Corporate disclosure is gaining much more attention in Washington. This coming October, the Securities and Exchange Commission (SEC) is expected to announce rulemaking on climate disclosure, with board diversity and human capital soon to follow. On Capitol Hill, a recent package adopted in the House included sweeping changes in many areas of corporate governance. Here, we take a close look at this bill as it offers a glimpse of where the partisan fault lines might be for regulatory and legislative action in the future.
In March 2021, the SEC issued a request for public comment evaluating mandatory standards and disclosure framework on ESG issues. The SEC is expected to soon undertake a rulemaking in the autumn of 2021. While the SEC is an independent commission, it is currently divided 3-2 along party lines including President Biden’s pick for Chairman, Gary Gensler.
Congress is also looking at SEC disclosure issues. In June, by a 215-214 vote, the House of Representatives passed H.R. 1187 The Corporate Governance Improvement and Investor Protection Act of 2021 (“Disclosure Act”) with no Republican votes and all but 4 Democratic votes. The original H.R. 1187, the ESG Disclosure and Simplification Act, was used as the vehicle for several bills on disclosure.
The Disclosure Act was a response to the growing interest in “what” material information companies disclose and “how” they disclose that information to the SEC. These issues were the subject of a candid conversation with Reps. Gregory Meeks (D-NY) and Bill Huizenga (R-MI) hosted by BPC in June.
BPC Disclosure Event
As Congressman Meeks (D-NY) indicated, the Disclosure Act is a means to fill the gaps left unresolved by market forces. However, he acknowledged that this was a messaging bill and that the legislation will need to be refined through the legislative process. It can be surmised that opponents of the bill were concerned with the breadth of ESG disclosure issues addressed in it. Congressman Huizenga (R-MI) indicated that Congress is asking the SEC to weigh in on social and political issues that are better debated in the halls of Congress rather than at an independent agency.
Both Congressmen agreed that ESG disclosure will continue to expand for the foreseeable future. They also both support the SEC’s tripartite mission to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”
The Disclosure Act (“Act”) would require the SEC to mandate ESG disclosure and develop the metrics for such disclosure. It specifically requires disclosing information on political expenditures; pay ratios of certain employees; climate risk; tax havens; workforce demographics; workplace harassment; cyber security; board diversity; and forced labor. Proponents of the legislation argue investors need more ESG information to make sound investment decisions. Opponents, however, argue that under the existing materiality standard the types of information listed in the Act are already required to be disclosed if the information is material to a reasonable investor.
Congress found that the SEC has the authority to require the disclosure of ESG information that is material or in the interest of investors. It currently does not require companies to disclose ESG matters, nor does it have any standards to follow. Further, ESG matters are material. Lastly, that investors have reported that voluntary disclosure is inadequate and that the SEC must mandate reporting and some form of standardization for that reporting.
The legislation specifies that the SEC must require disclosure, including but not limited to, the links between ESG metrics and the long-term business strategy; and the processes used to determine the impact of ESG metrics on strategy. It also requires the SEC to define ESG Metrics and create a Sustainable Finance Advisory Committee.
The opposition indicated that changing the materiality standard would disrupt the U.S. public markets by adding unnecessary costs and reducing the number of companies that might otherwise go public. Furthermore, it would undermine the U.S. Supreme Court’s rationale in establishing a materiality standard in that it was intended to protect a “reasonable investor” from an overflow of information that would not be used by a reasonable investor making investment decisions. Further, the disclosure of non-material information would likely be used by competitors, as well as activists, to gain an unfair competitive advantage or to “name and shame” companies into engaging in issues that have historically been the purview of elected officials. Lastly, that regulation S-K already addresses non-financial disclosure requirements including those dealing with ESG and climate change, and therefore this legislation is duplicative.
Congress found that these provisions are necessary because corporations make significant political contributions and expenditures that influence elections with no input from shareholders. Shareholders and the public have a right to know about these expenditures.
The bill requires companies to disclose independent expenditures, elections related or other public communications, and dues to 501(c) organizations. While it does not require disclosing lobbying activities, as it is statutorily required elsewhere, it does require companies to submit quarterly and annual reports including the description, date, and amount spent including specific information about individual candidates, and projected expenditures for the forthcoming year. Once received, the SEC is also required to analyze the disclosed information and report compliance to Congress.
The opposition indicated that the Federal Election Campaign Act of 1971 already requires the disclosure of independent expenditures, electioneering communication, and other public communications. While certain organizations, such as trade associations, are exempt they must disclose information through their annual reporting. Furthermore, the SEC already requires the disclosure of political spending if it is material to a company
A previous committee report found that during Covid CEO pay increased as unemployment increased. Under Dodd-Frank, CEO compensation was required to be disclosed and as a result, shareholders increasingly withheld support for certain compensation packages. Therefore, expanded disclosure of compensation would provide shareholders more information on pay equity and allow a transparent and accountable comparison between workers and executives in addressing worker inequality.
The bill requires disclosing the percentage increase in annual compensation of executives and employees. In addition, companies must disclose the pay ratio between executive and employees with a comparison to inflation.
The opposition indicated that the bill fails to recognize that each company’s pay ratio is unique and explaining the numbers or its uniqueness would be an additional burden on companies with no discernable benefit to investors. Also, requiring this additional disclosure is the type that dissuades private companies from going public, thus continuing the decline of public traded companies.
Congress found that financial and economic climate-related risks and opportunities are important for investors (i.e., material) in their investment decisions. These risks include physical and transition, implications on business strategy, board-level oversight, comparison of data and performance, and a price on GHG emissions that reflects the social cost of carbon.
