The ESG Threat by Shareholders and Proxy Challenges

By Marc Ross

Sep 7, 2022

In the broader world of Environmental, Social & Governance (ESG), Environment, Health & Safety (EHS) compliance is only one threat to industry operators. Another is the growing use of proxy challenges and shareholder actions against publicly-traded companies. Socially responsible investors and activist board members have been throwing their ESG weight around during the last few proxy seasons at annual shareholder meetings. They demand action on climate change, decarbonization, and "net-zero" carbon footprints. They insist on diverse boards and senior leadership, restrict campaign donations, divestment in specific industries, and request measurement, benchmarking, and reporting of comprehensive ESG impacts.

Among the then-record-setting proposals in 2021, one stands out. In May 2021, Engine No. 1 fired the most powerful shot across the bow of petroleum behemoth Exxon Mobile with a successful bid to elect activist members to the board of directors and push through proposals that required the company to report on lobbying activities annually. This was the first time that a board election turned on ESG issues and Engine No. 1, a relatively small activist hedge fund, did it with only a 0.02% stake in the company. Meanwhile, Engine No. 1 was also able to convince more significant stakeholders to join the fight (Vanguard, Blackrock and State Street) and support the actions, along with the California Public Employees Retirement System (CalPERS) and the New York State Common Retirement Fund.

An early examination of the 2022 proxy season revealed an unprecedented number of ESG shareholder proposals. Of the 924 proposals submitted, 286 had votes, with 30 relating to environmental matters, 107 to social issues, and 149 to governance. While total average support for ESG proposals was down slightly from 2021, more proposals passed in 2022. Civil rights/racial equity audits, labor issues, political lobbying and contributions received the most substantial investor support, though there were some notable environmental proxy challenges. For example, over the opposition of Costco's board, shareholders voted on a proposal requiring the company set plans to reach net-zero emissions by 2050.

Meanwhile, as companies across all sectors face rising pressure from investors and regulators to account for environmental issues in their financial risk management and reporting, corporate directors are coming under scrutiny with lawsuits targeting directors for their failures to assess climate risk. Recent legal opinions from Hong Kong, India, Singapore, and Malaysia have held company directors and board members responsible for incorporating climate change risks into their decision-making. Failure to do so can expose them to shareholder litigation or regulatory enforcement. Globally, climate-related litigation cases have more than doubled since 2015, with 1,200 cases filed in the last eight years.

Recently, ClientEarth, a UK NGO, brought legal action against 13 directors at Shell, claiming they had breached their legal duty to prepare the company for the energy transition. In 2021, Shell was ordered by a Dutch Court to reduce its overall emissions.

The number of cases with strategic ambitions continues to rise, with actions increasingly targeting the food, agriculture, transport, plastics, and finance sectors. In addition, with the SEC's adoption of new rules for "Universal Proxies," the volume of proxy contests is expected to grow quickly and potentially provide activists with an advantage. Meanwhile, employees are increasingly vocal about ESG issues, resulting in more shareholder proposals at their companies.

Not only do these cases and rule changes pose liability concerns to individual directors, but also company reputations with additional negative press, potentially impacting a company's share price.

As with all areas of emerging environmental law, the cannabis industry is seen as a target for investor lawsuits. Although not an ESG matter, this past April the Rosen Law Firm, a global investor rights law firm, filed a class action against Innovative Industrial Properties, seeking to recover damages under securities laws for, among other things, allegedly misrepresenting the valuations of the properties it represents.

Most cannabis companies have not even started to address environmental sustainability issues or comprehensively measure their environmental, social, and governance impacts, gaps, and policies. Formal ESG and Impact reports are rare in the nascent industry, creating a risk to the companies and boards from outside (and inside) activist stakeholders seeking to exert their influence. It is only a matter of time before publicly traded cannabis companies face investor lawsuits, proxy challenges, and activist board elections to move the industry to act with greater responsibility on all environmental and social matters, and governance.

For assistance in ESG-related matters, including corporate social responsibility plans, environmental sustainability and DEI, contact VS’s Impact & ESG team.

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