Shareholder Engagement Strategies for Environmental, Social, and Political Issues Board MemorandumShareholder Engagement Strategies for Environmental, Social, and Political Issues Board Memorandum

TO: Board of Directors (the "Board") of [company] (the "Company")

FROM: [name], [title/firm]

SUBJECT: Shareholder Engagement Strategies for Environmental, Social, and Governance (“ESG”) Issues

DATE: [date]

As discussed in [a recent meeting of the Board / the meeting of the Board dated [date],] [and] [i]n view of the increased significance of ESG issues to shareholders and recent shareholder proposals relating to ESG issues submitted to similarly-situated companies in the Company’s industry[, including proposals relating to sustainability disclosures, gender pay equity, diversity of the membership of the board of directors,] the Board has determined to ensure the Company’s shareholder engagement strategy is ready to address shareholders’ ESG-related concerns in an effective manner.

To aid the Board in achieving this goal, this memo will review ESG-related shifts in shareholder priorities, how different types of shareholders and outside parties approach ESG issues, and effective engagement strategies the Company may employ.

• ESG issues remain of critical importance to shareholders’ voting patterns. [Morningstar, Inc. research shows that the one-to-three year average support among institutional managers for key ESG resolutions is approximately 50% as of January 2, 2024. Although this reflects a decrease since the previous proxy year, ESG remains a significant shareholder focus.] This reflects a shift in the types of investors that hold public company shares from retail to institutional shareholders and a resulting shift in priorities from short- to long-term value. Institutional investors, who tend to value long-term gains, now own approximately 80% of the U.S. equity market capitalization, up from 67% in 2010. Institutional investors agree that these issues are extremely important to them; affect their voting deeply; and should receive fulsome disclosure, with a connection to long-term financial risks, opportunities, and outcomes, by their portfolio companies. For example, BlackRock and State Street have published letters to clients discussing their increased scrutiny of the disclosure and handling of environmental issues by companies in which they invest

• ESG issues are diverse, shift in public visibility quickly and dramatically, and evolve over time. A few examples include: climate change, sustainable energy sources, gender pay equity, LGBTQIA+ representation, representation of people of color, ethical or “fair trade” supply chains, and outsourcing practices. Companies have had to adapt their shareholder engagement strategies to accommodate the increased importance of ESG issues to investors and address the concerns of institutional shareholders, the strategies of activist shareholders, and the pressures of proxy advisory companies.

• The increased shareholding of institutional investors has brought their priorities to the forefront. Institutional investors, especially passive institutional investors, tend not to be able to divest from any particular company easily, relative to retail investors, and therefore compute value differently. The main difference, from an ESG perspective, is that they place more emphasis on long-term performance. This emphasis means that they are likely to engage with their portfolio companies on issues which historically have been given little weight by investors focused on the short-term. They use this more active engagement style to decrease their “downside risk,” the risk of loss of value due to market conditions, arising from ESG issues.

• A single ESG issue can pose several types of downside risk. The following are examples of three categories of risk arising from a single issue, [climate change]:

  • • Regulatory risk. [As the effects of climate change intensify, governments may promulgate rules, laws, or policies to mitigate these effects. The imposition of carbon taxes or a decrease or elimination of subsidies for fossil fuels as part of a transition to renewable and sustainable power generation would be particularly relevant to The Company.]

  • • Business risk. [The effects of climate change, if not sufficiently mitigated, may directly impact The Company's customers, suppliers, facilities, or assets. If the Company's datacenters in [location] were to experience higher average temperatures or increased flood risk, the cost of maintaining such datacenters would rise.]

  • • Reputational risk. [The Company's policies and communications relating to climate change may harm its perception in the market. If the Company were to make a political contribution that customers viewed as an impediment to shifting from fossil fuels to sustainable and renewable sources of power, it may damage the Company's reputation.]

