Moving Forward in Our Lane: Remarks at the Inaugural ECGI Responsible Capitalism Summit

This speech was originally published on the U.S. Securities and Exchange Commission website on 21 October 2022.

Moving Forward in Our Lane: Remarks at the Inaugural ECGI Responsible Capitalism Summit

Introduction

It is a pleasure to be here today at the Inaugural ECGI Responsible Capitalism Summit. Coincidentally, this is my inaugural trip overseas as a Commissioner. I came into office in the midst of the global pandemic, so I have not had the opportunity to meet with groups of academics, policy-makers, members of industry, and the general public in-person. I am glad to be able to do so now and I hope to benefit from the ideas and discussions produced at this forum. Thank you to Professor [Marco] Becht for organizing today’s discussions, and to Professor [Eilis] Ferran for that kind introduction.

As always, I must give the standard disclaimer that the views I express today do not necessarily represent those of the Commission, my fellow Commissioners, or members of the Commission’s staff.

When I accepted the invitation to this conference, I did not realize that my remarks would precede a Nobel Laureate, Professor Oliver Hart. My praises to Professor Becht for putting together such an esteemed group. I’m pleased to precede Professor Hart, who is here today to discuss his new paper, The New Corporate Governance, co-authored with Professor Zingales, a highly accomplished professor in his own right, and the author of the renowned book Saving Capitalism from the Capitalists, as well as a co-host to a podcast that my staff and I regularly discuss. As I considered how best to contribute to today’s discussion, I turned to their work for inspiration. And I hope that I can offer you some interesting perspectives from my vantage point as a U.S. securities lawyer and policy-maker – a vantage point that is, admittedly, somewhat narrow in scope, both in terms of geography and specialized subject matter. The mission of the U.S. Securities and Exchange Commission (SEC) is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. Although that may, at first blush, sound broad, our foundational and authorizing statutes, interpreted by the U.S. judiciary and a near-century of agency practice, provide certain bounds to carrying out that mission. This is the perspective through which I read the Hart and Zingales paper, and this is the perspective that I bring to my work as an SEC Commissioner. More specifically, this is the lens through which I consider the SEC’s proposed climate-related disclosure rule that I will discuss today.

As I read it, Professors Hart and Zingales argue that shareholders are taking a new view of value. The storied Milton Friedman’s traditional concept of shareholder value maximization is no longer an optimal view of corporate governance. Instead, investors are aware that today’s world is complex, and externalities and the interdependence of the world in which companies operate, matter.[1] On certain subjects, issuers themselves are likely in the best, least costly position to change corporate behaviors where shareholders have determined changes should be made.[2] So instead, shareholderism should evolve to what the Professors term “shareholder welfare maximization.”[3]

The discussion of shareholder welfare maximization in some ways, but not all, reflects the ongoing debate about whether corporations should emphasize stakeholderism or shareholderism in their governance.[4] Concepts like stakeholderism, shareholder-welfare maximization, or a reformation of the corporate purpose are all thoughtful and important ideas and I look forward to discussing them at forums such as this one.

That being said, I feel it important to be unequivocal and absolute on this point: such concepts, a re-purposing of the corporate form, or promoting new forms of capitalism are not a part of the SEC’s proposed rulemaking on climate-related disclosures. Neither are social issue concerns, environmental regulation, or environmental policy-making. So what is the proposal about? Let me go through, from my perspective, what the purpose of the SEC’s proposed rule on climate-related disclosures is, why I voted to propose it earlier this year and, oddly enough, spend some time discussing what this proposed rulemaking is not about.

I’ll start with some background. The rulemaking proposal includes both qualitative and quantitative disclosure about climate-related risks,[5] and disaggregated climate-related risk impacts to existing line items in audited financial statements.[6] More specifically, these disclosures would include discussion of the company’s assessment and management of climate-related risks along with greenhouse gas (GHG) emissions. The staff and the Commission, as required under U.S. administrative law, are now carefully and thoroughly reviewing the data, views, and arguments submitted in response to the proposal. This proposal, as many do, elicited a diverse set of commenters, with varied ideas and perspectives. Public companies, private companies, accountants, lawyers, academics, and investors of all stripes – individual, pensions, institutional – have written to provide their feedback. That feedback will be taken into account, and will shape the final rule. This is how administrative procedure in the United States was designed to work.

