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A few months ago, I blogged about the materiality standard and the hazards associated with the SEC serving up disclosure mandates designed to give investors “what they want.”  But in a recent speech, Commissioner Allison Herren Lee put forward a different perspective on the materiality standard. She made several provocative comments in her speech, but to me the most striking was her statement that “[f]inally, investors, the arbiters of materiality, have been overwhelmingly clear in their views that climate risk and other ESG matters are material to their investment and voting decisions.”

I think Commissioner Lee is pushing the envelope here. Investors are not “the arbiters of materiality” under the securities laws. Instead, materiality is determined by a third party’s assessment of whether information would be significant to a hypothetical “reasonable investor” in making an investment decision. It’s an objective test, and it contemplates a very different inquiry from one that focuses on the subjective assessments of  a particular investor or group of investors.

Don’t take my word for this – in the Reg FD adopting release, the SEC itself said that “materiality is an objective test keyed to the reasonable investor. . .” Prioritizing subjective and potentially agenda-driven investor statements about desired disclosure mandates isn’t a great fit with a purportedly objective standard. But such an approach would make it easier to avoid the need to show some financial consequences to public companies or the value of their stock before information could be regarded as material, and that may help explain its attraction to ESG disclosure advocates.

Financial considerations have always been fundamental to the materiality concept under the securities laws. After all, it’s a reasonable investor test and not a reasonable person test. I think this is where things get a little squishy with ESG disclosure. It’s indisputable that an issue like climate change will impose substantial costs on society as a whole. But it’s less clear that it will have a significant financial impact on most businesses and the value of their securities. In fact, a 2018 IPCC publication stated that “for most economic sectors, the impact of climate change will be small relative to the impacts of other drivers.”

For a financial regulator like the SEC, that discrepancy between societal costs and costs to public companies and markets creates a potential disconnect, the implications of which Commissioner Roisman highlighted in a recent speech:

It seems that some of the interest, particularly in “E” and “S” disclosures, is not in what risks environmental or social factors pose to the company, but rather what risks the company poses to, for example, the climate. To the extent that the interest is in understanding risks the company poses to the climate, what makes the SEC the appropriate federal government agency to require these disclosures, as opposed to, for example, the Environmental Protection Agency?

In a draft article submitted in response to the SEC’s request for comment on climate change disclosures, UVA law profs Paul and Julia Mahoney argue that the SEC is not the right agency to mandate ESG disclosures. They contend that the push for disclosure is being led by institutions whose purpose is in part “to pursue public policy goals outside the normal political process,” and whose statements asserting the supposed financial value of ESG are “cheap talk that conveys no information other than that the institution wants the SEC to require the disclosures.” What’s more, the article says that by doing so, the SEC “risks eroding public trust in its capacity and willingness to serve as an apolitical, technocratic regulator of the capital markets.”

– John Jenkins