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The Sustainable Shareholder

Why shareholders want materiality in reporting

<p>As the SEC and Congress get ready to examine what companies must disclose, shareholders look at the connection between financial and ESG success.</p>

The Securities and Exchange Commission is currently preparing a report to Congress from its review of disclosure rules for U.S. public companies as required by the Jumpstart Our Business Startups (JOBS) Act. These rules, also known as Regulations S-K and S-X, detail the requirements for financial statements. The goal of this report, according to the Commission, is "to comprehensively review the requirements and make recommendations on how to update them to facilitate timely, material disclosure by companies and shareholders' access to that information."

It is important that sustainable shareholders, who know the proven correlation between social and environmental performance and financial viability, contribute to defining the parameters of disclosure rules. This addresses the very nature of materiality, which research has repeatedly shown to be connected to and affected by environmental, social and governance issues.

While some of the rationale for reviewing disclosure rules is based on company complaints about the costs and so-called burdens on companies to provide material information, companies need to understand that some business-as-usual operational practices and policies pose material risks to both financial performance and share value. It seems obvious that reducing these risks can yield positive financial results, not to mention customer loyalty, and is therefore well worth any human resource costs to report such information to regulators and current and prospective investors.

Where laws must step in

Regulation of corporate practices has largely been inadequate when it comes to social and environmental consequences. Company risk-taking — whether it's cutting corners on international labor standards or damaging communities or environment — has weakened the global economy and increased societal ills.

Responsible behavior is the obvious solution, but if it is not embraced voluntarily by management, it must be required by law to protect the public interest. Disclosure requirements are part of the essential process of mitigating risks to both companies and society, and deserve to be made stronger, not weaker. Doing so is a clear benefit for shareholders, who deserve to understand how the companies in which they invest make and spend their money.

Sustainable shareholders believe there are significant gaps in current disclosure practices, including a general lack of ESG reporting. While there have been specific measures undertaken by the SEC regarding executive-employee pay ratio and disclosure of payments by resource extraction issuers, comprehensive ESG disclosure in areas of employee, community, political contribution and environmental concerns affects share value because of the inherent risks they can pose to financial performance. Shareholders must have all the information they need about such policies and practices to make fully informed decisions as owners, including advocacy for corporate social and environmental responsibility as warranted.

Mandatory ESG disclosure must be included in regulatory filings, including for all company subsidiaries that may be located outside the U.S. to skirt their tax responsibility. Issuers should be required to report annually on a comprehensive, uniform set of sustainability indicators comprised of both universally applicable and industry-specific components.

Three exchanges, including NASDAQ OMX and the Toronto Stock Exchange, already support the March 2014 recommendations by the Ceres-ledInvestor Network on Climate Risk that companies be required to conduct a materiality assessment disclosure in annual financial filings.

Through this, management addresses its approach to determining the company's material ESG issues and places a hyperlink in its annual financial filings to an online ESG disclosure spreadsheet based on the Global Reporting Initiative framework with the following categories: Governance and Ethical Oversight, Environmental Impact, Governmental Relations and Political Involvement, Climate Change, Diversity, Employee Relations, Human Rights, Product and Service Impact and Integrity, Supply Chain and Contracting and Communities and Community Relations.

Let's raise our standards

The simple truth is that a more stringent disclosure standard and requirement is necessary due to the lack of adherence to already existing laws. For example, though the SEC issued its Commission Guidance Regarding Disclosure Related to Climate Change four years ago, half of the largest 3000 companies in this country still don't report on it in their annual filings

In addition, corporate political disclosure continues to be an important issue to investors. Between 2010 and 2014, 274 shareholder proposals were filed calling for increased disclosure of company political spending or lobbying expenditures, and over 1 million public comment letters have been submitted to the SEC demanding such disclosure.

Investors understand that transparent markets and elections are essential to a well-functioning society, while investors have a right to know the legal, regulatory, operational, and reputational risks of a company that may be inconsistent with its business plan and public values and that may contribute to systemic risks to the economy. The Supreme Court, in its Citizens United decision, stated that complete real-time disclosure of public company political spending allows shareholders to "determine whether their corporation's political speech advances the corporation's interest in making profits."

Keep in mind that in Europe, ESG disclosure requirements were already implemented earlier this year with a non-financial reporting directive for the EU's 6000 largest companies with at least 500 employees. These companies must report policies, risks and outcomes in the areas of human rights, employee relations, corruption and bribery, board diversity and environmental impact.

This is not occurring only in Europe. In December 2013, KPMG, the United Nations Environment Programme Global Reporting Initiative published Carrots and Sticks: Sustainability reporting policies worldwide - today's best practice, tomorrow's trends [PDF], covering 45 countries and regions and 180 sustainability reporting policies and initiatives.

Clearly there is increased global interest in regulation and sustainability reporting, with several exchanges requiring it and the observation that corporate reports will increasingly focus on sustainability issues that are material for stakeholders and investors. It's time for us to embrace our responsibility to make money while adhering to responsible policies and practices, and being held accountable when failing to do so.

Top image of stock ticker by iamharin via Shutterstock.

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