Horizon 2020 Critical intelligence for boards in a fast-changing world - January 2020 - Freshfields Bruckhaus Deringer
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Horizon 2020
Critical intelligence for boards in a fast-changing world
January 2020
Critical intelligence for boards in a fast-changing world 1
Welcome to Freshfields’ Horizon 2020 Introduction The operating environment for multinational corporations in 2020 is set to be more volatile than ever. Economic conditions are uncertain, geopolitical instability casts a long shadow over global markets, regulatory regimes are evolving at speed and debate about the role of business in modern society continues to rage. Against this backdrop, the boards of public companies face a host of challenges. How can a coherent, long-term strategy be constructed when the short-term outlook is so dynamic? What impact will climate change and other environmental and sustainability concerns have on businesses and markets? How can technology be harnessed for growth amid shifting regulatory regimes? And how should directors engage with investors whose objectives may not always match their own? Delivering success requires a sophisticated understanding of this rapidly changing landscape. On the pages that follow we explore the key issues for boards and management in 2020, and offer practical guidance on how best to respond. With clarity of thought and careful preparation, every challenge can be addressed — and every risk becomes an opportunity. Best wishes from us all at Freshfields for a prosperous 2020. Critical intelligence for boards in a fast-changing world 2
Executive summary
Governance, HCM, ESG and All this focus on HCM, ESG and other governance issues
the purpose of a corporation can lead one to wonder about the true purpose of the
corporation. In Reforming the US corporation, we
“Good” corporate governance continues to be a big focus address the question of whether boards can serve more
for investors and other stakeholders. But one of the than their shareholders. The answer is, and has always
challenging issues for companies is the lack of agreement been, yes. But as the power of impact investing intensifies
on what is relevant, with each stakeholder seemingly and the market’s focus on the company’s effect on other
having a different focus. Against this backdrop, it is critical constituencies grows, boards and management are at
for boards and management to identify what is important risk of being driven to make decisions that benefit “other
to their company and be proactive about disclosure and
constituencies” to an untenable extent. This section
engagement on terms that are meaningful to their various
highlights ways in which boards and management can
stakeholders. A company-led effort on this front will be
protect themselves from unnecessary risks by, for example,
more productive than reactively responding to an ever-
carefully reviewing projections and forecasts the company
increasing number of disparate requests.
disseminates to the market and considering the benefits of
In Leveraging talent for growth, we focus on the being a public benefit corporation.
continually growing importance of human capital resources
These issues are at the center of the 2020 proxy season
in a labor market characterized by skills shortages, uneven
agenda. In Shareholder proposals, we describe how the
wage growth and rapidly changing technology, and the
shareholder proposal landscape continues to be robust with
corresponding focus by investors and other stakeholders on
proposals submitted on a wide variety of E, S & G topics.
these issues. Boards and management need to proactively
In Employee benefits: the forward view, we note that
identify their most significant HCM-related issues and
craft meaningful disclosure and effective engagement transparency on compensation program design will keep
strategies so that stakeholders are fully apprised of what Say on Pay in the spotlight throughout 2020. Similarly,
companies are doing in this critical area. Similarly, in compensation proposals continue to be routinely submitted
What sustainability means for business, we describe by shareholders. Companies that receive less than
the need for a more rational approach to disclosure and 90 percent approval on their Say on Pay vote or that receive
communication on ESG issues, that shifts from passively shareholder proposals relating to compensation practices
responding to overlapping (and at times conflicting) requests should expect to engage in meaningful outreach to
for information to proactively communicating with a wide investors, generally together with a member of the
range of stakeholders about a company’s risks and compensation committee, and provide additional disclosure
opportunities created by strategic ESG concerns. Shareholders, in their proxy statement. Directors should be prepared to
employees, consumers, supply chain participants and articulate how the company’s compensation structure is
regulators all have a vested interest in focusing on the designed to support its long-term strategy and how the
issues that matter. We also highlight some of the risks company plans to address any perceived shortcomings and
of getting it wrong, including the threat of litigation. inequality in the company’s pay practices. In this section we
While the trend is still relatively nascent, and early cases also cover some recent proposed IRS regulations that may
have not had a high degree of success, we expect plaintiffs impact the deductibility of compensation paid under
will continue to bring claims on a variety of grounds. certain contractual arrangements.
Critical intelligence for boards in a fast-changing world 3
Executive summary
The amount of time and resources companies devote to that boards and management can take to limit the amount
managing the shareholder proposal process also continues and type of information that courts may allow shareholders
to increase, and we explore the potential impact of certain to access, including to ensure that minutes and records are
changes by the SEC (either adopted or proposed) to the regular sufficiently detailed and complete to mitigate any demands
cadence of shareholder proposals and proxy advisory firm for personal communications (such as personal text
recommendations. Again, in Shareholder proposals, messages and emails). In Key themes in litigation, we note
we describe how the SEC has proposed changes to the that several other trends will color the litigation landscape
shareholder proposal submission and resubmission process for companies in the US, including more event-driven
that may have a significant impact on the number of litigation brought on the heels of the disclosure of bad news
proposals that certain shareholders are eligible to bring. such as #metoo scandals, bribery and product claims, more
Conversely, some of the reforms related to proxy advisory third party-funded lawsuits as well as more climate change
firms are unlikely to have a meaningful impact on the 2020 and sustainability-related cases. Interestingly, we are also
proxy season, with proxy firms continuing to release their seeing more globalized litigation, including class actions.
voting policy updates and to provide specific voting The global nature of these trends emphasizes the
recommendations. For companies that submit requests for importance for boards of not only understanding the risks
no-action relief to the SEC, we note that the SEC has of litigation, but also the risks of whether that litigation can
recently issued guidance reiterating the importance of be global and proactively implementing protective steps to
including the board’s views on some key issues. Given that ensure that the jurisdictional scope of any possible risk is
the shareholder proposal landscape is expected to continue appropriately cabined.