Investor Demand

The SEC, like all U.S. agencies, has a specific remit. Advancing that remit, and operating within its confines, is an obligation that the SEC takes seriously in every one of its regulatory actions. Accordingly, these disclosures are not designed to move markets or impact climate change. But investors are increasingly seeking and using climate-related information. Public and private funds, asset managers, index providers, among others, have demanded information on risks related to climate so they can fulfill their disclosure, fiduciary or other obligations to investors. [7] In other words, investors turn to these data to help inform their investment decisions.

Professors Hart and Zingales focus on shareholder proposals, which is another key indicator of investor demand for climate-related disclosures. In the 1970s, shareholder support for Exchange Act Rule 14a-8 advisory proposals that addressed social or environmental matters was roughly 3%.[8] During the 2021 proxy season, shareholders submitted 115 environmental proposals.[9] For the proposals that were not withdrawn, average shareholder support was greater than 50%.[10] What’s more, the number of environmental proposals withdrawn provides evidence of successful shareholder engagement, as it tends to indicate that issuers engaged with shareholder proponents rather than take the proposal to a vote.[11] This, of course, captures a very broad spectrum of shareholder engagement in the sense that the proposals call for a range of resolutions, some having to do with reporting and others having to do with various targets and goals. Although the resolutions may have different points of focus collectively, these shareholder proposals indicate investor demand for climate information through direct investor expression. Separately, surveys of a broad range of asset managers and other investor initiatives that range in specificity and detail provide additional evidence of the breadth and depth of shareholder demand and need for climate-related information.[12] And the SEC’s climate-related disclosure proposal details investor demand from myriad and diverse sources – an evidentiary record that presents a common through line – investors want to understand climate-related information because those risks relate to companies’ operations, financial condition, and prospects. As I think through how I can support the SEC’s critical mission to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation, I look to the record of investor use and demand for information as a guiding principle. Indeed, the Commission has for decades required companies to disclose a range of risks that impact firm value and investor decisions.

Agency Practice

Examples of agency precedent also are relevant. Looking to the past can help us understand what falls within the bounds of ordinary course disclosure, even if a particular type of disclosure is not specifically enumerated in statute. And there is certainly precedent for the type of disclosure and the process for rulemaking that we have undertaken regarding climate-related disclosures.

This proposal has not been advanced on a whim or impulse. We have engaged in a careful, calibrated, deliberate process that includes decades of market observation, guidance to the industry, a request for input, and, now, a proposed rule.[13] This is similar to the process the SEC has used to address other market developments over its history. For example, in the 1970’s, the agency undertook to investigate, study and draft rules related to “hot issues.”[14] Here, the Commission observed a period of “general optimism and speculative interest” in certain IPOs, which were called “hot issues.”[15] In recognizing this trend, the SEC teamed up with a third party, the National Association of Securities Dealers,[16] to form a task-force to examine concerns related to these offerings. The Commission held fact-finding hearings and developed a robust understanding of the relevant questions.[17] Informed by this this work, the Commission identified a disclosure gap, and engaged in notice and comment rulemaking to amend registration statements and periodic reports. The goal? To require meaningful disclosure to investors that ranged from management information to the status of new product development to general competitive conditions and, in the case of certain registrants offering securities for the first time, a description of their plan of operation.[18] As the Commission stated when it proposed the rule: “[a] recurring phenomenon...has resulted in disorderly markets and damage to public investors.”[19] So the Commission acted. In so doing, it noted that “Congress, in enacting the Federal securities statutes, created a continuous disclosure system designed to protect investors and to assure the maintenance of fair and honest securities markets.”[20]

And that “continuous disclosure system” is evident throughout our current rulebook. We require disclosure of information relating to litigation and other business costs arising out of compliance with federal, state, and local laws that regulate the discharge of materials into the environment or otherwise relate to the protection of the environment.[21] Other disclosures range from feasibility studies and technical reports relating to mining operations,[22] and disclosures, regardless of materiality determinations, relating to directors’ backgrounds and qualifications.[23] These are but a few examples of mandatory disclosures promulgated under the SEC’s statutory authorities.[24] These have been utilized time and time again for an array of disclosures implemented through the fact-finding process of administrative law.

