• Allon Advocacy

ESG Disclosure Rules Are Coming

The SEC is expected to issue regulations next month requiring public companies to disclose climate change impact and board diversity data.

While Congress busies itself over the next several weeks with a big-ticket “human” infrastructure and tax bill, fiscal year 2022 appropriations bills, and a debt ceiling increase, the U.S. Securities and Exchange Commission (SEC) is expected to finish writing rules to require public companies to disclose climate change risks and statistics about their board’s diversity. The rules will follow an executive order from President Joe Biden that called for “a comprehensive, [g]overnment-wide strategy” on climate-related financial risk and that said the SEC should “require the adoption of standards by which corporate issuers disclose material ESG [environmental, social, and governance] risks.”

In remarks this summer, SEC Chair Gary Gensler argued, “Public disclosure isn’t new. We’ve been requiring disclosure of important information from companies since the Great Depression.” Gensler also said, “When it comes to climate risk disclosures, investors are raising their hands and asking regulators for more.”

While both statements might be true, that does not mean these rules — which are expected to be released in October — will be without controversy.

In fact, we can expect plenty of it … at least from the country’s political class.

Surveys Show Consumers, Employees Want Companies To Do More On ESG

This past spring, PricewaterhouseCoopers (PwC) surveyed more than 5,000 consumers, 2,500 employees, and 1,250 business leaders in the United States, Brazil, United Kingdom, Germany, and India about their expectations from business when it comes to ESG issues.

According to PwC, “Consumers want to see business play an even bigger role in accelerating progress on ESG concerns.” Specifically, 83 percent of consumers said they think companies should be “actively” trying to shape ESG best practices. Additionally:

  • 57 percent of consumers said companies should do more to advance environmental issues;

  • 54 percent want more action on governance issues like pay inequity; and

  • 48 percent want companies to show more progress on social issues like data security and diversity.

Employees are even more supportive of action than consumers. The PwC survey found 86 percent of employees prefer to support or work for companies that care about the same issues they do. Eighty-four percent of employees said they are more likely to work for a company that puts a priority on environmental stewardship, for example.

Meanwhile, 91 percent of business leaders said they believe their company has a responsibility to act on ESG issues. Whether the SEC should be compelling that that action is a different story for companies, however.

A survey released last month by the U.S. Chamber of Commerce (USCC) and several other business trade associations found only 36 percent of companies support adoption of uniform climate change standards by the SEC. The same percentage oppose the idea.

Companies want guardrails in place if the SEC moves forward with disclosure rules. Specifically:

  • 74 percent of companies want the SEC to phase-in requirements for all issuers and 14 percent want a phase-in for at least small companies.

  • Almost half of companies (47 percent) do not want the SEC to require certification by the CEO, CFO, or other corporate officer of a company regarding climate disclosures. Only one-quarter (24 percent) support this idea.

  • Almost three-fifths of companies (57 percent) oppose a requirement to mandate an audit or other form of third-party assurance on climate change disclosures. Only 22 percent support this idea.

  • Forty-three percent of companies believe the SEC should adopt a comply-or-explain approach to climate disclosure. One-third oppose that idea.

The USCC survey also found many companies are already releasing ESG data. Specifically, 59 percent of companies said they are disclosing more information regarding climate change than they had previously, while 63 percent are communicating with their shareholders regarding the evolving risk of climate change.

What about investors? In May, Workiva Inc., a global employment software company, released the findings of a survey of individual investors. Workiva discovered approximately 70 percent of investors believe companies have a responsibility to demonstrate ESG performance to investors. Additionally, more than half of investors said they would be more likely to invest in a company that provides information about ESG performance.

Younger investors are particularly interested in this issue. Indeed, nearly three-quarters (72 percent) of 18–34 year-olds said they want to know whether a company lives up to their social and moral beliefs before they are willing to invest in it. Sixty percent of this group said they would be more likely to invest in a company that discloses information about ESG performance.

