Saturday, June 22, 2019
If only there were an agency tasked with developing uniform standards for reporting material information
SEC Commissioner Peirce recently delivered a speech to the American Enterprise Institute and there's a lot going on here.
First, though this wasn't the nominal topic of the speech, Commissioner Peirce took the opportunity to take some shots at proxy advisors, complaining that:
Proxy advisor Glass Lewis, for example, has only 360 employees, only about half of whom perform research, who cover more than 20,000 meetings per year in more than 100 countries. Companies may not get an opportunity to correct underlying errors. According to one recent survey, companies’ requests for a meeting with a proxy advisory firm were denied 57 percent of the time. Companies submitted over 130 supplemental proxy filings between 2016 and 2018 claiming that proxy advisors had made substantive mistakes, including dozens of factual errors. Proxy advisors ISS and Glass Lewis provide companies some opportunity to contest such errors, but access is not uniform for all issuers, and the process may not provide adequate opportunity for issuers to respond before proxies are voted. The ramifications for the affected companies can be dramatic, as investment advisers, unaware of the error, vote their proxies in accord with the recommendation.
I've previously posted about the SEC's new interest in regulating proxy advisors; the writing on the wall appears to be that whatever else the SEC does, it's likely to create some kind of formal process by which companies can contest proxy advisor recommendations - potentially before the recommendations are distributed to investors, which, depending on how the regulations are drafted, could wind up impeding proxy advisors' ability to distribute recommendations at all. Glass Lewis recently began a pilot program to circulate companies' rebuttals to Glass Lewis's analyses; Glass Lewis says this is not about staving off regulation, which. Sure, let's go with that.
But the real topic of the speech was ESG investing, which she likened to a scarlet letter used to shame companies based on dubious metrics with little connection to financial value. As she put it:
It is true that ESG issues may well be relevant to a company’s long-term financial value. At a recent hearing before the Senate Banking Committee, John Streur of Calvert Research and Management testified that it is a “misconception” that using ESG investment strategies results in the investor sacrificing returns. In fact, he said, research has found that “firms in the top quintile of performance on financially material ESG issues significantly outperformed those in the bottom quintile.” Why, then, must the word “ESG” must be used at all? Of course, firms in the top quintile of performance on financially material issues outperform those on the bottom. If ESG disclosures mean disclosing what is financially material, there is little controversy, but the ESG tent seems to house a shifting set of trendy issues of the day...
There is, for example, a growing group of self-identified ESG experts that produce ESG ratings. ESG scorers come in many varieties, but it is a lucrative business for the successful ones. The business is a good one because the nature of ESG is so amorphous and the demand for metrics is so strong. ESG is broad enough to mean just about anything to anyone. The ambiguity and breadth of ESG allows ESG experts great latitude to impose their own judgments, which may be rooted in nothing at all other than their own preferences. Not surprisingly then, there are many different scorecards and standards out there, each of which embodies the maker’s judgments about any issues it chooses to classify as ESG. The analysis can appear arbitrary as it may treat similarly situated companies differently and may even treat the same company differently over time for no clear reason. Putting aside the analysis that produces the final score, some ESG scores are grounded in inaccurate information....
Even if the rating is not wrong on its own terms, the different ratings available can vary so widely, and provide such bizarre results that it is difficult to see how they can effectively guide investment decisions....
People are free to invest their money as they wish, but they can only do so if the peddlers of ESG products and philosophies are honest about the limitations of those products. The collection of issues that gets dropped into the ESG bucket is diverse, but many of them simply cannot be reduced to a single, standardizable score. ... We ought to be wary of shrill cries from a crowd of self-appointed, self-righteous authorities, even when all they are crying for is a label.
Now, I completely agree that often the call for ESG investing conflates the idea of investing based on moral/ethical considerations, and the idea of investing based on nonfinancial metrics which have a moral cast but are in fact part of financial analysis. And I agree that there is a proliferation of untested, vague standards, as well as a wide variety of funds that market themselves as "ESG" without being anything of the sort.
Which probably explains why Cynthia Williams and Jill Fisch petitioned the SEC for formal rulemaking on the disclosure of ESG information. It also explains why the SEC's Investor Advisory Committee asked the SEC to consider modernizing the framework for reporting on human capital management. So, maybe if there's a demonstrated investor demand for reliable, consistent, comparable information about public companies, there's something the SEC could do to help them out besides warning them to "be wary"?