Investor group takes SASB to task for its "misdefinition" of materiality

The Investor Environmental Health Network sent a letter to the Sustainability Accounting Standards Board on Wednesday to provide feedback on the SASB Conceptual Framework as well as comments submitted by SASB to the Securities and Exchange Commission earlier in the week.

The IEHN letter notes that while SASB has undertaken a worthwhile effort to identify sustainability metrics that correlate directly to potential value impacts for reporting registrants, the Conceptual Framework and correspondence with the SECs or blurs the definition of materiality.

 Under Supreme Court decisions,materiality refers to information which a reasonable investor would seek in the total mix of information, which may affect decisions to buy or sell stock, or to affect voting decisions. Contrary to the SASB approach, material information is not limited to information with a direct correlation to financial value– for instance, disclosures on political spending or climate change impacts are relevant to investor interest and concerns regardless of whether they represent a significant financial impact on the registrant company. Similarly, disclosures regarding significant externalities or systemic risks imposed on society by a firm are of interest to the reasonable investor, regardless of the likely prospect for costly internalization to the firm.

 The letter notes that as a result of this distorted interpretation of materiality, the SASB took some positions in its comments to the SEC that were surprisingly off the mark. For instance, they took the position that line item disclosures of sustainability issues would not be appropriate to be required by the SEC, because they would require disclosure of immaterial information by some companies. This mistaken assumption seems to flow directly from the SASB’s erroneous interpretation of materiality. 

As as an attorney who has long focused on issues of disclosure and sustainability, I believe there would be significant long-term implications to the distortion of the materiality standard by the SASB, especially given the intention of SASB to become a third-party rule maker equivalent to the FASB. I am hopeful that by calling this issue to their attention at this point in the process, they will develop a more accurately articulated description of their own process as well as the definition of materiality.

- Sanford Lewis

What If Exxon's Climate Bet Fails? SEC to Allow ExxonMobil Shareholders to Press for Disclosure of Costs

by Sanford Lewis

The views expressed in this article are those of the author and do not necessarily reflect the views and opinions of the New York State Common Retirement Fund.

A recent SEC ruling on a shareholder proposal at Exxon Mobil seems a historic moment in investors'  efforts to get a handle on the costs and risks of climate change. It's not every day that a lawyer gets the feeling he just participated in history being made. This was one of those moments for me, as outside counsel to the New York State Common Retirement Fund (New York State employees pension).  

Short version: ExxonMobil has essentially been betting that economic pressures would preclude restrictions on oil and gas demand in public policy. In essence, the recent SEC ruling allows shareholders to vote on a proposal that would ask the company to disclose the costs and risks it will face if that bet fails.

Longer version:

In 2014, shareholders, including Arjuna Capital and the As You Sow Foundation, filed a proposal asking ExxonMobil to issue a report on climate risk. The result was a surprising and notorious report which simply claimed that national and world leaders will not have the backbone to restrict carbon sufficient to keep temperature increase down to 2°C, the global consensus target needed to prevent catastrophic climate impacts. The company asserted and continues to assert that the economic pressures to burn fossil fuels are just too strong. It also asserts that if there are carbon restrictions, other forms of carbon emitting fuels such as coal will be restricted before oil and gas.

As a result, according to ExxonMobil's published analysis, there is not much risk to their bottom line associated with climate change, because global policy will not restrain fossil fuels sufficiently to prevent them from selling their products.

The New York State Comptroller on behalf of the New York State Common Retirement Fund, which is a very large institutional shareholder and the pension fund for New York State employees, filed a shareholder proposal (together with the Church of England) which asks the company to nevertheless calculate the costs to its bottom line associated with successful global policy to restrain carbon sufficient to keep temperature increase down to 2°C. Many experts believe this means keeping a substantial portion of fossil fuels, Including oil and gas, in the ground.

