Should the SEC have to enforce so-called sustainability standards for corporate financial reports?
The Trump administration has strongly signaled its intention to review — and roll back — a range of environmental, labor and financial regulations. In doing so, it should be wary of a movement that would use the Securities and Exchange Commission to add to the regulatory burden in all those areas and more by infusing corporate accounting with environmental advocacy.
There is good reason to believe the SEC during the Obama years was hospitable to such "sustainability" reporting. Jay Clayton, Trump's pick to lead the SEC, should be asked about the subject in his confirmation hearings.
The idea of sustainability reporting is being championed by the Sustainable Accounting Standards Board (SASB), a group well-financed by benefactors such as the Ford Foundation and former New York mayor (and billionaire) Michael Bloomberg.
SASB's acronym is a riff on that of the Financial Standards Accounting Board (FASB), the private, nonprofit organization that the SEC has designated to set generally accepted accounting principles since 1973. SASB's goal is to add its criteria for environmental, social and governance concerns ("ESG") to the list of financial metrics required in publicly traded companies' SEC-mandated disclosures.
SASB and its supporters argue that social and policy concerns matter to many investors and that a range of nonfinancial dimensions are material to the long-term prospects of publicly traded firms. In a July 2016 letter to the SEC, SASB founder and President Jean Rogers argued: "Internationalization of manufacturing and supply chains has generated concomitant concerns about how U.S. companies are managing environmental, human rights and governance issues abroad."
Rogers offered these comments in response to an SEC request for proposals as to how to "modernize" Regulation S-K, which provides criteria for public company disclosure. The potential that the Obama-era SEC was interested in sustainability in that context should stand as a warning to the agency's new chairman as he gets to know the staff.
SASB has developed or is developing what it calls industry-specific sustainability standards for 80 industries in 10 economic sectors. Such standards include requiring airlines to report the "environmental footprint of fuel use"; automobile makers to report "materials efficiency and recycling"; and oil and gas firms to report their impact on "security, human rights, and rights of indigenous people."
By no means are all the sustainability standards related to environmental issues. Automobile companies are also asked to report on the "percentage of active workforce covered by collective-bargaining agreements, broken down by U.S. and foreign employees." The standards, in other words, are extremely detailed, and SASB's definition of sustainability reaches into virtually every type of business decision.
Of course, SASB has every right to try to persuade companies to agree voluntarily to make some or all of its preferred disclosures, as well as to offer investors its type of analysis. If investors agree with SASB that its disclosures are financially relevant — or if investors are committed to prioritizing nonfinancial goals in their investing — they can buy the securities of companies that make such voluntary disclosures and sell the securities of those that fail to do so.
But the dangers in using government as a tool to enforce such standards — and to designate SASB standards as the right set of reporting measures — are multiple.
The most obvious is the direct cost burden of such increased reporting. Reporting and compliance costs for publicly traded companies have already increased substantially in recent years. Such increased burdens implicitly favor larger firms — and thus increasing industry concentration — by favoring those who already have large legal and regulatory compliance staffs.
The more significant costs of mandatory SASB-style disclosures, however, are those flowing from the leverage that such mandated disclosures would necessarily give to politicized enforcement agents at the SEC and Department of Justice, to politically ambitious state attorneys general, and to class-action plaintiffs' lawyers seeking to pounce on alleged misstatements.
To be sure, state AGs and plaintiffs' lawyers may be able to harass or sue companies for voluntary disclosures using old-fashioned tort claims or overly broad state statutes like New York's Martin Act securities law. But with a mandatory SEC disclosure rule, the potential for regulation through litigation or prosecution outside the normal legislative lawmaking process would be greatly multiplied.
Most investors understand these risks, and they have already considered and rejected hosts of SASB-type disclosure ideas. According to the Manhattan Institute's Proxy Monitor database, Fortune 250 companies have faced more than 1,500 shareholder proposals since 2006 that sought environmental, political, or other social or policy goals, most seeking new disclosures.
Only one of these proposals has received majority shareholder support over board opposition — a compelling indicator that most market participants bound by fiduciary duties oriented around shareholder wealth maximization do not find SASB-type disclosures material.
There is no harm in SASB building a sustainability index, but throwing the government's weight behind it risks driving even more companies from America's publicly traded stock markets, which have fewer corporate listings today than in 1975. Let's hope that the SEC, under new leadership, will leave this idea alone.
This piece originally appeared in Investor's Business Daily
Howard Husock is the Vice President of Research and Publications at the Manhattan Institute. From 1987 through 2006, he was director of case studies in public policy and management at Harvard University’s Kennedy School of Government.
James R. Copland is a senior fellow and director of legal policy at the Manhattan Institute.