ESG Materiality Mandates are Out of Scope for the SEC

Environment, Social, and Governance (ESG) criteria “are a set of standards for a company’s operations that socially conscious investors use to screen potential investments.” On Feb. 24, the Securities and Exchange Commission’s acting chairwoman, Allison Herren Lee expressed her support for mandating certain ESG standards “to ensure that (investors) have access to material information.”

The SEC was established in 1934 under the Securities Exchange Act to strengthen the federal government’s ability to ensure public companies report accurate and reliable information to investors. The United States’ Financial Accounting Standards Board (FASB) was established by the SEC to set accounting standards for public companies.

The SEC’s substantial power has led some to fear it will overregulate and hurt the financial markets through favoring certain industries based on political preferences. This fear will become a reality should the SEC pronounce subjective ESG information as being material to investors.

FASB’s foundational documents, known as Concept Statements, which guide the board in establishing financial reporting standards (i.e. Generally Accepted Accounting Standards (GAAP) asserts that there is an extremely limited basis (if any) for an authoritative body to impose materiality rules or standards as “materiality is entity specific…materiality judgments can properly be made only by those that understand the reporting entity’s pertinent facts and circumstances.”  In other words, materiality must be determined by the companies themselves and their external auditors.

ESG is being weaponized by coastal elites to redefine the purpose of business and politicize more aspects of our lives. The consequence? Prices of goods and services will rise, affecting low income and historically disadvantaged groups, and companies will be less competitive in the global marketplace.

One argument being made in favor of ESG mandates is that because of the magnitude of the threat of climate change, ESG is material to investors and therefore within the scope of the SEC’s authority.  This scaremongering has been going on for decades and climate scientists, while mostly united on the reality of climate change, disagree about the magnitude of its consequences.

Forward looking statements two years out, let alone 30 years, are impossible to support. Further, slight differences in variables affect the outputs of financial models significantly. Unless the SEC plans to force companies to adopt certain models, which there is no precedent for and the organization ill-equipped to do, they have no business deeming the current administration’s political priorities as material.

Proponents of ESG-based funds argue that ESG is material to investors as it increases profits by pointing out that equity funds that meet certain ESG criteria have outperformed non-ESG equity funds by 4.3% the first half of 2020. If this continues to prove true, then collective mandates are unnecessary as companies would implement ESG on their own in pursuit of profit.

Further advocates, such as Mrs. Lee say that investors are demanding ESG standards to justify more costly requirements. However, the investors already have a powerful tool, the proxy, to force corporations to report certain ESG measures. As the Heritage Foundation’s Senior Fellow in Economics David Burton, points out, “shareholders can but rarely do, vote to instruct management to pursue various social goals even if it reduces profits.”

Private solutions have already been developed to provide guidance on standards around ESG for those companies who find ESG metrics to be material to the future of their organization, such as the Sustainable Accounting Standards Board. ESG metrics should remain optional to ensure the market remains efficient and minimize over-disclosure.

ESG is being used as a power play by radicals to reshape America in their image and they want to use government to implement their agenda by force.  In an attempt to achieve, in some cases, admirable goals, Democrats will destroy value and cede US hegemony to our rivals who do not share our values nor our goals for addressing issues like global warming and equality.

Therefore, the U.S. should not only not implement ESG mandates, but should work with our allies abroad to prevent similar requirements on global companies.