- I am Pamela Harper, a member of Griesing Law and welcome you to today's course "ESG, Why It Matters?" Last year, ESG accounted for $35 trillion in global assets under management. And data suggests that this growth is slated to continue. Shareholders are now demanding more than a financial return. And they're analyzing the extent to which ESG factors are integrated in business strategy, as well as operations. In today's session, we'll discuss ESG. What it really means, the driving forces, the issues gaining momentum, and the extent to which ESG is shaping corporate accountability. In terms of today's agenda, we'll address the following topics. Beginning with an overview of the ESG framework, followed by the key players driving the ESG dialogue. We'll then move on to take a look at the role of shareholder advocacy and activism followed by a look at ESG's impact in the boardroom and on corporate governance. Then we'll discuss the role of legislation and conclude with a look at the regulatory landscape, specifically focusing on the SEC's proposed role for climate disclosures. So the fundamentals. Over the last few years, ESG has emerged as a topic of major discussion. It's been touted by some as a tool for transformation and by others as a framework for accountability. I am less convinced that it's a tool for systemic corporate transformation, but I do agree that it indisputably creates a framework for accountability. And it is within that context that we'll discuss ESG today. Shareholders, institutional, as well as retail, are examining how companies are integrating ESG factors in their business strategy, and the answers are driving, in some instances, their investment decisions. So let's begin with the fundamentals. What does it mean E, environmental, S, social, G, governance. Environmental. Relative to the other two factors in the framework, the environmental prong in large part driven by climate change has precipitated the greatest degree of discussion. But the factor is far broader and goes beyond climate change and greenhouse gas emissions. It includes issues surrounding renewable energy sources, such as solar, energy efficiency, air, water, and waste management and biodiversity. Moving on the S. The social factor, I segment into three primary buckets. First workplace issues, such as sexual harassment, sexual misconduct, toxic work environments, and discrimination among others. The second bucket relates to social and human justice issues. And finally, the last bucket addresses issues related to diversity, equity and inclusion. And for the sake of clarity, I'm going to define these terms because diversity, equity and inclusion, the terms are often co-mingled. So diversity refers to the fact that every individual is unique. It recognizes individual differences, and those differences can be related to gender, ethnicity, and/or sexual orientation. This is their traditional lens through which diversity is viewed, but I'm also seeing increasing commentary regarding neurodiversity, as well as generational diversity. Equity is a reference to equal access and opportunity. It's a recognition that not everyone starts from the same place. If I start at third base, but my colleague, Joe, starts at first base, it doesn't mean that he won't make a home run, but I will clearly have a head start on him which is going to give me an advantage. And finally inclusion, which refers to the extent to which an individual feels a sense of belonging, that they are included rather than excluded from the group. It means that a chair is already at the table for them, so that they don't have to bring their own and sit on the sidelines. So diversity, uniqueness, equity, access, inclusion, belonging. So diversity, equity, and inclusion defined. So that there isn't any ambiguity with respect to the terminology. And moving on to the G, governance. And governance within the ESG context looks at executive and board-level governance surrounding issues, such as corporate ethics, risk oversight, board refreshment, which we will discuss in depth, executive compensation and corporate conflicts. We're going to dive into each factor, but regardless of the factor, there are a group of key drivers that are shaping the dialogue and they include large asset managers, like BlackRock and State Street among others. Institutional investors, such as pension funds, legislation, employees, and finally regulation. These are the key drivers of the dialogue. So let's start with the environmental factor. Investor advocacy has been particularly robust. One of the groups that I want to highlight within the context of the environmental factor is Climate Action 100+ which is an investor-led initiative focused on reducing exposure to climate risk. The group consists of over 600 investors, including universities, pension funds, and foundations managing about $65 trillion in assets. The advocacy group, Climate Action 100+, has identified 166 companies for engagement. And combined, those companies actually account for up to 80% of corporate, industrial greenhouse gas emissions. And basically there are three engagement issues. First, not surprisingly, is they want for companies to reduce their greenhouse gas emissions and achieve net zero by 2050. The second issue is for companies to provide enhanced corporate disclosures. And finally, they're looking for those companies to implement a strong governance framework on climate change. Independent of broad coalitions, such as Climate 100+, we're also seeing investor activism take more innovative approaches. One of the most talked about shareholder actions involved the relatively recent proxy battle surrounding ExxonMobil. Engine No. 1 is an impact investment firm that owned less than 1% of Exxon's shares. And its proxy strategy was based on