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E-MailDonna M. Nagy is the C. Ben Dutton Professor of Law and Executive Associate Dean at Indiana University Maurer School of Law–Bloomington; and Cynthia A. Williams is the Osler Chair in Business Law at Osgoode Hall Law School at York University. This post is based on their recent paper, forthcoming in the Texas Law Review.
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); Stakeholder Capitalism in the Time of COVID, by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); and Will Corporations Deliver Value to All Stakeholders?, by Lucian A. Bebchuk and Roberto Tallarita.
The SEC in the 1970s began efforts to provide investors with material information about environmental risks facing publicly traded companies, and in 2010, it issued related guidance to clarify for such companies their climate-risk disclosure responsibilities. But notwithstanding the fundamental shift since then amongst institutional investors and asset managers toward the integration of environmental, social and governance (ESG) data into fundamental value analysis, for more than a decade the loud and repeated calls for increased ESG disclosure went largely unanswered by the SEC. This regulatory approach began to change in 2021, when Interim SEC Chair Allison Herren Lee welcomed public input on climate-change disclosures. And now under SEC Chair Gary Gensler, the SEC is seeking public comments on a bold and thoughtfully framed rule proposal for the enhancement and standardization of climate-related disclosures (Release No. 33-11042, March 21, 2022).
Our paper looks back and analyzes four particular areas in which the SEC resisted ESG disclosure reform or impeded shareholders’ access to ESG information. These areas are: (1) the SEC’s refusal to act on several rulemaking petitions submitted during the years 2009 to 2018, which called for expanded ESG disclosure; (2) the SEC’s grudging promulgation of rules concerning social disclosures as required by Congress in the Dodd-Frank Act of 2010; (3) the SEC’s 2020 revisions to SEC Rule 14a-8, which make the submission of shareholder proposals more difficult, thereby thwarting investor efforts to raise ESG concerns; and (4) an SEC commitment beginning in 2016 to move away from line-item disclosure to a more principles-based system.
The paper then discusses several reasons for this ESG disclosure reticence, notwithstanding the clear trends among institutional and retail investors reflecting their growing understanding of the financial importance of ESG information. These reasons are predicated on unwarranted narrowing constructions of the original purposes of the Securities Act of 1933 and the Securities Exchange Act of 1934. Such reasons, which we called “blind spots,” are also reflected in early critiques of the SEC’s climate-disclosure rule proposal, including the substantial criticisms by Commissioner Hester Peirce set out in her dissenting statement as the proposal was published.
First, there is a mistaken view that assumes publicly traded companies already operate under an affirmative disclosure obligation whenever information, including ESG information, is material. That is a fundamentally inaccurate view of the way the U.S. securities laws operate. If information is not required to be disclosed by the line-item requirements of Regulation S-K, or is not related to information that a company has disclosed, either by requirement or voluntarily, then the securities issuer is permitted to stay silent. The U.S. Supreme Court has been clear on that point, in the context of the potential sale of a company, which is obviously material information: “Silence, absent a duty to disclose, is not misleading under Rule 10b-5.” (Basic v. Levinson, 485 U.S. 224, 239 fn.17). Topics that financially-motivated investors are now seeking, from how cybersecurity threats are being managed to human capital management data to greenhouse gas (GHG) emissions, are not yet clearly required to be disclosed, even if presenting material risks. Well-counselled firms may determine that Item 303 of Regulation S-K, Management Discussion and Analysis (MD&A), and its process of analysis of future risks, should require more disclosure of these matters. Empirical data, however, suggests the disclosure that there is of these matters, and other ESG matters, is patchy, incomplete, and inaccurate. Unless publicly traded companies are required to disclose this information, even if material, they are within their rights to remain silent.
Second, there is resistance in some quarters to the concept that much ESG information is material, decision-useful information using traditional definitions of materiality, which assumes financially-motivated investors. The clearest indication of investor interest in climate data is CDP, (formerly the Carbon Disclosure Project), which annually sends a short survey to hundreds of companies around the world. CDP is now using the Taskforce on Climate-related Financial Disclosures (TCFD) framework to ask about companies’ climate governance, risk evaluation and management, GHG emissions, and targets and metrics, if any, for reducing GHG emissions. In 2021, over $110 trillion of invested capital supported CDP’s efforts, up from $4 trillion in 2002 when CDP’s first survey was distributed. The world’s largest investor, BlackRock, with $10 trillion of assets under management as of March 31, 2022, has similarly been clear that climate risk is investment risk. Why? Because as explained in its CEO and Chairman’s 2020 annual letter, “climate change is almost invariably the top issue that clients around the world raise with BlackRock.” These and many other data points indicate investors’ views that information on a company’s management of climate change risks is material information, using standard, financially-motivated definitions of “materiality.”
But these blind spots toward ESG significance are also symptoms of a larger and more endemic blind spot. Specifically, many SEC officials adhere to an unduly narrow construction of the SEC’s tripartite mission—to protect investors; maintain fair, orderly, and efficient capital markets; and facilitate capital formation. Yet, in adopting the federal securities laws in the 1930s, Congress had a much broader understanding of the purposes of disclosure and of how to protect investors. These purposes, framed within broad, public-interest statutory language defining the Commission’s authority (see, e.g., Section 7 of the Securities Act [15 U.S.C. 77g] and Sections 12, 13, 14, and 15 of the Exchange Act [15 U.S.C. 78l, 78m, 78n and 78o]) included giving shareholders information on how America’s public companies were being managed and how companies and banks were exercising power—power that had profoundly affected the American economy. Fundamentally, Congress sought mechanisms of corporate accountability, which is precisely what it sought to achieve in the Dodd-Frank ESG provisions, and what some current investors are demanding through the shareholder-proposal process, through shareholder voting, and through ESG-rulemaking petitions.
Because this paper illuminates some of the more persistent misconceptions surrounding ESG disclosure, its analysis continues to be relevant as the SEC’s rulemaking process for climate disclosure unfolds.
The complete paper is available for download here.
One Comment
The SEC’s proposed climate-risk disclosures are very controversial. To me, the real issue is whether the SEC actually has the statutory authority to require a broad range of these disclosures. I find it does not.
However, according to Nagy and Williams (two excellent scholars), “many SEC officials adhere to an unduly narrow construction of the SEC’s tripartite mission—to protect investors; maintain fair, orderly, and efficient capital markets; and facilitate capital formation. Yet, in adopting the federal securities laws in the 1930s, Congress had a much broader understanding of the purposes of disclosure and of how to protect investors…. These purposes, framed within broad, public-interest statutory language defining the Commission’s authority ….”
Having this statutory authority is essential. As stated by the U.S. Supreme Court: “This Court’s cases have consistently held that the use of the words ‘public interest’ in a regulatory statute is not a broad license to promote the general public welfare. Rather, the words take meaning from the purposes of the regulatory legislation.” NAACP v. FPC, 425 U.S. 662, 669 (1976). (Interestingly, this imp. case is not referenced in their underlying article.)
However, wishing and wanting the SEC to have this authority is much different than the SEC actually having it. In my opinion, even though I appreciate their willingness to engage with the law, an approach which many interested parties seem reluctant to do, their argument fails to show that this statutory authority actually exists.