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Statement on the “Modernization” of Regulation S-K Items 101, 103, and 105

Commissioner Caroline Crenshaw

Aug. 26, 2020

Good morning, and thank you to the Chairman, my fellow Commissioners, and to the staff for helping me get up to speed on this rule in my first week and a half on the job. Thank you also to the staff for your dedication and hard work.[1] I have worked with some of you for many years now, and I appreciate your thoughtfulness and your unwavering dedication to the Commission’s mission.

While I appreciate hearing the perspectives of my fellow Commissioners, I share Commissioner Lee’s views. I am concerned that today—in the middle of a crisis affecting all aspects of our market—the majority of the Commission is failing to take the opportunity to provide investors with critical and useful information about key corporate metrics. This rule is presented as a “modernization” of certain provisions of Regulation S-K—but the rule before us today fails to deal adequately with two significant modern issues affecting financial performance: climate change risk and human capital. As Commissioner Lee noted in her statement, the final rule is also silent on diversity, an issue that is extremely important to investors and to the national conversation. The failure to grapple with these issues is, quite simply, a failure to modernize.

Although the Commission recognized more than a decade ago the impact that climate change related matters have on certain companies’ businesses and operations,[2] today’s “modernized” rule will reduce certain environmental risk disclosures by up to 30 percent.[3] And though the Commission has taken a step in the right direction by adding a reference in the final rule to human capital, I worry that the policy choice to impose a generic and vague principles-based requirement will fail to give American investors the information they need about how companies will weather this storm.

The question of whether climate change and human capital are material concerns of investors is no longer academic. The 2019 PG&E bankruptcy after the tragic California fires[4] and the more than $220 billion in damages to the U.S. economy from the 2017 hurricane season[5] demonstrate that the risks posed by climate change are here, real, and quantifiable.[6] Companies know how climate change is impacting their businesses, supply chains and the economy overall;[7] so should their investors.

The Commission’s steps to modernize the securities laws should facilitate the efficient comparison of long-term sustainability in the face of present-day risks to issuers.[8] But today’s failure to address climate change risk continues to hamper the efficient sorting and comparison of modern companies,[9] as does the failure to adopt detailed, specific disclosure requirements concerning human capital.

Human capital is a valuable asset in today’s economy, not simply a cost.[10] And a company’s management and investment in its people is one indicator of a modern company’s long-term sustainability.[11] The current COVID-19 crisis has made this clear. Recent research shows that companies that were able to shift their workforce to a remote work environment outperformed those that did or could not.[12] Imagine if companies had been required to disclose key human capital metrics prior to 2020, like workplace flexibility and safety, and employee turnover rates. Investors would have had a basis to weigh the impacts of COVID-19 across sectors and would have been able to assess how companies would perform during this crisis. But the final rule we adopt today lacks these standard requirements and, I fear, will ultimately undermine investors’ ability to evaluate them.

* * *

My time in the U.S. Army has taught me to value practicality and working collaboratively to forge a new path. I do think there is a path forward to truly modernizing our approach to these issues and it is one that I hope that my colleagues will embark on with me.

First and foremost, the Commission should form an internal task force to undertake an immediate study on how investors can and do use information about human capital management, climate change risk, and other Environmental, Social, and Governance (“ESG”) metrics to assess the long-term financial performance of a company.[13]

Second, given the widespread demand for more work in this area,[14] we should form an external ESG Advisory Committee to provide advice and guidance over the longer term.[15] An ESG Advisory Committee, comprised of investors, issuers, and subject matter experts, can ensure that the Commission is aware of and responding to current ESG trends affecting all aspects of the market, and hold it accountable for taking action.[16]

To the extent that my colleagues have concerns that ESG issues are too uncertain and variable across companies for the Commission to formulate detailed requirements, I say that it is our job to achieve clarity. It is imperative that the Commission keep pace with the evolving marketplace. And to do that, we need to establish a clear and standardized set of disclosure requirements that will allow investors to more easily assess the long-term sustainability of modern companies.

