A RESPONSE TO CALLS FOR SEC-MANDATED ESG DISCLOSURE.

• Author: Rose, Amanda M.
• Position: Environmental, social, and governance

ABSTRACT

This Article responds to recent proposals calling for the SEC to adopt a mandatory ESG-disclosure framework. It illustrates how the breadth and vagueness of these proposals obscures the important--and controversial--policy questions that would need to be addressed before the SEC could move forward on the proposals in a principled way. The questions raised include some of the most contested in the field of corporate and securities law, such as the value of interjurisdictional competition for corporate charters, the right way to conceptualize the purpose of the corporation, the proper allocation of managerial power as between the board and shareholders, and the social desirability of fraud-on-the-market class actions.

TABLE OF CONTENTS INTRODUCTION I. RECENT CALLS FOR SEC-MANDATED ESG DISCLOSURE II. THE SEC'S TYPICAL APPROACH TO MANDATORY DISCLOSURE III. ISSUES RAISED BY CALLS FOR AN SEC-MANDATED ESG DISCLOSURE FRAMEWORK CONCLUSION INTRODUCTION

The acronym "ESG" is used as shorthand for a dizzyingly broad array of "environmental," "social," and "governance" topics affecting businesses. The topics spanned include climate change, human capital management, supply chain management, human rights, cybersecurity, diversity and inclusion, corporate tax policy, corporate political spending, executive compensation practices, and more. (1) Members of the ESG movement are similarly diverse, in both identity and motivation. They include financially motivated investors and traditional asset managers who believe companies' approach to (at least certain) ESG topics will bear on the companies' long-term performance, or the long-term performance of the investors' or asset managers' broader investment portfolios. (2) They also include values-based investors who care about whether, and how, corporations address (at least certain) ESG topics due to religious or sociopolitical commitments. (3) The ESG umbrella also shelters various non-investor corporate stakeholders and third parties who care about whether, and how, corporations address (at least certain) ESG topics because they are personally affected (e.g., employees vis-a-vis labor practices) or due to religious or sociopolitical commitments (e.g., environmentalists vis-a-vis environmental impact). (4) ESG proponents also include members of an emerging corps of people and institutions who profit from the movement, including corporate sustainability officers, (5) providers of ESG ratings and indices, (6) accounting firms that offer ESG-related services, (7) and managers of specialized ESG-investment vehicles. (8)

Even the Business Roundtable, an association of chief executive officers of leading U.S. corporations, seemingly embraced ESG in its 2019 Statement on the Purpose of the Corporation, (9) though some suspect its motivations have more to do with public relations or a desire to protect executives from shareholder discipline than a true commitment to ESG. (10) The stated motivations of others involved in the movement can also be questioned. Traditional asset managers claim their commitment to ESG is motivated by a desire to improve long-term fund performance for the benefit of investors. (11) But agency costs offer an alternative potential explanation: embracing the ESG movement may help asset managers curry political favor, enabling them to fend off greater regulation of the industry; (12) it may advance the personal sociopolitical commitments of those who run them; (13) or it may offer a way to attract investors to fund offerings without imposing any meaningful limitations on how a fund is managed. (14)

The breadth of topics embraced by ESG, and the breadth of motivations spurring the ESG movement, has created a big tent that has undoubtedly served a purpose in terms of helping the various causes of those involved to gain momentum. But it has also created problems. For example, ESG performance ratings are inconsistent and difficult to decipher. Which of the myriad ESG issues are factored into a rating, how performance on those issues is measured, and the weight each issue is given are subjective, usually non-transparent determinations that vary across ratings providers. (15) The breadth of ESG topics also makes studies that purport to show a positive link between ESG performance and financial performance difficult to interpret. There is no a priori reason to believe that a company's approach to climate change and a company's approach to diversity or any other ESG issue will have the same sort of impact on a company's financial performance; yet these studies often bundle ESG issues together to measure ESG performance or rely on ESG performance ratings that themselves bundle the issues together. They therefore leave unanswered which, if any, discrete corporate policies related to ESG actually impact financial performance. (16)