  Drafting Note

  Drafting Note to Section 2., Second Paragraph

  Replace the bracketed text in each bullet point above with an example of a risk that is pertinent to your client's business or industry. Add or modify any categories of risk as applicable to your client. The risk factors set forth in your client's annual Form 10-K will likely provide helpful information here.

• Similar categories of risk may attend other ESG issues facing the Company.

• Activist investors understand these risks and priorities and have shifted the arguments they use to support their shareholder proposals accordingly. Their tactics include seeking institutional investor support by framing ESG issues in terms of long-term performance and leveraging reputational risk by linking ESG issues to their shareholder proposals and public comments about the target company.

• Activist investors tend to lack the funds to take large positions in their targets' voting stock. As a result, their primary means of applying pressure to a target company is by submitting shareholder proposals for inclusion in the company's proxy materials pursuant to Rule 14a-8 under the Securities Exchange Act of 1934, as amended ("Exchange Act"). They may also submit competing proxy materials to shareholders, although this is a more costly undertaking, pursuant to Regulation 14A under the Exchange Act. The pressuring effect of shareholder proposals leads most of them to end in settlement agreements between the activists and the company, but a significant number do go to a vote and pass.

  Drafting Note

  Drafting Note to Section 2., Fifth Paragraph

  This memorandum assumes that the board of directors is already familiar with shareholder proposals in general. If not, it is highly advisable to prepare a memorandum or a presentation explaining the overall process and consequences to them. For more information relating to Rule 14a-8 and Regulation 14A, as well as applicable state law, see Proxy Contest Preparation and the Proxy Statement and Annual Meeting Resource Kit.

• Additionally, changes to Regulation 14a in 2021 mandating the use of a universal proxy card for contested elections of directors makes it easier for activists to get their director nominees elected. ESG-focused activists can use a director-focused strategy to get more ESG-focused directors elected.

  Drafting Note

  Drafting Note to Section 2., Sixth Paragraph

  See Proxy Contest Preparation and Annual Meeting Universal Proxy Card.

• Proxy advisory firms, such as Institutional Shareholder Services (ISS) and Glass, Lewis, & Co., constitute a third source of ESG pressure. Although they have less influence than they once did, their voting recommendations are still widely read. ISS’ “E&S Disclosure Qualityscore” metric tracks hundreds of ESG-related issues and this score is playing an increasingly prominent role in their voting recommendations.

• The pressures and proposals on the Company from institutional investors, activist investors, and/or proxy advisors are likely to make demands similar to the following:

  • • Enhanced disclosure relating to an ESG issue

  • • Nomination and election of candidates to the board of directors who are, in the proponents' view, better positioned to address an ESG issue

  • • Setting specific ESG-related performance targets and linking management compensation to those targets

  • • Divestment from a particular supplier, line of business, or termination of a relationship with a specific customer (such as a government agency)

  • • Setting up a charitable or nonprofit structure to mitigate the effects of an ESG issue

  • • Modifications to internal company policies, such as hiring practices

• Given these trends, the Company should seek to understand who its particular shareholders are, their voting histories, the mix of institutional and other investor types holding its shares, and how the Company's industry bears on its shareholders' needs.

• [if applicable, insert a discussion of the Company's key shareholders, their prior voting patterns, and any other existing research or indicators]

  Drafting Note

  Drafting Note to Section 3., Second Paragraph

  If you are not part of an outside firm retained as part of a shareholder engagement initiative, it may not be clear exactly who your client's shareholders are. If a public company is still controlled by a small group of founders, it may have a weak shareholder engagement plan. These and other scenarios may limit your ability to discuss the company's particular circumstances. Researching the client’s shareholder base can help the company formulate a reasonably robust engagement strategy or bolster an existing one. If a client has a weak engagement strategy, you may wish to bring up the possibility of hiring a proxy solicitation firm to perform research and/or provide guidance and services on a long-term basis or at least as a means to get the company back on the right foot.

