Responses to questions from webinar on June 30, 2015: Does using the term materiality in your CSR report create risk?

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1 Responses to questions from webinar on June 30, 2015: Does using the term materiality in your CSR report create risk? Thank you to everyone who submitted a question. Because we received over 100 questions, we cannot respond to each question individually. The responses address the most common and important questions to the topic of the webinar. Some of the questions have been combined to cover as many issues as possible. Questions that are beyond the scope of the webinar may not be addressed here, but have either been addressed in existing SASB materials or will be addressed in future material and webinars. Please contact Doug Park at doug.park@sasb.org if you wish to follow up on any of the responses. The following SASB resources address many of the questions and issues discussed during the webinar: Securities Law, Not Semantics: Why is it (materiality) important? Focus on Materiality or Be Blinded By the Light: Putting the A Back in MD&A: Legal FAQs: Materiality Map: and Questions about different definitions of materiality and the determination of materiality Can a sustainability impact be deemed material for disclosure in a CSR/sustainability report but not deemed material for including in SEC filings? Can you speak to the difference in the SEC definition of materiality and the CSR method - i.e., importance to both the company and stakeholders If a CSR report follows GRI and is simply "overinclusive" in its definition of materiality (i.e., it meets SASB and Supreme Court definitions, but also contains additional information that it calls 2015 SASB 1 P a g e

2 "material"), what is the legal risk, if any? Can't the Company reasonably conclude that such information might alter the total mix of information and therefore it has been disclosed? These questions get at the differences in the definitions of materiality and why the differences matter. The definition of materiality matters because the securities law definition sets the standard of liability for securities fraud. First, two critical differences between the SEC definition and the CSR method are (1) the degree of impact and importance of the sustainability factor to the company s financial conditions or results of operations, and (2) the SEC definition focuses exclusively on information that would be important to the reasonable investor in making an investment decision. Under the CSR method, if the company s stakeholders do not believe an issue is important even if it is of high importance to the company s business the issue is likely not to be identified as material. However, an issue that is of high importance to a company s business would, in most circumstances, receive serious consideration as potentially material under the securities law definition of materiality. Second, using a materiality matrix or guidance from another sustainability framework will identify many sustainability issues that are material according to that matrix or guidance. However, that is not the same as material under the securities law definition. Third, calling information in the CSR/sustainability report material may create unnecessary risk for companies. See slides 22 to 25 of the deck and the responses below under managing risks of using different definitions of materiality. Fourth, being overinclusive in what the company calls material may increase the amount of information the company is required to disclose in SEC filings, and may also increase the other risks described during the webinar. As a result, the company may need to develop a higher degree of accuracy regarding its disclosures in its CSR/sustainability report. This is because investors have high expectations regarding the reliability of information that they use for investment decisions, and the internal controls and reliability of some sustainability information may not meet the expectations of investors or of the certification requirements of the Sections 302 and 906 of the Sarbanes-Oxley Act for information disclosed in Form 10-K or 20-F SASB 2 P a g e

3 I think you're trying to close the barn door after the horse has bolted. It will cause too much confusion to try and undo the materiality assessments that we have built over the last five years. Is "proprietary" the accurate term for standards that are developed through multi-stakeholder engagement? If the practice of using a proprietary definition of materiality in CR reports is ubiquitous, doesn't that indicate that most companies need to address broader stakeholders groups than just investors? If these companies are clear about their intended use of materiality, is it still risky? So, you are suggesting that material is used only when the factor is important to investors. For all other stakeholders their concerns are not material The SEC definition of materiality only serves the interests of shareholders. How should a company represent the interests of the broader pool of stakeholders that are critical to a company's license to operate if they only use a limited SEC definition of "material". GRI G4 now requires a "materiality" analysis to report to G4. How can companies do this while still protecting themselves legally? The materiality assessments that companies are doing using other sustainability frameworks are different from the materiality assessments done for securities law purposes. That causes confusion and unnecessary risk. The use of a definition of materiality other than the Supreme Court definition causes confusion because the Supreme Court definition has a long history. The Supreme Court announced the securities law definition of materiality nearly 40 years ago in TSC v. Northway, 426 US 438 (1976). Other definitions of materiality mentioned during the webinar were developed after Thus, the securities law definition predates proprietary definitions of materiality created by sustainability organizations. Proprietary refers to definitions of materiality other than the securities law definition, not the standards themselves. The definitions are proprietary because they were created by sustainability organizations on their own. By contrast, SASB follows the Supreme Court definition in its standards development process. Companies do need to address the interests of non-shareholders. They can address those needs by describing information targeted towards those groups care about by calling the information 2015 SASB 3 P a g e

