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ESG is at the forefront of contention at the SEC. Differences between Republican and Democratic commissioners are sharp and clear.
The Republican commissioners object to “broad disclosure mandates” because they are too “malleable” and lacking in clear definition of what is an acceptable ESG asset. This is the same core objection Democrats have expressed with Reg BI.
But the SEC’s efforts to address ESG continue.
In his March 2 Senate confirmation hearing, President Biden’s nominee for SEC Chair, Gary Gensler, supported strengthening disclosure of climate factors and ESG.
Acting SEC Chair, Allison Herren Lee, had already started acting. She announced in late February the SEC Corporate Finance Division would, “enhance its focus on climate-related disclosure” in public company filings. An SEC enforcement task force on ESG has been announced and Lee requested comments on March 15.
According to Investment News, the SEC is, “taking a “holistic look” at all the ways climate and ESG intersect with regulatory efforts across its divisions. Lee said, “It’s all hands on deck.”
Republican Commissioners Hester Peirce and Elad Roisan raised numerous questions about these initiatives in early March. They singled out corporate finance and company ESG disclosures. They stressed the importance of disclosure of “material” facts. According to Pierce and Roisan, “All the (finance) division’s work has been rooted in materiality, the touchstone we use in assessing issuer disclosure on all topics, including climate.”
At the March 19 Asset Management Advisory Committee, Peirce discussed her concerns about SEC ESG disclosure mandates on materiality.
Peirce said the risk of “broad ESG disclosure mandates” is significant. It would change regulation on the meaning of “materiality.” It would make it so “malleable” that it will “harm investors.”
….. To get to broad ESG disclosure mandates for issuers, we have to reimagine materiality. But reimagining materiality is the same as tossing it in favor of a more malleable new edition. Materiality has served us well and undermining it to accommodate ESG will harm investors. … I am happy to consider new SEC mandates for specific metrics that are likely to be material to every issuer in every industry. ESG standards, however, continue to be talked of in broad strokes that obfuscate the immaterial nature of many of the specific underlying disclosures.
“Broad mandates” could well be harmful to investors. But this hardly means that better and more meaningful disclosure should not become an industry standard to address investor queries.
Materiality in securities disclosure is central in corporate registrations. The Supreme Court explained in 2015 in the Omnicare case what this means. Companies may be sued if a registration statement contains, “an untrue statement of a material fact” or, “omits to state a material fact … necessary to make the statements therein not misleading.”
Peirce also warned of the risks of mandated disclosure for what she says, are “Issues nobody can define.”
… I urge the Committee to rethink the wisdom of recommending that we embark on a program to write standards for a set of issues nobody can define. They are not akin to accounting standards, which serve a clear, time-tested, universally understood objective. Having the SEC build a GAAP-like edifice around ESG standards would give investors a false sense of confidence in standards that are subjective, shifting, and sometimes even senseless.
Peirce and Roisan raised foundational issues regarding the materiality of information requiring disclosure and the clarity of standards requiring compliance. Those issues also apply to disclosure deficiencies in Reg BI.
Peirce stated that broad ESG disclosure would mean, “we have to reimagine materiality … (and this) is the same as tossing it in favor of a more malleable new edition.”
For an idea to be malleable, it must be capable of being altered, equivalent to lacking definition. This heralds Humpty Dumpty’s rule: “A word means, just what I choose it to mean.”
Republicans can complain about the lack of definition in the ESG rules, but that same malleability was welcomed when it came to enacting Reg BI.
For generations courts have equated best interest with fiduciary care. Then, in a complete u-turn, the SEC, in Reg BI, did two things. It effectively defined “best interest” as suitability with disclosure added – and then it implied that Reg BI is “fiduciary.”
Peirce also noted that ESG standards lack definition and thereby cause harm. Such disclosure, “would give investors a false sense of confidence in standards that are subjective ….”
But Reg BI is the epitome of subjectivity. When Reg BI was proposed, two commissioners rejected the “best interest” name and offered alternatives. Peirce called it “suitability plus” and Democratic Commissioner Kara Stein called it “regulation status quo.” Is there a better example of subjectivity?
Republican and Democratic commissioners differ on ESG disclosure. No news here. What will be news is how the new chair will reconcile those differences. Common ground? The Republican objection to ESG similarity with a Democratic objection to Reg BI is a start. It would sure beat adopting Humpty Dumpty’s rule.
Knut A. Rostad, MBA, is the co-founder and president of the Institute for the Fiduciary Standard, a nonprofit formed in 2011 to advance the fiduciary standard through research, education and advocacy.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.