forming a collaborative alliance with larger institutional investors, such as the California State Teachers' Retirement System, otherwise referred to as CalSTRS which also happens to be the second largest pension fund in the United States. Other large investors that were part of the coalition included the California Public Employees' Retirement System, known as CalPERS, and the New York Retirement Fund. By way of background, the campaign Reenergize Exxon was a response to what Engine No. 1 deemed as its underperformance as a result of continuing to focus on the demand for fossil fuels, which Engine No. 1 argued eroded shareholder value. The campaign consisted of four components. The first of which was to nominate four new independent directors to the board with, and this is the key point, expertise in the energy sector. They were actually successful during the proxy campaign in gaining three seats on the board. So pretty impressive. The second component of the campaign was to get Exxon to develop a more disciplined approach to long term capital allocation. The third was for the company to implement a strategic plan for investing in clean energy. And finally to align performance goals with shareholder values. So for example, aligning compensation with achieving more rigorous emission targets. This particular proxy campaign is actually now a case study at NYU Stern School of Businesss. So it was a very innovative approach within the ESG context. As another example, and similar in some respects, we have Carl Icahn's battle against McDonald's regarding animal welfare. And during the last proxy season, he sought two seats on the board. Like Engine No. 1, he was a relatively small shareholder. In this case according to published reports he owned about 200 shares. And at issue, was the use by suppliers of gestation crates, which are small crates that constrained pregnant pigs. It was his understanding that McDonald's pledged to stop buying pork by 2022 from producers who use gestation crates. And it was his expectation that the crates would be banned altogether by 2022. They were not. And hence they need to seek two additional seats on the board. That's why he sought two additional seats. He was actually, McDonald's actually prevailed in this particular proxy issue. And the proposal was not in this case successful. So those two seats were not gained, but again, relatively small investor. Not to be overlooked, our large institutional asset managers and they actually play an outsized role in terms of their impact. BlackRock's annual letter to CEOs is legendary. And the letter is actually publicly available and can be found on BlackRock's website under investor relations. This year's letter left absolutely no ambiguity with respect to BlackRock's priorities. asking company's CEOs, quote, "How are you preparing for and participating in the net zero transition as your industry gets transformed by the energy transition, will you go the way of the dodo or will you be a phoenix?" That goes on to ask "We are asking companies to set short, medium and long term targets for greenhouse gas emissions. These targets are critical to the long-term economic interests of your shareholders." Now, while BlackRock is renowned for its annual letter to CEOs, State Street, another large asset manager took an innovative approach by developing a scoring tool. And that scoring tool is the responsibility factor, otherwise referred to as the R factor. Launched in 2019, the tool measures the company's performance with respect to financially material ESG issues that face the company's industry. In its 2022 proxy voting and engagement guidelines, State Street noted that it would consider taking voting action against board leaders of companies that were our factor laggers. So what are laggers? Laggers are companies in the bottom 10% of scores relative to their peers. In addition, it noted that it would also take action against the board leaders of companies that were our factor momentum under performers. Momentum under performers are those that have consistently underperformed their peers for the last two years and are at the bottom 30% of scores relative to their industry peers. In addition, within the context of the, again, environmental factor, independent of investors, we are seeing a general heightened awareness, particularly with respect to climate change. For example, the Climate Pledge a commitment to reach net zero emissions by 2040 and note, the year is 2040 rather than 2050. So that's 10 years before the Paris Agreement timeline. The Climate Pledge now has 322 signatories across a broad range of industries. And one of the signatories notes on the website, Climate Pledge that quote the goals are not there to scare us but to challenge us. The goals are not there to scare us, but to challenge us. Moving on the role of legislation, particularly at the state level. As an example, in May of this year, the California Senate passed Senate Bill 1173, which addresses fossil fuel divestment. Under the bill, the California State Teachers' Retirement System, which we discussed earlier and the California Public Employees' Retirement System, also a part of Engine No. 1 coalition, would be prohibited from making new investments or renewing existing investments in the top 200 fossil fuel companies. In addition, they would be required to divest from their current investments by 2030, and that is actually a change. Because initially when the bill was crafted, it was 2027, so now they have until 2030 to divest from their current investments. In addition, beginning in 2024, they will need to disclose and to disclose investments that have been liquidated. So again, a common thread, whether through industry coalitions, institutional investors, large asset managers, or legislation, ESG