In its specifics the proposal asks:

“RESOLVED: Shareholders request that by 2017 ExxonMobil publish an annual assessment of long term portfolio impacts of public climate change policies, at reasonable cost and omitting proprietary information. The assessment can be incorporated into existing reporting and should analyze the impacts on ExxonMobil's oil and gas reserves and resources under a scenario in which reduction in demand results from carbon restrictions and related rules or commitments adopted by governments consistent with the globally agreed upon 2 degree target. The reporting should assess the resilience of the company's full portfolio of reserves and resources through 2040 and beyond and address the financial risks associated with such a scenario.

The Company challenged the proposal at the SEC saying, in essence, that since their analysis indicates that global policy will not restrain oil and gas, they shouldn't have to calculate those potential losses, the so-called stranded assets associated with their oil and gas development in the face of climate change. They claimed that their optimistic characterization of global climate policy as not constraining their product sales is the only risk analysis that they need to do to fulfill shareholder concerns.

Technically this argument was based on substantial implementation -- that they had fulfilled the essential purpose of the proposal, which, as they characterized it, was simply to weigh and disclose risks associated with climate policy. But to the shareholders who filed the proposal, the purpose was really to disclose what's at risk if Exxon Mobil loses its bet regarding global policy -- if the world DOES constrain fossil fuels to head off an even worse disaster than what's already happening.

The company also argued that the proposal was vague in requesting the disclosure of the risks associated with the 2° policy scenario, because no one can predict exactly what policy mechanisms will be put in place to implement needed constraints, and for instance, the Paris agreement, does not contain sufficient restrictions in itself to meet such a goal.

The SEC denied the company's unusually aggressive and detailed arguments. In so doing, it requires that shareholders be entitled to vote the proposal requesting that the company calculate the financial losses associated with a successful global climate policy framework.

In my opinion the underlying, unspoken issue is: what will it cost the company if its efforts to forestall effective global climate policy fail?

You can read the exchange of correspondence on this matter here. My letters on behalf of the New York State Common Retirement Fund are numbers 2 and 4. The SEC decision is number 5.

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* Thanks to Bill Baue for helpful feedback and critical thinking on this blog and issue.

A Counter-Proposal to FASB: Make Materiality Transparent

Sanford Lewis

Today is the deadline  for submitting comments to the Financial Accounting Standards Board on a proposed set of changes to the accounting rules that govern corporate disclosure in financial statements. While the proposed changes on definitions of "materiality" are written as if they are minor  technical reforms designed to reduce the inclusion of marginally useful information in corporate filings, in reality they are a misdirected set of proposals that send precisely the wrong message to the corporate community - that less disclosure is better. 

The author submitted a counter-proposal on behalf of the Investor Environmental Health Network, for  FASB to require transparency regarding the factors that go into a reporting company’s materiality determinations.

As Jonas Kron, Vice President of the investment firm,  Trillium Asset Management, noted in recent email correspondence:

One of the defining features of the past 15 years or so is being flooded with information.The internet and increasing computing power has led to this. One response would be to say we need less information, another response would be we need better information,  a third would be that we need better tools to manage and understand the information.   I would suggest that the third is more in line with a market system and an economy that wants innovation.  The third approach is consistent with the underlying philosophy of a regulated market; the first two are trying to put the genie back in the box, to roll back time, to give us a 20th Century economy where power was more consolidated in the hands of the few. 

As data management tools have made the sifting of large volumes of information increasingly feasible, the interest of shareholders is in more disclosure not less, to allow application of those sophisticated tools.   The inclusion of data in corporate reports is determined under accounting and SEC rules by whether the information is “material” to investors, which is based on whether the information would influence the judgment of a “reasonable person” or a “reasonable investor.”  

Since there is no single template for a “reasonable investor,” in reality the determination of materiality is better determined with reference to the array of relevant audiences reading the financial statements, as well as factors used to judge materiality – relevant time horizons, types of risks considered or excluded based on uncertainty, magnitude of risk to the firm, etc. Failure to clarify these factors causes confusion in materiality assessment and perhaps contributes to the misperception of current disclosures as including “excess.”

