The GAO report surveys practices and perspectives familiar to those well versed in contemporary ESG developments while underscoring trends that may be expected to characterize the ESG disclosure landscape in the coming year and beyond. Specifically, investors will continue to pressure public companies to provide more detailed disclosure about their ESG initiatives and results of those initiatives to enable investors to track and eventually compare performance. Investors are concerned with “gaps and inconsistencies in companies’ disclosures that limit their usefulness” and comparability, suggesting that investors and other constituencies will continue to press public companies to fill those gaps and attain greater conformity in their methods of disclosure. Notwithstanding investor interest in greater conformity in standards for disclosure, voluntary disclosure under standards developed by nongovernmental “standard setters” rather than mandated SEC disclosure will be the likely platform for expanded corporate disclosures regarding ESG, at least in the near term.
This article summarizes key findings of the GAO report, discusses the implications of the report’s findings and emerging trends in ESG disclosures, and provides practical guidance for companies navigating the changing ESG disclosure landscape.
Background and Scope of the Report
GAO released its report in response to a 2018 inquiry from U.S. Sen. Mark Warner, D-Va., then ranking member on the Senate Banking Subcommittee on Securities, Insurance, and Investment. The study was conducted in recognition of the fact that investors are increasingly asking companies to disclose information regarding ESG factors that go beyond what companies have historically disclosed in financial reporting under the Securities Exchange Act of 1934, as amended (the Exchange Act). GAO analyzed the disclosures of 32 large and midsize public companies on 33 topics related to climate change, resource management, human rights, personnel management, workforce diversity, occupational health and safety, board accountability, and data security. GAO interviewed 14 large and midsize institutional investors (seven private-sector asset management firms and seven public pension funds), 18 public companies, 13 market observers (including nongovernmental ESG standard-setting organizations, academics, and other groups), and stock exchange and industry association representatives. GAO also reviewed existing studies regarding ESG disclosures.
Investors Are Focused on ESG
Expanding interest in ESG by investors has been well documented for a number of years, and the report highlights this trend with a number of key observations:
- Investors see a link between positive ESG activity and financial value. Investors interviewed by GAO generally agree that corporate attention to ESG issues can have a positive effect on a company’s long-term financial performance. All seven private asset managers and five of seven public pension funds interviewed by GAO said that they seek ESG information to enhance their understanding of risks that could affect companies’ value over time. Note that this perspective is in line with recent evidence that substantial investor capital flowed into ESG-focused funds and that many such funds outperformed the market during the market downturn in February and March 2020 resulting from the COVID-19 pandemic.2
- Investors consider ESG performance when making voting decisions at annual meetings. Nine of 14 investors interviewed by GAO said that ESG data informs how they vote on director elections and other proposals at annual meetings. Two large public pension funds said they withhold votes for directors if a company’s board has not effectively disclosed information regarding certain issues such as climate risk.
- Investors generally value direct engagement on ESG matters but differ in their use of shareholder proposals. Among the GAO interviewees, all seven private asset managers and three of the seven public pension funds said they do not use shareholder proposals to influence companies’ ESG disclosures. One pension fund said that it found filing shareholder proposals unnecessary after engaging in dialogue with companies. By contrast, four of the seven pension funds interviewed by GAO have filed shareholder proposals to seek additional ESG disclosures. GAO observed from existing surveys that shareholder proposals related to ESG are brought by a relatively small number of investors who annually file multiple shareholder proposals at various companies.
- Investors are creating new ESG funds and portfolios. Five of 14 investors GAO interviewed said they created ESG-focused investment funds or portfolios with goals such as promoting social responsibility and environmental sustainability. Investors generally review companies’ ESG disclosures to determine which companies to include or exclude from these investors’ funds or portfolios.
Investors Find That ESG Disclosures Lack Detail, Consistency, and Comparability
Investors expressed concern to the GAO about the level of detail lacking in ESG information provided by companies. Not surprisingly given the voluntary nature of much of this disclosure, GAO found that differences in methods and measures that companies use to disclose information impair comparability of data disclosed across companies. Key observations of the report in this regard:
- Narrative disclosures are often incomplete or too generic. Most investors interviewed said that gaps and lack of specificity in narrative disclosures limit their ability to understand companies’ strategies for considering ESG risks and opportunities.
