New SEC guidance impacting corporate governance in wake of strengthened anti-ESG environment

The Securities Exchange Commission (SEC) recently released guidance that impacts shareholder engagement and shareholder proposals concerning potential environmental and social issues that may come up during proxy season. The SEC — with an acting chair and incomplete Commission due to several pending appointments — communicated this information through guidance rather than formal rulemaking during this interim period.

This SEC bulletin, known as SLB 14M, which came out February 12, reflects a return to a more traditional approach regarding the shareholder proposal process. In addition, it is also a shift back to previous principles-based rulemaking that focus primarily on financial materiality, according to June Hu, Special Counsel at Sullivan & Cromwell. The guidance also signals a potential reversal of previous rules passed in 2021, which had allowed stockholder proposals with “broad societal impact.”

This move by the SEC has important implications for shareholder proposals that raise social and ethical issues because a company could choose to exclude a proposal based on economic relevance of the stockholders who are supporting a proposal, according to Hu. Indeed, this new guidance essentially reverses the SEC’s 2021 action that allowed proposals touching on “broad societal significance” to bypass the ordinary business exclusion.

The 2021 action allowed such shareholder proposals to go forward based on two considerations: i) whether the proposal addresses issues essential to the management’s daily operation of the company and which makes it impractical for shareholders to directly oversee these matters; or ii) whether the proposal excessively controls or interferes with the company’s management processes.

Impact of this new SEC guidance on ESG

The effect of the ordinary business exclusion and the evaluation of shareholders’ economic relevance is expected to lead to more companies successfully excluding shareholder proposals, including those related to environmental, social & governance (ESG) and anti-ESG issues, according to analysis by Sullivan & Cromwell. In particular, the ordinary business exclusion emphasizes the need for a company-specific materiality analysis when determining whether shareholder proposals can be excluded from proxy materials. As a result, this shift is widely expected to make it easier for companies to exclude shareholder proposals from their proxy statements, particularly those related to ESG and political policies.

In addition, the return to principles-based and mandated reporting on financially material matters has two important implications for companies and their ESG reporting:

Strengthened separation of financial and sustainability data — This SEC guidance strengthens the likelihood that financial material information will be the sole focus of SEC filings and that non-financially significant information, like specific ESG disclosures, might be relocated to sustainability reports rather than being included in SEC filings, according to Hu. This distinction could help streamline SEC documents and makes sure that they remain focused on financial data relevant to investors.

Distinction between financial and sustainability reporting timelines — Before this new guidance, some companies were moving toward the simultaneous release of their annual financial reports and sustainability reports. This was a challenge for companies because “the reliance on third-party data, especially for Scope 3 emissions, presents hurdles in timely and accurate reporting,” Hu states. However, the focus now on principles-based reporting of financially impactful information ensures that the timelines are likely to remain different.

What should companies do now?

To navigate this murky environment, Hu advises companies to seek legal counsel to ensure compliance and strategic alignment with the evolving regulatory environment. In addition, companies should:

Monitor legal requirements — Make sure legal requirements are the foundation for their disclosures and decision-making processes. A company-specific materiality assessment is crucial in determining what issues are financially material and significant to the company’s business model, and thus, to shareholders.

Focus on principles in disclosures — Ensure that all filings align with the SEC’s principles-based approach to disclosure. Companies should focus only on financial information in their SEC filings and reserve other information for sustainability reports or other documents that cater to a wider stakeholder base.

Balance risks and benefits regarding what information to include in SEC filings — Hu also recommends that companies should conduct a cost-benefit analysis of disclosure placement and consistency. This means considering the potential risks and benefits of including certain information in their SEC filings rather than in other reports. By taking a thoughtful and company-specific approach to disclosure, companies can navigate the evolving regulatory landscape and make strategic decisions that align with their mission and the expectations of their stakeholders.

Caution is warranted on the horizon

Once fully staffed, the SEC will likely consider changes to existing rules around shareholder engagement. Likewise, Hu said she also expects the SEC to scrutinize those actions recommended by proxy advisors as signals for the proxy season’s voting patterns, particularly on proposals related to diversity, equity, and inclusion (DEI), especially as some companies narrow their activities in this area. However, it is a little early to know the impacts, she adds.

Either way, companies must proceed with caution and strike a balance between investor expectations and regulatory requirements, while primarily focusing on issues that are significant to their specific business model and bottom line.

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You can find out more about how the Securities and Exchange Commission is managing the current regulatory environment here