At a conference on Environmental, Social and Governance ("ESG") disclosure, SEC Commissioner Allison Herren Lee challenged the "myths and misconceptions" about materiality in the context of ESG disclosures.
First, Commissioner Lee argued that all ESG matters material to an investor are already disclosed under securities law. Commissioner Lee clarified that there is no general requirement for a public company to reveal all material information, and that a duty to disclose arises only (i) by an explicit SEC disclosure requirement or (ii) to ensure other statements made by a company are materially accurate.
Second, Commissioner Lee challenged the notion that where there is a duty to disclose ESG matters, the necessary disclosures are already being made. She argued that a principles-based standard for disclosure with a "broad-based concept of materiality" will not elicit material information relevant to the "reasonable investor" as defined in Basic Inc. v. Levinson. Ms. Lee asserted that managers, lawyers and auditors all see materiality differently from investors, and while lawyers and auditors check management's first determination of materiality, both "have an economic and psychological incentive to want to retain positive relations with management . . . causing [them] to often expend efforts to support, rather than independently analyze, management's decisions."
Third, Commissioner Lee challenged the idea that SEC disclosure requirements must be strictly limited to material information. She stated that materiality is invoked to limit anti-fraud liability under SEA Rules 10b-5 ("Employment of manipulative and deceptive devices") and 14a-9 ("False or misleading statements"). She argued that these regulations do not place a legal limitation on disclosure rulemaking by the SEC because the SEC's statutory authority under Section 7 ("Information required in registration statement") of the Securities Act grants the SEC authority to require disclosures "appropriate in the public interest or for the protection of investors."
Fourth, Commissioner Lee challenged the argument that ESG matters are of social or political concern and are not material to investing. She stated that investors or "the arbiters of materiality" have already demonstrated that climate risk is material to their investment and voting decisions.
Commentary Steven Lofchie
This is an important public statement by Commissioner Lee. She is working to establish a legal basis to require companies to disclose a greater amount of information as to ESG issues. Essentially, her argument is that the SEC should regard information as material if investors want the information, even if the information may not be relevant to the issuer's financial performance. Her analysis of the Securities Act provides a healthy counterpoint in a public dialogue with Commissioners Peirce and Roisman, who have expressed considerable skepticism as to mandated ESG disclosures.
In order to strengthen her case, Commissioner Lee may want to be more specific as to (i) what aspects of ESG she is focused on, (ii) why she thinks those aspects are significant, (iii) what disclosures she would require as to those matters, (iv) what is the extent to which those disclosures are relevant to a broad range of issuers and investors and (v) what are the costs of those disclosures.
Beyond the issue of defining materiality, there are other significant concerns over an SEC expanding its authority as to disclosure. In previous statements, Commissioner Lee indicated that the SEC might take actions that would disfavor issuers contributing to certain political candidates (if the SEC determined that the issuer claimed to be ESG-friendly, but the candidate was not) or even to issuers that advertised on disfavored television programs. See, e.g., SEC Acting Chair Requests Public Comment on ESG Disclosure. The potential for the financial regulators to abuse their authority in this manner is worrisome, and it becomes more so as regulators seek to expand their authority beyond traditional limits.
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