United States: Acting SEC Chair Lee Discusses A New Direction For The SEC On ESG

Elections have consequences, as they say, and one of those consequences is new leadership at the SEC who bring with them a markedly different agenda. In remarks yesterday to the Center for American Progress, entitled A Climate for Change: Meeting Investor Demand for Climate and ESG Information at the SEC, Acting SEC Chair Allison Lee provided important insights into where the SEC is headed with regard to environmental, social and governance issues. As Lee confirmed in the introduction to her speech, "no single issue has been more pressing for [her] than ensuring that the SEC is fully engaged in confronting the risks and opportunities that climate and ESG pose for investors, our financial system, and our economy." Investors are not getting the information they need, and that's why the SEC has "begun to take critical steps toward a comprehensive ESG disclosure framework." In addition, she has directed Corp Fin to revisit the shareholder proposal process and is also considering whether the SEC should establish a dedicated ESG standard setter. According to Lee, "climate and ESG are front and center for the SEC."

Lee began by observing that there is "no historical precedent for the magnitude of the shift in investor focus that we've witnessed over the last decade toward the analysis and use of climate and other ESG risks and impacts in investment decision-making." Not that investors in the past haven't cared about social or ethical issues in investing, but socially responsible investing was viewed as more of a niche that was unconnected to financial performance. But that distinction has almost evaporated as ESG risks and metrics "now underpin many traditional investment analyses on investments of all types-a dynamic sometimes referred to as 'ESG integration.' In other words, ESG factors often represent a core risk management strategy for portfolio construction. That's because investors, asset managers responsible for trillions in investments, issuers, lenders, credit rating agencies, analysts, index providers, and other financial market participants have observed their significance in terms of enterprise value. They have embraced sustainability factors and metrics as significant drivers in decision-making, capital allocation, and pricing." The crises of the last year-from COVID-19 to racial inequity-have revealed the interconnections among issues such as worker safety, racial injustice and climate risk: "With COVID, we saw supply chain disruptions similar to that which climate events can cause. We know climate presents heightened risks for marginalized communities, linking it to racial justice concerns. We saw in real time that the issues dominating our national conversation were the same as those dominating decision-making in the boardroom..That's why climate and ESG are front and center for the SEC. We understand these issues are key to investors-and therefore key to our core mission." [Emphasis added.]

Disclosure. According to Lee, the SEC's most fundamental role is disclosure-"helping to ensure material information gets into the markets in a timely manner." The current voluntary ESG disclosure is not adequately satisfying investor demand; it does not offer comparability, reliability or appropriate levels of assurance and many companies don't provide any ESG disclosure. In addition, companies are bombarded with various and "potentially conflicting" demands for information. Accordingly, the SEC has "begun to take critical steps toward a comprehensive ESG disclosure framework aimed at producing the consistent, comparable, and reliable data that investors need." [Emphasis added.] In the subsequent Q&A, Lee said that, while she believed that companies intend their voluntary disclosure to provide real insight, in some cases, companies tell only the best version of the story and sometimes no story at all. That's one reason, she said, why we need to set standards-to balance principles and metrics and add reliability. As an initial step, she noted, she has previously directed the Corp Fin staff to enhance its focus on reviewing the adequacy of climate-related disclosures under the existing 2010 guidance and to engage with public companies on these issues, with a goal of providing an update to the 2010 guidance and informing future policy. (See this PubCo post.) She also mentioned in the Q&A that the staff may compare the consistency of the voluntary reporting and disclosures in SEC filings.

In addition, she has contemporaneously issued a new statement requesting public comment on ESG disclosure, which will shift the discussion from "if" to "how"-that is, what is the best approach to obtaining climate disclosure: "what data and metrics are most useful and cut across industries, to what extent should we have an industry-specific approach, what can we learn from existing voluntary frameworks, how do we devise a climate disclosure regime that is sufficiently flexible to keep up with the latest market and scientific developments? Finally, how should we address the significant gap with respect to disclosure presented by the increasingly consequential private markets?" She hoped to hear responses reflecting a wide range of perspectives.