Unfortunately, for these reasons, I am unable to support adopting the rule today. I respectfully dissent.

[1] I want to extend my gratitude to our colleagues in the Division of Corporation Finance: Director Bill Hinman, Lisa Kohl, Johnny Gharib, Betsy Murphy, Felicia Kung, Sean Harrison, John Diamandis and Sandra Hunter Berkheimer. Thank you for working diligently and tirelessly on this proposal and for your dedication to the Commission’s mission. I regret that I cannot support this rule, but that is because of the underlying policy choices and does not reflect on the staff’s hard work.

[2] See Commission Guidance Regarding Disclosure Related to Climate Change, Rel. No. 33-9106 (Effective Date Feb. 8, 2010).

[3] Under the final rule, the dollar threshold for disclosing environmental proceedings to which the government is a party is increased from $100,000 to $300,000, or to such other amount that the registrant determines is reasonably designed to result in disclosure of any such proceeding that is material to the business or financial condition disclosed, with an upper bound of the lesser of $1 million or one percent of the registrant’s current assets. The release includes an analysis of the number of registrants that would be required to report these environmental proceedings following this change. It states that the increase in the disclosure threshold from $100,000 to $300,000, as well as the use of an alternative threshold that requires disclosure when disclosures exceed the lesser of $1 million or up to one percent of assets, “would have resulted on average in an upper bound decrease of 30% in the number of registrants that have to report such sanctions during the period under consideration.” See Modernization of Regulation S-K Items 101, 103, and 105, Release No. 33-[ ] at 104 (Aug. 26, 2020).

[4] Ian Gray and Gretchen Bakke, “Pacific Gas and Electric is a company that was just bankrupted by climate change. It won’t be the last,” The Washington Post (Jan. 30, 2019) (reporting that one of the U.S.’s largest investor-owned electric utilities filed for bankruptcy in the face of liabilities stemming from California wild fires traced to its power lines).

[5] See Matt Sheehan, “Hurricanes Harvey, Irma, and Maria cost re/insurers $80bn Impact Forecasting,” Reinsurance News (Apr. 5, 2018).

[6] Nonetheless, a 2016 review of almost 1,500 disclosures in annual filings of 637 companies in 72 industries found that almost 30 percent of the disclosures did not include any climate-related information, some contained boilerplate language or company-tailored narratives, and less than 20 percent included quantitative metrics. See Sustainability Accounting Standards Board (“SASB”), Climate Risk Technical Bulletin, Technical Bulletin #: TB001-10182016.

[7] A recent Deloitte survey of North American and European CFOs concluded that “climate risk is swiftly rising to the top of many companies’ agendas” and reported that more than 90 percent of North American CFOs surveyed “said their company has taken at least one action in response to climate change.” See How CFOs can help companies weather climate change,” Deloitte CFO Insights at 3 (Mar. 2020).

[8] Investors have been asking for high-quality sustainability disclosures for some time now. For example, SASB, which focuses on improving the effectiveness of corporate issuer reporting, highlighted in a 2017 report several large institutional investors, among others, that found sustainability factors to be important to their investment strategies. See The State of Disclosure 2017, SASB at 2 (Dec. 2007) (the “2017 SASB Report”). In addition, in June 2017, a Bank of America Merrill Lynch report concluded that ESG investing would help investors avoid bankruptcies and that ESG attributes “have been a better signal of future earnings volatility than any other measure [it has] found.” “Equity Strategy Focus Point ESG Part II: a deeper dive”, Bank of America Merrill Lynch, Research Report (June 15, 2017). Similarly, BlackRock recently issued an open letter to CEOs declaring “that all investors, along with regulators, insurers, and the public, need a clearer picture of how companies are managing sustainability-related questions.” BlackRock, “A Fundamental Reshaping of Finance,” (Jan. 14, 2020).

