Taking non-financial information into account when conducting financial analyzes is not entirely new to professional investors and analysts. But the demand for information beyond revenue, earnings, and other traditional accounting measures has increased dramatically in recent years. This year, investors with more than $130 trillion in assets asked more than 15,000 companies worldwide to specifically disclose environmental information so they can assess how it will affect their investments.
Companies are now reporting more non-financial ESG data than ever before. In fact, an analysis by White & Case LLP of 50 Fortune 100 companies found that all 50 companies had included environmental disclosures in their 2022 reports they filed with the U.S. Securities and Exchange Commission (SEC). When a company discloses non-financial information in its Form 10-K annual report or in other specified SEC filings, it becomes subject to the SEC filing review process.
Based on our survey of relevant academic literature, here’s what investors should know about the SEC’s filing review process and how it may affect corporate governance and environmental and social (ESG) disclosures.
Securities and Exchange Commission (SEC) Review Process
The SEC division of Corporation Finance treats the filing process as an important component of its day-to-day responsibilities. The SEC selectively reviews company filings under the Securities Act of 1933 and the Securities Act of 1934 for compliance with applicable accounting and disclosure requirements. The goal is to ensure that companies provide investors with material information to make informed investment decisions.
Under the Sarbanes-Oxley Act of 2002, the SEC must audit all companies at least once every three years. To manage this workload, the Securities and Exchange Commission (SEC) strategically schedules filing reviews throughout the year. Many of the largest companies by market capitalization have at least some aspects of their filings reviewed annually, while smaller companies may only have their files reviewed once every three years.
When SEC employees believe companies can enhance their disclosures, they issue a comment letter to the company and require a response within 10 business days. The general public can access these comments and response letters to understand the SEC’s concerns and how the companies have sought to address them.
There is no guarantee that ESG disclosures are complete and accurate
The SEC review process has some significant limitations—at least two of which create frequent misunderstandings. First, the SEC discloses those reviews that have provided at least one comment. They do not disclose deposits that I have reviewed without comment. Thus, the public will generally only know if the SEC reviewed a file without comment through onerous Freedom of Information Act (FOIA) requests. Second, the SEC may review an entire file from cover to cover or only certain portions of specific filings, but it does not disclose the scope of its review to the public.
What do these restrictions mean for ESG disclosures? The Securities and Exchange Commission (SEC) typically begins filing reviews with the annual report. But companies provide important ESG-related information in their DEF 14A proxy statements, which the SEC may or may not review. In fact, DEF 14A filings have received fewer than a third of the 10,000 annual reports of comment. In addition, if disclosures about environmental conservation and corporate governance are entirely outside the SEC’s file—in a sustainability report on a company’s website, for example—the SEC may not have a responsibility to review those disclosures.
Therefore, stakeholders should not assume that “there is no good news”. There may not be a record of an SEC comment letter related to an ESG disclosure because the SEC has not reviewed the disclosures. And even if it does review certain environmental and corporate governance information, the SEC makes clear that this does not guarantee that the disclosures were complete or accurate. The Securities Law does not require companies to disclose material ESG matters. It’s a “myth” or “misconception,” then-SEC Commissioner Alison Herren-Lee explained in a speech in May 2021.
Where would the SEC be most effective?
Our analysis of the literature indicates that the SEC is better at enforcing compliance with bright-line accounting and disclosure rules, but is less likely to issue a suspension letter when disclosures rely so heavily on a company’s professional judgment. Given the subjective nature of many ESG disclosures and the lack of a generally accepted reporting framework, it is not clear from a compliance monitoring perspective how SEC oversight of ESG disclosures might be.
Instead, academic research suggests that public release of the SEC’s comments and corporate responses can help companies reach consensus and convergence on disclosure standards. This will eventually take time and therefore may not keep pace with the growing demand for ESG information.
More ESG comment letters will be sent
Not surprisingly, the CFA Institute, BlackRock, and other investment professionals have applauded the SEC’s push to require climate-related information in company filing statements and annual reports.
As a result, we expect the SEC to increasingly comment on ESG-related disclosures to ensure compliance with relevant requirements. The message is clear: This field of reporting may not be entirely new, but it is evolving rapidly, and it is up to all of us to keep up.
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All posts are the opinion of the author(s). As such, it should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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