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Inside the brewing fight over the SEC’s ESG enforcement

Conservative groups are attacking new proposals from the SEC to hold companies accountable for disclosures around issues like climate risk, board diversity, and stock buybacks.

Inside the brewing fight over the SEC’s ESG enforcement
[Source Image: Zeynurbaba/iStock]

The nation’s top securities regulator had been warned.

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Soon after the Securities and Exchange Commission (SEC) released a proposal late last year to boost the presence of women, LGBTQ and other minorities on public company boards, hundreds of comment letters started rolling in. Among them: missives from conservative groups who trashed the plan.

Their criticisms ran the gamut. The proposal, which would impact 3,500 companies listed on the Nasdaq, was unconstitutional, racist, sexist and far outside the bounds of the SEC’s mandate, they groused—a bungled attempt at “faux diversity,” in the view of one writer.

On August 6, the SEC, which oversees Nasdaq, approved the diversity plan anyway. It took only three days for the conservative Alliance for Fair Board Recruitment (AFFBR) to hit the agency with a lawsuit asking a federal appeals court to overturn the decision. A similar suit was filed earlier this month by the National Center for Public Policy Research, a group that describes itself as “the conservative movement’s only full-service shareholder activism and education program.”

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An SEC spokesperson did not respond to an inquiry about the lawsuits.

Financial regulators are treading into matters related to environmental, social and governance (ESG), issues at an unprecedented pace, proposing rules and undertaking other initiatives that could ultimately play a role in addressing the nation’s income inequality crisis. The CEO–worker gap has exploded in the last four decades: While CEO compensation has grown 1,322% since 1978, the average U.S. worker’s compensation has risen just 18%, according to the Economic Policy Institute.

As opponents push back, though, the obvious question looms: How far can financial regulators go in pushing policies linked to social agendas and economic justice issues?

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Federal Reserve Governor Lael Brainard said in an October speech that the nation’s biggest banks should begin to account for the costs and physical risks of climate change. Wall Street’s self-regulator, the Financial Industry Regulatory Authority (FINRA), collected dozens of comment letters this year on ways that its rules, operations and administrative processes might be creating unintended barriers to diversity in the brokerage industry. And the Commodity Futures Trading Commission has formed an internal unit to better understand the role derivatives play in climate risk.

Among financial regulators, though, no agency has been as aggressive as the SEC. This year, it established a new position of senior policy adviser on climate and ESG; set up an Enforcement division task force to look for problems with companies’ ESG disclosure; and asked the corporate finance division to see if public companies were complying with the agency’s existing guidance for disclosure of climate change matters.

Furthermore, it has set an agenda that includes proposed rulemaking in key ESG areas, including new public company disclosure requirements related to climate risks, board diversity, human capital management, and corporate buybacks. SEC Chair Gary Gensler has said the proposals should be ready by early 2022.

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Some studies suggest strong links between diversity and company performance. A 2018 McKinsey study found that companies whose executive teams ranked in the top quartile for ethnic and cultural diversity were 33% more likely to have industry leading profitability. S&P Global said in 2019 that companies that had female chief financial officers produced $1.8 trillion in excess profits.

When financial regulators pursue rulemaking related to ESG, their efforts may not directly impact income inequality. But experts say the measures lay the groundwork to address it. Corporate disclosures can “shed quite a bit of light on problems,” said Alex Martin, senior policy analyst for climate and finance at the advocacy group Americans for Financial Reform. They can “open the door to companies being accountable for their behavior,” he said.

One way that might play out is if detailed disclosures about workforce pay and promotion by gender and race shame companies into addressing inequitable pay, says Tyler Gellasch, executive director at the Healthy Markets Association, a nonprofit that advocates for market reforms. The data could also impact customer loyalty, he said, “and if customers care, investors have to care, too.”

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New requirements for diversity information about corporate board members could similarly lead to change. Companies that are outed for their largely white, male boards often feel pressure to diversify the mix, and that can change conversations and decisions in the boardroom. Diverse boards may be more likely to raise questions about allocation of corporate resources and are linked to improved governance and oversight. “Companies with more women on their boards are less likely to be subject to costly public governance controversies such as bribery, fraud, or shareholder battles,” according to a report by Ariel Investments.

Buybacks, which have been blamed for increasing income inequality by boosting the wealth of corporate executives and draining resources for investments in workers are another issue: S&P 500 companies are expected to buy back $726 billion of their own stock this year, a sharp increase from 2020. As things stand, there are conditions that companies are supposed to meet before they proceed with a buyback, but they have no teeth. In 2015 then-SEC Chair Mary Jo White said that the agency didn’t even have the trading data it would need to verify that companies were following the rules.

