STANFORD INSTITUTIONAL INVESTORS’ FORUM Wednesday, June 12, 2019 Lane/Lyons/Lodato Room, Arrillaga Alumni Center Stanford, California
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STANFORD INSTITUTIONAL INVESTORS’ FORUM
Wednesday, June 12, 2019 Lane/Lyons/Lodato Room, Arrillaga Alumni Center
Stanford, California
STANFORD INSTITUTIONAL INVESTORS’ FORUM
June 12, 2019
Lane/Lyons/Lodato Room Arrillaga Alumni Center, Stanford University
326 Galvez Street, Stanford, CA 94305
AGENDA
7:45 a.m. BREAKFAST and REGISTRATION 8:00 a.m. WELCOME FROM CO-DIRECTORS and PARTICIPANT INTRODUCTIONS
Joseph A. Grundfest, William A. Franke Professor of Law and Business and Senior Faculty, Rock Center for Corporate Governance, Stanford University; Board Member, KKR; Co-Director, SIIF
Amanda K. Packel, Managing Director, Rock Center for Corporate Governance; Co-Director, SIIF
8:15 a.m. ESG Measurement and ESG-Specific Funds: Does Any of This Make Sense? Lydia I. Beebe (moderator), Principal, LIBB Advisors; Board Member, Aemetis Inc. and Kansas City
Southern Colleen Honigsberg, Assistant Professor of Law, Stanford Law School Samantha Ross, Former Chief of Staff, Public Company Accounting Oversight Board Michelle Edkins, Global Head of Investment Stewardship, BlackRock
9:15 a.m. Human Capital Management and the Future of Work Joseph A. Grundfest (moderator) James Andrus, Investment Manager, CalPERS
Peggy Foran, Chief Governance Officer, SVP, and Corporate Secretary, Prudential Financial; Board Member, Occidental Petroleum Nicole Isaac, Senior Director, North American Policy, LinkedIn
10:15 a.m. Break
10:35 a.m. Activism by Employees as Shareholders
Mike Callahan, Professor of the Practice of Law and Executive Director of the Rock Center for Corporate Governance, Stanford University
11:35 a.m. Lunch 12:15 p.m. Proxy Season Review and Update on Potential Reform of Proxy Advisors and the Proxy Process Anne Sheehan, Member, SEC Investor Advisory Committee; Board Member, L Brands; Advisor, PJT
Camberview; Former Director of Corporate Governance, CalSTRS 1:00 p.m. Research, Regulatory, and Litigation Updates – Expanded 10b-5 Liability, The Future of
Federal Forum Provisions, and More Insider Trading Litigation Joseph A. Grundfest 1:45 p.m. Adjournment The dinner on June 11, 2019 will be at the Stanford Park Hotel, 100 El Camino Real, Menlo Park, CA 94025, with cocktails at 6:15pm and dinner at 7pm. Our featured guest speaker will be Jennifer Eberhardt, Professor of Psychology at Stanford University, who will discuss her new book Biased: Uncovering the Hidden Prejudice That Shapes What We See, Think, and Do, as well as some new research on bias in investing.
STANFORD INSTITUTIONAL INVESTORS’ FORUM
June 12, 2019
Lane/Lyons/Lodato Room Arrillaga Alumni Center, Stanford University
326 Galvez Street, Stanford, CA 94305
MATERIALS SUMMARY ESG Measurement
• ESG activities – David F. Larcker and Brian Tayan, Stanford Graduate School of Business Corporate Governance Research Initiative. Research Spotlight.
• Making sense of the current ESG landscape – Peter Atkins, Marc Gerber, and Richard Grossman, Skadden, Arps, Slate, Meagher & Flom LLP. Harvard Law School Forum on Corporate Governance and Financial Regulation – October 18, 2018.
• Exploring ESG: a practitioner’s perspective – BlackRock Viewpoint – June, 2016.
• The ESG data challenge – Rakhi Kumar and Ali Weiner, State Street Global Advisors – March,
2019.
• The business case for ESG – Brandon Boze, Margarita Krivitski, David F. Larcker, Brian Tayan, and Eva Zlotnicka. Stanford Closer Look Series – May 23, 2019.
Human Capital and the Future of Work
• Where does human resources sit at the strategy table? – Courtney Hamilton, David F. Larcker, Stephen A. Miles, and Brian Tayan. Stanford Closer Look Series – February 15, 2019.
• A deeper dive into talent management: the new board imperative – PwC Governance Insights Center – May, 2019.
• Human capital management coalition petition to U.S. Securities and Exchange Commission –
Meredith Miller, Human Capital Management Coalition – July 6, 2017.
• BlackRock investment stewardship’s approach to engagement on human capital management – Michelle Edkins, BlackRock Investment Stewardship. Harvard Law School Forum on Corporate Governance and Financial Regulation – March 28, 2018.
• AI, automation, and the future of work: ten things to solve for – McKinsey Global Institute – June, 2018.
Employee Activism • Employees rising: seizing the opportunity in employee activism – Weber Shandwick and KRC
Research.
• Employee activism: a powerful, yet untapped, driver of climate action – Dominic Hofstetter. Medium.com – April 23, 2019.
Proxy Season Review and Hot Topics
• 2018 mini-season wrap-up and 2019 trends – ProxyPulse, a Broadrige + PwC initiative – 2019.
• What investors are expecting from the 2019 proxy season – Jamie Smith, EY – February 12, 2019.
• 2019 proxy season preview – Shirley Westcott, Alliance Advisors. Harvard Law School Forum
on Corporate Governance and Financial Regulation – April 15, 2019.
• Coalition of publicly traded companies’ letter to U.S. Securities and Exchange Commission Chairman Jay Clayton – Nasdaq, Inc. – February 4, 2019.
• Keynote remarks: ICI mutual funds and investment management conference – Elad L. Roisman,
U.S. Securities and Exchange Commission – March 18, 2019. Litigation, Research & Regulatory Updates
• Securities class action settlements – Laarni T. Bulan, Ellen M. Ryan, Laura E. Simmons, Cornerstone Research. 2018 Review and Analysis – 2019.
• Lorenzo v. Securities and Exchange Commission – Supreme Court of the United States – October, 2018.
• ‘Lorenzo’: what happens next and what to do about it? – Howard Fischer, Moses & Singer. New
York Law Journal – April 30, 2019.
• Matthew Sciabacucchi v. Matthew B. Salzberg – in the Court of Chancery of the State of Delaware – December 19, 2018.
• Mathew Martoma v. United States of America – Supreme Court of the United States – May 14,
2019.
Davi
d F.
Lar
cker
and
Bria
n Ta
yan
Corp
orat
e Go
vern
ance
Res
earc
h In
itiat
ive
Stan
ford
Gra
duat
e Sc
hool
of B
usin
ess
ESG
ACTI
VITI
ESRE
SEAR
CH S
POTL
IGH
T
KEY
CON
CEPT
S
Envi
ronm
enta
l, so
cial
, and
gov
erna
nce
(ESG
) act
iviti
es in
volv
es a
ctiv
ities
or
inve
stm
ent t
hat c
ompa
nies
mak
e to
add
ress
env
ironm
enta
l or s
ocia
l iss
ues
that
impa
ct th
e fir
m fr
om a
tota
l sta
keho
lder
per
spec
tive.
–
ESG
is a
ltern
ativ
ely
refe
rred
to a
s co
rpor
ate
soci
al re
spon
sibi
lity
(CSR
) or
soci
ally
resp
onsi
ble
inve
stin
g (S
RI).
•Po
tent
ial b
enef
its.
–Co
nsid
ers
the
inte
rest
s of
all
stak
ehol
ders
, not
just
shar
ehol
ders
.
–Ca
n de
crea
se ri
sk b
y in
tern
aliz
ing
cost
s tha
t mig
ht d
amag
e th
e fir
m o
r its
co
nstit
u ent
s ov
er th
e lo
ng-te
rm.
•Po
tent
ial c
osts
.–
Can
redu
ce v
alue
if it
requ
ires
subs
tant
ial i
nves
tmen
t.
Rese
arch
sho
ws t
hat E
SG is
mod
estly
ass
ocia
ted
with
hig
her f
irm p
erfo
rman
ce.
ESG
AND
FIRM
VAL
UE
•Do
wel
l, H
art,
and
Yeun
g (2
000)
stu
dy th
e re
latio
n be
twee
n co
rpor
ate
com
mitm
ent t
o en
viro
nmen
tal s
tand
ards
and
firm
val
ue.
•Sa
mpl
e: 8
9 S&
P 50
0 fir
ms,
199
4-19
97. E
nviro
nmen
tal d
ata
from
IRRC
.
•Ca
tego
rize
com
pani
es a
ccor
ding
to w
heth
er th
ey a
dher
e to
1. l
ocal
en
viro
nmen
tal s
tand
ards
, 2. U
.S. s
tand
ards
, or 3
. int
erna
l sta
ndar
ds th
at a
re
mor
e st
ringe
nt th
an a
ny n
atio
nal s
tand
ard.
•Fi
nd th
at c
ompa
nies
that
ado
pt s
trin
gent
inte
rnal
sta
ndar
ds h
ave
high
er v
alue
(T
obin
’ s Q
) tha
n co
mpa
nies
that
ado
pt lo
cal o
r U.S
. sta
ndar
ds.
•Co
nclu
sion
: com
pani
es c
omm
itted
to th
e en
viro
nmen
t per
form
bet
ter.
“Thi
s pap
er re
fute
s the
idea
that
ado
ptio
n of
glo
bal e
nviro
nmen
tal s
tand
ards
by
[mul
tinat
iona
l cor
pora
tions
] con
stitu
tes a
liab
ility
that
dep
ress
es m
arke
t val
ue.”
ESG
AND
FIRM
VAL
UE
•Li
ns, S
erva
es, a
nd T
amay
o (2
017)
stu
dy th
e pe
rform
ance
of c
ompa
nies
with
hi
gh C
SR s
core
s du
ring
the
finan
cial
cris
is.
•Sa
mpl
e: 1
,673
non
finan
cial
firm
s, 2
005-
2013
. CSR
dat
a fro
m M
SCI.
•Fi
nd th
at d
urin
g th
e cr
isis
, hig
h-CS
R fir
ms
expe
rienc
ed h
ighe
r ret
urns
, pr
ofita
bilit
y, g
row
th, a
nd s
ales
per
em
ploy
ee th
an lo
w-C
SR fi
rms.
•Fi
nd n
o si
gnifi
cant
ass
ocia
tions
dur
ing
the
perio
ds b
efor
e an
d af
ter t
he c
risis
.
•Co
nclu
sion
: com
pani
es c
omm
itted
to C
SR h
ave
low
er ri
sk.
“Tru
st b
etw
een
a fir
m a
nd b
oth
its st
akeh
olde
rs a
nd in
vest
ors,
bui
lt th
roug
h in
vest
men
ts in
soci
al c
apita
l, pa
ys o
ff w
hen
the
over
all l
evel
of
trus
t in
corp
orat
ions
and
mar
kets
suffe
rs a
neg
ativ
e sh
ock.
”
ESG
AND
FIRM
VAL
UE
•M
anch
iraju
and
Raj
gopa
l (20
17) s
tudy
the
rela
tion
betw
een
CSR
and
firm
va
lue
in th
e co
ntex
t of a
law
that
requ
ired
min
imum
CSR
spe
ndin
g.
•Sa
mpl
e: 2
,120
Indi
an c
ompa
nies
, 200
9-20
13.
–In
dian
Com
pani
es A
ct 2
013
requ
ired
com
pani
es m
eetin
g ce
rtain
thre
shol
ds fo
r net
w
orth
, sal
es, a
nd p
rofit
to s
pend
at l
east
2%
of a
vera
ge p
rofit
s on
CSR
activ
ities
.
•Fi
nd th
at c
ompa
nies
affe
cted
by
the
law
dec
lined
by
a m
arke
t-adj
uste
d 4.
1%
over
the
4 ye
ars
betw
een
intr
oduc
tion
of th
e bi
ll an
d fin
al p
assa
ge.
•In
terp
ret r
esul
ts a
s ev
iden
ce th
at fi
rms
choo
se o
ptim
al le
vels
of C
SR s
pend
ing
and
that
man
dato
ry s
pend
ing
beyo
nd th
is is
val
ue d
ecre
asin
g.
•Co
nclu
sion
: for
ced
CSR
spen
ding
dec
reas
es fi
rm v
alue
.
“Man
dato
ry C
SR a
ctiv
ities
can
impo
se so
cial
bur
dens
on
busi
ness
act
iviti
es a
t the
exp
ense
of s
hare
hold
ers.”
ESG
AND
FIRM
VAL
UE:
ACQ
UIS
ITIO
NS
•De
ng, K
ang,
and
Low
(201
3) s
tudy
the
rela
tion
betw
een
CSR
and
firm
val
ue b
y ex
amin
ing
stoc
k pr
ice
retu
rns
arou
nd a
cqui
sitio
n an
noun
cem
ents
.
•Sa
mpl
e: 1
,556
suc
cess
ful m
erge
rs, 8
01 fi
rms,
199
2-20
07. C
SR d
ata
from
KLD
.
•Fi
nd m
odes
t evi
denc
e th
at c
ompa
nies
with
hig
h CS
R sc
ores
exh
ibit:
–H
ighe
r ret
urns
aro
und
the
anno
unce
men
t (3-
day
perio
d, b
ut n
ot 5
-or 1
0-da
y).
–H
ighe
r lon
g-te
rm o
pera
ting
perfo
rman
ce (o
pera
ting
cash
flow
, 2 y
ears
pos
t-mer
ger).
–Di
ffere
nce
in re
turn
s is
driv
en b
y th
e fa
ct th
at fi
rms w
ith lo
w C
SR p
erfo
rm b
elow
av
erag
e; h
igh
CSR
firm
s do
not p
erfo
rm a
bove
ave
rage
.
•Co
nclu
sion
: com
pani
es c
omm
itted
to s
ocia
l goa
ls m
ight
per
form
bet
ter.
“Firm
s tha
t int
egra
te v
ario
us st
akeh
olde
rs’ i
nter
ests
…
ultim
atel
y in
crea
se sh
areh
olde
r wea
lth a
nd c
orpo
rate
valu
e.”
ESG
AND
FIRM
VAL
UE:
ACQ
UIS
ITIO
NS
•At
kas,
de
Bodt
, and
Cou
sin
(201
1) a
lso
stud
y th
e re
latio
n be
twee
n SR
I and
firm
va
lue
by e
xam
inin
g m
erge
r-ann
ounc
emen
t and
pos
t-mer
ger p
erfo
rman
ce.
•Sa
mpl
e: 1
06 m
erge
rs, 1
997-
2007
. SRI
dat
a fro
m In
nove
st.
•Fi
nd th
at c
ompa
nies
that
acq
uire
targ
ets
with
hig
h SR
I sco
res:
–H
ave
high
er a
nnou
ncem
ent r
etur
ns (3
-day
per
iod)
.
–Ex
hibi
t an
incr
ease
in th
eir o
wn
SRI s
core
follo
win
g th
e an
noun
cem
ent
(mea
sure
men
t ter
m n
ot s
peci
fied)
.
•Co
nclu
sion
: ESG
incr
ease
s fir
m v
alue
.
“Our
resu
lts su
ppor
t the
idea
that
the
acqu
irer l
earn
s fro
m th
e ta
rget
’s SR
I pra
ctic
es a
nd e
xper
ienc
es, a
nd so
cial
ly re
spon
sibl
e in
vest
ing
pays
for a
cqui
ring
shar
ehol
ders
.”
ESG
AND
FIRM
VAL
UE:
ACT
IVIS
T EN
GAGE
MEN
TS
•Di
mso
n, K
arak
aş, a
nd L
i (20
15) s
tudy
the
impa
ct o
f act
ivis
t eng
agem
ents
on
firm
per
form
ance
.
•Sa
mpl
e: 2
,152
ESG
act
ivis
t eng
agem
ent,
1999
-200
9. P
ropr
ieta
ry d
atas
et.
–Su
bdiv
ided
: 900
gov
erna
nce-
rela
ted,
1,2
52 E
S-re
late
d en
gage
men
ts.
•Fi
nd th
at s
ucce
ssfu
l ES-
rela
ted
enga
gem
ents
are
ass
ocia
ted
with
:–
Posi
tive
abno
rmal
retu
rns
(7.2
% o
ver 1
8 m
onth
s).
–Im
prov
ed a
ccou
ntin
g pe
rform
ance
(RO
A).
•Co
nclu
sion
: ESG
incr
ease
s fir
m v
alue
.
“Con
sist
ent w
ith a
rgum
ents
that
ESG
act
iviti
es a
ttra
ct so
cial
ly c
onsc
ious
cus
tom
ers
and
inve
stor
s, w
e fin
d th
at, a
fter s
ucce
ssfu
l eng
agem
ents
, par
ticul
arly
for t
hose
on
ES is
sues
, eng
aged
com
pani
es e
xper
ienc
e im
prov
emen
ts in
thei
r ope
ratin
g pe
rform
ance
, pro
fitab
ility
, effi
cien
cy, s
hare
hold
ing,
and
gov
erna
nce.”
ESG
AND
FIRM
VAL
UE:
EVE
NT
RETU
RNS
•Kr
üger
(201
5) e
xam
ines
how
sha
reho
lder
s re
spon
d to
CSR
-rela
ted
even
ts.
•Sa
mpl
e: 2
,115
eve
nts,
745
com
pani
es, 2
001-
2007
. Eve
nt d
ata
from
KLD
.–
“Eve
nts”
con
sist
of i
nsta
nces
whe
re K
LD m
akes
pos
itive
or n
egat
ive
note
of a
so
cial
, env
ironm
enta
l, or
pro
duct
-rela
ted
occu
rren
ce a
t the
com
pany
.
•Fi
nd th
at s
hare
hold
ers:
–Re
act n
egat
ivel
y to
neg
ativ
e ev
ents
(0.9
% o
ver 1
1-da
y pe
riod)
.
(b
reak
dow
n: n
o re
actio
n to
eve
nts
rela
ted
to d
iver
sity
or h
uman
righ
ts; n
egat
ive
reac
tion
to th
ose
rela
ted
to e
nviro
nmen
t, pr
oduc
t, co
mm
unity
, or e
mpl
oyee
s.)
–H
ave
no re
actio
n to
pos
itive
eve
nts.
•Co
nclu
sion
: som
e CS
R-re
late
d ev
ents
can
impa
ct fi
rm v
alue
.
“A n
egat
ive
reac
tion
with
resp
ect t
o ne
gativ
e ev
ents
is c
onsi
sten
t with
the
view
th
at a
subs
tant
ial c
ost i
s ass
ocia
ted
with
cor
pora
te so
cial
irre
spon
sibi
lity.”
ESG,
FIR
M V
ALU
E, A
ND
AGEN
CY P
ROBL
EMS
•Fe
rrel
l, Li
ang,
and
Ren
nebo
og (2
016)
stu
dy th
e re
latio
ns b
etw
een
CSR,
age
ncy
prob
lem
s, a
nd fi
rm v
alue
.
•Sa
mpl
e: 2
,500
glo
bal c
ompa
nies
, 199
9-20
11. C
SR d
ata
from
MSC
I and
Vig
eo.
•Fi
nd th
at fi
rms
with
:–
Low
age
ncy
prob
lem
s hav
e hi
gher
CSR
ratin
gs.
–Lo
w a
genc
y pr
oble
ms a
nd h
igh
CSR
ratin
gs a
lso
have
hig
her v
alue
(Tob
in’s
Q).
•Co
nclu
sion
: com
pani
es c
omm
itted
to C
SR d
o no
t hav
e hi
gher
age
ncy
prob
lem
s.
“Cor
pora
te so
cial
resp
onsi
bilit
y …
can
be c
onsi
sten
t with
a co
re va
lue
of
capi
talis
m, g
ener
atin
g m
ore
retu
rns t
o in
vest
ors,
thro
ugh
enha
ncin
g fir
m v
alue
an
d sh
areh
olde
r wea
lth.”
ESG
AND
FIRM
VAL
UE
•M
argo
lis, E
lfenb
ein,
and
Wal
sh (2
011)
con
duct
a m
eta-
anal
ysis
of t
he re
sear
ch
on C
SR a
nd fi
rm p
erfo
rman
ce.
•Sa
mpl
e: 2
51 s
tudi
es, 1
972-
2007
.
•Fi
nd:
–Sm
all p
ositi
ve re
latio
n be
twee
n CS
R an
d fir
m p
erfo
rman
ce.
–O
ver t
ime,
the
posi
tive
rela
tion
decl
ines
(i.e
., it
is m
ore
prom
inen
t in
early
stud
ies
than
late
r stu
dies
).
•Co
nclu
sion
: CSR
mig
ht in
crea
se v
alue
; it d
oes
not d
ecre
ase
valu
e.
“Afte
r thi
rty-
five
year
s of r
esea
rch,
the
prep
onde
ranc
e of
evi
denc
e in
dica
tes
a m
ildly
pos
itive
rela
tions
hip
betw
een
corp
orat
e so
cial
per
form
ance
and
cor
pora
te
finan
cial
per
form
ance
. The
ove
rall
aver
age
effe
ct …
acr
oss a
ll st
udie
s is
stat
istic
ally
sig
nific
ant,
but,
on a
n ab
solu
te b
asis
, it i
s sm
all.”
ESG
MU
TUAL
FU
ND
PERF
ORM
ANCE
•Ge
czy,
Sta
mba
ugh,
and
Lev
in (2
005)
stu
dy th
e in
vest
men
t ret
urns
gen
erat
ed
by m
utua
l fun
ds d
edic
ated
to s
ocia
lly re
spon
sibl
e in
vest
ing
(SRI
).
•Sa
mpl
e: 4
9 SR
I fun
ds o
ut o
f 894
tota
l fun
ds, 1
963-
2001
.
•Fi
nd th
at:
–SR
I mut
ual f
unds
hav
e hi
gher
ann
ual f
ees
(1.3
6%) t
han
non-
SRI f
unds
(1.1
0%).
–SR
I mut
ual f
unds
hav
e lo
wer
per
form
ance
(0.3
% p
er m
onth
).
–Sh
areh
olde
rs d
o no
t rec
eive
div
ersi
ficat
ion
bene
fits.
•Co
nclu
sion
: SRI
inve
stm
ents
und
erpe
rform
pee
rs.
ESG
MU
TUAL
FU
ND
PERF
ORM
ANCE
•Re
nneb
oog,
Ter
Hor
st, a
nd Z
hang
(200
8) a
lso
stud
y th
e pe
rform
ance
of S
RI
mut
ual f
unds
.
•Sa
mpl
e: 4
40 S
RI m
utua
l fun
ds o
ut o
f 16,
036
fund
s, 1
7 co
untr
ies.
199
1-20
03.
•Fi
nd th
at:
–SR
I mut
ual f
unds
und
erpe
rform
thei
r ben
chm
arks
by
2.2%
to 6
.5%
ann
ually
.
–Ri
sk-a
djus
ted
retu
rns
in m
any
coun
trie
s are
not
sign
ifica
ntly
diff
eren
t fro
m
com
para
ble
fund
s.
•Co
nclu
sion
: SRI
mut
ual f
unds
mig
ht u
nder
perfo
rm p
eers
.
“It s
eem
s tha
t inv
esto
rs p
ay a
pric
e fo
r eth
ics.”
ESG
MU
TUAL
FU
ND
PERF
ORM
ANCE
•El
Gho
ul a
nd K
arou
i (20
17) a
lso
stud
y th
e pe
rform
ance
of C
SR m
utua
l fun
ds.
•Sa
mpl
e: 2
,168
U.S
. mut
ual f
unds
, 200
3-20
11. C
SR d
ata
from
KLD
.–
Rath
er th
an c
ompa
re S
RI-fu
nds w
ith u
ncon
stra
ined
fund
s, th
e au
thor
s use
the
CSR
ratin
gs o
f the
com
pani
es in
the
port
folio
to d
eriv
e a
CSR
scor
e fo
r the
fund
.
–CS
R is
gra
ded
on a
spec
trum
, not
a b
inar
y m
etric
.
•Fi
nd th
at fu
nds
with
hig
h CS
R sc
ores
per
form
wor
se th
an th
ose
with
low
sco
res.
•Co
nclu
sion
: CSR
inve
stm
ents
und
erpe
rform
non
-CSR
inve
stm
ents
.
“Our
em
piric
al re
sults
reve
al th
at th
e CS
R sc
ore
of th
e po
rtfo
lio is
neg
ativ
ely
rela
ted
to ri
sk-a
djus
ted
perfo
rman
ce. …
Fur
ther
mor
e, w
e fin
d th
at th
e CS
R sc
ore
nega
tivel
y pr
edic
ts fu
ture
fund
per
form
ance
.”
ESG:
EQ
UIT
Y AN
D CR
EDIT
PER
FORM
ANCE
•Ge
rard
(201
8) c
ondu
cts
a lit
erat
ure
revi
ew o
f the
rese
arch
on
ESG,
incl
udin
g eq
uity
and
fixe
d in
com
e pe
rform
ance
.
•Sa
mpl
e: 5
5 st
udie
s, 2
000-
2018
.
•Fi
nds
that
:–
Hig
h ES
G sc
ores
are
rela
ted
to h
ighe
r pro
fitab
ility
and
stoc
k va
lue
(Tob
in’s
Q).
–Re
latio
n be
twee
n ES
G sc
ores
and
fixe
d in
com
e pr
ice
and
risk
is m
ixed
.
–Po
sitiv
e pe
rform
ance
diff
eren
tials
reco
rded
in th
e 19
90s d
ecre
ased
in th
e ea
rly
2000
s and
dis
appe
ared
in th
e 20
10s.
•Co
nclu
sion
: com
pani
es c
omm
itted
to E
SG p
erfo
rm b
ette
r and
hav
e lo
wer
risk
bu
t the
ir ac
tions
are
larg
ely
pric
ed in
to s
ecur
ities
mar
kets
.
CON
CLUS
ION
•Th
e re
sear
ch g
ener
ally
sho
ws
that
com
pani
es c
omm
itted
to e
nviro
nmen
tal
and
soci
al g
oals
hav
e be
tter
per
form
ance
and
low
er ri
sk.
•Th
e re
latio
ns in
mos
t stu
dies
are
mod
est.
•Re
sear
ch g
ener
ally
suf
fers
from
a p
robl
em o
f cau
salit
y: d
oes
a co
mm
itmen
t to
env
ironm
enta
l or s
ocia
l goa
ls m
ake
com
pani
es m
ore
prof
itabl
e, o
r are
m
ore
prof
itabl
e co
mpa
nies
abl
e to
spe
nd m
ore
on th
ese
activ
ities
?
•So
cial
ly re
spon
sibl
e in
vest
ing
is a
ssoc
iate
d w
ith lo
wer
risk
-adj
uste
d re
turn
s; a
ny c
orpo
rate
ben
efit
to E
SG is
pric
ed in
the
mar
ket.
•It
is n
ot c
lear
that
the
met
rics
that
third
-par
ty fi
rms
deve
lop
to m
easu
re
com
pani
es o
n ES
G di
men
sion
s ar
e ac
cura
te o
r rel
iabl
e.
BIBL
IOGR
APH
Y
Glen
Dow
ell,
Stua
rt H
art,
and
Bern
ard
Youn
g. D
o Co
rpor
ate
Glob
al E
nviro
nmen
tal S
tand
ards
Cre
ate
or D
estr
oy M
arke
t Val
ue?
Do
Corp
orat
e Gl
obal
Env
ironm
enta
l Sta
ndar
ds C
reat
e or
Des
troy
Mar
ket V
alue
? 20
00. M
anag
emen
t Sci
ence
.
Karl
V. L
ins,
Hen
ri Se
rvae
s, a
nd A
ne T
amay
o. S
ocia
l Cap
ital,
Trus
t, an
d Fi
rm P
erfo
rman
ce: T
he V
alue
of C
orpo
rate
Soc
ial
Resp
onsi
bilit
y Du
ring
the
Fina
ncia
l Cris
is. 2
017.
Jou
rnal
of F
inan
ce.
Har
iom
Man
chira
ju a
nd S
hira
m R
ajgo
pal.
Does
Cor
pora
te S
ocia
l Res
pons
ibili
ty (C
SR) C
reat
e Sh
areh
olde
r Val
ue?
Evid
ence
from
the
Indi
an C
ompa
nies
Act
201
3. 2
017.
Jou
rnal
of A
ccou
ntin
g Re
sear
ch.
Xin
Deng
, Jun
-koo
Kan
g, a
nd B
uen
Sin
Low
. Cor
pora
te S
ocia
l Res
pons
ibili
ty a
nd S
take
hold
er V
alue
Max
imiza
tion:
Evi
denc
e fro
m
Mer
gers
. 201
3. J
ourn
al o
f Fin
anci
al E
cono
mic
s.
Nih
at A
tkas
, Eric
de
Bodt
, and
Jea
n-Ga
brie
l Cou
sin.
Do
Fina
ncia
l Mar
kets
Car
e ab
out S
RI? E
vide
nce
from
Mer
gers
and
Acq
uisi
tions
.20
11. J
ourn
al o
f Ban
king
& F
inan
ce.
Elro
y Di
mso
n, O
ğuzh
an K
arak
aş, a
nd X
i Li.
Activ
e O
wne
rshi
p. 2
015.
Rev
iew
of F
inan
cial
Stu
dies
Phili
pp K
rüge
r. Co
rpor
ate
Good
ness
and
Sha
reho
lder
Wea
lth. 2
015.
Jou
rnal
of F
inan
cial
Eco
nom
ics.
Alle
n Fe
rrel
l, H
ao L
iang
, and
Luc
Ren
nebo
og. S
ocia
lly R
espo
nsib
le F
irms.
201
6. J
ourn
al o
f Fin
anci
al E
cono
mic
s.
Josh
ua D
. Mar
golis
, Hill
ary
Ange
r Elfe
nbei
n, a
nd J
ames
P. W
alsh
. Doe
s It P
ay to
Be
Good
… a
nd D
oes I
t Mat
ter?
A M
eta-
Anal
ysis
of
the
Rela
tions
hip
Betw
een
Corp
orat
e So
cial
and
Fin
anci
al P
erfo
rman
ce. 2
011.
Soc
ial S
cien
ce R
esea
rch
Net
wor
k.
BIBL
IOGR
APH
Y
Chris
toph
e C.
Gec
zy, R
ober
t F. S
tam
baug
h, a
nd D
avid
Lev
in. I
nves
ting
in S
ocia
lly R
espo
nsib
le M
utua
l Fun
ds. 2
005.
Luc
Renn
eboo
g, J
enke
Ter
Hor
st, a
nd C
hend
i Zha
ng. T
he P
rice
of E
thic
s an
d St
akeh
olde
r Gov
erna
nce:
The
Per
form
ance
of S
ocia
llyRe
spon
sibl
e M
utua
l Fun
ds. 2
008.
Jou
rnal
of C
orpo
rate
Fin
ance
.
Sado
k El
Gho
ul a
nd A
ymen
Kar
oui.
Does
Cor
pora
te S
ocia
l Res
pons
ibili
ty A
ffect
Mut
ual F
und
Perfo
rman
ce a
nd F
low
s? J
ourn
al o
f Ba
nkin
g &
Fina
nce.
Brun
o Ge
rard
. ESG
and
Soc
ially
Res
pons
ible
Inve
stm
ent:
A Cr
itica
l Rev
iew
. 201
8. S
ocia
l Sci
ence
Res
earc
h N
etw
ork.
1
Posted by Peter Atkins, Marc Gerber and Richard Grossman, Skadden, Arps, Slate, Meagher & Flom LLP, on Thursday, October 18, 2018
The question whether a public for-profit company can “do good” and make money at the same time has never been more relevant. Public companies are being bombarded with messages, requests and demands around “ESG”—environmental, social and governance—matters. These come from shareholders, asset managers, special interest groups, activist investors, private equity funds, ESG rating firms, trade groups, politicians, regulators, academics and others. They take a variety of forms, including shareholder proposals, surveys and questionnaires, letter writing campaigns, proxy voting policies, investor stewardship reports, speeches, white papers, academic studies, and legislation. Topics covered (putting aside the “G”—the governance issues with which boards are likely to be familiar) are numerous and varied, including sustainability, climate change, water management, human capital management, gender pay equity, board and workforce diversity, supply chain management, political and lobbying expenditures, the opioid crisis, and gun control. Boards of directors and management of public companies need to understand the increasing importance of this ESG landscape in which the company and investors are operating, including the growing prominence of ESG investing, the company’s environmental and social (E&S) profile and vulnerabilities, and the path forward for the company as it deals with particular E&S issues.
This post briefly summarizes some of the key trends of the rapidly evolving E&S landscape of which directors and company management should be aware. In addition, it highlights a corporate law framework that has particular relevance for directors of companies incorporated in states such as Delaware that follow a shareholder primacy model—that shareholder welfare is the sole goal of directors, and that other interests may be taken into account only to further that goal.
ESG Investment. Recent reports place the level of ESG-focused investment at approximately $20 trillion of assets under management. New ESG funds and ETFs are being launched on a regular basis and with increasing frequency, and studies show that millennials have a greater interest in socially responsible investing. Within this umbrella, ESG investing can take various forms, for example making investments in companies viewed as positively addressing environmental or social issues, choosing to exclude companies in certain industry sectors viewed as problematic from an ESG perspective, or integrating ESG data into an assessment of risk-adjusted returns in order to make investment decisions.
Editor’s note: Peter Atkins, Marc Gerber and Richard Grossman are partners at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on a Skadden memorandum by Mr. Atkins, Mr. Gerber, and Mr. Grossman. Related research from the Program on Corporate Governance includes Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here) and Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).
2
The demand for ESG investment approaches has spurred a number of traditional investors, activist funds and private equity funds to enter this space. For example, in January 2018, ValueAct Capital launched its Spring Fund to invest in companies addressing environmental and societal problems and capture the excess returns it believes will be generated thereby. Another activist investor, Jana Partners, is reported to have hired staff for a new socially responsible fund to be named Jana Impact Capital. Also, recent reports indicate that private equity firm TPG is raising $3 billion for its second social impact fund, after previously raising a $2 billion fund focused on investments with positive social and environmental impacts.
ESG Ratings. An inevitable corollary of the increase in ESG-focused investment is the demand by those investors for ESG data and the corresponding and exponential growth in the number of entrants into the business of collecting, aggregating, synthesizing and ranking that data. The challenge is that each ESG ratings provider has its own methodology, and a company may receive widely divergent ratings from different organizations. Moreover, the ESG rating agencies may use different combinations of data sources other than company disclosures, including press reports, litigation filings, internet postings and other third-party sources, even though the company may not agree with the veracity or accuracy of those data sources.
It is possible that, over time, some ratings methodologies may prevail over others and the field will narrow to two or three dominant raters, as is the case in the governance space with ISS and Glass Lewis. And ISS and Glass Lewis are attempting to protect their turf by also including E&S ratings in their reports. In February 2018, ISS announced the launch of its E&S QualityScore, which seeks to analyze company disclosure across more than 380 factors organized into four environmental pillars and four social pillars. ISS includes those scores in its annual meeting voting recommendations report, and in May 2018 expanded its E&S coverage to 4,700 companies. Recently, Glass Lewis announced that guidance on material ESG topics from the Sustainability Accounting Standards Board would be integrated into its proxy research reports and vote management application.
ESG Activism. On January 6, 2018, activist Jana Partners and the California State Teachers’ Retirement System (CalSTRS) published an open letter to Apple Inc. The letter expressed their view that Apple needed to offer parents more tools to protect children and to ensure that young customers use Apple products in an appropriate manner. Citing various studies regarding potential negative consequences of children’s use of smart phones, the letter linked the issue to Apple’s long-term value and called on Apple to take various steps to address the issue. Days later, Apple announced that it would introduce new features and tools to assist parents in combating children’s overuse of smart phones. It remains to be seen whether other traditional activist investors, seeking to attract ESG-focused capital, launch similar ESG-themed campaigns.
ESG activism can also take the form of industry-wide or issue-specific campaigns. For example, a coalition of 30 treasurers, asset managers, and faith-based, public and labor funds formed Investors for Opioid Accountability and filed shareholder proposals on board oversight of business risks related to opioids at 10 companies involved in the manufacturing or distribution of opioids. Recently, another group of investors launched a resource to evaluate and act on water risks in investment portfolios, including tips on engaging with companies and on water-related shareholder proposals.
3
ESG Shareholder Proposals. According to ISS data, for 2017 and year-to-date 2018, proposals relating to E&S now make up a majority of all shareholder proposals submitted to US companies, at 53.4 percent and 54.4 percent, respectively. ISS reports that the median vote results year-to-date are at a record high of 23.4 percent, but it is noteworthy that median results for some topics are significantly higher—41.4 percent for sustainability reporting and 36.4 percent for workforce diversity. In a turning point, in 2017, climate change proposals relating to two degree Celsius scenarios received majority support for the first time, at three different companies. Other 2017 majority-supported E&S proposals related to sustainability reporting and board diversity. This year appears to have set a new record, with 10 E&S proposals receiving majority support year-to-date: two on climate change, two on sustainability reporting, three on other environmental topics, one on governance measures related to managing the opioid crisis risk and two calling on gun manufacturers to produce reports on gun safety measures.
Perhaps in recognition of these increasing levels of support, 2018 has been noteworthy for the increased withdrawal rate, with almost half of all E&S proposals submitted being withdrawn. Based on various reports and anecdotal evidence, it is likely that a large portion of the withdrawals were the result of company engagement with proponents and reaching satisfactory agreement for the company to take some action or make some additional disclosure.
Company Actions. In the financial activist space, the advice that has crystallized over the past few years is to look at your company the way an activist and/or a long-term shareholder would; anticipate and analyze the potential criticisms and be ready to respond; engage with institutional investors to learn their views and establish the board’s and management’s credibility with them; and communicate the company’s business strategy, and the board’s role in overseeing the development and execution of that strategy, clearly and coherently, to build support before an activist shows up.
It turns out that there are many parallels in the ESG space and, as described above, the lines between financial activists and ESG activists may continue to blur. As a result, a company’s ESG vulnerability and profile may need to be given appropriate attention alongside traditional valuation and operational metrics.
Shareholder Primacy as a Guidepost. ESG should not be perceived as divorced from traditional economic metrics. At least for companies incorporated in states such as Delaware, that are subject to a fiduciary model of shareholder primacy—where the ultimate priority is the preservation and enhancement of shareholder welfare—boards should consider whether there is a nexus (and, if so, how strong) between specific ESG issues and the pursuit of shareholder welfare. The starting point involves consideration of ESG in light of the company’s business strategy, which is the driver of shareholder value, the dominant component of shareholder welfare. Questions may include: Will addressing ESG topics allow the company to satisfy growing consumer trends and increase sales? Will addressing other ESG factors position the company to have a better workforce and decrease worker attrition and the related costs?
Even in those cases where a particular ESG matter does not fit directly within a company’s business strategy, a company may need to consider whether inaction or a failure to be responsive to an issue presents risks to a company. These might include negative perceptions by consumers, regulators, employees or the public that could lead to a boycott of the company’s
4
products, regulatory intervention, active employee protest or morale decline, negative publicity, or other forms of harm to the company’s ability to compete and produce shareholder value.
The rise in ESG investing presents new risks and perhaps opportunities. ESG investors’ dissatisfaction with a company’s ESG policies (or lack thereof) or responsiveness may have significant adverse effects. In particular, this could include loss of interest in the company as an investment or, perhaps, initiation of a public campaign, submission of shareholder proposals, or an election contest or a “vote no” campaign focused on changing the company’s ESG position. On the positive side, understanding and anticipating ESG issues that may be promoted by investors might attract positive interest in the company and support from such investors.
These and many other potential questions are strategic decisions—like any other business strategy decisions—and as such are subject to board oversight. And once the board and management determine how, if at all, ESG factors align with that business strategy or are otherwise appropriate topics for action to preserve or enhance shareholder welfare, the board needs to determine the level of corporate investment appropriate in light of the expected returns (or losses avoided), how to measure success and how to incentivize management accordingly. Shareholder engagement then presents a forum to understand the concerns of investors and how they view the company, as well as to explain ESG in the context of that business strategy and the board’s oversight role. It then becomes critical for the company to communicate, whether in annual reports, proxy statements, sustainability or corporate social responsibility reports, or other public statements, its approach to ESG matters as part of its overall business strategy.
Over the years there has been a debate, which continues loudly today, about whether directors can or should consider the interests of non-shareholder constituencies. The Chief Justice of the Delaware Supreme Court, Leo E. Strine, Jr., has made clear where Delaware law stands on the subject:
“[A] clear-eyed look at the law of corporations in Delaware reveals that, within the limits of their discretion, directors must make stockholder welfare their sole end, and that other interests may be taken into consideration only as a means of promoting stockholder welfare.”1
ESG issues can be presented as having, and often do have, an “other, non-shareholder constituency” character. However, the context today is quite different than during the 1980s, which witnessed the rise of corporate constituency statutes that have been adopted by more than 30 states. That difference is manifested by the concentration of U.S. public company ownership in a relatively few institutional asset managers, the active and growing support from those entities (and from other equity owners) for environmental and social responsibility by public for-profit companies, and the heightened level of consciousness in the media, academia and general population regarding the demand for ESG responsibility by public for-profit companies.
To borrow a phrase from then-Justice Andrew Moore of the Delaware Supreme Court, in his 1985 Revlon decision, directors would appear to have wide latitude—and responsibility—for dealing with ESG issues to the extent they represent matters “rationally related [to] benefits
1 Leo E. Strine, Jr., “The Dangers of Denial: The Need for a Clear-Eyed Understanding of the Power and
Accountability Structure Established by the Delaware General Corporation Law,” 50 Wake Forest Law Review 761,771 (2015).
5
accruing to the stockholders.” That said, it is incumbent on directors to do their homework and apply appropriate processes to establish informed decision-making regarding that key determination—which also will enable them to defend challenges to spending shareholder money on “causes” that not all shareholders may support and to demonstrate to the “new” shareholder constituency, ESG investors, the attention paid to the subject at the board level.
Beyond that, of course, are a myriad of other important and potentially difficult decisions that may be required. These may include: Whether, when, to whom and how to engage in outreach regarding ESG issues. Choosing among ESG matters. Deciding how, how much and when to spend company resources to support selected ESG matters. How and when to communicate choices made and actions taken.
In the end, although more consequential than ever, these are board decisions just like others, requiring the exercise of business judgment in the best interests of the company and its shareholders.
EXPLORING ESG: A Practitioner’s PerspectiveJUNE 2016
.
The opinions expressed are as of June 2016 and may change as subsequent conditions vary.
SUMMARY OF POLICY RECOMMENDATIONSPolicy makers should focus on establishing a framework that enables stakeholders and market participants to develop detailed ESG standards and best-practice guidelines.1.Encourage standardized ESG disclosure within a consistent global reporting framework, similar to international accounting
standards, by:a.Recognizing the importance of identifying and managing ESG risks and opportunities as a component of investment analysis.b.Understanding the distinction between social, mission or “values” driven goals and investment (“value”) goals.c. Promoting clear and consistent definitions of ESG and developing a common lexicon.d.Providing guidance that recognizes the need to tailor reporting to industries.
2.Establish safe harbor provisions that ensure companies who initiate ESG factor reporting do not face retrospective litigation.3.Ensure regulation is designed and implemented to achieve policy objectives, rather than result in unnecessary disclosure.4. Review, understand, and remove barriers to ESG factor integration and reporting by investors and companies.5. Clarify how ESG considerations are part of investors’ and companies’ fiduciary duties.6. Require investors to report whether they integrate ESG factors in their investment analysis and, if so, their approach to
integrating them as well as stewardship activities.
Barbara Novick Vice Chairman
Deborah WinshelGlobal Head of BlackRock Impact
John McKinleyBlackRock Impact
Michelle EdkinsGlobal Head of Investment Stewardship
IntroductionInvestors consider a variety of factors when determining the long-term value of a company. Public records such as annual reports and earnings statements have served as the traditional source of this information, helping investors discern the effects of macroeconomic and company-specific issues on valuations. However, with the amount of and access to information expanding significantly in recent years, more and more investors have new types of data to glean investment insights.
Environmental, social, and governance (ESG) factors are one such type of information gaining in prominence and consideration among mainstream investors globally. ESG data spans a range of issues, including measures of company carbon emissions, labor and human rights policies, and corporate governance structures. Policy makers, asset owners1, and the public at large are focused on ESG factors as a means to promote sustainable business practices and products. Investment professionals increasingly see its potential links to company operational strength, efficiency, and management of long-term financial risks.2Nonetheless, there is still much ambiguity as to what exactly is meant by ESG, and how investors can gather relevant ESG data and apply this information in the investment process.
This ViewPoint sets out BlackRock’s views on ESG issues from the perspective of a fiduciary investor acting on behalf of asset owners, in this particular instance focusing specifically on corporate equities and debt. We define three areas in which investment managers integrate ESG factors, and our views on how ESG factors contribute to long-term value. We move to describe the current landscape of ESG disclosure initiatives across organizations and regulatory bodies. As a result of the challenges associated with assembling and evaluating ESG information, we conclude with our recommendations for policy makers to promote the standardization of ESG metrics and disclosure requirements.
Zachary OleksiukInvestment Stewardship
Kevin G. ChaversGovernment Relations & Public Policy
The ESG LexiconThe term ESG has become a catchall phrase that often means different things to different stakeholders. This has created the need to better define what is meant by ESG with respect to investing. Broadly speaking, ESG refers to the integration of environmental, social, and governance factors in the investment process. Today, investors can integrate ESG factors in three primary ways: (1) traditional investing, (2) sustainable investing, and (3) investment stewardship:
1. ESG integration in traditional investing is the inclusion of environmental, social, and governance factors into financial analysis to evaluate risks and opportunities. The intended purpose is not to apply social values to investment decisions, but to consider whether ESG factors contribute to or detract from the value of a given investment opportunity.3 An example of integration entails a fundamental active equity portfolio manager evaluating various ESG risks of their portfolio, such as the risk of regulatory action due to a company’s environmental track record, to inform their investment views and positioning.
2. Sustainable investing refers to the explicit incorporation of ESG objectives into investment products and strategies. The spectrum of sustainable investment strategies has evolved over several decades and can be defined by three core segments, which reflect the wide range of investors’ objectives from removing specific sectors to targeting positive social and environmental outcomes. ESG factors can inform the construction of sustainable investing product in a number of ways (see
Exhibit 1). Investment managers can apply ESG screens, or remove a particular ESG factor from a portfolio at a client’s request. This can include screening out companies that have significant labor law violations, for example. Another common approach to incorporate ESG into sustainable investment product is to maximize exposure to highly-rated ESG companies, which can be done through a broad or narrow approach. A broad approach would attempt to maximize a fund’s average ESG score while maintaining characteristics of a traditional market-cap weighted benchmark, while a narrow approach may focus specifically on companies that have low carbon emissions.
3. Investment stewardship, or corporate governance, is engagement with companies to protect and enhance the value of clients’ assets. Through dialogue and proxy voting, investors engage with business leaders to build a mutual understanding of the material risks facing companies and the expectations of management to mitigate these risks. Hence, identifying and managing relevant ESG risks are an important component of the engagement process and to encouraging sustainable financial performance over the long-term.4
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EXHIBIT 1: ESG FACTORS IN SUSTAINABLE INVESTMENT PRODUCT CONSTRUCTION
Description Example
Exclusionary Screens
Removing specific companies or industries not aligned with investors’ values or mission
Religious institution excludes tobacco, weapons, alcohol and gambling across its portfolio
ESGInvestments
Evaluating companies along ESG measures and weighting portfolios to increase exposure to best-in-class companies
Pension fund optimizes for high ESG exposure while minimizing tracking error to a standard benchmark
ImpactInvestments
Targeting specific social or environmental outcomes alongside financial returns
High-net worth investor seeks to reduce carbon emissions through investment in renewable power fund
BLACKROCK INVESTMENT STEWARDSHIP, ESG AND LONG-TERM PERSPECTIVEAs a fiduciary to our clients, BlackRock has a responsibility to protect and enhance the value of assets entrusted to us. The Investment Stewardship team contributes to this by engaging in thousands of conversations with companies each year on factors that are relevant to long-term economic performance.
Environmental, social, and governance issues are integral to our investment stewardship activities, as the majority of our clients are saving for long-term goals. It is over the long-term that ESG factors – ranging from climate change to diversity to board effectiveness – have real and quantifiable financial impacts. Our risk analysis extends across all sectors and geographies, helping us identify companies lagging behind peers on ESG issues. We seek to engage companies on these issues on behalf of our investors, irrespective of whether a holding is held in an active or a passive portfolio.
Engagement allows us to both share our philosophy and approach to investment stewardship and understand how a company’s governance and management structures support operational excellence. As a long-term investor, we are patient with companies, giving them time to change on their own terms, but also persistent to ensure they adopt sound practices that in our view support long-term value creation.
Our View of ESG FactorsWhen determining the long-term value of a company’s security, an enterprising investment analyst will often ask: what factors will differentiate this company’s performance from its peers? How does the company earn the trust and support of customers, employees, regulators, and other stakeholders? Does the company ensure efficient production processes that minimize or optimize the use of scarce (and expensive) natural resources? How do management and the board maintain credibility with investors to ensure reliable and affordable capital?
While ESG information alone will not answer these questions, it can be meaningfully accretive to fundamental financial and investment analysis. How a company manages the environmental (E) and social (S) aspects of its business –those that are relevant to performance and value creation – is a signal of how well the company is run and its long-term financial sustainability. Corporate governance (G) – including board composition and its role in shaping and overseeing strategy – is another signal of the quality of leadership and management. Examining ESG factors can therefore support and enhance traditional financial analysis.
The best companies strategically manage all aspects of the business and ensure that their investors, as well as other constituents of the company, have enough information to understand the drivers of, and risks to, sustainable financial performance. For example, a beverage company might manage, measure, and report on its access to clean water –an input to production as well as a social and environmental factor. Companies that manage relevant ESG issues well tend to quickly adapt to changing environmental and social trends, use resources efficiently, have engaged (and, therefore, productive) employees, and can face lower risks of regulatory fines or reputational damage.
In fact, an analysis of more than 160 academic studies demonstrates that companies with high ratings on ESG factors have a lower cost of capital,5 while separate research finds that greater transparency of public companies in disclosing non‐financial (ESG) data results in lower volatility.6Hence, investment managers that have examined and integrated this information into their processes have benefited. 2014 Research in the Journal of Investing points to advantages of ESG integration in the investment process, finding that active managers can utilize the association between corporate ESG ratings and stock return, volatility and risk, to enhance their stock-picking and portfolio construction ability. 7
But relevance is key. Recent work suggests that firms with good ratings on material sustainability issues significantly outperform firms with poor ratings on these issues.8 In contrast, firms with good ratings on immaterial sustainability issues do not significantly outperform firms with poor ratings on the same issues. Thus, there are no standard ESG factors that apply universally across companies, just as there are no universal non-ESG management factors that indicate potential performance – ESG factors need to be considered for their relevance to specific industries and companies.
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INTEGRATING CARBON RISK FACTORSAmongst the array of ESG issues, climate change has emerged as a mainstream investment consideration. Following the COP21 Paris climate conference, more and more investors are integrating carbon emissions data across their traditional investing, sustainable investing, and investment stewardship functions. This year, 10% of the world’s 500 biggest investors reported measuring the carbon footprint of their portfolios in an effort to manage risk, up from 7% in 2015. Over the same period, dedicated low carbon investments by this group grew 63% to $138B, and investors voting in favor of at least one shareholder resolution on climate change grew to 12%, up from 7% the year prior.9
Integration of emissions data reflects the growing desire to better understand and manage climate-related risks. Although increasing in popularity, investor challenges remain, as the ability to assess relevant carbon risk factors is dependent on forecasting the risks imposed by new climate-related policies and the availability and quality of data. A number of industry bodies have emerged to measure and collect material climate information, but large gaps remain. In the following section we examine the current state of carbon, in addition to broad ESG data disclosure and collection.
The Current State of ESG DisclosureAfter decades of increasing interest in ESG from various stakeholders (see Exhibit 2), a critical mass of data and practitioner experience are emerging. The landscape has shifted such that some companies are now explicitly identifying, managing, and reporting on ESG issues, with various market participants collecting and disseminating the data. The practitioner-led efforts to establish ESG reporting frameworks and analytical guidance are becoming more refined given years of collective, practical experience within the market. Third party investment research providers are expanding their offerings to include ESG alongside more traditional investment analysis – all with a view towards economic materiality.
Despite progress, these efforts are working against long-established corporate disclosure practices. Companies do not typically talk in terms of “ESG;” they have their own terminology. Corporate social responsibility (CSR), corporate citizenship, and sustainability are a few commonly used terms in the corporate world. Companies face a distinct challenge in that different issues will be important to different stakeholders. In our experience, current corporate sustainability reporting often includes disclosure about factors that, while honorable, are less relevant to investment decision making (e.g., corporate philanthropy). As a result, current reporting practices may make it difficult to identify investment decision-useful data (e.g., water usage and risks in the aforementioned beverage company example).
To facilitate the consistent disclosure and integration of material ESG factors by companies and asset managers, a number of organizations have emerged. Below we provide a brief summary of select major ESG standards initiatives:
Principles for Responsible Investment (PRI): an investor-sponsored initiative in partnership with UNEP Finance Initiative10 and UN Global Compact.11 Sets forth six voluntary and aspirational investment principles that offer possible actions for incorporating ESG issues into investment practice. Launched in 2006.12
CDP (formerly the Carbon Disclosure Project): an NGO that collects company-reported climate change, water, and forest-risk data. Works with global institutional investors holding $95 trillion in assets, thousands of companies, and local and national governments to address related risks and opportunities.13
Global Reporting Initiative (GRI): an international independent organization that helps businesses, governments, and other organizations understand and communicate the impact of business on critical sustainability issues such as climate change, human rights, corruption and many others.14 The GRI in 2013 released its fourth generation of reporting guidelines (G4), listing over 400 indicators on corporate sustainability performance.15 The GRI serves a broad range of stakeholders and includes factors that go beyond investment-related issues.
International Integrated Reporting Council (IIRC): a global coalition of regulators, investors, companies, standard setters, the accounting profession, and NGOs. The coalition is promoting communication about value creation as the next step in the evolution of corporate reporting.16
Global Impact Investing Rating System (GIIRS): a project of the non-profit B Lab, assesses the social and environmental impact of companies and funds. Each company receives an overall score and two ratings; one for its impact models and one for its operations (ESG standards).17
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Exhibit 2: HISTORY OF ESG INTEGRATION AND INVESTMENT
Source: “Ethical Screening in Modern Financial Markets” Michael Knoll, UN PRI https://www.unpri.org/, Global Sustainable Investment Alliance 2014 Review, United States Department of Labor https://www.dol.gov/ebsa/, COP21 UNEP http://www.cop21paris.org, California Department of Insurance http://www.insurance.ca.gov/.
Sustainable Stock Exchanges (SSE): a peer-to-peer learning platform for exploring how exchanges, in collaboration with investors, regulators, and companies, can enhance corporate transparency – and ultimately performance – on ESG issues and encourage sustainable investment. The SSE is organized by the UN Conference on Trade and Development (UNCTAD), the UN Global Compact, the UN Environment Program Finance Initiative (UNEP FI), and the Principles for Responsible Investment.18
Ceres: a non-profit organization advocating for sustainability leadership, comprising a network of investors, companies, and public interest groups. Seeks to accelerate and expand the adoption of sustainable business practices and solutions to build a healthy global economy.19
Financial Stability Board (FSB): comprised of G20 members and chaired by Mark Carney, has established an industry-led Task Force, chaired by Michael Bloomberg, to report by the end of 2016 disclosure standards for companies on climate-related issues. This is to enable investors and policy makers to better incorporate this into their long-term decision-making.20
Sustainability Accounting Standards Board (SASB): an independent non-profit whose mission is to develop and disseminate sustainability accounting standards that help US public corporations disclose material, decision-useful information to investors. Standard setting occurs through evidence-based research and broad, balanced stakeholder participation.21
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SUSTAINABILITY ACCOUNTING STANDARDS BOARD (SASB)
The SASB in the US is a preeminent example of an industry body seeking standardized ESG disclosures that are relevant to business performance. SASB is an independent non-profit whose mission is to develop and disseminate sustainability accounting standards that help public corporations disclose material, decision-useful information to investors. That mission is accomplished through a rigorous process that includes evidence-based research and broad, balanced stakeholder participation.
Through 2016, SASB is developing sustainability accounting standards for more than 80 industries in 10 sectors.
SASB standards are designed for the disclosure of material sustainability information in mandatory SEC filings, such as the Form 10-K and 20-F.
SASB is an ANSI accredited standards developer.
SASB is not affiliated with FASB, GASB, IASB or any other accounting standards boards.
See Exhibit 3 for the SASB Materiality Map, an interactive tool that identifies and compares likely material sustainability issues across different industries and sectors.
In addition to industry bodies, market data providers have entered the space, seeing a competitive opportunity to develop ESG assessments of companies and investment funds. MSCI ESG Research22 and Sustainalytics are two of the more prominent providers of ESG performance evaluation. This year, both MSCI ESG and Morningstar, in partnership with Sustainalytics, published ESG and sustainability scores on over 20,000 mutual funds and ETFs. In addition to differences in data coverage (e.g., by asset class and market capitalization), they and other sources of company ESG ratings measure different aspects of company sustainability, including through sometimes conflicting evaluation methodologies and data inputs. Just as the range of investment research philosophies demonstrates there is no single way to predict company financial performance, no single approach to evaluate the ESG performance of companies or funds has emerged.
From a public policy perspective, there has been increased focus encouraging the integration of ESG factors as a core part of investment processes. While ESG is clearly not new to the public policy arena, we have observed a new impetus to establish market-level policies that advance ESG practices, even at the regional and global level. The list of global initiatives set forth below and detailed in the Appendix highlights a number of the separate initiatives in place to address a breadth of ESG-related investment issues.
One catalytic public policy initiative was the build up to, and output of, the Paris Climate Conference (Conference of Parties 21 or COP21), held in December 2015. The goal of this meeting was to reduce greenhouse gas emissions in order to limit global temperature increases. The resultant COP21 Agreement23, signed by over 170 nations, sets a goal of limiting average global temperature rise to 2 degrees C above pre-industrial levels while pursuing efforts to limit the increase to 1.5 degrees C. Achieving this requires national emissions reductions of increasing stringency and the monitoring and reporting of progress. Focus now turns to government plans to meet their respective goals, and the implications for carbon intensive industries. International organizations – namely the G20 and OECD – are examining the role ESG factors will play in financing broader climate change objectives. The OECD is looking specifically at investment governance, and whether existing fiduciary standards sufficiently incorporate climate-related risks.
INVESTOR STATEMENT ON CLIMATE CHANGEBlackRock signed the 2014 Global Investor Statement on Climate Change. We believe that the emphasis on having a long-term, predictable policy framework is important to long-term investors seeking to incorporate environmental considerations in their analysis and decision-making. A more certain policy framework and long-term approach from governments is necessary for well-informed capital allocation decisions to be taken by investors and companies.
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Infr
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Environment
GHG emissions
Air quality
Energy management
Fuel management
Water and wastewater management
Waste and hazardous materials management
Biodiversity impacts
Social Capital
Human rights and community relations
Access and affordability
Customer welfare
Data security and customer privacy
Fair disclosure and labeling
Fair marketing and advertising
Human Capital
Labor relations
Fair labor practices
Employee health, safety and wellbeing
Diversity and inclusion
Compensation and benefits
Recruitment, development and retention
Business Model and Innovation
Lifecycle impacts of products and services
Environmental, social impacts on assets & operations
Product packaging
Product quality and safety
Leadership and Governance
Systemic risk management
Accident and safety management
Business ethics and transparency of payments
Competitive behavior
Regulatory capture and political influence
Materials sourcing
Supply chain management
EXHIBIT 3: SASB MATERIALITY MAPIdentifies and compares likely material sustainability issues across different industries and sectors
Sector Level Map Key
Issue is likely to be material for more than 50% of industries in sector
Issue is likely to be material for less than 50% of industries in sector
Issue is not likely to be material for any of the industries in sector
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EXHIBIT 4: GLOBAL INITIATIVES COVERING ELEMENTS OF ESG INVESTING AS OF MAY 2016
ORGANIZATION INITIATIVE
United Nations
UN Principles for Responsible Investment (UNPRI)
UN Environment Programme (UNEP)
UN Green Climate Fund
G20G20 Green Finance Study Group
Global Infrastructure Hub
OECDHigh-Level Principles on Long-Term Investment
Work stream on Governance and Fiduciary Duty
Financial Stability Board (FSB) Task Force on Climate-Related Financial Risks
European Union
EU Energy Union
EU Capital Markets Union
European Find for Strategic Investments (EFSI)
EU Non-Financial Reporting Directive
ESG and Fiduciary Duty initiatives
Product disclosure initiatives
BelgiumVandebroucke Law (2003)
Laws against financing of landmines and cluster munitions (2007)
Denmark Amendment to the Danish Financial Statements Act
FranceGrenelle Law II, Articles 224 and 225
Energy Transition for Green Growth Law, Article 173
GermanyThe Renewable Energy Act
Amendment in regulations concerning pensions funds
ItalyMandatory disclosure of ESG for pension funds
New measure on pension funds’ investment policy
Netherlands Green Investment Directive
Norway Norwegian Act on Annual Accounting
SpainSustainable Economy Law – Mandatory disclosure of ESG
Law modernising Spain’s Social Security System
SwedenMandatory Disclosure of ESG for pension funds
Public Pension Funds Act
United Kingdom Amendments to 1995 Pensions Act: Pension disclosure regulation
Hong Kong Social Innovation and Entrepreneurship Development Fund (SIE Fund)
India Indian Ministry of Corporate Affairs’ new Corporate and Social Responsibility policy under the Companies Act 2013
Japan Principles for Financial Action for the 21st Century
Philippines National Renewable Energy Program 2011-2013
Vietnam Climate Investment Funds’ Clean Technology Fund
Thailand Feed-in premium program
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Current Challenges Despite the myriad of standards and initiatives, more work needs to be done. The variety of market data providers’ methodology and the lack of ESG disclosure standards contribute to corporate complaints of survey fatigue and to investor challenges identifying the most material ESG issues. As an investor, we value the efforts to date to disclose and aggregate ESG data. However, we caution that the information is still in an early stage with discrepancies in quality and coverage, and the variety of providers may create more confusion than clarity. Three key challenges of the current state of ESG disclosure include:
1. Reliance on self-reported data to questionnaires and industry bodiesCompany disclosed information is sparse and disparate across industries and regions. The reliance on self-reported data to private aggregators allows companies to disclose favorable data or opt out completely. Furthermore, there is no accountability or overarching governing body ensuring accuracy of reported information.
2. Inconsistent collection, management, and distribution of ESG dataESG data is collected, managed, and dispersed by multiple data providers and is not easily accessible to all investors in a standard form. This creates a challenge for investment professionals attempting to systematically compare companies across industries and regions, either in real time or over historical time periods.
3. Disparate approaches to measure and report ESG information to investorsDue to different methodologies and disclosures, index providers and asset managers report ESG considerations inconsistently, creating challenges for investors seeking to compare ESG investment strategies, objectives and outcomes consistently.
Policy Recommendations and ConclusionThere is a need for comprehensive, standardized, and comparable data to accurately measure how companies are managing relevant ESG issues. We note that although setting international reporting standards can be a generations-long process, the results can be meaningful and lasting for the investment industry. For example, efforts to drive convergence of international accounting standards that first arose in the late 1950s involved numerous standard-setting bodies that continue to this day.31 However, now, if an investor wants to compare the financial performance of, for example, the telecom companies in Singapore, the US and Spain, they can rely on a set of those widely understood international accounting standards. This is not the case if they want to compare the carbon dependency, employee turnover levels, or the number of independent directors of those companies. Accordingly, it is necessary to coordinate and consolidate a standardized ESG factor reporting framework.
Looking regionally, Europe could be a bellwether for legislative action. On the company side, the EU’s Non-Financial Reporting Directive provides a legislative framework to require public companies to disclose a range of information, including ESG factors. As part of the implementation process, the European Commission has sought the views of investors on what types of ESG information they find important to investment decisions. On the investor side, the EU Shareholder Rights Directive, currently under consideration, would mandate institutional investors to disclose more information on their investment stewardship and engagement policies, with some focus on ESG factors.
Policy makers in other regions are similarly active on ESG. As of January 1, 2016, in Canada, the amended Ontario Pension & Benefit Act requires certain pension plans to disclose whether ESG factors are incorporated in pension funds’ investment policies and procedures. In the United States, publicly traded companies are required, as of 2010, to disclose material business risks that climate change developments may have on their business. The Dodd-Frank Wall Street Reform and Consumer Protection Act requires US companies also disclose information regarding mine safety and conflict minerals in supply chains. Finally, the Department of Labor in the US issued 2015 guidance stating, in part, that pension fund fiduciaries can consider ESG factors in their investment decisions, acknowledging that ESG factors may have a direct relationship to the financial value of an investment.24
Stock exchanges are often in a unique position at the intersection of public and private ownership to collaborate with their global peers to establish consistent guidance and structures across markets. Several have adopted listing rules on ESG or sustainability reporting. In South Africa, the Johannesburg Stock Exchange requires companies to comply with the principles of the King Code on Corporate Governance, including, as of 2010, a recommendation that companies integrate their approach to and reporting on risks and opportunities across financial and sustainability considerations.25 Similar to the Brazilian BM&FBOVESPA exchange, the Australian Securities Exchange recommends, as of 2014, listed entities to disclose any material exposure to economic, environmental and social sustainability risks and, if it does, how it manages or intends to manage those risks.26
The Hong Kong Stock Exchange requires companies to report on ESG issues on a comply or explain basis.27 The stock exchanges in Singapore and Malaysia28 have indicated their intention to use listing requirements to improve sustainability reporting.29 The World Federation of Exchanges30 could play a role in coordinating peer exchanges to follow suit in order to avoid a patchwork of 100 different ESG reporting regimes.
