SEC Commissioner slays ‘myth’ that ESG disclosure rules must pass materiality test

Belief that corporate disclosure rules must be based on materiality is ‘legally incorrect, historically unsupported’, says Allison Herren Lee

The US Securities and Exchange Commission (SEC) is not bound by the concept of materiality when creating corporate disclosure rules, including those around ESG and climate change, according to Allison Herren Lee, one of its commissioners.

In a speech yesterday, Herren-Lee dismantled widely-held but false “myths” on the topic. 

“The idea that the SEC must establish the materiality of each specific piece of information required to be disclosed in our rules is legally incorrect, historically unsupported, and inconsistent with the needs of modern investors, especially when it comes to climate and ESG”, Herren Lee said in an address to an event co-hosted by the Sustainability Accounting Standards Board (SASB). Her speech is titled Living in a Material World: Myths and Misconceptions about ‘Materiality.’

Herren Lee recently stepped down from the role of acting-Chair at the US regulator, following the appointment of Gary Gensler, but during her brief spell at the helm unveiled a raft of ESG and climate-focused work streams – including the launch of a public consultation, which closes next month, on drafting climate risk disclosure rules for US firms. 

Financial giants JP Morgan, Legal & General Investment Management America and State Street Global Advisors have all had meetings with SEC officials to discuss the topic of climate risk disclosure – as have representatives of corporate interest groups the Business Roundtable and the US Chamber of Commerce, according to the SEC’s records.

‘We must not operate under the false assumption that the securities laws already effectively elicit the information investors need’ – SEC Commissioner Allison Herren Lee

Herren Lee’s speech, which came just days after President Biden unveiled wide ranging plans to address climate-related financial risks, sets the record straight on what is within the regulator’s power to lay down in disclosure rules, amid widespread misconceptions.

“[A]s debates around climate and ESG disclosure have intensified, I have found through dozens if not hundreds of conversations that a number of misconceptions about materiality – what it is and what it is not – have proliferated,” she said. 

Three other “myths” are also unpicked by Herren Lee in her speech, all of which centre on the preoccupation with materiality, which she said many appear to believe “currently works almost preternaturally, on its own with no need for regulatory involvement, to produce all important information from all public companies at all times”.

The most prevalent misconception highlighted is the belief that all material matters, including those on ESG, are already required to be disclosed under the current securities laws. “This is simply not true, and reflects a fundamental misunderstanding,” Herren Lee said. 

“The bottom line is that absent a duty to disclose, the importance or materiality of information alone simply does not mandate its disclosure,” she said, using the example of political donations, which are not required to be disclosed, to illustrate her point. 

The next misconception Herren Lee took aim at is the claim that material climate and ESG information is already being disclosed. Not only is the commissioner doubtful of this, she also highlights that it would be difficult to know one way or the other anyway, “since the omitted information will often not be known to the public or the SEC”. Herren Lee argues that without “sufficient specificity”, a disclosure system that “relies too heavily on a broad-based concept of materiality will fall short of eliciting information material to reasonable investors”. 

Herren Lee also refutes the argument that climate and ESG matters are simply political issues and not material. “If anything, it’s the insistence that science and data must or should be ignored that appears questionable,” she said, adding: “[I]nvestors, 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.”

She concluded her speech by urging: “We must not operate under the false assumption that the securities laws already effectively elicit the information investors need. We must not be diverted by mistaken views regarding the SEC’s rulemaking authority. And we must not be persuaded to ignore scientific evidence or other decision-useful data on the grounds that it intersects with issues of political or social concern.”