Should shareholder proposals be early warnings for emerging issues and retail challenges? SEC Staff says no.
The socially responsible investment community views the shareholder resolution process as a vehicle for allowing investors to raise and debate issues that may eventually impinge on the corporate bottom line. However, a recent meeting with the staff of the Securities and Exchange Commission indicated that such a view is not necessarily shared by the SEC staff.
First, some legal background. Shareholders that hold over $2000 of shares in a company for over a year are entitled under SEC rules to submit proposals for the company to publish on the proxy statement it issues before its annual meeting. However, the SEC staff also oversees a process of assessing whether particular proposals can be excluded from the proxy based on various SEC rules allowing certain proposals to be excluded. One of the exclusion rules most commonly asserted by companies is that a resolution impinges on the company’s “ordinary business” — addressing issues so mundane that they are not considered appropriate for shareholder deliberations. There are several wrinkles in the staff definition of ordinary business that can determine whether an issue will be kept off the proxy.
Risk evaluation. Prior to 2009, resolutions asking for a company to disclose the financial risks associated with their activities were deemed by the SEC to be excludable as “risk evaluation”. On this basis, in 2008 proposals at Washington Mutual, Bear Stearns, and Lehman Brothers asking for a report on subprime lending practices and risks were kept off the proxy by the SEC. Needless to say, keeping this information out of the proxy did not work out well for investors in these companies. In 2009, after the subprime lending crisis hit, the SEC issued Staff Legal Bulletin 14 E. which changed its policy on risk evaluation. The new policy is to allow shareholders to submit proposals on risk evaluation, but only if the core issue of the proposal addresses what the staff considers to be a “significant policy issue.”
But other staff decisions relating to “significant policy issue” were controversial. For example, this year the staff found proposed issues not “significant” included:
• Net neutrality (a free and open internet) filed at internet providers, even though President Obama had himself publicly declared it an important issue.
• Bottled water quality and labeling, even though this issue is garnering high visibility media and decisions of numerous state and local governments to avoid buying bottled water.
Members of the SEC staff noted in a meeting with stakeholders (including investors and companies) on July 12, 2010 that they view their job as determining whether an issue may have the staying power or whether it could be just a fad. In their view, only firmly engrained issues are appropriate to go to the proxy. The Director of the Division of Corporation Finance, Meredith Cross, stated that the staff decision-making process may lag behind some shareholders’ expectations. She stated that the staff should not, for instance, treat as “significant” this year an issue that they think might yet become significant next year.
Significant policy issue. The SEC staff deliberates on a case-by-case basis as to whether a proposal addresses a “significant policy issue” such that it will not be considered ordinary business. This year, the staff concluded that even though it might seem “ordinary business” for a poultry farm to decide what kind of additives to put in chicken feed, a proposal seeking a phaseout of certain antibiotics in chicken feed presented a significant social policy issue that could appear on the Tyson Foods proxy. What apparently made the issue significant to the staff was that the practice is being banned in Europe. Similarly, even though environmental management of facilities generally could be ordinary business, environmental impacts and financial risks associated with the natural gas extraction process known as hydraulic fracturing were deemed a “significant policy issue” due to the level of environmental concern facing these practices.
Retail product selection. While allowing proposals filed at manufacturing companies addressing the products that they sell, the SEC staff routinely excludes proposals that ask retailers to take some responsibility on their end for potential impacts of products that they sell. For instance, the staff has allowed exclusion of numerous proposals asking retailers to avoid selling toxic cosmetics, toys or nanomaterials. Similarly, in the past year, the staff blocked proposals at two banks that proposed altering bank lending practices to ban loans to companies engaged in coal mining through mountaintop removal.
Opportunities for Shareholder Response
1. The current process places proposals on emerging issues at the mercy of the SEC staff to assess whether they are “significant enough” this year to appear on the proxy, even though many issues and risks of great concern to investors evolve quickly. Witness the staff decision, in the midst of the subprime lending crisis, to rethink prior exclusions of “risk disclosure” proposals. The SEC policies for disallowing proposals on emerging issues and retail products are not mandated by court decisions or regulatory language, but rather are products of SEC staff deliberation. As such, these policies could be overturned by the Commissioners.
2. Comments of Corporation Finance Director Cross implied that the staff may declare some new issues to be “significant” prior to each proxy season. Therefore, it may be appropriate for shareholders to notify the Division of Corporation Finance prior to the coming proxy season (no later than September) of any specific issues that they believe to be “significant social policy issues,” and to seek a staff declaration that those issues are appropriate for resolutions in the upcoming season.