The bill requires the SEC promulgate a rulemaking(s), within 2 years, that include establishing climate-related risk disclosure rules for specific industries. Within specific sectors, companies must include reporting standards for estimating direct and indirect GHG emissions; the total amount of fossil fuel-related assets-owned; and the parameters, assumptions, and analysis for climate rick scenarios over 5-, 10-, and 20-year time frames.
In addition, it requires disclosing quantitative analysis and industry specific metrics on climate-related risks, risk management actions taken in addressing identified risks, and the resiliency of the strategy taken. It also requires the disclosure of the total cost of direct and indirect GHG emissions including the social cost of carbon; and an analysis of a 1.5-degree scenario including a baseline scenario that addresses the physical impact of climate change. Finally, has a specific section for the commercial development of fossil fuels where it has specific disclosure requirements on emissions and other environmental management issues.
The opposition indicated that the materiality standard should not be changed to make a one-size-fits-all disclosure framework. They argue the SEC does not have the technical expertise to determine the reporting metrics and industry standards from climate, environmental, and energy related issues across multiple economic sectors. Further, more information is needed to determine whether investors are receiving decision useful information from the voluntary disclosure standards. Opponents also argue that the referenced disclosure framework seeks to target one sector of the economy over others. Lastly, disclosing forecasts of indirect GHG emissions 20 years in the future cannot possibly be decision useful information given the lack of accuracy of such projections.
Congress found that corporate tax practices may impose material financial risk and investors will not be able to adequately assess a company’s tax liability without the disclosed information. Companies are using U.S. tax laws to shelter money that would otherwise be taxed. Investors need country-by-country tax information to make more informed decisions about their investments and to ensure that companies “pay their fair share” of taxes.
The bill requires the SEC to promulgate a rulemaking within 18 months that requires an annual country-by-country reporting including: all the names of businesses they use and corresponding tax jurisdiction; all revenues and profits before and after taxes under those businesses; the total number of full-time employees under those businesses; and the net book value of all tangible assets under those businesses.
The opposition indicated that if corporate tax practices impose a material financial risk, it must already be disclosed. Further, if the current tax code is not adequate to capture the “lost” revenue suggested in the findings, then the tax code should be updated. Also, there is only political value in knowing how a company is legally navigating the tax code. Lastly, the disclosure of different tax codes from different jurisdictions may confuse a reasonable investor and make investment decisions more difficult.
Congress found that companies are not hiring workers at different educational levels with the intent of investing in their development and have invested less in training over the past 10 years. They further argue that companies are incentivized to invest in physical assets rather than their workforce. Companies have different policies regarding their workforce and investors should have this information as workforce development increases long-term financial performance. Moreover, companies track this internally, so it would be minimal burden to make this information public. Furthermore, a robust benefits package to workers increases productivity as well as mental and physical wellbeing. Finally, companies should disclose their policies to reduce discrimination as discrimination leads to lower productivity and overall company morale.
The bill requires the SEC, within 2 years, to require the annual reporting of Demographics (full-time; part-time; race ethnicity; gender); stability information (turn-over rates; internal hirings; promotions etc.); composition (data of diversity including policies to address); skills and capabilities (training etc.); health, safety, and well-being (injuries; physical and mental illness; expenditures on health, safety, and well-being; OCHA claims; harassment or discrimination instances); compensation and incentives (salaries, benefits, policies on performance etc.); recruiting and needs (number of new jobs; educational requirements; retention rates); and engagement and productivity (mental well-being; life-work-balance).
The opposition is concerned with disclosing this type of information, if not material, because it goes to the heart of day-to-day business decisions, including maintaining a competitive advantage. These types of internal decisions have traditionally been left to management and not the type that the SEC or the courts have allowed investors to weigh-in on.
Congress found that companies should disclose whether they have expended funds to resolve, settle, or litigate claims of workplace harassment. They should also disclose whether executives and managers are complying with prohibitions against harassment and facilitate a culture of silence, disrespect, intimidation, and abuse that negatively affects the health and safety or workers.
The bill requires the SEC, within 1 year, to promulgate a rule that requires the disclosure of workplace harassment and retaliation for reporting, resisting, opposing, or assisting in the investigation. Also, it requires the disclosure of the number of settlements and/or judgements including the amount paid to settle or because of a judgement.
The general opposition to this type of disclosure requirement is that if the information is determined to be material, then it is already a requirement to disclose to investors.
There were no Congressional findings. The text merely requires the SEC, within 1 year, to promulgate a rule that requires the disclosure of whether any member of the governing body (e.g., Board) has cybersecurity expertise or experience; and if not, what has been done by non-governing members to address it. The opposition indicated that there is no support or findings to justify this information to be disclosed.
There were no Congressional findings. The text requires the SEC to mandate companies disclose the demographics of their boards. This includes the “voluntary self-identification” of racial, ethnic, gender identity, sexual orientation, and veterans. Also, to disclose whether the board adopted any policy, plan, or strategy to promote racial, ethnic, and gender diversity amongst directors and executive officers. The text also creates the Director of the Office of Minority and Women Inclusion at the SEC. The newly created office must submit a “best-practices” for compliance to Congress every 3 years.
The bill also establishes a diversity advisory group made up of federal governments, academia, and the private sector. The group must study and identify strategies to increase gender identity, racial, ethnic, and sexual orientation diversity among board members. It must also submit a report to Congress with 270 days of its establishment and then annual reports thereafter.
There were no Congressional findings. The text requires the SEC to promulgate a limited rule that requires the disclosure of information regarding goods imported, originated in forced labor camps, or manufactured from the Xinjiang Uyghur Autonomous Region. Also, that the SEC shall assess compliance and submit an annual report to Congress. The GAO must do a periodic report on this disclosure topic as well.
There were no Congressional findings. The text requires the SEC, within 12 months, to conduct a study regarding the impact of disclosure requirements on small businesses.