Government officials and legislators with more traditional views on materiality have held out that ESG concerns are not typically material to investment decisions (other than in certain industries). However, the SEC has telegraphed that its viewpoint on this may be changing, with Chairman Gensler having
testified during his confirmation hearing that investors get to decide what is material. Some stakeholders have expressed concern that this is an excessively broad window and poses serious risks to another clear concept in financial markets regulation: boards and executives are best positioned to manage the company, day-to-day and strategically.
In a May 24 speech, Commissioner Lee addressed the definition of materiality and took aim at the following “myths” (in her view) regarding materiality and environmental risks:
- ESG matters (and all material matters) are already required to be disclosed;
- Those material ESG concerns are already being disclosed;
- SEC disclosure requirements are strictly limited to material information; and
- Climate and ESG are social or “political” issues and not material to investors.
Commissioner Lee’s speech specifically targeted the use of principles-based rules and the idea that all disclosures must be material. In criticizing principles-based rules, she noted that management’s principles and definition of material information are likely to be different than investors. In criticizing the centrality of materiality, she touched on executive compensation, noting that the SEC requires specific data disclosures that investors may like to know but may not be material to each company making the disclosure. If Chairman Gensler is staking out the position that investors determine materiality, Commissioner Lee’s speech signals two additional arguments for prescriptive rules – principles-based rules do not produce useful disclosures and materiality is not the end-all-be-all disclosures standard.
Commissioner Lee does not seem to have much faith in the idea that increasing investor pressure is already encouraging companies to provide these disclosures. However,
shareholder support for ESG proposals is dramatically higher this year with average support at 40% (vs 33% in 2020) and more than a quarter of proposals gaining majority support. Further, the principles-based approach to HCM reporting in the 10-K has driven investors to ask for additional clarity. An
article from Agenda highlighted growing investor focus on employee engagement and performance evaluation.
The Center continues to believe (and will advocate for) a principles-based approach to disclosure wherever possible and will encourage the SEC to take note of the effectiveness of shareholder engagement rather than mandates when furthering the interests of investors.
