By Chandler Smith.
The Securities and Exchange Commission (“SEC”) requires companies to provide shareholders with proxy statements containing information they can use to make informed decisions at annual meetings. Institutional Shareholder Services, Inc. (“ISS”) is a proxy advisory firm that shareholders and investors use to inform their votes in addition to proxy statements. Glass, Lewis & Co. (“GL”) is a similarly situated proxy advisory firm. ISS and GL are the two most prominent and trusted advisory bodies that provide industry-leading viewpoints and proxy vote management solutions to boards across the world. Some say that ISS and GL have “taken the fun out of being a director” and replaced it with rigidity and compliance. Regardless, for most institutional investors, when ISS and GL speak—they listen. Accordingly, lawyers and firms must be kept abreast of yearly changes to ISS and GL proxy disclosure guidelines.
This year, ISS and GL’s guidelines have an increased focus on environmental, social, and governance (“ESG”) matters. It is imperative that public companies are aware of this trend, as a failure to responsibly oversee ESG matters can have significant financial, legal, and reputational consequences. The environmental subcategory, or the “E” in ESG, includes areas such as carbon and climate; natural resources; waste and toxicity, etc. The social subcategory of ESG includes human rights; labor, health and safety; product safety and quality; and more. Finally, the governance subcategory of ESG includes board structure, compensation, and shareholder rights, among other areas. The social unrest that followed the 2020 protests against police brutality in the aftermath of the high profile deaths of George Floyd and Breonna Taylor, among others, also exposed many companies’ lack of risk management on ESG issues. Additionally, the COVID-19 pandemic has exposed employee health and safety issues in companies with little ESG focus. Shareholders and investors will undoubtedly want to be apprised of company disclosures on environmental and social issues this year. Voluntary ESG disclosure is advised and allows for companies to control their message on important social matters while being transparent with shareholders and investors.
2021 ISS and GL Guidelines on ESG
ISS and GL released their proxy voting guidelines in November 2020, which apply to annual meetings beginning 2021. The 2021 ISS Guidelines add poor risk oversight of ESG issues to its list of material failures of governance, stewardship, and fiduciary responsibility. For ESG compensation-related proposals, ISS recommends shareholders vote case-by-case on proposals to link executive compensation to sustainability criteria. In considering environmental and social proposals, boards should consider:
- The scope and prescriptive nature of the proposal;
- Whether the company has significant and/or persistent controversies or regulatory violations regarding social and/or environmental issues;
- Whether the company has management systems and oversight mechanisms in place regarding its social and environmental performance;
- The degree to which industry peers have incorporated similar non-financial performance criteria in their executive compensation practices; and
- The company’s current level of disclosure regarding its environmental and social performance.
Similarly, GL seeks to promote responsible management of ESG issues, stating its belief that “part of the board’s role is to ensure that management conducts a complete risk analysis of company operations, including those that have environmental and social implications.” GL’s 2021 guidelines state that it will generally recommend in favor of resolutions that will promote more and better disclosure of relevant risk factors where such disclosure is lacking, inadequate, or will otherwise serve the best long-term interests of shareholders. Further, GL will note as a concern a company that has not adequately managed environmental or social issues to the detriment of shareholders. GL will note these concerns and may recommend that shareholders vote to signal these concerns on any applicable management or shareholder proposal.
ISS and GL will take a case-by-case approach to ESG proposals. ISS and GL recommend considering factors such as how ESG proposals will affect shareholders, if there is a competing shareholder proposal, how responsive the company is to ESG issues, and whether the proposal is binding or advisory. GL will generally support shareholder proposals on climate change related disclosures and diversity reporting. GL will also generally recommend against companies seeking to limit participation in trade associations.
Despite the potentially philanthropic purpose behind ESG disclosures, companies must be careful to ensure that these filings are accurate and clear to avoid SEC liability. For example, Mayer Brown states that “from a liability perspective, it may be prudent to describe corporate ESG initiatives in aspirational terms rather than as commitments to achieve specific results.” It also may be useful for companies to include disclaimers in ESG disclosures. Companies’ annual proxy statements provide a critical opportunity for transparency with investors regarding efforts in environmental and social areas that investors clearly care about.
ESG Importance in 2021 and Beyond
It is important that lawyers, shareholders, and investors are aware of the increased attention on environmental and social issues when it comes to proxy disclosures. In addition to this increased focus on ESG matters, ISS and GL also made changes to promote board diversity and close racial/ethnic pay gaps. Additionally, third parties such as the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-Related Financial Disclosures (TCFD) are ESG frameworks that have grown in influence. These resources can also be used for guidance on proxy disclosures. In 2021 and the coming years, boards that don’t properly inform shareholders of their efforts on pressing ESG issues will pay the price. ESG proposals and disclosures are, and will continue to be, an imperative part of safeguarding companies’ financial interests.