- Companies disclose measures taken but not the results. GAO observed that while some companies disclose details about steps those companies are taking to manage ESG-related risks or opportunities, many companies do not also discuss the results of their efforts.
- Quantitative disclosures are based on divergent methods and criteria. GAO found that investors are dissatisfied with inconsistencies in companies’ quantitative disclosures, which can limit comparability. Investors reported that different companies use different metrics to report on the same topics and that individual companies may change the metrics they use to disclose on an ESG topic from year to year, making disclosures difficult to compare over time and across companies.
- Companies report on different topics. GAO observed that companies report on different ESG factors, in part because certain factors are less applicable or inapplicable for certain businesses. GAO characterizes this state of disclosures as the result of an absence of a universally applicable ESG disclosure framework.
- Disclosures are located in different formats and outside of the Exchange Act framework. GAO found that companies disclose ESG information variously in annual reports, proxy statements, multi-issue sustainability reports, single-issue reports, dynamic webpages, investor presentations, earnings calls, and shareholder bulletins. The GAO report does not identify specific concerns with these disparate methods. However, the result is that most companies publish their sustainability and other single-issue reports on their company websites and do not file them with the SEC. Therefore, investors do not have access to a one-stop shop for ESG disclosures. Furthermore, leading proponents of ESG disclosures are working toward requiring these disclosures to be incorporated into SEC reporting.3
- The coexistence of competing, voluntary disclosure standards and frameworks has pros and cons. The existence of multiple voluntary disclosure regimes, such as GRI, SASB, CDP, and TCFD,4 may be viewed as a plus for market participants who support the continuing expansion of companies’ ESG disclosures. Conversely, GAO found that this variety of disclosure methods leaves companies unsure as to which methods to use and makes it difficult for investors to compare ESG performance across companies.
Select Standard Setters and Framework Developers for ESG Disclosures
– GAO Report at 6, 32. (Organizations listed alphabetically.)
Institutional Investors and Standard Setters Are Leading the Way — for Now
According to the GAO report, nongovernmental standard setters and framework developers (such as GRI, SASB, CDP, and TCFD) are driving the changing landscape of ESG disclosures, while the SEC carefully observes these developments. The report juxtaposes the sprawling disclosure guidance of these standard setters and framework developers with the traditional disclosure regime of the U.S. federal securities laws.
SEC rules and regulations generally require public companies to disclose known trends, events, and uncertainties reasonably likely to have a material effect on a company’s financial condition or operating performance as well as potential risks to investing in the company. The SEC considers information material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision in the context of the total mix of available information. Public companies disclose this information on an ongoing basis through annual and quarterly reports, proxy statements, and other disclosures filed with the SEC. While federal securities laws generally do not specifically address the disclosure of information on environmental and social topics, disclosure on these topics may fall under certain existing disclosure requirements to the extent they are material to the company. Regulation S-K already mandates disclosure for certain governance-related topics, but not a broader range of topics that proponents of expanded ESG disclosure would like to see in companies’ financial filings with the SEC.
The GAO report observes that the SEC’s Division of Corporation Finance relies primarily on companies themselves to determine the information that is material and required to be disclosed in their SEC filings. SEC Chairman Jay Clayton stated in January 2020 the SEC’s approach to disclosure on environmental topics should continue to be rooted in materiality.5 Chairman Clayton’s response to the GAO report, which is included in the GAO report as an appendix, notes that the SEC’s focus on materiality is “time tested” and “has served our capital markets well” for over 85 years.6
As noted in the GAO report, the SEC is monitoring how investor views may be gradually moving the goal line for what constitutes materiality in ESG-related reporting. The Division of Corporation Finance conducts ongoing research to identify new material information that may be relevant to SEC filings. In 2018, the SEC also created the Office of Risk and Strategy within the Division of Corporation Finance to identify emerging issues that may be material for public companies by reviewing press articles, speeches, and information from other sources such as industry experts. The GAO report indicates that while the SEC currently intends to stand by its traditional materiality concept as the principle for determining information that must be disclosed in SEC filings, it is open to reviewing and revising over time its understanding of what constitutes material information.