Regulators have also pointed out problems with use of the term "ESG." SEC officials have expressed concerns regarding its use in mutual fund advertising, because its vagueness can leave fund investors with misimpressions regarding what exactly they are buying into. (17) Rule changes may follow. (18) The Department of Labor (DOL) cited a lack of clarity regarding the goals of ESG investment funds as a basis for a recent rule proposal that would have clarified that ERISA plan fiduciaries cannot offer or invest in a fund if the fund's strategy allows it to prioritize non-economic ESG benefits or risks at the expense of financial returns. (19) The proposed rule was severely criticized by ESG proponents, who contended that it would discourage ESG investing. (20) The final rule, issued late last year, continues to require that ERISA plan fiduciaries focus only on pecuniary factors when making investment decisions, but removed any specific references to "ESG." (21) In the preamble to the final rule, the DOL explained that "'ESG' terminology, although used in common parlance when discussing investments and investment strategies, is not a clear or helpful lexicon for a regulatory standard." (22) The DOL found fault with the term in part because "by conflating unrelated environmental, social, and corporate governance factors into a single term, ESG invites a less than appropriately rigorous analytical approach in evaluating whether any given E, S, or G consideration presents a material business risk or opportunity to a company that corporate officers and directors should manage as part of the company's business plan and that qualified investment professionals would treat as economic considerations in evaluating an investment in that company." (23) In this Article I address one manifestation of what we might call the "ESG fuzziness problem." The SEC has recently come under pressure to mandate ESG disclosures by public companies in their SEC filings, and a recent House bill would require it to do so. (24) Although a large percentage of public companies voluntarily disclose ESG-related information in standalone sustainability reports, (25) they utilize divergent frameworks developed by private standard-setters, and the disclosures may not be produced in the same careful manner as disclosures in SEC filings. Proponents of an SEC-mandated ESG disclosure regime argue it would enhance investors' ability to compare companies on ESG dimensions, combat the problem of selective ESG disclosure (also known as "greenwashing"), and improve the quality of ESG disclosures. (26) I offer no opinion as to whether the SEC ought to mandate disclosure of information related to any particular ESG topic, or whether it should--as recent proposals advocate--adopt a mandatory ESG disclosure framework. My purpose, rather, is to illustrate how the breadth and vagueness of the recent proposals obscure the important--and controversial--policy questions that would need to be addressed before the SEC could move forward on the proposals in a principled way. The questions raised include some of the most contested in the field of corporate and securities law, such as the value of interjurisdictional competition for corporate charters, the right way to conceptualize the purpose of the corporation, the proper allocation of managerial power as between the board and shareholders, and the social desirability of fraud-on-the-market class actions.

1. RECENT CALLS FOR SEC-MANDATED ESG DISCLOSURE

   On April 15, 2016, the SEC issued a concept release seeking input on whether the disclosure requirements in Regulation S-K elicit the information that investors need for investment and voting decisions, how registrants can most effectively present the information, and the costs and benefits of disclosure requirements for companies and investors. (27) Some of the questions that the SEC sought feedback on concerned "the importance of sustainability and public policy matters to informed investment and voting decisions." (28) The release explained that the Commission "has determined in the past that disclosure relating to environmental and other matters of social concern should not be required of all registrants unless appropriate to further a specific congressional mandate or unless, under the particular facts and circumstances, such matters are material." (29) It thus asked that commentators provide "feedback on which, if any, sustainability and public policy disclosures are important to an understanding of a registrant's business and financial condition and whether there are other considerations that make these disclosures important to investment and voting decisions," as well as the "potential challenges and costs associated with compiling and disclosing this information." (30) The Concept Release elicited over 25,000 comments. (31) According to one review, 348 of those comments were unique while the rest were form comments solicited in response to public interest campaigns run by Public Citizen and Americans for Tax Fairness. (32) Professor Harper Ho reports that "[t]he vast majority of the...