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SEC Commissioner Lee Speaks on Myths and Misconceptions about “Materiality”

Thank you, Neil [Stewart] for the introduction and for having me today as you discuss the important and timely topic of climate and ESG disclosures. I very much look forward to hearing from Janine [Guillot] and Julie [Bell Lindsay]. You both bring years of experience and significant expertise to these issues, and your organizations, SASB and CAQ, have contributed significantly to the development and understanding of ESG disclosure and assurance related to such disclosures.

This is a highly sophisticated audience of accountants, auditors, attorneys, and other professionals, with deep knowledge concerning public company accounting and other disclosures – how to identify, prepare, and verify them. The SEC needs your advice, your thoughts, and your expertise as we endeavor to craft a rule proposal for climate and ESG disclosures.[1]

As we all debate and deliberate over these issues, a great deal of attention is focused on the concept of materiality. Materiality is a fundamental proposition in the securities laws and in our capital markets more broadly. The system for public company disclosure is generally oriented around providing information that is important to reasonable investors. Although the SEC must craft the rules, and companies, with the help of lawyers and accountants, must comply with them, the viewpoint of the reasonable investor is the lens through which we all are meant to operate.[2] From a policy perspective, it is unfailingly simple and makes perfect sense: those with the money are the ones who decide how to spend it. And there is a clear corollary to that point – reinforced by Supreme Court precedent[3] – which is that investors are also the ones who decide what information they need to make those choices.

But as debates around climate and ESG disclosure have intensified, I have found through dozens if not hundreds of conversations that a number of misconceptions about materiality – what it is and what it is not – have proliferated. For example, many appear to believe that materiality currently works almost preternaturally, on its own with no need for regulatory involvement, to produce all important information from all public companies at all times. Many have also come to believe (incorrectly) that the SEC is legally prohibited from requiring specific disclosures unless it can demonstrate that each such disclosure is individually material to the bottom line of every public company.

Given the import of materiality to the current debate regarding climate and ESG disclosures, this is an opportune moment to discuss some of these myths and misconceptions – especially with this audience, one that is well-equipped to bring careful thought and analysis to these issues.

Myth #1: ESG matters (indeed all matters) material to investors are already required to be disclosed under the securities laws.

Let me start with the myth that I believe is the most prevalent. We frequently hear that new climate or ESG disclosure requirements are unnecessary because the existing disclosure regime already requires the disclosure of all material information.[4] This is simply not true, and reflects a fundamental misunderstanding of the securities laws. Public company disclosure is not automatically triggered by the occurrence or existence of a material fact. There is no general requirement under the securities laws to reveal all material information. Rather, disclosure is only required when a specific duty to disclose exists.[5]

In a seminal Supreme Court case on materiality, Basic v. Levinson, the court found that preliminary merger negotiations may be material, affirming that materiality is to be gauged through the eyes of the “reasonable investor.”[6] But Basic also acknowledged the fundamental principle that, under the securities laws, an omission of information – even material information – is not actionable absent a duty to disclose.[7] In Basic, the duty to disclose the pre-merger negotiations arose out of public statements the company made asserting that it was unaware of any developments that might explain high trading volumes and price fluctuations in its shares.[8]

So, what are the possible sources of a duty to disclose? A duty may arise by virtue of an explicit SEC disclosure requirement, such as those set forth in Regulation S-K.[9] A duty may also arise, as it did in Basic, in order to make other statements made by a company materially accurate or not misleading.

Let’s take political spending by public companies as an example because it illuminates the principles behind both types of possible duties. We know that this type of information can be extremely important to reasonable investors.[10] Indeed the SEC received over a million requests to require such disclosures.[11] As the late founder of Vanguard, John Bogle, once said “corporate managers are likely to try to shape government policy in a way that serves their own interests over the interests of their shareholders.”[12] When companies use shareholder funds for political influence, it stands to reason that shareholders would want to be able to assess for themselves whether such spending is in their interests.

