The House Financial Services Committee concluded its second markup of the 117th Congress’s first session by reporting three securities bills focused on the "E" and "G" components of environmental, social, and governance (ESG) investing along party lines. The bills address public company disclosures about climate change risk, executive compensation, and offshore tax havens. The climate bill was the second bill of its type to clear the House FSC this session and is the more prescriptive of the two bills addressed by the committee thus far. The executive compensation bill would mandate disclosure of companies’ pay raise ratios by comparing executives’ pay increases to those of non-executive employees. The tax haven bill would require companies to explain the extent to which they shunt profits to foreign jurisdictions with tax rates far below those in the U.S. All three bills were re-introductions of bills pressed in the last Congress with the climate and executive compensation bills having previously been reported by the House FSC.
The debates on the three securities bills featured several extended colloquies but the upshot of members’ remarks was to reiterate a familiar divide between Democrats and Republicans over the use of the federal securities laws to mandate public company disclosures related to ESG issues. Republicans offered amendments to all three bills that would have provided that a public company need not make a disclosure unless the thing to be disclosed met the materiality standard expressed by the Supreme Court in TSC Indus., Inc. v. Northway, Inc. (1976), in which the court stated that an item is material if "there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote" or "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." The amendment was offered to the climate bill by Rep. Andy Barr (R-Ky) and to the executive compensation and tax haven bills by Rep. Bryan Steil (R-Wis); the amendment was rejected in each instance by party line votes.
Moreover, an amendment offered by Rep. French Hill (R-Ark) to replace the climate change bill with an SEC study also failed. An amendment offered by Rep. Bill Huizenga (R-Mich) to replace the executive compensation bill with a repeal of the Dodd-Frank Act’s pay ratio disclosure requirement and its provisions on conflict minerals, mine safety, and resource extraction issuers failed by a vote of 24-29. Lastly, an amendment to the tax haven bill offered by Rep. Roger Williams (R-Texas) stating a preference for Trump-era tax cut policies failed by a vote of 22-29.
Climate risk disclosures. The Climate Risk Disclosure Act of 2021 (H.R. 2570), sponsored by Rep. Sean Casten (D-Ill), would require the SEC to adopt rules mandating public companies filing reports under Exchange Act Sections 13(a) or 15(d) make certain disclosures about the climate risks inherent in their businesses. The bill was previously introduced in the 116th Congress and was at that time reported by the House FSC along party lines by a vote of 34-25; the Senate version received no activity (See H.R. 3623; S. 2075). The latest version of the bill was reported by the House FSC by a vote of 28-24.
According to Rep. Casten, climate change is a risk to the global financial system and the bill is a market-based approach to informing investors of that risk. The representative also said the SEC does not need additional authority to act on climate risk. Representative Casten also sought to preempt Republican members’ objections by positing that the bill was more than just a moral or political imperative.
Representative Hill criticized the Casten bill for ignoring scientific definitions of key climate terms while noting the differing approaches taken by the recently reported ESG Disclosure Simplification Act of 2021 (H.R. 1187), sponsored by Rep. Juan Vargas (D-Calif), and the Casten bill. According to Rep. Hill, the Vargas bill requires a company’s annual report to disclose long-term strategy based on current metrics, while the Casten bill adds social, economic, and reputational costs that refer to both current and future metrics.
Congressional findings included in the Casten bill would state, among other things, that near- to long-term climate change risks are a type of information companies should reasonably expect will alter investment decisions by shareholder and, thus, should be identified, evaluated, and disclosed on a regular basis. A sense of Congress contained in the bill, among other things, likewise would posit that climate change is a "significant and increasing threat" to U.S. economic growth and stability and that the SEC "has a duty to promote a risk-informed securities market." The term "climate change" would be defined consistent with the concept of the Anthropocene era to mean climate change resulting from human activity that alters the composition of the global atmosphere in addition to natural climate cycles.
Companies subject to the bill’s requirements would have to disclose information regarding:
- Risk management strategies to address physical and transition risks ("physical risks" include the financial impact to long-lived fixed assets, locations, operations, or value chains from increased temperature, temperature extremes, or storms of greater frequency and severity; "transition risks" are financial risks attributable to mitigation/adaptation efforts and a broad range of costs, including costs of compliance with domestic and international laws and treaties);
- corporate governance processes and structures used to identify, assess, and manage climate-related risks;
- the company’s specific actions taken to mitigate identifiable risks;
- a description of the resilience of strategies for climate risks when differing climate scenarios are considered; and
- a description of how climate risk is incorporated into overall risk management strategy.
With respect to the content of the SEC’s rulemaking, the bill would require the SEC to address:
- rules for specialized industry sectors, including finance, insurance, transportation, electric power, mining, and non-renewable energy;
- reporting standards for companies to estimate and disclose GHG emissions, including, if possible, disclosure about each GHG a company releases;
- reporting standards for companies that own or manage fossil fuel-related assets with a disclosure of the percent of total assets that are fossil fuel-related assets; and
- standards for disclosing inputs and assumptions regarding climate scenario analyses, including present value discount rates and time frames, such as 5, 10, and 20 years.
