By Farzad F. Damania and Ryan A. Lilley
On January 6, Katten Capital Markets partner Farzad Damania, along with Zally Ahmadi of D.F. King, George Lu of ADEC ESG Solutions and Ari Frankel of Solebury Trout, presented a program sharing their insights into the trends in ESG shareholder proposals and the steps companies should take to meet investor expectations. They noted that shareholder proposals received a record level of support, reaching 36.3 percent across all ESG categories. The panel measured the ESG trends using data for companies within the Russell 3000 Index during the 2021 proxy season. A number of trends and developments in ESG are highlighted below.
Support for Environmental Proposals Booms
There were 105 shareholder proposals on environmental reform in 2021, and nearly half of all environmental proposals that made it to the ballot passed (compared to zero in 2019). The top environmental proposal submitted was a request for climate change reporting, and support increased from 35 percent in 2020 to 52 percent in 2021. Additionally, 80 percent of greenhouse gas (GHG) emissions-related proposals that made it onto ballots received majority support in 2021.
Say on Climate: In 2021, a "say on climate" initiative emerged. Such proposals request an annual advisory vote on a company's climate-related plans. Proponents have indicated that they plan to file several similar proposals for the 2022 proxy season. However, such "say on climate" proposals had significantly less success than other environmental proposals in 2021. Four "say on climate" proposals were voted on but did not pass, with three receiving 30 percent support and one receiving only 7 percent support.
Social Proposals Have Strong Presence in Top 10 ESG Proposals
In 2021, the number of social proposal submissions nearly tripled. Of the 258 that were proposed, 133 made it to the ballot. These social proposals included EEO-1/diversity reporting, board and management diversity proposals, and racial equity proposals. Within these three categories, EEO-1/diversity reporting had the highest number of submissions and received an average level of support of 55.66 percent in 2021. Notably, pension funds and social impact investors, including the NYC Comptroller's Office and Calvert Research, are continuing with their campaigns in 2022, demanding various forms of workforce disclosure, including the publication of EEO-1 reports.
Board and Management Diversity: Board and management diversity proposals received the highest average level of support at 61.98 percent in 2021, compared to just 13.3 percent in 2019. Proxy advisory firms and institutional investors continue to take action and have stated that they expect companies to provide board diversity disclosures. Some institutional investors have gone further and now expect companies to disclose the role diversity plays in their long-term strategy, their diversity goals and progress toward those goals.
Governance Proposals Continue to Have a Strong Presence
Nearly 80 percent of governance proposals went to a vote in the 2021 proxy season. The most common governance proposal continues to be the written consent proposals and support for such proposals increased from 35 percent in 2020 to 41 percent in 2021. Eight written consent proposals passed in 2021 compared to just two in each of 2020 and 2019. Average support for proposals requesting the elimination of supermajority provisions also increased to almost 90 percent. During the 2021 proxy season, 18 proposals to eliminate the supermajority voting provision made it onto ballots and ultimately received over a majority of shareholder support. Notably, in 2021, there was a decrease in the number of proposals to lower the ownership threshold to call a special meeting but an increase in the number of proposals to require a majority vote for the election of directors. The average support for these proposals was 35.05 percent and 51.63 percent, respectively.
SEC Developments on Shareholder Proposals
Background: Rule 14a-8 of the Securities Exchange Act provides the procedure whereby a shareholder can propose a matter to be voted on at a company's shareholder meeting. Under Rule 14a-8, a public company must include a shareholder's proposal in its proxy statement if the shareholder proposed the matter using proper procedure and the company lacks a substantive basis to exclude such proposal.
SLB 14L: On November 3, 2021, the staff of the Division of Corporation Finance of the SEC (Staff) published Staff Legal Bulletin No. 14L (SLB 14L), which limits the ability of public companies to exclude shareholder proposals relating to social issues from proxy statements and provides clarification regarding the procedural requirements applicable to shareholder proposals. SLB 14L rescinds the interpretive positions taken in Staff Legal Bulletin Nos.14I (2017), 14J (2018) and 14K (2019). By rescinding the SEC's prior positions, SLB 14L creates a tougher threshold for no-action relief, and will likely result in more E&S‑styled shareholder proposals. The Staff stated in SLB 14L that it will decide whether to allow a proposal based on the social policy significance of the issue in the shareholder proposal, rather than the significance of the policy issue to the subject company. Accordingly, companies no longer need to include a board analysis under the economic relevance or ordinary business exclusions.
Human Capital Management: SLB 14L provides new guidance stating that proposals raising human capital management issues with a broad societal impact, such as employment discrimination, may no longer be excludable on economic relevance and ordinary business grounds. With the Staff reducing avenues to exclude shareholder proposals, more companies are likely to consider other grounds for excluding shareholder proposals, including substantial implementation and negotiation with shareholder proponents in their efforts to convince the proponents to withdraw their proposals.
Climate Change Initiatives: SLB 14L also specifically provides that when a shareholder proposal requests that a company adopt targets or timelines for climate change initiatives, the Staff may not grant no-action relief on the basis of ordinary business, so long as the proposals afford discretion to management as to how to achieve such goals. As SLB 14L clearly states the Staff's position on climate-related proposals, it is expected to result in more proposals, including, for example, adoption of science-based targets and net zero commitments.
