Federalist Society and SEC’s Roisman on Future of ESG, Corporate Governance

Yesterday the Federalist Society held an excellent virtual event on corporate social responsibility (CSR) and environmental, social and governance (ESG) theory, addressing “the divergent views that drive the ongoing debate about shareholder versus stakeholder capitalism.” Former Securities and Exchange Commission (SEC) member Paul Atkins (also a former CEI event guest) served as moderator and opened the event with a reference to Milton Friedman’s famous 1970 New York Times Magazine article, “The Social Responsibility of Business Is to Increase Its Profits.”

Despite its half-century vintage, Friedman’s article remains a lightning rod for hot takes about the role of business in the modern world. The Times published a symposium of (mostly negative) short articles on its anniversary last year, and many other outlets published their own, including National Review, which had a great column written by editor Ramesh Ponnuru, and a subsequent one written by yours truly. Despite large volumes of digital ink providing multiple layers of nuance to the discussion, the Friedman dichotomy remains the starting point for most conversations on the topic. Should business primarily be about products and profits (the traditionalist view) or should business be equally about profits and social policy (the CSR/ESG view)?

The event with Atkins, SEC Commissioner Elad Roisman, and former Delaware Supreme Court Chief Justice Myron Steele was too short to address every possible angle, but it did generate a few important points. Justice Steele said that traditionalist shareholders who object to new ESG priorities are likely not going to get much purchase in state courts like Delaware’s. The First State, despite being tiny in size, has a famously uneven influence on corporate law, given the large number of U.S. corporations that are chartered there. One of the applicable legal provisions, both in Delaware and elsewhere, is the “business judgment” rule, which (to simplify) holds that court generally defer to directors and managers on questions of firm management, unless there is some obviously corrupt dealing, breach of fiduciary duty, or conflict of interest at stake.

Since ESG priorities are routinely justified as contributing toward long-term profitability because of reputational benefits or reduced political risk, they are likely to pass muster even under the traditional regime of shareholder primacy. However, that still hinges on an ESG-embracing firm’s directors claiming that their long-term goal remains profitability for shareholders, a goal that more radical ESG proponents oppose. So, for the foreseeable future, most companies will be free to adopt more “socially responsible” policies, though in the long run they will be on a collision course with progressive activists whose goal is to overturn shareholder primacy entirely.

On a similar note, the panelists discussed demands that firms be required to disclose more detailed data about their operations, and that those demands are in line with the information that the SEC has long required under the aegis of “materiality.” If the information in question is related to the financial performance of the firm, it is considered material to investors. Plenty of ESG advocates have made the case that things like greenhouse gas emissions qualify, since firms might end up incurring liability for them under a new regulatory regime that mandates limited emissions. Commissioner Roisman emphasized, however, that much like allegedly reputation-enhancing ESG initiatives, the claim must ultimately rest on financial impact to the firm, not an argument that such disclosures are a moral necessity irrespective of monetary impact.   

Roisman also addressed the recent SEC policy change on shareholder resolutions and proxy statements (Rule 14a-8), which updated the threshold by which shareholders of public companies are allowed to put forward such resolutions. He was quoted in a Commission press release at the time of the announcement, saying:

The only constant in our markets is the fact that they will change. It is our job as regulators to make sure our rules keep pace. The amendments to Rule 14a-8 that the Commission adopted today aim to ensure that shareholder-proponents demonstrate a sufficient economic stake or investment interest in a company before they are able to submit proposals to be included in a company’s proxy statement, paid for by all shareholders.

Shareholder resolution rights and ESG theory are closely linked, as many of the progressive policies that have been advanced via the former in recent years are elements of the latter. The SEC’s decision was controversial at the time it was announced, generating a strong dissent by then-SEC commissioner (and current acting chair) Allison Herren Lee, despite Roisman’s characterization of it on Thursday as a “modest” reform. Roisman emphasized that while it does limit the ability of some small and recent shareholders from participating in the process, that participation can come with significant costs for the firm in question and other third parties, saying “Everyone is entitled to their own soapbox in America, but you’re not entitled to have someone else pay for it.” He also suggested that the shareholder resolution and proxy process had been “abused” in the past by certain political activists.

Under the current administration, we will likely see a far greater emphasis on ESG-style regulation and disclosure mandates, if the public remarks of acting Chair Lee are anything to go by. For more background on and predictions of future policy developments, see my recent articles for National Review‘s “Capital Matters” vertical:

See also Commissioner Roisman’s keynote address to the Society for Corporate Governance’s National Conference in July 2020, in which he discusses “ESG (and What It Means to You and Me).”