The SEC's ESG disclosure focus — slighting the real concerns

September 29, 2021 - From all indications, the U.S. Securities and Exchange Commission under the leadership of Chairman Gary Gensler is making ESG (environmental, social, and governance) disclosures a top priority. Disagreeing with this focus, critics argue that the SEC is stretching its mandate too far afield from the economic materiality mandate that underlies the federal securities law framework.

Yet, what the commission is seeking to bring about, as it has done in earlier eras, is to impact substantive corporate conduct through the guise of disclosure. Dating back to 1961, the SEC sought to impact insider conduct by requiring disclosure of management self-dealing transactions.

And, after the Supreme Court in the 1970s rebuffed efforts to elevate the antifraud provisions to encompass substantive fairness, the SEC adopted a rule requiring disclosure by insiders whether they reasonably believe that a going-private transaction is fair or unfair to unaffiliated shareholders. By engaging in these regulations premised on disclosure, the commission in effect sought to facilitate enhanced corporate governance practices.

The same rationale applies to this latest focus by the commission. Through the requirement of ESG disclosures, the expectation (whether realistic or not) is that publicly held companies will become more sensitized, acting in a more socially conscious manner to protect the environment, promote diversity, and further social awareness — among other objectives.

What is more likely to occur, as it did with the commission's mandate expanding executive remuneration disclosure, is even lengthier disclosure documents exacerbating the information overload problem.

Thus far, the commission is missing the mark. There are real problematic issues that should be addressed. ESG disclosures are mere window-dressing compared to the systematic gaps that currently exist.

In my recent Oxford University Press book "Rethinking Securities Law," I identify 125 recommendations where meaningful reform is needed. A handful of them will be highlighted here. For example, unlike the rule adopted by many developed markets (such as the European Union), a publicly held company has no affirmative duty to disclose under our securities laws all material information to the investing public.

The result is that, without adequate business justification, highly important information can be withheld from the markets. This gap impairs the price efficiency of the securities markets and harms investors. The solution is for the securities laws to timely require, absent the presence of justifiable business reason, the public disclosure of all material information.

As a second example, the status of "accredited investor" was adopted by the SEC in Regulation D in 1982. For individuals, it signifies that those persons who have a net worth of $1 million (exclusive of the value of one's principal residence) are irrefutably deemed to have financial sophistication and to have access to registration-type information. The consequence is that in specified exempt offerings, such as Rule 506 offerings, no disclosure is required to be made to such individuals.

Clearly, many of these individuals lack financial sophistication, having reached the $1 million net worth status through, for example, retirement plans, inheritance, or appreciation of personal assets. While the commission should thoroughly reconsider the propriety of accredited investor application, the immediate focus should be on increasing the $1 million net worth level to 2021 dollars adjusted for inflation.

As the commission itself recently admitted, it has declined to do so fearful that such an increase would impede private capital raising. While promoting private capital raising may be a legitimate objective for the commission, it should not outweigh the SEC's investor protection mandate.

Moreover, many SEC disclosure documents run well over 100 pages, resulting in information overload. Relatively few individuals and even organizations have the wherewithal to studiously review these documents.

Two measures, among others, should be adopted. First, the SEC should undertake an examination of its disclosure rules and minimize requiring disclosure of information that is not material. Second, a comprehensive Summary Section should be required for specified SEC filings, such as for registration statements, proxy statements, and quarterly and annual reports.

The inclusion of a mandatory Summary Section contained in the front part of these SEC filings should improve the disclosure process and provide ordinary investors with better access to important information — thereby enabling them to make more informed investment and voting decisions.

As a last example, the U.S. law of insider trading is abysmal. Inconsistencies prevail resulting in disparate treatment for similarly situated persons. Understandably, no other developed market has opted to adopt our approach to insider trading.

Two recommendations are made here. First, a comprehensive "access" approach should be enacted, prohibiting those who have unequal access to material nonpublic information from trading on or tipping that information to others.

Second, because insiders always have more information about their companies than outsiders, officers and directors should be required before they trade (rather than afterward which is the current rule) to file a Form with the SEC that is made publicly available.

If the transaction is otherwise permissible, they may then trade their company's securities one business day after filing. As fiduciaries, insiders should not be permitted to be at the front of the line (even with respect to supposedly "non-material" information) and relegate shareholders and the investing public to the back of the queue.

There is much meaningful work for the SEC to undertake. The question is whether the members of the commission will have the wherewithal to implement much-needed reform of our securities laws.