We see the potential over time for convergence towards a more holistic, integrated approach to managing, reporting, and analyzing business performance. Although some companies now issue a separate sustainability report, we believe that ESG issues of relevance to business performance should be integrated into fundamental company communications, publication and disclosures. In addition, some companies may find it useful to prepare sustainability reports addressing values-oriented stakeholders or employees wishing to understand their company’s citizenship, however, that should not be confused with reporting on ESG issues of relevance to business performance.
Policy makers should focus on establishing a framework that enables practitioners to develop detailed standards and best practice guidelines.32 As noted, considerable data is now available and progress continues to evolve at a rapid pace in response to market forces. Consistent, comparable, high quality data and information are key to ensure sound decision-making by investors, companies, regulators, and policy makers. To that end, we recommend that policy makers:
1. Encourage standard ESG factor disclosure by companies within a consistent global reporting framework (e.g. comparable to international accounting standards). ESG reporting should be relevant to operational and financial performance and their management to achieve long-term financial sustainability. Policy makers can encourage this by:
a. Recognizing the importance of identifying and managing ESG risks and opportunities as a component of investment analysis, and understanding how practitioners use ESG data;
b. Understanding the distinction between purely social, mission or “values” driven goals and investment (“value”) goals;
c. Promoting clear and consistent definitions of ESG, understanding the distinction between these factors driving long-term financial performance of companies from a values-driven approach taken by investors or companies;33
d. Providing guidance that recognizes the need to tailor reporting across diverse industries, because relevant ESG factors can vary primarily by industry, and also by geography, and even by specific company;
2. Establish safe harbor provisions that ensure that companies which initiate ESG factor reporting do not face retrospective litigation, as the underlying ESG factors that may be material to the investment decision or relevant to business performance can be evolving quickly;
3. Monitor to ensure that, where regulation is in place, it is designed and implemented to achieve the actual prescribed policy objectives, and does not require or contribute to unnecessary disclosures or other compliance activities that do not add value to investment practitioners’ abilities to use ESG information;
4. Review, understand, and remove barriers to ESG factor integration and reporting by investors and companies, such as conflicting ESG frameworks, ambiguous or competing definitions of materiality and fiduciary duty, lack of widely available globally standardized ESG data, and public policies that may not achieve prescribed policy objectives;
5. Clarify how ESG considerations are part of investors’ and companies’ fiduciary duties; and,
6. Require investors to report whether they integrate ESG factors in their investment analysis, and if so, their approach to integrating ESG factors in their investment processes and stewardship activities, including an explanation of specific policies, implementation guidance, and the resources deployed. Investors should also report the outcomes from engagements undertaken to protect and enhance long-term financial returns.
We anticipate that there will be consolidation amongst the practitioner-led policy initiatives in the near term. Policy makers and regulators can play a supportive, galvanizing, and potentially convening role. Given the increasing global significance of ESG amongst relevant stakeholders and the long-term nature of the investments necessary by companies – in innovation, reporting systems and, in some cases, physical assets – policy makers and regulators can play a vital role in establishing a long-term, standardized, focused, and predictable policy framework to encourage informed capital allocation decisions.
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APPENDIX A: LIST OF GLOBAL POLICY INITIATIVES
ORGANIZATION INITIATIVE ACTION PLAN YEAR OF INITIATION / PROGRESS
United Nations UN Principles for Responsible Investment (UNPRI)
Voluntary initiative (currently with 1300+ signatories w ~$60tn in assets) to adhere to 6 principles to incorporate ESG issues into investment practices.
2005*March 2016
consultation on additional accountability
provisions
UN Environment Programme (UNEP)
UNEP Sustainable Energy Finance Initiative (SEFI) is a platform to bring financiers and developers together to facilitate financing of renewable energy and energy efficiency investments.
2008
UN Green Climate Fund
Fund’s goal is to raise $100 billion annually by 2020 from both global public and private sectors (so far, only $10 billion pledged from developed nations) to help mitigate the effects of climate change in developing countries.
2010
G20 G20 Green Finance Study Group
Co-Chaired by Bank of England (BoE) and People’s Bank of China (PBoC), with secretariat support from UNEP. Tasked with identifying institutional and market barriers to green finance, developing best practice to mobilize green investment.
Initial Report due by G20 Finance Ministers’ meeting
July 2016
Global Infrastructure Hub
Global Infrastructure Hub works to better connect public and private sectors to increase the flow of funding to infrastructure projects.
2014
OECD High-Level Principles on Long-Term Investment
High-level principles to help governments facilitate and promote long-term investment by institutional investors. 2014
Work stream on Governance and Fiduciary Duty
OECD currently conducting research on investment governance and responsible investing. End result will be a report on whether current fiduciary standards amongst institutional investors are adequate with regard to ESG analysis and climate change risks.
Timeframe unclear
Financial Stability Board (FSB)
Task Force on Climate-Related Financial Risks
Chaired by Michael Bloomberg – TF will develop voluntary climate-related financial risk disclosures for use by companies to allow market participants and policymakers to better understand an manage climate-related risks.
Final Report due by end of Chinese G20 Presidency
(end 2016)
European Union EU Energy Union Strategic initiative to create a single EU energy market – at the same time incorporating climate goals and financing low-carbon technology.
Framework in place by 2019 for Single EU
Energy MarketReduction of energy
usage by 27% by 203040% reduction of greenhouse gas
emissions by 2030
EU Capital Markets Union
Promoting increased markets-based finance. specific work on Green investment (e.g., green bonds), infrastructure investment
Framework in place by 2019
European Find for Strategic Investments (EFSI)
€315 billion (public sector guarantees and private co-investment). Fund aimed at financing strategic infrastructure projects in EU (strong focus on sustainable energy infrastructure)
2015
EU Non-Financial Reporting Directive
Legislation requiring disclosure of a range of ESG-related information by listed companies and other designated entities with 500+ employees.
Applies as of Jan 2017
ESG and Fiduciary Duty initiatives
Promoting ESG factors as part of investor fiduciary responsibility and encouraging more disclosure of ESG information by companies. End result will feed into Guidelines supporting the Non-Financial Reporting Directive.
Currently under consultation: Guidelines
due by end 2016
Product disclosure initiatives
Various financial product (esp. funds) disclosure rules (UCITS and PRIPs KIIDs) include provisions on disclosure of ESG policy.
Various
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APPENDIX A: LIST OF GLOBAL POLICY INITIATIVES (cont’d)
ORGANIZATION INITIATIVE ACTION PLAN PROGRESS / YEAR OF INITIATION
Belgium Vandebroucke Law (2003)
Mandatory disclosure of pensions funds in their annual reports to which degree SEE criteria and considered in the investment strategy.
2003
Laws against financing of landmines and cluster munitions (2007)
Exclusion of investments in landmines and cluster munitions.
2007
Denmark Amendment to the Danish Financial Statements Act
Mandatory ESG disclosure for companies and investors. Information must include: Mandatory reporting on human rights and/or climate change for organizations with policies referencing one or both of those issues. Applies to both institutional investors and corporates.
2012
France Grenelle Law II, Articles 224 and 225
Public disclosure of open-ended investment companies and investment management companies (fund managers) how they integrate ESG objectives in their investment decisions, first on their websites, then in their annual reports.
2010 / 12
Energy Transition for Green Growth Law, Article 173
Disclosure of how a wide range of investors integrate ESG issues into their investment policies and risk management (e.g. climate change-related risks), also incl. carbon reporting.
2016
Germany The Renewable Energy Act
Tax advantages to closed-end funds to invest in wind-energy. 2010 / 12
Amendment in regulations concerning pensions funds
Information of pension funds to clients how ESG issues are considered in the use of deposited funds when signing the contract, and in annual report. 2001
Italy Mandatory disclosure of ESG for pension funds
Mandatory disclosure for pension funds of nonfinancial factors whether and to what extent ESG influencing the investment decisions and the exercise of their voting rights in their communication and in their annual reports.
2011
New measure on pension fund’s investment policy
Mandatory communication (if any) ethical, environmental and social criteria are in the statement of investment principles. 2012
Netherlands Green Investment Directive
Tax reduction for green investments, such as wind and solar energy or organic farming. 1995
Norway Norwegian Act on Annual Accounting
Annual reporting on business integration of corporate social responsibility, including human rights, workers’ rights and social issues, the environment and measures against corruption. The report must contain information on policies, principles, procedures and company standards. Companies that do not have policies must disclose this fact. The company’s auditor must assess the accuracy and consistency of the reporting. Companies that report within UN Global Compact or GRI are exempt.
2013
Spain Sustainable Economy Law –Mandatory disclosure of ESG
Mandatory reporting for pension funds on an annual basis whether or not they use ESG criteria in their investment approach. 2011
Law modernising Spain’s Social Security System
Mandatory reporting for occupational pension funds in their annual reports on investment criteria in regard to SRI as well as how they implement, manage and monitor ESG issues.
2013
[ 12 ]
APPENDIX A: LIST OF GLOBAL POLICY INITIATIVES (cont’d)
ORGANIZATION INITIATIVE ACTION PLAN PROGRESS / YEAR OF INITIATION
Sweden Mandatory Disclosure of ESG for pension funds
Mandatory reporting requirements for private and public pension funds in the annual business plan how environmental and ethical considerations are taken into account in investment activities and the impacts of these activities for the funds performance and management.
2000
Public Pension Funds Act
The seven AP funds must take environmental and ethical considerations into account without relinquishing the overall goal of a high return on capital.
2002
United Kingdom Amendments to 1995 Pensions Act: Pension disclosure regulation
Pension funds are required to disclose in the Statement of Investment Principles (SIP) the extent (if at all) to which social, environmental and ethical considerations are taken into account in the selection, retention and realization of investment.
1999
Hong Kong Social Innovation and Entrepreneurship Development Fund (SIE Fund)
Aimed at helping to overcome some obstacles in ESG investing in the region, such as the absence of a platform for investor-project matchmaking, limited information sharing and cross-sector learning, as well as incoherent policies and guidelines. ESG Reporting Guidelines have been published by the HK Stock Exchange as well.
2012
India Indian Ministry of Corporate Affairs’ new Corporate and Social Responsibility policy under the Companies Act 2013
Authorities in India have deployed multiple policy tools—such as Renewable Purchase Obligations and Renewable Energy Certificates—to close the demand gap by encouraging investment into renewable energy growth. 2013
Japan Principles for Financial Action for the 21st Century
192 signatory financial institutions as of the end of October 2014 have joined for the aim of the principles to steer society toward sustainability by changing the flow of money to those activities which correspond to such sustainability goals.
2014
Philippines National Renewable Energy Program 2011-2013
The Government of the Philippines, following on the Renewable Energy Act of 2008, set ambitious targets in the National Renewable Energy Program 2011-2013 to triple the country’s current renewable capacity by 2030.
2011-2013
Vietnam Climate Investment Funds’ Clean Technology Fund
The government, in coordination with the Asian Development Bank, has developed a plan for low-carbon investments in the power, transport and industrial sectors, funded by the Climate Investment Funds’ Clean Technology Fund.
Thailand Feed-in premium program
Thailand has more than doubled its installed clean energy capacity with the help of the feed-in premium program introduced in 2010.
2010
As of May 2016.
Notes1. When we refer to asset owners, we mean the people and institutions whose capital is invested in global markets - including individual
savers and households, as well as the institutions, like pension funds or insurance companies, who invest on their behalf. In this paper, we refer to the asset owner as ‘investors’ more broadly, and ‘our clients’ more specifically. Each type of asset owner has different needs, objectives and considerations that affect their investment objectives and considerations (and, if they delegate to asset managers, the mandates or funds in which they invest). See BlackRock, ViewPoint, Who Owns the Assets? (May 2014), available at http://www.blackrock.com/corporate/en-us/literature/whitepaper/viewpoint-who-owns-the-assets-may-2014.pdf.
2. 73% of global investors surveyed by the CFA Institute in 2015 indicated they take ESG issues into account in their investment analysis and decisions. Matt Orsagh, CFA Institute, CFA Institute Survey: How Do ESG Issues Factor into Investment Decisions? (Aug. 17, 2015), available at https://blogs.cfainstitute.org/marketintegrity/2015/08/17/cfa-institute-survey-how-do-esg-issues-factor-into-investment-decisions/.
3. It is important to note that ESG issues may often intersect with or be inseparable from deeply held personal or societal beliefs. As a fiduciary asset manager, BlackRock does not express value judgments or political views, but rather incorporates clients’ stated investment objectives and constraints into portfolios. Sometimes, this means our clients explicitly identify sustainability objectives.
4. BlackRock and Ceres, 21st Century Engagement: Investor Strategies for Incorporating ESG Considerations into Corporate Interactions (2015), available at http://www.blackrock.com/corporate/en-us/literature/publication/blk-ceres-engagementguide2015.pdf.
5. DB Climate Change Advisors, Deutsche Bank Group, Sustainable Investing: Establishing Long-Term Value and Performance (Jun. 2012), available at https://www.db.com/cr/en/docs/Sustainable_Investing_2012.pdf.
6. Teresa Czerwińska and Piotr Kaźmierkiewicz, ESG Rating in Investment Risk Analysis of Companies Listed on the Public Market in Poland, ECONOMIC NOTES, Vol. 44, Issue 2, at 211-248 (Jul. 2015), available at http://dx.doi.org/10.1111/ecno.12031.
7. Indrani De and Michelle Clayman, The Benefits of Socially Responsible Investing: An Active Manager's Perspective, Journal of Investing(Jul. 9, 2014), available at http://ssrn.com/abstract=2464204.
8. Mozaffar Khan, George Serafeim, and Aaron Yoon, Corporate Sustainability: First Evidence on Materiality, The Accounting Review (Mar. 9, 2015), available at http://ssrn.com/abstract=2575912.
9. Asset Owners Disclosure Project, “World’s Biggest Investors Step Up Action to Protect Millions of Pension for Climate Risk” (May 2016), available at http://aodproject.net/worlds-biggest-investors-step-up-action-to-protect-millions-of-pensions-from-climate-risk/.
10. UNEP Finance Initiative is a global partnership between UNEP and the financial sector. Over 200 institutions, including banks, insurers and fund managers, work with UNEP to understand the impacts of environmental and social considerations on financial performance.UNEP Finance Initiative, http://www.unepfi.org/.
11. UN Global Compact is a voluntary initiative based on CEO commitments to implement universal sustainability principles and to take steps to support UN goals, with over 8,000 signatories in almost 170 countries. See United Nations Global Compact, https://www.unglobalcompact.org/.
12. BlackRock has been a signatory to the PRI since 2008. Being a signatory has not changed BlackRock’s approach, as we have long been a strong proponent of active stewardship, including considering ESG factors as they pertain to long-term economic value creation. See Principles for Responsible Investment, available at https://www.unpri.org/.
13. About CDP, CDP, https://www.cdp.net/en-US/Pages/About-Us.aspx.14. About GRI, Global Reporting Initiative, https://www.globalreporting.org/Information/about-gri/Pages/default.aspx.15. Financial Services Council and Australian Council of Superannuation Investors, ESG Reporting Guide for Australian Companies (2015),
http://www.fsc.org.au/downloads/file/PublicationsFile/2016_0302_ESGReportingGuideFinal2015.pdf. 16. The IIRC, Integrated Reporting, http://integratedreporting.org/the-iirc-2/.17. B Analytics, Global Impact Investing Rating System (GIIRS) Company Ratings, http://b-analytics.net/products/giirs-ratings/company-
ratings-methodology.18. About the Sustainable Stock Exchanges (SSE) initiative, Sustainable Stock Exchanges Initiative, http://www.sseinitiative.org/about/.19. Who we are, Ceres, http://www.ceres.org/about-us/who-we-are.20. BlackRock is a member of the FSB Climate Task Force.21. Sustainability Accounting Standards Board (SASB), http://www.sasb.org/.22. BlackRock is a subscriber to MSCI ESG Research.23. UN Climate Change Paris Agreement, available at http://newsroom.unfccc.int/paris-agreement/; United Nations Framework Convention on
Climate Change, available at http://unfccc.int/resource/docs/2015/cop21/eng/10.pdf. 24. Department of Labor, Employee Benefits Security Administration, 80 Fed. Reg. 65135 (Oct. 26, 2015), available at
https://www.gpo.gov/fdsys/pkg/FR-2015-10-26/pdf/2015-27146.pdf.25. Regulator, Influencer, Advocate, Johannesburg Stock Exchange, https://www.jse.co.za/about/sustainability/regulator-influencer-advocate.26. The World Federation of Exchanges Sustainability Working Group, Exchanges and ESG Initiatives (2015), and ASX Corporate
Governance Council, Corporate Governance Principles and Recommendations (2014), available at http://www.asx.com.au/documents/asx-compliance/cgc-principles-and-recommendations-3rd-edn.pdf.
27. News Release, Hong Kong Exchanges and Clearing, Exchange to Strengthen ESG Guide in its Listing Rules (Dec. 21, 2015), available at https://www.hkex.com.hk/eng/newsconsul/hkexnews/2015/151221news.htm.
28. BlackRock, Comment Letter, Consultation Paper 1/2015: Proposed Amendments to the Listing Requirements Relating to Sustainability Statement in Annual Reports and the Sustainability Reporting Guide (Aug. 24, 2015), available at http://www.blackrock.com/corporate/en-us/literature/publication/sustainability-listing-requirments-bursa-malaysia-082415.pdf.
29. Christine Chow, Hong Kong Joins Push for Sustainable Stock Exchanges, South China Morning Post (Sep. 18, 2015), available athttp://www.scmp.com/business/markets/article/1859225/hong-kong-joins-push-sustainable-stock-exchanges.
30. World Federation of Exchanges represents 64 regulated exchanges across the world, and acts on behalf of a total of 99 organizations including affiliate members and clearinghouses. WFE Mission & Vision, World Federation of Exchanges, http://www.world-exchanges.org/home/index.php/about/wfe-mission-vision.
[ 13 ]
This publication represents the views of BlackRock and is intended for educational purposes to discuss topics related to public policy matters and issues helpful in understanding the policy and regulatory environment. The information in this publication should not be construed as research or relied upon in making investment decisions with respect to a specific company or security or be used as legal advice. It should not be construed as research.
This material may contain ‘forward-looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass.
The opinions expressed herein are as of June 2016 and are subject to change at any time due to changes in market, economic or other conditions. The information and opinions contained herein are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, but are not necessarily all inclusive and are not guaranteed as to accuracy or completeness. No part of this material may be reproduced, stored in any retrieval system or transmitted in any form or by any means, electronic, mechanical, recording or otherwise, without the prior written consent of BlackRock.
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In Hong Kong, this material is issued by BlackRock Asset Management North Asia Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong. This material is for distribution to "Professional Investors" (as defined in the Securities and Futures Ordinance (Cap.571 of the laws of Hong Kong) and any rules made under that ordinance) and should not be relied upon by any otherpersons or redistributed to retail clients in Hong Kong. In Singapore, this is issued by BlackRock (Singapore) Limited (Co. registration no. 200010143N) for use only with institutional investors as defined in Section 4A of the Securities and Futures Act, Chapter 289 of Singapore. In Korea, this material is for Qualified Professional Investors. In Japan, this is issued by BlackRock Japan. Co., Ltd. (Financial Instruments Business Operator: The Kanto Regional Financial Bureau. License No375, Association Memberships: Japan Investment Advisers Association, The Investment Trusts Association, Japan, Japan Securities Dealers Association, Type II Financial Instruments FirmsAssociation.) for Professional Investors only (Professional Investor is defined in Financial Instruments and Exchange Act) and for information or educational purposes only, and does not constitute investment advice or an offer or solicitation to purchase or sells in any securities or any investment strategies. In Taiwan, independently operated by BlackRock Investment Management (Taiwan) Limited. Address: 28/F, No. 95, Tun Hwa South Road, Section 2, Taipei 106, Taiwan. Tel: (02)23261600. Issued in Australia and New Zealand by BlackRock InvestmentManagement (Australia) Limited ABN 13 006 165 975 AFSL 230 523 (BIMAL) for the exclusive use of the recipient who warrants by receipt of this material that they are a wholesale client and not a retail client as those terms are defined under the Australian Corporations Act 2001 (Cth) and the New Zealand Financial Advisers Act 2008 respectively. This material contains general information only and does not constitute financial product advice. This material has been prepared without taking into account any person’s objectives, financial situation or needs. Before making any investment decision based on this material, a person should assess whether the information is appropriate having regard to the person’s objectives, financial situation and needs and consult their financial, tax, legal, accounting or other professional advisor about the information contained in this material. This material is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. BIMAL is the issuer of financial products and acts as an investment manager in Australia. BIMAL does not offer financial products to persons in New Zealand who are retail investors (as that term is defined in the Financial Markets Conduct Act 2013 (FMCA)). This material does not constitute or relate to such an offer. To the extent that this material does constitute or relate to such an offer of financial products, the offer is only made to, and capable of acceptance by, persons in New Zealand who are wholesale investors (as that term is defined in the FMCA). BIMAL is a part of the global BlackRock Group which comprises of financial product issuers and investment managers around the world. This material has not been prepared specifically for Australian or New Zealand investors. It may contain references to dollar amounts which are not Australian or New Zealand dollars and may contain financial information which is not prepared in accordance with Australian or New Zealand law or practices. BIMAL, its officers, employees and agents believe that the information in this material and the sources on which the information is based (which may be sourced from third parties) are correct as at the date specified in this material. While every care has been taken in the preparation of this material, no warranty of accuracy or reliability is given and no responsibility for this information is accepted by BIMAL, its officers, employees or agents. Except where contrary to law, BIMAL excludes all liability for this information. Past performance is not a reliable indicator of future performance. Investing involves risk including loss of principal. No guarantee as to the capital value of investments nor future returns is made by BIMAL or any company in the BlackRock Group.
©2016 BlackRock. All rights reserved. BLACKROCK is a registered trademark of BlackRock. All other marks are property of their respective owners.
GOV-0093
Notes (cont’d)31. Comparability in International Accounting Standards – A Brief History, Financial Accounting Standards Board,
http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176156304264.32. See, e.g., International Capital Market Association, The Green Bond Principles, 2015: Voluntary Process Guidelines for Issuing Green
Bonds (Mar. 27, 2015). http://www.icmagroup.org/assets/documents/Regulatory/Green-Bonds/GBP_2015_27-March.pdf. 33. B Corps, for example, are for-profit companies certified by the nonprofit B Lab to meet rigorous standards of social and environmental
performance, accountability, and transparency. There are more than 1,600 Certified B Corps from 42 countries and over 120 industries. What are B Corps? B Corporations, available at http://www.icmagroup.org/Regulatory-Policy-and-Market-Practice/green-bonds/green-bond-principles/.
The ESG Data Challenge
• Quality data about companies’ Environmental, Social and Governance (ESG) practices is critical for effective investment analysis.
• The lack of standardization and transparency in ESG reporting and scoring presents major challenges for investors.
• Third-party ESG data providers play an important role, but there are limitations with this data — especially in terms of differing methodologies that lead to variance in scores — which asset owners should understand.
• Moreover, there is a lack of market infrastructure to give companies insights into how they are evaluated with respect to ESG scoring.
• To improve the quality of the ESG data we use to make investment decisions for our clients, State Street has built a scoring system that uses data from multiple best-in-class providers, leverages Sustainability Accounting Standards Board’s (SASB) transparent materiality framework and incorporates our stewardship insights.
• We outline the considerations that asset owners should incorporate into their evaluation of ESG data providers.
Article ESG
March 2019
Headwinds to ESG Data Quality
Quality data is the lifeblood of investment analysis. While “quality” can be defined in several ways, most investors agree that consistency and comparability in the availability of data across companies are essential elements of an effective data set.
Unfortunately, the current landscape provides headwinds to achieving those elements of quality when it comes to data about a company’s ESG practices. Governments around the world don’t require companies to report on most ESG data. Companies are left to determine for themselves which ESG factors are material to their business performance and what information to disclose to investors.
Asset owners and their investment managers seek solutions to the challenges posed by a lack of consistent, comparable, and material information. Investors increasingly view material ESG factors as being critical drivers of a company’s ability to generate sustainable long-term performance. In turn, ESG data has increasing importance for investors’ ability to allocate capital most effectively.
2The ESG Data Challenge
ESG Data Providers — Contributions and Considerations
Differences in Data Collection and Methodologies
ESG data providers play an important role in the investment process by gathering and assessing information about companies’ ESG practices and then scoring those companies accordingly. The development of these ratings systems has helped to nurture the growth of ESG investing by giving asset owners and managers an alternative to conducting such extensive diligence themselves.
As of 2016, there were more than 125 ESG data providers, according to The Global Initiative for Sustainability Ratings. These include well-known providers with global coverage such as Bloomberg, FTSE, MSCI, Sustainalytics, Thomson Reuters, and Vigeo EIRIS, as well as specialized data providers such as S&P’s Trucost (providing carbon and “brown revenue” data), GRESB (sustainability performance in real estate) and ISS (corporate governance, climate, and responsible investing solutions).
Despite the valuable contributions these data providers have made in advancing ESG investing globally, it’s important for asset owners and managers to understand the inherent limitations of this data, as well as the challenges of relying on any one provider.
Lack of standardization and transparency in providers’ data collection and scoring methodologies pose key challenges for investors.
ESG data providers generally develop their own sourcing, research, and scoring methodologies. As a result, the rating for a single company can vary widely across different providers. We recently conducted research to quantify the degree to which this lack of standardization leads to variance among the ESG scores used by investors. (See “A Blueprint for Integrating ESG Into Equity Portfolios ,” by Bender, Bridges, et al.)1
As part of an 18-month due diligence process in which we looked at more than 30 data providers, we examined the cross-sectional correlations for four leading data providers’ ESG scores, using the MSCI World Index as the coverage universe. MSCI and Sustainalytics are two of the most widely used ESG data providers. But, as shown in Figure 1, our research determined a correlation of only 0.53 among their scores, meaning that their ratings of companies are only consistent for about half of the coverage universe.
Sustainalytics MSCI RobecoSAM Bloomberg ESG
Sustainalytics 1 0.53 0.76 0.66
MSCI 1 0.48 0.47
RobecoSAM 1 0.68
Bloomberg ESG 1
Figure 1 ESG Scores are Different Across Providers (Cross Sectional Correlation for Constituents of the MSCI World Index, June 30, 2017)
These differing methodologies have implications for investors. In choosing a particular provider, investors are, in effect, aligning themselves with that company's ESG investment philosophy in terms of data acquisition, materiality, and aggregation and weighting.
This choice is complicated by the lack of transparency into those methodologies. Most data providers treat their methodologies as proprietary information. By relying on an ESG data provider’s score, asset owners are taking on the perspectives of that provider without a full understanding of how the provider arrived at those conclusions.
3The ESG Data Challenge
Assessing the Differences Given the lack of consistency among ESG scores, it’s helpful to understand the factors that are leading to this variance. In our research, three primary points of difference among the methodologies and approaches used by ESG data providers were identified:
Materiality. A critical part of any ESG scoring is determining which factors are material to a company’s financial performance; the importance of materiality has been supported by academic research.2 As part of the proprietary nature of their solutions, ESG data providers typically make their own determinations on materiality issues — and don’t provide full transparency into how these determinations are made. These differences in how materiality is defined and unveiled add to the difficulty asset owners and managers face in selecting an ESG data provider.
Data Acquisition and Estimation. We found discernable differences in how ESG data providers source and acquire raw data. In addition to using traditional sourcing techniques to gather data that is disclosed by the company or is otherwise publicly available, ESG data providers use statistical models to create estimates for unreported data. These models are based on averages and trends from what the data provider views as similar companies and industry benchmarks. This is an example of how investors are incorporating judgement calls by the data provider into their investment processes.
Aggregation and Weighting. Each ESG data provider has developed a method to aggregate and weight particular ESG factors for its summary scores. Again, these are proprietary judgments made by each provider.
Case Study: MSCI versus Sustainalytics
MSCI Sustainalytics
Materiality Proprietary Definition of Materiality International Financial Reporting Standards (IFRS) Definition of Materiality
Normalization Key Issue Weighted Average by Global Industry Classification System Sub-Industry
Key Issue Weighted Average by 42 Peer Groups
Weighting Key Issue Weights (proprietary model) Key Issue Weights (proprietary model)
Aggregation 37 Metrics 60–80 Metrics
Figure 2 Comparison of MSCI and Sustainalytics Approaches to ESG Scores
Examining the different methodologies used by two of the leading ESG data providers highlights the challenge investors face when selecting a provider. Both MSCI and Sustainalytics are widely used across the asset management industry, and each of them offers global ESG product suites — including ESG ratings and climate-focused products. But, as Figure 2 illustrates, there are distinct differences in the way the two companies collect and analyze ESG data.
4The ESG Data Challenge
At State Street, we believe that ESG factors are directly linked to a company’s ability to generate sustainable long term performance. As fiduciaries, we have a duty to rigorously analyze all financial and nonfinancial factors that can affect a company’s performance, and we believe that ESG factors can be used to mitigate risk and identify potential alpha signals.
To address the gaps in the current market infrastructure, we are building our own scoring system, known as R-Factor. This scoring system will address the data challenges that we’ve articulated above.
Our approach to ESG data and scoring is guided by three goals:
• Bring greater transparency to materiality considerations that drive ESG scores
• Develop ESG scores that are based on frameworks supported by a large number of investors
• Promote market infrastructure that both integrates stewardship into ESG scoring and incentivizes greater corporate disclosure of investor-relevant ESG information
We invite you to contact your State Street Relationship Manager to learn more about R-Factor and our broader ESG capabilities.
ESG Scoring at State Street: Our Goals and Approach
State Street Global Advisors ESG Resources
Understanding & Comparing ESG TerminologyA practical framework for identifying the ESG long-term strategy that is right for you.
Next Generation ESG for Better AlphaA tailored approach to ESG metrics for active equity strategies.
Harnessing ESG as an Alpha Source in Active Quantitative EquityInsights into leveraging ESG factors to increase portfolio returns.
Rakhi Kumar, CA Head of ESG Investments and Asset Stewardship
Ali Weiner ESG Investment Strategy
Authors
Endnotes 1 Bender, Bridges, et al. “A Blueprint for Integrating ESG into Equity Portfolios.” Journal of Investment Management Volume 16 No. 1, 2018.
2 Mozaffar Khan, George Serafeim, and Aaron Yoon, Corporate Sustainability: First Evidence on Materiality (November 9, 2016).
5The ESG Data Challenge
ssga.com
State Street Global Advisors Worldwide Entities
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Stanford CloSer looK SerieS
Stanford CloSer looK SerieS 1
By Brandon Boze, Margarita KrivitsKi, david F. LarcKer, Brian tayan, and eva zLotnicKaMay 23, 2019
the business case for esg
introduction
Recently there has been increased debate among corporate
managers, boards of directors, and institutional investors around
how best to incorporate ESG (environmental, social, governance)
factors into strategic and investment decision-making processes.
Central to this discussion is the premise that both companies
and investors have become too short-term oriented in their
investment horizon, leading to decisions that increase near-term
reported profits at the expense of the long-term sustainability of
those profits. The costs of those decisions are assumed to manifest
themselves as externalities, borne by members of the workforce
or society at large.1
Prominent investors such as Larry Fink at BlackRock adopt
this viewpoint:
To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate. Without a sense of purpose, no company, either public or private, can achieve its full potential. It will ultimately lose the license to operate from key stakeholders. It will succumb to short-term pressures to distribute earnings, and, in the process, sacrifice investments in employee development, innovation, and capital expenditures that are necessary for long-term growth.2
Similarly, Martin Lipton of law firm Wachtell, Lipton, Rosen
& Katz has urged corporate clients to adopt what he calls “The
New Paradigm,” a more stakeholder-centric orientation that
emphasizes a long-term investment horizon:
In essence, the New Paradigm recalibrates the relationship between public corporations and their major institutional investors and conceives of corporate governance as a collaboration among corporations, shareholders, and other stakeholders working together to achieve long-term value and resist short-termism.3
Evaluating claims such as these on a national or macro-level
would require an accurate measurement of the time horizons
of business managers today and the degree to which, if any, they
ignore or underestimate long-term environmental or social costs
in the pursuit of near-term profits.4
Boards can improve their analysis of ESG risks and
opportunities at a practical level by considering how long-term
investors integrate ESG factors into their decision-making
process. To do so, we examine a framework informed by the
experience of ValueAct Capital. ValueAct is a long-term investor
that aims to work constructively with portfolio company
management teams and boards in a variety of ways, including at
times having a ValueAct representative serve on the board.
Broad integration of eSg factorS
In many ways, a focus on the durability of earnings and downside
risk inherently incorporates many concepts commonly associated
with ESG. To that end, ValueAct has also adopted an approach to
evaluate ESG-related factors as part of its decision-making process
and has deepened engagement with its portfolio companies
around these issues. It does so because analysis of ESG factors can:
• Provide an effective risk-management framework• Provide a new lens for strategy development and growth
opportunities • Address the demands of stakeholders such as customers,
employees, and investors
As such, ValueAct generally incorporates ESG factors into its
process by identifying relevant stakeholders and factors, isolating
and evaluating potential risks, and supporting companies as they
invest in their businesses to increase returns.
IdentIfyIng Relevant factoRs
The first step is to map the ecosystem of stakeholders associated
with the company and analyze their interests (i.e., their incentives,
values, viewpoints, etc.). These stakeholders typically include
customers, suppliers, employees, regulators, the general public
(including environmental impact), shareholders, and competitors.
Once this ecosystem is mapped, it is easier to understand which
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2Stanford CloSer looK SerieS
ESG factors are most relevant to a particular company. Certain
factors, such as governance and human capital, might be applicable
broadly while others, such as environmental footprint, might be
more limited.
As an example of this process, ValueAct created an ecosystem
map as part of its diligence of the private student loan industry,
including the leading provider Sallie Mae (see Exhibit 1). The
map identifies students and their parents, colleges and their
financial aid officers, government regulators, U.S. taxpayers, and
shareholders as key stakeholders and summarizes the goals of
each.
IsolatIng and evaluatIng PotentIal RIsks
Once the relevant factors have been identified, one can evaluate
and quantify (to the extent possible) the company’s position
and associated risk in each area. The active engagement of an
investor with a significant stake and long-term perspective can
elevate a company’s discussion of risk at the C-suite and board
level, encourage corporate investment to mitigate risk if needed
(even at the expense of near-term profit), and provide support for
the management team as it justifies its decisions to the broader
investment community.
In the example of the student loan industry above, the federal
government is an important focal point given its dual role as
lender and policy maker. This suggests several questions:
• Can private student loans provide better value to students than federal programs?
• How might policy changes impact the competitive dynamic between private and federal programs?
• What impact do various sources of student loans have on both school and student outcomes?
In attempting to answer these questions from an investor’s
perspective, ValueAct was better able to evaluate how private
student loan providers could play a positive role in any higher
education policy focused on access, quality, and affordability, and
therefore serve as an important part of the long-term solution to
fund higher education.
InvestIng to IncRease RetuRns
Beyond risk reduction, ESG factor analysis can lead to the
identification of investments or activities by the company that
increase long-term returns. For example, a company’s investment
in a more sustainable supply chain can deepen relationships with
customers (thereby promoting volume growth and premium
pricing), attract talent to the organization, and perhaps reduce
costs. In the private student loan ecosystem, investments behind
improving student outcomes can significantly reduce default
risk while also improving the brand in the eyes of customers,
employees, and regulators. These positive effects can build on
one another and create a powerful flywheel effect. To identify
and capitalize on opportunities such as these, senior business
leadership must consider material ESG factors as core inputs into
their strategy development.
Beyond eSg: inveSting Behind BuSineSS ModelS and tranSitionS integral to Solving gloBal ProBleMS
Integration of ESG-related factors is broadly applicable across all
companies. In ValueAct’s experience, there is also an opportunity
for institutional investors to identify and invest behind companies
where sustainability is at the center of the investment thesis, or
whose business models are core to the ultimate solution for specific
environmental and social problems (increasingly referred to as
“impact investing”). These global problems can include carbon
emissions, waste recovery, access to education, affordability of
healthcare, and biodiversity loss, to name a few.
Below we explore two of those problems—carbon emissions
and access to education—and provide an example of companies
that are transitioning their business models to address these
problems.
caRbon emIssIons
Electricity production accounts for over a quarter (27.5 percent)
of greenhouse gas emissions in the United States.5 Approximately
64 percent of electricity production comes from fossil fuels such
as coal and natural gas, 19 percent from nuclear, and 17 percent
from renewables such as wind and solar.6 Renewables have
steadily gained share as they have become more cost competitive
with fossil fuels in certain geographies. Increased investment can
accelerate this transition and pull forward the benefits from a
climate change perspective.
Global power company AES has a 38-year history of owning
and operating contracted generating capacity to utilities around
the world. By early 2018, AES was addressing the environmental
cost of its reliance on coal as an energy source and was in the
process of repositioning its portfolio to renewable sources. The
company subsequently made a series of changes to accelerate the
transition of its business model. In early 2018, AES announced
a broad reorganization, including asset divestitures primarily
related to coal plants. The company also committed to a target of
decreasing reliance on coal from 41 percent of supply in 2015 to
29 percent by 2020.7 It publicly set a carbon intensity reduction
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3Stanford CloSer looK SerieS
target of 70 percent by 2030.8 Through joint ventures with Siemens
and others, it built capacity for energy storage and development
of renewables. In November 2018, the company voluntarily
released a Climate Scenario Report, claiming to be the first U.S.
publicly listed energy-related business to do so in accordance with
guidelines set by the Task Force for Climate-related Financial
Disclosures (TCFD). The company also modified its mission
statement to emphasize its commitment to transformation to:
“Improve lives by accelerating a safer and greener energy future.”
These actions appear to have had a number of ripple effects.
According to AES, the updated mission statement galvanized the
company’s culture, helping it to attract talent, increase workforce
productivity, and further innovation. The company also received
recognition from external parties for its reporting efforts.9
Shareholders who had pressured the company to conduct a
climate-change risk assessment voluntarily withdrew their proxy
resolution, and according to AES, some foreign and domestic
investors, who previously would not invest in AES because of
its exposure to coal, made new investments. During this time of
investment in a less carbon intensive business, the company’s
price-to-earnings multiple expanded from approximately 9x in
January 2018 to 14x by March 2019, and its stock price outpaced
industry indexes (see Exhibit 2).
access to educatIon
Higher education is a critical determinant of future wages, with
college graduates earnings approximately 80 percent more
per year than those with only a high school degree. The cost of
college education, however, has been rising significantly for
many years, and student loans become the fastest-growing
category of consumer debt, rising to $1.6 trillion by the end of
2018. Addressing the problems of access and affordability while
maintaining quality offers substantial potential benefits for U.S.
citizens and the economy.
The for-profit education industry has long had the potential
to provide this solution by offering a less expensive educational
experience focused on occupational training. By and large,
however, the industry had not achieved this objective. By the
early 2010s, poor student outcomes and high student loan default
rates led to regulatory scrutiny. The federal government began to
enforce punitive performance requirements and cut off funding
to those institutions whose graduates could not find well-paying
jobs. These actions led to the collapse of several companies in
the industry, such as ITT Educational and Corinthian Colleges.
Meanwhile, the survivors experienced precipitous declines in
revenue and profits. In the case of Strategic Education (formerly
Strayer Education), one of the largest for-profit education
companies in the United States whose history dates back to
1892, operating margins, which exceeded 35 percent prior to the
change, fell into the teens. The company’s stock price declined
from a high of $254 in April 2010 to a low of $34 in December
2013 (see Exhibit 3).
Since mid-2015, Strategic Education made a series of
changes to reposition itself for durable growth, based on a
business model that contributes to positive societal change. The
company reduced tuition rates to increase affordability.10 It made
investment in machine learning and artificial intelligence to lower
its costs and improve student outcomes, passing on the savings
as lower tuition.11 It also increased its efforts to measure student
outcomes and take the learnings to foster continuous innovation
in the education experience. Recently, it merged with Capella
University—an online graduate school education company—to
build scale and further its competency-based learning. Strategic
Education has also expanded non-degree educational offerings
for employed workforce members, with corporate partnerships
representing approximately a quarter of enrollment and growing.12
Subsequently, student experience and retention improved,
leading to higher unit economics. Operating margins and profits
increased. In 2018 alone, enrollment at Strayer University increased
by 8 percent to nearly 48,000 students while the continuation
rate and number of students completing the requirements for
graduation also rose.13 Importantly, the company has positioned
itself as a contributor to positive social outcomes by improving
education and training for students and adults at lower cost.
IncoRPoRatIng stakeholdeR conceRns
The examples of AES and Strategic Education illustrate how some
companies can benefit from a foundational shift in their business
model to explicitly address stakeholder concerns, leading to more
sustainable long-term economics. In some cases, it requires that
management and the board be amenable to collaborating with
stakeholders to determine how to achieve those changes or with
a significant shareholder to champion this decision among the
broader shareholder base. Ultimately, certain incumbents whose
industry faces significant environmental or social challenges can
create value and generate returns by more centrally focusing on
addressing those challenges.
Why thiS MatterS
1. The examples included in this Closer Look involve companies
that appear to have a long-term investment horizon and are
willing to bear the cost of an up-front investment in order to
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4Stanford CloSer looK SerieS
increase long-term value. How prevalent are companies with a
long-term perspective? How many companies miss long-term
opportunities because they are excessively focused on short-
term profits? If many, what does this say about the quality of
corporate governance and board oversight in companies today?
2. This Closer Look offers two case studies of companies
transitioning “beyond ESG” to solve global problems. Both are
traditional businesses whose executives and board members
recast their business models to try to solve environmental and/
or social problems and improve long-term profit opportunities.
How widespread are such opportunities? Can every company
achieve such a transition and do so profitably? If not, what
factors determine whether a company has such an opportunity?
3. The approach described in this Closer Look suggests that
opportunities exist for investors to earn competitive risk-
adjusted returns with a favorable ESG focus. How large is this
opportunity? How does this compare to the total universe of
publicly traded companies?
1 An externality is the cost of a commercial activity that is not incorporated in the cost of goods or services provided and is borne by third parties.
2 BlackRock, “Larry Fink’s 2018 Letter to CEOs: A Sense of Purpose,” available at: https://www.blackrock.com/corporate/investor-relations/2018-larry-fink-ceo-letter.
3 Implicit in this argument is the practical consideration that by embracing broad stakeholder objectives corporations can forestall costs, such as those due to regulations that politicians will impose on them to satisfy the demands of their constituents. See Martin Lipton, Steven A. Rosenblum, Sabastian V. Niles, Sara J. Lewis, and Kisho Watanabe, in collaboration with Michael Drexler, “The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors to Achieve Sustainable Long-Term Investment and Growth,” World Economic Forum (September 2016).
4 For example, it would require an accurate measure of the extent to which short-termism is actually prevalent in corporate decision making today, the time horizon of institutional investors (perhaps as a proxy the stock market) and the impact this has on corporate decision making, the extent to which corporate managers take into account (or ignore) the needs of employee and non-employee stakeholders, the cost (or benefit) of including stakeholder considerations in decision making, and the reduction in financial returns (if any) that investment professionals are willing to accept in pursuit of ESG objectives. Some research finds that companies that embrace ESG principles perform better, although the results are mixed. Lins, Servaes, and Tamayo (2017) find that during the financial crisis, high-ESG firms experienced greater returns, profitability, growth, and sales per employee relative to low-ESG firms. Deng, Kang, and Low (2013) look at value creation from mergers, showing that high-ESG acquiring firms experience significantly more positive returns from acquisitions than low-ESG firms. Ferrell, Liang, and Renneboog (2016) provide evidence that well-governed firms that suffer less from agency concerns engage more in ESG activities, and that a positive relation exists between ESG and firm value. However, Margolis, Elfenbein, and Walsh (2011) find, in a meta-analysis of 251 studies from 1972 to 2007, that the “overall average effect [of ESG…] across all studies is
statistically significant, but on an absolute basis it is small.” For a review of the research literature, including these papers, see David F. Larcker and Brian Tayan, “Environmental, Social, and Governance Activities: Research Spotlight,” Stanford Quick Guide Series (March 2019), available at: https://www.gsb.stanford.edu/faculty-research/publications/environmental-social-governance-activities.
5 It is the second-largest source after transportation (29 percent). See U.S. Environmental Protection Agency (2019), Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990-2017.
6 U.S. Energy Information Administration (EIA), “U.S. Electricity Generation by Source, Amount, and Share of Total in 2018,” accessed April 2019.
7 AES, Fourth Quarter & Full Year 2017 Financial Review (February 2018).
8 Base year 2016. AES, Climate Scenario Report (November 2018).9 Ceres press release, “New Disclosure Report from Major Global Power
Company Highlights Shift Toward New Low-Carbon Investments,” (November 13, 2018).
10 Jeff Clabaugh, “Strayer Cuts Tuition by as much as 40 percent,” Washington Business Journal (November 22, 2013).
11 Ari Chanen, “Using Artificial Intelligence and Machine Learning to Improve Student Success,” posted on LinkedIn (January 2, 2018).
12 “4Q18 Strategic Education Inc Earnings Call,” CQ FD Disclosure (March 1, 2019).
13 Strategic Education, 2018 Annual Report.
Brandon Boze is Partner of ValueAct Capital. Margarita Krivitski is Vice President of ValueAct Capital. David Larcker is Director of the Corporate Governance Research Initiative at the Stanford Graduate School of Business and senior faculty member at the Rock Center for Corporate Governance at Stanford University. Brian Tayan is a researcher at the Stanford Graduate School of Business. Eva Zlotnicka is Vice President of ValueAct Capital. Larcker and Tayan are coauthors of the books Corporate Governance Matters and A Real Look at Real World Corporate Governance. The authors would like to thank Michelle E. Gutman and Edward M. Watts for research assistance with these materials.
The Stanford Closer Look Series is dedicated to the memory of our colleague Nicholas Donatiello.
This material is presented for informational or educational purposes only and should not be considered a recommendation of any particular security, strategy or investment product, or as investing advice of any kind. This material is not presented or provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. The content contained herein is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax, and/or legal professional regarding your specific situation. Funds managed by ValueAct Capital Management, L.P. (“ValueAct Capital”) are or were invested in companies referenced in this material. Past performance is not indicative of future results.
This material contains opinions of the authors but not necessarily those of ValueAct Capital or its affiliates. The opinions contained herein are subject to change without notice. Forward-looking statements,
The Business Case for ESG
5Stanford CloSer looK SerieS
estimates, and certain information contained herein are based upon non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but are not assured as to accuracy. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information. The authors of this paper have not sought or obtained consent from any third party to use any statements or information, which are described in this paper as having been obtained or derived from statements made or published by third parties. Any such statements or information should not be viewed as indicating the support of such third party for the views expressed in the white papers. No warranty is made that data or information, whether derived or obtained from filings made with the Securities and Exchange Commission or from any third party, are accurate.
The Stanford Closer Look Series is a collection of short case studies that explore topics, issues, and controversies in corporate governance and leadership. It is published by the Corporate Governance Research Initiative at the Stanford Graduate School of Business and the Rock Center for Corporate Governance at Stanford University. For more information, visit: http:/www.gsb.stanford.edu/cgri-research.
Copyright © 2019 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved.
The Business Case for ESG
6Stanford CloSer looK SerieS
exhiBit 1 — Private Student loan ecoSySteM
Source: ValueAct Capital.
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7Stanford CloSer looK SerieS
exhiBit 2 — aeS Stock Price and MileStoneS
Note: The price of VPU is indexed to September 1, 2017. P/E refers to NTM (next 12 months) price-to-earnings ratio.
Source: CapitalIQ.
1. AES announces investments in energy storage.
2. ValueAct announces investment in AES; joins the board of directors.
3. AES announces cost reduction efforts; carbon intensity reduction target of 50% by 2030.
4. AES commits to adopting recommendations of Task Force on Climate-Related Financial Disclosure.
5. Shareholders voluntarily withdraw resolution requiring climate-risk assessment.
6. AES changes mission statement.
7. AES increases carbon intensity reduction target to 50% by 2022 and 70% by 2030.
1
2
3
4
5
6
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8Stanford CloSer looK SerieS
exhiBit 3 — Strategic education Stock Price vS. Selected coMPetitorS
Source: Center for Research in Security Prices (CRSP) and Yahoo! Finance.
Stanford CloSer looK SerieS
Stanford CloSer looK SerieS 1
By courtney Hamilton, DaviD F. larcker, StepHen a. mileS, anD Brian tayanFeBruary 15, 2019
Where Does human resources sit at the strategy table?
introduction
Two decades ago McKinsey advanced the idea that large U.S.
companies are engaged in “war for talent” and that to remain
competitive they need to make a strategic effort to attract, retain,
and develop the highest-performing executives.1 Since that time,
some companies have pursued this objective by elevating the
importance of the human resources department and broadening
its responsibilities beyond workforce administration to include
strategic talent and organizational issues.2
Studies have examined whether human resource (HR)
departments have succeeded in this transition. For the most
part, the results are negative, suggesting that significant gaps
remain between the potential and actual contribution of HR to
corporate outcomes. For example, research by The Conference
Board and McKinsey finds that “business unit leaders view HR
as lagging in strategic performance relative to transactional
duties,” such as payroll, benefits, and recordkeeping.3 A 2016
study by Development Dimensions International finds that
human resources leaders score below their peers on a variety of
dimensions, including business savvy, financial acumen, and global
acumen.4 KPMG finds that only a third (35 percent) of executives
believes that HR excels in contributing to the company’s people
strategy; only 17 percent believe HR demonstrates the value it
provides to the business; and only 15 percent see HR as able to
provide insightful and predictive workforce analytics.5 A piece
in Harvard Business Review claims that “CEOs worldwide … rank
HR as only the eighth or ninth most important function in a
company.”6
This assessment is reflected in compensation figures.
According to Equilar, chief human resource officers are paid
significantly below their peers in the C-suite, earning on average
a third less in total compensation than chief marketing officers
and general counsel, and half the amounts paid to chief financial
officers.7
The problem, if it exists, might originate at the top of
organizations. A 2013 survey by The Miles Group and the
Rock Center for Corporate Governance at Stanford University
finds that talent development and workplace issues play a very
insignificant part in the performance evaluation and bonus
calculations for CEOs, suggesting that boards do not place the
same weight on human capital as they do on other strategic and
financial objectives.8
Strategic Human reSourceS
To understand the contribution of the human resources
department to company strategy, we surveyed 85 CEOs and chief
human resources officers (CHRO) at Fortune 1000 companies.9
Unlike prior research, we find significant positive assessments of
the role that human resources departments and CHROs play in
strategic planning, workforce development, and company culture.
Of note, we find no discernable difference in the perception that
CEOs and CHROs have in the value of HR to the organization’s
success, which are equally positive.
Ninety-six percent of respondents strongly agree or agree
that the human resources department is vitally important to the
strategic success of their company (see Exhibit 1). Respondents
believe that HR plays a lead role in actively managing company
culture and values (4.6 on a scale of 1 to 5, with 5 indicating “to
a great extent” and 1 indicating “not at all”). They give a similar
assessment (4.6) of the extent to which HR is highly attuned
to employee sentiment, including workplace satisfaction and
negative chatter. To a lesser degree, they believe that HR directly
contributes to the financial performance of the company (4.0).
CEOs and CHROs share a positive assessment of the important
role that the chief human resources officer plays in the senior
management and strategic planning of the organization. Ninety-
four percent of respondents say that the CHRO meets very
frequently or frequently one-on-one or in small groups with the
CEO. Ninety-one percent of respondents say that the CHRO very
frequently or frequently discusses strategic, long-range personnel
issues with the CEO. CEOs and CHROs widely believe that the
CEO relies on the CHRO as a confidant or sounding board to
Strategic Human Resources
2Stanford CloSer looK SerieS
discuss strategic, cultural, or organizational issues (4.4 on a scale
of 1 to 5).
One issue where we found significant disagreement between
the CEO and CHRO is over the role that the human resources
department plays in senior-level discussions about company
culture: 71 percent of CHROs claim that they lead the discussion
on culture, whereas only 36 percent of CEOs believe that the
CHRO leads the discussion. Instead, CEOs say that the chief
human resources officer contributes to the discussion but does
not lead it.
Respondents state that the chief human resources officer
plays an important role in communicating management’s human
capital issues to the board of directors. Eighty-seven percent
say that the CHRO presents succession planning issues to the
board, 80 percent say the CHRO presents on the company’s
talent development efforts, and 78 percent say this executive
presents on the company’s compensation and benefits programs.
Other human capital issues presented to the board include talent
recruitment (60 percent), workplace programs (54 percent),
internal workplace issues (35 percent), and workplace policies (29
percent). That said, the CHRO rarely participates in a company’s
analyst or investor day conferences: only 3 percent of companies
with an analyst or investor day invite the CHRO to present.
Sixty percent of companies in our sample have a formal talent-
development program for senior executives. Among those, the
CHRO plays a prominent role in the program, with 84 percent
of respondents saying that the CHRO leads this program, 9
percent saying that the CHRO participates in but does not lead
the program, and 7 percent saying that the CHRO plays no role in
the management of the program.
CEOs and CHROs report a variety of challenges around
talent development and recruitment at their companies. The
most prominent of these are an insufficient leadership pipeline
(24 percent), difficulty in finding talent (20 percent), and too
much competition for talent (17 percent). Difficulty in developing
talent (11 percent), lack of leadership attention to talent issues
(10 percent), lack of resources for development and recruitment
(6 percent), and difficulty in retaining talent (2 percent) are also
referenced.
CEOs and CHROs are confident in the contribution that the
human resources department makes to the strategic success of
their companies; however, there is some indication of room for
improvement. Only 18 percent rate their company a 5 on a scale
of 1 to 5 when asked to what extent their HR department does
an outstanding job contributing to the strategic success of the
organization. Sixty percent rate the company a 4, and a sizeable
minority assign their companies ratings of 3 (15 percent) and 2 (5
percent). These numbers suggest that while respondents might be
highly favorable of the contribution that the CHRO makes to the
organization and its strategic management, the contribution that
this individual makes might not cascade down through the HR
department as a whole.
Overall, these survey results are surprising in their optimism,
particularly in contrast to the studies cited in the introduction.
While those studies rely on the opinions of a broad set of senior
executives, the survey results here exclusively reflect those of
the CEO and CHRO, suggesting a potentially wide disconnect
between the viewpoints of those expected to lead human capital
management efforts and the rest of the company.
This raises the question of how (and whether) the leaders of
a company—CEO, the senior management team, and the board
of directors—validate the quality and effectiveness of its human
capital strategy.
In a general sense, approving HR strategy is analogous to
approving corporate strategy, including the establishment of
overall objectives for the organization, identifying the steps
necessary to achieving those objectives, establishing targets and
metrics to track progress, and developing the supporting budget.
The CEO and CHRO cannot drive HR strategy alone; each leader
throughout the organization must be aligned and accountable for
prioritizing and delivering against the HR strategy (as they would
corporate strategy). To further reinforce the concept that human
capital is central to the success of corporate strategy, specific
targets should be included in compensation contracts and bonus
targets.
Furthermore, the board of directors plays an important role
in assessing the acceptability of the human capital strategy. This
includes not only advising senior management in HR strategy
development but also challenging the CEO and CHRO to
defend situations where their assessment differs from those of
division heads and the broad base of employees. To facilitate the
discussion, the board should request that management develop
reliable metrics and demonstrate the success or potential areas
to improve its efforts through data pulled from human resource
management systems (HRMS).
For HR strategy to succeed, it needs to be treated more like
corporate strategy, as opposed to an addendum to the board book.
WHy tHiS matterS
1. Two decades after McKinsey coined the term “war for talent,”
there is relatively little evidence that companies have made
tangible progress developing and implementing strategies
Strategic Human Resources
3Stanford CloSer looK SerieS
to compete for human talent. Broadly speaking, have HR
departments grown beyond their historical role of workplace
administrators and compliance specialists to contribute in the
vital area of human capital development?
2. The survey data summarized in this Closer Look indicates that
both CEOs and CHROs are highly positive of the contribution
that the human resources department makes to the strategic
success of the company. However, a variety of observers
claim just the opposite. What role does HR actually play in
the development of corporate strategy? Do they have an equal
voice in this process, or are they junior members of the senior
management team? How directly important is HR to the
financial performance of the company?
3. If human resources is vitally important to the strategic success
of an organization, it should be a key area of interest not only
for management but also for the board of directors. Do boards
see human resources and human capital as critical to corporate
performance? If so, what questions do they ask to ascertain
whether management has the right human capital strategy?
How does the process for developing an HR strategy differ
from that of developing a corporate strategy?
4. Companies are increasingly sophisticated in capturing
information on human capital. How adept are they at using this
data? What data do they review to monitor company progress?
Do they ask the management team to mine data from the
company’s internal systems to gain insight into what programs
and strategies work effectively and why? Are predictive analytic
approaches used by top companies to explore these questions?
5. What type of human capital information should the company
disclose to shareholders and stakeholders? Many voluntary
reports now consist of standard items like voluntary and
involuntary turnover rates, hours of training, expenditures
on human resource programs, and pay differential across
employee gender. How informative are these data about the
quality of the human resources effort?
1 Elizabeth G. Chambers, Mark Foulon, Helen Handfield-Jones, Steven M. Hankin, and Edward G. Michaels III, “The War for Talent,” The McKinsey Quarterly (1998).
2 Prominent institutional investors, such as BlackRock, are also becoming more vocal in prompting their portfolio companies to pay more attention to workforce needs. See BlackRock, “Larry Fink’s 2019 Letter to CEOs: Profit and Purpose,” available at: https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter.
3 The Conference Board and McKinsey & Company, “The State of Human Capital 2012: False Summit,” (2012).
4 Development Dimensions International (DDI), “High Resolution Leadership: A Synthesis of 15,000 Assessments into How Leaders Shape
the Business Landscape,” (2016). See also: Ernst & Young, “The Call for a More Strategic HR: How Its Leaders Are Stepping up to the Plate,” Harvard Business Review (April 24, 2016).
5 HR received the highest marks among these executives for its ability to “manage costs.” See KPMG, “Rethinking Human Resources in a Changing World,” (2016).
6 The viewpoint that human resource officers might not hold the same standing within organizations as other senior executives is suggested in a recent Wall Street Journal article about Goldman Sachs, which explains that in order to reduce the size of the company’s management committee, “executives from nonrevenue divisions such as human resources and legal might be shifted to a broader, less-powerful operating committee.” See Liz Hoffman, “Goldman Sets a New Path—David M. Solomon, Tapped as Next CEO, Will Push for Fresh Sources of Growth,” The Wall Street Journal ( July 18, 2018). See also Ram, Charan, Dominic Barton, and Dennis Carey, “People Before Strategy: A New Role for the CHRO,” Harvard Business Review ( July-August 2015).
7 See Equilar, “View from the Top: Executive Pay Beyond the CEO and CFO,” C-Suite (Winter 2018); Equilar, “CFO Pay Has Remained Stagnant Since 2013,” (October 9, 2018); and Equilar, “Human Resources Executive Pay Trends,” (November 13, 2018).
8 Stanford Graduate School of Business, the Rock Center for Corporate Governance, The Miles Group, “2013 CEO Performance Evaluation Survey,” (2013).
9 Proprietary survey of 85 chief executive officers and chief human resource officers at Fortune 1000 companies, conducted by The Miles Group and Rock Center for Corporate Governance at Stanford University in summer and fall of 2018. Breakdown of respondents: 33 CEOs, 48 CHROs, and 4 undisclosed. For convenience, we refer to the most senior human resource executive at a company as its chief human resource officer, even if this executive has a different title (such as VP, SVP, EVP, or chief people person) or more than one title.
Courtney Hamilton is Managing Director, The Miles Group. David Larcker is Director of the Corporate Governance Research Initiative at the Stanford Graduate School of Business and senior faculty member at the Rock Center for Corporate Governance at Stanford University. Stephen Miles is Chief Executive Officer, The Miles Group. Brian Tayan is a researcher with Stanford’s Corporate Governance Research Initiative. Larcker and Tayan are coauthors of the books Corporate Governance Matters and A Real Look at Real World Corporate Governance. The authors would like to thank Michelle E. Gutman for research assistance with these materials.
The Stanford Closer Look Series is dedicated to the memory of our colleague Nicholas Donatiello.
The Stanford Closer Look Series is a collection of short case studies that explore topics, issues, and controversies in corporate governance and leadership. It is published by the Corporate Governance Research Initiative at the Stanford Graduate School of Business and the Rock Center for Corporate Governance at Stanford University. For more information, visit: http:/www.gsb.stanford.edu/cgri-research.
Copyright © 2019 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved.
Strategic Human Resources
4Stanford CloSer looK SerieS
exHibit 1 — Survey data on Strategic LeveL of Human reSourceS
What prior executive-level experience, if any, does the chief human resources officer have Working in a function
outside of human resources? (select all that apply)
15%
2%
4%
5%
5%
8%
8%
11%
22%
49%
Other
R&D
Accounting or finance
Marketing
Sales
Legal
Technology
Divisional head
Operations
None
to What extent do you agree that the human resources department is vitally important to the strategic success
of your company?
88%
8%
1% 0% 2%
Strongly agree
Agree
Neither agree nor disagree
Disagree
Strongly disagree
Strategic Human Resources
5Stanford CloSer looK SerieS
exHibit 1 — continued
to What extent does the human resources department directly contribute to the financial performance of
your company?
2%
5%
13%
54%
25%
Not at all - 1
2
3
4
To a great extent - 5
to What extent does the human resources department play a lead role in actively managing the company’s
culture and values?
0%
1%
5%
28%
66%
Not at all - 1
2
3
4
To a great extent - 5
Strategic Human Resources
6Stanford CloSer looK SerieS
exHibit 1 — continued
to What extent is the human resources department highly attuned to employee sentiment, including Workplace
satisfaction and negative chatter?
1%
0%
5%
28%
66%
Not at all - 1
2
3
4
To a great extent - 5
hoW frequently does the chief human resources officer meet one-on-one or in small groups With the ceo of
your company?
75%
19%
4%2%
0%
Very frequently
Frequently
Occasionally
Rarely
Never
Strategic Human Resources
7Stanford CloSer looK SerieS
exHibit 1 — continued
hoW frequently does the chief human resources officer discuss strategic, long-range personnel issues With
the ceo?
47%
44%
7%
2% 0%
Very frequently
Frequently
Occasionally
Rarely
Never
to What extent does the ceo rely on the human resources officer as a confidant or sounding board to discuss
strategic, cultural, or organizational issues?
1%
5%
6%
26%
62%
Not at all - 1
2
3
4
To a great extent - 5
Strategic Human Resources
8Stanford CloSer looK SerieS
exHibit 1 — continued
What role does the chief human resources officer play in senior-level discussions about company culture?
3%
9%
52%
36%
0%
0%
29%
71%
Does not participate in discussions.Executes policies.
Contributes somewhat todiscussions
Contributes heavily to discussions
Leads discussions
HRO Respondents CEO Respondents
What information does the chief human resources officer present to the board of directors?
(select all that apply)
25%
29%
35%
54%
60%
78%
80%
87%
4%
Other
Workplace policies
Internal workplace issues
Workplace programs
Talent recruitment
Compensation and benefits
Talent development
Succession planning
Does not present
Strategic Human Resources
9Stanford CloSer looK SerieS
exHibit 1 — continued
does your company have a formal talent development program for senior-level executives?
[if yes] does the chief human resources officer manage this program?
84%
9%
7%
Yes, leads themanagement of this
program
Yes, participates inthe management of
this program
No
What is the single greatest challenge around talent recruitment and development that your company faces?
18%
2%
2%
4%
10%
11%
17%
20%
24%
1%
Other
Difficulty in retaining talent
Lack of sufficient resources for recruitment
Lack of sufficient resources for development
Lack of leadership attention to talent issues
Difficulty in developing talent
Too much competition for talent
Difficulty in finding talent
Insufficient leadership pipeline
None
Strategic Human Resources
10Stanford CloSer looK SerieS
exHibit 1 — continued
What high-level functional skills are most important to your organization’s strategic success over the next
five years? (select all that apply)
16%
16%
28%
31%
33%
35%
38%
40%
41%
47%
51%
55%
60%
69%
84%
Other
Employee or labor relations expertise
Regulatory or legal expertise
Investor relations
Product marketing
Corporate development expertise
Research and development
Sales leadership
Product management
Financial acumen
Engineering or technology expertise
Data analytics
Talent strategy
Strategic planning
Talent recruitment & development
What high-level leadership skills are most important to your organization’s strategic success over the next
five years? (select all that apply)
7%15%
27%34%
38%40%
42%42%44%
46%49%51%
58%62%
68%79%80%
OtherNegotiation
Stakeholder managementCultural awareness
Matrix leadership or leading without authorityGlobal focus
Digital literacyTeam-building
Ability to lead geographically dispersed teamsAbility to inclusively lead diverse teams
Comfort challenging others or the status quoSetting the right tone at the top
Growth expertiseChange management expertise
Ability to drive innovation and disruptionDrives for results
Ability to inspire & motivate
Strategic Human Resources
11Stanford CloSer looK SerieS
exHibit 1 — continued
Source: Proprietary survey of 85 chief executive officers and chief human resource officers at Fortune 1000 companies, conducted by The Miles Group and Rock Center for Corporate Governance at Stanford University in summer and fall of 2018.
What percent of your senior management team Was promoted to their current positions from Within the
company (as opposed to recruited from outside your company)?
28%
40%
16%
15%More than 75%
Between 50% and 75%
Between 25% and 50%
Less than 25%
to What extent do you believe that the human resources department does an outstanding job supporting the
strategic goals of your company?
0%
5%
15%
60%
18%
Not at all - 1
2
3
4
To a great extent - 5
Governance Insights Center
A deeper dive into talent management: the new board imperative
May 2019
Corporate directors have traditionally focused their talent management efforts on the C-suite, leaving oversight of the broader workforce to senior executives. But talent shortages, pressure from investors, and the astonishing pace of business and digital change have made it critical for boards to provide greater oversight of talent management at multiple levels of the organization.
pwc.com/us/governanceinsightscenter
As business transformation continues to drive demand for new skills, directors need to ensure companies have the right talent to execute corporate strategies.