4 relevant, interesting, or significant. Thus, companies can appropriately refer to information identified using a materiality analysis that does not follow the securities law definition using these adjectives. The company should ask itself: why is it so important to call information intended for a broad range of shareholders material when doing so may create unnecessary risks for the company? Regardless of where the company is located, legal counsel can help the company weigh the benefits and risks of using different language to describe sustainability information in different reporting channels. Is it realistic to expect financial reporting and CSR reporting to use the same materiality thresholds? Liability concern is legitimate, but what is the value of materiality? What does materiality enable? Determination of materiality in practice involves professional judgment of those with an accounting background. How should accounting professionals bring the same depth of judgment to assessing the materiality of sustainability topics, which are usually outside the purview and not in the curricula of accountant training? Materiality is a valuable concept because it zooms in on information that is useful to investors in making investment decisions. Materiality acts as a filter, screening out information that is background noise and would not enter into the deliberations of the reasonable investor. For information to be material, however, it does not need to actually change the reasonable investor s investment decisions. See TSC v. Northway, 426 U.S. 438 (1976). The threshold for materiality is whether the information would have been viewed by the reasonable investor as having significantly altered the total mix of information. That threshold applies to sustainability information as well as financial information. Information that is incomplete, inaccurate, misleading, or false alters the total mix of information for the reasonable investor by changing how the investor views, understands, and analyzes the factor. Accountants play an important role in materiality determination of financial information, and they also play an important role in the materiality determination of sustainability information. The 2015 SASB 4 P a g e

5 accounting profession is becoming more interested in sustainability. The American Accounting Association, an organization of accounting faculty and academics, is exposing its members to the topic of sustainability accounting. A small number of colleges and universities are beginning to offer classes on sustainability accounting and non-financial accounting. Recently, the Financial Accounting Standards Board tentatively voted to adopt the securities law definition of materiality and incorporate language from the TSC v. Northway case. This change in definition will likely make the accountant s exercise of judgement concerning the materiality of all information, including sustainability information, move toward how lawyers think about materiality. Accountants and lawyers may need to work more closely on materiality determinations of sustainability information. To better understand how of materiality of sustainability information can be understood and assessed using the securities law definition, it is useful to look to the Securities and Exchange Commission s (SEC) guidance on the disclosure of climate change matters. In 2010, the SEC issued guidance on the circumstances under which companies might need to disclose climate change information in SEC filings, such as the Form 10-K and 20-F. The SEC applied the same threshold for the materiality of climate change that applies to other types of information and clarified that companies may be obligated to disclose material information about climate change under existing rules and regulations. Doug seems to be suggesting that the GRI definition is less legitimate than the US Supreme Court one. The GRI one is from an international, broad based, user informed standard. The Supreme Court one applies to one country and for narrow investor purposes. So hard to see the GRI one as being less legitimate for CSR reporting purposes. The materiality matrix is what GRI guides us to do so that's why everyone is using it. Are you saying it's incorrect? Or just that it differs? How can we use GRI guideline in order to report based on materiality? Are there examples of securities fraud implications with regard to the GRI materiality definition? The GRI definition of materiality is not more or less legitimate than the Supreme Court s definition for CSR and sustainability information. The GRI definition is different from the Supreme Court 2015 SASB 5 P a g e

6 definition and is not intended to provide information to investors that is useful in making investment decisions. GRI s definition is intended for and appropriate for the voluntary disclosure of sustainability information in CSR/sustainability/GRI reports. Likewise, GRI s materiality matrix and the guidelines are not incorrect. They can help a company identify information that a wide range of stakeholders might care about, but they are not designed to identify material information for investors. The sustainability reports involved in the securities fraud allegations in the BP case used the GRI framework (see slide 23 of the deck; In re BP p.l.c. Sec. Litig., 852 F. Supp. 2d 767, 796 (S.D. Tex. 2012)). Questions about SASB s approach to materiality and reporting in the Form 10-K/20-F But what about the specificity of materiality on a case by case basis? This is a major asset of the GRI definition as the GRI proposes to identify and discusses the materiality context to know what actual materiality issues are. Even if 'legitimate' how does SASB deals with the issue of specificity on a case by case? SASB standards do not substitute for or replace a company s determination as to what information is material under the securities law definition. The standards provide a useful guide for companies as they make their materiality assessments. If I understand this correctly: SASB uses the SEC definition of materiality, but then has determined which issues of the business (such as product safety, supply chain, etc) are materiality to particular industries. Aren't those essentially proprietary definitions of material issues by industry? SASB has issued a series of material aspects by industry. Are those aligned with the Supreme Court definition? Fact: if you look at the SASB's own set of standards for professinal service companies, there is not a single metric for environmental performance. How do you suggest that a standard 2015 SASB 6 P a g e

