Political lobbying risks in the US

4D Infrastructure

July 2023

In recent years, political controversies involving US utility companies have caused significant concern for investors.

There have been instances where lobbying activities have contravened the law and resulted in companies and individuals being criminally investigated and punished. Other instances, though not necessarily criminal, have also resulted in negative market reactions. In both scenarios, political lobbying controversies have been difficult for investors to foresee and, therefore, difficult to avoid.

Utilities' role in US politics

Utilities are responsible for the delivery of power and gas from source to end-customers, and are considered key players in the energy supply chain. As a result of the importance of both energy prices and reliability to businesses and consumers alike, utilities are central to economic growth, efficiency and quality of life in their operating jurisdictions.

For these reasons, utility operators believe their corporate responsibility dictates that they should have a voice in the development of energy legislation. With energy legislation and regulation established at both federal and state levels in the US, lobbying is considered important in ensuring that legislation is in the best interest of all stakeholders, including shareholders.

Risk to investors of inappropriate lobbying

Lobbying undertaken by utilities in an open and ethical manner supports a more thorough understanding of energy markets for legislators and a better outcome for both customers and shareholders. The obvious concern is that utilities and/or management teams lobby for their own self-interest or solely that of their shareholders, with little consideration to other stakeholders such as customers. Problems eventuate when lobbying contravenes the law and/or ethical expectations.

Companies should have ethical charters outlining the values that guide how they operate, including how they interact in the political sphere. The old saying, "would you feel comfortable with your behaviour being published on the front page of the newspaper" is also a good guide for what constitutes ethical political lobbying.

Potential violations of the law are often difficult to identify until it's too late and enforcement agencies are involved. Regardless of guilt, once a review is underway, the utility in question will feel pressure as the process evolves. This potentially includes:

1. a lengthy process in which share prices remain deflated;
2.  significant financial penalties if found liable;
3. management disruption as changes are made and teams focus on remedial actions;
4. disruption to regulatory/legislative relationships held by the company; and/or
5. reputational harm which is difficult to quantify and doesn't go away for an extended period of time.

Utilities across the world are bound by a social license to operate. Regardless of strict legality, that social license may be tarnished based on the public's perception that the company has received special treatment from legislators/regulators based on aggressive/unethical lobbying activities. This scenario could result in public backlash, and regulators/legislators taking detrimental action against the utility to reinforce their independence. This can take the form of fines, difficult regulatory decisions, out-of-cycle regulatory reviews and irrational oversight. Negative financial ramifications and poor market sentiment are the result, and re-establishing customer faith in regulators and utilities takes a long time.

4D's approach to political lobbying risk

Due to the high legal, financial and reputational risk associated with lobbying activities, 4D undertakes significant due diligence to identify utilities that are at higher risk and steps being taken to mitigate this risk.

Internal controls

Political lobbying should be guided by a political engagement policy or a similar document recognised by the company board. It should be easily publicly available and outline a set of criteria guiding lobbying efforts and political contributions, and provide authority for contributions and oversight.

Best practice for authority of contributions is for the annual political contributions budget to be developed by the corporate affairs team (or equivalent). The individual contributions should be reviewed by a legal professional and signed off by the most senior executive in the team. It's often a good idea to include an executive or leadership committee review it to ensure widespread knowledge and acceptance of contributions. In our view, large contributions should be reviewed and signed off by the CEO (~>$1 million).

The board audit subcommittee should also review contributions on behalf of the board. A recommendation should then be provided to the board as part of that oversight. Any newly planned contributions should also be reviewed by an audit committee.

This ensures that senior leadership approve all contributions, approvals involve multiple parties, and the board has ultimate oversight.

Transparency

Ensure public transparency of all contributions to individual political figures and parties, political action committees (PAC), other tax-exempt structures (such as 501(c)4 structures), trade associations and political consultancy/advisory groups.

Stakeholders should have access to all internal control and governance documents relating to political engagement.

Appropriate size of contributions

The size of political contributions should be moderated so that they don't give the impression that a political favour is expected in exchange for the contribution. Many utilities have outlined that any individual contribution over $1 million requires CEO sign-off, suggesting that this size of contribution is rare.

Overall contributions need to be moderated as no financial return should be expected on these funds - it should be perceived more as a cost, rather than an investment with the expectation of receiving something in return.

Focus on the utilisation of structures for contributions

Some tax-exempt structures provide anonymity to contributors. Companies should seriously question why they need/prefer anonymity when making a contribution. Generally speaking, such structures have attracted scepticism from the media and stakeholders, and should be avoided unless there is a specific reason for their use.

Some utilities in the past have engaged political consultancy groups. These groups have historically provided anonymity in political lobbying. Interactions with these groups should be transparent internally and externally, including taking meeting minutes for all interactions. Companies should be very clear on their motivations for engaging such groups, and they shouldn't be considered as vehicles to undertake clandestine political manoeuvres.

US federal election laws prohibit corporations and labour unions from making political contributions to federal candidates and national political parties. As a result, companies often use their own, or third party, PACs to make contributions to individuals and parties.

'Pay for play' legislation

Some utility management teams suggest that when a company makes significant contributions to support or oppose a particular ballot measure, it can be interpreted as a 'pay for play' situation. Rightfully or wrongfully, this could be perceived as bribery or a quid-pro-quo arrangement. Best practice would be to lobby through trade associations or PACs with correct governance practices in place to avoid any direct link between the company and an individual ballot measure or proposal.

Third party verification of lobbying controls and practices

Third party verification of companies' political disclosures and practices can support investors' due diligence efforts. One of the more well-known verification groups is the Center for Political Accountability (CPA), which releases the CPA-Zicklin Index annually. Using 24 metrics, or "indicators", the CPA-Zicklin Index assesses companies' disclosure practices, spending and accountability policies for utilisation of corporate funds to influence elections. It does not address company spending on lobbying or PACs.

4D's actions post lobbying controversies

Recent lobbying controversies have influenced our decision to divest companies from our funds. We have exited positions based on the likelihood that a controversy violated the law, disrupted relationships with regulators and stakeholders, and/or there was a lack of definitive action from boards in identifying and rectifying flaws in lobbying controls, processes and disclosures. By contrast, we have also retained positions where our due diligence suggested the above negative thresholds were not violated. Every situation is considered on a case-by-case basis involving internal due diligence as well as engagement with the company in question.

As part of our research into political lobbying best practice, we reached out to companies who rate highly on the CPA-Zicklin Index for comment on this paper and their approach to lobbying. Two such companies in Southern Company and CMS Energy provided their feedback below.

"CMS Energy is ranked First Tier in the CPA-Zicklin Index. We are engaged in the political process, supporting pragmatic policies that are focused on safe, reliable, and affordable energy for Michigan. Our code of conduct and other policies strictly prohibit impermissible political activity, and we have strong controls and oversight established to ensure ethical compliance with all relevant laws. We include more information regarding our political engagement on our website." - CMS Energy.

"This paper highlights the tangible benefits of a clear and comprehensive approach to political disclosure and accountability. Southern Company takes pride in our status as a Trendsetter in the CPA-Zicklin Index of Corporate Political Disclosure and Accountability as we seek to achieve optimal outcomes for our customers." - Southern Company.

Funds operated by this manager:

4D Global Infrastructure Fund (Unhedged), 4D Global Infrastructure Fund (AUD Hedged), 4D Emerging Markets Infrastructure Fund

For more information about 4D Infrastructure, visit https://www.4dinfra.com/

^{The content contained in this article represents the opinions of the authors. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely as an avenue for the authors to express their personal views on investing and for the entertainment of the reader.}