From Laggard to Leader: Updating the Securities Regulatory Framework to Better Meet the Needs of Investors and Society

By | February 23, 2021

The following is the executive summary of a just released report from the Global Financial Markets Center titled: “From Laggard to Leader: Updating the Securities Regulatory Framework to Better Meet the Needs of Investors and Society.” The full report can be accessed here.

Climate change, systemic racism, and unprecedented income and wealth inequality pose direct and immediate threats to our capital markets. This report outlines the steps that the Securities and Exchange Commission (SEC) should consider taking to ensure that companies operating in the United States identify, assess, and disclose the risks and opportunities these challenges present.

Any of these crises alone threaten to cause sudden and widespread asset deflations, disrupt supply chains, strain work forces, and render entire business models and industries obsolete. Now more than ever, it is crucial that investors, stakeholders, and the public have the power to hold corporations accountable and the ability to efficiently allocate capital towards a sustainable future. But this will not be possible without bold action from the SEC.

The SEC needs to ensure that all companies, both private and public, are held accountable for how they address environmental, social, and governance (ESG) factors. To this end, the SEC should:

  1. Restore Public Accountability to the Unregulated Private Markets.
  2. Require Enhanced Public ESG-Related Disclosures.
  3. Enhance Stakeholder Rights and Engagement.
  4. Modernize Expectations for Investment Fiduciaries.
  5. Promote Integrity of ESG-Related Labeling of Investment Funds and Products.
  6. Enhance Oversight Over Gatekeepers: Credit Rating Agencies and Index Providers.
  7. Enhance Auditing and Accounting Rules and Enforcement.
  8. Revise the SEC’s Staffing and Structure to Prioritize ESG Integration.

1. Restore Public Accountability to the Unregulated Private Markets

There exists a stark contrast between the disclosure requirements for public and private companies. The extensive disclosure requirements for public companies ensures the widespread dissemination of consistent and decision-useful information about a firm’s operations and finances. But private companies are generally not required to provide any substantive disclosures, and investors often receive inconsistent and limited information. As a result, investors and stakeholders are unable to hold private companies accountable.

Notably, the size of the private market is expanding, and the SEC has failed to address the growing number of “unicorn” private corporations with valuations greater than $1 billion. Predicating disclosure on the public / private divide no longer reflects the realities of the market, and private markets need to be better regulated in order to facilitate proper disclosure. The SEC should consider amending its definition of “shareholder of record,” which currently permits private issuers to easily avoid the Section 12(g) trigger by obfuscating the actual owners of their securities. Further, the SEC should consider revising the application of exemptions to offering rules for private funds to capture funds with more than $1 billion in assets or more than 100 beneficial owners to require them to register as investment companies.

The SEC should consider revising Rule 144A, Rule 506, and Regulation AB to mandate disclosures for large “private” offerings to better align with the requirements for registered offerings. Additionally, the SEC should consider limiting exemptions from the federal securities law information and rights requirements.

Finally, the SEC should consider amending Rules 504, 505, and 506 of Regulation D. In general, Regulation D allows for the sale of an unlimited number of securities to an unlimited number of investors, provided that those investors are “accredited.” Problematically, the definition of “accredited investor” is far too broad, and the SEC can no longer assume that these high-net-worth individuals (requiring an annual income exceeding $200,000 as an individual investor, or a net worth exceeding $1,000,000) are better suited to evaluate risk absent disclosure requirements. The SEC should consider revising the “accredited investor” definition to be based on a combination of sophistication, income, wealth, and access to “the kind of information which registration would disclose.”[1]

2. Require Enhanced Public ESG-Related Disclosures

Investors are dissatisfied with the quality, consistency, and comparability of ESG disclosures. Though the proliferation of ESG-disclosure regimes by non-governmental organizations has helped fill the gap left by the SEC’s failure to act in this critical area, the wide range of voluntary disclosure templates has led to inconsistent, incomplete, and inadequate disclosure practices. Absent a government-mandated disclosure regime for ESG factors, investors and stakeholders remain unable to compare firms, assess ESG-related risks, and instill corporate accountability. Ultimately, the SEC’s failure to mandate consistent and decision-useful disclosure of relevant ESG-related information has made it impossible to efficiently allocate capital towards a sustainable future.

The SEC should therefore consider requiring financial and non-financial firms to enhance disclosure relating to, at a minimum, the following ESG factors:

  • climate change;
  • political spending;
  • human capital;
  • tax practices;
  • stock buybacks; and
  • any other issues that may arise.