You can read the details of the FASB proposals in our letter and elsewhere (here and here)  but suffice it to say that the FASB proposal would replace a current accounting rule defining materiality with one that gives lots more leeway to companies and auditors to leave out information.The tone of the proposals conveys a message - when in doubt, leave it out.  

If the FASB’s proposed changes are adopted, it would have the effect of reducing disclosures that a company  views as "at the margins" of materiality.  Since those criteria for determining materiality are unarticulated, and disclosure of bad news in particular is typically only disclosed where auditors, accountants or lawyers assert a legal or accounting necessity, creating more discretion without requiring transparency in the materiality determination process means generating less disclosure. 

Materality is in the eye of the beholder. The determination of materiality may be based, for instance, on a company’s assumption that short term investors are driving the company’s stock price, and therefore the only information that is deemed material is information relevant to quarterly returns, or more generously, a 3-5 year timeline.  Alternatively, companies less concerned about meeting the quarterly earnings estimates of analysts and who are focused on delivering returns over a 3-5 year time frame are likely to consider a different set of information as material.

What are the array of investment scenarios and considerations that merit treatment as material?  Does the firm consider investors that may hold shares in the company for the next 15 years? Does it consider investors that are using environmental, social and governance (ESG) matters as a proxy for management quality? Does it consider the investors who are making buy and sell decisions based on long-term considerations such as climate change, and therefore for instance, considering the extent to which a company is committed to fossil fuels?

Materiality determinations made without transparency encourage  manipulation of disclosures  by delayed quantification, narrowed time horizons, and narrow interpretation of the “reasonable investor” to whom the data is of interest.      

Disclosure must meet the needs of a very diverse array of users with different risk tolerances, time horizons, strategies, perspectives and concerns. And, the determination is made by a gatekeeper with a strong interest in non-disclosure.  A Harvard Business School working paper, Materiality in Corporate Governance: The Statement of Significant Audiences and Materiality by Robert G. Eccles Tim Youmans suggests  that registrants be required to file a “Statement of Significant Audiences and Materiality,” (“The Statement”) which would help in some instances to explain how materiality determinations are made. The authors noted:  

When issuing “The Statement” the board must make judgments, tough judgments, since it cannot claim that all audiences are significant. Saying “We will create value for our shareholders by meeting the needs of all of our stakeholders” is not a Statement, it is puffery. It is greenwashing. A corporation, no matter how large, has limited resources and has to set priorities in terms of how they are allocated. For example, a corporation may choose to lay off employees or cut back on its R&D expenses in order to meet its quarterly earnings target. Implicitly, this is making short‐term shareholders a more significant audience than employees or than long‐term shareholders who would benefit from this research. Or the firm can have a different view, such as cutting dividends before “downsizing.” Short‐term shareholders may not like this decision, but long‐term investors (e.g., pension funds) might applaud it.  

The Statement should also be clear about the time frames in which the corporation evaluates the impact of its decisions on its significant audiences. A 10‐year horizon is very different than a one‐year horizon. 

Our recommendation is that  FASB require transparency regarding the process companies use to determine what they regard as material disclosures. This leaves substantial discretion to company management, which is appropriate. Each reporting company should include in its filing a description clarifying how it determines materiality:

• - identify the groups or categories of investors to whom materiality assessments are directed, 
• - relevant time frames, 
• - rationales and 
• - issues of known or potential interest to significant subgroups of its investors. 

In addition, recognizing that financial disclosures are also a key source of information to other constituencies, FASB rules should allow reporting companies, in their discretion, to identify other audiences of investors or stakeholders to whom disclosures have also been addressed.