But companies rarely disclose political spending in reports filed with the SEC for the simple reason that there are no explicit SEC rules requiring such disclosure.[13]

As I mentioned, another means by which a duty may arise is through statements a company makes on a topic which may then require the disclosure of additional information “necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading.”[14] In other words, if a company makes statements on a topic, a duty may arise to disclose additional information needed to ensure that those statements are materially accurate and complete.[15]

Continuing with the political spending example, after the events at the Capitol on January 6th, we saw companies increasingly making public pledges regarding their political spending practices.[16] One might argue that these public pledges give rise to a duty to disclose their actual political contributions – not unlike the duty to disclose merger negotiations in Basic – to ensure that such statements are not misleading, especially if actual contributions run contrary to these pledges. But such a duty would arise only based on discretionary statements made by management, not solely on the basis that information regarding political contributions is material to investors.

The bottom line is that absent a duty to disclose, the importance or materiality of information alone simply does not mandate its disclosure.

The securities laws currently include little in the way of explicit climate or other sustainability disclosure requirements.[17] In many instances, therefore, disclosure may be required only when a particular discussion of climate is collateral to something else disclosed by the company. The same is true for many ESG matters that lack express disclosure requirements. Thus, climate and ESG information important to a reasonable investor is not necessarily required to be disclosed simply because it is material.

Myth #2: Where there is a duty to disclose climate and ESG matters, we can rest assured that such disclosures are being made.

Investors are essentially told that if something is material, it is already being disclosed, suggesting that such disclosure is both required and effective. Even when a duty to disclose exists, however, a principles-based standard that broadly requires disclosure of “material” information presupposes that managers, including their lawyers, accountants, and auditors, will get the materiality determination right. In fact, they often do not.

Although dependent upon the views of the reasonable investor, materiality determinations are typically made in the first instance by management. In doing so, management may rely on a “gut” feeling, anecdotal interactions, and even their own experience as investors.[18] We know that in making these determinations, management frequently sees things differently from investors.[19] Academic literature indicates that preparers and auditors often employ higher materiality thresholds than do investors.[20] SEC enforcement cases likewise reveal infirmities in materiality determinations, as year after year the SEC brings scores of cases for negligence in making these assessments.[21]

The difference is perhaps not entirely unexpected. Management may view matters with an enthusiasm that reflects a belief in the nature and direction of their business.[22] Developments that investors may see as negative and in need of disclosure may be viewed by management as a temporary aberration or even a positive development.

That is, in part, why the system builds in checks and balances. Managerial judgments are usually subject to review by other professionals. Auditors examine the financial statements; lawyers review much of the narrative in SEC filings. Particularly with respect to materiality determinations and the content of SEC filings, management often relies extensively on the advice of legal counsel.

Yet, lawyers and auditors can also get the decision wrong. As with managers, they may see materiality differently from investors.[23] Academic studies reveal the consequences of this tendency.[24] Studies of restatements[25] and the obligation to disclose material loans,[26] for example, suggest that material information may be incorrectly characterized as immaterial.

Lawyers and auditors, like managers, are asked to apply the “reasonable investor” test without necessarily having sufficient understanding of what investors want or expect. But there’s more to it than that. Both lawyers and auditors have built-in incentives to agree with management, particularly on close cases. They have an economic[27] and psychological[28] incentive to want to retain positive relations with management.[29] This can create a form of implicit bias or predisposition,[30] causing auditors and lawyers to often expend efforts to support, rather than independently analyze, management’s decisions.[31]

Take, for example, well-known litigation against Bank of America for failing to disclose burgeoning losses incurred by Merrill Lynch in connection with the bank’s acquisition of that firm in late 2008.[32] The bank issued proxy materials seeking shareholder approval of the acquisition that purported to detail the economics of the transaction but failed to disclose billions in estimated losses. As the public record shows, the issue of whether these losses were material was vetted by legal counsel in what appears to be a thorough manner.[33] Counsel in the end concluded that the information was not material and therefore disclosure was not required.[34] Management relied on that advice in deciding not to disclose. Ultimately, however, the non-disclosure contributed to Bank of America paying damages and penalties of nearly $2.5 billion.[35]

Thus lawyers, auditors, and managers can and do get the determination of materiality wrong. And while our Enforcement Division stands ready to act whenever material information required to be disclosed is improperly withheld, these types of cases can be particularly difficult to police since the omitted information will often not be known to the public or the SEC.[36]

A disclosure system that lacks sufficient specificity and relies too heavily on a broad-based concept of materiality will fall short of eliciting information material to reasonable investors.

Myth #3: SEC disclosure requirements must be strictly limited to material information.

This assertion rivals the first myth in terms of its prevalence. It is often made without citation and appears to be a widely held assumption.[37] However, this is affirmatively not what the law requires, and thus not how the SEC has in fact approached disclosure rulemaking.

