Shareholder proposals urging corporate boards to report on climate‑related risk made headlines in 2017 when they earned majority support from investors at ExxonMobil, Occidental Petroleum, and PPL.[1] The key to this historic vote was the support of the Big Three index fund managers – BlackRock, State Street, and Vanguard, which broke with management and cast their votes for the proposals.[2] The 2018 proxy season saw several more climate‑related proposals earn majority support, and in 2018 and 2019 record numbers of proposals were withdrawn after the companies agreed to respond to shareholders’ requests.[3]

The highly visible 2017 proposal, like others that followed it, illustrates a number of key aspects of shareholder activism today:

• The mainstreaming of shareholder activism. Shareholder activism has its origins in the civil rights and socially responsible investment movements, but now the largest institutional investors are also beginning to integrate non-financial factors like environmental, social, and governance (ESG) into their voting and investment policies.[4]
• The broader focus of ESG-related shareholder activism. Climate risk and corporate environmental impacts now account for around 30 percent of all shareholder proposals.[5] This represents a broader focus for shareholder activism beyond the civil rights, labor, and human rights issues that were its major targets throughout much of the 20^th
• ESG materiality. Mainstream investors like BlackRock and Vanguard explain their support for ESG-oriented activism in economic terms, signaling recognition of the materiality of some ESG factors. BlackRock’s public statement explaining its 2017 vote is a case in point. It states: “[w]e will continue our dialogue over time with Exxon and other companies on a range of issues of economic relevance, including but not limited to climate-related risks.”[6]
• The use of shareholder activism to expand disclosure. Around 20 percent of environmental and social proposals in recent proxy seasons, like the 2017 Exxon proposal, seek better corporate disclosure about ESG risks and impacts, either to better inform investor decision‑making or to prompt changes in corporate practice (or both).[7] This raises the question of whether private ordering is an adequate (or preferred) alternative to new ESG disclosure mandates.

My article, From Public Policy to Materiality: Non-Financial Reporting, Shareholder Engagement, & Rule 14a-8’s Ordinary Business Exception, argues that shareholder activism is not an efficient substitute for disclosure reform under the federal securities laws – in fact, it has impeded it.

To place this argument in context, I show first that a striking shift has occurred over the past decade in how investors, governments, and many companies think about ESG materiality, and that this shift has driven higher demand for investment-grade ESG information among investors. These trends are also reflected in the high levels of investor support for ESG disclosure reform in public comments to the SEC’s 2016 Regulation S-K Concept Release,[8] in recent investor surveys, in IOSCO’s 2019 Statement on Disclosure of ESG Matters by Issuers, and in ESG disclosure reforms introduced by over 60 governments and multilateral institutions worldwide. Here again, the 2017 ExxonMobil proposal itself illustrates the point:

Item 12–Report on Impacts of Climate Change Policies: RESOLVED: Shareholders request that, beginning in 2018, ExxonMobil publish an annual assessment of the long-term portfolio impacts of technological advances and global climate change policies [that may be adopted under the Paris Climate Accord], at reasonable cost and omitting proprietary information. . . . This reporting should assess the resilience of the company’s full portfolio of reserves and resources through 2040 and beyond, and address the financial risks associated with such a scenario.

Business organizations and their legal counsel have actively opposed any effort by the SEC to introduce new ESG disclosure rules, in part by arguing that private ordering through shareholder activism is a better, more tailored approach.[9]  In reality, Rule 14a-8 of the federal proxy rules, which establishes how and when shareholders can submit proposals to a shareholder vote, actually restricts shareholders’ ability to push for better corporate disclosure and forces shareholders to frame their proposals in a way that discounts the materiality of ESG information.  I argue that the SEC’s interpretation of Rule 14a-8’s “ordinary business exception,” together with the rule’s long use in shareholder activism around “public policy and social issues,” therefore discourage support for new rulemaking that could improve investor and market access to material ESG information.