to be frothy, in Proxy advisers: the essentials, we
The globalization trend in litigation can be felt in the
underscore the importance of effective engagement and
enforcement area as well. In Priority areas for global
disclosure strategies as a way of ensuring that shareholders
enforcers, we describe the increasing cooperation among
and the proxy advisory firms understand a company’s
global regulators and the continued focus on individual
unique circumstances, thereby increasing the likelihood
liability in the US and globally. Far from simplifying the
of having a successful voting outcome.
process, the global nature of enforcement can also result in
significant challenges, such as the different treatment of
Significant trends in interview notes and privilege and the difficulty of
litigation and enforcement navigating conflicting regulatory requirements. In no area
While the pace of enforcement actions may have slowed is this more acutely felt these days than data privacy, where
over the last few years, the level of civil litigation has been companies will need to continue to focus on how best to
consistently high. We are seeing higher levels of event- store, manage and protect their data. For these reasons and
driven litigation, litigation grounded in insufficient board many others, board and management oversight, combined
oversight, climate-related litigation and further use of with robust risk management, should continue to serve as
Section 220 demands. the first lines of defense in areas of enforcement.
Trends in Delaware litigation highlights two significant Activism, M&A, antitrust
developments in the Delaware courts with which boards
should be familiar. First, we describe the import of the
and national security concerns
Marchand and Clovis cases, both of which were focused on Stockholder activism remained a prominent tactic in 2019
whether the level of director oversight was sufficient. and there is no reason to suspect a contraction in 2020.
And while these cases relate to companies in heavily While each situation is different, Trends in stockholder
regulated sectors, they underscore the need to focus on activism highlights the key themes that emerged in 2019,
board-level compliance programs and their oversight that including increasing activity at large caps where exits are
can help directors avoid similar outcomes. Second, we logistically simpler given the greater liquidity opportunities.
describe the rise of Section 220 requests relating to We also look at how M&A transactions continue to drive
stockholders’ statutory right to inspect corporate books and activism campaigns – underscoring the essential need for
records for a “proper purpose.” There are several measures companies to sell the M&A deal to investors by demonstrating
Critical intelligence for boards in a fast-changing world 4
Executive summary
why the acquisition fits their strategy and why the price is on antitrust considerations. Many of the 2020 presidential
right – and the increasing interest in activism campaigns on candidates have raised concerns about the power of certain
the part of actively managed funds and first-time activists. businesses and antitrust enforcement more generally, so
Given this sustained activity, it is critical for boards and boards need to keep developments in the political landscape
management to understand their standalone plan and in mind as the year progresses.
effectively communicate it to investors, thereby dispelling
In Navigating foreign investment rules, we note that the
any investor misunderstandings or skepticism.
regulations implementing the 2018 Foreign Investment Risk
As in years past, activism campaigns have also led to Review Modernization Act, the most sweeping reform of
M&A activity. In Deal-making 2020, we describe the CFIUS in 30 years, will take effect in February. It will be
factors that will influence M&A in 2020 including continued imperative for boards to track these developments as they
macro uncertainty, the challenges of navigating complex will have major consequences for how investments are
antitrust and national security regimes, and the need to made, cross-border collaboration and a host of other issues
continually evolve to emerging opportunities such as ESG that may be important to the development of future
and digitalization. Amid these challenges, boards will need technologies. Moreover, the continuing consensus that
to be well prepared so that they can move quickly to spot China poses a leading threat to US national security will
and execute opportunities. continue to make deals with the PRC very challenging.
With corporate venture capital programs on the rise as Finally, here, too, the globalization trend has become
companies continue to expand their investment portfolios evident. Today over 100 countries have laws that allow the
in an effort to keep pace with technological change, another review of foreign investment on security or public interest
key trend that we expect to continue is described in grounds, so boards and senior management will, more than
Corporate minority investments. Founders are ever, need to consider foreign investment issues early on in
increasingly looking to join forces with strategic corporate any cross-border deal to avoid any unwanted surprises.
investors willing to provide funding alongside a commercial
partnership. And while boards generally need not Regulation of the
micro-manage small minority stakes, it is important that business of technology
they maintain oversight of the strategy and associated risks,
since the potential reputational and operational As virtually all companies can be characterized as technology
consequences for a corporate strategic investor are higher businesses, regulators are increasingly focusing on the
than for a traditional financial sponsor. In particular, specific issues that are raised by this shift in business models.
boards should understand the strategic objectives For example, 2019 was characterized by major fines imposed
underlying their investment portfolio and how they fit with by European regulators and the FTC relating to cybersecurity
the company’s overall strategy, the compliance and matters and violations of data protection regulations,
regulatory risks arising from the more limited diligence and we expect these trends to continue in 2020 in Europe
performed in connection with these investments as well as and the US. In addition, in Technology and business,
the possible conflicts arising from multiple board we describe how antitrust agencies have begun, and are
representations and co-investments from competitors. expected to continue, to regulate the collection and use of
Understanding the M&A landscape for 2020 also requires personal data. This is a potentially fundamental shift
an in-depth focus on antitrust and a thorough representing an effort to block certain data collection and
understanding of CFIUS and other national security uses in themselves, rather than merely regulate how data
regimes. In The shifting antitrust landscape, we describe practices are disclosed. We also expect to see transfers of
the potential impact on deal approval of several themes, data between countries to be a continuing focus for
including the intensifying focus from enforcement regulators. With the California Consumer Privacy Act
authorities on the tech sector, the increased length of having come into force on January 1, will 2020 be the year
review and rigor in complex merger cases (particularly at that the US adopts a federal data privacy statute as many
the DOJ), the rising number of investigations into innovative other countries now have? These data privacy statutes and
businesses and the likely impact of the presidential election regulations are presenting challenges for boards as they
Critical intelligence for boards in a fast-changing world 5
Executive summary
continue to grapple with how best to discharge their they intend to review carefully California’s Assembly Bill
fiduciary duties in an ever-evolving regulatory landscape. no. 5, which limits the ability of companies in California
In recognition of the significance of these issues on a to classify workers as independent contractors rather
company’s strategy, risks and reputation, the SEC has issued than employees. The EU is also considering whether gig
new guidance on the disclosure requirements for US employees should be allowed to collectively bargain for
reporting companies in relation to technology, intellectual their rights, which would go against customary practice in
property and cybersecurity risks. In SEC disclosure the US. As the nature of the workforce undergoes dramatic
obligations we describe the importance for companies changes, these issues present serious strategic questions for
of getting this right, as it continues to be a top priority boards and management teams who will need to tread
for the SEC. carefully about how they handle their most valuable assets,
their employees.