is a mechanism for accountability. Next the S and G in ESG. And the social factor has proven to be a source of discomfort. Particularly as CEOs are increasingly expected to take public positions on social issues. And for the most part, they're not comfortable opining on social issues, not what they signed up for. And as the discussions surrounding Disney's response to LGBTQ legislation in Florida demonstrated, silence is not always an option just to quickly review. At issue was the parental rights in education bill otherwise referred to throughout the media as Don't Say Gay bill, that prohibited classroom instruction on sexual orientation or gender identity in kindergarten through third grade. Initially Disney's CEO was silent on the matter which precipitated employee protests. Eventually, he spoke out in opposition to the bill, but the Disney matter is an illustration of how the S in ESG is impacting CEO behavior. It can be a very delicate dance and requires a certain amount of nimbleness, speaking up and speaking out is not without reputational risk, but employees certainly expect their CEOs to be proactive and shareholders assess it. The S is also impacting how companies position their products. And it has prompted some companies to innovate and think creatively. So for example, a company that sells trading software developed an app that allows users to filter investments based on certain ESG criteria, such as fair labor, racial equality, and sustainability factors, among others. We're also seeing within the context of the S factor, culture as a construct. In the boardroom though still in the embryonic stage, in addition to the standard committees, which are nomination, audit, and compensation, some companies are establishing separate standing committees that address culture and ESG. Last year, for example, Coca-Cola established the ESG and public policy committee as a standing board committee. And according to its charter, which can be found on Coca-Cola's website, under governance, the committee was established to assist the board in overseeing the company's policies and programs related to risks to the company that concern environmental, social, legislative, regulatory, and public policy matters. I consider that an extremely broad portfolio. And though the committee, as you can well imagine, has a number of responsibilities, several stood out to me. And the ones that stood out to me were the following. First, that the committee will review environmental, social, legislative, and public policy trends that could impact the company's business operations, performance, and this is what really got my attention, reputation. Too many companies ignore potential reputational risk, which is why we continue to be bombarded by coverage of misconduct. Second responsibility that stood out for me was to review the company's sustainability program and goals, and more importantly, equally importantly, to monitor progress on those goals. The next responsibility was reviewing the workplace and human right practices of the company including within its supply chain, and finally reviewing investor sentiment related to the company's environmental and social footprint. And again, as I indicated, there are a number of responsibilities for the committee, but those in particular stood out. On the management side, we are seeing companies being very clear or some companies at least, being very clear about their cultural values and reflecting that in their organizational structure. So Salesforce, for example, hired a chief ethical and humane use officer to develop a framework for the company's use of technology. We are even seeing an impact in terms of transactions, particularly with respect to mergers and acquisitions. Due diligence is no longer confined to the financial and operational. Social due diligence has now emerged as its own discipline. And it expands the lens to look at patterns of misconduct, settlement agreements, and the results of internal investigations. It is social due diligence and #MeToo that beget the Weinstein clause in which the acquired firm makes certain warranties and reps with respect to allegations of sexual misconduct by senior executives and discloses any applicable settlement agreements, which in an ideal world, there would be none though, we know regrettably that not to be the case. And issues surrounding the workplace are actually one of the key catalysts for employee activism. Employees like shareholders are driving the ESG dialogue, though in a different way. We already referenced the case of Disney and employees' response to its initial neutrality on Florida's Don't Say Gay bill. But we see that employee activism is particularly prevalent in the technology industry. One of the most prominent examples being the worldwide walkout of 20,000 Google employees in response to a $90 million payout to a former senior executive, not withstanding allegations of sexual misconduct. For employees, there's usually a triggering event in the case of an online furniture retailer, for example, it was the sale of furniture to immigrant detention facilities along the border in Texas. Some companies handle social issues better than others. And there are steps that can be taken to gain greater intellectual bandwidth around these types of issues. And I recommend several, including the first step is for companies to simply pay attention to culture and take the internal pulse of the organization by, for example, conducting an annual cultural audit. Culture is an area that tends to get short shrift. As a general rule, it's not a particularly prominent board agenda item, if at all, which is a tactical error, 'cause you can't address a problem if you don't know you have a problem. And why do I mention this? Because tone at the top, and the