Rise of the Shadow ESG Regulators: Investment Advisers, Sustainability Accounting, and Their Effects on Corporate Social Responsibility
| Date | 01 February 2019 |
| Author |
2-2019 NEWS & ANALYSIS 49 ELR 10155
Rise of the Shadow
ESG Regulators:
Investment
Advisers,
Sustainability
Accounting, and
Their Effects on
Corporate Social
Responsibility
by Paul Rissman and Diana Kearney
Paul Rissman is Co-Founder of Rights CoLab, where he
researches nancial tools for advancing environmental
and human rights. Diana Kearney is Legal and
Shareholder Advocacy Advisor at Oxfam America, where
she specializes in business and human rights law.
Summary
Actions that fall under the catchall of “corporate social
responsibility” have been viewed with skepticism. In the
United States, part of the blame lies with lax laws and regu-
lations surrounding social and environmental disclosure.
Disclosure may soon be vastly improved with nali zation of
the Sustainability A ccounting Standards Board’s nancially
material social and environmental reporting standards.
While the standards are voluntary, the fact that they have
been endorsed as “material” by many of the world’s largest
investment advisers will tra nsform them into legally action-
able stand ards.
[D]isclosure has become the most important method to reg-
ulate corporate managers. . . .
—Robert B. ompson & Hillary A. Sale1
[B]y and large, companies continue to take a minimally
compliant approach to sustainability disclosure. . . .
—Sustainability Accounting Standards Board2
Because federal securities law is grounded in the
principle of disclosure, one could deduce from the
quotes above that the sustainability practices of
business might be better regulated if companies reported
about them with greater care. Such strengthening would
yield important benets both for environmental protection
and the global cause of human rights.3 Corporate social
responsibility (CSR)4 ac quires even more salience in light of
the perceived rollback of human rights protections around
the world,5 setbacks to the environmental movement such
as the United States’ rejection of the Paris Agreement on
climate,6 and the weakening of U.S. Environmental Pro-
tection Agency (EPA) regulations domestically.7 CSR is
growing in importance, both in terms of public awareness8
1. Robert B. ompson & Hillary A. Sale, Securities Fraud as Corporate Gover-
nance: Reections Upon Federalism, 56 V. L. R. 859, 861 (2003).
2. SASB, T S D 2017, at 3 (2017), available at https://
www.sasb.org/wp-content/uploads/2017/12/2017State-of-Disclosure-Re-
port-web.pdf.
3. M K N C, C P
H R 1 (2016) (discussing “[t]he pervasive inuence of the cor-
poration and its ever-increasing eects on human rights globally”).
4. Here, CSR broadly refers to business initiatives that promote environmental
and social well-being. is is typically done through assessing and account-
ing for a company’s human rights and environmental impacts to ensure that
they are operating in a responsible manner; some actors also view this as
encapsulating provision of services to communities likely to be impacted by
private-sector operations.
5. Interview by Ari Shapiro, National Public Radio, With Larry Diamond,
Senior Fellow, Stanford University (Aug. 3, 2017), https://www.npr.
org/2017/08/03/541432445/decline-in-democracy-spreads-across-the-
globe-as-authoritarian-leaders-rise.
6. Robinson Meyer, Syria Is Joining the Paris Agreement. Now What?, A-
, No v. 8, 2017, https://www.theatlantic.com/science/archive/2017/11/
syria-is-joining-the-paris-agreement-now-what/545261.
7. Jennifer Ludden, Public to EPA on Cutting Regulations: “No!,” N’
P. R, May 19, 2017, https://www.npr.org/sections/thetwo-way/
2017/05/19/528993681/public-to-epa-on-cutting-regulations-no.
8. N, T S I 2 (2015) (“Sixty-six percent of
consumers say they are willing to pay more for sustainable brands—up from
55% in 2014 and 50% in 2013.”), http://www.nielsen.com/content/dam/
corporate/us/en/reports-downloads/2015-reports/global-sustainability-
report-oct-2015.pdf.
Authors’ Note: We’d like to thank commenters on earlier versions
of the Article: Donna Conforti, Kenneth Gerstein, Jonas Kron,
Sanford Lewis, Mark McDivitt, Edwin Rekosh, and Max, Gabe,
and Zach Rissman.
Copyright © 2019 Environmental Law Institute®, Washington, DC. Reprinted with permission from ELR®, http://www.eli.org, 1-800-433-5120.
