United States: SEC Chair Clayton Discusses Short-Termism And ESG Disclosure

Last Updated: July 29 2019
Article by Cydney Posner

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.


At a meeting of the SEC's Investor Advisory Committee in December 2018, one meeting participant contended that the voluntary nature of current standards is a problem because it 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. Another participant 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. That participant 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. (See this PubCo post.)

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.)


In his speech, Hinman described "principles-based disclosure" as a framework where "requirements articulate an objective and look to management to exercise judgment in satisfying that objective by providing appropriate disclosure when necessary." One benefit of principles-based disclosure was that its inherent flexibility allowed disclosure to evolve with emerging issues.

Hinman viewed the issue of ESG disclosure as "complicated," largely because of the tension between the desire of some for specific sustainability disclosure requirements—along with the debate about which set of reporting standards should apply—and the concern of others that specific sustainability disclosure requirements would elicit information that was not really material to a reasonable investor. (See, for example, this PubCo post and this PubCo post.) These issues had not yet settled out in the marketplace, and the SEC was continuing to monitor the evolution of market-driven solutions, comparing information in SEC filings with information provided voluntarily outside of SEC filings. In particular, the SEC was wary of imposing specific bright-line disclosure requirements that could increase the costs being a public company without delivering relevant and material information to investors and others, thus potentially decreasing the attractiveness of public-company status.

In preparing principles-based disclosure regarding sustainability, Hinman advised that companies apply the MD&A standard of allowing investors to see the company "through the eyes of management," including describing plans to mitigate material risks and the material impact of these decisions on the business. He suggested evaluating the disclosure relative to the disclosure that management provides to the board.

With regard to climate-related disclosures specifically, Hinman referred to the SEC's 2010 interpretive release, which discussed the application of existing disclosure requirements to climate change issues. The approach taken here was consistent with the approach to cybersecurity—looking to the current disclosure obligations under existing laws and regulations for direction. Hinman cited as examples the discussions in the guidance of how "businesses that may be vulnerable to severe weather or climate-related events should consider disclosing material risks of, or consequences from, these events," as well as the nature of the disclosure that a company should provide, if material, if the company "determines that its physical plants and facilities are exposed to extreme weather risks and it is making significant business decisions about relocation or insurance." Hinman noted that the guidance did not address the board's risk management role in this area, but that board risk oversight, including the relationship between the board and senior management in managing material risks, was a disclosure requirement under Item 407(h) of Reg S-K and Item 7 of Schedule 14A. Accordingly, Hinman advised, "[t]o the extent a matter presents a material risk to a company's business, the company's disclosure should discuss the nature of the board's role in overseeing the management of that risk." Hinman suggested that the SEC's cybersecurity guidance may provide useful parallels to sustainability and other emerging risks. (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.)


What is human capital management? According to SASB, HCM "addresses the management of a company's human resources (employees and individual contractors) as key assets to delivering long-term value. It includes issues—such as labor practices, employee health and safety and employee engagement, diversity and inclusion—that affect the productivity of employees, management of labor relations, and management of the health and safety of employees and the ability to create a safety culture." (See this PubCo post.)

As discussed in this PubCo post, human capital management has become a significant concern of institutional investors. In its compilation of investors' top priorities for companies for 2018 (involving interviews with over 60 institutional investors with an aggregate of $32 trillion under management), EY identified HCM as one of investors' top five priorities. For many investors, EY reported, hiring and retention of the best talent can be key to remaining competitive over the long term, and company culture can play a role. Some institutional investors have also encouraged companies to provide more transparency on HCM practices. But what exactly should they disclose? In a 2017 petition for rulemaking, the Human Capital Management Coalition, a group of 25 institutional investors with more than $2.8 trillion in assets under management, asked the SEC to adopt rules requiring "issuers to disclose information about their human capital management policies, practices and performance." (See this PubCo post. See also this PubCo post discussing a new ISO standard.)

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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