Disclosure Rules Are the Wrong Way to Push Social Change

Government regulation is a hammer: blunt, and when used wantonly, destructive.
June 24, 2015 • Commentary
This article appeared in American Banker on June 24, 2015.

“If all you’ve got is a hammer, everything looks like a nail,” the old adage holds. The hammer of choice for some lawmakers and investors is now securities regulation, and every perceived social ill is a nail.

Policymakers have increasingly embraced the idea of using the Securities and Exchange Commission as a tool to extract information from public companies that is aimed not at helping investors determine whether a company is a sound investment, but at highlighting company practices that some believe to be “bad.”

This is partly an outgrowth of the impact investing movement, which seeks to do good. But its effects when coupled with legally mandated disclosures are ultimately pernicious.

Impact investing involves supporting companies whose practices align with investors’ beliefs. For example, an impact investor might invest in a company because that company promises to adhere to certain labor standards in its overseas factories.

There is nothing inherently problematic about such an approach to investing. It’s true that some investors may not be sufficiently informed to make educated decisions about the effect of various labor practices on a factory in Laos, and not all investors will agree on what practices are indeed beneficial to society. But ultimately people should be able to invest their money however they want.

Unfortunately, the impulse toward facilitating social change through investment has not stopped there. New rules promulgated under Dodd‐​Frank require public companies to disclose their use of “conflict minerals.” Another Dodd‐​Frank provision, targeting concerns about income inequality, requires companies to disclose the ratio of a chief executive’s pay to the median pay of other employees. Finally, some investors, in the wake of the Supreme Court’s Citizens United decision, want the SEC to require companies to disclose political contributions.

Public companies, who sell securities to the general public, already must provide extensive periodic disclosures to the SEC. These disclosures are intended to protect investors by ensuring that they have the information they need to make informed investment decisions.

Whenever you have legally mandated disclosures, “extensive” means “expensive.” The SEC has estimated that the cost of ongoing compliance for a public company is $1.5 million annually. Every additional disclosure adds to this cost.

To the extent that SEC‐​mandated disclosures exist, they should have two characteristics. First, they should provide the information that most investors would want about any company in which they invest. Second, they should relate to the regulators’ area of expertise.

Because most investors are looking for a return on investment, SEC disclosures have typically focused on whether companies are well run and likely to be profitable. This type of disclosure satisfies both prongs of the test. The new disclosures, however, satisfy neither.

Embedded in the Dodd‐​Frank Act is a requirement that public companies disclose whether they use “conflict minerals” in their products. According to the SEC, “Congress enacted [this provision] because of concerns that the exploitation and trade of conflict minerals by armed groups is helping to finance conflict in the Democratic Republic of the Congo and is contributing to an emergency humanitarian crisis.”

Alleviating a humanitarian crisis is praiseworthy and compelling. But how does this relate to securities regulation? And what does the SEC know about minerals like tungsten or tantalum, the mining industry in the DRC, or the DRC in general?

The conflict minerals example is only the most egregious. Dodd‐​Frank also requires public companies to disclose the ratio between the CEO’s pay and the median salary for the company’s other employees.

While executive compensation can be relevant to determining whether a company is well run, this particular provision seems aimed not at allowing investors to determine whether the CEO is “worth” the pay offered, but to highlight income inequality between CEO and other workers. A CEO’s compensation can be effectively measured by a number of metrics, such as what peer companies pay their CEOs, the extent to which the company’s value has increased under the CEO’s watch, or whether the company has increased market share. The median employee salary has no relation to any of these metrics.

Most recently, as a response to the Citizens United decision, investors have requestedrulemaking that would require companies to disclose their political contributions. Once again, it is difficult to see how this relates to either the soundness of an investment in the company or the SEC’s area of expertise.

The problem is not that investors want to know this kind of information. An investor should be free to use whatever information she wants to make her decision. But securities regulation, especially regulation aimed at all federally registered companies, should not be larded with ideologically motivated requirements.

First of all, the SEC is simply not qualified to conduct rulemaking on such wide‐​ranging subjects. Second, once such a rule is final, its repeal is unlikely. As new causes emerge, we risk piling one required disclosure on top of another to satisfy the demand that securities law remedy the issue du jour. Interest in the causes of a few years ago will fade, but companies will have to continue producing (and paying for) disclosures that no one reads or cares about.

Third, and most dangerously, once an agency’s authority is decoupled from its presumed jurisdiction, it can be used as a tool to promote any agenda. Could the Department of Education be required to write a rule that teachers whose schools receive federal funding must ask parents about marijuana use? Could the Department of Defense be required to write a rule that demands all service members disclose their family members’ religious practices? If the SEC can be used to indirectly monitor mining activities in foreign countries, it’s hard to see what would stop other agencies from being used to monitor other unpopular behaviors here in the U.S.

This is not a path we should go down. If investors want this type of information, companies seeking funding will provide it on their own. The law already discourages companies from lying; the existing anti‐​fraud provisions in the securities law are quite strong. And if companies refuse to provide the information, they’ll have to resign themselves to missing out on money.

Moreover, regulation is not the only way to get information. Individuals or organizations interested in certain causes spend a great deal of time and effort tracking down exactly the kind of information regulations would provide under the new disclosure rules. For example, the International Labor Rights Forum tracks information about companies’ labor practices around the world. Open Secrets provides information about companies’ political donations, and a number of organizations, including the Sierra Club, universities, and several publications, track companies’ pollution data. If this information is valuable to investors, it seems they would be willing to pay others to provide it.

In addition, “benefit corporation” legislation is proliferating at the state level. The new “B Corp” form allows a company to opt into a regulatory regime in which it promises to provide, in addition to a potential return on investment, “social or environmental benefits.” This provides a means for companies to opt into focusing on the ideological causes near and dear to their own and their investors’ hearts. There is no reason to make these types of disclosures a blanket requirement.

Government regulation is indeed a hammer: blunt, and when used wantonly, destructive. To the extent that investors want to use their money to promote social goals, there are other tools at their disposal that are better suited to the task.

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