top is the board, tone at the top really does matter, tone at the top, mood in the middle, buzz at the bottom. This, of course, is distinct from willfully ignoring a known problem in the misguided hope that it either disappear into the ether or simply not resonate with employees. The second step companies can take is to recognize the importance of middle management and nurture it. Middle management is grossly, grossly underrated. It is preferable for a concerned employee to discuss their issues with an empowered midlevel manager who can escalate the matter accordingly if necessary. This is sometimes a far more palatable option for employees than consulting human resources, which unfortunately in some instances has gained the reputation of being part of a problem rather than the solution. I have been told more than once by HR industry colleagues that HR represents the company not employees. The third suggestion is for board directors to really probe on these issues and ask the uncomfortable questions. And it's not that they don't ask questions. It's just not usually related to culture. The role of the board of directors as fiduciary is oversight. For a variety of reasons, however, boards really struggle with dissent. And board members often have an aversion to expressing a contrarian point of view or asking the difficult questions, particularly with respect to sensitive issues related to culture. At the opposite end of the spectrum, and arguably worse, is when a board chooses to actively ignore misconduct as was the case in connection with the payment of a fairly large settlement in excess of $7 million to a former employee by a CEO. Shareholders filed an action against the board alleging breach of its fiduciary duty. Why? They argued that it intentionally disregarded decades, not years, decades of known misconduct by the CEO while assuring shareholders that the company's risk compliance and governance controls were effective to prevent and protect misconduct. And the failure to prevent and detect misconduct, those against the very grain of corporate compliance. Under US Sentencing Guidelines, quote, to have an effective corporate and compliance and ethics program and organization shall first, exercise due diligence to prevent and detect operative words, criminal conduct. And two, promote an organizational culture, underscore the word culture there, that encourages ethical conduct and a commitment to compliance with a law. Following the filing, the company shares fell over 19% and S&P downgraded its outlook. This is but one of many examples of how boards are being held accountable for the S in ESG. More shareholder derivative actions alleging breach of fiduciary duty. So again, pay attention to culture, take the pulse of the organization, appreciate middle management and board needs to ask uncomfortable questions. Culture as a construct. Bottom line workplace-related issues under the ESG framework cannot be dismissed or selectively ignored because employees will speak up, walk out and be heard. Finally, the S factor has even entered the realm of geopolitics with over 1,000 companies suspending or in some cases completely terminating operations in Russia since the invasion of Ukraine. And this is an industry agnostic group ranging from financial service companies to food and beverage companies like McDonald's, which actually sold its operations and oil and gas companies. So the S has a broad impact. Leaving on to the G in ESG. We're going to discuss governance within the context of two areas, board composition, and aligning ESG metrics with executive compensation. Over the last few years, there have been a number of initiatives to address board diversity. And again, California was in the vanguard with Senate bill 826 in 2018. By way of background. The impetus for the bill was the board composition, rather of companies in California. At the time among 446 publicly traded companies in the Russell 3000 Index that were headquartered in California, women only held 15.5% of the board seats. The bill established a tiered based in approach. By 2019 companies were expected to have at least one woman on the board. By 2021 if the board had four members or less, then a minimum of one, operative word minimum. If a total of five board members, then a minimum of two. And if six or more board members then a minimum of three. Penalties were imposed for failing to comply. $100,000 for the first violation and $300,000 for the second violation. And just so we're clear, a violation was defined as each director's seat required to be held which was not held by a woman. The upshot? Women now hold 31% of board seats in California of companies in the Russell 3000 Index. So that's a 100% increase. The bill clearly had an impact, before it was found unconstitutional in May. So just a few months ago by the LA County Superior Court, because it quote, "failed to identify a specific, purposeful, intentional, and unlawful instance of discrimination to be remedied." California has appealed. We cannot discuss board composition without addressing the NASDAQ role. Approved by the SEC last August, publicly traded companies on NASDAQ Exchange are required to publicly disclose its annual proxy statement, board level diversity statistics, and to provide an explanation in the absence of having at least two diverse directors. And they're specifically looking at one who is a woman in terms of two to one, who is a woman and the other as one who self identifies as an underrepresented minority or member of the LGBTQ+ community. In terms of third party momentum addressing boardroom composition, one of the most aggressive has been the city and state of New York. In 2014 the city of New York launched the New York Boardroom Accountability project led by the office of the controller