In this article from Directors & Boards, SEC Chair Jay Clayton talks again about short-termism and discusses his views on ESG disclosure, particularly disclosure regarding human capital management.
With regard to short-termism, Clayton reiterated his concern that short-termism may be harmful to Main Street investors, who are investing for the long term to fund their retirements and other long-term needs. In addition, short-termism can deter companies that want to manage their business on a long-term basis from engaging in capital raising in the public capital markets and may encourage them instead to stick with the private markets, where short-termism is less of a driver. (See e.g., this PubCo post and this PubCo post.) In Clayton’s view, investors want disclosure that reflects a balance of short-term and long-term: “markets and investors have a thirst for high-quality, timely information regarding company performance and material corporate events. But we also recognize that companies and investors are interested in planning for (and investing for) the long term. Our disclosure rules should reflect both of these perspectives and be tailored to ensure that neither one dominates or ‘crowds out’ the other.”
In addition, not all shareholders have the same objectives or share the same approaches to pursuing them, nor do all necessarily agree with management’s approaches. The best way to address a lack of alignment, in Clayton’s view, is through engagement with shareholders to “identify the areas of commonality. Pursuing long-term returns to shareholders—and I emphasize long-term—has proven in many cases to be an effective focal point for discussing and reaching consensus on the appropriate path to serve shareholder interests.”
Clayton’s views on ESG (environmental, social and governance) issues are somewhat nuanced. While he “acknowledges the growing drumbeat for ESG reporting standards,” the different components of ESG mean “many different things to different constituencies and ‘continuing to lump them all together, will slow our efforts to move our disclosure framework forward.’” Matters in the “G” category are more typically “core governance issues that investors have come to expect in terms of disclosure from our public companies. There are long-standing rules and conventions, many driven by generally applicable law, that investors have monitored. In contrast, matters considered to be in the “E” category, such as regulatory risk, and risk to property and equipment vary widely from industry to industry and country to country. In some cases, the issues are material to an investment decision. In other cases they are not. So, the disclosure approach for all ESG matters, and in particular “E” and “S” matters, cannot be the same, as issuers and investors approach each of them differently.”
With that in mind, when it comes to mounting calls for rulemaking that standardizes ESG disclosure, Clayton was less than enthusiastic: “My view is that in many areas we should not attempt to impose rigid standards or metrics for ESG disclosures on all public companies. Such a step would be inconsistent with our mandate, would be a departure from our long-standing commitment to a materiality-based disclosure regime, and could effectively substitute the SEC’s judgment for the company’s judgment on operational matters.” In terms of marketwide metrics, he identified U.S. GAAP as an example of a system that effectively allows a reasonable level of comparability across all companies, but, in his view, the development of non-GAAP financial measures in some ways illustrates the point that across-the-board metrics can be tricky–sometimes even GAAP works only at a company level.
Instead of imposing marketwide ESG regulation, Clayton favored the application of “the ‘materiality’ based approach to disclosure regulation. This has been the commission’s perspective for 84 years and it has served our investors and markets very well. Keeping that perspective in mind is critical to our mission.” What that meant to Clayton was that if a matter was “going to affect the company’s bottom line or presents a significant risk to the business, I would expect them to do something about it. If the matter is material, I also would expect the company to disclose the matter and what they are doing about it. This is consistent with general fiduciary obligations of directors and officers, as well as our disclosure rules.” In particular, he adverted to a recent speech by Corp Fin Director Bill Hinman, which addressed the application of principles-based disclosure requirements to complex and evolving disclosure questions. (See this PubCo post.)
However, Clayton observed, if some investors believed that companies must follow ESG standards, “regardless of whether the standards are aligned with the company’s assessment of what is important to its business and prospects,” that would be a “complex and vexing issue.” He believed investors were much better served by understanding how each company looked at its business, its assets and risks. Imposing rigid standards could “effectively substitute the SEC’s judgment for the company’s judgment on operational matters.” What he wanted to avoid was “mandated disclosure that is not material to a reasonable investor and, worse, inconsistent with the way the company views the issue.” In addition, he observed that the SEC’s role was regulation of disclosure, not governance; as a result, “our rules do not, and should not, tell companies how to run their business or mandate that they take action to promote the social good or, as you say, balance profits and social good. As a disclosure agency, our job at the SEC is to ensure that reporting companies provide the material information that a reasonable investor needs to make informed investment and voting decisions.”
One “exception” to Clayton’s reluctance to impose any new regulatory mandate—an area where “we need to move forward”— was disclosure about human capital management. As Clayton has previously observed, the current disclosure requirements are somewhat out of date: Items 101 and 102 of Reg S-K, which address, to a limited extent, people and properties, were adopted back when companies’ most valuable assets were plant, property and equipment, and human capital was primarily considered a cost on the income statement. But now, “human capital represents an essential driver of performance for many companies albeit in different ways. It is clear that, in certain cases, such as a growth-oriented data sciences company, understanding a company’s approach to human capital may be material to an investment or voting decision. SEC staff has been working to evaluate and recommend improvements to our disclosure requirements and I expect human capital disclosures to be among the issues under consideration.” But, even though some regulation in this area may make sense, given that disclosure requirements should elicit information that was material to making investment decisions, “how we move forward will vary from industry to industry and even company to company.” That is, in this area, Clayton believed it was “more important that any metrics allow for meaningful period to period comparability for the company (and in some cases the industry) rather than marketwide metrics that are different from the metrics management and investors use to assess the performance and prospects of the business.” (See this PubCo post.)
