The SEC’s Rule 14a-8, which gives shareholders the right to put proposals to a vote of other shareholders, was adopted to allow shareholders access to other shareholders and management, BlackRock Head of External Affairs Dalia Blass explained. But it came with some protections to prevent proposals that would be a waste of time, such as those that had little to do with the company’s business. Ahead of the 2022 proxy season, the SEC changed its approach, making it harder for companies to exclude shareholder proposals, even highly prescriptive or granular, micromanaging measures.

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💡 Featured Guests 💡

Dalia Blas - BlackRock

Marc Gerber - Skadden

Gabrielle Wolf - Innisfree M&A

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From Skadden, you're listening to the Informed Board, a podcast for directors facing the rapidly evolving challenges of a global market. A complement to our newsletter for directors, our aim with this podcast is to help flag potential problems that may not be fully appreciated, explain trends, share our observations, and give directors practical guidance without a lot of legal jargon. Join Skadden partners who draw on years of frontline experience inside boardrooms to explore the complex issues facing directors today.

Welcome to the Informed Board Skadden's podcast for directors. I'm your host, Ann Beth Stebbins, a partner in Skadden's M&A practice. On today's episode, we are joined by experts who will provide their insights on how ESG topics will feature in 2023 annual meetings. I'm joined today by Gabrielle Wolf, a director at Innisfree M&A, a leader in shareholder intelligence, Dalia Blass, the head of external affairs at BlackRock, and prior to BlackRock, Dalia was the director of the Division of Investment Management at the SEC, and finally, my partner, Marc Gerber, who focuses on corporate governance issues here at Skadden. Welcome to our experts and let's dive in.

I'd like to start our conversation today with stockholder proposals. Last year we saw a record number of stockholder proposals and many of these proposals related to ESG issues. Let's start with Dalia. Dalia, under SEC rules, and in particular rule 14a-8, stockholders have always had the ability to submit proposals to a company for inclusion in the company's proxy statement. Let's talk about how 14a-8 works in practice and how that's changed under the current SEC.

So as you know, 14a-8, it's a foundational rule and it was adopted to provide shareholders access to management and to fellow shareholders, but with important limits to prevent misuse or waste of resources. So essentially, companies have to include any shareholder proposal unless they can rely on an exception. Before the beginning of the 2022 season, the proxy season, the SEC rescinded prior guidance that had afforded companies leeway in excluding certain shareholder proposals under two key exclusions, the ordinary business and the economic relevance.

There are certain thresholds for how much you own and how long you have to hold before you can submit shareholder proposals, but they're not huge. They're not massive thresholds with the idea that you are supposed to democratize access of investors to the management and fellow shareholders. That's an important concept. But again, this is why 14a-8 has certain exclusions so that you narrow the pool to things that don't waste the time and resources of the company and they were liberalized recently by the commission before the '22 proxy season. In a way, that resulted in an influx of shareholder proposals last season that were very prescriptive and granular.

So let's look at the broader ones, so the significant social policy exception. Under the prior guidance a company could exclude, unless there was a company specific nexus to the significant social policy. It had to relate to its business, right? Under the new guidance, the staff said that you no longer focus on the nexus between the social policy and the specific company, and instead you have to focus on the significance of the social policy itself. What does that mean?

For anyone? For society, not just for the company?

Yeah, a human capital management with broader social societal impact, even if it's not significant into the company, shareholder proposal around that would have to be included, but there's no specific guidance, there is no metric on how the staff will determine whether it has a broad societal impact or not. So even if it doesn't have a company impact, how do you make that determination of that broad societal impact?

Another one was the micromanagement. If something was sought very intricate details about or imposed a very specific timeline on management, that was also something companies were able to exclude under prior guidance. The new guidance limited the scope of this definition of micromanagement. So you can have shareholder proposals that ask for very rigid timeframes, that ask for certain actions to be done or not done. So things that historically would've been excluded under micromanagement in 2022 made their way into the proxy season.

So Marc, what kind of proposals are we seeing in 2023?

The proposals fall into two camps. A lot of them are what I call tried and true. So they're proposals that got in maybe just last season or in prior seasons. So in the governance space, you still see a lot of independent share proposals, a lot of special meeting proposals.

That's the stuff that would've gotten in in the old days too.

That would've gotten in in the old days. On the S and the E, right? So still seeing a lot of environmental proposals. In '22, we saw a pretty wide variety. Some were very prescriptive and those proposals didn't do as well, shareholders like BlackRock and others didn't vote for those proposals. So proponents take that into consideration. We're seeing some that have a track record, some that got in last year and we're seeing those repeats. Then we still see some new ones, but maybe not as widely varied as last year. On the social side, we're still seeing a lot of racial equity proposals. Those did really well last year.