Recent Statements of the SEC Chairman Regarding Environmental and Climate-Related Disclosures
On January 30, 2020, SEC Chairman Clayton issued a public statement acknowledging that the “issue of environmental and climate-related securities law disclosures has received increasing attention from regulators, investors and other market ... and non-market participants.” Noting that the SEC has been “actively engaged on this issue for over a decade,” Chairman Clayton stated that the SEC’s approach to date has been “consistent with [the SEC’s] ongoing commitment to ensure that our disclosure regime provides investors with a mix of information that facilitates well-informed capital allocation decisions.... [T]his commitment has been, and in my view should remain, disclosure-based and rooted in materiality, including providing investors with insight regarding the issuer’s assessment of, and plans for addressing, material risks to its business and operations.”
The Chairman cited past and present efforts of the SEC to account for environmental and climate-related issues in its oversight of the U.S. securities law disclosure regime. Among them:
Chairman Clayton noted that the “SEC staff has continued to consider these matters ... as part of regular reviews of annual and periodic reports and other company filings” and that while the “staff has generally found robust efforts to comply with the disclosure requirements,” it has also issued comments to companies in certain situations with respect to questioning “the sufficiency and consistency” of disclosures.
The Chairman also noted that the SEC is a member of the multi-national Financial Stability Board, which formed the Task Force on Climate-related Financial Disclosures (TCFD), and that the SEC staff provides input on an ongoing basis to the FSB. The Chairman stated that as circumstances change, the SEC’s principles-based disclosure requirements, as applied to environmental and climate-related matters, “may require modification.”
– See Public Statement, Proposed Amendments to Modernize and Enhance Financial Disclosures; Other Ongoing Disclosure Modernization Initiatives; Impact of the Coronavirus; Environmental and Climate-Related Disclosure, Chairman Jay Clayton (Jan. 30, 2020), https://www.sec.gov/news/public-statement/clayton-mda-2020-01-30. See also Public Statement, Remarks at Meeting of the Investor Advisory Committee, Chairman Jay Clayton (May 21, 2020), https://www.sec.gov/news/public-statement/clayton-statement-investor-advisory-committee-meeting-052120; Remarks at Meeting of the Asset Management Advisory Committee, Chairman Jay Clayton (May 27, 2020), https://www.sec.gov/news/public-statement/clayton-amac-opening-2020-05-27.
Policy Options — Everything on the Table
GAO reports that investors and market observers have proposed a range of policy options to improve the quality and usefulness of ESG disclosures. Key options cited by the report include:
- Legislative action. Some institutional investors and market observers have proposed new legislative or regulatory initiatives to enhance public company ESG disclosures. GAO identified bills recently introduced in the House and Senate that would require companies to disclose additional ESG information, such as climate change risks and the racial and gender composition of boards of directors and senior management teams.
- Rulemaking and rule interpretation. Some market participants have recommended that the SEC issue new rules pertaining to ESG disclosures, such as mandating specific ESG disclosures or endorsing an ESG disclosure framework such as GRI or SASB. Market participants have also suggested the SEC issue new interpretive releases addressing how ESG topics fit within existing disclosure requirements. These recommendations are consistent with recent recommendations of the SEC’s Investor Advisor Committee (see below).7 After the release of the GAO report, on July 6, 2020, Sen. Warner issued a public statement calling on the SEC to “grapple directly with the metrics that GRI and SASB have developed ... and issue guidance on quantifiable and comparable disclosures.”8
- Stock exchange listing requirements. GAO notes that in some countries, stock exchanges have incorporated ESG disclosure requirements into their listing standards. GAO observes that although Nasdaq produces a voluntary ESG reporting guide and the New York Stock Exchange has declared support for ESG disclosures by its listed companies, neither exchange currently makes ESG reporting a listing requirement.
