New SEC Guidance Confirms "Materiality Standard" in Disclosure of ESG Issues

February 21, 2020

Despite the objections of Democratic Commissioners seeking more prescriptive disclosures, newly-issued SEC guidance consistent with HR Policy Association recommendations reaffirms that companies are only required to disclose environmental, social, and governance matters such as climate change and human capital if they are material to the company.

For some time, the Securities and Exchange Commission has been engaging in a disclosure reform project.  During this initiative, the SEC has seen a significant push to incorporate specific environmental, social, and governance metric disclosures into the 10-K Annual Report.  The HR Policy Association and other business groups urged the SEC to continue to require only principles-based disclosures based on the materiality standard.

SEC affirms materiality standard for disclosures, eschewing specific requirements:  In recently issued guidance, which dealt with “financial condition and result of operations” disclosures in the 10-K report's Management Discussion & Analysis, the SEC decided against requiring the disclosure of specific metrics for climate change and other ESG factors.  Instead, the Commission reaffirmed disclosures should be based on the materiality standard—what a reasonable investor would find important in making an investment decision.

“Today’s proposal is most notable for what it does not do: make any attempt to address investors’ need for standardized disclosure on climate change risk,” noted Democratic Commissioner Allison Lee, encapsulating the view that the “principles-based 'materiality' standard has not produced sufficient disclosure to ensure that investors are getting the information they need—that is, disclosures that are consistent, reliable, and comparable.”

Yet, as noted by Republican Commissioner Hester Peirce, "[t]here is reason to question the materiality of ESG and sustainability disclosure."  Peirce further noted that materiality as a principle works due to its limited focus and "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."

Guidance notes workforce factors may potentially be material information:  Notably, the guidance did not deny there could be cases where ESG information is material.  In an example of potentially material non-financial metrics, the guidance included “voluntary and/or involuntary employee turnover rate [and] percentage breakdown of workforce (e.g., active workforce covered under collective bargaining agreements).”