The home page of the Securities and Exchange Commission (SEC) website declares a commitment to Main Street investors, acknowledging that U.S. households own $38 trillion worth of equities — almost 60% of the U.S. equity market — either directly or indirectly through mutual funds, retirement accounts and other investments.
Yet Main Street is nowhere to be seen in the SEC’s recent 500-page proposal prescribing extensive company disclosure concerning greenhouse-gas emissions in their operations as well as in those of their suppliers and customers.
While tackling this topic is important, the SEC appears to have gotten carried away with representing the views of the largest institutional investors, especially the massive index funds, rather than consider the interests of individual investors, whose views may differ radically.
With 1,068 footnotes, this tome of dense prose was most certainly not written for Main Street. Rather, the proposal’s drafters, an anonymous staff of mostly lawyers and economists, refers repeatedly to institutional investors, citing writings and studies that lend support for a prescriptive rule proposal detailing everything from how a company’s board thinks about climate change to minute calculations of the carbon emissions throughout its supply chain and distribution channels.
The document refers to individual retail investors only once. This occurs when it says that if institutional investor analysts digest the detailed climate disclosure using certain advanced software, “this would likely benefit retail investors, who have generally been observed to rely on analysts’ interpretation of financial disclosures rather than directly analyzing those disclosures themselves.”
The SEC’s proposal contains a cost-benefit discussion, as the law requires. The SEC is clear that its rules would certainly impose substantial compliance costs on companies, approaching $1 million per year apiece. But the SEC rightly recognizes that it cannot be sure of what benefits, if any, its proposal will produce. The document refers repeatedly to benefits that “could,” “may” or “might” arise. The proposal gives the example of possibly enabling investors to tell whether a retail store chain is relocating its outlets closer to public transportation so customers don’t have to drive as much.
Institutional investors can afford such an uncertain cost-benefit analysis, but individual investors might want to know whether the effort is worthwhile. Indeed, as the proposal expressly acknowledges, the focus of large index funds is on the average market return, not on the profitability of particular companies. While individual investors would care a great deal about how much a company paid in relation to the gain, institutional index investors would not care at all.
Main Street vs. Wall Street
In its next draft of this proposal, the SEC should differentiate between the interests of powerful institutional investors and everyday American investors and delineate the different costs and benefits the proposal offers to each.
The SEC should also compare the purported gains to individual investors to the likely gains for other interested groups, especially lawyers. The SEC recognizes that a major cost of its proposal concerns litigation risk. But it suggests that this is a cost for companies who fail to comply. In fact, however, detailed prescriptive disclosure rules like those proposed are magnets for lawsuits, including those that are frivolous or borderline. Such suits can cost tens of millions of dollars each and produce scant or no benefits for either particular companies or society. The SEC should explain these trades-off candidly and clearly.
Litigation risk is amplified by the inherent uncertainty embedded in what the SEC is asking companies to disclose. For example, if a company fails to anticipate or disclose a risk of a climate related extreme natural disaster — such as a fire or flood — will the company face lawsuits for the board failing to anticipate such a risk or failing to make such a prediction? The SEC would do well to preempt such scenarios by curtailing the proposal’s reach or at the very least explaining why such an outcome is desirable for investors.
Another looming question is whether the SEC even has the power to enact the proposed rules. The SEC was created by a statute that limits its power. The power is primarily to protect investors, along with promoting efficiency, competition and capital formation. The proposal talks a lot about institutional investor demand for the prescribed disclosure but has a hard time explaining why it is a matter of investor protection or other statutory powers. The chief argument is that companies might face legal and reputational risks from having bad climate policies, making disclosure about those risks a matter of investor concern.
But, as the proposal acknowledges, existing SEC rules already require that kind of disclosure under a variety of other headings. That raises the question: Is a new, massive, prescriptive disclosure regime related to climate matters necessary? It might well be. But just because institutional investors say so, does not make it so, and the SEC owes it to individual investors to weigh their interests and explain how it protects them.
Make yourself heard
Individual retail investors might consider reminding the SEC of their presence and relevance. Anyone can submit a comment asking the SEC to explain what its proposal would mean to ordinary American investors and asking for a clear explanation in the next draft. Feel free to cut, paste and edit the following and submit it at the SEC’s website:
“We understand that the SEC has a large sophisticated staff who put an enormous amount of time into this climate disclosure proposal. The proposal, with more than 1,000 footnotes, cites abundant sources from equally sophisticated researchers and institutions. We also understand that the hearts of these participants are probably in the right place.
“But the law does require the proposal to evaluate the costs and benefits to investors, and the SEC has long been the champion of the individual investor, the ordinary American. Yet the retail investor is mentioned only once in the 500+-page document.
“We ask the SEC in its next draft of this proposal to include an extensive section addressing the costs and benefits to the everyday individual investor, reflecting the diversity of views on this complex topic and acknowledging that not all Americans will agree with the views or conclusions of the SEC’s sophisticated staffers and large powerful institutional investors and asset managers.”