Representatives Juan Vargas (D-CA) and co-sponsor Jesús G. Garcia (D-IL) introduced legislation that would update environmental, social and governance ("ESG") disclosure requirements for public companies. Under the legislation, "ESG metrics" would be deemed "de facto material for purposes of disclosures" under the Securities Act and the Exchange Act.

Specifically, H.R. 4329 (the "ESG Disclosure Simplification Act of 2019") would:

  • require public companies to provide a "clear" description of (i) the connection between ESG metrics and long-term business strategies and (ii) the process used to determine how ESG metrics impact the long-term business strategies of the issuer; and

  • amend SEA Section 4 to require the SEC to establish a permanent advisory committee, called the "Sustainable Finance Advisory Committee," to be made up of up to 20 members who may serve for up to four years. Each Commissioner of the SEC would select an equal number of members of the Committee. Members of the Committee are required to represent individuals and entities with an interest in "sustainable finance." The work of the Committee is to be supported by staff personnel of the Investor Advocate who are dedicated to ESG issues. For this purpose, "sustainable finance" means investments that take into account "environmental, social and governance considerations."

Commentary 

ESG is a broad and open-ended concept which provokes many questions that do not have clear answers. Whose decision is it as to what is "socially" correct? What is the relationship between the manner in which a firm is governed and sustainable finance? Are startups that provide their founders with disproportionate governance influence inherently inconsistent with "sustainable finance?"

As a practical concern, the statement that ESG disclosure is inherently "material" seems an invitation for firms to be sued by investors if their ESG disclosure is deemed to be inadequate, even if, in the real world, their disclosure is immaterial to the business of the company. If anyone would like an example of the type of government regulation that discourages issuers from going public, here it is.

The unspoken presumption of this disclosure requirement is that companies with a high ESG metric will be more profitable or their stock prices will rise. But what if Leo Durocher was right? Imposing political correctness disclosures (e.g., pay ratio, conflict minerals) on issuers may feel good, but the economic effect is a tax on public companies that does not provide a corresponding economic benefit to society.