We continue to see a lot of workplace related social proposals. Dalia mentioned human capital and those can take different forms. They can be proposals about non-disclosure agreements, and there's a variety. You see some that get excluded, that get too detailed about training programs and things like that. We're also seeing a lot relating to executive compensation, which is not really in the S or the E, but falls depending on how you look at it, falls across a few things. On the S side, you're seeing things like gender pay audits is a gap in the median pay based on gender or based on racial diversity as well.

Gabby, anything new that you've seen either by way of subject matter or tactics that ESG proponents are utilizing?

There are some new subject matter topics. As Marc was saying, there's been a increasingly prescriptive and granular demands made in these shareholder proposals. It used to be that your asset retirement obligations might have been included in a description of a lot of other disclosures. Now, there's a shareholder proposal just about asset retirement obligations and how material they might be to the company, the company's bottom line.

The most proposals ever were submitted in 2022. As Dalia said, more went to a vote as a percentage than ever before. But actually average shareholder's port decreased for the first time since 2018. This is not only because, as Dalia said, a lot more proposals did not get no action relief, but also there were anti-ESG proposals that were submitted in record numbers and those have far less voting support, generally about 7 or 8% of votes cast, and those anti-ESG proposals are included in the average for ESG shareholder proposal support.

The increasingly prescriptive nature of proposals, as we talked about a little bit, and also the ideological nature of the proponents who are putting forth these proposals, they're less likely to negotiate and withdraw their proposals than before. So a lot more are going the distance and getting a little bit less support. That said, a bunch of institutional investors, including some of the big three index funds, pulled back from their support on ESG proposals because the proposals were getting unduly prescriptive and constraining on the decision making of the board.

These long-term institutional holders often view the board as in the best position to address matters and decide what's material to the company and decide how a company should deliver long-term value. A lot of the proposals we're getting a little bit too in the weeds for that. So I think that's the reason we've seen support go down and I'd expect it to be probably similar this year.

So that kind of goes back to Dalia's micromanagement point, that to the extent that shareholder proposals attempted to take away responsibilities of the board and management and ship those to shareholders, the SEC had previously permitted those types to be excluded. Is there a line, Dalia, some level of micromanagement that won't be tolerated? Or is it more in the hands of the investors? The SEC will let those types of proposals in and if the index funds think they're too prescriptive, then they vote against them.

You saw that in the '22 season, so much has gone through and they did not pass muster in terms of getting that the voting needed to actually be effectuated. So what you are seeing is a tremendous amount of time and resources spent on shareholder proposals that eventually are not successful. Noting something, asset managers at BlackRock, we did not change how we voted. We vote individually on the issue, on the shareholder proposal specific to the company. So what you saw was not a change in how we voted or less support for things that we think are drivers of long-term value.

What you saw was an influx of a change in the nature of shareholder proposals and in a manner that would make it really hard for an asset manager as a fiduciary looking for movements that would drive long-term value to support things that take away the management's ability to drive that value in a way that they think is best for the company. That's sort of the fundamental issue here when you have these proposals that are prescriptive, are granular, tell management what to do.

Who is best situated to drive that conversation? As Gabby said, it's really management and the board. We want disclosure. We want to understand what the issues are and what management is doing. It's not for us to tell management how to do their job. I mean, that's why they're there and that's why the board is there to oversee management doing its job.

To add to that, what I would say is there's still a test. There is still a bucket of things that could be in micromanagement, but that bucket is much smaller than it was a couple years ago. So yes, there were many years where you saw very few proposals be excluded as micromanagement, and that changed in the last few years prior to 2022. But then when the new guidance came out, the staff basically narrowed that bucket down again significantly. So it's always an argument that we think about when we look at proposals, but it's a staff that's much less willing to entertain that argument than the staff used to be.

In one more point, I wonder if also part of the reduction in support that we've been seeing, especially in environmental proposals, was as a result of the global energy shortage and the war in Ukraine. It's a little bit harder to push oil and gas companies to strengthen their climate commitments in light of the environment that we're in right now. So I suspect we see this a little bit more of the same this coming season.

With the lack of support for these more prescriptive proposals, is there any effect on the proponents? Are proponents less likely to put in proposals that have a lower likelihood of success or it's more this ideological platform and it's an avenue for them to express their views on certain topics regardless of what the success rate is at a meeting?

I think there are different camps of proponents. There are some proponents who really do want to see proposals pass and are strategic in their thinking. If they see certain types of proposals or the way a proposal is worded be more successful rather than less successful, they will gravitate in that direction because they ultimately want to be successful. Some of those same proponents might see a proposal that in year one didn't get as much support, but they'll go back at it, and in year two it'll increase, in year three it'll increase, as they build support for the concept or the risk or the issue that they're concerned about.