7 that does not even consider ANY environmental/energy performance can be considered a reasonable core "sustainability" standard? Are the SASB indicators specifically for use in SEC filings? SASB uses the SEC definition of materiality in our standards setting process, but our identification of disclosure topics is not a proprietary definition of material issues by industry. As an initial matter, SASB does not identify material issues. We identify sustainability topics that are likely to constitute material information, as understood under securities law. The company, not SASB, determines whether the information is material. Further, proprietary as used during the webinar and herein refers to definitions of materiality other than the Supreme Court definition, not to any set of standards. SASB standards are designed for use in SEC filings, especially the Management s Discussion and Analysis (MD&A) section of Form 10-K and 20-F. The standards can help companies prioritize which sustainability topics to disclose information on in mandatory filings (e.g, Form 10-K and 20-F) based on the topics that are likely to constitute material information. Our research process uncovers evidence of investor interest and evidence of financial impact on sustainability factors for companies in a specific industry. In this way, SASB standards can serve as a core sustainability standard on sustainability topics that are likely to constitute material information for companies within a given industry. One webinar participant sent in a comment that said: It would seem that the same definition of materiality would comparison of apples to apples. SASB agrees with that comment. Industry specific sustainability standards help investors and analysts benchmark and compare the performance of companies on sustainability factors that drive financial value. Questions about how to manage the risks of using different definitions of materiality Why is it not recommended to use the word material if the supreme court definition is not used? 2015 SASB 7 P a g e

8 The webinar discussed unnecessary risks that a company may create by using a definition of materiality that differs from the Supreme Court definition. The risks are: 1. Risk of liability for securities fraud (specific to US listed companies) 2. Risk of contradiction (depends on company s jurisdiction; applies to US listed companies) 3. Risk of inappropriate communication (depends on company s jurisdiction; applies to US listed companies) 4. Risk of investor overload (applies to all companies) 5. Risk of management misalignment (applies to all companies) See slides 22 to 25 of the deck. Please clarify slide 20. Can companies be liable or not if using proprietary definition? Companies can potentially be liable for using a proprietary definition of materiality. Two different messages here. One is that using another framework besides SASB's SC-driven standard creates risk and is a bad idea. Now you just backtracked and said they are both fine. Which is it? The message is that using a definition of materiality other than the securities law definition to make a materiality assessment may create unnecessary risks for company. It is fine to report using both GRI and SASB, if the company uses appropriate language for different reporting channels and discloses information appropriate for the intended audience. Companies can appropriately use another sustainability framework to disclose sustainability information, so long as they do not describe the information identified as material. Information that meets the Supreme Court definition of materiality may be required to be disclosed the information in the Form 10-K or 20-F under SEC rules and 2015 SASB 8 P a g e

9 regulations. If so, companies should consider whether to disclose the information in two places, since that could increase the risk of inconsistent and duplicative information. If a company explains that some disclosures are "material" in one way for one audience and "material" in another way for another, does that mitigate risk? How are issuers "disclaiming" that any information in their CSR or sustainability reports are "material" for SEC purposes? Does the disclaimer appear in the CSR report and the 10-K? It sounds like you're saying providing a separate definition of sustainability materiality is a best practice and ALSO a risk? Would companies protect themselves by adding a sentence in their sustainability report that says "we are using the GRI definition or its own definition of materiality and not the US Supreme Court definition". What alternative word do you suggest companies use to convey materiality in the context of sustainability reporting in order to avoid confusion since "materiality" is a legal term in the context of SEC reporting. To avoid this issue, we use the term "significant," unless the issue is "material" from an SEC perspective. Does this create any issue with GRI, or CDP? Using two different definitions of materiality is not a best practice because of the potential risks. Using the term significant unless the issue is material from an SEC perspective is a good practice. This practice likely will not create issues with other sustainability frameworks. Trying to use the word material in two different contexts is confusing and increases the potential risks discussed during the webinar. Adding the disclaimer about which definition of materiality is being used in the CSR/sustainability report does not solve the problem. Shareholders can dispute the company s characterization of information as being material only under a proprietary definition from sustainability. Disclaimers do not eliminate the risk that shareholders may scrutinize or challenge the company s materiality descriptions SASB 9 P a g e