Showing posts with label CSrwirePosts. Show all posts
Showing posts with label CSrwirePosts. Show all posts
Thursday, July 15, 2010
Sunday, April 25, 2010
Will Integrated Financial And Sustainability Reporting Become A Legal Mandate?
Much of what we think of as corporate sustainability reporting is currently done on a voluntary basis. But most observers believe it is only a matter of time until sustainability disclosure will be a legal requirement just as financial disclosure is today.
The Securities and Exchange Commission recently took an important and celebrated step toward mandating sustainability disclosure with a guidance on climate related risks. The guidance clarified duties of companies to disclose certain kinds of climate data and analysis in SEC filings. The guidance was based on existing legal requirements, such as the duties to report on litigation and liabilities and on emerging trends, events and uncertainties.
Since these requirements are already on the books, why the need for guidance? NGO and investor reviews of SEC filings show that, in the absence of SEC guidance, environmental and social issues disclosure in SEC filings is sparse, inconsistent, and typically omits large issues facing the reporting company.
For instance, there is growing concern by investors on how potential environmental impacts from natural gas extraction including drilling and related processes may affect energy companies. An estimated 60-80% of natural gas wells drilled in the next decade will require a process known as “hydraulic fracturing” (“fraccing”) in which huge volumes of water, chemicals and particles are injected underground to release natural gas. Public concerns regarding toxicity and water impacts are already having an effect.
For instance, Chesapeake Energy, recently withdrew several natural gas-related development plans after public and government expressions of concern on potential environmental hazards. These included plans to drill in the New York City watershed, to dispose of waste water in an abandoned well near a water supply in upstate New York, and to withdraw water for fracturing from the Delaware River basin. Yet, the company did not mention these problems in its latest annual 10-K report filed with the SEC.
Another company, Cabot Oil & Gas, was hit with numerous environmental enforcement actions in 2009 around its operations in Pennsylvania due to toxic spills, and to methane entering nearby private drinking wells. Enforcement included a temporary shutdown order and a consent agreement containing a civil penalty of $120,000. Again, these did not appear in the Company’s SEC filings.
The lack of disclosure of the $120,000 penalty might seem notable in light of an SEC regulation requiring disclosure of pending or likely environmental enforcement actions where the penalty is expected to exceed $100,000. But a recent study found that 73% of all companies are not disclosing environmental enforcement actions with penalties in excess of $100,000. It seems either the rule’s applicability to specific cases is considered by companies to be equivocal, or the absence of SEC enforcement is not inspiring broad compliance.
For Cabot, the $120,000 penalty was not the end of the matter. On April 15, 2010, the state modified the consent agreement with a fine of $240,000, and a continuing penalty of $30,000 per month until Cabot rectifies identified environmental problems. The new order also bans the company from drilling new wells in the area for a year. In response, the company issued a news release (but so far, not an SEC disclosure) noting that “This modified order does not impact the number of wells scheduled to be drilled under Cabot’s 2010 drilling effort, nor will it impact our production guidance.”
Shareholders monitoring the gas companies remain concerned about poor disclosure. New York State Comptroller Thomas DiNapoli, Green Century Funds and numerous other investors are attempting to fill the natural gas sector’s disclosure gap through a series of shareholder resolutions requesting reports on this issue by energy companies. Beyond the disclosure gaps on this specific issue, it is obvious that additional SEC guidance and enforcement could enhance disclosure of an array of issues in SEC filings.
On the other hand, better enforcement or single issue approaches like the climate guidance, are not the end-all and be-all of sustainability disclosure. Arguably, fully integrating current financial reporting to the SEC with data associated with impacts of the corporation on society could be far more useful. The Social Investment Forum submitted a proposal to the SEC last summer calling for movement in the direction of an integrated disclosure requirement, such as that suggested by Harvard business professor Robert G. Eccles and Michael P. Krzus of Grant Thornton LLP in their new book, One Report: Integrated Reporting for a Sustainable Strategy.
The SIF proposal had two elements. First it requested that the SEC require issuers to report annually on a comprehensive, uniform set of sustainability indicators. The letter suggested that the Global Reporting Initiative (GRI) reporting guidelines would be a reasonable starting point. Secondly, it asked that the SEC issue a guidance to ensure disclosure of short- and long-term sustainability risks in the Management Discussion and Analysis section of the 10-K (MD&A). The latter proposal would reduce the subjectivity of a company’s decisions to disclose by providing more objective thresholds to trigger disclosure obligations, such as disclosing the emergence of peer-reviewed studies indicating potential hazards of a company’s products or activities.
