United States: Clayton Q&A And ESG At The SEC's Investor Advisory Committee Meeting

Last Updated: December 21 2018
Article by Cydney Posner

At last week's meeting of the SEC's Investor Advisory Committee, the Committee members held a Q&A session with SEC Chair Jay Clayton, followed by a discussion of environmental, social and governance disclosure, where the main question appeared to be whether to recommend that ESG disclosure be required through regulation, continued as voluntary disclosure but under a particular framework advocated by the SEC or continued only to the extent of private ordering as is currently the case.

Among the points addressed in the Q&A was a potential government shutdown. Clayton said that the SEC was planning for a possible shutdown, and that, as in previous shutdowns, he expected the SEC would be able to continue its operations for a number of days post-shutdown.

In his opening statement, Clayton observed that demands for ESG information have increased and, in response, many companies have voluntarily increased the amount of ESG information they disclose. In providing this information, Clayton advised, companies "should focus on providing material disclosure that a reasonable investor needs to make informed investment and voting decisions based on each company's particular facts and circumstances." Likewise investors—principally asset managers—should also focus on each company's particular facts and circumstances. Importantly, he stressed that these advisers should not put their own interests in ESG or other matters before those of their clients. If investors integrate ESG into their strategies, they should make sure that the material facts about the strategy are disclosed. Although some market participants have called for companies to follow designated frameworks to increase comparability, "that does not mean that issuers should be required to follow these frameworks in order to comply with SEC rules." The standard frameworks may not fit the circumstances of each company or industry, but that doesn't mean that they don't add value to the mix of information. Rather, Clayton suggests, their value is analogous to that provided by "appropriately presented non-GAAP financial measures and key performance indicators (KPIs)."

In her last committee meeting as an SEC Commissioner, Kara Stein (besides tearing up, which was very sweet), also addressed ESG in her opening statement. She noted that, although traditionally, ESG factors were not considered to be components of financial analyses, now many investors do consider the long-term investment risks and benefits of ESG issues. And these concerns were not limited to institutional investors: "43% of shareholder proposals submitted during the last proxy season focused on these matters. Why? Because these investors believe that there are verifiable links between ESG matters and a company's operational strength, efficiency, and management. These investors believe it is important to have an understanding of these issues in order to better assess the company's performance. On the other hand, other investors maintain that focusing on ESG matters should not come at the expense of investment returns." Hopefully, she suggested, the meeting discussion would provide some insight on the right balance of these ideas.

For her part, Commissioner Hester Peirce conveyed her attitude pretty clearly when she indicated that "ESG" stands for "enabling shareholder graft." Hmmm, seems to be in sync with former Senator Phil Gramm. (See this PubCo post.) While that may sound "unfriendly" to ESG, at its essence, it does reflect the view of a significant segment, which is that ESG should not be wielded as a tool to impose one's "values" on companies where the impact may be detrimental to shareholders; rather it should be a driving force only to the extent that it is expected to have a positive effect on shareholder value.

[Based on my notes, so standard caveats apply.]

Clayton Q&A

Sustainability as part of disclosure framework. The Q&A started with a kind of meta-analysis of our disclosure framework; that is, wouldn't the incorporation of "sustainability" (apparently the preferred term for ESG among many) into disclosure requirements really just reflect a necessary modernization of the disclosure framework? The example given was that, initially, assets reflected on balance sheets were primarily fixed assets such as property, plant and equipment. Now companies' most valuable assets are human capital, intellectual property and other intangible assets. Doesn't the whole framework need to be modernized? In response, Clayton contended that the current materiality disclosure framework ("materiality, comparability, flexibility, efficiency and responsibility (i.e., liability) are the lynchpins") is the right one, but that what goes into it needs to reassessed. That is, we need to recognize when things have changed, and, Clayton maintained, what is important now is forward-looking information. For example, Clayton observed that, because the market reflects anticipated future performance, stocks tend to move at the time of the earnings release and analyst call—when guidance tends to be issued—not at the time of filing of the 10-Q. (Is that a harbinger of his view on the need for quarterly filings, now that it's back on the agenda? See this PubCo post.) Although KPIs are valued because they can presage future performance, they're not part of the regulatory framework because there is little comparability across companies or industries. As a result, adding KPIs and NGFMs to GAAP is really difficult. What Clayton would like to see with regard to KPIs and NGFMs is a clear tie-back to GAAP and period-to-period consistency for each company. In addition, he indicated, these types of measures should track how management looks at its business, not just how management wants to present its business.