10 Information in the CSR/sustainability report that is material under the Supreme Court may trigger a requirement to disclose in the Form 10-K or 20-F. If that is the case, the company should consider moving the information from the CSR/sustainability Since sustainability theory and practice is not taught in law schools, why should we rely on attorneys to review the materiality of companies' sustainability disclosures? This issue a 2-way street, isn't it? If legal counsel reviews report and sees discrepancies between CSR report and SEC filings, is it most prudent to take things out of the CSR report, or put things into the SEC filing, or neither? What is the action that is recommended? Calling information material has legal and risk implications, and lawyers take the term materiality seriously no matter what definition is used. The risk of a securities fraud lawsuit is a big concern of corporate counsel, and they want to manage and reduce that and other risks. Lawyers are becoming increasingly aware and savvy about CSR and sustainability. Consider the following activities by lawyers related to CSR and sustainability: 1. Several articles on CSR and sustainability legal issues in the American Bar Association s Business Law Today publication of January Articles include Sustainability Reporting: The Lawyer s Response, Investor Interest in Non-Financial Information: What Lawyers Need to Know, and others. 2. CSR and sustainability related task forces in the American Bar Association (ABA) a. Sustainable Development Task Force (an ABA wide task force bringing together lawyers from many practice areas, including environmental, securities, corporate governance, real estate, energy, and sustainability professionals) b. CSR Law Task Force, and the CSR Disclosure and Reporting Committee c. Sustainability and Governance Subcommittee of the Corporate Governance Committee 3. Law firms and in-house counsel advising companies on CSR and sustainability issues 2015 SASB 10 P a g e

11 4. Panel discussions and webinar on CSR and sustainability where lawyers and sustainability professionals speak and participate. In light of the growing interest among lawyers in CSR and sustainability, sustainability professionals should consider whether and how to work with their corporate counsel regarding the disclosure and management of CSR and sustainability. There is an opportunity for collaboration and education between sustainability professionals and lawyers. Don't companies still have a risk of a) incomplete SEC disclosures and b) the risk of investors relying on factors publicly disclosed that may be inaccurate --- regardless of if they are called material Regarding a material omission - is this only if the company has the information but decides not to report it? What if they don't collect certain information related to material impacts? Appropriately describing sustainability information that is material does not eliminate the risks of incomplete SEC disclosures or investors relying on inaccurate information. These risks apply to both financial and non-financial information. Companies must be diligent in managing the risks of making incomplete and inaccurate disclosures of material sustainability information. The SEC explains in its 2010 climate change guidance that companies should take care to collect information on sustainability factors that will need to consider for materiality determination purposes, including those factors that they not have to ultimately disclose. Because only certain information would be considered material under the securities law definition, the company should decide which sustainability factors have and are likely to have material impacts on financial condition and results of operations. Question about corporate governance implications How does the US Supreme Court definition relate to sustainability reporting requirements to Boards for companies publically listed in the US? 2015 SASB 11 P a g e

12 The company s board of directors may need to oversee sustainability factors once the company begins to assess whether such factors are material under the Supreme Court definition. Three reasons why the board should oversee sustainability factors are their responsibilities of risk oversight, strategy and value creation, and fiduciary duties. See Three Reasons Boards of Directors Should Oversee Sustainability Factors, May 27, Questions about SASB having a possible chilling effect on reporting How is SASB addressing the risk of a chilling effect on progress in corporate sustainability from its stance on materiality? Here is a comment from a webinar participant that addresses the question: Hi Doug: To agree with and amplify what you just said, in my opinion, SASB is not trying to change or chill the definition of materilaity vis a vis sustianability. Rather, to paraphrase Marc Wiseman, SASB is trying to lengthen the time frame for materiality. In the intergenerational context, ESG factors converge with financial factors in value creation. Is the basic argument here that everyone should limit all of its sustainability efforts, reports, and goals, to materials deemed "material" for SEC purposes under the Supreme Court definition? Doesn't that effectively co-opt, if not gut, the original concept of sustainability The argument is that companies should use the term material only to describe sustainability information that meets the securities law definition. Information that is identified as material using a materiality matrix or approach that does not align with the Supreme Court definition should not be 2015 SASB 12 P a g e

