For boards, it's back to black

If today's ESG proxy resolutions end, there are two choices for change

The global financial markets function on clear and accurate disclosures and information, and while I have many problems with disclosures because they distract from action, their purpose remains true. This has largely been the driving focus of ESG disclosures from regulators through to the board and management team.

The pressure for compliance is real. Globally, the ESG regulatory march continues with the first companies launching their CSRD reports in early 2025, jurisdictions adopting the IFRS S1 and S2, and others preparing for California State Bills 253 and 261.

Yet, for the US Securities and Exchange Commission (SEC), which protects investors and the US capital markets, their Climate Rule will never see the light of day thanks to ongoing legal challenges and the incoming administration.

There’s a lot of buzz around new appointments with the administration changes coming in January, but the one that hasn’t been announced yet has been the head of the SEC.

Since his appointment by Biden in 2021, SEC Chair Gary Gensler has undoubtedly tried to clarify various ESG activities for investors and pushed for the Climate Rule, ESG fund disclosures, and more. With the anti-ESG pushback, if Trump could replace him easily, he likely would.

The SEC has legal protections that can make it challenging for the President to replace a sitting chair, so it is entirely possible for Gensler to stay and continue to push for ESG disclosures. Moreover, to ensure the commission is nonpartisan, it is led by five commissioners, of whom no more than three can be from the same political party. Still, Gensler has hinted he will resign, allowing Trump to appoint someone else.

While this article isn’t about who might lead the SEC next, it is about a Staff Bulletin released under Gensler that could be rolled back. As a result of this bulletin, board directors may have been able to hide and deflect on ESG issues through a primary benefit of stock ownership: proxy resolution filing and voting.

Removing an ESG roadblock

A few months after Gensler became SEC Chair, the ESG floodgates opened, and it had nothing to do with disclosures.

In Staff Legal Bulletin No. 14L, the SEC allowed shareholders to exercise their rights in a new way. Previously, proxy resolutions brought by shareholders that affected less than 5% of net earnings and gross sales during the fiscal year could be excluded by the company from a shareholder vote. Theoretically, ESG proxy resolutions could be filed, but had to adhere to the 5% rule.

Traditionally, proxy resolutions followed a pretty close script. Investors vote directors in or out. Shareholders vote on serious issues, like executive pay or corporate oversight of a material matter. These resolutions are filed in a proxy document with the SEC, and the board weighs in on its recommendations.

And again, before this updated bulletin, non-financial matters that were hard to quantify under the 5% rule, like an ESG issue, could be easily left off the ballot.

As ESG data, understanding of ESG issues, and investor attention to ESG took off, this bulletin gave investors the ability to bring forth these resolutions for a vote:

…proposals that raise issues of broad social or ethical concern related to the company’s business may not be excluded, even if the relevant business falls below the economic thresholds of Rule 14a-8(i)(5).

And further related to climate issues specifically:

While the analysis in this bulletin may apply to any subject matter, many of the proposals addressed in the rescinded SLBs requested companies adopt timeframes or targets to address climate change that the staff concurred were excludable on micromanagement grounds.[9] Going forward we would not concur in the exclusion of similar proposals that suggest targets or timelines so long as the proposals afford discretion to management as to how to achieve such goals.

With companies no longer able to stop ESG-related proxy resolutions from being included in the Annual General Meeting, there has been an increase in both ESG and anti-ESG proposals.

One of the primary benefits of stock ownership is the board’s accountability to investors through this ability to bring proxy resolutions forward and vote. It isn’t legally binding and lets a board know where investors stand. Yet, as you might imagine, there is a lot of complexity that can keep power consolidated around the company’s preferences. Executives might own enough stock and have enough influence to control the vote. Companies with dual-class shares can create two classes: shares with powerful voting rights and others with limited or no rights. Individual equities can be obfuscated in funds, confusing investors about their power. And, of course, there are massive institutional firms who, while passive investors, own the majority of shares and have policies on how to vote.

Above all else though, investors just don’t vote or defer to their asset manager.

These challenges aside, proxy resolutions are a window into the mind of investors. ESG proxy resolutions will continue to be filed if this bulletin is rolled back because ESG issues are still top of mind. Still, if this bulletin doesn’t hold, there might be some changes ahead for investors and companies.

Two outcomes of a rollback

If proxy resolutions go back to the 5% rule, investor preference could surface in other ways.