There's another group of proponents that really just want the platform and they're happy for the proposal to get single digit or low double digit just enough to be able to resubmit it again the following year. If they can't submit that one, they'll submit something else, but they're looking for a platform to espouse their viewpoint.

One thing that we talked about when we were prepping for this session were proposals that seem to address the same topic, but from opposite sides of the spectrum. So Gabby, you had mentioned anti-ESG, anti-ESG backlash. How do you see that manifesting itself in shareholder proposals?

There were actually I think 54 of these proposals in 2022, which was double the number in 2021. They're basically proposals that address ESG topics and they request that companies assess the costs and benefits of these activities including climate related activities, civil rights, racial equity audits. For example, the National Center for Public Policy Research asked issuers to abandon the use of ESG policies relating to the appointment of diverse employees. Some anti-ESG entities indicated they'll submit proposals on the topic of reproductive rights following the Dobbs decision. So that's the kind of thing that we're talking about.

Often, as you were saying, Ann Beth, those proposals are worded in such a way that if you only read the resolved provision, you might not know the supporting statement contains a lot of anti-ESG messaging. So it's really important to first of all, read carefully, but I also tell my clients to include the proponent's name who's submitting the proposal in your proxy statement because that really is a clear indicator for people who are reading it on which side of the aisle we're coming from on these ESG matters.

Which brings me to my next question for Dalia, why is ESG so polarizing? Why can't investors and companies get behind certain categories of social good and why has it become this blue-red phenomenon?

Four things. First, we're having a conversation without using the same language. There is a very material and fundamental misunderstanding about what sustainable investing is. Stakeholders read very different things when you use the term ESG. It's important for us to step back and explain what it is for the capital markets because we are not going to have a conversation until we have that piece. The SEC proposals in this space to some degree actually do create more issues for this rather than help. By way of one example, they had ESG integration as a fund category when ESG integration is an investment process.

The second point is how sustainability is integrated into the investment process is not understood. There is a difference between an impact fund or a fund that has a sustainability objective versus a fund that screens certain investments versus fund managers that look at ESG risks and integrate them to produce the best risk adjusted returns. There are fundamental differences. It's a complicated arena, and yet we just use the term ESG and people read into it whatever they want to read into it.

The third point there is a fundamental lack of understanding of asset management. It's other people's money. Clients have a choice in where to put this money. They give you mandates for how to manage that money. One mandate could be sustainability, another mandate may not want you to consider climate risks or opportunities in that.

But that's their choice. That's their choice when they're making their asset allocation.

Absolutely. As a fiduciary asset manager, it's fundamental. You have to abide by the client's mandate and you have to as a fiduciary act in their best interest to provide them those best risk adjusted returns. That is your role. Then the fourth point is voting. That was a hot topic of conversation during my hearing down in Marshall, Texas. Asset managers by law are required to be very transparent in how they vote. So it's out there, you can look at it, you can scrub all the data and look at how BlackRock votes versus Vanguard versus State Street versus Fidelity. You name it, it's out there. It's required. It's filed with the SEC.

So when you parse through it, we have a lot of people who say we don't like how we vote in one direction or don't like how we vote in the other direction. But this is why a very important piece to this debate that we're talking about is how we can democratize voting so more voices are being brought to the table. It's those four things that are creating a lot of the noise you're hearing in the ecosystem.

So let's talk about democratizing voting. ISS, Glass Lewis have a lot of influence over the way that shares are voted? How do ISS and Glass Lewis view ESG topics? Marc, what have you seen on that front?

ISS and ESG will make recommendations on whatever's on the ballot, whether it's ESG, not ESG, it doesn't matter. If something's being voted on by shareholders, by their subscribers, their clients, they will issue a voting recommendation. They, I would say, are partial to many ESG topics, but they do have policies. They do analyze these proposals. Oftentimes their policy will say, "We look at this on a case by case basis and we take into consideration that 10 different things listed plus maybe company performance plus company governance, plus anything else that kind of tickles their fancy at the moment." So-

But Marc, are they looking at the effect on the company and the company's returns, or are they taking a broader view like the SEC and thinking about the societal benefit of proposals?

So their policies would say they look at this company by company, or in some cases they may have a default of generally recommending in favor of certain kinds of proposals to call for greater disclosure, right? So they're not getting into the granularity of what's the impact on this company's balance sheet or earning statement. They're not doing that. But in fairness, notwithstanding the fact that they support many ESG proposals, there are proposals that they don't support, not necessarily by category, but again, they will sometimes find proposals to be too prescriptive or too granular and view them and recommend against them.