SideBar

In Lee's statement requesting public input on climate disclosure, Lee observed that, since the 2010 guidance, investor demand for climate disclosure has increased dramatically, and questions have arisen about "whether climate change disclosures adequately inform investors about known material risks, uncertainties, impacts, and opportunities, and whether greater consistency could be achieved." The statement provides a webform and email box for public input and lists a number of questions to consider. The public is encouraged to comment on existing or potential new disclosure requirements, potential new disclosure frameworks that the SEC might adopt, as well as how the SEC might best regulate and monitor these disclosures. Commenters are also encouraged to provide empirical data and other support. To illustrate, copied below are examples of just some of the questions:

• Should any such disclosures be included in annual reports, other periodic filings, or otherwise be furnished?
• What information related to climate risks can be quantified and measured? How are markets currently using quantified information? Are there specific metrics on which all registrants should report (such as, for example, scopes 1, 2, and 3 greenhouse gas emissions, and greenhouse gas reduction goals)? What quantified and measured information or metrics should be disclosed because it may be material to an investment or voting decision? Should disclosures be tiered or scaled based on the size and/or type of registrant)? If so, how? Should disclosures be phased in over time?
• What are the advantages and disadvantages of permitting investors, registrants, and other industry participants to develop disclosure standards mutually agreed by them?
• What are the advantages and disadvantages of rules that incorporate or draw on existing frameworks, such as, for example, those developed by the Task Force on Climate-Related Financial Disclosures (TCFD), the Sustainability Accounting Standards Board (SASB), and the Climate Disclosure Standards Board (CDSB)? Are there any specific frameworks that the Commission should consider? If so, which frameworks and why?
• How should any disclosure requirements be updated, improved, augmented, or otherwise changed over time?
• How, if at all, should registrants disclose their internal governance and oversight of climate-related issues?
• How should disclosures under any such standards be enforced or assessed? For example, what are the advantages and disadvantages of making disclosures subject to audit or another form of assurance? If there is an audit or assurance process or requirement, what organization(s) should perform such tasks?
• What are the advantages and disadvantages of a "comply or explain" framework for climate change that would permit registrants to either comply with, or if they do not comply, explain why they have not complied with the disclosure rules?
• What climate-related information is available with respect to private companies, and how should the Commission's rules address private companies' climate disclosures, such as through exempt offerings, or its oversight of certain investment advisers and funds?
• Should climate-related requirements be one component of a broader ESG disclosure framework?

The comment period will be open for 90 days.

Although Lee viewed climate as clearly the most pressing issue, she also advocated reaching beyond climate to address standardized ESG disclosure more broadly with the longer-term goal of a comprehensive ESG disclosure framework. In the near term, however, she advocated that the SEC address ESG issues individually, such as by "offering guidance on human capital disclosure to encourage the reporting of specific metrics like workforce diversity, and considering more specific guidance or rulemaking on board diversity." She also asked whether the SEC should consider imposing an ESG-specific policies-and-procedures requirement. Lee also stressed the importance of political spending disclosure, noting in particular that investors need to be able to ascertain inconsistencies between a company's public statements and its corporate political donations. She cited research showing that many companies that made carbon-neutral pledges or statements in support of climate initiatives have donated to candidates with "climate voting records inconsistent with such assertions." In this context, disclosure is key to accountability.

SideBar

Issues regarding political donations have been thrown into sharp relief recently in light of the stands taken by a number of companies to pause or discontinue some or all political donations in response to the events of January 6. A number of companies announced that their corporate PACs had suspended-temporarily or permanently-their contributions to one or both political parties or to lawmakers who objected to certification of the presidential election. Whether the company or the PAC it sponsors suspended or declined to suspend political contributions, the current contentious political climate has made political contributions more fraught than ever and heightened sensitivity to any dissonance or conflict between a company's public statements or announced core values and its political contributions. The nonpartisan Center for Political Accountability reported in its June newsletter that support for shareholder proposals in favor of political spending disclosure hit record highs this past proxy season. (See this PubCo post.) And mandatory political spending disclosure shows up high on many lists of expected actions from the new Administration in Washington. (See this PubCo post.)

As Lee noted, the SEC is currently prevented from finalizing a rule on political spending disclosure. That's because Section 631 of the most recent appropriations act, the ''Consolidated Appropriations Act, 2021,'' prohibits the SEC from using any of the funds made available "to finalize, issue, or implement any rule, regulation, or order regarding the disclosure of political contributions, contributions to tax exempt organizations, or dues paid to trade associations." Similar provisions to that effect have been included in appropriations bill for several years and have even been sticking points in negotiations. (See, e.g., this PubCo post and this PubCo post.) Unless Congress acted-and the provision would be repealed if the current version of HR 1, For the People Act of 2021, were signed into law-there could be a delay in adopting political spending disclosure requirements, at least until the next round of appropriations.