Governance Insights Center
2 | A deeper dive into talent management: the new board imperative
Providing oversight of a company’s top talent has long been a core responsibility of corporate boards. They play a critical role in the hiring and firing of the CEO, evaluate the performance of top executives, develop leadership succession plans and ensure their companies have a robust pipeline of talent to execute company strategy.
Traditionally, directors have focused their talent management efforts on the C-suite, leaving oversight of the broader workforce to senior executives. But many boards have come to understand that a strategy is only as good as a company’s ability to execute it. And strong execution requires talented people at all levels of the organization—particularly when most companies are reinventing themselves to contend with disruption and technological advancements.
These days, the ability to attract, develop and retain the best talent has become a critical business differentiator. Yet it is a challenge. In a recent survey, CEOs cited the low availability of key skills as one of the top three threats to business in 2019.1 As widespread transformation continues to drive demand for workers with new skills,
not having a comprehensive plan for acquiring and developing these workers can hurt a company’s ability to grow and innovate. As a result, boards must play a larger role in ensuring their organizations have the talent they need to execute new strategies.
Rethinking talent
Governance Insights Center
3 | A deeper dive into talent management: the new board imperative
Institutional investors have also begun paying closer attention to talent management. They realize that even a great company strategy can’t go far without the right people to execute it. And so they are urging boards to become more involved in workforce planning and development.
In January 2019, State Street Global Advisors sent a letter to the lead directors of S&P 500 and FTSE-350 companies calling for greater board oversight of culture and talent-related issues. The letter emphasized the connection of these issues to long-term corporate performance.2 BlackRock has also identified human capital management as one of its key engagement priorities, pressing companies to invest in diversity efforts and upskill employees to succeed in increasingly automated work environments.
At the request of the Human Capital Management Coalition (HCMC), a group of 26 institutional investors with aggregate assets of over $3 trillion, the SEC is considering requiring public companies to disclose more information about their human capital management policies and practices.3 Companies now only have to report
Rising investor pressure
Governance Insights Center
4 | A deeper dive into talent management: the new board imperative
their employee headcounts. While some companies already disclose metrics like their employee retention rates as a measurement of their performance, the HCMC is pushing for required disclosure of detailed human capital metrics, such as workforce demographics, skills and capabilities, health and safety, and compensation and incentives.
Amid this rising investor and stakeholder pressure, directors are taking a hard look at talent management at their companies. And they see room for improvement. Nearly half of the directors in PwC’s 2018 Annual Corporate Directors Survey say their companies are doing a “poor” or only “fair” job of developing a diverse pool of executive talent. And roughly one-third say they are missing the mark on recruiting a diverse workforce and addressing gender-related pay differences.4 These are important issues given the research showing that diversity in the workforce leads to greater innovation, better decision making and stronger company performance.5
Needs improvement
Directors say management needs to do a better job of:
Developing diverse executive talent
Recruiting a diverse workforce
Recognizing and addressing gender pay disparity
Source: PwC, 2018 Annual Corporate Directors Survey, October 2018.
Governance Insights Center
5 | A deeper dive into talent management: the new board imperative
Taking on a more substantive talent management oversight role isn’t easy. It requires boards to strike a balance between acting strategically to ensure the strength of the company without stepping into the role of management. To maintain a healthy balance, here’s what directors should focus on at three levels of an organization:
1. The C-suite. Directors are responsible for selecting and monitoring the performance of the CEO. As part of that responsibility, the board needs to hold the CEO and other C-level executives accountable for company performance on talent management. This has become even more important as CEO tenure has fallen to a median of five years, down from six years in 2013.6 As tenures get shorter, CEOs are under more pressure to deliver short-term results. Tackling longer-term initiatives such as upskilling the workforce and increasing diversity become even more challenging. So, boards must demand that talent development remains a top management priority despite the pressure to meet shorter-term performance targets.
Three steps to broader board oversight
They can do this by requiring top executives to:
• Achieve strategic talent management objectives
• Uphold healthy and ethical corporate values to set the right tone at the top
• Model desired workplace behaviors
• Create a diverse and inclusive culture
2. Up-and-comers. Boards need to ensure the company has a strong talent pipeline for all C-suite functions. They can do this by using a “C-Suite Readiness Chart” (refer to chart on pg. 6) that identifies senior executives who could assume those positions now, as well as in one to five years in the future. In the meantime, they should take steps to get to know and assess the capabilities of these high performers by:
• Having them present to the board on major initiatives
• Assigning them to work on special board projects
• Inviting them to board dinners and other social events
Governance Insights Center
6 | A deeper dive into talent management: the new board imperative
3. Middle management. Getting to know middle managers is particularly difficult for board members. At this level, the board can provide oversight by gaining an understanding of the organization’s talent philosophy, culture and talent needs for the future. This includes:
• Reviewing talent retention strategies and compensation programs to ensure they address issues like gender equity and diversity and inclusion
• Reviewing metrics that indicate whether the culture aligns with company strategy
• Asking how management plans to address current and future skills gaps created by the adoption of artificial intelligence, machine learning, big data, advanced analytics, cloud technology and automation
Ready 3-5 Years
Chief Financial Officer
[name]SVP, Accounting
[name]VP, FP & A
[name]VP, Treasury
[name]VP, Investor Relations
[name]VP, Tax
Ready Now
Fran SmithBrian Bowman
External Hire Barbara BoulderTom Holder
Re-Organize Evan JonesGlenn Martinez
Ed North Kwame GoldTim Anderson
Tim Bridges Fran Smith
Rich O’Hara Rebecca ChamberlainMike Devlin
David BraunDorothy Hertzel
Ready 1-3 Years
Sample C-Suite readiness chart
Source: National Association of Corporate Directors, Talent Development: A Boardroom Imperative, October 2013.
Governance Insights Center
7 | A deeper dive into talent management: the new board imperative
Board oversight in action
Board efforts to ensure a company’s talent management efforts align with corporate strategy are best supported by three tools: 1. Data. In today’s data-driven world, understanding and monitoring key metrics can help board members spot warning signs and make better informed decisions. A review of talent management-related key performance indicators (KPIs) can identify red flags and opportunities for improvement. Helpful data points include: • High turnover and high-performer
departure rates
• Unfavorable exit interviews (particularly those of high-performing employees)
• Positions that remain unfilled for long periods
• Succession plan success (number of times a plan has been established, but management ultimately hires someone else)
• Low employee engagement scores
• Lack of progress on diversity and inclusion efforts
• Whistleblower complaints and lawsuits involving HR issues such as harassment and discrimination
2. First-hand information. Aside from data, directors benefit from exposure to employees from as many levels of the organization as possible. Paying attention to employee sentiment and behaviors can identify areas of strength or concern. This can be done by:
• Getting a sense of the tone at the top through observation and the use of quantitative metrics
• Observing interactions between management team members during board presentations to identify potentially unhealthy dynamics, such as top executives seeming wary of being candid
• Interacting with employees below the C-suite during social events, site visits and board programs
• Using the company’s products and services to interact with frontline employees and get a sense of its customer service style
• Reviewing employee engagement surveys and requesting reports and presentations on corporate culture
Governance Insights Center
8 | A deeper dive into talent management: the new board imperative
3. Accountability. Focus from the board can ensure that developing and managing talent is one of a company’s top priorities. Directors should consider five actions as they broaden their roles to provide greater oversight:
• Assign talent management responsibility to either the full board or a dedicated committee so everyone understands their roles and responsibilities. Talent oversight is typically considered a full-board responsibility with committees overseeing the talent aspects associated with their areas of oversight.7 However, some boards assign responsibility to a designated committee. For example, 20% of public companies have expanded the purview of their compensation committees to include leadership and talent management.8
• Incorporate talent into strategy discussions. When assessing the viability of strategic initiatives, directors sometimes focus on the financial implications of these decisions without discussing whether the company has the right people to execute them. One way directors can ensure that talent receives greater consideration in strategy discussions is to request that management include a “talent component” in every new initiative they present to the board.
• Make talent management experience a key selection criteria for new board members and highlight existing capability. Although not every board needs a director
with human resources experience, broader talent management skills can be beneficial. Boards can prioritize recruiting directors who have managed entire divisions or regions to get those with greater talent management experience into their boardrooms. It’s also helpful to highlight this expertise among current directors in the company’s proxy statement. Keep in mind that the “leadership skills” of current and former CEOs can also be characterized as talent development experience, which would clarify for investors the extent to which the board has this expertise.
• Elevate the chief human resources officer (CHRO) to a more strategic role and ask for regular updates. Many companies have elevated their human capital leaders, giving them greater responsibility for overseeing talent development and culture efforts. As a member of the C-suite, the CHRO should have a regular spot on the board’s agenda. Some boards have their CHRO present a talent review to the entire board once a year, with updates as needed.
• Make talent management a KPI for executive compensation. Establishing specific people-development metrics and goals in areas like diversity and inclusion, as well as retention targets for new hires and high-potential performers, can encourage leaders to place greater focus on talent issues. This requires having incentive plans with non-financial goals for the CEO and top executives rather than solely a focus on financial performance.
Governance Insights Center
9 | A deeper dive into talent management: the new board imperative
The shortage of skilled labor, the astonishing pace of business and digital change, and demands from investors are just a few reasons why boards need to shoulder greater oversight responsibility for talent management. While day-to-day development responsibilities should remain with management, directors need to ensure their company’s approach to talent supports the company’s long-term objectives.
When boards and management teams prioritize investing time and resources in human capital development throughout the organization, they are more likely to win the talent wars while becoming more agile, innovative and productive.
Building talent for tomorrow PwC perspective: communicating the board’s talent management approach in the proxy statement
Investors are increasingly interested in how boards approach oversight of talent. As part of providing greater transparency to investors, companies should consider the benefits of disclosing the following information in their annual proxy statements:
• How the board approaches its oversight of talent management
• How often the board discusses talent management issues
• How often these discussions include updates on the company’s diversity and inclusion efforts
• How the board plans for succession beyond the CEO
Governance Insights Center
10 | A deeper dive into talent management: the new board imperative
Overall strategy
1. Do we have a workforce plan that forecasts our talent needs now and three to five years in the future?
2. What’s our strategy for acquiring or developing that talent?
3. What are the challenges to executing on our people strategy?
4. Are we adequately investing in skill development, reskilling, upskilling, job redesign and alternate workforce models to address rapid technology advancements?
5. Does senior leadership recognize the strategic importance of human capital?
6. Does our CHRO have the right level of visibility in the boardroom?
Succession planning
7. How good are we at succession planning and following through on what we’ve decided?
8. Are the executives two to three levels below the C-suite getting the experience and training they need to drive strategy—even completely new strategies?
Diversity and inclusion
9. How are we investing in recruiting, developing and promoting a diverse workforce?
10. What are the results of those efforts?
11. If we don’t have a diverse workforce, have we conducted a root-cause analysis to determine why, and decided how we will address the problem?
12. Should we consider adopting the Rooney Rule of interviewing at least one minority candidate for certain management positions?
Board composition
13. Does the board have sufficient talent management experience? And to what extent have we prioritized this experience when recruiting new directors?
14. In proxy disclosures, are we fully articulating the extent of talent management experience on the board?
15. How should we assign responsibility for talent oversight on the board?
Appendix 1: Talent questions for directors to ask
Governance Insights Center
11 | A deeper dive into talent management: the new board imperative
Advancements in high speed mobile internet and artificial intelligence, along with widespread adoption of big data analytics and cloud technology are forecast to drive business growth from 2018 to 2022.10 As a result, more than half of all employees across all industries will require significant reskilling. With board input, companies will need to make major investment decisions about talent in two areas:
1. Workforce strategy and planning. As technology advancement continues to accelerate, companies are getting the chance to completely rethink what their workforce will look like. The focus is shifting from the jobs to the skills they require to execute their strategies. Which functions will they automate? Which ones will they augment? Which functions can be performed by contingent workers? Which ones will require full-time employees? With more options than
Appendix 2: What directors need to know about the future of work
ever for getting work done, companies need to project how their talent needs will change over time and develop action plans to address them.
2. Continuous learning. People are the main success factor in digital, business model and supply chain transformation projects. Many organizations are deciding whether to acquire the new skills these projects require, or invest in workforce reskilling. How companies approach the potential for widespread unemployment in sectors susceptible to automation could have a major impact on their ability to attract and retain talent. Those that opt to retrain workers to meet the demands of their evolving business models can’t just focus on teaching digital skills. They must also create an environment of continuous learning that cultivates soft skills such as creativity, problem solving and empathy.
How companies will address shifting skills needs by 2022
Hire new permanent staff with skills relevant to new technologies
Look to automate the work
Retrain existing employees
Expect existing employees to pick up skills on the job
Outsource some business functions to external contractors
Hire new temporary staff with skills relevant to new technologies
Hire freelancers with skills relevant to new technologies
Strategic redundancies of staff who lack the skills to use new technologies
84%
81%
72%
65%
64%
61%
54%
46%
Source: World Economic Forum, The Future of Jobs Report 2018, September 2018.
Likely Equally likely Unlikely
Appendix 1: Talent questions for directors to ask
Governance Insights Center
12 | A deeper dive into talent management: the new board imperative
1. PwC, 22nd Annual Global CEO Survey: CEOs’ curbed confidence spells caution, 2019.
2. State Street Global Advisors letter, January 15, 2019.
3. U.S. Securities and Exchange Commission, “Remarks for Telephone Call with SEC Investor Advisory Committee Members,” by J. Clayton. February 6, 2019.
4. PwC, 2018 Annual Corporate Directors Survey, October 2018.
5. McKinsey & Company, Delivering through diversity, January 2018.
6. Equilar, “CEO Tenure Drops to Just Five Years,” January 2018.
7. National Association of Corporate Directors, Talent Development: A Boardroom Imperative, October 2013.
8. Pearl Meyer, “The Board’s Role in Talent and Corporate Culture,” by J. Koors. February 2017.
9. U.S. Securities and Exchange Commission, “Remarks for Telephone Call with SEC Investor Advisory Committee Members,” February 2019.
10. World Economic Forum, The Future of Jobs Report 2018, September 2018.
Endnotes
Contacts
Paula LoopLeader PwC’s Governance Insights [email protected]
Paul DeNicolaPrincipal PwC’s Governance Insights [email protected]
Julia Lamm Director People and Organisation Practice - PwC [email protected]
Marketing:
Christine CareyMarketing Manager PwC’s Governance Insights [email protected]
pwc.com
This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
© 2019 PricewaterhouseCoopers LLP. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network.Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. 564498-2019 fo.
July 6, 2017 William Hinman Director, Division of Corporate Finance Brent J. Fields, Secretary Securities and Exchange Commission 100 F Street, N.E. Washington, DC 20549 Dear Mr. Hinman: The Human Capital Management Coalition (the “HCM Coalition”) respectfully submits this petition for rulemaking pursuant to Rule 192(a) of the Commission’s Rules of Practice.1 As representatives of the HCM Coalition, a group of institutional investors with $2.8 trillion in assets, we request that the Commission adopt new rules, or amend existing rules, to require issuers to disclose information about their human capital management policies, practices and performance.
There is broad consensus that human capital management is important to the bottom line, and a large body of empirical work has shown that skillful management of human capital is associated with better corporate performance, including better risk mitigation. We view effective human capital management as essential to long-term value creation and therefore material to evaluating a company’s prospects.
Requiring disclosure regarding human capital
management would fulfill the Commission’s core mission of investor protection; satisfy Congressional mandates to promote efficiency, competition and capital formation; and serve the public interest, for the following reasons:
• Given the key role of human capital, investors
under current Commission disclosure requirements cannot adequately assess a company’s business, risks and prospects, for investment, engagement or voting purposes, without information about how it is managing its human capital.
• Greater transparency would allow investors to more efficiently direct capital to its highest value use, thus lowering the cost of capital for well-managed companies.
1 Rules of Practice and Rules on Fair Fund and Disgorgement Plans, section 192(a) (Sept. 2016)(available at https://www.sec.gov/about/rules-of-practice-2016.pdf).
2
• Consistent mandatory disclosure standards would obviate the need for issuers to respond to a multitude of investor requests for human capital-related information; make that information easier for all investors to collect and analyze; and level the playing field for investors that are not large enough to demand or otherwise access individualized disclosure.
• There is broad consensus that long-term investing strategies are needed to stabilize and improve our markets and to effect the efficient allocation of capital. Human capital management metrics are precisely the type of information that enables investors to take the long view.
In the last section of this petition, we suggest key
categories of information that we believe are fundamental to furthering investors’ understanding of how well a company is managing its human capital. These categories include: workforce demographics; workforce stability; workforce composition; workforce skills and capabilities; workforce culture and empowerment; workforce health and safety; workforce productivity; human rights; and workforce compensation and incentives.
The HCM Coalition is a collaborative effort among a
global group of institutional investors to further elevate human capital management as a critical component in company performance and in the creation of long-term shareholder value. More information on the HCM Coalition and its members is available here. In the main body of this letter, we provide detailed evidence that supports our belief that human capital is a company’s most valuable asset and that stewarding human capital with that in mind will help to preserve and add value. Human Capital and Value Creation
Over the past several decades, the importance of human capital to corporate value creation has surged. There is broad agreement that human capital encompasses the knowledge, motivation, skills and experience of a company’s workforce, as well as its alignment with the company’s mission and values.2
2 See, e.g., Gary Becker, The Age of Human Capital, at 3 (2002) (“Human capital refers to the knowledge, information, ideas, skills, and health of individuals.”); National Association of Pension Funds, “Where is the Workforce in Corporate Reporting,” at 8 (June 2015)
3
As the global economy has become more knowledge-
intensive and competitive, companies are under increasing pressure to adapt to new technologies and differentiate themselves.3 Human capital is responsible for innovation, as well as effectively managing and carrying out companies’ day to day work—whether that is shelving goods at a store, caring for hospital patients, repairing equipment or investing assets to provide retirement benefits for its employees.
Human capital is thus key to getting and maintaining
competitive advantage. Former Secretary of Labor Robert Reich asserted, “The only unique assets that a business has for gaining competitive advantage over its rivals are the skills and dedication of its employees.”4 One influential finance scholar has characterized human capital as firms’ “most valuable asset.”5 Companies and their leaders recognize the paramount importance of human capital. Global CEOs surveyed by PricewaterhouseCoopers in 2015 identified “availability of key skills” as the second most worrying risk, ahead of geopolitical uncertainty, tax burden and shift in consumer spending and behaviors.6 Kevin Ryan, founder and CEO of Gilt Group, put it this way:
Of all the duties facing a CEO, obsessing over talent provides the biggest return. Making sure that the
(http://www.plsa.co.uk/PolicyandResearch/DocumentLibrary/0439-Where-is-the-workforce-in-corporate-reporting-An-NAPF-discussion-paper.aspx). 3 E.g., Bo Hansson, “Employers’ Perspectives on the Roles of Human Capital Development and Management in Creating Value,” at 7, Apr. 2006 ("As economies continue to become more global and technological change continues to favour the highly educated and skilled, the already-significant role of human capital is likely to increase.”) (http://files.eric.ed.gov/fulltext/ED530787.pdf) 4 https://blogs.oracle.com/oraclehcm/create-great-employee-experiences; see also Michael Adelowotan, "The Significance of Human Capital Disclosures in Corporate Annual Reports of Top South African Listed Companies: Evidence From the Financial Directors and Managers”, Afr. J. Bus. Mgmt., Vol. 7(34), 3248-58 (2013), at 3249 (“Human capital is an asset that can provide a source of sustained competitive advantage because they are often difficult to imitate [citation omitted].”) (http://academicjournals.org/journal/AJBM/article-full-text-pdf/61F9D6E20836). 5 Luigi Zingales, “In Search of New Foundations,” The Journal of Finance, Vol. LV, No. 4, 1623-1653 (Aug. 2000), at 1642-43 (faculty.chicagobooth.edu/luigi.zingales/papers/research/search.pdf). 6 PricewaterhouseCoopers, “18th Annual Global CEO Survey,” at 9 (2015) (http://www.pwc.com/gx/en/ceo-survey/2015/assets/pwc-18th-annual-global-ceo-survey-jan-2015.pdf).
4
environment is good, that people are learning, and that they know we’re investing in them every day—I’m constantly thinking about that, yet I still don’t feel I’m doing enough. If CEOs did absolutely nothing but act as chief talent officers, I believe, there’s a reasonable chance their companies would perform better.7
Materiality of Human Capital Management
The importance of human capital is supported by
decades of research. A large body of empirical work has shown that thoughtful management of human capital is associated with better corporate performance, including risk mitigation.
Research has shown that differences in human capital
management performance can form the basis for successful investment strategies. Studies by Laurie Bassi, former director of research at the American Society for Training and Development, show that stock selection using training and other human capital management practices can produce superior investment outcomes. Two portfolios of large-capitalization companies launched in 2001 and 2003 using criteria related to training and employee development outperformed the S&P 500 on an annualized basis by 3.1% and 4.4%, respectively, through May 25, 2010.8 Four other portfolios launched in 2008, selected using a wider variety of HCM factors including commitment to talent management also outperformed the S&P 500 through May 25, 2010 on an annualized basis to varying degrees, from .1% to 11.9%.9
Similarly, investing in companies identified as desirable workplaces can generate superior returns. A study by Wharton’s Alex Edmans found that investing in a value-weighted portfolio of companies in the Fortune 100 America’s Best Companies to Work For from 1984 through 2009 generated excess risk-adjusted returns of 3.5% per year.10
7 Kevin Ryan, “Gilt Group’s CEO on Building a Team of A Players,” Harvard Business Review, Jan.-Feb. 2012 (available at https://hbr.org/2012/01/gilt-groupes-ceo-on-building-a-team-of-a-players). 8 Laurie Bassi & Dan McMurrer, “Human Capital Management Predicts Stock Prices,” at 1 (June 2010) (http://mcbassi.com/wp/resources/documents/HCMPredictsStockPrices.pdf) (hereinafter, “Bassi & McMurrer Stock Prices”). 9 Bassi & McMurrer Stock Prices, at 1. 10 Alex Edmans, “Does the Stock Market Fully Value Intangibles,” Journal of Financial Economics, Vol. 101, 621-640 (2011), at 621 (http://faculty.london.edu/aedmans/Rowe.pdf).
5
A recent report by the Harvard Law School Pensions and Capital Stewardship Program reviewed 92 studies that measured performance using metrics of value to investors, such as total shareholder return, return on assets, return on capital, profitability and Tobin’s Q.11 The Harvard Report found that in a majority of studies human capital management policies were associated with better financial performance.12
Many academic studies have concluded that
combinations or bundles of policies and practices affect firm performance, and significant attention has been paid to the impact of a “high-performance” or “high commitment” workplace. Although there is no single definition, these are policies and practices designed to reduce turnover, encourage greater employee commitment and motivation and enhance employee skills.
For example, Mark Huselid analyzed a group of high
performance workplace practices and determined that such practices are associated with lower turnover as well as better productivity and firm financial performance. Specifically, the study found that certain combinations of high-performance workplace practices were associated with statistically significant increases in productivity, Tobin’s Q and gross rate of return on capital. 13 Similarly, Huselid and Barry Becker found that high performance workplace practices have a statistically significant positive effect on firm performance.14 More recent scholarship has found that specialized high-performance workplace practices enhanced performance in
11 Aaron Bernstein and Larry Beeferman, “The Materiality of Human Capital to Corporate Financial Performance,” Pensions and Capital Stewardship Project, Labor and Worklife Program, Harvard Law School, Apr. 2015. (http://law.harvard.edu/programs/lwp/pensions/publications/FINAL%20Human%20capital%20Materiality%20April%2023%202015.pdf). 12 Bernstein & Beeferman, at 12. 13 Mark Huselid, “The Impact of Human Resource Management Practices on Turnover, Productivity, and Corporate Financial Performance,” Academy of Management Journal, at 645-47 (1995), at 658-659 (http://www.markhuselid.com/pdfs/articles/1995_AMJ_HPWS_Paper.pdf). 14 Mark Huselid & Brian Becker, “The Strategic Impact of High Performance Work Systems,” at 2 (Aug. 25, 1995) (http://www.bhbassociates.com/docs/articles/1995_Strategic_Impact_of_HR.pdf); see also Brian Becker & Barry Gerhart, "The Impact of Human Resource Management on Organizational Performance: Progress and Prospects,” Academy of Management Journal Vol. 39, No. 4, at 797 (1996) ("In sum, at multiple levels of analysis there is consistent empirical support for the hypothesis that HR can make a meaningful difference to a firm's bottom line.”) (amj.aom.org/content/39/4/779.short?rss+1&ssource=mfr).
6 interdependent work settings by supporting the relationships among roles needed to carry out tasks effectively.15
There is evidence that training can positively affect corporate performance. The Harvard Report reviewed 36 studies, of which 22 found that training was “associated only with superior investment outcomes.”16 Other overviews of studies have found ample evidence that the provision of training or higher training expenditures is linked to better performance on intermediate measures, such as productivity and customer satisfaction, as well as financial performance.17 Some of the studies reviewed measured performance in years subsequent to the years in which training was measured, to address the question of causation. Research by Zeynep Ton, an expert on operations management, suggests one avenue by which training may improve performance in retail. Ton’s research has found that high-performing retailers use cross-training to provide flexibility and address variability in demand—thus better satisfying customers--without resorting to practices like last-minute (“just-in-time”) scheduling and extremely short shifts that lead to higher turnover and lower motivation.18 Ton’s research also showed that cutting labor hours, a common strategy among retailers looking to control expenses, often backfires in the form of reduced profitability. Ton obtained store-level data for over 250 Borders bookstores from 1999 through 2002 and analyzed their spending on labor; she found that increasing labor spending resulted in higher profit margins or, put another way, that increased labor costs 15 Jody Hoffer Gittell et al., “A Relational Model of How High-Performance Work Systems Work,” Organizational Science, Vol. 21, No. 2 (Mar.-Apr. 2010) (http://www.jstor.org/stable/27765979?seq=1#page_scan_tab_contents). 16 Bernstein & Beeferman, at 10. 17 Hansson, at 19-23 ("In one of the few U.S.-based studies that analyzed actual training expenditures, a recent analysis of financial institutions conducted for the American Bankers Association (2004) found that those financial institutions with higher-than-average training expenditures per employee subsequently had better outcomes than other institutions on five key financial measures examined: return on assets, return on equity, net income per employee, total assets per employee, and stock return.”); Laurie Bassi et al., “Profiting From Learning Firm-Level Effects of Training Investments and Market Implications, Singapore Management Review, Vol. 24, No. 3, 61-76 (2002), at 63 (http://home.uchicago.edu/ludwigj/papers/BassiEtal-Singapore-2002.pdf). The author of the first overview noted that few training studies had been done on U.S. companies due to data constraints. 18 Zeynep Ton, The Good Jobs Strategy, 138-148 (2014).
7 generated sales increases large enough to raise overall profitability.19 Understaffing led to “phantom stockouts,” where a product is in the store but cannot be located for the customer, bungled promotions, theft and spoilage.20 Similar conclusions were reached in a study by Vidya Mani and two colleagues, who found systematic understaffing during peak hours at 41 retail stores and estimated that appropriate staffing would improve profitability by 5.74%.21 Managing human capital by treating it solely as an expense to be minimized, then, can depress performance in retail. Employee engagement, which many employers measure, has also been found to have a positive association with firm performance. Definitions of employee engagement vary, but it is generally agreed to include the strength of an employee’s commitment to the employer and the employee’s willingness to expend effort in his or her role.22
The reciprocal nature of employee engagement—its dependence on employer as well as employee commitment—differentiates it from employee satisfaction. Consultant Aon Hewitt has emphasized the need for senior leaders to create a “culture of engagement.”23 As one author put it, “The degree to which employee engagement technology translates into a happier, more productive workforce, however, may depend on company culture and management’s willingness to examine and act on its own shortcomings.”24 An analysis of 50 global firms by Towers Watson determined that the average one-year operating margins of companies with low engagement scores trailed those at companies with high “sustainable engagement” scores by 17
19 Ton, at 38-40. 20 Ton, at 40. 21 Vidya Mani et al., “Estimating the Impact of Understaffing on Sales and Profitability in Retail Stores,” Production and Operations Management, Vol. 24, No. 2, 201-218 (2015) (http://public.kenan-flagler.unc.edu/faculty/kesavans/understaffing.pdf). 22 Dinah Wisenberg Brin, “Technology for Employee Engagement on the Rise,” Society for Human Resource Management (Feb. 9, 2016) (https://www.shrm.org/ResourcesAndTools/hr-topics/technology/Pages/Technology-for-Employee-Engagement-Rising.aspx). 23 Aon Hewitt, “2015 Trends in Global Employee Engagement,” at 4 (2015) (http://www.aon.com/attachments/human-capital-consulting/2015-Trends-in-Global-Employee-Engagement-Report.pdf). 24 Gemma Richardson-Smith and Walter Bappert, “Employee Engagement: A Review of Current Thinking,” Institute for Employment Studies, at 14 (2009); Brin.
8 percentage points.25 A 2002 meta-analysis found that higher employee engagement is associated with higher customer satisfaction and loyalty, productivity and profitability, as well as lower turnover.26 Aon Hewitt estimates that a 5% increase in employee engagement leads to a 3% increase in revenue growth the following year.27
A case study by the Human Capital Management Institute (HCMI) found that Jet Blue locations and flights with a higher average “net promoter score”—a measure of how likely an employee is to recommend Jet Blue as an employer (often used in lieu of employee engagement measures)—had higher customer satisfaction and revenue. The HCMI estimated that a 5% increase in net promoter score was associated with a 1% increase in revenue.28
Further, board and workplace diversity has been linked
to financial performance. A growing body of empirical research indicates a significant positive relationship between firm value and the percentage of women and minorities on boards. A 2012 Credit Suisse Research Institute evaluated the performance of 2,360 companies globally over six years and found that companies with one or more women on boards delivered higher average returns on equity, lower leverage, better average growth and higher price/book value multiples.29 A 2015 McKinsey study of 366 companies found that corporate leadership in the top quartile for racial and ethnic diversity were 35 percent more likely to have financial returns above their national industry median.30
Human capital management matters not only when it
confers competitive advantage and improves firm performance. Material risks related to human capital management can 25 Tony Schwartz, “New Research: How Employee Engagement Hits the Bottom Line,” Harvard Business Review, Nov. 8, 2012 (https://hbr.org/2012/11/creating-sustainable-employee.html). 26 James K. Harter et al., “Business-Unit-Level Relationship Between Employee Satisfaction, Employee Engagement, and Business Outcomes: A Meta-Analysis,” Journal of Applied Psychology Vol. 87, No. 2, 268-79 (2002) (www.factorhappiness.at/downloads/quellen/S17_Harter.pdf). 27 Aon Hewitt, at 1. 28 http://www.hcminst.com/casestudy/jetblues-profit-to-engagement-linkage-case-study/. 29 Credit Suisse, “Does Gender Diversity Improve Performance?” Jul. 31, 2012 (https://www.credit-suisse.com/us/en/about-us/research/research-institute/news-and-videos/articles/news-and-expertise/2012/07/en/does-gender-diversity-improve-performance.html) 30 Vivian Hunt, Dennis Layton & Sara Prince, “Diversity Matters,” McKinsey & Company, Feb. 2, 2015 (http://www.diversitas.co.nz/Portals/25/Docs/Diversity%20Matters.pdf)
9 create substantial risks for companies and investors, damaging corporate reputation, generating legal liabilities and undermining relationships with key stakeholders.
Human capital-related risks are not limited to a
company’s direct employees. Major shifts in the organization of work over the past several decades, including the rise of outsourcing, subcontracting, franchising and complex global supply chains, have multiplied those risks. When a company’s products or services are made or provided by its employees, that company has control over the work and, as a general matter, liability for legal violations related to it. As employment relationships are increasingly supplanted by contractual ones, there is a growing concern that the incentives of the company’s contracting partners are not necessarily aligned with those of the company. This misalignment may lead to financial and reputational damage.31
It is not unusual for there to be multiple layers of contractors and subcontractors whose employees produce goods or provide services for a firm and who may be spread out across multiple countries or geographic regions. Generally, the further down the chain one goes, the greater the incentives are to cut corners through nonpayment of owed wages, safety shortcuts and other violations.32 A company’s ability to control how work is performed on its behalf depends on clear performance standards and robust monitoring, enforcement and coordination mechanisms; falling short on any of these can have serious consequences. For example, investigators have concluded that BP’s 2010 Deepwater Horizon explosion and oil spill, which killed 11 workers, cost shareholders billions and released nearly five million barrels of oil into the Gulf of Mexico,33 resulted from, among other things, the lack of hazard assessment coordination between BP and the contractor actually operating the drilling rig.34 31 See, e.g., David Linich, “The Path to Supply Chain Transparency: A Practical Guide to Defining, Understanding, and Building Supply Chain Transparency in a Global Economy,” at 2 (2014) (“The dispersed nature of today’s supply chains creates increasing levels of risk for multinational businesses, making transparency both critical and complex.”) (dupress.deloitte.com/content/dam/dup-us-en/articles/supply-chain-transparency/DUP785_ThePathtoSupplyChainTransparency.pdf) 32 David Weil, “How to Make Employment Fair in the Age of Contracting and Temp Work,” Harvard Business Review, Mar. 24, 2017. 33 Campbell Robertson & Clifford Krauss, “Gulf Spill is the Largest of its Kind, Scientists Say,” The New York Times, Aug. 2, 2010 (http://www.nytimes.com/2010/08/03/us/03spill.html). 34 See U.S. Chemical Safety Board, “CSB Investigation: At the Time of 2010 Blowout, Transocean, BP, Industry Associations, and Government Offshore
10
Candy maker The Hershey Company (Hershey) was
blindsided in 2011 when a subcontractor of a subcontractor of Hershey’s packing facility contractor used an educational travel program to bring foreign students to the U.S. to pack and move heavy boxes. Eventually, the students staged a public walkout to protest working conditions, the deduction of fees and inflated rent from their paychecks and the fact that they were required to continue working at the facility in order to maintain their educational travel visas.35 Hershey, its packing facility contractor Exel, and Exel’s staffing subcontractor SHS all claimed not to know about the students’ plight, since the student workers were provided by yet another subcontractor, raising questions about the adequacy of the firms’ oversight of their staffing providers.36
Evolving norms are calling for more due diligence and
transparency on human capital risks in the supply chain. A 2010 Harvard Business Review article noted, “Consumers, governments, and companies are demanding details about the systems and sources that deliver the goods.”37 Regulators have responded by instituting measures that encourage attention to these risks. In the United Kingdom (U.K.), the Modern Slavery Act requires larger businesses to prepare a “slavery and human trafficking statement” for each fiscal year, confirming that the firm has taken steps to ensure that slavery and human trafficking is not taking place in any of its supply chains and in any part of its own business. The firm can, alternatively, state that it has taken no such steps.38 In California, the Transparency in Supply Chains Act requires that large companies doing business in California disclose their “efforts to eradicate slavery and human trafficking from [their] direct supply chain for tangible goods offered for sale,” Regulators Had Not Effectively Learned Critical Lessons From 2005 BP Refinery Explosion in Implementing Safety Performance Indicators,” July 24, 2012 (http://www.csb.gov/csb-investigation-at-the-time-of-2010-gulf-blowout-transocean-bp-industry-associations-and-government-offshore-regulators-had-not-effectively-learned-critical-lessons-from-2005-bp-refinery-explosion-in-implementing-safety-performance-indicators/). 35 Julia Preston, “Foreign Students in Work Visa Program Stage Walkout at Plant,” The New York Times, Aug, 17, 2011 (http://www.nytimes.com/2011/08/18/us/18immig.html). 36 Dave Jamieson, “Student Guestworkers at Hershey Plant Allege Exploitative Conditions,” The Huffington Post, Aug. 17, 2011 (http://www.huffingtonpost.com/2011/08/17/student-guestworkers-at-hershey-plant_n_930014.html). 37 Steve New, “The Transparent Supply Chain,” Harvard Business Review, Oct. 2010 (https://hbr.org/2010/10/the-transparent-supply-chain). 38 See http://www.legislation.gov.uk/ukpga/2015/30/section/54/enacted.
11 including certification, audits, verification, internal accountability and training.39 Current Lack of Comparable Data on Human Capital Despite the importance of human capital management to company performance, human capital is nearly invisible in the Commission’s disclosure rules. Regulation S-K, which sets forth disclosures required in registration statements and various reports under the integrated disclosure system, contains one item related to human capital: Item 101(c)(xiii), in the “Narrative Description of Business” section, mandates disclosure of the “number of persons employed by the registrant.”40 Companies often make mention of human capital-related risk factors in periodic filings with the Commission; these disclosures, however, tend to be boilerplate, designed to limit liability rather than convey meaningful information about human capital management practices. A study by the Sustainability Accounting Standards Board (SASB) found that more than 40% of all 10-K disclosures on sustainability topics were boilerplate and that lack of standardization limited the utility of the 15% of disclosures that used metrics.41 Boilerplate disclosures are not only unhelpful to investors; there is some evidence that vague risk factor disclosures are construed negatively by the market, leading to higher costs of capital.42
Surveys conducted by environmental, social and governance (ESG) data providers do not solve these problems. Many companies are overwhelmed with disclosure requests and limit their responsiveness, often to the largest investors.43 Even if an investor or data provider asks for uniform 39 Kamala Harris, The California Transparency in Supply Chains Act: A Resource Guide, at I (2015) (oag.ca.gov/sites/all/files/agweb/pdfs/sb657/resource-guide.pdf). 40 https://www.law.cornell.edu/cfr/text/17/229.101. 41 Comment of the Sustainability Accounting Standards Board on “Concept Release: Business and Financial Disclosure Required by Regulation S-K,” dated July 1, 2016 (https://www.sec.gov/comments/s7-06-16/s70616-25.pdf) (hereinafter, “S-K Concept Release”). 42 Ole-Kristian Hope et al., “The Benefits of Specific Risk-Factor Disclosures,” at 11 (Feb. 26, 2016) (“greater specificity in risk factor disclosure reduces the variance uncertainty premium and thus the expected cost of capital”) (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2457045). 43 E.g., Mike Hower, “Could Sustainability ‘Survey Fatigue’ Launch a $1 Billion Industry?” Greenbiz, Apr. 2, 2015 (https://www.greenbiz.com/article/gisr-program-cuts-core-esg-research-and-ratings).
12 information from all companies it surveys, responses may be incomplete, may not adhere to the requested format and may calculate metrics differently, making it difficult to compare companies across industries and markets.
Some companies do not respond to reasonable requests
for information at all, leaving investors few options for recourse. Filing shareholder proposals is one strategy used by investors to encourage companies to report on various risks not captured fully by existing disclosure requirements, but rules limiting the topic and scope of these proposals effectively preclude investors from obtaining comprehensive human capital-related information in this way. For example, a shareholder may request information about human rights risks in the supply chain but proposals addressing other human capital matters, such wages and benefits, are barred, with few exceptions, by the “ordinary business” exclusion in the shareholder proposal rule.44 Recent efforts to place tighter restrictions on shareholder proposals, such as legislation that would dramatically increase the ownership threshold investors must meet to file a proposal, may effectively eliminate this strategy.45
Data acquired by searching websites have similar
shortcomings. Some investors have turned to online social media sources such as Glassdoor, a jobs and recruiting site with a database of millions of employee reviews of companies as well as salary information.46 Reviewers can describe pros and cons of a company, indicate whether they approve of its CEO and critique their employee benefits. Users can also provide information about interviews at companies. Glassdoor data thus have the potential to shed light on companies’ human capital management. Glassdoor reviews are anonymous, though, and thus vulnerable to manipulation by companies seeking to project a positive image. Even assuming all reviews are penned by actual current or former employees, Glassdoor is subject to the same bias as other review sites: 44 E.g., Best Buy Co., Inc. (Mar. 8, 2016) (allowing exclusion on ordinary business grounds of proposal regarding minimum wage, reasoning it dealt with “general compensation matters”); Pilgrim’s Pride Corp. (Feb. 25, 2016) (permitting exclusion on ordinary business grounds of proposal requesting report on certain occupational safety and health matters). 45 See http://www.cii.org/files/issues_and_advocacy/correspondence/2017/Apr%2024%20Letter%20Committee%20on%20Financial%20Services_FINAL.pdf. 46 E.g., Laurie Bassi, “Should You Be Worried About Your Company’s Glassdoor Scores?” Blog Post, Feb. 11, 2016 (http://mcbassi.com/2016/02/11/should-you-be-worried-about-your-companys-glassdoor-scores/).
13 unhappy employees will be more motivated to share their views than happy ones.
Disclosure Requirements Evolve in Response to Investor Needs In sum, investors do not currently have the ability to obtain comparable human capital data from U.S. issuers. But the Commission’s rules are not static; it has broad authority conferred in the Securities Act and Exchange Act to “promulgate rules for registrant disclosure as necessary or appropriate in the public interest or for the protection of investors.”47
Evolving investor needs have led to updates in disclosure requirements. For example, the corporate governance disclosure items, including director qualifications and executive compensation, have been revised to accommodate investors’ increased interest in board accountability and desire for more granular disclosure around executive compensation packages.48 Similarly, the Commission has expanded the events triggering an obligation to disclose on Form 8-K (Current Report) and reduced the number of days registrants have to make those disclosures to keep pace with changing investor expectations.49
The Commission has recognized that current
requirements governing periodic reporting about companies’ businesses and risks are likely outdated. Last year the Commission solicited comments from investors on a wide variety of potential changes to both the substance and format of disclosures as part of its Disclosure Effectiveness initiative.50 Commissioner Kara Stein noted last year: 47 See Securities Act Release No. 10064, “Business and Financial Disclosure Required by Regulation S-K,” at 21-22 & n.50 (Apr. 13, 2016) (available at https://www.sec.gov/rules/concept/2016/33-10064.pdf). 48 See, e.g., “Report on Review of Disclosure Requirements in Regulation S-K,” at 53 (Dec. 2013) (https://www.sec.gov/news/studies/2013/reg-sk-disclosure-requirements-review.pdf); Straka, at 806. 49 See Securities Act Release No. 8400, “Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date” (Mar. 16, 2004) (adopting release) (available at https://www.sec.gov/rules/final/33-8400.htm) and Securities Act Release No, 8106, “Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date” (June 19, 2002) (proposing release) (stating that “investors and the securities markets today demand and expect more ‘real-time’ access to a greater range of reliable information concerning important corporate events that affect publicly traded securities”) (available at https://www.sec.gov/rules/proposed/33-8106.htm). 50 See Securities Act Release No. 10064, supra.
14
What investors want changes. Materiality evolves. It changes as society changes, and it also changes with the availability of new and better data. To achieve effective disclosure, we must understand what is important to today’s investors.51
As discussed below, investors have significant appetite for disclosures regarding human capital management and would use such information to inform their investment and voting decisions in a number of different ways. Investor Demand for Human Capital Data A wide range of investors have shown interest in obtaining information that will enable them to analyze the effectiveness of companies’ human capital management practices. Investor appetite for human capital disclosure should be understood within the larger context of concern over short-termism. In a widely publicized letter to CEOs at S&P 500 companies, BlackRock chief Larry Fink advocated “resistance to the powerful forces of short-termism” and investment in long-term growth. To that end, he urged CEOs to develop a strategic framework for long-term value creation and disclose more about their vision and plans for the future, including how they are “developing [their] talent.”52
Asset manager UBS has tied underinvestment in the workforce to short-termism: “A key reason behind the outperformance of the best places to work seems to lie in the short-/long-term conundrum created by human capital investments – often essential to long-term profit generation, but likely to hurt performance in the short term.”53 As long-term investors, we need to understand the drivers of sustainable value creation and address barriers to efficient capital allocation.
Investor participation in several major initiatives
evidences support for human capital disclosure.54 The U.N.- 51 Speech of Commissioner Kara M. Stein, “Disclosure in the Digital Age: Time for a New Revolution,” May 6, 2016 (available at https://www.sec.gov/news/speech/speech-stein-05062016.html). 52 Matt Turner, “Here is the Letter the World’s Largest Investor, BlackRock CEO Larry Fink, Just Sent to CEOs Everywhere,” Business Insider, Feb. 2, 2016 (http://www.businessinsider.com/blackrock-ceo-larry-fink-letter-to-sp-500-ceos-2016-2). 53 UBS Investment Research, “Corporate Culture: Relevant to Investors?” at 1, Aug. 19, 2013 (http://faculty.london.edu/aedmans/Rowe%20UBS3.pdf). 54 In the interest of brevity, we do not discuss all investor initiatives related to human capital disclosure. A matrix prepared by the Human Capital
15 supported Principles for Responsible Investment (“PRI”) has 1500 signatories with $62 trillion in assets under management who agree to incorporate ESG issues into investment decision making and seek those disclosures from companies in which they invest.55 The PRI’s Employee Relations Group coordinated an investor campaign from 2013-2015 that aimed to enhance human capital management and reporting at 27 global retailers. The group’s steering committee identified core metrics most strongly correlated with firm performance based on empirical research—employee turnover, absences, training and engagement. Subsequently, 24 PRI signatories engaged with the companies. According to the group’s report, the company engagement brought about some improvements, but left “much scope” for further work.56
Investors have also backed the work of SASB to establish
sustainability accounting standards, including standards for human capital reporting. SASB explains its mission as follows:
A new, standardized language is needed to articulate the material, non-financial risks and opportunities facing companies today. These non-financial risks and opportunities that affect corporations’ ability to create long-term value are characterized as “sustainability” issues. Sustainability issues vary by industry because they are closely aligned with business models, the way companies compete, their use of resources, and their impact on society.57
SASB has identified one or more human capital issues as
“material” for accounting purposes for at least some industries in each of its 10 sectors.58 It has characterized human capital as a “cross-cutting” issue.59
Management Institute, reproduced in a publication by the UK’s Pensions and Lifetime Savings Association, identifies additional efforts. Pension and Lifetime Savings Association, “Understanding the Worth of the Workforce: A Stewardship Toolkit for Pension Funds” (July 2016), at 9 (http://www.plsa.co.uk/PolicyandResearch/DocumentLibrary/~/media/Policy/Documents/0591-Understanding-the-worth-of-the-workforce-a-stewardship-toolkit-for-pension-funds.pdf). 55 https://www.unpri.org/about. 56 PRI, “An Investor Guide to Engaging Retailers on Employee Relations,” at 4-5 (2015) (https://www.unglobalcompact.org/library/4071) 57 http://www.sasb.org/sasb/vision-mission/ 58 http://www.sasb.org/materiality/sasb-materiality-map/ 59 www.sasb.org/blog-moving-from-provisional-to-codified-an-update-on-the-consultation-period.
16
SASB’s board of directors includes numerous investor representatives.60 As well, representatives of many large asset managers and owners, including CalPERS, CalSTRS, PGGM, Vanguard, Goldman Sachs, State Street Global Advisors and BlackRock, serve on SASB’s investor advisory group.61
The integrated reporting movement also recognizes the
importance of human capital disclosure to investors. The push for integrated reporting--providing information on all factors that create value, not just traditional measures of financial and physical capital, in one report—is spearheaded by the International Integrated Reporting Council (IIRC). The IIRC is a “global coalition of regulators, investors, companies, standard setters, the accounting profession and NGOs”62 whose board63 and council64 include institutional investor representatives.
The IIRC’s objective is to use integrated reporting—to embed “integrated thinking” within “mainstream business practice in the public and private sectors.”65 The IIRC defines integrated thinking as “the active consideration by an organization of the relationships between its various operating and functional units and the capitals that the organization uses or affects.”66 The benefits the IIRC suggests for integrated reporting include better decision making by providers of financial capital.67
Human capital, defined as “[p]eople’s competencies,
capabilities and experience, and their motivations to innovate,” is one of the six capitals on which disclosure should be made in an integrated report.68 Information about human capital, the IIRC says, needs to be treated with “similar rigour and accountability as is afforded to financial capital.”69
60 http://www.sasb.org/sasb/board-directors/ 61 http://using.sasb.org/investor-advisory-group/ 62 http://integratedreporting.org/the-iirc-2/ 63 http://integratedreporting.org/the-iirc-2/structure-of-the-iirc/the-iirc-board/ 64 http://integratedreporting.org/the-iirc-2/structure-of-the-iirc/council/ 65 The International <IR> Framework, at 2 (2013) (http://integratedreporting.org/wp-content/uploads/2015/03/13-12-08-THE-INTERNATIONAL-IR-FRAMEWORK-2-1.pdf) 66 The Integrated <IR> Framework, at 2. 67 The Integrated <IR> Framework, at 2. 68 The Integrated <IR> Framework, at 4, 12. 69 IIRC, “Creating Value: The Value of Human Capital Reporting,” at 4 (2015) (http://integratedreporting.org/wp-content/uploads/2015/12/CreatingValueHumanCapitalReporting_IIRC06_16.pdf).
17
The Global Reporting Initiative (“GRI”) also illustrates investors’ desire for standardized information about sustainability issues, including human capital. The GRI describes its mission as “help[ing] businesses, governments and other organizations understand and communicate the impact of business on critical sustainability issues such as climate change, human rights, corruption and many others.”70
To that end, the GRI Global Sustainability Standards
Board sets reporting standards,71 which include standards on training, labor/management relations, diversity, freedom of association and collective bargaining and several other subjects relevant to human capital.72 Shareholders sometimes refer to the GRI’s framework in shareholder proposals asking companies to issue a sustainability report.73 In 41 countries, almost 80% of the largest 100 companies issuing sustainability reports use the GRI’s guidelines.74
The international human resources and financial
community are also currently pursuing the development of human capital disclosure standards. A committee of global experts, working under the International Organization of Standardization’s (ISO) directives for standards development are writing a standard called “Guidelines -Human Capital Reporting for Internal and External Stakeholders.” Since November 2015, this working group has aimed “to establish a common global understanding on human capital reporting” to allow stakeholders more easily to “access and derive an understanding of an organization’s human capital and its present and future performance.”75
The Global Unions Committee on Workers’ Capital (“CWC”) recently endorsed the Guidelines on Workers’ Rights
70 https://www.globalreporting.org/information/about-gri/Pages/default.aspx. 71 https://www.globalreporting.org/information/about-gri/governance-bodies/Global-Sustainability-Standard-Board/Pages/default.aspx. 72 https://www.globalreporting.org/standards/gri-standards-download-center/. 73 E.g., http://www.asyousow.org/wp-content/uploads/2013/09/2010-apple-reso.pdf. 74 https://www.globalreporting.org/information/news-and-press-center/Pages/GRI-is-the-global-standard-as-sustainability-reporting-goes-mainstream-says-KPMG-survey.aspx. 75 “Q&A: Professor Stefanie Becker Says Human Capital and Engagement are Worldwide Issues,” undated (available at http://enterpriseengagement.org/newswire/content/8475926/qa-professor-stefanie-becker-says-human-capital-and-engagement-are-worldwide-issues/).
18 and Labour Standards, which recommends, among other things, disclosure of human capital metrics to improve asset owners’ understanding of “company commitments to worker well-being.” These metrics include data on workforce composition, including workers employed by staffing agencies, franchisees and subcontractors; turnover relative to industry; human rights due diligence; leading worker health and safety indicators; and access to training. The CWC is an international labor union network that promotes dialogue and action on the stewardship of workers’ retirement savings and works to educate fund trustees on responsible investment.76
The Pensions and Lifetime Savings Association (the
“PLSA”) recently sent letters to the chair of each company whose stock is a constituent of the FTSE 350 index of large- and mid-capitalization U.K. companies, asking for disclosure of the number of full- and part-time employees, as well as employee turnover. The PLSA’s chief executive Joanne Segars explained, “It's essential that pension funds know more about how the companies, in which they invest, manage and engage their employees. We know that engaged workers make for stronger companies and stronger companies make for better investment returns - creating an economy that works for everyone.”77
Investor Uses for Human Capital Disclosures
Investors are interested in using human capital disclosure for different purposes, depending on their investment strategy. Many investors favor more robust human capital disclosures to permit them to identify and invest in companies that manage their human capital most effectively; for these investors, human capital management is an input for fundamental analysis alongside more traditional inputs like product quality, technological innovation and distribution channels.
Comment letters submitted in response to the
Commission’s Disclosure Effectiveness Concept Release reflect investors’ interest in human capital disclosure. The CFA Institute, an association of investment professionals, stated in its comment letter that investors “want disclosures that help them understand how changes in the business and competitive
76 http://www.workerscapital.org/priorities/. 77 http://www.professionalpensions.com/professional-pensions/news/2476649/plsa-urges-ftse-350-leaders-to-share-more-data-about-workforce.
19 environment, the economy, management, and business drivers will affect company performance . . . . [R]egistrants should provide disclosures on the different types of resources that help them generate revenues, cash and profit . . .[including] human resources.” More specifically, the CFA Institute urged the Commission to require more granular disclosure about the types of employees a company employs, to allow investors “to determine whether a company’s current employees matches the mix of employees that is optimal.”78
Similarly, Cornerstone Capital, an advisory firm with
institutional investor clients, opined that “human capital is a key intangible factor for all companies,” and advocated that companies be required to report their total payroll cost, turnover and diversity data.”79 RPMI Railpen, which invests the 21 billion pounds sterling of assets in the U.K. Railways Pension Scheme, commented that employee engagement and turnover data were highly informative.80
Some investors also view human capital management as an integral part of corporate culture, which investors have regarded as an important indicator of performance but have struggled to define and measure. For example, financial advisor and asset manager UBS has stated that “[c]orporate culture is an important, difficult and likely under-analyzed topic” in which employee engagement and satisfaction play an important role. According to UBS, evaluating culture presents “analytical challenges” due to the paucity of data. Conceding the limitations of the sources, UBS analysts compiled an employee satisfaction index from data on career websites such as Glassdoor, then analyzed employee comments and developed investment themes to identify suitable companies for investment.81 Similarly, according to the National Association of Pension Funds, for long-term investors such as pension funds, information about the workforce is “crucial to understanding a company’s culture.”82
In addition to viewing human capital management as a
criterion for identifying desirable companies in which to invest,
78 Comment of CFA Institute on S-K Concept Release, dated Oct. 6, 2016, at 2-4 (https://www.sec.gov/comments/s7-06-16/s70616-375.pdf). 79 Comment of Cornerstone Capital Group on S-K Concept Release, dated July 21, 2016, at 5 (https://www.sec.gov/comments/s7-06-16/s70616-308.pdf). 80 Comment of Railpen Investments on S-K Concept Release, dated July 21, 2016, at 2-3 (https://www.sec.gov/comments/s7-06-16/s70616-200.pdf). 81 UBS, at 4. 82 National Association of Pension Funds, at 13.
20 investors also want data that will help them avoid material risks created by poor workplace practices and to inform engagements.
The role of disclosure in addressing these risks is
underscored by the U.N. Guiding Principles on Business and Human Rights, which charge companies with respecting human rights throughout their operations.83 The Guiding Principles state that business is responsible for respecting, among other things, the International Labor Organization’s Declaration on Fundamental Principles and Rights at Work--including freedom of association and freedom for discrimination, forced labor and child labor.84 The Guiding Principles favor disclosure of human rights risks; they direct governments to “[e]ncourage, and where appropriate require, business enterprises to communicate how they address their human rights impacts.”85
Investor interest in information about human capital-
related risks is evident from the substantial number of shareholder proposals filed on the limited number of human capital-related topics that are permissible under the shareholder proposal rule, such as human rights risk in the supply chain, workforce diversity and pay equity. According to data from the Sustainable Investments Institute, in 2016 shareholders submitted 96 proposals on “social” subjects, a large proportion of which sought human capital-related disclosure or policy changes. Settlements were reached on some proposals after the company agreed to take action on the proposal.86 BlackRock’s Corporate Governance and Responsible Investment team has intensified its attention to human capital issues, spurred by the belief that human capital can be a source of both competitive strength and risk. BlackRock highlights this commitment in a presentation to a local municipal authority discussing —a four year engagement it undertook with a UK public transport company over employee health and safety and freedom of association, which BlackRock
83 United Nations Office of the High Commissioner on Human Rights, “U.N. Guiding Principles on Business and Human Rights,” at 13 (2011) (http://www.ohchr.org/Documents/Publications/GuidingPrinciplesBusinessHR_EN.pdf). 84 U.N. Guiding Principles, at 13. 85 U.N. Guiding Principles, at 4. 86 See, e.g., As You Sow & Sustainable Investments Institute, “Proxy Preview 2016,” at 36-43 (describing settlements) (http://www.proxypreview.org/proxy-preview-2016/).
21 believed posed reputational and financial risks.87 During the engagement, the company improved its disclosure, reduced employee injuries and accidents and appointed a new executive director with human capital experience. BlackRock predicted that such engagements will become more common, as “companies will become increasingly active in discussing human capital with their investors.”88 For 2017-2018, BlackRock has identified human capital management as an engagement priority.89 Many commenters on the Commission’s Disclosure Effectiveness Concept Release stated that improved human capital disclosure would allow them to avoid investing in companies with high levels of human capital-related risk or to engage risky companies in which they had already invested to advocate improved practices. The following statement in the comment by the Presbyterian Church U.S.A. is an example:
Information about the human rights risks present in a company’s operations and supply chain, as well as the management of those risks, is relevant information for an investor in assessing a company’s performance and management approach in both the short‐ and long‐ term. Poor management of human rights risks can lead to significant reputational, regulatory, and litigation risk for a company and can have a material impact on financial performance.90
Several commenters also pointed to legal liabilities for discrimination and pay inequity, health and safety violations and labor disruptions as material risks related to human capital management practices.91 87 BlackRock presentation to the London Borough of Lewisham, at 8 (February 19, 2015) (http://councilmeetings.lewisham.gov.uk/documents/s33886/BlackRock%20Annual%20Presentation%2019-02-15.pdf) 88 “BlackRock Corporate Governance and Responsible Investment Report: Europe, the Middle East and Africa,” at 10 (June 30, 2015) (https://www.blackrock.com/corporate/en-il/literature/fact-sheet/blk-qtrly-commentary-2015-q2-emea.pdf). 89 See www.blackrock.com/corporate/en-us/about-us/investment-stewardship/engagement-priorities. 90 Comment of Presbyterian Church U.S.A. on S-K Concept Release, dated July 21, 2016, at 7 (https://www.sec.gov/comments/s7-06-16/s70616-290.pdf). 91 See Comment of AFSCME on S-K Concept Release, dated July 21, 2016, at 5 (https://www.sec.gov/comments/s7-06-16/s70616-269.pdf); Comment of Christian Brothers Investment Service on S-K Concept Release, dated July 21, 2016, at 18; Comment of Rockefeller & Co. on S-K Concept Release, dated July 21, 2016, at 2-3.
22 Human capital disclosures can also, to some investors’ thinking, shed light on the quality of upper management and the board’s stewardship of the company; that, in turn, can be relevant to proxy voting decisions. Although proxy voting guidelines generally explicitly mention human capital issues only as they relate to votes on shareholder proposals addressing human capital-related risks, investors and proxy advisors take into account such factors when deciding whether to vote for director nominees.92 In its announcement that human capital management would be a 2017-2018 engagement priority, BlackRock stated that such engagement “also provides a lens into the company’s culture, long-term operational risk management practices and, more broadly, the quality of the board’s oversight.”93 Human capital disclosures may also signal broader challenges facing a company. Coalition member Sycomore Asset Management noted in 2013 an increase in fatal accidents at a French portfolio company reported pursuant to French disclosure requirements. Upon following up with a former safety manager, Sycomore learned that deep budget cuts had led to increased pressure on workers and decided to sell its stake. Shortly thereafter, the share price began to decline, and it remains far below 2013 levels today.94
Investors may also use human capital disclosures for “screening” purposes. They may wish to include in a fund or portfolio only companies with exemplary human capital management practices, or to exclude companies whose practices are viewed as problematic. Human capital disclosures could also enable investors to identify industries or geographic regions to screen in or out. The sustainable, responsible and impact (SRI) investing sector95 has grown tremendously: According to The Forum for Sustainable and Responsible Investment, one out of every six dollars under professional 92 See e.g., Goldman Sachs Asset Management, Global Proxy Voting Policy, Procedures and Guidelines, at 6 (may vote against or withhold support from nominees for “Material failures of governance, stewardship, or fiduciary responsibilities at the company”) (https://www.gsam.com/content/dam/gsam/pdfs/us/en/miscellaneous/voting_proxy_policy.pdf?sa=n&rd=n). 93 See www.blackrock.com/corporate/en-us/about-us/investment-stewardship/engagement-priorities. 94 Email from Claire Bataillie, SRI Analyst, Sycomore Asset Management on Mar. 24, 2017. 95 It is worth noting that responsible investment is not limited to screening, but also includes engagement, which benefits from robust human capital information.
23 management in the U.S. at the end of 2013 was invested using SRI strategies.96 SRI investors applying screens to U.S. companies must rely on voluntary disclosures, with their flaws of incompleteness and inconsistency, and the information researchers can hand-collect from sources like court dockets, news accounts and databases of Occupational Safety and Health Administration violations.97
Human capital management disclosures could also be
used by investment managers to create indexes and investable products. Investment managers are using those types of human capital data that are currently available for that purpose. For example, State Street Global Advisors has created a Gender Diversity Index made up of large capitalization U.S. companies with the highest levels of senior leadership gender diversity in their sectors.98 State Street considers the proportion of women on the board, whether a company has a female CEO and the number of women among senior leadership.99 The JPX (Japan Stock Exchange)/S&P CAPEX and Human Capital Index chooses companies using data from RobecoSAM on capital expenditures and human capital, including labor rights, employee development, employee turnover and talent attraction/retention.100
Finally, robust human capital disclosures would benefit
investors that are “universal owners” by supporting long-term investment strategies, thereby stabilizing our markets, and encouraging employers to invest in their workforces. Universal owners are investors with such widely diversified portfolios that they “effectively own the economy as a whole.”101 As a result, universal owners, including many HCM Coalition members, have “an economic interest in the overall
96 http://www.ussif.org/sribasics. 97 By contrast, in France, where human capital disclosure requirements are more extensive, socially responsible investment firm Sycomore Investments has launched a fund called “Happy@Work”, which uses performance indicators on quality of work life, motivation and empowerment. (http://en.sycomore-am.com/files/P/R/572265a0-PR_Launch_Sycomore_Happy_Work_July2015.pdf) 98 https://www.ssga.com/investment-topics/general-investing/2016/she-gender-diversity-index-introduction.pdf. 99 Julie Segal, “SHE: The ETF That Trades on Female Empowerment,” Institutional Investor, May 12, 2016 (available at http://www.institutionalinvestor.com/inside-edge/3554005/she-the-etf-that-trades-on-female-empowerment.html). 100 http://www.indexologyblog.com/2016/11/03/sustainability-why-does-the-social-category-matter/ 101 Hawley & Williams, at 286.
24 performance of the financial markets and broader economy” in which they invest.102
Human capital disclosure would strengthen both our
financial markets and the U.S. economy. More transparency about human capital management would improve investors’ decision making and lead to more efficient capital allocation.103 And greater transparency, at least in financial reporting, has been found to be economically beneficial.104
As well, disclosure could promote a longer-term
orientation. At present, a variety of factors, including short-term earnings pressures,105 accounting policies106 and compensation structures, create incentives for corporate managers to produce short-term results, which may lead to underinvestment in the workforce, though lack of data impedes
102 Office of the New York City Comptroller, Corporate Governance Principles and Proxy Voting Guidelines, at 7 (Apr. 2016) (http://comptroller.nyc.gov/wp-content/uploads/documents/Corporate_Governance_Principles_and_Proxy_Voting_Guidelines.pdf). 103 See, e.g., Mary E. Barth & Katherine Schipper, “Financial Reporting Transparency,” J. Acctg., Auditing & Fin., Vol. 23, Issue 2, Apr. 2008, at 174 (greater transparency can lower the cost of capital, provided the information “reduces nondiversifiable risk that arises from information asymmetry among investors or increases the average precision of investors’ assessments of the firm’s future cash flows”); see also Securities Act Release No. 10064, supra (“Lowering information asymmetries between managers of companies and investors may enhance capital formation and the allocative efficiency of the capital markets.”). 104 See Barth & Schipper, at 174, 179 (“Research also suggests that financial reporting transparency is associated with positive macroeconomic effects.”) 105 See Dominic Barton & Mark Wiseman, “Focusing Capital on the Long Term,” Harvard Business Review, Jan-Feb. 2014 (citing 2013 study by McKinsey and the Canada Pension Plan Investment Board of 1,000 board members and C-suite executives; 63% reported increasing pressure over the previous five years to generate short-term returns and 79% reported feeling especially pressured to demonstrate strong financial performance over a two-year or shorter period). 106 For example, under Generally Accepted Accounting Principles, research and development (R&D) costs must be expensed in the period when they are made. There is evidence that this immediate impact on earnings leads to manipulation of investment to meet earnings targets. See Stephen J. Terry, “The Macro Impact of Short-Termism,” at 8-10 (2015) (economics.yale.edu/sites/default/files/terry_macrows_mifet_latest_draft.pd_.pdf) (firms that narrowly meet earnings targets lower their investment in R&D and intangibles, “consistent with systematic manipulation of long-term investment to meet analyst forecasts of earnings,” leading to misallocation of R&D across firms).
25 efforts to quantify the extent of underinvestment.107 The influence of financial markets often encourages companies to shift from direct employment to contractual arrangements such as outsourcing, subcontracting and franchising as a way to lower labor costs. Human capital disclosure, which would inform investors about the long-term risks associated with cost-cutting measures, could help counter those forces and promote a longer-term approach for both companies and investors. More stable capital markets and investment in the workforce would in turn benefit the broader public interest, as well as diversified investors. Principles for Crafting Human Capital Disclosure Requirements
Having established the ways in which human capital disclosure requirements would advance the Commission’s mission, we now describe how we believe the Commission should proceed in this area. We have not included in this petition the text of disclosure requirements we believe the Commission should adopt. Instead, we urge the Commission to solicit input from all affected constituencies, with an emphasis on the needs of investors, to identify the matters on which disclosure would be most useful. The Commission has undertaken similar efforts when formulating rule proposals in other complex areas such as executive compensation.