Democrats Support Gensler, Republicans Oppose SEC ESG Rules

Perhaps predictably, in public policy and political circles, support for and opposition to these rules falls along traditional ideological divides. Right-leaning think tanks and lawmakers have not only argued against the merits of the rules — they question whether or not the SEC even has the authority to write them.

The Texas Public Policy Foundation, for example, has said that the SEC’s founding documents provide only an “extremely limited basis” to impose such rules. Every single Republican lawmaker on the U.S. Senate Banking Committee signed a letter this summer that told the SEC and Gensler that ESG rules “will only serve to further discourage firms from becoming publicly traded, thus denying significant investment opportunities to retail investors.”

In June, a group of 16 Republican state attorneys general (AGs) sent a letter to the SEC that argued the commission’s authority is limited to mandating required reporting that is necessary and appropriate for the protection of markets and investors and that power does not include the ability to require public companies to make statements on any topic for which there may be investor demand.

West Virginia AG Patrick Morrissey led that letter. Back in March, he threatened to sue the SEC if it requires ESG disclosures. As lawyers at Cozen O’Conner LLP have explained, Morrissey argued mandating ESG disclosures from companies that are not related to their financial performance would represent regulatory overreach and would be unconstitutional because it would not “withstand strict scrutiny” under free speech rights.

Not to be outdone, one week before the Republican AGs wrote to the SEC, a group of 12 Democratic state AGs sent a letter to the SEC supporting the rules. Additionally, the Center for American Progress, a left-leaning think tank, has argued:

“The SEC has the ability and responsibility to require disclosures, including ESG-related disclosures, that would further its mission to protect investors; promote more fair, orderly, and efficient markets; promote capital formation; and protect the public interest. These responsibilities require the SEC to ensure that market participants have reliable, consistent, and comparable climate- and ESG-related information that is important to their business decision-making.”

Who Has Judicial Precedent On Their Side?

These ideological arguments are not new to the SEC or to Capitol Hill.

As a recent CFO Magazine article explained, the 2010 Dodd-Frank Wall Street Reform Act required public companies to disclose “whether their supply chains contained even trace amounts of minerals linked to human rights abuses in the Democratic Republic of the Congo.” Companies were expected to regularly review the materials they used in products and to “regularly” release their findings to ensure that they were “conflict free.”

The SEC wrote the rule implementing the Dodd-Frank provision, but a federal appeals court later ruled part of the rule unconstitutional on free speech grounds. In other words, the rule went down using more or less the same arguments Republicans are using now against ESG rules.

Business groups, those representing manufacturers in particular, strongly opposed the SEC conflict minerals rule. The commission never challenged the appeals court’s decision in the Supreme Court and the Trump administration abandoned enforcement of the conflict minerals regulation. (There were other arguments against the rule as well. Practically, it was difficult to implement. As CFO Magazine explained, “A GAO report in August 2015 found that two-thirds of public companies subject to the conflict minerals disclosure rule were unable to determine the origins of their conflict minerals.” The GAO also said the regulation “had little effect on stemming human rights abuses.”)

Will this precedent, and the growing political tension over the ESG rules, cause Gensler and his colleagues to hesitate? InvestmentNews reporter Mark Schoeff Jr. doesn’t think so. In June, he noted “Under Gensler, the SEC has a 3-2 Democratic majority. Although the SEC is an independent agency, it is going to do its part in President Joe Biden’s government-wide push to combat climate change.” Schoeff also explained that other controversial regulations, including Regulation Best Interest, were approved with a split vote. Schoeff also said, “Gensler is a savvy politician” who knows how to overpower his opponents.

Which brings us to our final point: it currently is easier for the SEC to act on ESG disclosures – or anything, really – than it is for Congress. In June, the U.S. House passed the ESG Disclosure Simplification Act, which would require public companies to make certain disclosures. The bill passed by just one vote — making this issue even harder to tackle on Capitol Hill than the debt ceiling.

If President Biden wants to make disclosures happen, it’s up to Gensler.

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