The Adopting Release’s inaction on ESG disclosures drew dissension from two SEC Commissioners.

By Paul A. Davies, Paul M. Dudek, Ryan J. Maierson, and Kristina S. Wyatt

Background

On August 26, 2020, the US Securities and Exchange Commission (SEC or Commission) adopted amendments to Regulation S-K — the key rules guiding companies’ disclosures in registration statements and periodic reports filed with the SEC.[1] Specifically, the Commission amended Items 101, 103, and 105 of Regulation S-K, relating to registrants’ description of their business, legal proceedings, and risk factors. The Adopting Release explained that the amendments were intended to improve disclosures for investors and ease compliance burdens for companies.

The amendments have been a long time in the making, and the Commission noted that it had not conducted a wholesale amendment to these disclosure rules in over 30 years. Following enactment of the Jumpstart Our Business Startups Act (known as the JOBS Act) in 2012, the SEC staff undertook a comprehensive evaluation of the Commission’s disclosure requirements in what became known as the Disclosure Effectiveness Initiative. This evaluated such matters as what information the Commission should require registrants to disclose, where that information should be disclosed and in what format, and whether technology might facilitate and streamline the disclosure process.

As part of the Disclosure Effectiveness Initiative, the Commission issued a Concept Release in 2016 in which it solicited public comment on the disclosure provisions of Regulation S-K and, in particular, whether the existing rules cause investors to receive the information they need in order to make informed investment decisions.[2] The comments received in response to the Concept Release fed into proposals to amend Regulation S-K,[3] which ultimately resulted in these most recent amendments that the Commission adopted on August 26.

Silence on ESG Disclosures

The Adopting Release is notable for its silence on ESG disclosure provisions save for modest amendments to the disclosure provisions around human capital management. On the one hand, this silence is not terribly surprising, because the Proposing Release was quiet on ESG issues. On the other hand, the Proposing Release was issued in August 2019, before Larry Fink’s seminal letters to BlackRock’s stakeholders, before COVID-19, and before the recent unrest focused on social inequities in the United States, all of which have raised the significance and urgency of ESG issues for many investors. Moreover, the public comment letters that the Commission received on the Concept Release and the Proposing Release included a disproportionate share of comments in which investors urged the SEC to adopt rules to improve the quality and comparability of public companies’ ESG disclosures.

The Adopting Release’s inaction on ESG disclosures drew sharp dissension from SEC Commissioners Allison Herren Lee and Caroline Crenshaw, who both voted against the amendments. Commissioner Lee noted:

“The final rules today look largely like the proposal, ignoring both overwhelming investor comment and intervening events. We have declined to include even a discussion of climate risk in the release despite significant comment on this subject. And we have declined to go beyond merely introducing the topic of human capital generally, despite investors’ views that this is not nearly enough. … There is room for discussion as to which specific ESG risks and impacts should be disclosed and how. But the time for silence has passed. It’s time for the SEC to lead a discussion — to bring all interested parties to the table and begin to work through how to get investors the standardized, consistent, reliable, and comparable ESG disclosures they need to protect their investments and allocate capital toward a sustainable economy.”

Commissioner Crenshaw adopted a similar tone, noting that “this rule is presented as a ‘modernization’ of certain provisions of Regulation S-K — but the rule before us today fails to deal adequately with two significant modern issues affecting financial performance: climate change risk and human capital.” Like Commissioner Lee, Commissioner Crenshaw urged the Commission to continue to evaluate the impact of ESG factors on investors’ decision-making process. Specifically, Commissioner Crenshaw proposed the formation of an internal SEC taskforce to study how investors use ESG information in their evaluation of companies’ long-term investment prospects. Further, she proposed the formation of an external ESG advisory committee composed of issuers, investors, and other subject-matter experts to help keep the Commission informed as to evolving ESG trends.

The issue likely will arise again when the Commission takes up the adoption of rules to amend Item 303 of Regulation S-K, which governs the disclosure of Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A). Proposals for these rules are still pending.[4]

Latham & Watkins will continue to monitor developments in this area.

Endnotes

[1] “Modernization of Regulation S-K Items 101, 103, and 105” Final Rule, SEC Rel. Nos. 33-10825 and 34-89670 (August 26, 2020), available at https://www.sec.gov/rules/final/2020/33-10825.pdf (Adopting Release).

[2] “Business and Financial Disclosure Required by Regulation S-K” SEC Rel. No. 33-10064 (April 13, 2016), available at https://www.sec.gov/rules/concept/2016/33-10064.pdf (Concept Release).

[3] See “Modernization of Regulation S-K Items 101, 103, and 105” SEC Rel. No 33-10668 (August 23, 2019), available at https://www.sec.gov/rules/proposed/2019/33-10668.pdf (Proposing Release).

[4] “Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information” SEC Rel. 33-10750 (January 30, 2020), available at https://www.sec.gov/rules/proposed/2020/33-10750.pdf.