On March 17, at a virtual conference of the ICI, Acting SEC Chair Lee defined the principal that is “the basis of shareholder democracy: through clear and timely disclosure, we empower investors to hold the companies they own accountable—including accountability on climate and ESG matters.” Expressing concern that “our regulations have not kept up with this new landscape of institutional investor-driven corporate governance,” Lee called for changes to shareholder proxy voting disclosures that would incorporate “soaring demand” for ESG investment strategies.

According to Benjamin D. Stone of Mintz Insights, “Should President-elect Biden successfully institute a regulatory framework for corporate ESG disclosures, investment funds will be well-positioned to deliver trillions of dollars of investment capital into the U.S. economy to meet climate goals.”

Still, the SEC has yet to define ESG or direct companies on exactly which ESG-related risks it wants them to disclose. The United States lags well behind Europe in this regard. The EU Sustainable Finance Disclosure Regulation (2019/2088) comes into force on March 10, 2021. In the United Kingdom, new climate-related disclosure regulations that apply to investment managers in the U.K. are expected to be phased in from 2022.

It remains to be seen whether the United States can catch up.