- Private-sector approaches. Some market participants have recommended private-sector-based approaches to improve companies’ ESG disclosures on the theory that such approaches provide companies with needed flexibility and allow industry players to design the most appropriate disclosure standards for their industry.9 Private sector approaches include private ordering that stems from shareholder proposals and other engagement encouraging individual companies to expand their ESG reporting.
In addition to the approaches summarized in the GAO report, it bears noting that nongovernmental standard setters such as GRI and SASB are continuously working on their own initiatives to improve and expand the scope, detail, and rigor of their reporting standards.10 GRI and SASB also announced in July 2020 a new project to collaborate for the purpose of “promoting clarity and compatibility in the sustainability landscape.”11
Perspectives of the SEC Investor Advisory Committee on ESG Disclosures
In May 2020, the Investor-as-Owner Subcommittee of the SEC Investor Advisory Committee (IAC) recommended that the SEC “begin in earnest an effort” to provide public companies with an updated “framework to disclose material, decision-useful, comparable and consistent information in respect of their own businesses, rather than the current situation where investors largely rely on third party ESG data providers ....”
Established under the Dodd-Frank Act to advise the SEC on regulatory priorities and composed of investors and other market experts, the IAC held three sessions on the topic of ESG disclosures in 2016, 2018, and 2019. The IAC’s report stressed that investors “consider certain ESG information material to their investment and voting decisions” but expressed concern that “despite a plethora of data, there is a lack of material, comparable, consistent information available upon which to base” investment decisions. The diversity of ESG data providers, the IAC argues, also creates a “significant burden” for U.S. issuers because each data provider uses different information sources to conduct its analysis and produce its work product.” The IAC observes that companies are “inundated with requests for ESG information,” and those who disregard certain inquiries or do not fully complete questionnaires risk low ESG ratings, which in turn “can have a direct impact on their stock price and ability to access capital ....”
The IAC recommends that issuers, rather than third-party data providers, should “directly provide material information to the market relating to ESG issues.” It argues that an updated ESG disclosure framework, developed by the SEC, will “level the playing field between issuers,” as small, midcap and capital constrained companies are less able to keep up with sprawling and diverse demands of third-party data providers. The IAC also urged the SEC to “take the lead” in developing new ESG disclosure frameworks for the U.S. capital markets “before other jurisdictions impose disclosure regimes on U.S. Issuers and investors alike.”
– See Recommendation from the Investor-as-Owner Subcommittee of the SEC Investor Advisory Committee Relating to ESG Disclosure (as of May 14, 2020), https://www.sec.gov/spotlight/investor-advisory-committee-2012/recommendation-of-the-investor-as-owner-subcommittee-on-esg-disclosure.pdf.
Likely Expectations of Investors and Standard Setters Going Forward
The GAO report identifies prevailing issues, practices, and perspectives that have been documented in other recent surveys,12 reflecting trends that may be expected to characterize the ESG disclosure landscape in the coming year and beyond. ESG-minded investors will expect public companies to continue to produce increasingly more detailed disclosure about their ESG initiatives as well as actual results of those initiatives. Investors, nongovernmental standard setters and other interested constituencies will push public companies to expand their disclosure of ESG initiatives and results, including voluntary disclosure of ESG data under standards designed to make that data easier to compare within and across industries. In the near term, nongovernmental standard setters, framework developers, and investors will continue to drive the evolving landscape of ESG disclosures. The SEC, as it has indicated, will continue to monitor changing views of investors regarding the meaning of materiality in the ESG context. This may have longer-term implications for SEC reporting. Proponents of enhanced ESG disclosures will likely continue to seek to influence Congress, the SEC, stock exchanges, and trade associations for more demanding and uniform ESG disclosure requirements. While at this time it does not appear that legislative and regulatory change is likely in the very near term, federal activity in this sphere bears watching.