Such changes would go much further in ensuring that investors and other stakeholders have ready access to the information needed for an integrated examination of where and how finances and sustainability converge.
The Securities and Exchange Commission recently took an important and celebrated step toward mandating sustainability disclosure with a guidance on climate related risks. The guidance clarified duties of companies to disclose certain kinds of climate data and analysis in SEC filings. The guidance was based on existing legal requirements, such as the duties to report on litigation and liabilities and on emerging trends, events and uncertainties.
Since these requirements are already on the books, why the need for guidance? NGO and investor reviews of SEC filings show that, in the absence of SEC guidance, environmental and social issues disclosure in SEC filings is sparse, inconsistent, and typically omits large issues facing the reporting company.
For instance, there is growing concern by investors on how potential environmental impacts from natural gas extraction including drilling and related processes may affect energy companies. An estimated 60-80% of natural gas wells drilled in the next decade will require a process known as “hydraulic fracturing” (“fraccing”) in which huge volumes of water, chemicals and particles are injected underground to release natural gas. Public concerns regarding toxicity and water impacts are already having an effect.
For instance, Chesapeake Energy, recently withdrew several natural gas-related development plans after public and government expressions of concern on potential environmental hazards. These included plans to drill in the New York City watershed, to dispose of waste water in an abandoned well near a water supply in upstate New York, and to withdraw water for fracturing from the Delaware River basin. Yet, the company did not mention these problems in its latest annual 10-K report filed with the SEC.
Another company, Cabot Oil & Gas, was hit with numerous environmental enforcement actions in 2009 around its operations in Pennsylvania due to toxic spills, and to methane entering nearby private drinking wells. Enforcement included a temporary shutdown order and a consent agreement containing a civil penalty of $120,000. Again, these did not appear in the Company’s SEC filings.
The lack of disclosure of the $120,000 penalty might seem notable in light of an SEC regulation requiring disclosure of pending or likely environmental enforcement actions where the penalty is expected to exceed $100,000. But a recent study found that 73% of all companies are not disclosing environmental enforcement actions with penalties in excess of $100,000. It seems either the rule’s applicability to specific cases is considered by companies to be equivocal, or the absence of SEC enforcement is not inspiring broad compliance.
For Cabot, the $120,000 penalty was not the end of the matter. On April 15, 2010, the state modified the consent agreement with a fine of $240,000, and a continuing penalty of $30,000 per month until Cabot rectifies identified environmental problems. The new order also bans the company from drilling new wells in the area for a year. In response, the company issued a news release (but so far, not an SEC disclosure) noting that “This modified order does not impact the number of wells scheduled to be drilled under Cabot’s 2010 drilling effort, nor will it impact our production guidance.”
Shareholders monitoring the gas companies remain concerned about poor disclosure. New York State Comptroller Thomas DiNapoli, Green Century Funds and numerous other investors are attempting to fill the natural gas sector’s disclosure gap through a series of shareholder resolutions requesting reports on this issue by energy companies. Beyond the disclosure gaps on this specific issue, it is obvious that additional SEC guidance and enforcement could enhance disclosure of an array of issues in SEC filings.
On the other hand, better enforcement or single issue approaches like the climate guidance, are not the end-all and be-all of sustainability disclosure. Arguably, fully integrating current financial reporting to the SEC with data associated with impacts of the corporation on society could be far more useful. The Social Investment Forum submitted a proposal to the SEC last summer calling for movement in the direction of an integrated disclosure requirement, such as that suggested by Harvard business professor Robert G. Eccles and Michael P. Krzus of Grant Thornton LLP in their new book, One Report: Integrated Reporting for a Sustainable Strategy.
The SIF proposal had two elements. First it requested that the SEC require issuers to report annually on a comprehensive, uniform set of sustainability indicators. The letter suggested that the Global Reporting Initiative (GRI) reporting guidelines would be a reasonable starting point. Secondly, it asked that the SEC issue a guidance to ensure disclosure of short- and long-term sustainability risks in the Management Discussion and Analysis section of the 10-K (MD&A). The latter proposal would reduce the subjectivity of a company’s decisions to disclose by providing more objective thresholds to trigger disclosure obligations, such as disclosing the emergence of peer-reviewed studies indicating potential hazards of a company’s products or activities.