of the city, in conjunction with New York City pension funds during the first phase, the project focused on proxy access, which allowed shareholders that held 3% for at least three years to nominate directors to run against the company's chosen slate and have those nominees listed on the corporate bill. The second phase of the accountability project in 2017, addressed for diversity by calling on companies to disclose the skills, gender, and ethnicity of their board members. And finally, phase 3.0 was launched in 2019. Similar to the Rooney Rule, it urged publicly traded companies to consider women and underrepresented minorities for every board seat that became available as well as for CEO appointments. And finally, at the state level, The New York State Retirement Fund, which coincidentally happens to be the third largest US pension fund with about 279 billion in assets, they updated its proxy voting guidelines, and they specifically addressed board composition. First, the guidelines indicate they will vote against all incumbent nominees if the company lacks directors from underrepresented minorities. Second, that it will vote against all incumbent nominating committee members if the board does not have more than one director from an underrepresented minority. Also that it will vote against all incumbent nominating committee members at companies that don't disclose the ethnic diversity of their board directors. And finally that they will vote against all incumbent nominating committee members that have not listed gender and racial or ethnic diversity as explicit considerations in their search for new directors. So this is meant to send a clear signal that they expect the values of the companies in which they invest, again, they are the third largest US pension fund in the US that they expect the values of the companies in which they invest to align with their values as a pension fund that they can clearly consider board diversity a high priority and that they are prepared to hold incumbent, nominating committee members accountable. So that is the state of New York. Notwithstanding these initiatives, why is board refreshment in general, setting aside the discussion with respect to diversity? Why is board refreshment so glacial? And glacial is the universal term used throughout corporate governance literature to describe board refreshment. So I did not coin the phrase. However, I think there are three key reasons all of which are structural. The first is board term limits or more precisely the lack thereof. Most boards don't have term limits. So those that do are the exception rather than rule. As a result, board tenure, the second structural reason, board tenures tend to be long. Most board members are not in a rush to vacate their seats, particularly since they are being paid. How much they're paid depends on the size of the company and whether they chair a standing committee. Generally, the compensation is going to be higher for a Fortune 500 company than a Russell 3000 company, or certainly for a privately held company. And board compensation, by the way, is publicly available and can be found in annual proxy filings, which you can easily simply Google. So I selected a company, a household name, and I went to this year's proxy filing, under director, compensation. The company indicated that last year each nonemployee director, so each independent director, received an annual retainer of $280,000. 50,000 of which was in cash. The remainder in deferred shares. At most companies, there is an additional compensation premium for serving as the chair of a standing committee, usually with the audit chair receiving the highest premium. In this particular case, according to the proxy statement for this company, the audit chair received $25,000. So that was an additional $25,000 serving as audit chair. The other chair, the other committee chairs actually received $20,000. But again, this varies by company. Third structural reason is the retirement structure. The universe for board seats is finite. It's not an unlimited pool. Last year, there were less than 500 new S&P 500 board directors. And when the average retirement age is mid-70s, that creates a major barrier to entry. So combined, these three structural factors, lack of term limits or rarely are there term limits, long tenures, which contribute to low turnover, and liberal retirement policies contribute not only to internal resistance to board refreshment, but they also create a petri dish for group think. Group think is the enemy of good corporate governance. It stifles descent, it compromises the board's oversight role, and it fundamentally fails to serve the best interests of the organization and therefore shareholders. So there is board refreshment by activism, as was the case with Engine No. 1, which we discussed earlier and in the worst case by necessity as was the case with Wells Fargo. Now the prevails of Wells Fargo and its sales practices are well documented. And in issuing the cease-and-desist order, the federal reserve noted that the company, quote, pursued a business strategy that emphasized sales and growth without ensuring that senior management had established an adequate risk framework, which resulted in weak compliance practices. As a result, as we all know, the Federal Reserve announced the restriction of the company's growth and asset size until it, quote, sufficiently improves its governance and controls. And improving its governance meant among other actions addressing the composition of its board with the bank ultimately deciding to replace four board members, that's how the bank handled it. Refreshment by necessity, never an optimal model. In addition, the bank paid $3 billion to settle potential claims with the DOJ's announcement of the settlement