Moreover, the SEC should address the unique climate risks faced by financial companies. First, the SEC should consider requiring banks and bank holding companies to disclose climate-related risks that may impact:

  • their holdings directly; and
  • the banking industry generally.

Second, to ensure that financial companies are adequately disclosing the transition risks associate with climate change, the SEC should consider requiring the inclusion of a new category of assets in “Distribution of Assets” disclosure to identify assets within “high impact sectors.” Finally, the SEC should consider requiring banks and BHCs to disclose “climate impact” analyses based on financed emissions.

The SEC should also consider mandatory disclosures for all sales of unregistered securities that may be impacted by climate risks. These reforms are particularly relevant given the recent surge in debt issuances by U.S. oil and gas companies.

3. Enhance Stakeholder Rights and Engagement

Beyond disclosure, investors and stakeholders must be able to make efficient use of information in their decisions. They must also be empowered to effectively engage with companies, make informed and impactful votes, and have sufficient access to courts and class actions. Despite the overwhelming investor demand for greater access to information and the growing need for enhanced corporate accountability, the SEC has instead taken action to significantly limit shareholder rights. Notably, in 2020, the agency limited investment advisers’ use of proxy advisorsand curtailed the ability to offer shareholder proposals through Rule 14a-8. The current ubiquity of tiered share structures and the outdated director election process further restricts investor ability to exercise key rights.

Accordingly, the SEC should consider:

  • increasing shareholder proxy access;
  • creating a new process for investors to more easily compel corporate disclosures;
  • increasing investor access and ability to rely upon expert advice from proxy advisors;
  • ending dual class share structures;
  • adopting universal proxy ballots to permit replacing management supported directors; and
  • prohibiting unreasonable restrictions on private rights of action.

4. Modernize Expectations for Investment Fiduciaries

Investment fiduciaries are responsible for advising and directing the deployment of trillions of dollars in investor assets. Importantly, millions of American businesses, organizations, families, and retirees depend on investment fiduciaries for responsibly managing their assets.

Though the SEC has generally imposed no substantive or process requirements on investment fiduciaries related to consideration of ESG-related factors, thousands of these asset managers are incorporating ESG information into their decisions voluntarily. Importantly, they are doing so not only in response to an increase in investor appetite for “sustainable” investments, but because they understand that the consideration of ESG factors is crucial for long-term investment success and a critical component of their responsibilities to their customers and beneficiaries.

But investment fiduciaries are not required to report on how they have implemented these commitments, and the ESG information being made available voluntarily is often neither complete, specific, comparable, widely available, or well-verified. As such, stakeholders have struggled to match investment advisers’ ESG-related claims to their investment-related decisions, and there is a growing concern than many advisers are engaging in “greenwashing.”

To address these concerns, the SEC should consider:

  • requiring sustainable investment policies (and related disclosures);
  • adopting guidance to consider relevant ESG factors; and
  • requiring investment advisers and brokers to identify and address customer preferences.

5. Promote Integrity of ESG-Related Labeling of Investment Funds and Products

Investor demand for ESG-related funds and financial products has grown drastically in recent years, and the market for funds and instruments labeled and marketed as “ESG,” “green,” or “sustainable,” has expanded accordingly. Notably, during the COVID-19 pandemic, while stock markets registered an unprecedented increase in intra-day trading and volatility, ESG funds proved to be more resilient and greatly outperformed non-ESG funds.[2]

Despite the explosive growth, and success, of funds and products marketed as “sustainable,” the SEC has failed to establish uniform standards or criteria for determining whether such funds or products are accurately labeled. Moreover, there is no government-sanctioned process for verification of “sustainable” status. Importantly, companies receive greater premiums and charge higher fees for products marketed as “sustainable” when compared to similar products without “ESG” or “sustainability” labeling.

This lack of standardization and transparency, coupled with the potential to garner higher fees and decrease borrowing costs, creates significant risk that firms are engaging in “greenwashing” by falsely labeling their products and practices as “sustainable.”

Accordingly, the SEC should consider adopting clear, uniform taxonomies for securities and investment vehicles labeled or marketed as “sustainable.” To this end, the SEC should consider requiring all ESG-labeled securities and funds to meet an independent, objective, and verifiable standard for such designation.