Finally, enhanced climate disclosure “could have knock-on effects that help us address income inequality,” said Martin, because they help assess “the size and scale of the problem” and provide the basis for corrective action. “With climate change, it’s the low and moderate income communities and communities of color who have the most vulnerability.” Naysayers argue that regulators have no business getting involved in social issues, but supporters counter that regulators are just doing their jobs. The SEC, for example, has a mandate to ensure that investors get the information they need to make informed decisions—and investors have made it clear that they want more data about climate change, corporate diversity, and pay.

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“The SEC isn’t telling a company to pay any worker more and they’re not telling a company that their diversity is abysmal,” said Gellasch. “They’re saying, ‘just tell us what these things are and let the market participants act.'”

Gellasch is referring to a concept that’s central to the SEC’s mandate: The agency requires that public companies reveal facts that are “material” to their business, which the Supreme Court has defined as information to which there is “a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security.”

In a survey earlier this year, 75% of institutional investors said that ESG factors are an integral part of sound investing.

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But investors aren’t getting the important data that they need, said Meredith Benton, founder of the ESG consulting firm Whistle Stop Capital and a consultant with As You Sow, an ESG shareholder advocate. Employee retention rates, for example, could provide key information to investors about deficiencies in a company’s human capital management, but few companies share retention information about their female and Black employees, she said. In research conducted over the summer, researchers at Whistle Stop and As You Sow found only 77 companies in the S&P 500 that either committed to share, or were already sharing, information about their retention of women, Benton said. That number drops to 11 out of 500 for Black employees. “You want employees to want to work there,” Benton said in an interview. When companies don’t supply retention data, “to me, that implies a churn culture, and that’s very toxic.”

Signet Jewelers, the world’s largest diamond jewelry retailer, saw its stock tank by 13% on February 28, 2017, after The Washington Post published an article detailing horrific discrimination and sexual harassment at Signet-owned Sterling Jewelers. A company policy had relegated the women’s class-wide complaints to secretive arbitration, but details started to get out when I wrote a piece in The New York Times in 2014. Three years later, the Post article added substantial detail about systemic sexual harassment and pay discrimination based on more than 1,300 just-released pages of sworn statements from women who worked there. The article’s revelations caused so much turbulence in Signet’s stock that the company had to ask the New York Stock Exchange to halt trading.

The company’s failure to reveal the depth of the discrimination in its ranks has cost it dearly. A class-action lawsuit in 2018 included allegations that Signet had downplayed the gravity of the women’s complaints, leaving shareholders unaware of the company’s reputational and business risk. The case was settled last year for $240 million.

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Activision Blizzard, the video game publisher, is another example of a problematic company culture that led to shareholder losses. The company suffered a piling on of bad publicity beginning July 21, when, after a two-year investigation, California’s Department of Fair Employment and Housing filed a lawsuit that said women earned less than men in similar jobs and were subject to “constant sexual harassment.” Activision had a “frat boy” culture that was so bad that some men in the office would even make jokes about rape, the complaint said. On September 20, The Wall Street Journal reported that the SEC was investigating Activision’s disclosures about employment matters. Ann M. Lipton, a business law professor and corporate governance expert at Tulane Law School, said, “I can’t think of anything that’s comparable” to the SEC getting involved in a matter related to sexual harassment.

In the months since the California lawsuit in July, the company’s shares have fallen from $91.51 to $67.64 as of the November 5 close.

Activision did not respond to requests for comment.

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The company revealed nothing about the ongoing California investigation when it filed its annual report with the SEC in February 2021. It did, however, regale investors with upbeat information about participation rates in its company-wide employee surveys, which in the company’s view illustrated “our collective commitment that Activision Blizzard remains a great place to work.” Activision, the document said, was committed to a culture “where everyone thrives.” Like other public companies, Activision had included the human capital report in the wake of a new SEC rule that required companies to describe their human capital resources “to the extent the disclosure is material to an understanding of the business as a whole.”

Leaving out information about a state investigation while touting its inclusion efforts puts the company at risk of breaking disclosure rules, said Benjamin Edwards, a professor of securities law at the University of Nevada, Las Vegas’s Boyd School of Law. The SEC is putting pressure on public companies “to make sure that their behavior behind closed doors matches what they tell the public,” Edwards said.

