Climate Change Disclosures and Private Companies

The SEC recently called for public comment on the issue of mandatory climate reporting, and the comments are in the process of being posted at the SEC’s site.  In the original request for information, Acting Chair Lee asked:

What climate-related information is available with respect to private companies, and how should the Commission’s rules address private companies’ climate disclosures, such as through exempt offerings, or its oversight of certain investment advisers and funds?

Not all of the commenters responded to this question, but here are some highlights:

The Institutional Limited Partners Association, which is a group of institutional investors in private equity, said:

If appropriate standards for minimum disclosures are established for SEC registrants, these standards will subsequently influence private markets. In anticipation of potentially listing private fund portfolio companies, GPs will seek to align to the SEC standard. LPs, particularly those looking to measure climate implications across their public and private investment portfolios, will benefit from this alignment. Furthermore, LPs that currently struggle to collect climate-related information will benefit from SEC requirements, which will serve as a framework to encourage GP reporting alignment

Private equity said:

From a regulatory perspective, the AIC believes that the existing private offering framework, under the federal securities laws, adequately facilitates disclosure by private equity and private credit firms. We look forward to working with the SEC on climate-related and other ESG disclosure topics as the SEC considers this framework.

Private issuers generally and, specifically, private equity and private credit firms and the funds they sponsor, are subject to a legal and regulatory framework that results in disclosure requirements appropriate for participants in private securities offerings.

Private issuers in the U.S. are customarily exempt from specific disclosure requirements in connection with private offerings of their securities, while public issuers are subject to a registration regime that, by design, is fundamentally different. This is because offerings exempt from registration under the Securities Act of 1933, as amended (the Securities Act) have long been recognized as precisely that – exempt – generally because the risk to the public is mitigated by the private nature of the offering and, very often, because of the sophistication of the investors in the offering.

Neither of these is very surprising; things get a little more interesting when we turn to the Democratic AGs, whose letter was not up at the SEC’s site as of the time of this posting, but was reported on by Law360:

[E]xempt offerings under Regulation Crowdfunding (“Reg CF”) and Regulation A (“Reg A”) must include certain offering information that is filed with the SEC and made available to potential and current investors. The SEC should add climate-related information to these exempt offering disclosures. Given the potential disparity in the sizes of publicly traded companies and firms that undertake Reg A and

Reg CF offerings, the SEC could base the type and extent of climate-related disclosures on the size of the firm and the industry in which the firm operates, with larger firms and firms in riskier and more heavily impacted industries required to make more extensive disclosures.

The SEC should also address climate-related disclosures as part of a broader review of and amendments to Regulation D (“Reg D”). Reg D, which permits companies to make exempt offerings to “accredited investors” and a limited number of unaccredited investors, exposes millions of retail investors to exempt offerings that currently have no disclosure requirements so long as those investors meet the wealth or income thresholds the SEC set in 1982. The SEC should extend Reg D’s disclosure requirements for unaccredited investors to all individual investors, whether accredited or unaccredited.  Because those disclosure requirements in turn refer to Form 1-A (as used in Reg A filings) and to Regulation S-K, the SEC’s addition of climate-related disclosures to Reg A/Form 1-A and to Reg S-K/Form S-1 would provide a pathway for that requirement to apply to disclosures for individual investors.

So, first thing: on the issue of climate change disclosures, are they seriously arguing that the kind of tiny local businesses that are hard-pressed even to provide an accurate balance sheet should now be disclosing greenhouse gas emissions?

Second and more broadly, though, the Regulation D proposal is less about climate change than about protecting individual investors.  There’s long been a debate about whether individuals can adequately vet private offerings, and whether the accredited investor definition provides them with sufficient protection (here’s a recent New York Times article about the perils of what was apparently a Reg D offering marketed to wealthy individuals).  If all Reg D sales to individuals included mandated disclosures, we’d probably see a lot fewer of those sales.  Not a criticism; that is, I assume, the point of the recommendation.

