On Thursday, January 30, the SEC proposed amendments designed to simplify and modernize MD&A and the other financial disclosure requirements of Reg S-K. (See this PubCo post.) Although the SEC did not hold an open meeting to consider the proposal, several of the Commissioners issued statements that addressed, for the most part, not what was in the proposal, but rather, what wasn’t—standardized disclosure requirements related to climate change. These statements allow us a peek into an apparently heated debate among the Commissioners on the issue of climate disclosure.
Statement by Allison Lee. Let’s start with Commissioner Allison Lee, who dissented from the proposal, primarily as a result of the failure of the proposal to tackle climate risk disclosure. In her statement, “Modernizing” Regulation S-K: Ignoring the Elephant in the Room,” she observed that, although the SEC’s 2010 guidance on climate highlighted four items in Reg S-K—business, legal proceedings, risk factors and MD&A—that could elicit climate disclosure, the SEC had “now proposed to ‘modernize’ every one of these four items without mentioning climate change or even asking a single question about its relevance to these disclosures.” Since 2010, she noted, there have been a number of significant changes in perspectives on climate change from scientists, economists, investors, companies and regulators around the world—all viewing the effects of climate as increasingly dire and the demand for disclosure more insistent. In particular, she remarked,
“investors are overwhelmingly telling us, through comment letters and petitions for rulemaking, that they need consistent, reliable, and comparable disclosures of the risks and opportunities related to sustainability measures, particularly climate risk. Investors have been clear that this information is material to their decision-making process, and a growing body of research confirms that. And MD&A is uniquely suited to disclosures related to climate risk; it provides a lens through which investors can assess the perspective of the stewards of their investment capital on this complex and critical issue.”
What’s more, she contended, the “broad, principles-based ‘materiality’ standard” has not elicited the type of standardized disclosure that investors crave, nor has the SEC’s disclosure review process been regularly employed to produce improved climate disclosure under the materiality standard: indeed, “in recent years there’s been minimal comment on climate disclosure.” Instead, in response to the investors’ pressure campaigns, companies have provided some sustainability disclosure, often in separate reports, but, “these voluntary disclosures, while a welcome development, are no substitute for Commission action”: in the absence of a mandatory standardized framework, the disclosures are variable and not comparable; the proliferation of frameworks and demands for various information puts undue pressure on companies; and the disclosures may not be reliable, lack independent verification and may not provide adequate remedies to investors.
Lee disclaims any suggestion that determining the best regulatory approach is a simple matter; there are lots of challenging issues about matters such as metrics, location, frameworks, and prescriptive v. principles-based disclosure. Rather, she is lamenting the failure to take up the challenge: “[w]e purport to modernize, without mentioning what may be the single most momentous risk to face markets since the financial crisis. Where we should be showing leadership, we are conspicuously silent. In so doing, we risk falling behind international efforts and putting US companies at a competitive disadvantage globally.”
(In the notes to Commissioner Lee’s statement, she advises that the staff is considering a roundtable on climate, so stay tuned for that.)
Statement by Jay Clayton. I’ll speculate that the commitment by SEC Chair Jay Clayton of well over half of his statement on the MD&A proposal to a discussion of climate-related disclosure issues was triggered by Lee’s strenuous objection above. Clayton has long taken the position that the SEC’s approach “has been, and in my view, should remain, disclosure-based and rooted in materiality, including providing investors with insight regarding the issuer’s assessment of, and plans for addressing, material risks to its business and operations.”