A number of frameworks, including the Integrated
Reporting Framework, SASB’s standards, the Global Reporting Initiative, the CWC Guidelines and the U.N. Guiding Principles on Business and Human Rights, recommend disclosure requirements and can provide a starting point for this process. Some companies, as well, have made high-quality disclosures in particular areas of human capital. For example,108 Diesel & Motor Engineering plc, breaks down its workforce by position, gender and age, and discloses turnover, employee satisfaction scores and average training hours per employee.109 Unilever reports on turnover, training—including
107 Angela Hanks et al., “Workers or Waste?” Center for American Progress, at 5-12 (June 2016) (https://cdn.americanprogress.org/wp-content/uploads/2016/06/03042031/HumanCapital.pdf). 108 These examples are not intended to illustrate comprehensive disclosure on all human capital-related topics but rather to show various approaches the Commission might consider on particular matters. 109 See dimolanka.com/annualreport2014/human-capital.html.
26 within the supply chain, “where the bulk of [our] people work”—accident rates and gender equality.110 Below we set forth our views on some of the larger questions that the Commission will likely need to consider.
First, it may be argued that no human capital management practice or data point is applicable to all issuers, regardless of size, maturity and industry, and that the Commission should therefore not impose any across-the-board disclosure requirements. Although we agree that it may be appropriate to tailor some disclosure requirements more precisely, there is broad agreement that certain categories of information are fundamental to human capital analysis, and some disclosures from each category, whether quantitative or qualitative (or both), should be required (examples, which are not intended to be exhaustive, are in parentheses after each category):
1. Workforce demographics (number of full-time and
part-time workers, number of contingent workers, policies on and use of subcontracting and outsourcing)
2. Workforce stability (turnover (voluntary and involuntary), internal hire rate)
3. Workforce composition (diversity,111 pay equity policies/audits/ratios)
4. Workforce skills and capabilities (training, alignment with business strategy, skills gaps)
5. Workforce culture and empowerment (employee engagement, union representation, work-life initiatives)
6. Workforce health and safety (work-related injuries and fatalities, lost day rate)
7. Workforce productivity (return on cost of workforce, profit/revenue per full-time employee)
8. Human rights commitments and their implementation (principles used to evaluate risk, constituency consultation processes, supplier due diligence)
9. Workforce compensation and incentives (bonus metrics used for employees below the named
110 See www.unilever.com/images/annual_report_and_accounts_ar15_tcm244-478426_en.pdf. 111 The regulation could provide a limited exception for disclosure of workforce composition outside the United States, to the extent that local laws may restrict such disclosure.
27
executive officer level, measures to counterbalance risks created by incentives)
Both specific, rules-based disclosures, such as the amount spent on employee training in the past year, and more open-ended principles-based disclosures like how training expenditures are aligned with a changing business strategy, would provide investors with valuable information about human capital management. The Commission will need to find the appropriate balance between these two approaches when crafting disclosure requirements.
Line-item disclosures are easier to extract through an automated process leveraging keywords or tags because every issuer makes the same disclosure in the same place in a filing using a consistent format. As a result, line-item disclosures are less expensive to collect and thus more accessible to a range of investors. Line-item disclosures can be entered into a database or spreadsheet and thus lend themselves to comparison and analysis. An investor could, for example, examine training expenditures for a particular industry and identify typical industry practice and outliers for further research. Line-item disclosures can be easily analyzed over time, to identify trends.
Investors value consistency and comparability highly.
The CFA Institute argued in favor of uniformity and specificity in its comment on the Commission’s Disclosure Effectiveness Concept Release:
In general, principles-based requirements will have one, some, or all of three primary outcomes. First, issuers will withhold disclosure based on an internal determination that the information is immaterial. Second, issuers will group information in a manner that obfuscates negative performance or conditions. And third, different issuers will apply the “principles” differently, thus making the information incomparable across different issuers. For data-driven disclosures, therefore, we believe the Commission needs to provide prescriptive rules as to what must be reported, the manner in which it is reported, and the assumptions behind the reporting. As noted above, without such prescription, investors may not receive materially important information, may not be aware of material information, and/or they would not be able to compare disclosures across companies or across industries.112
112 Comment of CFA Institute on S-K Concept Release, at 5.
28
Narrative reporting, by contrast, allows companies to
provide a fuller picture and can give investors information they need to put quantitative disclosures into context. An investment researcher interviewed for an IIRC publication put it this way:
In this area there is always going to be a role for more narrative reporting. It is useful to know the staff turnover figure, but you want to know why it is at that level, what the baseline for that industry is. If there has been a move up or down, why that has occurred, has there been a business restructuring or has it been that the staff have become more dissatisfied over the past year?113
In many cases, quantitative and qualitative disclosures will complement each other. Investors have found that to be the case with the Commission’s executive compensation disclosures: Quantitative (and easily retrievable) data allows investors to identify companies where pay practices might be problematic, and the Compensation Discussion and Analysis narrative disclosure supplies important context and explanation for the reported data.
Finally, disclosure requirements should encompass the entire workforce, regardless of location, to provide investors with the most complete picture of an issuer’s human capital management practices. Global coverage is especially important for disclosures regarding human rights, given the increased human rights risks of operating in countries with weaker protections for workers. Including non-U.S. workers would also be consistent with the CEO to average worker pay ratio disclosure requirements taking effect for 2017;114 indeed, the same systems companies will rely on to comply with the CEO to average worker pay ratio disclosure mandate would facilitate data collection and calculation of metrics related to human capital management.
The Commission will need to consider the extent to which disclosure should be made about workers making a company’s products or providing its services pursuant to contractual arrangements between the company and a contractor, franchisee or supplier. In light of the proliferation
113 IIRC, Creating Value, at 24. 114 Securities Act Release No. 9877, “Pay Ratio Disclosure” (Aug. 5, 2015) (https://www.sec.gov/rules/final/2015/33-9877.pdf).
29 of such arrangements, disclosure about the mechanisms used to monitor and enforce performance, and mitigate risks associated with the loss of direct control, would likely be useful for investors.
We appreciate the opportunity to express our views to the Commission. If the Commission or Staff have any questions about this Petition, or if we can provide any additional information, please contact Meredith Miller, Chief Corporate Governance Officer for the UAW Retiree Medical Benefits Trust, at [email protected].
Respectfully submitted,
The Human Capital Management Coalition
On behalf of the Human Capital Management Coalition:
Sincerely,
Meredith Miller, Chief Corporate Governance Officer UAW Retiree Medical Benefits Trusts 734-929-5789 [email protected]
Tags: BlackRock, Board oversight, Boards of Directors, Corporate culture, Diversity, Engagement, Fiduciaryduties, Human capital, Institutional Investors, Management, Shareholder value, Stakeholders, Stewardship,Transparency
More from: Michelle Edkins, BlackRock
Editor's Note: Michelle Edkins is the Managing Director and Global Head of BlackRock Investment Stewardship. Thispost is based on a publication prepared by BlackRock Investment Stewardship.
BlackRock has an industry leading global investment stewardship program that promotes corporate governance bestpractices at the companies in which we invest. This program is part of the investment function at BlackRock, fulfilling ourfiduciary duty to protect and enhance the value of our clients’ assets.
As Larry Fink recently wrote in his 2018 annual letter to CEOs:
Companies must ask themselves: What role do we play in the community? Are we working to create a diverseworkforce? Are we adapting to technological change? Are we providing the retraining and opportunities thatour employees and our business will need to adjust to an increasingly automated world?
For several years, the BlackRock Investment Stewardship (BIS) team has been engaging companies on the topic ofhuman capital which we also identify as one of our 2018 engagement priorities. [1] The BIS team has been in discussionswith companies about their management of employees as an investment issue.
This post sets out in some detail our thinking on human capital management (HCM) and explains how we approachengagement on the topic.
Why Human Capital Management is an Investment Issue
Most companies BlackRock invests in on behalf of clients have, to varying degrees, articulated in their public disclosuresthat they are operating in a talent constrained environment, or put differently, are in a war for talent. It is thereforeimportant to investors that companies explain as part of their corporate strategy how they establish themselves as theemployer of choice for the workers on whom they depend. A company’s approach to HCM—employee development,diversity and a commitment to equal employment opportunity, health and safety, labor relations, and supply chain laborstandards, amongst other things—will vary across sectors but is a factor in business continuity and success. In light ofevolving market trends like shortages of skilled labor, uneven wage growth, and technology that is transforming the labormarket, many companies and investors consider robust HCM a competitive advantage.
Research has consistently shown the importance of human capital to company performance. Companies included inFortune magazine’s “100 Best Companies to Work For” lists earned, over the long-term, excess risk-adjusted returns of3.5%. [2] Another report surveyed a multitude of studies on human capital and found that there is a positive correlationbetween human resource initiatives and investment outcomes such as total shareholder return, return on assets, return onearnings, return on investment and return on capital employed. [3] A survey concluded that companies that had a
Harvard Law School Forum on Corporate Governance and Financial Regulation
BlackRock Investment Stewardship’s Approach to Engagementon Human Capital ManagementPosted by Michelle Edkins, BlackRock Investment Stewardship, on Wednesday, March 28, 2018
workforce that was not engaged had an average one-year operating margin below 10%; however, those that consistentlypromoted workers’ well-being had an average one-year operating margin of 27%.
BlackRock’s Engagement On Human Capital Management
HCM is both a board and a management issue. We would expect a company’s board to be deeply engaged in theoversight of a company’s strategy and the defining of a company’s purpose—to help ensure the effective strategicimplementation of HCM throughout their organization. Companies that can better articulate their purpose are more likelyto build strong relationships with their employees (and customers), and have a clear sense of their strategic objectives.These are essential components of long-term growth. Employees who do not feel valued by their organization aregenerally less productive or more likely to leave. Product quality and reputation can suffer when employees are not fullyengaged and supportive of the company, its business and goals. When present, these dynamics make it much moredifficult for a company to meet its strategic objectives. For management, it is an issue that is central to their everydayduties. We also expect that boards, acting as fiduciaries on behalf of investors and as those who help set the tone at thetop, to be focused on the opportunities and risks associated with HCM.
The BIS team is aware that disclosure of information on HCM is still evolving and that the way HCM risks manifestthemselves may vary by industry and market. We are members of the Investor Advisory Group of the SustainabilityAccounting Standards Board (SASB), which provides industry-specific HCM metrics. We encourage companies to aimover time to go beyond commentaries and provide more transparency on their practices. Investors recognize that mostcompanies are already in possession of HCM data on their workforce, but are cautious of disclosing this information. Webelieve that both qualitative and quantifiable indicators can help effectively distinguish companies that are managing thisimportant driver of value in their business.
Our engagements seek to be constructive, aiming to build mutual understanding while asking probing questions. Wherewe believe a company’s practices fall short relative to market or peer practice, we will share our insights and perspectives.
When engaging boards on HCM we are likely to discuss:
Oversight of policies meant to protect employees (e.g., whistleblowing, codes of conduct, EEO policies) and thelevel of reporting the board receives from management to assess their implementation
Process to oversee that the many components of a company’s HCM strategy align themselves to create a healthyculture and prevent unwanted behaviors
Reporting to the board on the integration of HCM risks into risk management processes
Current board and employee composition as it relates to diversity
Consideration of linking HCM performance to executive compensation to promote board accountability
Board member visits to establishments or factories to independently assess the culture and operations of thecompany
When engaging management teams, the topics we may cover include:
Policies to encourage employee engagement outcomes and key drivers (e.g., wellness programs, support ofemployee networks, training and development programs, and stock participation programs)
Process for ensuring employee health and safety and complying with occupational health and safety policies
Voluntary and involuntary turnover on various dimensions (e.g., seniority of roles, tenure, gender, and ethnicity)
Statistics on gender and other diversity characteristics as well as promotion rates for and compensation gapsacross different employee demographics
Programs to engage organized labor and their representatives, where relevant
Systems to oversee matters related to the supply chain (including contingent workers, contractors andsubcontractors)
Endnotes1 BIS’ 2017-2018 engagement priorities are publicly available on our website athttps://www.blackrock.com/corporate/en-gb/about-us/investment-stewardship/voting-guidelines-reports-position-papers#2017-2018-priorities(go back)
2 Edmans, Alex. “Does the Stock Market Fully Value Intangibles,” Journal of Financial Economics 101 (2011): 621-640.(go back)
3 Bernstein, Aaron and Larry Beeferman, “The Materiality of Human Capital to Corporate Financial Performance,”Pensions and Capital Stewardship Project, Labor and Worklife Program, Harvard Law School, April 2015(go back)
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AI, AUTOMATION, AND THE FUTURE OF WORK: TEN THINGS TO SOLVE FOR
BRIEFING NOTEPREPARED FOR THE TECH4GOOD SUMMIT, ORGANIZED BY THE FRENCH PRESIDENCYJUNE 2018
Automation and artificial intelligence (AI) are transforming businesses and will contribute to economic growth via contributions to productivity. They will also help address “moonshot” societal challenges in areas from health to climate change. At the same time, these technologies will transform the nature of work and the workplace itself—which is the focus of this briefing note. Machines will be able to carry out more of the tasks done by humans, complement the work that humans do, and even perform some tasks that go beyond what humans can do. As a result, some occupations will decline, others will grow, and many more will change. While we believe there will be enough work to go around (barring extreme scenarios), society will need to grapple with significant workforce transitions and dislocation. Workers will need to acquire new skills and adapt to the increasingly capable machines alongside them in the workplace. They may have to move from declining occupations to growing and, in some cases, new occupations. This briefing note, which draws on the latest research from the McKinsey Global Institute, examines both the promise and the challenge of automation and AI in the workplace and outlines some of the critical issues that policy makers, companies, and individuals will need to solve for.
1. Accelerating progress in AI andautomation is creating opportunities forbusinesses, the economy, and societyAutomation and AI are not new, but recenttechnological progress is pushing the frontier ofwhat machines can do. Our research suggeststhat society needs these improvements to providevalue for businesses, contribute to economicgrowth, and make once unimaginable progresson some of our most difficult societal challenges.1
In summary:
Rapid technological progressBeyond traditional industrial automation and advanced robots, new generations of more capable autonomous systems are appearing in environments ranging from autonomous vehicles on roads to automated check-outs in grocery stores.2 Much of this progress has been driven by improvements in systems and components, including mechanics, sensors, and software. AI has made especially large strides in recent years, as machine-learning algorithms have become more sophisticated and made use of huge increases in computing power and of the exponential growth in data available to train algorithms. Spectacular breakthroughs are making headlines, many involving beyond-human
AI, automation, and the future of work:Ten things to solve for 2 McKinsey Global Institute
capabilities in computer vision, natural language processing, and complex games such as Go.
Potential to transform businesses and contribute to economic growthThese technologies are already generating value in various products and services, and companies across sectors use them in an array of processes to personalize product recommendations, find anomalies in production, identify fraudulent transactions, and more. The latest generation of AI advances, including techniques that address classification, estimation, and clustering problems, promises significantly more value still. An analysis we conducted of several hundred AI use cases found that the most advanced deep learning techniques deploying artificial neural networks could account for as much as $3.5 trillion to $5.8 trillion in annual value, or 40 percent of the value created by all analytics techniques.3
Deployment of AI and automation technologies can do much to lift the global economy and increase global prosperity, at a time when aging and falling birth rates are acting as a drag on growth. Labor productivity growth, a key driver of economic growth, has slowed in many economies, dropping to an average of 0.5 percent in 2010–14 from 2.4 percent a decade earlier in the United States and major European economies, in the aftermath of the 2008 financial crisis after a previous productivity boom had waned. AI and automation have the potential to reverse that decline: productivity growth could potentially reach 2 percent annually over the next decade, with 60 percent of this increase from digital opportunities.4
Potential to help tackle several societal “moonshot” challengesAI is also being used in areas ranging from material science to medical research and climate science. Application of the technologies in these and other disciplines could help tackle societal “moonshot” challenges.5 For example, researchers at Geisinger have developed an algorithm that could reduce diagnostic times for intracranial hemorrhaging by up to 96 percent.6 Researchers at George Washington University, meanwhile, are using machine learning to more accurately weight the climate models used by the Intergovernmental Panel on Climate Change.7
Challenges remain before these technologies can live up to their potential for the good of the economy and societyAI and automation still face challenges. The limitations are partly technical, such as the need for massive training data and difficulties “generalizing” algorithms across use cases. Recent innovations are just starting to address these issues. Other challenges are in the use of AI techniques. For example, explaining decisions made by machine learning algorithms is technically challenging, which particularly matters for use cases involving financial lending or legal applications. Potential bias in the training data and algorithms, as well as data privacy, malicious use, and security are all issues that must addressed.8 Europe is leading with the new General Data Protection Regulation, which codifies more rights for users over data collection and usage. A different sort of challenge concerns the ability of organizations to adopt these technologies, where people, data availability, technology, and process readiness often make it difficult. Adoption is already uneven across sectors and countries. The finance, automotive, and telecommunications sectors lead AI adoption. Among countries, US investment in AI ranked first at $15 billion to $23 billion in 2016, followed by Asia’s investments of $8 billion to $12 billion, with Europe lagging at $3 billion to $4 billion.9
2. How AI and automation will affect workEven as AI and automation bring benefits to business and society, we will need to prepare for major disruptions to work.
About half of the activities (not jobs) carried out by workers could be automatedOur analysis of more than 2000 work activities across more than 800 occupations shows that certain categories of activities are more easily automatable than others. They include physical activities in highly predictable and structured environments, as well as data collection and data processing. These account for roughly half of the activities that people do across all sectors. The least susceptible categories include managing others, providing expertise, and interfacing with stakeholders.
3McKinsey Global Institute AI, automation, and the future of work:Ten things to solve for
Nearly all occupations will be affected by automation, but only about 5 percent of occupations could be fully automated by currently demonstrated technologies. Many more occupations have portions of their constituent activities that are automatable: we find that about 30 percent of the activities in 60 percent of all occupations could be automated. This means that most workers—from welders to mortgage brokers to CEOs—will work alongside rapidly evolving machines. The nature of these occupations will likely change as a result.
Jobs lost: Some occupations will see significant declines by 2030Automation will displace some workers. We have found that around 15 percent of the global workforce, or about 400 million workers, could be displaced by automation in the period 2016–30. This reflects our mid-point scenario in projecting the pace and scope of adoption. Under the fastest scenario we have modeled, that figure rises to 30 percent, or 800 million workers. In our slowest adoption scenario, only about 10 million people would be displaced, close to zero percent of the global workforce.10
The wide range underscores the multiple factors that will impact the pace and scope of AI and automation adoption. Technical feasibility of automation is only the first influencing factor. Other factors include the cost of deployment; labor-market dynamics, including labor supply quantity, quality, and the associated wages; the benefits beyond labor substitution that contribute to business cases for adoption; and, finally, social norms and acceptance. Adoption will continue to vary significantly across countries and sectors because of differences in the above factors, especially labor-market dynamics: in advanced economies with relatively high wage levels, such as France, Japan, and the United States, automation could displace 20 to 25 percent of the workforce by 2030, in a midpoint adoption scenario, more than double the rate in India.
Jobs gained: In the same period, jobs will also be createdEven as workers are displaced, there will be growth in demand for work and consequently jobs. We developed scenarios for labor demand to 2030 from several catalysts of demand for work,
including rising incomes, increased spending on healthcare, and continuing or stepped-up investment in infrastructure, energy, and technology development and deployment. These scenarios showed a range of additional labor demand of between 21 percent to 33 percent of the global workforce (555 million and 890 million jobs) to 2030, more than offsetting the numbers of jobs lost. Some of the largest gains will be in emerging economies such as India, where the working-age population is already growing rapidly.11
Additional economic growth, including from business dynamism and rising productivity growth, will also continue to create jobs. Many other new occupations that we cannot currently imagine will also emerge and may account for as much as 10 percent of jobs created by 2030, if history is a guide. Moreover, technology itself has historically been a net job creator. For example, the introduction of the personal computer in the 1970s and 1980s created millions of jobs not just for semiconductor makers, but also for software and app developers of all types, customer service representatives, and information analysts.
Jobs changed: More jobs than those lost or gained will be changed as machines complement human labor in the workplacePartial automation will become more prevalent as machines complement human labor. For example, AI algorithms that can read diagnostic scans with a high degree of accuracy will help doctors diagnose patient cases and identify suitable treatment. In other fields, jobs with repetitive tasks could shift toward a model of managing and troubleshooting automated systems. At retailer Amazon, employees who previously lifted and stacked objects are becoming robot operators, monitoring the automated arms and resolving issues such as an interruption in the flow of objects.12
3. Key workforce transitions and challengesWhile we expect there will be enough work to ensure full employment in 2030 based on most of our scenarios, the transitions that will accompany automation and AI adoption will be significant. The mix of occupations will change, as will skill and educational requirements. Work will need to be redesigned to ensure that humans work alongside machines most effectively.
AI, automation, and the future of work:Ten things to solve for 4 McKinsey Global Institute
Workers will need different skills to thrive in the workplace of the futureAutomation will accelerate the shift in required workforce skills we have seen over the past 15 years. Demand for advanced technological skills such as programming will grow rapidly. Social, emotional, and higher cognitive skills, such as creativity, critical thinking, and complex information processing, will also see growing demand. Basic digital skills demand has been increasing and that trend will continue and accelerate. Demand for physical and manual skills will decline, but will remain the single largest category of workforce skills in 2030 in many countries.13 This will put additional pressure on the already existing workforce skills challenge, as well as the need for new credentialing systems. While some innovative solutions are emerging, solutions that can match the scale of the challenge will be needed.
Many workers will likely need to change occupationsOur research suggests that, in a mid-point scenario, around 3 percent of the global workforce will need to change occupational categories by 2030, though scenarios range from about 0 to 14 percent. Some of these shifts will happen within companies and sectors, but many will occur across sectors and even geographies. Occupations made up of physical activities in highly structured environments or in data processing or collection will see declines. Growing occupations will include those with difficult to automate activities such as managers, and those in unpredictable physical environments such as plumbers. Other occupations that will see increasing demand for work include teachers, nursing aides, and tech and other professionals.
Digital platforms, the gig economy, and the rise of tech-enabled independent workThe rise of digital talent platforms, the gig economy, and tech-enabled independent work are also affecting the future of work. They are already having a transformative effect on some sectors, and they have the potential to help address some of the labor markets’ challenges in matching jobs to workers and in signaling information to prospective employers. At the same time, they challenge some entrenched ways of working and, in some countries, the workings of social systems.
Digital talent platforms create transparency and efficiency in labor markets. Surveys by LinkedIn find that workers using digital platforms are eight times more likely to be at the same company after two years and 11 percent more satisfied than in their previous jobs. By improving worker satisfaction across the economy, these platforms can drive productivity. About 40 percent of respondents to the surveys said digital platforms helped them secure a job they would not have otherwise found. By drawing more people into more formal employment, these platforms can raise labor-force participation. MGI estimates that these effects together could contribute $2.7 trillion to global GDP annually by 2025.1 As automation
1 A labor market that works: Connecting talent with opportunity in the digital age, June 2015.
changes workforce skills, such platforms are becoming part of an essential suite of HR recruiting tools. To harness them, companies will need to take a more strategic look at their talent needs, and adapt their human resources function to align it more clearly with the CEO agenda.2
Digital platforms can also give a boost to independent work. MGI research finds that 20 to 30 percent of the working age population in the United States and the European Union is engaged in independent work, with 70 percent of those doing so out of preference. While only about 15 percent of independent work is conducted on digital platforms now, that proportion is growing rapidly. Independent workers span all demographic groups: about half of senior earners have participated in independent work, and youth make up about a quarter of the independent workforce.3 While those who pursue independent work (digitally enabled or not) out of preference are generally satisfied, those who pursue it out of necessity are unsatisfied with the income variability and the lack of benefits typically associated with traditional work. Policy makers and innovators will need to grapple with solutions to these challenges.
2 Ram Charan, Dominic Barton, and Dennis Carey, Talent wins; The new playbook for putting people first, Harvard Business Review Press, 2018.
3 Independent work: Choice, necessity, and the gig economy, October 2016.
5McKinsey Global Institute AI, automation, and the future of work:Ten things to solve for
Workplaces and workflows will change as more people work alongside machinesAs intelligent machines and software are integrated more deeply into the workplace, workflows and workspaces will continue to evolve to enable humans and machines to work together. As self-checkout machines are introduced in stores, for example, cashiers can become checkout assistance helpers, who can help answer questions or troubleshoot the machines. More system-level solutions will prompt rethinking of the entire workflow and workspace. Warehouse design may change significantly as some portions are designed to accommodate primarily robots and others to facilitate safe human-machine interaction.
Automation will likely put pressure on average wages in advanced economiesThe occupational mix shifts will likely put pressure on wages. Many of the current middle-wage jobs in advanced economies are dominated by highly automatable activities, such as in manufacturing or in accounting, which are likely to decline. High-wage jobs will grow significantly, especially for high-skill medical and tech or other professionals, but a large portion of jobs expected to be created, including teachers and nursing aides, typically have lower wage structures. The risk is that automation could exacerbate wage polarization, income inequality, and the lack of income advancement that has characterized the past decade across advanced economies, stoking social, and political tensions.14
In the face of these looming challenges, workforce challenges already existMost countries already face the challenge of adequately educating and training their workforces to meet the current requirements of employers. Across the OECD, spending on worker education and training has been declining over the last two decades. Spending on worker transition and dislocation assistance has also continued to shrink as a percentage of GDP. One lesson of the past decade is that while globalization may have benefited economic growth and people as consumers, the wage and dislocation effects on workers were not adequately addressed. Most analyses, including our own, suggest that the scale of these issues is likely to grow in the coming decades. We have also seen in the past that large-scale workforce transitions can have a lasting effect on wages; during the 19th century Industrial Revolution, wages in the United Kingdom
remained stagnant for about half a century despite rising productivity—a phenomenon known as “Engels’ Pause,” after the German philosopher who identified it.
4. Ten things to solve forIn the search for appropriate measures and policies to address these challenges, we should not seek to roll back or slow diffusion of the technologies. Companies and governments should harness automation and AI to benefit from the enhanced performance and productivity contributions as well as the societal benefits. These technologies will create the economic surpluses that will help societies manage workforce transitions. Rather, the focus should be on ways to ensure that the workforce transitions are as smooth as possible. This is likely to require more actionable and scalable solutions in several key areas:
� Ensuring robust economic and productivity growth. Strong growth is not the magic answer for all the challenges posed by automation, but it is a pre-requisite for job growth and increasing prosperity. Productivity growth is a key contributor to economic growth. Therefore, unlocking investment and demand, as well as embracing automation for its productivity contributions, is critical.
� Fostering business dynamism. Entrepreneurship and more rapid new business formation will not only boost productivity, but also drive job creation. A vibrant environment for small businesses as well as a competitive environment for large business fosters business dynamism and, with it, job growth. Accelerating the rate of new business formation and the growth and competitiveness of businesses, large and small, will require simpler and evolved regulations, tax and other incentives.
� Evolving education systems and learning for a changed workplace. Policy makers working with education providers (traditional and non-traditional) and employers themselves could do more to improve basic STEM skills through the school systems and improved on-the-job training. A new emphasis is needed on creativity, critical and systems thinking, and adaptive and life-long learning. There will need to be solutions at scale.
� Investing in human capital. Reversing the trend of low, and in some countries, declining public investment in worker training is critical.15
AI, automation, and the future of work:Ten things to solve for 6 McKinsey Global Institute
Through tax benefits and other incentives, policy makers can encourage companies to invest in human capital, including job creation, learning and capability building, and wage growth, similar to incentives for the private sector to invest in other types of capital, including R&D.
� Improving labor market dynamism. Information signals that enable matching of workers to work, credentialing, could all work better in most economies. Digital platforms can also help match people with jobs and restore vibrancy to the labor market. When more people change jobs, even within a company, evidence suggests that wages rise.16 As more varieties of work and income-earning opportunities emerge, including the gig economy, we will need to solve for issues such as portability of benefits, worker classification, and wage variability.17
� Redesigning work. Workflow design and workspace design will need to adapt to a new era in which people work more closely with machines. This is both an opportunity and a challenge, in terms of creating a safe and productive environment. Organizations are changing too, as work becomes more collaborative and companies seek to become increasingly agile and non-hierarchical.
� Rethinking incomes. If automation (full or partial) does result in a significant reduction in employment and/or greater pressure on wages, some ideas such as conditional transfers, support for mobility, universal basic income, and adapted social safety nets could be considered and tested. The key will be to find solutions that are economically viable and incorporate the multiple roles that work plays for workers, including providing not only income, but also meaning, purpose, and dignity.
� Rethinking transition support and safety nets for workers affected. As work evolves at higher rates of change between sectors, locations, activities, and skill requirements, many workers will need assistance adjusting. Many best practice approaches to transition
safety nets are available, and should be adopted and adapted, while new approaches should be considered and tested.
� Investing in drivers of demand for work. Governments will need to consider stepping up investments that are beneficial in their own right and will also contribute to demand for work (e.g. infrastructure, climate change adaptation). These types of jobs, from construction to rewiring buildings and installing solar panels, are often middle-wage jobs, those most affected by automation.
� Embracing AI and automation safely. Even as we capture the productivity benefits of these rapidly evolving technologies, we need to actively guard against the risks and mitigate any dangers. The use of data must always take into account concerns, including data security, privacy, malicious use, and potential issues of bias, issues that policy makers, tech and other firms, and individuals will need to find effective ways to address.
•••
There is work for everyone today and there will be work for everyone tomorrow, even in a future with automation. Yet that work will be different, requiring new skills, and a far greater adaptability of the workforce than we have seen. Training and retraining both midcareer workers and new generations for the coming challenges will be an imperative. Government, private sector leaders, and innovators all need to work together to better coordinate public and private initiatives, including creating the right incentives to invest more in human capital. The future with automation and AI will be challenging, but a much richer one if we harness the technologies with aplomb—and mitigate the negative effects.
This briefing note was written by James Manyika, chairman and director of the McKinsey Global Institute and a senior partner at McKinsey & Company, based in San Francisco; and Kevin Sneader, McKinsey & Company’s global managing partner-elect, based in Hong Kong.
McKinsey Global Institute research reports are available on www.mckinsey.com/mgi.
Further readingDavid Autor, “Why are there still so many jobs? The history and future of workplace automation,” Journal of Economic Perspectives, Summer 2015.
David Autor and Anna Salomons, “Does productivity growth threaten employment?” working paper prepared for ECB Forum on Central Banking, June 2017.
Erik Brynjolffson and Andrew McAfee, The second machine age: Work, progress, and prosperity in a time of brilliant technologies, WW Norton, 2014.
Jason Furman “Should we be reassured if automation in the future looks like automation in the past?” in NBER book The Economics of Artificial Intelligence: An Agenda, Ajay K. Agrawal, Joshua Gans, and Avi Goldfarb, ed., NBER, forthcoming.
Terry Gregory, Anna Salomons, and Ulrich Zierhahn, Racing with or against the machine? Evidence from Europe, Centre for European Economic Research, discussion paper 16-053, July 2016.
William R. Kerr, Allison Ciechanover, and Jeff Huizinga, Managing the future of work, Harvard Business School, May 2018.
Ljubice Nedelkoska and Glenda Quintini, Automation, skills use and training, OECD social, employment and migration working papers, number 202, March 2018.
Endnotes1 Recent MGI reports on automation and the future of work,
including A future that works: Automation, employment, and productivity, January 2017 and Jobs lost, jobs gained: Workforce transitions in a time of automation, December 2017.
2 Disruptive technologies: Advances that will transform life, business, and the global economy, May 2013.
3 Notes from the AI frontier: Insights from hundreds of use cases, April 2018.
4 Solving the productivity puzzle: The role of demand and the promise of digitization, February 2018.
5 Nicola Nosengo, “Can artificial intelligence create the next wonder material?” Nature, May 4, 2016.
6 Mohammad R. Arbabshirani et al., “Advanced machine learning in action: identification of intracranial hemorrhage on computed tomography scans of the head with clinical workflow integration,” npj Digital Medicine, volume 1, article 9, April 2018.
7 Nicola Jones, “How machine learning could help to improve climate forecasts,” Nature, August 23, 2017.
8 Michael Chui, James Manyika, and Mehdi Miremadi, “What AI can and can’t do (yet) for your business,” McKinsey Quarterly, January 2018.
9 Artificial intelligence: The next digital frontier? June 2017.
10 Jobs lost, jobs gained: Workforce transitions in a time of automation, December 2017.
11 Ibid.
12 Nick Wingfield, “As Amazon pushes forward with robots, workers find new roles,” The New York Times, September 10, 2017.
13 Skill shift: automation and the future of the workforce, May 2018.
14 Poorer than their parents? Flat or falling incomes in advanced economies, July 2016.
15 Public spending on labour markets, OECD.
16 A labor market that works: Connecting talent with opportunity in the digital age, June 2015.
17 Independent work: Choice, necessity, and the gig economy, October 2016.
McKinsey Global Institute | Copyright © McKinsey & Company 2018www.mckinsey.com/mgi @McKinsey_MGI McKinseyGlobalInstitute
Employees Rising: Seizing the Opportunity in Employee Activism
01INTRODUCTION
What about employee activists? Are employee activists the next wave that leaders need to be ready for? Who is asking this question?
Management, human resources and communications departments of Fortune 500 companies are rightfully laser-focused on employee satisfaction and engagement. In fact, global research conducted by Weber Shandwick and Spencer Stuart among chief communications officers found that employee satisfaction as a critical metric of communications effectiveness rose dramatically during a five-year span (from 61% in 2007 to 79% in 2012).
Weber Shandwick strongly believes that employee engagement is central to company success and is the underlying foundation for high-performing companies. Yet we also believe that to prepare for the future workforce, employers will need to build upon engagement and acknowledge and embrace employee activism. Employee activists are different — they make their engagement visible, defend their employers from criticism and act as active advocates, online and off. Many employee activists already exist today. Sometimes their activism is stimulated by the employer, but, more often than not, it rises organically out of self-motivation and determination. Employers can’t afford to miss the open window of opportunity to lean in and capitalize on this movement that will only increase in the years ahead.
In Employees Rising: Seizing the Opportunity in Employee Activism, Weber Shandwick explores the employee activist movement to help our clients and other organizations understand what it takes to catch the rising tide of employee activism.
“In today’s environment where there is an alarming lack of trust in all institutions, employees are increasingly the key prism for brand credibility and trust. Engaging them can provide companies the best way to humanize and unify their enterprise voice — a strategic imperative in today’s environment.”
Micho Spring Chair, Global Corporate Practice Weber Shandwick
Social activists. Environmental activists. Consumer activists. Activist shareholders. Today, there is no shortage of activists affecting business operations in some way. These stand-up-for-what-is-right campaigners may either be an employer’s best advocates or its worst opponents. In either case, they are change agents.
Employees Rising: Seizing the Opportunity in Employee Activism Page 2
02HOW WE DID THE RESEARCH
Our survey included a mix of attitudinal and behavioral questions. Employee attitudes were measured on 5-point scales. Conclusions are based on the top scale point of “5” to capture the highest level of intensity of feelings toward and perceptions about employers. Activism was measured
by presenting lists of behaviors that respondents selected, and segmentation modeling identified distinct groups of employees based on these self-reported actions. The specific actions and process of classifying employees is discussed in greater detail later in this report.
Weber Shandwick, in partnership with KRC Research, conducted a global online survey of 2,300 employees. Respondents were between the ages of 18 and 65, worked 30 hours per week or more and were employed by an organization with over 500 employees.
United KingdomFranceGermanyItaly
North America
United States Canada
Latin America
Brazil
Asia Pacific
AustraliaChinaHong KongIndiaIndonesiaJapanSingaporeSouth Korea
Europe
Survey respondents represented 15 markets.
Page 3Employees Rising: Seizing the Opportunity in Employee Activism
03UNREST IN THE WORKFORCE
Employees are in a state of upheaval. More than eight in 10 (84%) have experienced some kind of employer change in the past few years — most typically a leadership change (45%). More than four in 10 (42%) report
undergoing a major event at work, such as a mass lay-off, merger or acquisition and/or crisis. That is a lot of flux for the workforce to handle.
Employees are on the defense. Employers probably don’t know it, but many employees are out there now defending the reputations of their organiza-tions. Nearly six in 10 (56%) respondents surveyed have either defended their employer to family and friends or in a more public venue — such as on a website, blog, or in a
newspaper. These “first responders” are even more prevalent in organizations that experienced a top-tier change event (59%), indicating that employees are rising up to support organiza-tions in time of need. It may also indicate that employees are strongly identifying with their employers.
42%TOP-TIER
CHANGE EVENT
(net)
84%ANY
CHANGE EVENT
(net)
45%
33%
30%
27%
22%
12%
17%
18%
22%
% of employees experienced the following events at their current employers in the past few years
Before we delve into the new wave of employee activism, it is important to understand the challenges facing employees today.
Employees of a Fortune 500 agribusiness started their own blog in reaction to criticism about their company. They debuted the blog by saying, “If anyone should speak to [our company’s] vision of the world, it’s those of us who come to work here every day and collectively make this company what it is…We’re hoping this blog will offer a more personal view of our company.”
Page 4Employees Rising: Seizing the Opportunity in Employee Activism
03 UNREST IN THE WORKFORCE
Employers are not effectively communicating to employees.The research revealed that only four in 10 employees can confidently describe to others what their employer does or what its goals are (42% and 37%, respectively). Fewer than three in 10 report that they are being communicated with, listened to and kept in the loop. Fewer than one in five (17%) highly rate communications from senior management. As expected, immediate supervisors are rated as better communicators than senior leadership but still not as highly as might be assumed.
These weak ratings are not a byproduct of too few communications — employees report that they receive, on average, 4.4 different types of communications from their employers. The general lack of effective employer-to-employee communications is surprising considering how technology has accelerated the proliferation of collaboration and communications tools available to most workforces.
“An engaged employee is a worker who cares about the future and success of his company and therefore is actively involved in what is going on, making a positive contribution.”
— Italian employee
“Listening and responding are leadership skills critical to driving employee engagement. Ultimately, companies that work hard at communicating and listening — from the mailroom to the boardroom — are the ones that win in the workplace and marketplace.”
Andy Polansky CEO, Weber Shandwick
I know enough to explain to others what my employer does 42I understand my employer’s goals 37My manager / supervisor frequently communicates with me 29My employer listens and responds well to customers 28My manager / supervisor listens and responds well to me 26My employer surveys employees every 1-2 years on how well it communicates with employees 26My employer does a good job of keeping me informed 25My employer communicates frequently with employees 24
Top leader 17 Senior leadership just below top leader 17Department head 25Immediate manager/ supervisor 31
% employees highly rate communications from...
Total % (rated 5 on 5-point scale)
% employees completely agree with the following statements
Employers are not effectively communicating to employees
Page 5Employees Rising: Seizing the Opportunity in Employee Activism
03 UNREST IN THE WORKFORCE
Only three in 10 employees are deeply engaged with their employers. How could employers reasonably expect more engagement when the workforce is in upheaval and employees do not feel informed or listened to? This 3-in-10 engagement level the survey uncovered is comprised of nine factors, the highest rated of which is “I put a great deal of effort into my job, doing more than is required” (38%) on down to “I feel a strong connection to my employer” (23%).
While deep engagement — on the whole — is weak, the results show that the workforce is in fact multi-dimensional. As will be seen later in this report, some employee segments are highly engaged and go to great lengths to show it. Some are engaged and need assistance to show it. And some are
highly disengaged and, sadly, show it. That is why we believe that employers should take these findings seriously and look more deeply into their workforce to identify and cultivate groups of employees that can serve as activists for their brands and reputations.
Our analysis identified approximately one in five employees (21%) who feel strongly that they are putting more effort than is required into their job yet do not feel strongly that they are being valued by their employer. This perceptual gap between giving and receiving on the job is a recipe for resentment that impairs engagement.
“Someone who is fully involved in and enthusiastic about their work, and will act in a way that furthers their organization’s interest is what engagement means to me.” — Canadian employee
Employee engagement benchmarks (% employees rated 5 on 5-point agreement scale)
I put a great dealof effort into myjob, doing morethan is required
I care a greatdeal about my
employer’ssuccess
I care a greatdeal about my
employer’sreputation
I am enthusiasticabout the work
I do
I am proud towork for my
employer
I would recommend my
employer to others as a place to work
I am verysatisfied with
my job
I feel valuedas an employee
I feel a strongconnection to my
employer
23%24%26%28%30%33%33%35%38%
30%(average)
Overall % of employees who are deeply engaged
Page 6Employees Rising: Seizing the Opportunity in Employee Activism
04THE BIG BANG: SOCIAL MEDIA’S IGNITION OF EMPLOYEE ACTIVISM
Employees are sharing socially. For many, the divide between work and personal lives barely exists. For employers, the opportunity and challenge is to embrace this new reality and understand what drives employees to be positive activists. While it is not feasible for every company or every sector
to embrace social media as an employee activist enabler, all employers need to be prepared to rally their employee activists and strive to have their supporters outnumber their detractors.
What some employers don’t realize is how critical social media is to employee engagement and how it fuels employee activism. Employees have multiple social platforms on which they can air their likes and dislikes of their jobs, bosses and organizations. While many employers are fearful that their employees will destroy their reputations with one easy click of a social media “share” button, the fact is that we now live in an always-connected-online world that is not going to reverse course.
As business leaders know, the impact of social media on an employer’s reputation is now an everyday reality.
use at least one social media site for personal use
post messages, pictures or videos in social media about employer often or from time-to-time
have shared praise or positive comments online about employer
post messages, pictures or videos about employer in social media often or from time-to-time without any encouragement from employer
have shared criticism or negative comments online about employer
have posted something about employer in social media that they wish they hadn’t
88% 50%
39%
33%
16%
14%
Here are some eye-opening statistics from our research about employees:
According to LinkedIn research, 61% of LinkedIn members who follow your organization are willing to be your brand ambassadors and share your Employee Value Proposition with their networks.
How leaders are using digital communications and modeling that use internally is the next frontier for organizational change.
Page 7Employees Rising: Seizing the Opportunity in Employee Activism
05THE EMPLOYEE ACTIVIST IS NOW AMONGST US
“As employee activists gain numbers and strength, organizations need to be prepared to facilitate the activism of these employees. Internal communications needs to move beyond being company news briefs and alerts to being more content-rich. Company storytelling is not just for external media anymore, it’s a way of ensuring that employees are informed and have something meaningful to say about their employers.”
Kate Bullinger Co-Lead, Global Employee Engagement & Change Management Weber Shandwick
Using segmentation modeling, all respondents were sorted by their reported actions toward their employers — both supporting and detracting actions — to develop deeper, more descriptive and more targetable profiles of the workforce.
This analysis uncovered a sizeable segment of employees — 21%, employee activists — who are all taking positive actions (#1-#9 above) and nearly no negative actions. For a workforce of 5,000, this means that approximately 1,000 employees are enthusiastically letting others know they stand behind their employer.
21%
Employees were asked if they had ever done any of the following:1. Worn clothing or other accessories outside of work
with employer’s name or symbol2. Done volunteer work for a cause employer supports3. Recommended employer to others as a place to work4. Encouraged others to buy company’s products
or services5. Voted for employer in a poll or contest 6. Made positive comments about employer where
others could see or read them 7. Made positive comments about employer to
friends or family
8. Defended employer to family and friends 9. Defended employer where others could see or read it 10. Discouraged others from considering employer as a
place to work11. Discouraged others from buying company’s products
or services12. Made negative comments about employer where
others could see or read them13. Made negative comments about employer to friends
or family
Page 8Employees Rising: Seizing the Opportunity in Employee Activism
06WHAT DRIVES EMPLOYEE ACTIVISM?Our survey also asked respondents to rate their employers on a series of nearly 30 attitudinal statements covering a wide range of organizational qualities from leadership to internal communications to HR (Human Resources) to CSR (Corporate Social Responsibility). Regression analysis determined how much each statement was correlated with the propensity for engagement and activism.
In comparing employee perceptions about each of these drivers in our survey, we find that employers severely underperform. That means that employers have a lot of work to do to improve perceptions if they are to develop additional
activists and fully maximize the activism of current activists. We address these issues later in the report as we identify triggers of employee activism based on targeted employee activist segments.
*These are the top drivers of activism out of 29 items presented to respondents. The Activism Impact Score is the average of all the components in a set of multiple statements about each driver. Only the components that scored above the driver’s average are listed in this table. For each driver, there are many other components, with lower scores, that comprise the average score.
Significantly, we learned that leadership is most important for influencing employee activism, but not to the exclusion of other organizational activities and characteristics. What this means is that leadership plays a critical role in driving employee support, from making the company an employer of choice to building a reputation of trustworthiness and demonstrating that it listens and responds to employees.
By modeling responsiveness, leaders show employees that they value their ideas and intangibles such as reputation and culture. Internal communications, fair treatment of all employees regardless of race, gender, age, sexual orientation or cultural differences, and community responsibility are also not to be overlooked in terms of deepening employee activism.
Employee Activism Driver Top Components of Activism Score* (individual score in parentheses)
Activism Impact Score
Leadership
• Employer values employee ideas and opinions (82)• Leadership makes it a good place to work (80)• Employer has a very good reputation (78)• Leadership is trustworthy (78)• Leadership listens and responds well to employees (76)
75
InternalCommunications
• Employer does a good job of keeping employees informed (81)• Employer communicates frequently with employees (77) 70
HR/EmployeeDevelopment
• Employees have many opportunities to grow and learn (83)• Employer provides training and resources needed to do the job well (77)
70
Corporate SocialResponsibility (CSR)
• Employees are treated fairly regardless of their differences (69)• Employer plays an active role in the community (68)• Employer works to protect and improve the environment (68)
67
Page 9Employees Rising: Seizing the Opportunity in Employee Activism
06 WHAT DRIVES EMPLOYEE ACTIVISM
“Our research proves that leadership has a catalytic impact on employee engagement and willingness to be an ardent employer supporter. In the absence of trust in leadership, and credible and relevant communications from leadership, organizations run the risk of having more detractors than activists.”
Renee AustinCo-Lead, Global Employee Engagement & Change ManagementWeber Shandwick
Although social media is not included in the driver analysis, its force can’t be ignored. Our survey found that one-third of employers — 33% — encourage their employees to use social media to share news and information about the organization. This sounds risky, but this social encouragement has an outsized impact on employer advocacy among employees. For example, employees with socially-encouraging employers are significantly more likely to help boost sales than employees whose employers aren’t socially encouraging (72% vs. 48%, respectively).
Actions employees have ever taken for current employer (% employees who have taken these actions)
Encouraged others to buy company’s
products or services
Recommended employer to others as a place to work
Made positive comments about employer where
others could see or read them
Defended employer to family and friends
Done volunteer work for a cause
employer supports
Defended employer where others could
see or read it
Voted for employer in a poll or contest
72%
28%
54%52%
60%63%68%
55%
48%54%
32%
44%
30%24% 22%
Employer encourages employee use of social media to share news and information about employer* Employer DOES NOT encourage
*All actions are significantly higher than those whose employers don’t encourage brand socialization
“An engaged employee is an active member of the workforce that is part of the team. Knows the business and the values and spreads a positive message. On the look-out for new and innovative ways to do business.” — Australian employee
Page 10Employees Rising: Seizing the Opportunity in Employee Activism
06 WHAT DRIVES EMPLOYEE ACTIVISM
How do these employers encourage their employees to be social stewards?
At a very basic level, they provide the tools and content to enable sharing, but a wide variety of tactics requiring modest investment are also used.
Provide readily accessible tools for employees to use in social media (55%)Provide messages about the employer for employees to use in social media (50%)Provide easy-to-understand guidelines to employees for using social media (42%)Ask employees to stay alert to social media postings about the employer (39%)Provide training for how to use social media properly (37%)Provide access to social media at work (35%)Provide updates about changes in social media so that employees can stay current on the latest tools and uses (35%)Provide employees with one or more social media accounts to use (13%)
How does your employer encourage employees to use social media to share news and information about your work or your employer?
Zappos encourages employees to include company information and opinions on their Facebook, Twitter and personal blogs in addition to their LinkedIn profile. The company even has a Twitter aggregate of all employee twitter feeds. This serves as an excellent word-of-mouth platform for marketing as well as recruitment.
VoiceStorm by Dynamic Signal is a social advocacy platform that gives employees access to sharable messages and content in a convenient and brand-safe environment through a social media hub. Employees are encouraged to engage with this platform by earning points that they can redeem for rewards and employers are reassured that the content meets corporate compliancy guidelines.
Page 11Employees Rising: Seizing the Opportunity in Employee Activism
07THE WORKFORCE ACTIVISM SPECTRUMOur segmentation model identified six distinct segments of employees, including the 21% segment noted earlier who we call ProActivists because of their high engagement and activist profile.
ReActivists Mostly take positive actions but also have a high propensity for detraction. Have an average level of engagement. Are critical of workplace conditions. Highly social.
HyperActives The wildcard of employee activism. Have the most potential to both help and damage employer’s reputation. Half of them have posted something online about their employer that they regret. Are the most engaged next to ProActivists. Two-thirds have a job that entails social media so are highly social.
ProActivists The embodiment of employee activism. Conduct the most positive actions with nearly no negative actions. Have the highest level of employer engagement. Highly social.
21%
26%
7%11%
13%
22%PreActivists All take positive actions but not nearly as many positive actions as ProActivists. Engage in more negative actions than ProActivists. Actions are not as social as those of ProActivists. Have an average level of engagement.
Detractors All take negative actions against their employer. Are the least engaged and are the most distrustful of leadership. Not social so damage is contained offline.
InActives Report little or no employer support or detraction behaviors. Almost as unengaged as Detractors. Are the least likely to put a great deal of effort into their jobs and few can explain to others what their employer does. Little motivates them to do a good job, even pay increases.
Page 12Employees Rising: Seizing the Opportunity in Employee Activism
07 THE WORKFORCE ACTIVISM SPECTRUM
PreActivistsHyperActivesDetractors
ProActivistsPreActivistsDetractors
ProActivistsHyperActivesReActivists
ProActivistsHyperActivesReActivistsInActives
ProActivistsPreActivists
With the exception of Japan, each of the 15 markets in our study has each of these segments (Japan has no HyperActives and few ProActivists). However, some segments are concentrated more heavily in certain markets.
Page 13Employees Rising: Seizing the Opportunity in Employee Activism
08GET TO KNOW THY SEGMENTSThe six employee segments show considerable variation in demographics, employer engagement, job description, employer profile and social media confidence.
ProActivistsHighest employer engagement level
Millennial
University-educated
Executive/managerial
Use social media for work
PreActivistsAverage employer engagement level
Younger Boomers
Least likely to use social media for work
ReActivistsAverage employer engagement level
Millennial
University-educated
Executive/managerial
Work the fewest hours
Use social media for work
Most likely to work for a B2C
Experienced top-tier change event
Often post online about work
Regret posting something about work
Critical of employer’s reputation, diversity practices, training/resources, workplace safety and code of conduct
Lowest employer engagement level
Most likely to be female
Least likely to be Millennial
Least likely to be university-educated
Most likely to have physical/manual job
Longest tenured
Most likely to work for domestic operation
Most likely to have experienced top-tier change event
Least likely to use social media for work
Highly distrustful of employer leadership
Detractors
The chart below points out each segment’s distinctive traits relative to the average employee in our study. It is worth noting that no segment is “all of anything.” These traits are directional skews, not absolutes.
Low employer engagement level
Least likely to be executive/managerial
Least likely to have experienced any kind of change event
Least likely to have a personal social media account
Least likely to use social media for work
Unmotivated to perform well for work, even by pay increases
InActives
HyperActives
High employer engagement level
Most likely to be male
Most likely to be Millennial
Most likely to be university-educated
Most likely to have an executive/managerial or artistic/creative job
Work the most hours
Most use social media for work
Most likely to regret posting something online about work
Work for a multinational
Most likely to work for a B2B
Care more about recognition from top leadership than pay increases
Page 14Employees Rising: Seizing the Opportunity in Employee Activism
08 GET TO KNOW THY SEGMENTS
After a major automobile manufacturer’s reputation for quality took a serious hit because of widespread recalls, the company launched an ad campaign featuring its employees discussing how they personally ensure every vehicle is built to the highest caliber. In describing the campaign, one executive said, “[Our employees’] incredible passion, commitment to quality, safety for our customers is what has built our reputation. We want to show this human face. The real, authentic [company].”
“Millennials work more closely together, leverage right- and left-brain skills, ask the right questions, learn faster and take risks previous generations resisted. They truly want to change the world and use technology to do so.”
Mike MarascoLeader of Northwestern University’s NUvention program, The New York Times, November 9, 2013
A Global Fortune 500 bank experienced reputational damage because of a sensitive employee lay-off in which the CEO was criticized in the media. Coming to the bank’s defense: employees who wanted to know how they could help.
CMO
Employee
What can I do to help?
ProActivists are the employees every leader or manager wants on his or her team because their actions are entirely positive and influential. They are an organization’s brand and reputation champions. They are the most highly engaged segment, with 49% reporting deep engagement, compared to the average 30% for employees overall.
Compared to the average employee in our study, ProActivists are more likely to be Millennials (18-36 years old) and university-educated. However, this is not to suggest they are strictly highly educated Milliennials — 22% do not have a university degree and 39% are GenX or older. They are the most likely of any group to be executives or managers, but not all are (43% vs. global average of 30%). They are the most likely segment to have multiple social media accounts for personal use and are more likely than employees overall to use social media as part of their jobs (these are not, however, all digital or IT jobs; they may be using social media for competitive intelligence, marketing, etc.). Nearly half (46%) report that they often post about work or their employer on social media.
PreActivists have high potential to become ProActivists; impeding their activism is a relatively low level of social media usage, but they are engaged (34%) and predominately positive action-takers offline. As the largest segment representing more than one-quarter of employees (26%), they are worth investing resources in.
Compared to the average employee in our study, PreActivists are slightly more likely to be Younger Boomers (49-58 years old) and are less likely to have a university degree. While they are just as likely to have a personal social media account as employees overall, they are less likely to use social media for their job, which is probably one reason their activism is kept to a close circle of friends and family.
Page 15Employees Rising: Seizing the Opportunity in Employee Activism
08 GET TO KNOW THY SEGMENTS
HyperActives are taking positive actions but their adverse actions are likely negating their positives. Because their negative behaviors don’t reflect their high engagement level (44%), they can alternatively be thought of as “wildcards.”
HyperActives are the most likely of the segments to be men, Millennials and university graduates and to have an executive/managerial or artistic/creative job. They put in the most hours at work of any segment. They are very social media savvy, as 63% of them use social media as part of their jobs. Interestingly, they are more motivated than any other segment by top leadership recognition. Because leadership recognition is slightly more inspiring to them than pay increases, they may be the “ladder climbers” of the employee universe.
LinkedIn research shows that engaged “employer promoters” have 40% MORE internal company connections than extreme detractors.
In October 2013, a woman named Marina Shifrin posted a video of herself on YouTube explaining why she was quitting her job while dancing around her Taiwanese office during the middle of the night. Within weeks of its release, the video had more than 16 million views and she appeared on major entertainment broadcast shows.
Marina is an example of a ReActivist.
ReActivists are also behaving both positively and negatively, but can be very critical of internal actions by their employers and voice those criticisms publicly. ReActivists’ engagement level falls slightly below average (26%).
Compared to the average employee, ReActivists are more likely to be Millennials. Of all our segments, they work the fewest hours per week and are employed by relatively
smaller companies (between 500 and 1,000 employees). They are more likely than average to work for an employer that has recently endured a top-tier change event, such as extensive lay-offs, a merger/acquisition or a crisis/disaster. They are also more likely than average to have a job that entails using social media, although not to the same extent as HyperActives, and half of them often post about work or their employer on social media.
Page 16Employees Rising: Seizing the Opportunity in Employee Activism
InActives, a large segment of more than one in five (22%) employees, exhibit minimal positive or negative behaviors. They are highly unengaged, with an average engagement level of just 16%, and little motivates them
to do a good job — pay increases top their list but that is cited by only 43% of them. We do not recommend that employers invest in an employee activism program for this segment. The focus for InActives should be on building engagement instead.
Compared to the average employee, InActives are more likely to be over 36 years of age and are the least likely to be executive/managerial. They are also the least likely to report that their employer recently experienced a change event and to be on social media.
Detractors’ engagement level seems almost beyond repair (12%). They are not candidates to be employee activists, so employers need to defuse their criticism and lessen their potential reputational harm.
Compared to the average employee, Detractors skew female, older than 36 and not university-educated. They are the most likely group to have a physical/manual job, are the longest tenured and are less likely than the average employee to work at headquarters. They are also the most likely to work for an employer that has recently undergone a major change event, likely contributing to an exceptionally high lack of leadership trust. While they are just as likely as the average employee to use social media in their personal lives, they are less likely to have multiple accounts or to use social media as part of their job.
“A worker who is engaged is a person who truly cares about the organization for which he/she works, a person who does more than ‘show up’ for work, a person who gives his/her ‘all’ on the job.”
— U.S. employee
08 GET TO KNOW THY SEGMENTS
Page 17Employees Rising: Seizing the Opportunity in Employee Activism
In addition to the diverse profiles just discussed, the segments also differ in their perceptions of the activism drivers. This requires employers to “flip different switches” on various aspects of leadership, internal communications, human resources and corporate social responsibility in order to effectively drive activism or reduce detraction. Here are four strategies for activating employees:
1. Accelerate the activism of ProActivists. Ignite the activism of PreActivists and HyperActives
2. Negate the negatives for ReActivists and Detractors
3. Communicate in ways that matter
4. Customize strategies and tactics for each segment
“An engaged employee is one who is very much devoted to his work and other aspects of the company, be it events, volunteer work or promotion of certain sales.” — Singapore employee
Page 18Employees Rising: Seizing the Opportunity in Employee Activism
09THE PLAYBOOK FOR ACTIVATING EMPLOYEES
09 THE PLAYBOOK FOR ACTIVATING EMPLOYEES
Every one of the top drivers of activism is rated highly by ProActivists (hence, their activism!). To sustain their ProActivist status, this segment needs continual reinforcement of what they perceive as their employers’ best traits, leading with their employer’s reputation (48%) and fair treatment of all employees regardless of race, gender, age, sexual orientation or cultural differences (48%). PreActivists need more convincing to spur their activism but fair treatment of all employees is most meaningful to them (43%). HyperActives also rate the top drivers highly but they need additional reinforcement of these perceptions so that their positive actions overcome their negative inclinations. They rate their employers most
highly on keeping employees informed (45%), so internal communications is a must-have for turning their activism on.
PreActivists are less social media savvy, and therefore presumably less social media confident, than ProActivists and HyperActives. More than one-third of them say they would be more inclined to use social media to share news and information about their work or employer if they were given easy-to-understand guidelines (34%), access to social media at work (32%) or the right tools (31%). Employers should take note — these provisions are fairly basic and would help turn many PreActivists into ProActivists.
Accelerate the activism of ProActivists. Ignite the activism of PreActivists and HyperActives
1.
60%
50%
40%
30%
20%
10%
0%
Leadership Internalcommunications
Human Resources/Policies
Corporate social responsibility
ProActivists HyperActivesPreActivists
Employer values employee id
eas and opinions
Leadership makes it
a good place to work
Employer has a very good re
putation
Leadership is tr
ustworth
y
Leadership liste
ns and responds well t
o employees
Employer does a good jo
b of keeping employees in
form
ed
Employer communicate
s frequently
with employees
Employees have many opportu
nities to
grow and learn
Employer provides tr
aining and resources needed to
do job
Employees are treate
d fairly
regard
less of their d
ifferences
Employer plays an activ
e role in
the community
Employer works to
prote
ct and im
prove the enviro
nment
ProActivists HyperActivesPreActivists
Perceptions of top drivers of activism (% employees rated 5 on 5-point agreement scale)
Page 19Employees Rising: Seizing the Opportunity in Employee Activism
Negate the negatives for ReActivists and Detractors
ReActivists are more critical than the average employee of their employers’ reputations, provision of training and resources, and climate of diversity and inclusion. These perceptions need to be improved to mobilize their activism or at least take the edge off of their negativity. Although not a driver of activism, ReActivists also rate their employer more harshly on safe working conditions than the average employee (27% vs. 34%). Perhaps employers should try competing for some of the Best Places to Work lists and improving their workplace benefits to counter their negative workplace perceptions. With more than one-quarter (27%) of ReActivists often posting something negative online about their employer, their criticisms need to be addressed.Not surprisingly, every one of the top drivers of activism is
rated very poorly by Detractors. Their weakest perception is trust in leadership — only 6% of them rate leadership as trustworthy — but taken altogether, none of the drivers are perceived positively. Employers should focus first on leadership issues since leadership is the most important driver of activism to begin building trust and reputation.
2.
“A professional who is dedicated, interested and always looking to give their best for the company is engaged with their employer.” — Brazilian employee
09 THE PLAYBOOK FOR ACTIVATING EMPLOYEES
Perceptions of top drivers of activism (% employees rated 5 on 5-point agreement scale)
ReActivists Detractors
60%
50%
40%
30%
20%
10%
0%
Leadership Internalcommunications
Human Resources/Policies
Corporate social responsibility
ReActivists Detractors
Employer values employee id
eas and opinions
Leadership makes it
a good place to work
Employer has a very good re
putation
Leadership is tr
ustworth
y
Leadership liste
ns and responds well t
o employees
Employer does a good jo
b of keeping employees in
form
ed
Employer communicate
s frequently
with employees
Employees have many opportu
nities to
grow and learn
Employer provides tr
aining and resources needed to
do job
Employees are treate
d fairly
regard
less of their d
ifferences
Employer plays an activ
e role in
the community
Employer works to
prote
ct and im
prove the enviro
nment
Page 20Employees Rising: Seizing the Opportunity in Employee Activism
Communicate in ways that matter Employees, regardless of their segment, would like their employers to communicate with them more frequently through written means (73%). Work email is the driving force behind written communications (48%). It is surprising in this high-tech digital world that email is the default
communications method, but perhaps employees like the control that comes with deciding when to open and respond to email, or perhaps it is what they know best and can’t imagine anything being easier or more efficient.
“There’s no doubt organizations have begun to realize significant value from largely external uses of social. Yet internal applications have barely begun to tap their full potential, even though about two-thirds of social’s estimated economic value stems from improved collaboration and communication within enterprises. Although more than 80 percent of executives say their companies deploy social technologies, few have figured out how to use them in ways that could have a large-scale, replicable, and measurable impact at an enterprise level. “
“Building the Social Enterprise,” McKinsey Quarterly, November 2013
Beyond email, segments diverge on other forms of employer communications they would like more often. Digital/Online, driven by intranets and social media, is in greater demand by the most social media savvy — ProActivists, HyperActives and ReActivists. In-person meetings are more important
to ProActivists, PreActivists and Detractors than to other segments. Surprisingly, InActives are no less amenable to any form of communications than other segments. This may be a sign that there is some hope of engaging this very passive group.
3.
0
20%
40%
60%
80%
100%
ProActivists PreActivists HyperActives ReActivists Detractors InActives
Written Digital/Online Face-to-Face Telecommunications
Page 19
Communications employees would like to receive more often
09 THE PLAYBOOK FOR ACTIVATING EMPLOYEES
Page 21Employees Rising: Seizing the Opportunity in Employee Activism
09 THE PLAYBOOK FOR ACTIVATING EMPLOYEES
Customize strategies and tactics for each segment
Given the diverse nature of the workforce segments, it is clear that mobilizing employee activists cannot be a “one-size-fits-all” approach. Based on our survey analysis, here are our recommendations, by segment, for an employer
considering launching an employee activist program to transform their organization, accelerate change or drive performance:
4.
“An engaged employee is one who is involved in his work, satisfied with what he is doing and contributes positively in the organization.” — Indian employee
The employee activism tip sheet
Segment Strategy Tactics
Leverage and empower their activism
• Maintain their high engagement level• Continually reinforce their perceptions of top activism drivers• Provide socially sharable content that showcases the drivers they rate highest• Improve leadership drivers, especially responsiveness to employees
Ignite their activism: Upgrade to ProActivists
• Continually reinforce their perceptions of top activism drivers• Improve leadership drivers, especially responsiveness to employees• Provide a social activism platform: social media guidelines, training and access
Handle with care: Upgrade to ProActivists
• Feed their need to share with positive messages and make those messages socially sharable
• Make handy and reinforce social media guidelines• Continually reinforce their perceptions of top activism drivers• Communicate with them frequently• Have senior management acknowledge their contributions
Attend to internal matters
• Improve perceptions of all top drivers• Do a better job disseminating information about employer values and goals• Focus internal communications messages on internal issues, such as employee training and
diversity• Provide social media tools, guidelines, work access and sharable messages
Brace for and defuse
• Fix negative leadership trust perceptions• Implement a change management program even if it is after the fact• Ensure social media guidelines are in place and well-understood. Even though this segment is
not highly social, most have a personal social media account• Ensure online monitoring tools are in place to flag behavior that is in violation of organization’s
social policies
Focus on engagement, not activism
• Implement a localized engagement program with direct supervisors identifying InActives and enacting an engagement plan
• Review Weber Shandwick UK’s Science of Ingagement study which provides guidance on build-ing engagement
ProActivists
PreActivists
HyperActives
ReActivists
Detractors
InActives
Page 22Employees Rising: Seizing the Opportunity in Employee Activism Page 22Employees Rising: Seizing the Opportunity in Employee Activism
10IN CLOSINGWeber Shandwick’s Employees Rising: Seizing the Opportunity in Employee Activism was designed to help organizations recognize and understand that employee activism is a movement coming their way.
It needs to be accepted and proactively managed. Just focusing on employee ambassadors or champions is not enough anymore in an always-on and super-enabled environment. Employers will increasingly need a band of employees who can take action by spreading the right messages for them, helping them recruit the best of the best or defending their position when they are under scrutiny. Organizations need to move quickly since employees are already taking matters into their own hands and, left unattended for too long, will define their employers’ brands and reputations on their own. Social media enhances this risk, but also the opportunities.
To ensure they define brand and reputation in the most authentic light and win support during the tough times as well as the easier ones, employers need to provide a culture of trust that is rooted at the leadership level. Employers need to communicate with employees in ways that are relevant to them, with messages tailored for a variety of worker segments.
Employees will continue to rise to new heights of influence. This influence needs to be tapped into so that employers can maximize the opportunity of this exciting and transformative movement.
