After announcing a newly-formed task force aimed at “increasing investor focus and reliance on” environment, social, and governance (“ESG”)-related disclosures and investments earlier this month, the U.S. Securities and Exchange Commission (“SEC”) is calling on investors, registrants, and other market participants to provide public comment on its current climate change disclosure policies and practices, and insight on how the agency can “best regulate, monitor, review, and guide climate change disclosures in order to provide more consistent, comparable, and reliable information for investors while also providing greater clarity to registrants as to what is expected of them.”
In a public statement on Monday, Acting SEC Chair Allison Herren Lee revealed that since the SEC released its Climate Change Guidance in 2010, which provided direction to issuers as to how existing disclosure requirements apply to climate change matters, “Investor demand for – and company disclosure of information about – climate change risks, impacts, and opportunities has grown dramatically.” Consequently, Lee stated that questions have arisen “about whether climate change disclosures adequately inform investors about known material risks, uncertainties, impacts, and opportunities, and whether greater consistency could be achieved.”
With the growing importance of ESG issues for consumers and investors, alike, in mind, the ESG Subcommittee of the SEC Asset Management Advisory Committee issued a preliminary recommendation late last year that proposes “requir[ing] the adoption of standards by which corporate issuers disclose material ESG risks.” The Subcommittee asserted in December that its “recommendation is limited in scope” because “significant” SEC-specific disclosure requirements already mandate that securities-issuers (i.e., corporations, investment trusts, and/or governments that sell securities to finance their operations) disclose “material risks” – or in other words issues that could have a financial impact on a company if they are not managed appropriately.
Given that material risk disclosure requirements already exist, and were updated as recently as August 2020, “We do not see the need to change the disclosure laws to improve the quality and comparability of ESG for investors,” the ESG Subcommittee stated.
What the Subcommittee does recommend, however, is “the adoption of standards for those disclosures,” namely, “mandatory, rather than voluntary, standards,” since it claims that “the current, unguided approach has not resulted in consistent, comparable, complete and meaningful disclosure.” Specifically, in its December 2020 recommendation, the Subcommittee suggests that for securities-issuer disclosures, the SEC should: “(1) require the adoption of standards by which corporate issuers disclose material ESG risks; (2) utilize standard setters’ framework” – such as that of the Financial Accounting Standards Board – “to require disclosure of material ESG risks; and (3) require that material ESG risks be disclosed in a manner consistent with the presentation of other financial disclosures.”
In short: the ESG Subcommittee proposes requiring standardized – and thus, comparable – disclosures of material risks (and presumably, “uncertainties, impacts, and opportunities,” as well) by all issuers.
As for what those standards might look like, Lee provided some insight by way of her statement on Monday, which calls on relevant parties to evaluate the proposed disclosure rules and sets out over a dozen questions that commenters might find “useful to consider as part of this evaluation.” Among those questions, a few are particularly striking: “What information related to climate risks can be quantified and measured?,” for one. And also, “What are the advantages and disadvantages of establishing different climate change reporting standards for different industries, such as the financial sector, oil and gas, transportation, etc.? How should any such industry-focused standards be developed and implemented?”
These questions are interesting in that they seem to suggest that the Subcommittee is considering the adoption of specified measures that aid in pin-pointing “material risks,” and potentially, tracking issuers’ success when it comes to their claims about tackling these risks and impact of these risks. (Enter: publicly-traded apparel and fashion groups’ voluntarily-revealed targets to reduce greenhouse emissions and their claims about the impact of recycling or water-use initiates, etc.).
Even a broad – but harmonized – framework dictating what issuers have to reveal would be significant given the scope of ESG issues (including “environmental, social and governance practices; sustainability; impact investing; responsible investing, and other similar terms,” according to the Subcommittee) and the corresponding lack of clarity when it comes to reporting standards, which largely leaves the determination of what constitutes “known material risks” and how related processes should be measures to the disclosing party. As a result, the disclosures are not only potentially unreliable, but they are difficult – if not impossible – to compare from one company to another.
(It is also worth noting that since federal securities laws generally do not require the disclosure of ESG data except in limited instances, the practice of companies making their ESG-specific goals available on their websites and/or in government filings is firmly within each individual entity’s discretion as of now. Those claims are important, nonetheless, as federal law mandates that even voluntary ESG disclosures must not be “materially misleading or false,” which means that even discretionary claims made by companies on the ESG front are subject to legal liability.)
An allowance for “apples-to-apples comparisons across companies’ disclosures” is important to investors, according to Foley Hoag’s Matthew Miller, who asserted in December that such standardization would, in turn, “facilitate [their] investment decisions.” Standardized disclosure rules would ultimately be “welcomed by issuers, as well as ESG auditors,” he says, given that “standards form the basis for defenses to potential litigation and investigation exposure.”
Hardly a theoretical issue, Bracewell LLP attorneys Rachel Goldman, Troy Harder, Tony Visage, and Thomas Kokalas recently asserted that with the increasingly focus on ESG by consumers and the SEC, alike, “Companies can expect securities litigation based on these disclosures to increase.” A surge in litigation in this arena “will likely be fueled by actions filed following increased SEC enforcement, but it will also be driven by independent shareholder actions,” they note, citing “an increase in the last few years of event-driven litigation, where securities class actions are brought based on the occurrence of an event that negatively affects stock price and company value (e.g., #MeToo movement impacts, environmental events, and cybersecurity breaches).” Set standards and a routine way of disclosing risk and gauging companies’ attempts to address such risk could prove helpful in this regard.
In a speech at the Center for American Progress on Monday, Lee stated that “human capital, human rights, climate change — these issues are fundamental to our markets, and investors want to and can help drive sustainable solutions on these issues.” As such, she said it is time “to move from the question of ‘if’ – to the more difficult question of how we obtain disclosure on climate.” With that in mind, the SEC is soliciting public comment for the next 90 days.
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