In Taxing the digital economy, we note that this year
there are likely to be important developments in the way
Financing and refinancing updates
many countries tax cross-border business. In particular, US
corporations that provide goods and services to European Finally, for companies wondering about the state of the
consumers through the internet, rather than a local credit markets amid all of these changes, in Debt forecast,
presence, are likely to face increased foreign taxes. In we note that the sustainability trend continues to influence
addition, the US Treasury has recently proposed new rules financing considerations, and that sustainability-linked
that, if adopted, would help protect US taxing jurisdiction instruments and loans offer issuers lower margins when
over income from an increasingly important form of they meet certain ESG criteria. We also highlight the rising
e-commerce: cloud computing. Together with management, risk of creditors who hold short positions in loans and bonds
boards will need to consider their global structures for in the credit default swaps market pressuring borrowers to
marketing and distributing goods and services and declare defaults. Boards can protect against this threat by
determine whether any structural changes are necessary ensuring that their company has negotiated robust
contractual protections. In addition, companies should
to deal with the increased tax burden.
review any credit documentation based on forms that are
Appropriate regulation of gig employees has been a more than a year or two old as borrowers have been able to
hotly debated issue in recent years as the number of gig agree ever-looser covenants and obtain additional flexibility
employees in the digital economy steadily increases. from lenders in recent years. We also remind boards that
In Employee benefits: the forward view, we note that with the fast-approaching end of LIBOR in 2021, companies
the EU Commission has better protection for gig workers should ensure that they have renegotiated or otherwise
high on its agenda. While it is not yet clear what this means addressed any financing instrument with a floating rate
in practice, one of the EU Commissioners has indicated that interest tied to the benchmark rate.
Critical intelligence for boards in a fast-changing world 6
Contents
Leveraging talent What sustainability Reforming the
for growth means for business US corporation
Emphasizing the “human” ESG, climate change and Can boards serve more than
in human capital management litigation risk their shareholders?
08 11 15
Employee benefits: Shareholder proposals Proxy advisers:
the forward view A renewed focus on process the essentials
Say on Pay, activism and Dealing with the proxy
compensation deductibility advisory firms
18 21 24
Trends in Key themes in litigation Priority areas
Delaware litigation From “event-driven” claims to for global enforcers
Managing the threat of the rise of third-party funding What’s on the agenda for
stockholder action regulators and prosecutors?
26 29 31
Trends in Deal-making in 2020 Corporate minority
stockholder activism M&A drivers for the year ahead investments
Where will campaigns focus next? Managing the risks of
non-controlling stakes
34 37 41
The shifting Navigating foreign Technology
antitrust landscape investment rules and business
Themes in tech, merger control, CFIUS and other Cybersecurity, data
consortium bids and innovation international frameworks and regulatory risk
44 48 51
SEC disclosure obligations Taxing the Debt forecast
Continuing focus on technology, IP and digital economy Libor transition, creditor risk
cybersecurity risks What shifting rules mean and flexible covenants
for global businesses
54 56 60
Critical intelligence for boards in a fast-changing world 7
Leveraging talent
for growth
Emphasizing the “human”
in human capital management
Pamela Marcogliese Elizabeth Bieber Jillian Simons
Partner, New York Counsel, New York Associate, New York
In recent decades the employees of a company have S&P 500 market-value contributors
become, in many respects, one of its most significant
100%
assets. As a result, the ability to recruit, train and retain
90% 13%
employees is becoming a measure of corporate success.
20% 87%
Businesses with strong track records in this area are 80%
80%
increasingly finding a competitive advantage in a labor 70% 32%
market characterized by skills shortages, uneven wage 68%
60%
growth and rapidly-changing technology.
50%
It can be difficult to quantify the impact of an effective
40%
approach to human capital management (HCM), and 68%
companies have struggled with how to invest in and 30%
32%
describe an area not directly reflected in their financial 20% 83%
statements. However, investors recognize that part of a 10% 17%
company’s market value is driven by intangible factors such
0%
as these – poor HCM practices have been associated with 1975 1985 1995 2005 2015
higher employee attrition rates and reduced productivity
Source: Ocean Tomo, LLC Intangible assets Tangible assets
and product quality.1
In response, companies and investors have focused on regarding HCM are an engagement priority, with BlackRock
private ordering disclosure in the absence of mandated focusing its HCM engagement on issues such as policies,
transparency, although these efforts have not yet coalesced diversity initiatives and compensation linked to HCM
around specific universal indicators or metrics. Having performance, alongside employee programs, diversity
said this, in September 2019 the Sustainability Accounting pay gaps, organized labor engagement and supply chain
Standards Board (SASB) announced its Human Capital (including contractors and contingent workers, among
Research Project, which will identify a framework of others).3 State Street meanwhile is focusing on corporate
financially-material HCM issues.2 culture “as one of the many, growing intangible value
Institutional investors, including BlackRock since 2018 and drivers that affect a company’s ability to execute its
State Street since 2019, have also indicated that discussions long‑term strategy”.4
Critical intelligence for boards in a fast-changing world 8
Leveraging talent for growth
How are companies addressing HCM in their disclosure? For companies that are beginning to address HCM disclosure
there are a variety of options, including:
A 2019 analysis of Fortune 100 companies’ proxy statements
by EY revealed that HCM disclosure remains limited and is • letters to shareholders from leadership;
often noted only as part of the description of committee • incorporating in risk oversight responsibility explanations;
responsibilities. However, there are early indications at the • seeking directors with HCM skills/qualifications and
start of the 2020 proxy season that companies are devoting including information in director biographies;
more resources to this area.
