SEC Chief Takes on Short-Termism and ESG
Chairman Jay Clayton wants to bolster long-termism by streamlining reporting requirements, and his agency is evaluating new human-capital risk disclosures.
The decline of long-term thinking “bothers” Jay Clayton, the chairman of the Securities & Exchange Commission.
It isn’t good for investors or Corporate America as a whole, he maintains, and he’s focused his efforts on doing something about it, including holding a roundtable on the topic this summer; analyzing whether reporting requirements such as quarterly earnings may be contributing to the problem; and simplifying disclosure standards.
When it comes to the environmental, social and governance movement, Clayton acknowledges the growing drumbeat for ESG reporting standards, but he warned that ESG means many different things to different constituencies and “continuing to lump them all together, will slow our efforts to move our disclosure framework forward.”
On the human capital side of ESG specifically, his agency has been evaluating whether human capital disclosures may be needed.
“Our current disclosure requirements date back to a time when companies relied significantly on plant, property and equipment to drive value,” he explains.
Clayton provides his insights on the short-termism/long-termism imbalance and ESG disclosure in this Q&A with Directors & Boards:
Short-termism is seen as a major factor undermining corporations and the greater community today, and it’s something you’ve been vocal about. How do you see short-termism impacting what you’ve said is the SEC’s mission to protect investors; maintain fair, orderly and efficient markets; and facilitate capital formation?
If by short-termism you mean companies, in response to market and other pressures, pursuing short-term objectives to the detriment of long-term performance, it bothers me. It principally bothers me because that type of short-term perspective generally is inconsistent with the investment objectives of our Main Street investors. In addition, if our public capital markets are overly short-term focused, that perspective may undermine capital formation in our public markets. I will elaborate on both of these concerns.
We should recognize that our Main Street investors, and in particular their willingness to commit their hard-earned money to our capital markets for the long term, have been instrumental in providing the depth that is necessary for markets to function efficiently and effectively over time. It is their money — 401(k)s, IRAs, pension funds, insurance contracts, etc. — that fuels our markets.
We also should recognize that our Main Street investors — whether they participate in our markets directly or through an intermediary such as an investment adviser — now, more than ever, have a substantial responsibility to fund their own retirement and other long term financial needs. For these and many other reasons, we owe it to our Main Street investors to ensure that our markets appropriately reflect these long-term needs and objectives.
Short-termism, or more accurately too much short-termism, also is inconsistent with facilitating capital formation. Said another way, short-termism can deter companies that are looking to raise capital from doing so in our public capital markets. Companies seeking capital often expect to invest that capital for the long term and manage their business on a similar long-term basis. If these types of companies believe our public markets are dominated by participants with a short term perspective, they may look elsewhere for longer term growth capital.
What is the SEC doing under your leadership to combat short-termism and boost long-term thinking in corporate America?
We recently announced that our staff will hold a roundtable this summer that will seek to explore whether short-termism should be a concern and, if so, what are its causes and what can and should be done from a regulatory perspective in response. We also intend to facilitate conversations on whether there are market-based initiatives and regulatory changes that could ensure an appropriate balance between short-term and long-term perspectives in our public capital markets.
We are analyzing several issues that may be contributing to an imbalance in favor of short-termism, including our reporting requirements and voluntary disclosures such as earnings guidance. There is an ongoing debate regarding the effects of our mandated quarterly reports and the prevalence of optional quarterly guidance. We recently requested public input on whether our existing periodic reporting system, alone or in combination with other factors, may incentivize managers and other market participants to disproportionally focus on short-term results. We also recognize that markets thirst for information and that timely and accurate disclosure facilitates liquidity and enhances market confidence. At the end of the day, we are interested in ways we can maintain, and in some cases enhance, disclosure effectiveness and investor protections, while reducing burdens on reporting companies that come from our quarterly reporting processes.
The SEC has been examining a variety of steps to simplify and update disclosure requirements. Have there been any decisions made?
We have taken significant action to simplify and update disclosure requirements. For example, this past March the SEC finalized amendments to modernize and simplify disclosure requirements for reporting companies, a mandate in the Fixing America’s Surface Transportation Act. We also updated financial disclosure requirements that were outdated, overlapping or duplicative with other Commission rules or U.S. Generally Accepted Accounting Principles. These amendments should reduce costs for companies and their shareholders. Importantly, they will not adversely affect the availability of material information and, in many cases, will enhance the quality of information and increase investor protection.