First, we must recognize that this wouldn’t mean the end of ESG proxy resolutions, but maybe the end of activist proposals covering broad ESG-related issues. In other words, many non-material or lightly material activist proposals make their way through today. Let’s look at an example of a prescient material proxy resolution intersecting with plastics.

In the 2024 proxy season, As You Sow filed a resolution for Keurig Dr Pepper:

Shareholders request the Board issue a report, at reasonable expense and excluding proprietary information, describing the potential and options for the Company to rapidly reduce dependence on single-use plastic packaging in alignment with the findings of the Pew Report or other authoritative sources.

The company's opposition statement is on page 64 of its Schedule 14A filing, and the proxy resolution only received 8.9% support. Yet, by September, the SEC fined the company as their statements on recycling its single-use cups didn’t match up with what the two largest commercial recyclers in the US could achieve. One could argue that there is a link between the attention this proxy resolution surfaced and the fine. Had the company dug deeper, it may have uncovered the problem.

On the other hand, there are also questionably material proxy resolutions with nebulous company value, like ones that ask the company to indiscriminately account for its carbon emissions or examine its retirement strategy for high-carbon investments.

If we’re talking about a return to the 5% risk for filing resolutions, I’m not sure these examples are material, as it would need to be such an egregious risk that it would severely impact talent attraction and retention. Activists would then have to work harder to make it matter to the company, which coincidentally, is why I started this newsletter. I believe that this could be a benefit to shift the company’s mindset on these issues, but it puts the burden of proof on the activist investor.

There may also be a second result. If ESG proxy resolutions cease altogether or slow down, an investor can support change by replacing board members. This is the way it has been all along, but a mechanism rarely used.

Per PwC, for the past five years, board director support for the Russell 3000 has remained above 94%, meaning that directors were elected with the vast majority of shareholders on the board. Investors are either thrilled with the people in charge of the companies they invest in, indifferent to change, lack enough information to make an informed decision and vote anyway, or defer to the investment firm to decide.

The PwC report linked above also calls out:

Over the past few years, investors have appeared to be more comfortable registering their dissatisfaction, with average director support falling steadily.

Yet, this is ridiculous, as the metrics dropped from 94.9% support in 2020 and 94.7% support in 2021 to 94.3% in 2022 and 2023. This is hardly a referendum on directors.

Still, without another mechanism to affect the change they want to see, activist investors will have no choice but to vote against board directors who are misaligned with their preferences. Regular investors who lead with fiduciary responsibility should pay attention to this. After all, understanding the directors on their board, their qualifications, and their unique value proposition is a key part how the business is governed.

As a reminder, the board has three primary fiduciary duties it must uphold to shareholders:

• Duty of Care: Taking reasonable action to prevent harm and manage risks, relying on all available information to make a quality and prudent decision for the company.

• Duty of Loyalty: Acting in the company’s best interest, not for personal gain.

• Duty of Obedience: Ensure the company follows regulations, bylaws, etc.

While all of these duties are governance concern, Duty of Care has a unique intersection with ESG as it tries to ensure a quality, well-informed decision.

Are we at an inflection point where investors take a more active role?

For example, when ExxonMobil decided to sue shareholders Arjuna Capital for exercising their right to file a proxy resolution, CalPERS recommended voting against all board directors. In their public statement, they remind us all of what we seem to have forgotten:

When you own shares of stock in a publicly traded company, you have a vested interest in how that company is run and whether its leaders are doing all they can to ensure lasting financial success.

You have a right to have your concerns heard by corporate directors and executives. They work for you.

Again, they work for you.

Even without a vote, struggling drugstore chain CVS, decided to expand its board to add four new directors through pressure from activist investor Glenview. While not necessarily an ESG decision, it was absolutely one grounded in governance.

Back to black

From the recent market reaction to the US election, it is clear that investors believe a low regulatory operating environment will lead to companies being in the black. But in a market where the power of stock ownership becomes more restrictive through the limits of proxy resolutions brough forward, the only choice is to either take a material approach to the proxy resolution or pay closer attention to board directors and the company’s governance.

This isn’t a referendum on the trust in leadership. Instead, this is just how things might get done.

Activist investors should shore up their ESG expertise to help file material proxy resolutions and to switch their proxy resolution strategies beyond targeted ESG efforts to make specific recommendations for/against board directors based on their records and alignment with the issues they support or dissent against. For others, understanding the board members opens up the possibility of solving some of the world’s new challenges, as there is no returning to how things were.

For directors, this may mean ‘back to black’ as Amy Winehouse sings about where a relationship has ended only in this case, it will be investors who do the breaking up for the company.