“Weber Shandwick’s new study demonstrates how organizations need to think ahead as to what is next. Our research uncovered an emerging trend of vital importance for employers looking to mobilize support as they exit difficult times and transform their organizations to be successful in a fast- approaching future.”
Leslie Gaines-Ross Chief Reputation Strategist Weber Shandwick
Page 23Employees Rising: Seizing the Opportunity in Employee Activism
Jack LeslieChairmanWeber [email protected]
Andy PolanskyCEOWeber [email protected]
Gail HeimannPresident and Chief Strategy OfficerWeber [email protected]
Cathy CalhounChief Client OfficerWeber [email protected]
Sara GavinPresident, North AmericaWeber [email protected]
Micho SpringChair, Global Corporate PracticeWeber [email protected]
Paul JensenPresident, North American Corporate PracticeWeber [email protected]
Leslie Gaines-RossChief Reputation StrategistWeber [email protected]
Renee AustinCo-Lead, Global Employee Engagement & Change ManagementWeber [email protected]
/WeberShandwick
@WeberShandwick
/WeberShandwick
/Company/Weber-Shandwick
/WeberShandwickGlobal
+WeberShandwick
Kate BullingerCo-Lead, Global Employee Engagement & Change ManagementWeber [email protected]
Colin ByrneChief Executive Officer, UK & EuropeWeber [email protected]
Jim DonaldsonExecutive Vice President, Corporate Communications EMEAWeber [email protected]
Tim SuttonChairman, Asia PacificWeber [email protected]
Tyler Kim Head of Corporate & Crisis, Asia PacificWeber [email protected]
Zé SchiavoniCEO, S2Publicom Weber [email protected]
Bradley HonanCEOKRC [email protected]
You can also visit:www.webershandwick.com
For more information about Employees Rising: Seizing the Opportunity in Employee Activism, or Weber Shandwick’s Employee Engagement & Change Management services, please contact:
Page 24Employees Rising: Seizing the Opportunity in Employee Activism
5/28/2019 Employee Activism: A Powerful, Yet Untapped, Driver of Climate Action
https://medium.com/in-search-of-leverage/employee-activism-a-powerful-yet-untapped-driver-of-climate-action-bdfdf5dc6eea 1/7
Employee Activism: A Powerful, YetUntapped, Driver of Climate Action
10 April 2019, the initiative Amazon Employees for Climate
Justice submitted an open letter to Amazon’s CEO Jeff Bezos,
demanding that the tech giant take greater action on climate change.
“We have the resources and scale to spark the world’s imagination and
redefine what is possible and necessary to address the climate crisis”,
the letter states. So far, it has been signed by more than 6’700
employees.
What seems like a small symbolic gesture might well mark a turning
point in our effort to stem global warming. Employee activism holds
enormous potential to set the world on the right course for
safeguarding human civilization as we know it. To unlock its power, we
need to spark a new social movement.
Dominic Hofstetter Follow
Apr 23 · 6 min read
On
. . .
Amazon CEO Je� Bezos (left) is one of a handful of corporate executives who could set the world on a
course to avoid the most perilous e�ects of global warming. (Photo by Grant Miller for the GWB
Presidential Center)
5/28/2019 Employee Activism: A Powerful, Yet Untapped, Driver of Climate Action
https://medium.com/in-search-of-leverage/employee-activism-a-powerful-yet-untapped-driver-of-climate-action-bdfdf5dc6eea 2/7
he world has been grappling with climate change for more than 40
years. As of this writing, we are still not on track to avoid the most
perilous effects of a warming planet. Our continued inability to make
significant progress is mainly a result of political inaction. The failure of
our political system is so severe that the British journalist George
Monbiot recently argued that the only thing that could still prevent an
ecological apocalypse was mass civil disobedience.
Policy is critical because it sets the goals, defines the rules, and
distributes the power in our society. Regrettably, anti-climate lobbying
groups excel at influencing the legislative process in almost all of the
world’s political arenas. Not only do they outspend and outsmart
climate advocates. They also monopolize narratives around job
creation and economic growth — arguments that are often the decisive
factors in shaping legislation.
Herein lies the tragedy. The argument that environmental regulation
kills jobs is not supported by research. In fact, economists predict that
unchecked climate change will have devastating effects on the world’s
economy. A recent study in Nature estimates that the difference in
economic cost between 1.5 and 2 degrees of global warming could be
as much as $20 trillion, or 26% of world GDP. So all companies —
except those in the business of selling carbon — should have an
incentive to lobby for decisive climate action.
Indeed, a growing number of multinationals appear to be serious about
reducing their carbon footprints, including Unilever, DSM, Coca-Cola,
Apple, Microsoft, Novartis, IKEA, and Google — and countless other
large corporations that have publicly spoken out for more stringent
climate action.
But why don’t these companies use their power to influence climate
policy?
T
. . .
he answer lies in an unwritten rule of corporate lobbying:
companies only intervene in legislative processes related to their
core business. Food companies care are about packaging rules,
technology companies about labor regulation, and retailers about trade
law. Lobbying agendas are driven primarily by rational monetary
T
5/28/2019 Employee Activism: A Powerful, Yet Untapped, Driver of Climate Action
https://medium.com/in-search-of-leverage/employee-activism-a-powerful-yet-untapped-driver-of-climate-action-bdfdf5dc6eea 3/7
interests. If a piece of legislation doesn’t have a significant impact on a
company’s bottom line, its regulatory affairs team will not engage.
Climate change is too diffuse an issue to directly relate to anyone’s core
business, with the exception of those industries relying on fossil fuels.
Moreover, the impacts of global warming materialize over a time
horizon that is too long to be relevant to a company’s financial
performance. So even those corporations most committed to curbing
global warming don’t lobby for stringent climate legislation.
“Washington’s dirty secret is that even the American companies that are
really good on sustainability put net zero effort into lobbying Congress
on climate change.”, wrote U.S. Senator Sheldon Whitehouse in 2016.
“Mars is going fully carbon neutral. No lobbying. Walmart is spending
tens of millions of dollars to become sustainable. No lobbying. Apple
and Google and Facebook are forward-looking, cutting-edge companies
of the future, and they lead in sustainability. No lobbying.”, he added in
a Harvard Business Review article.
So how do we encourage companies to start lobbying for more decisive
climate policy?
. . .
orporate lobbying agendas are often set directly by the CEO.
Therefore, the key to mobilizing companies for climate action is to
make the CEO care. Three groups of people are best positioned to do
that: owners, customers, and employees.
Shareholders and consumers have an impressive track record in
influencing corporate behavior around a broad range of environmental
concerns. In contrast, employee activism is a relatively recent
phenomenon. It has started to make headlines in mainstream media at
numerous occasions over the past couple of years, most notably when
Google employees successfully mobilized against the company’s
handling of sexual harassment, its involvement in a defense project
involving drone footage analysis, and more recently over its
appointment of an ethics committee on artificial intelligence.
Facebook, Salesforce, Uber, and Microsoft have also faced backlash
from their employees over ethically questionable business conduct.
C
5/28/2019 Employee Activism: A Powerful, Yet Untapped, Driver of Climate Action
https://medium.com/in-search-of-leverage/employee-activism-a-powerful-yet-untapped-driver-of-climate-action-bdfdf5dc6eea 4/7
The increasing popularity of employee activism is driven by a growing
collective conscience amongst workers. A 2017 study on corporate
activism and employee engagement inside Fortune 100 companies
showed that 45% of respondents care about a company’s actions on
societal issues. In a world where dozens of companies are now bigger
than entire countries, employees have the potential to wield power of
geopolitical scale.
. . .
harness that power, we need to spark a social movement around
employee activism. As with all social movements, the first step is
to raise people’s consciousness. “At its core, consciousness translates
into awareness, both internal awareness of self and external awareness
of context”, argues David A. Snow, a professor of sociology at the
University of California and an authority in the field of social
movements.
With climate change featuring more prominently in the news, general
awareness of its existence and threat is at an all-time peak. However,
we do need to heighten the public’s consciousness in understanding
what Snow calls the locus of blame — the causal link between a
company’s action and the climate injustice it creates. Here,
organizations like InfluenceMap — which analyzes corporate lobbying
practices related to climate change — and the Carbon Disclosure Project
— which collects company-level emissions data and maintains a
database with the world’s major climate offenders— can provide
information that is critical for employees to understand what role their
companies play in driving climate change.
To
Employee activism in action: Google employees at the company’s Sunnyvale campus walk-out on 1
November 2018 to protest the company’s handling of sexual harassment allegations. (Source:
Wikipedia)
5/28/2019 Employee Activism: A Powerful, Yet Untapped, Driver of Climate Action
https://medium.com/in-search-of-leverage/employee-activism-a-powerful-yet-untapped-driver-of-climate-action-bdfdf5dc6eea 5/7
Consciousness can then give rise to conscience — the value-laden
component of awareness. Views about what’s morally proper and
timely are important motivational factors in social movements,
according to Snow. To develop such opinions, employees must first
recognize their power to influence their firm’s business policies and
then move from a self-identity of bystander to one of activist. Learning
about successful activism campaigns can help with both.
Any new corporate conscience will have to oust current corporate
norms, especially those emerging from the shareholder value
paradigm. The idea that the firm exists to serve its owners is so
entrenched that employee activists will inevitably be forced to fight an
uphill battle.
Here is where civil society actors such as NGOs could make a difference
by lending structural support to initiatives of employee activism. They
could provide best practice examples around a range of topics,
including how to use online petition platforms, leverage the benefits of
peer-to-peer support groups, facilitate conversations about values with
co-workers, and establish a line of communications between concerned
employees and senior management. They could also provide legal
advice and representation for activists, the need for which was made
clear by Google’s repressive reaction to the November 2018 employee
walk-out. In situations where employer repercussion might be severe,
they could even play the role of voice aggregator, engaging with senior
executives on behalf of employees and thus providing the first line of
defense against individual punishment.
. . .
2019 is the year of unprecedented public support for climate
legislation. The world seems to be far closer to serious climate action
than at any point since the turn of the millennium. According to
Senator Sheldon Whitehouse, the only thing that’s missing is “for the
good guys in the corporate sector to start showing up.” Nobody is better
positioned to make CEOs care than employees.
2018Mini-Season Wrap-Up and 2019 Trends
This edition of ProxyPulseTM provides insights into the corporate governance trends to look for in the 2019 proxy season. It also looks back on shareholder voting at 1,024 meetings held during the “mini-season” between July 1 and December 31, 2018. What’s diff erent about the mini-season? Fewer companies hold meetings during the mini-season, and those that do tend to be smaller. Twenty percent of all public company annual meetings took place from July 1 to December 31, 2018.
ProxyPulse™ data is based on Broadridge’s processing of shares held in street name.
What to look for in 2019.
“Unnerved by fundamental economic changes and the failure of government to provide lasting solutions, society is increasingly looking to companies, both public and private, to address pressing social and economic issues.”
Investors continue to focus on long-term growth, highlighting the impact of culture, purpose and stewardship on a company’s long-term strategy and success.
— LARRY FINK, CEO OF BLACKROCK
BlackRock CEO Larry Fink’s 2019 annual letter to portfolio
company CEOs highlighted the link between profi t and purpose
noting that companies can realize long-term benefi ts by fulfi lling
their duties to the communities in which they operate.
State Street Global Advisors (“State Street”) President and CEO
Cyrus Taraporevala’s 2019 letter to portfolio company boards
announced the investment fi rm’s 2019 stewardship focus on
corporate culture.
Environmental and social topics continue to be front and center in the conversation as they comprised the largest segment of shareholder proposals in the 2018 calendar year. Early indications are that this trend is continuing in 2019.
PAGE 2
On September 30, 2018, Governor Jerry Brown signed into law
California Senate Bill 826 aimed at boosting female representation on
company boards headquartered in the state of California. A similar bill
was introduced in New Jersey in late November 2018.
In September 2018, State Street announced that in 2020 it would
start voting against the entire nominating and governance committee
(not just the chair) at companies without at least one woman on their
board.1 BlackRock “encourages” boards to have at least two female
directors2 and Vanguard is broadly supportive of initiatives to increase
gender diversity in the boardroom.3
Starting in 2019, proxy advisory fi rm Glass Lewis will generally
recommend voting against nominating committee chairs on boards
without a single female director. 4 In some cases, the recommendation
may extend to other members of the committee as well. Institutional
Shareholder Services (ISS) will recommend voting against nominating
committee chairs on boards of Russell 3000 or S&P 1500 companies
with no female directors in the 2020 proxy season.5
Legislators, investors and proxy advisors are weighing in on gender diversity.
1 State Street Global Advisors, “State Street Global Advisors Reports Fearless Girl’s Impact: More than 300 Companies Have Added Female Directors,” September 27, 2018.
2 BlackRock, Proxy voting guidelines for U.S. securities, January 2019.
3 Vanguard, “Advocating for the long term,”April 24, 2018.
4 Glass Lewis, 2019 Proxy Paper Guidelines (United States), 2018.
5 Institutional Shareholder Services, United States Proxy Voting Guidelines, December 2018.
PAGE 3
A look back on shareholder ownership and voting in the 2018 mini-season.
ShareOwnership1
Year over year (2018 vs. 2017 mini-seasons), there was no
change in the percentage of shares owned by institutional
and retail shareholders.
OWNERSHIP COMPOSITION
BREAKDOWN BY SHARES
RETAIL35%
65%INSTITUTIONAL
PAGE 4
Shareholder Voting
2Retail voting participation was up slightly
over the same period in 2017. This was
largely due to higher levels of solicitations
at a few large shareholder meetings.
SHAREHOLDER PARTICIPATION
PERCENTAGE OF SHARES BY SEGMENT
RETAILINSTITUTIONAL
2017 MINI-SEASON 2018 MINI-SEASON
84%
29%
86%
27%
Director Elections*
3 On average, retail shareholders cast 90% of their voted shares in favor of directors,
down from 92% in the prior year. In contrast, institutional shareholders cast 87%
of their voted shares in favor of directors, up slightly from 86% in 2017. Overall,
directors were supported by 89% of the voted shares, down 1% from 90% in 2017.
A total of 3,637 directors stood for election this past season. 143 of them failed to
receive majority support and 428 directors failed to attain at least 70% support, a
threshold monitored by some proxy advisors.
DIREC TORS AT A GLANCE
2018 MINI-SEASON
FAILED TO ATTAIN70% SUPPORT
FAILED TO ATTAIN MAJORITY SUPPORT
TOTAL NUMBER UP FOR ELECTION
143
4283,637
DIREC TOR ELEC TIONS
AVERAGE SUPPORT
2017 MINI-SEASON
80%
90%
0%
100%
RETAILINSTITUTIONAL
2018 MINI-SEASON
92%
86% 87%
90%
PAGE 5
Say-on-Pay*
4On average, retail shareholders cast 82% of their voted shares in favor of say-on-pay
proposals, down from 83% the prior year. By comparison, institutional shareholders cast
85% of their voted shares in favor, down from 86% in 2017. Overall support averaged
83% versus 85% in the prior year. A total of 392 say-on-pay proposals were put to a
vote; 36 failed to receive majority support and 79 failed to attain at least 70% support.
86% 85%
82%83%
SAY-ON-PAY PROPOSALS
AVERAGE SUPPORT
RETAILINSTITUTIONAL
2017 MINI-SEASON 2018 MINI-SEASON
ShareholderProposals*
5
Overall support for shareholder proposals rose
to 43%, on average, from 36% during the same
period in the prior year. Retail support increased
to 25% from 22% in the same period last year
and institutional support increased to 46% this
season from 40% in the prior year.
SHAREHOLDER PROPOSALS
FAVORABILITY(% OF VOTED SHARES)
OVERALL
INSTITUTIONAL
22%25%
2017 MINI-SEASON 2018 MINI-SEASON
36%
43%
40%
46%
PROPOSALS AT A GLANCE
2018 MINI-SEASON
FAILED TO ATTAIN70% SUPPORT
FAILED TO ATTAIN MAJORITY SUPPORT36
79
TOTAL NUMBER PUT TO A VOTE392
RETAIL
PAGE 6
OVERALL
INSTITUTIONAL
About ProxyPulse™ ProxyPulse is based in part on analysis of company Form 8-K fi lings from
EDGAR and Broadridge’s processing of shares held in street name, which
accounts for over 80% of all shares outstanding of US publicly-listed
companies. Shareholder voting trends during the proxy season represent
a snapshot in time and may not be predictive of full-year results.
Broadridge Financial Solutions is the leading third-party processor of
shareholder communications and proxy voting.
PwC’s Governance Insights Center is a group within PwC whose
mission is to provide insights to directors and investors to help them
better understand governance topics and trends.
CONTACTS
Broadridge Financial Solutions:
Chuck Callan
Senior Vice President
Regulatory Aff airs
+1 845 398 0550
Mike Donowitz
Vice President
Regulatory Aff airs
+1 631 559 2486
PwC’s Governance Insights Center:
Paula Loop
Leader
Governance Insights Center
+1 646 471 1881
Paul DeNicola
Principal
Governance Insights Center
+1 646 471 8897
Catie Hall
Director
Governance Insights Center
+1 973 236 5718
PAGE 7
* In the past we reported voting outcomes by aggregating all votes cast across all meetings. In limited instances, reported outcomes could be impacted somewhat by a few companies with unusually large numbers of shares or heavy solicitations. In this report, each proposal is equally weighted, regardless of each issuer’s total shares outstanding.
ProxyPulse™
PRIVACY The data provided in these reports is anonymous, aggregated data, which is a result of the data processing involved in the voting process. As a result of the automated processing used to quantify and report on proxy voting, data is aggregated and disassociated from individual companies, financial intermediaries and shareholders. We do not provide any data without sufficient voting volume to eliminate association with the voting party.
PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
PricewaterhouseCoopers LLP did not examine, compile or perform any procedures with respect to the ProxyPulse report, and, accordingly, PricewaterhouseCoopers LLP does not express an opinion or any other form of assurance with respect thereto.
© 2019 Broadridge Investor Communication Solutions, Inc. All rights reserved.
© 2019 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved.
By Jamie Smith
18 minute read 12 Feb 2019
Top investors look to boards to focus on social impact oversee emergingrisk.
What investors are expectingfrom the 2019 proxy season
I nstitutional investors tell us they want boards to help set the tone at the top for diversity and culture and betterarticulate how the company is investing in talent and transformation. They want to understand how companies areintegrating business-relevant environmental and social considerations into a sustainable strategy that creates long-term value for a wide range of stakeholders. And they want to know how the board is overseeing emerging threats andopportunities amid continued market volatility and evolving risks.
Many investors are also further integrating environmental, social and governance (ESG) considerations into theirstewardship programs and broader approach. For example, some asset managers are doing more to embed such factorsinto their investment processes and offering new ESG products and solutions; and asset owners are asking morequestions around how their current and potential external managers are approaching ESG matters.
The 2019 proxy season preview
This is the eighth year the EY Center for Board Matters has engaged with governance specialistsfrom the investor community to learn about their priorities for the coming year. This report bringstogether investor input and draws on our tracking of governance trends across more than 3,000US listed companies.
These are some of the themes emerging from conversations with more than 60 institutional investors representing overUS$32 trillion in assets under management, including asset managers (42% of participants), public funds (22%), laborfunds (13%), socially responsible (13%) and faith-based investors (8%), as well as investor associations and advisors(3%). The themes focus on:
1. The top three areas investors want boards to focus on in 2019
2. Opportunities for enhancing communications around long-term strategy
3. Key factors investors use to assess board oversight of risk
4. Tips for more effective engagement
5. Shareholder proposal trends
Top three areas where investors want boards to focus in 2019
1. Board diversity — investors push for diverse directors as focus on board composition continues
Just over half (53%) of the investors we spoke with emphasized that board diversity, primarily inclusive of gender, raceand ethnicity, should be a top board focus in 2019, up from one-third three years ago. An additional 19% cited diversityas part of a broader set of board composition considerations, including skill set, refreshment and assessmentapproaches.
Many investors said they want to see boards recognize and truly embrace the value of diversity to decision-making andperformance, including by fostering an inclusive board culture as well as embedding diversity considerations intorecruitment and assessment policies. They further shared that the dynamics of engagement conversations on diversitycan reveal whether boards are “checking the box” or genuinely upholding diversity as a value. Many investors also noted the value of board diversity in setting a tone at the top that reflects a dynamic and inclusiveview of talent. Relatedly, more investors are also expanding their focus to senior executives. Fourteen percent ofinvestors explicitly raised both board and executive diversity as an important focus for boards, up from 4% three yearsago. Some characterized a lack of diversity among directors and executive leadership as a human capital risk,particularly given today’s war on talent and the spotlight on corporate culture.
The push for diversity is occurring against a backdrop of slow-moving change in the boardroom. From 2017 to 2018,the percentage of women-held S&P 1500 directorships inched up two percentage points from 19% to 21%. That isdouble the annual one-percentage-point rate of increase we have observed since 2013.
Assessing racial and ethnic board diversity continues to be challenging for investors given the lack of disclosure. Thirtypercent of investors who want boards to focus on diversity told us they are asking companies for better disclosure ofdirector demographics. However, some directors may not want to self-identify for personal reasons.
Key board takeaway
Consider whether the board’s diversity and related communications (e.g., proxy disclosures regarding boardcomposition and the role of diversity in board recruitment and assessment) set the appropriate tone at the top for thevalue the company places on diversity.
2. Company-relevant environmental and social issues, particularly climate risk
Around half (49%) of investors said a top board focus should be business-relevant environmental and social factors.That is, those that are most likely to impact the company’s strategy, risk profile and brand, such as water managementfor food and beverage companies; access and affordability for health care companies; and plastic pollution forconsumer goods companies. Generally, these investors want to understand how boards and management are
connecting these kinds of environmental and social issues to their long-term success and embedding relatedconsiderations into their risk management and strategy setting. And they want to see this integration consistentlycommunicated in company disclosures on strategy and risk.
Most of these investors — more than a third (38%) of investors overall — are specifically focused on climate change,which is up from 15% three years ago. Notably, the types of investors citing climate risk were evenly divided amongmainstream asset managers, public funds, and faith-based and socially responsible investors, reinforcing theincreasingly broad spectrum of investors focused on this issue.
The direct relevance of climate risk is different for each company, and most investors focused on climate are engagingheavy greenhouse gas (GHG) emitters, such as those in the industrial or energy sectors. Regarding these companies,investors raised the need for concrete and significant GHG reduction goals and climate scenario planning that tests theresilience of company strategy against a 2 degree Celsius or lower scenario — both core elements of the FinancialStability Board’s Task Force on Climate related Financial Disclosures’ (TCFD) recommendations. Thirty-eight percentof investors citing climate change raised that they are actively asking companies to take these steps.
Another key theme arising from the conversation on climate risk was the need for enhanced reporting. Close to half(46%) of the investors citing climate risk raised the TCFD as a reporting framework they support. These investors notedthe importance of such reporting for companies’ strategic planning and risk management, and many noted that theyare part of the Climate Action 100+, an investor-led initiative that promotes voluntary disclosure in line with theTCFD’s recommendations.
As for expectations around board governance of environmental and social factors, including climate risk, investorexpectations may vary based on company specific circumstances. Nonetheless, most investors told us they recognizeeffective oversight can come in different forms, such as charging a dedicated board committee or one of the keycommittees with related oversight, recruiting directors with business-relevant sustainability expertise, talking toexternal independent specialists, or setting a clear and ongoing agenda for the board to discuss sustainability impacts.
Key board takeaway
Challenge whether the company’s risk management processes, capital allocation decisions and strategic planningintegrate business-relevant environmental and social considerations, and whether the company’s reporting processconsistently demonstrates this integration. Consider the extent to which key stakeholders support external frameworks,such as the TCFD and the Sustainability Accounting Standards Board (SASB), and how company disclosures align withthese frameworks.
3. Human capital management – investors seek to understand how boards are governing talent andculture
More than a third (39%) of investors told us human capital management and corporate culture should be a top boardfocus, up from just 6% three years ago. While some are focused on particular issues (e.g., workforce diversity, payequity), most are taking a broad view of the topic.
Several investors shared that recent business, technology and societal trends have played a role in them paying closerattention to human capital and culture, including a more discerning and empowered consumer base, radical shifts inthe workforce and the growing importance of talent to an organization’s intangible value in today’s digital economy.
At a high level these investors want to understand the role of human capital management in the company’s long-termstrategy and how the company is evolving, investing in and developing its talent to further innovate and meet futureneeds, particularly in industries or geographies where talent scarcities are on the horizon, such as technology andfinancial services. They also want to understand how companies are addressing, including how boards are assessing,potential cultural and workforce issues to support long-term strategy and enhance and protect the company’sreputation, brand value and ability to attract the best talent.
Twenty percent of the investors citing human capital management seek increased disclosure around related topics, andsome view the pay ratio as an opportunity for companies to provide deeper context around their investments in humancapital. Most told us that, at least for now, they are prioritizing dialogue over disclosure. Some even indicated that thiskind of information need not be for public consumption, and that they are seeking assurance that boards are activelyengaged in reviewing related metrics. Overall, there was consensus that investors would like to better understand howboards are engaged and exercising oversight in this space.
Key board takeaway
Assess how the board is governing around talent and culture, including how well the board understands the currentculture, and whether the human capital metrics the board is reviewing and the quality and frequency of managementreporting to the board are sufficient for robust oversight.
Opportunities for enhancing communications around long-term strategy
We asked investors if they think most companies are doing a good job of balancing their investments for the short- andlong-term. Nearly all qualified their responses, stressing that it is highly dependent on the company and acknowledgingthe market pressures that encourage short-termism. A quarter declined to answer, with most explaining that this is anevaluation they leave to their investment professionals and a few stating that this is a debate they avoid. But mostrevealing to us was this: nearly 20% said it is hard to answer the question because of the current lack of disclosurearound long-term strategy.
Some of these investors applauded particular companies for doing a great job in communicating their long-termapproach but noted that many companies maintain a heavy emphasis on the short-term, including businesses withwhat appeared to them to be unacknowledged and unmitigated long-term risks. Notably, some said that when there isexternal pressure, such as an activist waging a proxy contest, companies are very articulate about their long-termstrategy, but there is opportunity to better tell this story as part of their regular communications.
Investors generally want to understand how companies are anticipating and responding to external marketdevelopments and industry trends. They would like to see that a company’s identification of key risks and strategicopportunities includes environmental and social factors that impact the company’s business sustainability, and theywant to see consistent messaging across various communications (e.g., the 10-K, the sustainability report and investor
presentations). They also want a clear picture of how short-term goals and executive pay tie into and support long-termstrategy.
To assess whether companies are effectively balancing the short- and long-term, investors told us they are looking at:
The company’s story. Is the company consistently communicating a strategy around long-term growth? Isthere a strong articulation of the company’s purpose and how the company is managing its business to createlong-term value?
Executive compensation. Does the pay program promote longer-term focus or does it primarily emphasizea one-year time frame? Are companies rewarding innovation, investment in the company, and progress tied toenvironmental or social goals?
Capital allocation/stock buybacks. How is the company investing in services, products, retraining orinnovation that could build long-term value? And how do recent stock buybacks reflect the best use of cash?
Environmental and social metrics. Is the company investing energy, focus and disclosures around long-term sustainability goals? Does company strategy address business-specific opportunities and risks onenvironmental and social matters?
Risk disclosures. Does there appear to be an underappreciation of significant risks, such as environmentalrisks, cybersecurity or broader technology challenges?
Sell-side research. Is the company articulating business planning for the long-term?
Key board takeaway
Assess opportunities for enhancing communication of long-term strategy, and how near-term goals and pay incentivessupport that strategy.
Five factors investors use to assess board oversight of risk
We asked investors if they are raising particular risk issues (e.g., cybersecurity, talent/human capital management,climate, geopolitical) in company engagements and how they are assessing board oversight of those risks. Most saidthey don’t want to be prescriptive regarding board oversight; they want to see evidence that the board is engaged and tounderstand related oversight structures and procedures. Some of the key factors they raised included:
1. Management reporting to the board. Investors are interested in how management is reporting to theboard on key risk issues at a high level and may raise related questions in engagement discussions, e.g., whofrom management is reporting, how often and what kind of information is discussed.
2. Committee oversight. Investors generally want to see that a board committee has responsibility over and isengaged on key risks, or that there are procedures in place to maintain sufficient attention to the issue by thefull board.
3. Director qualifications and use of outside specialists. Investors generally want the board to includerelevant expertise tied to key risks the company is facing. They also want assurances that the board is accessingoutside specialists as needed to stay current on external developments and challenge internal bias, asappropriate.
4. Directors’ ability to speak to risks disclosed in the 10-K. Several investors said they expect boardmembers to be able to speak fluently on how they are overseeing key risks identified in the annual report andmay raise related questions in engagement conversations.
5. Explanation of differences between company’s disclosed risks and externalframeworks/research. Several investors said they often compare a company’s disclosed risks to otherbenchmarks (e.g., industry research, ESG ratings reports, the SASB framework) and may raise questions aboutperceived gaps or areas of misalignment.
Tips for more effective engagement
We asked investors what they wish were different about their engagements with companies. Close to a third (30%) saidthat overall engagement has improved significantly, with most citing increased director involvement and a morerespectful approach as important developments. Still, 91% cited opportunities for continuing to improve the process.Here are some tips based on what we heard:
Avoid engaging for engaging’s sake — engage as needed outside of proxy season and avoiddiscussing proxy advisory firm views. Investors said companies come across as tone deaf when they reachout in the spring (when investors are voting thousands of company ballots) or with no clear agenda, and whenthey focus on the views of proxy advisory firms that investors do not rely on for voting guidance.
Have a mutually agreed-upon agenda and the right people on the call. Having an agenda thatbenefits both parties provides for a richer conversation and allows both sides to prepare accordingly. Havingthe relevant decision-makers and subject matter specialists involved — including directors as appropriate — canmake conversation more productive and efficient. Some investors noted that when boards rely solely onsustainability officers to discuss environmental and social issues, that may reinforce concerns that these issuesare isolated from board discussions on strategy and risk. Similarly, when a compensation committee defers tomanagement or the compensation consultant, this may raise questions about the extent to which the committeeowns the pay philosophy and decision-making. Overall, many expressed frustration at IR playing a lead role inengagement, given the perceived lack of familiarity on company-specific governance and sustainability topicsand focus on “canned” messaging.
Make the discussion more investor specific. The more the company understands the investor’s approachand position on governance issues, the more focused the engagement. While many investors post their proxyvoting guidelines and stewardship reports on their websites (and some send letters to portfolio companiesidentifying engagement priorities), many said they do not expect companies to do in-depth research before ameeting, but at least expect the company to understand whether they are talking to an active or passivemanager, or an asset manager or owner. Further, several investors said they wish companies would reviewnotes from previous conversations with them to help move the dialogue forward. Finally, recognize that someinvestors view the shareholder proposal process as an important part of investor/company engagement.
Be forthcoming about challenges and controversies, as well as changes made in response tofeedback. Several investors noted frustration around companies not directly raising challenges orcontroversies. They said that, when coupled with “all is well” type messaging, the communication raises
concern that companies are obfuscating, which makes investors skeptical about what the company does share,and results in a missed opportunity for relationship-building. Conversely, companies that directly raise thechallenges they face and discuss plans to address them build trust. Further, companies that reach out to sharerecent or potential changes made in response to feedback reinforce the value of engagement and relationship-building efforts.
One shortcut to understanding widely heldinvestor expectations is the Investor
Stewardship Group’s (ISG) framework ofcorporate governance principles, which
reflects the common corporate governancestandards of ISG members, which includesome of the largest US-based institutional
investors and global asset managers.
Shareholder proposal trends
Shareholder proposal submissions in 2018 were down 20% from five years ago based on our tracking of proposalssubmitted at Russell 3000 companies. Over the same time period, the portion of proposals that were withdrawn (inmost cases because the proponents and the companies reached agreement) held steady at around one-third of allsubmissions. Notably, average support for proposals that went to a vote on environmental sustainability topics (e.g.,asking companies to report on sustainability, climate risk, energy efficiency, greenhouse gas emissions) grew from 22%to 31%.
More changes to the shareholder proposal landscape may be ahead. Following a November 2018 U.S. Securities andExchange Commission roundtable, Chairman Jay Clayton identified improving the proxy process as a key 2019initiative for the Commission, specifically including examination of the share ownership and voting thresholds thatdetermine whether shareholder proposals can be submitted and resubmitted.
To set the context for proxy season 2019, here are the top shareholder proposal topics by average vote support in 2018,a year in which a total of 281 companies had shareholder proposals voted.
Top 20 shareholder proposal topics in2018, based on average supportreceived*
Average support Maximum support
Eliminate classified board 87% 96%
Adopt majority vote to elect directors 78% 98%
Eliminate supermajority vote 64% 87%
Allow shareholders to act by written consent 43% 86%
Report on sustainability 41% 80%
Allow shareholders to call special meeting 40% 94%
Address corporate EEO/diversity 39% 48%
Review/report on health care/medicine 32% 62%
Address political spending 32% 47%
Enhance payforperformance alignment 32% 48%
Address greenhouse gas emissions 32% 57%
Appoint independent board chair 32% 58%
Adopt/amend proxy access 32% 85%
Eliminate dualclass common stock 30% 41%
Limit postemployment executive pay 30% 43%
Address food/consumer products 28% 43%
Address lobbying activities 26% 41%
Address alternative, renewable energy 23% 46%
Address internet/data security risks 20% 36%
Address board diversity 18% 33%
**Where at least five proposals were voted.Accordingly, certain topics that received strong,and even majority support, in 2018 are notincluded (e.g., proposals to address climate riskaveraged 42% support last year, but only fourcame to vote while 17 were withdrawn).
The ES of ESG is growing in prominence, and many investors want to understand how companies are embeddingrelevant considerations in their long-term strategy. Many investors also want boards to set the tone at the top fordiversity and do a better job of articulating oversight of long-term strategy, including how the company is investing inand developing talent, living its values and navigating external risks.
While these high-level insights come from a broad range of investors, boards must remember that institutional investorviews can vary significantly.
Questions for the board to consider
Does the board’s makeup and culture reflect the company’s broader commitment to diversity and inclusion?And how is the board challenging itself to find diverse director candidates and communicating those efforts toinvestors?
Do the company’s various reporting channels (e.g., proxy statement, annual report, sustainability report,quarterly reports and earnings calls) tell a consistent story about long-term strategy and related risks, includingbusiness-relevant environmental and social factors? Is it clear how the executive pay program and short-termperformance goals support that strategy?
How is the company investing in and developing its talent as the business evolves? What is the company doingto provide for its talent needs in 3—5 years?
Does the board understand how the company’s culture aligns with the company’s purpose, values and strategy,along with any particular cultural strengths or opportunities for improvement?
Is the board able to articulate how it oversees the key risk factors disclosed by the company in its annual report?And has the company considered how its disclosed risks align to those of peers and external frameworks such asSASB or the TCFD?
Are there opportunities to make the company’s shareholder engagement program more targeted and outcome-driven?
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Summary
Institutional investors expect boards to be focused on board composition, climate risk and talent management. Theyalso want effective communication and and engagement with boards.
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Tags: Board composition, Climate change, Diversity, Environmental disclosure, ESG, Proxy season, Proxyvoting, Shareholder proposals, Shareholder voting, Sustainability
More from: Shirley Westcott, Alliance Advisors
Editor's Note: Shirley Westcott is a Senior Vice President at Alliance Advisors LLC. This post is based on an AllianceAdvisors publication by Ms. Westcott. Related research from the Program on Corporate Governance includes SocialResponsibility Resolutions by Scott Hirst (discussed on the Forum here).
With the 2019 proxy season now underway, several trends are emerging in shareholder campaigns:
Environmental and social (E&S) topics will once again dominate the shareholder proposal landscape. For a thirdconsecutive year, E&S issues account for a majority of all shareholder proposals filed, outpacing those related togovernance and compensation. Topping the list of submissions are political spending resolutions, which proponents haveramped up in advance of the 2020 elections (see Table 1).
Withdrawals could approach last year’s record. In 2018, nearly half of E&S resolutions were withdrawn as a result ofproductive engagements, a trend that is likely to continue. Companies are showing more willingness to reach agreementswith proponents due to shifts in investor voting, particularly among some of the largest institutional investors, notablyBlackRock, Vanguard Group and Fidelity Investments. According to a recent Institutional Shareholder Services (ISS)study, more shareholders are supporting E&S proposals rather than casting abstention votes, which declined from 16% ofvotes cast in 2010 to 3% in 2018. This in turn translated into a record 12 majority votes on E&S resolutions in 2018, whileanother 20 received support in the 40% range.
The six-week federal government shutdown in January also spurred a number of withdrawals due to delays in the SEC’sprocessing of no-action requests. At least 17 companies withdrew their petitions after the government reopened as aresult of reaching settlements with proponents.
New players are joining the E&S mix. The growing momentum of E&S campaigns is attracting new proponents. Nowthat many large-cap companies have shareholder-friendly governance provisions, corporate gadflies John Chevedden,James McRitchie, Myra Young and the Steiner family (the “Chevedden group”) are broadening their focus in 2019 to E&Sproposals, particularly political spending where they account for one-third of all submissions. Although they are stilladvocating for independent board chairs, simple majority voting and written consent, they have downplayed their calls foramending proxy access bylaws and easing eligibility requirements for shareholders to call special meetings.
Employee activism is also on the rise. Silicon Valley workers are leveraging their stock compensation to agitate for changeat their employers via proxy proposals. After staging a massive walkout last fall over their company’s handling of sexualharassment claims, Google employees have once again teamed up with Zevin Asset Management on a proposal to linkexecutive compensation to diversity and inclusion goals. Similarly, over a dozen Amazon.com employees have filed aresolution asking the company to release a comprehensive plan to address climate change. Amazon.com holds thedistinction this year of receiving the most shareholder resolutions—14 in all.
No-action challenges are usurping a number of new and recurring campaigns. Shareholder proponents and issuerscontinue to grapple with SEC interpretive guidance issued in 2017 and 2018 (Staff Legal Bulletins (SLB) 14I and 14J),
Harvard Law School Forum on Corporate Governance and Financial Regulation
2019 Proxy Season PreviewPosted by Shirley Westcott, Alliance Advisors, on Monday, April 15, 2019
which deal with ordinary business and economic relevance exclusions. Although these clarifications did not substantiallyimpact the outcome of no-action requests in 2018, climate-related proposals were disproportionately affected.
Climate resolutions remain in the crosshairs of ordinary business challenges following a 2018 staff decision that aresolution at EOG Resources to set company-wide, quantitative, time-bound targets for reducing greenhouse gas (GHG)emissions constituted micromanagement of the company. This reversal of longstanding precedent has resulted in theomission of five proposals this year to align carbon emissions with the goals of the 2015 Paris Climate Agreement tomaintain global warming at well below 2° C. Five similar no-action requests are pending.
Several other staff reversals have occurred this year on compensation topics, based on the micromanagementconsiderations of SLB 14J. These include proposals to exclude legal and compliance costs from executive pay (AbbVieand Johnson & Johnson) and on revolving door payments (JPMorgan Chase), which were disqualified as ordinarybusiness in past years because they dealt with senior executive compensation.
First-time shareholder initiatives drawn from news headlines—the explosion of stock buybacks, illegal immigrant detentionand fair employment practices—are also being squeezed out by ordinary business exclusions. As a result, some of thisyear’s social justice topics are unlikely to generate the level of investor and media attention that occurred last year withresolutions on opioid abuse and gun violence.
A more detailed look at some of the season’s key shareholder campaigns follows below.
Governance
Special Meetings
Last year, the most prominent governance initiative—with 84 proposals filed and 65 voted on—called on companies toadopt or reduce the ownership thresholds required for shareholders to call special meetings to
10% or 15%. Notably, seven companies were able to omit the resolutions under the conflicting proposal exclusion bysubstituting a management resolution to ratify their existing provisions. Although all of these passed, issuers may bereluctant pursue this course of action going forward now that ISS and Glass Lewis have adopted policies to opposegovernance committee chairs at companies that engage in this practice.
So far, only two firms are taking this approach this year. At Franklin Resources’ February meeting, shareholders backed amanagement ratification proposal by 88.2% and supported the governance committee chair by 83%, notwithstandingnegative proxy advisor recommendations. United Technologies also sought a Rule 14a-8(i)(9) exclusion in favor ofratification of the 15% special meeting threshold it adopted last fall (reduced from 25%). Ironically, the shareholder request(20%) would now result in an increase in the special meeting threshold. While that alone may have alleviated any proxyadvisor backlash, the proposal was ultimately omitted because the sponsor failed to present a similar proposal at the 2018annual meeting.
The proponents—the Chevedden group—have backed off from unleashing another deluge of special meeting resolutionsthis year, including refiling at the seven “offending companies” that knocked out their proposals last year. Instead, they areproposing other measures at those firms, such as an independent board chair, written consent, simple majority voting andmore lenient proxy access provisions.
Proxy Access
As in 2018, the volume of proxy access proposals is trending down due to corporate adoptions. To date, about 579companies have implemented access rights—including 70% of the S&P 500 and 18.6% of the Russell 3000—and over80% of their bylaws adhere to a 3/3/20/20 structure, typically with a two-director minimum.
Proxy access “fix-it” proposals—sponsored by the Chevedden group—are also receding after averaging only 28% supportin 2017 and 2018. Most of those sought a package of enhancements to existing access bylaws or the expansion of groupaggregations to 40, 50 or an unlimited number of shareholders. This year, the proponents have toned down their requeststo a single, often minor revision, such as adding a two-director minimum to the board seat cap (Apple) or eliminating the
vote requirement for renomination of access candidates (AMN Healthcare Services, Bank of America, JPMorgan Chase,Newell Brands, Spirit AeroSystems). So far, even their minimalist approach is not gaining traction. The vote at Apple was29.5%, suggesting that the proposed change was immaterial to most shareholders.
This season also marks the second attempt to use proxy access after GAMCO’s aborted effort two years ago at NationalFuel Gas. A Schedule 14N was filed in December at Joint by Steven Colmar, a co-founder and former director of thecompany, who left the board in 2017 over disagreements about the company’s strategic direction. His nominee, GlennKrevlin, is the founder of hedge fund Glennhill Capital.
Stock Buybacks
Shareholder activists are reviving proposals related to stock buybacks in the wake of the 2017 Tax Cuts and Jobs Act,which contributed to a record $1 trillion in corporate share repurchases in 2018, according to TrimTabs InvestmentResearch. Critics argue that the tax savings have primarily benefited corporate executives and shareholders rather thanbeing used for job-creating investments, thereby exacerbating wealth inequality.
Several variations of shareholder proposals are being submitted this season, largely by the Chevedden group. The first,which was omitted as ordinary business, would have required shareholder approval of any open-market share repurchaseprograms or stock buybacks adopted by the board. Another version asks American Express and Boeing to exclude theimpact of share repurchases from the financial metrics used for determining senior executive pay. Similar resolutions havetypically garnered only single-digit support in the past. The proponents are also referencing stock buybacks in some oftheir independent chair and simple majority vote proposals as an argument for better board oversight.
Oxfam America has submitted a new resolution, which is pending at Merck, that addresses concerns over executivesprofiting from buybacks by cashing their equity compensation during the stock price pop that often follows a buybackannouncement. In line with recommendations by SEC Commissioner Robert Jackson, the proposal urges thecompensation committee to adopt a policy to approve sales of shares acquired through equity compensation programs. Ifapproval is granted, the committee should disclose to shareholders why the sale is in the company’s long-term bestinterest.
Senate lawmakers are also considering legislation to discourage corporate stock buybacks. Tammy Baldwin (D-Wisc.)recently reintroduced the 2018 Reward Work Act, which would ban open-market stock repurchases altogether. In a similarvein, Chuck Schumer (D-N.Y.) and Bernie Sanders (I-Vt.) plan to offer a bill that would precondition share repurchases ona company’s commitment to invest in workers and communities through better pay and benefits. A less drastic approach,proposed by Marco Rubio (R-Fla.), would eliminate the preferential tax treatment of share repurchases by taxing them asdividends rather than as capital gains.
Investors, for their part, remain largely supportive of stock repurchase plans. Consistent with past surveys, 43% ofinstitutional investors polled by Corbin Advisors in 2018 believed that buybacks were the best use of a company’s cash,second only to M&A, which was preferred by 49% of investors. The Council of Institutional Investors (CII) furthercautioned that restricting buybacks would interfere with corporations’ decisions about how best to allocate their capital.Instead, CII calls for better disclosure of buyback rationales and links to pay.
E&S
Diversity & Inclusion
Board DiversityIssuers can expect a greater degree of negative reaction to all-male boards as Glass Lewis’s new board gender diversitypolicy comes online this season. Glass Lewis will begin recommending against the nominating committee chairs ofRussell 3000 firms with no female directors unless they disclose a timetable for addressing the lack of gender diversity onthe board or specific restrictions in place regarding the board’s composition. ISS has adopted a similar policy for Russell3000 and S&P 1500 firms, which goes into effect in 2020.
The proxy advisor policies follow suit with the positions adopted by some major Institutional investors. Since the launch ofits “Fearless Girl” campaign in 2017, State Street Global Advisors (SSGA) has been voting against nominating chairs ifthere are no female directors on the board. Beginning in 2020, SSGA will expand its dissenting votes to the entirenominating committee. BlackRock also plans to oppose nominating committee members at companies that do not have atleast two women on the board and have not set a timeframe for improvement.
California-headquartered companies are additionally facing a newly enacted law (Senate Bill No. 826) that mandatesgender quotas in the boardroom: at least one female director by the end of 2019 and two to three female directors,depending on board size, by the end of 2021. Based on data from Board Governance Research, some 184 California-based companies would need to add a woman to the board this year to comply with the law, while a total of 1,060 firmswould need to appoint female board members to meet the 2021 deadline. New Jersey legislators proposed a nearlyidentical law last November (NJ Assembly No. 4726), which could impact as many as 42% of New Jersey-based firms,according to estimates by 2020 Women on Boards.
Issuers may also need to review their board diversity disclosures in light of two Regulation S-K Compliance andDisclosure Interpretations (C&DIs) issued by the SEC in February. To the extent that the board or nominating committee,as well as the company’s diversity policies, take into account self-identified personal attributes (race, gender, ethnicity,religion, nationality, disability, sexual orientation or cultural background) the staff expects Item 401 and Item 407discussions to identify those characteristics and how they were considered, assuming the directors and nominees consentto having the information publicized.
Federal lawmakers are similarly promoting more transparency around diversity rather than outright quotas. House andSenate Democrats have introduced companion bills (“Improving Corporate Governance through Diversity Act of 2019”)which would require public companies to disclose in their proxy statements data on the racial, ethnic and gendercomposition, as well as veteran status, of both their board members and executive officers based on voluntary self-identification. It would also require disclosure of any board policy, plan or strategy to promote racial, ethnic and genderdiversity. The bills have been endorsed by CII and the U.S. Chamber of Commerce.
For their part, shareholder activists on both the left and right continue to advocate for the inclusion of diversitycharacteristics in a director skills and qualifications matrix. As part of its Boardroom Accountability Project 2.0, the NewYork City Comptroller has filed eight resolutions seeking a board diversity matrix, including a resubmission at Exxon Mobil,which received 16.5% in 2018.
Meanwhile, to counter liberal bias in boardrooms, the National Center for Public Policy Research (NCPPR) is proposingan alternative matrix that reflects “true board diversity”—namely, each nominee’s skills, experience and ideologicalperspectives. To date, votes are in line with last year, receiving 1.7% support at both Apple and Starbucks. NCPPR hasalso reportedly withdrawn a number of its resolutions in exchange for the companies adopting some form of the request.
Executive DiversityThis year, diversity campaigns are increasingly expanding to the C-Suite, where female and minority representation hasremained relatively flat. Trillium Asset Management has submitted proposals at five companies to report on the diversity oftheir executive leadership team and their plans to make it more diverse in terms of race, gender and ethnicity.
In line with this, recent studies by Calvert Impact Capital and ISS suggest that investors’ focus on gender diversity at theboard level is misdirected. According to the research, the number of women in senior management positions—thosereporting directly to the CEO—has a much greater impact on company performance than the number of female directorsor the gender of the company founder or CEO.
Workplace DiversityTrillium and As You Sow are also continuing their bottom-up approach to diversity by asking for workplace diversity reports(EEO-1 data), which break down a company’s workforce by race, gender and broad job category. 2017 was a breakoutyear for this campaign when filings nearly tripled in volume from the prior year, and one proposal (at Palo Alto Networks)received majority support.
This year, the number of submissions has fallen dramatically—to eight from 23 in 2018—but the scope of the requestshas expanded in some cases. At Fastenal, for example, the proponents are calling for a more robust report based on theSustainability Accounting Standard Board’s (SASB) industry-specific, material risk metrics. This would include gender datafor global operations and EEO-1 racial/ethnic data for U.S. operations, disaggregated into management (executive andmid-level officials) and non-management employees.
Investor demands for EEO-1 reports are likely to accelerate after a federal court recently lifted a stay on a 2016 EqualEmployment Opportunity Commission (EEOC) requirement to include pay data. Companies with more than 100employees will be required to report the gender, racial and ethnic makeup of workers in each EEO-1 job category within12 pay ranges, along with the total hours worked. The measure was frozen in 2017 after the Office of Management andBudget (OMB) concluded that it was overly burdensome for employers, but labor and women’s rights groups successfullysued to have it reinstated. The EEOC and OMB have until April 3 to advise employers on how and when to submit their2018 EEO-1 data. Given the unexpected court ruling—and the possibility that the OMB will appeal it—the May 31reporting deadline is likely to be extended.
Gender Pay EquityProposals addressing gender pay disparities are making a comeback this season after highly successful campaigns inrecent years. Since 2016, the primary sponsor Arjuna Capital has prodded 22 companies in the technology, consumer andfinancial services sectors to share their “pay equity” (“equal pay for equal work”) data and take steps to close any gaps.
This year, Arjuna is shifting its campaign to request global median gender pay gap disclosures from a dozen financial andtechnology firms. Median pay gaps measure the median pay of all men versus the median pay of all women in acompany’s workforce, irrespective of position. Unlike equal pay data, these disclosures shed light on the “leadership gap,”namely, the extent that women are underrepresented in the top-ranking, highest-paying jobs. The initiative is in keepingwith a new mandate in the U.K. requiring companies with over 250 employees to report their mean and median genderpay gaps.
Among the targeted firms, Citigroup became the first U.S. company to report median pay gap data for women andminorities, resulting in a withdrawal of Arjuna’s resolution. Based on its analysis, Citigroup plans to increaserepresentation at the Assistant Vice President through Managing Director levels to at least 40% for women globally and8% for black employees in the U.S. by the end of 2021.
Corporate Culture and Human Capital ManagementThe #MeToo movement and high-profile corporate scandals has sharpened investor attention to risks related to corporateculture and human capital management (HCM) that can negatively impact long-term performance. According to MorrowSodali’s 2019 survey of 46 global institutional investors, 83% want more detailed information on HCM and 67% want abetter understanding of how the board overseas corporate culture and the tone at the top. Similarly, a
survey of 60 institutional investors conducted by the EY Center for Board Matters found that 39% believe HCM andcorporate culture should be a top board focus, up from 6% three years ago. Twenty percent of these investors want moretransparency around HCM-related topics, such as pay ratios, though most are prioritizing dialogue over disclosure.
In line with this, BlackRock has designated HCM as one of its 2019 engagement priorities, while SSGA has created aframework to assist boards and managements in aligning their corporate culture with their long-term strategies. Similarly,a coalition of California pension funds has developed a set of principles to manage and mitigate HCM-related risks,including company policies on sexual harassment, diversity throughout the organization, restrictive labor practices, andworkers’ rights.
HCM is additionally factoring into proxy proposals this year, though many are getting withdrawn for technical reasons oromitted as ordinary business. The New York City Pension Funds (NYC Funds) and Change-to-Win (CtW) InvestmentGroup filed resolutions at seven companies to adopt a policy not to engage in any “inequitable employment practices” thatkeep workplace misconduct in the shadows. These include mandatory arbitration of employment-related claims, non-compete agreements, no-poach agreements and involuntary non-disclosure agreements. Other union-
sponsored proposals deal with how companies’ mandatory arbitration policies are impacting employees and sexual
harassment claims and with formalizing the board’s oversight responsibility for managing and mitigating risks related tosexual harassment.
Following last fall’s global walkout of 20,000 Google employees over exit payments made to executives accused of sexualmisconduct, CtW is presenting one of their demands in a first-time proxy proposal. It is asking parent company Alphabetto appoint an employee representative to the board by 2020 to help mitigate risks related to human capital and corporateculture and prevent the reputational damage caused by employee protests. Although the proposal will face certain defeatbecause of the founders’ superior voting rights, the concept of worker representation on corporate boards is featuring inlegislation proposed by Senate and House Democrats and the platforms of
several 2020 presidential contenders.
Human Rights
Immigrant DetentionIn response to the Trump administration’s zero-tolerance policy on illegal immigration, faith-based investors and theService Employees International Union (SEIU) are engaging and submitting proposals at companies in the private prison,technology, and defense sectors deemed at risk for human rights violations as a result of their contracts with Immigrationand Customs Enforcement, Customs and Border Protection and other federal agencies.
Specifically, they are asking e-commerce firms, such as Amazon.com, to stop selling facial recognition technology togovernment agencies unless the board determines, using independent evidence, that it does not cause or contribute toviolations of privacy, civil liberties and human rights. Similar risk assessments are being sought from governmentcontractors, such as Northrop Grumman, which is developing biometric identification systems for the Department ofHomeland Security. The proponents contend that these technologies facilitate immigrant surveillance and racial profiling.
Shareholder groups are also facing off with CoreCivic and GEO Group, the largest operators of private prisons and illegalimmigrant detention centers. Religious orders want more details on the treatment of people held at their facilities and howrespect for inmate and detainee human rights is incorporated into senior executive pay arrangements. Alex Friedman ofthe Human Rights Defense Center—a longstanding agitator for inmate rights—has proposed that the companies refrainfrom housing unaccompanied minors or illegal adults who have been separated from their children. The Friedmanresolutions were successfully challenged as ordinary business.
Activists have made headway with banks that lend to CoreCivic and GEO Group, withdrawing all four of their proposals.Among the targeted firms was JPMorgan Chase, which is ending its financing of private prison operators, and WellsFargo, which is reducing its exposure to this sector.
HealthRelated
Opioid CrisisThe Investors for Opioid Accountability (IOA)—a coalition of over 50 institutional investors—is continuing its highlysuccessful campaign against opioid abuse with drug manufacturers, distributors and retailers. Over the past year, the IOAhas reached agreements with a dozen companies on governance measures to more effectively monitor and managefinancial and reputational risks related to the opioid crisis. These include producing a board risk report, separating thechair and CEO positions, adopting a misconduct-based clawback policy, enhancing lobbying/political spending disclosure,and not adjusting executive compensation performance metrics to exclude legal costs. In addition, three resolutions onboard risk reporting received majority support at Assertio Therapeutics, Rite Aid and, most recently, Walgreens BootsAlliance.
Nine opioid-related resolutions are currently pending for 2019 annual meetings, including three calling for riskmanagement reports and the remainder for governance reforms. Given the strong investor and proxy advisor support forthis initiative, some of these could ultimately be settled.
Drug Pricing
For a fifth year, faith-based investors are revisiting the issue of high prescription drug costs at major pharmaceuticalcompanies. To avoid the ordinary business exclusions that have occurred in the past, the proponents are asking ninecompanies for compensation committee risk reports to show the extent that their drug pricing strategies are tied intosenior executive compensation. Last year, these proposals averaged 23.3% support and were backed by ISS, butopposed by Glass Lewis.
Other proposal variations may not make it to ballots due to negotiated withdrawals. These include a new resolution toformalize board oversight of prescription drug pricing in a new or existing board committee and to add drug pricing riskexpertise to the director qualifications matrix.
EnvironmentalRelated
Climate ChangeRisks related to climate change will be a top priority for investors this year, both in their discussions with issuers and inproxy proposals. Morrow Sodali’s recent survey of 46 global investors found that 85% considered climate change theirmost important engagement topic, up from 31% last year.
According to ISS, companies will face a record 75 or more climate-related resolutions this year. Yet despite the onslaught,some of the largest index investors (BlackRock, Vanguard and Fidelity) have historically backed only a small fraction ofthe proposals.
BlackRock, in particular, has been called out by a dozen environmental groups and social investment funds for its votingpractices and “poor contribution to environmental goals.”
This year’s climate campaigns are going beyond stress-testing business plans and are asking carbon-intensivecompanies to establish hard targets for reducing their emissions. The Church of England, New York State CommonRetirement Funds (NYSCRF) and other filers have submitted a first-time proposal, which is pending at Exxon Mobil, to setand disclose short-, medium- and long-term targets for cutting GHG emissions—for both its own operations and theproducts it sells—that are aligned with the goals of the Paris climate agreement.
This follows after rival Royal Dutch Shell relented to investor pressure last fall and announced that it would introducethree- and five-year carbon reduction targets that would include customers’ use of its fuels (Scope 3 emissions) and tie-ins to executive pay. BP and Chevron have similarly pledged to link employee bonuses to GHG reduction targets.
Aside from aggressive carbon reduction demands, one proponent (the NYC Funds) went to so far as to sue aerospaceparts manufacturer TransDigm Group in federal district court for trying to omit their resolution to adopt goals for managingGHG emissions. The plaintiffs sought both declaratory and injunctive relief, claiming that exclusion of the proposal wouldcause them “irreparable injury.” Rather than fight the matter, TransDigm withdrew its no-action request and let theproposal go to a vote, which registered 34.9% support. However, the incident has raised concerns that the NYC Funds—or other proponents—will pursue judicial intervention to keep resolutions on the ballot.
Separately, the New York City Comptroller and a coalition of 19 public pension systems, social investment funds and faith-based investors have launched an ambitious campaign to eliminate carbon pollution from the country’s 20 largest electricpower utilities, which account for nearly half of the sector’s emissions. In recent letters, they asked the utilities to committo achieving net-zero carbon emissions by 2050, with near-term benchmarks in 2025 and 2030, and to adopt policies toensure that their executive compensation and political activities are aligned with that goal. Of the companies targeted,only one (Xcel Energy) has committed to the net-zero-by-2050 objective. If the others fail to make this commitment bytheir 2020 annual meetings, the coalition will recommend that asset owners and managers vote against the board chairand/or lead director.
Plastic PollutionFor 2019, As You Sow and a coalition of 40 international investors—the Plastic Solutions Investor Alliance—are steppingup their efforts to combat plastic waste and marine pollution. In their first vote of the season, a repeat proposal at
Starbucks to boost plastic recycling and transition to sustainable packaging won 44.5% support, a record high on thistopic. Similar resolutions are pending at three other consumer goods companies.
This year, the proponents are broadening their campaign to include petrochemical companies (Chevron, DowDupont,Exxon Mobil and Phillips 66) to annually report on plastic pellet spills and cleanup measures during the resin productionprocess and actions taken to prevent future contamination. Studies estimate that plastic pellets (“nurdles”) are the secondlargest direct source of microplastic pollution in the ocean by weight. So far, one resolution has been withdrawn at ExxonMobil after the company agreed to the reporting.
Aside from proxy proposals, Walden Asset Management and the Sierra Club have written letters to a dozen companies todrop their support of the Plastics Industry Association (PLASTICS), which has lobbied for statewide preemption of localordinances that ban or tax plastic bags. One recipient (Becton, Dickinson) decided to withdraw its associationmembership, while privately-held SC Johnson will ensure that its dues do not go towards funding plastic bag lobbying.
Conclusion
This year’s annual meetings will give issuers additional insight into two key matters which will help frame post-seasonengagements and shape next year’s shareholder campaigns: the extent that investor views are shifting on E&S issuesand how the SEC is applying new guidance on Rule 14a-8(i)(7) and 14a-8(i)(5) exclusions. As the season progresses,Alliance Advisors will keep issuers apprised of these and other key developments as they arise.
Table 1:
Proposal2019
(as of March 31)Proposal
2018 (full year)
Political spending 56 Special meetings 84
Independent chairman 46 Independent chairman 58
Supermajority voting 35 Proxy access 55
Grassroots lobbying 35 Grassroots lobbying 51
Written consent 33 Written consent 45
Gender pay equity 28 GHG emissions reduction 31
Proxy access 21 Sustainability report 31
Board diversity—liberalversion
21Board diversity—liberalversion
30
Sustainability report 21 Political spending 27
GHG emissions reduction 19 Gender pay equity 27
Link pay to social issues 19 Supermajority voting 26
Source: SEC filings, proponent websites and media reports.
The complete publication, including footnotes, is available here.
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February 4, 2019
The Honorable Jay Clayton Chairman U.S. Securities and Exchange Commission 100 F Street, NE Washington, DC 20549
Dear Chairman Clayton:
We, the undersigned publicly traded companies, want to thank you for conducting the Roundtable on the Proxy Process on November 15, 2018. The U.S. proxy process is critical to public company governance, and we appreciate the Commission’s recognition that areas within the process need to be reformed.
These issues have real effects on the economy, job creation and global competitiveness. As many have communicated to the SEC in the past several years, these issues are part of a poorly-calibrated regulatory ecosystem that is producing fewer IPOs and driving many companies out of the public markets.
The proxy process is a key opportunity for companies to communicate with shareholders. A transparent, accurate and verifiable proxy system that is oriented toward long-term value creation is vital to constructive shareholder engagement and the successful operation of public companies. The Commission emphasized this point in the 2010 Concept Release on the U.S. Proxy System, which noted: “With 600 billion shares voted every year at more than 13,000 shareholder meetings, shareholders should be served by a well-functioning proxy system that promotes efficient and accurate voting.”
The November 15th Roundtable provided for open discussion on several issues where reform is necessary for a more useful and efficient proxy system. As publicly traded companies, we urge the SEC to address the following critical items:
Proxy Advisory Firms: The SEC must take strong action to regulate proxy advisory firms to address three critical frustrations with their current operations:
Conflicts of Interest: The SEC should adopt strong protections for both companies and users of proxy advisory services to ensure that conflicts of interest are eliminated where possible, minimized and/or mitigated where appropriate, and transparent to the users and subjects of reports. Conflicts should be disclosed on the front page of proxy advisor reports on companies so that investors make fully informed voting decisions.
Accuracy: The SEC should require transparent processes and practices that allow ALL public companies, regardless of their market capitalization, to engage with proxy advisory firms on matters of mistakes, misstatements of fact and other significant disputes so that timely resolution of those disputes and corrections to the record can be made to minimize the negative impacts that such mistakes can have on the subject company’s proxy voting outreach and its shareholders. Such policies and procedures are absolutely critical to any reforms considered by the SEC. Given the impact of the proxy advisory firms’ decision-making and recommendations on the capital markets, and the large percentage of institutional voting that follows their recommendations, the ability to identify and correct errors is crucial for accuracy and accountability.
Transparency of proxy voting standards: Proxy advisors currently play a critical role in the development of de facto market rules through their policies and recommendations. The SEC should require public transparency, including a formal public comment period, when a proxy advisory firm intends to change its voting policies from one proxy season to the next and ensure that companies have the ability to determine, on their own, whether they can satisfy those policies. Proxy advisory firms should not be allowed to significantly affect voting recommendations using opaque rules, which require paid services to interpret. Moreover, in the absence of transparent policies, neither the proxy advisory firms’ clients, nor the companies they report on, can determine whether a policy is applied correctly or if a recommendation is based on factual errors.
Shareholder Proposals: The SEC should modernize the shareholder proposal process so that it reflects more reasonable standards for submission and resubmission of shareholder proposals and is oriented toward creating long-term value for all shareholders. Reasonable standards for resubmissions were previously proposed by the SEC in 1997, which would have required 6 percent support for the first resubmission, 15 percent for the second, and 30 percent for the third.
Shareholder Communications: The SEC should focus on streamlining shareholder communications to enable companies to directly and cost-effectively communicate with their shareholders. The Commission should repeal the distinction between objecting and non-objecting beneficial owners (OBOs and NOBOs), which inhibits the ability of companies to communicate with the majority of investors who are not registered shareholders.
Proxy Process: The SEC needs to update the proxy voting process to make voting more transparent and verifiable and to increase retail investor participation.
Maintaining a viable public company model is of the upmost importance for companies that need capital, but also for Main Street investors and the overall economy. Addressing these critical proxy process issues will make our capital markets stronger and improve the experience for public companies and benefit their long-term investors.
Sincerely,
Nasdaq, Inc. Abraxas Petroleum Corporation Achieve Life Sciences, Inc. Aclaris Therapeutics, Inc. Acorda Therapeutics, Inc. Adial Pharmaceuticals, Inc. Advanced Emissions Solutions, Inc. Advanced Energy Industries, Inc. Aemetis, Inc. AgroFresh Solutions, Inc. Air T, Inc. Allegiant Travel Company AMAG Pharmaceuticals, Inc. Ambac Financial Group, Inc.