Many of you may be thinking that reading Professors Hart’s and Zingales’ paper is akin to an action packed murder mystery when hearing me quote a 50-year old securities regulation. And you are not wrong. But I felt it important to highlight, as this history informs the exercise the Commission is currently engaged in: evaluating a rule proposal that is part of the SEC’s oversight of corporate disclosure designed to provide investors with information they are demanding in order to allocate their capital and decide how to vote. In the current case, it’s climate-related disclosures. The SEC’s proposal on the matter, as noted above, identified gaps in disclosure in the voluntary climate risk reporting regime. After decades of staff experience, a thorough dialogue with the public, through Acting Chair Lee’s Request for Input, and now through the notice-and-comment rulemaking process, the SEC is seeking to ensure that the continuous disclosure system is responding to investors. The Commission did not rely on a new or expansive theory of corporate governance when it formulated the climate-related disclosure proposal. Rather, the proposal originated as a careful response to our age-old statutory mandate. Simply put, this proposal is squarely within the SEC’s remit to promulgate disclosure rules for the protection of investors.

In the time since the proposal, there have been demonstrably false assertions that the SEC is acting as an environmental regulator, is seeking to decarbonize the economy and is crossing a line in terms of its authority with this type of regulatory action.[25] As a factual matter, the proposed rulemaking concerns disclosure of information by public companies concerning climate-related risks. It neither usurps a board’s business judgment, nor does it seek to nudge behavior into a normative outcome, regulate the environmental impact of companies, or restructure the capital markets. Rather, it seeks to standardize disclosures that investors use to inform their investment and voting decisions.[26] Again, work that the SEC has been doing for decades to protect investors and fulfill all elements of its tri-partite mission. From my perspective, whether investors are allocating capital to companies that are pursuing aggressive carbon reduction or selecting companies that have high-emissions is irrelevant to the rationale articulated in the proposal, because achieving a certain environmental impact is not part of the rationale.[27] As I wrote in my statement when the SEC voted to approve the proposal, it is not my job as a Commissioner to dictate to shareholders what they should want.[28] When it comes to U.S. disclosure rulemakings, framework, and program – my approach is to exclude normative biases of how the world outside my remit ought to be, and ground myself in the law, precedent, a near-century of SEC practice, and issuer and investor input.

The Markets Have Already Moved, the SEC Is Following

The motivation for the climate-related disclosure proposal is not just about what investors are demanding. While investors and others wait for the SEC to take final action, the market has evolved.

Climate-related disclosures and strategies exist and are used by companies today. Companies are making claims about becoming carbon neutral, and advertising their eco-friendliness.[29] Climate-related management and risk strategies are being disclosed, and such strategies exist on a spectrum – from those seeking investments that pursue emissions reductions strategies to those that deliberately pursue high-emissions or otherwise anti-ESG strategies.[30]

The SEC staff have observed that between 2019 and 2020, 33% of all annual reports contained disclosure related to climate change.[31] Academic studies have found that the majority of Russell 3000 firms provide climate-related information and the extent of the information in voluntary disclosures has grown.[32] Additionally, the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness (CCMC) conducted a survey finding that over half of U.S. public companies have been publishing corporate social responsibility, sustainability, ESG or similar reports that include climate-related information, with emissions being one of the most discussed topics in these reports.[33] And I am only skimming the surface.[34]

Companies are also setting targets and goals. Reports have noted that two-thirds of S&P 500 companies have established a target for carbon emissions and monitoring emissions on a more granular level than ever before.[35] And beyond emissions targets and tracking, companies are making pledges to other “green” goals.[36] Climate-related strategies are being marketed to consumers and the public, including to investors and prospective investors, in many ways.