In questioning by the Senate Committee on Banking, Housing and Urban Affairs, nominee for SEC Chair, Gary Gensler, was asked by both sides about political spending disclosure. Gensler replied that his position on the issue would be grounded in economic analysis and the courts' views of materiality as the information reasonable investors want to see as part of the total mix of information. Gensler added that he considered the 80 shareholder proposals submitted last year on the topic and the 40% vote in favor as a strong indicator. In light of that level of investor interest, political spending disclosure was something he thought the SEC should consider. Similarly, with regard to climate, Gensler reiterated that reasonable investors are the ones who decide what is important, not the government. Gensler said that he would be guided by that. In 2021, Gensler agreed that investors with tens of trillions of invested assets are seeking information about climate risk, and the SEC has a role to play to bring comparability and consistency. (Note that, in the Q&A following her remarks, Lee also referred to the "reasonable investor" standard as the guide for determining materiality, and, she said, investors have been "crystal clear" about ESG.) He also noted that issuers could benefit from standardization and the clarity of guidance. Gensler said that, based on good economic analysis and public feedback, he would work with the staff on a rulemaking on climate. (See this PubCo post and this PubCo post.) The Senate Committee voted 14 to 10 in favor of sending Gensler's nomination for SEC Chair to the Senate floor for confirmation.

Climate attestation. Another issue Lee has been considering is whether there should be a requirement for verification of climate and ESG disclosures, including potentially "auditor attestation of current voluntary sustainability reporting? And should the PCAOB establish better standards or guidance for how auditors currently address companies' climate and ESG-related financial statement disclosures? How also do we encourage enhanced transparency by credit rating agencies regarding how they consider ESG factors? This is by no means an exhaustive list. These and other challenges remain." She later remarked in the Q&A that symmetry around ESG and financial reporting, such as through attestation, needs to be the "ultimate goal."

Shareholder Proposals. Lee indicated that investors are increasingly submitting shareholder proposals on ESG-related issues, constituting more than half of all proposals filed in recent seasons, and support for these proposals has almost tripled in the last decade. Some proposals have actually received majority support. Accordingly, Lee viewed the shareholder proposal process as an "important mechanism for investors to improve corporate governance and advance sustainable long-term strategies at the businesses they own." Lee reported that she is looking at revisiting the shareholder proposal process: she has

Universal Proxy. Lee has also asked the staff to consider whether the SEC should "re-open the comment file on the 2016 universal proxy rule proposal to take into account market developments since then and move towards finalization." Under that proposal, universal proxy cards identifying all the candidates for director on both slates would be required in contested director elections, replicating more closely in-person voting. In Lee's view, the proposal would be "a common-sense step forward in modernizing our proxy rules and protecting shareholder rights. The proposal has been outstanding for far too long and should be finalized." (See this PubCo post and this PubCo post.)

Proxy Voting. Because funds may not always reflect investor preferences for ESG strategies in their voting, Lee stressed that the SEC's rules and guidance should clearly emphasize the importance of voting as part of funds' and advisers' fiduciary obligations and should help ensure transparency for investors. To that end, Lee has asked the staff to consider revising 2019 guidance that she believes discourages fiduciaries from voting in certain circumstances, and to consider updates to disclosures of fund voting decisions on Form N-PX to maximize transparency.

Division of Enforcement's Climate and ESG Task Force. Lee also referred to the SEC's new Climate and ESG Task Force within the Division of Enforcement, intended to proactively detect climate and ESG-related misconduct and misstatements or omissions in company disclosure of climate risks. (See this PubCo post.)

International Efforts. Climate change is obviously a global issue and Lee confirmed her commitment to international engagement and cooperation. In particular, Lee indicated that she was pleased with the possibility of development of disclosure standards by a new Sustainability Standards Board created under the IFRS Foundation. According to Lee, the SSB "represents a promising approach toward the development of an international baseline for sustainability reporting upon which individual jurisdictions could build consistent with their own unique consideration."

SideBar

As reported in this article in Bloomberg, the IFRS Foundation, parent body of the International Accounting Standards Board, said it would create a new board to develop sustainability reporting standards. The new "global sustainability reporting rules will initially focus on climate change and will aim solely at giving investors information." The measures will be aimed at an audience no wider than existing accounting standards, which focus exclusively on information for the financial sector. According to Bloomberg, the SSB "would focus on information that is material to the decisions of investors, lenders and other creditors," and build upon the work of the Task Force on Climate-related Financial Disclosures (TCFD).

Domestic Sustainability Standard-Setter. The creation of an international standard setter also raises the question of whether the SEC should establish a comparable standard-setter for ESG (similar to the FASB) under SEC oversight dedicated to devising an ESG reporting framework that would complement the SEC's financial reporting framework. The goal would be to "devise a climate and ESG disclosure framework that is flexible and can efficiently evolve as needed." Another approach might be to recognize another existing set of standards, much like the COSO framework is recognized with respect to internal control. She stressed that the nature of climate and ESG mean that the SEC must work with market participants and regulators around the globe to address these issues, but the market alone is "not likely to be sufficient to mitigate these risks."

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