The House Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets recently held a hearing titled, “Building a Sustainable and Competitive Economy: An Examination of Proposals to Improve Environmental, Social and Governance Disclosures.” The hearing focused on the requirement of public companies to file periodic and current reports with the Securities and Exchange Commission (SEC) disclosing business and financial information relevant to the company. Though any of the bills discussed may survive the Democratic-held U.S. House of Representatives (the Climate Risk Disclosure Act of 2019 was recently voted successfully out of the full Committee, for example), it should not be expected for any of the bills to be considered in the Senate.
The reason for these reports is to provide the public, specifically investors, with information needed to make informed investment and voting decisions. Disclosures mitigate asymmetries of information between a company’s management and its shareholders. Robust, routine disclosures of material information to shareholders expands accountability and enhances stock price accuracy, both of which lead to more efficient allocations of capital.
As the hearing title suggests, this discussion focused on improving Environmental, Social and Governance (ESG) disclosures. These matters generally include issues relating to environmental sustainability, such as climate change; social issues such as human rights and labor practices; and governance issues such as gender, racial, and ethnic diversity at both the executive and board levels. Not only have investors been recently demanding a more robust disclosure of ESG information by public companies, but credit rating agencies have now also begun incorporating these ESG factors into their ratings methodologies. S&P, for example, has taken over 100 rating actions because of environmental and climate concerns.
The SEC has broad authority to publish rules requiring the disclosure of information it deems relevant to the interest of the public or protection of the investor. Regulation S-K (Reg S-K) outlines the disclosure requirements for public companies. While Reg S-K requires the disclosure of information likely to have a ‘material’ effect on a company’s finances or competitive operational performance, the regulation does not stipulate that companies can only disclose information that meets the standard of ‘materiality.’ Historically, the SEC has identified a broad, wide-ranging assortment of categories of information believed material, relied on specific line-items within those categories, and allowed the discretion of the company’s management to determine additional material information relevant to the public and investors. In issues related to public policy, Congress also has the authority to mandate additional disclosures.
As climate change increasingly becomes a flagship issue for Democratic politicians, both in Congress and the 2020 presidential contest, a focus on this issue by the Democratic-controlled House of Representatives should not be surprising. The hearing also follows extensive actions by the United Kingdom (UK) and European Union (EU) on the issue of ESGs and investments. Most recently, the UK announced that all publically listed companies, as well as large asset owners, would now be required to report on information related to climate issues. Additionally, the EU recently adopted requirements that financial professionals incorporate ESG criteria into their financial management processes.
The five bills discussed at the hearing were:
- 2075 and H.R. ____, The Climate Risk Disclosure Act of 2019
- R. ____, The ESG Disclosure Simplification Act of 2019
- R. ____, The Shareholder Protection Act of 2019
- R. ____, The Corporate Human Rights Risk Assessment, Prevention, and Mitigation Act of 2019
- R. ____, [Corporate Tax Reporting]
House Democrats’ calls to promote transparency and increase the reporting of ESG issues by public companies were met with cost, implementation, and profitability impact concerns by their Republican counterparts. Many questions and theoretical scenarios were discussed throughout the hearing. Questions discussed and debated included:
- How should companies adhere to increasing reporting demands without incurring substantial expenses; especially when many of the filings, forms, and questionnaires that must be submitted to not pertain to their sectors?
- For companies determining what information is ‘material,’ what defines a ‘reasonable investor?’
- With an increasing number of global and transnational public companies, how should companies adhere to the various, differing reporting requirements and standards that individual nations implement. Surely, such a complicated web of reporting requirements will only increase confusion for the investor and place an undue burden on the company.
- What should the process and ‘material’ ESG information look like?
- 2075 and H.R. ____, The Climate Risk Disclosure Act of 2019
- Key piece of Senator Elizabeth Warren’s climate platform. Introduced in the last Congress and reintroduced in the 116th
- This bill, recently passed by the full House Financial Services Committee, would require the disclosure of physical and transition risks posed by climate change in the annual reports of public companies.
- The SEC would be required to create industry-specific climate reporting metrics. This would include an estimate and disclosure of greenhouse gas emissions, as well as the reporting of the social cost of carbon output by companies.
H.R. ____, The Shareholder Protection Act of 2019
- Would require quarterly reports submitted to the SEC and investors by public companies on expenses related to political activities. This includes contributions to trade associations.
H.R. ____, The ESG Disclosure Simplification Act of 2019
- Would establish a Sustainable Finance Advisory Committee (SFAC) responsible for advising the SEC on sustainability issues. The SFAC would provide policy recommendations to the SEC to promote the flow of capital towards ESG investments.
- Would require an annual disclosure on the link between ESG metrics and a public company’s long-term business strategy.
- The bill would require the disclosure of ESG factors in any public filing requiring audited financial statements.
- The bill would define ESG metrics as ‘material’ information.
H.R. ____, [Corporate Tax Reporting]
- Would require disclosure of total pre-tax profits in 10-Qs and 10-Ks, as well as amounts paid in State, Federal, and foreign taxes.
H.R. ____, The Corporate Human Rights Risk Assessment, Prevention, and Mitigation Act of 2019
- Would amend the Exchange Act and require the disclosure of human rights practices by public companies.
- Annual analysis identifying and ranking by severity any human rights risks in their operations and supply chains would also be required.
The July 10, 2019 hearing by the Subcommittee on Investor Protection, Entrepreneurship and Capital Markets highlighted the increasing interest in and awareness of ESG reporting issues in Congress, the United States, and abroad. Especially as foreign nations and international groups expand ESG reporting requirements (and as the public ramps up its own ESG expectations), these reporting concerns and questions will only grow. Though it is clear the political makeup in the current Congress does not give any of these bills a high likelihood of enactment, stakeholders should remain cognizant and informed of any and all developments in this area.
 Information is considered ‘material’ if there is a substantial likelihood that a reasonable investor would consider the information important in the investment decision-making process. The Supreme Court has also explained that information is ‘material’ if the disclosure of the omitted fact would have been viewed by a reasonable investor has having significantly altered the ‘total mix’ of information available.
 A notable example of this is the Iran Threat Reduction and Syria Human Rights Act of 2012 which required public companies to disclose any contacts with, or support for, Iran or certain other persons involved in terrorism or the creation of weapons of mass destruction.