The markets have moved. The markets are disclosing this information. But there is a problem: the disclosures are made with varying degrees of specificity, standardization and, sometimes, with unreliability.[37] Investors have said they do not have the ability to understand and track how strategies are being implemented.[38] Meanwhile, the location of these disclosures is, quite literally, all over the place, making comparability a major challenge. It is important to the SEC that investor protection not be left behind as the markets surge ahead. It is the SEC’s job to help ensure that investors have adequate information and that companies can be held accountable for the information they are providing to investors, that investors then use to make investment decisions. Regardless of the subject area, companies need to be accountable for the accuracy, reliability, and integrity of the claims they make to investors.

The SEC turns to investors, markets, and the administrative process in order to understand how the disclosure and reporting frameworks need to change in order to remain current and meaningful.

Continuous Development

Finally, there is one last point that I would like to make, using a timely example. It has to do with the Inflation Reduction Act of 2022 (the Act). The Act was signed into law this past August and it helps illustrate why investors seek climate-related information and how that need may become even greater.

The Act is potentially significant because it includes incentives for households and companies to transition to lower-carbon practices, the flip side of transition risks – transition opportunities. Specifically, the Act creates incentives – through tax credits, grants, loans – for entities to engage in clean electricity and fuel projects, lower emitting transportation, building and equipment efficiency, carbon capture, and related manufacturing and supply chains to support this.[39] Overall, the Act incentivizes business and individual consumers to utilize lower emission products and services, which should affect demand. [40]

As with most new laws, many of the details of implementation remain to be determined. However, observers have begun to note that the Act “definitively changes the narrative from risk mitigation to opportunity to capture.”[41] Some companies will be better-positioned than others to capitalize on the opportunities presented. A company’s ability, or lack thereof, to capitalize on these incentives could impact returns. When markets start to shift to alternative products, processes, and energy production – whether because of this statute, other governmental actions, or dynamics that have nothing to do with government – companies that do not respond deftly may suffer competitively or incur other losses. This is a textbook example of transition risk. Climate-related disclosures can help investors understand how effectively companies are responding to the opportunities and risks the Act creates, and how well-positioned they are to respond to other opportunities and risks that may arise in the future.[42]

Conclusion

Before I wrap up, I would like to stress again that we have arrived at this point after decades of relevant experience and work with investors and issuers, as well as fiduciaries that invest money on behalf of investors: workers, parents, teachers, retirees.

Prior to becoming a Commissioner, I worked on staff at the SEC for almost a decade. I believe in the work of the Commission, and I believe in, and work to support, our capital markets. I know that the SEC is committed to fulfilling the agency’s mission with integrity and to faithfully implementing the statutory authorities promulgated by Congress. The SEC has a long and storied history of protecting investors by providing a reliable framework of reporting and disclosure. I also have enough awareness and humility to note that not everything the SEC does is perfect. That, however, is the beauty of the notice and comment rulemaking process. I want all investors, issuers, investment advisers, and other stakeholders to know that they should and can come to the SEC and talk with us at any time. And that the comment letters we receive are carefully reviewed and considered.

I want to thank the professors and academics, who have dedicated their research to the topics discussed today. I look forward to your continued work.

--------------------------------

By Caroline A. Crenshaw, Commissioner of the U.S. Securities and Exchange Commission.

This article reflects solely the views and opinions of the authors. The ECGI does not, consistent with its constitutional purpose, have a view or opinion. If you wish to respond to this article, you can submit a blog article or 'letter to the editor' by clicking here.

This address was originally posted on www.sec.gov

 

[1] Oliver Hart & Luigi Zingales, The New Corporate Governance, 1 U. Chi. Bus. L. Rev., 195-216 (forthcoming 2022).