Or in some cases decide that the company's existing disclosures are satisfactory, meet investor needs, and therefore the proposal under consideration wouldn't add anything. So no question. They are, well, I'll say pro-ESG as opposed to anti-ESG, we were talking about earlier. They do engage in some analysis. Many clients might disagree with ISS or Glass Lewis' conclusions, but they do engage in some analysis and they have a tendency to support ESG proposals, but not all of them.

Are there any other factors that boards should be aware of that could influence voting on ESG proposals or voting patterns, generally?

I think boards, anytime they get a shareholder proposal, have to analyze does it make sense for the company, how does it fit, is it value enhancing or not, is it something that shareholders feel strongly about or not, or other stakeholders for that matter, like employees or customers, and ultimately have to figure out how does this topic ultimately tie to shareholder value or, related to that, minimizing risk. If it does, there may be a way to implement it, and if it does, it may get a lot of support even if you don't implement it.

Obviously the more support it gets, the more you may the following year end up wanting to implement the proposal or at least something close or some portion of the proposal. At the end of the day, I think if you're a board, while you get the voting analysis, you get the projection, you ultimately have to do the work to say, "Does this make sense for us? If it does, maybe we'll negotiate with the proponent and see if we can get it withdrawn." Sometimes you see companies even recommend in the proxy the shareholders vote for a proposal.

Alternatively, if the proposal really doesn't make sense for the company, make your best argument in the proxy and in your engagement efforts and hope that you are convincing and that people ultimately, that shareholders and voters, ultimately agree with your analysis that the proposal doesn't make sense for your company, whether it's too prescriptive, not value enhancing, et cetera.

So last topic. As more investment dollars flow into ESG funds or funds that purport to have ESG objectives, it may be harder for those funds to achieve returns that are at the same level of funds that are more focused on traditional metrics. Do you see the pendulum swinging back as investors see returns that are inferior to what they could achieve in funds that don't have a stated ESG objective?

With changes in government policies, technological advances and changing consumer preferences around climate risks and the transition to a low carbon economy, sustainable funds are likely to continue to attract assets and grow. Your point about performance, as with any investment strategy, you will have periods of underperformance, but periodic under or over performance is not what drives whether the strategy is appropriate or not, the driver is client choice, the client mandate and how the clients want their money invested.

But to get to this particular point when you're talking about sustainable strategies of underperformance or overperformance, or too expensive or whatnot, and you've seen this, our research indicates that actually ESG funds have outperformed their non-ESG counterparts, if you're looking at the correct counterparts for about three and a half year period from 2019 through the 3Q 2022. There, we compared 49 sustainable indices against their non-sustainable counterparts and 76% of them outperformed.

So if you're looking to evaluate sustainable strategies, you do have to look apples to apples as opposed to sustainable funds or strategies against broad market indices because that will not be the right comparison. So depending on the time horizon, depending on what you're comparing it to, our research shows that over the long term, sustainable strategies are what is producing the best risk adjusted returns for our clients.

Gabby, what do you see as the future of ESG as an investment priority?

Look, I think millennials and younger generation see ESG as really important and meaningful to them, though I do think that people will keep investing in ESG funds, even if there are blips in the market, that mean that they don't necessarily outperform the S&P 500 or Russell 3000 or whatever it is. But those people who are investing in companies, they still don't vote. The data's out there is a little messy, but I think generally retail holders, the retail holders who actually bother to vote are the older retail holders and not the millennials, not the ones who are a little more predisposed to ESG friendly causes.

We haven't seen less flows into ESG funds. That has continued to grow, but we have seen already some backlash against some ESG focused companies. So we're definitely seeing both sides. I think this goes to what Dalia said before, which was it's just really polarized out there. People feel strongly on both sides, and yet these people who feel so strongly still don't vote. So this is your friendly proxy solicitor reminding you to vote.

Marc, any closing comments from you on what we can expect this annual meeting season?

Well, I think the issues that we've been talking about that fall within ESG, those issues are not going away. So whether it's climate change, whether it's diversity, equity and inclusion, Gabby mentioned the Dobbs decision earlier, these issues are out there front and center. Some may impact shareholder values, some may not, but the issues aren't going away, so the shareholder proposals are not going to go away.

I'd like to thank Dalia, Marc, and Gabby for joining this discussion, and I hope you found it informative. If you haven't listened to our episode with these same experts discussing shareholder democratization and the unintended consequences, I would encourage you to do so.

Thank you for joining us for today's episode of the Informed Board. If you like what you're hearing, be sure to subscribe in your favorite podcast app so you don't miss any future conversations. Additional information about Skadden can be found at skadden.com. The Informed Board is a podcast by Skadden, Arps, Slate, Meagher & Flom and Affiliates. This podcast is provided for educational and informational purposes only and is not intended and should not be construed as legal advice. This podcast is considered advertising under applicable state laws.