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E-MailCydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); and Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock by Leo E. Strine, Jr. (discussed on the Forum here).
In remarks [June 3, 2021] before the ESG Board Forum, Putting the Electric Cart before the Horse: Addressing Inevitable Costs of a New ESG Disclosure Regime, SEC Commissioner Elad Roisman weighed in with his views on mandatory prescriptive ESG requirements and the likely associated costs. As he has indicated before, he’s not really keen on the idea, particularly the environmental and social components of potential requirements. As a general matter, while investors want to see comparable standardized environmental data, in his view, standardization of that type of information is really hard to do; some of it “is inherently imprecise, relies on underlying assumptions that continually evolve, and can be reasonably calculated in different ways. And ultimately, unless this information can meaningfully inform an investment decision, it is at best not useful and at worst misleading.” But, if a new regulatory regime requiring ESG disclosure is adopted—and it certainly looks that way— he has some ideas for ways to make it less costly for companies to comply.
In contrast to Commissioner Allison Lee, Roisman believes that more disclosure requirements are practically superfluous because the SEC’s disclosure framework already requires companies to disclose information that is material to investors, and that includes ESG information. More specifically, he noted that the SEC issued guidance in 2010 on the application of existing SEC rules to the material effects of climate (see this PubCo post) and amended Reg S-K to expressly require disclosure about human capital (see this PubCo post). What’s more, he sees no basis for omitting disclosure of any other material risks. So why is more regulation requiring ESG disclosure even necessary?
SideBar
In keynote remarks to the 2021 ESG Disclosure Priorities Event, Lee viewed the concept that ESG matters material to investors are already required to be disclosed under the securities laws as a myth, and one of the most prevalent myths about materiality at that. The idea that the securities disclosure system already imposes an affirmative duty to disclose all material information, she contended, “is simply not true, and reflects a fundamental misunderstanding of the securities laws….Rather, disclosure is only required when a specific duty to disclose exists.” And, she observes, an affirmative duty arises only under specific circumstances, among them, an SEC regulatory requirement, a sale or purchase by the issuer of its own stock, when leaks or rumors in the marketplace are attributable to the issuer or when the issuer is already speaking on an issue and information is necessary to make the issuer’s statements accurate or not misleading. For example, in Basic v. Levinson, Lee notes, the duty to disclose pre-merger negotiations arose out of public statements the company made asserting that it was unaware of any developments that might explain high trading volumes and price fluctuations in its shares. Her prime example is political spending, an issue that can be extremely important to reasonable investors, particularly because shareholders want to be able to assess the use by companies of shareholder funds for political influence. But, despite rulemaking petitions and other efforts, there are no SEC requirements to disclose political spending and, as a result, it’s rarely disclosed in SEC reports. In the end, she said, “absent a duty to disclose, the importance or materiality of information alone simply does not mandate its disclosure.” (See this PubCo post.)
Nevertheless, given that the new the SEC Chair has placed ESG disclosure on the agenda—not that Roisman is in favor if it—he identifies a number of questions about these initiatives:
- “What precise items of ‘E,’ ‘S,’ and ‘G’ information are investors not getting that are material to making informed investment decisions?
- It seems that some of the interest, particularly in ‘E’ and ‘S’ disclosures, is not in what risks environmental or social factors pose to the company, but rather what risks the company poses to, for example, the climate. To the extent that the interest is in understanding risks the company poses to the climate, what makes the SEC the appropriate federal government agency to require these disclosures, as opposed to, for example, the Environmental Protection Agency?
- How would the SEC come up with ‘E’ and ‘S’ disclosure requirements—now, and on an ongoing basis? What expertise is needed?
- Some have advocated that the SEC try to incorporate the work of external standard-setters. That idea raises additional questions. How would the agency oversee them—in terms of governance, funding, and substantive work product—on an ongoing basis? What kind of new infrastructure would be required inside the SEC and at the standard-setters themselves?
- If the Commission were to come up with the type of information that we hope to have companies disclose, how should we tailor our requirements to balance the benefits we are looking to achieve with such rules’ inevitable costs?”
His remarks focus on the last question above: the potential costs of prescriptive line-item ESG disclosure requirements and ways to mitigate them. In Roisman’s view, the costs are fairly obvious: the costs of collecting (and in some cases, calculating) and preparing the information as well as the costs of increased liability for making the disclosures, both from potential Enforcement actions as well as civil litigation. Although these types of costs are prevalent with most disclosure requirements, he suggests that the scope and novelty of ESG disclosure may increase them. To try to reduce these costs, he offer several ways to tailor ESG disclosure requirements.
- Scaling. First, he suggests that the disclosure requirements be scaled for smaller companies, an approach that has been taken with a number of other disclosure requirements. He also rejects the idea that has been floated by some that the SEC also impose ESG disclosure requirements on private companies. (See this PubCo post and this PubCo post.)
- Flexibility. Roisman advocates that the SEC be reasonable in its expectations of “what companies can disclose and how they disclose it.” He cites as an example the difficulty of obtaining reliable information about Scope 3 greenhouse gas emissions, which depends on the company’s “gathering information from sources wholly outside the company’s control, both upstream and downstream from its organizational activities.” Companies may not be in a position to disclose that type of information with much precision and, to provide it at all, may need to access outside vendors, inflating demand and cost for the data. For similar reasons, he expresses concerns about requiring verification through an audit or an attestation.
- Safe Harbors. To address litigation risk and avoid chilling the disclosure effort, he suggests addition of a safe harbor—much like the safe harbor in the PSLRA for forward-looking statements with accompanying cautionary statements—for good faith efforts to provide the required information.
- Furnished, not Filed. Again, in light of increased litigation risk, Roisman advocates categorizing environmental and social disclosures as “furnished” to the SEC, not “filed,” comparable to the approach taken with disclosure of resource extraction payments. (See this PubCo post.) In his view, if the argument is that investors want the information and would benefit from the uniformity and comparability, “those benefits can be realized without imposing the level of liability that filing with the SEC presents.”
- Extended Implementation Period. Finally, he hopes to see a long phase-in and extended implementation period. Companies will need time for the back-and-forth of questions as well as to implement staff guidance, to learn from other companies’ disclosures ideas (another reason, he suggests, for scaling) and to absorb feedback and make improvements.