Such changes would go much further in ensuring that investors and other stakeholders have ready access to the information needed for an integrated examination of where and how finances and sustainability converge.
Monday, April 5, 2010
Do Directors have a fiduciary duty on sustainability?
I'm a guest blogger today on CSRwire Talkback on "Legal frontiers of Sustainability." As investor's counsel, I explain why/how we asked Intel's Board to address CSR/Sustainability as fiduciaries.
According to a recent CERES report, aligning economic prosperity and environmental sustainability will demand new strategies in the board room and executive suite. First among the strategies identified by CERES is a need for every corporate board of directors to assign a board committee to oversee sustainability. A number of US companies have already taken this step. There is a sound business case for doing so. Companies that are attentive to sustainability in many sectors have done better than average financially during the financial slowdown. Also, many companies are finding that they can use a sustainability focus to drive their leadership as innovators.
Notably, just a week after CERES issued its report, Intel’s Board of Directors decided to modify a committee charter to better integrate sustainability and corporate social responsibility. Moreover, the company acknowledged that the change makes these issues part of committee members’ fiduciary duties.
These changes to the committee charter happened after my legal client, Harrington Investments, Inc. (HII) http://harringtoninvestments.com had filed a shareholder resolution, for the second year in a row, to amend Intel’s bylaws to create a Board Committee on Sustainability. Intel initially opposed the resolution at the Securities and Exchange Commission. But a subsequent dialogue with HII yielded an agreement (in exchange for withdrawal of the resolution) to propose changing the governance and nominating committee charter to require the committee to:
“review(s) and report(s) to the Board on a periodic basis with regards to matters of corporate responsibility and sustainability performance, including potential long and short term trends and impacts to our business of environmental, social and governance issues, including the company’s public reporting on these topics.”
As part of the dialogue, Intel also had its outside legal counsel Gibson, Dunn & Crutcher LLP ink an opinion clarifying that pursuant to Delaware law, the committee’s charter generates a fiduciary obligation. The legal memo cites the notion of a “charter imposed duty” as clarified by In re Walt Disney Co. Derivative Litigation, 906 A.2d 27, 53-54 (Del. 2006).
Although the case cited, Walt Disney involved a finding by the Delaware Supreme Court that a $130 million severance payment to Michael Ovitz did not entail a breach of the directors’ duties, the case is widely cited for the notion that directors have a fiduciary duty to “act in the face of a known duty to act.” Thus by integrating sustainability and corporate social responsibility into a committee charter, committee members gain a fiduciary duty to attend to those issues.
As HII’s lawyer in this process, I find the inevitable legal questions flowing out of this analysis particularly interesting. First of all, do all directors already have a fiduciary obligation regarding sustainability and corporate social responsibility? The answer is that within certain relatively uncharted boundaries they do. For instance, when it comes to oversight of environmental compliance, or social issues that may affect a company’s reputation, the duty of care attendant to directorship clearly extends such issues interwoven with the company’s prospects. An excellent aw review article, “Is There An Emerging Fiduciary Duty To Consider Human Rights?” by law professor Cynthia Williams details this obligation, for instance, in the arena of human rights.
How then does the insertion of specific language into a committee charter alter the scope of directors’ fiduciary duty on these issues? Contrary to the vagaries of evolving fiduciary obligations, with little delineation of the scope of a director’s obligation, the committee charter is very specific. It asks for the members to examine, for instance, “potential long and short-term trends and impacts to our business of environmental, social and governance issues.” It gives much clearer guidance as to the range of issues under committee scrutiny, including “long term” trends, and “potential” issues.
Finally, under what circumstances might the resulting fiduciary duty be deemed enforceable by the courts?
In general, the deliberations of directors are shielded by the “business judgment rule” which“ presumes that ‘in making a business decision the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company.’ ” Aronson v. Lewis, 473 A.2d 805, 812 (Del.1984). So, it takes more than just a mistake by board members to face any liability exposure. In general, the kinds of failures in their duties of care and good faith that would trigger liability would involve intentional dereliction, a conscious disregard for one’s responsibilities, an actual intent to do harm, or gross negligence.
I believe the most immediate legal implication may be the enhanced duty of the directors to inquire and to oversee. Specifically, when potential sustainability or corporate social responsibility issue present significant risks or opportunities to the company, the committee members have a duty to ensure that they are reasonably well informed. Secondly, they must ensure that the management is on top of the details, with sufficient internal controls in place, such as enterprise risk management systems.