Indeed our statutory rulemaking authority under Section 7 of the Securities Act of 1933 gives the SEC full rulemaking authority to require disclosures in the public interest and for the protection of investors.[38] That statutory authority is not qualified by “materiality.” Similarly, the provisions for periodic reporting in Sections 12, 13 and 15 of the Securities Exchange Act of 1934 are not qualified by “materiality.” [39]

The concept of materiality arises under anti-fraud rules such as Rules 10b-5 and 14a-9,[40] where it plays a role in limiting how much information must be provided.In other words, materiality places limits on anti-fraud liability; it is not a legal limitation on disclosure rulemaking by the SEC.

In practice Regulation S-K has, from the outset, required periodic reports to include information that is important to investors but may or may not be material in every respect to every company making the disclosure.[41] We have done this, for example, with respect to disclosures of related party transactions,[42] environmental proceedings,[43] share repurchases,[44] and executive compensation.[45]

For disclosures of related party transactions and environmental proceedings, there are bright line disclosure thresholds, without regard for materiality.[46] For disclosures of share buybacks, all repurchases must be disclosed without reference to materiality. In adopting this requirement, the Commission recognized that buyback information overall “is important to investors” and warrants an item requirement designed to “enhance the transparency of issuer repurchases.”[47]

Similarly, the topic of executive compensation is itself material broadly. But the rule lays out a very specific regime for precisely what each company must disclose, including a tabular disclosure of numerous data points. It was not determined that each individual metric required is material to each and every public company subject to the rule.[48]

Moreover, if SEC disclosure rulemaking authority were artificially circumscribed by both an item-by-item, and company-by-company, analysis of materiality, comparability would be sacrificed almost completely. Indeed such an approach would be at odds with modern capital markets which have become increasingly comparative in nature[49] thus requiring at least some specific metrics in order to make appropriate comparisons.

The idea that the SEC must establish the materiality of each specific piece of information required to be disclosed in our rules is legally incorrect, historically unsupported, and inconsistent with the needs of modern investors, especially when it comes to climate and ESG.

Myth #4: Climate and ESG are matters of social or “political” concern, and not material to investment or voting decisions.

This is one I’ve often addressed in the past,[50] so I’ll just review a couple of summary points on this today. First, the idea that investor concerns with scientifically supported risks like those associated with climate change is grounded in “politics” turns fact-based analysis on its head. If anything, it’s the insistence that science and data must or should be ignored that appears questionable. Second, the fact that a topic may have political or social significance does not foreclose its being material, either qualitatively[51] or quantitatively. To the contrary, we are increasingly seeing all manner of market participants embrace ESG factors as significant drivers of decision-making, risk assessment, and capital allocation precisely because of their relationship to firm value.[52] Finally, investors, the arbiters of materiality, have been overwhelmingly clear in their views that climate risk and other ESG matters are material to their investment and voting decisions.[53]

* * *

Where does this all leave us in the debate regarding climate and ESG disclosures? We must not operate under the false assumption that the securities laws already effectively elicit the information investors need. We must not be diverted by mistaken views regarding the SEC’s rulemaking authority. And we must not be persuaded to ignore scientific evidence or other decision-useful data on the grounds that it intersects with issues of political or social concern. I hope we can dispense with these misnomers as we continue the important debate on how best to craft a rule proposal on climate and ESG risks and opportunities. Thank you for having me and I look forward to hearing from you in the comment process.

ENDNOTES

[1] Public Input Welcomed on Climate Change Disclosures (Mar. 15, 2021).

[2] See Basic Inc. v. Levinson, 485 U.S. 224, 240 (1988) (“[M]ateriality depends on the significance the reasonable investor would place on the withheld or misrepresented information.); TSC Industries, Inc. v. Northway, Inc., 426 U. S. 438, 449 (1977) (“[A]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote… Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”).

[3] See id.

[4] See Timothy Massad, The SEC Needs to Catch Up on Sustainability, Bloomberg (Jan. 27, 2021) (“The primary argument against new rules has been that the existing principles-based disclosure regime, which requires disclosure of any information that’s material to a reasonable investor, is sufficient.”).