Mechanics of Climate Proposals
Task Force on Climate-Related Financial Disclosures (TCFD) and Risk Assessment: The TCFD was created in 2015 by the Financial Stability Board to develop consistent climate-related financial risk disclosures. The number of companies that support TCFD has rapidly increased since 2017. In 2017, fewer than 500 companies supported TCFD but that number has nearly doubled each year since. As of April 27, there are 3,300 companies supporting TCFD in 93 jurisdictions. The TCFD provides recommendations for companies aiming to improve their climate-related financial risk disclosures. First, the TCFD recommends that a company establish board oversight and management of climate-related risks such as physical and transitional risks. Physical risks arise from exposure of company-owned facilities, supply chains and capital assets to sea-level rise, flooding, heat wave, and the like. Transitional risks, on the other hand, are the risks inherent in changing strategies and policies in an effort to reduce reliance on carbon. Second, a company should identify climate-related risks and opportunities by conducting scenario analyses to evaluate mechanisms available to address climate-related risks and opportunities, the magnitude and likelihood of climate-related risks impacting the company, and the resilience of the company against climate-related risks. Third, a company should manage climate-related risk by establishing an enterprise risk management program. A company should use metrics to assess climate-related risks and opportunities and demonstrate performance with an emphasis on GHG data management. A company should integrate such metrics into the company's enterprise risk management program. Finally, a company should establish internal education and engagement related to climate change and ESG initiatives.
Science Based Targets (SBT): When establishing a low-carbon transition plan, companies should consider guidance and frameworks from the Science-Based Targets initiative (SBTi) and from GHG Protocol. SBTi is an organization committed to reducing emissions and offers resources and guidance for companies establishing a science-based low-carbon transition plan. GHG Protocol partners with the World Resources Institute and the World Business Council for Sustainable Development to establish global standardized frameworks to measure and manage greenhouse gas. One consideration for companies establishing a low-carbon transition plan is the plan's boundary, under which targets must cover company-wide Scope 1 and Scope 2 emissions and all relevant GHGs as required in GHG Protocol's international standards. Companies also must consider the timeframe, which must cover a minimum of five years and a maximum of 15 years from the date of announcement of the target. Moving too far beyond 15 years can make planning for future events impractical. For many companies, the minimum target will be consistent with the level of decarbonization required to keep global temperature increase to 1.5°C compared to pre-industrial temperatures. Companies should set ambitious Scope 3 targets, which is required by SBTi when Scope 3 emissions constitute over 40 percent of a given company's overall emissions. Scope 3 emissions fall into 15 distinct categories, but not all of these categories are inherently relevant to any one company. Therefore, companies should screen Scope 3 categories for relevancy. Once companies target the most relevant Scope 3 emissions, companies should inform their investors on how they will act to reduce Scope 3 emissions. Companies should make mitigation and reducing Scope 3 emissions a priority, but Scope 3 emissions are not in a company's direct control, so setting appropriate investor expectations is important. Finally, companies should disclose company-wide GHG emissions inventory on an annual basis as part of the plan.
Combination of TCFD and Science-Based Targets: Companies should consider risk and opportunities throughout operations (GHG inventory, TCFD/ERM analysis). Prioritization of projects and capital investments (technologies, energy efficiency, and renewables) is vital for reducing emissions and meeting targets. Companies should combine TCFD and SBT results to identify key risk and opportunity areas. Additionally, companies should convene or create an ESG steering committee for a multidisciplinary approach and develop an internal understanding and public-facing narrative of the business case for a low-carbon transition plan. The effect of combining TCFD and SBT results is complementary, as companies that follow TCFD procedures will be in a better position to meet their SBTs. Conversely, companies that set SBTs in compliance with SBTi and GHG Protocol standards will be in a strong position to disclose the information required by the TCFD.
Proactive Engagement of Shareholders
Create a Narrative: There is an opportunity to create comradery within an ESG-focused company, including with employees and suppliers, and to satisfy investor expectations. Part of creating a narrative is determining what is important to a company and creating internal engagement to bring a company together around that focus point. Once a company determines what is material to its ESG plan, it should establish a narrative and communicate that narrative to shareholders. Generally, if a shareholder proposes an ESG initiative focusing on a particular issue, that issue is probably material to the company.
Be Proactive: Many shareholders are willing to side with companies once they see those companies making genuine efforts to address their concerns. Shareholders are more sophisticated than ever before and are aware of the various nuances for proposals and for meeting goals. While there is an uptick in environmental proposals right now, shareholders are not currently expecting full programs to be in place. If a shareholder proposal is submitted before a company has an ESG program in place, the company should focus on communicating its sustainability journey, which typically includes several steps: collecting data, analyzing the data, creating a plan, implementing the plan, tracking and automating the company's progress and reporting back to shareholders. A company should consider the steps it wants to take and when, but it should try not to overcommit. Companies that have engaged with shareholders and clearly communicated their plans have had some success in convincing proponents to withdraw their proposals. However, even companies with strong ESG programs can encounter unexpected shareholder proposals. These situations usually arise when there is not enough proactive engagement with the shareholder base. Some companies have been successful in getting these proposals withdrawn by providing key information to the proponent. Companies that have proactively engaged with shareholders have had more success in avoiding proposals, having proposals withdrawn and defeating proposals that have gone to a vote.
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