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.

SideBar

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.

SideBar

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions