Environmental and Social Factors in Investing too Vague for Legal Definitions

Recently, Securities and Exchange Commission (SEC) chairman Gary Gensler released a video explaining his concerns about investment products that market themselves using terms like “green” or “sustainable.” In it, he worried that investors might be confused about the environmental, social, or governance (ESG) claims that various investment products are making or could make in the future. He suggested that this might be a favorable opportunity for the SEC to weigh in with new rules defining those claims. In an op-ed this week for Real Clear Policy, I argue that many of the ESG claims he and others are worried about defining are actually too vague to be subject to such rules:

The problem with generalizing this idea [of requiring clear product labeling] to investing, and especially to ESG criteria, is that the financial issues that people are most concerned with are not simple and quantifiable. The terms that Gensler cites early in the video—“green” and “sustainable”—are inherently subjective and hotly contested.

The SEC seems determined to burrow itself into this area, however. In March 2021 the agency established a Climate and ESG Task Force in the Division of Enforcement to “proactively identify ESG-related misconduct” and “identify any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.” The most important existing policy on climate-related information prior to the agency’s most recent efforts was a 2010 publication intended to “provide guidance on certain existing disclosure rules that may require a company to disclose the impact that business or legal developments related to climate change may have on its business.”

More recent initiatives in this area, like the new task force, have been regarded as validating the seriousness and importance of ESG theory. But, as I noted in Fortune last May, stricter enforcement will likely make market participants less likely to embrace the bold vision of “responsible investing” that its proponents envision:

The SEC pivoting toward a stricter approach may well cause both investment firms and public companies to become more conservative about ESG claims going forward. Many voices in the investing world have pointed out that if ESG metrics are to be of real use, they need to more universal and verifiable. In the short term, at least, erecting new legal risks for companies who do it the “wrong” way will likely make firms more reluctant to take on these issues at all.

Even the new proposed climate disclosure rule that the agency is currently considering could cool market enthusiasm, since it includes several conditional requirements that are only triggered if companies have chosen to set certain climate goals. Given the expense, complexity, and legal risk involved in this expanding area of regulation, firms would be smart to retrench as far as the law will allow and do the absolute minimum to comply, rather than follow the lead of activist groups and build out ever more ambitious climate targets for themselves.

Much like the famous Miranda warning in criminal proceedings, the government reserves the right to use a firm’s public climate goals against it, whether in a court of law or a regulatory enforcement action. They are unlikely to ever be considered exculpatory.