For smaller companies, last year we expanded the definition of “smaller reporting company” — these are the companies that qualify for certain scaled disclosure accommodations. This amendment recognizes that a one-size regulatory structure for public companies does not fit all.
We also took steps aimed at encouraging issuers to consider raising capital in a registered initial public offering. I am concerned that good companies are not entering our public markets or are putting off entering our public markets while they are growing, and entering our public markets only after they are large. In both cases, our Main Street investors are deprived of investment opportunities.
SEC staff expanded benefits in the Jumpstart Our Business Startups (JOBS) Act to permit all companies to submit non-public draft registration statements for review at the time of the initial registration statement and for subsequent offerings within one year of the initial registration statement. In addition, earlier this year, the SEC proposed amendments to expand “test-the-waters” — another popular JOBS Act benefit that would allow all companies (not just emerging growth companies) to gauge market interest in a possible initial public offering or other proposed registered securities offering by permitting discussions with certain investors prior to the filing of a registration statement. This amendment would permit investor views about potential offerings to be taken into account at an earlier stage in the process than is the case today.
How important is improved corporate reporting to bolstering long-term thinking?
Our markets and investors have a thirst for high-quality, timely information regarding company performance and material corporate events. But we also recognize that companies and investors are interested in planning for (and investing for) the long term. Our disclosure rules should reflect both of these perspectives and be tailored to ensure that neither one dominates or “crowds out” the other.
Some critics have argued that the SEC has been dropping the ball when it comes to disclosure mandates needed for information that could impact a company longer term, especially ESG disclosure. You’ve been quoted as saying that ESG disclosure by publicly traded companies should not be required. Do you still believe this is the case and why?
As an overarching principle, I believe our disclosure rules and guidance, and our issuers, should focus on the information that a reasonable investor needs to make informed investment and voting decisions. This perspective often is referred to as the “materiality” based approach to disclosure regulation. This has been the commission’s perspective for 84 years and it has served our investors and markets very well. Keeping that perspective in mind is critical to our mission.
More specifically, and turning to your ESG question, we need to keep in mind that not all ESG matters are created equal — in fact, they are quite different and are different in multiple ways.
Starting with “G,” matters considered to be in the “G” category tend to be a lot closer to the core governance issues that investors have come to expect in terms of disclosure from our public companies. There are long-standing rules and conventions, many driven by generally applicable law, that investors have monitored. In contrast, matters considered to be in the “E” category, such as regulatory risk, and risk to property and equipment vary widely from industry to industry and country to country. In some cases, the issues are material to an investment decision. In other cases they are not.
So, the disclosure approach for all ESG matters, and in particular “E” and “S” matters, cannot be the same, as issuers and investors approach each of them differently. Continuing to lump them all together, will slow our efforts to move our disclosure framework forward.
Let me give you an example of an area where I believe we need to move forward — human capital — and how we move forward will vary from industry to industry and even company to company.
Our current disclosure requirements date back to a time when companies relied significantly on plant, property and equipment to drive value. Today, human capital represents an essential driver of performance for many companies albeit in different ways. It is clear that, in certain cases, such as a growth-oriented data sciences company, understanding a company’s approach to human capital may be material to an investment or voting decision. SEC staff has been working to evaluate and recommend improvements to our disclosure requirements and I expect human capital disclosures to be among the issues under consideration.
What would you say to boards of directors who want some sort of standardization because they don’t want ESG risks to impact their company’s bottom line and potentially face investors’ wrath? Do you think such disclosure, via third-party standards such as the Global Reporting Initiative and the UN Sustainable Development Goals, if done voluntarily has value? Why?
If a matter — whether it is considered an ESG matter or not — is going to affect the company’s bottom line or presents a significant risk to the business, I would expect them to do something about it. If the matter is material, I also would expect the company to disclose the matter and what they are doing about it. This is consistent with general fiduciary obligations of directors and officers, as well as our disclosure rules.
Now, if we are discussing concerns among certain investors if a company does not follow ESG standards, regardless of whether the standards are aligned with the company’s assessment of what is important to its business and prospects, that is a more complex and vexing issue. My view is that in many areas we should not attempt to impose rigid standards or metrics for ESG disclosures on all public companies. Such a step would be inconsistent with our mandate, would be a departure from our long-standing commitment to a materiality-based disclosure regime, and could effectively substitute the SEC’s judgment for the company’s judgment on operational matters.