After making his position plain, Clayton then identified five interrelated threshold issues in crafting and evaluating climate-related disclosure mandates and guidance that underpin his conclusion above and can be expected to guide his thinking in the future:
- the complex, uncertain, multi-national/jurisdictional and dynamic landscape that surrounds climate issues;
- for “both issuers and investors, capital allocation decisions based on, or materially influenced by, climate-related factors are substantially forward-looking and likely involve estimates and assumptions regarding, again, complex and uncertain matters that are both issuer- and industry-specific, as well as regional, national and multi-national/jurisdictional, in nature”;
- under the disclosure system, issuers generally provide verifiable and largely historic issuer-specific information, and forward-looking disclosure that is required or provided voluntarily is typically afforded safe-harbor protection;
- as a standard setter, Clayton is mindful that he should not substitute his “operational and capital allocation judgments for those of issuers and investors” and that he (and other standard setters) must “stay within the bounds of their regulatory mandate”; and
- in coordinating with other domestic or international regulators, the need to keep in mind that the U.S. regulatory regime “stands apart” from the perspectives of investor protection, liability and enforcement and that “facially analogous disclosure mandates should not be expected to equate to uniform effects across jurisdictions.”
Currently, Clayton pointed out, companies can continue to look to the SEC’s 2010 interpretive release for guidance regarding climate disclosure (with regard to which the “staff has generally found robust efforts to comply”), as well as staff comments that are part of the disclosure review process. (You might recall the interpretive release was approved on a split vote at the SEC, with two commissioners voting against it for a variety of reasons, one of which was that the science was “unsettled.”) The staff also engages with investors and others, focusing on
“(1) better understanding the environmental and climate-related information investors currently use and how they analyze that information to make investment decisions on both an issuer- and industry-specific basis and more generally; (2) better understanding the extent to which (and how) issuers identify, assess and manage environmental and climate-related risks in their particular business and industry; and (3) reminding issuers and other market participants of how the Commission’s principles-based disclosure requirements apply to environmental or climate-related matters and, as circumstances change (for example, as a result of changes in environmental regulation or changes in costs of operations) prior disclosures may require modification.”
Clayton identified the first two points above as especially important. The SEC also received substantial feedback on the issue in connection with the Reg S-K Concept Release, which was part of its Disclosure Effectiveness Initiative and solicited public comment on modernizing certain business and financial disclosure requirements in Reg S-K.
Clayton also remarked that SEC has participated in various international regulatory efforts related to climate disclosure, including, in 2015, as part of the Financial Stability Board, as well as with other international regulators, seeking “decision-useful” disclosures. The FSB convened private market participants to form the Task Force on Climate-Related Financial Disclosures (TCFD). the TCFD has developed Recommendations of the Task Force on Climate-related Financial Disclosures—and supporting materials, designed to provide a standardized framework and detailed guidance for voluntary, consistent climate-related financial risk disclosures. (See this PubCo post and this PubCo post.)
Clayton encouraged continued engagement with market participants, particularly on the threshold issues identified above and the use of climate-related information in capital allocation decisions, especially by issuers such as property and casualty insurers, and by asset managers.
Statement by Hester Peirce. Finally, we come to the statement from Commissioner Hester Peirce, who was pleased that, faced with “repeated calls to expand our disclosure framework to require ESG and sustainability disclosures regardless of materiality” from “an elite crowd pledging loudly to spend virtuously other people’s money,” the SEC did “not bow to demands for a new disclosure framework, but instead support[ed] the principles-based approach that has served us well for decades.” In her view, the
“concept of materiality has worked well over time because it considers disclosure through the prism of the reasonable investor, who is occupied with the long-term financial value of the enterprises in which she invests…. Materiality does not turn on what is important to non-investors or to a select group of investors motivated by objectives unrelated or only tangentially connected to their investment’s profitability. If materiality were so loosely defined, it would lead to information overload in disclosure documents, increased costs associated with being a public company, increased litigation risk for public companies, a decrease in the attractiveness of our public capital markets, reduced investment returns, and—most alarmingly—a misallocation of capital.”
Existing practices, she argued, provide “reason to question the materiality of ESG and sustainability disclosure.” If these disclosures were material, why do they appear regularly in voluntary sustainability reports but rarely in Forms 10-K? While she did not question the “materiality determinations of companies that did report these metrics,” she was likewise not “ready to mandate that every other company make the same materiality determination.” She urged securities regulators not to “grow weak-kneed in defending the concept of materiality, which continues to play a central role in ensuring the vibrancy of our capital markets. We ought not step outside our lane and take on the role of environmental regulator or social engineer.”