[5] See Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27, 44 (2011) (“Moreover, it bears emphasis that §10(b) and Rule 10b-5(b) do not create an affirmative duty to disclose any and all material information. Disclosure is required under these provisions only when necessary ‘to make . . . statements made, in the light of the circumstances under which they were made, not misleading.’”); ZVI Trading Corp. Employees’ Money Purchase Pension Plan & Tr. v. Ross (In re Time Warner Inc. Sec. Litig.), 9 F.3d 259, 267 (2d Cir. 1993) (“[A] corporation is not required to disclose a fact merely because a reasonable investor would very much like to know that fact. Rather, an omission is actionable under the securities laws only when the corporation is subject to a duty to disclose the omitted facts.”); see also Virginia Harper Ho, Nonfinancial Risk Disclosure and the Costs of Private Ordering, 55 Am. Bus. L.J. 407, 430 (“The limited amount of material ESG information contained in most firms’ financial reports is due in part to the fact that federal securities law does not require issuers to disclose all material information within periodic reporting.”); Donald C. Langevoort & G. Mitu Gulati, The Muddled Duty to Disclose Under Rule 10b-5, 57 Vand. L. Rev. 1639, 1644 (2004) (“Materiality refers to the matter of whether a piece of information would likely be important to the reasonable investor. Duty, by contrast, refers to whether there is an obligation to disclose a certain category of information. As the courts state repeatedly, the former is usually a factual question and the latter a question of law. There are many facts (such as preliminary merger negotiations) that can fall within the definition of materiality yet do not have to be disclosed.”); Marc I. Steinberg and Robin M. Goldman, Issuer Affirmative Disclosure Obligations – An Analytical Framework for Merger Negotiations, Soft Information, and Bad News, 46 Md. L. Rev. 923, 923-24 (1987) (“Despite cogent arguments in favor of an affirmative duty to disclose, neither the courts nor the SEC has been willing to recognize such a general mandate. Affirmative disclosure obligations, however, clearly exist in a number of specific circumstances. For example, an issuer must affirmatively disclose when: (1) SEC rules and regulations require disclosure of specified information; (2) the issuer is purchasing or selling its stock in the securities markets; (3) the issuer previously has made a public statement that, although accurate when made, has become false or misleading as a result of subsequent events; and (4) information has been leaked by, or rumors in the marketplace are attributable to, the issuer.”).

[6] See Basic, supra note 2.

[7] Id. at 239 n.17 (“Silence, absent a duty to disclose, is not misleading under Rule 10b-5.”).

[8] Id. at 224.

[9] See, e.g., 17 CFR § 229.101 (Description of Business); 17 CFR 229.402 (Executive Compensation).

[10] We see this through increased support for shareholder proposals addressing political spending. See Political Activity Disclosures: A Hidden ESG Requirement, King & Spalding (Apr. 22, 2021) (“[I]n the 2018 proxy year, there were 51 proposals at S&P 500 companies to enhance reporting of political and lobbying activity. None passed, with an average of 28.7% support. In the proxy year that ended June 30, 2020, there were 55 such shareholder proposals. Average support increased to 35.5% and six proposals received majority support.”); see also Tory Newmyer,Activist shareholders pressing companies to disclose more of their political activity after Capitol attack, Washington Post (Feb. 23, 2021); Michael E. Porter and Bruce F. Freed,Companies need to reevaluate the full range of their political spending, Boston Globe (Jan. 26, 2021).

[12] Letter from John Bogle, SEC File No. 4-637 (Jan. 17, 2012).

[13] The SEC is currently prevented from finalizing a rule on this subject. SeeConsolidated Appropriations Act, 2021, H.R. 133, Pub. Law No. 116-260, Sec. 631 (“None of the funds made available by this Act shall be used by the Securities and Exchange Commission to finalize, issue, or implement any rule, regulation, or order regarding the disclosure of political contributions, contributions to tax exempt organizations, or dues paid to trade associations.”).

[14] See 17 CFR § 240.12b-20 (“In addition to the information expressly required to be included in a statement or report, there shall be added such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made not misleading.”).

[15] See Matrixx, supra note 5.

[17] See Commission Guidance Regarding Disclosure Related to Climate Change, Rel. No. 33-9106 (Feb. 2, 2010) (identifying four existing Regulation S-K disclosure requirements that may give rise to climate disclosure obligations, Item 101 (Description of Business), Item 103 (Legal Proceedings), Item 503(c) [now Item 105] (Risk Factors), and Item 303 (Management’s Discussion and Analysis).