Any qualitative or quantitative risk analysis statement disclosed must consider a baseline scenario of the physical impacts of climate change (i.e., a widely-recognized analysis in which GHG emissions raise the global average temperature by 1.5 degrees Celsius or more above pre-industrial levels), a 1.5 degrees scenario (i.e., a scenario in which GHG emissions are curbed so that global warming is limited to 1.5 degrees Celsius above pre-industrial levels), and other scenarios the SEC deems appropriate after consultation with the climate principals. For companies that engage in the commercial development of fossil fuels, additional detailed disclosures would be required; companies affected would cover the entire range of upstream, midstream, and downstream activities related to the production, transport, and refining of oil, natural gas, coal, and related byproducts.
Lastly, the SEC, after consulting with the climate principals, could require still more disclosures that are: (1) necessary; (2) appropriate to safeguard the public interest; or (3) directed at ensuring that investors have information consistent with the Congressional findings in the bill.
Executive compensation. Under the Greater Accountability in Pay Act (H.R. 1188), sponsored by Rep. Nydia Velazquez (D-NY), the Exchange Act’s reporting requirements would be amended to mandate that any company filing reports under Exchange Act Sections 13(a) or 15(d), and that is not an emerging growth company, disclose additional information about how much more money its executives are paid via pay raises versus other employees. The proposed disclosure would be similar to the pay ratio disclosure required under Dodd-Frank Act Section 953(b). The bill was previously introduced in the 116th Congress and was reported by the House FSC by a vote of 32-21 (See H.R. 4242). The latest version of the bill was reported by a vote of 29-23.
Specifically, a company would have to disclose in its annual report the ratio of the percentage resulting from a comparison of the percentage increase in the median of the annual total compensation of all executive officers to the percentage increase in the median of the annual total compensation of all non-executive officer employees. Company data would be drawn from data for the last completed fiscal year. Moreover, a company would have to compare the percentage increase in the median of the annual total compensation of all executive officers and the percentage increase in the median of the annual total compensation of all non-executive officer employees to the percentage change in the Consumer Price Index for the same period.
Tax haven disclosures. Under the Disclosure of Tax Havens and Offshoring Act (H.R. 3007), sponsored by Rep. Cynthia Axne (D-Iowa), public companies with constituent entities located overseas would have to make disclosures about the taxes paid by those entities in their resident tax jurisdictions. As with the other two bills considered by the House FSC, this one too was previously introduced in the 116th Congress, where it and its Senate companion received no committee or floor action (See H.R. 5933; S. 1609). The latest version of the bill was reported by the House FSC by a vote of 28-23.
Under the bill, a company would have to disclose information about: (1) the legal name of constituent entities; (2) a constituent entity’s tax jurisdiction; (3) the tax jurisdiction where the entity is organized or incorporated (if not the same as its resident tax jurisdiction); (4) an entity’s tax identification number in its tax jurisdiction; and (5) the entity’s main business activities.
Moreover, a company subject to the bill would have to disclose certain aggregated or consolidated information on its multiple constituent entities, including:
- revenues from transactions with other constituent entities;
- revenue not from transactions with other constituent entities;
- profits and losses before income taxes;
- total income tax paid on a cash basis in all tax jurisdictions;
- stated capital;
- total accumulated earnings;
- total full time-equivalent employees; and
- net book value of tangible assets (cash, intangible assets, and financial assets would be excluded).
The SEC would be required to propose implementing regulations within 270 days of enactment and would be expected to finalize those regulations within one year of enactment. SEC regulations would have to abide by U.S. and international standards for making country-by-country disclosures. The effective date of amended Exchange Act Section 13 would one year after the SEC issues final regulations.
Industry reaction and climate materiality. The U.S. Chamber of Commerce said in a letter submitted to the House FSC in advance of the markup that it opposed the climate risk bill for the same reasons as Republican members of the committee, chiefly that materiality along the lines of Northway should be the touchstone for disclosure rather than the detailed requirements set forth in the Casten bill. The debate over materiality in the climate risk space allows for a closer comparison of the Vargas and Casten bills and how the Commission might address climate risk going forward.
One possible advantage of the Vargas bill as compared to the Casten bill, is that the Vargas bill seeks to resolve the materiality issue ab initio by providing that climate risk disclosures are de facto material. The Casten bill, by contrast, is more prescriptive in stating what disclosures must be made and mentions material climate risks but without the strong presumption of materiality contained in the Vargas bill.
SEC Chair Gary Gensler had been asked at his confirmation hearing by Senate Banking Committee Ranking Member Patrick Toomey (R-Pa) to respond to a lengthy hypothetical question about how significant a climate risk item must be to merit disclosure by a public company. Gensler agreed with Sen. Toomey that materiality is key and that he would consider the economic aspects of materiality. Specifically, Gensler said materiality depends on the total mix of information such that a small item must be considered in context. Toomey continued the hypothetical, suggesting that the small nature of an expenditure would be per se nonmaterial. Gensler replied that recently many investors had, via proxy votes, made it clear that this kind of information is material.