6. Enhance Oversight Over Gatekeepers: Credit Rating Agencies and Index Providers

Credit rating agencies and index providers allow companies, investors, and the public to identify, assess, and address key issues. Because of their essential role in the proper functioning of capital markets and their significant influence over trillions of dollars of investment capital, the SEC should enhance oversight over these key gatekeepers.

In the credit markets, credit rating agencies are in place to enable investors to evaluate the risks associated with particular securities and their issuers. Because of their expertise, resources, and unique access to information, credit rating agencies provide transparency and external oversight, allowing investors to allocate capital confidently and efficiently. But accurate credit ratings depend on complete, thorough, and transparent assessments.

As made clear by the surge in extreme weather events and the coronavirus fallout, climate- and worker-related risks are not only significant and growing concerns for companies and investors, but they are also insufficiently incorporated into the capital markets. Credit rating methodologies for evaluating ESG-related risks remain vague and permit a wide range of outcomes stemming from identical information. The SEC should ensure that credit rating agencies have sufficient expertise and methodologies to properly identify ESG-related risks and are accurately and transparently incorporating those ESG-related risks into their ratings. The SEC should therefore consider requiring credit rating firms to adopt, integrate, and publish policies regarding their consideration of ESG factors to ensure that investors understand exactly what is being factored into credit ratings.

Further, index providers, which cover equity securities, debt securities, and other assets, similarly influence trillions of dollars of investment capital. Despite widespread findings of fraud and manipulation in indexes, the United States currently has no federal regulatory requirements for index providers. The SEC should thus consider developing a regulatory framework designed to address index governance, quality, methodology, and accountability.

7. Enhance Auditing and Accounting Rules and Enforcement

It is clear that the current U.S. accounting and auditing regime does not sufficiently incorporate ESG-related risks. Importantly, the SEC has failed to sufficiently scrutinize ESG-related accounting methods and disclosures, ensure compliance with existing accounting and auditing standards, and update auditing standards to adequately reflect ESG-related risks.

First, the SEC should consider taking more aggressive steps to ensure compliance with existing ESG‑related rules and guidance.

Second, the SEC should consider pressing the PCAOB to revise auditing standards to reflect updates in ESG-related requirements. Importantly, as the SEC updates and enhances disclosure requirements to ensure the disclosure of essential ESG-related risks, there will be significant pressure from companies and carbon-focused industries to “massage” the disclosed information. New, robust audit standards will thus be essential to ensure that market participants provide reliable, accurate, consistent, and comparable information as they incorporate new disclosure requirements into their practices.

Third, the SEC should consider identifying and announcing specific ESG-related priorities for inspections of audit firms. In particular, these priorities could include:

  • the role of risk assessment in designing the nature and extent of audit procedures;and
  • the auditor’s responsibility regarding other ESG-related information.

Finally, the SEC should consider establishing a “Sustainability Standards Board” within the FASB. The Sustainability Standards Board would engage with regulators and market participants to develop harmonized disclosure standards for ESG-related information. In doing so, the Sustainability Standards Board could leverage and build upon the large body of private ESG-related disclosure standards.

8. Revise the SECs Staffing and Structure to Prioritize ESG Integration

To ensure that the SEC is focused on enhancing corporate accountability and addressing ESG-related issues, the agency will need to expand staff expertise and shift the orientation of its Divisions. Moreover, to effectively develop, implement, and enforce ESG-related rules and guidance, the SEC will need to seek assistance from market participants and outside experts.

First, the SEC Chair should consider establishing an “ESG Office” committed to racial justice, worker rights, and climate science. The ESG Office should be led by an executive with significant expertise on ESG-related issues who will report directly to the Chair. The ESG Office should be responsible for coordinating ESG-related efforts across the SEC and other federal regulatory bodies.

Second, the SEC should consider revising the process of appointing members to its advisory committees to ensure that all committees have sufficient expertise on ESG-related factors. Moreover, the SEC should consider establishing an “ESG Investing” advisory subcommittee of the Investor Advisory Committee.

Tyler Gellasch is a non-resident fellow at the Global Financial Markets Center

Lee Reiners is the executive director of the Global Financial Markets Center

[1] SEC v. Ralston Purina Co., 346 U.S. 119, 127 (1953).

[2] Stefano Spinaci, Briefing, Green and Sustainable Finance, PE 679.081, Eur. Parl. Research Serv. (Feb. 2021), available at

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