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What Is Materiality?

Recent years have seen significant debate over what publicly traded companies do, or do not, disclose regarding their finances and operations. Here’s a quick look at this disclosure requirement and one of the key bases for determining what gets disclosed.

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Why do companies have to disclose information to the Securities and Exchange Commission (SEC)?

To raise capital (money) from the public, the federal government requires companies to disclose certain information so that investors can make informed investment decisions.

How is that determined? By what is known as materiality.

Why is materiality so important when it comes to disclosure?

The question of materiality is a balancing act between companies withholding what a reasonable investor would find relevant for investment decisions and companies offering an overload of information that might result in confusion to investors and unnecessary costs to a company.

Materiality Modifiers

The materiality standard articulated by Justice Marshall has been consistently and routinely applied in the United States for nearly 50 years. Globally, however, materiality is coming to mean something different in different jurisdictions. Two different notions have taken hold in recent years.

Double materiality

Looks at the impact on both shareholders and other stakeholders. It can be said to look outward at how a company affects the human environment and whether that impact is material. Largely accepted in the European Union.

Nested materiality

Used by multiple stakeholders to include financial data, sustainability topics that are financially material, and a company’s impact on the human environment. Some say it’s the more likely concept to be adopted in the United States

Why is the concept of double materiality relevant?

The SEC’s role, as opposed to a broader federal government agenda, is narrowly focused on investors or shareholders in the U.S. capital markets. Double materiality, by contrast, takes into consideration not only financially material information but also a broader group of stakeholders and how a company affects their interests. Some shareholders believe that stakeholders’ interests are equally important. Others invest their money with the specific goal of maximizing a return on their investment and believe that not all stakeholders’ interests are financially material.

Materiality Evolving?

The SEC has a tripartite mission: protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation. This should continue to direct corporate disclosure of certain non-financial information—there are undoubtedly compelling reasons for companies to do so. Most well-run companies have been analyzing such non-financial information from the time they were established.

Now that a seemingly growing number of stakeholders, including investors, want to analyze more ESG data it will be up to the SEC to create a disclosure framework based on the materiality standard that balances the desire for the information from a reasonable investor and as Justice Marshall warned an “avalanche of trivial information” that would not be “conducive to informed decision making.”

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