focusing on the scope and duration of the misconduct, which actually occurred over a 14-year-period from 2002 to 2016. So finally again, I emphasized the importance of culture. The normalization of misconduct beyond exposure to legal liability is a sign of corporate governance that needs improvement. One of the emerging trends that we're beginning to see is the linkage of ESG metrics with executive compensation. And as a corporate governance issue, one of the most sensitive issues has always been and will continue to be executive compensation. So I wanna highlight three companies, each from different industries, and the approach that they've taken. We begin with Chipotle which grants a 15% bonus based on three factors. Increased use of organic and locally grown food, increased diversity of internal candidates for promotion, and reduced greenhouse gas emissions by 5%. So that's Chipotle. Intel, on the other hand, links executive compensation to ESG metrics that align with the goal of RISE. And RISE represents Intel's commitment to create a responsible, inclusive, sustainable world enabled by technology and employees, hence RISE, R for responsible, I inclusive, S sustainable, E enabled by technology. So some of the goals include conserving more than 5 billion gallons of water in operations. Increasing the use of renewable energy to 75% globally and doubling the number of women and minorities in senior leadership positions globally. And there are many other goals, but those are just some of the goals. Salesforce. Earlier this year, Salesforce announced that a portion of executive pay, the executive VP level and above would be determined by certain equality and sustainability ESG measures. With respect to equality the measure focuses on increasing the representation of black, Latinx, indigenous and multiracial employees in the US and for women globally. With respect to sustainability, reducing air travel emissions, as well as increasing its span with suppliers that have signed on to Salesforce sustainability exhibit, which is essentially a procurement contract with the goal of reducing carbon footprint and helping suppliers meet their climate targets. So three different companies, three different industries, food, microprocessors, cloud-based software, three different approaches. But each taking an innovative approach to compensation and linking it to various ESG metrics. Now we're going to shift gears and take a look at the regulatory landscape, specifically the SEC's impact. Last March the SEC established a climate and ESG task force. And this year we've begun to see some of the activity undertaken as an output of the task force. Though not garnering as much attention as the proposed rule regarding climate risk disclosures, which we're gonna discuss, earlier this year, the SEC filed a complaint against the mining company. And there are a number of allegations in the complaint, including false and misleading ESG disclosures to investors regarding the stability of the dams and the financial consequences should a high risk dam collapse. Well, one of the dams actually did collapse, which resulted in the death of 270 people. And the SEC noted that investors rely on ESG disclosures, like those contained in annual sustainability reports and other public filings, to make informed decisions. And that by allegedly manipulating those disclosures, it undermine the investors' ability to really intelligently evaluate the risks. So climate disclosures are clearly an SEC priority, and it's proposed rule has generated a great deal of discussion and controversy. The disclosures were not universally embraced rule, was not universally embraced by all of the commissioners. And there is a fairly robust debate surrounding the question of whether the SEC is exceeding its statutory authority and stepping outside of its zone by addressing environmental issues. But the SEC issued the proposed rule with the intent to achieve two key objectives: consistency, and comparability in disclosures. Because currently to the extent that climate disclosures are made and many companies make climate disclosures, but they are neither consistent nor standardized. And, therefore, it's not easy for investors to compare them. Hence the proposed rule. And under the rule as currently proposed, there are five different disclosures. And we'll examine each of them. Climate-related risk disclosures, climate-related impacts on strategy, business model and outlook, governance disclosures, risk management disclosures, and greenhouse gas emissions disclosure. The first set of disclosures relate to climate-related risks. And here the SEC is specifically looking for companies to disclose climate-related risks over the short, medium and long term. In doing so, companies would be asked to indicate whether the risk is physical or transitional. With respect to physical risks, they're classified as either acute or chronic. Acute risks are typically short term, such as hurricanes, tornadoes, the recent flooding in Kentucky. Those are example of acute. Chronic risks, however, are more long term in nature. Such as high temperature, sea level rise, or drought. So physical risks, either acute or chronic, short term or long term. Transitional risks, on the other hand, are related to challenges in adapting to regulatory, technological, or market changes. So, as an example, an auto manufacturer might describe how market force factors such as growing consumer demand for electric or low emissions vehicles will impact its production and future expenditure. The second set of disclosures relate to climate-related impacts on a company's business in four key areas; business operations, products and or services depending which is applicable, suppliers and other parties in their value chain, and finally research