[18] For an article examining some of the considerations that go into a determination of materiality by management, see Andrew A. Acito, Jeffrey J. Burks, & W. Bruce Johnson, The Materiality of Accounting Errors: Evidence from SEC Comment Letters, 36 Contemp. Acct. Res. 839 (2019) (“Surprisingly, managers frequently deem an error immaterial while acknowledging that it exceeds the common 5 percent threshold in one or more periods, often by a large degree. Managers often defend this conclusion by arguing that the benchmark is abnormally low. Also surprisingly, we find that managers are not consistent in mentioning the nine SAB No. 99 qualitative considerations, but they do cite many other qualitative considerations.”).

[19] See Elizabeth C. Altiero, Yoon Ju Kang & Mark E. Peecher, Motivated Perspective Taking: Why Auditors Asked to Step Into Investors’ Shoes Are No More (or Even Less) Apt to View Negative Audit Adjustments as Material, 1 (2018) (noting that “compared to investors, auditors and management have materiality thresholds that tend to be both larger and less sensitive to qualitative factors”); see also Mohini Singh & Sandra J. Peters, CFA Institute, Materiality: Investor Perspectives (2015) (“Research demonstrates that, in general, users have lower materiality thresholds than preparers and auditors. Materiality is, however, to be assessed in the eyes of the user of financial statements.”).

[20] See Preeti Choudhary, Kenneth Merkley, Katherine Schipper, Immaterial Error Corrections and Financial Reporting Reliability (2021) (“We interpret this evidence as supporting the view that investors view some immaterial errors as equity-valuation-relevant”). In discussing the article, Professor Choudhary stated that “[t]he significant share price movement suggests that managers and investors disagree about the importance of the errors.” Jean Eaglesham, Shh! Companies Are Fixing Accounting Errors Quietly, Wall Street Journal (Dec. 5, 2019).

[22] See Donald C. Langevoort, The Epistemology of Corporate-Securities Lawyering: Beliefs, Biases and Organizational Behavior, 63 Brooklyn L. Rev. 629, 642 (1997) (“Once people have made some voluntary commitment to a person or course of behavior, there is a strong subconscious need to maintain consistency in the face of subsequent events, to justify the commitment to themselves and others. This underlies the well-known concept of cognitive dissonance. Thus, managers who make an investment are motivated to focus on the project’s upside potential more than its downside risks, to bolster the wisdom of the choice.”).

[23] Final Report of the Advisory Committee on Improvements to Financial Reporting to the US Securities and Exchange Commission (Aug. 1, 2008) (“We believe that those who judge the materiality of a financial statement error should make the decision based upon the interests, and the viewpoint, of a reasonable investor and based upon how that error impacts the total mix of information available to a reasonable investor. Preparers, audit committees, and auditors must ‘step into the shoes’ of a reasonable investor when making these judgments. We believe that too many materiality judgments are being made in practice without full consideration of how a reasonable investor would evaluate the error.”).

[24] See Judson Caskey, Kanyuan (Kevin) Huang, & Daniel Saavedra, Noncompliance with SEC Regulations: Evidence from Timely Loan disclosures, 21 (2021) (“This result suggests that firms with non-Big-4 auditors more often hide large loans than firms with Big-4 auditors. Further, our results on loan spread and loan size indicate that auditors’ materiality decisions emphasize loan magnitude, but not other informative characteristics such as loan spreads.”); see also Eaglesham, supra note 20 (“The significant share price movement suggests that managers and investors disagree about the importance of the errors”).

[25]See Rachel Thompson, Reporting Misstatements as Revisions: An Evaluation of Managers’ Use of Materiality Discretion (2020) (research suggesting “materiality discretion is being used opportunistically to conceal material misstatements as revisions”).

[26] See Caskey, supra note 24, at 2 (“[T]he average firm is more likely to disclose loans when borrowing costs are lower and to hide loans when borrowing costs are higher. Moreover, we find that this result is stronger for ‘immaterial’ loans, which suggests that firms may exploit the ambiguous definition of materiality.”).

[27] Statement of Maureen McNichols, Marriner S. Eccles Professor of Public and Private Management and Professor of Accounting, Stanford Graduate School of Business, Public Company Accounting Oversight Board, Public Meeting on Auditor Independence and Auditor Rotation (June 28, 2012) (“Auditors are less likely to question a management judgment if a client relationship is at risk.”).

