A final rule the U.S. Securities and Exchange Commission adopted on August 26, 2020 and effective 30 days after publication in the Federal Register may be more significant for what is not in the rule.
The rule is silent on ESG disclosures, including climate risk.
SEC disclosure requirements, which had not undergone significant revisions in over 30 years, impact a broad breadth of environmental matters, for not only the thousands of public companies, but also for the millions who invest in them, when the Commission alters the description of business, legal proceedings, and risk factor disclosures that public companies are required to make pursuant to Regulation S-K.
While this topic may appear dense, what was done here, including what was not done, is actually fairly straight forward. Longstanding Federal law requires disclosure of “any material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which a [public company] or any of its subsidiaries is a party or of which any of their property is subject.” SEC instructions have long described an administrative or judicial proceeding involving an environmental penalty of $100,000 or more, as not being “ordinary routine litigation incidental to the business.” Under the new rule, that we have been discussing advising public companies about for more than a month, the SEC has increased the disclosure threshold from $100,000 to $300,000 (eliminating an estimated more than 30% of those disclosures for environmental matters).
The SEC will also under this new rule also afford a company some flexibility by allowing management, at its election, to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings, provided that the threshold does not exceed the lesser of $1 million or one percent of the current assets of the company.
Additionally, the final rule will require, to the extent material to an understanding of the business taken as a whole, “disclosure of the material effects that compliance with government regulations, including environmental regulations, may have upon the capital expenditures, earnings, and competitive position of the registrant and its subsidiaries.” This is an expansion from the longstanding rule that companies disclose the material effect of environmental laws to ‘all’ laws. The final rule also will continue to require registrants to include the estimated capital expenditures for environmental control facilities.
But in keeping with the current positions of the SEC, this new rule takes no position when it does not require or specify ESG related disclosures, arguably because the Commissioner’s principles based disclosure regime already produces disclosures on these topics, if any, that are material.
The same is true for climate risk. In 2010, the SEC issued guidance stating that issuers should include a discussion of climate risk in items 101 and 103, two of the provisions that were amend, to the extent it is material. But that guidance was not altered or even mentioned here.
So, while these express changes to environmental matters are positive, what may be most significant is that this new rule on environmental disclosures is silent on the topic of ESG disclosures including climate risk. A policy making official at a major NYSE member firm suggested, “the only reasonable inference is that these matters are not ‘material’ in the parlance of security regulation by the Federal government.”
And this intentional omission is in a climate when the subject is hot. Last Tuesday, the California Governor pushed the President to accept the role climate change in the California wildfires. On Thursday, the Shanghai stock exchange, China’s largest, proposed listed companies would not be subject to EU ESG and other environmental disclosure requirements. On Friday, a registered investment advisor reported publicly that it had responded to a U.S. Department of Labor inquiry about their use of ESG disclosures. Just last Saturday, the Wall Street Journal published an Op-Ed, “Sustainable Investing is a Self-Defeating Strategy.”
And I published a blog, ESG Going the Way of the Dodo?, last month describing the Labor Department putting another nail in the coffin of ESG disclosures. It may be premature to describe this SEC final rule as the final nail in that coffin, but it now appears more likely than not that ESG disclosures will become extinct like the dodo bird.