Elections have consequences, as they say, and one of those consequences is new leadership at the SEC who bring with them a markedly different agenda. In remarks yesterday to the Center for American Progress, entitled A Climate for Change: Meeting Investor Demand for Climate and ESG Information at the SEC, Acting SEC Chair Allison Lee provided important insights into where the SEC is headed with regard to environmental, social and governance issues. As Lee confirmed in the introduction to her speech, “no single issue has been more pressing for [her] than ensuring that the SEC is fully engaged in confronting the risks and opportunities that climate and ESG pose for investors, our financial system, and our economy.” Investors are not getting the information they need, and that’s why the SEC has “begun to take critical steps toward a comprehensive ESG disclosure framework.” In addition, she has directed Corp Fin to revisit the shareholder proposal process and is also considering whether the SEC should establish a dedicated ESG standard setter. According to Lee, “climate and ESG are front and center for the SEC.”
Lee began by observing that there is “no historical precedent for the magnitude of the shift in investor focus that we’ve witnessed over the last decade toward the analysis and use of climate and other ESG risks and impacts in investment decision-making.” Not that investors in the past haven’t cared about social or ethical issues in investing, but socially responsible investing was viewed as more of a niche that was unconnected to financial performance. But that distinction has almost evaporated as ESG risks and metrics “now underpin many traditional investment analyses on investments of all types—a dynamic sometimes referred to as ‘ESG integration.’ In other words, ESG factors often represent a core risk management strategy for portfolio construction. That’s because investors, asset managers responsible for trillions in investments, issuers, lenders, credit rating agencies, analysts, index providers, and other financial market participants have observed their significance in terms of enterprise value. They have embraced sustainability factors and metrics as significant drivers in decision-making, capital allocation, and pricing.” The crises of the last year—from COVID-19 to racial inequity—have revealed the interconnections among issues such as worker safety, racial injustice and climate risk: “With COVID, we saw supply chain disruptions similar to that which climate events can cause. We know climate presents heightened risks for marginalized communities, linking it to racial justice concerns. We saw in real time that the issues dominating our national conversation were the same as those dominating decision-making in the boardroom….That’s why climate and ESG are front and center for the SEC. We understand these issues are key to investors—and therefore key to our core mission.” [Emphasis added.]
Disclosure. According to Lee, the SEC’s most fundamental role is disclosure—”helping to ensure material information gets into the markets in a timely manner.” The current voluntary ESG disclosure is not adequately satisfying investor demand; it does not offer comparability, reliability or appropriate levels of assurance and many companies don’t provide any ESG disclosure. In addition, companies are bombarded with various and “potentially conflicting” demands for information. Accordingly, the SEC has “begun to take critical steps toward a comprehensive ESG disclosure framework aimed at producing the consistent, comparable, and reliable data that investors need.” [Emphasis added.] In the subsequent Q&A, Lee said that, while she believed that companies intend their voluntary disclosure to provide real insight, in some cases, companies tell only the best version of the story and sometimes no story at all. That’s one reason, she said, why we need to set standards—to balance principles and metrics and add reliability. As an initial step, she noted, she has previously directed the Corp Fin staff to enhance its focus on reviewing the adequacy of climate-related disclosures under the existing 2010 guidance and to engage with public companies on these issues, with a goal of providing an update to the 2010 guidance and informing future policy. (See this PubCo post.) She also mentioned in the Q&A that the staff may compare the consistency of the voluntary reporting and disclosures in SEC filings.
In addition, she has contemporaneously issued a new statement requesting public comment on ESG disclosure, which will shift the discussion from “if” to “how”—that is, what is the best approach to obtaining climate disclosure: “what data and metrics are most useful and cut across industries, to what extent should we have an industry-specific approach, what can we learn from existing voluntary frameworks, how do we devise a climate disclosure regime that is sufficiently flexible to keep up with the latest market and scientific developments? Finally, how should we address the significant gap with respect to disclosure presented by the increasingly consequential private markets?” She hoped to hear responses reflecting a wide range of perspectives.
Although Lee viewed climate as clearly the most pressing issue, she also advocated reaching beyond climate to address standardized ESG disclosure more broadly with the longer-term goal of a comprehensive ESG disclosure framework. In the near term, however, she advocated that the SEC address ESG issues individually, such as by “offering guidance on human capital disclosure to encourage the reporting of specific metrics like workforce diversity, and considering more specific guidance or rulemaking on board diversity.” She also asked whether the SEC should consider imposing an ESG-specific policies-and-procedures requirement.