Practical Guidance for Public Companies
Recognizing that public companies are variously situated in their approaches to ESG disclosure, the following practical guidance is provided for consideration:
- Public companies should stay informed of developments and trends in the area of ESG disclosure. In addition to SEC statements and guidance, companies should be aware of initiatives and statements of significant and influential investors, broader trends in shareholder proposals and initiatives, activities of nongovernmental standard setters, ESG disclosures of peer companies, and activity in the federal legislative sphere. Senior management and the board of directors (or appropriate board committee) should be briefed on a regular periodic basis.
- Companies that disclose only the limited ESG information required by SEC reporting obligations should periodically review their approach and consider whether it remains appropriate to their circumstances, while building an understanding of the competing voluntary disclosure regimes and the approaches of peer companies. This exercise is worthwhile even where management and the board prefer to avoid voluntary ESG disclosures for the time being; benchmarking peer disclosures provides insights into strategies of competitors and assessment of competing disclosure regimes, and may also indicate where modest improvements in disclosures could lead to improvements in a company’s ESG profile with rating agencies, investors, funds, indices and proxy advisers. Changes in peer disclosures (as with watching trends in shareholder proposals and voting patterns) may also highlight areas where pressure is imminent from the company’s own shareholders. Proactive ESG disclosures may preempt shareholder proposals calling for specific disclosures that have already been submitted to peer companies.
- Companies that already disclose ESG information with reference to a voluntary disclosure regime should monitor peer disclosure and take stock of informational gaps and methodological concerns that may be identified by investors. This work may involve benchmarking a company’s disclosures and calculation methods for disclosures against those of its peers, and considering where changes could be made and then communicated to investors. A company can review how to boost its standings with ESG-focused raters, rankers and indices. This review effort can also involve engaging with investors further to gather new feedback, weigh their evolving and competing demands, and shape the company’s disclosure priorities for the next year.
- Every public company should make a strategic decision about which ESG disclosures it will develop, if any, and how. While this decision is partly a “business call,” it is also a legal decision that reflects the company’s judgment regarding materiality of corporate information. It is especially important for this reason to engage with investors continuously to keep track of what matters to them and how their viewpoints are changing in the current, dynamic environment of investor opinion; some investors may be more vocal than others but not represent a broader viewpoint or appreciate the totality of management’s considerations.
- Companies should consider investor demands for new disclosures but apply business judgment. Engagement strategies and a clear explanation of the company’s approach to these types of demands should be developed. In an environment in which the company’s approach to environmental and social issues may have significant reputational implications, companies are well served by developing and articulating an ESG policy that explains the company’s values and culture along with the exigencies of the company’s business. Such a policy provides a framework for addressing ESG issues and requests for disclosure as they arise.
- Companies should consider whether and in what respects adopting or refining ESG policies, initiatives and voluntary disclosures presents both opportunity and risk. With growing interest in ESG activities among investors, employees, customers and other key constituents, enhanced attention to a company’s ESG position could provide competitive advantage. It may also change the company’s risk profile in both positive and negative respects, depending on how the company has implemented its ESG-related programs. If a company discloses a new or revised initiative in a given year, it should craft its related disclosure mindful that the company may need to report on the results of the initiative in a subsequent year.
- Companies should remain aware that “materiality” for SEC reporting purposes is a concept that is not static, but can change over time. Many companies publish ESG information in reports outside of the SEC disclosure framework, for example, on their corporate webpages, on the rationale that this information is of interest to investors but not material so as to necessitate including in SEC filings. Meanwhile, voluntary reporting regimes such as SASB and TCFD recommend that information disclosed under their regimes also be included in SEC filings. It is important to keep in mind that information published today outside of the Exchange Act framework could in the future become deemed material in the minds of investors – and hence the SEC.
1 U.S. Gov’t Accountability Off., GAO-20-530, Public Companies: Disclosure of Environmental, Social, and Governance Factors and Options to Enhance Them (Jul. 2020), https://www.gao.gov/products/gao-20-530 (hereinafter, GAO Report). All cited websites were last accessed July 16, 2020.