As I have said before, I think investors are much better served by understanding the lens through which each company looks at its business, including assets like human capital and risks like climate change and potential future regulation.
The U.S. capital markets have a wide diversity of companies—from startup biotechnology companies to well-established manufacturing companies. In some cases it is possible to identify metrics that provide for reasonable marketwide comparability across all companies (for example, U.S. GAAP). In other cases, this is not possible at a market-wide level, and comparability is reasonably possible at an industry level or only at a company level (this is demonstrated by the development of non-GAAP financial measures).
I fear that if we try to apply standardization across all companies in our markets we will end, in many cases, with mandated disclosure that is not material to a reasonable investor and, worse, inconsistent with the way the company views the issue. For example, for human capital, I believe it is more important that any metrics allow for meaningful period to period comparability for the company (and in some cases the industry) rather than marketwide metrics that are different from the metrics management and investors use to assess the performance and prospects of the business.
More and more investors are taking ESG factors into consideration when it comes to investing. Where should they go to make sure corporations are following similar standards? Aren’t there societal risks like income inequality, climate change, etc., that could impact a company’s bottom line? How should companies be addressing these issues if there are no standards to follow?
Bill Hinman, the SEC’s director of the Division of Corporation Finance, recently gave a speech addressing how to apply our principles-based disclosure requirements to complex and evolving disclosure questions. I commend everyone, especially boards of directors and those who prepare and review company disclosures, to take a look at those remarks.
We’ve focused our coverage this year on something we’re calling the “Character of the Corporation,” basically how companies can balance profits and social good. Do you think it’s the SEC’s job to ensure that corporations are not just doing right by investors, but doing right by society?
When it comes to the regulation of our reporting companies, the SEC is a disclosure agency, so our rules do not, and should not, tell companies how to run their business or mandate that they take action to promote the social good or, as you say, balance profits and social good. As a disclosure agency, our job at the SEC is to ensure that reporting companies provide the material information that a reasonable investor needs to make informed investment and voting decisions.
While many large investors, including BlackRock and Vanguard, have been touting the importance of long-term thinking, some critics, including Delaware Supreme Court Chief Justice Leo Strine, point the finger, in part, at these mega investors controlling more and more of the investment dollars for the increase in short-term thinking, and the undervaluing of employees — many of who are investors in those mega funds. Is the SEC concerned about this? If so, what can be done?
I consider Chief Justice Strine to be one of the most significant contributors to our understanding of corporate governance and our capital markets. I enjoy and find valuable the time I have spent with him.
While the U.S. approach to firm governance is proven — and with the benefit of having practiced law in many jurisdictions, I believe the best approach for investors —it is not a perfect one. At any one company we are sure to have shareholder alignment issues. Not all shareholders have the same objectives and, where they do share objectives, they may disagree on how best to pursue them.
Further, some shareholders may not share management’s view on how best to pursue the company’s objectives. This is not a surprise and is not new, but it is a complex and multi-layered issue. The layers include management and the board of directors (the fiduciary agents of shareholders), shareholders (who come in many different forms, including investment vehicles such as mutual funds, ETFs and pension funds) and owners and beneficiaries of those investment vehicles.
I believe that the key to understanding — and acting on — what is in the best interest of shareholders — the ultimate owners of capital — is to engage with shareholders of all types and identify the areas of commonality. Pursuing long-term returns to shareholders — and I emphasize long-term — has proven in many cases to be an effective focal point for discussing and reaching consensus on the appropriate path to server shareholder interests.
What would you say to board of directors who want to think long-term but feel constrained by quarterly earnings reports, large investors and activists looking for quick returns?
Share your thoughts with us. As I like to say “we are open for business.” Last December the Commission solicited input on the nature, content, and timing of earnings releases and quarterly reports made by public companies. We want thoughts on how we can improve our disclosure regime to enable companies to focus on the long-term view.
Are you hopeful Corporate America will ever get back to focusing on the long-term? If so, why?
Many investors and market participants agree on the importance of long-term investing. I believe dialogues like this one are also an important step to emphasize the importance of a long-term view in our capital markets. I am not expecting change to happen overnight. But I am confident that the work we are doing at the SEC will continue to advance the issue.