• including in shareholder engagement topics;
• factoring into growth strategy;
• adding as a performance factor in compensation/awards; and
• incorporating in diversity and inclusion metrics and goals.
Voluntarily-highlighted HCM workforce disclosure subjects in proxy statements5
Stability 6%
Skills/Capabilities 22%
Health & Safety 22%
Culture Initiatives 33%
Compensation 34%
Diversity 60%
Source: EY
Critical intelligence for boards in a fast-changing world 9
Leveraging talent for growth
The SEC steps in? responded that the disclosure would be burdensome and
In 2017, a group of more than 25 institutional investors without sufficient benefit, while some investors and others
(representing more than $2.8 trillion in assets) sent a letter urged the SEC to expand the information requirements.
to the SEC requesting that it require registrants to disclose This will be an area to watch in 2020 as companies begin
information about their HCM policies, practices and to think about how they will modify their disclosure if the
proposed rules are finalized.
performance. In 2018, another group (representing more
than $5 trillion in assets) sent a similar letter echoing the In 2020 we expect HCM issues to be of growing importance
prior request.6 to investors, employees, regulators and other stakeholders
alike. As the number of constituencies focused on these
In March 2019, the SEC Investor Advisory Committee (IAC)
issues increases, so does the diversity of the types of
issued a recommendation to the SEC supporting expanded
information that may be relevant to each. In addition, this
HCM disclosure to include:
challenge can have significant reputational consequences
• employee classification; and an adverse impact on employee morale if mismanaged.
• KPIs on diversity, hiring and promotion, safety, training, For these reasons we believe it is critical for companies to
and employee satisfaction; and ensure that they are disclosing their HCM efforts and
• a statement on competitive conditions. initiatives so that stakeholders are fully apprised of what
they are doing. They should proactively identify their most
In August 2019, the SEC released a proposal for rule significant HCM-related issues and craft meaningful
amendments to modernize and simplify the description disclosure. It is also vital that they develop an engagement
of business under Regulation S-K, which (in part) included strategy that offers compelling information to stakeholders,
human capital resources (e.g. recruitment, development, rather than being reactive to requests for information that
and retention) as a separate required disclosure topic is not relevant to the company. Doing so can be an effective
if material to understanding the company’s business.7 way to manage the multiplying requests for disparate
The proposal has proved controversial; some issuers information that companies receive in this area.
Critical intelligence for boards in a fast-changing world 10What sustainability
means for business
ESG, climate change and litigation risk
Timothy Wilkins Oliver Dudok van Heel Teresa Ko
Global Partner for Client Head of Client Sustainability Partner and China
Sustainability, New York and Environment, London Chairman, Hong Kong
The legal risks associated with climate change and Pressure from investors and other stakeholders grows
other environmental, social and governance (ESG)
One of the greatest challenges that companies face
factors will continue to feature prominently in 2020
regarding disclosure of environmental and sustainability
for three primary reasons.
issues is the lack of uniformity in what stakeholders are
seeking. Sustainability is not a consistently defined term,
Investors continue to request
1 increasing amounts of information
with each stakeholder ascribing to it a different meaning
and, therefore, a different set of expectations.
on ESG issues;
In recent years we have seen increasing interest among
investors in these issues, yet each has a particular view of
National and regional regulators
2 are beginning to expand their
what information they would find useful and what topics
they would like to discuss during their engagements.
ESG purview; and
At the same time the number of stakeholders focused on
Climate-related litigation is evolving ESG matters has spiked. For example, consumers and other
3 beyond claims for historical emissions customers have become very focused on sustainability,
to failures relating to disclosures and particularly in relation to packaging, water usage and
permitting requirements. energy. Employees, long focused on the mission of their
companies, are becoming more vocal about ESG matters.
Supply chain issues have been catapulted to the forefront
of public consciousness following high-profile scandals.
And regulators often find themselves squarely in the middle
of the debate.
Against this backdrop, the disclosure agenda is
currently more stakeholder- than regulation-led; various
constituencies are seeking more clarity on material ESG
risks while the regulatory environment is still developing.
In the US, there are no line-item disclosure requirements
Critical intelligence for boards in a fast-changing world 11What sustainability means for business
when it comes to sustainability. Back in 2010, the SEC currently treat the flood of ESG quantitative data). For these
published Commission Guidance Regarding Disclosure issues, rather than responding to the constant requests for
Related to Climate Change,8 which underscores that existing disparate information, companies should develop their own
disclosure requirements already cover environmental and disclosure and define their own engagement strategies to
sustainability issues and that the threshold for disclosure provide stakeholders with the information they seek.
is materiality. At the same time, several organizations, Being proactive in this way gives boards and management
including the Sustainability Accounting Standards Board the opportunity to have a meaningful dialogue with their
(SASB), have attempted to devise frameworks that could stakeholders about the issues that are important to them and
assist companies in determining and disclosing material to the company, without diluting the message with less
sustainability risks in a way that enables investors to useful information.
compare them across companies and industry sectors.