[28] Robert A. Prentice, The Case of the Irrational Auditor: A Behavioral Insight Into Securities Fraud Litigation, 95 NW U.L. Rev. 133, 169-70 (2000) (“Accountants’ perceptions, memories, and judgments are subject to the self-serving bias. This has been confirmed in studies involving accountants serving in a capacity other than as auditors.… In other words, if the auditors believe that the client is unlikely to fail and thus they are unlikely to be sued, they are more likely to make inappropriate concessions than if they fear that they will be sued.”).

[29] Prepared Statement of Professor Richard L. Kaplan, University of Illinois, Urbana-Champaign, Public Company Accounting Oversight Board, Public Meeting on Auditor Independence and Audit Firm Rotation (“[A]uditors are prone to bias their conclusions to best preserve the client relationship that pays their bills”).

[30] See Altiero, supra 19, at 2 (“Research shows that auditors have pre-existing motivations to justify management-preferred conclusions.”).

[31] See id. (“Collectively, our two experiments provide evidence that prompting auditors to take an investor

perspective can cause motivated perspective taking, by which they assess lower likelihoods that audit adjustments are material”); see also Caroline Harrington, Attorney Gatekeeper Duties in an Increasingly Complex World: Revisiting the “Noisy Withdrawal” Proposal of SEC Rule 205, 22 Geo. J. Legal Ethics 893, 906 (2009) (“[T]he attorney faces pressures to acquiesce in the decisions and conduct of managers and officers. Institutional incentives, including reluctance to jeopardize business relationships or to act beyond the scope of a ‘faithful agent,’ apply, though perhaps to varying degrees, to both in-house and outside counsel. In addition, as mentioned above, to the extent that outside counsel are fungible, they have an incentive to go along with managerial decisions for fear of being replaced.”).

[32] See SEC v. Bank of America Corporation (Civil Action Nos. 09-6829, 10-0215 (S.D.N.Y)), Lit. Rel. No. 21407 (Feb. 4, 2010) (“The Securities and Exchange Commission today filed a motion seeking court approval of a proposed settlement whereby Bank of America will pay $150 million and strengthen its corporate governance and disclosure practices to settle SEC charges that the company failed to properly disclose employee bonuses and financial losses at Merrill Lynch before shareholders approved the merger of the companies in December 2008.”); Bank of America Corp. Sec. Litig., No. 09 MDL 2058 (DC) (S.D.N.Y.), Settlement Notice (Dec. 24, 2012) (announcing a $2.43 billion class action settlement for related conduct).

[33] See SEC v. Bank of America Corporation, Civil Action Nos. 09-6829, 10-0215 (S.D.N.Y), Final Consent Judgment as to Defendant Bank of America Corporation, Statement of Facts at 17-18 (Feb. 4, 2010).

[34] See Statement of Timothy J. Mayopoulos, 4-5, United States House of Representatives Committee on Oversight and Government Reform and Subcommittee on Domestic Policy (Nov 7. 2009).

[35] See settlement notices, supra note 32.

[36] See, e.g., U.S. Government Accountability Office, Supply Chain Risk: SEC’s Plans to Determine If Additional Action Is Needed on Climate-Related Disclosure Have Evolved, 18 (Jan. 2016) (“According to SEC staff, it is difficult for SEC reviewers to know whether a company faces a material climate-related supply chair risk that it is not disclosing.”). As a side note it is worth a reminder here to auditors and lawyers: where you know that the materiality determination is a close one and could be viewed by investors differently, the possibility exists of a disclosure violation under the federal securities laws. Under the so called “up the ladder” requirements for lawyers and reporting obligations for auditors with respect to noncompliance with laws and regulations, there may be an obligation to report this information to the client, including, in some cases, the board of directors. See Implementation of Standards of Professional Conduct for Attorneys, Rel. No. 33-8185 (Jan. 29, 2003); Accounting Standard 2401: Consideration of Fraud in a Financial Statement Audit.

[37] See, e.g., Letter from E. Scott Pruitt, et al., SEC File No. S7-06-16 (July 21, 2016) (“By requiring mandatory climate change disclosures that do not, in all instances, meet the stringent test for materiality, the contemplated new disclosures threaten to upend the carefully balanced regime designed solely to protect investors.”).