2
Ambarella, Inc. American Outdoor Brands Corporation ANGI Homeservices Inc. Apogee Enterprises, Inc. Apollo Endosurgery, Inc. Approach Resources Inc. Aquinox Pharmaceuticals, Inc. ArcBest Corporation Arch Capital Group Ltd. Aridis Pharmaceuticals, Inc. Artesian Resources Corporation Arthur J. Gallagher & Company Ascena Retail Group, Inc. Aspen Technology, Inc. Assembly Biosciences, Inc. Atara Biotherapeutics Inc. Athersys, Inc. Atomera Incorporated Attis Industries, Inc. Automatic Data Processing, Inc. (ADP) Avadel Pharmaceuticals Plc Avid Bioservices, Inc. Axon Enterprise, Inc. Axonics Modulation Technologies, Inc. Balchem Corporation Biogen Inc. BIO-key International, Inc. BioMarin Pharmaceutical Inc. Boingo Wireless, Inc. Box Boxlight Corporation Brainstorm Cell Therapeutics Inc. Brightcove Inc. Bryn Mawr Bank Corporation CaCanterbury Park Holding Corp Cadiz Inc. Caladrius Biosciences, Inc. Calithera Biosciences, Inc. Cardtronics plc Career Education Corporation Carrizo Oil & Gas, Inc. Casella Waste Systems, Inc. Century Communities Charles & Colvard, Ltd. Chart Industries, Inc. Chefs' Warehouse, Inc. Chevron Corp. ChromaDex Corporation
3
Ciena Corporation Cimpress N.V. Cincinnati Financial Corporation City Holding Company Clean Energy Fuels Corp. Cloud Peak Energy, Inc. Colliers International Group Inc. Colony Bankcorp, Inc. CommVault Systems, Inc. Computer Programs and Systems, Inc. (CPSI) Conformis, Inc. CONMED Corporation Core-Mark Holding Company, Inc. Core-Mark Holding Company, Inc. Coupa Software, Inc. Covenant Transportation Group, Inc. Cowen Inc. Criteo Crocs, Inc. Crown Crafts, Inc. CSW Industrials, Inc. CTI Industries Corporation CUI Global, Inc. CytomX Therapeutics, Inc. Dael Victoria Reyes Trust Data I/O Corporation Denny's Corporation Destination XL Group, Inc. DiaMedica Therapeutics Inc. Diodes Incorporated Dixie Group, Inc. Dollar Tree, Inc. Domo, Inc. Dynamic Signal E.W. Scripps Company Eagle Bancorp Montana, Inc. Eagle Bancorp, Inc. Ecolab Inc. EdtechX Holdings Acquisition Corp Encana Corporation Endo International Plc ENGlobal Corporation Ensign Group, Inc. Esperion Therapeutics, Inc. Esquire Financial Holdings, Inc. Euronet Worldwide, Inc. EZCORP, Inc. Finjan Holdings, Inc.
4
First Mid-Illinois Bancshares, Inc. First Solar, Inc. FirstCash, Inc. Five Star Senior Living Inc. Flexion Therapeutics, Inc. Flushing Financial Corporation FMC Corporation FNCB Bancorp, Inc. Franklin Templeton Fuel Tech, Inc. Full House Resorts, Inc. Funko, Inc. Gaia, Inc. Gaming and Leisure Properties, Inc. Genius Brands International, Inc. Genocea Biosciences, Inc. Geospace Technologies Corporation Gilead Sciences, Inc. Glacier Bancorp, Inc. Global Blood Therapeutics, Inc. Goosehead Insurance, Inc. Government Properties Income Trust Green Plains Inc. Grindrod Shipping Holdings Ltd. Hallador Energy Company Hamilton Bancorp, Inc. Healthcare Services Group, Inc. Hennessy Advisors, Inc. Hercules Capital, Inc. Heritage Financial Corporation Home Federal Savings Bank HomeStreet, Inc. Hooker Furniture Corporation Hospitality Properties Trust Howard Bancorp, Inc. IAC ICU Medical, Inc. ImmunoGen, Inc. Incyte Corporation Independent Bank Group, Inc. Industrial Logistics Properties Trust Innospec Inc. Inogen, Inc. Inseego Corp. Insteel Industries, Inc. Internap Corporation International Bancshares Corporation Investors Bancorp, Inc.
5
Investors Title Company Itron, Inc. IZEA Worldwide, Inc. Jack Henry & Associates, Inc. Jack in the Box Inc. Kforce Inc. Kindred Biosciences, Inc. Kinsale Capital Group, Inc. Kirby Corporation Kirkland’s, Inc. Lake City Bank Lamar Advertising Company Landmark Bancorp, Inc. Lazydays Holdings, Inc. LCNB Corp. Liberty Global, Inc. Lifetime Brands, Inc. Lifeway Foods, Inc. Live Ventures Incorporated Lumentum Holdings, Inc. Madrigal Pharmaceuticals, Inc. Magyar Bancorp, Inc. Manhattan Associates, Inc. Marathon Petroleum Corp. Marin Software, Inc. Marrone Bio Innovations, Inc. Marvell Semiconductor Masimo Corporation Maxim Integrated Products, Inc. Medical Transcription Billing Corp. (MTBC) Melrose Bancorp Inc. Meta Financial Group, Inc. Micron Technology, Inc. Middlefield Banc Corp. MidWestOne Financial Group, Inc. Misonix, Inc. MKS Instruments, Inc. Monmouth Real Estate Investment Corporation Monolithic Power Systems, Inc. MyoKardia, Inc. MYOS RENS Technology Inc. NantKwest, Inc. Nature’s Sunshine Products, Inc. NetScout Systems, Inc. NI Holdings, Inc. Novan, Inc. NutriSystem, Inc. Obalon Therapeutics, Inc.
6
Old Line Bancshares, Inc. Old National Bancorp OneSpan Inc. OptiNose, Inc. Oracle Organovo Holdings, Inc. Orthofix Medical, Inc. Otter Tail Corporation Overstock.com, Inc. Oxbridge Re Holdings Limited Pacific Premier Bancorp, Inc. Pacira Pharmaceuticals, Inc. PayPal Holdings Inc. Penn National Gaming, Inc. People’s Utah Bancorp Perma-Pipe International Holdings Inc. Plexus Corp. Pluralsight, Inc. Pool Corporation Power Integrations Inc. PRA Group Inc. Premier, Inc. PriceSmart, Inc. Principal Financial Group, Inc. Principia Biopharma, Inc. Profire Energy, Inc. Progress Software Corporation Proofpoint, Inc. Prothena Corp. Plc QIWI plc QuinStreet, Inc. Rambus Inc. Real Goods Solar, Inc. Red Rock Resorts, Inc. Rimini Street, Inc. Riverview Community Bank Rocky Mountain Chocolate Factory, Inc. Royal Gold, Inc. Ryanair Ryder System, Inc. S&T Bancorp, Inc. Salisbury Bancorp, Inc. Seagate Technology PLC Select Income REIT Senior Housing Properties Trust Shore Bancshares, Inc. SI-BONE, Inc. Sierra Oncology, Inc.
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Signature Bank Simmons First National Corporation SINA Corp. SINTX Technologies, Inc. Spectrum Pharmaceuticals, Inc. Splunk Inc. Spok Holdings, Inc. SSR Mining Inc. STAAR Surgical Company Star Bulk Carriers Corp. Stein Mart, Inc. Steven Madden, Ltd. StoneCastle Financial Corp. Strategic Education, Inc. Streamline Health Solutions, Inc. Sunesis Pharmaceuticals, Inc. Sunrun Inc. SurveyMonkey Sutro Biopharma, Inc. Sykes Enterprises, Incorporated Symantec Corporation Synaptics Incorporated Tactile Systems Technology, Inc. Tech Data Corporation TechNet Teligent, Inc. Tenable Holdings, Inc. Tenax Therapeutics, Inc. Teradyne, Inc. Territorial Bancorp Inc. The Bancorp, Inc. The Boeing Company The Eastern Company The First of Long Island Corporation The Michaels Company, Inc. The RMR Group Inc. The Travelers Companies, Inc. Tilray, Inc. Tractor Supply Company Transcat, Inc. TravelCenters of America LLC Tremont Mortgage Trust TTM Technologies, Inc. Union Bankshares Corporation United Insurance Holdings Corp. Urban Outfitters, Inc. U.S. Chamber of Commerce Utah Medical Products, Inc.
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Verisk Analytics Inc. Viking Therapeutics, Inc. W. R. Berkley Corporation Walgreens Boots Alliance, Inc. Washington Federal, Inc. Weibo Corp. Werner Enterprises, Inc. Westfield Bank Willamette Valley Vineyards, Inc. Willis Towers Watson Public Limited Company Windstream Holdings, Inc. WVS Financial Corp. Wynn Resorts, Limited Yum! Brands, Inc. Zafgen, Inc. Zagg Inc. Zebra Technologies Corporation Zions Bancorporation Zynerba Pharmaceuticals Inc.
9
Keynote Remarks: ICI Mutual Funds andInvestment Management Conference
San Diego, CA
March 18, 2019
I. Introduction
Thank you, Susan [Olson], for the kind introduction. I am excited to join you here and deliver my first formal speechas a Commissioner. It has been a little over six months since I started in my new role at the Securities andExchange Commission (“SEC”), and I can still say that it’s a very surreal feeling. Not a day goes by when I do notthink about how incredible an honor it is to serve the investing public. My path to this job has not been linear. Butmy experiences along the way—working in private practice as an attorney, at the parent public company of a largestock exchange, in the role of counsel to an SEC Commissioner, and on the staff of the Banking Committee in theU.S. Senate—have given me a broad view of the markets that the SEC regulates and a deep commitment to theagency’s mission. I mean this, truly: it is a privilege to be serving in my role.
Today, I will talk about the proxy process. But, before I segue into any substance, this is a good time for me toprovide my first standard disclaimer: My views and remarks are my own, and do not necessarily represent those ofthe SEC or other Commissioners.
Last year, Chairman Jay Clayton announced that the Commission would review the existing SEC rules that governthe proxy system.[1] The staff held a roundtable that raised many issues in this area and invited public commentprior to and following the event.[2] Recently, the Chairman asked me to take the lead on the Commission’s effortsto consider improvements to the proxy process. I gladly accepted and feel honored to have this opportunity.[3]
During my time at a law firm and as an in-house counsel at an exchange, as well as at the SEC and in Congress, Iwas able to interact with managers, directors, and shareholders of U.S. public companies. One of my mostinteresting professional experiences was working with the Corporate Secretary of my former employer, a job thatinvolved preparing materials for board meetings and taking minutes. In these meetings, I saw, first-hand, howseriously directors took their jobs: challenging management, scrutinizing the business’s trajectory, and striving toact in ways that serve the interests of the company’s shareholders. I also worked on drafting the company’s proxystatement and annual report, as well as organizing and running the annual shareholder meeting. My interactionswith management, directors, law firms, printers, proxy solicitors, proxy advisory firms, transfer agents, shareholders(including funds), and shareholder proponents still are fresh in my mind.
Commissioner Elad L. Roisman
Speech
These experiences led me to take great interest in the proxy process and recognize its fundamental importance toour capital markets. They are premised on the notion that shareholders demand economic value from thecompanies they own and vote in ways that can influence their corporate management to deliver that value. Thisshareholder-company dynamic drives productivity in our economy and helps investors grow their wealth.
I remember thinking every April, as the annual meeting approached: is this the best system we have for the world’sbest capital markets? (I also remember thinking “Who is Evelyn Y. Davis?” “Why am I responsible for escorting herto the meeting?” and “What does it mean to be ‘the Queen of the Corporate Jungle?’”[4]) I thought some aspects ofproxy season worked well and noticed others that did not. But after each meeting, I breathed a sigh of relief thatnine or ten months stood between me and the next proxy season, and I’d start working on other matters.
Today, I am happy to bring all my experiences to my current role, where I am fortunate to engage with others whohave equally passionate views on the proxy voting ecosystem.
II. Proxy Voting
This brings me to the here and now: I am excited to talk to this group, in particular, about proxy voting becauseyou, in this room, represent some of the most influential shareholders in our economy today: the funds youmanage. Long gone are the days when retail shareholders directly held the majority of shares in U.S. publiccompanies. Today, over 100 million individuals, representing nearly 45% of U.S. households, own open-end funds.[5] And, in today’s market, funds own 1/3 of the shares of U.S.-issued equities outstanding.[6] Of course, thatmakes the task of voting proxies—as ICI put it in its comment letter last year—“no small job.”[7] In the 2017 proxyseason, the average mutual fund voted on 1,504 separate proxy proposals.[8] It is an understatement to say thatyour voting has a direct impact on the economic returns of countless investors.
Today, I hope to follow up on a number of questions I posed at the November roundtable[9]:
How are fund boards and advisers fulfilling their fiduciary duty in the context of proxy voting?
How are they relying on proxy advisory firms?
Should the SEC take any actions to alter the current state of affairs?
Since the roundtable, my staff and I have spent countless hours reviewing the roundtable transcript and commentletters submitted to the file, reading additional literature on the topic, and combing through a broad sampling ofrelevant disclosures (on Forms N-1A, N-PX, and ADV) and fund stewardship documents. We have also met withmany participants from across the capital markets to discuss their views in greater detail.
As with many things in life, the more I learn, the more knowledge I wish I had. So, I would like to take thisopportunity to share my current thoughts and pose some questions on which I hope you will engage with mefurther.
To give you a preview, I have noticed certain asset management practices with respect to proxy voting that haveraised questions. In particular, why some advisers 1) aim to vote every proxy for every company in every fund’sportfolio; 2) centralize proxy voting functions within a complex and vote uniformly across funds in the complex; and3) rely on third-party proxy advisory firms to assist with devising and implementing voting policies. These are notnecessarily inherently problematic practices, but without further insight into the thinking behind them, I can seeways in which they might not align with the best interests of individual funds.
I recognize that there is great variety in the asset management industry; there are large fund complexes, as well assmaller and medium-sized fund groups that each have differing objectives and investments. I hope my remarkstoday will inspire further comments and engagement on these practices from many different types of advisers, butparticularly the smaller managers to understand where they face greater obstacles for compliance. I would also beinterested in feedback on how Commission action could provide clarity on or recalibrate how our current proxyvoting system can best (or better) serve investors.
III. Existing SEC Rules and Guidance
The SEC’s current rules governing fund advisers’ roles in voting proxies focus on principles and disclosure. Mostrelevant here, in 2003, the Commission adopted the explicit requirement that each investment adviser adopt andimplement policies and procedures that are reasonably designed to ensure that advisers vote clients’ proxies in theclients’ best interests.[10] Over a decade later, the Commission’s staff in the Divisions of Investment Managementand Corporation Finance published additional guidance in a Staff Legal Bulletin.[11] This Q&A stated that advisoryclients (such as fund boards) could limit how often advisers vote proxies if the costs of voting on certain types ofproposals or issuers do not serve a client’s best interest.[12]
The Commission’s principles-based and disclosure-based approach to regulating in this area has left a lot offlexibility for fund advisers, relying on their fiduciary duty to fill in the gaps. We all know that funds invest otherpeople’s money. While a large asset manager might exercise a high level of influence in our capital markets, itspower emanates from this agency role. More than merely an agent, a fund adviser is a fiduciary, having theobligation not to place its own interests ahead of its clients’ interests.[13] This applies in the proxy voting context:when advisers vote proxies for the funds they manage, they must do so in a way that serves the best interests ofeach fund.[14]
IV. Certain Asset Management Practices
This leads me to the critical question: What is in the best interest of a fund in the context of proxy voting? [15] Ihave thought about this a lot and continue to seek further insight on the question, as I believe its answer shouldform the basis of any Commission action in this area. As I have studied this issue, I have observed certainpractices that I would like to understand better, in terms of how advisers believe they serve each fund under theirpurview.
A. To Vote or Not To Vote?For example, it appears to be the default position of many advisers that they vote every proxy, for every company,in every fund’s portfolio. This is interesting since, in any given proxy season, a fund’s shares could be voted onissues as far-ranging as independent auditor ratification to corporate political spending, for the largest and smallestof the fund’s holdings. Since a fund adviser derives its authority to vote from its position as the fund’s agent, Iwould think that the nature and scope of the fund’s investment objective would logically influence whether, when,and how the adviser votes the fund’s shares. Do advisers believe that voting on all of these issues is material to afund’s investment objective and benefits the fund?[16]
There is also the consideration of cost. The Commission acknowledged in the Proxy Voting Rule Release (and sodid the SEC staff in SLB 20) that voting proxies has associated costs.[17] Obviously, these include the adviser’stime and cost of performing research. Opportunity cost may also be significant, such as foregone income fromshares on loan that have to be recalled to be voted or shares that are restricted from being lent out for this samereason. I imagine these costs could add up quickly, considering the differing matters of the many companies whoseproxies fund advisers are often asked to vote.[18]
I would like to hear input on whether it would be helpful for the Commission to provide further guidance in this area.There appears to be some understandable confusion about what our rules require with respect to whether anadviser must vote. SLB 20 included Question 2, which asks “Is an investment adviser required to vote everyproxy?” I can’t help but notice that the 342-word answer did not contain either the word “yes” or “no.” I believe theanswer should be, in some cases, NO.[19] I would be interested in perspectives on what considerations couldfactor into an adviser’s analysis. Some that spring to my mind are: 1) Is a company a material part of the fund’sportfolio?; 2) Is the outcome of the vote material to the fund’s investment objective?; 3) What is the opportunity costto the fund of voting proxies for this company?; and 4) Would the potential benefits of voting justify the costs?
B. Discerning Differences between FundsNext, it seems that some asset managers have moved toward centralizing proxy voting (and “stewardship”)functions within the fund complex, moving these roles farther away from portfolio management. Additionally, itappears that some asset managers aim to vote uniformly across funds. I would like to better understand how suchpractices account for differences between funds.
Funds themselves are distinct entities. They may be part of the same complex and managed by the same adviser,and even have some common investment objectives, time horizons, and portfolio holdings. But it seems to me thatdistinct funds could have different interests in proxy voting that could lead them rationally to desire differentoutcomes from the same company’s proxy contest, transformative transaction, or contested shareholder proposal.
One example is a merger, where the deal appears better for one company (say, the target) than the other (here,the acquirer, who may be taking on a struggling business and large debt obligations).[20] Let’s say an advisermanages two funds, one with a long position in the target that would benefit from the merger, and another, heavilyinvested in the acquirer, that could lose value. Shouldn’t the adviser vote both funds’ shares differently, one in favorof the transaction, and the other against? More broadly, it seems that conflicts could exist between funds withdifferent investment objectives. Consider the preferences of a portfolio manager at a growth fund, which targetscompanies with high growth prospects, and an income/dividend fund, which seeks to generate an income streamfor shareholders in the form of dividends or interest payments. If there is a proxy contest led by an investor toincrease dividend payments, shouldn’t these funds vote differently? It would seem to me that voting these funds’shares the same way could risk subsidizing one fund’s votes with votes of another.[21]
I am interested in exploring how advisers handle these types of conflicting interests. How have advisers remainedcognizant of distinctions between funds when designing processes for centralizing voting and stewardship roles?Have advisers found voting policies that are flexible enough to apply to all funds, yet account for differencesbetween them—in other words, can one size fit all?
V. The Role of Proxy Advisory Firms
Next, it has been widely recognized that many asset managers have come to rely on third party proxy advisoryfirms in several aspects of the proxy voting process. Let me say up front: I recognize that proxy advisory firmsprovide services that their clients greatly value. For that reason, I do not believe we should impose additionalregulations upon them without thorough consideration. But, I believe it is incumbent upon their clients (i.e. assetmanagers) to use their services responsibly.[22] And, I am interested to hear how asset managers have gottencomfortable that they are doing that.
A. Voting GuidelinesFor example, I have seen many Forms ADV, in which asset managers disclose that they have adopted the proxyvoting policies developed by proxy advisory firms. Yet, after reading through some proxy advisory firms’ votingguidelines myself, I noticed several things that would give me pause before adopting them wholesale. Theseinclude instances in which various guidelines appear either to undermine existing legal rights or to set benchmarksunrelated to legal requirements and company-specific attributes.[23]
How do asset managers come to understand what they are signing on to when adopting these guidelines orbecome comfortable that such guidelines best serve their clients? Also, to what extent are advisers customizing theguidelines before adopting them for their clients?
B. Robo-Voting or Pre-Populating?Regardless of which voting policies and procedures an asset manager decides to adopt, there is the matter ofimplementing them when voting. I have seen some evidence indicating that asset managers may be relying heavilyon proxy advisory firms in this area.[24] Some have characterized this as “robo-voting,” suggesting that proxy
advisory firms are going too far in acting on behalf of their clients. Others argue that proxy advisory firms merelypre-populate votes in electronic proxy cards to make the process less burdensome. I would be interested to heardirectly from asset managers about how they are utilizing proxy advisory firms to cast votes. For example, howmuch upfront instruction does an asset manager provide to a proxy advisory firm about how to pre-populate anelectronic proxy card? How much discretion does this leave to a proxy advisor? To what extent do advisers reviewand sometimes override the pre-populated suggestions of the proxy advisory firms before submitting their votes tobe counted?
C. Accuracy and CompletenessAs I consider how asset managers may be relying on proxy advisors, I remain cognizant of recurring concerns withaspects of how these firms operate. Many have criticized proxy advisors’ processes for developingrecommendations as being prone to errors and suppressing viewpoints from the companies they research.[25] Iam primarily concerned about factual errors, rather than disagreements about the interpretation of those facts orunpopular recommendations resulting from accurate factual inputs. It is commonly known that proxy advisory firmsdo not allow most issuers an opportunity to review or correct errors in their reports in advance of sending thereports to clients, something that companies understandably find frustrating.[26] When an asset manager discoversthat a proxy advisory firm has made some material error in its recommendation or underlying research, how doasset managers reassess how they are using the proxy advisory firm? I am also interested in hearing how advisersreceive or account for input from issuers before voting proxies (including issuers’ reactions to what they mightcharacterize as proxy advisory firms’ analytical errors). Should the Commission explore ways of making it easier foradvisers to get this information in a timely manner?
D. Conflicts of InterestAnother important concern with proxy advisory firms relates to their potential conflicts of interest, an issue that goesto the efficacy of the information and services they provide. These conflicts may emanate from proxy advisoryfirms’ organizational and ownership structure, affiliates, lines of business, clientele (including preferential treatmentor disproportionate influence of certain clients), and other business relationships.[27] For example, it is well-knownthat certain proxy advisory firms consult for public issuers on corporate governance matters. When corporategovernance matters of the proxy advisory firms’ corporate customers are put forward for a vote, is it likely that theproxy advisors would recommend against their own consulting services?[28]
It appears that proxy advisory firms have varying approaches to disclosing and otherwise mitigating these conflicts.I would be interested to hear how asset managers are diligencing proxy advisory firms’ conflicts and becomingcomfortable with their methodologies before utilizing their proxy recommendations and products. Additionally, sincethese conflicts affect company-specific recommendations, it would be important to know—at the time an assetmanager reviews the proxy advisory firm’s recommendations on each company’s proxy—whether the proxyadvisory firm has a conflict with respect to that company or a shareholder proponent. I understand that some proxyadvisory firms offer a way for their clients to have this information presented, along with their recommendations foreach meeting, in the clients’ electronic portals. Do asset managers find that useful? Are there better ways to havethis information presented or otherwise made more transparent? What ongoing monitoring or conflict review areasset managers conducting?
E. Where Should the Commission Go From Here?As the primary consumers of proxy advisory services, asset managers are in a unique position to provide input onthese types of questions. From this input, I hope to understand whether industry demand could produce betterresults from proxy advisory firms or whether the Commission should consider other ways.
The Commission, undeniably, played a role in the evolution of proxy voting today, including the growth of proxyadvisory firms. In 2004, the SEC staff gave investment advisers a green light to rely almost wholesale on proxyadvisory firms, when it advised one firm that “the recommendations of a third party who is in fact independent of aninvestment adviser may cleanse the vote of the adviser’s conflict [of interest].”[29] That same year, the staff also
blessed a key conflict of interest endemic to many proxy advisory firms’ business models when it affirmed thatselling corporate governance consulting services to companies “generally would not affect the [proxy advisoryfirm’s] independence.” [30]
I commend [the Division of Investment Management’s] Director Dalia Blass for withdrawing these staff letters.[31] Ido not believe that the SEC staff should unilaterally alter the intent of Commission rules by approving, across-the-board, practices that could be construed as outsourcing fiduciary duty or ignoring major conflicts of interest.
In light of this history and the questions I posed earlier, I believe it is a good time for the Commission to considerwhether guidance would be helpful to asset managers as they consider how to utilize the services of proxyadvisory firms. Relatedly, since proxy advisory firms rely on the proxy solicitation exemptions available undercertain Exchange Act rules,[32] it may be appropriate for the Commission to reassess whether their currentpractices fit within the intended scope and purpose of these exemptions.
VI. Other Proxy-Related Reforms
I am also interested in other areas of the proxy process that are less directly related to asset managers, but whichare worth noting here.
I have been focusing extensively on what the Commission can do to improve the “plumbing” that underlies ourproxy voting system. The November roundtable shed light on how complex, inefficient, and, at times, unreliable thisinfrastructure is. I believe the Commission needs to consider not only “quick-fixes” that could marginally improvesome aspects of how the system works, but also comprehensive solutions based on modern technology. Forexample, I think it is incumbent on all of us to find a way to achieve end-to-end voting confirmation. I am interestedin hearing, from all those involved, about short-term and long-term ways to accomplish this and otherimprovements. For all of these suggestions, I particularly hope to hear feedback about what private ordering couldaccomplish versus what Commission action might be needed (either to remove barriers to private action or solvecollective action issues among private actors).
Another aspect of proxy voting that I am interested in is thresholds for submission and resubmission of shareholderproposals. It is important to achieve a balance here so that we allow for robust shareholder engagement withoutproviding a mechanism for certain shareholders with idiosyncratic views to use the shareholder proposal system ina way that does not benefit the interests of the majority of long-term shareholders. In that spirit, reviewing whetherthe current monetary threshold and holding period for submissions strikes this balance, or whether otheralternatives could better do so, may be appropriate. Relatedly, I am interested in perspectives on whether raising ormodifying resubmission thresholds would preserve management’s time, and shareholders’ money, from beingspent considering the same proposals repeatedly, after they have been rejected by the majority of shareholders.
Another area where more discussion would be helpful is “proposal by proxy.” I am aware that the Division ofCorporation Finance stated in 2017 that it is of the view that a shareholder’s submission by proxy is consistent withRule 14a-8.[33] But, I would like to further understand how it is in the long-term interest of shareholders to allowthis practice, when the proponent either is not a shareholder or cannot qualify to bring the proposal on his or herown.
VII. Conclusion
Let me conclude this round of 20+ questions with a sincere word of thanks to all of you who have already taken thetime to meet with me or submit letters to the comment file. This includes, of course, ICI who thoughtfully andextensively provided comments to the Commission on many of these issues.[34] I view it as a positive sign thatproxy issues are receiving so much attention inside and outside the Commission—this is a testament to theirfundamental importance to our capital markets. I look forward to engaging further with all interested stakeholderswho would like to share their points of view. My door is open, and I hope you come and visit.
[1] See Chairman Jay Clayton, “Statement Announcing SEC Staff Roundtable on the Proxy Process” (July 30,2018), https://www.sec.gov/news/public-statement/statement-announcing-sec-staff-roundtable-proxy-process.
[2] See the Commission’s “Spotlight on Proxy Process,” https://www.sec.gov/proxy-roundtable-2018, forinformation about the November 15, 2018 staff roundtable and a link to comments submitted before and after thisevent.
[3] See Chairman Jay Clayton, “Remarks for Telephone Call with SEC Investor Advisory Committee Members”(Feb. 6, 2019), https://www.sec.gov/news/public-statement/clayton-remarks-investor-advisory-committee-call-020619; Commissioner Elad L. Roisman, “Brief Statement on Proxy Voting Process: Call with the SEC InvestorAdvisory Committee” (Feb. 6, 2019), https://www.sec.gov/news/public-statement/statement-roisman-020619.
[4] See “Evelyn Y. Davis, Shareholder Scourge of C.E.O.s, Dies at 89” by Emily Flitter of the New York Times (Nov.7, 2018).
[5] See2018 Investment Company Fact Book (58th ed. 2018), https://www.ici.org/pdf/2018_factbook.pdf (“ICI FactBook”), Figure 7.2.
[6] ICI Fact Book, at 39.
[7] Letter from Paul Schott Stevens, President and CEO of the Investment Company Institute, Re: Roundtable onthe Proxy Process (File No. 4-725) (Nov. 14, 2018), https://www.sec.gov/comments/4-725/4725-4702049-176465.pdf (“ICI Letter”).
[8] ICI Viewpoints, “Funds and Proxy Voting: The Mix of Proposals Matter” (Nov. 5, 2018), at 2.
[9] Commissioner Elad L. Roisman, “Statement at Proxy Process Roundtable” (Nov. 15, 2018),https://www.sec.gov/news/public-statement/statement-roisman-111518.
[10] These policies and procedures must address conflicts of interest that may arise between the adviser’sinterests and those of its clients. The rules also require the adviser to describe to clients its voting policies andprocedures and disclose to clients how they can obtain information about how the adviser actually voted theproxies. See Rule 206(4)-6 of the Investment Advisers Act of 1940 (“Advisers Act”), 17 C.F.R. 275.206(4)-6 (the“Proxy Voting Rule”); and “Proxy Voting by Investment Advisers,” Release No. IA-2106 (Jan. 31, 2003) (the “ProxyVoting Rule Release”). At the same time, the Commission adopted explicit requirements that each fund mustdisclose in its registration statement the policies and procedures that it uses to determine how to vote proxiesrelating to portfolio securities and publish the fund’s voting record annually on Form N-PX. See Rule 30b1-4 of theInvestment Company Act of 1940 (“Investment Company Act”), 17 C.F.R. 270.30b1-4; Amendments to Form N-1A,Prescribed under the Investment Company Act, 17 C.F.R 274.128; “Disclosure of Proxy Voting Policies and ProxyVoting Records by Registered Management Investment Companies,” Release No. IC-25922 (Jan. 31, 2003).Assuming a fund board adopts the investment adviser’s policies and procedures, rather than designing andadopting its own distinct policies and procedures for the fund, the voting policy would be part of the complianceprogram and subject to approval and review under Investment Company Act Rule 38a-1.
[11] See Staff Legal Bulletin No. 20 (IM/CF) “Proxy Voting: Proxy Voting Responsibilities of Investment Advisersand Availability of Exemptions from the Proxy Rules for Proxy Advisory Firms” (Jun. 30, 2014) (“SLB 20”),https://www.sec.gov/interps/legal/cfslb20.htm.
[12] See SLB 20, Answer to Question 2.
[13] SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963).
[14] See Proxy Voting Rule Release (“[A]n adviser is a fiduciary that owes each of its clients duties of care andloyalty with respect to all services undertaken on the client’s behalf, including proxy voting.”). An investmentadviser’s fiduciary duty under the Adviser’s Act comprises a duty of care and a duty of loyalty. This combination ofcare and loyalty obligations has been characterized as requiring the investment adviser to act in the “best interest”of its client at all times. See Amendments to Form ADV, Release No. IA-3060 (July 28, 2010).
[15] I think it is important to note here that the interests of a fund cannot be fully gleaned by looking only at itsunderlying shareholders. Unlike corporate directors, who owe fiduciary duties to a company’s shareholders, a fundadviser owes its fiduciary duties to each of its clients—the funds—not to the individual underlying shareholders ofeach fund. I believe this distinction is important because some have proposed that the SEC require advisers toconduct pass-through voting, in which they collect proxy votes from a fund’s underlying shareholders before theysubmit the fund’s votes. While this type of proposal has some democratic appeal, I do not see how it squares inevery case with the legal requirement that the adviser look out for a fund as its own entity. In certain situations,underlying shareholders’ interests may differ from—and potentially conflict with—the fund’s interests. In thesecases, the fund adviser must serve the best interests of the fund, even if it means going against the desires ofcertain underlying investors. It is possible that some asset managers currently use pass-through voting or similartypes of voting methodologies. If so, it seems prudent for those asset managers to have analyzed how it is in thebest interest of each particular fund as its own entity.
[16] What if an issue up for vote is not related to a fund’s investment objective? For example, an adviser to a plainvanilla index-tracking fund may be asked to vote fund shares on proxies related to sustainability. If the fund doesnot market itself as an “ESG” fund, disclosing these particular objectives in its regulatory filings, investors may nothave reason to think this fund would vote on such issues.
[17] See Proxy Voting Rule Release (“We do not suggest that an adviser that fails to vote every proxy wouldnecessarily violate its fiduciary obligations. There may even be times when refraining from voting a proxy is in theclient’s best interest, such as when the adviser determines that the cost of voting the proxy exceeds the expectedbenefit to the client.”); see also SLB 20, Answer to Question 2.
[18] See the ICI Letter, in note 7 above.
[19] I understand that there may be requirements, outside the federal securities laws, which could obligate certainadvisers to vote their clients’ shares (e.g., ERISA). My views here are solely limited to an adviser’s requirementsunder the Advisers Act and the Investment Company Act.
[20] For a thorough discussion of potential conflicts between the interests of different types of funds when voting,see Sean J. Griffith & Dorothy S. Lund, “Conflicted Mutual Fund Voting in Corporate Law” (working paper,forthcoming in the Boston University Law Review).
[21] With respect to conflicting interests of different funds and advisory clients, the Commission has brought atleast one enforcement action against an adviser for using funds’ proxy votes to benefit (and attract business from)other clients and failing to disclose its conflict of interest to investors. See In the Matter of Intech InvestmentManagement, LLC and David E. Hurley, Rel. No. 2872 (May 7, 2009), https://www.sec.gov/news/press/2009/2009-105.htm.
[22] See, e.g., SLB 20, Answer to Question 3 (“When considering whether to retain or continue retaining anyparticular proxy advisory firm to provide proxy voting recommendations, the staff believes that an investmentadviser should ascertain, among other things, whether the proxy advisory firm has the capacity and competency toadequately analyze proxy issues.”)
[23] For example, Glass Lewis’s 2019 Proxy Paper Guidelines state that they will make note of instances where apublic company has successfully petitioned the SEC to exclude shareholder proposals and potentially recommendagainst members of the company’s governance committee. See, e.g., Glass Lewis’s 2019 Proxy Paper Guidelines,at 29. It troubles me that the exercise of legal rights and responsibilities under the SEC’s rules would be heldagainst a company or its directors. In an example of seemingly arbitrary guidelines, Institutional ShareholderServices, Inc.’s (“ISS”) recently updated “QualityScore” evaluates the diversity of companies’ boards of directorsand considers “how many women are named executive officers [(“NEOs”)] at the company?” It states that“[c]ompanies without any women as NEOs will lose credit, and credit will be capped for companies having morethan two.” See ISS QualityScore: Overview and Updates (Dec. 19, 2018), at 41,https://www.issgovernance.com/file/products/qualityscore-techdoc.pdf. For funds with objectives to improvediversity in leadership, how could this seemingly arbitrary cap possibly further this goal?
[24] For example, one recent comment letter noted a research paper that found, in the 2016 and 2017 proxyseason, 20% of shareholders’ votes were cast within three days after one proxy advisory firm issued itsrecommendations. See Letter from Timothy M. Doyle, Vice President of Policy and General Counsel, AmericanCouncil for Capital Formation Re: File Number 4-725; SEC Staff Roundtable on the Proxy Process (Nov. 14, 2018),https://www.sec.gov/comments/4-725/4725-4649199-176473.pdf.
[25] Nasdaq recently sent a letter to the Commission, signed by 319 public issuers, representing almost $2 trillionin market capitalization across 13 industries (in addition to organizations such as TechNet and the U.S. Chamber ofCommerce), outlining several concerns about proxy advisory firms’ process of resolving misstatements of fact intheir reports, among other things. The letter is available on the Commission’s website:https://www.sec.gov/comments/4-725/4725-4872519-177389.pdf.
[26] ISS’s website states that only issuers in the S&P 500 are allowed one day to review reports before they areissued to clients.
[27] See Independent Directors Counsel and ICI, “Report on Funds’ Use of Proxy Advisory Firms” (Jan. 2015), at14.
[28] In similar contexts, we have seen such conflicts prohibited. Consider the auditor independence rules thatstrictly forbid an auditor from telling an audit client how to account for a matter and then providing an audit opinionto investors with respect to that exact same matter. See Rule 2-0l(b) & (c)(4) of Regulation S-X. The temptation forone side of the house to rubber-stamp the advice provided by the other side of the house is simply too great.
[29] See Institutional Shareholder Services, Inc., No-Action Letter (Sept. 15, 2004), withdrawn Sept. 13, 2018,https://www.sec.gov/news/public-statement/statement-regarding-staff-proxy-advisory-letters.
[30] See Egan-Jones, Inc., No-Action Letter (May 27, 2004), withdrawn Sept. 13, 2018,https://www.sec.gov/news/public-statement/statement-regarding-staff-proxy-advisory-letters.
[31] See the SEC’s Division of Investment Management, “Statement Regarding Staff Proxy Advisory Letters”)(Sept. 13, 2018), https://www.sec.gov/news/public-statement/statement-regarding-staff-proxy-advisory-letters.
[32] See Securities and Exchange Act of 1934 (“Exchange Act”), Rules 14a-2(b)(1) and 14a-2(b)(3).
[33] See Staff Legal Bulletin No. 14I (CF) “Shareholder Proposals” (Nov. 1, 2017),https://www.sec.gov/interps/legal/cfslb14i.htm.
[34] See ICI Letter referenced above in note 7; see also Letter from Paul Schott Stevens, President and CEO of theInvestment Company Institute, Re: Roundtable on the Proxy Process (File No. 4-725) (March 15, 2019).
1 (Slip Opinion) OCTOBER TERM, 2018
Syllabus
NOTE: Where it is feasible, a syllabus (headnote) will be released, as is being done in connection with this case, at the time the opinion is issued. The syllabus constitutes no part of the opinion of the Court but has been prepared by the Reporter of Decisions for the convenience of the reader. See United States v. Detroit Timber & Lumber Co., 200 U. S. 321, 337.
SUPREME COURT OF THE UNITED STATES
Syllabus
LORENZO v. SECURITIES AND EXCHANGE COMMISSION
CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE DISTRICT OF COLUMBIA CIRCUIT
No. 17–1077. Argued December 3, 2018—Decided March 27, 2019
Securities and Exchange Commission Rule 10b–5 makes it unlawful to (a) “employ any device, scheme, or artifice to defraud,” (b) “make any untrue statement of a material fact,” or (c) “engage in any act, prac-tice, or course of business” that “operates . . . as a fraud or deceit” in connection with the purchase or sale of securities. In Janus Capital Group, Inc. v. First Derivative Traders, 564 U. S. 135, this Court held that to be a “maker” of a statement under subsection (b) of that Rule,one must have “ultimate authority over the statement, including its content and whether and how to communicate it.” Id., at 142 (em-phasis added). On the facts of Janus, this meant that an investment adviser who had merely “participat[ed] in the drafting of a false statement” “made” by another could not be held liable in a private ac-tion under subsection (b). Id., at 145.
Petitioner Francis Lorenzo, while the director of investment bank-ing at an SEC-registered brokerage firm, sent two e-mails to prospec-tive investors. The content of those e-mails, which Lorenzo’s boss supplied, described a potential investment in a company with “con-firmed assets” of $10 million. In fact, Lorenzo knew that the compa-ny had recently disclosed that its total assets were worth less than $400,000.
In 2015, the Commission found that Lorenzo had violated Rule 10b–5, §10(b) of the Exchange Act, and §17(a)(1) of the Securities Act by sending false and misleading statements to investors with intent to defraud. On appeal, the District of Columbia Circuit held that Lo-renzo could not be held liable as a “maker” under subsection (b) of the Rule in light of Janus, but sustained the Commission’s finding with respect to subsections (a) and (c) of the Rule, as well as §10(b) and
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§17(a)(1).
Held: Dissemination of false or misleading statements with intent to defraud can fall within the scope of Rules 10b–5(a) and (c), as well as the relevant statutory provisions, even if the disseminator did not “make” the statements and consequently falls outside Rule 10b–5(b). Pp. 5–13.
(a) It would seem obvious that the words in these provisions are, as ordinarily used, sufficiently broad to include within their scope the dissemination of false or misleading information with the intent todefraud. By sending e-mails he understood to contain material un-truths, Lorenzo “employ[ed]” a “device,” “scheme,” and “artifice to de-fraud” within the meaning of subsection (a) of the Rule, §10(b), and§17(a)(1). By the same conduct, he “engage[d] in a[n] act, practice, orcourse of business” that “operate[d] . . . as a fraud or deceit” undersubsection (c) of the Rule. As Lorenzo does not challenge the appeals court’s scienter finding, it is undisputed that he sent the e-mails with“intent to deceive, manipulate, or defraud” the recipients. Aaron v. SEC, 446 U. S. 680, 686, and n. 5. Resort to the expansive dictionarydefinitions of “device,” “scheme,” and “artifice” in Rule 10b–5(a) and §17(a)(1), and of “act” and “practice” in Rule 10b–5(c), only strength-ens this conclusion. Under the circumstances, it is difficult to see how Lorenzo’s actions could escape the reach of these provisions.Pp. 5–7.
(b) Lorenzo counters that the only way to be liable for false state-ments is through those provisions of the securities laws—like Rule10b–5(b)—that refer specifically to false statements. Holding to thecontrary, he and the dissent say, would render subsection (b) “super-fluous.” The premise of this argument is that each subsection gov-erns different, mutually exclusive, spheres of conduct. But this Court and the Commission have long recognized considerable overlapamong the subsections of the Rule and related provisions of the secu-rities laws. And the idea that each subsection governs a separatetype of conduct is difficult to reconcile with the Rule’s language, since at least some conduct that amounts to “employ[ing]” a “device, scheme, or artifice to defraud” under subsection (a) also amounts to “engag[ing] in a[n] act . . . which operates . . . as a fraud” under sub-section (c). This Court’s conviction is strengthened by the fact that the plainly fraudulent behavior confronted here might otherwise fall outside the Rule’s scope. Using false representations to induce thepurchase of securities would seem a paradigmatic example of securi-ties fraud. Pp. 7–9.
(c) Lorenzo and the dissent make a few other important arguments. The dissent contends that applying Rules 10b–5(a) and (c) to conduct like Lorenzo’s would render Janus “a dead letter.” Post, at 9. But
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Janus concerned subsection (b), and it said nothing about the Rule’s application to the dissemination of false or misleading information.Thus, Janus would remain relevant (and preclude liability) where anindividual neither makes nor disseminates false information— provided, of course, that the individual is not involved in some other form of fraud. Lorenzo also claims that imposing primary liability upon his conduct would erase or at least weaken the distinction be-tween primary and secondary liability under the statute’s “aiding and abetting” provision. See 15 U. S. C. §78t(e). But the line the Court adopts today is clear: Those who disseminate false statements with intent to defraud are primarily liable under Rules 10b–5(a) and (c), §10(b), and §17(a)(1), even if they are secondarily liable under Rule 10b–5(b). As for Lorenzo’s suggestion that those like him ought to beheld secondarily liable, this offer will, too often, prove illusory.Where a “maker” of a false statement does not violate subsection (b)of the Rule (perhaps because he lacked the necessary intent), a dis-seminator of those statements, even one knowingly engaged in an egregious fraud, could not be held to have violated the “aiding and abetting” statute. And if, as Lorenzo claims, the disseminator has not primarily violated other parts of Rule 10b–5, then such a fraud, whatever its intent or consequences, might escape liability altogeth-er. That anomalous result is not what Congress intended. Pp. 9–13.
872 F. 3d 578, affirmed.
BREYER, J., delivered the opinion of the Court, in which ROBERTS, C. J., and GINSBURG, ALITO, SOTOMAYOR, and KAGAN, JJ., joined. THOM-
AS, J., filed a dissenting opinion, in which GORSUCH, J., joined. KAV-ANAUGH, J., took no part in the consideration or decision of the case.
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NOTICE: This opinion is subject to formal revision before publication in thepreliminary print of the United States Reports. Readers are requested to notify the Reporter of Decisions, Supreme Court of the United States, Wash-ington, D. C. 20543, of any typographical or other formal errors, in orderthat corrections may be made before the preliminary print goes to press.
SUPREME COURT OF THE UNITED STATES
No. 17–1077
FRANCIS V. LORENZO, PETITIONER v. SECURITIES AND EXCHANGE COMMISSION
ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE DISTRICT OF COLUMBIA CIRCUIT
[March 27, 2019]
JUSTICE BREYER delivered the opinion of the Court. Securities and Exchange Commission Rule 10b–5 makes
it unlawful:
“(a) To employ any device, scheme, or artifice to defraud,
“(b) To make any untrue statement of a material fact . . . , or
“(c) To engage in any act, practice, or course of busi-ness which operates or would operate as a fraud or deceit . . . in connection with the purchase or sale of any security.”17 CFR §240.10b–5 (2018).
In Janus Capital Group, Inc. v. First Derivative Traders, 564 U. S. 135 (2011), we examined the second of these provisions, Rule 10b–5(b), which forbids the “mak[ing]” of “any untrue statement of a material fact.” We held that the “maker of a statement is the person or entity with ultimate authority over the statement, including its con-tent and whether and how to communicate it.” Id., at 142 (emphasis added). We said that “[w]ithout control, a person or entity can merely suggest what to say, not
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‘make’ a statement in its own right.” Ibid. And we illus-trated our holding with an analogy: “[W]hen a speechwriter drafts a speech, the content is entirely within the controlof the person who delivers it. And it is the speaker who takes credit—or blame—for what is ultimately said.” Id., at 143. On the facts of Janus, this meant that an invest-ment adviser who had merely “participat[ed] in the draft-ing of a false statement” “made” by another could not beheld liable in a private action under subsection (b) of Rule10b–5. Id., at 145.
In this case, we consider whether those who do not “make” statements (as Janus defined “make”), but who disseminate false or misleading statements to potentialinvestors with the intent to defraud, can be found to have violated the other parts of Rule 10b–5, subsections (a) and (c), as well as related provisions of the securities laws,§10(b) of the Securities Exchange Act of 1934, 48 Stat.891, as amended, 15 U. S. C. §78j(b), and §17(a)(1) of the Securities Act of 1933, 48 Stat. 84–85, as amended, 15 U. S. C. §77q(a)(1). We believe that they can.
I A
For our purposes, the relevant facts are not in dispute. Francis Lorenzo, the petitioner, was the director of in-vestment banking at Charles Vista, LLC, a registeredbroker-dealer in Staten Island, New York. Lorenzo’s onlyinvestment banking client at the time was Waste2Energy Holdings, Inc., a company developing technology to con-vert “solid waste” into “clean renewable energy.”
In a June 2009 public filing, Waste2Energy stated thatits total assets were worth about $14 million. This figureincluded intangible assets, namely, intellectual property, valued at more than $10 million. Lorenzo was skeptical of this valuation, later testifying that the intangibles were a “dead asset” because the technology “didn’t really work.”
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During the summer and early fall of 2009, Waste2Energy hired Lorenzo’s firm, Charles Vista, to sellto investors $15 million worth of debentures, a form of “debt secured only by the debtor’s earning power, not by a lien on any specific asset,” Black’s Law Dictionary 486(10th ed. 2014).
In early October 2009, Waste2Energy publicly disclosed, and Lorenzo was told, that its intellectual property was worthless, that it had “ ‘ “[w]rit[ten] off . . . all [of its] in-tangible assets,” ’ ” and that its total assets (as of March31, 2009) amounted to $370,552.
Shortly thereafter, on October 14, 2009, Lorenzo sent two e-mails to prospective investors describing the deben-ture offering. According to later testimony by Lorenzo, he sent the e-mails at the direction of his boss, who supplied the content and “approved” the messages. The e-mails described the investment in Waste2Energy as having “3 layers of protection,” including $10 million in “confirmed assets.” The e-mails nowhere revealed the fact that Waste2Energy had publicly stated that its assets were in fact worth less than $400,000. Lorenzo signed thee-mails with his own name, he identified himself as “Vice President—Investment Banking,” and he invited the recipients to “call with any questions.”
B In 2013, the Securities and Exchange Commission
instituted proceedings against Lorenzo (along with hisboss and Charles Vista). The Commission charged that Lorenzo had violated Rule 10b–5, §10(b) of the Exchange Act, and §17(a)(1) of the Securities Act. Ultimately, theCommission found that Lorenzo had run afoul of these provisions by sending false and misleading statements to investors with intent to defraud. As a sanction, it fined Lorenzo $15,000, ordered him to cease and desist from violating the securities laws, and barred him from working
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in the securities industry for life. Lorenzo appealed, arguing primarily that in sending the
e-mails he lacked the intent required to establish a viola-tion of Rule 10b–5, §10(b), and §17(a)(1), which we have characterized as “ ‘a mental state embracing intent to deceive, manipulate, or defraud.’ ” Aaron v. SEC, 446 U. S. 680, 686, and n. 5 (1980). With one judge dissenting,the Court of Appeals panel rejected Lorenzo’s lack-of-intent argument. 872 F. 3d 578, 583 (CADC 2017). Lo-renzo does not challenge the panel’s scienter finding.Reply Brief 17.
Lorenzo also argued that, in light of Janus, he could not be held liable under subsection (b) of Rule 10b–5. 872 F. 3d, at 586–587. The panel agreed. Because his boss “asked Lorenzo to send the emails, supplied the central content, and approved the messages for distribution,” id., at 588, it was the boss that had “ultimate authority” over the content of the statement “and whether and how to communicate it,” Janus, 563 U. S., at 142. (We took thiscase on the assumption that Lorenzo was not a “maker”under subsection (b) of Rule 10b–5, and do not revisit thecourt’s decision on this point.)
The Court of Appeals nonetheless sustained (with one judge dissenting) the Commission’s finding that, by know-ingly disseminating false information to prospective inves-tors, Lorenzo had violated other parts of Rule 10b–5, subsections (a) and (c), as well as §10(b) and §17(a)(1).
Lorenzo then filed a petition for certiorari in this Court.We granted review to resolve disagreement about whether someone who is not a “maker” of a misstatement under Janus can nevertheless be found to have violated the other subsections of Rule 10b–5 and related provisions of the securities laws, when the only conduct involved concerns amisstatement. Compare e.g., 872 F. 3d 578, with WPP Luxembourg Gamma Three Sarl v. Spot Runner, Inc., 655 F. 3d 1039, 1057–1058 (CA9 2011).
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II A
At the outset, we review the relevant provisions of Rule10b–5 and of the statutes. See Appendix, infra. As we have said, subsection (a) of the Rule makes it unlawful to “employ any device, scheme, or artifice to defraud.” Sub-section (b) makes it unlawful to “make any untrue state-ment of a material fact.” And subsection (c) makes itunlawful to “engage in any act, practice, or course of busi-ness” that “operates . . . as a fraud or deceit.” See 17 CFR §240.10b–5.
There are also two statutes at issue. Section 10(b)makes it unlawful to “use or employ . . . any manipulative or deceptive device or contrivance” in contravention of Commission rules and regulations. 15 U. S. C. §78j(b). Byits authority under that section, the Commission promul-gated Rule 10b–5. The second statutory provision is§17(a), which, like Rule 10b–5, is organized into threesubsections. 15 U. S. C. §77q(a). Here, however, we con-sider only the first subsection, §17(a)(1), for this is theonly subsection that the Commission charged Lorenzowith violating. Like Rule 10b–5(a), (a)(1) makes it unlaw-ful to “employ any device, scheme, or artifice to defraud.”
B After examining the relevant language, precedent, and
purpose, we conclude that (assuming other here-irrelevant legal requirements are met) dissemination of false or misleading statements with intent to defraud can fall within the scope of subsections (a) and (c) of Rule 10b–5, as well as the relevant statutory provisions. In our view, that is so even if the disseminator did not “make” the statements and consequently falls outside subsection (b) of the Rule.
It would seem obvious that the words in these provisions are, as ordinarily used, sufficiently broad to include within
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their scope the dissemination of false or misleading infor-mation with the intent to defraud. By sending emails heunderstood to contain material untruths, Lorenzo “em-ploy[ed]” a “device,” “scheme,” and “artifice to defraud” within the meaning of subsection (a) of the Rule, §10(b),and §17(a)(1). By the same conduct, he “engage[d] in a[n]act, practice, or course of business” that “operate[d] . . . as a fraud or deceit” under subsection (c) of the Rule. Recall that Lorenzo does not challenge the appeals court’s scien-ter finding, so we take for granted that he sent the emails with “intent to deceive, manipulate, or defraud” the recipi-ents. Aaron, 446 U. S., at 686, n. 5. Under the circum-stances, it is difficult to see how his actions could escapethe reach of those provisions.
Resort to dictionary definitions only strengthens this conclusion. A “ ‘device,’ ” we have observed, is simply“ ‘[t]hat which is devised, or formed by design’ ”; a “ ‘scheme’ ” is a “ ‘project,’ ” “ ‘plan[,] or program of some-thing to be done’ ”; and an “ ‘artifice’ ” is “ ‘an artful strata-gem or trick.’ ” Id., at 696, n. 13 (quoting Webster’s Inter-national Dictionary 713, 2234, 157 (2d ed. 1934)(Webster’s Second)). By these lights, dissemination offalse or misleading material is easily an “artful stratagem”or a “plan,” “devised” to defraud an investor under subsec-tion (a). See Rule 10b–5(a) (making it unlawful to “employ any device, scheme, or artifice to defraud”); §17(a)(1) (same). The words “act” and “practice” in subsection (c)are similarly expansive. Webster’s Second 25 (defining“act” as “a doing” or a “thing done”); id., at 1937 (defining “practice” as an “action” or “deed”); see Rule 10b–5(c) (making it unlawful to “engage in a[n] act, practice, or course of business” that “operates . . . as a fraud or deceit”).
These provisions capture a wide range of conduct.Applying them may present difficult problems of scope in borderline cases. Purpose, precedent, and circumstance
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could lead to narrowing their reach in other contexts. But we see nothing borderline about this case, where the relevant conduct (as found by the Commission) consists of disseminating false or misleading information to prospec-tive investors with the intent to defraud. And while one can readily imagine other actors tangentially involved in dissemination—say, a mailroom clerk—for whom liability would typically be inappropriate, the petitioner in thiscase sent false statements directly to investors, invited them to follow up with questions, and did so in his capacityas vice president of an investment banking company.
C Lorenzo argues that, despite the natural meaning of
these provisions, they should not reach his conduct. This is so, he says, because the only way to be liable for false statements is through those provisions that refer specifi-cally to false statements. Other provisions, he says, con-cern “scheme liability claims” and are violated only when conduct other than misstatements is involved. Brief for Petitioner 4–6, 28–30. Thus, only those who “make” un-true statements under subsection (b) can violate Rule 10b–5 in connection with statements. (Similarly, §17(a)(2)would be the sole route for finding liability for statementsunder §17(a).) Holding to the contrary, he and the dissentinsist, would render subsection (b) of Rule 10b–5 “super-fluous.” See post, at 6–7 (opinion of THOMAS, J.).
The premise of this argument is that each of theseprovisions should be read as governing different, mutuallyexclusive, spheres of conduct. But this Court and the Commission have long recognized considerable overlapamong the subsections of the Rule and related provisions of the securities laws. See Herman & MacLean v. Huddle-ston, 459 U. S. 375, 383 (1983) (“[I]t is hardly a novel proposition that” different portions of the securities laws “prohibit some of the same conduct” (internal quotation
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marks omitted)). As we have explained, these laws marked the “first experiment in federal regulation of the securities industry.” SEC v. Capital Gains Research Bureau, Inc., 375 U. S. 180, 198 (1963). It is “understand-able, therefore,” that “in declaring certain practices unlaw-ful,” it was thought prudent “to include both a general proscription against fraudulent and deceptive practices and, out of an abundance of caution, a specific proscriptionagainst nondisclosure” even though “a specific proscription against nondisclosure” might in other circumstances be deemed “surplusage.” Id., at 198–199. “Each succeedingprohibition” was thus “meant to cover additional kinds ofillegalities—not to narrow the reach of the prior sections.” United States v. Naftalin, 441 U. S. 768, 774 (1979). We have found “ ‘no warrant for narrowing alternative provi-sions . . . adopted with the purpose of affording added safeguards.’ ” Ibid. (quoting United States v. Gilliland, 312 U. S. 86, 93 (1941)); see Affiliated Ute Citizens of Utah v. United States, 406 U. S. 128, 152–153 (1972) (While “thesecond subparagraph of [Rule 10b–5] specifies the makingof an untrue statement . . . [t]he first and third subpara-graphs are not so restricted”). And since its earliest days, the Commission has not viewed these provisions as mutu-ally exclusive. See, e.g., In re R. D. Bayly & Co., 19 S. E. C. 773 (1945) (finding violations of what would become Rules 10b–5(b) and (c) based on the same misrepresentationsand omissions); In re Arthur Hays & Co., 5 S. E. C. 271 (1939) (finding violations of both §§17(a)(2) and (a)(3) based on false representations in stock sales).
The idea that each subsection of Rule 10b–5 governs aseparate type of conduct is also difficult to reconcile withthe language of subsections (a) and (c). It should go with-out saying that at least some conduct amounts to “em-ploy[ing]” a “device, scheme, or artifice to defraud” undersubsection (a) as well as “engag[ing] in a[n] act . . . which operates . . . as a fraud” under subsection (c). In Affiliated
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Ute, for instance, we described the “defendants’ activities” as falling “within the very language of one or the other of those subparagraphs, a ‘course of business’ or a ‘device, scheme, or artifice’ that operated as a fraud.” 406 U. S., at 153. (The dissent, for its part, offers no account of how thesuperfluity problems that motivate its interpretation can be avoided where subsections (a) and (c) are concerned.)
Coupled with the Rule’s expansive language, whichreadily embraces the conduct before us, this considerable overlap suggests we should not hesitate to hold that Lo-renzo’s conduct ran afoul of subsections (a) and (c), as well as the related statutory provisions. Our conviction is strengthened by the fact that we here confront behavior that, though plainly fraudulent, might otherwise falloutside the scope of the Rule. Lorenzo’s view that subsec-tion (b), the making-false-statements provision, exclusively regulates conduct involving false or misleading statementswould mean those who disseminate false statements with the intent to cheat investors might escape liability under the Rule altogether. But using false representations toinduce the purchase of securities would seem a paradig-matic example of securities fraud. We do not know whyCongress or the Commission would have wanted to disarmenforcement in this way. And we cannot easily reconcile Lorenzo’s approach with the basic purpose behind these laws: “to substitute a philosophy of full disclosure for thephilosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry.” Capital Gains, 375 U. S., at 186. See also, e.g., SEC v. W. J. Howey Co., 328 U. S. 293, 299 (1946) (the securities lawswere designed “to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits”).
III Lorenzo and the dissent make a few other important
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arguments. They contend that applying subsections (a) or (c) of Rule 10b–5 to conduct like his would render our decision in Janus (which we described at the outset, su-pra, at 1–2) “a dead letter,” post, at 9. But we do not see how that is so. In Janus, we considered the language insubsection (b), which prohibits the “mak[ing]” of “anyuntrue statement of a material fact.” See 564 U. S., at 141–143. We held that the “maker” of a “statement” is the “person or entity with ultimate authority over the state-ment.” Id., at 142. And we found that subsection (b) did not (under the circumstances) cover an investment adviserwho helped draft misstatements issued by a different entity that controlled the statements’ content. Id., at 146– 148. We said nothing about the Rule’s application to the dissemination of false or misleading information. And we can assume that Janus would remain relevant (and pre-clude liability) where an individual neither makes nor disseminates false information—provided, of course, that the individual is not involved in some other form of fraud.
Next, Lorenzo points to the statute’s “aiding and abet-ting” provision. 15 U. S. C. §78t(e). This provision, en-forceable only by the Commission (and not by private parties), makes it unlawful to “knowingly or recklessly . . . provid[e] substantial assistance to another person” who violates the Rule. Ibid.; see Janus, 564 U. S., at 143 (cit-ing Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N. A., 511 U. S. 164 (1994)). Lorenzo claims that imposing primary liability upon his conduct would erase or at least weaken what is otherwise a clear distinc-tion between primary and secondary (i.e., aiding and abetting) liability. He emphasizes that, under today’sholding, a disseminator might be a primary offender withrespect to subsection (a) of Rule 10b–5 (by employing a “scheme” to “defraud”) and also secondarily liable as an aider and abettor with respect to subsection (b) (by provid-ing substantial assistance to one who “makes” a false
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statement). And he refers to two cases that, in his view, argue in favor of circumscribing primary liability. See Central Bank, 511 U. S., at 164; Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U. S. 148 (2008).
We do not believe, however, that our decision creates a serious anomaly or otherwise weakens the distinction between primary and secondary liability. For one thing, itis hardly unusual for the same conduct to be a primary violation with respect to one offense and aiding and abet-ting with respect to another. John, for example, might sell Bill an unregistered firearm in order to help Bill rob abank, under circumstances that make him primarily li-able for the gun sale and secondarily liable for the bank robbery.
For another, the cases to which Lorenzo refers do not help his cause. Take Central Bank, where we held that Rule 10b–5’s private right of action does not permit suitsagainst secondary violators. 511 U. S., at 177. The hold-ing of Central Bank, we have said, suggests the need for a “clean line” between conduct that constitutes a primaryviolation of Rule 10b–5 and conduct that amounts to a secondary violation. Janus, 564 U. S., at 143, and n. 6. Thus, in Janus, we sought an interpretation of “make”that could neatly divide primary violators and actors too far removed from the ultimate decision to communicate a statement. Ibid. (citing Central Bank, 511 U. S. 164). The line we adopt today is just as administrable: Those whodisseminate false statements with intent to defraud are primarily liable under Rules 10b–5(a) and (c), §10(b), and §17(a)(1), even if they are secondarily liable under Rule10b–5(b). Lorenzo suggests that classifying dissemination as a primary violation would inappropriately subject peripheral players in fraud (including him, naturally) tosubstantial liability. We suspect the investors who re-ceived Lorenzo’s e-mails would not view the deception so
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favorably. And as Central Bank itself made clear, even a bit participant in the securities markets “may be liable as a primary violator under [Rule] 10b–5” so long as “all of the requirements for primary liability . . . are met.” Id., at 191.
Lorenzo’s reliance on Stoneridge is even further afield. There, we held that private plaintiffs could not bring suit against certain securities defendants based on undisclosed deceptions upon which the plaintiffs could not haverelied. 552 U. S., at 159. But the Commission, unlike private parties, need not show reliance in its enforcementactions. And even supposing reliance were relevant here,Lorenzo’s conduct involved the direct transmission of false statements to prospective investors intended to induce reliance—far from the kind of concealed fraud at issue in Stoneridge.
As for Lorenzo’s suggestion that those like him ought tobe held secondarily liable, this offer will, far too often,prove illusory. In instances where a “maker” of a false statement does not violate subsection (b) of the Rule (per-haps because he lacked the necessary intent), a dissemina-tor of those statements, even one knowingly engaged in an egregious fraud, could not be held to have violated the “aiding and abetting” statute. That is because the statute insists that there be a primary violator to whom the sec-ondary violator provided “substantial assistance.” 15 U. S. C. §78t(e). And the latter can be “deemed to be in violation” of the provision only “to the same extent as the person to whom such assistance is provided.” Ibid. In other words, if Acme Corp. could not be held liable under subsection (b) for a statement it made, then a knowing disseminator of those statements could not be held liable for aiding and abetting Acme under subsection (b). And if, as Lorenzo claims, the disseminator has not primarilyviolated other parts of Rule 10b–5, then such a fraud, whatever its intent or consequences, might escape liability
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altogether.That is not what Congress intended. Rather, Congress
intended to root out all manner of fraud in the securities industry. And it gave to the Commission the tools to accomplish that job.
* * * For these reasons, the judgment of the Court of Appeals
is affirmed. So ordered.
JUSTICE KAVANAUGH took no part in the considerationor decision of this case.
Opinion of the Court
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Appendix to opinion of the Court
APPENDIX
17 CFR §240.10b–5
“It shall be unlawful for any person, directly or indirectly,by the use of any means or instrumentality of interstatecommerce, or of the mails or of any facility of any national securities exchange,
“(a) To employ any device, scheme, or artifice to defraud,
“(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in or-der to make the statements made, in the light of the circumstances under which they were made, not mis-leading, or
“(c) To engage in any act, practice, or course of busi-ness which operates or would operate as a fraud or deceit upon any person
in connection with the purchase or sale of any security.”
15 U. S. C. §78j
“It shall be unlawful for any person, directly or in-directly, by the use of any means or instrumentality of in- terstate commerce or of the mails, or of any facility of any national securities exchange—
* * *
“(b) To use or employ, in connection with the purchaseor sale of any security registered on a national securities ex- change or any security not so registered, or any securities-based swap agreement[,] any manipulative or decep- tive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as
Opinion of the Court
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Appendix to opinion of the Court
necessary or appropriate in the public interest or for the protection of investors.”
15 U. S. C. §77q
“(a) Use of interstate commerce for purpose of fraud ordeceit
“It shall be unlawful for any person in the offer or sale of any securities (including security-based swaps) or anysecurity-based swap agreement . . . by the use of any means or instruments of transportation or communication in interstate commerce or by use of the mails, directly or indirectly—
“(1) to employ any device, scheme, or artifice to de-fraud, or
“(2) to obtain money or property by means of any untrue statement of a material fact or any omission tostate a material fact necessary in order to make thestatements made, in light of the circumstances under which they were made, not misleading; or
“(3) to engage in any transaction, practice, or courseof business which operates or would operate as a fraud or deceit upon the purchaser.”
15 U. S. C. §78t
“(e) Prosecution of persons who aid and abet violations
“For purposes of any action brought by the Commission . . . , any person that knowingly or recklessly providessubstantial assistance to another person in violation of a provision of this chapter, or of any rule or regulationissued under this chapter, shall be deemed in violation of such provision to the same extent as the person to whomsuch assistance is provided.
_________________
_________________
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THOMAS, J., dissenting
SUPREME COURT OF THE UNITED STATES
No. 17–1077
FRANCIS V. LORENZO, PETITIONER v. SECURITIES AND EXCHANGE COMMISSION
ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE DISTRICT OF COLUMBIA CIRCUIT
[March 27, 2019]
JUSTICE THOMAS, with whom JUSTICE GORSUCH joins,dissenting.
In Janus Capital Group, Inc. v. First Derivative Traders, 564 U. S. 135 (2011), we drew a clear line between primary and secondary liability in fraudulent-misstatement cases:A person does not “make” a fraudulent misstatement within the meaning of Securities and Exchange Commis-sion (SEC) Rule 10b–5(b)—and thus is not primarily liable for the statement—if the person lacks “ultimate authorityover the statement.” Id., at 142. Such a person could,however, be liable as an aider and abettor under principlesof secondary liability.
Today, the Court eviscerates this distinction by holding that a person who has not “made” a fraudulent misstate-ment can nevertheless be primarily liable for it. Because the majority misconstrues the securities laws and flouts our precedent in a way that is likely to have far-reachingconsequences, I respectfully dissent.