[2] For instance, environmentally-conscious shareholders of a manufacturer that produces a significant amount of plastic may better be able to achieve their environmental goals by getting the manufacturer to reduce its plastic output than by making a donation to the Sierra Club. Id. at 204.

[3] The idea is that “[w]hen externalities are important or at least some investors are prosocial,” investors may have non-pecuniary goals that do not always perfectly overlap with the goal of maximizing profit. Shareholder welfare maximization, as opposed to shareholder value maximization, would have corporations account for these other goals when making business decisions. Id.

[4] See Edward B. Rock, For Whom Is the Corporation Managed in 2020? The Debate over Corporate Purpose, 76 Bus. Law. 363 (2021) (discussing the history and current state of the debate over corporate purpose).

[5] The Enhancement and Standardization of Climate-Related Disclosures for Investors, Release Nos. 33-11042; 34-94478) (proposed on Mar. 21, 2022) (hereinafter the Proposal). As proposed, the disclosures would require climate-related risks, but climate-related opportunities are permissive, they “may” be disclosed. See Proposal at 498-499.

[6] Id.

[7] See, e.g., U.S. Securities and Exchange Commission, Investor Advisory Committee, Recommendation of the SEC Investor Advisory Committee Related to Climate-Related Disclosure Rule Proposals (Sept. 21, 2022) (referencing Recommendation from the Investor-as-Owner Subcommittee of the SEC Investor Advisory Committee Relating to ESG Disclosure (May 14, 2020) (recommending that the SEC make updates to the integrated disclosure regime related to ESG matters because of investor demand for material, comparable, consistent information needed to make investment and voting decisions after working with “investment advisors, asset managers and asset owners, US and foreign Issuers, third party data providers”)).

[8] See, e.g., J. Robert Brown, Jr., Essay: Mother Nature on the Run: The SEC, Climate Change Disclosure, and the Major Questions Doctrine, San Diego L. Rev. (forthcoming) (manuscript at n. 135).

[9] See Marc Treviño, June M. Hu, and Joshua L. Levin, 2021 Proxy Season Review: Shareholder Proposals on Environmental Matters, Harv. L. Sch. F. Corp. Governance (Aug. 11, 2021).

[10] See id. This excludes anti-ESP proposals, which received low votes.

[11] See id. Of the 115 proposals submitted, over half were withdrawn. The major proponents rarely settled with companies unless the company committed to take actions towards the specified environmental goals or at least adopted their disclosure-based demand.

[12] Proposal at 319-321.

[13] The investor demand for decision-useful, accurate, and comparable information has been documented over decades of SEC practice, drove the 2010 Commission level guidance on climate-related disclosures, and then was more fully contemplated formalized in the Request for Input that Acting Chair Allison Lee opened in March of 2021. And bringing standardization, comparability, and accuracy to disclosures is at the heart of our agency’s mandate and daily work. To use an idiom, it is the “bread and butter” of the SEC. And, now, additional further data and information received as part of through the proposal’s notice and comment period will be appropriately incorporated into a final rule. I am, of course, as I am required to do under administrative requirements, keeping an open mind of about how what that final rule will look like based upon the public comment on the proposal.

[14] See, e.g., U.S. Securities and Exchange Commission, Report of the Securities and Exchange Commission Concerning the Hot Issues Market (1984); Eileen Shanahan, S.E.C. Opens Hearings on ‘Hot Issues’, N.Y. Times (Feb. 29, 1972).

[15] See id. at 5.

[16] The National Association of Securities Dealers was consolidated into what is known as FINRA today.

[17] See Report of the Securities and Exchange Commission Concerning the Hot Issues Market, supra note 14, at 9.

[18] See id.

[19] See Meaningful Disclosures on New Stock Issues, 37 Fed. Reg. 16005 at 16007 (proposed Aug. 9, 1972)

[20] See id.

[21] See, e.g., Proposal at 16; Amendments to Registration Forms Adopted to Require Disclosure of Effects of Compliance with Environmental Requirements, SEC Rel. No. 33-5386 (Apr. 20, 1973).

[22] See SEC Industry Guide 7.