[38] See 15 U.S.C. § 77g(a)(1) (“Any such registration statement shall contain such other information, and be accompanied by such other documents, as the Commission may by rules or regulations require as being necessary or appropriate in the public interest or for the protection of investors.”).

[39] See 15 U.S.C. § 78m(a) (“Every issuer of a security registered pursuant to section 12 of this title shall file with the Commission, in accordance with such rules and regulations as the Commission may prescribe as necessary or appropriate for the proper protection of investors and to insure fair dealing in the security” annual reports.); see also 15 U.S.C. § 78l(b); 15 U.S.C. § 78o(d).

[40] 17 CFR § 240.10b-5; 17 CFR § 240.14a-9; see also 17 CFR § 240.12b-20.

[41] Indeed, “immaterial information is often required to be disclosed (although not under Rule 10b-5).” See Langevoort, supra note 5, at 1645 n. 18 (2004) (“Although the rationale for the construction of the various disclosure obligations of companies – such as their periodic filing obligations in Forms 10-Q and 10-K – is that the information is likely to be important to investors, not every piece of information required is going to be important in every instance.”).

[42] 17 CFR § 229.404.

[43] 17 CFR § 229.103(c)(3).

[44] Form 10Q, Item 2(e).

[45] 17 CFR § 229.402.

[46] For disclosures of environmental proceedings, Item 103 previously provided for a simple $100,000 threshold for disclosure. The item was recently revised to incorporate materiality judgments for proceedings not exceeding $1 million, but still effectively provides a bright line threshold of $1 million, above which disclosure is required without reference to materiality.Modernization of Regulation S-K Items 101, 103, and 105, Rel. No. 33-10825 (Aug. 26, 2020).

[48] In updating Item 402, the adopting release noted that the summary compensation table is “designed to disclose all compensation.” The release further provides that “[n]arrative disclosure will follow the two [compensation] tables, providing disclosure of material information necessary to an understanding of the information disclosed in the tables.” Executive Compensation and Related Person Disclosure, Rel. No. 33-8732A (Aug. 29, 2006). In other words, materiality functions to add supplemental narrative information to the metrics disclosed, not to limit them.

[49] See Dawn Lim, Index Funds Are the New Kings of Wall Street, Wall Street Journal (Sept. 18, 2019).

[50] See Allison Herren Lee, A Climate for Change: Meeting Investor Demand for Climate and ESG Information at the SEC (Mar. 15, 2021); Allison Herren Lee, Big Business’s Undisclosed Climate Crisis Plans, New York Times (Sept. 27, 2020).

[52] See, e.g., Bank of America,2020 Annual Report(“As our Global Research team has found, companies that pay close attention to environmental, social and governance (ESG) priorities are much less likely to fail than companies that do not, giving investors a significant opportunity to build investment portfolios for the long-term. And — through research and our own lived experience — we know that ESG commitments can translate into a better brand, more client favorability and a better place for our teammates to work.”); State Street Global Advisors,The ESG Data Challenge(Mar. 2019) (“Asset owners and their investment managers seek solutions to the challenges posed by a lack of consistent, comparable, and material information. Investors increasingly view material ESG factors as being critical drivers of a company’s ability to generate sustainable long-term performance. In turn, ESG data has increasing importance for investors’ ability to allocate capital most effectively.”); Fitch Ratings,Fitch Ratings Launches ESG Relevance Scores to Show Impact of ESG on Credit(Jan. 7, 2019); Morningstar,Morningstar Formally Integrates ESG into Its Analysis of Stocks, Funds, and Asset Managers(Nov. 17, 2020).

[53] See, e.g., Climate Action 100+, representing $54 trillion in assets; Blackrock,Toward a Common Language for SustainableInvestment (Jan. 2020) (“Our investment conviction is that sustainability-integrated portfolios – composed of more sustainable building-block products – can provide better risk-adjusted returns to investors. With the impact of sustainability on investment returns increasing, we believe that sustainable investment will be a critical foundation for client portfolios going forward.”).

These remarks were delivered on May 24, 2021, by Allison Herren Lee, commissioner of the U.S. Securities and Exchange Commission, at the 2021 ESG Disclosure Priorities Event hosted by the American Institute of CPAs & the Chartered Institute of Management Accountants, Sustainability Accounting Standards Board, and the Center for Audit Quality, in Washington, D.C.

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