DEI in the Dock
Litigation looms, but US attempts to erase the acronym are unlikely to diminish the value of human capital to investors.
The concept of diversity, equity and inclusion (DEI) has taken a battering since US President Donald Trump issued two executive orders (EOs 14151 and 14173) against “illegal DEI” in late January, prompting many companies to drop or alter their initiatives to increase diversity among the workforce and senior management.
A handful of high profile companies and financial institutions – such as McDonald’s, Walmart, Meta, and Goldman Sachs – announced plans to pull back even before the EOs were signed, while others waited for the ink to dry before removing or watering down language around DEI policies. Among the most recent to retreat is State Street, which installed the famous ‘Fearless Girl’ statue in Manhattan in 2017.
Amid the general mayhem, several developments impacting shareholder engagement have caught institutional investors’ attention as they head into proxy season.
On 11 February Institutional Shareholder Services (ISS), which manages proxy voting processes on behalf of many investors, stated that it would no longer consider the diversity of a company’s board when making vote recommendations with respect to the election or re-election of directors at US companies.
Fellow proxy advisor Glass Lewis said it would carry a ‘for your attention’ flag to clients any recommendations to vote against a director at a US company for diversity reasons, due to the “potential risks”.
At the same time, the US Securities and Exchange Commission (SEC) announced major shift in the way it deals with shareholder proposals, giving companies more scope to exclude proposals. Staff Legal Bulletin 14M, which retrospectively applies to proposals filed before the rule was introduced, sets thresholds for filings in terms of ‘ordinary business’ and ‘economic relevance’.
In addition, the SEC has issued separate guidance requiring extended disclosures from shareholders to dissuade them from asserting their intention to vote against management to influence decision-making.
Turbulent times
Companies, asset owners and managers are being forced to react quickly in a fast-changing environment during a busy period in the corporate calendar.
Hyewon Han, Director of Shareholder Advocacy at Trillium Asset Management, a Boston-based specialist ESG-focused investment manager with more than US$5 billion in AUM, believes that much of the fallout from the EOs has already occurred. “It seems like the handful of companies that planned to pull back or change their policies and programmes have done so, and now we’re in a quiet period,” she says.
Han also highlights the companies that have decided to double down on retaining their programmes and policies, such as Costco and Apple, with shareholders solidly rejecting anti-ESG/anti-DEI proposals. More recently, 98.7% of investors in Deere & Co voted against curbing DEI efforts at the farm equipment manufacturer.
However, many companies that had implemented pro-DEI policies and related measures over the past few years feel caught between having to mitigate risk related to Trump’s EOs – which come with reputational and legal risk – and ensuring that they meet shareholders’ expectations, according to Greg Demers, Partner at US multinational legal firm Ropes & Gray.
“There’s a lot of uncertainty in a very charged political environment,” he says. “As such, many companies – the large ones in particular – don’t want to be seen doing something outside the mainstream, at least until this initial wave of enforcement subsides.” He believes that enforcement efforts at the federal and state level will continue, and expects to see an uptick in purported whistleblowers under the False Claims Act.
Caroline Boden, Director of Shareholder Advocacy, Mercy Investment Services, a member of the Interfaith Center on Corporate Responsibility, agrees that significant potential legal, financial, and reputational risks remain, as US companies are legally obligated to comply with anti-discrimination and civil rights laws.
“Companies’ rollback of DEI policies and programmes may potentially expose them to increased legal and litigation risks,” she says. “On the financial and reputational risk side, we’re seeing customers push back against these changes and express their concern on social media and, in some cases, call for boycotts. Diverse-owned suppliers are also speaking out about how these changes affect their small businesses.”
Lindsey Stewart, Director of Investment Stewardship and Policy, Morningstar Sustainalytics, sees recent developments as an escalation of a process that’s been ongoing over the past two years, where companies have increasingly come under attack from conservative activists, either through litigation or proxy voting.
“Yet it’s different when the US president signs EOs explicitly targeting DEI initiatives,” he says. “While the EOs are mainly focused on the federal workforce, there is direct impact for companies that are federal contractors, so they will need to think carefully about how they proceed with ongoing programmes.”