Regulators are catching up
The focus on material disclosures is also reflected in
the work of the Task Force on Climate-related Financial National and regional regulators are looking to meet the
Disclosures (TCFD) which seeks to develop voluntary, obligations of the Paris Climate Agreement, and, to a lesser
consistent climate-related financial risk disclosures by extent, the UN Sustainable Development Goals.
which companies can provide information to investors,
In some jurisdictions, especially in Europe, lawmakers are
lenders, insurers and other stakeholders. TCFD members –
seeking to expand disclosure requirements to include ESG
which include leading corporates and financial institutions
considerations. The EU’s Sustainable Finance Action Plan,
– are seeking to both show leadership in disclosure and
for example, provides recommendations to companies
influence regulators for pending disclosure regimes.
on reporting how their activities impact climate change
In some jurisdictions, stock exchanges are also steering and the effect climate change is having on their business
disclosure, either by making ESG transparency a listing through a classification system (or taxonomy) of what
requirement (e.g. Euronext France) or by proposing a set of constitutes sustainable business activity. Critics of the
guidelines for voluntary disclosure (such as on the London EU plan however question whether the detailed
Stock Exchange and NASDAQ). classification system is sufficiently clear or meaningful to
guide companies or investors.
So, what should companies do? In a world of overlapping
(and sometimes competing) expectations, both boards and Central banks are also weighing in, driven by concerns
management need to determine for themselves what issues about physical risks to assets and supply chains caused by
are material to their company and ensure that they satisfy extreme weather events and transition risks that will arise
their disclosure obligations and risk oversight duties. as regulators’, investors’ and consumers’ demands shift to
But they cannot stop there – in this ever-evolving address the threat of climate change. To date, 46 central
landscape, they should also acknowledge that there are banks and regulators have joined the Network for Greening
many other issues that, while not material, may nevertheless the Financial System, launched by Mark Carney, governor
be important to investors and other stakeholders. of the Bank of England (until March), and his counterparts
(Click here to read our report on how institutional investors in France and China, among others.
Critical intelligence for boards in a fast-changing world 12What sustainability means for business
Hong Kong regulator requires mandatory HKEX’s plea for boards to disclose what is material
ESG reporting (or in its own words, “truly material”) is helpful, as is
the regulator’s position that comply or explain are
In December 2019, Hong Kong’s front-line both “acceptable options”. Boards and management
regulator, the Hong Kong Stock Exchange (HKEX), now need to take a thoughtful approach to
announced that boards of listed companies will now reviewing all the subject areas, aspects, general
be required to issue statements setting out their disclosures and KPIs in the HKEX’s ESG reporting
consideration of ESG issues. guide, so that the assessment, consideration,
determination, and follow-through expected by the
ESG reporting started as a voluntary exercise in
regulator can be achieved.
Hong Kong in 2012, evolving into a “comply or
explain” regime with recommended disclosures in There is a fairly long transition period as it is
acknowledged that issuers will need to put internal
2016. However, a periodic review of ESG reporting by
infrastructure in place to capture the data required.
400 public companies during the 2017/18 financial
The first enhanced ESG reports will have to be
year revealed a “mechanical, box-ticking” approach
published by issuers for any financial year starting
that lacked “a desirable level of quality and depth of after July 1, 2020 (i.e. the first reports will cover the
detail”. In response the HKEX imposed its period from January 1, 2021 to December 31, 2021 for
mandatory reporting obligation, which establishes issuers that have a December 31 year-end), although
ESG disclosure and risk management as an issue on the HKEX is encouraging issuers to start the process
which boards must take the lead. as early as possible.
Legal risk and climate change 1. Common law tort and public nuisance cases of the type
that emerged in the US around 20 years ago and have
According to data from Columbia University and the London
since begun to spread in Europe. These claims are
School of Economics, there have been almost 1,400 climate-
primarily designed to hold companies to account for
related lawsuits launched around the world, with more than
130 aimed at companies by the start of December 2019. allegations related to their past environmental conduct,
and have often failed to get past initial hearings.
In the US, this is primarily because federal law and
We expect more “behavior-moderating” cases regulators like the Environmental Protection Agency
in 2020 in which litigants expand the focus of their take precedence over state legislation – and because US
claims from past emissions to current and future
courts view responding to climate change as a matter
corporate revenue-generating activities.
for government policy. In other countries, litigants have
Broadly speaking, climate-related cases can be split into generally been unable to satisfy the causation and other
three groups. legal tests required to bring their claims.
Critical intelligence for boards in a fast-changing world 13What sustainability means for business
2. Cases that take aim at future corporate conduct, for There are likely to be more “behavior-moderating” cases
example by demanding improved disclosures around in 2020, in which litigants expand the focus of their
climate-related risk and/or changes in strategic direction claims from past emissions to current corporate revenue-
in relation to carbon emissions. These claims may be generating activities. Furthermore, claims will no longer
more attractive to plaintiffs where issues of material be brought just by governments and NGOs; we expect a
non-disclosure are present, but are still challenged by growing number of individuals to launch shareholder suits,
the struggle to meet strict causation tests. and institutional investors to add their voices to calls for
greater transparency.
3. Cases that involve challenges to the granting of
industrial permits on the grounds that climate change For more information on legal risk and climate change take
impacts have not been properly considered. Although not a look at our research report on the climate risk landscape,
as high profile, suits that target the “licence to operate” which examines the emerging threat of litigation against
are potentially more significant for businesses. multinational corporations.
In some jurisdictions, lawmakers are expanding
disclosure requirements to include ESG considerations.
Central banks are joining in, driven by concerns
about physical and transition risks.
Critical intelligence for boards in a fast-changing world 14Reforming the
US corporation
Can boards serve more than
their shareholders?