and development expenditures. So again, same example, the auto manufacturer may decide to modify its business model by expanding its product line to invest in electric vehicles. As with the risk disclosures, the SEC is looking for actual and potential impacts, short, medium, and long term. Third set of disclosures address governance issues. And the SEC makes a distinction between board-related disclosures and management-related disclosures. With respect to board-related disclosures, the focus is risk driven, and there are five major disclosures under the proposed rule. First, the SEC is looking for companies to identify any board member or, for that matter, board committee responsible for the oversight of climate-related risks. Secondly, whether there's any board member who has subject matter expertise in climate-related risk. And again, remember, this was one of the objectives with Engine No. 1 was to have support seats that are held by members with expertise in the energy sector. And I suspect that even independent of the proposed rule, given the impact of climate change, this skillset is going to become a greater priority in board searches and highly prized. Expertise in the energy industry, expertise in climate change. The disclosures must also include a description of the processes and the frequency that the board discusses climate-related risk. So for example, is it on the agenda at every board meeting? Is it once a year? Again, is there a separate committee that specifically addresses climate-related risks or does it get pushed to the audit committee? This is the type of information that's being sought. Also the SEC would be looking for a description of whether and how the board sets climate-related targets and how it monitors its progress, those goals. And finally, for a description of whether and how a board considers climate-related risks as part of its business strategy and financial oversight. Again, still looking at governance disclosures with respect to management-related governance disclosures, they're expected to address whether certain management positions or committees are responsible for assessing and mitigating climate-related risks. And as a general management best practice, there is certainly most companies have a chief risk officer, many have risk committees, and if there is a risk committee, So for example, is there a separate subcommittee of the risk committee that addresses climate-related risks? If there is a position or committee, does it report to the board? So how does it report to the board? And finally, how is management informed about climate-related risks? So these are the type of disclosures with respect to management governance oversight. The fourth set of disclosures, which quite frankly overlap with some of the previous disclosures relate to risk management. Essentially companies should disclose their process for identifying, assessing, and managing climate-related risks. And then we get to greenhouse gas emission disclosures. Briefly, there are three emission scopes. Scope one are emissions from operations that are owned or controlled by the company. Scope two are indirect emissions from the generation of purchased energy. That energy could be electricity, could be steam, heat, cooling, but the energy is consumed by operations owned or controlled by the company. Both of these scope one and scope two must be disclosed under the proposed rule as currently drafted. And then we get to scope three. Scope three are indirect emissions that occur upstream and downstream in a company's value chain. So examples of scope three emissions include business travel, employee commuting, the transportation of purchased fuel. Scope three emissions, which obviously are more challenging to capture, are disclosed only if they're material, material meaning they create a substantial likelihood that a reasonable investor would consider it important when making an investment decision. So scope one and two must be disclosed. Scope three, if it meets the materiality test. Regardless of the scope, one, two, or three, all greenhouse gas emissions, whatever is disclosed is subject to third party translation. It must be audited. So these disclosures must be audited. The comment period is now closed on the proposed rule. And it'd be interesting to see the outcome of the final rule given the controversy that it has generated. Now, though the proposed rule for climate disclosures has generated the most discussion, the SEC has been quite impactful in influencing our most recent proxy season. Late last year, the SEC issued Staff Bulletin 14L. Quick background. The Securities Exchange Act Rule 1488 governs a process for the submission of shareholder proposals under the act, a company that seeks to exclude a shareholder proposal must file its reasons with the SEC no later than 80 days before it files its proxy statement. The SEC will evaluate it. If it concur with the reasons for exclusion, it'll issue a new action letter, which basically means it will not take any action if the shareholder proposal is excluded. Typically, there are two basis for exclusion. First is economic relevance. Previously companies were permitted to exclude a proposal if it related to operations that accounted for less than 5% of its total assets, net earnings or sales. That's no longer the standard under economic relevance. With the new bulletin, if a proposal raises broad social or ethical concerns related to a company's business, it may not be excluded, notwithstanding for 5% threshold. So even if the proposal relates to operations that account for less than 5%, if it addresses broad social or ethical concerns, then it is no longer excluded. The second basis of exclusion was the ordinary business exception. And obviously the purpose of this