SEC Attempts to Regulate Indefinable “ESG” Topics
Today is the filing deadline for public comments on a new Securities and Exchange Commission (SEC) proposed rule titled “Investment Company Names.” This proposal would amend the current SEC rule on investment company names first published in 2001. The goal of the proposed amendment, according to the SEC, is “to promote consistent, comparable, and reliable information for investors concerning funds’ and advisers’ incorporation of environmental, social, and governance (“ESG”) factors.” However, as I write in my comment letter, the SEC’s goal faces one big conceptual obstacle.
The terminology the SEC has regulated investment funds on in the past have been easy to define and prove (or falsify). This is not true of ESG themes:
The agency explains the background of the current rule by pointing out that fund names that reference investment type (stocks or bonds), industry focus (utilities or healthcare), or geographical concentration (Japan or Latin America) are subject to an 80% value requirement. But those examples have one important thing in common that does not apply to many of the topics covered by the current proposal: they are objective criteria. There is not a great deal of debate about how an equity share is different from a municipal bond or whether a given company is headquartered in Nagoya or San Salvador. The same cannot be said about what investment options count as “value,” “growth,” or—especially—“ESG.”
The squishy definitions around ESG topics are also not just a matter of waiting for the field to mature; they are intrinsic to ESG theory itself:
The confusion and inconsistent definitions endemic to the world of ESG analysis are also not, as some advocates have claimed, merely the growing pains of an infant concept destined to mature into a substantial and reliable field. The problem with ESG theory is that it is inherently subjective and not conceptually amendable to the kind of rigor needed for governmental policymaking, especially if there are non-trivial legal sanctions awaiting regulated parties that act in ways inconsistent with such rules. The term “corporate social responsibility”—which is conceptually very similar to what most commenters mean when they use the phrase “ESG” today—was discussed in detail at least as early as the 1950s. If its proponents were capable of describing their goals and definitions in objective detail, they would have done so by now.
Instead of creating new procedures to regulate inherently subjective concepts, I recommend that the agency simply embrace this unsolvable ambiguity and use their public education programs to teach investors how to navigate the landscape:
Going forward, our best option is to acknowledge what we currently have now: a bifurcated system. The current fund names rule (and other more general anti-fraud provisions) protect investors from specific, clearly false claims. We also should maintain an open arena for inherently subjective names, expecting individual investors to perform the due diligence necessary to evaluate any subjective representations implied by a fund’s name. …
The SEC should fight actual fraud wherever it finds it. It should not, however, attempt to regulate concepts that have no objective definitions. To the extent that consumers need protection and guidance, the SEC should use its existing educational programs to teach them how to evaluate subjective claims in investment products, just as it teaches them how to evaluate different options and opportunities regarding brokerage accounts, financial privacy, and retirement savings.
Now that the comment period is closing, the SEC will likely take several more months to review submissions and craft a final rule. At the same time, it will also continue to work on its even bigger and more ambitious climate disclosure rule, which wrapped its comment period in mid-June. Both my colleague Marlo Lewis (here) and I (here) filed comment letters in response.
For more analysis on corporate climate disclosure and the limits of the SEC’s authority, watch the policy panel event I hosted in May 2022, “Does the Federal Government Have Authority for ESG Mandates?” with guests David R. Burton (Heritage Foundation), Christina Parajon Skinner (Wharton School), and Andrew Vollmer (Mercatus Center).