• A. Responsibilities of the Investor Relations Team or Contact 

  • The essential rules of shareholder engagement are even more critical in the context of a sensitive ESG issue. The speed and intensity of social media can cause an ESG issue to impact a company's public image, and even share price, quickly and without warning. In response, an increasing number of public companies are setting up dedicated investor relations (IR) teams to handle the increased speed, complexity, and sensitivity of modern shareholder engagement. Setting up a dedicated IR team allows a company to engage early and often with shareholders, ensures conflicting messages don't come from different sources, and allows team members to develop the expertise and depth of knowledge on complex or sensitive ESG issues faced by the company needed to respond in a clear, informed way. Some companies hire the services of an investor relations firm as an alternative. In the absence of a dedicated investor relations team, the Company should at least designate a single point of contact for shareholder concerns and provide that contact with as much support as possible.

    Drafting Note

    Drafting Note to Section 3.A., First Paragraph

    For a form memorandum relating to activist shareholder engagement generally, developing the points in this section further, see Shareholder Activist Engagement Board Memorandum. You may find it expedient to combine sections from that memorandum into this one.

  • The IR team or contact will need to, at a minimum:

    • • Understand current ESG-related concerns of the company's shareholders and predict, or at least plan for, their future ESG-related concerns

    • • Be well-versed in how the board of directors and management are addressing ESG-related concerns and able to communicate the steps the company has taken to address them

    • • Avoid Regulation FD violations by refraining from selective disclosure of material non-public information

    Drafting Note

    Drafting Note to Section 3.A., Second Paragraph

    Regulation FD requires companies to reveal material non-public information to the public simultaneously with, or a short time after, any private disclosure is made. The board should be made familiar with these rules if it is not already. For more information, see Regulation FD and Regulation FD Training Presentation Materials.

  • The IR team or contact should work with the Company's counsel on ESG-related disclosures that keep investors informed while complying with the regulatory requirements governing those disclosures.

    • • Periodic reports on [Form 10-K or Form 10-Q]: in these forms, ESG-related disclosures will primarily take the form of risk factor disclosure. If material, the progress of a given initiative relevant to ESG concerns, such as [an initiative to use only certified carbon-neutral energy sources in production by a given date], may be disclosed.

    • • Proxy statements: disclosures in proxy materials will primarily relate to shareholder proposals and the election of directors, each of which may be ESG-related.

    • • Voluntary reports, press releases, newsletters, social media, and other communications: these are good venues for the Company to highlight its successes, affirm its values, and shape the conversation around its actions. Many companies voluntarily release sustainability reports, diversity reports, and other metrics highlighting their commitment to ESG issues. Although these communications are less formal than disclosures made in periodic reports and proxy statements, it is essential that proper internal controls are observed prior to release.

• B. Responsibilities of the Board of Directors and Management 

  • The IR team will need to have the ear of the Board and Company management with respect to ESG issues. The Board, the Chief Executive Officer, and other shareholder-facing management should receive reports on ESG issues from the IR team, help to shape the Company's talking points around them, and be prepared to answer questions from the media and from shareholders directly on these issues. This will help the Board and management set the "tone at the top" as one that is not merely reactive to ESG issues, but one which is proactive, informed, and engaged in addressing them in a meaningful way.

  • Direct experience by Board members with ESG issues faced by the Company will inspire trust and confidence in shareholders and make communications easier. The Board should consider modifying the criteria it uses to evaluate candidates for Board membership to emphasize experience with ESG issues; evaluate its current level of ESG experience; and take a proactive posture toward addressing, whether through board consultants or independent audits of ESG issues, any experience gaps which activist investors may highlight when submitting a competing slate of directors.

  • In addition, the Board, or a committee thereof, should review all internal policies, such as hiring policies and parental leave policies, and employee handbooks for ESG issues, as well as internal controls for preventing and reporting violations of such policies.

  • [I am/We are] always available to provide further assistance to the Board with respect to these issues. For further information, or if you have any questions or concerns, please contact [name], [title] at [phone number] or by email at [email address].