[23] See Reg. S-K 401(e)(1) (requiring disclosure of the “specific experience, qualifications, attributes or skills” that led the board to conclude that an individual should serve as a director). And that is just one example. See, e.g., Allison Herren Lee, Living in a Material World: Myths and Misconceptions about “Materiality” (May 24, 2021) (“Indeed our statutory rulemaking authority under Section 7 of the Securities Act of 1933 gives the SEC full rulemaking authority to require disclosures in the public interest and for the protection of investors. That statutory authority is not qualified by ‘materiality.’ Similarly, the provisions for periodic reporting in Sections 12, 13 and 15 of the Securities Exchange Act of 1934 are not qualified by ‘materiality.’…In practice Regulation S-K has, from the outset, required periodic reports to include information that is important to investors but may or may not be material in every respect to every company making the disclosure. We have done this, for example, with respect to disclosures of related party transactions, environmental proceedings, share repurchases, and executive compensation.”).

[24] As noted in the Proposal, “The Commission has broad authority to promulgate disclosure requirements that are ‘necessary or appropriate in the public interest or for the protection of investors.” See, e.g., Section 7 of the Securities Act [15 U.S.C. 77g] and Sections 12, 13, and 15 of the Exchange Act [15 U.S.C. 78l, 78m, and 78o].

[25] See, e.g., Bernard S. Sharfman and James R. Copland, Opinion, The SEC Can’t Transform Itself Into a Climate-Change Enforcer, Wall St. J. (Sept. 14, 2022); Paul Atkins & Paul Ray, Opinion, The SEC’s Climate Rule Won’t Hold Up in Court, Wall St. J. (July 12, 2022); Jan Wolfe, Amara Omeokwe, & Andrew Ackerman, Supreme Court Climate Ruling Adds Obstacles to SEC, Wall St. J. (July 1, 2022) (arguing that the proposed rule runs afoul of the Supreme Court’s holding in West Virginia v. EPA, 597 U.S. __).

[26] See Proposal at 7 (“We are proposing to require registrants to provide certain climate-related information in

their registration statements and annual reports, including certain information about climate-related financial risks and climate-related financial metrics in their financial statements. The disclosure of this information would provide consistent, comparable, and reliable—and therefore decision-useful—information to investors to enable them to make informed judgments about the impact of climate-related risks on current and potential investments.”)

[27] See Matt Levine, Opinion, Anti-ESG Can Be Good Business, Bloomberg (Oct. 11, 2022).

[28] See Commissioner Caroline A. Crenshaw, Statement on the Enhancement and Standardization of Climate-Related Disclosures for Investors (Mar. 21, 2022) (“As a Commissioner, it is not my job to decide for millions of investors what information is material to them.”).

[29] See, e.g., Proposal at n. 673, 676 & accompanying text.

[30] See Levine, supra note 28.

[31] See Proposal at 302.

[32] See Proposal at 310.

[33] See Proposal at 310 (the most frequently discussed topics are energy (74%), emissions (70%), environmental policy (69%), water (59%), climate mitigation strategy (57%), and supplier environmental policies (35%)).

[34] The proposal details the various sources of investor use and demand. See, e.g., Proposal at I.B, I.C, I.D, IV.A.5.

[35] See Proposal at n. 66.

[36] See Proposal at 310.

[37] See Proposal at 322.

[38] See Investor Advisory Committee, supra note 9.

[39] See Inflation Reduction Act of 2022, H.R.5376, 117th Cong. (2022).

[40] See id.

[41] See Robinson Meyer, The Climate Economy is About to Explode, The Atlantic (Oct. 5, 2022).

[42] As I mentioned earlier, I do not have a normative opinion on whether transition opportunity is what companies should or should not be doing. Investors may judge that companies may overinvest in responses to transition risk (or physical risk). But climate-related disclosure would still be providing the same function to investors: allowing them to assess for themselves the appropriateness of the response of the company to risk and make their investment and voting decisions accordingly. Again, our disclosures are not about nudging companies towards environmental goals.