On October 28, Activision announced new initiatives that included waiving mandatory arbitration of sexual harassment and discrimination claims and devoting $250 million to “accelerate opportunities for diverse talent.” The CEO said he was reducing his compensation to $62,500 and declining bonuses and equity to “ensure that every available resource” was being used in the service of workplace excellence.

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The more data that companies are forced to disclose, the better the chances that investors can anticipate problems in the making. During a speech earlier this year, John Coates, former acting director of the SEC’s division of corporate finance, compared today’s situation to that of the early years of asbestos disclosure. “For years, asbestos-related risks were invisible, and information about asbestos would likely have been called ‘nonfinancial,'” he said. “Over time, those risks went from invisible to visible to extremely clear, and clearly financial.”

The fight for more ESG disclosure will intensify when the conversation moves to highly granular disclosures—particularly potentially explosive data about employees. Edwards says the simplest human capital disclosure requirements for companies to provide would be those “where there are things you can count,” such as discrimination complaints, internal investigations, and outcomes of those investigations.

“The context is changing and what’s material is changing,” said Stephen W. Hall, legal director and securities specialist at the advocacy group Better Markets. Investors “want to know what sort of corporate character they’re investing in.” Many companies in the U.S., though, have for years suppressed information about such complaints by demanding private arbitration, and they are not likely to begin revealing incriminatory data without a fight.

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And as financial regulators move forward with ESG agendas, they face powerful opponents.

The conservative Heritage Foundation, which took in nearly $117 million in contributions and grants in 2019, has been a vocal critic of efforts to diversify boardrooms, and panned the Nasdaq diversity proposal as “racist,” “sexist” and “a marked step backwards.” The nonprofit Society for Human Resource Management warned the SEC that it should “proceed with caution” when considering disclosure rules related to human capital because advocacy groups and plaintiffs’ lawyers could “unfairly distort” company practices if they had access to broad data about employees.

Edward Blum, a longtime conservative activist known for fighting affirmative action laws, is another big opponent of financial regulators who get involved with social issues. He’s the founder of the Alliance for Fair Board Recruitment, one of the two nonprofits that sued the SEC over the Nasdaq diversity rule. He did not respond to email requests for an interview, but previously told Reuters that he formed the Alliance to protect his members, whose identities are confidential, from “negative social repercussions.” His group sued California Secretary of State Shirley Weber in July, complaining that the state’s new law mandating the inclusion of members of underrepresented communities on corporate boards amounted to “patronizing social engineering.”

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The California complaint said that members of the Alliance are biological males “who do not self-identify as women or underrepresented minorities” and are seeking corporate director positions. One member is a former corporate board director who was “ousted” from his position because he is not a woman or underrepresented minority, according to the complaint.

The other group seeking to overturn the new Nasdaq rule, the National Center for Public Policy Research, has asked a federal appeals court to join its legal action against the SEC with the one filed by Blum’s group. Justin Danhof, the group’s executive vice president, told Breitbart News earlier this month that the SEC is allowing Nasdaq to discriminate against “white, straight Christian men.” The Center brought in $4.9 million in gifts, grants, contributions, and membership fees in 2019, its most recent publicly available IRS filing. Danhof did not respond to requests for comment.

Opposition to some of the calls for disclosure can be found even at the SEC. Republican Commissioner Elad Roisman said in a June 22 speech that while it’s true that there are investors who have objectives that are not related to risk and return—such as retail investors who buy ESG mutual funds—those ESG goals don’t count as “material.” The SEC should not concern itself with “products that have stated objectives outside of profit-seeking” unless the agency finds that some existing, non-ESG rules have been broken, he said.

Given all the regulatory action, companies are being advised to keep a close eye on developments. The SEC will be soliciting public comment on new proposals, and securities lawyers expect it to open more human capital investigations in the wake of the Activision case. The Atlanta-based law firm King & Spalding warned clients in September to monitor the Activision case “and make sure company disclosures will pass muster upon review, because review is coming, one way or the other.”

Gellasch, the Healthy Markets executive, says that conservative groups that oppose ESG disclosures are preparing for bigger fights. “I think there’s a fair amount of waiting to have something to shoot at.”


Capital & Main is an award-winning publication that reports from California on economic, political, and social issues.

Copyright 2021 Capital & Main.

Susan Antilla is an award-winning investigative journalist and author who has written about employment discrimination and investor fraud for publications including The New York Times, The Nation, Bloomberg, and The Intercept.

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