White House overreaches with SEC climate disclosure plan
As has been expected for months, the Federal Emergency Management Agency this coming morning will publish in the Aug. 19 edition of the Federal Register its regulations implementing President Barack Obama’s Executive Order 13690, which call for the first major overhaul to federal flood-risk management standards in 40 years.
Originally proposed by the White House back in January 2015, the new rules look to address heightened flood risks to federal programs and facilities that stem from climate change and sea-level rise, issues of particular salience this week as we watch the State of Louisiana reel from devastating and unprecedented floods. Given the exponential growth in disaster risks borne by U.S. taxpayers, this investment in risk mitigation should (but may not) have bipartisan support.
Alas, the administration couldn’t just leave it at that. In an op-ed that went live on the Wall Street Journal‘s website the evening of Aug. 18, White House Senior Adviser Brian Deese and Jeff Zients, director of the National Economic Council, signaled the next front in Obama’s seemingly perpetual battle to reach peak executive overreach.
Pitched as “government and the private sector working together to develop assessments of climate risks,” the officials sketched out a plan to use the Securities and Exchange Commission to require extensive disclosures from all public companies of the sort that, not coincidentally, have been sought by various activist investors who promote complete fossil-fuel divestment. As Deese and Zients frame the issue:
Here in the U.S., the Securities and Exchange Commission has already taken important steps to make clear that today’s climate risks can be financially material, which is necessary to trigger mandatory disclosure requirements. But shareholders are increasingly pushing management to be more attentive to climate risk.
You see what they did there? If you listen closely for the dog whistle, that little shift from the first sentence to the second tells you all you need to know. Deese and Zients lay out first that the SEC already has and uses its authority to require public companies to disclose climate risks that are “financially material.” And then there’s that word: “But…”
Everyone’s got a big but. We’ll come back to that.
The “shareholders” of whom Deese and Zients speak include folks like New York City Comptroller Scott Stringer, an elected official who also happens to serve as administrator of the city’s $160 billion public employees’ pension funds. I wrote a paper last year analyzing his ongoing efforts to push through proxy-access proposals at firms in which the funds are invested, including dozens of oil, gas, coal and utility firms. I argued then that Stringer’s campaign did not represent shareholder empowerment, but rather, a new form of mercantilism, in which government officials acting as institutional investors would prioritize punishing politically disfavored industries over their fiduciary duties to, in this case, pension beneficiaries.
Stringer continued that effort in the 2016 proxy season, and his were among “record-setting 94 climate-related proposals at shareholder meetings of U.S. companies” Deese and Zients describe favorably. Setting an exceptionally low bar, they also report excitedly that “these proposals garnered majorities or near-majorities in several high-profile shareholder votes.” If, among 94 proxy votes, only “several” came even close to passing, it does not exactly suggest a groundswell of support.
So, about that “but.” When Deese and Zients write “[b]ut shareholders are increasingly pushing management to be more attentive to climate risk,” the clear implication is that requiring public companies to disclose only those climate risks that are “financial materially” is in some way insufficient. No, no, what regulators really need is the power to require companies to disclose risks even if they are utterly immaterial!
Ok, so what’s a “material” risk? In the broad and utterly circular sense in which the term is defined by the Risk Management Association, a material risk is any risk large enough to threaten a firm’s ability to succeed in any material way. This will always include market, credit and operational risks; it will often include liquidity and asset-liability management risks; and, depending on the nature of the firm, might even include things like reputational and strategic risks.
Moving to somewhat more concrete legal standards, the U.S. Supreme Court defined materiality in the 1976 TSC Industries v. Northway decision authored by Justice Thurgood Marshall, which found that omitted facts are considered material “if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”
Building on that decision, the SEC laid out its prevailing definition in a document known as Staff Accounting Bulletin No. 99, which sets both a quantitative rule of thumb (a fact ought be presumed material if its omission would lead financial results to be overstated by more than 5 percent) and a broader holistic view that even omissions that would result in only very small overstatements might be material if they fall under:
…those matters to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security registered.
As you can see, that’s a pretty broad definition. If there is any climate risk (or any risk at all) faced by a public company that it believes, or should have believed, a “reasonable” investor would consider important to whether to buy the company’s equities or debt obligations, current law and practice already requires that risk must be disclosed.
So what sorts of risks would that leave, if the SEC is going to require even more disclosure? Well, interestingly, in sketching out that part, Deese and Zients shift suddenly from talking about “risks” actually faced by a given firm to talking about “data” and “transparency.”
The SEC could adopt detailed and standardized industry specific requirements for disclosure, and, once in place, aggressively hold public companies to account when it comes to those obligations to disclose. That will ensure that the market has the transparency and data it needs to efficiently price climate risk and to spur innovation that could ultimately decrease the magnitude of these risks across the economy.
We’ve heard this song before. It’s the same tune California Insurance Commissioner Dave Jones has been singing with his call for “voluntary” divestment by insurance companies from coal-related stocks and bonds. But Jones at least went through the pretense of framing his pitch as being related in some way to climate change creating “stranded assets” and the impact that might have on insurer solvency. The pitch is pretty transparently phony, given how small a share of insurers’ investment portfolios we’re talking about. But hey, at least he was in the ballpark of being justified.
Here, the White House doesn’t even pretend that this is in any way about protecting investors. At best, requiring companies to disclose immaterial risks amounts to pointless paperwork. At worst, it paints a target on some companies’ backs, inviting meddlesome proxy-challenge protests from activist investors whose interests are not in any way aligned with maximizing shareholder value.
