Yesterday, in remarks at an accounting conference that was co-hosted by Sustainability Accounting Standards Board (SASB) and the Center for Audit Quality (CAQ), SEC Commissioner Allison Herren Lee continued to signal that she’d get behind prescriptive ESG disclosure rules. The whole speech is worth reading, but I’ve pulled some key takeaways:
Concerning the commonly-raised point that ESG matters are already required to be reported to the SEC:
Public company disclosure is not automatically triggered by the occurrence or existence of a material fact. There is no general requirement under the securities laws to reveal all material information. Rather, disclosure is only required when a specific duty to disclose exists…
Let’s take political spending by public companies as an example because it illuminates the principles behind both types of possible duties… When companies use shareholder funds for political influence, it stands to reason that shareholders would want to be able to assess for themselves whether such spending is in their interests. But companies rarely disclose political spending in reports filed with the SEC for the simple reason that there are no explicit SEC rules requiring such disclosure.
The bottom line is absent a duty to disclose, the importance or materiality of information alone simply does not mandate its disclosure.
Concerning “principles-based” disclosure rules:
Even when a duty to disclose exists, however, a principles-based standard that broadly requires disclosure of “material” information presupposes that managers, including their lawyers, accountants, and auditors, will get the materiality determination right. In fact, they often do not.
Although dependent upon the views of the reasonable investor, materiality determinations are typically made in the first instance by management. In doing so, management may rely on a “gut” feeling, anecdotal interactions, and even their own experience as investors. We know that in making these determinations, management frequently sees things differently from investors. Managerial judgments are usually subject to review by other professionals. Auditors examine the financial statements; lawyers review much of the narrative in SEC filings. Particularly with respect to materiality determinations and the content of SEC filings, management often relies extensively on the advice of legal counsel.
Yet, lawyers and auditors can also get the decision wrong. As with managers, they may see materiality differently from investors. A disclosure system that lacks sufficient specificity and relies too heavily on a broad-based concept of materiality will fall short of eliciting information material to reasonable investors.
Concerning the SEC’s authority to require ESG disclosures:
In practice Regulation S-K has, from the outset, required periodic reports to include information that is important to investors but may or may not be material in every respect to every company making the disclosure. We have done this, for example, with respect to disclosures of related party transactions, environmental proceedings, share repurchases, and executive compensation. The idea that the SEC must establish the materiality of each specific piece of information required to be disclosed in our rules is legally incorrect, historically unsupported, and inconsistent with the needs of modern investors, especially when it comes to climate and ESG.
On the argument that ESG disclosure is motivated by political agendas and are not really material:
… The fact that a topic may have political or social significance does not foreclose its being material, either qualitatively or quantitatively… investors, the arbiters of materiality, have been overwhelmingly clear in their views that climate risk and other ESG matters are material their investment and voting decisions.