13 called material. Companies should consider whether sustainability information that meets the securities law definition should be disclosed in the Form 10-K or 20-F. Companies should continue their sustainability efforts, reports, and goals on issues that may be of interest to many different stakeholders. However, sustainability efforts, reports, and goals that do not align with the Supreme Court definition are not material, and that calling information related to those matters material may create unnecessary risks. Question about reporting using the SASB standards for the first time If a company adopts SASB standards in 2016, is this is an implicit acknowledgment that material disclosures made in 2016 should also have been made in prior years? How does a company protect itself from that risk? This question is addressed in our Legal FAQs under: Will reporting on sustainability topics in this manner expose our company and our industry to more lawsuits? Question about disclosing material information in the 10-K then moving it to the CSR report Doug: If a US publicly listed company has a decades long track record of making a certain material governance disclosure in every 10-K filing, then that company abruptly drops any mention of this material governance disclosure in its 10-Ks without any mention of why this disclosure was dropped from the 10-K (no explanation in MD&A nor anywhere else in the 10-K). Yet, that same firm continues to make this same material governance disclosure in its corporate responsibility report? Would this firm be creating additional risk? If so, how? Companies are not required to explain why it is no longer reporting certain information in the 10-K. They usually do not give this explanation. It is possible for information to be material, but not fit 2015 SASB 13 P a g e

14 into any disclosure requirement for the 10-K. It is important to keep in mind that companies regularly disclose material information outside of the 10-K that meets the securities law definition, and that they do so intentionally. However, information that is material and that is subject to a 10-K disclosure requirement should be disclosed in the 10-K. Compliance with SEC disclosure requirements is not optional for US publicly listed companies. The company may be creating additional risk by moving the information, if it is still material under the Supreme Court definition, from the 10-K to the CSR report. Rule 10b-5 securities fraud suits are almost always brought for information disclosed outside the 10-K (see slides 22 and 23 of the deck). This is because the federal circuit courts of appeal are split on whether a 10b-5 claim can be brought for failing to meet the MD&A disclosure requirements of the 10-K. There are grounds other than Rule 10b-5 liability for materially misleading or false information (including omissions) in the 10-K. The other grounds of liability often involve lower potential costs to the company than Rule 10b-5 litigaton. Thus, information outside the 10-K is more likely to be challenged as materially misleading or false in a Rule 10b-5 securities lawsuit than information in the 10-K. Question about applicability SASB standards to non-us companies Is it possible for non-us listed companies to apply to SASB in any way? It is possible for non-us listed companies to apply the SASB standards. They may find the standards useful in engaging with investors or in managing sustainability factors that are related to strategy and value creation. Non-US listed companies should exercise caution in using the SASB standards to make sure that the standards are applicable in their business context SASB 14 P a g e

15 Questions about Harvard Business School study on evidence of material effects from SASB factors The HBS study proxies materiality with a set of environmental performance indicators, making the empirical test rather weak and prone to a self-fulfilling hypothesis. For sake of intellectual honesty, such an issue should be made explicit. You should disclose the authors of the Harvard report and the conflict of interest (nonindependence) issue. How did the HBS study determine which companies were performing well in SASB areas? I thought only Bloomberg had formally published a "SASB report" Thank you for pointing out that one of the authors of the HBS study, Professor George Serafeim, has an affiliation with SASB, as there was not enough time to discuss the study in detail during the webinar. Professor Serafeim is one of three authors on the paper, and he is the second author. The first author, Professor Mozaffar Khan, has no affiliation or relationship with SASB. Neither does the third author, Aaron Yoon, who is a doctoral student at HBS. SASB did not provide any funding, support, or assistance for the research. The HBS study is the first to attempt to distinguish between the financial effects of material and immaterial sustainability factors. The authors compared companies that were in the top quintile of performance on the SASB factors to companies that were in the bottom quintile. They looked at the relationship of performance on the SASB factors to the companies future stock performance and future accounting performance over a 20 year period, controlling for a number of alternative explanations. Further details on the researchers methods and results are contained in their paper, Corporate Sustainability: First Evidence on Materiality. If you have further questions regarding the research, please feel free to contact the researchers SASB 15 P a g e