Making Sustainability Disclosure Sustainable

Issuers, investors and regulators are paying increasing attention to corporate sustainability.  Commentators have proffered a variety of explanations for this attention ranging from the argument that corporations are morally obligated to act in a socially responsible manner to the claim that sustainability is linked to economic performance.  Responding to the demand for sustainability information, issuers are producing hundreds of pages of sustainability reports, and the number of intermediaries that have developed reporting standards and sustainability rating systems has proliferated. The range of approaches to disclosure, however, limit the comparability and reliability of the information disclosed, and investors repeatedly express dissatisfaction with the quality of sustainability disclosure. These limitations also create challenges for efforts to evaluate the economic impact of sustainable business practices.  The shortcomings of the current system were highlighted when the Dow Jones Sustainability Index named Volkswagen the world’s most sustainable car company by the Dow Jones Sustainability Index just one week before U.S. regulators publicly announced the emissions scandal.   

The problems stem, in part, from the fact that most sustainability disclosure is voluntary. Historically, the Securities & Exchange Commission (SEC) has resisted mandated sustainability disclosure, reasoning that that its disclosure requirements should be limited to information that is economically material to investors.  In 1977, the Advisory Committee on Corporate Disclosure led by former Commissioner A. A. Sommer, Jr. concluded that the SEC “should not try to use its powers to compel disclosure concerning, for instance, social or environmental matters, hiring practices, and the like, unless it could be shown that such matters were material to investors.” A.A. Sommer Jr., The U.S. Securities and Exchange Commission Disclosure Study, 1 J. Comp. Corp. L.& Sec.Reg.145, 149 (1978).  More recently, the SEC has acknowledged the value of sustainability disclosures in certain areas such as climate change but has attempted to shoehorn these disclosures into the management discussion and analysis (MD&A) or risk factor disclosures rather than establishing an independent disclosure framework.  Critics have challenged this approach as ineffective and urged the SEC to do more to formalize sustainability disclosure.

In April 2016, as part of its Disclosure Effectiveness Initiative, the SEC issued a Concept Release on Disclosure Effectiveness.     As part of the release, the SEC invited comment on the extent to which SEC rules should mandate sustainability disclosure.   The release generated widespread requests from investors for “the SEC to require annual, uniform sustainability reporting from public companies as part of the overhaul of the agency's disclosure regime” (Che Odom, Investors Want Sustainability Disclosures in SEC Overhaul, Bloomberg Law, July 21, 2016). The appropriate framework for mandating sustainability disclosure, however, remains highly contested, due in part to the challenges of establishing a workable reporting requirement. 

My article, Making Sustainability Disclosure Sustainable, available here and forthcoming in the Georgetown Law Journal, argues that claims about the relationship between issuer sustainability practices and risk management, business plan and economic vulnerability, as well as the need for investors and regulators to be able to evaluate those claims, warrant incorporating sustainability information into SEC-mandated financial reporting.  The article provides an innovative framework for sustainability disclosure.  My proposal, which I term sustainability discussion and analysis or SD&A, would require that sustainability disclosure be included as part of an issuer’s annual report to shareholders.  SD&A is a principles-based approach modeled after the existing MD&A and compensation discussion and analysis (CD&A) requirements with several key modifications.             

Under my proposal, an issuer would be required to disclose in its SD&A, at a minimum, the three sustainability issues that are most significant for the firm’s operations, to explain the basis for its selection and to explain the impact of those issues on firm performance.  To ensure the board’s involvement in overseeing both the development of an issuer’s sustainability practices and the disclosure of those practices, the proposal would require directors to certify the accuracy of the disclosures contained in the SD&A.  This requirement would establish a mechanism for effective director oversight that would bring accountability to the disclosure regime, thereby addressing a key investor concern – that boards consider sustainability practices that have a material impact on or pose material risks to the firm’s operations and incorporate those considerations into their strategic planning.

The proposal contemplates that the SEC’s adopting release would provide additional guidance with respect to the nature and scope of sustainability issues, similar to the guidance provided for CD&A.  Specifically, the guidance would identify the range of topics that have been identified within the framework of sustainability such as “climate change, resource scarcity, corporate social responsibility, and good corporate citizenship,” Concept Release on Disclosure Effectiveness at 206, but would note that the identification of material sustainability issues is industry- and issuer-specific.  The release would also note that the materiality of specific sustainability issues can evolve over time and is a product of a variety of considerations including the relevance of the issue to earnings quality and volatility, reputational and regulatory risk, and the quality of board oversight and internal controls.  

Finally, the Article proposes that the SD&A requirement be enforced through a combination of public and private enforcement. The SEC staff would review and comment on issuers’ SD&A disclosures as part of its review of securities filings and would have the authority to bring enforcement actions against issuers and individual directors to failure to comply. In addition, fraudulent misrepresentations and omissions in an issuer’s SD&A would be actionable under Rule 10b-5, and shareholders could, in appropriate cases, pursue private litigation.

The Article argues that the SD&A requirement is a practical first step that would increase the utility of sustainability disclosure while ensuring its manageability. Subjecting sustainability disclosures to the discipline of financial reporting and the SEC review process is likely to produce more reliable disclosure and to generate common disclosure policies among issuers, particularly those in the same or related industries. The combination of public and private enforcement will impose accountability on corporate boards to oversee and understand their companies’ sustainability practices better, while the existing limitations on fraud liability such as the materiality and loss causation requirements will minimize the potential for excessive litigation.  

The complete paper is available on SSRN.

Jill E. Fisch is the Saul A. Fox Distinguished Professor of Business Law at the University of Pennsylvania Law School.