That said, it’s not entirely clear to me whether the AG’s are advocating for climate disclosures for other exempt offerings, i.e., exempt offerings under Regulation D that are marketed solely to institutions. The letter does say:

In response to the SEC’s inquiry regarding climate-related disclosures for private companies (Question 14), the SEC should also direct firms that undertake exempt securities offerings to provide climate-related disclosures. Based on currently available (albeit likely incomplete) data, the private offerings market dwarfs the public market, with exempt offerings totaling $3 trillion in 2017, as compared to $1.5 trillion in registered offerings.  Failure by the SEC to impose any requirements on companies issuing exempt securities—especially large companies with many investors—could undermine the benefits of mandatory disclosures made by publicly-traded companies by not affording investors with critical information necessary to bring about efficient capital allocation.

But since the only specific discussions concern Reg CF, Reg A, and individual investors under Reg D – well, let’s just say motes, beams, and eyes come to mind.

Things start to get more interesting when we move to T. Rowe Price’s letter:

In order to level the playing field for sustainability-related disclosures, reduce data gaps for investors, and mitigate the potential for public-private company arbitrage of so-called “dirty” assets, the SEC’s disclosure framework should apply to certain private companies as well as public companies. We encourage the Commission to consider using the same threshold that applies to private company 10-K reporting.  This would avoid creating incentives to transfer businesses with high carbon intensity from public markets to private, which would perversely result in equal or greater greenhouse gas emissions with less transparency to investors.

Which is actually less shocking than it seems on first blush, because the “same threshold that applies to private company 10-K reporting” requires at least 2,000 shareholders of record (with some exceptions), and the way that’s calculated means that very few companies meet the standard.  In other words, T. Rowe Price is acknowledging the possibility of arbitrage by public companies who move ownership of dirty assets to private companies, but its proposed solution is a mirage: in practice, if the assets are going to be sold, they’ll be sold to a company with only a handful of shareholders that doesn’t meet the reporting threshold. 

Which is why the Investment Company Institute (ie., the advocacy organization for mutual funds) plays a similar shell game:

Our members support requiring private companies of the size that must provide periodic reports, or Rule 12g-1 reporting companies, to disclose the same sustainability-related information as public companies.

Beyond that, their main position is, “not it.”

We would strongly object to the Commission addressing private companies' climate change-related disclosures through its oversight of investment advisers and funds. If the Commission determines that this information should be mandated, it should require the information directly from private companies, not indirectly by imposing disclosure requirements on funds and advisers. Proper sequencing is critical to avoid creating the regulatory conundrum of requiring funds to disclose information about companies that the companies themselves are not required to provide to the funds.

But here’s the punchline – BlackRock:

At present, climate-related information with respect to private issuers is lacking in comparison to what is increasingly available from public issuers. To avoid regulatory arbitrage between public and private market climate-related disclosures, we believe that climate-related disclosure mandates should not be limited to public issuers.

Therefore, we encourage the SEC to explore its existing regulatory authority to mandate climate-related disclosures with respect to large private market issuers.  Improving and standardizing climate disclosures across public and private issuers would benefit institutional investors (by increasing information for climate-related assessments), issuers (by avoiding multiple nuanced requests for information from various investors) and asset owners (by expanding transparency and reporting).  As an investor in both public and private issuers, this equalized transparency would help us make more informed investment decisions with respect to climate-related issues in both markets.

With no qualifications at all that I can see. That’s a serious eyebrow-raiser, and one that particularly hits home because a few days ago, the Commission announced that Boston College Professor Renee Jones is the new head of Corporate Finance.  As has been widely reported, Jones recently published an article about the distortive effect that expansive offering/reporting exemptions have on corporate governance – regular readers may recall that I actually blogged my comments on that article when it was first published.  Jones also testified before Congress to make the same arguments.

So, this is a sleeper issue I’m keeping my eye on.

Update: State Street’s letter is now available and, in footnote 5, it indicates it’s also in favor of private company disclosure.