Lee also stressed the importance of political spending disclosure, noting in particular that investors need to be able to ascertain inconsistencies between a company’s public statements and its corporate political donations. Political spending disclosure, she said, “is inextricably linked to ESG issues.” She cited research showing that many companies that made carbon-neutral pledges or statements in support of climate initiatives have donated to candidates with “climate voting records inconsistent with such assertions.” In this context, disclosure is key to accountability.
Climate attestation. Another issue Lee has been considering is whether there should be a requirement for verification of climate and ESG disclosures, including potentially “auditor attestation of current voluntary sustainability reporting? And should the PCAOB establish better standards or guidance for how auditors currently address companies’ climate and ESG-related financial statement disclosures? How also do we encourage enhanced transparency by credit rating agencies regarding how they consider ESG factors? This is by no means an exhaustive list. These and other challenges remain.” She later remarked in the Q&A that symmetry around ESG and financial reporting, such as through attestation, needs to be the “ultimate goal.”
Shareholder Proposals. Lee indicated that investors are increasingly submitting shareholder proposals on ESG-related issues, constituting more than half of all proposals filed in recent seasons, and support for these proposals has almost tripled in the last decade. Some proposals have actually received majority support. Accordingly, Lee viewed the shareholder proposal process as an “important mechanism for investors to improve corporate governance and advance sustainable long-term strategies at the businesses they own.” Lee reported that she is looking at revisiting the shareholder proposal process: she has
“asked the staff to develop proposals for revising Commission or staff guidance on the no-action process, and potentially revising Rule 14a-8 itself. The goal is to bring greater clarity to the no-action relief process, increase the number of proposals on the ballot that are well-designed for shareholder deliberation and votes, and reduce the number that are not. This could involve reversing last year’s mistaken decision to bar proponents from working together and restricting their ability to act through experienced agents. It could also involve reaffirming that proposals cannot be excluded if they concern socially significant issues, such as climate change, just because they may include components that could otherwise be viewed as ‘ordinary business.’” (See this PubCo post.)
Universal Proxy. Lee has also asked the staff to consider whether the SEC should “re-open the comment file on the 2016 universal proxy rule proposal to take into account market developments since then and move towards finalization.” Under that proposal, universal proxy cards identifying all the candidates for director on both slates would be required in contested director elections, replicating more closely in-person voting. In Lee’s view, the proposal would be “a common-sense step forward in modernizing our proxy rules and protecting shareholder rights. The proposal has been outstanding for far too long and should be finalized.” (See this PubCo post and this PubCo post.)
Proxy Voting. Because funds may not always reflect investor preferences for ESG strategies in their voting, Lee stressed that the SEC’s rules and guidance should clearly emphasize the importance of voting as part of funds’ and advisers’ fiduciary obligations and should help ensure transparency for investors. To that end, Lee has asked the staff to consider revising 2019 guidance that she believes discourages fiduciaries from voting in certain circumstances, and to consider updates to disclosures of fund voting decisions on Form N-PX to maximize transparency.
Division of Enforcement’s Climate and ESG Task Force. Lee also referred to the SEC’s new Climate and ESG Task Force within the Division of Enforcement, intended to proactively detect climate and ESG-related misconduct and misstatements or omissions in company disclosure of climate risks. (See this PubCo post.)
International Efforts. Climate change is obviously a global issue and Lee confirmed her commitment to international engagement and cooperation. In particular, Lee indicated that she was pleased with the possibility of development of disclosure standards by a new Sustainability Standards Board created under the IFRS Foundation. According to Lee, the SSB “represents a promising approach toward the development of an international baseline for sustainability reporting upon which individual jurisdictions could build consistent with their own unique consideration.”
Domestic Sustainability Standard-Setter. The creation of an international standard setter also raises the question of whether the SEC should establish a comparable standard-setter for ESG (similar to the FASB) under SEC oversight dedicated to devising an ESG reporting framework that would complement the SEC’s financial reporting framework. The goal would be to “devise a climate and ESG disclosure framework that is flexible and can efficiently evolve as needed.” Another approach might be to recognize another existing set of standards, much like the COSO framework is recognized with respect to internal control. She stressed that the nature of climate and ESG mean that the SEC must work with market participants and regulators around the globe to address these issues, but the market alone is “not likely to be sufficient to mitigate these risks.”