Ethan Klingsberg
Partner, New York
In 2019, we witnessed, in a year of rocky IPOs, the First, a slice of the market remains focused on metrics that
success beyond all expectations of the Beyond Meat indicate rapid, short-term growth to the exclusion of all
listing. The differentiator: socially conscious investors other objectives. Up until now, companies have failed to
(focused, in this instance, on the environmental counter this dynamic. Yes, fluffy statements by founders
benefits of a shift to plant-based food) comprised the and CEOs about long-termism and values regularly take up
critical component of the underwriters’ IPO order book space in IPO prospectuses and follow-up communications.
that was missing from other, less successful, flotations. But these well-intentioned sentiments are at risk of being
Estimates put the assets under management of overwhelmed by management’s widespread distribution
impact investing at more than $500 billion, dwarfing of powerful data that is often incompatible with these
the $143 billion dedicated to activist equity strategies. sentiments and ironically does not even make it into the
IPO prospectus: internal financial projections.
As the magnitude of funds aimed at socially beneficial
businesses has grown, investors and their intermediaries All the founders’ letters and statements of corporate values
(such as proxy advisory firms like ISS and Glass Lewis, in the world are not going to alter the commitment to near-
independent designers of best practices for disclosure like term growth at all costs that is necessary if management
the Sustainability Accounting Standards Board, and hands analysts and investors sets of aggressively optimistic
watchdog and rating organizations like Sustainalytics) have management projections. This syndrome is especially
contributed to the proliferation of ways to measure and problematic in connection with IPOs, where there is pressure to
evaluate each corporation’s impacts on the environment, provide the best possible financial forecasts during roadshows.
customers, workers and local communities.
Countering the focus on short-term growth All the statements of corporate values in the
world are not going to alter the commitment to
The companies in the IPO pipeline for 2020 – and indeed near-term growth at all costs that is necessary
lots of existing publicly-traded corporations – are now if management hands the market aggressively
considering how to harness this development to improve optimistic projections.
relations with their spectrum of stakeholders. But to
achieve this objective, they will need to take innovative
steps to manage two countervailing forces.
Critical intelligence for boards in a fast-changing world 15Reforming the US corporation
Are directors who think beyond shareholders But as the power of impact investing grows and the
in breach of their fiduciary duties? market’s measurement of corporations’ impact on “other
constituencies” becomes more precise (but also more
Second, corporate law in most states provides that directors
disparate), fiduciaries of corporations are at risk of being
and officers must act in the best interests of the corporation
driven to make decisions that benefit “other constituencies”
and its shareholders, not other constituencies. There is a
to an untenable extent. The answer to clients’ questions
limit to how much a director can squeeze the square peg of
may start to become, “Actually, you may not be complying
benefiting “other constituencies” into the round hole of a
with your fiduciary duties if you take that step.”
duty to maximize shareholder value at every turn.
Interestingly, in advance of the Business Roundtable’s How boards can flip the narrative
recent pronouncement that looking out for stakeholders In 2020, successful IPO issuers, and even some courageous
other than shareholders is part of the corporate mission, a companies that are already publicly traded, will have the
number of clients called to ask whether their companies’ opportunity to take strong steps to counter these two forces.
support of the Roundtable’s position would put their First, management can moderate the growth projections
directors and officers in conflict with their fiduciary duties. they provide to the market, especially during IPO roadshows,
The answer was an easy, “No problem.” and be comfortable that the cost of this decision will be
offset by compelling, substantive disclosure that both
Because most states’ corporate law provides that directors details the company’s public benefit and sustainability
and officers must act in the best interests of the corporation mission and is sufficient to attract a healthy layer of
and its shareholders, the Roundtable’s statement relies impact investors into the IPO order book and long-term
on a realization that has been around for over a century: shareholder profile.
a company’s actions that benefit non-shareholder
constituencies may simultaneously be in the best interests Second, the limits of corporate law can be overcome by
of the corporation and its stockholders. Absent this taking advantage of a Delaware statute that has until
realization, all acts of corporate charity and responsibility now been virtually ignored by publicly traded companies.
would constitute corporate waste. It provides that a corporation may amend its charter to
become a public benefit corporation (or PBC) and redefine
fiduciary duties to focus on not only the interests of
The Roundtable’s statement relies on a realization shareholders but also the interests of other constituencies
that has been around for over a century – that a (and, even better, of whatever public benefits the charter
company’s actions that benefit non-shareholder specifies). Moreover, this statute generously insulates
constituencies may simultaneously be in the best directors and officers from claims for breach of duty so
interests of the corporation and its stockholders. long as no self-dealing is involved.
Critical intelligence for boards in a fast-changing world 16Reforming the US corporation
Delaware legislature needs to help corporations her insulation from liability if her balancing of shareholder
make the shift value, other constituencies, and the designated public
benefit ends up favoring shareholder value.
That said, there are a few fixes that the Delaware legislature
needs to adopt urgently to permit corporations to move Finally, when a corporation’s narrative is framed by detailed
in this direction. For one, modifications should be made environmental and social impact disclosure and the adoption
that harmonize the process of conversion to a PBC with the of an alternative fiduciary duty paradigm, the insulation of
provisions applicable to other charter amendments – the this narrative through structural features (such as high-vote
requisite shareholder approval should be reduced from shares for the pre-IPO stockholders and a classified board
662/3 percent to a simple majority of the outstanding shares, arrangement whereby only a third of the directors are up
and the conversion to a PBC should not trigger appraisal for re-election each year) becomes justifiable rather than a
rights. In addition, the statutory protection of fiduciaries source of controversy. It is no longer the ability of self-
against liability should make clear that the holding of centered founders to do whatever they want that is being
shares by a director or officer would not, by itself, result in insulated – rather it is a well-articulated and designed
her being deemed to be engaged in self-dealing that negates mission to serve a broader purpose than short-term growth.
