In March 2022, the SEC proposed rules (the “Proposed Rules”) that, if adopted, will require public companies to include extensive climate-related disclosures in their periodic reports.[1] According to the SEC, this disclosure will help investors “make informed judgments about the impact of climate-related risks on current and potential investments.”[2] However, requiring public companies to disclose information about climate-related risks is not enough to protect investors or ensure that they are fully informed. The SEC also needs to require public companies to disclose additional information about their corporate governance practices, especially those relating to shareholder rights.
In my recent article, I address the largely overlooked relationship between governance, on the one hand, and environmental and social risks, on the other. Good corporate governance practices are necessary to ensure that public companies appropriately manage their environmental and social risks. In fact, the group of investment banks and institutional investors credited with creating the term “ESG” recognized this, noting that:
[s]ound corporate governance and risk management systems are crucial pre-requisites to successfully implementing policies and measures to address environmental and social challenges. That is why we have chosen to use the term “environmental, social and governance issues” throughout this report, as a way of highlighting the fact that these three areas are closely inter-linked.[3]
The connection between corporate governance and environmental and social risks can be easily demonstrated. For example, the board is responsible for managing company risks, including environmental and social risks. To manage these risks, the company needs to follow good corporate governance practices and ensure that the board has the appropriate mix of experience and skills. A board that does not have sufficient knowledge of environmental and social risks will not be able to successfully oversee the “E” and the “S.”
Less clear is the link between effective oversight of environmental and social risks and shareholder rights. Even a well-qualified board might do a poor job of managing environmental and social risks. The threat – express or implied – that shareholders will vote directors out of office if they do will presumably lead to more effective management of these risks. Therefore, corporate governance practices that promote board accountability are crucial to ensuring effective oversight of environmental and social risks.
The link between the “G” and the “ES” means that requiring public companies to disclose information about environmental and social risks is not enough to protect investors. They also need information about the company’s corporate governance practices.
The Proposed Rules do include a single corporate governance disclosure item that focuses on board oversight of climate-related risks.[4] If the rules are adopted, Item 1501 will be added to Regulation S-K. It will require public companies to describe the board’s oversight of climate-related risks, including whether any member of the board of directors has expertise in climate-related risks and a description of the nature of the expertise.
While this is a good start, the SEC did not go far enough. Shareholders also need to know whether they will be able to hold the board accountable if the board fails in its oversight of those risks. To assess board accountability, shareholders need to know basic information about their voting rights, including:
- Whether the full board stands for election each year;
- Whether shareholders have reasonable access to the company’s proxy materials;
- Whether proxy votes are kept confidential;
- Whether shareholders have the power to call special meetings;
- Whether shareholders can act by written consent without a meeting; and
- Whether bylaws can be amended by a majority vote of the shareholders.
Surprisingly, this information is not currently required to be disclosed by public companies.
To ensure that shareholders will be able to “make informed judgments about the impact of climate-related risks on current and potential investments,” I argue that the SEC should require companies to disclose this basic governance information about shareholder rights. Moreover, I recommend that information about a public company’s fundamental corporate governance practices should be presented in a new “Summary Corporate Governance Table” included in a company’s proxy statement and on the company’s corporate website.
The SEC’s Proposed Rules, and future ESG-disclosure initiatives, will help shareholders become better informed about environmental and social challenges facing public companies. However, these initiatives will not be completely successful unless the SEC recognizes the importance of the “G” in “ESG.”
ENDNOTES
[1] The Enhancement and Standardization of Climate-Related Disclosures for Investors, Securities Act Release No. 33-11042, 87 Fed. Reg. 21334 (March 21, 2022).
[2] Id. at 7.
[3] Who Cares Wins: Connecting Financial Markets to a Changing World, U.N. Glob. Compact 2 (Dec. 2004), https://d306pr3pise04h.cloudfront.net/docs/issues_doc%2FFinancial_markets%2Fwho_cares_who_wins.pdf.
[4] See proposed 17 CFR 229.1501.
This post comes to us from Professor Jennifer O’Hare at Villanova University’s Charles Widger School of Law. It is based on her recent article, “Don’t Forget the ‘G’ in ESG: The SEC and Corporate Governance Disclosure,” recently published in the Arizona Law Review and available here.