49 ELR 10156 ENVIRONMENTAL LAW REPORTER 2-2019
and in corporate acknowledgement.9 Business managers
are aware of the harms of authoritarianism and climate
change,10 and have spoken out and undertaken remedial
actions.11 But these actions have been halting and unsatis-
factory to many in the elds of human rig hts and environ-
mental protection; “corporate greed” is a phrase yet alive
and well in common parlance,12 and business attempts to
rectify socia l and environmental damage are often dis-
missed as “greenwashing.”13 is disappointing progress
is all the more distressing in light of the aforementioned
backsliding by government.
e thesis of this Article, however, is that a measure of
pessimism surrounding responsible business practices can
soon be ameliorated. We predict that corporations are on
the cusp of moving along the spectrum from castigation
to approval. is will have nothing to do with a sudden
change of heart on the part of a company’s directors and
ocers. ese persons will va lue what they have always val-
ued: a duty to their investors. Rather, it is the attitude of
a critical subset of stockholders and bondholders that has
begun to change: the largest professional asset managers.
While more than one cause will foment this change,14
the factor that will seal the shift in stockholder attitude,
and in turn push CSR to the forefront of corporate con-
sciousness, is the nalization of a set of material disclo-
sure standards for sustainability topics.15 Nonnancial
sustainability reporting, regarding such business impacts
as human rights violations or eects upon climate change,
has not been considered universally material. e eort to
demonstrate material implications for specic rms has
been an ongoing project by certain investors and organiza-
tions for several decades, yet U.S. corporate issuers seldom
face liability if they neg lect to report such impacts to share-
holders or the public.
9. Susan McPherson, 6 CSR Trends to Watch in 2017, F, Jan. 19, 2017
(“In the past decade, we’ve witnessed a stunning transition as corporate
social responsibility (CSR) evolved from a nice-to-have silo to a funda-
mental strategic priority for businesses large and small.”), https://www.
forbes.com/sites/susanmcpherson/2017/01/19/6-csr-trends-to-watch-in-
2017/#2bcbbc1ab1cc.
10. See infra Part I.
11. Id.
12. End Corporate Greed! Rights Now! A Sign-On Statement to Stop the Poisoning
of the People and the Planet, P A P., Dec. 3, 2017, http://panap.
net/2017/12/end-corporate-greed-sign-on/; AFL-CIO, Corporate Greed
(“It seems that hard work doesn’t matter anymore. is is the corporate
attitude.” Mary Willis, laid o Nabisco/Mondelēz International worker),
https://acio.org/issues/corporate-greed (last visited Dec. 1, 2018); Derek
Burnett, Corporate Greed: ese Companies Deceived America for Prot—And
You Probably Helped em, R’ D., https://www.rd.com/culture/
corporate-greed/ (last visited Dec. 1, 2018).
13. Yermi Brenner, Greenwashing: Consumers Confronted by Dubiously “Con-
scious” Fashion, A J, May 19, 2014, http://america.aljazeera.com/ar-
ticles/2014/5/19/consumers-greenwashingfashion.html; Gabe Smalley, Pep-
siCo’s Greenwash: All Talk, No Action, R A N, Aug.
14, 2017, https://www.ran.org/pepsico_greenwash_all_talk_no_action;
Bruce Watson, e Troubling Evolution of Corporate Greenwashing, G,
Aug. 20, 2016, https://www.theguardian.com/sustainable-business/2016/
aug/20/greenwashing-environmentalism-lies-companies.
14. See infra Part III.
15. Material disclosure refers to information that shareholders would nd im-
portant when weighing the decision whether or not to invest or vote on a
corporate resolution. For a detailed discussion, see infra Part II.
e Sustainability Accounting Standards Board
(SASB), however, an organization conceived explicitly to
formulate standards that comply with the U.S. Supreme
Court’s denition of materiality, can soon be instrumen-
talized to transform these long-standing tenets of corpo-
rate practice. Due to the process of consultation and voting
utilized by SASB, there will be a clear record of investors
publicly endorsing the “materiality” of a range of human
rights, environmental, or related standards that they have
helped formulate.