2 See, e.g., “Sustainable Funds Weather Downturns Better Than Peers,” Morningstar.com (June 15, 2020), https://www.morningstar.com/articles/988114/sustainable-funds-weather-downturns-better-than-peers; “ESG Funds Setting a Record Pace for Launches in 2020,” Morningstar.com (June 24, 2020), https://www.morningstar.com/articles/989209/esg-funds-setting-a-record-pace-for-launches-in-2020; “Majority of ESG Funds Outperform Wider Market over 10 Years,” FT.com (June 30, 2020), https://www.ft.com/content/733ee6ff-446e-4f8b-86b2-19ef42da3824.
3 See SASB, SASB Conceptual Framework at 6, 9 (Feb. 2017), https://www.sasb.org/wp-content/uploads/2020/02/SASB_Conceptual-Framework_WATERMARK.pdf; TCFD, Final Report: Recommendations of the Task Force on Climate-related Financial Disclosures at 33 (June 2017).
4 On the Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), CDP (previously the Carbon Disclosure Project), Task Force on Climate-related Financial Disclosures (TCFD) and other standard setters and disclosure frameworks, see GAO Report at 6.
5 Public Statement, Proposed Amendments to Modernize and Enhance Financial Disclosures; Other Ongoing Disclosure Modernization Initiatives; Impact of the Coronavirus; Environmental and Climate-Related Disclosure, Chairman Jay Clayton (Jan. 30, 2020), https://www.sec.gov/news/public-statement/clayton-mda-2020-01-30.
6 GAO Report at 54.
7 See also Recommendation from the Investor-as-Owner Subcommittee of the SEC Investor Advisory Committee Relating to ESG Disclosure (as of May 14, 2020), https://www.sec.gov/spotlight/investor-advisory-committee-2012/recommendation-of-the-investor-as-owner-subcommittee-on-esg-disclosure.pdf.
8 “Warner on New GAO Report Highlighting Importance of Requiring Corporate Disclosure of Environmental, Social and Governance Issues” (Jul. 6, 2020), https://www.warner.senate.gov/public/index.cfm/2020/7/warner-on-new-gao-report-highlighting-importance-of-requiring-corporate-disclosure-of-environmental-social-and-governance-issues.
9 GAO provides the example of the Edison Electric Institute and the American Gas Association, which partnered to develop standards to guide ESG reporting by electric and natural gas companies. Edison Electric Institute, ESG/Sustainability, https://www.eei.org/issuesandpolicy/Pages/FinanceAndTax-ESG.aspx.
10 For example, in June 2020, GRI commenced a comment period to gather feedback on how to develop its reporting standards, and in August 2020, SASB will open a comment period related to the revision of SASB Conceptual Framework. See GRI, A Stronger Foundation for Impact Driven Reporting (June 11, 2020),; SASB, Conceptual Framework, Project Status (as of March 4, 2020), https://www.sasb.org/standard-setting-process/current-projects/conceptual-framework/.
11 SASB, GRI, “Promoting Clarity and Compatibility in the Sustainability Landscape” (July 12, 2020), https://www.sasb.org/blog/promoting-clarity-and-compatibility-in-the-sustainability-landscape-gri-and-sasb-announce-collaboration/.
12 See, e.g., State Street Global Advisors, Into the Mainstream: ESG at the Tipping Point (Jan. 2020), https://www.ssga.com/library-content/pdfs/insights/into-the-mainstream.pdf; Preqin Ltd., 2020 Preqin Global Private Equity & Venture Capital Report, 124–27, www.preqin.com; State Street Global Advisors, The ESG Data Challenge (Mar. 2019), https://www.ssga.com/investment-topics/environmental-social-governance/2019/03/esg-data-challenge.pdf.
Sidley Austin LLP provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship. Readers should not act upon this information without seeking advice from professional advisers.
Attorney Advertising—Sidley Austin LLP, One South Dearborn, Chicago, IL 60603. +1 312 853 7000. Sidley and Sidley Austin refer to Sidley Austin LLP and affiliated partnerships, as explained at www.sidley.com/disclaimer.
© Sidley Austin LLP