exception was to confine the resolution of ordinary business issues to management. However, the SEC found that too much of a focus was being placed on evaluating the significance of a policy issue to a particular company and its business. As a result of the focus is no longer on the nexus between the policy and the company, but rather on the social policy significance, that is whether the policy raises issues with a broad societal impact, broad societal impact is standard. So let's take a look at some examples from this year's proxy season. The first involves a proposal that was submitted for a company to adopt and disclose a paid sick leave policy for full-time and part-time employees. The company requested a new action letter, which the SEC denied noting that the proposal quote, transcended ordinary business matters because it raises human capital management issues with a broad societal impact. Second example. Shareholders submitted a proposal that a company conduct a civil rights audit of its policies and procedures. Particularly since this particular company had experienced some racial incidents. Also denied. And actually in this case, 55% of investors backed the resolution and the company is now in the process of conducting the audit. So you can see the impact of the bulletin. Obviously, if it's not on the ballot, shareholders can't vote. And as a result of the increase in denials to exclude shareholder proposals, which is resulted in a decrease in their action letters, we're seeing more ESG-related proposals on the ballot and being voted on. Finally, we turn our attention to the SEC and its scrutiny of the asset management industry within the context of ESG issues. Last April, the SEC issued a risk alert, in which it shared observations with respect to industry's practice. And the commissioner did several disturbing trends, and this is again note specifically to investment advisers. Including misleading statements regarding ESG investing processes, lack of policies and procedures related to ESG investing, weak documentation of ESG-related investment decisions. Generally, and I say this as a former chief compliance officer for an asset management company, documentation is your best friend when it comes to the SEC. Inadequate controls to monitor and update client ESG-related dialogue. So for example, if a client restriction guidelines indicates no sense stocks, is that being properly monitored to ensure that client funds have not inadvertently been invested in a casino or a cigarette company. So inadequate controls to monitor and update client ESG guidelines. And finally, they noted inadequate controls to ensure that ESG-related disclosures and marketing disclosures were consistent. And SEC and I mean the risk alert specifically noted unsubstantiated claims regarding investment practices. The one that was cited was quote, we only invest in companies, well, with high employee satisfaction. Well, begs the question, how does ABC investment advisor know that a particular company has high employee satisfaction? Did they see some documentation? Did the company share with them employee satisfaction survey? How do they know? We only invest in companies with high employee satisfaction. What's the documentation to support the claim? So that's what that's getting at. As one commissioner noted quote, firm's claiming to be conducting ESG investing need to explain to investors what they mean by ESG and they need to do what say they are doing. So bottom line, which has been the recurring theme throughout today's course, the need for accountability and ESG as a mechanism for accountability. Not surprisingly ESG was designated as an SEC exam priority for 2022. And what are they looking for? The SEC is looking for whether investment advisors are first accurately disclosing their ESG investing approaches. And they've adopted and implemented policies and procedures to prevent federal securities law violations in connection with those ESG disclosures. Secondly, they're looking at whether they're voting client securities in accordance with ESG-related mandates and client restrictions. And finally they're looking at whether investment advisors are overstating or misrepresenting ESG factors in their portfolio. I leave you with these four takeaways. First, the E in ESG continues to gain prominence, particularly, particularly, in the wake of climate change. And though the E is prominent, the S is gaining increasing attention due to a confluence of factors, ranging from CEO misconduct, we now have the Weinstein clause too aggressive, very aggressive employee activism in the workplace. Employee activism will continue to be a driving force and companies that choose to ignore it will do so at their own peril. Second, board rooms are being forced, sometimes by necessity, to reexamine their protocols around board composition and refreshment. Whether it's expanding the areas of board members subject matter expertise as a result of shareholder action, such as with Engine No. 1, or diversifying the demographics of boards in terms of gender, ethnicity, or sexual orientation, ESG has been a fundamental catalyst for change in terms of board composition and refreshment. Yes, it's still glacial, but it's movement. Third, regulatory scrutiny on ESG-related issues is likely to escalate. Regardless of the final outcome of the SEC's proposed climate-related disclosures, in terms of the regulatory landscape, ESG is no longer exclusively within the purview regulatory agencies such as the EPA. Its range is broad as seen by regulators' examination of ESG investing. And finally, third party efficacy, whether by shareholders, employees, pension funds, or asset managers. They all have had an impact in raising the dialogue, driving accountability. Thank you for joining me today.