Decline in research for smaller companies. Clayton attributed the decline to the impact of MiFID II, the revision in the EU to the Markets in Financial Instruments Directive, which required the disclosure of the amount of commission payment used for research (and was predicted to reduce the levels of research for smaller companies in an effort to show lower research expenses). He suggested that it was not proving to be successful and had reduced the supply of research.

Roundtable takeaways. When asked to identify his takeaways from the SEC's recent proxy process roundtable, Clayton mentioned needed process changes, the need to improve the shareholder proposal process without adversely affecting shareholder engagement and, with regard to proxy advisor reform, the need to clarify the dynamic between advisor and client and to reaffirm that the investment advisor still retains responsibility. While he recognized that proxy advisors add value and efficiencies, the process required improvements such as an opportunity for companies to respond.

Investor town halls. When asked about the town halls that the SEC is conducting, Clayton seemed to view them as very successful. He said that the most important question for investors to ask is "how much of my money is going to work for me?" How is the investment advisor paid and what are the revenue incentives for the advisor?

Accredited investors. Clayton noted that he was not in love with the current accredited investor system because it was entirely binary: if the individual qualifies, they can stand to lose all and if they don't qualify, they can't be at risk at all. However, the current system offers the advantage of being easy to administer, so a new system would need a strong verification system. The SEC plans to conduct a comprehensive review of the entire patchwork system of registration exemptions.

Discussion of ESG disclosure

Former SEC General Counsel and former PCAOB member Dan Goelzer described the historic development (or rather the lack of development) of ESG regulation. Currently, there are few specific regulations governing ESG disclosure and the nature and level of disclosure is determined primarily on the basis of materiality and material omissions. Following litigation in the 1970s to compel the SEC to adopt environmental and social disclosure requirements, in 1975, the SEC issued a release indicating that the SEC would not consider social and environmental goals on their own; rather any regulation must be designed to protect the economic interests of investors. At that time, only a small number of investors were motivated by social concerns. Subsequently, rules were adopted addressing the impact of environmental expenses on earnings and, pursuant to Dodd-Frank, rules regarding conflict minerals. With the SEC's climate change release, disclosure of the material impact of climate change could be required under several existing requirements, such as risk factors and MD&A. Now, however, there is a much greater interest in the economic significance of sustainability, and many institutional investors take sustainability into account in making investment decisions.


The growing interest of investors in ESG issues is reflected in their increasing support for shareholder proposals addressing environmental and social topics. BNA reports that large asset managers, such as BlackRock, Vanguard and State Street, are "now twice as likely as individual investors to back shareholder advocacy on environmental and social issues," according to data from Broadridge and PwC. Overall, in 2018, votes in favor of social and environmental proposals increased to 27% from 18% in 2014, reflecting perhaps the risk that some institutions have identified in issues like climate change. You may recall that a number of climate disclosure proposals even received majority votes in favor in the last couple of years, supported by several large institutions. (See this PubCo post and this PubCo post.) In 2018, almost 29% of shares held by institutional investors were voted in favor of environmental and social shareholder proposals, up from 19% in 2014. (See this PubCo post.)As a result, many companies now provide voluntary sustainability reports and some even include the information in their SEC filings. Goelzer reported that 73% address ¾ of the topics identified by the Sustainability Accounting Standards Board and 42% address all the topics. However, he contended that much of the voluntary disclosure was not really well suited to provide information because much of it was boilerplate and not comparable across companies or even year to year. As a result, many investors are dissatisfied with the disclosure and calling for regulation. (See this PubCo post regarding a rulemaking petition advocating that the SEC mandate ESG disclosure under a standardized comprehensive framework.) However, it may be hard to justify applying regulations across the board and, in Goelzer's view, the application of non-governmental standards under a framework may be the best bridge. In his view, SASB standards are most closely aligned with SEC standards, and the SEC could encourage the use of the framework, without even needing to resort to formal rulemaking, by signaling from its bully pulpit about the importance of the information and the need to ensure that it is investor-grade, as well as through the staff comment process on statements made.

