Regulatory Policy

When ‘Voluntary’ Becomes Obligatory — Regulatory Creep and the SEC

Securities and Exchange Commission headquarters in Washington, D.C. (Jonathan Ernst/Reuters)
Forcing the creation of ‘socially responsible’ corporations

There was a time — not so long ago — when it was widely accepted that the primary purpose of a corporation was to generate return for its shareholders. In recent years, however, there has been a wide-ranging effort to promote the idea that U.S. corporations should become environmental activists and social workers as well. Whatever you may think about such standards of capitalist conduct — whether they’re “responsible,” “stakeholder,” or “environmental, social, and governance” (ESG)-based — they have at least been voluntary. Something, in theory, that companies decided for themselves. Now the question is becoming whether such standards should continue as voluntary or become a matter of government mandate. Anyone concerned about ethics should seriously prefer the former, ensuring that people’s decisions are determined by individual conscience. Recent developments at the Securities and Exchange Commission (SEC), however, could undermine that goal.

While current SEC chair Gary Gensler awaited Senate confirmation, then–acting chair and current commissioner Allison Herren Lee announced a series of high-profile initiatives to substantially change the agency’s policy on nonfinancial corporate behavior. At Lee’s direction, the SEC staff is currently evaluating the agency’s climate-disclosure rules, for example, and the public has until June 11 to file on that effort.

But such new plans are not just related to climate. In a March speech, Lee claimed that “the perceived barrier between social value and market value is breaking down.” That statement signals a dramatic shift away from the SEC’s traditional focus. Lee’s analysis suggests that many “social” issues now fall under the SEC’s mandate. To take a more cynical view, such issues merely amount to those that are in line with the administration’s attitudes and/or make headlines and thus could be something about which corporations are, in this new era, expected to take a stand. That means that nonfinancial issues as diverse as public health, police reform, and climate change are suddenly included within the mission of an agency established to protect investors, maintain orderly markets, and facilitate capital formation.

For years, proponents of corporate-social-responsibility frameworks, including the growing ESG movement, insisted that their recommendations were no threat to the market economy because they were voluntary, and many were presided over by successful businesspeople themselves.

But that window of voluntary initiative appears to be closing. Last September, Commissioner Lee wrote in the New York Times that properly informing the public about climate risks “can happen only through mandatory public disclosure.” Michael Jantzi, CEO of leading ESG-ratings firm Sustainalytics, announced that he had changed his own mind last year, telling the Financial Times, “I was not a fan of mandatory disclosure. But now I have shifted. We have passed the time of voluntary disclosure mechanisms.” The SEC’s own Investor Advisory Committee also issued recommendations last year calling on the agency to require specific disclosures on ESG topics.

This is a problem for several reasons. First, regulating environmental quality — much less civil rights or public health — is beyond the agency’s statutory authority. Second, and more fundamentally, the question of what falls under the aegis of ESG in the first place is too vague to constitute a meaningful boundary for policy-making. One of the arguments for the SEC’s involvement in this area is that ESG should be defined on a consistent basis; yet giving federal officials the job of defining what it should mean, and enforcing regulations based on that definition, would hand far too much power to unelected agency officials, even if disclosure does not become mandatory. Making such disclosures mandatory would, of course, make a bad situation worse.

Some advocates suggest ESG guidelines are just common sense or that, even if they are complicated, it will just require getting a team of experts in a room together to figure out the details. But that is a dangerously false assumption. Deciding how a privately owned corporation should be made to approach issues of this kind raises fundamental questions over the nature of private property. Beyond that, handling these issues will inevitably involve difficult trade-offs. No well-intentioned geek squad can solve these problems for us and nor should they be given the power to do so.

Should we, for example, insist that banks finance only zero-carbon-emissions projects, or should we allow them to help poor countries to develop more-affordable sources of energy? Should we use codes of conduct imposed on U.S. corporations to try to stamp out child labor abroad, even if that means teenage workers end up moving from a textile factory into destitution? If we outlaw so-called conflict minerals from central Africa, will that mean ending natural-resource development there that kills off economic activity on which local people depend to feed their families?

And that doesn’t even touch domestic issues. Most ESG frameworks make gender equality a key goal. For most advocates, that requires employers to provide health insurance that covers contraception and abortion. The Affordable Care Act’s similar requirements in 2010 generated a political firestorm and over a decade of lawsuits that are even now still playing out in the federal courts. Do we really want to let the SEC set policies on controversial issues like that for every public company in America?

No firm needs to be forced by the SEC to adopt the ostensibly beneficial policies ESG theorists are urging. Requiring job creators to act against their own assessment of their own interests is extending the reach of government too far. We should look for an off-ramp from that road as quickly as possible.

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