Based on letter to FASB submitted by the author on behalf of the Investor Environmental Health Network 

New Climate Ruling by SEC Strengthens Shareholder Advocacy

Sanford Lewis, Esq.* 

 A new ruling by the Securities and Exchange Commission (SEC)  holds far-reaching implications for investor efforts to promote proactive corporate responses to climate change.  Every spring in annual meetings, shareholders vote on hundreds of proposals asking  corporations to take more proactive action to consider and reduce  impacts on climate change –  to shift toward renewable energy sources, to reduce greenhouse gas emissions, and to consider risks to their financial future associated with an overemphasis on fossil fuels. 

The proposals are filed by public pension funds, religious institutions and socially responsible investors holding stock in the companies. However,  a massive portion of the vote for or against the proposals is controlled by large mutual funds which  often vote reflexively against shareholder proposals, with  limited accountability to explain their rationale.

 In a letter issued November 24, 2015, SEC Staff held that a proposal seeking to hold a mutual fund accountable for its poor voting record on climate proposals is not excludable from the proxy statement. The proposal at Franklin Resources Inc.( doing business as Franklin Templeton Investments) was submitted by Zevin Asset Management LLC on behalf of its clients.[1] In the proposal which will now appear on the proxy in the spring:

Shareowners request that the Board of Directors issue a climate change report to shareholders by September 2016, …[to] assess any incongruities between the proxy voting practices of the company and its subsidiaries within the last year, and any of the company's policy positions regarding climate change.

This assessment should list all instances of votes cast that appeared to be inconsistent with the company's climate change positions, and explanations of the incongruency. The report should also discuss policy measures that the company can adopt to help enhance congruency between its climate policies and proxy voting.

 Perhaps most notably, the Company argued to the SEC in a request for a no action letter (that would allow the company to exclude the proposal) that its existing legally required [2]disclosures of  its proxy voting records and guidelines  “substantially implement”  the request of the proposal. Those disclosures reveal that the company’s voting record on climate change is near the bottom of the pack among mutual funds (See chart, courtesy of CERES). The guidelines show that its subsidiaries have a great deal of flexibility  to decide whether to vote for or against climate proposals.

The proponent argued that since the company says it takes a “long-term” view of investments and  has endorsed the UN Principles for Responsible Investment, this posture of environmental leadership seemed inconsistent with its climate voting record.  Shareholders are entitled to ask  the company for  a better explanation of this seeming inconsistency, and also to encourage the company to do better.

  The Company argued that the subject matter of the proposal was proxy voting (excludable based on prior decisions as relating to ordinary business), while the proponents successfully asserted that the proposal focused on  a transcendent policy issue of climate change, which is not excludable. The decision was a first  opportunity for the SEC to apply its newly minted Staff Legal Bulletin 14H (CH) which held that if the focus is a significant policy issue, it’s not excludable even  if the proposal touches on “nitty gritty” business practices.[3] 

The Company also argued that as a parent company, Franklin Resources Inc., lacked the power to evaluate or influence proxy voting of its subsidiaries. Subsidiaries have a fiduciary duty to evaluate proxy proposals on behalf of their clients without “undue influence” by a parent company. However, proponents asserted that the proposal left leeway for the parent company to provide legitimate assistance to the subsidiaries, for instance risk assessment resources,  without crossing a line into improper influence.

 Download the full text of the SEC decision and correspondence from the company and the proponent. 

 *Disclosure: The author represented the proponents in defending the proposal before the SEC.

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[1] The Proposal was also co-filed by First Affirmative Financial Network, LLC ("FAFN"), on behalf of its client, Waterglass, LLC, and Friends Fiduciary Corporation ("FFC”).

[2] Form N-PX

[3] http://www.sec.gov/interps/legal/cfslb14h.htm  “[T]he Commission has stated that proposals focusing on a significant policy issue are not excludable under the ordinary business exception “because the proposals would transcend the day-to-day business matters and raise policy issues so significant that it would be appropriate for a shareholder vote.” Thus, a proposal may transcend a company’s ordinary business operations even if the significant policy issue relates to the “nitty-gritty of its core business.” Therefore, proposals that focus on a significant policy issue transcend a company’s ordinary business operations and are not excludable under Rule 14a-8(i)(7).”