The limits of corporate law can be overcome by
taking advantage of a Delaware statute that has until
now been virtually ignored by public companies.
Critical intelligence for boards in a fast-changing world 17Employee benefits:
the forward view
Say on Pay, activism and
compensation deductibility
Howard Klein Kevin Kay
Partner, New York Senior Associate, New York
Say on Pay remains on investors’ agenda Compensation-related proposals continue to drive
shareholder activism
High investor demand for transparency on compensation
program design will keep Say on Pay in the spotlight Shareholder activism has been on the rise in recent years,
throughout 2020. The proxy advisory firms continue to with compensation-related proposals at the center of this
enhance their voting guidelines with a clear focus on movement. There is also a developing trend of proposals
ensuring a strong orientation towards “pay for performance”, derived from employee shareholders, with new generations
with ISS introducing an “economic value added” metric in of workers more aggressive in challenging their employers
its quantitative pay-for-performance analysis. Companies in relation to social goals.
should be aiming for a Say on Pay vote that is supported by
These shareholder proposals have attempted to address
at least 90 percent of shareholders, and should expect to
various topics, including inequitable employment practices,
engage in meaningful outreach and provide robust proxy
sexual harassment risk management, gender pay equity,
disclosure of the process. This should include the lessons
gender diversity on boards, employee representative
learned from shareholder concerns and any compensation
directors and other environmental, social and governance
changes made in response, particularly where Say on Pay
(ESG) factors. We expect boards and compensation
support falls below the 90 percent threshold.
committees to give increasing consideration to such factors
In 2019, some of the primary reasons for poor shareholder when making compensation decisions as they become more
support included lack of performance-based long-term important to stakeholders. This will require a careful
incentives, short performance periods for long-term awards, balance with the more traditional financial and operational
discretionary short-term incentive plans, improper peer performance goals that are fundamental to the growth
group composition for compensation benchmarking and and success of any for-profit business.
vague or incomplete disclosure. Through 2020 we expect
shareholders to continue to seek common compensation
program features including a pay mix heavily weighted Companies should aim for 90 percent support
toward performance-based rewards, comprehensive for any Say on Pay vote, and should expect to
claw-back mechanisms, meaningful stock ownership engage in meaningful outreach and provide
policies and the elimination of tax gross-ups. robust proxy disclosure of the process.
Critical intelligence for boards in a fast-changing world 18Employee benefits: the forward view
IRS guidance on executive pay deductibility New international standard for
whistleblower protection
Section 162(m) of the Internal Revenue Code imposes a
$1 million cap on the deductibility of compensation paid to Outside the US, a new EU directive on whistleblower
certain executives by public companies. Prior to the passage protection entered in force in December 2019, setting
of the Tax Cuts and Jobs Act of 2017, Section 162(m) included out a European framework that has far-reaching
an exclusion from the cap for commission-based and qualified implications for global businesses.
performance-based compensation. For tax years beginning
The directive introduces “common minimum standards” to
after December 31, 2017, the Tax Cuts and Jobs Act amended
protect workers from retaliation if they report breaches of
Section 162(m) so that, among other things, it will cover more
laws in specific EU policy areas. As a result, it comes with a
executive officers and will no longer include these exceptions.
limited material scope yet it establishes for the first time an
international standard in the absence of any other law at EU
The IRS’s August notice left many questions or international level governing whistleblowing procedures.
unanswered and there remains a fair amount The EU Commission made clear in its communication that
of uncertainty as to the proper application it would like member states to implement the directive in
of the rule. the broadest way possible. Implementation must happen by
December 2021, after which businesses will have to establish
The Tax Cuts and Jobs Act provides an important transition
channels for internal reporting and member states will have
rule (commonly referred to as the “grandfather rule”) for
to designate a national authority for external reporting.
compensation offered under a “written binding contract” in
effect on, and not “materially modified” after, November 2,
2017. Compensation covered by this rule is subject to the The EU directive requires companies to
more favorable Section 162(m) rules that were in force prior protect whistleblowers’ identities and to
to the enactment of the Tax Cuts and Jobs Act. On August respect data protection rights.
21, 2018, the Internal Revenue Service (IRS) issued Notice
2018-68 to address key questions regarding the scope of the It is similar in some ways to the US system, which has a
grandfather rule. However, this notice left many questions well-established methodology for reporting misconduct that
unanswered and there remains a fair amount of uncertainty is reflected in industry practice and in the DOJ’s guidance
among practitioners as to the proper application of the rule. from 2019. The DOJ guidance allows allegations to be
reported either confidentially or anonymously, while the
In late December 2019, the IRS issued proposed regulations
EU directive requires companies to protect whistleblowers’
expanding on the guidance released in August 2018 to
identities and to respect data protection rights (in particular
provide more clarifications on the grandfather rule and to
the right of individuals to access their personal data under
further limit some aggressive positions previously being
the EU General Data Protection Regulation). The issue of
taken by taxpayers. Public companies should consult legal
whether anonymous reporting is permitted is left to the
counsel regarding the impact that this new guidance may
discretion of EU member states. In response to this shifting
have on the deductibility of compensation paid under
landscape, global employers should encourage internal
pre-existing contractual arrangements.
whistleblowing and establish a single whistleblowing
system across their operations.
