'ESG' Disclosure and Securities Regulation: An SEC push for environmental, social, and governance disclosure would cater to Wall Street instead of Main Street.

• Author: Mahoney, Paul G.

Politicians, policy experts, and academics have long debated the merits of socially motivated investing and corporate management. In recent months, these debates have intensified as leading institutional investors have joined environmental and social activists to urge the Securities and Exchange Commission to require public companies to disclose additional "Environmental, Social, and Governance" (ESG) factors. There are signs that the SEC will soon heed these calls and impose new ESG disclosure requirements. The most obvious candidate in the near term is disclosure on the potential effects on firm finances of climate change and governmental efforts to mitigate it.

If put in force, ESG disclosure mandates would represent a substantial change in the SEC's approach to its stated mission of protecting "Main Street investors" and "maintaining fair, orderly, and efficient markets," in the words of its website. Since its founding in 1934, the SEC has maintained a regulatory framework centered on the disclosure of material risks to the businesses of companies with publicly traded securities. Information is considered material if a reasonable investor would consider it important in deciding whether to invest. The disclosure system attempts to put large and small investors on a more nearly equal informational footing and thereby promotes public trust that the financial markets are fair rather than rigged in favor of market professionals. As we discuss below, ESG mandates risk eroding that trust for the simple reason that they prioritize the social and political views of the largest Wall Street asset management firms over the financial well-being of the households whose savings they manage.

A shift in the criteria for disclosure from materiality to the pursuit of amorphous social goals could therefore have detrimental consequences for both the smooth functioning of the capital markets and the SEC's reputation as an effective and respected nonpartisan regulator. The shift could fuel the impression that regulators are open to playing favorites by raising the costs of capital for companies not in step with the current priorities of the governing political party--a danger with which the Federal Reserve is also flirting. The costs of capital for any given company could then fluctuate with each change in administration. Investors in the U.S. markets would have to become expert in assessing political risks, just like investors in emerging markets.

SECURITIES LAW, DISCLOSURE, AND ESG INVESTMENT

At the core of securities law lies mandatory disclosure of material information. Under current law and practice, companies must disclose specific risks that are material to their businesses, which may include potential losses from extreme weather events, foreseeable future regulatory changes, and so forth. Some companies also choose voluntarily to follow disclosure principles promulgated by nonprofit organizations such as the Sustainability Accounting Standards Board.

The supporters of ESG disclosure mandates argue that this is...