Given the fiduciary duties that accompany this expanded committee role, it seems well worthwhile to encourage more boards of directors to ensure that sustainability and corporate social responsibility are well- delineated in committee charters.
According to a recent CERES report, aligning economic prosperity and environmental sustainability will demand new strategies in the board room and executive suite. First among the strategies identified by CERES is a need for every corporate board of directors to assign a board committee to oversee sustainability. A number of US companies have already taken this step. There is a sound business case for doing so. Companies that are attentive to sustainability in many sectors have done better than average financially during the financial slowdown. Also, many companies are finding that they can use a sustainability focus to drive their leadership as innovators.
Notably, just a week after CERES issued its report, Intel’s Board of Directors decided to modify a committee charter to better integrate sustainability and corporate social responsibility. Moreover, the company acknowledged that the change makes these issues part of committee members’ fiduciary duties.
These changes to the committee charter happened after my legal client, Harrington Investments, Inc. (HII) http://harringtoninvestments.com had filed a shareholder resolution, for the second year in a row, to amend Intel’s bylaws to create a Board Committee on Sustainability. Intel initially opposed the resolution at the Securities and Exchange Commission. But a subsequent dialogue with HII yielded an agreement (in exchange for withdrawal of the resolution) to propose changing the governance and nominating committee charter to require the committee to:
“review(s) and report(s) to the Board on a periodic basis with regards to matters of corporate responsibility and sustainability performance, including potential long and short term trends and impacts to our business of environmental, social and governance issues, including the company’s public reporting on these topics.”
As part of the dialogue, Intel also had its outside legal counsel Gibson, Dunn & Crutcher LLP ink an opinion clarifying that pursuant to Delaware law, the committee’s charter generates a fiduciary obligation. The legal memo cites the notion of a “charter imposed duty” as clarified by In re Walt Disney Co. Derivative Litigation, 906 A.2d 27, 53-54 (Del. 2006).
Although the case cited, Walt Disney involved a finding by the Delaware Supreme Court that a $130 million severance payment to Michael Ovitz did not entail a breach of the directors’ duties, the case is widely cited for the notion that directors have a fiduciary duty to “act in the face of a known duty to act.” Thus by integrating sustainability and corporate social responsibility into a committee charter, committee members gain a fiduciary duty to attend to those issues.
As HII’s lawyer in this process, I find the inevitable legal questions flowing out of this analysis particularly interesting. First of all, do all directors already have a fiduciary obligation regarding sustainability and corporate social responsibility? The answer is that within certain relatively uncharted boundaries they do. For instance, when it comes to oversight of environmental compliance, or social issues that may affect a company’s reputation, the duty of care attendant to directorship clearly extends such issues interwoven with the company’s prospects. An excellent aw review article, “Is There An Emerging Fiduciary Duty To Consider Human Rights?” by law professor Cynthia Williams details this obligation, for instance, in the arena of human rights.
How then does the insertion of specific language into a committee charter alter the scope of directors’ fiduciary duty on these issues? Contrary to the vagaries of evolving fiduciary obligations, with little delineation of the scope of a director’s obligation, the committee charter is very specific. It asks for the members to examine, for instance, “potential long and short-term trends and impacts to our business of environmental, social and governance issues.” It gives much clearer guidance as to the range of issues under committee scrutiny, including “long term” trends, and “potential” issues.
Finally, under what circumstances might the resulting fiduciary duty be deemed enforceable by the courts?
In general, the deliberations of directors are shielded by the “business judgment rule” which“ presumes that ‘in making a business decision the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company.’ ” Aronson v. Lewis, 473 A.2d 805, 812 (Del.1984). So, it takes more than just a mistake by board members to face any liability exposure. In general, the kinds of failures in their duties of care and good faith that would trigger liability would involve intentional dereliction, a conscious disregard for one’s responsibilities, an actual intent to do harm, or gross negligence.
I believe the most immediate legal implication may be the enhanced duty of the directors to inquire and to oversee. Specifically, when potential sustainability or corporate social responsibility issue present significant risks or opportunities to the company, the committee members have a duty to ensure that they are reasonably well informed. Secondly, they must ensure that the management is on top of the details, with sufficient internal controls in place, such as enterprise risk management systems.
Given the fiduciary duties that accompany this expanded committee role, it seems well worthwhile to encourage more boards of directors to ensure that sustainability and corporate social responsibility are well- delineated in committee charters.
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