A few of the key reasons why shareholder activism is not an effective substitute for (and may even impede) federal disclosure reform are that:

• Shareholder activism is an imprecise tool to elicit material disclosure. According to the legislative history of Rule 14a-8, shareholder proposals are intended as a megaphone for investors, not primarily as a conduit of information to the market. In other words, Rule 14a-8 is an inefficient way to achieve the goals of the federal disclosure regime.
• ESG proposals almost always concern the “ordinary business” of the company, and so can readily be challenged by management. Shareholder proposals dealing with environmental or social concerns often relate to some aspect of the company’s operations – its “ordinary business” – and are therefore readily subject to exclusion from the corporate proxy, unless shareholders can show that the proposal also implicates a “significant policy issue” and does not seek to “micromanage.”
• The prohibition on “micro-management” makes Rule 14a-8 a poor tool for improving the comparability and standardization of ESG reporting. The more prescriptive a proposal, the more likely it is to be found to “micromanage” the company’s approach to its workforce, environmental concerns, or existing public reporting obligations and therefore be blocked from appearing on the corporate proxy.[10]
• The application of the “ordinary business exception” forces non-economic framing. Because the SEC has generally defined “significant” in terms of “social or policy” issues, shareholders who want to use the shareholder proposal process to obtain even material information must frame their proposal as raising a “significant policy” But forcing ESG proposals to be framed in “public policy” terms perpetuates the perception that these issues are immaterial and an inappropriate subject of future disclosure reform.

I argue for a simple solution: The SEC should modify the language it routinely uses in no-action letters, staff guidance, policy statements, and interpretations to make clear that ESG issues may also be “substantial” or “significant” under Rule 14a-8(i)(7) because of their economic significance and potential materiality.  This reading would in fact accord with the earliest of the SEC’s own explanations of the rule, and by acknowledging the economic significance of non-financial issues, the SEC can dispel the false perception that these matters are not material to investors. Such a shift would also prevent the incongruity of shareholder proponents having to defend proposals on material ESG issues from exclusion on ordinary business grounds by playing up their social and political interest rather than their economic relevance.

ENDNOTES

[1] See Steve Mufson, Financial Firms Lead Shareholder Rebellion Against ExxonMobil Climate Change Policies, Wash. Post, May 31, 2017 (reporting support of over 60 percent of shareholders on the Exxon vote and over 65 percent at Occidental); ExxonMobil Corporation, Notice of 2017 Annual Meeting and Proxy Statement, Schedule 14A, SEC (Apr. 13, 2017).

[2] See Mufson, id.

[3] See Five Takeaways From the 2019 Proxy Season, Ernst & Young (2019); see also Andrew Logan, The Hidden Story of Climate Proposals in the 2018 Proxy Season, Ceres (May 29, 2018).

[4] See Vanguard’s Responsible Investment Policy, Vanguard; 2019 Proxy Voting and Engagement Guidelines: North America, St. Street Global Advisors (Mar. 2019); Proxy Voting Guidelines for U.S. Securities, BlackRock (Jan. 2019).

[5] See, e.g. Heidi Welsh et al., Proxy Preview 2019, Harv. L. S. Corp. Gov. (Apr. 1, 2019).

[6] BlackRock Vote Bulletin, BlackRock (May 2017) (emphasis added).

[7] See The Conference Board, Proxy Voting Analytics (2015– 2018) 31 & chart 7, 86 & chart 24 (2018) (by subscription).

[8] See Sustainability Accounting Standards Bd., The State of Disclosure 2016: An analysis of the effectiveness of sustainability disclosure in SEC filings 4 (2016) (finding over 80 percent of respondents support ESG disclosure reform); see also Virginia Harper Ho, Disclosure Overload? Lessons for Risk Disclosure & ESG Reporting Reform From the Regulation S-K Concept Release, 65 Vill. L. Rev. __ (2019) (same).

[9] See, e.g. Comment of Shearman & Sterling LLP on Regulation S-K Concept Release to Brent J. Fields, Sec’y, U.S. Sec. & Exch. Comm’n (Aug. 31, 2016).

[10] For example, in 2018, the SEC, in a surprising departure from past practice, concluded that a resolution asking EOG Resources to adopt greenhouse gas emission goals and report on its progress sought to micromanage the company and could therefore be excluded.  EOG Resources No-Action Letter, U.S. Sec. & Exch. Comm’n (Feb. 26, 2018).

This post comes to us from Virginia Harper Ho, the Earl B. Shurtz Research Professor of Law and the asociate dean for international & comparative law at the University of Kansas School of Law. It is based on her recent article, “From Public Policy to Materiality: Non-Financial Reporting, Shareholder Engagement, & Rule 14a-8’s Ordinary Business Exception,” forthcoming in the Washington & Lee Law Review and available here.