[9] The 2017 SASB Report also found that “most sustainability disclosure consists of boilerplate language, which is largely useless to investors” and is used more than 50 percent of the time in such disclosures. See 2017 SASB Report at 2. SASB concluded in the same report that “sustainability performance metrics are rarely disclosed and lack comparability when they are.” Id.

[10] See Recommendation from the Commission’s Investor Advisory Committee on Human Capital Disclosure at 2 (Mar. 29, 2019) (the Commission’s “historic view is that human capital is a cost, but this is no longer the case. We need to understand that to modernize disclosures effectively.”).

[11] See id. (“Research has found that high quality [human capital management (“HCM”)] practices correlate with lower employee turnover, higher productivity, and better corporate financial performance, producing a considerable and sustained alpha over time. The value-relevance of HCM metrics is consistently demonstrated in financial research. A meta-review was conducted in 2015 by Harvard researchers of 92 studies that measured performance using metrics of value to investors, such as total shareholder return, return on assets, return on capital, profitability and Tobin’s Q. The review found positive relationships in a majority of studies between financial performance, however measured, and disclosed training programs or HR policies on such topics as employee participation and pay for performance.”).

[12] Dimitris Papanikolaou and Lawrence D.W. Schmidt, “The Supply-Side Impact of COVID”, VOX EU (July 23, 2020).

[13] Senator Warner has called on the Commission to appoint a task force to “establish a robust set of quantifiable and comparable ESG metrics that all public companies can adhere to” and he is right, we should. See Office of Senator Mark R. Warner, Warner on New GAO Report Highlighting Importance of Requiring Corporate Disclosure of Environmental, Social, and Governance Issues” (July 6, 2020). The task force could analyze disclosures made in the aftermath of COVID to identify emerging patterns in human capital management and identify best practices that we would publish in guidance and then assess the impact of those disclosures on the market. The task force could similarly analyze the disclosures and performance of companies impacted by the recent wave of wild fires and hurricanes.

[14] For years now, investors, investment professionals, the Government Accountability Office, members of Congress, and the Commission’s own Investor Advisory Committee have urged the Commission to set forth a standard and have identified the key performance indicators that issuers should report. See, e.g., supra n. 8-11, 13; GAO Report, “Public Companies, Disclosure of Environmental, Social, and Governance Factors and Options to Enhance Them” (July 2020). Moreover, the 2020 proxy season has demonstrated that climate-related reporting proposals are receiving increased majority support among shareholders. See Hannah Orowitz, et al, “An Early Look at the 2020 Proxy Season,” Harvard Law School Forum on Corporate Governance (June 10, 2020).

[15] The Commission has several external committees that advise it on regulatory priorities in key areas. This includes the Investor Advisory Committee, Fixed Income Market Structure Advisory Committee, Asset Management Advisory Committee, and the Small Business Capital Formation Advisory Committee. ESG issues deserve similar attention. Although the Investor Advisory Committee also considers social and governance issues, and the Asset Management Advisory Committee has formed an ESG subcommittee, the mandates of those committees are very broad. A dedicated ESG Committee is necessary to cultivate expertise on and devote attention to these pressing issues specifically, particularly given that these risks are relevant across all of the Commission’s offices and divisions. An ESG Committee could also work closely with the Sustainability Accounting Standards Board, the Global Reporting Initiative, the FSB Task Force on Climate-Related Financial Disclosures, the International Integrated Reporting Council, the Partnership for Carbon Accounting Financials, and other organizations that have examined and made meaningful recommendations on these issues.

[16] The committee could review and consolidate recommendations and report on case studies of companies affected by human capital and environmental issues, and how it has impacted financial performance. It could then recommend the most effective ways for companies to provide that information to investors. The committee could also examine whether investors receive sufficient information regarding how their money managers vote their shares on proposals relating to climate risks. It could also examine how our rules can help investors get what they bargained for when they select a fund with a sustainability strategy and ensure that those funds are appropriately classified and their strategies clearly disclosed.

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