At the meeting, the SASB representative indicated that SASB looks at topics most likely to affect financial performance and includes performance metrics to aid in comparability and consistency over time. With regard to sustainability disclosure, what has been missing are accepted standards, and the SASB representative joined in advocating that the SEC take steps to recognize SASB as an acceptable framework for disclosure, in the same way as it has for the COSO framework for internal control over financial reporting and the OECD framework for conflict minerals.


As discussed in this PubCo post, independent standard-setting organization SASB has announced that it has published a series of sustainability accounting standards specifically tailored for 77 industries. According to the SASB Chair, the publication of these standards represents an "important milestone" because they provide "codified, market-based standards for measuring, managing, and reporting on sustainability factors that drive value and affect financial performance." The SASB standards—according to SASB, "the world's first set of industry-specific sustainability accounting standards covering financially material issues"— were published after six years of study and market consultation (see this News Brief from 2013 describing the release of the SASB standards for the health care sector). By focusing on development of standards and associated metrics specific to particular industries, SASB seeks to identify a "subset of sustainability factors most likely to have financially material impacts on the typical company in an industry." The objective is to provide investors and companies "decision-useful" information, information that can help them make more informed decisions. What is "sustainability accounting"? According to SASB, "[s]ustainability accounting reflects the management of a corporation's environmental and social impacts arising from production of goods and services, as well as its management of the environmental and social capitals necessary to create long-term value. It also includes the impacts that sustainability challenges have on innovation, business models, and corporate governance and vice versa." It is also noteworthy in this context that proxy advisor Glass Lewis has announced that SASB guidance on material ESG will be integrated into GL's research reports and vote management application.

A Bloomberg representative contended that the problem is with the voluntary nature of current standards, which allows companies to engage in cherry-picking and "greenwashing," that is, filtering to portray an environmentally responsible public image. Nearly all companies, he maintained, were at economic risk from climate change, be it physical risk or transition risk. Investors want to know their processes for addressing these risks and how climate change affects their strategies, metrics and targets. With regard to climate change scenario analyses, he suggested that they could indicate the company's resilience as well as the quality of management. He also advocated that the SEC acknowledge that, if companies are voluntarily reporting, the SASB framework provides a good approach.

The representative from State Street suggested that ESG concerns are mainstream now, as many studies have shown that higher ESG scores are aligned with lower cost of capital, better operating performance and stock price improvements. However, because the data can be subjective, the framework was important. ESG data has proliferated and research has emerged from many sources, resulting in a lot of noise. The SSGA representative advocated broad adoption of a framework like SASB; the baseline question, she said, was whether the company has performed an analysis, but the use of different frameworks impairs comparability and consistency. Interestingly, she observed that there is some misunderstanding of the quality of the information reported—the underlying information is more primitive than financial information that is then analyzed to come up with ratings. Similarly, one committee member noted that some metrics are not really reducible to numbers.

A representative from Travelers noted that, in the past year, the company had 55 ESG-related survey requests, which required the expenditure of substantial time and money. She contended that there was some confusion about what ESG comprehended: it should be about "value," she argued, not "values." However, she thought private ordering of ESG disclosure worked well and did not favor the imposition of SEC requirements. In contrast, the representative from CalPERS contended that private ordering was inefficient and the resulting data risked becoming just "noise." The time was ripe to move to the regulatory arena. For example, how should investors address the fact that most companies do not voluntarily report? With all the companies CalPERS has to monitor, the current process was too ad hoc.

Another committee member commented that companies should keep in mind that even voluntary sustainability reports are subject to Rule 10b-5 liability and, according, should be subject to disclosure controls and other processes in place for SEC filings. In addition, he noted that some companies objected to scenario analyses on the basis that they could reveal competitive information.

So the question became whether the SEC disclosure regime "under-mandated" disclosure regarding ESG issues. From Goelzer's perspective, rulemaking such as that requested by the ESG petition could be difficult because, unlike MD&A, which is based on financial statements prepared under GAAP, there was no comparable starting point for ESG disclosure. Whether any rulemaking would be too burdensome would depend on the difficulty of the requirements. And rulemaking might actually ease the burden to the extent that it streamlined the process and eliminated the need to respond to the proliferation of surveys. In addition the absence of an SEC reporting requirement means that a lot of power resided in the ESG rating agencies.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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