I To appreciate the sweeping nature of the Court’s hold-
ing, it is helpful to begin with the facts of this case. On October 14, 2009, the owner of the firm at which petitioner Frank Lorenzo worked instructed him to send e-mails to two clients regarding a debenture offering. The owner
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explained that he wanted the e-mails to come from thefirm’s investment-banking division, which Lorenzo di-rected. Lorenzo promptly addressed an e-mail to eachclient, “cut and pasted” the contents of each e-mail—which he received from the owner—into the body, and “sent [them] out.” App. 321. It is undisputed that Lorenzo did not draft the e-mails’ contents, though he knew that theycontained false or misleading statements regarding the debenture offering. Both e-mails stated that they were sent “[a]t the request of ” the owner of the firm. Id., at 403, 405. No other allegedly fraudulent conduct is atissue.
In 2013, the SEC brought enforcement proceedings against the owner of the firm, the firm itself, and Lorenzo.Even though Lorenzo sent the e-mails at the owner’s request, the SEC did not charge Lorenzo with aiding and abetting fraud committed by the owner. See 15 U. S. C. §§ 77o(b), 78o(b)(4)(E), 78t(e). Instead, the SEC charged Lorenzo as a primary violator of multiple securities laws,1
including Rule 10b–5(b), which prohibits “mak[ing] any untrue statement of a material fact . . . in connection with the purchase or sale of any security.” 17 CFR §240.10b– 5(b) (2018); see Ernst & Ernst v. Hochfelder, 425 U. S. 185, 212–214 (1976) (construing Rule 10b–5(b) to require scien-ter). The SEC ultimately concluded that, by “knowinglysen[ding] materially misleading language from his own email account to prospective investors,” App. to Pet. forCert. 77, Lorenzo violated Rule 10b–5(b) and several other antifraud provisions of the securities laws. The SEC “barred [him] from serving in the securities industry” forlife. Id., at 91.
The Court of Appeals unanimously rejected the SEC’sdetermination that Lorenzo violated Rule 10b–5(b). Ap-
—————— 1 For ease of reference, I use “securities laws” to refer to both statutes
and SEC regulations.
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plying Janus, the court held that Lorenzo did not “make” the false statements at issue because he merely “transmit-ted statements devised by [his boss] at [his boss’] direc-tion.” 872 F. 3d 578, 587 (CADC 2017). The SEC has not challenged that aspect of the decision below.
The panel majority nevertheless upheld the SEC’s deci-sion holding Lorenzo primarily liable for the same falsestatements under other provisions of the securities laws—specifically, §10(b) of the Securities Exchange Act of 1934(1934 Act), Rules 10b–5(a) and (c), and §17(a)(1) of the Securities Act of 1933 (1933 Act). Unlike Rule 10b–5(b),none of these provisions pertains specifically to fraudulent misstatements.
II Even though Lorenzo undisputedly did not “make” the
false statements at issue in this case under Rule 10b–5(b),the Court follows the SEC in holding him primarily liablefor those statements under other provisions of the securi-ties laws. As construed by the Court, each of these moregeneral laws completely subsumes Rule 10b–5(b) and §17(a)(2) of the 1933 Act in cases involving fraudulentmisstatements, even though these provisions specifically govern false statements. The majority’s interpretation ofthese provisions cannot be reconciled with their text or our precedents. Thus, I am once again compelled to “disa-gre[e] with the SEC’s broad view” of the securities laws. Janus, supra, at 145, n. 8.
A I begin with the text. The Court of Appeals held that
Lorenzo violated §10(b) of the 1934 Act and Rules 10b–5(a) and (c). In relevant part, §10(b) makes it unlawful for a person, in connection with the purchase or sale of a security,“[t]o use or employ . . . any manipulative or deceptivedevice or contrivance” in contravention of an SEC rule. 15
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U. S. C. §78j(b). Rule 10b–5 was promulgated under thisstatutory authority. That Rule makes it unlawful, in connection with the purchase or sale of any security,
“(a) To employ any device, scheme, or artifice to defraud,
“(b) To make any untrue statement of a material fact . . . , or
“(c) To engage in any act, practice, or course of busi-ness which operates or would operate as a fraud or deceit . . . .” 17 CFR §240.10b–5.
The Court of Appeals also held that Lorenzo violated §17(a)(1) of the 1933 Act. Similar to Rule 10b–5, §17(a) ofthe Act provides that it is unlawful, in connection with the offer or sale of a security,
“(1) to employ any device, scheme, or artifice to de-fraud, or
“(2) to obtain money or property by means of any untrue statement of a material fact . . . ; or
“(3) to engage in any transaction, practice, or courseof business which operates or would operate as a fraud or deceit upon the purchaser.” 15 U. S. C. §77q(a)(1).
We can quickly dispose of Rule 10b–5(a) and §17(a)(1).The act of knowingly disseminating a false statement at the behest of its maker, without more, does not amount to “employ[ing] any device, scheme, or artifice to defraud” within the meaning of those provisions. As the contempo-raneous dictionary definitions cited by the majority make clear, each of these words requires some form of planning, designing, devising, or strategizing. See ante, at 6. We have previously observed that “the terms ‘device,’ ‘scheme,’ and ‘artifice’ all connote knowing or intentional practices.” Aaron v. SEC, 446 U. S. 680, 696 (1980) (emphasis added).In other words, they encompass “fraudulent scheme[s],”
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such as a “ ‘short selling’ scheme,” a wash sale, a matchedorder, price rigging, or similar conduct. United States v. Naftalin, 441 U. S. 768, 770, 778 (1979) (applying §17(a)(1)); see Santa Fe Industries, Inc. v. Green, 430 U. S. 462, 473 (1977) (interpreting the term “manipulative” in§10(b)).
Here, it is undisputed that Lorenzo did not engage inany conduct involving planning, scheming, designing, or strategizing, as Rule 10b–5(a) and §17(a)(1) require for aprimary violation. He sent two e-mails drafted by a supe-rior, to recipients specified by the superior, pursuant to instructions given by the superior, without collaboratingon the substance of the e-mails or otherwise playing anindependent role in perpetrating a fraud. That Lorenzo knew the messages contained falsities does not change theessentially administrative nature of his conduct here; hemight have assisted in a scheme, but he did not himself plan, scheme, design, or strategize. In my view, the plaintext of Rule 10b–5(a) and §17(a)(1) thus does not encom-pass Lorenzo’s conduct as a matter of primary liability.
The remaining provision, Rule 10b–5(c), seems broaderat first blush. But the scope of this conduct-basedprovision—and, for that matter, Rule 10b–5(a) and §17(a)(1)—must be understood in light of its codificationalongside a prohibition specifically addressing primaryliability for false statements. Rule 10b–5(b) imposesprimary liability on the “make[r]” of a fraudulent mis-statement. 17 CFR §240.10b–5(b); see Janus, 564 U. S., at 141–142. And §17(a)(2) imposes primary liability on a person who “obtain[s] money or property by means of ” a false statement. 15 U. S. C. §77q(a)(2). The conduct-based provisions of Rules 10b–5(a) and (c) and §17(a)(1) must be interpreted in view of the specificity of these false-statement provisions, and therefore cannot be con-strued to encompass primary liability solely for false statements. This view is consistent with our previous
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recognition that “each subparagraph of §17(a) ‘proscribes adistinct category of misconduct’ ” and “ ‘is meant to cover additional kinds of illegalities.’ ” Aaron, supra, at 697 (quoting Naftalin, supra, at 774; emphasis added).
The majority disregards these express limitations.Under the Court’s rule, a person who has not “made” a fraudulent misstatement within the meaning of Rule 10b–5(b) nevertheless could be held primarily liable for facili-tating that same statement; the SEC or plaintiff need onlyrelabel the person’s involvement as an “act,” “device,”“scheme,” or “artifice” that violates Rule 10b–5(a) or (c). And a person could be held liable for a fraudulent mis-statement under §17(a)(1) even if the person did not ob-tain money or property by means of the statement. In short, Rule 10b–5(b) and §17(a)(2) are rendered entirely superfluous in fraud cases under the majority’s reading.2
This approach is in tension with “ ‘the cardinal rule that, if possible, effect shall be given to every clause and part of a statute.’ ” RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U. S. 639, 645 (2012) (quoting D. Ginsberg & Sons, Inc. v. Popkin, 285 U. S. 204, 208 (1932)). I would therefore apply the “old and familiar rule” that “the specificgoverns the general.” RadLAX, supra, at 645–646 (inter-nal quotation marks omitted); see A. Scalia & B. Garner, Reading Law 51 (2012) (canon equally applicable to stat-utes and regulations). This canon of construction appliesnot only to resolve “contradiction[s]” between general andspecific provisions, but also to avoid “the superfluity of a specific provision that is swallowed by the general one.” RadLAX, 566 U. S., at 645. Here, liability for false state-——————
2 I recognize that §17(a)(1) could be deemed narrower than §17(a)(2) in the sense that it requires scienter, whereas §17(a)(2) does not. Aaron v. SEC, 446 U. S. 680, 697 (1980). But scienter is not disputed in this case, and the specific terms of §17(a)(2) are otherwise completely subsumed within the more general terms of §17(a)(1), as interpreted by the majority.
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ments is “ ‘specifically dealt with’ ” in Rule 10b–5(b) and §17(a)(2). Id., at 646 (quoting D. Ginsberg & Sons, supra, at 208). But Rule 10b–5 and §17(a) also contain generalprohibitions that, “ ‘in [their] most comprehensive sense,would include what is embraced in’ ” the more specificprovisions. 566 U. S., at 646. I would hold that the provi-sions specifically addressing false statements “ ‘must beoperative’ ” as to false-statement cases, and that the more general provisions should be read to apply “ ‘only [to] such cases within [their] general language as are not within the’ ” purview of the specific provisions on false state-ments. Ibid.
Adopting this approach to the statutory text would alignwith our previous admonitions that the securities lawsshould not be “[v]iewed in isolation” and stretched to their limits. Hochfelder, 425 U. S., at 212. In Hochfelder, for example, we concluded that the key words of §10(b) em-ployed the “terminology of intentional wrongdoing” and thus “strongly suggest[ed]” that it “proscribe[s] knowing or intentional misconduct,” even though the statute did not expressly state as much. Id., at 197, 214. We took a similar approach to §17(a)(1) of the 1933 Act. Aaron, 446 U. S., at 695–697. We have also limited the terms of Rule 10b–5 by recognizing that it was adopted pursuant to§10(b) and thus “encompasses only conduct already pro-hibited by §10(b).” Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U. S. 148, 157 (2008); see Hochfelder, supra, at 212–214.
Contrary to the suggestion of the majority, this ap-proach does not necessarily require treating each provi-sion of Rule 10b–5 or §17(a) as “governing different, mu-tually exclusive, spheres of conduct.” Ante, at 7. Nor does it prevent the securities laws from mutually reinforcing one another or overlapping to some extent. Ante, at 7–8. It simply contemplates giving full effect to the specificprohibitions on false statements in Rule 10b–5(b) and
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§17(a)(2) instead of rendering them superfluous. The majority worries that this approach would allow
people who disseminate false statements with the intentto defraud to escape liability under Rule 10b–5. Ante, at 9. That is not so. If a person’s only role is transmittingfraudulent misstatements at the behest of the statements’ maker, the person’s conduct would be appropriately as-sessed as a matter of secondary liability pursuant to pro-visions like 15 U. S. C. §§77o(b), 78t(e), and 78o(b)(4)(E). And if a person engages in other acts prohibited by theRule, such as developing and employing a fraudulent scheme, the person would be primarily liable for that conduct.
The majority suggests that secondary liability may oftenprove illusory. It hypothesizes, for example, a situation in which the “maker” of a false statement does not know that it was false and thus does not violate Rule 10b–5(b), but the disseminator knows that the statement is false. Un-der that scenario, the majority fears that the person dis-seminating the statements could be “engaged in an egre-gious fraud,” yet would not be liable as an aider and abettor for lack of a primary violator. Ante, at 12. This concern is misplaced. As an initial matter, I note that §17(a)(2) does not require scienter, so the maker of the statement may still be liable under that provision. Aaron, supra, at 695–697. Moreover, an ongoing, “egregious”fraud is likely to independently constitute a primaryviolation of the conduct-based securities laws, whollyapart from the laws prohibiting fraudulent misstatements.Here, by contrast, we are concerned with the dissemina-tion of two misstatements at the request of their maker. This type of conduct is appropriately assessed under prin-ciples of secondary liability.
B The majority’s approach contradicts our precedent in
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two distinct ways.First, the majority’s opinion renders Janus a dead let-
ter. In Janus, we held that liability under Rule 10b–5(b)was limited to the “make[r]” of the statement and that “[o]ne who prepares or publishes a statement on behalf of another is not its maker” within the meaning of Rule 10b–5(b). 564 U. S., at 142 (emphasis added). It is undisputedhere that Lorenzo was not the maker of the fraudulent misstatements. The majority nevertheless finds primary liability under different provisions of Rule 10b–5, without any real effort to reconcile its decision with Janus. Al-though it “assume[s] that Janus would remain relevant (and preclude liability) where an individual neither makes nor disseminates false information,” in the next breath the majority states that this would be true only if “the indi-vidual is not involved in some other form of fraud.” Ante, at 10. Given that, under the majority’s rule, administra-tive acts undertaken in connection with a fraudulent misstatement qualify as “other form[s] of fraud,” the ma-jority’s supposed preservation of Janus is illusory.
Second, the majority fails to maintain a clear line between primary and secondary liability in fraudulent-misstatement cases. Maintaining this distinction is im-portant because, as the majority notes, there is no privateright of action against mere aiders and abettors. Ante, at 10; see Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N. A., 511 U. S. 164, 191 (1994). Here, however, the majority does precisely what we declined todo in Janus: impose broad liability for fraudulent mis-statements in a way that makes the category of aiders and abettors in these cases “almost nonexistent.” 564 U. S., at 143. If Lorenzo’s conduct here qualifies for primary liabil-ity under §10(b) and Rule 10b–5(a) or (c), then virtually any person who assists with the making of a fraudulent misstatement will be primarily liable and thereby subject not only to SEC enforcement, but private lawsuits.
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THOMAS, J., dissenting
The Court correctly notes that it is not uncommon forthe same conduct to be a primary violation with respectto one offense and aiding and abetting with respect toanother—as, for example, when someone illegally sells a gun to help another person rob a bank. Ante, at 11. But this case does not involve two distinct crimes. The majority has interpreted certain provisions of an offense so broadlyas to render superfluous the more stringent, on-pointrequirements of a narrower provision of the same offense.Criminal laws regularly and permissibly overlap with eachother in a way that allows the same conduct to constitutedifferent crimes with different punishments. That differs significantly from interpreting provisions in a law to com-pletely eliminate specific limitations in a neighboring provision of that very same law. The majority’soverreading of Rules 10b–5(a) and (c) and §17(a)(1) isespecially problematic because the heartland of theseprovisions is conduct-based fraud—“employ[ing] [a] device, scheme, or artifice to defraud” or “engag[ing] in any act,practice, or course of business”—not mere misstatements.15 U. S. C. §77q(a)(1); 17 CFR §§240.10b–5(a), (c).
The Court attempts to cabin the implications of itsholding by highlighting several facts that supposedlywould distinguish this case from a case involving a secre-tary or other person “tangentially involved in dissemi-nat[ing]” fraudulent misstatements. Ante, at 7. None of these distinctions withstands scrutiny. The fact that Lorenzo “sent false statements directly to investors” in e-mails that “invited [investors] to follow up with ques-tions,” ibid., puts him in precisely the same position as a secretary asked to send an identical message from her e-mail account. And under the unduly capacious interpreta-tion that the majority gives to the securities laws, I do notsee why it would matter whether the sender is the “vicepresident of an investment banking company” or a secre-tary, ibid.—if the sender knowingly sent false statements,
11 Cite as: 587 U. S. ____ (2019)
THOMAS, J., dissenting
the sender apparently would be primarily liable. To be sure, I agree with the majority that liability would be “inappropriate” for a secretary put in a situation similar toLorenzo’s. Ibid. But I can discern no legal principle in themajority opinion that would preclude the secretary from being pursued for primary violations of the securities laws.
* * * Instead of blurring the distinction between primary and
secondary liability, I would hold that Lorenzo’s conduct did not amount to a primary violation of the securities laws and reverse the judgment of the Court of Appeals.Accordingly, I respectfully dissent.
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‘Lorenzo’: What Happens Nextand What To Do About It?By expanding the scope of liability for those who are involved indisseminating misrepresentations even if they are not the authors ororiginators of them, 'Lorenzo' conceivably could have a vast impact onboth SEC enforcement, as well as private lawsuits.By Howard Fischer | April 30, 2019
Several years ago, in the landmark case
of Janus Capital Group v. First DerivativeTraders, 564 U.S. 135 (2011), the
Supreme Court held only the author of a
misstatement, its maker, could be held
liable under Securities and Exchange
Commission Rule 10b-5(b), promulgated
under Section 10(b) of the Exchange Act
of 1934. In the intervening years, many
courts accepted that the statutory anti-
fraud provisions of Section 10(b) of the Exchange Act of 1934 and Rule 10b-5
thereunder encompassed two di�erent kinds of misconduct. Rule 10b-5(b) addressed
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misstatements and omissions while subsections (a) and (c) addressed fraud by conduct
—e.g., wash sales, painting the tape, various forms of manipulative trading, and so on,
that did not have a misstatement component.
It became accepted that a scheme claim could not be asserted if the basis was a
misstatement or omission. Indeed, just last month, in SEC v. Rio Tinto PLC, 2019 U.S.
Dist. LEXIS 43986, *51-52 (March 18, 2019), the U.S. District Court for the Southern
District of New York ruled that “in order to state a claim based on scheme liability, the
SEC must allege conduct beyond misrepresentations and omissions.” See also AlphaCapital Anstalt v. Schwell Wimpfheimer & Assocs., 2018 U.S. Dist. LEXIS 54594, * 34
(S.D.N.Y. March 30, 2018) (“subsections (a) and (c) may not be sued as a ‘back door into
liability for those who help others make a false statement or omission … ‘”); SEC v. Wey,
246 F. Supp. 3d 894, 917-18 (S.D.N.Y. 2017) (listing cases holding that scheme liability
hinges on the performance of an inherently deceptive act or conduct distinct from
alleged misrepresentations or omissions); SEC v. China Northeast Petroleum HoldingsLtd., 27 F. Supp. 3d 379, 391-92 (S.D.N.Y. 2014) (scheme liability requires conduct
beyond misrepresentations or omissions); In re Smith Barney Transfer Agent Litig., 884
F. Supp. 2d 152, 161 (S.D.N.Y. 2012) (“[T]he three subsections of Rule 10b-5 are distinct,
and courts must scrutinize pleadings to ensure that misrepresentation or omission
claims do not proceed under the scheme liability rubric.”). At the SEC, it was widely
accepted that one did not assert scheme liability claims under Rule 10b-5(a) and (c)
based on misstatements or omissions, and that such theories were unlikely to be
approved by senior management.
This well-accepted distinction between misstatement fraud and manipulative and
deceptive conduct was sharply eroded, if not erased, on March 27, 2019, by the
Supreme Court’s decision in the case of Lorenzo v. Securities and ExchangeCommission, 139 S. Ct. 1094 (2019), by a 6-2 vote (Justice Brett Kavanaugh did not
participate). Lorenzo addressed the question of whether or not a non-author—
someone who merely disseminated the fraudulent statements made by another—
could be held liable under subsections (a) and (c) of Rule 10b-5.
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The relevant facts are as follows. Francis Lorenzo was the director of investment
banking at a registered broker-dealer. One of his clients—in fact, his only client—was a
company that purported to have technology that would convert waste to clean
renewable energy. Lorenzo’s �rm had been hired to sell $15 million in debentures to
investors. Although he knew that its total assets were comparatively negligible, Lorenzo
sent to investors, at the direction of his boss, two emails describing the o�ering.
Lorenzo’s emails, which he signed with his own name, identifying himself as “Vice-
President—Investment Banking,” in�ated the company’s assets from less than $400,000
to at least $10 million, and invited the recipients to call him with any questions.
Surprising many who expected a contrary result, the Supreme Court held in Lorenzothat, even if disseminating the statements of another would not establish liability under
subsection 10b-5(b), it would count as a “device, scheme or arti�ce to defraud” under
10b-5(a) (and under Section 17(a)(1) of the Securities Act as well) in addition to as
engaging in “an act, practice or course of business” that operates “as a fraud or deceit”
under Rule 10b-5(c).
By expanding the scope of liability for those who are involved in disseminating
misrepresentations even if they are not the authors or originators of them, Lorenzoconceivably could have a vast impact on both SEC enforcement, as well as private
lawsuits. Indeed, soon after the opinion came out various SEC enforcement sta�, giddy
with a decision they see gifting them with an expansive writ, were widely reported to
have stated at the annual “SEC Speaks” CLE program that the Division of Enforcement
anticipates the opinion will be applied “broadly”—for example, not only to people who
distribute a false statement but those that direct others to draft or distribute false
statements.
Private plainti�s have also been given extra ammunition. As Justice Clarence Thomas
pointed out in the dissent, the fear that Lorenzo’s wrongful conduct lacked an
enforcement remedy was misplaced, since his conduct could also have been charged
as aiding and abetting another’s fraud. This avenue would not, however, be available to
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a private plainti�, as there is no private right of action for aiding and abetting a
securities fraud. By e�ectively converting such a claim to a direct claim, Lorenzo added
a powerful arrow to the quiver of the plainti�s’ bar.
However, the �oodgates might not be propped open as widely as some fear. A
practitioner has several avenues available for keeping her client out of trouble, some
based on a strict reading of the Lorenzo decision, others on the pragmatic realities of
the SEC enforcement regime.
The �rst line of defense is to distinguish one’s client’s conduct from that of Mr. Lorenzo,
and to limit Lorenzo’s scope to its speci�c facts. Arguably, the Supreme Court
recognized that Lorenzo might be construed as overly expansive, and cautioned against
such a reading, speci�cally excluding “actors tangentially involved in dissemination—
say, a mailroom clerk—for whom liability would typically be inappropriate.” Nor is there
much support in the text of the decision for expanding Lorenzo beyond dissemination,
as SEC enforcement sta� seems to think. In fact, in every single instance in which the
decision refers to misconduct at issue, it is either some version of the word
“disseminate” (15 times) or its synonym “send” (four times). As the Court explicitly
noted, it only intended to make liable “those who disseminate false statements with the
intent to cheat investors.” Moreover, the opinion notes that the preclusion of Januswould still apply “where an individual neither makes nor disseminates false information
—provided, of course, that the individual is not involved in some other form of fraud.”
It is also important to point out that although he might not have been the “maker” of
the misstatements, Mr. Lorenzo’s conduct e�ectively “vouched” for them. He held
himself out to investors as someone in a position of authority, using his title in his
emails to them. He invited the recipients to contact him if they had any questions, “and
did so in his capacity as vice president of an investment banking company” further
adding to his implied authority and bolstering the idea that he was the person with
knowledge. He had direct contact with investors. Moreover, Mr. Lorenzo knew the
statements were false, and intended to defraud investors.
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Thus, a persuasive argument can likely be made that the Supreme Court meant to
inculpate only the most egregious of o�enders, and to limit the scope of the decision to
those who knowingly disseminate false information directly to investors with the intent
to defraud. (Of course, these arguments can be made whether the adversary is the SEC
or a private plainti�).
Furthermore, there are practical considerations that might limit a radical expansion of
SEC enforcement activity. First, the SEC lacks the resources and sta� to investigate and
prosecute every instance of securities fraud (and that was true before Lorenzo) and has
to make pragmatic assessments of which conduct to prosecute. Defense counsel
should communicate to sta� that their client’s conduct is not of a su�cient severity to
warrant the expenditure of scarce enforcement resources, especially if there are risks
that it falls outside the narrow area of “dissemination” targeted by the Lorenzodecision.
Second, regardless of what some senior sta� at the Division of Enforcement might
believe about the breadth of the Lorenzo decision, the fact remains that it is not the
enforcement sta� that makes the �nal decision as to whether or not to bring charges.
That decision is left to the full Commission, after consultations with the various
divisions. A sizable portion of the current Commission is skeptical about expansive
claims of liability. Reference to that skepticism in pre-charge negotiations with the sta�
might be a useful method for whittling down charges.
Given the limiting language of the Lorenzo decision, the resource limitations at the SEC,
and the currently conservative Commission, a practitioner has signi�cant room to
argue against wide theories of liability and for a more limited reading of the decision.
The next few years should see some fascinating judicial decisions determining which
side of the argument prevails.
Howard Fischer is a partner at Moses & Singer and a former senior trial counsel at theNew York Regional O�ce of the Securities & Exchange Commission.
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Copyright 2019. ALM Media Properties, LLC. All rights reserved.
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
MATTHEW SCIABACUCCHI, on behalf of himself and all others similarly situated,
Plaintiff,
v. MATTHEW B. SALZBERG, JULIE M.B. BRADLEY, TRACY BRITT COOL, KENNETH A. FOX, ROBERT P. GOODMAN, GARY R. HIRSHBERG, BRIAN P. KELLEY, KATRINA LAKE, STEVEN ANDERSON, J. WILLIAM GURLEY, MARKA HANSEN, SHARON MCCOLLAM, ANTHONY WOOD, RAVI AHUJA, SHAWN CAROLAN, JEFFREY HASTINGS, ALAN HENDRICKS, NEIL HUNT, DANIEL LEFF, and RAY ROTHROCK,
Defendants,
and
BLUE APRON HOLDINGS, INC., STITCH FIX, INC., and ROKU, INC.,
Nominal Defendants.
) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) )
C.A. No. 2017-0931-JTL
MEMORANDUM OPINION
Date Submitted: September 27, 2018 Date Decided: December 19, 2018
Kurt M. Heyman, Melissa N. Donimirski, HEYMAN ENERIO GATTUSO & HIRZEL LLP, Wilmington, Delaware; Jason M. Leviton, Joel A. Fleming, BLOCK & LEVITON LLP, Boston, Massachusetts; Counsel for Plaintiff.
William B. Chandler III, Randy J. Holland, Bradley D. Sorrels, Lindsay Kwoka Faccenda, WILSON SONSINI GOODRICH & ROSATI, P.C., Wilmington, Delaware; Boris Feldman, David J. Berger, WILSON SONSINI GOODRICH & ROSATI, P.C., Palo Alto, California; Counsel for Defendants Katrina Lake, Steven Anderson, J. William Gurley, Marka Hansen, Sharon McCollam, Anthony Wood, Ravi Ahuja, Shawn Carolan, Jeffrey Hastings, Alan Hendricks, Neil Hunt, Daniel Leff, Ray Rothrock, and Nominal Defendants Stitch Fix, Inc. and Roku, Inc. Catherine G. Dearlove, Sarah T. Andrade, RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; Michael G. Bongiorno, WILMER CUTLER PICKERING HALE AND DORR LLP, New York, New York; Timothy J. Perla, WILMER CUTLER PICKERING HALE AND DORR LLP, Boston, Massachusetts; Counsel for Defendants Matthew B. Salzberg, Julie M.B. Bradley, Tracy Britt Cool, Kenneth A. Fox, Robert P. Goodman, Gary R. Hirshberg, and Brian P. Kelley, and Nominal Defendant Blue Apron Holdings, Inc. LASTER, V.C.
The Securities Act of 1933 (the “1933 Act”) bars any person from offering or selling
securities except pursuant to a registration statement approved by the Securities and
Exchange Commission (the “SEC”) or in compliance with an exemption. The 1933 Act
grants private rights of action to purchasers of securities so they can enforce its registration
and disclosure requirements.
When Congress enacted the 1933 Act, it gave state and federal courts concurrent
jurisdiction over claims by private plaintiffs and barred defendants from removing actions
filed in state court to federal court. In 1998, Congress amended the 1933 Act in a manner
that cast doubt on this jurisdictional allocation. In 2018, the Supreme Court of the United
States held that state courts continue to have concurrent jurisdiction over claims by private
plaintiffs and that defendants cannot remove actions filed in state court to federal court.1
Before their initial public offerings, the three nominal defendants adopted
provisions in their certificates of incorporation that require any claim under the 1933 Act
to be filed in federal court (the “Federal Forum Provisions”). Contrary to the federal
regime, the provisions preclude a plaintiff from asserting a 1933 Act claim in state court.
This decision concludes that the Federal Forum Provisions are ineffective. In
Boilermakers,2 Chief Justice Strine held while serving on this court that a Delaware
corporation can adopt a forum-selection bylaw for internal-affairs claims. In reaching this
1 Cyan, Inc. v. Beaver Cty. Empls. Ret. Fund, 138 S. Ct. 1061 (2018).
2 Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013) (Strine, C.).
2
conclusion, he reasoned that Section 109(b) of the Delaware General Corporation Law (the
“DGCL”), which specifies what subjects bylaws can address, authorizes the bylaws to
regulate “internal affairs claims brought by stockholders qua stockholders.”3 But he
stressed that Section 109(b) does not authorize a Delaware corporation to regulate external
relationships. The Boilermakers decision noted that a bylaw cannot dictate the forum for
tort or contract claims against the company, even if the plaintiff happens to be a
stockholder.4
Section 102(b)(1) of the DGCL specifies what charter provisions can address. Its
scope parallels Section 109(b), so the reasoning in Boilermakers applies to charter-based
provisions.
The Boilermakers distinction between internal and external claims answers whether
a forum-selection provision can govern claims under the 1933 Act. It cannot, because a
1933 Act claim is external to the corporation. Federal law creates the claim, defines the
elements of the claim, and specifies who can be a plaintiff or defendant. The 1933 Act
establishes a statutory regime that applies when a particular type of property—securities—
is offered for sale in particular scenarios that the federal government has chosen to regulate.
The cause of action belongs to a purchaser of a security, and it arises out of an offer or sale.
The defined term “security” encompasses a wide range of financial products. Shares of
3 Id. at 952.
4 Id.
3
stock are just one of many types of securities, and shares in a Delaware corporation are just
one subtype. A claim under the 1933 Act does not turn on the rights, powers, or preferences
of the shares, language in the corporation’s charter or bylaws, a provision in the DGCL, or
the equitable relationships that flow from the internal structure of the corporation. Under
Boilermakers, a 1933 Act claim is distinct from “internal affairs claims brought by
stockholders qua stockholders.”5
This result derives from first principles. The certificate of incorporation differs from
an ordinary contract, in which private parties execute a private agreement in their personal
capacities to allocate their rights and obligations. When accepted by the Delaware
Secretary of State, the filing of a certificate of incorporation effectuates the sovereign act
of creating a “body corporate”—a legally separate entity. The State of Delaware is an ever-
present party to the resulting corporate contract, and the terms of the corporate contract
incorporate the provisions of the DGCL. Various sections of the DGCL specify what the
contract must contain, may contain, and cannot contain. The DGCL also constrains how
the contract can be amended.
As the sovereign that created the entity, Delaware can use its corporate law to
regulate the corporation’s internal affairs. For example, Delaware corporate law can
specify the rights, powers, and privileges of a share of stock, determine who holds a
corporate office, and adjudicate the fiduciary relationships that exist within the corporate
5 Id.
4
form. When doing so, Delaware deploys the corporate law to determine the parameters of
the property rights that the state has chosen to create.
But Delaware’s authority as the creator of the corporation does not extend to its
creation’s external relationships, particularly when the laws of other sovereigns govern
those relationships. Other states exercise territorial jurisdiction over a Delaware
corporation’s external interactions. A Delaware corporation that operates in other states
must abide by the labor, environmental, health and welfare, and securities law regimes (to
name a few) that apply in those jurisdictions. When litigation arises out of those
relationships, the DGCL cannot provide the necessary authority to regulate the claims.
This limitation applies even when the party asserting the claim happens to be a
stockholder. Envision a customer who happens to own stock and who wishes to assert a
product liability claim against the corporation. Even though the corporation’s relationships
with its customers are part of its business and affairs, and even though the customer-
stockholder plaintiff would own stock, the shares are incidental to the operative legal
relationship. Only a state exercising its territorial authority can regulate the product liability
claim. Because the claim exists outside of the corporate contract, it is beyond the power of
state corporate law to regulate.
This limitation applies even when shares of a Delaware corporation comprise the
property that is the subject of the external claim. If a third party engages in the tort of
conversion by stealing a stock certificate, the shares constitute the stolen property. The
claim for conversion is not an attribute of the shares, nor does it arise out of the corporate
contract. The fact that the stolen property consists of shares is incidental to the claim. The
5
legal relationship does not change if the corporation itself takes the shares. The conversion
claim is still not an attribute of the shares, and it still does not arise out of the corporate
contract. The same is true when a plaintiff asserts a claim for fraud involving shares. The
speaker may have made fraudulent statements about the shares, or which relate to the
shares, but the claim for fraud is not an attribute of the shares and does not arise out of the
corporate contract.
Whether a purchaser of securities may have bought shares in a Delaware corporation
is incidental to a claim under the 1933 Act. That happenstance does not provide a sufficient
legal connection to enable the constitutive documents of a Delaware corporation to regulate
the resulting lawsuit. The claim does not arise out of the corporate contract and does not
implicate the internal affairs of the corporation. To the contrary, assuming the securities in
question are shares, the claim arises from the investor’s purchase of the shares. At the time
the predicate act occurs, the purchaser is not yet a stockholder and lacks any relationship
with the corporation that is grounded in corporate law.
The constitutive documents of a Delaware corporation cannot bind a plaintiff to a
particular forum when the claim does not involve rights or relationships that were
established by or under Delaware’s corporate law. In this case, the Federal Forum
Provisions attempt to accomplish that feat. They are therefore ineffective and invalid.
I. FACTUAL BACKGROUND
The facts are drawn from the materials presented in support of the cross-motions for
summary judgment. The operative facts are undisputed.
6
A. The Federal Backdrop
The question of Delaware law presented by this case emerges from a backdrop of
federal law. A basic understanding of the 1933 Act provides essential context.
The 1933 Act
After the Crash of 1929, in the midst of the Great Depression, Congress enacted the
1933 Act “to promote honest practices in the securities markets.”6 The 1933 Act requires
a company offering securities to the public “to make full and fair disclosure of relevant
information” by filing a registration statement with the SEC.7
Congress created private rights of action for investors and provided that the causes
of action could be asserted in state or federal court.8 “More unusually, Congress also barred
the removal of such actions from state to federal court. So if a plaintiff chose to bring a
1933 Act suit in state court, the defendant could not change the forum.”9
Section 11 of the 1933 Act “allows purchasers of a registered security to sue certain
6 Cyan, 138 S. Ct. at 1066. See generally Fed. Hous. Fin. Agency v. Nomura Hldg. Am., Inc., 873 F.3d 85, 96 (2d Cir. 2017) (“In the wake of the Great Depression, Congress took measures to protect the U.S. economy from suffering another catastrophic collapse. Congress’s first step in that endeavor was the Securities Act of 1933. The Act’s chief innovation was to replace the traditional buyer-beware or caveat emptor rule of contract with an affirmative duty on sellers to disclose all material information fully and fairly prior to public offerings of securities. That change marked a paradigm shift in the securities markets.” (citation omitted)).
7 See Cyan, 138 S. Ct. at 1066 (internal quotation marks omitted).
8 Id.
9 Id. (citation omitted).
7
enumerated parties in a registered offering when false or misleading information is
included in a registration statement.”10 Its purpose is to “assure compliance with the
disclosure provisions of the Act by imposing a stringent standard of liability on the parties
who play a direct role in a registered offering.”11 “If a plaintiff purchased a security issued
pursuant to a registration statement, he need only show a material misstatement or omission
to establish his prima facie case. Liability against the issuer of a security is virtually
absolute, even for innocent misstatements.”12 “[E]very person who signed the registration
statement” may be liable,13 though defendants other than the issuer may avoid liability by
proving a due diligence defense.14
10 Herman & MacLean v. Huddleston, 459 U.S. 375, 381 (1983); see 15 U.S.C. § 77k(a) (providing for liability where “any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading”); Omnicare, Inc. v. Laborers Dist. Council Const. Indus. Pension Fund, 135 S. Ct. 1318, 1323 (2015) (“Section 11 . . . creates two ways to hold issuers liable for the contents of a registration statement—one focusing on what the statement says and the other on what it leaves out.”).
11 Huddleston, 459 U.S. at 381–82 (footnote omitted); see Omnicare, 135 S. Ct. at 1331 (explaining that Section 11 “establish[es] a strict liability offense promoting ‘full and fair disclosure’ of material information”).
12 Huddleston, 459 U.S. at 381 (footnote omitted).
13 15 U.S.C. § 77k(a)(1).
14 See Huddleston, 459 U.S. at 382; 15 U.S.C. § 77k(b) (setting forth due diligence and other defenses); see also Donna M. Nagy et al., Securities Litigation and Enforcement: Cases and Materials 262 (2003) (“[U]nless the issuer proves that the plaintiff knew of the misstatement or omission at issue at the time of purchasing the security or unless the statute of limitations has run, the issuer has no defenses. . . . Defendants other than the issuer . . . . can avoid liability by establishing that they acted diligently in investigating the facts set forth in the registration statement. Such defendants may also avoid liability based on the
8
If a person offers securities without complying with the registration requirements of
the 1933 Act, Section 12(a)(1) provides relief.15 Section 12(a)(2) of the 1933 Act provides
an additional cause of action when a prospectus contains material misstatements or
omissions.16
The PLSRA and SLUSA
In 1995, Congress passed the Private Securities Litigation Reform Act (the
“PLSRA”) to address “perceived abuses of the class-action vehicle in litigation involving
plaintiff’s knowledge of the misstatement or omission, the statute of limitations, or negative causation.” (citations omitted)).
15 15 U.S.C. § 77l(a)(1) (providing for liability for “[a]ny person who . . . offers or sells a security in violation of” Section 5 of the 1933 Act); see Zacharias v. SEC, 569 F.3d 458, 464 (D.C. Cir. 2009) (“Sections 5(a) and (c) of the Securities Act prohibit the ‘sale’ and ‘offer for sale’ of any securities unless a registration statement is in effect or there is an applicable exemption from registration.”). See generally Pinter v. Dahl, 486 U.S. 622, 638 (1988) (“The primary purpose of the Securities Act is to protect investors by requiring publication of material information thought necessary to allow them to make informed investment decisions concerning public offerings of securities in interstate commerce. The registration requirements are the heart of the Act, and § 12(1) imposes strict liability for violating those requirements. Liability under § 12(1) is a particularly important enforcement tool, because in many instances a private suit is the only effective means of detecting and deterring a seller’s wrongful failure to register securities before offering them for sale.” (citations and footnote omitted)).
16 15 U.S.C. § 77l(a)(2) (providing for liability for “[a]ny person who . . . offers or sells a security . . . by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading”); see Gustafson v. Alloyd Co., 513 U.S. 561, 571 (1995) (“Section 11 provides for liability on account of false registration statements; § 12(2) for liability based on misstatements in prospectuses.”).
9
nationally traded securities.”17 According to the congressional findings, “nuisance filings,
targeting of deep-pocket defendants, vexatious discovery requests, and ‘manipulation by
class action lawyers of the clients whom they purportedly represent’ had become rampant
in recent years.”18 The PSLRA imposed various procedural requirements for cases filed in
federal court, including an automatic stay of discovery pending a decision on a motion to
dismiss.19
The PSLRA “had an unintended consequence: It prompted at least some members
of the plaintiffs’ bar to avoid the federal forum altogether.”20 “Rather than face the
obstacles set in their path by the [PSLRA], plaintiffs and their representatives began
bringing class actions under state law, often in state court.”21
In 1998, Congress adopted the Securities Litigation Uniform Standards Act
(“SLUSA”) to prevent plaintiffs from circumventing the PSLRA by filing state law claims
17 Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 81 (2006).
18 Id.
19 15 U.S.C. § 77z–1; see Cyan, 138 S. Ct. at 1066–67.
20 Dabit, 547 U.S. at 82.
21 Id.; see In re Lord Abbett Mutual Funds Fee Litig., 553 F.3d 248, 250 (3d Cir. 2009) (“In reaction to the rigors of the PSLRA, plaintiffs began filing cases in state courts under less strict state securities laws.”); see also Dabit, 547 U.S. at 82 (“The evidence presented to Congress during a 1997 hearing to evaluate the effects of the [PSLRA] suggested that this phenomenon was a novel one; state-court litigation of class actions involving nationally traded securities had previously been rare.”).
10
in state court.22 SLUSA’s core provision states:
No covered class action based upon the statutory or common law of any State or subdivision thereof may be maintained in any State or Federal court by any private party alleging—
(1) an untrue statement or omission of a material fact in connection with the purchase or sale of a covered security; or
(2) that the defendant used or employed any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security.23
This decision refers to this provision as the “Federal Jurisdiction Statute.”
The Federal Jurisdiction Statute forces plaintiffs to sue in federal court if they wish
to pursue class-wide relief involving publicly traded securities on a fraud-based theory,
regardless of whether the cause of action invokes federal or state law.24 To make sure that
plaintiffs cannot bypass the Federal Jurisdiction Statute by ignoring it and filing in state
22 See Dabit, 547 U.S. at 82; Madden v. Cowen & Co., 576 F.3d 957, 963–64 (9th Cir. 2009); Sofonia v. Principal Life Ins. Co., 465 F.3d 873, 876 (8th Cir. 2006).
23 15 U.S.C. § 77p(b); see also Dabit, 547 U.S. at 83–84 (discussing provision in the Securities Exchange Act of 1934 that is analogous to the Federal Jurisdiction Statute).
24 See 15 U.S.C. § 77p(f)(2)(A) (defining “covered class action”); Cyan, 138 S. Ct. at 1067 (explaining that the Federal Jurisdiction Statute “completely disallows (in both state and federal courts) sizable class actions that are founded on state law and allege dishonest practices respecting a nationally traded security’s purchase or sale”). SLUSA recognized two exceptions known colloquially as the “Delaware carve-outs.” Malone v. Brincat, 722 A.2d 5, 13 (Del. 1998). First, SLUSA permits an “exclusively derivative action” to be maintained in state court. 15 U.S.C. § 77p(f)(2)(B). Second, SLUSA authorizes class actions “based upon the statutory or common law of the State in which the issuer is incorporated” to be maintained in state court. 15 U.S.C. § 77p(d)(1)(A). These exceptions preserved the ability of state courts to continue hearing internal-affairs claims. See Malone, 722 A.2d at 13 n.42.
11
court, SLUSA permits the removal of certain class actions to federal court.25
SLUSA also modified the jurisdictional provision in the 1933 Act.26 Before SLUSA,
the 1933 Act provided that state and federal courts had concurrent jurisdiction over claims
arising under the act.27 SLUSA modified the statutory provision to say that concurrent
jurisdiction existed “except as provided in [SLUSA].28 Likewise, before SLUSA, the 1933
Act provided that claims brought in state court that asserted violations of the 1933 Act were
not removable.29 Congress amended this provision to preserve the prohibition on removal
“[e]xcept as provided in [SLUSA].”30
A Federal Split Spurs Corporations To Impose Their Preference For A Federal Forum.
The federal courts split on how to interpret SLUSA’s changes.31 Some held that
25 15 U.S.C. § 77p(c); see Cyan, 138 S. Ct. at 1067.
26 Cyan, 138 S. Ct. at 1067–68.
27 Id. at 1068.
28 15 U.S.C. § 77v(a) (“The district courts of the United States . . . shall have jurisdiction . . . concurrent with State . . . courts, except as provided in [SLUSA] with respect to covered class actions, of all suits in equity and actions at law brought to enforce any liability or duty created by this subchapter.”).
29 Cyan, 138 S. Ct. at 1068.
30 15 U.S.C. § 77v(a) (“Except as provided in [SLUSA], no case arising under this subchapter and brought in any State court of competent jurisdiction shall be removed to any court of the United States.”).
31 Cyan, 138 S. Ct. at 1068–69 & n.1; see Unschuld v. Tri-S Sec. Corp., 2007 WL 2729011, at *1 (N.D. Ga. Sept. 14, 2007) (“[B]ecause the specific removal provision and the general provision governing concurrent jurisdiction [over] federal securities [cases] are fraught with confusion, . . . . district courts are split, with some finding removal of such
12
SLUSA only permitted the removal of covered class actions that raised state law claims,
while others held that claims under the 1933 Act could now be removed to federal court.32
Corporations and their advisors preferred federal court.33 In an effort to lock in their
preferred forum despite the split in authority on removal, corporations began adopting
forum-selection provisions that identified the federal courts as the exclusive forum for 1933
Act claims.34
B. The Initial Public Offerings
On June 1, 2017, nominal defendant Blue Apron Holdings, Inc. filed a registration
statement with the SEC for its shares of common stock and launched an initial public
offering. Blue Apron is a Delaware corporation. Before filing its registration statement,
Blue Apron adopted a charter-based Federal Forum Provision.
On September 1, 2017, nominal defendant Roku, Inc. filed a registration statement
with the SEC for its shares of common stock and launched an initial public offering. Roku
is a Delaware corporation. Before filing its registration statement, Roku adopted a charter-
federal claims from state court to be proper and with others finding that these federal claims must be remanded to state court.”).
32 Compare, e.g., Fortunato v. Akebia Therapeutics, Inc., 183 F. Supp. 3d 326 (D. Mass. 2016) (granting motion to remand), with Brody v. Homestore, Inc., 240 F. Supp. 2d 1122 (C.D. Cal. 2003) (denying motion to remand). See generally Niitsoo v. Alpha Nat. Res., 902 F. Supp. 2d 797, 800–807 (S.D.W. Va. 2012) (pre-Cyan discussion of multiple ways to interpret SLUSA’s jurisdictional and removal provisions).
33 See Donimirski Aff., Ex. A at 3 (presentation summarizing perceived advantages for defendants of litigating in federal court and concerns raised by litigating in state court).
34 See id. at 2; see also id. at 10–11.
13
based Federal Forum Provision.
On October 19, 2017, Stitch Fix, Inc. filed a registration statement with the SEC for
its shares of common stock and launched an initial public offering. Stitch Fix is a Delaware
corporation. Before filing its registration statement, Stitch Fix adopted a charter-based
Federal Forum Provision.
Roku and Stitch Fix adopted substantively identical provisions:
Unless the Company consents in writing to the selection of an alternative forum, the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act of 1933. Any person or entity purchasing or otherwise acquiring any interest in any security of the Corporation shall be deemed to have notice of and consented to [this provision].35
Blue Apron hedged a bit. Its provision states that “the federal district courts of the United
States of America shall, to the fullest extent permitted by law, be the sole and exclusive
forum for the resolution of any complaint asserting a cause of action arising under the
Securities Act of 1933.”36 Except for this phrase, its provision tracked the other two.
C. This Litigation
Plaintiff Matthew Sciabacucchi bought shares of common stock under each nominal
defendant’s registration statement, either in the initial public offering or shortly thereafter.
He therefore could sue under Section 11 of the 1933 Act to address any material
35 Compl. ¶¶ 15–16.
36 Id. ¶ 14 (emphasis added).
14
misstatements or omissions in the registration statements.37 He likewise could sue under
Section 12(a)(1) to enforce the 1933 Act’s registration requirements.38 He potentially could
sue under Section 12(a)(2) over a material misstatement or omission in a prospectus.39
On December 29, 2017, Sciabacucchi filed this action. His complaint named as
defendants twenty individuals who signed the registration statements for Blue Apron,
Stitch Fix, and Roku and who have served as their directors since they went public. His
complaint sought a declaratory judgment that the Federal Forum Provisions are invalid.
D. The Supreme Court of the United States Interprets SLUSA.
On March 20, 2018, the Supreme Court of the United States resolved the split in
37 See DeMaria v. Andersen, 318 F.3d 170, 176 (2d. Cir. 2003) (“[W]here there has been only one stock offering, any person who acquires the security may sue under § 11, ‘regardless of whether he bought in the initial offering, a week later, or a month after that.’” (quoting Hertzberg v. Dignity P’rs, Inc., 191 F.3d 1076, 1080 (9th Cir. 1999)).
38 See Pinter, 486 U.S. at 642 (“[T]he language of § 12(1) contemplates a buyer-seller relationship not unlike traditional contractual privity. Thus, it is settled that § 12(1) imposes liability on the owner who passed title, or other interest in the security, to the buyer for value.”).
39 “There is no clear appellate authority as to whether aftermarket purchasers may have § 12(a)(2) standing.” In re Wash. Mut., Inc. Sec., Deriv. & ERISA Litig., 694 F. Supp. 2d 1192, 1225 (W.D. Wash. 2009). Compare In re Wells Fargo Mortgage-Backed Certificates Litig., 712 F. Supp. 2d 958, 966 (N.D. Cal. 2010) (“Unlike Section 11, which permits an action by a plaintiff who has purchased a security that is merely ‘traceable to’ the challenged misstatement or omission, Section 12(a)(2) requires a plaintiff to plead and prove that it purchased a security directly from the issuer as part of the initial offering, rather than in the secondary market.”), with Feiner v. SS & C Techs., Inc., 47 F. Supp. 2d 250, 253 (D. Conn. 1999) (“This court now holds that § 12(a)(2) extends to aftermarket trading of a publicly offered security, so long as that aftermarket trading occurs ‘by means of a prospectus or oral communication.’” (quoting 15 U.S.C. § 77l(a)(2)). See generally Primo v. Pac. Biosciences of Cal., Inc., 940 F. Supp. 2d 1105, 1124 (N.D. Cal. 2013) (describing split in authority).
15
federal authority over SLUSA’s implications for the jurisdictional and removal provisions
in the 1933 Act. The justices held that class actions filed in state court which asserted
violations of the 1933 Act could not be removed to federal court.40 After the decision, under
the federal regime, a plaintiff wishing to sue under the 1933 Act could maintain an action
in either state or federal court.
II. LEGAL ANALYSIS
The parties have filed cross motions for summary judgment. Summary judgment
may be granted if the moving party demonstrates that there is “no genuine issue as to any
material fact” and that it is “entitled to a judgment as a matter of law.”41 A facial challenge
to the Federal Forum Provisions presents a question of law suitable for disposition on a
motion for summary judgment.42
A. Existing Law Indicates That The Federal Forum Provisions Are Ineffective.
The practice of including forum-selection provisions in the constitutive documents
of a corporation is a relatively recent development.43 The arc of the law in this area provides
40 Cyan, 138 S. Ct. at 1069.
41 Ct. Ch. R. 56(c).
42 See ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554, 557 (Del. 2014) (addressing certified question regarding facial validity of fee-shifting bylaw as a matter of law); Solak v. Sarowitz, 153 A.3d 729, 740 (Del. Ch. 2016) (deciding facial challenge to fee-shifting bylaw as a matter of law in context of a Rule 12(b)(6) motion to dismiss); Boilermakers, 73 A.3d at 938–39 (addressing facial validity of forum-selection bylaw as a matter of law in ruling on Rule 12(c) motion for judgment on the pleadings).
43 See, e.g., Helen Hershkoff & Marcel Kahan, Forum-Selection Provisions in Corporate “Contracts”, 93 Wash. L. Rev. 265, 267 (2018) (describing the “emergent practice” of “including a clause in a corporation’s charter or bylaws that specifies and so
16
insight into the permissible scope of forum-selection provisions. The authorities indicate
that the Federal Forum Provisions cannot accomplish what they attempt to achieve.
The Origins Of The Corporate Forum-Selection Phenomenon
The impetus for corporate forum-selection provisions came from an epidemic of
stockholder litigation, in which competing plaintiffs filed a bevy of lawsuits, often in
different multiple jurisdictions, before settling for non-monetary relief and an award of
attorneys’ fees.44 These frequently meritless cases imposed costs on corporations and
society without concomitant benefit. Courts had to expend resources coordinating the
actions and processing non-substantive settlements.45
limits where lawsuits may be filed”); George S. Geis, Ex-Ante Corporate Governance, 41 J. Corp. L. 609, 611 (2016) (“Long neglected, bylaws are gaining new attention as a vehicle for expanding, constraining, or channeling power in the corporate ecosystem.”); Verity Winship, Shareholder Litigation by Contract, 96 B.U. L. Rev. 486, 487 (2016) [hereinafter Shareholder Litigation] (tracing development of “corporate contract procedure,” including forum-selection provisions).
44 See, e.g., Verity Winship, Contracting Around Securities Litigation: Some Thoughts on the Scope of Litigation Bylaws, 68 SMU L. Rev. 913, 914 (2015) [hereinafter Contracting] (describing “[a] particular litigation pattern [that] triggered the development of these clauses”). See generally Edward B. Micheletti & Jenness E. Parker, Multi-Jurisdictional Litigation: Who Caused This Problem, and Can It Be Fixed?, 37 Del. J. Corp. L. 1, 6–14 (2016).
45 See generally In re Trulia, Inc. S’holder Litig., 129 A.3d 884, 891–99 (Del. Ch. 2016); Jill E. Fisch, Sean J. Griffith & Steven Davidoff Solomon, Confronting the Peppercorn Settlement in Merger Litigation: An Empirical Analysis and a Proposal for Reform, 93 Tex. L. Rev. 557, 557–72 (2015); Browning Jeffries, The Plaintiffs’ Lawyer’s Transaction Tax: The New Cost of Doing Business in Public Company Deals, 11 Berkeley Bus. L.J. 55, 66–91 (2014); Sean J. Griffith & Alexandra D. Lahav, The Market for Preclusion in Merger Litigation, 66 Vand. L. Rev. 1053, 1060–73 (2013).
17
In Revlon,46 I replaced class counsel for failing to provide adequate representation
when agreeing to a non-substantive settlement. When discussing the policy rationale for
this outcome, I posited that “[a]ll else equal, the threat of replacement should cause
representative counsel to invest more significantly in individual cases, which in turn should
lead representative counsel to analyze cases to identify actions whose potential merit
justifies the investment.”47 But I recognized that if Delaware sought to regulate abusive
litigation, then plaintiffs’ counsel might “accelerate their efforts to populate their portfolios
by filing in other jurisdictions.”48 As a possible response, I suggested: “If they do, and if
boards of directors and stockholders believe that a particular forum would provide an
efficient and value-promoting locus for dispute resolution, then corporations are free to
respond with charter provisions selecting an exclusive forum for intra-entity disputes.”49
46 In re Revlon, Inc. S’holders Litig., 990 A.2d 940 (Del. Ch. 2010).
47 Id. at 960.
48 Id. (citing Anywhere But Chancery: Ted Mirvis Sounds an Alarm and Suggests Some Solutions, M&A J. May 2007, at 17, 17).
49 Id. (citing 8 Del. C. § 102(b)(1)). I focused on charter-based provisions because I harbored concern about Sections 102(a)(4) and 151(a) of the DGCL, which generally require that any qualifications, limitations, or restrictions on the rights, powers, and preferences of shares appear in the certificate of incorporation. See 8 Del. C. §§ 102(a)(4), 151(a). Stockholders possess three fundamental rights: to vote, sell, and sue. Strougo v. Hollander, 111 A.3d 590, 595 n.21 (Del. Ch. 2015). It seemed arguable that a forum-selection provision constituted a limitation or restriction on the right to sue that needed to appear in the charter. Although Section 109(b) of the DGCL permits bylaws “relating to” a wide range of subjects, including “the rights or powers of [the] stockholders,” that section recognizes that a bylaw cannot be “inconsistent with law or with the certificate of incorporation . . . .” 8 Del. C. § 109(b). “For purposes of evaluating the statutory validity of a bylaw, therefore, it is not enough to measure it only against the ‘relating to’ language
18
Because the Revlon case did not involve a forum-selection provision, I observed
that “[t]he issues implicated by an exclusive forum selection provision must await
resolution in an appropriate case.”50 It was nevertheless my expectation that a forum-
selection provision implemented through the corporation’s constitutive documents only
would extend to “intra-entity disputes.”51
The Revlon dictum appears to have stirred practitioners and their clients to adopt
of Section 109(b). It is also necessary to consider what other sections of the DGCL say about the matter.” Sinchareonkul v. Fahnemann, 2015 WL 292314, at *7 (Del. Ch. Jan. 22, 2015). To avoid hazarding a view on the viability of a bylaw-based forum-selection provision, I only referred to charter provisions, where these statutory issues did not arise.
Arguments about the locus of forum-selection provisions evolved in a different direction. Rather than considering Sections 102(a)(4) and 151, the arguments prioritized the different approvals required for implementation or removal. Subsequent Court of Chancery decisions held that a bylaw-based forum-selection provision represented a statutorily valid exercise of authority under Section 109(b). See City of Providence v. First Citizen BancShares, Inc., 99 A.3d 229, 233–34 (Del. Ch. 2014); Boilermakers, 73 A.3d at 951–56. Although these holdings did not address Sections 102(a)(4) or 151, the Boilermakers decision cited the distinction between bylaws that validly establish procedural requirements and those that invalidly attempt to impose substantive limitations. 73 A.3d at 951–52 (citing CA, Inc. v. AFSCME Empls. Pension Plan, 953 A.2d 227, 236–37 (Del. 2008)). In my view, the same distinction would apply for purposes of Sections 102(a)(4) and 151. Under these provisions, a substantive limitation must appear in the charter; a procedural regulation can appear in the bylaws. See CA, 953 A.2d at 235 (describing bylaws as “procedural” and “process-oriented”).
The General Assembly has now authorized both charter-based and bylaw-based forum-selection provisions, rendering moot any concern about Sections 102(a)(4) or 151 for these clauses. See 8 Del. C. § 115. The implications of Sections 102(a)(4) and 151 remain salient for other types of provisions. See Geis, supra, at 640–42.
50 Revlon, 990 A.2d at 960 n.8.
51 See id. at 960.
19
forum-selection provisions.52 Before Revlon, forum-selection provisions appeared in the
charters or bylaws of sixteen publicly traded companies.53 A year later, approximately 195
public companies had either adopted forum-selection provisions or proposed them.54 By
August 2014, 746 publicly traded corporations had adopted them.55
Boilermakers
In 2013, while serving as Chancellor, Chief Justice Strine issued the seminal
decision on the validity of forum-selection provisions in the corporate contract. FedEx
Corporation and Chevron Corporation had both adopted forum-selection bylaws. In
Boilermakers, stockholders challenged these provisions, asserting that the corporations
lacked authority to adopt them under Section 109(b) of the DGCL.
The FedEx bylaw stated:
Unless the Corporation consents in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall be the sole and
52 See, e.g., Winship, Contracting, at 915 (positing that corporations and their advisors responded to the Revlon dictum); Joseph A. Grundfest, The History and Evolution of Intra-Corporate Forum Selection Clauses: An Empirical Analysis, 37 Del. J. Corp. L. 333, 339 (2012) (“During the fifteen months between Revlon’s issuance on March 16, 2010, and the June 30, 2011 cut-off date for this Article’s data analysis, the population of publicly traded entities with intra-corporate forum selection clauses in their organic documents more than octupled, increasing from 16 to 133.”).
53 Grundfest, supra, at 336.
54 Dominick T. Gattuso & Meghan A. Adams, Delaware Insider: Forum Selection Provisions in Corporate Charters and Bylaws: Validity vs. Enforceability, Bus. L. Today, Dec. 2013, at 1, 1.
55 See Matthew D. Cain, Jill E. Fisch, Steven Davidoff Solomon & Randall S. Thomas, The Shifting Tides of Merger Litigation, 71 Vand. L. Rev. 603, 618 (2018).
20
exclusive forum for
(i) any derivative action or proceeding brought on behalf of the Corporation,
(ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer or other employee of the Corporation to the Corporation or the Corporation’s stockholders,
(iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, or
(iv) any action asserting a claim governed by the internal affairs doctrine.
Any person or entity purchasing or otherwise acquiring any interest in shares of capital stock of the Corporation shall be deemed to have notice of any consented to the provisions of this [bylaw].56
Chevron’s bylaw originally tracked FedEx’s, but in response to the lawsuit, Chevron’s
board amended it in two ways. First, the amended bylaw permitted suits to be filed in any
state or federal court in Delaware having jurisdiction over the subject matter and the parties.
Second, the amended bylaw would not apply unless the court in Delaware could exercise
personal jurisdiction over all indispensable parties to the action.57
The defendants argued that the provisions covered four types of suits:
Derivative suits. The issue of whether a derivative plaintiff is qualified to sue on behalf of the corporation and whether that derivative plaintiff has or is excused from making demand on the board is a matter of corporate governance, because it goes to the very nature of who may speak for the corporation.
Fiduciary duty suits. The law of fiduciary duties regulates the
56 Boilermakers, 73 A.3d at 942 (alteration in original) (formatting added).
57 Id.
21
relationships between directors, officers, the corporation, and its stockholders.
D.G.C.L. suits. The Delaware General Corporation Law provides the underpinning framework for all Delaware corporations. That statute goes to the core of how such corporations are governed.
Internal affairs suits. As the U.S. Supreme Court has explained, “internal affairs,” in the context of corporate law, are those “matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders.”58
Although the defendants reserved the “internal affairs” label for the fourth category, all
four types involved the internal affairs of a Delaware corporation. Chief Justice Strine
described the categories as “all relating to internal corporate governance[.]”59
Because the forum-selection provisions appeared in the bylaws, Chief Justice Strine
examined their facial validity under Section 109(b). At the time, this statutory provision
stated: “The bylaws may contain any provision, not inconsistent with law or with the
certificate of incorporation, relating to the business of the corporation, the conduct of its
affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers
or employees.”60
58 Id. at 943 (quoting Defs.’ Opening Br. 30–31 (quoting Edgar v. MITE Corp., 457 U.S. 624, 645 (1982))).
59 Id. at 942; accord id. at 943 (observing that the defendants’ description of the forum-selection bylaws was “consistent with what the plain language of the bylaws suggests” and that the bylaws were intended only to regulate “where internal governance suits may be brought”).
60 8 Del. C. § 109(b). As discussed later, the General Assembly amended Section 109(b) in 2015 to add a second sentence: “The bylaws may not contain any provision that would impose liability on a stockholder for the attorneys’ fees or expenses of the
22
Chief Justice Strine had no difficulty holding that the forum-selection bylaws fell
within the scope of Section 109(b) because, as he repeatedly noted, they addressed internal-
affairs claims:
As a matter of easy linguistics, the forum selection bylaws address the “rights” of the stockholders, because they regulate where stockholders can exercise their right to bring certain internal affairs claims against the corporation and its directors and officers. They also plainly relate to the conduct of the corporation by channeling internal affairs cases into the courts of the state of incorporation, providing for the opportunity to have internal affairs cases resolved authoritatively by our Supreme Court if any party wishes to take an appeal. That is, because the forum selection bylaws address internal affairs claims, the subject matter of the actions the bylaws govern relates quintessentially to “the corporation’s business, the conduct of its affairs, and the rights of its stockholders [qua stockholders].”61
Notably, Chief Justice Strine did not stop with the statutory language—“rights of its
stockholders”—but emphasized that the forum-selection bylaws governed the rights of
“stockholders qua stockholders.”
Consistent with this point of emphasis, Chief Justice Strine provided two examples
of the causes of action that a bylaw could not regulate:
By contrast, the bylaws would be regulating external matters if the board adopted a bylaw that purported to bind a plaintiff, even a stockholder plaintiff, who sought to bring a tort claim against the company based on a personal injury she suffered that occurred on the company’s premises or a contract claim based on a commercial contract with the corporation.62
corporation or any other party in connection with an internal corporate claim, as defined in § 115 of this title.”
61 Boilermakers, 73 A.3d at 950–51 (alteration in original) (footnotes omitted) (quoting 8 Del. C. § 109(b)).
62 Id. at 952.
23
Leaving no doubt that a bylaw could not regulate cases of this type, Chief Justice Strine
stated: “The reason why those kinds of bylaws would be beyond the statutory language of
8 Del. C. § 109(b) is obvious: the bylaws would not deal with the rights and powers of the
plaintiff-stockholder as a stockholder.”63 Later in the opinion, Chief Justice Strine
emphasized that the bylaws did not purport “in any way to foreclose a plaintiff from
exercising any statutory right of action created by the federal government.”64
Boilermakers thus validated the ability of a corporation to adopt a forum-selection
provision for internal-affairs claims. The phrase “internal affairs” appears four times in the
opening paragraph, and the decision as a whole deployed either those words or an
equivalent concept (such as “internal governance”) over forty times. The decision also
drew a line at internal-affairs claims. When describing cases where it would be “obvious”
that a forum-selection provision would not apply, the decision cited causes of action that
did not involve internal affairs, such as tort or contract claims that did not depend on the
stockholder’s rights qua stockholder.
ATP
After Boilermakers, commentators debated whether charter and bylaw provisions
could regulate other aspects of stockholder litigation.65 In ATP, the Delaware Supreme
63 Id.
64 Id. at 962.
65 See, e.g., Alison Frankel, Wake Up, Shareholders! Your Right to Sue Corporations May Be in Danger, Reuters, June 25, 2013, https://www.reuters.com/article/ us-column-frankel-shareholders-idUSBRE95O1HO20130625 (positing that “[a] company
24
Court moved beyond forum selection by upholding the validity of a fee-shifting provision
in the bylaws of a non-stock corporation that applied to “intra-corporate litigation.”66
The ATP decision addressed four questions of law that the United States District
Court for the District of Delaware had certified to the Delaware Supreme Court.67 The
underlying suit involved a membership corporation that operated a men’s tennis league
(the “League”). The League’s members included entities that owned and operated
tournaments. Two members sued the League after the board of directors made changes to
the tour schedule.68 The plaintiffs asserted federal antitrust claims and state law claims for
breach of fiduciary duty, tortious interference with contract, and conversion.69 The district
court granted the League’s motion for judgment as a matter of law on the state law claims,
and a jury found in the League’s favor on the antitrust claims.70
could evade the SEC’s IPO strictures by imposing mandatory shareholder arbitration through a bylaw amendment rather than in a charter, pointing to [the] language [in Boilermakers] on shareholders’ implicit contractual consent. Then, when shareholders claimed their statutory rights were cut off because they couldn’t vindicate securities fraud or breach-of-duty claims through individual arbitration, the corporation could point to [American Express Co. v. Italian Colors Restaurant, 570 U.S. 228 (2013)] and say, ‘Tough luck.’”).
66 See ATP, 91 A.3d at 555. Later, the Delaware Supreme Court observed that “[a] bylaw that allocates risk among parties in intra-corporate litigation” would satisfy the requirements of Section 109(b). Id. at 558.
