In preparation for the 2023 proxy season, proxy advisory firms Glass Lewis and Institutional Shareholder Services (ISS) announced updates to their voting guidelines for investors, effective on January 1, 2023, and February 1, 2023, respectively. Several updates to these guidelines relate to environmental, social, and governance (ESG) topics, including—as discussed below—updates related to climate-related accountability and climate disclosures as well as racial equity audits. The firms’ approaches to ESG, including their guidelines, recently drew criticism as 21 state attorneys general sent a letter to Glass Lewis and ISS accusing the firms of violating their fiduciary duty by prioritizing social goals over the financial interests of their clients.
Linking Executive Compensation to Sustainability (Environmental and Social) Criteria
Previously, ISS’s policy regarding shareholder proposals that linked executive compensation to sustainability criteria was based in part on the degree to which industry peers incorporated similar criteria in their executive compensation practices and whether the company has management systems and oversight mechanisms in place regarding its social and environmental performance. Under its 2023 guidelines, when determining whether to support a shareholder proposal, ISS will now take into consideration the degree to which a company’s board or compensation committee already discloses information on whether the company considers environmental and sustainability-related criteria—for example, through environmental impact reports or environmental justice audits. The new guidelines emphasize that the company’s board or compensation committee is generally in the best position to determine these performance metrics. This policy change incentivizes company boards to disclose preemptively, rather than in response to potentially prescriptive shareholder proposals. The guidelines explain that improved disclosures, including the rationale for determining performance and pay metrics, increase transparency with respect to how a company links executive compensation and sustainability, and benefit shareholders.
In its previous guidelines, Glass Lewis deferred to an individual company’s unique circumstances––such as industry, size, risk profile, and performance—when reviewing proposals seeking to tie executive compensation to sustainability criteria. Under its 2023 guidelines, Glass Lewis will review a company’s compliance with applicable laws and regulations and examine any history of environmentally and socially related concerns, including those resulting in material investigations, lawsuits, fines, or settlements. Glass Lewis will also review the company’s current compensation policies and practices but will leave the selection of performance metrics for executive compensation to the company’s compensation committee.
In 2022, ISS implemented guidelines applicable to “high emitting” companies on the Climate Action 100 Focus List. Under this set of guidelines, ISS recommended voting against responsible committee chairs if it determined that the company was not taking “minimum steps” to understand, assess, and mitigate climate risks to the company and to the larger economy. Previously, minimum steps required a detailed disclosure of climate-related risks and “appropriate greenhouse gas (GHG) emissions reductions targets.” In its 2023 guidelines, ISS defines “appropriate GHG emissions reductions targets” to mean “medium-term GHG reduction targets” or “net-zero-by-2050” GHG reduction targets for a company’s operations (Scope 1) and electricity use (Scope 2). Further, these targets must cover 95% of the company’s direct emissions.
Glass Lewis also updated its guidelines concerning board accountability for environmental and social performance and climate-related issues. The new guidelines indicate that in situations where a company has not properly managed or mitigated material environmental or social risks, Glass Lewis may recommend that shareholders vote against members of the company’s board who are responsible for oversight of these risks. Additionally, in situations where Glass Lewis finds a company’s climate-related disclosures to be insufficient, it may recommend against directors responsible for oversight of climate-related issues.
These guideline updates come after the Securities and Exchange Commission (SEC) proposed a rule in March 2022 that would require registrants to include certain climate-related disclosures in their registration statements and periodic reports. The ISS recommendations are less extensive than the anticipated SEC climate-disclosure rules but reflect a growing demand for GHG emissions data. Indeed, preliminary reporting from the 2023 proxy season shows an increase in proposals seeking expanded reporting on GHG emissions across the “full value chain,” which generally includes Scope 3 emissions.
Racial Equity Audits
The 2022 proxy season saw a dramatic increase in the number of filed shareholder proposals calling on companies to conduct “civil rights” or “racial equity” audits, with several of these proposals garnering majority shareholder support. Heading into the 2023 proxy season, Glass Lewis and ISS have issued updated voting guidelines that anticipate continued momentum for such proposals.
While Glass Lewis has previously supported proposals for racial equity audits, its previous proxy guidelines did not include a specific policy on racial equity or civil rights audits. Its 2023 proxy guidelines “codified [its] approach” with respect to proposals requesting such audits: When analyzing these proposals, Glass Lewis will assess company-specific factors—(i) the nature of the company’s operations; (ii) the company and its peers’ level of disclosure on its stakeholder impacts and the steps it is taking to mitigate any attendant risks; and (iii) any relevant controversies, fines, or lawsuits—and will generally recommend voting in favor of such proposals when doing so could help the target company identify and mitigate potentially significant risks. The updated guidelines explain that Glass Lewis “believe[s] that companies should be taking steps to mitigate any potential adverse impacts both internally and externally” and that “in many cases,” undertaking an audit could be beneficial.
ISS’s 2023 guidelines update its criteria for case-by-case analysis of racial equity and/or civil rights audit proposals to include consideration of whether a company adequately discloses workforce diversity and inclusion metrics and goals and to remove from consideration alignment with market norms on civil rights and racial or ethnic diversity. The updated guidelines explain that a focus on a company’s disclosure of workforce diversity and inclusion metrics and goals allows for quantitative assessments of progress.
Given the likelihood of continued proposals for equity audits, these updated voting guidelines are instructive—both as companies internally assess their ongoing DEI efforts and disclosure practices and as they consider how to engage with investors focused on these issues.
As noted, the ISS and Glass Lewis guidelines have been met with some criticism. On January 17, 2023, a coalition of state attorneys general wrote a letter to Glass Lewis and ISS asking the firms to defend their rationales for urging companies to adopt policies in line with ESG goals and requesting a response to a series of questions. The letter criticizes the firms for potentially violating their legal and contractual duties as proxy advisors by promoting guidelines—including climate-related guidelines regarding the implementation of “net zero emissions” goals and guidelines on board diversity and racial equity audits—that may “elevat[e] non-financial considerations over financial ones”; promote “a conflict of interest between [the firms’] interests and some of [their] clients’ interests”; and “expose both States and companies to significant legal liability for discriminating on prohibited bases.” ISS and Glass Lewis each responded to the state attorneys general on January 31, 2023, defending their 2023 guidelines and approaches to ESG proposals as consistent with promoting long-term shareholder value. Glass Lewis asserts in its letter that its approach is consistent with “mitigating risk and promoting the long-term economic interest of shareholders,” while ISS states that considering material ESG factors is consistent with its “duty to manage the long-term financial prospects of its investment portfolios.”
Given the likelihood of continued pressure from investors and other stakeholders on ESG-related proposals, companies should closely track developments in this area and should ready themselves for possible external engagement on ESG issues.
WilmerHale monitors trends in this area and regularly advises companies on navigating developments. Please contact the WilmerHale ESG team to learn more.