White & Case LLP has partnered with the Financial Times on the publication of its Moral Money Forum reports, which explore key issues from the ESG debate. This article has been reproduced with permission from the Financial Times.
Following the global spotlight on racial justice after the death of George Floyd in May 2020, companies face mounting scrutiny to refocus boardroom efforts on expanding corporate DEI initiatives. Many have since made significant strides in designing, enhancing and implementing DEI programmes and commitments. Against this backdrop, novel legal, reputational and shareholder activism risks are emerging, and not only in the US.
Scrutiny of DEI disclosures will accelerate due to an inevitable surge in the availability and quality of data with new regulatory requirements across jurisdictions which companies need to monitor, and include:
- In the UK, the Financial Conduct Authority introduced new rules in 2022 for certain companies to include disclosures on ethnic minority and gender representation on boards.
- Subject to transitional measures, Nasdaq-listed companies are now required to disclose board level diversity statistics through a board diversity matrix on an annual basis or disclose why they do not have a minimum of two diverse board members.
- The EU's Corporate Sustainability Reporting Directive will require in-scope companies to make DEI disclosures under the European Sustainability Reporting Standards. These are defined within ESRS S1 (Own Workforce), which cover over a dozen separate data points ranging from key DE&I policies and practices, targets and actions, to workforce diversity and pay equity data.
- In late 2023, California also passed a diversity reporting law requiring certain "covered entities" to report on the diversity of founding members of businesses in which they invested during the previous year. Although targeted at venture capital, the law appears to be worded broadly enough to apply to many private equity funds.
- The International Sustainability Standards Board has also indicated that it would research the development of DEI-specific reporting standards.
- The launch of the Taskforce on Inequality and Social-related Financial Disclosures is expected in the third quarter of 2024, to develop a voluntary baseline reporting framework covering a range of DEI issues. Along with the Taskforce on Nature-related Financial Disclosures framework, the TISFD could follow in the footsteps of the Task Force on Climate-Related Financial Disclosures regime in becoming mandatory in many jurisdictions.
As well as regulatory changes, proxy advisers (such as ISS and Glass Lewis) and institutional investors (like BlackRock and Vanguard) have sought to introduce board diversity requirements or policies.
Pursuing different agendas
Using increased disclosures, anti-ESG sentiment has targeted DEI, with tactics including actual or threatened litigation, state attorney-general investigations, shareholder activism, legislation proposals and federal investigations. All create new risks for companies implementing DEI programmes, commitments and targets. Examples include the National Center for Public Policy Research's lawsuit filed against Starbucks executives and directors in their personal capacity, and America First Legal's civil rights complaints against several companies (eg, Alaska Airlines, Unilever), alleging that their DEI initiatives amount to discrimination. The US Supreme Court's recent decision finding that universities may not make use of race-based admissions systems in higher education (the so-called affirmative action ruling) may embolden claimants to challenge corporate DEI initiatives. In response to the judgment, Strive Asset Management demanded that one of its portfolio companies rescind diversity targets for employees and suppliers.
Investor pressures
According to Georgeson's Investor Voting Insights Report, 140 shareholder proposals were filed on human capital management and DEI in the US in 2023. The DEI resolutions centre around racial equity/civil rights audits, pay gap reports, reports on DEI effectiveness and inclusive hiring, racial justice, board diversity, AI equity and the decline in investment firms' voting records on pro-DEI resolutions at portfolio companies.
Despite the broad range of shareholder proposals, it is likely that most action will take place behind the scenes, as boards seek to negotiate agreements with activists to keep proposals off the ballot or to have them withdrawn ahead of AGMs.
Board engagement
Boards should prepare for the DEI debate moving beyond shareholder proposals; extending into votes on issues such as (i) inclusion of DEI metrics in executive compensation packages (more than 75 per cent of S&P 500 companies link executive pay to ESG metrics with increases in DEI outcomes); and (ii) elections or re-elections of directors or CEOs who have been embroiled in DEI controversies.
Consumer and employee activism
Consumer boycotts or "cancel culture" and employee demands bring new challenges. Campaigns such as Black Lives Matter, Stop Asian Hate and positive activism on behalf of the trans community have prompted changes in practices and marketing.
Mitigating legal risks
Companies at varying stages of building their DEI strategy can accelerate and enhance efforts to mitigate the legal risks with key objectives on the board's agenda:
- Assessing the company's short- and medium-term DEI aspirations, and the roadblocks to achieving desired outcomes.
- Appropriate cross-functional teams to ensure that any goals and challenges are appropriately reflected across DEI-related policies and public disclosures to mitigate the risk of allegations of "DEI-washing" or "DEI-hushing".
- Taking stock of how the company is currently placed to gather the data required to meet existing or emerging legal frameworks.
- Proactively engaging with activist investors to pre-empt and mitigate the filing of resolutions.
- Engaging in meaningful dialogue with internal and external stakeholders to develop the company's DEI strategy/road map, and mitigate the risk of whistleblowing, the filing of grievances, or consumer boycotts.
Taking these steps can help companies not only mitigate risk, but can also help demonstrate both DEI progress and accountability to stakeholders and regulators. Robust data can help to inform DEI-insights, gain a better understanding of the company's progress, and develop an appropriate and effective path forward for delivering stronger DEI outcomes for the future.
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