67 Id. at 557.
68 Id. at 556.
69 See Winship, Shareholder Litigation, at 508 (describing complaint).
70 See id. (describing trial court outcome).
25
Having prevailed on all counts, the League moved to recover $17,865,504.51 in
expenses.71 As the sole basis for its recovery, the League relied on the following bylaw:
In the event that (i) any Claiming Party initiates or asserts any Claim . . . against the League or any member or owners (including any Claim purportedly filed on behalf of the League or any member), and (ii) the Claiming Party . . . does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought, then each Claiming Party shall be obligated jointly and severally to reimburse the League and any such member or Owners for all fees, costs and expenses of every kind and description (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses) . . . that the parties may incur in connection with such Claim.72
The district court denied the application, observing that the League had cited “no case in
which a court held that a board-adopted corporate bylaw can form the basis for the recovery
of attorney’s fees from members who sue the corporation, much less in actions where the
bylaws are not directly in the dispute.”73 The district court also noted that the bylaw had
been “adopted only after the plaintiff became a member of the corporation”74 and “less
than five months before the complaint in this case was filed,” at a time when the League’s
board was discussing the events giving rise to the litigation.75 In the dispositive portion of
its analysis, the court reasoned that “allowing antitrust defendants to collect attorneys’ fees
71 Deutscher Tennis Bund v. ATP Tour, Inc., 2009 WL 3367041, at *1 (D. Del. Oct. 19, 2009), vacated, 480 Fed. App’x 124 (3d Cir. 2012).
72 Id.
73 Id. at *3.
74 Id.
75 Id. at *4 n.4.
26
in this case would be contrary both to longstanding Third Circuit precedent and to the
policies underlying the federal antitrust laws.”76
On appeal, in a per curiam ruling, the United States Court of Appeals for the Third
Circuit reversed. The Court of Appeals held that the district court should have determined
whether the fee-shifting bylaw was enforceable under Delaware law before considering
whether it was preempted by the antitrust laws.77 The Court of Appeals expressed “doubts
that Delaware courts would conclude that Article 23.3 imposes a legally enforceable
burden on [the plaintiffs].”78
After the remand, the district court certified four questions to the Delaware
Supreme Court:
1. May the Board of a Delaware non-stock corporation lawfully adopt a bylaw (i) that applies in the event that a member brings a claim against another member, a member sues the corporation, or the corporation sues a member (ii) pursuant to which the claimant is obligated to pay for “all fees, costs, and expenses of every kind and description (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses)” of the party against which the claim is made in the event that the claimant “does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought”?
76 See id. at *3 (citing Byram Concretetanks, Inc. v. Warren Concrete Prods. Co., 374 F.2d 649, 651 (3d Cir. 1967)).
77 Deutscher Tennis Bund v. ATP Tour, Inc., 480 Fed. App’x 124, 127 (3d Cir. 2012) (“Because a determination that Article 23.3 is invalid under Delaware law would allow us (and the District Court) to avoid the constitutional question of preemption, it is an independent state law ground. Consequently, the by-law validity issue needs to be addressed, and a finding of validity must be made, before the constitutional issue of preemption can be considered.”).
78 Id.
27
2. May such a bylaw be lawfully enforced against a member that obtains no relief at all on its claims against the corporation, even if the bylaw might be unenforceable in a different situation where the member obtains some relief?
3. Is such a bylaw rendered unenforceable as a matter of law if one or more Board members subjectively intended the adoption of the bylaw to deter legal challenges by members to other potential corporate action then under consideration?
4. Is such a bylaw enforceable against a member if it was adopted after the member had joined the corporation, but where the member had agreed to be bound by the corporation’s rules “that may be adopted and/or amended from time to time” by the corporation’s Board, and where the member was a member at the time that it commenced the lawsuit against the corporation?79
The Delaware Supreme Court answered the first, second, and fourth question in the
affirmative, but held that it could not answer the third question as a matter of law.
When addressing the first question, the Delaware Supreme Court held that the bylaw
fell within the scope of Section 109(b) of the DGCL. As the high court explained, “[a]
bylaw that allocates risk among parties in intra-corporate litigation would . . . appear to
satisfy the DGCL’s requirement that bylaws must ‘relat[e] to the business of the
corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its
stockholders, directors, officers or employees.’”80 The court therefore concluded that the
fee-shifting bylaw was a facially valid exercise of corporate authority.
For present purposes, the Delaware Supreme Court’s repeated references to “intra-
79 ATP, 91 A.3d at 557.
80 Id. at 558 (quoting 8 Del. C. § 109(b)).
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corporate litigation” are important.81 Although the plaintiffs in the underlying action also
asserted claims for antitrust violations, tortious interference, and conversion, the Delaware
Supreme Court interpreted the certified question as only asking about the validity of the
bylaw for purposes of “intra-corporate litigation.”82 The Delaware Supreme Court then
held that the bylaw was facially valid because it “allocate[d] risk among parties in intra-
corporate litigation . . . .”83 The Delaware Supreme Court did not suggest that that the
corporate contract can be used to regulate other types of claims.
The 2015 Amendments
In 2015, the Corporation Law Council of the Delaware State Bar Association
recommended that the General Assembly enact legislation that addressed both forum-
selection provisions and fee-shifting provisions.84 The General Assembly responded by
81 See id. at 555, 557–558.
82 Id. at 557 (“The first certified question asks whether the board of a Delaware non-stock corporation may lawfully adopt a bylaw that shifts all litigation expenses to a plaintiff in intra-corporate litigation who ‘does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought.’” (footnotes omitted)).
83 Id. at 558; see Henry duPont Ridgely, The Emerging Role of Bylaws in Corporate Governance, 68 SMU L. Rev. 317, 325 (2015) (describing the ATP ruling as addressing a bylaw involving “an intra-corporate suit”); Ann M. Lipton, Manufactured Consent: The Problem of Arbitration Clauses in Corporate Charters and Bylaws, 104 Geo. L.J. 583, 599 (2016) (“ATP Tour likewise limited its discussion of fee-shifting bylaws only to claims concerning intra-corporate litigation (an oddity to be sure, because the bylaw at issue purported to extend to any claim brought by a member, and the case was certified to the Delaware Supreme Court out of concern for the bylaw’s application to the antitrust laws).” (footnotes omitted)).
84 See Corporation Law Council, Explanation of Council Legislative Proposal (2015) [hereinafter Explanation of Council], available at Dkt. 26, Tab 7.
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adding Section 115 to the DGCL and amending Sections 102 and 109.85
The new Section 115 addressed the ability of Delaware corporations to adopt
forum-selection provisions in their charters and bylaws. It states:
The certificate of incorporation or the bylaws may require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in this State, and no provision of the certificate of incorporation or the bylaws may prohibit bringing such claims in the courts of this State.
“Internal corporate claims” means claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery.86
The General Assembly thus addressed only “internal corporate claims,” defined to
encompass claims covered by the internal-affairs doctrine.87
Through the adoption of Section 115, the General Assembly codified the ruling in
Boilermakers.88 When describing the intent of that provision before recommending it to
the General Assembly, the Corporation Law Council stated that “[t]he proposed legislation
85 See Del. S.B. 75 syn., 148th Gen. Assem. (2015).
86 8 Del. C. § 115 (formatting added).
87 See generally Lawrence A. Hamermesh & Norman M. Monhait, Fee-Shifting Bylaw: A Study in Federalism, Institute of Delaware Corporate and Business Law (June 29, 2015) (“By its terms, the legislation only applies to bylaws that provide for fee-shifting in connection with ‘internal corporate claims.’”), http://blogs.law.widener.edu/delcorp/201 5/06/29/fee-shifting-bylaws-a-study-in-federalism/.
88 Solak, 153 A.3d at 732 (“In 2015, Section 115 was added to the [DGCL], codifying this Court’s decision in Boilermakers . . . .”).
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would give statutory force to the Boilermakers decision.”89 The synopsis of the bill
expanded on this statement:
New Section 115 confirms, as held in [Boilermakers], that the certificate of incorporation and bylaws of the corporation may effectively specify, consistent with applicable jurisdictional requirements, that claims arising under the DGCL, including claims of breach of fiduciary duty by current or former directors or officers or controlling stockholders of the corporation, or persons who aid and abet such a breach, must be brought only in the courts (including the federal court) in this State.90
As the parties recognize, Section 115 does not say explicitly that the charter or
bylaws cannot include forum-selection provisions addressing other types of claims. The
omission comports with the precedent leading up to Section 115, which recognized that the
charter and bylaws can only address internal-affairs claims. Two past presidents and
leading members of the Corporation Law Council have said as much. Responding to a
debate about whether Section 115 permits Delaware corporations to adopt charter or bylaw
provisions that would regulate securities law claims, they agreed that a securities law claim
is not an “internal corporate claim” within the meaning of the amendments.91 But they
regarded that fact as beside the point, because the corporate charter and bylaws could not
be used to regulate external claims.92 They explained that in light of these views, the
89 Explanation of Council, supra, at 9.
90 Del. S.B. 75 syn., 148th Gen. Assem. (2015).
91 See generally Hamermesh & Monhait, supra.
92 See id. (“[S]ections 102(b)(1) and 109(b) cannot be read, despite their breadth and the presumptive validity of provisions adopted pursuant to them, to authorize provisions regulating litigation under the federal securities laws.”); id. (“[T]he subject matter scope of Sections 102(b)(1) and 109(b) is broad. But it is not limitless . . . . And in our view, it does
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Council “saw no reason for a statutory amendment that purported to reach beyond the
confines of internal governance litigation . . . .”93
In addition to enacting Section 115 to codify Boilermakers, the General Assembly
amended Sections 102 and 109 to “limit ATP to its facts . . . .”94 Together, the amended
sections ban fee-shifting provisions from both the charter and the bylaws. To address
charter-based provisions, the General Assembly adopted a new Section 102(f), which
states: “The certificate of incorporation may not contain any provision that would impose
liability on a stockholder for attorneys’ fees or expenses of the corporation, or any other
party in connection with an internal corporate claim, as defined in § 115 of this title.”95 To
address bylaw-based provisions, the General Assembly added a sentence to Section 109(b),
which states: “The bylaws may not contain any provision that would impose liability on a
stockholder for the attorneys’ fees or expenses of the corporation or any other party in
connection with an internal corporate claim, as defined in § 115 of this title.”
The amendments to Sections 102 and 109 reinforce the conclusion that the
not extend so far as to permit the charter or the bylaws to create a power to bind stockholders in regard to fee-shifting in, or the venue for, federal securities class actions.”).
93 Id.
94 See Solak, 153 A.3d at 734 (“Within one year of the ATP decision, the Corporation Law Council of the Delaware State Bar Association proposed legislation to ‘limit ATP to its facts’ and prevent the boards of Delaware stock corporations from adopting fee-shifting bylaws.” (quoting Explanation of Council, supra, at 12)); see also Explanation of Council, supra, at 4–6, 9 (explaining Corporation Law Council’s rationale for proposing ban on fee-shifting provisions).
95 8 Del. C. § 102(f).
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Corporation Law Council and the General Assembly only believed that the charter and
bylaws could regulate internal corporate claims. Their overarching policy goal was to ban
fee-shifting provisions from the corporate contract.96 If they thought that the charter or
bylaws could regulate other types of claims, then the prohibitions would have swept more
broadly. The drafters would not have taken the half measure of banning fee-shifting
provisions for a subset of claims, thereby permitting experimentation in other areas.
Implications For This Case
The development of the law governing forum-selection provisions indicates that the
nominal defendants cannot use the Federal Forum Provisions to specify a forum for 1933
Act claims.
First, the reasoning in Boilermakers applies equally to a charter-based provision.
The language of Section 102(b)(1) states:
In addition to the matters required to be set forth in the certificate of incorporation by subsection (a) of this section, the certificate of incorporation may also contain any or all of the following matters:
(1) Any provision for the management of the business and for the conduct of the affairs of the corporation, and any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders, or the governing body, members, or any class or group of members of a nonstock corporation; if such provisions are not contrary to the laws of this State. Any provision which is required or permitted by any section of this chapter to be stated in the bylaws may instead be stated in the certificate of incorporation . . . .97
96 See Solak, 153 A.3d at 741–42.
97 8 Del. C. § 102(b)(1).
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As leading commentators have observed, “[t]he language of Section 109(b) dealing with
the subject matter of bylaws parallels in large measure the language of Section 102(b)(1)
dealing with what may be included in a certificate of incorporation.”98 Stitch Fix and Roku
agree that “[a]lthough there are subtle differences between the language of Sections
102(b)(1) and 109(b), the provisions are generally viewed as covering the same broad
subject matter.”99
To reiterate, the authorizing language of Section 109(b) states that “[t]he bylaws
may contain any provision, not inconsistent with law or with the certificate of
incorporation, relating to [1] the business of the corporation, [2] the conduct of its affairs,
and [3] its rights or powers or [4] the rights or powers of its stockholders, directors, officers
or employees.”100 Although its phrasing differs slightly, Section 102(b)(1) permits the
certificate of incorporation to address the same subjects:
[1 & 2] [T]he management of the business and for the conduct of the affairs of the corporation, and [3 & 4] any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders . . . if such provisions are not contrary to the laws of this State.101
98 1 David A. Drexler et al., Delaware Corporation Law and Practice § 9.03, at 9-5 to -6 (2018) (footnote omitted); see Strougo, 111 A.3d at 599 n.42 (interpreting Section 109(b) but noting that “[a]n equivalent limitation would apply to charter provisions” because of the comparable scope of Sections 109(b) and 102(b)(1)).
99 Dkt. 18, at 20 n.14.
100 8 Del. C. § 109(b).
101 8 Del. C. § 102(b)(1).
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If anything, Section 109(b) is slightly broader, because it includes “employees,” whom
Section 102(b)(1) does not mention.
The parallelism between Sections 109(b) and 102(b)(1) means that Chief Justice
Strine’s distinction in Boilermakers between internal and external claims applies equally
to charter-based provisions. Such a provision cannot “bind a plaintiff, even a stockholder
plaintiff, who sought to bring a tort claim against the company based on a personal injury
she suffered that occurred on the company’s premises or a contract claim based on a
commercial contract with the corporation.”102 A charter-based forum-selection provision
cannot govern these claims because the provision would not be addressing “the rights and
powers of the plaintiff-stockholder as a stockholder.”103
This reasoning applies fully to claims under the 1933 Act, which assert specialized
and wholly statutory causes of action:
Although limited in scope, Section 11 [of the 1933 Act] places a relatively minimal burden on a plaintiff. In contrast, Section 10(b) [of the Securities and Exchange Act of 1934] is a “catchall” antifraud provision, but it requires a plaintiff to carry a heavier burden to establish a cause of action. While a Section 11 action must be brought by a purchaser of a registered security, must be based on misstatements or omissions in a registration statement, and can only be brought against certain parties, a Section 10(b) action can be brought by a purchaser or seller of “any security” against “any person” who has used “any manipulative or deceptive device or contrivance” in connection with the purchase or sale of a security. However, [unlike with a
102 See Boilermakers, 73 A.3d at 952.
103 See id.
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Section 11 claim,] a Section 10(b) plaintiff . . . . must prove that the defendant acted with scienter . . . .104
A plaintiff asserting a violation of the 1933 Act need only contend either that (i) the
registration statement or prospectus contained a material misstatement or omission
(Sections 11 & 12(a)(2))105 or (ii) the issuer “wrongful[ly] fail[ed] to register securities
before offering them for sale” (Section 12(a)(1)).106 The distinct nature of a claim based on
a defective registration statement demonstrates its external status.
The identity of the possible defendants for a 1933 Act claim further demonstrates
that the claim is not internal to the corporation. Under Section 11 of the 1933 Act, a plaintiff
may sue:
“every person who signed the registration statement”;
“every person who was a director of (or person performing similar functions) or partner of the issuer at the time of the filing of the part of the registration statement with respect to which his liability is asserted”;
“every person who, with his consent, is named in the registration statement as being or about to become a director, person performing similar functions, or partner”;
“every accountant, engineer, appraiser, or any person whose profession gives authority to a statement made by him, who has with his consent been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report which is used in connection with the registration statement, with respect to the statement in such registration
104 Huddleston, 459 U.S. at 382 (citation and footnote omitted).
105 See Gustafson, 513 U.S. at 571.
106 See Pinter, 486 U.S. at 638.
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statement, report, or valuation, which purports to have been prepared or certified by him”; and
“every underwriter with respect to such security.”107
Director status is not required. Officer status is not required. An internal role with the
corporation is not required.
The definition of a “security” underscores the absence of any meaningful connection
between a 1933 Act claim and stockholder status. A share of stock can be a “security,” but
the 1933 Act defines that term far more broadly:
The term “security” means any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security”, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.108
Depending on how one counts the cross-referenced categories, this definition could
identify as few as fifty or as many as 369 different types of securities. Shares are just one
of these many types of securities, and shares of a Delaware corporation are only one subset
of that one type. There is no necessary connection between a 1933 Act claim and the shares
107 15 U.S.C. § 77k(a).
108 15 U.S.C. § 77b(a)(1).
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of a Delaware corporation.
Finally, even when the investor does purchase a share of stock (as opposed to a
different kind of security), the predicate act is the purchase.109 The cause of action does not
arise out of or relate to the ownership of the share, but rather from the purchase of the share.
At the moment the predicate act of purchasing occurs, the purchaser is not yet a stockholder
and does not yet have any relationship with the corporation that is governed by Delaware
corporate law. Nor must the purchaser continue to own the security to be able to assert a
claim under the 1933 Act: the plaintiff can sue even if it subsequently sells and is no longer
a stockholder.110
For purposes of the analysis in Boilermakers, a 1933 Act claim resembles a tort or
contract claim brought by a third-party plaintiff who was not a stockholder at the time the
claim arose. At best for the defendants, a 1933 Act claim resembles a tort or contract claim
brought by a plaintiff who happens also to be a stockholder, but under circumstances where
stockholder status is incidental to the claim. A 1933 Act claim is an external claim that falls
109 See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 752 (1975) (“[T]he 1934 Act . . . is general in scope but chiefly concerned with the regulation of post-distribution trading on the Nation’s stock exchanges and securities trading markets. The 1933 Act is a far narrower statute chiefly concerned with disclosure and fraud in connection with offerings of securities—primarily . . . initial distributions of newly issued stock from corporate issuers.”).
110 See 15 U.S.C. § 77k(e) (“The suit authorized under [Section 11] may be to recover such damages as shall represent the difference between the amount paid for the security (not exceeding the price at which the security was offered to the public) and (1) the value thereof as of the time such suit was brought, or (2) the price at which such security shall have been disposed of in the market before suit . . . .” (emphasis added)).
38
outside the scope of the corporate contract.
Under existing Delaware authority, a Delaware corporation does not have the power
to adopt in its charter or bylaws a forum-selection provision that governs external claims.
The Federal Forum Provisions purport to regulate the forum in which parties external to
the corporation (purchasers of securities) can sue under a body of law external to the
corporate contract (the 1933 Act). They cannot accomplish that feat, rendering the
provisions ineffective.
B. First Principles Indicate That The Federal Forum Provisions Are Ineffective.
As discussed in the preceding section, the seminal Boilermakers decision and other
extant authorities indicate that a Delaware corporation cannot use its charter or bylaws to
regulate the forum in which parties bring external claims, such as federal securities law
claims. The defendants argue that these authorities are distinguishable because they do not
speak to the Federal Forum Provisions, which present an issue of first impression. The
same result derives from first principles.
The defendants ask the court to start with the plain language of Section 102(b)(1),
and they argue that its phrasing is broad enough to encompass a Federal Forum Provision.
But reasoning from first principles requires more fundamental starting points: the concept
of the corporation and the nature of its constitutive documents.
For purposes of Delaware law, a corporation is a legal entity—a “body corporate”—
39
created through the sovereign power of the state.111 Although the promulgation of general
incorporation statutes like the DGCL has reduced the visibility of the state’s role by
eliminating the need for special legislation, the issuance of a corporate charter remains a
sovereign act.112 When an incorporator files a certificate of incorporation that complies
with the requirements of the DGCL, the acceptance of the filing by the Delaware Secretary
of State gives rise to an artificial entity having attributes that only the state can bestow,
such as separate legal existence,113 presumptively perpetual life,114 and limited liability for
its investors.115
111 8 Del. C. § 106 (“Upon the filing with the Secretary of State of the certificate of incorporation, executed and acknowledged in accordance with § 103 of this title, the incorporator or incorporators who signed the certificate, and such incorporator’s or incorporators’ successors and assigns, shall, from the date of such filing, be and constitute a body corporate . . . .”).
112 See Del. Const. art. IX, § 1 (“No corporation shall hereafter be created, amended, renewed or revived by special act, but only by or under general law, nor shall any existing corporate charter be amended, renewed or revived by special act, but only by or under general law; but the foregoing provisions shall not apply to municipal corporations, banks or corporations for charitable, penal, reformatory, or educational purposes, sustained in whole or in part by the State. . . .”).
113 8 Del. C. § 106.
114 8 Del. C. § 102(b)(5) (authorizing the certificate of incorporation to contain “[a] provision limiting the duration of the corporation’s existence to a specified date; otherwise, the corporation shall have perpetual existence”); 8 Del. C. § 122(1) (“Every corporation created under this chapter shall have power to: (1) Have perpetual succession by its corporate name, unless a limited period of duration is stated in its certificate of incorporation . . . .”).
115 8 Del. C. § 102(b)(6) (authorizing a provision in the certificate of incorporation to “impos[e] personal liability for the debts of the corporation on its stockholders . . .; otherwise, the stockholders of a corporation shall not be personally liable for the payment of the corporation’s debts except as they may be liable by reason of their own conduct or
40
By virtue of Delaware’s exercise of its sovereign authority, a Delaware corporation
comes into existence and gains the power to act in the world. The DGCL defines what
powers the corporation can exercise, identifying both general116 and specific powers117 that
a Delaware corporation possesses. A Delaware corporation only can wield the powers that
the DGCL provides.118 When a corporation purports to take an action that it lacks the
capacity or power to accomplish, that action is ultra vires and void.119
acts”); 8 Del. C. § 162(a) (authorizing liability of stockholder or subscriber only when consideration for shares of corporation has not been paid in full and the assets of the corporation are insufficient to satisfy its creditors; limiting liability to “the amount of the unpaid balance of the consideration for which such shares were issued”).
116 See 8 Del. C. § 121.
117 See 8 Del. C. §§ 122–123.
118 Lawson v. Household Fin. Corp., 152 A. 723, 726 (Del. 1930); accord Trustees of Dartmouth College v. Woodward, 17 U.S. 518, 636 (1819) (“[A corporation] possesses only those properties which the charter of its creation confers upon it, either expressly, or as incidental to its very existence.”).
119 See Carsanaro v. Bloodhound Techs., Inc., 65 A.3d 618, 648–54 (Del. Ch. 2013) (discussing the largely outdated concept of “capacity or power” and its relationship to the ultra vires doctrine), abrogated on other grounds by El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, 152 A.3d 1248, 1264 (Del. 2016) (rejecting Carsanaro’s analysis of post-merger derivative standing). The ultra vires doctrine is largely a relic of the past because the DGCL retains only three limitations on corporate capacity or power. See 1 R. Franklin Balotti & Jesse A. Finkelstein, The Delaware Law of Corporations and Business Organizations §§ 2.4–2.6 (3d ed. 1997 & Supp. 2013). First, with specified exceptions, no corporation formed under the DGCL after April 18, 1945, may confer academic or honorary degrees. 8 Del. C. § 125. Second, no corporation formed under the DGCL can exercise banking power. 8 Del. C. § 126(a). Third, a Delaware corporation that is designated as a private foundation under the Internal Revenue Code must comply with certain tax provisions, unless its charter provides that the restriction is inapplicable. 8 Del. C. § 127. A corporation nevertheless retains the ability to impose limitations on (and create uncertainty about) its capacity or power by including provisions in its charter that forbid it
41
The contract that gives rise to the artificial entity and confers these powers is not an
ordinary private contract among private actors.120 The certificate of incorporation is a
multi-party contract that includes the State of Delaware.121 Unlike an ordinary contract, a
certificate of incorporation always incorporates by reference the limitations imposed by the
DGCL.122 Unlike an ordinary contract, a certificate of incorporation can only be amended
from entering into particular lines of business or engaging in particular acts. See Balotti & Finkelstein, supra, § 2.1.
120 See Hershkoff & Kahan, supra, at 277–85. As mentioned in the introduction, this decision uses the term “ordinary contract” to refer to a purely private contract between purely private parties, in which the signatories allocate their rights and obligations. Such a contract is governed by the principles set out in the Restatement (Second) of Contracts, including requirements for contract formation that include an offer, acceptance, consideration, and a meeting of the minds on material terms. See Lipton, supra, at 586 n.14 (using this definition).
121 STARR Surgical Co. v. Waggoner, 588 A.2d 1130, 1136 (Del. 1991) (“[A] corporate charter is both a contract between the State and the corporation, and the corporation and its shareholders.”); Lawson, 152 A. at 727 (“[T]he charter of a corporation is a contract both between the corporation and the state and the corporation and its stockholders. It is not necessary to cite authorities to support this proposition.”); see Hershkoff & Kahan, supra, at 277 (“A corporation’s charter and bylaws, however, are no ordinary contracts. They are instead a hybrid between an ordinary contract and state law—they are highly regulated constitutive documents that order collective decision-making.”).
122 8 Del. C. § 121(b) (“Every corporation shall be governed by the provisions and be subject to the restricts and liabilities contained in this chapter.”); 8 Del. C. § 394 (“This chapter and all amendments thereof shall be a part of the charter or certificate of incorporation of every corporation except so far as the same are inapplicable and inappropriate to the objects of the corporation.”); see STARR Surgical, 588 A.2d at 1136 (“[I]t is a basic concept that the General Corporation Law is a part of the certificate of incorporation of every Delaware company.”); Fed. United Corp. v. Havender, 11 A.2d 331, 333 (Del. 1940) (“It is elementary that [the Delaware General Corporation Law’s] provisions are written into every corporate charter.”).
42
in compliance with the DGCL.123 Unlike an ordinary contract, a certificate of incorporation
may only contain provisions authorized by the DGCL.124 Although courts enforce both
types of contracts, they deploy different principles, with courts enforcing the relationships
created by the corporate contract using an overlay of fiduciary duty.125
Because the state of incorporation creates the corporation, the state has the power
through its corporation law to regulate the corporation’s internal affairs.126 For example,
the certificate of incorporation can specify the rights, powers, and privileges of shares of
stock, thereby specifying contractual rights that accompany those shares.127 It can specify
123 See 8 Del. C. §§ 241–242.
124 See Berlin v. Emerald P’rs, 552 A.2d 482, 488 (Del. 1988) (“In examining the provisions of a certificate of incorporation, courts apply the rules of contract interpretation. . . . Nevertheless, the contract rights of the stockholders of the corporation are also subject to the provisions of the Delaware General Corporation Law.”); see also Boilermakers, 73 A.3d at 940 (“[O]ur Supreme Court has long noted that bylaws, together with the certificate of incorporation and the broader DGCL, form part of a flexible contract between corporations and stockholders . . . .”); In re Activision Blizzard, Inc. S’holder Litig., 124 A.3d 1025, 1050 & n.11 (Del. Ch. 2015) (collecting authorities).
125 See, e.g., Stone ex rel. AmSouth Bancorporation v. Ritter, 911 A.2d 362, 370 (Del. 2006) (explaining that directors owe duties of care and loyalty and that the duty of loyalty includes “a requirement to act in good faith”); Mills Acq. Co. v. Macmillan, Inc., 559 A.2d 1261, 1280 (Del. 1989) (“[D]irectors owe fiduciary duties of care and loyalty to the corporation and its shareholders.”); Polk v. Good, 507 A.2d 531, 536 (Del. 1986) (“In performing their duties the directors owe fundamental fiduciary duties of loyalty and care to the corporation and its shareholders.”).
126 See generally Jack B. Jacobs, The Reach of State Corporation Law Beyond State Borders: Reflections Upon Federalism, 84 N.Y.U. L. Rev. 1149 (2009).
127 8 Del. C. §§ 102(a)(4), 151(a).
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the composition and structure of the board of directors128 and what powers the board can
exercise.129 When taking these actions, Delaware deploys the corporate law to determine
the parameters of the property rights that the state has chosen to establish.
The power of the state of incorporation to address these matters manifests itself
through the internal-affairs doctrine. No matter where the corporation conducts its
operations or locates its headquarters, the law of the state of incorporation governs the
entity’s internal affairs.130 The corporation’s contacts with the forum state do not affect the
choice-of-law analysis because the questions are internal to the corporation.131
128 See 8 Del. C. § 141(b), (d) & (f).
129 See 8 Del. C. § 141(a) (“The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation.”).
130 McDermott Inc. v. Lewis, 531 A.2d 206, 215 (Del. 1987) (“The internal affairs doctrine requires that the law of the state of incorporation should determine issues relating to internal corporate affairs.”); accord Sagarra Inversiones, S.L. v. Cementos Portland Valderrivas, S.A., 34 A.3d 1074, 1081 (Del. 2011) (“The term ‘internal affairs’ encompasses ‘those matters that pertain to the relationships among or between the corporation and its officers, directors, and shareholders.’ The [internal affairs] doctrine requires that the law of the state (or, in this case, the sovereign nation) of incorporation must govern those relationships.” (footnote omitted)); VantagePoint Venture P’rs 1996 v. Examen, Inc., 871 A.2d 1108, 1116 (Del. 2005) (“[W]e hold Delaware’s well-established choice of law rules and the federal constitution mandated that Examen’s internals, and in particular, VantagePoint’s voting rights, be adjudicated exclusively in accordance with the law of its state of incorporation, in this case, the law of Delaware.” (footnotes omitted)).
131 McDermott, 531 A.2d at 214–15 (“Corporations and individuals alike enter into contracts, commit torts, and deal in personal and real property. Choice of law decisions
44
But the state of incorporation cannot use corporate law to regulate the corporation’s
external relationships. Jurisdictions invariably enact laws addressing unfair competition,
employment relationships, health and welfare standards, and numerous other issues that
affect a corporation’s business. When states regulate these activities, they exercise
authority over actors and activities within their territorial jurisdictions (or which have a
sufficient nexus with their territorial jurisdictions).132 State “blue sky” statutes, for
example, extend only to securities that are offered for sale or purchased within the state.133
relating to such corporate activities are usually determined after consideration of the facts of each transaction. . . . The internal affairs doctrine has no applicability to these situations. Rather, this doctrine governs the choice of law determinations involving matters peculiar to corporations, that is, those activities concerning the relationships inter se of the corporation, its directors, officers and shareholders.”).
132 See Singer v. Magnavox Co., 380 A.2d 969, 981 (Del. 1977) (discussing the “presumption that a law is not intended to apply outside the territorial jurisdiction of the State in which it is enacted”), overruled on other grounds by Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983); Ward v. CareFusion Solutions, LLC, 2018 WL 1320225, at *2–3 (Del. Super. Mar. 13, 2018) (interpreting California Labor Code as only applying within California); Marshall v. Priceline.com Inc., 2006 WL 3175318, at *2 (Del. Super. Oct. 31, 2006) (holding that Delaware Consumer Fraud Act does not have extraterritorial effect); Carter v. Dep’t of Public Safety, 290 A.2d 652, 655 (Del. Super. 1972) (declining to interpret Delaware statute requiring the forwarding of convictions to the Delaware Division of Motor Vehicles as having extraterritorial effect).
133 See Singer, 380 A.2d at 981–82 (holding that the Delaware Securities Act is a commercial statute that applies to certain purchases or sales of securities with a “sufficient nexus” with Delaware, and that the statute did not apply simply because the issuer was a Delaware corporation, nor because the vote on the merger that resulted in the issuance took place in Delaware); FdG Logistics LLC v. A&R Logistics Hldgs., 131 A.3d 842, 846 (Del. 2016) (rejecting interpretation of choice-of-law clause that “would lead to the bizarre result of converting a blue-sky statute that the Legislature intended to regulate intrastate securities transactions into one that would regulate interstate securities transactions”); Lipton, supra, at 598 (“Unlike corporate governance (and to the extent not preempted by
45
When determining what law governs state securities law claims, state courts apply
territorial principles; they “do not look to the terms of the corporate charter of the law of
the state of incorporation . . . .”134
Without more, the corporate contract does not enable Delaware to regulate the
activities of parties that are beyond its territorial jurisdiction. Delaware can regulate the
internal affairs of its corporate creations, regardless of their location, but only their internal
affairs. While serving on this court, Chief Justice Strine articulated the resulting distinction
between what Delaware can regulate using its corporate law and what it cannot:
Delaware’s corporation law is not what, in a European context, might be called a broad-based company law. Aspects of company law like competition law, labor law, trade, and requirements for the filing of regular disclosures to public investors, are not part of Delaware’s corporation law. . . . Delaware corporation law governs only the internal affairs of the corporation. In that sense, our law is a specialized form of contract law that governs the relationship between corporate managers—the directors and officers—of corporations, and the stockholders.135
Put self-referentially, the corporate contract can only regulate claims involving the
corporate contract. It cannot regulate external activities, nor the behavior of parties in other
capacities.
In light of these principles, “there is no reason to believe that corporate governance
federal law), states regulate the offers, sales, and purchases of securities on a territorial basis.”).
134 Lipton, supra, at 598; accord Singer, 380 A.2d at 981–82.
135 Leo E. Strine, Jr., The Delaware Way: How We Do Corporate Law and Some of the New Challenges We (and Europe) Face, 30 Del. J. Corp. L. 673, 674 (2005).
46
documents, regulated by the law of the state of incorporation, can dictate mechanisms for
bringing claims that do not concern corporate internal affairs, such as claims alleging fraud
in connection with a securities sale.”136 The state cannot assert authority over other types
of claims based on the corporate contract, because the claims do not arise out of internal
corporate relationships, and the fact of incorporation is not a sufficient nexus to support
applying the chartering state’s law to external claims.137
These first principles establish the framework within which Section 102 of the
DGCL operates. Titled “Contents of certificate of incorporation,” it specifies information
that the charter must contain and identifies provisions that the charter may contain.138
Section 102(a) identifies the mandatory information.139 Section 102(b) identifies the
optional provisions.140 Perhaps the most well-known option is Section 102(b)(7), which
136 Lipton, supra, at 598.
137 See Singer, 380 A.2d at 981–82 (holding that fact of Delaware incorporation was not a sufficient nexus to warrant application of Delaware Securities Act to issuance of shares in connection with merger); Marshall, 2006 WL 3175318, at *2 (“[W]hile incorporation may be enough to allow Delaware law to apply to a dispute, it is not enough to allow the [Delaware Consumer Fraud Act] to apply to fraudulent transactions which did not occur in Delaware.”).
138 8 Del. C. § 102.
139 8 Del. C. § 102(a) (“The certificate of incorporation shall set forth . . . .”).
140 See 8 Del. C. § 102(b) (“In addition to the matters required to be set forth in the certificate of information by subsection (a) of this section, the certificate of incorporation may also contain any or all of the following matters . . . .”); 1 Drexler, supra, § 6.02, at 6-8 (“While Section 102(a) lists the matters which must be covered in the certificate of a Delaware corporation, Section 102(b) identifies certain optional provisions which may be included in the certificate.”); accord 1 Balotti & Finkelstein, supra, § 1.3, at 1-5 n.18 (“[Sections] 102(a) and (b) provide an outline of the provisions that must be included in
47
permits a corporation to exculpate directors from liability for breach of the fiduciary duty
of care.141
Section 102(b)(1) provides general authority for the charter to contain non-
mandatory provisions.142 Leading Delaware commentators describe it as “an all-purpose
provision which grants authority for a broad variety of charter provisions dealing with
corporate management and the relations of stockholders inter sese.”143 Notably, they regard
it as dealing with the internal affairs of the corporation. They do not mention Section
102(b)(1) authorizing the certificate of incorporation to regulate the rights that external
every charter, Section 102(a), and a listing of the subjects that may be included in the charter, Section 102(b).”).
141 See 8 Del. C. § 102(b)(7) (permitting exculpation from liability except for (i) any breach of the director's duty of loyalty; (ii) an act or omission not in good faith or involving intentional misconduct or a knowing violation of law; (iii) an unlawful dividend or stock repurchase under Section 174; and (iv) any transaction from which the director derived an improper personal benefit); Stone, 911 A.2d at 367 (explaining that a Section 102(b)(7) provision “can exculpate directors from monetary liability for a breach of the duty of care, but not for conduct that is not in good faith or a breach of the duty of loyalty” (footnote omitted)); 1 Drexler, supra, § 6.02[7], at 6-18 (“The totality of these limitations or exemptions . . . is to eliminate . . . director liability only for ‘duty of care’ violations.”). The presence of an exculpatory provision does not eliminate the underlying duty of care or the potential for fiduciaries to breach that duty. See Malpiede v. Townson, 780 A.2d 1075, 1095 n.68 (Del. 2001); In re Walt Disney Co. Deriv. Litig., 907 A.2d 693, 752 (Del. Ch. 2005), aff’d, 906 A.2d 27 (Del. 2006). Consequently, “[t]he duty of care continues to have vitality in remedial contexts as opposed to actions for personal monetary damages against directors as individuals.” E. Norman Veasey et al., Delaware Supports Directors With a Three–Legged Stool of Limited Liability, Indemnification, and Insurance, 42 Bus. Law. 399, 403 (1987).
142 8 Del. C. § 102(b)(1).
143 1 Drexler, supra, § 6.02[1], at 6-8.
48
actors might have against the corporation.
In an effort to expand the reach of the DGCL and the scope of Section 102(b)(1),
the defendants cite cases that discuss Delaware’s support for private ordering, but each of
these cases focuses on the internal affairs of Delaware corporations, not external issues.144
Consistent with the scope of what Delaware can regulate through the DGCL, Section
102(b)(1) only provides authority for the charter to govern internal claims.
As discussed at length in the previous section, a federal claim under the 1933 Act is
a clear example of an external claim. The plaintiff is a purchaser of securities, and the
source of the cause of action is the sale of a security that violates the federal regulatory
regime. The defendants need not be directors or officers of the corporation; they can be
anyone that the 1933 Act identifies as a viable defendant. The fact that the plaintiff might
144 See Jones Apparel Gp. v. Maxwell Shoe Co., 883 A.2d 837, 845 (Del. Ch. 2004) (Strine, V.C.) (“As Professor Folk noted in his comments on the 1969 amendments to the DGCL, and particularly on the enabling feature of § 141(a), ‘the Delaware corporation enjoys the broadest grant of power in the English-speaking world to establish the most appropriate internal organization and structure for the enterprise.’” (emphasis added)); Sagusa, Inc. v. Magellan Petroleum Corp., 1993 WL 512487, at *2 (Del. Ch. Dec. 1, 1993) (“[T]he public policy applicable to Delaware’s corporation law is expressed in 8 Del. C. § 102(b)(1), which authorizes companies to include in their charters any corporate governance provisions that do not violate Delaware law.” (emphasis added)); Frankel v. Donovan, 120 A.2d 311, 316 (Del. Ch. 1956) (“Charter provisions which facilitate corporate action and to which a stockholder assents by becoming a stockholder are normally upheld by the court unless they contravene a principle implicit in statutory or settled decisional law governing corporate management.” (emphasis added) (citations omitted)); see also Sterling v. Mayflower Hotel Corp., 93 A.2d 107, 118 (Del. 1952) (upholding validity of charter provision permitting interested directors to be counted for quorum purposes because it “relat[ed] to the powers of the directors in conducting the corporate business” (emphasis added)).
49
have purchased shares in a Delaware corporation is incidental to the claim; shares are but
one type of security covered by the 1933 Act. Even if the purchase did involve shares, the
event giving rise to the claim takes place just before the plaintiff becomes a stockholder,
before the corporate contract applies. Nor is continuing stockholder status necessary to
assert a 1933 Act claim: the plaintiff can sue even if it sells and is no longer a stockholder.
The federal claim does not invoke the stockholder’s legal or equitable rights under the state
law corporate contract.
Despite this array of distinctions, the defendants have argued that issuing securities
and defending against securities lawsuits involve the business and affairs of the
corporation. That is true, but it does not follow that these matters involve the internal
affairs of the corporation. Many aspects of the corporation’s business and affairs involve
external relationships. The certificate of incorporation and Delaware law cannot regulate
those external relationships.
The defendants have also argued that a claim under the 1933 Act involves internal
corporate relationships because a Section 11 claim seeks to hold corporate officials
accountable for the content of registration statements. That is also true, but the claim
remains external to the corporate contract.
Reasoning from first principles generates the same result as applying Boilermakers.
The nominal defendants lack authority to use their certificates of incorporation to regulate
claims under the 1933 Act. The Federal Forum Provisions are ineffective and invalid.
C. Other Arguments
The plaintiff argues alternatively that the Federal Forum Provisions are invalid
50
because they “transgress . . . a public policy settled by the common law or implicit in the
General Corporation Law itself.”145 He observes that the Federal Forum Provisions take
Delaware out of its traditional lane of corporate governance and into the federal lane of
securities regulation.146 The extent of the infringement in this case might not seem
significant (excluding one of two forums that federal law permits), but the implications
would be vast (asserting that state corporate law could be used to regulate federal claims).
The Federal Forum Provisions would thus violate Delaware public policy and be invalid.
There are also grounds to believe that because the Federal Forum Provisions conflict with
the forum alternatives that the 1933 Act permits, the provisions could be preempted.147
145 Sterling, 93 A.2d at 118; see Jones Apparel, 883 A.2d at 848 (“[T]he court must determine, based on a careful, context-specific review in keeping with Sterling, whether a particular certificate provision contravenes Delaware public policy, i.e., our law, whether it be in the form of statutory or common law.”).
146 See, e.g., Myron T. Steele, Sarbanes-Oxley: The Delaware Perspective, 52 N.Y.L. Sch. L. Rev. 503, 506–07 (2008) (“[T]he focus of the federal lane has always been, and should always be, market fraud and disclosure. On the other hand, monitoring the structure of internal corporate governance is the focus of the state lane.”).
147 See Hamermesh & Monhait, supra (“[A] state authorization of charter and bylaw provisions purporting to control fee-shifting and venue in federal securities class action is likely to be held pre-empted, regardless of their validity or effect under state law.”); cf. John C. Coffee, Jr., “Loser Pays”: The Latest Installment in the Battle-Scarred, Cliff-Hanging Survival of the Rule 10b-5 Class Action, 68 SMU L. Rev. 689, 696–701 (2015) (discussing preemption doctrines in the context of conflict between fee-shifting bylaws and provisions of the federal securities laws); William K. Sjostrom, Jr., The Intersection of Fee-Shifting Bylaws and Securities Fraud Litigation, 93 Wash. U. L. Rev. 379, 405–14 (2015) (same).
51
This decision has not reached these additional arguments.
D. Blue Apron’s Ripeness Argument
Blue Apron (but not Stitch Fix or Roku) argues that its Federal Forum Provision is
unripe for challenge. This is an interesting position, because multiple actions under the
1933 Act are pending against defendants affiliated with Blue Apron, including an action
filed in state court that is stayed.148 Even without the existence of these actions, the
challenge to the Federal Forum Provision is ripe.
Section 111(a)(1) of the DGCL confers jurisdiction on the Court of Chancery to
“determine the validity of the provisions of . . . [t]he certificate of incorporation . . . of a
corporation . . . .”149 Delaware’s declaratory judgment statute permits a court “to declare
rights, status and other legal relations whether or not further relief is or could be
claimed.”150 The dispute must present an “actual controversy,” which includes the
requirement that it “be ripe for judicial determination.”151
Courts decline to render hypothetical opinions, that is, dependent on supposition, for two basic reasons. First, judicial resources are limited and must not be squandered on disagreements that have no significant current impact and may never ripen into legal action [appropriate for judicial resolution]. Second, to the extent that the judicial branch contributes to law creation in our legal system, it legitimately does so interstitially and because it is required to do so by reason of specific facts that necessitate a judicial
148 See Dkt. 32, Ex. B (stipulation staying New York state court action pending resolution of motion to dismiss or settlement in the federal action).
149 8 Del. C. § 111(a)(1).
150 10 Del. C. § 6501.
151 Rollins Int’l, Inc. v. Int’l Hydronics Corp., 303 A.2d 660, 662–63 (Del. 1973).
52
judgment.152
Determining whether a case is ripe requires “a common sense assessment[.]”153 “The
reasons for not rendering a hypothetical opinion must be weighed against the benefits to
be derived from the rendering of a declaratory judgment. This weighing process requires
the exercise of judicial discretion which should turn importantly upon a practical evaluation
of the circumstances of the case.”154 “Generally, a dispute will be deemed ripe if litigation
sooner or later appears to be unavoidable and where the material facts are static.”155
“Facial challenges to the legality of provisions in corporate instruments are regularly
resolved by this Court.”156 The ripeness doctrine permits a court to postpone review until
the disputed issue “arises in some more concrete and final form,”157 but there is no point in
doing so here. A facial challenge presents a pure question of law.158 The material facts are
152 Stroud v. Milliken Enters., 552 A.2d 476, 480 (Del. 1989) (alteration in original) (internal quotation marks omitted).
153 XL Specialty Ins. Co. v. WMI Liquidating Tr., 93 A.3d 1208, 1217 (Del. 2014).
154 Stroud, 552 A.2d at 480 (internal quotation marks omitted).
155 XL Specialty, 93 A.3d at 1217 (internal quotation marks omitted).
156 Lions Gate Entm’t Corp. v. Image Entm’t Inc., 2006 WL 1668051, at *6 (Del. Ch. June 5, 2006); accord Solak, 153 A.3d at 737.
157 Stroud, 552 A.2d at 480 (quoting Continental Air Lines, Inc. v. C.A.B., 522 F.2d 107, 124–25 (D.C. Cir. 1974)); see XL Specialty, 93 A.3d at 1217–18 (“[A] dispute will be deemed not ripe where the claim is based on ‘uncertain and contingent events that may not occur,’ or where ‘future events may obviate the need’ for judicial intervention.” (footnote omitted)).
158 Solak, 153 A.3d at 740.
53
static, and litigation over the validity of the Federal Forum Provisions appears likely.159 It
would add nothing to the record to wait to see if Blue Apron relies on its Federal Forum
Provision to move to dismiss a 1933 Act claim.
The current dispute is also ripe because the Federal Forum Provisions “have a
substantial deterrent effect.”160 The Federal Forum Provisions should cause a plaintiff to
think twice before filing a 1933 Act claim in state court, facing a motion to dismiss on
jurisdictional grounds, and incurring the costs and delay that a plaintiff who filed in federal
court would not have to bear. Few stockholders would pursue that course. Instead, plaintiffs
will abide by its requirements, enabling the provision to evade review.161
Declining to review the Federal Forum Provisions could also encourage other
corporations to adopt similar provisions to take advantage of their deterrent effect. As in
other cases involving facial challenges, deciding “the basic legal questions presented” will
provide “efficiency benefits to not only the defendants and their stockholders, but to other
corporations and their investors.”162
Under a common sense assessment, the challenge to Blue Apron’s provision is ripe.
159 See Dkt. 41, at 5–6 (plaintiff’s counsel commenting that Blue Apron defendants can be expected to move to dismiss the state court action on forum selection grounds once stay is lifted).
160 Id. at 737.
161 See id.; Strougo, 111 A.3d at 595 & n.19.
162 Solak, 153 A.3d at 738 (quoting Boilermakers, 73 A.3d at 938).
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E. Blue Apron’s Savings Clause Argument
Blue Apron argues that its Federal Forum Provision should be upheld because it
“will never operate contrary to Delaware law.”163 According to Blue Apron, its provision
achieves this ideal state by requiring claims under the 1933 Act to be brought in federal
court only “to the fullest extent permitted by law[.]”
Blue Apron’s savings clause argument fails because there is no context in which
Blue Apron’s Federal Forum Provision could operate validly.164 “For a savings clause to
negate a facial challenge . . ., there logically must be something left in the challenged
provision for the savings clause to save.”165 Under the reasoning set forth in this decision,
the corporate contract cannot be used to regulate federal securities claims under the 1933
Act. As a result, there is no possibility that Blue Apron’s Federal Forum Provision could
comply with Delaware law. The savings clause does not save it.
III. CONCLUSION
Judgment is entered for the plaintiff. The defendants’ motions for summary
judgment are denied.
163 Dkt. 19, ¶ 3.
164 See Solak, 153 A.3d at 743 (rejecting similar argument based on savings clause because “the Fee-Shifting Bylaw is wholly invalid”).
165 Id.
NO. 18-972
In the Supreme Court of the United States
________________
MATHEW MARTOMA, Petitioner,
v. UNITED STATES OF AMERICA,
Respondent. ________________
On Petition for Writ of Certiorari to the United States Court of Appeals
for the Second Circuit ________________
REPLY BRIEF FOR PETITIONER ________________
ALEXANDRA A.E. SHAPIRO ERIC S. OLNEY SHAPIRO ARATO
BACH LLP 500 Fifth Avenue 40th Floor New York, NY 10110
PAUL D. CLEMENT Counsel of Record ERIN E. MURPHY C. HARKER RHODES IV KIRKLAND & ELLIS LLP 1301 Pennsylvania Ave., NW Washington, DC 20004 (202) 389-5000 [email protected]
Counsel for Petitioner
May 14, 2019
TABLE OF CONTENTS TABLE OF AUTHORITIES ....................................... ii REPLY BRIEF ............................................................ 1
I. The Decision Below Radically Departs From This Court’s Precedents And The Many Decisions Faithfully Following Them ................. 2
II. The Question Presented Is Exceptionally Important ............................................................. 6
III. This Case Is An Excellent Vehicle For Resolving The Critically Important Question Presented ............................................................. 7
CONCLUSION ......................................................... 13
ii
TABLE OF AUTHORITIES Cases
Dirks v. SEC, 463 U.S. 646 (1983) ........................................ passim
Salman v. United States, 137 S. Ct. 420 (2016) ........................................ 1, 3, 4
United States v. Bray, 853 F.3d 18 (1st Cir. 2017) ...................................... 5
United States v. Newman, 773 F.3d 438 (2d Cir. 2014) ............................. 11, 12
Other Authorities
Petition, United States v. Newman, No. 15-137 (filed July 30, 2015) .............................. 6
SEC Br., SEC v. Waldman, No. 17-cv-2088 (S.D.N.Y. filed Feb. 19, 2019) .................................. 8
Tr. of Oral Argument, Salman v. United States, No. 15-628 (U.S. argued Oct. 5, 2016) ....................................... 4
U.S. Mem., Marshall v. United States, No. 17-cv-2951 (S.D.N.Y. filed July 26, 2018) .................................. 8
REPLY BRIEF The government’s brief in opposition is
remarkable for what it does not say. The government does not even try to put forward any substantive defense of the Second Circuit’s paradoxical holding that an intention to give a benefit to the tippee somehow equates to the receipt of a personal benefit by the tipper. Nor does it try to explain how that holding could be reconciled with Dirks v. SEC, 463 U.S. 646 (1983), or with this Court’s decision not to adopt an equivalent test in Salman v. United States, 137 S. Ct. 420 (2016).
The government says equally little about the substantial importance of the question presented. It does not dispute that the decision below has the practical effect of revising federal insider-trading law nationwide, as every insider-trading prosecution can be (and now will be) brought in the Second Circuit. Nor does it address the significant threat—highlighted by amici—that the Second Circuit’s judicial expansion of the quasi-common-law crime of insider trading poses to the financial markets and to individual liberty.
Instead, the government proceeds as if the decision below were an unpublished opinion focused only on the sufficiency of the evidence of financial benefit to the tipper from consulting arrangements. But that is not the case the government argued or the opinion the Second Circuit wrote—and with good reason, as the tipper’s own testimony disclaimed that theory. The Second Circuit’s purported alternative holding cannot be reconciled with the government’s trial strategy or divorced from the court’s extreme
2
dilution of the personal benefit standard. And there is simply no denying that the Second Circuit consciously adopted a test for “personal benefit” to the tipper that requires nothing more than an intent to benefit someone else (i.e., the tippee). Indeed, the notion that this is just a run-of-the-mill quid pro quo case is belied by the months that the panel spent waiting for Salman, holding reargument after Salman, and then writing and revising its opinion to embrace a sweeping new personal benefit test. Nor is there any denying that the panel majority’s new test will now govern every prosecution in the Second Circuit, which is to say virtually every insider-trading case in the country.
The Second Circuit’s test not only is inconsistent with Dirks but is essentially no test at all, as it captures everything but inadvertent disclosures (and thus suggests that Dirks itself was wrongly decided). The government has been trying, heretofore unsuccessfully, to get such a non-test for decades. Now that it has gotten its wish, it should not be allowed to shirk the responsibility of defending that sweeping ruling, especially when the personal benefit test is all that stands between lawful activity that is essential to the proper functioning of the market and activity that the government deems felonious. The issues here are too important to accept the government’s effort to have its Dirks-defying standard and evade plenary review too. I. The Decision Below Radically Departs From
This Court’s Precedents And The Many Decisions Faithfully Following Them. The core holding of Dirks is straightforward: To
determine whether a tipper has disclosed information
3
in violation of a fiduciary duty, and thus whether trading on that information is criminal, “the test is whether the [tipper] personally will benefit, directly or indirectly, from his disclosure.” Dirks, 463 U.S. at 662; see Salman, 137 S. Ct. at 427 (reaffirming Dirks). The divided decision below turns that test on its head. Instead of asking whether the tipper will receive a benefit, it holds that the test is whether the tipper intended to confer one on the tippee. Pet.App.21. That radical holding is wrong three times over: It focuses on the wrong thing (intent to benefit another versus actual receipt of a personal benefit); divorces the federal crime of insider trading from its longstanding theoretical basis; and severs the already-tenuous connection between that quasi-common-law crime and the generic statute on which it purports to be based. See Pet.19-28; NACDL Br.2-3, 8-10.
Remarkably, the government makes no attempt to reconcile the Second Circuit’s novel intention-to-benefit standard with Dirks (which found the statute inapplicable to a tip intended to benefit the tippee)—or even to defend that standard on its merits. The government recognizes that the critical question under Dirks is whether the tipper “personally will benefit” from his disclosure, not whether he intends to confer a benefit on someone else. Opp.15 (quoting Dirks, 463 U.S. at 662). And it refrains from embracing the majority’s strained suggestion that when Dirks described the kind of “relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient,” 463 U.S. at 664, it meant to adopt the nonsensical proposition that an intent to confer a benefit on someone else constitutes a
4
“standalone personal benefit” to the tipper, Pet.App.16. See Pet.25-26; Professors Br.5-7. Faced with a misguided holding that all but eliminates the personal benefit requirement while making a hash out of Dirks, the government responds with deafening silence.
The government has equally little to say about the striking fact that the decision below adopts the same basic test the government urged on this Court unsuccessfully three years ago in Salman. See Pet.11-12, 23-25. There, the government argued criminal liability should attach “whenever the tipper discloses confidential trading information for a noncorporate purpose,” regardless of whether that purpose involved any benefit to the tipper. Salman, 137 S. Ct. at 426. Indeed, the government specifically asserted that it should be able to obtain a conviction by showing that the tipper was trying to obtain a benefit “either for himself or somebody else.” Tr. of Oral Argument 25, Salman, No. 15-628 (U.S. argued Oct. 5, 2016) (emphasis added). But as several members of this Court suggested at oral argument, that benefit-to-anyone approach cannot be reconciled with the line drawn in Dirks and consistently followed ever since. Id. at 28-29, 42, 46; see Pet.24. Unsurprisingly, this Court pointedly avoided espousing the government’s approach, choosing instead to “adhere to Dirks.” Salman, 137 S. Ct. at 427.
The decision below ignores that lesson. Instead of following Dirks, it judicially enlarges the crime of insider trading to cover any case in which the tipper intended to benefit a third party, which is at least as expansive as the no-legitimate-government-purpose
5
standard rejected in Salman. Pet.24-25; see Pet.App.27 (holding that jury “can often infer that a corporate insider receives a personal benefit” when he discloses inside information “without a corporate purpose”); Professors Br.7-8; NACDL Br.9-10. Indeed, the government does not dispute that if mere intent to benefit the tippee sufficed, then Dirks itself should have come out the other way. Pet.26-27. As Judge Pooler thus pointedly noted in dissent, the majority’s approach not only allows the government to “convict based on circular reasoning,” but “flirts with the possibility that the personal benefit test that goes back to Dirks may no longer be good law.” Pet.App.47. The majority’s approach also conflicts with numerous cases that have followed Dirks and refused to treat a disclosure intended to benefit the tippee as a personal benefit to the tipper unless the two were relatives or friends. See Pet.22; Professors Br.8-10.1 The Second Circuit’s stark departure from the settled jurisprudence of this Court and other circuits readily warrants review.
1 The government’s feeble attempts to distinguish these cases
fall flat. It especially misreads United States v. Bray, 853 F.3d 18 (1st Cir. 2017). Bray does not hold that a personal benefit to the tipper can be inferred from a mere “intention to benefit the [tippee].” Contra Opp.20. On the contrary, Bray follows Dirks, holding that a benefit to the tipper can be inferred when the “relationship between the tipper and the recipient” suffices to infer a benefit the tipper. 853 F.3d at 26 (emphasis added). That is why Bray specifically analyzed whether the tipper and tippee had a “close relationship.” Id. at 26-27.
6
II. The Question Presented Is Exceptionally Important. The government not only makes no attempt to
defend the core holding of the decision below, but also makes no attempt to deny the exceptional importance of the question presented. As the circuit that includes the nation’s financial capital (and the world’s largest securities market), the Second Circuit’s decisions govern all of the countless professional traders that work in New York and all of the countless trades that pass through the city every day, effectively “defin[ing] the scope of criminal liability for market participants nationwide.” NACDL Br.3; see Pet.28; Petition at 32-34, United States v. Newman, No. 15-137 (filed July 30, 2015). And because the decision below all but eliminates one of the key elements of the crime, the federal government will have every incentive to bring any insider-trading prosecution with an arguable nexus to New York (which is to say virtually all of them) in the Second Circuit. Pet.28-29; Professors Br.17. In short, it is no exaggeration to say that two judges on a divided panel have essentially rewritten the law of insider trading nationwide.
That radical revision will impose substantial costs on the nation’s financial markets and on individual liberty. Professional traders play a critical role in the securities markets by ferreting out and trading on information that is better than that reflected in prevailing market prices—a process that is “necessary to the preservation of a healthy market.” Dirks, 463 U.S. at 658. But under the decision below, anyone who trades on such information risks federal prison if the information is traced back to an insider who intended
7
to benefit some outsider. Pet.29-30; Professors Br.15-16.
The government offers no response or reassurance, presumably because some federal prosecutors have long sought a prohibition on trading while in possession of inside information. But Congress has never authorized that regime. Indeed, in reading the government’s brief it is easy to forget that this entire insider-trading edifice is built upon the generic prohibitions in §10(b) and Rule 10(b)(5). By eviscerating the personal benefit test, the decision below severs one of the few remaining links between the government’s insider-trading prosecutions and the statute that purports to justify them. Moreover, the Second Circuit’s ever-shifting personal benefit law raises serious due process and fair notice concerns, and provides a powerful reminder of why this Court abolished common-law crimes. Pet.30-31; Professors Br.11-15; NACDL Br.7-8. Those concerns—and the government’s marked silence in response to them—confirm the need for this Court’s intervention. III. This Case Is An Excellent Vehicle For
Resolving The Critically Important Question Presented. Unable to defend the decision below on the merits
or deny its importance, the government concentrates its efforts on obscuring the court’s holding and conjuring up illusory vehicle concerns. Those efforts are unavailing. The Second Circuit issued a sweeping precedential decision for a reason, and the government’s efforts to convert that ruling into a narrow case-specific ruling are not accurate. Nor have they stopped the government from invoking the ruling
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as a circuit precedent that eliminates the personal benefit test as a meaningful element of insider trading.2
1. The government attempts to portray the decision below as a routine application of plain-error principles. It claims there was no plain error here because the jury instructions were not obviously incorrect and a properly instructed jury would have convicted based on purportedly “compelling evidence of a quid pro quo relationship.” Opp.17. Neither contention withstands scrutiny.
As for the first, the government never explains exactly which aspects of the instructions it thinks were erroneous or correct, but rather suggests that they “closely tracked the language of Dirks.” Opp.15. In fact, they deviated from Dirks in two critical respects. Dirks allows an inference of personal benefit only when there is a “relationship between the [tipper] and the [tippee] that suggests … an intention to benefit the [tippee],” such as the tippee’s relationship with a “trading relative or friend.” 463 U.S. at 664 (emphasis added). The instructions here, by contrast, allowed the jury to convict by finding that Gilman shared inside information to “confer[] a benefit on Mr. Martoma,” or to give him “a gift with the goal of maintaining or developing a personal friendship or a useful networking contact.” Pet.App.8 (emphasis added).
2 See U.S. Mem.4, Marshall v. United States, No. 17-cv-2951
(S.D.N.Y. filed July 26, 2018), Dkt.39; SEC Br.27, SEC v. Waldman, No. 17-cv-2088 (S.D.N.Y. filed Feb. 19, 2019), Dkt.106.
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Those instructions are plainly incorrect under Dirks, which requires a genuine benefit to the tipper. Indeed, the majority deemed them (mostly) correct only because of its profoundly mistaken view that the “tipper personally benefits by giving inside information” to the tippee, Pet.App.78 (emphasis added)—a proposition that the government never advanced in any of its ever-shifting efforts to procure and then defend the conviction in this case.
As for its contention that any error was harmless, the government emphasizes the majority’s cavalier claim—sharply disputed by the dissent, see Pet.App.46—that the government produced such “compelling evidence” of a quid pro quo relationship between Gilman and Martoma that a properly instructed jury necessarily would have found that Gilman disclosed inside information in exchange for some actual or expected financial benefit. Pet.App.25-26; see Opp.16-17. But Gilman disclaimed that theory at trial, testifying that he neither wanted nor received any financial benefit for the inside information that drove the charged trades. Pet.9, 32; see Pet.App.46; C.A.App.179. To be sure, the government could have persisted in a financial benefit theory despite that testimony, but doing so would have come at the cost of directly undermining the credibility of its star witness. Understandably, the government instead shifted horses and emphasized its alternative “friendship” theory to the jury. See Pet.32; C.A.App.158. The government cannot be faulted for that tactical choice, which was permitted by pre-Newman circuit law, but neither can it avoid review of the decision below by reviving a theory it walked away
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from and could not have emphasized without undermining the credibility of its key witness.3
The government’s harmless error theory is further belied by the history of this case. If the evidence that Gilman received a financial benefit for disclosing the critical efficacy data—despite his contrary testimony—really was so compelling that no rational jury could reject it, then the decision below should have been a summary order affirming the conviction on that narrow ground, not a wide-ranging precedential opinion that redefines the crime of insider trading. There likewise would have been no need for the Second Circuit to wait several months for this Court to provide guidance on non-financial benefit cases in Salman, then hold reargument after Salman, and ultimately spend nine months revising the initial panel decision to alter its test for non-financial personal benefits. The claim that this was a straightforward case about a financial quid pro quo all along blinks reality.
Ultimately, moreover, the government’s harmless error argument boils down to the untenable proposition that no rational jury could decline to convict when “inside information is revealed within a paid consulting relationship.” Pet.App.46. Once again, the government provides no comfort that this is not the inevitable consequence of the decision below, or that the decision will not produce an enormous
3 The government’s references to Dr. Ross are a red herring. As the Second Circuit recognized, “it was Dr. Gilman, not Dr. Ross, who gave Martoma the final efficacy data” that was the purported basis of the charged trades, so any benefit to Dr. Ross is irrelevant. Pet.App.10 n.3.
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chilling effect on legitimate activity that is vital to the markets. In an area that demands bright-line rules promulgated by politically accountable actors, the regulated community is left with ambiguous judge-made rules that skew the playing field toward prosecutors and against values like fair notice.
2. Instead of confronting the question presented, the government argues that the petition is about something completely different: whether the decision below “adhered to the prior panel opinion in Newman.” Opp.18-19; see United States v. Newman, 773 F.3d 438 (2d Cir. 2014). That is both incorrect and disingenuous. As the petition makes clear from the outset and throughout, the question presented is whether the government “must demonstrate that the tipper received a personal benefit in exchange for providing insider information, as required by Dirks, or whether it suffices for the government to show that the tipper intended to confer a benefit on the tippee.” Pet.i. That is a question about whether the test that the Second Circuit adopted in this case is correct, not about whether the majority “adhered to the prior panel opinion in Newman.” Opp.19.
To be sure, the majority decidedly did not adhere to Newman and its “meaningfully close personal relationship” test. Pet.21-22. But that is relevant not to suggest that petitioner mistakenly filed his en banc papers in this Court, but because Newman, unlike the decision below, adopted a test consistent with Dirks. In other words, the distance between the decision below and Newman is important not for its own sake, but as a yardstick for the conflict between the decision below and Dirks (not to mention decisions from other
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courts adhering to Dirks). As Newman and those decisions correctly recognized, Dirks’ gift-giving analogy applies only when the tipper and tippee have the kind of “meaningfully close personal relationship,” Newman, 773 F.3d at 452, in which “[t]he tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.” Dirks, 463 U.S. at 664.
Here, the Second Circuit not only allowed the government to invoke a gift-giving theory without abiding by that limit, but concluded that an intent to “gift” inside information to anyone—even “a perfect stranger,” Pet.App.18—constitutes a “standalone personal benefit” to the tipper, Pet.App.16. In doing so, the majority expanded the federal crime of insider trading far beyond the bounds set by Dirks, with grave consequences for the financial markets and for individual liberty. This Court should not allow that profoundly misguided decision to become the de facto law of the land.
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CONCLUSION This Court should grant the petition.
Respectfully submitted,
ALEXANDRA A.E. SHAPIRO ERIC S. OLNEY SHAPIRO ARATO
BACH LLP 500 Fifth Avenue 40th Floor New York, NY 10110
PAUL D. CLEMENT Counsel of Record ERIN E. MURPHY C. HARKER RHODES IV KIRKLAND & ELLIS LLP 1301 Pennsylvania Ave., NW Washington, DC 20004 (202) 389-5000 [email protected]
Counsel for Petitioner May 14, 2019
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