Proxy season pivot
Stewart doesn’t think anti-DEI shareholder proposals will cause a big stir during the upcoming AGM season, as they are consistently very poorly supported. “The institutional investor community has already decided that anti-DEI proposals are not useful,” he says. “However, that won’t insulate companies against challenges from elsewhere, be it lawsuits or hostile regulatory and law changes in the US.”
The bigger question in Stewart’s mind is how the so-called ‘pro-DEI’ proposals will fare, such as those that request reporting on pay gaps, workforce composition, etc.
“This may have become harder to read because of the SEC guidance reintroducing restrictions on the types of shareholder proposals that make it to the proxy ballot,” he says. “Ongoing engagement requests from investors are being considered against a different standard to last year or even several weeks ago. As a result, we may see fewer of such votes coming to the ballot this year.”
Han also expects less DEI/ESG-related proposals to vote on compared to other years, due to the SEC 14M bulletin. “Anti-ESG sentiment was on the rise prior to the Trump administration, and 2024 was also considered a bad year for anti-ESG proposals,” she says. “So, 2025 is going to be similar to 2024, if not worse.”
Han, for one, is baffled by ISS’s decision to roll back on a core pillar of governance, which she believes displeased a large swathe of investors, not those strongly focused on sustainability themes. “Even in the realm of traditional investment management, firms have long held there is sufficient academic evidence supporting [diverse] boards,” she says.
US-based shareholder advocacy NGO As You Sow published a report in November 2023 analysing more than 1,600 publicly traded US companies, which found that greater diversity in corporate management correlated with many benefits, including improved income after taxes and long-term growth.
“Data shows that all white male management teams underperform against diverse ones,” says As You Sow’s CEO Andrew Behar. He adds that the NGO’s As You Vote service has received increased interest following ISS’s decision.
While not convinced that proxy votes themselves are essential, being non-binding in the US, Behar emphasises the need for strong communication between a company and its shareholders. “Companies need to understand what the shareholders think is important, and most appreciate the value that their shareholders bring,” he says.
Stewart also promotes regular interaction between investors and companies.
“As often happens with stewardship and governance, we need open dialogue between boards of directors and investors trying to seek optimal solutions that deliver on fiduciary duty and shareholder value, but also respect the sustainability and social preferences of large investors,” he says. “That’s never an easy dance, even in less volatile times.”
DEI reset?
While more US companies may quietly pull back on DEI initiatives in future, Han points out that they will continue to need to provide for their employees’ health and well-being to maintain productivity. “Companies have a vested interest in strong human capital management. Therefore, we may see cosmetic changes to the language used and public disclosures, but we’ll have to wait to see if that translates into real change in practice,” she says.
Both Han and Behar question whether the DEI label will continue to be widely used, not because it has served its purpose – as alleged by Goldman Sachs – but because the acronym has been tainted by the backlash in the US.
“I doubt anyone’s going to use the DEI acronym again, but the practice of optimising human capital will continue,” says Behar. “Data shows that a diverse workforce outperforms financially, so investors will move their money and overweight their portfolios with better management teams.”
Morningstar’s Stewart suggests most changes wrought by recent regulatory changes will be largely superficial.
“Labels come and go. If a country’s government is hostile to DEI explicitly, then there will be reaction to that. However, I do not believe there is any point at which large, and often multinational, businesses can completely ignore the effects of the issues that are considered within DEI programmes,” he adds. “Workforce composition, the ease of attracting certain groups and the relevance of a company to different groups of consumers will always be considerations, even if a label isn’t applied to it.”
Boden believes that society as a whole – consumers, shareholders, workers and constituents – doesn’t want to go back to overlooking how systemic racism, discrimination and ableism creates barriers to equal opportunities.
“It is the principles of these acts, as well as the commitment that all are created equal, that form the foundation of what DEI stand for – creating equal access to opportunities and addressing systemic and structural barriers,” she says.
The post DEI in the Dock appeared first on ESG Investor.