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Statement on Proposed Amendments to Modernize and Enhance Financial Disclosures

Jan. 30, 2020

I am delighted to support the proposed amendments and companion guidance released today.  The proposal is the latest in a string of efforts by the Commission to simplify and update disclosure requirements in a way that reduces costs ultimately borne by shareholders while preserving important investor protections.  Thank you to the staff of the Divisions of Corporation Finance and Economic and Risk Analysis and to the Office of General Counsel for their efforts on the rulemaking.

The MD&A disclosure requirements are rooted in a simple and straightforward purpose: to provide a narrative explanation of a company’s financial statements that allows investors to view the registrant from management’s perspective.  This principles-based disclosure framework provides management with the flexibility to tailor effectively its disclosure to provide the information about its specific financial condition that is material to an investment decision.  Such flexibility is possible because of the concept of materiality, which is the longstanding touchstone of our disclosure regime. 

Thanks in part to an elite crowd pledging loudly to spend virtuously other people’s money,[1] the concept of materiality is at risk of degradation.  We face repeated calls to expand our disclosure framework to require ESG and sustainability disclosures regardless of materiality.  The proposed amendments and companion guidance do not bow to demands for a new disclosure framework, but instead support the principles-based approach that has served us well for decades. 

The concept of materiality has worked well over time because it considers disclosure through the prism of the reasonable investor, who is occupied with the long-term financial value of the enterprises in which she invests.  The reasonable investor standard ensures that the analysis focuses on whether the information at issue is broadly useful to investors in the context of seeking a return on their investment.  Materiality does not turn on what is important to non-investors or to a select group of investors motivated by objectives unrelated or only tangentially connected to their investment’s profitability.  If materiality were so loosely defined, it would lead to information overload in disclosure documents, increased costs associated with being a public company, increased litigation risk for public companies, a decrease in the attractiveness of our public capital markets, reduced investment returns, and—most alarmingly—a misallocation of capital.  Capital, for example, might be diverted away from a company that otherwise would have developed a revolutionary approach to addressing water shortages or climate change.

There is reason to question the materiality of ESG and sustainability disclosure based on existing practices.  In the guidance, the Commission notes that some companies voluntarily disclose environmental metrics.  While such metrics are widely used in the voluntary and supplemental sustainability reports available on company websites, the use of such metrics in annual reports filed with the Commission—where materiality is the controlling standard—is less common.  For example, one sustainability metric highlighted in the guidance, total energy consumed, only showed up in approximately six Form 10-Ks filed in 2019.  Contrast that with another metric mentioned in the guidance, operating margin, which approximately 499 registrants reported in their 2019 Form 10-K.  I am not questioning the materiality determinations of companies that did report these metrics.  Neither am I ready to mandate that every other company make the same materiality determination. 

Securities regulators of this generation must not grow weak-kneed in defending the concept of materiality, which continues to play a central role in ensuring the vibrancy of our capital markets.  We ought not step outside our lane and take on the role of environmental regulator or social engineer.  SEC Commissioner and fellow Clevelander A. A. Sommer, Jr. warned of this concern forty-four years ago:

Materiality is a concept that will bear virtually any burden; it can justify almost any disclosure; it can be expanded all but limitlessly.  But we must constantly bear in mind that overloading it, unduly burdening it, excessively expanding it, may result in significant changes in the role of the Commission, the role of other enforcement agencies, and our ability to carry out our statutory duties.[2]

I am pleased that we heeded Commissioner Sommer’s prescient words with respect to the proposal and guidance.  No matter the pressures we face, we would be wise to continue to do so. 

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