A. Pressure for Mandatory ESG Disclosure in the U.S.
Whether the U.S. government will mandate broad environmental, governance, and social (ESG) disclosures is a crucial question today. Voluntary ESG disclosure standards have evolved and expanded over the past two decades. But many investors and money managers are frustrated by the variation they perceive in corporate interpretation and application of voluntary standards. Voluntary measures such as third party ESG ratings, attestation or audits have had limited effect. At the same time, interest among investors and money managers in comprehensive and meaningful ESG disclosure has increased considerably.
Marketplace and political pressure has led to changes in the law. Some 23 foreign countries and seven stock exchanges outside the U.S. mandate ESG disclosures to one extent or another. The U.S. Department of Labor has made clear that fiduciaries managing employee benefit plans are permitted to consider ESG matters in making investment decisions. Similar guidance has been issued for state pension fund managers. These developments add to the marketplace clamor for more and better ESG disclosures.
B. Recent SEC Consideration of Mandatory ESG Disclosures
In 2016, the Securities and Exchange Commission issued a concept release concerning, among other things, the possibility of mandating broad ESG disclosures. But the SEC has yet to decide to whether or not to proceed. The SEC may have doubts about its legal authority to promulgate broad ESG disclosure standards. It may hesitate because of judicial rulings against its regulation for conflict minerals disclosure. It may blanch at the prospect of attempting to regulate ESG matters that sometimes cannot easily be quantified. The potential for litigation to challenge new broad rules may also discourage the SEC.
C. The Potential for Case-By-Case Judicial Development of ESG Disclosure Law
Litigation, however, could be another source of pressure to adopt compulsory broad ESG disclosures. As more and more cases over ESG disclosures (or non-disclosures) are brought, courts may gradually create a body of law for ESG disclosure requirements. Such case-by-case judicial development of ESG disclosure requirements could create a patchwork of differing legal mandates and standards, varying from federal district to federal district and federal circuit to federal circuit, which might prove a compliance nightmare for national and multi-national corporations. In such circumstances, public companies and investors would likely turn to the SEC for faster and more definitive ways to attain nationwide consistency.
Another potential source of pressure for SEC action could emanate from climate change litigation. In a landmark 2016 decision captioned Juliana v. United States, 217 F. Supp. 3d 1224 (D. Ore. 2016), the federal district court in Oregon ruled, that there is a fundamental right under the Constitution to a climate that would sustain human life. The novelty of the decision triggered a frenzy of appellate activity that continues to date. If the Juliana decision becomes the law of the land, it could enable ESG activists to seek judicial rulings compelling the SEC to prescribe regulations requiring a broad range of ESG disclosures.
D. The Potential for Foreign Mandatory ESG Disclosures to Set Worldwide Standards
A growing number of nations now mandate at least certain ESG disclosures. Standards in other nations could eventually coalesce into a single set of international standards utilized by all or almost all nations, as has happened with international financial accounting standards. With the U.S. not yet having its own mandatory broad ESG disclosure standards, U.S. companies will likely face substantial pressure to adhere to international ESG standards. U.S. authorities, if they come late to the game, could be pressured to adopt international mandatory ESG disclosure standards in order to prevent a global regulatory divergence such as exists with financial accounting standards. Many multi-national corporations may well advocate the adoption of unified worldwide ESG disclosure standards for the sake of uniformity . As long as the U.S. does not mandate broad ESG disclosures, it likely will have little or no voice in the international evolution of global ESG disclosure requirements. If, however, the U.S. adopts mandatory broad ESG disclosures, its vast, highly liquid securities markets will necessarily make it part of the global dialogue on unifying standards.
E. The Likelihood of Mandatory Broad ESG Disclosure
Ultimately, regulation cannot lag too far behind the market. The growing materiality of ESG disclosure in the minds of numerous market participants will increase the already significant pressure for mandatory broad disclosures.
Moreover, as ESG disclosures grow in importance to investors, stock valuations will increasingly be affected by those disclosures. The potential for losses from inaccurate or fraudulent ESG disclosures will rise. Fraud and deception gravitate toward unguarded venues. Investor losses from ESG disclosure failures could increase pressure for broad mandatory disclosure requirements. Companies should anticipate a high probability for eventual broad ESG disclosure rules.
F. Preparing for the Future
Public companies can look forward to an increased future role for ESG in corporate life. Companies should avoid being defensive about their ESG disclosures. Answering the siren call of expediency by making such disclosures so general, aspirational and subjective as to thwart shareholder and SEC lawsuits can easily result in disclosures of little value to investors and money managers. The company may end up seeming too clever by half and frustrating important stakeholders instead of impressing them.
A better choice would be ESG disclosures that are substantial and informative. A company should establish reliable and comprehensive internal information gathering systems and internal controls for ESG disclosures. It should make ESG a significant management responsibility, and the board of directors should include ESG in its regular oversight activities. Thus, the company would be better prepared for compulsory disclosure rules if and when they are mandated by the SEC. The economically advanced nations of the world are transitioning toward mandatory broad ESG disclosures, and this is a transition the United States, however reluctantly, is likely to make in time.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Readers seeking more detailed information should consult Bloomberg Tax & Accounting Portfolio 5506-3rd, Wang, Corporate Governance of the Financial Reporting Process and SEC Regulation of ESG Disclosures (Accounting Policy and Practice Series).
Mr. Wang is a former Assistant Director, Division of Enforcement, of the U.S. Securities and Exchange Commission. During a 22-year career at the SEC, Mr. Wang received the Chairman’s Award For Excellence, the Stanley Sporkin Award, the Capital Markets Award and the Division of Enforcement Director’s Award. Mr. Wang was also elected to Phi Beta Kappa, Phi Kappa Phi, the Order of the Coif and the editorial board of the Wisconsin Law Review, and is a member of the District of Columbia Bar and State Bar of Wisconsin.