Among the investors that have assisted in crafting the
standards are a signicant group of investment advisers,
including six of the 10 largest asset managers globally.16
Released in November 2018,17 the standards are purely
voluntary and exist apart from the reporting compendium
that is enforced by the U.S. Securities and Exch ange Com-
mission (SEC). We argue, however, that by endorsing the
materiality of the standards, these specic investors will
have created for themselves an extension of their duciary
duty of care to their customers: an implied duty to ask for,
and evaluate, reporting th at satises the standards. Consci-
entious customers, then, can pressure these asset managers
that have publicly supported the materiality of the SASB
standards, ensuring that best eorts are made to force dis-
closure of such human rights and environmental issues.
Finally, the evolving nature of the asset management
industry itself provides the catalyst to turn duciaries
into eective de facto regulators. Small shareholders have
largely been replaced by large inst itutional i nvestors; as t he
concentration of stock ownership into the hands of a few
grows, so too does the power wielded by these large owners.
Today, the largest asset managers own staggeringly large
amounts of stock on behalf of their clients, spread over
thousands of companies around the world.18 Once these
investors nd themselves compelled to consider material
sustainability disclosure, they will demand such disclosure
from vast swaths of the global corporate world. We predict
that this will set o a virtuous circle of disclosure impact-
ing behavior change.
e Article will procee d as follows: rst, we desc ribe the
current situation in which corporations have a deepening
nancial interest in ghting against authoritarianism and
climate change. Despite some admirable eorts, however,
most companies still have far to go in strengthening their
16. SASB, Supporters, https://www.sasb.org/investor-use/supporters/ (last vis-
ited Dec. 1, 2018). For a list of the largest asset managers, see IPE Reference
Hub, Total Global AUM Table 2018, https://hub.ipe.com/top-400/total-
global-aum-table-2017/10007066.article (last visited Dec. 1, 2018).
17. Ken Tysic, SASB Publishes Industry-Specic Sustainability Accounting
Standards, J. A (Nov. 9, 2018), https://www.journal
ofaccountancy.com/news/2018/nov/sasb-sustainability-accounting-stan-
dard-201820089.html.
18. Index fund providers are among the largest asset managers. An index fund
is a stock mutual fund or separately managed account that is explicitly de-
signed to hold every stock in a given index, such as the Standard & Poor's
(S&P) 500 or the MSCI All Country World Index (comprising approxi-
mately 2,500 constituents around the globe). “Closet indexers,” investment
advisers that are so large that by virtue of their size they are forced to own
diversied portfolios containing a myriad of holdings, are also among the
largest asset managers. See infra note 138.
Copyright © 2019 Environmental Law Institute®, Washington, DC. Reprinted with permission from ELR®, http://www.eli.org, 1-800-433-5120.
2-2019 NEWS & ANALYSIS 49 ELR 10157
CSR records. In Part II, we highlig ht a signicant root of
this problem, which stems from the principle of investor
protection: the Supreme Court has decreed that inves-
tors should be shielded from immaterial disclosure, and
the SEC has presumed that investors regard nonnancial
environmental, social, and governance (ESG) disclosure
as largely immateria l. Taken together, these two factors
severely limit the ESG achievements and embarra ssments
that companies reveal. Because federal securities statutes
have essentially surmounted state law as the primary regu-
latory mechanism for a broad range of corporate ethical
beh avio r,19 eective regulation is impaired. Indeed, even
when companies actively seek to be “good actors,” they can
be thwarted by their duties to short-term investors priori-
tizing nancial optimization.
Parts III and IV then discuss potential solutions to the
problem, and identify the shortcomings currently pre-
venting them from taking root. Specic ally, structural
impediments in the asset management industry discour-
age many of the largest investors from act ing in more than
a minimally responsible fashion. We conclude that the
nalization of SASB’s material ESG standards can sur-
mount these challenges.
In Part V we describe SASB’s mandate, how it operates,
and why its focus on nancial materia lity is unique com-
pared to the multitude of other disclosure regimes whose
eectiveness has been limited. Fortu nately, the pressures
that these emerging principles generate will be felt most
acutely by the world’s largest (and most inuential) invest-
ment advisers who have formulated and endorsed the mate-
riality of the standa rds; this will extend their duciary dut y
of care to cover ESG criteria, as will be discussed below,
and will transform them into “shadow regulators” of com-
panies’ human rights and environmental performance.