Critical intelligence for boards in a fast-changing world 19Employee benefits: the forward view
EU Commission considers protections for gig workers brief as Executive Vice President for a Europe Fit for the
Digital Age, has previously declared that gig economy
The new EU Commission, which took office on December 1,
2019, has put better protection for gig workers high on its workers are falsely labeled as self-employed. In her view
agenda. What this means in practice remains to be seen, they should be allowed to collectively bargain for their
but the Commission could go as far as to grant self-employed rights, and that if they did it would not constitute unlawful
workers the same rights as full-time employees, including cartel behavior.
allowing them to enter into collective bargaining. Nicholas
Schmit, the EU Commissioner for Jobs and Social Rights,
has said he believes it is important to address new forms of The EU Executive Vice President for a Europe Fit for
precariousness in the labor market in preparation for future the Digital Age, Margrethe Vestager, believes gig
downturns in the digital economy, and has expressly economy workers should be allowed to collectively
referenced California’s Assembly Bill no. 5 – which was bargain for their rights, and that if they did it would
enacted in September 2019 – as an initiative he admires.
not constitute unlawful cartel behavior.
The bill limits the ability of companies in the state to classify
workers as independent contractors rather than employees. If this approach is implemented in the EU it would go
Margrethe Vestager, the former EU Competition against customary practice in the US, where collective
Commissioner who has been reappointed to an expanded bargaining for non-employees generally does not exist.
The new EU whistleblower directive comes
with a limited material scope yet establishes
for the first time an international standard
in the absence of any other law.
Critical intelligence for boards in a fast-changing world 20Shareholder
proposals
A renewed focus on process
Pamela Marcogliese Elizabeth Bieber Jillian Simons
Partner, New York Counsel, New York Associate, New York
While early indications from the 2020 proxy season Shareholder proposals for independent chairs
are that existing substantive trends in shareholder
proposals are likely to continue, there have been some 80%
significant changes to the SEC’s process for reviewing
2018 2019
and responding to no-action letter requests, as well
62
as proposed new rules relating to the submission and
60%
resubmission of shareholder proposals. If passed, these
54 54
measures are likely to have a major impact on how the
47
landscape evolves.
40%
Early indicators: trends in shareholder proposals
Initial trends in shareholder proposals seem consistent
with those of the last few years. However some notable 20%
developments for this proxy season include the following.
Governance – separation of chair and CEO. Investors and
0 0
shareholder proponents continue to focus on independent
0%
leadership. Since 2015, shareholder proposals relating Shareholder Shareholder Shareholder
to this issue have been unsuccessful, but there remains proposals proposals proposals
submitted voted on passed
a steady submission of proposals for independent board
chairs, evidenced by the incoming requests for no-action
Governance – shareholder ability to effect governance
relief through mid-December 2019.
changes. For the 2020 proxy season, proponents continue
Interestingly, for the 2020 proxy season, Legal & General to submit proposals requesting changes that provide
Investment Management, a large asset manager based in shareholders with greater power to enact governance
the UK, announced that it will vote against or withhold in changes, including the ability to act by written consent and
connection with all combined chair/CEOs. via lowering the threshold by which special meetings can
Critical intelligence for boards in a fast-changing world 21Shareholder proposals
be called by shareholders. While such proposals generally E&S – lobbying. In a significant election year, scrutiny of
have not succeeded (only 10 of the 64 combined proposals political lobbying disclosure is likely to increase (as it tends
passed in 2019), they continue to generate significant to whenever voters go to the polls). In 2020, this builds on
support from shareholders. Companies that have received momentum from an already robust 2019 proxy season on
these proposals (or are at risk of doing so) should engage this issue.
with their shareholders to determine the best course of
The SEC’s procedural changes for responding to
action. Because support can be high – and companies often
no-action requests in the 2020 proxy season
face repeat proposals – companies should also engage with
their shareholders after the vote and ensure that disclosure In 2019, the SEC released additional guidance as it relates to
about any next steps and rationale is included in their shareholder proposals and related requests for no-action relief.
following year’s proxy statement. • The SEC Division of Corporation Finance released informal
E&S – environmental. Environmental shareholder guidance that its Staff may decide not to respond by letter
proposals are not going away, and it can be difficult in many to all requests for no-action relief. In some cases the Staff
cases to exclude proposals under Rule 14a-8, in part because will email the company and proponent that its response
repeat proponents have become skilled at developing will be posted to an online chart. The Staff also noted that it
submissions for which there is little basis to request no- may decline to take a view on a request, but that companies
action relief. The good news for companies is that in the should not interpret the declination as a requirement to
2019 season, environmental proposals were withdrawn include the proposal in the company’s proxy materials.9
at the highest rates after engagement, and those that What the SEC’s proposed changes to shareholder
went to a vote received majority support relatively rarely. proposals rules mean in practice
As companies have increased their efforts and related
disclosure in these areas, investors have shown slightly less In November 2019 the SEC released proposed rules
appetite for such shareholder moves. on, among other things, procedural requirements for
submission of shareholder proposals and resubmission
E&S – diversity. In 2019 the New York City Comptroller thresholds. They reflect the SEC’s focus over the last few
launched Boardroom Accountability 3.0, which requested years on modernizing the shareholder proposal process.
the adoption of the Rooney Rule for board candidates and
Potential changes to shareholder proposal
CEOs at 56 companies. In this context, the Rooney Rule
procedural requirements.
would require companies to adopt a policy requiring the
consideration of women and diverse candidates for every • Ownership requirements would be a multi-tiered system
director and CEO search. Combined with related shareholder that would depend on the dollar amount held as a factor
proposals and increasing focus among investors on diversity of time, reflecting a connection between economic
at board, committee, leadership and executive management commitment and investment horizon rather than the
levels, we expect this topic to remain top of mind in 2020. current $2,000-held-for-one-year rule. Unlike the now
Companies should continue to review and revise board ubiquitous proxy access construct, shareholders would
policies and nominating and governance committee not be permitted to aggregate ownership to meet any of
charters, as well as proxy disclosure on these issues. the thresholds.
Critical intelligence for boards in a fast-changing world 22You can also read