Part VI then explores the implications of this new reg-
ulatory role that large asset managers have unwittingly
assumed. By publicly arming the materia lity of human
rights and environmental criteria, these managers have
changed what information their customers should expect
them to demand from their corporate holdings. Finally, we
turn to the role of the customer, and explain how he or she
will galvanize this shift in asset managers’ duties. In order
for investment advisers to become eective shadow regu-
lators, customers may need to litigate to prod their asset
managers to recognize their ESG obligations and develop
tactics to ensure that the companies they own disclose
these practices. Nongovernmental organizations (NGOs)
can facilitate the process by allying with investment advis-
ers to this end.
rough this process, the SASB principles are poised to
set o a chain reaction that could end in virtually all pub-
lic companies disclosing— and, in turn, improving—envi-
ronmental and human rights practices.
19. See infra Part II.
I. Multinational Corporations’
Hesitant Embrace of CSR
In many respects, one would expect that the private sec-
tor would be a natural ally for social causes. Corporations
typically thrive when the rules under which they operate
are transparent and predictable, for exa mple20; they should,
therefore, all things bei ng equal, support strengthening the
rule of law in their jurisdictions. Corporations also thrive
when their access to critical information is unimpeded.21
us, they should similarly encourage t he free ow of data,
including data disseminated by the press. Finally, corpora-
tions thrive when they are able to eciently allocate capita l
resources, human and otherwise, across their geographies.
at is why corporations oppose boundaries that limit
capital ows.
In light of these corporate needs, it is striking that gov-
ernments across the globe, in turning toward authoritari-
anism a nd nationalism,22 are ac tively harming the business
climate for multinational companies. e weakening rule
of l aw,23 attacks on the press,24 and attempts to restrict
20. Transparent rules usually benet businesses, allowing them to make the
most ecient investment and operational decisions. See generally Michael
Ewing-Chow et al., e Facilitation of Trade by the Rule of Law: e Cases of
Singapore and ASEAN, in C G M 129 (Marion
Jansen et al. eds., World Trade Organization 2014) (quantifying the positive
impact that stable rule of law has upon trade); J S, S L
S (1999) (detailing the benets of operating in a “legible society”
that has clear rules); I S, T W B C
W 54-56 (1991) (declaring that a prerequisite for development is that
rules must be widely known in advance). is holds particularly true in
stable societies.
However, corporations can also benet nancially when the rules under
which they operate are transparent and predictable as applied to the compa-
ny itself, but are hidden to business competitors or the general public; com-
panies can then exploit this asymmetry of information or ability to navigate
the legal framework. See, e.g., James Holston, e Misrule of Law: Land and
Usurpation in Brazil, 33 C. S. S’ H. 695 (1991) (observing
that irresolution in Brazilian property laws can be a strategy that the elite
may use to secure their own rights, while lower-income groups may be un-
able to do the same); H S, T O P 132 (2002)
(arguing that companies benet when they are able to take advantage of
laws that are too confusing for members of the general public to navigate).
21. See, e.g., N C, I T I F-
, C-B D F: W A B, W
D T C (2017) (stating that “data localization and other barriers
to data ows impose signicant costs”), http://www2.itif.org/2017-cross-
border-data-ows.pdf; Douglass North, e New Institutional Economics
and ird World Development, in T N I E
T W D 17 (John Harris et al. eds., Routledge 1995)
(pointing out that lack of access to information hinders growth). ough
unimpeded access to information generally benets corporations, it is also
possible that there are situations in which companies may not benet from
unimpeded access for all—rather, they may benet most when their own ac-
cess to information is unimpeded, but competitors or the general public do
not have free access. In those cases, lobbying for the free ow of data would
not necessarily be advantageous.
22. Interview by Ari Shapiro, supra note 5.
23. Sean Illing, 20 of America’s Top Political Scientists Gathered to Discuss Our
Democracy. ey’re Scared., V , Oct. 13, 2017 (interviewing the na-
tion’s preeminent political scientists about the erosion of the rule of law
across the United States), https://www.vox.com/2017/10/13/16431502/
america-democracy-decline-liberalism.
24. Michael Grynbaum, Trump’s Attacks on the Press: Telling Escalation
From Empty reats, N.Y. T, Oct. 12, 2017, https://www.nytimes.
com/2017/10/12/business/media/trump-news-media-attacks.html.
Copyright © 2019 Environmental Law Institute®, Washington, DC. Reprinted with permission from ELR®, http://www.eli.org, 1-800-433-5120.
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